Archive for August 21st, 2009

Jaimini Bhagwati’s advice for Indian economists

August 21, 2009

Jaimini Bhagwati, India’s Ambassador to the European Union, Belgium and Luxembourg has a superb article in Business Standard today. He first reviews the chaos in economic thinking which is becoming a norm these days. Then he has a few suggestions for India:

1) Finance Ministry should also have a Chief Financial Advisor like Chief Economic Advisor:

In the late 1990s, an important insight of the then President of the World Bank was that economists needed to understand finance. To that end he insisted that all senior managers, which included many PhDs in economics, undergo basic finance training and learn how to read a balance sheet. The recent economic meltdown was triggered by a breakdown in investment banking and international capital markets. It is conceivable that central bankers and other regulators may have acted earlier if they were better informed about capital markets in general, and derivatives markets in particular. Consequently, in the Indian context, it would be useful to have a Chief Financial Adviser (CFA) in the ministry of finance in addition to a Chief Economic Adviser. The CFA could complement the work of the CEA to give the finance ministry a more in-depth picture of the health of financial markets and provide inputs on the state of accounting and corporate governance. A CFA could also highlight the need to move faster on deregulation of interest rates on small savings, making the government yield curve arbitrage free etc.

I am not sure how this would work? The roles will not be easy to define at all. There arew likely to be cases CFA says something different and CEA has a different view. Moreover, economists are suggestingto have a finance sceptic as Fed Chief. Perhaps, CEA office should have people more trained in financial economics and have a holistic perspective on the same.

2) His second suggestion is:

India’s systemic shortcomings in eg providing assured irrigation, basic infrastructure, pricing of power, fertiliser and petroleum products and corporate governance (Satyam) or the problems of companies such as General Motors in the US, banks in Europe stem from a variety of factors. Clearly, purely formulaic remedies such as inflation targeting, liberalising exchange rate policies, introduction of exchange-traded forex derivatives, developing corporate bond markets, raising/lowering of interest rates and safeguarding the independence of RBI may not be sufficient or even appropriate. India-based economists and finance specialists have been relatively quiet about the applicability of recommendations based essentially on available data and static models. Further, we also need to reflect a bit more about the continuing capture of economic and financial sector policies by special interests in developed countries when thinking about solutions for comparable situations in India.

(Emphasis is mine).

This is quite an important lesson of this crisis. The special interest theory in policymaking/reform package should be analysed properly. This is particularly important for India where we just blindly look at all the western developed economy models and try and implement them in India. Thankfully our regulators don’t buy in to all the ideas.

Iceland reviewing its monetary policy framework

August 21, 2009

What was once considered to be holy cow – inflation targeting framework, large financial sector, highly open small economies etc etc is being reviewed now.

Iceland Prime Minister has asked Bank of Iceland to review its Inflation Targeting Framework. The Bank economists have prepared a paper reviewing the framework and some suggestions. It is just a preliminary analysis and initial thoughts. More detailed assessment is on the way. The broad findings:

Most likely, pursuing independent, inflation-targeting monetary policy will always be more difficult in a very small open economy as Iceland than it is in a larger currency region. It is doubtful that the country could be considered an optimum currency area.

However, in view of the fact that an application for European Union membership or a referendum on such an application could result in Iceland’s remaining outside the EU, and therefore outside the EMU, for a long period of time, and given that it could take a long time to develop an alternative currency regime, it is also important to give serious consideration to improving the current arrangement.

 It does not appear feasible to revert to the former fixed exchange rate policy because removal of capital account restrictions is planned and, in view of the EEA Agreement, is the only conceivable option.

 In the absence of a shift to a different currency regime, it would be most advisable to reinforce the Central Bank’s contingency measures and ability to restrict excessive growth of the financial system and to improve the fiscal policy framework so that it provides better support for monetary policy, thus reducing the likelihood of volatile capital inflows and economic instability.

Interesting times. The paper also gives you a quick overview on why ITF was adopted in Iceland and its experiences.

Developing Asia embracing inclusive growth

August 21, 2009

Ifzal Ali and Juzhong Zhunag of ADB have written an interesting paper on why Asian developing countries need to adopt inclusive growth as a policy agenda.

The poverty levels have declined in recent years  tracking high growth.  Reducing poverty ratios in future are highly dependent on sustained growth levels. The growth rates have declined quite a bit in this crisis and is not expected to pick up anytime soon. The question really being raised is whether we can still achieve pre-crisis growth levels? 

Another equally big concern is inequality has risen in these economies despite high growth levels. This has led to thrust for inclusive growth. Growth is important but it has to be inclusive.

Nice paper with interesting charts and comparisons.

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