Archive for September 1st, 2009

It is murder on the US economy express after all

September 1, 2009

When I wrote this post recently, I didn’t know my ideas would match with Charlie Bean of Bank of England. In his recent speech, he gives an excellent review of the crisis (though mainly focuses on the US which is disappointing as I wanted more of UK experience). He starts from the great moderation phase and follows with the discussion on the crisis. Much is known by now in numerous such speeches but this one is still a must read. It has superb graphs as well.

Now to the title of the post. He says there are a few lessons from the crisis:

 First, in my view it would be a mistake to look for a single guilty culprit. Underestimation of risk born of the Great Moderation, loose monetary policy in the United States and a  perverse pattern of international capital flows together provided fertile territory for the emergence of a credit/asset-price bubble. The creation of an array of complex new assets that were supposed to spread risk more widely ended up destroying information about the scale and location of losses, which proved to be crucial when the market turned. And an array of distorted incentives led the financial system to build up excessive leverage, increasing the vulnerabilities when asset prices began to fall. As in Agatha Christie’s Murder on the Orient Express , everyone had a hand in it.

🙂 Precisley what I said here.

 Second, the economics profession has oversold the virtues of unfettered financial markets. We usually start from a presumption that markets work best when they are left to themselves, unless there are obvious market failures present. 

 Third, we need to pay more heed to the lessons of history. Financial booms and busts have occurred with some regularity ever since the Tulip Mania of 1636-7. Yet we tend to treat them as pathologies that happen at other times or in other places. Their frequency suggests that we would be better advised to think of them as a central feature of capitalist economies that our models should aspire to explain.

Fourth, we need to put credit back into macroeconomics in a meaningful way. Financial intermediaries are conspicuous by their absence in the workhorse New Keynesian/New Classical DSGE model. 

All three have been discussed by other economists and reported by this blog. In the last learning he points to some interesting papers/ideas which are trying to get finance sector in basic macro models (but they are just models r’ber).

Lets see whether these lessons get implemented or just remain suggestions.  It looks like latter is going to prevail as the second lesson goes. As things have started to improve fin market players have started reacting to any form of regulation.

Recently, there was a mention of Tobin tax on financial transactions by UK Chancellor. However, the industry reacted negatively. Here are some reactions:

Lord Turner’s critics said he had overstepped his remit as a regulator and risked damaging London’s standing as Europe’s leading financial centre.

Stuart Fraser, chairman of policy at the City of London Corporation, said Lord Turner was playing into the hands of rival financial capitals, such as Frankfurt and Paris.

Boris Johnson, the London mayor, said anybody who did not believe the FSA’s responsibilities included protecting the international competitiveness of the City was “crackers”.

John Cridland, deputy director-general of the CBI, said: “The government and regulators should be very wary of undermining the competitiveness of the UK’s financial services industry.”

The British Bankers’ Association was among the most trenchant in its criticism. “If we introduce the wrong kind of regulation or the wrong kind of taxes we could so easily lose that position by driving business abroad … On so many occasions in the past the country has lost chunks of industry through making the wrong decisions. Let’s not do that again.”

The Investment Management Association and the Association of British Insurers were critical of the likely impact on investors. “It is just illogical to want to shrink one of your most important industries,” said one London banker. “If you want to turn London into a Marxist society, then great.”

US bankers also opposed the idea of a global transaction tax. “We vigorously oppose a tax on the industry,” said Scott Talbott, head of government affairs at the Financial Services Roundtable, which represents the top 97 US institutions.   

Some things never change really. After causing so much damage to the UK economy, they still think it to be all this. Really sad to see all these developments. How will things ever improve in finance sector? As the crisis eases further, there is likely to be more disappointment than hope.

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First list of FinMin Rupee Design Contest

September 1, 2009

Kay Shiv points on the Fin Min Rupee Design Contest post that first list of shortlisted candidates has been put up today. The list is here and has 2455 short-listed candidates.

Ricardo expressed benefits of CBI in 1824

September 1, 2009

Yeah. David Ricardo had expressed the need to have Central Bank Independence in a note in 1824. I came across this 1994 speech by then  RBA Governor, B.W.Fraser.

He points:

The issue is as old as central banking itself, having been debated on and off over the past couple of hundred years. The hallmarks of independence – namely, autonomy from the government and non-financing of budgets – were identified clearly by David Ricardo in a paper on the establishment of a national bank in 1824:

‘It is said that Government could not be safely entrusted with the power of issuing paper money; that it would most certainly abuse it … There would, I confess, be great danger of this if Government – that is to say, the Ministers – were themselves to be entrusted with the power of issuing paper the hands of Commissioners, not removable from their official situation but by a vote of one or both Houses of Parliament. I propose also to prevent all intercourse between these Commissioners and Ministers, by forbidding any species of money transactions between them.

The Commissioners should never, on any pretense, lend money to Government, nor in the slightest degree be under its control or influence … If Government wanted money, it should be obliged to raise it in the legitimate way; by taxing the people; by the issue and sale of exchequer bills; by funded loans; or by borrowing from any of the numerous banks which might exist in the country; but in no case should it be allowed to borrow from those who have the power of creating money.’

Amazing stuff. What seemed like a major contribution of modern monetary economics is as old as 1800s. It is pretty much basic economics. Only economists keep recycling the old ideas and pose them as new. Again, knowing history is so so important.

He then also points to Keynes and his mention of setting RBI as an independent central bank:

Earlier this century, Keynes expressed his thoughts on central bank independence
while testifying before the 1913 Royal Commission into an Indian central bank.
The ideal central bank, he said, ‘would combine ultimate government responsibility with a high degree of dayto- day independence for the authorities of the bank’. He added that it would be desirable ‘to preserve unimpaired authority in the executive officers of the bank, whose duty it would be to take a broad and not always commercial view of policy’. 

 I had read about the Keynes and RBI connection but this is interesting as well. It is a pretty good speech which covers basics of CBI and what it means.

 ‘Independence’ in this context means the freedom of central banks to pursue monetary policies which are not dictated by political considerations. It does not preclude Ministers from commenting on monetary policies, and it does not preclude central banks from consulting with the government on monetary and other policies. In practice, varying degrees of independence have been exercised
through a variety of approaches.

Increased central bank independence does not necessarily lead to lower inflation. This is because monetary policies, on their own, cannot guarantee to deliver lower inflation without unacceptable costs in terms of lost output and jobs. Fiscal and wages policies have an important bearing on inflation outcomes, and these need to be compatible with an anti-inflation monetary policy.

Credibility’ is helpful to central banks in implementing monetary policy and a pre-condition for this is that the central bank be perceived to be independent and free from political interference. Beyond that, however, credibility has to be earned, essentially through the consistent demonstration over a long period of the bank’s determination to achieve its goals.

And finally something on cricket and CBI:

The competence of central banks and the personalities of their Governors, and of Treasurers and other Ministers, are obviously important, whatever the precise legislative framework. In this regard, central bank independence can be likened to a game of cricket. The legal framework that central banks operate in is important, as the rules of the game are important in cricket. What matters most to the outcome of the game, however, is the performance of the players on the field. 

Get on with the game mate 🙂

Financial Innovation – back to basics

September 1, 2009

Simon Johnson and James Kwak have been thrashing financial innovation in their blog whenever they get a chance (see the new post for instance). And rightly so. Financial innovation is one of  the most misunderstood word in financial jargon. As I try and explain in this paper it has basically come to mean something really complex and benefiting the creators.

Now in this new article, the duo revisit the topic and suggest it is good only if it results in financial intermediation. Nice read.


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