Archive for December 16th, 2009

Would Bundesbank have helped US escape Great Inflation of 1970s?

December 16, 2009

Keeping Jurgen Stark’s criticism aside that Americans always call economic events great, let us look at this interesting paper

The Great Inflation of 1970s led to the monetary policy revolution and we saw much lower inflation rates from thereon. There were papers which asked if we brought Greenspan back to 1970s would America escape the great inflation? The papers largely said no Greenspan would not have helped and blamed the extraordinary economic situation which led to the inflation then. 

This paper looks at the problem from the other angle. Bundesbank’s track record in Great Inflation was admirable. Its track record overall was exemplary. So what if Bundesbank was made incharge of America’s monetary policy. Would it have helped? Ideally, it should lead to lower inflation. 

However, the author finds this is not the case which is a big surprise. We never know what Greenspan would have done in 1970s as America only learnt its monetary policy lessons after Volcker showed how Fed could lower inflation. But we surely know what Bundesbank would have done as we know its strategy. So to see Bundesbank not being effective is a surprise. 

The conclusions the author draws are more interesting. These kinds of studies use a technique called Structural VAR (SVAR) to evaluate these situations. The author says instead of thinking that Bundesbank would not have helped; we should instead see the results from SVAR with some suspicion. 

Since the structural VAR methodology came to essentially dominate applied macroeconomic research, around mid-1980s, policy counterfactuals have been one of its
main applications. As we have discussed, the outcome of such counterfactuals is seldom questioned, and the results they produce are usually taken at face value. In this
paper we have shown that standard structural VAR methodology, when applied to a specific policy counterfactual–‘bringing the Bundesbank to the post-WWII United
States’–produces a result which the vast majority of macroeconomists would likely find extremely hard to believe: the very same central bank which burnished its ‘hardmoney’,
anti-inflation reputation by successfully countering the 1970s’ inflationary impulses in West Germany would not have been able to deliver a comparable performance
had it been put in charge of U.S. monetary policy. The fact that (i) such counterfactual is a ‘standard’ one–in the specific sense that, instead of being performed
within a single country and across time, it is performed across countries–and (ii) it has been produced based on ‘off-the-shelf’ methods (in terms of both estimation
 and identification), sounds a cautionary note on taking the outcome of SVAR-based policy counterfactuals at face value, and raises questions on their very reliability.  

So the key issue here, in our view, is the mapping between the underlying true model of the economy and its structural VAR representation, and in particular the ability of counterfactuals based on the latter to correctly capture the true counterfactuals based on the former. Both issues are currently being investigated in our work in progress.

Exciting stuff. What amazing research these guys end up doing.


To read how Bundesbank avoided Great Inflation see this Otmar Issing piece



History of Central Banks … originated for financing wars

December 16, 2009

J. Lawrence Broz has written a fascinating paper on history of central banking. He points most central banks were developed to finance wars – Riksbank in 1688, Bank of England in 1698, Bank of France in 1800, First Bank of United States etc. 

The main idea goes  like this. The Governments were always under war with someone else and incurred huge expenditure. So, people were worried that govts would default. The Govts faced both credibility and time consistency issues (whether govt will honor its debts). Hence, central banks were set up that served as institutions to lend to governments. The central banks in turn solved both the credibility and time consistency issues. Hence, it was a win-win situation for both – The Government gained credibility that it would not default and Central banks got privileged rights to be the banker to the government.

Over a period of time wars declined. Then central banks leveraged their privileged status to become the central banks as we know them now.

There is another paper I pointed out which looked at reasons why politicians decided to delegate powers to  central banks to determine their own goals. This was a more current situation perspective.  In the era of wars, the above paper tells you why central banks came into being.

I don’t have the time to discuss the paper in entirety. But it is a must read. Excellent discussion on political economy

Goods and Services Tax – Finance Commission Reports

December 16, 2009

Finance Commission has released two important reports on Goods and Services Tax (GST).

First is a much awaited task force report on GST.  This report details on the GST design, the included and excluded sectors, tax rates, impact etc. The terms of reference for the task force:

(a) the GST model best suited for the country;
(b) the modalities of the implementation of GST including threshold limits, composition limits, treatment of inter-state transactions, place of supply rules;
(c) the potential tax base of the GST as exhaustively as possible and determine an appropriate revenue neutral rate for the Centre and the states;
 (d) suggest ways to incentivize states to adopt a model GST; and
 (e) recommend a framework for administering the GST including payment of compensation, monitoring of compliance and institutional mechanism for making any change in the initial design of the GST.

 The report is 170 pages and would require some reading. The main points are:

  • 12% GST rate – 5% for Centre GST and 7% for State GST
  • Exempts 3 sectors- unprocessed food, school & college education, and non-governmental health services.
  • GST to cover real estate sector
  • Road map to implement GST by October 2010

Second is a Fin-Com NCAER report which assesses the impact of GST on Indian economy. It assesses impact on economic growth and international trade; changes in rewards to the factors of production; and output, prices, capital, employment, efficiency and international trade at the sectoral level. The findings of the report were partly discussed by Mr Kelkar in his speech.

The findings are:  

  • Implementation of a comprehensive GST across goods and services is expected, ceteris paribus, to provide gains to India’s GDP somewhere within a range of 0.9 to 1.7 per cent. The corresponding change in absolute values of GDP over 2008-09 is expected to be between Rs. 42,789 crore and Rs. 83,899 crore, respectively.
  • The additional gain in GDP, originating from the GST reform, would be earned during all years in future over and above the growth in GDP which would have been achieved otherwise. The present value of total gain in GDP has been computed as between Rs. 1,469 thousand crores and 2,881 thousand crores. The corresponding dollar values are $325 billion and $637 billion.
  • The sectors of manufacturing would benefit from economies of scale. Output of sectors including textiles and readymade garments; minerals other than coal, petroleum, gas and iron ore; organic heavy chemicals; industrial machinery for food and textiles; beverages; and miscellaneous manufacturing is expected to increase. The sectors in which output is expected to decline includee natural gas and crude petroleum; iron ore; coal tar products; and nonferrous metal industries.
  • Gains in exports are expected to vary between 3.2 and 6.3 per cent with corresponding absolute value range as Rs. 24,669 crore and Rs. 48,661 crore. Imports are expected to gain somewhere between 2.4 and 4.7 per cent with corresponding absolute values ranging between Rs. 31,173 crore and Rs. 61,501 crore.
  • Prices of agricultural commodities and services are expected to rise. Most of the manufactured goods would be available at relatively low prices especially textiles and readymade garments. Consequently, the terms-of-trade move in favour of agriculture vis-à vis manufactured goods within a range of 1.8 to 3.8 per cent.
  • GST would lead to efficient allocation of factors of production. The overall price level would go down. It is expected that the real returns to the factors of production would go up. Our results show gains in real returns to land ranging between 0.42 and 0.82 per cent. Wage rate gains vary between 0.68 and 1.33 per cent. The real returns to capital would gain somewhere between 0.37 and 0.74 per cent.

Phew… The benefits of GST are just tremendous. But yeah, one can see the opposition coming from the industries who are expected to lose out.

The First Discussion Paper was recently released but did not really show promise. Hope the next ones show more promise and urgency. But knowing India’s political economy, we shouldn’t really expect anything. 

I was talking to a couple of Chartered Accountants related to GST and DTC (Direct Tax Code). Most think both tax reforms would lead to umpteen problems. The implementation is not easy at all and creates more loopholes than fills previous ones.

I also remember attending a VAT conference in 2003 when VAT was being discussed and implemented. Similar issues were raised by businessmen and professionals in the conference. However, after a few glitches VAT took off. I expect (and hope) same goes for GST as well. It is much more about willingness of political parties to get this going. Economics is well-known. The unknown is political willingness

Nobel Prize Lecture 2009

December 16, 2009

The Nobel Prize Lectures of Elinor Ostrom and Oliver Williamson have been put on the Nobel Prize website.  Ostrom’s lecture is put up as a video and Williamson’s lecture has both Video and ppt slides

 I was just going through Williamson’s slides. It makes a good reading on how he came about his main ideas.

But I prefer to read the Prize lectures in a proper written text format. The Prize Committee first puts up videos and some winners share their ppt slides. It is much later that the text format lecture is added.  I just realised Krugman’s lecture has just been added recently. But these do not give the complete flavour. You cannot also imbibe much watching videos or seeing ppt slides. The lectures also serve as a very useful literature survey on the winner’s main papers, ideas, thoughts, synchronisation with previous ideas etc. One keeps referring to these lectures oft and on.

So am waiting for the proper speech text. Till then see whatever is available.

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