More interesting stuff to read

There is a deluge of interesting stuff to read:

  • Simon Johnson and Peter Boone vote for Montek Ahluwalia to head IMF. The bigger part of the article deals with the stiff choices Europe faces now.
  • Dallas Fed President Richard Fischer speaks on Minsky Moments and Financial Regulatory Reform. There is also an interesting article by him in Dallas Fed Annual Report 2009. He also gives his views on managing TBTF.

I come away from the past two years with four fundamental beliefs—all honed not only by my five years as a monetary policymaker but also by my decades of experience as a market operator. First, I am more convinced than ever that financial institutions and financial markets require a healthy dose of regulation to function efficiently. Second, I am more convinced than ever of the importance of regulatory and supervisory authority to the proper conduct of monetary policy. Third, I am more convinced than ever that too-big-to-fail banks are dangerous and should be contained, if not broken up. Fourth, I am more convinced than ever that central banks operate most effectively when insulated from political passions

Q: …..in the policy statement as a reference to neutral rate being negative, I just want to understand – and I would not ask you what that neutral rate is, because I know you would not tell me – but more in terms of that we understand exactly that do you mean it is the non-inflationary trend GDP growth rate for India or is there some other matrix or definition that is being implied.

A: about neutral rate, in fact we picked it up from you analysts who have been talking about our need to reach the neutral rate as soon as possible and I have enquired with our staff here, our economists here. They told me that neutral rate is the rate that is consistent with potential output and low and stable inflation. But again, I understand that this is a textbook concept, more applicable to mature economies and not to an economy like that of India which has huge growth potential, huge room for improvement on productivity, on efficiency and the demographic dynamics. And that it is not an observable construct in India.

Having said that, I believe there is an IMF study of January 2010 perhaps (done) as part of their Article IV, I do not know, where they have said that the neutral rate is or the effective rate – which at that time was the reverse repo rate – that is 200 basis points below the neutral rate. So if you take that calculation, the neutral rate should have been about 5.25% and if you take the 75 basis points corridor on either side the rate could be 6% on the upside 4.5% on the reverse repo side. I am also told that if you take the range that our rate succeed during the time when the economy was set to have been overheating the repo rate was 9% and during the depth of the crisis the repo rate was 4.75%. So the neutral rate would be approximately somewhere in between there and I believe that is what everybody, I think that tallies with the estimates of most.

Norges Bank has a discussion on the normal/neutral rate concept

  • RBI Governor Subbarao gives a superb speech on the challenges/questions asked of RBI. He looks at four issues: (i) Capital flows (ii) Exchange rate management
    (iii) Inflation targetting (iv) Harmonizing monetary and fiscal policies (v) Improving monetary policy transmission
  • Krugman as always has a superb piece on Europe woes. He says there are two insights. One, Europe has gotten into trouble for the same reasons which were echoed at the time of formation of EMU but were ignored (same point made by Boone and Johnson above). Two, most cite high public debt as the main reason for the crisis, the real issue is not being flexible and fast on policies at times of recession like this.I don’t really agree to the second point. True they should have been more fast and flexible but they spent more than their incomes in good years. The prices had to be paid just like US did. The difference is timing. Us faced the costs earlier and Europe later.

    Even on the first issue, it would have been pretty difficult for policymakers to design EMU if it took this kind of crisis into account. EMU did have benefits. This crisis is a watershed event on many a things about economics.

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