This is the title of my new paper. Comments/Suggestions are welcome.
Archive for March, 2011
This is the title of another superb speech from Subir Gokarn, Deputy Governor of RBI. He keeps coming up with some really useful speeches on Indian economy. The speeches are a good mix of economic research and analysis.
In this speech he gives a nice demand-supply perspective on financial inclusion. There is always a question – Is lack of financial inclusion a supply problem (not enough banks etc) or a demand problem (people do not want these services)? The speech does not answer that definitely. But it does show there could be a certain demand for some financial products which help manage medical and wedding planning costs. Hence the focus of the speech is to use demand and supply of financial inclusion to design better financial products.
He sums up the key messages from his analysis:
Brian Wynter, Governor of the Bank of Jamaica gives a nice speech on the topic.
Bank of Jamaica is celebrating its 50th year of foundation and so it is time for introspection for the bank. He begins looking at the options at the time of independence:
I will begin with a sketch of the path that was taken after independence and during the post-Bretton Woods era. Among the group of former British colonies in the Caribbean, Jamaica was the first to establish a central bank, followed by Trinidad & Tobago in 1964 and Guyana in 1965. By the end of the 1960s these central banks had taken over the note issuing function of the currency boards that they replaced but would have done little else in the way of exercising discretion over monetary and exchange rate policies. So, while national currencies appeared, they maintained the look and the parities of the old money except that they were now issued by institutions of the newly christened nation states.
B-Woods break up changed this currency board arrangement:
After the break-up of the Bretton Woods system in 1971 and the adoption of generalised floating by the major industrial countries, Caribbean nations, like other developing countries, were faced with the issue of what type of monetary arrangements they should adopt. Typically, the considerations included a desire for policy independence, “balanced growth” and price stability at home, all in the context of continued traditional trade links with the industrial countries. The options they faced ranged from the creation of currency enclaves as in Panama or Puerto Rico, a wide variety of pegging arrangements and institutional structures, to the formation of currency unions such as the one eventually adopted in the Eastern Caribbean. The most liberal extreme, joining the system of independently floating currencies, was not immediately feasible. For the most part, these developing countries responded to the changes in the international monetary system by pegging to the currency of their major trading partner.
However, pegging arrangements came under unprecedented pressure following the oil shocks of the 1970s and the subsequent swings in demand for commodity exports from developing countries. The alternative to the economic compression and restructuring demanded by these sharp changes was international borrowing; indeed, this proved to be the road most travelled. But, as it became clearer in the 1980s that further large-scale borrowing was unaffordable and that economic restructuring was inevitable, the question of suitable monetary and exchange arrangements once again arose.
IN 1980s the carribean economies differed on their mon pol choices:
The smallest states of the Caribbean – member countries of the Eastern Caribbean Central Bank – as well as Barbados, Belize and The Bahamas chose to make adjustments to their economies without changing the exchange rate and, in the process, experienced some loss in competitiveness but not obviously more than elsewhere. In these territories, wage awards and monetary conditions needed to be consistent with low inflation and a stable exchange rate, leaving the brunt of the adjustment process on government finances, employment and output.
The larger states of the Caribbean – Jamaica, Guyana and Trinidad & Tobago – all adopted flexible exchange rates as part of their structural adjustment programs. The prevailing consensus on development thinking, led by the Washington-based institutions, pointed to the likelihood of greater export diversity, sustainable balance of payments and improved economic efficiency if the adoption of flexible exchange rate regimes was accompanied by other economy-wide reforms.
Jamaica’s episode was interesting:
One outcome of this process that was particularly sharp in Jamaica was its impact on inflation. Even after the initial adjustments to the domestic price level that accompanied these changes tapered off, they had set in motion a wave of negative expectations about exchange rate depreciation accompanied by inflation which, in turn, pushed organized labour into making wage demands to protect living standards. Government expenditure expanded to meet these and other needs which were funded, in large measure, by borrowing. Fiscal dominance, an open capital account and the absence of reserves defined a heavy role for monetary policy in reining in domestic expenditure. A large part of the book “Bank of Jamaica – The First Forty Years’ is devoted to narrating the range of policy responses undertaken by the Central Bank and the uphill fight to maintain macroeconomic stability.
Similar choices are available even now.
We have on the menu essentially the same set of options that policymakers had post-Bretton Woods: pegging (or fixing) the exchange rate, monetary union, dollarisation and independent central banks. The difference now is that we have had 40years of experience since then and have spent a lot of time and energy in discussing some of them as regional issues.
The first three – a fixed peg, a monetary union and dollarisation – all imply relinquishing discretion over monetary policy. They differ in the degree of commitment or reversibility inherent in each regime and, in a sense, what the actual currency units would look like. The answer to the question “what’s in your wallet?” would tell the world what your choice was.
He discusses all these three and says independent central bank is the best. The other three are inflexible and depend on other nations.
An autonomous central bank would be one that is insulated from short-term political priorities both by its terms of reference and by its governance provisions. Its focus on low and stable inflation would be monitored by its reporting to Parliament and by its implementation of an inflation targeting regime which has proven to be an effective anchor for inflation expectations in a growing number of industrial and developing countries. It would retain responsibility for financial stability and would thus have the mandate and the wherewithal to respond to potential threats to stability before they arise and to support systemically significant entities where the need arises. Such an institution would be of our making, could achieve all of the goals that we think are important to our collective well-being and would see us through the next 50 years proudly holding Jamaican dollars in our wallets.
Nice speech. The various monetary policy choices available and selection of one provides a good reading. Covers many issues in the process.
Abhijit Banerjee of MIT Poverty Action Lab has a terrific monthly column in Hindustan Times called The Poverty Line.
In December column, he tried answering an an important question – Aren’t all Indian economists Bengali and mathematicians South Indians? He skipped the maths part but did look into the economics bit. He says it is not something to do with genes but some excellent economics teachers in Calcutta which drove the passion for economics.
In his recent March column, he takes one back to old Calcutta days when the city was vibrant and drew talent from all parts of the country (great economists as well). However, in his youth time the concerns started and people lost hope in Bengal. Exodus of talent led to even more exodus thanks to some poor policies:
After the crisis, kind of things one gets to read these days has been so shocking. One really wonders what has been happening in so-called developed economies.
The financial crisis showed how there was a revolving door between people in the financial industry and regulators. One could be a regulator one day and walk next day to become a key financial player. As he got bored, he makes a comeback as regulator. Hence the term revolving door.
He says though Japan is ranked highly on governance indicators, but still ranks much lower in developed economies. Chile and Nordic economies which are smaller economies rank higher. The lower rankings had an impact on the poor handling of the 2011 earthquake and tsunami. The deficiency was glaring in particular with handling of the nuclear reactor crisis.
If you thought that America’s financial sector had gotten enough of bad publicity, think again. The insider-trading trial of Raj Rajaratnam, a billionaire hedge-fund manager, has now begun. It is likely to provide an especially lurid exposé of the corrupt underbelly of the financial world.
We usually assume in a bribe, both the giver of the bribe and taker of the bribe are equally responsible and punished equally as well.
Kaushik Basu, Chief Economic Adviser of Ministry of Finance gives this game an interesting twist.
- He says the punishment to the giver and taker should be asymmetric.
- The giver should not be penalised but the taker should be doubly penalised. Hence, the total amount of fine remains the same.
- This should apply to bribes which are harassment bribes i.e. those bribes where the giver is entitled to something but only gets it after paying a bribe. Like passport, driving licence, income tax refund etc
- THis change will do two things. One the giver will try and get the taker trapped. Two, this might discourage the taker itself from taking the bribe.
José Viñals of IMF writes this superb post on the topic.
So far, most books and models treated govt bonds as risk-free. Not any more. Another major impact of this crisis has been that government bonds can no more be seen as risk-free.
One thing is now very clear: government bonds are no longer the risk-free assets they once were. This carries far reaching implications for policymakers, central bankers, debt managers, and how the demand and supply sides of government bond markets function.
After a recent IMF conference on a new approach to government risk, I’d like to highlight three key aspects:
- In a world without a risk free rate, the health of the financial sector and the government are closely interconnected.
- Countries with large potential liabilities from their banking sectors need to identify, assess, monitor, and report related risks closely.
- The risks involved call for stronger emphasis on stress tests.
A recent paper from FRBSF econs says it is cyclical.
They look at employment of college graduates. If it is a structural unemployment then one should see employment rising in college graduates as there is no problem of skill mismatch etc. But they find employment has declined even in college graduate space. Hence it is more of a cyclical problem with lower demand for labor across sectors.
I was seeing previous lectures and saw this 2007 lecture by Ngozi Okonjo-Iweala, former finance minister and minister of foreign affairs of Nigeria (Review the pictures, video, and transcript from the lecture). Ngozi gives an amazing lecture on corruption in developing economies and role the developed economies play in the same.
In this lecture, I would like to take a more in-depth look at corruption, and the way it undermines development in poor countries. In the course of the lecture, I would touch on this idea of myth and reality: what are the easy assumptions on corruption? And what are the realities? Are we focusing adequately on important aspects of corruption? What solutions can one proffer to guide developing countries with very weak institutions such as we find on the African continent? And what can be done, and has been done as good practice, to tackle corruption in developing countries?
She says corruption is often seen as a greaser in an economy mired with bureaucracies and delays. So it has been accepted by many economies and economists. But this leads to a much larger problem with corruption becoming systemic:
Some literature even showed evidence of growth and economic development in countries with high degrees of corruption (such as Indonesia under Suharto, Bangladesh, and China) as evidence that corruption had a limited or ambiguous impact on growth.
The problem with many of these arguments above is that they point to the microeconomic efficiency of an isolated corrupt event without examining its long-run systemic impacts. In the long-run, widespread corruption often creates much larger negative externalities which could hinder the long-term dynamic efficiency of an economy. We understand this in Nigeria, and many countries in Africa where we have long struggled with systemic corruption that has diverted resources, corrupted values, and led to rent-seeking activities in place of productive ones.
She points to 4 tales of corruption in Nigeria. The cases range from looting and transferring public assets by former dictator, mismanagement in public health program, foreign companies brining to get public contracts. But this one is really sad:
The third tale is a tale of corruption in education on a small yet worrying scale. It is the tale of Rose, a twenty one-year old university student, who finally made it out of her village and family as the first child to get a university education. Rose, from a poor rural family, could not purchase the series of class notes sold by her lecturer to students as part of the reading material for the class. The lecturer, who used these monies to supplement his income noticed Rose was not purchasing the notes and penalized her through low grades for her work.
When she explained she couldn’t pay she was asked to make up with other favors which she refused. The failing grade she was given in the course was instrumental in her withdrawal from the university which put an end to her higher education. An individual and entire family lost their hope and pathway to escape poverty. When I followed up on this story, I found that it was by no means an isolated case. It was part of a systemic rot that had befallen what had once been a very good tertiary education system in Nigeria.
Story of so many corrupt economies…
She then adds an interesting point. She says much of corruption focus on economic corruption. Not much on political corruption:
In many instances, the corruption debate is centered on economic corruption – on cases of rent-seeking, on procurement fraud, on leakages in government budgets and so on. If you look at the World Bank’s Governance and Anti-Corruption Action Plan you will see that it says its focus is on strengthening state accountability and capability. This is interpreted all in economic terms – looking at the area of economic corruption- financial management, budget, procurement, judiciary etc. Politics and money are mentioned but there is never any elaboration because the Banks’ articles forbid it from entering the political arena. Indeed, during my time in Government, my colleagues and I worked tirelessly to tackle various forms of economic corruption. Yet, we will all be deluding ourselves if we believed this myth that economic corruption is the key to tackling corruption in developing countries. I want to argue that the big elephant in the room which is often ignored is political corruption, and unless tackled this will and does undermine all the focus on fighting economic corruption and improving governance in the economic sphere.
She points how this winning elections using private sector finance has become such an illicit practice:
Political corruption, particularly relating to political party finance and to campaign finance, is increasingly becoming the major challenge in developing countries. Running a multiparty democracy is becoming an increasingly difficult and expensive business.
Well, political parties and the political process in emerging democracies invariably become very prone to corruption. I am worried that political corruption in pernicious forms may be taking hold on the African continent as ways are sought to emulate Western forms of campaign finance but without the strong institutions and safeguards existing in Western democracies. Politicians in Africa have observed that in the UK and USA, big business and wealthy individuals help to finance elections and sometimes develop a symbiotic relationship with those in power. In the absence of big indigenous businessmen and women, the attempt is to create them by granting special favors, licenses, and concessions in a manner that enables these business people to make huge sums of money – a good deal of which is then kicked back into political finance. This is the new frontier in corruption and the financing of democracy.
She says developed economies have not set right example by indulging in this kind of political campaigns. Another issue is how developed economies have become sanctuaries for funds looted from developing countries.
estimated US$20 and US$40 billion of funds is said to have been stolen by corrupt leaders in many poor countries particularly in Africa and hidden overseas. This matter is under-discussed in international fora. To me, it falls within the category of what Amartya Sen terms as an underdiscussed serious problem of global “commission” that must be addressed for elementary global justice9. There are a number of important international cases, such as former President Marcos of the Philippines who is alleged to have stolen about US$5 to $10 billion of public funds during his 21 years in power, while as noted above military leader of Nigeria, General Abacha, looted about US$3 – 5 billion from the Nigerian treasury. In many instances, developed country (and now increasingly emerging market) financial centers become recipients of these funds.
He proposes reforms for both developing and developed. Developing need to have an institutional and serious approach to tackling corruption. Developed need to reform their political finance and monitoring all these stolen funds. Civil society should be as active.
One could just replace all these Nigerian case studies for India as well. It is amazing how corruption has become so ingrained and essential part of Indian society. It was seen as a grease earlier thanks to draconian laws where work was possible only via bribing and corruption. Now even though many laws have been reformed, we still struggle and pay bribes/donations for every service under the sun. Like the example of the little girl in Nigeria stopping education as she could not pay the lecturer. We have similar standards in India where parents are forced into paying donations to even the top schools in the city. Though who have the monies/borrowing sources pay, those who don’t are forced into looking for other low-rung schools.
Such things happening at even top cities is a serious problem. But is just ignored. One could understand these things happening at smaller cities where rule of law is weak. But it happening right in country’s political and financial capital is amazing. But who cares… India is shining, people are earning more so let them pay more. How does it matter!
Then this issue of political vs economic corruption is well said. But we really did not need to learn from west here. Political campaign finance has been happening for so long in highly innovative ways. So much so, Wall Street executives have some lessons to learn from Indian political system.
Anyways, there seems to some global agreement to tackle corruption now. Indian government has also decided to be part of this agenda. Let’s see what happens ..
This is another of the surprising papers/speeches by a noted economist.
Ken Rogoff of Harvard says IMF lending programs are wrongly accused of pushing the countries into fiscal austerity drive. Infact IMF imposes much lesser stringent conditions than other lenders would impose! Rogoff says IMF does not go to countries but countries come to IMF. The countries susuaully goto IMF whwn all other options have been exhausted. Given the situation, IMF lends on more favorable conditions than other private sector lenders..
This crisis shows econs are not sure about many topics which are taught as priciples in basics of economics (or Econ 101). One such topic is Ricardian Equivalence:
The Ricardian equivalence proposition (also known as the Barro-Ricardo equivalence theorem) is an economic theory that suggests consumers internalise the government’s budget constraint and thus the timing of any tax change does not affect their change in spending. Consequently, Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy being the same.
WB chief econ Justin Lin in a speech says:
In my view, a global push for investment along the line of Keynesian stimulus is the key for a sustained global recovery; however, the stimulus needs to go beyond the traditional Keynesian investment. The products of high-income countries’ manufacturing sectors are mainly capital goods. A push for investment will increase the demand for capital goods and reduce manufacturing sectors’ underutilization of capacity in high-income countries, which in turn will increase the high-income countries’ employment, consumption, demand for housing, opportunity for private investment, and growth. With more revenues from higher growth and less needs for social spending, the high-income countries’ fiscal position will be strengthened and sovereign and state debt issues can be solved or mitigated.
But how can the Ricardian trap be avoided, i.e. an outcome where the government stimulus fails to boost aggregate demand because economic agents expect future tax increases to pay for larger deficits and thereby increase savings?
To avoid the Ricardian trap, it is important to go beyond conventional Keynesian stimulus of “digging a hole and paving a hole” by investing in projects which increase future productivity. So the investment will increase jobs and demands for capital goods now and increase the growth and government’s revenue in the future. The increase in revenue can pay back the cost of investment without increasing household’s future tax liability.
So he pushes Keynes stimulus theory but says it should go into meaningful projects. He points to examples of China which did the same in SE Asian crisis:
The Chinese experience in the East Asian financial crisis shows that a “new new normal” is not only a theoretical possibility but also can be a reality. Facing a situation similar to the recent global downturn during the East Asian financial crisis, China focused its fiscal stimulus investments on highways, railroads, port facilities, and electricity, areas that were bottlenecks to China’s growth. As a result, for example, the highway network in China increased from 4,700 km in 1997 to 25,100 km in 2002. Such investments are growth-enhancing and bottleneck releasing can be seen from the facts that China’s annual growth rate increased 1.3 percentage point from an average of 9.6 percent in 1979-2002 to 10.9 percent in 2003-2010; and prior to 2002, 2-digit growth rate was always accompanied by a 2-digit inflation rate whereas in 2002-2010 the inflation rate was not more than 5 percent. Meanwhile, as a result of increase in growth rate, public debts in China as a percentage of GDP reduced from over 30 percent in the early 2000s down to 23 percent in 2008.
This idea of Ricardian equivalence and getting away with it has been debated bigtime in the blogs. In his blog Lin sums up the links:
In a recent blog post “Ricardian Confusions”, Paul Krugman commented on my paper “Beyond Keynesianism and the New New Normal” delivered at the Council on Foreign Relations on Feb. 28. He points out that the government’s fiscal stimulus generally is temporary and households will not increase savings by the full amount of the stimulus. As a result, the stimulus is expansionary even if Ricardian equivalence holds. His comment triggered a series of discussions (Antonio Fatas and Ilian Mihov, Mark Thoma, Paul Krugman, Nick Rowe, and Brad Delong).
I have no disagreement with Paul about the possibility of an expansionary effect of a temporary fiscal stimulus. But if the effect exists and the stimulus does not increase productivity as in his example, there will also be a contractionary effect after the exit of stimulus and the increase of tax to retire the public debts. At the end the issue of underutilization of capacity, which my paper attempts to address, will still be there.
With the existence of large underutilization of capacity in the industrialized countries’ capital goods sector, I see the need for a Keynesian type of stimulus. However, as elaborated in my paper, the stimulus should be used for projects that are bottleneck-releasing, productivity-enhancing and self liquidating instead of “digging a hole and paving a hole”. Such investments will increase jobs and demand now, and increase the growth and government’s revenue in the future. I am delighted to see that this important part of my argument was picked up by Nick Rowe, who differentiated between useless government expenditure and useful government expenditure.
Read all the links Lin mentions and scratch your head as there are wide disagreements…. Say as a graduate student you are asked this question – What does one mean by Ricardian Equivalence? What would students answer reading all these debates? It all boils down to who you follow…