Archive for April, 2011

How to resolve a bank in distress?

April 22, 2011

LArs Nyberg of Riksbank has a nice speech covering the whole debate on the topic .

He began by noting that it is in practice difficult to allow banks, particularly if they are large and important to the financial system, to go bankrupt in the same way as ordinary companies. This was made clear during the recent financial crisis, for instance, when a number of banks around the world were rescued and in many countries taxpayers had to foot rather substantial bills. In a normal bankruptcy the shareholders are the first to be affected by losses, followed by the creditors. But if a bank is saved from bankruptcy, the creditors and actually often the shareholders are also saved from losses. Instead, the taxpayers suffer. This is clearly wrong, said Mr Nyberg.

 What we need is legislation for banks that cannot be allowed to go bankrupt like normal companies, which ensures that shareholders and creditors will foot the bill if the bank is mismanaged and becomes insolvent. Mr Nyberg said that one of the hot topics this spring, both in Sweden and abroad, is how to formulate suitable legislation for this.

 He went on to describe why banks cannot be allowed to go bankrupt like ordinary companies. But, he said, if the traditional bankruptcy legislation is not appropriate for banks, what kind of legislation would be suitable? He felt that some form of consensus on this was now emerging in the international discussions. Mr Nyberg also described the components he considers important in such legislation.

 Firstly, the state needs to be able to intervene at an early stage if the bank is to survive. This means before the bank is formally declared insolvent. The intervention then needs to be followed by a speedy procedure.

 Secondly, the state needs to have special tools to effect a resolution. These tools must give the authorities the possibility to sell and restructure a bank, for instance, by dividing it up into a good part and a bad part.

 One also needs to have, as a last resort, the possibility of a state takeover. This is a sensitive issue in certain parts of the world, but it is sometimes necessary. It is then better to have regulations on how to do this, rather than to deny the possibility of it happening, according to Mr Nyberg.

 Of course, the best thing would be if one could avoid the state taking over banks. But then one would have to find other ways of improving the distressed bank’s capital situation if it is to carry on. One alternative is to write off some of the debts, or convert them into shares. This is called a “bail-in”. Mr Nyberg went on to describe different forms of bail-in, but also said that there are still some problems that need to be resolved in this area.

 After describing what should be included, Mr Nyberg moved on to talk about what is actually taking place. He gave a brief description of the regulatory frameworks in the United States and the United Kingdom and of developments in the EU. He also compared these with the components he believes should be included in the legislation, and with the Swedish Support to Credit Institutions Act.

 Mr Nyberg felt that all of the regulatory structures can manage the most important problem, namely resolving a bank so that the shareholders are the ones affected most, and not the taxpayers. But there are differences, and he pointed to three of them, namely the way creditors are treated, how views differ regarding state takeovers, and how small banks are treated.

 With regard to the latter, the treatment of small banks, Sweden is the country that differs, concluded Mr Nyberg. Unlike the United States and the United Kingdom, Sweden has no special regulations for banks that are not systemically important; instead the normal bankruptcy procedure applies to them. Mr Nyberg argued in favour of a general legislation that can be applied to all banks. One important reason for this is that in real-life situations it is very difficult to determine whether or not a bank is systemically important, and each assessment contains a large measure of discretion. It does not feel right, Mr Nyberg said, that the consequences for so many people should unnecessarily be so dependent on assessments that are far from self-evident.

Bank of Canada should shift from inflation targeting to precision targeting

April 21, 2011

This is a a superb paper from Christopher Ragan – Precision Targeting: The Economics – and Politics – of Improving Canada’s Inflation-Targeting Framework.

The idea is that BoC and Canadian government are to review the inflation targeting framework in 2011. So whether it has worked or not? What are the changes needed etc?

Howe argues for five changes:


Anti-Keyesians are Keynesians after all….

April 20, 2011

Dave Altig in Atlanta Fed’s super macroblog asks- Can Keynesians be anti-Keynesian?

He points to how certain so called anti-keynesian economists like John Taylor, Ken Rogoff and Mundell are actually Keynesians. They are at the centre of development of New Keyensian thought:

One of the interesting things about the article is that among the economists cited as being among the critics of “Keynesianism,” you find the names John TaylorRobert Mundell, and Kenneth Rogoff. I find that list interesting because if you follow the links I attached to those names you will find work with models that are decidedly Keynesian in structure. Works by Taylor and Rogoff are, in fact, seminal contributions to the “New Keynesian” paradigm that dominates macroeconomics today.

As far as I know, none of these men have repudiated the basic worldview that motivates the referenced work.

What explains this divergence then? Well it is again the confusion between Keynes and Friedman thoughts:

How, then, to explain the Keynesian predilections of the economists mentioned as presumed carriers of the anti-Keynesian mantle? The source of the confusion, I think, goes back to the historical, but somewhat obsolete, distinction between so-called Keynesianism and monetarism. The latter was, of course, personified in Milton Friedman and his dispute with what was the orthodoxy in the three decades following the Great Depression. Lost in the early-days labeling, however, was the fact that the disputes were more about the empirical details of theory rather than the theory itself.

In particular, Friedman did not deny the effectiveness of policy in principle but rather its wisdom or impact in practice. This sentiment is exactly the one he expressed in his prescient and transformative 1968 presidential address to the American Economics Association:

“In the United States the revival of belief in the potency of monetary policy was strengthened also by the increasing disillusionment with fiscal policy, not so much by its potential to increase aggregate demand as with the practical and political feasibility of so using it.”


My point is that it has absolutely nothing to do with whether one believes (or does not believe) that the New Keynesian framework is the right way to view the world. The essential policy implications of the New Keynesian idea (like the old Keynesian idea) is that changes in gross domestic product can be driven by changes in desired spending by households, businesses, foreigners, and the government in sum. You can believe that and still believe in fiscal policy ineffectiveness, as long as you believe that total spending is unaltered by a particular policy intervention.

There are, of course, plenty of arguments against fiscal policy activism that do not require adherence to Ricardian equivalence, in total or in part. The most obvious would be the position that any short-term rush from stimulative policies is more than reversed in the long run by the negative consequences of higher tax rates on productive activity, or the redirection of private investment to lower return public spending. Again, the point is that a self-professed adherent to a Keynesian reality need suffer no doubts about the coherence of his or her intellectual framework if he or she objects to fiscal policies aimed at juicing the economy through greater government spending.

This whole discussion may seem like a bit of inside baseball, and perhaps it is. But the stakes in this debate are high, as clearly illustrated by today’s announcement from rating agency Standard & Poor’s that it reduced its outlook to negative on the triple-A credit rating of the United States. In my view, productive discussions about the truly pressing issues of our day are unlikely unless we understand where the disagreements lie—and where they do not.

Krugman adds in his typical style:

One thing I guarantee you: if John McCain were living in the White House, these same people would have lots of good things to say about the stimulative effects of deficits in a depressed economy.


McCain is a Republican and all these econs are Republicans as well…Sad state of economics affairs really…

Apart from telling while writing in media whether they are part of some financial firm, they need to also tell us whether they are democrat or republican (US economists that is) and other parties in other countries

Conflict of interest between financial economists and their financial interests: ethical standards for the profession is needed?

April 20, 2011

Gerald Epstein & Jessica Carrick-Hagenbart write a paper with this long and title:  Financial Economists, Financial Interests and Dark Corners of the Meltdown: It’s Time to Set Ethical Standards for the Economics

In this paper they look at how financial economists have behaved before and after this crisis. Quite a few comment and write for the media on topics, such as financial regulation. And then they are affiliated to private sector as consultants/directors etc. The authors say most of thes e guys while writing on these matters fail to report their private financial affiliations. This leads to conflict of interest:


Should one rent or own a house: an economic perspective

April 18, 2011

This is a question most people face. But for most the answer is a given – buy a house. There is nothing more satisfying than having your own house and doing what you want to in the house. In a rented house, one is always dependent on the owner’s whims and permissions. Rented house also means one has to keep searching for a new place each time the owner decides to have a new tenant etc.

The choice is not as straight forward. Jordan Rappaport from Kansas Fed explores these choices in this paper. The summary is presented here.


Trust in Public Institutions over the Business Cycle

April 17, 2011

This  paper from Justin Wolfers and Betsey Stevenson shows just waht one would expect. The trust in public institutions moves along with the  business cycle. It is procyclical -trust increases in a boom and declines in the bust.


Will Fed portfolio be under risk when it raises rates?

April 17, 2011

Glenn D. Rudebusch of FRBSF rules out the interest rate risk for Fed portfolio. As we know Fed has bought billions of  securities from the market via its QE (and credit easing)  programs. As  these have been bought at a time when interest rates were declining. If it raises rates, will it be under any risk? Will there be any loss on the portfolio? This is an important paper as few talk about this issue.

It looks at the portfolio and says rates will have to rise to above 7% for a loss. This probability is  far far- off:


China to change its GDP data release

April 16, 2011

This is am amazing post from China realtime Blog. China has changed the way it releases its GDP data and growth rates. Earlier it was year on year growth (Q1- 2011 over Q1-2010). Now it would be quarter on quarter growth (Q2 2011 over Q1 2011) and sesonally adjusted growth rates to account for changes in the twop quarters. This is how US presents its data and is an international standard.


US and Europe have identical inflation but opposite policies

April 16, 2011

From WSJ BLog:

U.S. and euro zone inflation were at identical 2.7% annual rates in March, according to their respective statistics agencies in separate reports Friday. Core inflation is more or less the same (1.2% in the U.S., 1.3% in the euro bloc). Until last month, inflation had been running slightly faster in the euro zone.

Yet given the same set of inflation dynamics, the European Central Bank has already raised interest rates once and, based on Friday’s report, is likely to do so again as early as June. TheFederal Reserve, in contrast, continues to pump money into the economy via QE2, and isn’t expected to lift interest rates from near zero for many months.

In large part, it’s a difference of emphasis. Fed officials think higher commodity prices are temporary, and that core inflation is a better gauge of underlying price trends. ECB officials target headline inflation, and worry that higher energy and food prices will filter through the economy via “second round” effects, namely higher wages and retail prices.

I really did not note inflation numbers are so simialr in both the areas. What is even more amazing is that most experts talk about US econo y growing faster and Europe still struggling. Hence future is more promising for US (and still Fed prefers to pasue) where as bleak for Europe (and still ECB hikes).

There are other forces at work, too. The U.S. has a higher growth potential, meaning the recession created a larger output gap there than it did in Europe. That presumably gives the Fed more time to see how long higher commodity prices stick.

The Fed also has a dual inflation-employment mandate (the ECB is only responsible for keeping inflation just below 2%). Though unemployment in the euro zone is higher than it is in the U.S., ECB officials think that is more a structural issue for governments than it is a monetary-policy problem.

It will be nice to see whether ECB again hikes rates when things are not as rosy as it did in 2008. It hiked rates just ahead of LEhman crisis leading to criticisms…

Whatever the reasons, the two biggest central banks in the world can’t have such divergent views without consequences down the road.

If the ECB is right and higher commodity-driven inflation must be addressed quickly, then it may be able to keep inflation expectations under control without large-scale rate increases. If the Fed errs in waiting too long, it could be forced to play catch-up with more aggressive, and damaging, rate increases down the road.

If, however, the ECB is being unnecessarily spooked by commodity prices that are largely outside its control, it may unnecessarily damage the economy, especially in the already fragile periphery.


In case you thought Great Depression was all doom…

April 13, 2011

Atleast this blog thought so. But economists never cease to amaze you really.

Economix blog points to this interview of Alexander J. Field of Santa Clara University. He says the 1930s decades was the most technologically progressive decade of the century!


Inequality may lead to lower growth

April 13, 2011

One of the many interesting debates on India economy is role of inequality. Some say it has risen with others saying it has lowered thanks to high growth in last 7-8 years. While others say inequality is a natural outcome of a high growth process where it is survival of the fittest. So the well-educated and healthy get maximum advantage. This does not mean the growth process is wrong but state needs to work on the education, health care etc so that opportunities are shared by all.

The debate now is not limited to India (and other Emerging econs). It is a major issue in US as well with Raghu Rajan showing how inequality is one of the major causes of the crisis. This has led to some exciting debate in US as well amidst Tyler Cowen and all. Earlier research by Emmanuel Saez showed how inequality has been rising in US but was not really looked into. Now one is seeing some regular research flowing into the topic.

IMF economists in this paper look at this inequality and growth linkage. They say countries which are more unequal find it difficult to sustain growth. To put it other way, countries which manage to lower inequality tend to grow for a longer time.


Shiller on how should the financial crisis change teaching economics?

April 13, 2011

Apart from this excellent paper on returning economics to worldly philosophical ways, here is another nice paper from Robert Shiller. This one is on how economics teaching should change after the crisis.

The overall message is the same – economics needs to be taught with other fields as well. And then knowing economic history is so important. He also discusses crisis in economic research and says more important is to tell students what we don’t know:


A review of measuring inflation expectations

April 13, 2011

Simon Potter of NY Fed has a nice speech on the one of the hot topics in global economy – inflation expectations.

He discusses the two methods of inflation measures – from market instruments and survey based. There are divergences but overall the estimates suggest the expectations are anchored as of now (again many economists differ on this).

More importantly he discusses how NY Fed is trying to improve these measures especially surveys:


Celebrating Easter at Bank of England!

April 11, 2011

Central Banks are doing amazing things these days. Apart from serrious stuff of revamping their mon policy, they are aslo doing some fun stuff.

BoE is planning to organise an event in Easter holidays for the whole family:


Applications of Behavioral economics in European Commission

April 11, 2011

Geary behavioural economics blog points (alas the blog has closed down) European Health and Consumer Directorate, in particular its consumer division, has been taking an active interest in behavioural economics. There have been two conferences (link here and here) discussing the subject and its applications.

There is a nice paper  by Emmanuele Ciriole, economist with the division summarising the policy applications. As one cannot extract text from pdf, I can just point to some highlights.


How India’s financial markets have evolved and developed over the years?

April 11, 2011

K.P. Krishnan  (at Capital Markets Division of the Department of Economic Affairs, Ministry of Finance)  writes a paper tracking developments in various segments of India’s financial markets

The paper is good as it covers a lot of ground covering many segments of financial markets. However, its policy suggestions are questionable given the global crisis.

It begins looking at research measuring financial development in general and in India. The summary is:


Should economists be worldly philosophers?

April 11, 2011

Robert Shiller and Virginia Shiller (Robert Shiller’s wife) have written this nice paper looking at economists in this crisis.

Shiller couple argues that economists have lost their worldly philosophical ways. Earlier economics was taught along with philosophy and other social sciences streams.  Now they have been divorced with economics becoming more specialised and technical over the years. THis has both positives ane negatives. Positive is their field has become more enriched with more and more research. Negative is economists have been unable to link various dots and missed seeing the crisis coming.


Emergence of Chinese Automobile sector

April 8, 2011

Mark Baker and Markus Hyvonen of Reserve Bank of Australia have written a nice writeup on the topic.

People might not be knowing this – China has become the largest producer of automobiles in the world. Authors say:


History of clearing houses..

April 8, 2011

In case some have missed it, Bernanke’s recent speech on clearing houses is a good read.

What are clearing houses?


Is QE by Fed fueling the Rise in Commodity Prices?

April 8, 2011

No says Reuven Glick and Sylvain Leduc of FRBSF in this paper. Their paper shows it is actually an opposite case. Fed passing QE signals that US economy is weak and there would be lower demand. This leads to lower commodity prices and not higher as most make it out to be.

This Economic Letter examines the effects of Fed LSAP announcements on commodity prices and other financial variables. Using daily data, we show that commodity prices actually tended to fall following such announcements. These effects suggest that market participants may have viewed LSAP announcements as signaling lower future economic growth in the United States or indicating greater risk rather than implying higher inflationary pressures.


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