Archive for July 8th, 2011

Are real rates negative in India?

July 8, 2011

RBI Deputy Governor Subor Gokarn gives an overall assessment of current economic situation in India.

He looks at many issues – elevated inflation, IIP volatility, growth etc. It is a summary of several points he made in earlier speeches on importance of proteins in inflation, interst rate sensitivity of capital goods and consumer durables etc.

On real interest rates RBI is criticised for being behind the curve as nominal interest rates remain lower than inflation. Gokarn responds:

Finally, in the context of monetary actions and transmission, let me address the issue of real rates. One consistent critique of the monetary stance, that it has been behind the curve, is based on the criterion that real rates have been and still are negative. Of course, this leads to a usually inconclusive debate on what the deflator should be, but widespread perceptions that real rates are negative are likely to impact both spending behaviour and expectations. This then leads to the more operational issue of whether rates are to be brought into positive territory relatively rapidly or gradually.

Charts 12 and Charts 13 provide some perspective on the real rate issue. As Chart 12 shows, with the recent acceleration in inflation, many real rates, measured in the simplest way of subtracting either current headline inflation or core inflation from the nominal rate, are negative when the headline rate is used to deflate. The picture changes, but hardly decisively, if the core (non-food manufacturing) inflation is used. So, going by some of these indicators,  it may appear that the policy stance is not contractionary enough. However, when we look at some other measures of real rates, specifically bank lending rates as depicted in Chart 13, the picture is a little different. Allowing for differences in risk and other differentiating prices, real rates are significantly positive. As I said, this is a criterion on which the debate in the Indian context is yet unresolved and is keeping some of my colleagues in the research departments engaged. The point I would like to make is that, at least in terms of a large proportion of financial transactions, real rates are positive. It remains a matter of judgment whether they are lower than they should be and, if so, how quickly the necessary adjustment should be made.

This judgment is partly related to the issue of expectations. Looking back over the past year and a half, the balancing act between growth and inflation can also be seen in a slightly different way. There is also a tradeoff between minimizing the sacrifice of growth and not letting expectations run out of control as a result of inflation persistence, exacerbated by new shocks.

Given the interesting debate on headline vs core and differences, this is a global problem. If you look at headline, inflation looks high and with core it is subdued. This leads to policy differences as well.

Same with India…With headline real rates look much lower than it does for core.

However, the problem is not as much rates. It is inflation which just refuses to go away. With each revision in inflation, final numbers are higher by 1% and more.  No policymaker can really do anything with such high revised numbers. In India, barring headline and core one also wonders whether to look at provisional or final inflation.

US high debt/deficit result of low revenues or high expenditure?

July 8, 2011

Superb short note from St Louis Fed econs Kevin L. Kliesen and Daniel L. Thornton.

They track US debt/deficit levels since 1950s and look whether rise in debt is a result of lower revenue or higher expenditure or both. They say rise in US debt and deficit levels is a result of rise in expenditure. Tax revenues have remained constant.

First the debt picture:

The first chart shows the federal debt in trillions of dollars and as a percent of gross domestic product (GDP) from 1950 through 2010. From 1950 to 2007, the debt increased from about $0.25 trillion to nearly $9 trillion. The debt initially declined relative to the nation’s output, from about 94 percent of GDP in 1950 to a trough of about 32 percent of GDP in 1981. In the early 1980s, however, both actual debt and debt relative to GDP began to rise sharply, reaching 64 percent of GDP in 2007 (vertical line). There was a very large increase in the debt as a result of the financial crisis and subsequent recession. In just three years (2008-10),the nation’s debt increased by about $4.5 trillion, a 50 percent increase over its 2007 level. The debt relative to GDP rose to 93.2 percent.

Now the revenues vs expenditure picture:

From 1950 through 1974, on average, revenues remained relatively constant at about 18 percent
of GDP—averaging 17.6 percentof GDP for 1950-74 and 18.2 percent of GDP for 1975-2007. In contrast, expenditures wereabove their 1950-74 average level in all but 5 of the 38 years from 1970 through 2007: On average, expenditures increased from 18.3 percent of GDP for 1950-74 to 20.8 percent of GDP for 1975-2007. In short, the average deficit as a share of GDP rose 1.9 percentage points from 1950-74 to 1975-2007, which is more than accounted for by the same period’s 2.5-percentage-point increase in spending as a share of GDP.

They add recent years picture is slightly different as it is a combi of both – revenues falling and expenditures rising pretty fast.

It is not really because of the crisis. The situation had been worsening slowly over the last 60 years..

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