Archive for October, 2011

From negatively sloping Philips curve to Backward Bending Philips Curve

October 20, 2011

RBI has been explaining this idea of backward bending Philips curve in may speeches and papers. The concept has helped RBI explain (atleast tried to) that there is a threshold level of inflation where the curve bends backwards. Hence, instead of inflation acting as a grease for growth it acts as a sand.

This paper from RBI econs Sitikantha Pattanaik and G V Nadhanael explains the whole shift in thinking from (-ly) sloping Philips curve to backward bending Philips curve.

Table 1 in the paper is titled – From NAIRU (-ly sloping) to MURI (Minimum Unemployment Rate of Inflation or backward sloping Philips curve). In the table you have the equation of Philips curve and how it has changed over the years. It is just amazingly explained.

Table-1: Growth-Inflation Tradeoff in Theory– from NAIRU to MURI

1.   w = f(u – u*)                                                                      Lipsey (1960)
2.   π = f(u – u*) + πe                                        Friedman (1968) and Phelps (1968), Lucas (1972)
3.   π = f(u – u*) + λπe                                                             Tobin (1971)
4.   π = f(U – U*) + λ(U)πe                                                        Palley (1994, 1997)
5.   π = f(U – U*) + πe(π)                                                          Akerlof (2000)
6.   π = f(U – U*) + λ(πee                                                      Palley (2003)

Source: Palley (2011, 2008)

Read the paper for details. It is a must going back to basics of Macro..

The paper towards the end looks at threshold level for India and comes at the same conclusions as this paper – around 6%.

I just have one problem with these India growth-inflation papers. Indian growth story is very recent and is not even a decade old. So say you study the threshold from 1970s or 1960s, most of the data you get is of low growth and low inflation phase. Compared to other developing econs, India’s record on inflation has been more sober. So, you get much lower threshold level for inflation.

Since 2006 we have started to face both high growth and high inflation. I believe calculations will change as we move on in this current India growth story phase.  I mean just like threshold inflation we have threshold growth as well where inflation starts to rise moment it crosses the threshold. This threshold is widely believed as 8-9% but is actually much lower. The potential may be much higher but for that you need adequate supply as well.

Nevertheless, nice paper explaining concepts neatly. If not every bit you get some flavor..





Trying to revive India’s Interest rate futures market and failing each time

October 19, 2011

This IRF market has been one of the biggest mysteries of India’s financial markets. It just doesn’t kick-off.

It was first started in 2003 and collapsed in a few days of trading. The problem then was that IRF was based on Zero Coupon Yield  curve (ZCYC)  whereas Indian bind market was based on Yield to maturity and no one really understood the famed ZCYC.

The other reason for its failure was earlier IRF products required physical settlement and not cash  settlement. Physical settlement is when people have to give the bond at settlement (or commodities in case of commodity derivatives) where as in cash one adjusts the differences based on cash.

In 2010 (or was it 2009, it was again tried to restart this based on YTM and only for 10 year. Again regulators kept physical settlement and again it failed to pick up.

This time people also said  we need IRF for short-term as well. The hedging was improper etc.  As a result 91 day T-Bill IRF was started  but trading has become zilch again. There was some euphoria after 91 day T-bill launch  but nothing as of now.

BS in an article said SEBI planning to start IRF in 2-year and 3-year bonds. They will be cash settled and not physical settlement:


ECB staff grading Jean Claude Trichet

October 19, 2011

IPSO or International and European Public Services Organisation is trade union of ECB.There are currently 1502 employees in ECB and around 40% are IPSO members (around 600).

It ran a survey to assess and grade outgoing ECB President – Jean Claude Trichet’s performance in the eyes of IPSO members.  The survey findings were released. 507 people answered the survey:


10 Athletes Who Desperately Need Financial Counseling

October 19, 2011

Jena Ellis of sends this superb link on the topic:

Athletes make more money than they know what to do with. As soon as they sign that million or multi-million dollar contract, all self control goes out the window. Before they know it, they’ve got mansions, luxury cars, fine jewelry and other extravagant items in their name. Of course this isn’t true for all athletes, but most struggle to spend and save wisely. With a little dose of reality and some professional financial counseling, these 10 athletes can finally get their money in check.

The 10 athletes listed are:


A prize to propose a plan for orderly exit of a Eurozone member state

October 19, 2011

THis will not amuse the EMU leaders one bit.

UK’s Charles Wolfson Charitable Trust has announced a plan (FT write-up as well for the subscribers). The plan is for academic economists who can draw a plan which will help EMU economies exit from the Eurozone without much pains! The prize is worth 250,000 GBP and is the second highest prize money to an academic economist after Nobel Prize.

Policy Exchange, an independent think-tank will manage this prize:


Inflation and Monetary Policy: 2006-08 vs 2009-11

October 18, 2011

This paper has been keeping me busy for a while. Finally it is complete or atleast broad thoughts are in place.

In this paper I have compared the two episodes of inflation in India 2006-08 and current inflation phase theta started from Oct-09. The paper looks the inflation levels, monetary policy and impact of markets in both the periods. It also looks at various monetary indicators to understand the role of money and credit in both the phases of inflation.

Read the paper for more details….

Did RBI’s purchase of 200 tonnes of gold increase gold prices?

October 18, 2011

This is a superb paper by A Karunagaran of RBI.

RBI was in news for purchasing 200 tons of Gold. Some said this led to rise in price of gold and others said RBI was just diversifying its reserves. Some even said RBI is restoring the pride as it was forced to keep gold with IMF in the 1991 crisis.  This prompted the study:


How Occupy Wall Street Protest is itself becoming a Too Big to Fail.

October 18, 2011

This blog has been silent on this ongoing protests about Wall Street Practices at NY’s Zuccotti Park as have been preoccupied with so many things.

Came across two terrific articles on the same.


What drove oil prices in 2008? Speculation or Fundamentals?

October 18, 2011

Michael D. Plante and Mine K. Yücel have released two short papers on the topic. First one looks at spot market and second one at futures market to answer the question. In both, fundamentals is the winner.

In spot market study, they point to following reasons:


Black Swan Moments or Platypus Moments?

October 17, 2011

Luci Ellis of RBA brings a truly Aussie perspective  to this whole financial stability debate.

He says we should not really think about Black Swan moments as they cannot be predicted. Instead the focus should be on Platypus moments. Platypus is a strange animal and is really bizzare to know that such an animal exists. So, if you find certain economic and financial developments as bizzare but they are true, time to take notice. It is the Platypus moment for you:


So instead of looking for the unimaginable black swan, I would advocate observing those attitudes and behaviours, as well as the data. And the test I would apply is inspired by another member of Australia’s weird and wonderful fauna – the platypus. You see, when Europeans first saw a black swan, it would have been a surprise, but I doubt it rocked their world. There are plenty of other cases where the same species of animal is a different colour in different regions. But the platypus is strange. It is a mammal, but it has a duck’s bill; it is the only mammal with venomous spurs; it lays eggs; and it is a monotreme. When European scientists first saw the stuffed body of a platypus, they found it so bizarre that they thought it was a fake.

It’s that sense of disbelief, of incredulity, that something is too ridiculous to be true, and yet it is true: that feeling is telling you something. When you have that feeling, you are having what I have come to describe as a Platypus Moment. And it is that moment, that feeling, we should be alert to. It is not just a reaction to a statement or claim you find unbelievable. The reaction is to a practice or behaviour you concede is truly occurring, but find bizarre or foolish. The motivations underlying the behaviour are not coherent. The behaviour spurred by the motivations is not internally consistent, at least not from the perspective of the system.

He recalls a Platypus moment when he heard about this happening in US:

To give a personal example, some years ago I experienced a Platypus Moment when I first read about vendor-financed down payment assistance charities in the United States. They became quite common during the housing boom there. Home-building companies would donate money to charities that in turn gave money to first-home buyers to fund their deposits. Usually these charities were quite local, so the builder that funded them often got the money back by inflating the sale price of the house. Unsurprisingly, US government housing agencies have found that borrowers who had received this kind of assistance were three times more likely to default on their mortgage as those who had not (Montgomery 2008).

‘How’, I asked myself, ‘is this even legal?’

Sometimes it will be better, and more effective, just to point out that the platypus is strange. Like black swans, they turn up more often than you expect.

Hmmm.. Central Bankers/economists taking cues from zoology, ornithology (as they are referrred as hawks, doves, pigeons etc) is interesting stuff. Bringing different perspectives from other fields to explain things is always interesting.


Hmm… Australia has so many bizzare animals – Kangaroos,

Tragedy of projecting India’s inflation

October 17, 2011

I have been doing some research on inflation trends (research to be out soon).

Thought of sharing this research with you. It is interesting to look at RBI’s inflation projections since 2006-07 in each of its monetary policies.


RBI WPI Inflation Projections for Mar-end (in %)


Annual Policy




March Mid-term review



5 to 5.5

5 to 5.5

5 to 5.5

5 to 5.5

















6.5 with upward bias






5.5 (under the new series)





6 with upward bias

7 with upward bias

Source:: RBI

Barring 2008-09 when inflation declined because of global factors, RBI has been missing its year-end inflation target by a wide margin. The challenges become extremely complex from 2009-10 onwards when despite RBI revising inflation projections upwards in each policy, the actual number has only been higher. The inflation trajectory in this period has been volatile and is a complex mix of supply and demand factors. This has made both forecasting and taking appropriate policy actions an extremely difficult task.

India has not had this kind of history where inflation has remained elevated for close to 2 years now. Hence, one cannot even draw policy lessons from history.

Trying to make menu costs as low as possible..

October 17, 2011

Have been thinking about writing this for a while but could not click a picture to show this. Ajay Shah helps by posting a picture about this interesting innovation.

Basically, we also understand inflation by looking at menu costs which is the cost of printing new price menus. If inflation keeps rising so would menu costs.  So, central bankers should be looking at targeting inflation at a level which makes menu costs negligible.

As in India we keep failing to lower inflation (especially food inflation), people have come with innovative ideas. As prices of raw materials keeps rising, so does costs of items sold (like tea, coffee etc). This involves rising menu costs. So it is important to have a strategy by which one can keep changing the prices on the menu with as little costs as possible.

Like this Ajay Shah post showing  a tea stall writing the prices in chalks instead of getting the prices printed. I have noticed a similar thing in one of the Frankey Roll outlet next to my office in Mumbai.

Innovative stuff. What else can people do?

I would imagine that restaurant owners to use magical ink pens whose writing can be rubbed off easily to lower menu costs on the smaller book-menus as well….




Institutional perspective of EMU economies

October 14, 2011

A nice paper on the topic from ECB econs.

It divided the institutional developments (and deterioration) from 1999 0nwards. It divides the phases as pre-crisis, post-crisis and way ahead:

This Occasional Paper examines how and why the institutional framework governing EMU has evolved since the creation of the euro. Building on theories of institutionalism, the paper in particular investigates to what extent functional spillovers from the single currency into other policy domains, like macroeconomic policies or financial regulation, met with an adequate  institutional response, and to what extent the existing institutional framework conditioned the response to the financial crisis.

The interaction between policy requirements and institutional capabilities is examined both in “ordinary times” (1999-2007) and under “crisis conditions” (2007-10). The paper uses a typology of change which helps to put into perspective both the resilience of the institutional framework of EMU and its capacity to adapt. In this respect, it allows for a better understanding and framing of the current reforms of EMU economic governance. It concludes that even though the crisis will accelerate institutional development, it will do so only gradually, as path dependence and an inbuilt bias towards incremental change will prevent policy-makers from pursuing a “clean slate” strategy.

It says instis are developed in following ways. It gives a nice typology:

  • Layering is an institutional change which happens when new institutional elements are added to existing ones.Applied to the context of EMU, this process can be seen in the successive addition of institutions (such as the EFSM/EFSF or the “codifi cation” of the Eurogroup in the Lisbon Treaty), processes (creation of the Lisbon agenda and related process) and policy instruments.
  • Displacement takes place when an element of the institutional structure becomes more salient over time. The ECB provides an interesting instance of “displacement”:
  • Redirection occurs when an institution has its parameters changed and its objectives reorientated, be it in a fundamental way or in a marginal manner. One example of such a change is the Stability and Growth Pact which has gone beyond being a mere disciplinarian device
  • Drift happens when institutional structures are overwhelmed by external developments. Such a case can be found in the discrepancy between fi nancial integration
  • Depletion can be identifi ed when institutions experience a gradual breakdown over time. Clearly, this variety of gradual change  hardly applies to EMU since it is still a relatively young “institution”.


Superb stuff. The paper details on this typology and helps you understand how one should analyse things from an insti perspective…One can use this to analyse many such instis…

Using eco textbooks to develop better eco history

October 14, 2011

A superb speech/paper by Steven G. Medema of University of Colorado, Denver.

He says economists pay minimal attention to textbooks as source of economic history. Some textbooks are written for the current time focusing on the economic thought then and some are thoughtful forward looking textbooks. There is data etc in textbooks which can be used as well. Hence, they are useful to build on economic history:

Historians of economics have paid minimal attention to the diffusion of economic ideas in the textbook literature. Given the low esteem in which textbooks are held as embodiments of scholarship and the propensity of historians of economics – and intellectual historians generally – to focus on the production of scholarship through more lofty venues such as journal articles and scholarly books, this lack of attention to the textbook literature is in some ways understandable. This paper attempts to make the case that the textbook literature constitutes an incredibly rich data source for the historian of economics. In doing so, it draws illustrations from the treatment of the Coase theorem in the textbooks, with a view both to showing how the textbook literature enhances our understanding of the diffusion of economic ideas and how attempts by authors to grapple with new ideas in the context of the textbook literature can result in divergences between how these ideas are treated in the scholarly and textbook literatures.

Due to lack of time, cannot really cover the details. A good different read.

The economic impact of the rugby world cup in NZ 2011

October 13, 2011

NZ’s central bank has a paper on this. The Rugby World Cup has started and the  paper was written earlier. But just missed posting on it. Apart from the findings itself, paper provides some clarity on how to think about this issue:

It is expected to provide benefits for the NZ economy:


Remembering your school’s history teacher

October 13, 2011

PIMCO guys seem to have donned writers’ hat and seem to be writing some really interesting stuff (What more can one do with such markets).

Bill Gross has been entertaining a lot with his writing (see this, this).

Neel Kashkari joins in as well (wrote a earlier good piece as well). In this new piece, he goes back to his school days:


Economic adjustment in EMU.. lessons from Latvia?

October 13, 2011

Jurgen Stark in his last few days at ECB gives a food for thought speech on the topic.

First, when a mon union faces a shock what should it do? He says there are 3 ways to adjust (based on Robert Mundell):


Why Greece’s current account deficits never corrected?

October 12, 2011

Aaron Tornell &  Frank Westermann   solve this mystery on why Greece current account deficits never corrected. In previous crisis economies, their current account deficits were reduced sharply as currency weakened leading to higher exports and there was no capital flow from other economies forcing countries to balance their account.

In Greece case we know currency cannot weaken but that is just one part of the story. What is even more interesting is how Greece continues to get capital from Eurosystem central banks. So there is no real pressure to make adjustments as well:


Pure lemon juice is barely drinkable..similarly pure market economy is barely workable

October 12, 2011

A superb article from Dani Rodrik who writes on Friedman’s ideas and its impact on the world. Next year is Friedman’s 100th birth anniversary and Rodrik looks at what  the great economist offered to the world economy.

He says despite Friedman’s major work being in mon pol and consumption economics, he is always remembered for his compete defence for free markets:


How the crisis shaped Iceland’s new constitution..

October 12, 2011

The crisis in Iceland led to a revolution (called nicely as pots and pans/kitchen revolution as these items were used to create noise in public gatherings). Interestingly, the revolution which started to protest against financial crisis and favoring financial firms led to a bigger call to have a new constitution.

We have debated the impact of crisis on so many things – central banking, financial regulation, teaching etc etc. On constitution is pretty interesting.

Thorvaldur Gylfason of Univ of Iceland writes on this fascinating set of events in Iceland. He begins saying previous crisis too led to changes in constis:


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