Archive for June 9th, 2015

How economists are biased and self-selective about monetary history..

June 9, 2015

An insightful post by Prof George Selgin.

He picks a ppt from a Fed official who taught monetary economics to a school class. Prof Selgin says that the official tried to show how Fed is a superior system compared to the alternatives:

One of the chief goals of Cato’s Center for Monetary and Financial Alternatives is to make people aware of alternatives to conventional monetary systems—that is, systems managed by central bankers wielding considerable, if not unlimited, discretionary authority.  The challenge isn’t just one of informing the general public: even professional monetary economists, with relatively few exceptions, are surprisingly ill-informed about such alternatives.

I recently came across a document that perfectly illustrates this last point: a power point presentation by a senior Federal Reserve Bank research economist, given at a conference aimed at school teachers specializing in economics.

I have no desire to single-out the economist in question, who I will therefore refer to simply as “our economist.”  On the contrary: I offer his presentation as an example of the all-too common tendency for otherwise competent monetary economists (and our economist is in fact very accomplished) to misread the historical record regarding potential alternatives to central banking and to otherwise give such alternatives short shrift.

This unfortunate tendency rests in part on the fact that most economics graduate programs stopped teaching any sort of economic history decades ago (our economist earned his PhD in the early 1990s), while burdening their students with enough mathematics and statistics to all but guarantee that they never so much as crack open a book on the subject.  But the trouble isn’t just that many monetary economists don’t know their monetary history: it’s that they know, and teach, monetary history that ain’t so.  That’s what our economist did when he lectured a roomful of teachers on the merits of central banks and “Alternative Monetary Systems.”

Hmm.. Standard way to show how useful you are to the society.

It is frustrating how none of the real monetary history is taught to students. I mean one may disagree with free banking stuff, but atleast it should be taught.

Do we need the Indian Meterological Dept and its forecasts?

June 9, 2015

Shreekant Sambrani has a nice food for thought article on the mania around IMD’s monsoon forecasts.

He actually questions the need to have a centralised IMD in today’times. One can do a much better job with a decentralised system:


Why CPI based inflation targeting does not lead to price stability..

June 9, 2015

Axel Weber, former head of Bundebank (who could have become ECB chief if he had not resigned) has this nice piece.

He says why CPI based inflation targeting is too narrow an objective. Above all, it does not even guarantee price stability:

Over the last two decades, inflation targeting has become the predominant monetary-policy framework. It has been essentially (though not explicitly) adopted by major central banks, including the US Federal Reserve, the European Central Bank, and the Swiss National Bank. But the 2008 global economic crisis, from which the world has yet to recover fully, has cast serious doubt on this approach.

The Bank for International Settlements has long argued that pure inflation targeting is not compatible with financial stability. It does not take into account the financial cycle, and thus produces excessively expansionary and asymmetric monetary policy. Moreover, a major argument in favor of inflation targeting – that it has contributed to a decline in inflation since the early 1990s – is questionable, at best. Disinflation actually began in the early 1980s – well before inflation targeting was invented – thanks to the concerted efforts of then-US Federal Reserve Board Chair Paul Volcker. And, from the 1990s on, globalization – in particular, China’s integration into the world economy – has probably been the main reason for the decline in global inflationary pressure.

A more recent indication that inflation targeting has not caused the disinflation seen since the 1990s is the unsuccessful effort by a growing number of central banks to reflate their economies. If central banks are unable to increase inflation, it stands to reason that they may not have been instrumental in reducing it.

The fact is that the original objective of central banks was not consumer-price stability; consumer-price indices did not even exist when most of them were founded. Central banks were established to provide war financing to governments. Later, their mission was expanded to include the role of lender of last resort. It was not until the excessive inflation of the 1970s that central banks discovered – or, in a sense, rediscovered – the desirability of keeping the value of money stable.

But how to measure the value of money? One approach centers on prices, with the consumer price index appearing to be the most obvious indicator. The problem is that the relationship between the money supply (which ultimately determines the value of money) and prices is an unstable one. For starters, the lag time between changes in the money supply and price movements is long, variable, and unpredictable. Given this, targeting consumer prices in the next 2-3 years will not guarantee that the value of money remains stable in the long term.

Moreover, different methods of collecting consumer prices yield different results, depending on how housing costs are treated and the hedonic adjustment applied. In short, monetary policy has been shaped by an imprecise, small, and shrinking subset of prices that exhibits long and variable lags vis-à-vis changes in the money supply. Unfortunately, monetary policymakers’ effort to operationalize the objective of ensuring that the value of money remains stable has taken on a life of its own. Today’s economics textbooks assume that a primary objective of central banks is to stabilize consumer prices, rather than the value of money.

Furthermore, economists now understand inflation as a rise in consumer prices, not as a decline in the value of money resulting from an excessive increase in the money supply. Making matters worse, central banks routinely deny responsibility for any prices other than consumer prices, ignoring that the value of money is reflected in all prices, including commodities, real estate, stocks, bonds, and, perhaps most important, exchange rates.

In short, while price stabilization through inflation targeting is a commendable objective, central banks’ narrow focus on consumer prices – within a relatively short time frame, no less – is inadequate to achieve it. This was highlighted by the surge in many countries’ housing prices in the run-up to the 2008 financial crisis, the steep decline in asset and commodity prices immediately after Lehman Brothers collapsed, the return to asset-price inflation since then, and recent large currency fluctuations. All are inconsistent with a stable value of money.

I mean all this has been so obvious but the obsession with IT continues.

Infact Weber says central banks need to look at multiple things:

Central banks’ exclusive focus on consumer prices may even be counterproductive. By undermining the efficient allocation of capital and fostering mal-investment, CPI-focused monetary policy is distorting economic structures, blocking growth-enhancing creative destruction, creating moral hazard, and sowing the seeds for future instability in the value of money.

Within a complex and constantly evolving economy, a simplistic inflation-targeting framework will not stabilize the value of money. Only an equally complex and highly adaptable monetary-policy approach – one that emphasizes risk management and reliance on policymakers’ judgment, rather than a clear-cut formula – can do that. Such an approach would be less predictable and eliminate forward guidance, thereby discouraging excessive risk-taking and reducing moral hazard.

History hints at what a stability-oriented framework could look like. In the last quarter of the twentieth century, many central banks used intermediate targets, including monetary aggregates. Such targets could potentially be applied to credit, interest rates, exchange rates, asset and commodity prices, risk premiums, and/or intermediate-goods prices.

Short-term consumer-price stability does not guarantee economic, financial, or monetary stability. It is time for central banks to accept this fact and adopt a comprehensive, long-term monetary-policy approach – even if it means that, in the short term, consumer-price inflation deviates from what is currently understood as “price stability.” Temporary fluctuations in a narrow and imprecisely measured CPI are a small price to pay to secure the long-term stability of money.

Indian central bank had exactly this kind of framework only to be rejected by the fashionable IT framework. Some IT central banks like say BoE, ECB, etc have atleast understood the limitations of IT game. They have missed the forest for the woods and continue to pay for their mistakes. But they still call them as IT central banks and have added the euphemism flexible to it.

 Most fashionable economic ideas of today are only proved as duds in future.  This is because we believe too much in scientification of economics. Some idea works in some time and we make a big deal of it and think it will work all the time. Soon the idea is projected as a big theory. The theory becomes even bugger if it comes from the hallowed schools of economics in US. And here is an idea whose limitations have been exposed in the crisi.s But it continues to remain.

Book Review – Monsoon: The Indian Ocean and the Future of American Powe

June 9, 2015

Yesterday was World Ocean’s Day and a perfect day to read this book by Robert Kaplan. Kaplan is  a senior fellow at the Center for a New American Security in Washington. Ideally one should have read a book on importance of oceans in human lives but even to know the role oceans play in geo-politics is quite interesting and important as well.

I am sure there are better books on history of Indian ocean and South Asia. But this one is a great way to be introduced to such an important and fascinating subject.  As economics textbooks have taken out politics, history and geography (even economics) from them, one is just amazed to read all such accounts.

The main thesis of the book is that geography matters in determining destinies of countries. This is against the institutional view which says only good institutions matter. But having favorable geography does determine the state of nations over a long term. Having access to sea routes and good ports, is a huge natural advantage on which one can build on.

The author picks why Indian ocean and countries around the ocean will play a key role in coming years/decades. He says just like Atlantic Ocean played a crucial role since the World Wars, same will be the case with Indian Ocean. US was the key player in importance of Atlantic Ocean and China (along with others) is likely to play a key role in Indian Ocean. This is also nothing new really. Indian Ocean played a dominating role earlier as well when European colonisers navigated through the ocean to make most of Asia their colonies. Even before them, when India and China ruled the world Indian Ocean played a key role as well (though Silk Route or land route played the dominant role then).


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