Why the same inflation target may not fit all countries?

As Federal Reserve changes gears to Average Inflation targeting, it has to be seen what other central banks do.

Meanwhile one question to be asked is why most developed country central banks target 2% inflation? This St Louis Fed blogpost analyses drivers of inflation across countries.

Over the past few decades, many central banks have adopted the monetary policy of inflation targeting, in which they set an explicit target rate for inflation. For the U.S., the European Union, the United Kingdom and Japan, this target inflation rate is at or near 2%. But is the same inflation target optimal for all economies?

In a Regional Economist article, Research Officer and Economist YiLi Chien and Research Associate Julie Bennett noted that inflation rates for several advanced economies have fallen short of their 2% targets for most of the past decade, which raises questions about the optimal level of inflation targets.

“In practice, the specific 2% inflation target may not be universally optimal,” the authors wrote. “The driving forces behind inflation rates could be quite different across countries; therefore, the implementation of the same monetary policy tools—such as forward guidance or quantitative easing—could have varied effects on inflation rates.”

In their analysis, the authors found the main contributors to inflation have varied across countries.

Using national consumer price index (CPI) data from the Paris-based Organization for Economic Cooperation and Development (OECD),¹ the authors identified different inflation drivers for the U.S., Japan, France, Germany and the U.K. for the period from January 2012 to September 2019. For each country, the average overall CPI inflation rate was below 2%, ranging from 1.8% in the U.K. to 0.69% in Japan.

For all the countries except Japan, the category of housing, water, electricity, gas and other fuel expenditures contributed most to overall inflation. However, this broad category’s share of overall inflation varied by country. In the U.S., expenditures in this category contributed 1 percentage point to the average overall inflation rate, representing a 64% share of overall inflation. In France, Germany and the U.K., this share was much lower at 26%, 29% and 33%, respectively, while in Japan it was 13%.

Interesting…

Advertisement

Central Bank of Brazil creates study group on central bank digital currency

Game is heating. Central Bank of Brazil joins the race of CBDC:

The object of a worldwide study, the issuance of digital currency by central banks ( central bank digital currency – CBDC) aims to evolve the physical support of fiduciary currencies to the electronic medium. In order to anticipate the future of financial relations, the Central Bank decided to create a working group to discuss the impacts of an eventual issuance of digital currency in Brazil.

With technological developments, payment systems have been digitized and have stopped using paper. “The number of electronic payments has been growing in recent years, thanks, in particular, to the evolution of mobile device and communication technology. However, our money remains materialized in paper and metal circles, and there is still no digital representation of money accessible to the citizen. So, a digital currency issued by a central bank would allow Brazilians to interact with their money in a completely electronic way ”, explains the coordinator of the study group, Aristides Andrade Cavalcante Neto, from the Information Technology Department (Deinf) of the Central Bank.

Rafael Sarres de Almeida, also from Deinf and alternate coordinator of the study group, points out that “the subject of digital coins issued by central banks has been on the research agenda of many central banks for some time, however, this year, there was a greater focus in a more practical approach. China has already entered the final testing phase of its digital currency and many monetary authorities have announced new projects ”. According to Rafael, the initiative of the Central Bank aims to deepen studies “on the future of our currency. It is important to emphasize, however, that the group’s approval does not mean that the BC will issue a digital currency, but that the monetary authority will study the issue and give society a response on the topic. ”

Studying the digital currency issuance model is essential to understand the phenomenon and its potential impacts. This is what Arnaldo Francisco Vitaliano Filho, from the Department of Promotion of Financial Citizenship (Depef) of the Central Bank believes. “The working group will allow us to evaluate possible implications in areas such as financial inclusion, economic growth, technological innovation and increased efficiency of transactions, and, thus, give more clarity on the subject to the BC”, he says.

 

Jackson Hole Symposium 2020: Should RBI follow the US Federal Reserve in targeting average inflation?

Whether one likes it or not, Federal Reserve Chair Jerome Powell gave a game changing speech in Jackson Hole Symposium 2020.

By announcing a shift in policy to Average Inflation Targeting, the Federal Reserve has taken a lead in how policies are likely to be conducted in developed countries going forward.

In my new MC piece, I review the decision and what it means for RBI.

 

Going negative: the ECB’s experience

Isabel Schnabel of ECB, reviews ECB’s negative interest rate policy:

First, the ECB’s negative interest rate policy has been successful in turning the zero lower bound into an effective lower bound well below zero and supporting bank lending. This fundamentally improved monetary transmission and helped to stimulate the economy and raise inflation.

Second, negative rates can have side effects on banks’ profitability and risk-taking behaviour. That said, the experience of the euro area over the past few years suggests that the positive effects dominated, supported by the use of other policy measures that directly mitigate the costs of negative rates.

Finally, side effects are likely to become more relevant over time. Since negative rates largely reflect adverse macroeconomic trends outside the remit of central banks, a forceful policy response by governments to the pandemic is indispensable for raising potential growth, thereby paving the way for positive interest rates in the future.

What times. Much of Europe remains entangled in negative interest rates..

 

Evolution of different types of firms..

Timothy Guinnane and Susana Martínez-Rodríguez in this voxeu piece:

The decline in public corporations in the recent past has raised some concerns due to their perceived contribution to economic growth and lesser tendency to engage in corruption. This column utilises historical time series data from Spain along with complementary data from countries including Germany to examine patterns in the choice of enterprise form and evaluate the motives behind their adoption. It concludes that some of the seemingly new patterns in enterprise form may essentially be similar to those already seen in the past, making close analysis of historical data very important. 

Partnership firms also saw similar decline in the past..

Immaculate Deception: How and Why Bankers Still Enjoy a Global Rescue Network

Edward Kane in this new INET research:

During the years leading up to the Great Financial Crisis, Fed officials began to tell outsiders more and more about what members of the Federal Open Market Committee (FOMC) were thinking in setting operative interest-rate and price-level targets. My new INET Working Paper is adapted from a chapter in a book I am now writing. It treats the flood of selected policymaking information released by the committee after each meeting as misleading patter meant to distract the committee’s audience from observing the hard-to-defend cumulative effects Fed policies have had on the distribution of income and wealth. As in stage magic, lobbying activity that determines how differently FOMC policies actually impact the rich, the poor, and the middle classes still takes place behind an informational curtain.

 

New Daily Federal Funds Rate series and history of the Federal Funds Market, 1928-1954

Fascinating paper by Sriya Anbil, Mark Carlson, Christopher Hanes, and David C. Wheelock:

This article describes the origins and development of the federal funds market from its inception in the 1920s to the early 1950s. We present a newly digitized daily data series on the federal funds rate from April 1928 through June 1954. We compare the behavior of the funds rate with other money market interest rates and the Federal Reserve discount rate. Our federal funds rate series will enhance the ability of researchers to study an eventful period in U.S. financial history and to better understand how monetary policy was transmitted to banking and financial markets. For the 1920s and 1930s, our series is the best available measure of the overnight risk-free interest rate, better than the call money rate which many studies have used for that purpose. For the 1940s-1950s, our series provides new information about the transition away from wartime interest-rate pegs culminating in the 1951 Treasury-Federal Reserve Accord.

 

 

ICICI Bank uses satellite images to asses credit to farmers

Interesting bit of news from ICICI Bank:

ICICI Bank today announced the usage of satellite data—imagery from Earth observation satellites—to assess credit worthiness of its customers belonging to the farm sector. The Bank is the first in India and among few globally to use satellite data to measure an array of parameters related to the land, irrigation and crop patterns and use it in combination with demographic and financial parameters to make expeditious lending decisions for farmers. This use of innovative technology helps farmers with existing credit to enhance their eligibility, while new-to-credit farmers can now get better access to credit. Additionally, since the land verification is done in a contactless manner with the help of satellite data, credit assessments are being done within a few days as against the industry practice of upto 15 days.

The Bank has been using satellite data for the past few months in over 500 villages in Maharashtra, Madhya Pradesh and Gujarat and plans to scale up the initiative to over 63,000 villages shortly across the country.

This initiative gains significance at a time when people are advised to stay indoors and avoid travel in the wake of the Coronavirus pandemic. This use of satellite data provides quick and technically sound analysis of the land, crop and irrigation patterns from remote locations, without the need of the customer or a bank official having to visit the land. It offers farmers the significant advantage of reliable data being provided to the Bank without any hassles of travel, operational or logistical expenditure to them.

Commenting on this new initiative, Mr. Anup Bagchi, Executive Director, ICICI Bank, said, “ICICI Bank has a legacy of pioneering innovations in technology to create propositions that provide increased convenience to customers. We have created new paradigms in the financial services industry by taking the lead in introducing path breaking innovations including firsts like internet banking in 1998, mobile banking (2008), Tab banking (2012), 24×7 Touch Banking branches (2012), Software Robotics (2016) and Blockchain deployment (2016).

We are bringing forth yet another futuristic technology of using satellite data and analysis to provide key inputs for credit assessments for lending to farmers. Earlier, one had to visit remote locations to manually assess a host of parameters on the land location, irrigation levels and crop quality patterns to forecast future revenues of the farmers. Now, imagery from earth observation satellite gives us ground-breaking ability to track many information across large areas in a contactless and highly reliable manner. This, combined with demographic and financial details, provides strong information on the land asset of the farmers. We believe that usage of this technology will enhance accessibility to credit as new-to-credit farmers will have easy access to formal credit, as well as farmers with existing credit lines will be able to securely expand their eligibility. With encouraging response to our pilot project in over 500 villages, we will shortly cover over 63,000 villages in the country for lending with this technology.”

The Bank has partnered with agri–fintech companies specialising in harnessing space technology and weather information for commercial usage. It has worked closely with them to build reports with over 40 parameters for assessing credit-worthiness of a farmer with deep study of the land, irrigation and crop patterns. The analysis is put together using algorithms to analyse images available from satellites around the planet. Additionally, the Bank has worked on further scoring models to create indices at district level, village level as well as for individual land to provide an estimate of the past and future agriculture income, the timing of harvest and sources of income, and thus, provide key inputs to credit assessments.

 

The Bimal Jalan committee binds RBI transfers to the government

In early August, RBI announced that it will transfer Rs 571 billion to the Government as this year dividend.

In its Annual Report released few days ago, we got the mechanics of transfer.

My new Moneycontrol piece which notes how rules framed under Bimal Jalan Committee has bound the RBI transfers.

From Complementary to Competitive: The London and U.K. Provincial Stock Markets

Meeghan Rogers, Gareth Campbell, and John Turner in this superb paper (paper is freely downloadable for few days) track how stock exchange trading shifted based from provincial stock markets to London:

For many decades, there were stock exchanges operating in provincial cities across Britain. We analyze why companies listed on these markets and how this changed over time. We find that the provincial exchanges had traditionally been complementary to London, providing a trading venue for smaller regional companies. However, they gradually lost their uniqueness and were increasingly competing with London by listing similar stocks. Much of this change can be explained by shifts in industrial composition, leading to more companies being headquartered and listed in the capital and many of the remaining regional firms cross-listing in London to achieve certification.

Something similar happened towards Bombay Stick exchange as well. Should be an interesting study..

Are We All Keynesians Again?

Andres Velasco in this Proj Synd piece:

Governments can and should serve as the insurer of last resort in the face of a catastrophic aggregate shock. But they can perform that crucial function only if we ensure that they have the necessary resources today. This is especially true in emerging and developing economies, where limits on public borrowing are anything but loose.

A common refrain nowadays is that after COVID-19, Milton Friedman is out and John Maynard Keynes is in. But if, as the famous quote often attributed to Richard Nixon puts it, “we are all Keynesians now,” we must remember what Keynes taught: fiscal policy should be tightened during good times, precisely so that it can be expansionary during bad times.

Indian economy resembling the game of monopoly?

Andy Mukherjee yet again in this terrific piece:

Two years ago, India rolled out a laudable plan to unlock the capital trapped in some of its smaller airports. But the actual outcome from privatization was less than reassuring: All six airfields put on the block went to one bidder. 

If that wasn’t enough, multiple media reports now say that Ahmedabad, Gujarat-based billionaire Gautam Adani, an early and enthusiastic supporter of Prime Minister Narendra Modi, might also succeed in taking control of the already-privatized Mumbai airport, as well as a new one coming up on the financial center’s outskirts. 

Airports are natural monopolies. To have one private owner controlling eight or more — a fresh batch of six will soon go under the hammer — can’t possibly be great news for airlines, fliers, or businesses operating from the premises. 

More worryingly, the concentration of economic power in aviation infrastructure is now symptomatic of a broader trend in India, particularly in businesses where the government supplies a key ingredient, such as telecom spectrum.

Let’s talk inflation: Bank of Canada launches public consultation on inflation targeting

In 2020 and 2021, quite a few central banks are lined up for a review of their practices: Fed, ECB, RBI and Bank of Canada.

BoC has launched public consultation ahead of the review calling it Let’s talk inflation:

Evolution of India’s insurance sector: challenges and opportunities

Saon Ray, Vasundhara Thakur and Kuntala Bandyopadhyay in this ICRIER WP trace the evolution of India’s insurance sector:

India’s insurance sector has been growing dynamically in the last couple of years. Despite the suite of reforms that have been implemented to stoke the sector’s growth, it still has a long way to go, as its share in the global insurance market remains abysmally low. In this paper, we analyse the Indian insurance sector and trace its evolution and growth. We also identify the key challenges facing the sector. As underlined in the paper, low penetration and density rates, less investment in insurance products, the dominant position of public sector insurers and their deteriorating financial health are some of the challenges facing the sector. Since India’s economic growth depends on how shock-absorbent India’s economy is, addressing these challenges assumes importance for developing a sound insurance sector.

A very useful paper on a highly important yet ignored sector as we move from one crisis to another without having adequate insurance…

Google’s Plan to Disrupt the College Degree…

Jon Miltimore in this FEE piece:

In July Kent Walker, Google’s Senior Vice President for Global Affairs and Chief Legal Officer, announced on Twitter that the company was expanding its education options.

It was a direct salvo at America’s higher education industry.

“College degrees are out of reach for many Americans, and you shouldn’t need a college diploma to have economic security,” Walker wrote on Google’s blog. “We need new, accessible job-training solutions—from enhanced vocational programs to online education—to help America recover and rebuild.”

To be sure, it’s hard to imagine anyone taking on America’s $600 billion higher education industry. Nevertheless, a quick look at Google’s model shows why colleges should be worried.

Google is launching various professional courses that offer training for specific high-paying jobs that are in high demand. Program graduates can earn a “Google Career Certificate” in one of the following positions: Project manager ($93,000); Data analyst ($66,000); UX designer ($75,000).

While Google didn’t say how much it would cost to earn a certificate, if it’s anything close to Google’s IT Support Professional Certificate, the cost is quite low, especially compared to college.

That Google IT support program costs enrollees $49 per month. That means a six-month program would cost about $300—about what many college students cough up on textbooks alone in a semester, Inc points out.

Compare that price tag to that of college, where students on average pay about $30,000 per year when tuition, housing, room and board, fees, and other expenses are factored in.

.….

Parents of the world, rejoice!

And colleges of the world, be dreaded?

 

Does bonus cap curb risk taking? An experimental study of relative performance pay and bonus regulation

Qun Harris, Misa Tanaka and Emma Soane of Bank of England in this paper:

We conducted a lab experiment with 253 participants to examine how constraints on bonus akin to bonus regulations, such as bonus cap and malus, could affect individuals’ risk-taking in the presence of relative performance pay.

Our study examined how specific restrictions on bonus could influence risk-taking and how these restrictions may interact with common features of bonus structures in the banking sector – such as relative performance pay – to affect risk-taking. While strong conclusions on policy should not be drawn based on a lab experiment alone, our study highlights a number of ways in which bonus structure could affect risk taking.

First, a bonus structure that rewards positive returns but does not penalise negative returns could lead to greater risk-taking than what individuals consider optimal when they are exposed to both gains and losses from their investment. Second, without relative performance pay, bonus cap and malus could reduce risktaking. Third, relative performance pay may increase risk-taking. The more competitive the relative performance pay is, the more risk-taking it might lead to. Fourth, the presence of relative performance pay could undermine the risk-mitigating effects of bonus cap and malus. Finally, making individuals’ bonus payments conditional on their team avoiding a loss could rein in some risk-taking.

Pp

Exit vs. Voice: promoting socially desirable outcomes in companies

Eleonora Broccardo, Oliver D. Hart, Luigi Zingales in this new NBER paper draw from Hirschman’s famous work on Exit, Voice and Loyalty:

We study the relative effectiveness of exit (divestment and boycott) and voice (engagement) strategies in promoting socially desirable outcomes in companies. We show that in a competitive world exit is less effective than voice in pushing firms to act in a socially responsible manner. Furthermore, we demonstrate that individual incentives to join an exit strategy are not necessarily aligned with social incentives, whereas they are when well-diversified investors are allowed to express their voice. We discuss what social and legal considerations might sometimes make exit preferable to voice.

 

 

 

The Rise and Fall of Import Substitution since 1950s

Douglas Irwin in this Peterson Institute working paper traces the history of import substitution since 1950s:

In the 1950s, the idea that developing countries should pursue a policy of import substitution was in vogue among thought leaders in development economics. Yet this paper finds, perhaps surprisingly, that even the leading proponents of the idea were hardly unqualified advocates of the policy. Moreover, there was little uniformity in their views: Prebisch favored import substitution but was an export
pessimist, Myrdal favored import substitution but supported export promotion, and Nurkse opposed import substitution but was an export pessimist. Hirschman was perhaps the only one in the group who was initially critical of import substitution and supportive of promoting exports.

Although Prebisch and Myrdal rejected the idea of free trade and believed that import restrictions would facilitate development, they were also aware of potential problems if such restrictions were taken too far. By the 1960s, such problems in practice had become apparent. Yet Prebisch and Myrdal never repudiated their support for the idea of import substitution. Both acknowledged the shortcomings, such as the inherent anti-export bias of such policies, but the problems they recognized were not enough to make them reject the idea of
import substitution in its entirety.

Like others, Prebisch found fault not with the goals of import substitution but with its implementation in various countries. And yet Prebisch never pressed developing countries to reform their policies and reduce their barriers to imports. The decline of import substitution as a policy idea accelerated after empirical studies from the mid-1960s began identifying the impact and cost of import restrictions.

Much later, as Love (2018) points out, economists at ECLA and elsewhere who were sympathetic with the goals of import substitution shifted their emphasis from import restrictions to build up manufacturing to a new idea— “neostructuralism”—focused on achieving a more equal distribution of income, expansion of export markets, and more rapid technological change. Instead of using government policy to restrict imports, the idea was to use industrial policies geared more toward promoting rather than protecting certain sectors of the economy. The debate over such policies continues to this day. 

Prof Arvina Panagaruya recently argued that India is revisiting import substitution and should not repeat the mistakes.

Central Bank of Bahamas becomes the first central bank to put digital currency on its balance sheet

Just missed this news completely. Thanks to Michael McSweeney for pointing it out.

I had blogged about how Central Bank of Bahamas is in the race to issue digital currency named Sand Dollar.

On 7 May 2020, Central Bank issued its annual report. As you scroll the balance sheet (page 47 of the report), you see Sand Dollars in Circulation in the liabilities side worth Bahamian $48,000

From the notes to this entry:

During the year, the Bank entered into a contract with a 3rd party for the development of the Bahamas digital currency known as the Sand Dollar. Progress billings on the project are accumulated under the “Receivables and other asset” on the statement of financial position. Outstanding commitments on the project follows:

                                                                  2019 $
Contract cost of the project                   7,127,712
Less: Progress billings during the year (2,223,338)
                                                                4,904,374
The Bank made a pilot testing of the Sand Dollar in Exuma and has issued Sand Dollars in circulation valued at $48,000 to various retailers.

So Bahamas central bank wins round one of the CBDC race…

Neobanks: Banks by Any Other Name?

Terri Bradford of Kansas Fed in this piece:

Neobanks offer novel services and leverage technologies that may make them attractive to particular consumer groups. Banks enable the services neobanks provide, either via BaaS platforms or direct-to-bank integration. However, some neobanks are also pursuing bank charters, and a new OCC payments charter 1.0 may affect how neobanks provide services in the future.

Meanwhile, some banks have chosen to view neobanks as customers, and thus have monetized their infrastructures and established strong relationships with fintechs. These relationships may enable banks to get ahead of future banking offerings, as well as accumulate additional data from third parties. Other banks are competing with neobanks by either creating neobanks of their own or offering services and features that target similar consumer groups.

Most banks, however, are not yet taking significant action. The adoption of real-time payments, such as the forthcoming FedNow^SM Service and The Clearing House’s Real-Time Payments, may allow banks to compete with neobanks by offering services such as P2P payments, early access to payroll, and push notifications—prevalent among neobank offerings. Still, neobanks are also using AI, platform integrations, analyses, and more tailored services and features than are typically found at traditional banks. Much like traditional banks have seen their markets for mortgages or car loans disrupted by mortgage originators or dealer financing, the sharing economy and expanded offerings from neobanks may continue to disrupt the traditional banking business model.

Never ignore the competition.