Let’s close the gap: Revising teaching materials to reflect how the Federal Reserve implements monetary policy

Jane Ihrig and Scott Wolla in this Federal Reserve Working Paper:

The topic of the Federal Reserve’s (the Fed’s) implementation of monetary policy has a significant presence in economics textbooks as well as standards and guidelines for economics instruction. This presence likely reflects the fact that it is the implementation framework that helps ensure that the Fed’s desired level of its policy interest rate is transmitted to financial markets, which helps it steer the economy toward the Congressional dual mandate of maximum employment and price stability.

Over the past decade or so, the Fed has purposefully shifted the way it implements monetary policy to an environment with ample reserves in the banking system, and it has introduced new policy tools along the way.

This paper shows that, unfortunately, many teaching resources are not in sync with the Fed’s current framework. We review six, 2020 or 2021 edition, principles of economics textbooks, and we find they vary greatly in their coverage of the concepts associated with the way the Fed implements policy today and in the longer run.

We provide recommendations on how the authors can improve the next editions of their textbooks. We also review standards and guidelines used by secondary school educators. All of these are out of date, and we provide proposals for how these materials can be updated.

As textbooks don’t catch up, central bank researchers are trying to do their bit.

Reserve Bank of Australia economist also released similar research last year.

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Revisiting the rise of Italian fascism

Daron Acemoğlu, Giuseppe De Feo, Giacomo De Luca, Gianluca Russo in this research article at voxeu :

Right-wing populist movements often come to power by exploiting people’s anxieties and fears. Following WWI, fascists in Italy likely exploited the perceived threat of socialism to gain support among the elite and the middle classes. This column explores the link between the threat of socialism and Mussolini’s rise to power and finds a strong association between the Red Scare in Italy and the subsequent local support for the Fascist Party in the early 1920s. Local elites, especially large landowners, played an important role in boosting Fascist Party activity and support.

….

What are the lessons for today? On the one hand, if the interwar nationalism, militarism, and the veritable threat of socialist revolution were critical for the mass appeal (and violence and murderous activities) of extreme right-wing parties, then we may have less to fear that today’s right-wing populism will turn into a version of militant fascism. On the other hand, our results can also be read as a warning that we should watch out for heightening fears and anxieties rooted in economic instability, large immigrant flows or nationalism fuelled by international tensions, lest these start simultaneously radicalising right-wing populists and broadening their appeal among the population.

There is fair bit of resurgence in research on fascism and right wing movements. What times…

Payments in Sweden 2020

Sweden was the leader and at the centre of digital payments and digital currency not so long ago. The attention since then has shifted to countries such as China.

Neverthelss Sweden remains a strong player in digital payments space. Riksbank has released a report on Payments in Sweden-2020:

People in Sweden are paying more frequently by card or the app Swish, instead of in cash. This trend has grown stronger during the coronavirus pandemic. To prepare for the future, the Riksbank is investigating the possibility of issuing digital cash – the so-called e-krona. The Riksbank is additionally making preparations to allow instant payments, such as Swish, to be made using the Riksbank’s system. The Riksbank and ECB are also investigating the possibility of implementing instant payments between European currencies such as the Swedish krona and euro. In addition, it is the Riksbank’s opinion that those who want to use cash should be able to continue to do so. It is also necessary that payments in Sweden can continue to function in times of crisis and heightened alert.

 

The banking crisis in Ireland

Patrizia Baudino, Diarmuid Murphy and Jean-Philippe Svoronos in this BIS WP:

This paper covers the banking crisis in Ireland that started in 2008, which stemmed from a combination of macroeconomic developments, risky bank practices and unsustainable fiscal policies. In line with the scope of this series, the paper focuses on the policy response. This involved the restructuring of the banking sector, requiring measures to restore bank capital, address asset quality issues and ensure the provision of funding.

Several rounds of stress tests, deleveraging plans and the provision of central bank liquidity, as well as the creation of an asset management company, were among the key measures put in place.

The Irish banking crisis offers important lessons. One is the need to recognise the limits of emergency liquidity assistance and the boundary between such assistance and fiscal support. Others concern bank restructuring and the best modalities for it. Finally, some legacy issues remain, for instance those related to the remaining stock of non-performing assets.

The main lesson is: avoid getting into a banking crisis at the first place.

Indian Banking history in Hindi

I do a podcast on Indian banking history in Hindi with Puliyabaazi run by Pranay Kotasthane and Saurab Chandra.

This was a lot of fun!!

Not an ordinary bank but a great engine of state: The Bank of England and the British economy, 1694-1844

Interesting paper by Patrick K. O’Brien (LSE) and Nuno Palma (Univ of Manchester):

From its foundation as a private corporation in 1694 the Bank of England extended large amounts of credit to support the British private economy and to support an increasingly  centralized British state. The Bank helped the British state reach a position of geopolitical and  economic hegemony in the international economic order.

In this paper, we deploy recalibrated financial data to analyse an evolving trajectory of connections between the  British economy, the state, and the Bank of England.

We show how these connections contributed to form an effective and efficient fiscal-naval state and promoted the  development of a system of financial intermediation for the economy. This symbiotic relationship became stronger after 1793. The evidence that we consider here shows that although the Bank was nominally a private institution and profits were paid to its  shareholders, it was playing a public role well before Bagehot’s doctrine.

 

Digital currency push in Pacific: The purpose is different compared to developed countries

Lotte Schou-Zibell, regional director at the Asian Development Bank, talks to Bhavin Patel of OMFIF:

BP: What are the prominent use cases and policy objectives for implementing a CBDC in small island economies? How do these differ when compared to developed and emerging economies?

LSZ: People in many developing countries have long needed more convenient digital solutions for payments. CBDC could address the high costs of remittances. We are trying to solve the operational costs and risks of physical currency.

CBDCs could give unbanked and underbanked communities opportunity to create credit history, critical for access to services offered by financial institutions. Financial inclusion is not about access to cash or digital currency. It is about access to the positive effects that come from the financial market.

Offline capabilities are important considerations as any digital system, including digital currencies, are exposed to outages, especially in small island nations. Sveriges Riksbank suggests that a centralised ledger-based CBDC could offer offline functionality. Other ways of dealing with the problem include rechargeable cards, quick response code-based prepaid cards and smart chip enabled banknotes

BP: How do you think projects such as the sand dollar in the Bahamas or the Eastern Caribbean Central Bank will influence other small islands when they reconsider their own payment infrastructures?

LSZ: Pacific island countries have many similarities with those in the Caribbean, some of which have recently launched the ECCB digital currency Dcash. The two regions face high costs of current payment methods and banking services, inadequate banking services, and inefficient methods of settling transactions. DCash seeks to increase opportunities for financial inclusion, growth, competitiveness and resilience. While the ECCB considers DCash legal tender, the intention is not to eliminate cash.

 

Bank of Hindostan was established in Calcutta in 1770: Marks 250 years of advent of British private banking in India

In 1770, Alexander and Company established Bank of Hindostan in Calcutta which marks the advent of British Banking in India. Amiya Bagchi pointed that British tried to open banks earlier as well but there are hardly any records. Whereas we have information about BoH.

Thus year 2020 marks as 250th anniversary of Bank of Hindostan. India had banking/lending institutions much before BoH but the organisation called bank began to take shape from 1770 onwards.

BoH bank was not started on joint stock principles and was more like a branch of Alexander and Company which engaged in trading business.

The bank issued its own notes which circulated locally in Calcutta. RBI Museum website has following information:

The Bank of Hindostan (1770-1832) was set up by the agency house of Alexander and Company was particularly successful. It survived three panic runs on it. The Bank of Hindostan finally went under when its parent firm M/s Alexander and Co. failed in the commercial crisis of 1832.

Nortcote Cooke in his book (The rise, progress and present conditions of banking in India 1863) has some more information. He says the bank’s notes were not accepted as legal tender by the Government. The market conditions led to wide fluctuations of the amount of issuances from two lakhs in some months to 25 lakhs.

As RBI says, BoH faced three panics. First in 1819 which was a malicious rumor. Second in 1829 when Palmer and Co. failed leading to wide disruptions in Calcutta.   Third in 1832, where a large crisis broke out in Calcutta leading to close down of not just BoH but several other banks as well. The Bank had also intertwined its operations closely with the parent trading firm which further accelerated its crisis and eventual closure.

The bank managed to survive for 60 plus years which was incredible given the volatility in economic conditions during the period. The experiment in turn influenced several other British private banks such as Commercial Bank (1819-32), Calcutta Bank (1824-29), Bank of Mirzapore (Yes 1835-37) etc. However, as you can see all these banks close down very quickly. And of course there was Presidency Bank of Bengal which opened in 1806. Bank of Bengal was supported by the East India Company and became a monopoly in Calcutta.

 

Institutional Cryptoeconomics: Everything You Need to Know about This Blockchain Concept

Sam Bocetta in this article:

Institutional cryptoeconomics involves the study of institutional outcomes of hard-to-predict cryptographically secure ledgers. It also understands the economy consists of rules, such as laws, property rights, languages, regulations, societal norms, and ideologies.

These rules allow opportunistic and dispersed people to coordinate their activities properly, and all while facilitating exchange. Again, we would like to emphasize that this exchange doesn’t have to be restricted to the economy, and can extend to social and political exchanges as well.

Economic principles and theories justifying the blockchain and alternative blockchain implementations are the primary focus of cryptoeconomics. Game theory and incentive design are major influencers here since they relate to blockchain mechanism design.

Neoclassical and classical economists, on the other hand, understand the purpose of economics as the study of the production and distribution of scarce resources, along with the factors that support the production and distribution of the same resources.

To put things into perspective, institutional cryptoeconomics looks at the institutional economics of the cryptoeconomy and blockchain. While the economy itself is a system to coordinate exchange, institutional cryptoeconomics prioritizes ledgers (which is essentially data structured by rules) over generalized rules. It also deals with the social, political, and economic institutions that were developed to service these ledgers, and the way blockchain changes ledger patterns throughout society.

Hmm..

The importance of good framework conditions for the Swiss financial centre

Swiss National Bank Chairperson Thomas Jordan in this speech discusses good framework conditions which have led to Switzerland become a financial centre. Infact Swiss have multiple financial centres: Basel, Zurich and Geneva. Jordan speaks about another centre Ticino:

I am therefore particularly pleased to have this opportunity to congratulate the Ticino Banking Association in person on its 100th anniversary.

As Chairman of the SNB’s Governing Board, I visit Ticino often and have meetings with representatives of the Ticino Banking Association on an annual basis – under normal circumstances. The SNB has had good relations with your association for many years. This is not surprising, since the Ticino financial centre has a long history, as this centenary anniversary proves.

However, recent years have left their mark on banks and insurance companies in Ticino, as elsewhere. The financial crisis, the end of banking secrecy, the tax treaty with Italy and now the coronavirus pandemic have posed major challenges for many institutions. Nevertheless, the Ticino financial centre continues to be vitally important for employment and value added in the Italian-speaking region of Switzerland.

I will use my speech today to focus on aspects that I believe are important for the current and future potential not only of the Ticino financial centre, but of the Swiss financial centre as a whole,

Nice bit..

 

Milton Friedman and Exchange Rates in Developing Countries

Prof Sebastian Edwards of UCLA in this NBER WP:

Milton Friedman’s famous 1953 essay, “The case for flexible exchange rates,” deals entirely with advanced nations. An interesting question is what Friedman thought about exchange rate and monetary regimes in emerging economies. In this paper I investigate how his views on the subject evolved through time. I analyze speeches, articles, and interviews. I examine his archives for correspondence and unpublished manuscripts. I show that for him flexible rates were a second best solution for middle income and poor nations. I also analyze Friedman’s role in Chile’s failed attempt, during the Pinochet regime, at using a fixed exchange rate to stabilize the economy and eliminate inflation.

 

Conversation with Prof Pratap Bhanu Mehta

Next edition of Conversation Series at Ahmedabad University moves to Global Political Affairs. The speaker will be none other than Prof Pratap Bhanu Mehta.

Interested folks can register here:

To say that the world today is in turmoil is a gross understatement. The old order has broken down. There is no clear leader in this turbulent world. We went from two superpowers to one superpower to the current state of flux, where there is no undisputed superpower. The world, and India, is seeing a rise in populism, nationalism, and deglobalisation. Multilateral organisations – UN, WHO, NATO, EU – are all losing their shine. With China on the backfoot, is it time for India to shine? Is the mythical Indian Century finally about to become a reality?

When the dust settles, and the new world order emerges from the current shambles, will India find itself holding a dominant position in the new world, or even in its own backyard?

In this conversation, our eminent speaker will focus on the external challenges India faces in a Post-Covid World – at a time of internal turmoil within India. The conversation will discuss the complex inter-relationship between foreign and domestic policy in an uncertain world.

How Snakes and Ladders an Indian Board Game became a global phenomenon

Nice piece by Samuel Clark in Madras Courier.

Didnt know the origins of the game are that old. The game was developed by Sant Dnayeshwar in 13th century..

 

Book Review: Bringing Economic History Back into Curriculums

Profs Ajit Sinha and Alex Thomas co-edited this book trying to revive teaching economic history: Pluralistic Economics and Its History

I review the book in EPW.

Prof JR Varma explains his dissent in Oct-20 policy

RBI released the minutes of its Oct-20 policy. As this was the first policy under three new external members, the minutes were important. We knew Prof Varma has dissented on the accommodative stance. But what led to the dissent is explained in the minutes:

40. I have agonized a great deal about dissenting (in part) with a resolution on a narrow technicality when I am in agreement with the spirit of the resolution: am I making a mountain out of a molehill and creating unnecessary confusion? After prolonged deliberation, I have come to the conclusion that a dissent may be painful, but it is more consistent with the obligation of MPC members to express their views independently and candidly. Even when a disagreement is more philosophical than operative, it should not always be relegated to the individual statement; I see some merit in occasionally elevating it to a dissent.

41. My preferred formulation of the forward guidance would have been as follows: “The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. The MPC expects to maintain a low policy rate and an accommodative stance during the current financial year and well into the next financial year.”

42. It differs from the actual MPC resolution in two respects. First, in my formulation, the date based forward guidance is not a decision but an expectation. In a world that is full of unpleasant surprises, the MPC must of necessity be data driven. Covid-19 was an example of a totally unanticipated growth shock that came out of nowhere. If a similarly unforeseeable inflation shock were to hit the economy, I find it hard to believe that the MPC will remain accommodative. In practice, I suspect that the word “decided” only means an intention to remain accommodative as long as realized outcomes do not diverge drastically from what is currently expected. I am firmly of the view that the MPC risks a damage to its credibility when it uses words that do not accurately reflect what it means. I therefore disagree with the choice of the word “decided” when it comes to the date based forward guidance in the MPC resolution.

43. Second, my formulation is for a somewhat longer period and explicitly refers to interest rates. In my view, the principal motivation for the forward guidance is the fact that India has one of the steepest yield curves in the world. The Indian yield curve is extremely steep beyond a maturity of about a year: in the short term segment (1-2 years), the intermediate term segment (2- 5 years) and the long term segment (5-10 years). However, in the money market segment (up to a maturity of nearly one year), the yield curve is close to the reverse repo rate of 3.35% (which is the effective policy rate today because of the liquidity support). To have the desired impact, it is desirable that the forward guidance extend beyond the one year horizon at which the steepness of the yield curve sets in. Forward guidance of six months in the MPC resolution is in my view suboptimal. I would also point out that the weakness of investments in the Indian economy predates the Covid-19 pandemic, and this merits a longer term response that goes beyond six months.  

44. One of the hallmarks of a credible inflation targeting regime is a substantial compression of the inflation risk premium. If the market expects inflation to average close to the target rate of inflation, then, by definition, inflation risk is low and consequently the inflation risk premium should also be very small. What remains is essentially the liquidity risk premium which cannot explain the extraordinary steepness of the Indian yield curve.

45. It appears to me that the steep yield curve reflects a lack of credibility of the MPC’s existing accommodative guidance. The introduction of dated guidance in the MPC resolution is an attempt to solve this problem, and my only difficulty with this solution is the word “decided”. Just as the brakes allow the car to travel faster, the MPC’s guidance will be more effective if it works alongside and not in conflict with its inflation fighting resolve. I prefer the word “expected”
because it would preserve the commitment of the MPC to respond aggressively to inflation shocks that lie well above the upper band of the fan chart (Chart 1 of the Monetary Policy Statement).

Interesting right away. Prof Varma is bringing much needed discussion around yield curves etc as part of MPC decisions which traditionally only looks at macro. RBI MPC gets a much needed variety..

Goldman Sachs pays many a fine…

Goldman Sachs has agreed that it played a key role in the 1MDB scandal in Malaysia.

In a globally coordinated resolution, GS to pay a record fine of USD 2.9 billion:

The Goldman Sachs Group Inc. (Goldman Sachs or the Company), a global financial institution headquartered in New York, New York, and Goldman Sachs (Malaysia) Sdn. Bhd. (GS Malaysia), its Malaysian subsidiary, have admitted to conspiring to violate the Foreign Corrupt Practices Act (FCPA) in connection with a scheme to pay over $1 billion in bribes to Malaysian and Abu Dhabi officials to obtain lucrative business for Goldman Sachs, including its role in underwriting approximately $6.5 billion in three bond deals for 1Malaysia Development Bhd. (1MDB), for which the bank earned hundreds of millions in fees.  Goldman Sachs will pay more than $2.9 billion as part of a coordinated resolution with criminal and civil authorities in the United States, the United Kingdom, Singapore, and elsewhere. 

Within USD 2.9 billion, Federal Reserve has asked GS to pay USD 154 million:

The Federal Reserve Board on Thursday announced it has fined the Goldman Sachs Group, Inc. $154 million for the firm’s failure to maintain appropriate oversight, internal controls, and risk management with respect to Goldman’s involvement in a far-reaching scheme to defraud a Malaysian state-owned investment and development company, 1Malaysia Development Berhad (1MDB).

In 2012 and 2013, Goldman arranged and underwrote three bond offerings that raised $6.5 billion for 1MDB. Certain former Goldman bankers in Asia participated in a scheme with Malaysian businessman Low Taek Jho and others to divert substantial portions of the proceeds from the 1MDB offerings for their personal benefit and to pay bribes to certain foreign government officials. Goldman’s transaction approval processes and internal controls failed to detect or prevent the scheme or to address obvious red flags around the 1MDB offerings. The Board is requiring Goldman to improve its risk management and oversight of significant and complex transactions, enhance its due diligence related to these transactions, and improve its anti-bribery compliance program.

The Board’s action is being taken in conjunction with actions by other authorities including the U.S. Department of Justice, the Securities and Exchange Commission, the New York Department of Financial Services, the U.K. Financial Conduct Authority, and the Bank of England Prudential Regulation Authority, and other foreign authorities. The penalties and disgorgement announced by all of the agencies total approximately $2.9 billion.

Bank of England’s Prudential Regulatory Authority has fined the USD 63 million.

This is hardly the first time. GS (and other famed finance names) have paid so much fines since 2008 crisis. I mean it is one thing to do badly on account of bad bets. This is large scale fraud at several levels. Yet Goldman Sachs (and other finance top names) remain top choices for employment.

IMF is short for It’s Mostly Fiscal..

Interesting piece by Christian Kopf (Head Fixed income at Union Investment):

When the International Monetary Fund was created in 1944, its main purpose was to manage imbalances in trade flows between member states. Its role has changed considerably since the liberalisation of capital flows and the subsequent collapse of the fixed exchange rate system. Over the past 50 years, the IMF has dedicated much of its attention to helping over-indebted countries put their finances in order. It has done so through emergency loans tied to fiscal policy conditions. Hence the long-running joke that the acronym ‘IMF’ is really short for ‘It’s mostly fiscal’. Fiscal policy is taking a central role in the management of the Covid-19 crisis in industrialised nations, albeit not in the way the IMF had envisaged.

The most important message from this year’s IMF-World Bank Group annual meetings is that, for the foreseeable future, monetary policy will no longer be the dominant force in capital markets.

In earlier times, IMF would mainly stand for fiscal austerity. And not it is all about fiscal expansion. But yes, whichever way you look at IMF is It’s Mostly Fiscal…

Making It Big : Why Developing Countries Need More Large Firms

New World Bank report:

Economic and social progress requires a diverse ecosystem of firms that play complementary roles. Making It Big: Why Developing Countries Need More Large Firms constitutes one of the most up-to-date assessments of how large firms are created in low- and middle-income countries and their role in development.

It argues that large firms advance a range of development objectives in ways that other firms do not: large firms are more likely to innovate, export, and offer training and are more likely to adopt international standards of quality, among other contributions. Their particularities are closely associated with productivity advantages and translate into improved outcomes not only for their owners but also for their workers and for smaller enterprises in their value chains. The challenge for economic development, however, is that production does not reach economic scale in low- and middle-income countries. Why are large firms scarcer in developing countries?

Drawing on a rare set of data from public and private sources, as well as proprietary data from the International Finance Corporation and case studies, this book shows that large firms are often born large—or with the attributes of largeness. In other words, what is distinct about them is often in place from day one of their operations.

To fill the “missing top” of the firm-size distribution with additional large firms, governments should support the creation of such firms by opening markets to greater competition. In low-income countries, this objective can be achieved through simple policy reorientation, such as breaking oligopolies, removing unnecessary restrictions to international trade and investment, and establishing strong rules to prevent the abuse of market power.

Governments should also strive to ensure that private actors have the skills, technology, intelligence, infrastructure, and finance they need to create large ventures. Additionally, they should actively work to spread the benefits from production at scale across the largest possible number of market participants. This book seeks to bring frontier thinking and evidence on the role and origins of large firms to a wide range of readers, including academics, development practitioners and policy makers.

 

Digital Payment Transactions – Streamlining India’s QR Code infrastructure

RBI had formed a committee on Analysis of QR (Quick Response) Code which submitted its report in July.

Taking the reccos forward, RBI has decided to streamline the QR infra in India:

2. After examining the recommendations and the feedback received, the following has been decided:

1. 1. The two interoperable QR codes in existence – UPI QR and Bharat QR – shall continue as at present.
   2. Payment System Operators (PSOs) that use proprietary QR codes shall shift to one or more interoperable QR codes; the process of migration shall be completed by March 31, 2022.
   3. No new proprietary QR codes shall henceforth be launched by any PSO for any payment transaction.
   4. RBI shall continue a consultative process to standardise and improve interoperable QR codes, to enable beneficial features identified by the Phatak Committee.
   5. PSOs may take initiative to increase awareness about interoperable QR codes.

3. The above measures are expected to reinforce the acceptance infrastructure, provide better user convenience due to interoperability and enhance system efficiency.

Bharat QR is used for payment Person to Merchant whereas UPI is for both Person to Merchant and Person to Person. So we will just have these two QRs overtime. No other QR will be used for future payments.

 

 

Unemployment Rate Benchmarks

Richard K. Crump, Christopher J. Nekarda, and Nicolas Petrosky-Nadeau in this Federal Reserve paper:

This paper discusses various concepts of unemployment rate benchmarks that are frequently used by policymakers for assessing the current state of the economy as it relates to the pursuit of both price stability and maximum employment. In particular, we propose two broad categories of unemployment rate benchmarks: (1) a longer-run unemployment rate expected to prevail after adjusting to business cycle shocks and (2) a stable-price unemployment rate tied to inflationary pressures. We describes how various existing measures used as benchmark rates fit within this taxonomy with the goal of facilitating the use of a common set of terms for assessments of the current state of the economy and deliberations among policymakers.