History and evolution of the Economic Survey

Economic Survey 2021-22 has gone back to being single volume report. This is welcome as the Survey was becoming way too wordy and bulky.

The preface discusses the history of the Survey and how it has evolved over the years:

Tracking Development through 11 Satellite Images & Cartography

Economic Survey 2021-22 has an interesting chapter which only has satellite images and maps tracking India’s development.

An important theme of this year’s Economic Survey is the use of new forms of data and information for tracking economic activity and development. Chapter 1 looked at the use of high-frequency data for the real-time management of an economy through uncertain times. This chapter looks at the use of another kind of data – geo-spatial data and cartographic techniques – to track, compare and represent longer term developments. Geospatial maps not only lets users visualize data but also helps users to better understand trends, relationships and patterns.

The use of maps is not entirely new and previous Economic Surveys have used them for years, but there is now a plethora of information from satellites, drones, mobile phones and other sources. Moreover, there has also been a dramatic improvement in cartographic technology that allows for better representation of the information. This chapter illustrates some of the interesting ways of depicting geospatial data.

Using satellite images, India’s night-time luminosity is compared between 2012 and 2021 in Figures 1A and 1B. Night-time luminosity provides an interesting representation of the expansion of electricity supply, the geographical distribution of population and economic activity, urban expansion as well as growth of ribbon developments between urban hubs. Similarly, using geospatial and cartographic techniques, the subsequent maps show the extent of physical as well as financial infrastructure development in India. This includes expansion of national highways, airports, commercial bank branches, metros, etc. The maps in Figure 5A & 5B depict change in net sown area of India over the last 15 years. The maps have been created by combining satellite data over the course of a 12 month period in each year.

The images in Figures 6A & 6B compare the Kharif crop cycle in Moga district, Punjab during 2005 and 2021. The images show that Kharif sowing cycle has shifted ahead by around two-to-three weeks causing the Kharif harvest to almost coincide with Rabi sowing in November. The closing of the gap is a likely factor that encourages farmers to burn stubble and may be related to restrictions on early transplanting of Kharif paddy. These restrictions were introduced in 2009 in order to reduce pumping of ground-water but may have had the unintended consequence of damaging air quality.

Satellite imagery is used to show annual water storage cycle at Stanley Reservoir, Tamil Nadu in Figure 7A & 7B. Using new geo-spatial methods, population density of select Indian cities is compared over time, showing the extent of urban expansion in Delhi-NCR and Bangalore between 2001 and 2021. Finally, using satellite imagery, Figures 18A, 18B, 19A & 19B illustrate wasteland redeployment in Andhra Pradesh and Gujarat.

While this chapter has restricted itself to static two-dimensional images due to practical considerations of publication, readers will be aware that dynamic and multi-dimensional cartography is now commonplace for every-day activities like ordering a taxi or looking for an address.

Nice set of images…

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Currency Undervaluation and Comparative Advantage

Paul Bergin in the recent NBER paper discusses tradeoffs of currency undervaluation as a growth strategy:

This paper highlights a tradeoff implied by a policy of export-led growth through currency undervaluation. While undervaluation can foster domestic manufacturing in countries like China by sustaining trade surplus, it also can harm a country’s comparative advantage by altering the composition of exports. Undervaluation may discourage specializing in high-value added manufacturing and instead favor specialization in non-differentiated goods with higher price elasticity. A dynamic general equilibrium model of two traded good sectors and capital account restrictions shows that undervaluation can either raise or lower welfare depending on two competing effects on comparative advantage: agglomeration versus an elasticity effect.

Virtual/Digital banking and beyond: Thinking about several interconnected issues

Sally Chen, Derryl D’Silva, Frank Packer and Siddharth Tiwari in this BIS paper look at several issues in virtual banking:

The integration of technology, finance and services is rapidly changing the banking landscape, as big techs, fintech firms, non-bank financial institutions as well as incumbent banks take up stakes in virtual banking.

New technology-driven models exploit the expanding data footprints of individuals and firms to generate information capital and reduce the reliance on collateral when offering loans and other financial services.

Data and entities that manage data will be at the heart of this transformation.  Financial regulators thus need to ensure that regulatory oversight delivers on the inclusion and intermediation-enhancing benefits of digital finance without compromising traditional regulatory goals.  

At the same time, there is a pressing need for a system of data governance that allows consumers and business to exercise control over their data through the granting and withholding of consent to the use and transfer of their data.

How do we make money?

Gary B. Gorton, Chase P. Ross & Sharon Y. Ross in this NBER paper ask the question on how do we make money and more importantly get it accepted:

It is difficult for private agents to produce money that circulates at par with no questions asked. We study two cases of privately-produced money: pre-Civil War U.S. private banknotes and modern stablecoins. Private monies are introduced when there are no better alternatives, but they initially carry an inconvenience yield. Over time, these monies may become more money-like, but they do not always achieve a positive convenience yield. Technology advances and reputation formation pushed private banknotes toward a positive convenience yield. We show that the same forces are at work for stablecoins.

We are at some moment of history. Earlier fundamental questions about money and banking were mainly an academic pursuit but not anymore….

Why do supervisors rate banking organizations?

James Bergin and Kevin Stiroh in this NY Fed paper:

This article addresses a question that at first may appear simple: why do supervisors rate banking organizations? Prudential supervisors have a long-standing practice of confidentially rating the condition of the firms that they supervise. These ratings are used for a variety of purposes and can have important consequences.

The authors analyze the history and evolution of this practice and consider how the use of ratings advances the statutory and regulatory goals of supervision of banking organizations. They conclude with a discussion of the implications for the design and implementation of bank ratings systems.

The paper shows how CAMEL approach started- Capital, Asset quality, Management, Earnings, and Liquidity. CAMEL became CAMELS where sensitivity to market risk is added as sixth factor.  Currently Fed uses LFI approach: the LFI (large financial institution) system evaluates capital, liquidity, and governance and controls on a firmwide basis, with much less specific emphasis on the bank.

Federal Reserve policy explained in poetic lines

Suyash Choudhary Head of Fixed Income at IDFC Asset Management explains the Fed policy/dilemma using poetry:

And so the Fed Chair took his seat
As he does now after every FOMC meet
A brief nudge to the glasses
A small ruffling of the papers
A clearing of the throat, ever so discreet.

For a moment before he begins
A glazing of the eyes, a small reminiscence
Of the years last few
And the new Fed framework
And all that has transpired ever since.

The thinking was sound
In the last cycle even when jobs were abound
There was no real inflation
And in hindsight no real need for tightening
So why preemptively tighten this time around?

Yet it hadn’t gone to plan
Inflation came fast and man!
Wages grew as people withdrew
And yes there were supply bottlenecks but
It was fiscal that ultimately defeated the transitionary clan.

And this day had come
The gap from target just too bothersome
Even though the Fed had pivoted
It was still more in commentary
Rates were still zero and liquidity fullsome.

Still the gap between ‘is’ and ‘should’
Couldn’t be met overnight, try as you would
A very hawkish action
May cause financial conditions to tighten
And avoidable pain be unleashed, yes it could.

And yet the same financial condition
Could it be set so in motion?
That without the Fed moving still
Conditions began to tighten
If markets aligned to this notion.

The light was clear in the eyes of Powell
As in the press conference he appeared to throw in the towel
Everything was possible
From successive hikes to runoff’s
And lo! front end longs were made to grovel.

So while commentary, less economics and more politics
Continues to take aim at a Fed still behind the fix
Quite possibly the Fed Chair
Breathes a sigh, not yet of satisfaction
But of a sembalance of control finally in the mix.

Nicely done 🙂

Exciting world of digital payments: From online to offline

My new article in Moneycontrol arguing about how digital payments ecosystem is moving from online solutions to offline solutions.

Do foreign investors improve the quality of domestic institutions?

BIS paper by Deniz Igan, Alexandre R. Lauwers and Damien Puy look at the question of whether foreign investors improve quality of domestic institutions:

The conventional wisdom is that financial globalization and capital flows brings benefits to the recipient countries not only by relaxing financial constraints and transferring know-how but also by being a catalyst for better governance and institutions.

This paper examines three decades of capital flows data in a large sample of countries to investigate if such an institutional quality channel exists.

Our main finding that industries that are more dependent on good institutions grows more than other after foreign capital flows into the private sector supports the existence of such a channel. There are important threshold effects, however: the differential growth effect disappears and turns negative in countries with very low initial institutional quality.

These findings underscore the importance of sequencing capital account liberalization with structural policies so that the recipient country can reap the benefits.

 

Saga of Punjab and Maharashtra Cooperative Bank (1984-2022) reminds one of similar saga of Punjab Cooperative Bank (1904-97)

The RBI announced that Punjab and Maharashtra Cooperative Bank (PMCB) has finally been amalgamated with Unity Small Finance Bank Ltd.

The crisis and it eventual amalgamation took me to history lane of Indian banking. It reminded me of one another cooperative bank named Punjab Cooperative Bank (PCB) which went through a similar albeit longer journey of 93 years compared to PMCB journey of 38 years.

New Zealand: Changing the Conversation on Well-Being

NZ is trying to change the conversation on well-being and make it part of its public finance.

Anna Jaquiery of IMF in this article explains the change:

In 2019, New Zealand’s Labor government, led by Prime Minister Jacinda Ardern, unveiled a budget aimed at tackling some of the long-term challenges the country faces in areas such as domestic violence, child poverty, and housing.

The so-called Wellbeing Budget 2019 set out to prioritize five key areas: mental health, child well-being, supporting the aspirations of the Māori and Pasifika populations, building a productive nation, and transforming the economy. It unveiled billions for mental health services and child poverty as well as record investment in measures to tackle family violence.

New Zealand, a nation of 5 million people, performs well in many measures of well-being relative to most other countries in the Organization for Economic Co-operation and Development. But it is also among the worst for family and sexual violence, and child poverty is also a challenge. In 2020, up to 210,500 children lived in poverty (18.4 percent), according to New Zealand’s statistics agency.

A fundamental aspect of the country’s well-being approach is the recognition that all aspects of what constitutes a good life must be considered holistically, whether it’s access to health care and education or a strong sense of connection to  one’s community.

“The good news is that the conversation has changed,” says Girol Karacaoglu, former chief economist at the New Zealand Treasury and now head of the School of Government at Victoria University of Wellington. He is also the author of the book Love You: Public Policy for Intergenerational Wellbeing.

“There’s a realization that we need to worry about other things than income. New Zealand has taken this very seriously, and Budget 2019 is a good example of that.” The budget acknowledged that health and the economy go hand in hand. Kirk Hope, chief executive of BusinessNZ, sees this as a positive step.

“A lot of the investment is going into the health system. We need to get good outcomes for those investments. Well-being is critical to business. You won’t have a very productive workforce without it.”

We obviously keep going in circles on this one. If you say policies are changing bigtime as they focus on well-being, common person’s response would be what were you doing all this while?

African history through the lens of economics

Nathan Nunn, Stelios Michalopoulos, Elias Papaioannou and Léonard Wantchékon in this voxeu article introduce a new online course on African eco history:

Sectoral Impacts of Trade Wars

Wan-Jung Cheng and Ping Wang in this St Louis Fed paper analyse the impact of US-China trade war on different sectors:

In recent years, we have witnessed rising trade protectionism with broad ranges of tariffs imposed on intermediate products. In this article, we develop an accounting framework to evaluate the sectoral impacts of the current U.S.-China trade war.

We find that U.S. final demand and intermediate demand for goods produced by China decline significantly, with the largest losses occurring in the Electronic and ICT (information and communications technology) industry and the Electrical industry. We obtain sizable deadweight losses for the United States, particularly in the Electronic and ICT; Electrical; and Furniture industries. We also find that, with a leakage rate of 20 percent, total losses to U.S. consumers and importers are $3.3 billion, about 0.05 percent of gross U.S. output, whereas the full leakage losses are $10.7 billion, or 0.16 percent of gross U.S. output, which is twice as much as the annual welfare gains from the North America Free Trade Agreement.

Federal Reserve’s discussion paper on a potential U.S. central bank digital currency

Federal Reserve has released a discussion paper that examines the pros and cons of a potential U.S. CBDC:

The paper summarizes the current state of the domestic payments system and discusses the different types of digital payment methods and assets that have emerged in recent years, including stablecoins and other cryptocurrencies. It concludes by examining the potential benefits and risks of a CBDC, and identifies specific policy considerations.

Consumers and businesses have long held and transferred money in digital forms, via bank accounts, online transactions, or payment apps. The forms of money used in those transactions are liabilities of private entities, such as commercial banks. Conversely, a CBDC would be a liability of a central bank, like the Federal Reserve.

While a CBDC could provide a safe, digital payment option for households and businesses as the payments system continues to evolve, and may result in faster payment options between countries, there may also be downsides. They include how to ensure a CBDC would preserve monetary and financial stability as well as complement existing means of payment. Other key policy considerations include how to preserve the privacy of citizens and maintain the ability to combat illicit finance. The paper discusses these and other factors in more detail.

The paper has put up 20 questions for public comments. These are a good way to begin thinking about the

1. 1. What additional potential benefits, policy considerations, or risks of a CBDC may exist that have not been raised in this paper?
   2. Could some or all of the potential benefits of a CBDC be better achieved in a different way?
   3. Could a CBDC affect financial inclusion? Would the net effect be positive or negative for inclusion?
   4. How might a U.S. CBDC affect the Federal Reserve’s ability to effectively implement monetary policy in the pursuit of its maximum-employment and price-stability goals?
   5. How could a CBDC affect financial stability? Would the net effect be positive or negative for stability?
   6. Could a CBDC adversely affect the financial sector? How might a CBDC affect the financial sector differently from stablecoins or other nonbank money?
   7. What tools could be considered to mitigate any adverse impact of CBDC on the financial sector? Would some of these tools diminish the potential benefits of a CBDC?
   8. If cash usage declines, is it important to preserve the general public’s access to a form of central bank money that can be used widely for payments?
   9. How might domestic and cross-border digital payments evolve in the absence of a U.S. CBDC?
   10. How should decisions by other large economy nations to issue CBDCs influence the decision whether the United States should do so?
   11. Are there additional ways to manage potential risks associated with CBDC that were not raised in this paper?
   12. How could a CBDC provide privacy to consumers without providing complete anonymity and facilitating illicit financial activity?
   13. How could a CBDC be designed to foster operational and cyber resiliency? What operational or cyber risks might be unavoidable?
   14. Should a CBDC be legal tender?

CBDC Design

1. 15. Should a CBDC pay interest? If so, why and how? If not, why not?
   16. Should the amount of CBDC held by a single end user be subject to quantity limits?
   17. What types of firms should serve as intermediaries for CBDC? What should be the role and regulatory structure for these intermediaries?
   18. Should a CBDC have “offline” capabilities? If so, how might that be achieved?
   19. Should a CBDC be designed to maximize ease of use and acceptance at the point of sale? If so, how?
   20. How could a CBDC be designed to achieve transferability across multiple payment platforms? Would new technology or technical standards be needed?
   21. How might future technological innovations affect design and policy choices related to CBDC?
   22. Are there additional design principles that should be considered? Are there tradeoffs around any of the identified design principles, especially in trying to achieve the potential benefits of a CBDC?

 

Gatekeeping the gatekeepers: when big techs and fintechs own banks – benefits, risks and policy options

Important research by Raihan Zamil and Aidan Lawson of BIS.

Following the 2007–09 financial crisis, big techs and fintechs started to offer financial services without the need for or interest in a banking license. More recently, tech firms have obtained banking licences in several jurisdictions to access low-cost deposits and to gain the credibility a banking licence affords. These developments have been facilitated by a conducive regulatory environment, where some authorities have set aside historical concerns regarding the ownership of banks by non-financial companies (NFCs) and allowed new classes of NFCs – such as tech firms – to own banks, in the hope of improving consumer outcomes.   

This paper assesses the merits of extending a banking licence to tech firms and explores their regulatory landscape in seven jurisdictions.

To ascertain their risk characteristics, we categorise the universe of tech firms that provide financial services into three groups: standalone fintechs, large diversified fintechs and big techs.

Big techs and large diversified fintechs pose the most significant supervisory concerns, with the former requiring more onerous prudential measures than the latter.

To mitigate their perceived risks, authorities impose various quantitative and qualitative requirements during authorisation, but supervision and enforcement may pose formidable challenges. In this context, we outline a range of policy options that are mapped to the risk profile of tech firms seeking a banking licence, to help support the gatekeeping role of prudential authorities.

The paper discusses case of seven advanced economies where tech cos have been given licences: China, Hong Kong, Korea, EU, Singapore, UK and USA. The paper also lists the names of banks and owned by which tech company which is really useful.

Lots of ideas and food for thought on policy issues related to licencing tech companies to get bank licences.

The rum is gone! The impact of maritime piracy on trade and transport

Alexander Sandkamp, Vincent Stamer and Shuyao Yang in this voxeu article:

Despite having disappeared from the news since its peak in 2011, piracy continues to threaten maritime shipping. Combining firm-level customs data and ship position data with information on pirate attacks, this column sheds light on the dimensions along which piracy disrupts trade. It shows that exporting firms respond to piracy by switching from ocean to air shipping, while ships re-route in order to avoid affected regions. Despite these adjustments, total exports along affected routes decline. 

…..

Taken together with the dangers piracy poses for the crew of targeted ships, the trade-dampening effects of piracy imply the need for governments to deal with the problem. Increased naval presence would be an obvious short-term fix. In the long run, the improvement of living conditions in countries from which pirates operate might help by eliminating the need for individuals to turn to criminal activity in order to feed themselves and their families.

Even if maritime piracy continues to decline, the results presented in this column may also be relevant to more recent threats facing maritime shipping. In particular, terrorist attacks along the Suez Canal or military assaults by rival governments in the Strait of Hormuz (Cosar and Thomas 2021) may affect shipment costs and uncertainty in ways similar to piracy. Knowing about the potential distortions such conflicts may generate can help policy makers to minimize their impact on the global transport network. 

Liquidity, Liquidity Everywhere, Not a Drop to Use – Why Flooding Banks with Central Bank Reserves May Not Expand Liquidity

Viral V. Acharya & Raghuram Rajan in the new NBER paper:

Central bank balance sheet expansion is financed by commercial banks. It involves not just a substitution of liquid central bank reserves for other assets held by commercial banks, but also a counterpart alteration in commercial bank liabilities, such as in short-term deposits issued to finance reserves and in off-balance-sheet encumbrances pledged against reserves, which are also claims on liquidity.

In ordinary times, when these claims are not called on, central bank balance sheet expansion will typically enhance the net availability of liquidity to the system.

However, in times of stress when these offsetting claims on liquidity are exercised, the demand for liquidity can be significantly more.

Furthermore, liquid commercial banks, desiring to maintain unimpeachable balance sheets, may provide only limited re-intermediation of liquidity and contribute significantly to liquidity shortages. Commercial banks do not fully internalize prospective stress ex ante or take sufficient steps to avoid it.

Consequently, central bank balance sheet expansion need not eliminate episodes of stress; it may even exacerbate them. This may also attenuate any positive effects of central bank balance sheet expansion on economic activity.

The Second World War, Inequality and the Social Contract in England

Leander Heldring, James A. Robinson & Parker J. Whitfill in this NBER paper:

What is the impact of warfare on inequality and the social contract? Using local data on bombing, the evolution of wealth inequality and vote shares for the Labour Party in England around World War II we establish two results.

First, on average, we find no impact of bombing on inequality. However, there is considerable heterogeneity and this result is driven by the south. In the north of England bombing led to significant falls in inequality.

Second, heavier bombing led to a significant increase in the vote share for Labour after the War everywhere, but this effect is transitory in the south while it is permanent in the north.

Our results obtain both in a simple difference-in-differences framework as well as in a panel-regression discontinuity framework in which we exploit the limited range of German fighter escort planes.

Our results provide novel causal evidence for the inequality reducing impact of warfare and we interpret them as consistent with the notion that the impact of the War also led to a reconfiguration of the social contract in England.

 

Constructing a composite index of States’ fiscal performance and its impact on yields of State Development Loan

Ramesh Jangili, N.R.V.V.M.K. Rajendra Kumar and Jai Chander in this Interesting RBI paper construct a composite index of states fiscal performances. Then they assess the impact of index on yields of State Development Loans (state government bonds):

This paper constructs a composite index of States’ fiscal performance and examines if the constructed index can help in explaining the State Development Loan (SDL) yield spreads. Key fiscal parameters viz., deficit, debt, expenditure quality, revenue mobilisation efforts, and market liquidity of SDLs are considered for the composite index.

The inclusion of both fiscal as well as market indicators makes the study unique and broadens the analysis. Empirical results establish a statistically significant association of the index with SDL yield spreads suggesting that better fiscal management and improved market liquidity can help states to reduce their cost of borrowing. Further analysis of individual sub-indices revealed that deficit, expenditure quality and market liquidity are the important factors in determining yield spreads.

Thus, the index provides a menu of choice to state governments to reorient their policies towards improving their performance in order to reduce the cost of borrowing. The index provides investors with a single measure to make a more informed investment decision, thereby expecting to make the price discovery mechanism of SDLs more efficient.

The two states which feature in top rankings in each of the years are Karnataka and Gujarat. N.East states lag behind in all the years.

Economics is once again becoming a worldly science

Tom Bergin of Reuters in this aeon essay criticises the neoclassical approach in economics and mentions how some recent scholarship provides hope for a change. Tom is the author of Spills and Spin: The Inside Story of BP (2011) and Free Lunch Thinking: How Economics Ruins the Economy (2021).

Social sciences like economics face certain handicaps compared with the physical sciences where one can easily isolate the phenomena one wishes to observe and experiments can be repeated without too much difficulty. Yet there is no reason why adhering to the scientific method of basing conclusions and world views on observable facts should be more challenging in economics than in physics. Except that the incentives are against it. If you have a dogmatic neoclassical view of how the world works, you’ll always have a solution to the economic problem of the day. And, therefore, you will have influence. Looking at the facts first may well mean having to say ‘I don’t know.’

If economics is to become more useful, its practitioners have a lot to learn. But in terms of impact, more may be gained if they focus on unlearning the pervasive myths they advance to policymakers.