Dynamics of Inflation in South Asia

Michael Debabrata Patra, Deputy Governor, Reserve Bank of India in this speech discusses inflation in south asia.

In South Asia, inflation is critical:

Despite the diversity of the South Asian region in terms of country size, economic and social development, geography, population, trade and political systems, this daunting spectre of inflation haunts us all. Food is a large part of our average consumption basket as well as our price indices – its share in consumer prices ranging across the region between 35 and 47 per cent. South Asia is most vulnerable to food inflation, given the large segment of our populations battling poverty. Moreover, this is a region in which it is rising food prices that can trigger second round effects leading to the generalisation of inflation and its persistence. Furthermore, dependence on oil imports has made our countries commonly vulnerable to terms of trade and supply shocks. Consequently, inflation dynamics in the region show strong co-movements, with common drivers. On the other hand, our policy frameworks are somewhat diverse, reflecting country-specific circumstances, and this will condition our approach to controlling inflation. Our exchange rate regimes also reflect this diversity.

Dealing with the inflation crisis has become complicated as we battle global spillovers on an ongoing basis. The region now faces a tremendous developmental challenge within which recovering the losses due to black swan events like the pandemic look the most formidable. Our countries have also experienced sharp increases in fiscal deficits and deterioration of the balance of payments. The future appears uncertain and gloomy against the backdrop of an unprecedented slowdown in economic activity, employment and export earnings. Risks to our growth prospects are slanted to the downside. The dark shadow of stagflation looms over us and our outlook.

What should South Asian central banks do?

We face challenging trade-offs in our day-to-day functioning and keen public scrutiny. Mostly unsung, our role has undergone a transformation in recent years. From lenders of the last resort, we have become defenders of the first resort. Hence, our response to inflation shocks such as the one we face today has to be predicated on managing expectations and fortifying credibility.

If credibility is high and the shock is transitory, inflation returns to equilibrium without the need for any monetary policy action. On the other hand, repeated supply shocks – which we are encountering now – trigger second round effects through cost pushes, expectations, exchange rate and demand channels, warranting pre-emptive monetary policy action.

Even with perfect credibility, monetary policy cannot look through the second-round effects of repeated supply shocks. If the inflation target is breached for a prolonged period, this could unsettle expectations and eventually get reflected in higher inflation. Higher credibility can reduce – not substitute for – the monetary policy response to second round effects of repeated supply shocks.

At the current juncture, our experience is that by frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target. Another dimension of monetary policy credibility is the timing of its response. A delay in the monetary policy response leads to a further loss of credibility, unhinging of inflation expectations and eventually, higher inflation outcomes with a higher sacrifice of growth.

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Liquid Assets -Rain, rivers, coasts, and seas- Priceless and Undervalued

Esha Zaveri of Stanford University in this CASI article-

Rain, rivers, coasts, and seas have shaped our societies from the earliest days. Tales from classical antiquity to the Abrahamic religions to ancient Mesopotamia speak of how water changed the course of history. In India, the “crucible of the monsoon,” the annual drama of the moisture-carrying winds that bring 80 percent of the country’s rainfall between June and September, has long shaped everything from childhood to culture to commerce. Some of the first written accounts of managing rainfall variability date back to Kautilya’s ancient treatise Arthashatra, written in the 4th century BCE, which discussed ways to predict and adapt to monsoon rains. While rainfall variability is not a new phenomenon, what is new is the intensity of change as a consequence of climate change.

It is often said that if climate change is the shark, water is its teeth. Climate change is felt most deeply through water, with higher temperatures leading to droughts, floods, and increasing rainfall variability. Every increase in the degree of global warming is likely to intensify water-related risks. As concerns about what a hotter climate will bring grow, this important issue of too much water and too little water continues to occupy center stage in policy discussions. And even as uncertainties about the future fate of the monsoons remain and science evolves with new generations of climate models, scientists agree that changes in monsoon variability are underway and will continue. 

Popular Personal Financial Advice versus the Professors

New NBER paper by James Choi compares financial advice from popular financial books and academic economic models:

I survey the advice given by the fifty most popular personal finance books and compare it to the prescriptions of normative academic economic models. Popular advice frequently departs from normative principles derived from economic theory, which should motivate new hypotheses about why households make the financial choices they do, as well as what financial choices households should make. Popular advice is sometimes driven by fallacies, but it tries to take into account the limited willpower individuals have to stick to a financial plan, and its recommended actions are often easily computable by ordinary individuals. I cover advice on savings rates, the advisability of being a wealthy hand-to-mouth consumer, asset allocation, non-mortgage debt management, simultaneous holding of high-interest debt and low-interest savings, and mortgage choices.

 

Jackson Hole | US Fed reiterates its focus on price stability

The highly anticipated annual jackson hole symposium just got over during the weekend.

I review the proceedings of the symposium in moneycontrol. My earlier pieces on the previous symposiums are here.

Crypto and regulation: I can’t live with you, but I can’t live without you

Claudia Biancotti Director Bank of Italy in this voxeu column writes on cryptos and regulation:

In the spring of 2022, idiosyncratic weaknesses and adverse macro conditions combined to precipitate a major crisis in the crypto industry. But that crisis offered opportunity as well. This column depicts the crypto world at a turning point. If regulators and the industry cooperate, and bring order to many jurisdictions in the sector, crypto outfits will be free to focus on innovation rather than speculation. Still, roadblocks to constructive compromise abound – from anonymity issues and censorship resistance to tokens that embed no legal claims on any entity.

Adam Smith and Pin-making: Some Inconvenient Truths

Prof Timothy Taylor on his fab blog conversable economist says smith’s pin factory example is not a great example of gains of division of labour:

One of the famous anecdotes in economics is about division of labor in a pin factory, as told by Adam Smith starting in the third paragraph of The Wealth of Nations. (One suspects the fame of the story is partly related to the fact anyone who cracks open the book will find it at the very beginning.) Smith notes in the text that his example was already common at the time he used it. But those who specialize in this area have pointed that Smith’s example was based on second- and third-hand reporting, while actual studies of pin-making in the 18th century suggest that it may not be a great example of the gains from division of labor.

Read the post for more details.

RBI Central Board: Strength in numbers

My new article in Financial Express on how RBI Board suffers from problem of chronic vacancies .

Privatisation of India’s public sector banks is like Waiting for Godot

The RBI recently released its customary monthly bulletin for the month of august. One of the research articles in the bulletin on privatisation of public sector banks (PSBs) created a storm in the financial markets, and media. So much so, the central bank had to issue an unprecedented clarification on the purpose of the article.

What did the research article/paper say that it led to so much controversy?

My article on the controversy in moneycontrol.

Real-Time Monitoring of the Indian Economy

Anupam Prakash, Chaitali Bhowmick and Ishu Thakur in this rbi bulletin article develop new indices to track economic activity in India

The article presents weekly activity indices to track the latest developments in the Indian economy with the least possible lag. Two different weekly indices have been developed using daily/weekly indicators – (i) a 7-indicator weekly activity index (WAI) using the dynamic factor
model reflecting changes in economic activity on a yearon-year basis; (ii) a 15-indicator weekly diffusion index (WDI) reflecting directional movement on a sequential basis which compliments the model-based WAI. The WAI tracked the ebbs and flows in economic activity during the pandemic years followed by the more recent disruptions caused by the Russia-Ukraine war since February 2022.

The slaughter of the bison and reversal of fortunes on the great plains

Donn. L. Feir, Rob Gillezeau & Maggie E.C. Jones in this NBER paper oint how extinction of bison 

In the late nineteenth century, the North American bison was brought to the brink of extinction in just over a decade. We demonstrate that the loss of the bison had immediate, negative consequences for the Native Americans who relied on them and ultimately resulted in a permanent reversal of fortunes.

Once amongst the tallest people in the world, the generations of bison-reliant people born after the slaughter lost their entire height advantage. By the early twentieth century, child mortality was 16 percentage points higher and the probability of reporting an occupation 29.7 percentage points lower in bison nations compared to nations that were never reliant on the bison.

Throughout the latter half of the twentieth century and into the present, income per capita has remained 28 percent lower, on average, for bison nations. This persistent gap cannot be explained by differences in agricultural productivity, self-governance, or application of the Dawes Act.

We provide evidence that this historical shock altered the dynamic path of development for formerly bison-reliant nations. We demonstrate that limited access to credit constrained the ability of bison nations to adjust through respecialization and migration.

Impact of bison!

Corporations under autocracy: Lessons from Russian and German history

Caroline Fohlin  and Amanda Gregg in this voxeu piece:

Political institutions have important implications for economic growth. One key channel is through the impact on industrial activity. This column compares the impact of political institutions in Germany and Russia on corporations pre-WW1 to isolate the impact of political and economic openness, as the two countries were similar in other characteristics such as their autocratic political regimes, civil law legal systems, and their late industrialisation. Russia corporations faced greater barriers to entry, which resulted in fewer corporations, and greater reliance on bank debt, due to weaker development of Russian financial markets.

MC Explains | Why China is facing an economic crisis and how India can gain

My explainer on China’s economic crisis and what it means for world and India.

Governance, Efficiency and Soundness of Indian Banks

New RBI DRG study by Rachita Gulati, Sunil Kumar, S. Chinngaihlian, Rajendra Raghumanda and Prabal Bilantu.

This study adopts a granular research approach and empirically explores the nexus between governance, efficiency and soundness in the Indian banking industry at various disaggregation levels using the dynamic panel data models. Bank-wise composite indices of governance and soundness are computed using the non-parametric “Benefit-of-the-Doubt” approach, and the risk-adjusted profit efficiency scores for banks are estimated by employing the data envelopment analysis approach. The analysis has been completed utilising a unique bank-level panel dataset obtained from publicly available information on corporate governance in the individual bank’s annual report for the period from 2008-09 to 2017-18. The key findings from the study are as follows:

1. 1. Although banks in India have made significant progress in adhering to governance standards over the recent years, the current level of compliance is not adequate to mark the existing governance structure as “socially efficient”.
   2. The Indian banking industry remained reasonably sound from 2008-09 to 2012-13, before the early signs of a decline in asset quality and profitability were observed in 2013-14. In recent years, private banks have by and large shown an improvement in their soundness position. However, a low level of soundness remains a challenge for public sector banks (PSBs) because the above trend was more pervasive for PSBs.
   3. There exist noticeable asymmetries in the policy priorities of banks on the dimensions of governance and soundness. Private banks demonstrated relatively better performance in adhering to governance norms pertaining to audit function, followed by risk management and board effectiveness during the study period.
   4. Profit-efficient banks are sufficiently sound to keep up capital buffers and absorb shocks, which may diminish destabilising effects. Therefore, to avoid the risk of bank failure in the long run, business practices that assure sustainable profits with proportionate risk need to be encouraged.
   5. Econometric findings from the study reveal that the degree of governance compliance in banks significantly explains their soundness level. Non-adherence to governance principles can undermine the soundness of the banking system.
   6. An emphasis only on stringent compliance with board attributes without due attention to other important aspects of governance, including risk management and audit functions, can have implications for bank soundness.
   7. In all, the study reveals that traditional equity governance principles not only determine bank soundness in India, but compliance with debt governance standards also assumes an important role in determining bank soundness, particularly in the aftermath of 2014.

 

Does the Invisible Hand Efficiently Guide Entry and Exit? Evidence from a Vegetable Market Experiment in Indi

New nber paper by Abhijit Banerjee, Greg Fischer, Dean Karlan, Matt Lowe & Benjamin N. Roth

What accounts for the ubiquity of small vendors operating side-by-side in the urban centers of developing countries? Why don’t competitive forces drive some vendors out of the market? We ran an experiment in Kolkata vegetable markets in which we induced (via subsidizing) some vendors to sell additional produce. The vendors earned higher profits, even when excluding the value of the subsidy. Nevertheless, after the subsidies ended vendors largely stopped selling the additional produce. Our results are consistent with collusion and inertial business practices suppressing competition and efficient market exit.

Privatisation of Public Sector Banks: An Alternate Perspective

In the Aug-2022 bulletin, RBI researchers Snehal S. Herwadkar, Sonali Goel and Rishuka Bansal present an alternative perspective to big bang  privatisation of public sector banks;

Privatization of public sector banks (PSBs) has been widely viewed as a key area of pending reforms in India. This article empirically examines the performance of PSBs relative to private sector banks (PVBs). Using data envelopment analysis (DEA), it finds that while PVBs are more efficient in profit maximization, their public sector counterparts have done better in promoting financial inclusion.

The labour cost efficiency of PSBs is higher than PVBs. Empirical evidence also suggests that lending of PSBs is less procyclical than PVBs and thus PSBs help the countercyclical monetary policy action to gain traction.

…

Against the backdrop of these findings, a big bang approach of privatization of these banks may do  more harm than good. The government has already announced its intention to privatize two banks. Such a gradual approach would ensure that large scale privatization does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission.

Power, philosophy and heroism of central bankers

David Marsh of OMFIF in this article reviews this new book The Money Minders by Jagjit Chadha, director of the National Institute of Economics and Social Research

Tragedy and triumph habitually linger close together. In his book, Chadha voices the hope that ‘behind the scenes’ recalibration of central banks’ instruments and models will allow monetary policy-makers to carry out a ‘heroic role… to avoid Athenian tragedy’. In a similar inflation context to today’s, Arthur Burns, the supremely unheroic Fed chairman in 1970-78, gave a 1979 valedictory  lecture on power and philosophy in which he reflected on central bankers’ ‘anguish’ – the prelude to a successful (but painful) assault on price rises by Paul Volcker. The best central bank governors do not need to (and probably should not) be heroes. But worldwide central bank politicisation puts heroism – and, if necessary, willingness to die a martyr’s death – somewhat higher up the list of their necessary attributes.

A bit overstretched praise for central bankers?

One high-paid occupation where the gender wage gap has disappeared: Vice Chancellors of the UK’s universities

Ray Bachan  and Alex Bryson in this voxeu column–

The gender wage gap tends to be larger among high earners, and is particularly acute among academics. But for one occupation, this trend no longer holds – the gender gap among Vice Chancellors running UK universities has disappeared. This column finds no evidence that the quality of women entering the profession has risen. Instead, hiring practices have changed. A university’s success is increasingly reliant on attracting and retaining top talent, and the visibility of Vice Chancellors’ pay makes unequal treatment in the top jobs transparent, resulting in substantial disadvantages for institutions that discriminate.

Interesting…

The economics of central bank digital currency

Toni Ahnert, Katrin Assenmacher, Peter Hoffmann, Agnese Leonello, Cyril Monnet and Davide Porcellacchia in this ECB paper:

This paper provides a structured overview of the burgeoning literature on the economics of CBDC. We document the economic forces that shape the rise of digital money and review motives for the issuance of CBDC. We then study the implications for the financial system and discuss of a number of policy issues and challenges. While the academic literature broadly echoes policy makers’ concerns about bank disintermediation and financial stability risks, it also provides conditions under which such adverse effects may not materialize. We also point to several knowledge gaps that merit further work, including data privacy and the study of end‐user preferences for attributes of digital payment methods.

The US Inflation Reduction Act: more politics than economics

My new article on US Inflation Reduction Act in moneycontrol.

Getting schooled: The role of universities in attracting immigrant entrepreneurs

Natee Amornsiripanitch, Paul A. Gompers, George Hu and Kaushik Vasudevan in this interesting paper study the role of univs in attracting immigrant entrepreneurs:

We study immigrant founders of venture-capital backed firms using a new and detailed data set that we assemble on the backgrounds of founders.

Immigrant founders have been critical to the entrepreneurial ecosystem, accounting for roughly 20% of all venture capital-backed founders over the past 30 years.

We document the channels through which immigrant founders arrive in the United States and how those channels have changed over time.

Higher education has served as the primary entry channel for immigrant founders. The share of foreign-educated immigrant founders who initially arrive for work has decreased over time, while the share of immigrant founders with undergraduate education in the United States has increased over time. Immigrant founders are likely to start their companies in the state in which they were educated, leading to potentially large local economic benefits associated with attracting foreign students.

The results of this paper have important policy implications for the supply of entrepreneurial talent and efforts to promote entrepreneurial ecosystems. 

Hmm..