An Examination of First-Mover Advantage for a CBDC

Ken Isaacson, Jesse Leigh Maniff and Paul Wong in this research see little merit in first mover advantage for a CBDC:

This paper explores whether there could be a first-mover advantage for a jurisdiction issuing a central bank digital currency (CBDC) compared to other jurisdictions that subsequently issue their own CBDC. Conventional academic literature provides a framework by which one can assess a CBDC in the domestic payments market, the international payments market, and the technology markets that support payments. However, a CBDC may be more than just a means of payment and thus first-mover advantage is examined for both the asset component of reserve currency and a future financial system built on CBDCs. Overall, the first mover literature does not suggest that there is a compelling first-mover advantage for issuing a CBDC.

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What is the RBI pilot programme for a retail digital rupee?

The Reserve Bank of India (RBI) announced that it is starting the first pilot for its retail digital rupee on December 1, marking the first step towards the adoption of a retail digital rupee or retail central bank digital currency (retail CBDC).

I explain the concept of a retail CBDC and the RBI’s pilot project in this moneycontrol article.

Spillovers from China to global financial markets: What happens in China does not stay in China?

William L. Barcelona, Danilo Cascaldi-Garcia, Jasper J. Hoek and Eva Van Leemput in this Federal Reserve paper:

Spillovers from China to global financial markets have been found to be small owing to China’s limited integration in the global financial system. In this paper, however, we provide evidence that China constitutes an important driver of the global financial cycle.

We argue that because of China’s importance for global consumption, stronger Chinese growth raises global growth prospects, inducing an increase in global risk sentiment and an expansion in global asset prices and global credit.

Two contributions are key to this finding:

(1) We construct a measure of China’s credit impulse to identify Chinese policy-induced demand shocks. Our approach takes advantage of the fact that a primary tool of China’s stabilization policy-encompassing monetary, fiscal, and regulatory policies-is controlling the amount of credit in the economy. Without China’s credit impulse, it is difficult to discern global financial spillovers;

(2) We estimate an alternative measure of Chinese GDP growth that captures its business cycle given data concerns about the smoothness of official GDP data. Without China’s alternative GDP measure, it is difficult to attribute any global cycle movements to economic developments in China.

 

The lighter/humorous side of making monetary policy

Michael Debabrata Patra, Deputy Governor, Reserve Bank of India in this speech talks about lighter side of monetary policy:

I am honoured to be invited to this year’s Conclave. In a short span of eight years, the SBI Banking and Economics Conclave has emerged as an important platform of eminence and relevance for deliberating on issues shaping the banking system and more broadly, India’s financial sector. This year, the backdrop is a daunting one.

Across the world, monetary policy authorities are engaged in the most aggressive and synchronized tightening in decades. They are resolute in their determination to put the genie of inflation back into the bottle. ‘75’ is the new ‘25’. Their stances and forward guidance sound like the shrill calls of birds of prey. Financial markets are awash with surges of volatility – incoming data trigger either risk-off stampedes or relief rallies. Globally, a widespread fear is that the forceful monetary policy tightening will precipitate a hard landing, i.e., a recession, or several of them. Geopolitical strife with no end in sight, centrifugal forces threatening to tear apart the unifying influence of global integration, and financial fragmentation are the new forces that seem to be chiseling the evolving global economic outlook.

I thought that I would take this opportunity to step back from the heat and flying debris now being associated with the outcomes of monetary policy actions. Instead, I propose to slip backstage and peer into what goes on underneath these outcomes. Perhaps, this may help to understand the outcomes a little better. Perhaps, it will enable a more compassionate view of the people involved in the making of monetary policy, their trials and tribulations.

He points a paper which links how many times a policymaker laughts in the meeting to economic outlook

Turning to the deliberations of monetary policy committees, I would recommend a paper that models these discussions on the basis of verbatim transcripts of the meetings released to the public. It is titled “What’s So Funny About Making Monetary Policy?”¹⁶ These transcripts reveal that a member’s statement is sometimes followed by “[Laughter]”. Is there any association between the number of laughs elicited by a member during a meeting, on one hand, and the member’s expectations about the macroeconomy? 

The results show that a member elicits more laughter during a meeting if he or she expects relatively poor macroeconomic performance in the form of higher inflation or lower employment or slower growth. This is a finding of major significance. It transcends monetary policy and has profound sociological and psychological implications. 

haha.

This one on central bank communication:

 For years, central bankers were an endangered species. Maintaining a low profile and passing the blame elsewhere were central bankers’ survival toolkits. The story is told of a Chairman of the US Fed who made a courtesy call on his predecessor before taking up office. The predecessor handed the new Chairman three envelopes with the advice that whenever he found himself in trouble at work, he should open the envelopes but one at a time. Each would have advice on what to do. When the new Chairman found himself under attack, he opened the first envelope. It said: “Blame me”. So, the new Chairman blamed the predecessor. After some time, the new Chairman came under attack again. He opened the second envelope. It said: “Blame the government.” So he did that. After some more time passed, he came under attack again. So he opened the third envelope. It said: “prepare three envelopes.” On a serious note, the mainstream view of the 1960s is encapsulated in this remark by Gardner Ackley, then Chairman of the Council of Advisors under Lyndon Johnson, the 36th president of the US: “I would do everything I could to reduce or eliminate the independence of the Federal Reserve”¹⁰. Today, all that is changed. Governments uphold the independence of the central bank.

Interesting speech.

The benefits of road maintenance: Lessons from Indonesia

Alexander Rothenberg, Marco Gonzalez-Navarro, Tadeja Gračner and Paul J Gertler in this voxeu article:

Despite a large literature on the benefits of new transport links, we know little about the value of road maintenance. This column describes new evidence on the welfare effects of upgrading and maintaining highways in Indonesia.

Using comprehensive data on road quality from 1990-2017, the authors find that better roads help manufacturers create new jobs, enabling worker transitions out of informal employment, and increasing wages.  They estimate that a 10% increase in road quality increases household welfare by 1.6%.

Instant Payments: Regulatory Innovation and Payment Substitution Across Countries

Tanai Khiaonarong and David Humphrey in this IMF paper say countries have instant payments systems do not need retail CBDC:

Instant, or fast, payments are credit transfers completed and settled within seconds or minutes. They have low costs, reduce payment risk, and have significantly replaced the use of cash, cards, or check and direct debit payments. We note the role played by regulators in promoting instant payments and identify instances of significant payment instrument substitution across 12 advanced and emerging market economies. This substitution reflects the realized demand for attributes offered by instant payments. As these attributes are quite similar to those for CBDC, the demand for retail CBDC (if issued) may be less compelling.

 

How Do Deposit Rates Respond to Monetary Policy? US edition

the literature suggests that as central bank increases policy rates, there is a rise in interest rates of deposits and credit. This leads to rise in deposits and fall in credit. infact we are seeing opposite reactions as recent increases in rbi policy rates have led to rise in credit but no such growth in deposits. while credit growth was expected due to festive season. what is not understood is why deposits have not risen.

it seems this behaviour is not limited to India.

Alena Kang-Landsberg and Matthew Plosser in this NY Fed blog post:

Since the 1990s, the response of deposits to monetary policy has been attenuated. This can be explained by the growth in deposits over the post-crisis period relative to investment opportunities. Understanding deposit pricing dynamics requires thinking about the quantities of various funding sources and the presence (or lack thereof) of competing products. Taken together, current deposit betas are lower and slower given banks significant supply of deposit funding. However, going forward the rapid increase in the fed funds rate suggests that the deposit gap will be higher than recent rate cycles, causing depositors to look elsewhere and deposit rates to rise in response.  

How do Behavioral Approaches to Increase Savings Compare? Evidence from Multiple Interventions in the U.S. Army

Richard W. Patterson & William L. Skimmyhorn in this interesting NBER research do an experiment to increase savings in US army:

Information provision, choice simplification, social messaging, active-choice frameworks, and automatic enrollment all increase retirement savings. However, gauging the relative efficacy of these approaches is challenging because the supporting evidence spans widely different institutional settings, populations, and time periods.

In this study, we leverage experimental and quasi-experimental variation in a constant setting, the U.S. military between 2016-2018, to examine the effects of nearly two dozen experiments for four leading policy options (i.e., information emails, action steps, target contribution rates, active choice, and automatic enrollment) designed to increase retirement savings.

Consistent with previous literature, we find sizable effects of savings interventions on participation and cumulative contributions that increase with the intensity of the intervention.

We then exploit cost data to complete the first cost-effectiveness analysis in the literature. Our analysis suggests that active choice programs are the most cost-effective method to generate new program participation and contributions for small, medium, and large firms, while automatic enrollment is more cost-effective for very large firms.

Contributions of RBI’s Department of Economic and Policy Research (DEPR) and its role as a think-tank

RBI Governor Shaktikanta Das in this speech discusses the role of Department of Economic and Policy Research (DEPR) and its role as a think-tank:

11. For a full-service central bank like the RBI, its research function is all encompassing. Accordingly, the research department has a structure to be able to meet both the immediate as well as the strategic and policy research requirements. It has trained researchers, who not only specialise in specific areas, but also respond to the challenge of working on any issue of immediate relevance. Teamwork helps in pooling the comparative advantage of each, and a robust internal peer review process ensures reliability and quality of research inputs before their use in policy formulation.

12. As noted earlier, standard models, information collection systems and analytical frameworks used before COVID-19 became inadequate to deal with the complex dynamics associated with multiple shocks that hit the economy. Forecasting macroeconomic outcomes – crucial for conducting forward-looking monetary policy because of the usual lags in transmission – required a revamped approach. This involved strengthening the networks for direct collection of information from key stakeholders¹, greater reliance on survey-based information, wider use of AI/ML techniques, and new/modified models to capture changes in the behaviour of economic agents to different shocks facing the economy. A full information system, with about 70 high frequency lead/coincident indicators of the economy and use of state-of-the-art models to capture the time-varying dynamics helped us to generate results that passed the tests of robustness.

13. Studying the impact of the pandemic on growth-inflation dynamics and the outlook, proposing policy interventions with rationale and expected outcomes, and assessing the effectiveness of announced measures have been an integral part of the department’s work all through the pandemic. For inflation analysis, increased attention was paid to interpreting prices data available from alternative sources when official data collection came to a halt during the early part of the pandemic. Real time mobility indicators and market arrivals data for agricultural commodities were also put to use. It became critical to study the role of supply and demand side factors as well as the behaviour of price mark-ups in view of the lockdowns. A supply chain pressure index for India was constructed in line with the global supply chain pressure index, which is now updated and monitored regularly for policy purposes.

14. When the inflation target reset date for another five-year period was fast approaching (starting April 1, 2021), a lively debate surfaced outside the Reserve Bank on the appropriateness of the 4 per cent inflation target with the +/- 2 per cent tolerance band. The researchers of the RBI undertook a comprehensive review of the monetary policy framework, examining all relevant issues, and recommended retention of the same target for the next five years. We accepted this recommendation and sent proposals to the government accordingly. The Report on Currency and Finance (RCF) 2020-21 with the theme Reviewing the Monetary Policy Framework has greatly helped in providing clarity on monetary policy and issues related with the framework.

15. With the pandemic’s impact lingering and supply chain disruptions persisting, an objective assessment of the scars of the pandemic and identification of reforms that could raise the country’s growth trajectory became an important research issue. In the RCF 2021-22 with Revive and Reconstruct as theme, the department examined in detail the effectiveness and limits of crisis-time policies and the areas that needed policy attention to rejuvenate growth. The revival of the annual RCF, which had been published uninterruptedly since 1937, after a gap of seven years has been widely appreciated.

16. A widely read publication of the department is the monthly “State of the Economy” article in the RBI bulletin, which is being published since November 2020. This revived the tradition that began with the first issue of the bulletin in January 1947 but was interrupted in 1995. The bulletin also carries research articles on various topics of policy relevance that help inform and guide public debate. Some of the important policy issues on which the economists of the department joined national debate through bulletin articles expressing their independent views include: the impact of RBI’s pandemic related policy measures; the relationship between RBI’s balance sheet size and inflation; the equilibrium real interest rate in India; drivers of movements in the yield curve; COVID-19 impact on food price mark-ups; rural urban inflation dynamics; risk analysis of state finances; the quality of public expenditure; external debt sustainability and vulnerability; privatisation/consolidation of public sector banks; estimation of green GDP for India; and the silent revolution in renewable energy.

17. To further strengthen the general government statistics in India, the maiden Report on Municipal Finances – detailing the local government finances data – was published by the department this month. The report covers finances of 201 municipal corporations (out of around 221), accounting for nearly 70 per cent of the finances of urban local bodies in India. The coverage will be expanded going ahead.

18. The department has also been expanding its scope of research activities to meet evolving challenges in areas such as climate change, digitalisation and global spillovers. The department collaborated with domain experts outside the Bank to compile KLEMS (i.e., capital, labour, energy, material and services) data for India and has recently taken over the full responsibility for the same. The department would also be hosting the 6th Asia KLEMS conference in India next year.

Also on how RBI is strengthening its DEPR:

21. For the research function in the Bank to remain effective, it would require constant upgradation of skills of the economists in the department, recognising the new possibilities in the information age and access to superior computing power at lower costs these days. While the Bank has multiple schemes for training, both in India and abroad, for an economist there are two best ways to acquire the required skills – first, study and write more research papers regularly (or learning by doing); and second, have a PhD that prepares you with all basic skills for conducting research. An Economics Benchmark report by centralbanking.com in December 2021 after a survey of 33 central banks found that on average, one in five economists in a central bank have a PhD. I am glad to note that the Reserve Bank compares well as one in four economists in our research department has a PhD. The Bank provides paid leave and financial incentives for staff to acquire PhD degrees and I hope in future our ranking would improve further. An integral part of skill upgradation would be embracing new techniques for applied research. With growing sophistication of the algorithms, the manifold increase in the three Vs of data – volume, velocity and variety, and the quantum leaps in computing, human intelligence can be used better for analysis, with AI/ML allowing automation of data processing.

22. From the standpoint of the Bank, research is increasingly becoming important to almost every major function, as a result of which research units have been set up in other departments. That process needs to be sustained and scaled up pro-actively. Moreover, in a vast and diverse country like India, research on regional issues also merit policy attention.

23. The department must internalise strategic medium to long-term research issues in its research agenda. Separate teams may work on such issues. This would help in identifying and maintaining a list of structural policy changes that can raise the growth trajectory of the economy in a sustainable and inclusive manner.

24. The trifecta of deglobalisation, climate change and deeper penetration of technology appears to be the most anticipated trend for the future. This can be potentially disruptive, requiring strategies to mitigate the associated risks. The aftereffects of the three shocks I mentioned earlier are still unfolding and would warrant constant vigil. The research function of the Reserve Bank, therefore, must remain prepared to respond to these multiple possibilities as it has done in the past.

Monetary policy communication: Uncovering central bank tweeting

Oana Peia, Davide Romelli and Donato Masciandaro in this voxeu column analyse tweets from central bank handles:

Major central banks are increasingly relying on the more direct channel of disseminating policy communication via social media. This column explores recent efforts by central banks to engage with wider audiences via Twitter. Announcements about banknotes attract a disproportionally larger number of retweets compared to tweets related to all other topics. Tweets discussing monetary policy decisions and operations also prompt a significantly larger reaction from Twitter users.

Indian municipalities and their finances

The Reserve Bank of India (RBI) recently released its Report on Municipal Finances (RMF). The RBI has itself called RMF a “first of its kind” report; it’s the first analysis that aims to bridge the gap in public understanding of municipal finances.  RBI has published the report “with the objective of making it a regular annual publication.”

I explain the findings of the report in moneycontrol and its significance for Indian economy.

Why Macro is *Hard*?

Ashish echoes my thoughts on teaching macro in his super blog:

I began teaching a course on introductory macro this past Saturday at a college here in Pune. I often tell my students that my job in a macro course is to leave them more confused at the end than they were at the start. That always evokes laugther by way of response, but as anyone who has learnt (and especially taught!) macro will tell you, I’m quite serious.

Macroeconomics is hard, it is confusing and as the person responsible for teaching it, you’re always on your toes, because you’re never sure if you’ve understood it yourself!

Uzbekistan’s Transition to Inflation Targeting

Moayad Al Rasasi and Ezequiel Cabezon in this IMF working paper traces evolution and transition of inflation targeting in Uzbekistan:

Uzbekistan has significantly improved its monetary policy framework during 2017-21. Nevertheless, the transition to inflation targeting is challenging as the country is going through a period of deep structural reforms. Therefore, the Central Bank of Uzbekistan (CBU) will have to monitor structural reforms and calibrate monetary policy accordingly. This paper identifies institutional and structural gaps, and assesses the effectiveness of monetary policy transmission. Institutional gaps are assessed using institutional indexes while transmission is assessed using VARs. It concludes that in the coming years, reforms will need to continue, to further improve the CBU’s governance and independence, develop financial markets, but most of all to reduce the still large footprint of the state in the financial sector as well as in the overall economy.

 A  useful paper to learn about monetary reforms.

Payment Flows as Economic Indicators: Nowcasting Using a Hybrid Machine Learning Framework

Amit Kumar, Shivam Nigam and Sandhya Kuruganti of RBI in nov-22 bulletin article uses the high frequency payments data as a basis for growth iN GVA/GDP:

The purpose of this study is to nowcast GVA growth using high frequency data on payments flows based on both value and volume components. The analytical approach is based on a hybrid machine learning model framework involving mixed frequency econometric models and machine learning algorithms. The individual payment indicators based MIDAS models are selected based on multiple runs of a suite of different MIDAS specifications with varying lags.

Digital Money and Central Banks Balance Sheet

Nice paper by Adrian Armas and Manmohan Singh

Digital money is a logical step in a process of continuous technological advancement in payment systems. In response, central banks are reviewing their conduct of monetary operations in light of the new shape of financial markets and systems. The impact of digital money will depend on the type of money substitution by digital money. The paper straddles several cases where substitution of CiC (currency in circulation), and bank deposits may take place via digital money such as CBDC or other e-money, and how it would impact the central bank balance sheet. Remuneration of CBDC, if aligned to a new objective, could potentially amplify the effect on the interest rate channel of monetary policy.

Should Central Banks Have an Inequality Objective?

Roberto Chang of Rutgers University in this NBER paper:

Should central banks care about inequality? To address this question, we extend a standard model of time inconsistency in monetary policy to allow for heterogeneity. As in the standard analysis, lack of policy commitment leads to a bias towards socially excessive inflation. But the novel result is that, in the presence of heterogeneity, the bias can be offset by assigning the central bank a mandate under which agents with higher nominal wealth are given a higher relative weight than under the social welfare function. In other words, society should choose a central banker that is less egalitarian than itself, a result reminiscent of Rogoff’s “conservative central banker”. Our analysis underscores that including a concern for redistribution in the central bank’s mandate can enhance policy credibility, but the details can be unexpected and should reflect the role of the mandate in overcoming policy distortions.

Lost in Transmission? Financial Markets and Monetary Policy

Michael Debabrata Patra, Deputy Governor, Reserve Bank of India in this speech discusses how financial markets dont always react to monetary policy on expected lines.

A popular adage about monetary policy is that it operates with long and variable lags. In normal times, a rate change takes up to one year for its peak impact on growth and up to two years for its peak impact on inflation. This is an empirical result validated on high by Ben Bernanke, Nobel prize winner for economics in 2022, as well as on the earth by the Reserve Bank’s economists in the Report on Currency and Finance, 2021-22. These lags in transmission pose an existential dilemma for the central bank. For instance, seeing inflation rising in the future in its forecasts, it raises interest rates. A few months later, the economy goes through a phase of slowdown. Societal pressures build up on the central bank to support growth and it gives up on inflation control. Price pressures persist, get elevated and out of control, eventually killing growth. This is the classic problem of time inconsistency that haunts all central banks all the time.

A seminal contribution of two economists – Fynn Kydland and Edward Prescott – who won the Nobel prize in 2004, it has galvanised a worldwide search for proximate solutions such as appointing a conservative central banker who is more averse to inflation than the government (Kenneth Rogoff in 1985); writing a state-contingent wage contract with the head of the central bank, specifying the inflation rate to be achieved (Carl Walsh in 1995); independence of the central bank; and since the early 1990s, inflation targeting. You can gauge the lengths to which central banks have to go to be time consistent in the presence of lags in the operation of monetary policy.

Much of these lags emanates from frictions in financial markets, especially at the synapses. I will focus on the market segments over which the Reserve Bank exercises regulatory jurisdiction, namely, the money, government securities, forex and derivatives markets. Within this focal length, my interest is confined to impediments to monetary policy transmission that are encountered due to market microstructure as well as the manner in which each segment integrates into the continuum. My purpose is just to highlight a few instances of transmission and distribution losses that make my job adrenaline-driven and pressure-cooked, not to pontificate on any policy agenda.

 

RBI’s Database on Indian Economy gets a new look

RBI’s Database on Indian Economy gets a new look.

This feature called Economy Watch is lot Fred database develoed by St Louis Fed. not fully there but getting there..

Wage-Price Spirals: What is the Historical Evidence?

Jorge Alvarez, John Bluedorn, Niels-Jakob Hansen, Youyou Huang, Evgenia Pugacheva, and Alexandre Sollaci in this paper:

How often have wage-price spirals occurred, and what has happened in their aftermath? We investigate this by creating a database of past wage-price spirals among a wide set of advanced economies going back to the 1960s. We define a wage-price spiral as an episode where at least three out of four consecutive quarters saw accelerating consumer prices and rising nominal wages. Perhaps surprisingly, only a small minority of such episodes were followed by sustained acceleration in wages and prices. Instead, inflation and nominal wage growth tended to stabilize, leaving real wage growth broadly unchanged. A decomposition of wage dynamics using a wage Phillips curve suggests that nominal wage growth normally stabilizes at levels that are consistent with observed inflation and labor market tightness. When focusing on episodes that mimic the recent pattern of falling real wages and tightening labor markets, declining inflation and nominal wage growth increases tended to follow – thus allowing real wages to catch up. We conclude that an acceleration of nominal wages should not necessarily be seen as a sign that a wage-price spiral is taking hold.

Gender inflation expectations gap

Sabine Mauderer, Member of the Executive Board of the Deutsche Bundesbank in this speech discusses the differences between men and women when it comes to inflaiton expectations

Central bankers care a great deal about inflation expectations, because they indicate whether monetary policy is credible in maintaining price stability. What we observe is that women’s inflation expectations tend to be higher than men’s – especially in times of sharply rising grocery store prices. ³ Why? The answer is simple: Because women tend to do most of the weekly shopping. ⁴ As consumers, we observe and focus on the prices we encounter in our daily routines. These perceptions shape our expectations for future inflation.

When asked about future inflation, women place a greater focus on perceived food price inflation than men, who care more about the price developments of transportation and housing.⁵ While central bankers ­are generally aware of this “gender expectations gap”, ECB staff – in a recent blog – pointed to a need to gain a better understanding of how consumers form and update their inflation expectations.

This, they concluded, would not only enhance the analysis of the macroeconomic implications of monetary policy decisions. It would also bolster the credibility of central banks, especially when accompanied by a differentiated communication strategy.