Mark my words: the transmission of central bank communication to the general public via the print media

Tim Munday and James Brookes in this Bank of England paper analyse how central bank communicates to the general public via print media. It also suggests how central banks can improve their news coverage and readability:

We ask how central banks can change their communication in order to receive greater newspaper coverage. We write down a model of news production and consumption in which news generation is endogenous because the central bank must draft its communication in such a way that newspapers choose to report it, while still retaining the message the central bank wishes to convey to the public. We use our model to show that standard econometric techniques that correlate central bank text with measures of news coverage in order to determine what causes central bank communication to be reported on will likely prove to be biased.

We use techniques from computational linguistics combined with an event-study methodology to measure the extent of news coverage a central bank communication receives, and the textual features that might cause a communication to be more (or less) likely to be considered newsworthy.

We consider the case of the Bank of England, and estimate the relationship between news coverage and central bank communication implied by our model. We find that the interaction between the state of the economy and the way in which the Bank of England writes its communication is important for determining news coverage. We provide concrete suggestions for ways in which central bank communication can increase its news coverage by improving readability in line with our results.

Specifically, they find 5 ways in which communications can improve:

we find five main categories of features are significant in explaining the news coverage that central bank communication receives, and derive five policy implications from them. These are that the central bank, if it is designing communication that it wants to reach the general public, should:
1. Keep things simple. Our results show that one should avoid introducing embedded clauses and separable particle verb structures.
2. Be personal. Use we/us/you to engage the reader.
3. Write in short sentences. Long dependence arcs reduce the likelihood of newspaper coverage.
4. Summarise the message in the first sentence of the document.
5. Use facts and figures.   

What may happen when central banks wake up to more persistent inflation?

We are seeing inflation rise across most economies in the world. However, most central banks have treated the inflation as transitory.

Charles Goodhart and Manoj Pradhan look at this question of What may happen when central banks wake up to more persistent inflation:

The current mini-surge in inflation is forecast to return to central bank targets towards the end of 2022, or shortly thereafter. However, there is also a risk of inflation remaining persistently high for longer. This column discusses the implications of such a contingency for central banks and monetary policy.

The authors warn that sudden policy reversals could lead to severe downturns in financial markets and significantly damage public sector balance sheets.

Policy Suggestions:

So, central banks need to consider what their balance sheet policies should become in a world of rising nominal interest rates, and whether the current structure of quantitative easing and the massive availability of additional liquidity is still going to be optimal in such a different situation.

First, central banks will have to bear capital losses on their holdings and could need recapitalisation from governments. That process will have to be structured in a way that does not raise questions about central bank independence (see Allen et al. 2021).

Second, many of the quasi-fiscal uses of quantitative easing (such as propping up mortgage-backed securities (MBS) markets when they had assumed macroeconomic importance) will have to be unwound.

Finally, over a structural horizon, as age-related government debt rises, central bank balance sheets are more likely to expand than shrink. The balancing act will be about avoiding the creation of moral hazard by monetising too much of the debt, versus doing so little that markets push interest rates higher because of concerns surrounding the financing of this debt.

And, through all of that, central banks need to pull these policies together in a way that convinces financial markets that an orderly evolution is not just possible, but likely. In other words, fighting the right war is difficult enough. Fighting the last war would be a catastrophe. 

Challenges to monetary policy: lessons from Medieval Europe

Prof Nathan Sussman of Graduate Institute of Geneva in this post on Bank underground blog discusses monetary policy in Medieval France:

The monetary system is going through significant changes: the rise of cryptocurrencies, negative interest rates, and the decline in the role of traditional banks as intermediaries. History offers policymakers and academics useful case studies that can serve as distant mirrors beyond the study of crises and policy responses to them. Medieval Europe was a period of monetary experimentation and development. The rulers of this period faced similar challenges to those of modern central banks: competition with private monies, no recourse to interest rates as policy tools, and limited use of inside money created by deposit banks. This post draws on my research on monetary policy in late Medieval France to demonstrate the principles that guided policymakers in addressing these challenges.

Lessons:

The historical record shows that state currencies dominate private currencies in general public use for two main reasons. First, states enjoy a comparative advantage in establishing reputation and commitment and therefore are best suited to provide a medium of exchange – a public good – at the lowest cost. The debate about the environmentally unfriendly blockchain verification technology used by cryptocurrencies exemplifies this. Second, the state has a monopoly of the legal system that allows it to provide a legal – contracting – advantage to the state’s unit of account. Then, as now, the legal status of private (crypto) currencies is key to their ability to function as a medium of exchange rather than a financial asset (Rogoff (2017)).

The comparative advantage of the state in circulating a national medium of exchange creates a moral hazard. Historically, private currencies and competition from foreign currencies were a constraint on the state’s opportunistic behavior. However, this did not prevent occasional recourse to inflation tax. Only the independence of monetary policy from fiscal considerations, as Oresme advocated, can prevent this from happening.

Finally, the Medieval experience, which was not unique to France (Cipolla (1982)), shows that monetary policy can be conducted without going through the banking sector. This should be comforting news to central bankers in a world where the role of banks as financial intermediaries will decline (Benes and Kumhof (2012)). It also predates solutions to monetary policy at the effective lower bound based on the distinction between reserve money and the medium of exchange (Agarwal and Kimball (2015)). In the modern version, the government could vary the amount of reserves private institutions are required to hold against the issue of (digital) cash.

Fascinating to read and figure this monetary and banking history.

 

Economics of socialism and transition: The life and work of János Kornai, 1928-2021

Prof Janos Kornai passed away recently.

Prof Gerald Ronald of University of California, Berkeley pays tribute to Kornai in this voxeu piece.

The famous Hungarian economist János Kornai has left us. He was one of the most important intellectuals of the twentieth century. He suffered personally from both Nazism and communism, the two totalitarian regimes of the twentieth century. As a young Jew growing up in Budapest, he lost his father and a brother to the Nazis. Like many young Jews in Central Europe who survived the holocaust, he was for a couple of years an enthusiastic supporter of communism, the arch-enemy of Nazism. He became disillusioned after a few years, especially when learning about the Stalinist purges in Hungary in the early 1950s. He had been a journalist at that time.

His doctoral dissertation in economics, Overcentralization in Economic Administration, was full of facts about the flaws of central planning and represented a great breath of fresh air in the intellectual atmosphere of the times. He defended that dissertation just before the Soviet repression of the Hungarian revolution of 1956. His defence was attended by a big crowd and was one of the important intellectual events of that year. Given the visibility of his doctoral thesis, when the repression came, he lost his job at the Institute of Economics (later a hotbed of thinking about reforms), was interrogated, and eventually got marginal jobs, first at the Light Industry Planning Bureau and later at the Textile Industry Research Institute. 

Instead of becoming discouraged or cynical, he used the free time he had in these obscure jobs to study economics seriously and to get better acquainted with economic research that was being practiced in the West, on the other side of the Iron Curtain. His work on two-level planning with Tamás Lipták was published in Econometrica and became an important paper in the literature on the economics of planning. This earned him the recognition of top economists of the time: Kenneth Arrow, Leonid Hurwicz, Tjalling Koopmans, Edmond Malinvaud and others. The Hungarian authorities, who were more liberal than other communist regimes, even allowed him to travel to conferences in the West, albeit under heavy supervision of the secret police. 

Māori leaders from the banking sector have established the first Māori Bankers Rōpū (group)

Reserve Bank of NZ has been taking several initiatives to include the local Maori community in monetary and banking policies. So much so, the central bank communicates increasingly in the local language.

In one such development, the central bank informs that Maori leaders have taken another initiative to promote banking in the community:

Māori leaders from the banking sector have established the first Māori Bankers Rōpū (group), known as Tāwhia, to share ideas and deepen the understanding of key issues for Māori within the banking sector.

The Rōpū includes senior representatives from ASB, Westpac, ANZ, BNZ, Kiwibank, Heartland and the Reserve Bank of New Zealand – Te Pūtea Matua – as an observer and kaitiaki to the financial system.

 “We’re proud to stand alongside other leaders from the banking industry, as they come together to help deliver and promote outcomes centred on Māori financial inclusion and wellbeing,” says Te Pūtea Matua Governor Adrian Orr.

“At Te Pūtea Matua, we recognise that Te Ao Māori is integral to Aotearoa New Zealand and we’re proud to support this Rōpū and its kaupapa (vision and opportunities).”

Many banking industry participants have adopted their own Te Ao Māori initiatives, and the sector is working towards a more collective response. The Rōpū is grounded in the traditional tikanga of building a whare (traditional houses) by the collective, for the benefit of all.

Rōpū members have highlighted three key focus areas – bolstering access to capital, improving financial literacy for Māori and Māori employment in the banking sector.

“Our leadership team and staff at Te Pūtea Matua look forward to working with the Rōpū and providing our support and expertise, which will in turn benefit the banking sector, Māori customers and Aotearoa.”

Interesting to note how a modern central bank such as RBNZ is trying to balance modernity with protecting heritage.

Inflation, Interest, and the Secular Rise in Wealth Inequality in the U.S.: Is the Fed Responsible?

Prof Edward Wolff in this new NBER paper shows that Fed’s monetary effects have reduced wealth inequality:

Two hallmarks of U.S. monetary policy since the 1981-1982 recession have been declining interest rates and moderation in inflation. Coincident with these trends has been a surge in U.S. wealth inequality, with the Gini coefficient up by 0.070 between 1983 and 2019. This paper analyzes the connection between these two developments on the basis of the Survey of Consumer Finances.

Contrary to expectations, the paper finds that these two monetary effects have reduced wealth inequality rather than increasing it. The effect is sizeable, with the Gini coefficient declining by 0.045 over these years. Asset price changes and debt devaluation accounted for 72.6 percent of the advance of mean wealth over 1983-2019. They also would have led to a 204.9 percent gain in median wealth, compared to the actual rise of 23.4 percent.

Moreover, they have helped lower the racial wealth gap rather than enlarging it. These results are at odds with previous literature in which estimates range from a weak negative effect on inequality to neutral, small positive, and strong positive. In terms of methodology, this paper differs from previous work by focusing on only the direct effects of interest rate changes and inflation on the household balance sheet.

Structural change revisited: The rise of manufacturing jobs in the service sector

Dominik Boddin and Thilo Kroeger in this Bundesbank paper  analyse the labor market consequences of structural change in Germany over the past 43 years:

This paper reconsiders the labor market consequences of structural change over the past 43 years. Taking two different ways of defining manufacturing and service employment as point of departure – according to the industry classification of firms or establishments and
according to the occupation and hence the tasks of the workers – we show that structural change is far less pronounced than generally perceived.

Manufacturing and service employment numbers based on the occupations of workers deviate markedly from the employment
numbers based on the industry classification of employers. The decline in manufacturing jobs in Germany is far lower if the measurement of employment is based on the occupation of the worker. About 52% of manufacturing jobs that were lost in manufacturing industries
between 1975 and 2017 are offset by new manufacturing jobs in service industries. This also has important implications for empirical applications.

By way of example, we reestimate the effect of international trade on manufacturing employment based on the occupation of
the worker. Contrary to previously identified negative effects, we cannot identify significant effects of import exposure on employment in manufacturing occupations.

Using detailed, comprehensive German social security data, we show at the worker level that the service sector increasingly acts as a valuable alternative employment option for workers with manufacturing occupations. We estimate the causal effect s of a switch to the service sector on employment outcomes by following workers over time after mass layoffs. The results reinforce our claim that structural change is less pronounced than perceived, as workers who retain their initial occupation and switch to employment in the service sector experience no significant differences in future employment trajectories compared to workers who manage to stay in the manufacturing sector.

Hmm..

Capital Account Convertibility | RBI is moving ahead, one step at a time

RBI Deputy Governor T Rabi Shankar recently gave a speech on ‘India’s Capital Account Management – An assessment’.

My article in Moneycontrol discussing the speech in the backdrop of history of Capital Account Convertibility in India. Been quite a journey.

Debunking the idea that interwar hyperinflation in Germany led to the rise of the Nazi party

Prof Gregori Galofré-Vilà of Universidad Pública de Navarra in this LSE blogpost explains his recent research:

How much hyperinflation in interwar Germany contributed to the rise of the Nazis to political power is still, nearly a century later, a topic of debate. Gregori Galofré-Vilà explores the political and social consequences of hyperinflation in over 500 cities using prices and election returns for the seven federal elections held between 1924 and 1933 and find no connection between the traumatic experience of hyperinflation and the electoral success of the Nazis nearly a decade later.

Are Banks still ’Too Big to Fail’? – A market perspective

Nicole Allenspach, Oleg Reichmann and Javier Rodriguez-Martin in this Swiss National Bank paper:

This paper aims at deriving the market’s assessment as to whether banks worldwide still benefit from a Too Big To Fail (TBTF) subsidy. Such a subsidy reflects the market’s expectation of government support in the event of a crisis and results in reduced funding costs
for the benefiting bank. To capture this effect, we use two different extensions of the Merton (1974) framework. We find that large banks
benefit from a TBTF subsidy, while large nonfinancial firms do not. This subsidy has declined somewhat since the Global Financial Crisis
(GFC) but remains larger than before the crisis. These conclusions also hold when considering Contingent Convertible (CoCos) and bailin bonds as fully loss-absorbing. Moreover, we find differences in the TBTF subsidy across jurisdictions and provide evidence that these can to a large extent be explained by differences in bank health.

They also find TBTF subsidy appears to be more pronounced in Europe:

Second, over most of the period considered, the TBTF subsidy appears to be more pronounced in Europe than in the US. We show that in the
CreditGrades model, a large part of this differential is statistically explained by the US banks’ better “health”, as reflected by their higher leverage ratios and standalone ratings. Nevertheless, there remains a small but increasing differential in favour of European banks since 2017 after controlling for these factors. One cannot rule out at this stage that the market perceives US banks as less likely to be bailed out, other things being equal. This could be the case if, for instance, the market perceived resolution policies in the US as more effective than in Europe.

Third, in times of calm, the interpretation of low indicator values is ambiguous. On the one hand, a low value may imply that the market assesses government support of the bank in the event of a crisis as unlikely. On the other hand, the market may assess the probability that the bank will suffer from financial distress, and, hence, the probability that the bank will actually need financial support, as low. The probability of government support in case of a bank crisis and the probability of such a bank crisis cannot be disentangled as the indicator value is the product of both.4,5 Because of this identification problem, authorities should not exclusively rely on such TBTF indicators when periodically reviewing the TBTF issue, but rather use them in combination with expert judgement

 

Lessons from the History of the changing Regulatory Perimeter of US Banks

Federal Reserve researchers had released an interesting paper in June-21 on the changing regulatory perimeter of US banks.

The researchers have released a shorter version of the paper:

Banking organizations in the United States have long been subject to two broad categories of regulatory standards. The first is permissive: a “positive” grant of rights and privileges, typically via a charter for a corporate entity, to engage in the business of banking.² The second is restrictive: a “negative” set of conditions on those rights and privileges, limiting conduct and imposing a program of oversight and enforcement, by which the holder of that charter must abide.³

Together, these requirements form a legal cordon, or “regulatory perimeter,” around the U.S. banking sector. Inside that perimeter are firms, or other legal persons, that can legally conduct a set of banking activities, subject to various forms of regulation and supervision. Outside that perimeter are firms conducting other financial and non-financial activity, under the broad heading of “commerce”—subject to other laws and restrictions, but not to the specific combination of positive grants and negative restrictions of the perimeter. A range of firms lie close to the boundary, blurring the distinctions between the two.

Today’s regulatory perimeter faces a variety of challenges and pressures—from the “unbundling” and “re-bundling” of the traditional banking business; to the growth of stablecoins, stored-value platforms, and other new technologies; to the entry of commercial firms into the financial services space; to the advent of new financial services charters, with new uses for old ones. These developments are the topic of substantial current scholarship.⁴

A recent paper in the Finance and Economics Discussion Series (FEDS) attempts to situate these challenges within the broader history of federal banking law and, in so doing, to reveal new insights about the nature of the U.S. regulatory perimeter.⁵ This FEDS Note describes a handful of lessons that history holds for the perimeter challenges of today.

What are the lessons from this long history:

Lesson 1: The United States has always had a legal perimeter separating “banking” from “commerce.” That perimeter has rarely been clear; it has always been porous; and it has never been static.

Lesson 2: Challenges to the perimeter often follow a common pattern—starting with outside-in pressure, and frequently culminating in crisis.

Lesson 3: The core architecture of the U.S. perimeter is simpler than some current debates suggest.

Lesson 4: Nearly 40 years ago, Congress made an important and enduring shift in regulatory design. Over time, this shift has made the perimeter significantly more complex.

Very interesting paper which shows in pictures how the perimeter has changed. Similar paper is needed for India too!

Classical Liberalism in Finland in the 19th Century

Jens Grandell in this Economic Journal Watch research paper writes about classic liberalism in Finland in 19th century:

For centuries Finland has been a province of the Swedish empire, but in 1809 Finland became an autonomous part of Russia and so became tied to the eastern cultural sphere. For much of the first part of the century Finnish society was rather stagnant as the diet of Finland, the legislative assembly of the grand duchy of Finland, was not allowed to convene and censorship of the press stifled discussion on needed reforms. Slowly things however started to change, as liberalism broke thorough from the 1850s onward. What had mostly been an academic discussion during the early years of the century now became mainstream thought and characterized the tendency in economic policy for decades to come. The more liberally minded Russian emperor Alexander II, who succeeded to the throne in 1855, played an important role in the liberalization of Finland. In 1880 the Finnish liberal movement reached its peak as the short-lived Liberal Party was founded. From this point on liberalism as a political creed somewhat lost its luster as it was challenged by political competition from forces organized around the two language groups of Finland.

Profile of Prof Jens Grandell is super interesting.

Resignation of Bundesbank President Jen Weidmann complicates German political outlook

Central banks and central bankers see themselves as economic entities but in reality they are political-economic entities. One is now increasingly seeing news of appointments/resignations of central bankers having political tones.

Germany’s political outlook has become uncertain with recent election results. To complicate matters further, Germany Central Bank’s chief – Jens Weidmann – has resigned:

Bundesbank President Jens Weidmann today asked Federal President Frank-Walter Steinmeier to dismiss him from office on 31 December 2021. He is leaving the Bundesbank, which he has headed since May 2011, for personal reasons. “I have come to the conclusion that more than 10 years is a good measure of time to turn over a new leaf – for the Bundesbank, but also for me personally,” Weidmann wrote in a letter to the Bank’s staff.

In his words of thanks to the staff, Weidmann refers to the joint achievements: “The environment in which we operate has changed massively and the Bundesbank’s tasks have grown. The financial crisis, the sovereign debt crisis and most recently the pandemic have led to decisions in politics and monetary policy that will have long-lasting effects. It has always been important to me that the Bundesbank’s clear, stability-oriented voice remains clearly audible. With a great deal of expertise, the departments have contributed to the discussions on the right lessons to be learned from the crisis and on the framework of the monetary union. Important regulatory changes have been adopted. The reorganisation of banking supervision in Europe has not only led to completely new supervisory structures at the ECB, but also to a strengthened role for the Bundesbank. The Bundesbank’s new responsibilities in the area of financial stability also underline our central role when it comes to a functioning financial system.”

David Marsh and Pierre Ortlieb in this OMFIF article say that Weidmann’s resignation creates more problems:

Germany’s difficult coalition-building process has gained fresh complexity following the announcement of Jens Weidmann’s resignation shortly before the European Central bank takes far-reaching decisions on its expansive monetary policy. The departure of the Bundesbank president, unofficial leader of the ‘hawks’ on the ECB council for more than 10 years, is scheduled to take place on 31 December. The decision enshrines expansionary policies as the ECB’s preferred mode for the foreseeable future.

The timing, coinciding with the departure from office of his former boss, Chancellor Angela Merkel, will open decisions on the Bundesbank succession to possible squabbling among coalition partners of likely Chancellor Olaf Scholz. The current finance minister, from the Social Democratic Party (SPD), is trying to form a new government before Christmas. This would be the first SPD-led administration since 2005, marking a decisive break from 16 years of rule by Merkel’s conservative Christian Democrats, the last eight years in coalition with the SPD.

Although his bowing-out will be politically controversial in Germany, a veteran ECB official said it was an ‘elegant’ way of marking a new chapter in ECB-Bundesbank relations.

Weidmann’s most probable successor is Claudia Buch, a low-key economics professor who has been his deputy since 2014. Her promotion would match Scholz’s campaign to bring more women into front-line economic jobs. However other SPD leaders may favour a higher-profile, more political choice, such as Marcel Fratzscher, a well-respected former ECB official who heads Germany’s left-of-centre DIW economic research institute. Jörg Kukies, state secretary in Scholz’s finance ministry, a former Goldman Sachs banker, would be another prominent candidate.

Additionally, the Free Democratic Party and Greens, likely partners in Scholz’s putative ‘traffic light’ coalition, will wish to influence the choice both of Weidmann’s successor and of a possible new member of the Bundesbank board if the post is filled from within that body.

Weidmann’s exit focuses attention in Germany and beyond to growing antipathy between ECB policies of near-permanent monetary easing and the tighter stance habitually favoured by the Bundesbank and conservative German mainstream economic opinion.

According to one long-time Bundesbanker who knows Weidmann well, ‘The timing of the decision is a surprise, but the decision itself is not. He has made no secret of his opposition to the expansive policy the ECB is following. Over the longer term it was impossible to keep up this position. He’s going at the same time as Merkel. This is a political decision. It is taking place at a time when Germany has 5% inflation driven by a massive monetary overhang.’

‘He knows how little influence the Bundesbank president and Germany itself has on decisions taken by a majority of the ECB council. The decision-making is driven very strongly by Italy and France.’

This is 5th straight resignation of Bundesbank chief before completion of term:

Weidmann’s decision to step down after only two and a half years of his second eight-year term makes him the fifth consecutive German ECB governing council member to resign before the full completion of their term. Weidmann was previously Merkel’s chief economic adviser in the German chancellery. His decision bears some resemblance to Bundesbank president Axel Weber and ECB chief economist Jürgen Stark’s resignation seven months apart in 2011 in protest at the ECB’s easing policies aimed particularly at shoring up weaker members of monetary union. Both Weber (now chairman of Swiss bank UBS) and Stark have recently strongly criticised the ECB’s continued accommodative stance.

The Bundesbank says the 20 October announcement reflects 53-year-old Weidmann’s long-time consideration of his future career path. This follows his failure to become Mario Draghi’s successor as ECB president in November 2019. The official announcement paid tribute to ‘the open and constructive atmosphere’ at the ECB under Christine Lagarde, the new president, ‘in the sometimes difficult discussions of the past years’.

Weidmann’s frustration at his permanent membership of a ‘structural minority’ on the ECB council was a major element behind the decision. During his bouts of opposition to ECB policies, Weidmann fell out with both French President Emmanual Macron and with Draghi, now Italian premier. However frustrating this role may have proven, it was an indispensable one: his willingness to champion hawkish opinions while playing along behind the scenes was important in legitimating the decision-making processes of European monetary policy.

 

Five Ways to Build a New Macroeconomics

JW Mason reflects on the State of macroeconomics:

We need to be brutally honest: What is taught in today’s graduate programs as macroeconomics is entirely useless for the kinds of questions we are interested in. 

I have in front of me the macro comprehensive exam from a well-regarded mainstream economics PhD program. The comp starts with the familiar Euler equation with a representative agent maximizing their utility from consumption over an infinite future. Then we introduce various complications — instead of a single good we have a final and intermediate good, we allow firms to have some market power, we introduce random variation in the production technology or markup. The problem at each stage is to find what is the optimal path chosen by the representative household under the new set of constraints.

This is what macroeconomics education looks like in 2021. I submit that it provides no preparation whatsoever for thinking about the substantive questions we are interested in. It’s not that this or that assumption is unrealistic. It is that there is no point of contact between the world of these models and the real economies that we live in.

I don’t think that anyone in this conversation reasons this way when they are thinking about real economic questions. If you are asked how serious inflation is likely to be over the next year, or how much of a constraint public debt is on public spending, or how income distribution is likely to change based on labor market conditions, you will not base your answer on some kind of vaguely analogous questions about a world of rational households optimizing the tradeoff between labor and consumption over an infinite future. You will answer it based on your concrete institutional and historical knowledge of the world we live in today. 

He lists 5 changes the curriculum needs:

What should we be doing instead? There is no fully-fledged alternative to the mainstream, no heterodox theory that is ready to step in to replace the existing macro curriculum. Still, we don’t have to start from scratch. There are fragments, or building blocks, of a more scientific macroeconomics scattered around. We can find promising approaches in work from earlier generations, work in the margins of the profession, and work being done by people outside of economics, in the policy world, in finance, in other social sciences.  

This work, it seems to me, shares a number of characteristics.

First, it is in close contact with broader public debates. Macroeconomics exists not to study “the economy” in the abstract — there isn’t any such thing — but to help us address concrete problems with the economies that we live in. The questions of what topics are important, what assumptions are reasonable, what considerations are relevant, can only be answered from a perspective outside of theory itself. A useful macroeconomic theory cannot be an axiomatic system developed from first principles. It needs to start with the conversations among policymakers, business people, journalists, and so on, and then generalize and systematize them. 

A corollary of this is that we are looking not for a general model of the economy, but a lot of specialized models for particular questions. 

Second, it has national accounting at its center. Physical scientists spend an enormous amount of time refining and mastering their data collection tools. For macroeconomics, that means the national accounts, along with other sources of macro data. A major part of graduate education in economics should be gaining a deep understanding of existing accounting and data collection practices. If models are going to be relevant for policy or empirical work, they need to be built around the categories of macro data. One of the great vices of today’s macroeconomics is to treat a variable in a model as equivalent to a similarly-named item in the national accounts, even when they are defined quite differently.

Third, this work is fundamentally aggregative. The questions that macroeconomics asks involve aggregate variables like output, inflation, the wage share, the trade balance, etc. No matter how it is derived, the operational content of the theory is a set of causal relationships between these aggregate variables. You can certainly shed light on relationships between aggregates using micro data. But the questions we are asking always need to be posed in terms of observable aggregates. The disdain for “reduced form” models is something we have to rid ourselves of. 

Fourth, it is historical. There are few if any general laws for how “an economy” operates; what there are, are patterns that are more or less consistent over a certain span of time and space. Macroeconomics is also historical in a second sense: It deals with developments that unfold in historical time. (This, among other reasons, is why the intertemporal approach is fundamentally unsuitable.) We need fewer models of “the” business cycle, and more narrative descriptions of individual cycles. This requires a sort of figure-ground reversal in our thinking — instead of seeing concrete developments as case studies or tests of models, we need to see models as embedded in concrete stories. 

Fifth, it is monetary. The economies we live in are organized around money commitments and money flows, and most of the variables we are interested in are defined and measured in terms of money. These facts are not incidental. A model of a hypothetical non-monetary economy is not going to generate reliable intuitions about real economies. Of course it is sometimes useful to adjust money values for inflation, but it’s a bad habit to refer to the result quantities as “real” — it suggests that there is some objective quantity lying behind the monetary one, which is in no way the case.

In my ideal world, a macroeconomics education would proceed like this. First, here are the problems the external world is posing to us — the economic questions being asked by historians, policy makers, the business press. Second, here is the observable data relevant to those questions, here’s how the variables are defined and measured. Third, here are how those observables have evolved in some important historical cases. Fourth, here are some general patterns that seem to hold over a certain range  — and just as important, here is the range where they don’t. Finally, here are some stories that might explain those patterns, that are plausible given what we know about how economic activity is organized.

Read the comments too. Macro is another word for fights!

The low yield environment and Forex Reserves management

Ashish Saurabh and Nitin Madan of RBI in this Bulletin article write on an important but ignored issue.

Central banks of developing economies maintain and manage foreign exchange reserves. The reserves are usually invested in govt securities in developed economies primarily US. However, with interest rates remaining low, these reserves generate negligible returns. What options do central banks have in a low interest rate scenario? Ashish and Nitin discuss this topic in their paper.

Interest rates which have been on a declining trajectory over the last four decades in advanced economies, touched their historic lows in 2020. The prominent drivers of the declining trend in nominal yields are the sustained downward shift in real interest rates and low levels of
inflation, given well anchored inflation expectations. The structural low yield environment may persist in the  post COVID environment due to uncertainty about the growth outlook. This low yield environment has made it an arduous task for the Reserve Managers to generate
reasonable returns on their foreign assets. This article highlights the scope for looking beyond traditional ways to manage foreign exchange reserves in order to augment portfolio returns without undermining the predominant goals of safety and liquidity.     

Peer effects and debt accumulation: Evidence from lottery winnings

Magnus A. H. Gulbrandsen of Norges Bank in this interesting paper track the impact of lottery wins on neighborhoods:

I estimate the effect of lottery winnings on peers’ debt  accumulation using administrative data from Norway. I identify neighbors of lottery winners, and estimate an average debt response of 2.1 percent of the lottery prize among households that live up to ten houses from the winner. Analyzing heterogeneity, I find that neighborhood characteristics and shared characteristics with the winner matter for the debt response: there is a tendency for greater effects for those (1) residing closest to the winner, (2) residing in single-household dwellings, (3) with a longer tenure, and (4) with a household structure similar to that of the winner. Finally, estimates of the (imputed) expenditure response
among neighbors indicate that they accumulate debt to finance increased spending, consistent with a “keeping-up-with-the Joneses” type explanation, where neighbors react to each others expenditure. 

 

Should Financial Stability be a Monetary Policy Goal? Evidence from India

New paper in RBI Oc-21 bulletin by a team of RBI researchers ( Supriya Majumdar, Snehal S. Herwadkar, Jugnu Ansari, Arti Sinha, Radheshyam Verma, Jibin Jose, Sayantika Bhowmick, Arpita Agarwal and Sambhavi Dhingra).

The paper analyses whether RBI should have an explicit financial stability goal. Their paper says mix of monetary policy and macroprudential policy helps tide through both the goals of monetary and financial stability:

Empirical literature is divided on whether financial stability should be adopted by an inflation targeting central bank as an explicit policy objective. While arguments on both sides permeate, cross-country evidence suggests that there are only a few inflation-targeting central banks committing to such an explicit target, although all of them strive to achieve the financial stability goal.

In the Indian context, analysis using vector autoregression (VAR) framework suggests that while monetary policy has been most effective in containing inflation risks, macroprudential policies were efficaciously deployed to contain financial stability concerns. The present article argues that since their inception in early 2000s in India, macroprudential policies have generally complemented monetary policy and it is important to continue with the same approach.

 

Federal Reserve joins Central Bank Network for Indigenous Inclusion

Three Central banks – Australia, NZ and Canada- started a Central Bank Network for Indigenous Inclusion on Jan-21. The focus of the network was on:

• • Conducting research for and with Indigenous peoples on economic issues, including the development of best practices, such as using Indigenous data respectfully.
  • Building cultural awareness, recruitment practices and other aspects of corporate culture to foster Indigenous inclusion within member organisations.
  • Strengthening engagement practices with Indigenous groups and communities.
  • Supporting economic and financial education for and about Indigenous peoples.

In addition, the network will plan a recurring Central Bank Symposium on Indigenous Economics. The first symposium will be hosted by the Bank of Canada in late 2021.

Recently Federal Reserve has joined the network:

The Federal Reserve Board announced on Wednesday that it has joined the Central Bank Network for Indigenous Inclusion, which will foster ongoing dialogue, research, and education to raise awareness of economic and financial issues and opportunities around Indigenous economies.

The Board’s participation will be supported by the Center for Indian Country Development at the Federal Reserve Bank of Minneapolis and the Economic Education Partnership with Indian Country at the Federal Reserve Bank of St. Louis. The network is a collaboration with Te Pūtea Matua (the Reserve Bank of New Zealand), the Bank of Canada, and the Reserve Bank of Australia.

“The Federal Reserve Board is pleased to join the Central Bank Network for Indigenous Inclusion and I am personally looking forward to deepening our discussions with colleagues from around the world on economic issues that matter to Indigenous communities,” Governor Michelle W. Bowman said.

Inclusion and diversity are on top of central banks’ agenda..

IMF’s changing outlook on Indian economy

IMF’s outlook on Indian economy has gone through a sea change since the pandemic struck.

My review of this changing sentiment in Moneycontrol.

Introducing Market Design to students of Industrial Organisation

New NBER paper by Nikhil Agrawal and Eric Budish connects Market Design and IO:

This Handbook chapter seeks to introduce students and researchers of industrial organization (IO) to the field of market design. We emphasize two important points of connection between the IO and market design fields: a focus on market failures—both understanding sources of market failure and analyzing how to fix them—and an appreciation of institutional detail.

Section II reviews theory, focusing on introducing the theory of matching and assignment mechanisms to a broad audience. It introduces a novel “taxonomy” of market design problems, covers the key mechanisms and their properties, and emphasizes several points of connection to traditional economic theory involving prices and competitive equilibrium.

Section III reviews structural empirical methods that build on this theory. We describe how to estimate a workhorse random utility model under various data environments, ranging from data on reported preference data such as rank-order lists to data only on observed matches. These methods enable a quantification of trade-offs in designing markets and the effects of new market designs.

Section IV discusses a wide variety of applications. We organize this discussion into three broad aims of market design research: (i) diagnosing market failures; (ii) evaluating and comparing various market designs; (iii) proposing new, improved designs. A point of emphasis is that theoretical and empirical analysis have been highly complementary in this research.