Does money growth help explain the recent inflation surge?

Claudio Borio, Boris Hofmann and Egon Zakrajšek in this BIS Bulletin article:

• The strength of the link between money growth and inflation depends on the inflation regime: it is one-to-one when inflation is high and virtually non-existent when it is low.
• A link can also be seen in the recent possible transition from a low- to a high-inflation regime. An upsurge in money growth preceded the inflation flare-up, and countries with stronger money growth saw markedly higher inflation.
• Looking at money growth would have helped to improve post-pandemic inflation forecasts, suggesting that its information value may have been neglected.

Will monetary aggregates make a comeback?

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Past Economic Surveys put it best: Private investment is India’s best growth mantra

My new piece in moneycontrol summing one key lesson from previous economic surveys.

What are Large Global Banks Doing About Climate Change?

A team of economists -Daniel O. Beltran, Hannah Bensen, Amy Kvien, Erin McDevitt, Monica V. Sanz, and Pinar Uysal- in this Federal Reserve research review climate action plans of large global banks:

We review the “climate action plans” of Global Systemically Important Banks (GSIBs) and the progress they are making toward achieving them. G-SIBs have identified the drivers of climate risk and their transmission channels to credit and other risks. Additionally, some have started to measure and model these risks.

While most GSIBs have committed to fully offsetting their emissions by mid-century, they are only beginning to measure financed emissions resulting from their loans and investments, which comprise the vast majority of their emissions. G-SIBs have also committed to increase green finance and have started to do so.

All told, despite some progress by large global banks to address climate change considerations, much work lies ahead to properly measure and disclose climate-related risks, and to better align financing activities with their net-zero targets.

SEBI Study: Analysis of Profit and Loss of Individual Traders dealing in Equity Futures & Options Segment

SEBI has released a very interesting study on analysis of retail investors dealing in  Equity Futures & Options Segment.

Key findings:

• There has been a significant increase of over 500% in the number of individual traders in the equity F&O segment in FY 2021- 22, as compared to FY 2018-19.
• On average, loss makers registered net trading loss close to ₹ 50,000 in FY 2021-22. The average absolute net loss of a loss maker
  was over 15 times the net profit made by a profit maker.
• Over and above the net trading losses incurred, loss makers expended an additional 28%* of net trading losses as transaction costs.
• Those making net trading profits incurred between 15% to 50% of such profits as transaction cost.

Well, whether an investor makes losses or makes profits, the exchanges/brokers which collect majority of the transaction costs make major gains.

Brazil is undergoing a fintech revolution

Kate Jaquet is Co-portfolio Manager at Seafarer Capital Partners in this OMFIF article:

Technological innovations are shaking up the world of payments and finance in Brazil. The country has an impressive number of new fintech companies that are disintermediating a very concentrated banking system, serving consumers in ways that the incumbent banks haven’t and offering millions of Brazilians their first bank accounts. Some of these companies are revolutionising the country’s finance industry.

Brazil is well suited to fintech innovations for three main reasons. First, Brazil’s banking system is small relative to the size of the country, and it is heavily dominated by just a few banks. The country’s five bank asset concentration, which is a measure of the five largest banks as a share of total commercial banking assets, has long been around 80%. This bank concentration in the US is around 50%. The rigidity and oligopolistic nature of Brazil’s banking sector has constrained the economy, leaving too many Brazilians unbanked and consumers looking for better and more convenient options.

Second is changing consumer preferences. Brazil’s fintech start-ups identified broad consumer frustration with incumbent banks and quickly jumped in to provide a suite of fintech products, all available via a smartphone and on a comparatively fast time frame. There is also a well-ingrained culture of instalment payments in Brazil. The widespread use of payments for purchases both large and small began in the 1950s with the popularisation of ‘crediários’, whereby consumers could register with a store to purchase items but then pay for them over a series of months. This culture of instalment payments lends itself well to increased digital finance, resulting in a proliferation of payment-orientated fintech start-ups operating in Brazil.

Third, the government has provided several initiatives aimed at fostering greater competition in the banking and payments sectors. The first was in 2010 when Brazil’s regulator ended the duopoly enjoyed by the dominant credit card acquirers in Brazil. By introducing competition and reducing the fees that retailers pay for credit and debit card transactions, savings were passed on to the consumer, ending a period of supernormal profit for the acquirers. The incumbent banks who owned the acquirers were then forced to look for ways to replace these profits and grow in a more consumer-friendly way.

Creative destruction at work:

Another government initiative worthy of note is Pix, launched in November 2020. Pix is an instant payments system operated by the central bank whereby consumers and merchants can send and receive money via a QR code. Pix is a way for ordinary Brazilians to avoid some of the fees that banks have typically attached to standard services such as money transfers and it is very popular. An estimated 118m Brazilians (two-thirds of the population) use Pix.

There are dozens of new companies changing the way Brazilians buy, save, invest and access a myriad of financial services. These new companies are leapfrogging traditional banking, payments, wealth management and insurance services. They are successfully using consumer data and network effects to challenge and disrupt the sleepy incumbent banks and offer millions of Brazilians their first bank accounts and financial products.

However, there have been failures and there will likely be more to come. Companies in this sector have attracted capital with astounding rates of growth. Unfortunately, for some participants that growth was accompanied by mismanagement in the form of sloppy credit expansion. The most blatant examples have seen a reckoning in their share prices and there will most likely be some consolidation in the sector with stronger players scooping up distressed ones.

Consolidation may also occur due to the fact that consumers are unlikely to have more than a couple of payment or digital banking apps on their phones – there can only be a few winners. The companies most likely to thrive in this industry are ones able to successfully grow around deposit-taking and liability-based products (rather than driven by hasty credit growth).

Brazil’s fintech scene is a classic example of necessity breeding innovation. This is a country where millions have gone underserved by traditional banks for decades. The unmet need for basic banking services is a key reason why Brazil has such a vibrant and innovative fintech scene. The improved experience and lower fees are appreciated by Brazilians across the spectrum. Perhaps Brazil offers a partial roadmap to the future of financial innovations in emerging markets.

Using machine learning to measure financial risk in China

Alexander Al-Haschimi, Apostolos Apostolou, Andres Azqueta-Gavaldon and Martino Ricci in this ECB paper:

We develop a measure of overall financial risk in China by applying machine learning techniques to textual data. A pre-defined set of relevant newspaper articles is first selected using a specific constellation of risk-related keywords. Then, we employ topical modelling based on an unsupervised machine learning algorithm to decompose financial risk into its thematic drivers.

The resulting aggregated indicator can identify major episodes of overall heightened financial risks in China, which cannot be consistently captured using financial data. Finally, a structural VAR framework is employed to show that shocks to the financial risk measure have a significant impact on macroeconomic and financial variables in China and abroad.

 

Reserve Bank of New Zealand to build foreign exchnage reserves

Before 2008, the consensus was central banks should just target inflation and leave everythig else.  Post 2008 crisis, all kinds of things happening in world of central banking. The objectives are constantly expanding from monetary stability to growth, unemployment, financial stabiliy, climate change and so on.

Reserve Bank of New Zealand which pioneered inflation targeting was seen behind the pre-2008 consensus. All this is changing big time. The objective has been expanded to included financial stabiluty and employment.

As per latest developments, the central bank has signed an agreement with the government to intervene in foreign exchange markets and build foreign exchange reserves

We hold and manage foreign reserves in order to be able to intervene in the New Zealand dollar (NZD) market for financial stability or monetary policy reasons. Foreign reserves are safe and liquid assets held in currencies, such as United States dollars, Euros, and Australian dollars.

Our chairman Professor Neil Quigley says a well-functioning foreign exchange market is critical to New Zealand’s economy with many people — including exporters, importers, borrowers and investors — reliant on these markets to exchange New Zealand dollars for foreign currency.

“While foreign reserves are rarely used, it is important for us to be prepared to support the foreign exchange market in exceptional circumstances to maintain financial stability and ensure essential transactions can continue to occur.”  

As part of the framework, both the Reserve Bank and the Minister of Finance are required to agree to a level of foreign reserves that we should hold in order to meet our objectives. The level of foreign reserves had been largely unchanged since 2007. 

Given the growth in the economy and foreign exchange market since then, the Minister of Finance and our Board have agreed that an increase to foreign reserves holdings is needed. 

“The transition to this higher level of foreign reserves will take place over a number of years, in order to minimise the market impact,” Governor Adrian Orr said.

Due to market and policy sensitivities, we do not intend to make public any further details on the size or composition of this increase. However, our foreign reserves holdings will continue to be published on our website on a monthly basis.  

The Framework maintains the Monetary Policy Committee’s right to intervene in the exchange rate when the New Zealand dollar has moved to exceptionally low or high levels that cannot be justified by economic fundamentals. Interventions are expected to be rare and consistent with the Reserve Bank’s monetary policy objectives.

Interesting!

Common Currency for Latin American: Neymar and Messi in the same team doesn’t always work

My explainer in Moneycontrol on the proposed currency union in Latin America and Caribbean islands.

Austrian Economics as a relevant research program

Prof. Daniel J. Smith of Middle Tennessee State University in this paper argues for relevance of Austrian economics:

What is the relevancy of modern Austrian economics? Austrian economics, from its origins, has attempted to push economics towards greater relevance by developing and refining a methodological approach that enhances the operational validity of its scientific conclusions for decision-making in the real world. In a theoretical paradigm, this led to the development of theoretical insights on significant economic phenomena often excluded from static economics models. As the economics profession took an empirical turn, modern Austrian economics has demonstrated its continued relevancy through empirical methods that apply economic theory to pressing, long-standing policy issues.

What is relevancy:

…what I mean by relevance is specifically that we do scientific research with policy relevance and that we arrive at scientific conclusions that do not rely on limiting assumptions to the extent that would lead to potentially adverse unintended consequences if used today or in the future, as a basis for real-world decision-making (see, for instance, Munger 2022). It is the distinction, according to Radomysler (1946, p. 198), “between theory that does apply to reality and theory that does not.” An academic can eschew public policy and be wholly concerned only with long-standing problems in political economy but still seek to produce relevant research under this definition.

 

Open Market Operations in India – An Appraisal

Abhilasha, Bhimappa Arjun Talwar, Krishna Mohan Kushwaha and Indranil Bhattacharyya in this RBI Bulletin article discuss changes in OMO:

In a modern market-based monetary policy operating framework, open market operation (OMO) is the principal instrument of liquidity management by central banks. This article reviews the Indian experience on OMOs and examines their impact on the central bank’s balance sheet. It also examines the role OMOs play in a world with significant spillover effects.

Highlights:

1. Globally, the scale and extent of OMOs – both sales and purchases – have increased significantly over the past fifteen years. By augmenting/mopping up systemic liquidity, OMOs help in modulating yields which transmit to other financial market instruments.
2. In the Indian context, OMOs are instruments for altering durable liquidity conditions in the system barring special transactions such as Operation Twist (OT). OMO purchases increase the domestic assets in the balance sheet of the Reserve Bank, and also the reserve money, and vice versa for OMO sales.
3. An empirical examination in the Indian context reveals that external / exogenous factors such as movements in the US Treasury yields have a significant impact on domestic long-term yields. Given this, our empirical results show that OMOs remain a potent tool to steer long-term interest rates in alignment with the stance of monetary policy.

When central banks lend to banks whose board members are shareholders of the central bank: Case of Banque De France

Kris James Mitchener & Eric Monnet in this paper look at this very interesting case of connected lending by Banque De France in 1930s:

Because of secrecy, little is known about the political economy of central bank lending. Utilizing a novel, hand-collected historical daily dataset on loans to commercial banks, we analyze how personal connections matter for lending of last resort, highlighting the importance of governance for this core function of central banks. We show that, when faced with a banking panic in November 1930, the Banque de France (BdF) lent selectively rather than broadly, providing substantially more liquidity to connected banks – those whose board members were BdF shareholders. The BdF’s selective lending policy failed to internalize a negative externality – that lending would be insufficient to arrest the panic and that distress via contagion would spillover to connected banks. Connected lending of last resort fueled the worst banking crisis in French history, caused an unprecedented government bailout of the central bank, and resulted in loss of shareholder control over the central bank.

More Roads or Public Transit? Insights from Measuring City-Center Accessibility

Lucas J. Conwell, Fabian Eckert & Ahmed Mushfiq Mobarak in the new NBER paper research whether the cities should have more cars/roads or more public transit :

We propose a theory-inspired measure of the accessibility of a city’s center: the size of the surrounding area from which it can be reached within a specific time. Using publicly available optimal-routing software, we compute these “accessibility zones” for the 109 largest US and European cities, separately for cars and public transit commutes.

Compared with European cities, US cities are half as accessible via public transit and twice as accessible via cars.

Car accessibility zones are always larger than public transit zones, making US cities more accessible overall.

However, US cities’ car orientation comes at the cost of less green space, more congestion, and worse health and pollution externalities.

The Technology of Decentralized Finance (DeFi)

Raphael Auer, Bernhard Haslhofer, Stefan Kitzler, Pietro Saggese and Friedhelm Victor in this BIS paper:

Decentralized Finance (DeFi) is a new financial paradigm that leverages distributed ledger technologies to offer services such as lending, investing, or exchanging cryptoassets without relying on a traditional centralized intermediary. A range of DeFi protocols implements these services as a suite of smart contracts, ie software programs that encode the logic of conventional financial operations. Instead of transacting with a counterparty, DeFi users thus interact with software programs that pool the resources of other DeFi users to maintain control over their funds.

This paper provides a deep dive into the overall architecture, the technical primitives, and the financial functionalities of DeFi protocols. We analyse and explain the individual components and how they interact through the lens of a DeFi stack reference (DSR) model featuring three layers: settlement, applications and interfaces. We discuss the technical aspects of each layer of the DSR model. Then, we describe the financial services for the most relevant DeFi categories, ie decentralized exchanges, lending protocols, derivatives protocols and aggregators.

The latter exploit the property that smart contracts can be “composed”, ie utilize the functionalities of other protocols to provide novel financial services. We discuss how composability allows complex financial products to be assembled, which could have applications in the traditional financial industry. We discuss potential sources of systemic risk and conclude by mapping out an agenda for research in this area.

What Drives Startup Fundraising in India?

Rajas Saroy, Ashish Khobragade, Rekha Misra, Sakshi Awasthy and Sarat Dhal in the RBI Bulletin article:

This article presents an analysis of fundraising by the Indian startups over the past decade, along with an overview of the venture capital financing model. The article empirically derives the important factors that determine the quantum of start-up funding at the economy-wide level as well as at the firm level.

Highlights:

1. 1. There has been an upward level shift of fundraising by the Indian start-ups post-2014. This has been contributed to by the Startup India initiative, along with other enabling policies and the increasing digitalisation of the economy. COVID-19 provided a temporary boost to fundraising.
   2. At the aggregate level, long-run start-up funding is largely driven by the excess return offered by the domestic equity market over the global benchmark, and by the level of domestic economic activity.
   3. At the firm level, unconventional factors like the educational background of founders, pre-existing relationships with institutional investors and popularity matter for fundraising, in addition to the scale already achieved and the sector of operation.

 

Recession worries have replaced inflation concerns

In this oped in moneycontrol, I argue how quickly the recession worries have repalced inflation concerns.

Macro Effects of Formal Adoption of Inflation Targeting

Surjit Bhalla, Karan Bhasin  and Prakash Loungani in the new IMF paper:

We examine the impact of formal adoption of inflation targeting (IT) on inflation, growth and anchoring of inflation expectations in advanced economies and emerging markets and developing economies (EMDEs).

Our paper reports several findings relevant to assessing the success of IT regimes. We find that while the early adopters of IT (pre-2000) all saw declines in inflation rates following adoption, IT adopters since then have enjoyed such success in only about half the cases. Since there is not much difference, on average, between IT and non-IT countries in mean inflation, inflation volatility and the extent of inflation anchoring, it is not easy to sort out what role IT has played in ensuring good outcomes; in particular, we cannot rule out the possibility that the success of IT may be due to ‘regression to the mean’.

Our country-level analysis—using the Synthetic Control Method (SCM) to compare outcomes in IT countries to a synthetic cohort—shows that IT adoption delivers significant inflation gains in about a third of the cases. At the same time, we also find limited support for the concern that adoption of IT systematically leads to poorer growth outcomes. At a time when central banks are struggling to keep inflation in check, our results suggest that the belief that IT adoption will be sufficient to achieve this goal cannot be taken for granted.

Determinants of Financial Literacy and Financial Inclusion in North-Eastern Region of India: A Case Study of Mizoram

Bhartendu Singh, Raj Rajesh, Ramesh Golait and K. Samuel L in this RBI study discuss finacial inclusion in Mizoram:

The study evaluates the determinants of financial inclusion and financial literacy in the under-banked north-eastern region of India based on primary data collected through a survey in the State of Mizoram. A total of 523 respondents were selected from eight blocks covering four districts of Mizoram. The key findings of the study are as follows:

1. 1. The level of financial awareness in the region was limited – about 32 per cent of the respondents were not aware of any financial products other than the savings bank account.
   2. About 20 per cent of the respondents reported lack of knowledge about basic payment options, and about 43 per cent of the respondents reported lack of usage of available options despite awareness.
   3. About half of the respondents were found to be unaware of financial institutions other than banks, viz., non-banking financial companies, microfinance institutions and small finance banks.
   4. Use of life insurance cover was low among the respondents.
   5. The Financial Inclusion score and Financial Literacy score for the study region were generated using the OECD/INFE (Organisation for Economic Co-operation and Development/International Network on Financial Education) Toolkit. The estimated average financial literacy score was 14.37 on a scale of 0 to 21 (i.e., 68.43 per cent) and the average financial inclusion score was 3.35 on a scale of 0 to 7 (i.e., 47.86 per cent).
   6. Among the identified factors, the place of residence (block), employment type and nature of family (joint versus nuclear) of the respondents were seen to strongly influence their financial inclusion and financial literacy status.

By acting swiftly now we can prevent a Volcker shock

Olli Rehn, Governor Bank of Finland in this voxeu article writes on how we can avoid the Volcker shock:

There have been voices declaring – especially in retrospect – that the ECB should have hiked its rates earlier, and that frontloading should have been more forceful. This column argues that while there may be some truth in this argument, medium- and longer-term inflation expectations are still relatively well anchored and the task now is to maintain this by making strong enough moves so that a highly restrictive monetary policy shock can be avoided in the future.

Explainer: The endless US debt ceiling crisis

THe US debt ceiling has become a worry once again.

Janet Yellen, secretary of the US Treasury, wrote to the Congressional leadership last week to say that the government will reach the statutory debt limit of $31.381 trillion on January 19, 2023.

My moneycontrol explainer on the endless debt ceiling crisis.

Exorbitant Privilege? What explains the continued rise of the US Dollar?

Prof Perry Mehrling usually explains monetary systems from a different lens. In this new paper, he discusses what explains the continued rise iof US Dollar in the global monetary system.

He says academic theories and models are based on multiple currencies whereas the financial world is more inclined towards a universal currency or key currency as it helps in global payments. The academic world is clearly disconnected and ence surprised to see the continued rise of USD:

The global dollar system, though repeatedly reported to be on its last legs—most recently in the Global Financial Crisis of 2008, but most famously in the Nixon devaluation of 1971—has repeatedly instead consolidated and gone on to further geographical expansion (McCauley 2021).

The key currency approach to international monetary economics, first put forward by John H. Williams in the aftermath of the 1931 devaluation of sterling, suggests that such resilience arises from the actions of market practitioners who appreciate the convenience of a global means of payment.

So the question arises, why has the key currency approach remained a minority view, if not among practicing bankers then certainly among practicing academics? This paper proposes two main reasons—the discredit of monetary optimism during the depression, and the subsequent fateful adoption of Walrasian equilibrium as the frame for academic discussion after WWII.