Archive for the ‘Academic research & research papers’ Category

The Monetary Helicopters Are Coming: Friedman’s or MMT’s?

March 30, 2020

Well, well, well. Just as I had recently written that whether we like it or not, most central banks would be be following Modern Monetary Theory.

Willem Buiter in Proj Synd piece writes:


2008 crisis was a endogenous shock whereas Covid19 is an exogenous one`

March 30, 2020

Jon Danielsson, Robert Macrae, Dimitri Vayanos, Jean-Pierre Zigrand in this piece point to differences between the two shocks:

Comparison between the coronavirus crisis and the global systemic crisis of 2008 is inevitable, but seen through the lens of exogenous and endogenous risk they are quite different. 

2008 was a global systemic financial crisis fuelled by the endogenous interactions of market participants. The forces of the crisis fed on deep weaknesses in the financial system that had built up out of sight.

COVID-19 is an exogenous shock to the economy, and the question is whether there are sufficient latent weaknesses for it to prey on. We think this unlikely. Instead, the locus of the problem lies outside the financial industry, in a real economy in which shops, services and business are being closed by state fiat, and the income of employees involved is collapsing.   

In turn, that means the appropriate policy response cannot be limited to reducing interest rates or purchases of corporate or sovereign bonds on the open market, but should also encompass forbearance and targeted help and similar policies. 

With the most vulnerable part of the financial system – the banks – in much better shape now than in 2008, we feel that this is not the real problem and that any solution focused primarily on the financial system would fail.   

From one shock to another…

The road to funding in Australian Dollars..

March 30, 2020

The idea of original sin has again come to the fore. The original sin means most of the emerging nations cannot issue their bonds in their own currencies. This is because of several factors like lack of macro fundas, lack of deep markets and so on. This leads to problems as most countries then issue bonds in foreign currencies and when you have a Covid19 kind of crisis and currency depreciates, the liabilities suddenly balloon leading to defaults.

Here is an interesting research by Elliott James and Christian Vallence on Australia’s journey to issuing most of its overseas bonds in AU Dollar:

A key feature of Australia’s financial system is that nearly all liabilities are denominated in, or hedged into, Australian dollars. A pre-condition for this state of affairs is that investors are willing to hold Australian dollar-denominated assets. Investor confidence in Australian dollar assets is supported by Australia’s sound institutional framework, history of positive macroeconomic outcomes, and well-functioning financial system.

Australia’s journey to funding in its own currency spanned nearly a century and involved various costs. Today, these funding arrangements confer substantial benefits to the Australian economy, including by reinforcing the same positive economic, financial and institutional outcomes that made Australian dollar funding possible in the first place.



Europe is at last channeling Alexander Hamilton..

March 26, 2020

Jacob Funk Kirkegaard of PIIE in this piece says Europe has finally found its Hamilton. Hamilton had rescued US in 1790 and Europe is doing the same. Just that Lagarde as a central bank head has to play the role:


Will the pandemic crisis lead to multidisciplinary economics?

March 26, 2020

Mohammed El Erian in Proj Sync piece:

Given how extensive government interventions are likely to be this time around, it is critical that policymakers also recognize the limits of their interventions. No tax rebate, low-interest loan, or cheap mortgage refinancing will convince people to resume normal economic activity if they still fear for their own health. Besides, as long as the public-health emphasis is on social distancing as a means of quashing community transmission, governments won’t want people venturing out anyway.

All the issues raised above are ripe for more economic research. In pursuing these avenues of inquiry, many researchers in advanced economies will find themselves inevitably rubbing up against development economics – from crisis management and market failures to overcoming adjustment fatigue and putting in place better foundations for structurally sound, sustainable, and inclusive growth. Insofar as they adopt insights from both domains, economics will be better for it. Until recently, the profession has been far too resistant to eliminating artificial distinctions, let alone embracing a more multidisciplinary approach.

These self-imposed limits have persisted despite abundant evidence that, particularly since the early 2000s, advanced economies are saddled with structural and institutional impediments that have stifled growth in a manner quite familiar to developing economies. In the years since the global financial crisis in 2008, these problems have deepened political and societal divisions, undermined financial stability, and made it more difficult to confront the unprecedented crisis that is now knocking down our door.

Will there be a uniform currency in a cashless economy?

March 26, 2020

Walter Engert and Ben S. C. Fung of Bank of Canada in this short paper

Is cash necessary for a uniform currency? Consider the following transaction: a person could exchange a bank deposit for cash at face value and then deposit that cash at face value in another bank, thereby forcing a deposit transfer at face value via cash.1 In this way, cash could be used to establish a fixed one-to-one exchange rate between different bank deposit monies. In the absence of cash, obviously, it would not be possible to conduct this kind of transaction. So, without cash, would our uniform currency break down? In this note, we consider whether a uniform Canadian currency would continue in a cashless economy.

The next section provides some historical background, briefly recounting the experience of establishing a uniform Canadian currency in the 19th century. As will be seen, the institutional environment was very different than it is today. Section 3 then explains how a uniform currency is maintained in a contemporary setting and shows that cash is not important to achieve this outcome. As a result, a uniform currency would be maintained in Canada even if a cashless economy were to develop.


The perils of compounding come to fore during the Covid19 crisis

March 25, 2020

Economists live the concept of compounding especially for growth and finance matters. If your economy grows by 5% for 5 years, the overall growth is not 25% but 31.25% as one also has to multiply the incremental growth.

Prof Gernot Wagner who teaches climate economics at New York University says compounding runs both ways. Just like we look at its positives we should be weary of its negatives as well:


Could MMT rescue us from the Covid19 crisis?

March 23, 2020

My new piece in MC.

I must admit am no expert on MMT. This was just an attempt to understand what MMT folks are saying on the crisis and whether their ideas deserve a hearing this time around.

Pandemics and social capital: From the Spanish flu of 1918-19 to COVID-19

March 23, 2020

Research on covid19 is flowing thick and fast. This piece on voxeu says the impact on social capital/trust is going to last much longer than imagined. (by Arnstein Aassve, Guido Alfani, Francesco Gandolfi, Marco Le Moglie)

Taking selfies with brands..

March 20, 2020

Interesting paper by Reto Hofstetter, Gabriela Kunath, and Leslie K. John:

Increasingly, consumers are taking self-photos and marketers, eager to capitalize on this trend, have been asking consumers to take self-photos with brands (i.e., brand selfies). We suggest that consumer compliance with such requests sparks a self-inferential process that leads the consumer to feel connected to the brand (e.g., “If I took the brand selfie, I must feel connected to this brand”), increasing brand preference. Eight studies support this account. In a dataset of 283,140 user reviews from Yelp, study 1 documented a positive association between a reviewer’s propensity to take a brand selfie and the star rating he gives the restaurant. Seven experiments point to causality.

Participants randomized to take brand selfies felt greater self-brand connection and exhibited heightened brand preference, relative to those randomized to take: no photo at all (study 2a); a selfie (without the brand, studies 2b–6); or a photo of the brand (without the self, study 3). Two studies point to process in convergent ways, via serial mediation (study 4) and moderated mediation (study 5).

A final study documented a crucial moderator: dissatisfaction with one’s appearance in the selfie triggers defensive processing, reducing self-inference and, thereby, the capacity for brand selfie-taking to increase brand preference.


Popular governments may be a sign of future financial crises

March 20, 2020

A post on LSE blog. Summarises this paper which says popular governments can be a sign of future financial crisis mainly in emerging economies:

One well-documented predictor of financial crises are credit booms and capital flow bonanzas. Indeed, many banking and current account crises (sudden stops) have been preceded by unusual expansion of domestic and/or external credit (see for example Reinhart and Reinhart 2008Forbes and Warncock 2012Schularick and Taylor 2012Mendoza and Terrones 2012). To the best of our knowledge, however, not much research has focused on early warning indicators outside the realm of economic variables.

In this post, which is based on our research in Herrera et al. (2020), we discuss the role of political bonanzas (large increases of government popularity) in the run-up to financial crises, showing that this political variable can be helpful to predict crises. We propose new cross-country measures of government popularity, which covers more than 100 countries as far back as 1984. Specifically, we propose the use of the “International Country Risk Guide” (ICRG) sub-indicator of “government stability”, which measures “the government’s ability to carry out its declared program(s), and its ability to stay in office” and which we show is closely related to actual public opinion data for those countries and episodes for which actual government approval data is available (e.g. from Gallup)…..


Why do political booms precede financial crises only in emerging markets? We argue that governments with lower initial levels of popular support have more incentives to ride political booms simply because there is more margin for increasing their popularity than in advanced economies. Furthermore, if there is also high uncertainty about the government’s quality to begin with, then riding a boom also has more potential to change public opinion. Indeed, these preconditions are more typical in young democracies (including many emerging markets) rather than established ones – we show that government popularity in emerging markets is significantly lower than in advanced economies and also more volatile, meaning that the public is more uncertain about the quality of its politicians.

In our model, this implies that popularity is more responsive to the perceived economic environment and to governments’ actions and policies. To match this rationale, we further show empirically that governments with lower initial popularity levels are more likely to experience financial crises in the future. This result holds even in the subsample of emerging markets.

In sum, emerging markets may be more prone to crises than advanced economies because their governments, having on average a lower reputation and more uncertain quality, can gain more in popularity from riding credit booms that are doomed to fail.

Obviously the research is based on past data. Much of today’s developed world shows similar govts as emerging economies..


The Transportation‐​Communication Revolution: 50 Years of Dramatic Change in Economic Development

March 19, 2020

Paper in Cato Winter 2020 Journal:

The Industrial Revolution transformed subsistence living into sustained growth, but only for about 15 percent of the world’s population. Throughout the rest of the world, change was minimal. In 1950, the real per capita income for developing countries outside of Africa was slightly less than $4 per day, approximately the same as that of the high‐​income, developed countries at the onset of the Industrial Revolution. But income levels in the developing world have increased dramatically during the past half century, particularly for the 70 percent of the world’s population living in less geographically disadvantaged developing countries.

The huge reductions in transportation and communication costs over the past half century provided the foundation for the remarkable increases in economic development and worldwide income. The Transportation‐​Communication Revolution triggered four changes that have altered life in the developing world: gains from large increases in international trade; gains from higher rates of entrepreneurship and expanded opportunities to borrow successful technologies and business practices from high‐​income countries; improvement in economic freedom; and the virtuous cycle of development.

Our empirical analysis of the annual growth rate of real per capita GDP since 1960 indicates that the expansion of international trade, higher rates of economic freedom, and increases in the share of the global population in the prime working‐​age category have exerted a strong and highly significant impact on economic growth. Due to the sharp reductions in transportation and communication costs, the volume of international trade has risen sharply in recent decades. The growth of trade in less geographically disadvantaged developing countries has been particularly remarkable. Measured in real dollars, the size of the international trade sector in these countries was 44 times higher in 2017 than it was in 1960. This astonishing rate of growth in international trade was approximately 2.5 times higher than it was in high‐​income and more geographically disadvantaged countries over the same time frame. Propelled by the growth of trade, the real per capita GDP of the five billion people living in the less geographically disadvantaged developing world has grown at nearly twice the rate of high‐​income countries in recent decades. The historically high rates of economic growth have transformed these developing countries even more rapidly than the Industrial Revolution transformed the West between 1820 and 1950.

While the Industrial and Transportation‐​Communication Revolutions exerted a similar impact on the lives of those most affected, they differ in three major respects. Compared to the earlier economic revolution, the more recent revolution has been broader, generated more rapid rates of economic growth, and reduced income inequality rather than enlarged it. Both the general populace and the academic literature show an appreciation of the human progress that accompanied the Industrial Revolution. It is now time for both groups to recognize the remarkable human progress brought about by the Transportation‐​Communication Revolution.


Central banks’ “whatever it takes” moment: Will it help?

March 18, 2020

Central banks are again trying to throw the sink at the financial markets. They are searching for  a comment similar to Mario Draghi’s “Whatever it takes” which helped save Euro (atleast that is what we are told).

Some comments on the central bank actions:


RBI-Occasional Papers-Vol. 40, 2019

March 17, 2020

RBI has published its latest occasional paper series Vol 40:

1. Fiscal Rules and Cyclicality of Fiscal Policy: Evidence from Indian States

Dirghau Keshao Raut and Swati Raju examine the impact of fiscal rules on the cyclicality of fiscal policy of Indian states using data for the period from 1990 to 2018. The results suggest that fiscal rules have reduced pro-cyclicality of fiscal policy, particularly in terms of development expenditure, in the post-FRL period. Fiscal deficit also changed its nature from pro-cyclical in the pre-FRL period to acyclical in the post-FRL period. Capital outlay displayed acyclical behaviour in both pre-and post-FRL periods.

2. Payment Systems Innovation and Currency Demand in India: Some Applied Perspectives

Dipak R. Chaudhari, Sarat Dhal and Sonali M. Adki postulate currency demand for transaction purposes driven by income effect, and a payment technology induced substitution effect working through velocity of currency. Innovations in payment systems have shown a statistically significant long-run inverse relationship with currency demand in India. However, the magnitude of its coefficient indicates that the substitution effect of payment systems on currency demand is smaller than the dominant income effect.

3. Can Financial Markets Predict Banking Distress? Evidence from India

Snehal S. Herwadkar and Bhanu Pratap test whether equity markets provide any lead information about stress in the banking system before quarterly data become available to the supervisors. The authors find that markets are able to price-in the banking stress concurrently but not much in advance. As the supervisory data are available with a lag, there is some merit in incorporating market-based information to track banking distress. Interestingly, the findings suggest that markets are relatively less efficient in providing such lead information in the case of public sector banks vis-à-vis private sector banks.

The last paper is interesting. Did equity markets do better in indicating stress at Yes Bank given it is a private sector bank?

Helicopter money: The time is now

March 17, 2020

Jordi Gali in voxeu:

Capital market integration can reduce misallocation: Evidence from India

March 16, 2020

Interesting research by Natalie Bau and Adrien Matray. They try and find out whether India’s capital market reform has helped firms increase output and productivity:


Contagion of Fear: Bank failures during Great Depression

March 16, 2020

Kris James Mitchener and Gary Richardson in a new NBER working paper:

The Great Depression is infamous for banking panics, which were a symptomatic of a phenomenon that scholars have labeled a contagion of fear. Using geocoded, microdata on bank distress, we develop metrics that illuminate the incidence of these events and how banks that remained in operation after panics responded. We show that between 1929-32 banking panics reduced lending by 13%, relative to its 1929 value, and the money multiplier and money supply by 36%. The banking panics, in other words, caused about 41% of the decline in bank lending and about nine-tenths of the decline in the money multiplier during the Great Depression.

Surprised to see money multiplier being given prominence in banking/monetary research..

The Virus and the Australian Economy

March 12, 2020

Guy Debelle, Deputy Governor gives a speech on impact of Covid19 virus on Australian economy:

I had been intending to talk about investment, the theme of this conference. But, given the circumstances, instead I will provide a summary of how the Bank is seeing developments in the economy at the moment.[1] I will provide our assessment of where the economy was ahead of the onset of the coronavirus as well as an assessment of the effect of the virus to date, including on financial markets.

The December quarter national accounts confirmed our assessment that the Australian economy ended 2019 with a gradual pick-up in growth. Growth over the year was 2¼ per cent, up from a low of 1½ per cent. Consumption growth was a little stronger in the quarter, although still subdued. We had estimated that the bushfires will subtract around 0.2 percentage points from growth across the December and March quarters, but besides that, economic growth was set to continue to pick up supported by low interest rates, the lower exchange rate, a rise in mining investment, high levels of spending on infrastructure and an expected recovery in residential construction.

On the global side, around the turn of the year there were indications that the global economy was coming out of a soft patch of growth. The trade tensions between China and the US had abated, surveys of business conditions were picking up and industrial production was improving. Financial conditions were very stimulatory and supporting the pick-up in global growth.

Since then, there is no doubt that the outbreak of the virus has significantly disrupted this momentum, initially in China and now more broadly. We do not have a clear picture yet on the disruption to the Chinese economy caused by the virus and the measures put in place to contain the virus. But the following two graphs provide some sense of the significant disruption to the Chinese people and economy.

On the recent rate cut:

Turning to monetary policy, the Board met last week and decided to lower the cash rate by 25 basis points to 0.5 per cent. This decision was taken to support the economy by boosting demand and to offset the tightening in financial conditions that otherwise was occurring.

The reduction in the cash rate at the March meeting was passed in full through to mortgage rates. The cash rate has been reduced by 100 basis points since June. This has translated into a reduction in mortgage rates of 95 basis points. This has occurred through the combination of a reduction in the standard variable rate of 85 basis points, larger discounts to new borrowers and existing borrowers refinancing to take advantage of larger discounts. While a lower and flatter interest rate structure puts pressure on bank margins, it is important to remember that the easing in monetary policy will help support the Australian economy which in turn supports the credit quality of the banks’ portfolios of loans.

The virus is a shock to both demand and supply. Monetary policy does not have an effect on the supply side, but can work to ensure demand is stronger than it otherwise would be. Lower interest rates will provide more disposable income to the household sector and those businesses with debt. They may not spend it straight away, but it brings forward the day when they will be comfortable with their balance sheets and resume a normal pattern of spending. Monetary policy also works through the exchange rate which will help mitigate the effect of the virus’ impact on external demand.

The effect of the virus will come to an end at some point. Once we get beyond the effect of the virus, the Australian economy will be supported by the low level of interest rates, the lower exchange rate, a pick-up in mining investment, sustained spending on infrastructure and an expected recovery in residential construction.

The Government has announced its intention to support jobs, incomes, small business and investment which will provide welcome support to the economy. The combined effect of fiscal and monetary policy will help us navigate a difficult period for the Australian economy. They will also help ensure the Australian economy is well placed to bounce back quickly once the virus is contained.


Monetary Policy Transmission in India – Recent Trends and Impediments

March 12, 2020

RBI Monthly Bulletin Mar-2020 has an article on the burning question: Why is RBI’s monetary policy transmission weak?

The article is written by Arghya Kusum Mitra and Sadhan Kumar Chattopadhyay of Monetary Policy Department

This article examines monetary policy transmission to various segments of the financial system in India with aspecial emphasis on banks’ deposit and lending interest rates during the current easing cycle so far, i.e., since February 2019. While transmission to money market and long-term rates has been swift and almost complete, the transmission to deposit and lending interest rates has been muted. A key factor impeding quick and adequatetransmission to banks’ lending rates has been long maturity profile of bank deposits at fixed interest rates.

Even otherwise, banks are slow in adjusting their deposit interest rates. Under the external benchmark system introduced effective October 1, 2019 for select categories of loans, transmission to banks’ lending rates will no longer be contingent upon adjustment in deposit interest rates. Instead, changes in lending rates will induce changes in deposit interest rates.


Coronanomics 101

March 11, 2020

Prof Barry Eichengreen in this piece sums up:

In the fight against the COVID-19 pandemic, economists, economic policymakers, and bodies like the G7 should humbly acknowledge that “all appropriate tools” imply, above all, those wielded by medical practitioners and epidemiologists. Coordination, autonomy, and transparency must be the watchwords.


….monetary policy can’t mend broken supply chains. My colleague Brad DeLong has tried to convince me that an injection of central bank liquidity can help get global container traffic moving again, as it did in 2008. (Now you know the kind of elevator conversations we have at UC Berkeley.) But the problem in 2008 was disruptions to the flow of finance, which central banks’ liquidity injections could repair.

The problem today, however, is a sudden stop in production, which monetary policy can do little to offset. Fed Chair Jerome Powell can’t reopen factories shuttered by quarantine, whatever US President Donald Trump may think. Likewise, monetary policy will not get shoppers back to the malls or travelers back onto airplanes, insofar as their concerns center on safety, not cost. Rate cuts can’t hurt, given that inflation, already subdued, is headed downward; but not much real economic stimulus should be expected of them.

The same is true, unfortunately, of fiscal policy. Tax credits won’t get production restarted when firms are preoccupied by their workers’ health and the risk of spreading disease. Payroll-tax cuts won’t boost discretionary spending when consumers are worried about the safety of their favorite fast-food chain.

The priority therefore should be detection, containment, and treatment. These tasks require fiscal resources, but their success will hinge more importantly on administrative competence. Restoring public confidence requires transparency and accuracy in reporting infections and fatalities. It requires giving public health authorities the kind of autonomy enjoyed by independent central banks. (Unfortunately, this is not something that comes naturally to leaders like Trump.


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