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Inflation Dynamics in the Age of Robots: Evidence and Some Theory

Interesting BOJ working paper by Takuji Fueki and Kohei Maehashi.

Over the past decade, one of the central questions in macroeconomics has been the missing link observed between inflation and fluctuations in economic activity. We approach this issue with a particular focus on advances in robots, or what are essentially autonomous machines. The contributions of the
paper are twofold.

First, using a country level balanced panel dataset, we provide significant evidence to show that advances in robots are one factor behind the missing link. Second, we ask a standard New Keynesian model to rationalize this fact. The distinguishing feature is the introduction of capital which is substituted for human labor, and can therefore be interpreted as the use of robots.

Due to this feature and developments in robot, firms can adjust their production by using robots, whose efficiency is getting higher, instead of employing human labor. Hence, the responsiveness of marginal costs to changes in economic activity becomes weakened, and thus, our model supports the empirical fact that advances in robots are one factor behind the missing link.

 

Bridging the textbook gaps on how the central banks implement monetary policy

Kellie Bellrose of RBA explains the difference between how textbooks explains central banks implementing monetary policy vs how central banks actually implements it.

Though the article is for Reserve Bank of Australia but applies to most central banks.

The RBA’s implementation of monetary policy is an area of confusion for professional economists, commentators and educators alike, particularly in reference to how closely the actual process aligns with the standard textbook explanations. T

he two main gaps in typical textbook explanations relate to:

1. 1. The omission of the policy interest rate corridor. The corridor is key to how the RBA implements monetary policy, particularly a change in monetary policy, as it encourages banks to trade ES balances at the target cash rate.
   2. The use of open market operations. Textbooks often link OMOs with achieving a change in the cash rate when, in practice, the RBA uses OMOs to manage the supply of cash to keep the cash rate at its target.

In summary, the market automatically trades at the new cash rate target following a change to monetary policy. This is achieved by the policy interest rate corridor, which resets around the new cash rate target, and banks have no incentive to trade outside of this corridor. Given the automatic adjustment to the cash rate target, there is no need for additional OMOs. OMOs are instead used by the RBA to manage the supply of cash (liquidity) in the market on a daily basis as part of its liquidity management practices.

This information can be viewed at a glance in the accompanying table ‘The Reality of Monetary Policy Implementation’.

Nice bit.

 

The future of cash in New Zealand

Reserve Bak of NZ issued a report on future of cash in the country:

The future of cash¹ in New Zealand is uncertain. The Reserve Bank of New Zealand (Reserve Bank) is in the middle of a multi-year programme to establish The Future of Cash — Te Moni Anamata. This programme has identified that, despite an increasing trend in the overall cash in circulation (CIC), New Zealand is becoming a society that uses little cash.

New Zealanders are using cash less and less for transactions. As the transactional demand for cash falls, the per transaction cost of providing cash infrastructure increases. Commercial operators have natural incentives to reduce their costs and reduction in cash demand and use could lead them to reduce their provision of cash infrastructure, or to stop accepting and issuing cash. Such decisions — driven by commercial considerations — would in turn further increase the per-transaction costs of providing cash and lead to further reductions in the cash network.

The benefits of having cash become greater and greater as more and more people use it. This so-called ‘network effect’ of cash, also declines as fewer people use it. For example, if fewer consumers, businesses, and banks dealt with cash, the ability for people to use cash for transactions in stores and between individuals would decline. If this occurred, some of the unique roles of cash could be lost. The legal tender status of cash does not oblige anyone to accept cash as a means of payment except for debt.

A contraction in the cash network without regard to the wider benefits of cash in society might significantly disadvantage people who rely on the unique role that cash plays in their lives. This would be considered a market failure² to the extent that commercial operators did not fully incorporate the wider network benefits of cash. As a result, government action could be warranted following the completion of this review.

The Reserve Bank is the sole issuer of cash in New Zealand and is required to issue currency that meets the needs of the public.³ There is no agency responsible for over-seeing the usability of cash by the public or stability of the cash system in New Zealand. Therefore, the Reserve Bank is taking a leadership position to assess the future of cash.

This issues paper outlines our⁴ preliminary analysis of the role of cash in society and the trends in cash use and supply. It sets out the key issues to consider – both positive and negative – if less cash were being used in New Zealand accepted that:

1. 1. People who are financially or digitally excluded could be severely negatively affected. These include:
      1. People who are not banked or have limitations to accessing the banking system, such as people without identification and proof of address, people with convictions, people with disabilities, illegal immigrants and children.
      2. People who face barriers to digital inclusion, such as people with disabilities, senior citizens, people with low socio-economic status, people that live in rural communities with low internet service, migrants and refugees with English as a second language, Pasifika, and Māori.
   2. Tourists, people in some Pacific islands, and people who use cash for cultural customs might be negatively affected if they cannot use cash substitutes.
   3. All members of society would lose the freedom and autonomy that cash provides and the ability to use cash as a back-up form of payment, and might be more exposed to national and personal cyber threats.
   4. There would be limited or balanced effects for people’s ability to budget, New Zealand’s financial stability, and government revenue.
   5. Cash infrastructure is costly. Moving to a society with less cash could increase efficiency and reduce the overall transaction costs of payments.

The issues arising from a society with less cash have a broad reach. This issues paper invites your feedback on whether we have correctly identified the most important issues and whether there any other significant issues that should be taken into account. It also seeks initial views on the roles of government and Reserve Bank are regarding these main issues.

The Reserve Bank will publish an analysis of the feedback received, as well as further research. A formal policy consultation may follow depending upon what emerges from feedback on this paper and further research and analysis.

 

History of Australian equity market: 1917-79

Thomas Matthews of RBA in this paper:

This paper presents stylised facts about the historical Australian equity market, drawn from a new hand-collected unit record dataset on listed companies from 1917 to 1979. Among other things, I show that: i) dividends for the early 20th century were lower than previously believed; ii) the realised returns on equities has averaged about 4 percentage points above that on government bonds since 1917, somewhat lower than previous estimates; iii) the share of profits paid out as dividends increased substantially after the introduction of franking credits in the 1980s; iv) the current industry composition of the stock exchange is atypical relative to history, despite it being dominated by essentially the same companies for the past century; and v) price-to-earnings ratios are currently almost exactly at their very long-run average, in contrast with the experience of some other countries.

Good stuff!

Financial revolution in Republican China: 1900-1937 (rare case of finance being freed from State)

Nice research by Prof Debin Ma of LSE:

Over the last four decades, China’s economy grew at an astonishing pace while remaining firmly in the grip of an authoritarian political regime, thereby upending long-settled economic models. But an earlier era in Chinese history tells a different story. This column examines the period from 1900 to 1937, when rules governing the treaty port of Shanghai attracted major Western banks (and sheltered the Bank of China’s Shanghai branch) by curbing or side-stepping state power. This is a rare glimpse into a period of Chinese history in which financial practices were largely freed from the constraints of authoritarian rule. 

Hmm:

Further details:

Growing use of local currencies in Japanese trade with Asian countries

Takatoshi Ito, Satoshi Koibuchi, Kiyotaka Sato and Junko Shimizu in this research:

Japan exports to neither advanced nor Asian countries in yen, as would be expected. Using questionnaire data, this column shows why Japanese exporters tend to choose destination currencies in their exports to advanced countries and why the US dollar, rather than the yen, is more often used in their exports to Asia. It also presents new evidence that the share of local currency has recently increased markedly, while that of the US dollar has declined, in Japanese exports to Asia. 

…..

One major reason is that Asian countries have achieved steady economic growth and gradually removed control on financial and capital transactions. As discussed above, Japanese head offices have an incentive to shoulder foreign exchange risk by invoicing the importer’s currency even in exports to Asian-based subsidiaries. But, due to strict capital control and restrictions, Japanese head offices used to choose not the local currency but the US dollar. However, as financial and capital markets have been gradually deregulated in Asia, Japanese head offices have started to use the local currency in their exports to Asia-based subsidiaries. In addition, Asian countries, especially China, have become more important consumer markets for Japan. As long as Asia is the final destination market, Asian local currencies can be chosen as the invoicing currency along Asian production and value chains.

 

Will the weather Gods smile or frown? Evaluating Monsoon forecasts

RBI’s June-2019 Bulletin has this article by Priyanka Bajaj, D. Suganthi, Rishabh Kumar and Atri Mukherjee.

The India Meteorological Department (IMD) has predicted normal and well distributed South West Monsoon rainfall for 2019, which is at odds with the
forecasts of private and international agencies. This article drills analytically into past patterns of prediction outcome performances of various agencies through multiple statistical measures to evaluate their forecast accuracy.

The comparative assessment suggests that for generating macroeconomic forecasts, the use of IMD’s second stage long range forecast and the predictions of international agencies in conjunction may be appropriate as the preliminary forecasts of IMD and Skymet released in April appear to be noisy.

Good stuff RBI!

RIP Mr. Girish Karnad

Those who grew watching Malgudi days/Turning Point (and several other shows on Doordarshan), cannot forget Mr. Girish Karnad. One is not even listing his several other achievements. A person who wore multiple hats.

Rest in peace Sir.

 

Indian macro policy’s 2-4-6-8 framework..

Niranjan Rajadhyaksha continues to educate us this time via a working paper.

He gives this brilliant insight that Indian economy operates under a 2-4-6-8 framework. These are acceptable targets for current account deficit, retail inflation, consolidated fiscal deficit and growth rates:

Indian macro policy has been operating under an implicit 2-4-6-8 framework, which are the targets for the sustainable current account deficit, the desired level of retail inflation, the consolidated fiscal deficit target embedded in law and the aspirational rate of economic growth. There is a need to take a fresh look at this macro policy playbook for two reasons. First, the individual targets have been decided at different points of time by different parts of the economic policy ecosystem rather than emerging from a common analytical project. Two, there are reasons to doubt its internal coherence given that India has rarely been able to meet all four targets simultaneously over the past decade.

The tricky political economy decision for the new government elected in May 2019 is whether to ease some of the economic stability constraints such as the fiscal deficit, the current account deficit and retail inflation in a bid to maintain economic growth at 8 percent; or continue to prioritise hard-won economic stability while facing the risk of social unrest as lower economic growth fails to provide the adequate number of jobs in formal enterprises; or put in place policy reforms that can help raise potential growth without creating periodic bouts of macroeconomic instability. This working paper argues in favour of the third option with five sets of policy recommendations, so that economic growth accelerates without putting economic stability at risk.

 

The Macroeconomics of the Greek Depression: Would devaluation have helped

Gabriel Chodorow-Reich, Loukas Karabarbounis, Rohan Kekre in this NBER paper analyse the Greek depression:

The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we develop and estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust.

Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression.

Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects.

By contrast, shifting the burden of adjustment from taxes toward spending or from capital taxes toward other taxes would generate significant longer-term production and consumption gains.

 

Agricultural productivity shocks and poverty in India: The short- and long-term effects of monsoon rainfall

Bjorn Brey (University of Nottingham)  and Matthias S. Hertweck (Deutsche Bundesbank) in this paper:

This paper examines the dynamic effects of monsoon rainfall shocks on yield, wages, and prices in the Indian agricultural sector. We distinguish between positive and negative rainfall shocks and explicitly consider their spatial dimension (local/regional). We find that particularly negative regional shocks exert adverse effects. The enormous drop in agricultural yield is short-lived, but elicits a persistent decline (increase) in wages (food prices). Negative local shocks affect only wages, but not prices. This indicates that, in the food market, intra-regional trading mitigates the impact of local shocks. However, in the labour market, the arbitrage mechanism through migration appears substantially weaker.

Interesting to see Bundesbank researchers interested in monsoon in India.

Fiduciary duty and the market for financial advice

Interesting paper by Vivek Bhattacharya, Gaston Illanes and Manisha Padi:

Recent regulatory debate in the financial advice industry has focused on expanding fiduciary duties to broker-dealers. Proponents of this reform argue that it would improve the advice given to clients and limit losses from agency problems, while detractors counter that such regulation would increase compliance costs without directly improving consumer outcomes. This paper evaluates these claims empirically, using a transactions-level dataset for annuity sales from a major financial services provider and exploiting state-level variation in common law fiduciary duty.

We find that imposing fiduciary duty on broker-dealers shifts the set of products they sell to consumers, away from variable annuities and towards fixed indexed annuities. Within variable annuities, fiduciary duty induces a shift towards lower-fee, higher-return annuities with a wider array of investment options.

We develop a model that leverages the distributional changes in products sold to test the mechanism by which fiduciary duty operates. We find evidence that fiduciary duty does not solely increase the cost of doing business but that it has the intended effect of directly impacting financial advice.

A really important paper and finding given the crisis in practices of financial services…

Bank Deposits in India: Underlying Dynamics

Harendra Behera and Dirghau K. Raut and Arti Sinha of RBI in the monthly bulletin for May-2019 research analyse the recent trends in bank deposits:

Bank deposits remain an important part of the financial savings of households and key to the financing of bank lending.

Deposit growth is picking up in recent months in a cyclical upturn since December 2018, which is overwhelming a trend lowdown that has been underway since October 2009. The latter warrants policy consideration since deposit mobilisation is fundamental to India’s bankbased system of financial intermediation.

Empirical evidence puts forward several interesting facts about the behaviour of bank deposits.

First, it underscores the income as its most important determinant, both in the short-and in the long-run.

Second, interest rate matters for deposit mobilisation but only at the margin.

Third, financial inclusion has a boosting effect on deposit mobilisation over the long-run suggesting expansion of bank branches in unbanked areas.

Fourth, substitution effects associated with Sensex returns for deposit growth are limited to the short-run, warranting a careful appraisal of regulatory reforms and tax arbitrage, even as efforts need to be intensified to make both more market determined.

Finally, similar to Sensex return, small savings substitute bank deposits in the short-run but supplement deposits in the long-run, reflecting that limits on income tax exemption eventually evens out substitution effects and allow income to be the key determinant of both in the long-run.

In the final analysis, therefore, accelerating the rate of growth of the economy and disposable incomes holds the key to higher deposit mobilisation by the banking system.

Hmm..

How much equity capital should a central bank hold? Case of RBI

New paper by Ila Patnaik and Radhika Pandey of NIPFP:

The mechanism to calculate how much reserves the RBI transfers to the Central Government has been at the forefront of debate amongst experts and policy makers. The present legal framework allows the RBI to choose what proportion of reserves it transfers to the Government. As a consequence, it has built up reserves that are higher than most other central banks hold. This paper presents the logic for why central banks might hold reserves. Drawing on cross country practices, it presents a discussion of the possible arrangements for transfer of reserves to the Government. Any institutional arrangement to determine a framework for reserves transfer must consider these options.

One expects Bimal Jalan Committee to submit its report after election results. One expects the committee to advocate some rules for capital and reserve management of RBI..

Targeting financial stability: macroprudential or monetary policy?

David Aikman, Julia Giese, Sujit Kapadia and Michael McLeay in this ECB paper look at this question:

Monetary and macroprudential policies are set with reference to economic and financial cycles. This paper develops a simple macroeconomic model with the possibility of a financial crisis that describes how interest rates and macroprudential policy – as captured by the countercyclical capital buffer (CCyB) – interact in response to different shocks. It characterises situations in which the policy instruments move in the same, and in the opposite, direction. And it considers the appropriate design of policy under a range of potential shocks and challenges which policymakers may face.

First, the paper finds that there are minimal gains from monetary and macroprudential policy being set by a single policymaker compared with two distinct policymakers, one with a monetary policy objective and the other with a macroprudential policy objective.

Second, the paper shows that if monetary policy becomes constrained by the effective (zero) lower bound to interest rates, the trade-off faced by policy makers is worse because the CCyB must balance both objectives.  In particular, it should be activated later than otherwise, because its demand costs are larger without monetary policy to offset them.

Third, the paper explores a case in which there are leakages from tight macroprudential policy applied to banks into greater credit growth in the marketbased finance sector.The presence of market-based finance limits the effectiveness of the CCyB relative to monetary policy which affects all sectors equally and so it should be used less actively in the face of a credit boom.

In a final extension, the paper explores the risktaking channel of monetary policy. Tightening the CCyB is, by assumption, now less effective in constraining credit growth as low interest rates continue to induce high risktaking. But the CCyB remains a somewhat effective tool as it still improves resilience.

Hmm…

 

Nominal GDP Targeting as “Optimal Monetary Policy for the Masses”

St Louis Fed President James Bullard in this speech says NGDP targeting is an optimal mon pol for the masses.  The speech is based on this co-written paper.

In this blogpost, he explains the essence of the paper. The current models are silent on how mon pol leads to distribution and inequality:

Since the financial crisis, the topic of income inequality has become more important in monetary policymaking circles. In particular, monetary policy has been criticized as redistributing income to various parts of the population.

Along with income inequality among households, consumption inequality and financial wealth inequality are important considerations. Wealth inequality tends to be higher than income inequality, which tends to be higher than consumption inequality.

Many models used to assess the aggregate implications of monetary policy assume a representative agent. That is, a single household is meant to represent the distribution of households, and that household could be the median or average along some characteristic, for instance.

By construction, these models are silent on the redistribution effects of monetary policy. Instead, our model includes substantial heterogeneity (or differences) among households in terms of consumption, income and financial wealth and allows us to study the distributional effects of monetary policy.

In their paper, they work around addressing inequality:

The model in our paper is an extension of the model in a paper with Aarti Singh.² In these models, private credit markets play an important role in reallocating uneven income across the life cycle so that people can consume smoothly. As a practical matter, we can think of privately issued debt as similar to mortgage-backed securities.

However, there is a problem with the credit markets—households borrow in nominal (rather than real) terms and pay a nominal interest rate, neither of which depends on the state of the economy. This imperfection in the credit market is referred to as “non-state contingent nominal contracting.” This is an issue because optimal allocations of resources require contracts to be tied to the realization of aggregate productivity shocks.

Monetary policy fixes this problem in the credit markets by adjusting the aggregate price level in response to aggregate productivity shocks, which makes the nominal contracts real and state-contingent. The optimal monetary policy in these models is something very close to nominal GDP targeting because it calls for countercyclical price-level movements. To keep nominal GDP on its targeted path, the monetary policymaker would follow a policy rule whereby inflation would be relatively high when growth is low and it would be relatively low when growth is high.

In our recently released paper, the new aspect is the substantial heterogeneity among households. The amount of consumption, income and wealth inequality generated by our model is close to that in U.S. data, as measured using Gini coefficients. Nevertheless, in this environment, the optimal monetary policy—nominal GDP targeting—fixes credit markets for all agents.

Hmm..

 

How Black Death shaped European cities

Researchers Rémi Jedwab, Noel Johnson and Mark Koyama in this piece:

The Black Death killed 40% of Europe’s population between 1347 and 1352, but little is known about its spatial effects. The column uses variation in Plague mortality at the city level to explore the short-run and long-run impacts on city growth. After less than 200 years the impact of Black Death mortality in cities was close to zero, but the rate of urban recovery depended on advantages that favoured trade. 

Cities that favoured trade were more likely to attract labour afterwards…

Interesting..

State Finance Commissions: How successful have they been in Empowering Local Governments?

Interesting paper on one of the least known aspect of Indian fiscal federalism: Working of State Finance Commissions.

It is written by Manish Gupta and Pinaki Chakraborty of NIPFP:

While the Constitution provides for setting up of SFCs at regular intervals, this has not been adhered to by the states. The paper reviews the reports of the latest SFCs of 25 states in India. This involves examining the status of constitution of SFCs, their functioning and the approach adopted by them in carrying out their task and the principles adopted by them in allocating resources to local governments both vertically and horizontally. It also quantifies the devolution recommended by the SFCs in order to get a comparative picture of funds devolved by them across states. It is observed that there is huge variation
in the recommended per capita devolution across States.

We do not find any relation between the recommended per capita devolution and per capita income of States, but per capita devolution is in general very low across states in India. Is it that the state governments arbitrarily reject the recommendations or are the SFCs themselves to be blamed for non-acceptance of their recommendations? The paper also examines the quality of SFC reports from the point of view of their implementability and finds that at times state governments are constrained to implement these recommendations on the grounds of poor quality of SFC report.

Karnataka has consistently devolved the highest…

Lots of other interesting points in the paper.

Finance and monetary policy beyond neoliberalism: The way ahead for emerging markets

Rakesh Mohan in his new paper:

Broad consensus had been achieved around dominant neoliberal thinking in relation to financial sector regulation and monetary policy in the two decades leading up to the North Atlantic financial crisis (NAFC) that erupted in 2007-08. Whereas this thinking was essentially developed and applied in the advanced economies (AEs), similar policy prescriptions were advocated for emerging market economies (EMs). The general view was based on two theoretical propositions: the Efficient Markets Hypothesis (EMH) and the Rational Expectations Hypothesis (REH). “The EMH defines an efficient financial market as one in which securities prices fully and rationally reflect all available information…”^[1] The REH “proposed that individual agents in the economy—be they individuals or businesses—operate on the basis of rational assessments of how the future economy will develop.”^[2] Based on the belief that financial markets operate efficiently, it was assumed that free competition in financial markets would result in the efficient allocation of capital across the economy, and hence promote growth. And belief in the REH suggested that both individuals and financial institutions are capable of managing risks. The corollary was that regulation should be light touch only. ^[3]

Continued development of financial markets should therefore be encouraged; increasing financial depth and intensity is good for promoting economic growth, along with financial inclusion; and continued financial innovation helps price discovery, which promotes efficiency in the allocation of financial resources. “The pre-crisis orthodoxy was built on the idea that even if financial markets were in some ways imperfect, market liberalization and competition would at least bring us closer to perfection.”^[4] Such a theoretical view saw the economy and financial markets as being inherently self-stabilizing and efficient in allocating resources. A process of financial deregulation and deepening was therefore the order of the day, starting in the 1980s and lasting till the NAFC. Policy advisers to EMs and policymakers in EMs were not immune to this dominant strand of thinking.

Although this period was characterized as the Great Moderation, since the advanced economies experienced relatively consistent growth and low inflation, significant financial instability was experienced in different jurisdictions. Approximately 100 crises occurred during the 30 years before the NAFC, during which financial liberalization policies were dominant.^[5]Over this period, the financial sector grew much faster than the real economy in the advanced economies: private sector debt grew from around 50 percent of GDP in 1952 to 170 percent by 2006; trading in foreign exchange markets grew much faster than exports and imports; trading in commodities exceeded growth in commodity production; gross cross-border capital flows grew far in excess of investment; and financial innovation flourished with the introduction of widespread securitization and derivatives.^[6] The financial sector began to serve itself much more than the needs of the real economy. This relative explosion in financial sector development across the world was clearly not reflected in the real economy.

The excessive growth in overall debt and leverage in financial institutions, explosive growth in cross-border capital flows, along with the development of global macro and financial imbalances, finally led to the outbreak of the NAFC. This shock, the worst financial crisis since the Great Depression, has been instrumental in raising fundamental questions with respect to basic tenets of the neoliberal financial order outlined above.

The key lesson from this crisis has to be that financial markets on their own are not necessarily efficient, stable, or self-correcting: “serious economic and financial crises can happen, even in low inflation advanced market economies.”^[7]

Thus governments, central banks, and financial regulators have a crucial role to play in overall economic and financial sector regulation and management. Light financial regulation can no longer be sustained.

Hmm..