Modern Monetary Disasters (Examples from Latin America)

Prof Sebastian Edwards of UCLA in this piece:

MMT, or some version of it, has been tried in several Latin American countries, including Chile, Argentina, Brazil, Ecuador, Nicaragua, Peru, and Venezuela. All had their own currency at the time. Moreover, their governments – almost all of which were populist – relied on arguments similar to those used by today’s MMT supporters to justify huge increases in public expenditure financed by the central bank. And all of these experiments led to runaway inflation, huge currency devaluations, and precipitous declines in real wages.

Four episodes in particular are instructive: Chile under President Salvador Allende’s socialist regime from 1970 to 1973; Peru during President Alan García’s first administration (1985-1990); Argentina under Presidents Néstor Kirchner and Cristina Fernández de Kirchner from 2003 to 2015; and Venezuela since 1999 under Presidents Hugo Chávez and Nicolás Maduro.

In all four cases, a similar pattern emerged. After the authorities created money to finance very large fiscal deficits, an economic boom immediately followed. Wages increased (helped by substantial minimum-wage hikes) and unemployment declined. Soon, however, bottlenecks appeared and prices skyrocketed, in some cases at hyperinflationary rates. Inflation reached 500% in Chile in 1973, some 7,000% in Peru in 1990, and is expected to be almost ten million percent in Venezuela this year. In Argentina, meanwhile, inflation was more subdued but still very high, averaging 40% in 2015.

The authorities responded by imposing price and wage controls and stiff protectionist policies. But the controls did not work, and output and employment eventually collapsed. Worse still, in three of these four countries, inflation-adjusted wages fell sharply during the MMT-type experiment. In the periods in question, real wages declined by 39% in Chile, 41% in Peru, and by more than 50% in Venezuela – hurting the poor and the middle class.

In each case, the central bank was controlled by politicians, with predictable results. In Chile, the money supply grew by 360% in 1973 alone, helping to finance a budget deficit equivalent to an astonishing 24% of GDP. In Peru in 1989, money growth was 7,000%, and the fiscal deficit exceeded 10% of GDP. In Argentina in 2015, the deficit was 6% of GDP, with the annual rate of money creation surpassing 40%. And Venezuela currently has a deficit of 32% of GDP, with the money supply estimated to be growing at an annual rate of more than 1,000%.

As inflation increased in these countries, people greatly reduced their holdings of domestic money. But because governments required taxes to be paid in local currency, it did not completely disappear. Instead, the speed at which money changed hands – what economists call “velocity of circulation” – increased dramatically. No one wanted to be holding paper money that lost 20% or more of its value every month.

When the demand for money collapses, the effects of money growth on inflation are amplified, and a vicious circle develops. One serious consequence is that the currency depreciates rapidly in international markets. MMT supporters conveniently ignore the simple fact that demand for local money declines drastically when its value tumbles. Yet this is perhaps one of the theory’s biggest weaknesses, and one that makes it extremely risky for any country to implement.

The experience of Latin America should serve as a clear warning for today’s MMT enthusiasts. In a variety of countries, and at very different times, fiscal expansions that were financed by printing money resulted in an uncontrollable loss of economic stability. Economic-policy ideas are often as dangerous in practice as they are flawed in theory. MMT may be a case in point.

Hmm..

One key thing which MMT bashers miss is the context. MMT is being suggested in countries such as  US where despite record deficit levels, interest rates on government bonds have been low. Another point is this whole governance bit. In Latin America kinds of cases lot of this money was used not for any economic gains but for politicians gains and was a very different political game. Third, it is unlikely US Dollar will depreciate as sharply as it did in these economies. Most of US borrowings are in their own currency and depreciation will not effect them as much as it affected all these Latam countries.

MMT has its limitations for sure. But so is it the case with mainstream macroeconomics. Infact, both have similar diagnosis. The mainstream macroeconomics guys also say despite record debt levels, interest rates remain low. Hence, fiscal policy can be expanded to take advantage of this situation with central banks playing a supporting role.  MMT folks say the same and bring central bank directly into the picture.

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Why do central bankers buy and collect art?

Jens Weidmann of Bundesbank in this speech:

It gives me great pleasure to join you here today in opening this exhibition of artworks from the collections of the National Bank of Belgium and the Deutsche Bundesbank. I must say, this is an impressive and exceptionally pleasing space for an exhibition of this kind. We jumped at the chance of sending exhibits from our collection on a journey to Brussels, to our friends at the National Bank of Belgium in the capital city of Europe. It’s a premiere for us – never before have we shown our works outside Germany.

Both the National Bank of Belgium and the Bundesbank have been avid collectors of art for many decades now. Over the years, we have each gathered quite sizeable collections which shed some light on how art has evolved in Belgium and Germany. But why do central banks collect art in the first place? There are two reasons for that. First, because we’re looking to engage with society at large. As public institutions, we have a sense of commitment to the arts and culture in our respective countries. Second, we also feel that it is crucial to incorporate art into working life, because that brings our colleagues, and our guests and visitors, too, face to face with artistic expression. So over the years, collecting and exhibiting art has become part of our institutions’ DNA.

Encountering artworks on an everyday basis makes art part of our routine, a commonplace occurrence in our daily lives. Not just that: art also has the ability to surprise, challenge and inspire us. It lets us see things from a different angle and opens up a world beyond our own horizons. And in my experience, it can quite often be a cue for some fascinating conversations.

This exhibition now marks our own attempt to spark a special type of dialogue. Not just between visitors and the artworks, but also between two art collections which have evolved at two similar institutions in neighbouring countries. And that’s what makes the title of this exhibition – “Building a Dialogue” – so apt.

In this day and age, it’s certainly not a question of finding out what aspects of the collections are “typically Belgian” or “typically German”. Not least because artists in Europe, as we know, have been seeking to build a dialogue across national borders for centuries now. And yet for all that, it’s interesting to observe how well the works from the respective collections complement each other, and how the individual artistic statements interact.

Well, central banks also have the money!

Who wants a central bank job?

Debut piece for Business Standard.

I discuss how and why central bankers’s positions and authorities are being undermined in interesting ways across the world..

Why the World needs National Development Banks? (though India did away with NDBs…)

I don’t know but quite a few ideas which were rejected by Indian policymakers are making a comeback in global policy.

I blogged about how BIS is advising EME central banks to engage in forex markets. Now Stephany Griffith-Jones and and Jose Antonio Ocampo in this piece advocate national development banks, again an idea which took shape in India. Post-independence, we had development banks such as IFCI in 1949, ICICI in 1955 and IDBI in 1964. This was followed by NABARD in 1982, IDFC in 1997 and so on. In India, we called them Development Financial Institutions or DFIs.

Griffith-Jones and Ocampo say NDB’s offer following advantages:

Can the three musketeers click? Finance, technology, trust

Ravi Menon, Managing Director of Monetary Authority of Singapore in this speech names Finance, technology, trust as the three musketeers:

• Set in the 17th century, the novel recounts the journey of D’Artagnan, who left for Paris to join the Musketeers of the Guard, and how he overcomes all adversities.
• Together with him are three musketeers with contrasting personalities:
  • Athos who is intelligent;
  • Porthos who is adventurous; and
  • Aramis who is true and faithful.
• But together they form a well-balanced trio that supports D’Artagnan on his journey.

The three musketeers today are Finance, Technology, and Trust, corresponding to Athos, Porthos, and Aramis.  Society is D’Artagnan. 

• Can the three modern musketeers work together to support Society? 
• Can they complement one another?  Can they click?

Finance is Athos, Tech is Porthos and Trust Aramis:

Like Athos, Finance is wise but can be complicated, and to some extent, mysterious and non-accessible to many people.  As a result, Finance – at least in its traditional form – is losing its appeal.

Technology is akin to Porthos, the fearless musketeer who is eager to try new ways for a better future.  In a similar vein, Technology presents us opportunities to revitalise Finance.

Trust is similar to Aramis, the third musketeer who is faithful and values friendship. Trust is a key attribute for the success of a financial ecosystem.

Hmm..Nice way to present the complex ideas…

RBI’s once used multiple indicator approach is becoming preferred approach for EME monetary policy…

BIS chief Agustin Carstens in this speech reviews monetary policy framework in emerging markets.

He says it was thought that have an inflation target and allow the currency to float and find its own level.  However, this approach is not what emerging markets have strictly followed:

Selecting the next ECB chief: Avoid the song contest..

Stefan Gerlach (Chief Economist at EFG Bank in Zurich and Former Deputy Governor of the Central Bank of Ireland) in this piece:

Choosing the next president of the European Central Bank should not be like picking the winner of the Eurovision Song Contest. Instead, Europe should ask which criteria candidates must satisfy to be an effective ECB president, and then search for the person who best meets them.

He says following should be followed:

First, the president must be a team player. Journalists and commentators who have disagreed with the bank’s unconventional stance under Draghi often forget that the ECB president does not set policy, but rather chairs the Governing Council meetings at which policy decisions are taken.

Second, the ECB president needs a solid economics background. 

Third, the new ECB president must reflect the diversity of the eurozone.

Finally, one would hope to see several women among the main contenders for the position. But unless IMF Managing Director Christine Lagarde throws her hat in the ring, there may be no leading female candidates. That would be deeply regrettable, and out of tune with the tenor of the times.

Last bit of not having leading female candidates for the job is really disappointing…

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..

What differentiates central bank approach of monetary policy from financial stability policy?

Sir Jon Cunliffe in this speech speaks about Brexit risks to UK.

In the speech he serves this useful reminder on what differentiates mon policy from financial stability policy:

It cannot be repeated too often that the Bank’s approach to its financial stability objective is, in one key respect, very different to its approach to its monetary
stability objective. For the latter, the Monetary Policy Committee makes the best forecast we can of the path of the economy and the path of inflation – the central case. We set out clearly and graphically the risks around those forecast, but it is the central case – what we think most likely to happen – that informs our policy decisions.

For financial stability, the focus of the Financial Policy Committee (FPC) is not on the central case – on what is most likely to happen; rather it is on the risks – on what could happen even if it is not the most likely scenario. It is the risks, what could happen, that inform our policy decisions.

…

A colleague of mine recently asked me why the financial stability side of the Bank was so gloomy, always pointing to risks on the horizon and seeing the glass as half empty at best? My answer was that it was our job to worry about what could plausibly happen – and to ensure that if it did happen, the glass did not
suddenly empty entirely.

This is important. Monetary Policy looks at the mean while addressing risks. Financial stability while looking at the mean has to look at risks. Clarifies a lot on how we think about the two sets of policies…

Models, Markets, and Monetary Policy: From Friedman to Taylor to Data dependent policy

Nice speech by Richard Clarida.

Let me set the scene with a very brief—and certainly selective—review of the evolution over the past several decades of professional thinking about monetary policy. I will begin with Milton Friedman’s landmark 1967 American Economic Association presidential address, “The Role of Monetary Policy.”² This article is, of course, most famous for its message that there is no long-run, exploitable tradeoff between inflation and unemployment. And in this paper, Friedman introduced the concept of the “natural rate of unemployment,” which today we call u*.³ What is less widely appreciated is that Friedman’s article also contains a concise but insightful discussion of Wicksell’s “natural rate of interest”—r* in today’s terminology—the real interest rate consistent with price stability.

But while u* and r* provide key reference points in Friedman’s framework for assessing how far an economy may be from its long-run equilibrium in labor and financial markets, they play absolutely no role in the monetary policy rule he advocates: his well-known k-percent rule that central banks should aim for and deliver a constant rate of growth of a monetary aggregate. This simple rule, he believed, could deliver long-run price stability without requiring the central bank to take a stand on, model, or estimate either r* or u*. Although he acknowledged that shocks would push u away from u* (and, implicitly, r away from r*), Friedman felt the role of monetary policy was to operate with a simple quantity rule that did not itself introduce potential instability into the process by which an economy on its own would converge to u* and r*.⁴In Friedman’s policy framework, u* and r* are economic destinations, not policy rule inputs.

Of course, I do not need to elaborate for this audience that the history of k-percent rules is that they were rarely tried, and when they were tried in the 1970s and the 1980s, they were found to work much better in theory than in practice.

….

That vacuum, of course, was filled by John Taylor in his classic 1993 paper, “Discretion vs. Policy Rules in Practice.” Again, for this audience, I will not need to remind you of the enormous impact this single paper had not only on the field of monetary economics, but also—and more importantly—on the practice of monetary policy. For our purposes today, I will note that the crucial insight of John’s paper was that, whereas a central bank could pick the “k” in a “k-percent” rule on its own, without any reference to the underlying parameters of the economy (including r* and u*), a well-designed rule for setting a short-term interest rate as a policy instrument should, John argued, respect several requirements.

Hmm..

 

Undermining Central Bank independence, the Cyprus way (reads much like India’s story!)

It has been 5 months since RBI Governor resigned from the central bank. A lot was written exploring several reasons which led to his sudden exit from the central bank. But much of it is still speculation and truth is known to either Governor or someone close to the scenes in the Government. However, there is one book which reads much like what could have happened between the RBI and the Government.

The concerned book is written by Dr. Panicos Demetriades, former Governor of Cyprus (May-2012 to Apr-2014) and is titled as ‘A Diary of the Euro Crisis in Cyprus’. It is highly surprising that such an account by a central banker has not got due attention. The book was written in 2017 and should be on top of the charts. There are other central bankers who have written their accounts recently. But neither had they faced experiences as telling as those faced by Demetriades nor wrote as frankly as Demetriades.  One reason for ignorance is Cyprus being a tiny economy. Even then the book is a must read for those interested in political economy of central banking.

I came to know of this book by reading a recent speech by Lesetja Kganyago, Governor of the South African Reserve Bank. Kganyago speaks on how central bank independence is under attack including South Africa (which requires a separate article of its own) and picks insights from this book to reflect on Cyprus experiences. The events which happened in Cyprus during those 2 years read as the events in India during 2016-18. The resemblance is so striking, that it leaves you in splits.

What happened in Cyprus which is so telling?

First some basics. Before 2008, Cypriot banking sector grew enormously to touch 10 times the size of its GDP. The banks had invested heavily in Greek government bonds as they gave higher yields. Further, Cyprus banks not just offered higher deposit rates but also lend aggressively towards real estate sector. One of the real estate developers even became chairman of one of the Bank Boards. The financial transactions were not limited locally but funds flowed from and to Russia, Ukraine and Romania, becoming a deadly cocktail at the end. The banks were also the main advertisers in the media leading to no one really raising fingers.

Though, this was hardly unique to Cypriot banks as we saw banks in Iceland, Ireland, and US etc. following similar strategies only to end up in crises. In Cyprus too, the Greece crisis and European financial crisis engulfed banking system of Cyprus which was anyways built on shaky foundations. What is unique though is what transpired later.

Enter Panicos Demetriades who was appointed Governor of Cyprus Central Bank in May-2012. He had taken over from Athanasios Orphanides, who in in his send-off remarked that though banking system was quite stable under his tenure but wasn’t sure what would happen next.

Talk about prophecy as what followed was complete meltdown of the Cypriot banking system. The blame lies on Orphinades as well, as the fragile banking system took shape under his tenure. Demetriades knew he was sitting on a time bomb and tried to figure a solution but could not succeed. The troika of IMF, ECB and European Commission wanted to implement stricter norms for recapitalization which were not agreeable to politicians. The banks remained highly undercapitalized, politicians continued to underestimate the scale of problem also on account of high cronyism. Gradually losses mounted and the share of non-performing loans as a percentage of total loans in Cyprus was next only to Greece. Even today the share of NPLs are as high as 20% of total assets.

As banking problems worsened, a scape goat had to be identified and who better than a central banker! The media anyways disliked Demetriades right at his appointment as he was seen as an outsider. Soon, the political parties joined this chorus. The politicians wanted Demetriades to be ousted but as Cyprus was part of Eurosystem and under this system the central bank governor could not be fired. The only way was to pressurize the central banker and push him towards resignation.

The Government did two major things (apart from humiliation) in mid-2013 which pushed Demetriades towards his resignation – firing the Deputy Governor who backed the Governor and pushing the governance powers from Governor to the Central Bank Board!  Under the new legislation, the Government expanded the Central Bank Board membership from 5 to 7 with the two new members becoming Executive Directors. Further, the decisions related to licencing of new and old banks were to be made by the Board and not the Governor. The ECB protested against this legislation but to no avail.

The new Board stopped backing the Governor and even the loyal staff started complaining of harassment. Demetriades began to tire eventually and health started to suffer. The personal attacks mounted even bringing his family into picture. In March-2014, he submitted his resignation citing “personal reasons and difficulties working with the Board as the reason for resignation. This way the government won not just the battle but also the war against its own appointed Governor.

The events in Cyprus showed how governments can undermine central bank independence in interesting ways. The rules prevented the Governor from being fired but one could still build the pressure through the Board and firing the Deputy Governor.

Given this brief, there is a reason why I mention that Cyprus case reads much like India’s case. The RBI Governor was under pressure for rising NPAs, low credit growth and maintaining high reserves, leading to discontent with the Government. There was news on how the powers of governing RBI had shifted from the Governor to the Board members. There were also reports on how Governor Patel was tired fighting these battles and his health was suffering. In the end, these multiple events forced him to resign, also serving for two years just like his Cypriot counterpart. The resignation letter of the Governor also mentions personal reasons but not saying anything else.

The German classical archaeologist Gustav Hirschfeld once said ‘He who would become and remain a great power in the East must hold Cyprus in his hand.’  Paraphrasing the quote, those who believe in great power of central bank independence, should hold and read this account of Cyprus central bank Governor in their hands! Hope Dr Urjit Patel writes his own account as well.

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..

Is all economics local?

Interesting speech by Andy Haldane of Bank of England.

The speech uses lots of interesting data and graphs to understand local economy of UK. There are all kinds of patterns which suggest income inequality both between and within UK regions. The location matters a lot to well-being.

In his speech, our Chief Economist Andy Haldane looks at the economy at the local level. He uses data maps to show how peoples’ experiences of income, wealth, health and wellbeing vary depending on where they live.

Andy then considers how the latest developments in economic modelling and data could help give us a clearer, bottom-up picture of what’s happening in the economy.

Finally, he explains what we’ve been doing to make the Bank of England more engaged with what’s going on in local communities.

 

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…

 

Bank of England and Financial Times schools blogging competition…

BoE and FT organised a blogging competition (it was second edition).

They have put up the winners essays on the Bank Underground Blog:

Spelling mistake in Australian banknote..

I had pointed to this development in Australian banknotes (Sep-2018). RBA in her new banknotes has decided to feature Edith Cowan the Aboriginal writer who was the very first female member of an Australian Parliament. The notes would also feature a quote from Cowan.

Apparently Cowan’s quote spelt ‘responsibilty’ wrongly which has gone in the banknotes!

The goof first became known on Thursday when a listener on radio outlet Triple M sent the station a magnified photo of the Reserve Bank of Australia’s (RBA) new A$50 note highlighting the word “responsibility” misspelt as “responsibilty” three times.

The A$50 currency is the most widely circulated in Australia and accounts for nearly half the total value of other banknotes in use, according to the RBA.

The note came into circulation on Oct. 18, 2018 with new security features designed to deter counterfeiting and with tactile elements for the visually impaired. It sports a head-shot of Edith Cowan, who served as the first woman elected to an Australian legislature from 1921 to 1924.

The typo appears in an excerpt of Cowan’s maiden speech to Western Australia’s parliament, which features on the A$50 note.

The quote, which is repeated over on the banknote, reads: “It is a great responsibilty (sic) to be the only woman here and I want to emphasise the necessity which exists for other women being here.”

Phew!!

 

Iceland economy since the 2008 crisis

Iceland economy was one of the worst effected during the 2008 crisis.

Már Guðmundsson, outgoing Governor of the Central Bank  faced much of the brunt. In this final speech reviews the developments since 2008.

First, the crisis:

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..

 

Pakistan fires its central bank Governor and appoints a new one

The weekend was action packed in Pakistan. The Government removed both the central bank governor and head of Tax body:

Pakistan’s government has fired the governor of the central bank and the chairman of the tax collection body, two senior government officials told Reuters on Friday, in another setback to efforts to tackle economic turmoil.

The removal of the two comes only weeks after Finance Minister Asad Umar was asked to step down amid vital bailout negotiations with the International Monetary Fund, suggesting the government wants to overhaul its financial team amid weakening growth rates and soaring inflation.

“The government has decided to remove the governor of the State Bank and the chairman of FBR,” a Finance Ministry source said, referring to State Bank of Pakistan Chairman Tariq Bajwa and Federal Bureau of Revenue Chairman Jahanzeb Khan. A source at the prime minister’s office confirmed both had been sacked.

Central bank spokesman Abid Qamar told Reuters that Bajwa had “resigned”, and that it was unclear who would replace him.

Bajwa, appointed governor in 2017 during the tenure of the previous government, was one of the key figures in Pakistan’s ongoing bailout negotiations with the IMF. He was also seen to be close to Ishaq Dar, the former finance minister who appointed him and who championed a “strong rupee” policy that many analysts blame for Pakistan’s current economic woes, including ballooning budget and current account deficits.

The Government appointed a new Governor – Dr Reze Baqir,of IMF:

Dr. Reza Baqir has assumed the charge of Governor State Bank of Pakistan after President of Pakistan appointed him as Governor State Bank of Pakistan for a period of three years in pursuance of Section 10(3) of the State Bank of Pakistan Act 1956.

Dr. Reza Baqir has eighteen years of experience with the IMF and two years with the world Bank. He was the Head of the IMF’s Office in Egypt and Senior Resident Representative since August 2017. He has also held positions as IMF Mission Chief for Romania and Bulgaria, Division Chief of the IMF’s Debt Policy Division, Head of the IMF delegation to the Paris Club, Deputy Division Chief of the IMF’s Emerging Markets Division, IMF Resident Representative to the Philippines, and numerous other positions.

Dr. Baqir’s research has been published in top journals of the economics profession, including the Journal of Political Economy and the Quarterly Journal of Economics. Dr. Baqir holds a Ph.D in Economics from the University of California at Berkeley and an A.B. (Magna cum Laude) in Economics from Harvard University.

Not surprisingly, the opposition parties have called the appointment as new colonisation:

Pakistan Peoples Party Senator Raza Rabbani on Sunday branded the International Monetary Fund (IMF) as the “new East India Company”, adding that the appointment of the Fund’s Dr Reza Baqir as new governor of the State Bank of Pakistan (SBP) was “deplorable” and akin to “colonisation of Pakistan by international financial imperialists”.

The former Senate chairman said that “the SBP governor being an employee of the Fund which is giving a bailout package is a conflict of interest as it is obvious that his loyalties will not be with Pakistan.”

He said “it is a matter of shame that provincial finance ministers were made to appear before a middle ranking officer of the IMF (Baqir) and make promises of good behaviour.”

Rabbani said that Baqir’s appointment coupled with Dr Abdul Hafeez Shaikh’s induction into the cabinet as the prime minister’s adviser on finance means that the IMF has its “men in place” and “Pakistan’s financial sovereignty and national security has been compromised.”

The senator’s sentiments were also echoed by PML-N Vice President Maryam Nawaz, who in a series of cryptic tweets suggested that the government has surrendered the economy to the IMF.

“We will not go to the IMF; we will instead call the IMF here and hand over Pakistan to them,” Nawaz said, sarcastically referring to Prime Minister Imran Khan’s pre-election statements of never asking the Fund for another package when in power.

How politicians first mess up economy and then look for scapegoats. And how most of the time the scapegoat is the central banker who most likely would have warned of the economic mess for a while.

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..