Archive for the ‘Central Banks / Monetary Policy’ Category

Digging through India demonetization history — 12 Jan 1946 (Saturday) and 16 Jan 1978 (Monday)

November 11, 2016

Warning upfront: This is a long long post..

One is trying to break his head over both ongoing effects of demonetization (demon) and the historic bit as well. There are so many articles on the history bit that one is just confused. So here is more to the confusion.


Let me start with some trivia. It is interesting to see the similarities in the dates of previous two demons. Both were in Jan with just four days away from each other – 12 Jan 1946 and 16 Jan 1978. One could call it the Jan demon! Even the days are just seperated by the Sunday. In the third one, the date is 8 Nov 2016 which was a Tuesday. So you have 8, 12, 16 series. Next one whenever could be on 4th or 20th of perhaps December!

First Denom — 12 Jan 1946 (Source: RBI History 1935-51, pg 706)


Probable impact of demonetisation on RBI balance sheet and monetary system…

November 10, 2016

As this blogger was wondering about the economics and logistics of the demonitisation (demon) and some trends too), was woken up by friends from markets. Their worry and sense of excitement was completely different. Keeping these basic problems aside, the interest was mainly in arbitraging from this demon exercise. The questions were what happens now to RBI balance sheet? Will rise in deposits lead to lower or higher money market and G-sec rates? Will it lead to lower or higher liquidity? Whatever it is, financial market players are always looking to arbitrage whatever the situation. Take it or leave it.

One decided to take it and atleast think through the circle of events. Given one’s earlier work on the topic one started from some basics.

Right at the start one must admit that this post is laced with loads of assumptions. In one stroke it is assuming people will find it easy to exchange or deposit cash, have bank accounts and so on. The reality is obviously different. The main purpose is to just understand the flows  in the abstract monetary system.

First of all, demon should mean RBI Balance sheet should decline as that is what leads to money being taken away from the system. But this is not the case here as we have swapping with new notes. So things get complicated. Moreover, the swapping may not be one on one as some might not disclose the entire cash given penalties and charges.

So say before demon RBI Bal sheet is like this:

Liabs                                                Assets
Currency              100                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100

So say 20% of currency does not came back to RBI. This leads to lower liabs.

Liabs                                                Assets
Currency                80                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100

The question is should RBI reserves or give govt profits? Then balance sheet is like this:

Liabs                                                Assets
Currency                80                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100
Profits to Govt       10
Reserves                 10

The higher one time profits will lead to lower fiscal deficit and this will lead to lower yields. This is one of the hypothesis.  However, this defeats the purpose of demon. As any reserves or profits will eventually come back to the system.

For demon to make sense, ideally RBI should cut the assets by 20%. . Come to think of it this is what demon should mean. Mon means rise in reserve money or RBI Bal sheet and demon means decline.

The next q is how does rbi cut assets. Two ways. By reducing GSec or forex.

Liabs                                                Assets
Currency                80                        G-sec                                90
Bank Reserves     100                       Foreign assets (forex)   90

If forex, then RBI sells fores and sucks liquidity. This means  liquidity should tighten and money market rates should go up. There will be downwards pressure on rupee as well.

If G-sec via OMO sales then yields should go up and liq again declines. Either way liquidity declines and in OMO sales we see yields also going up.

What eventually happens will depend on currency coming back and RBI deciding what to do of demon. Though if history is any guide, then the opposite happened. Last time demon happened in 1977-78, we saw both currency in circulation and RBI Balance sheet actually rising in 1978-79! So no case of tight liquidity etc but liquidity actually rising…

Another point is inflation back then. If inflation was high than nominally these values will rise. Mid 1970s inflation was very high due to oil shock and then started to decline a bit. After this demon ideally inflation should have declined but it rose significantly as there was no demon really as explained above. Inflation also rose as we see fiscal deficits also rising from 1978 onwards…

However, story does not end here. Another angle is rise in bank deposits. People are going to exchange currency in two ways. One is the direct exchange and another is deposits via the banking system. The above changes in currency in RBI liabs will happen via the banking system. The cycle is likely to be this:

  1. People come to a bank.
  2. Some choose to exchange. This gets reflected in RBI liabs straight away with some lag.
  3. Others choose to deposit first and then take out money when needed.
  4. So first the deposits with banks go up. This leads to rise in so called CASA balances of the bank. Thus, banks may not need to go for deposits etc for sometime.
  5. This rise in CASA will lead banks to park 4% of proceeds as CRR with RBI.

How does this show in RBI balance sheet eventually. Let us say 50% choose to deposit and 50% choose to exchange. So the Rs 80 aboe is divided into Rs 40 between currency and deposits.

The balance sheet of RBI in near future will be like this:

Liabs                                                Assets
Currency                40                        G-sec                               ??
Bank Reserves      111.6                   Foreign assets (forex)   ??
Total                      151.6

We see steeper decline in balance sheet here from 180 to 152. This is because as explained above it takes time for deposits to be converted to currency. So we have a case for a steeper cash crunch in the economy in near term. So on one hand rise in CASA deposits puts downward pressure on interest rates. On the other as it takes time to be converted back to deposits, it indicates cash crunch at RBI end. It will again depend on net net between central bank and banks. Banks might not be impacted as they have deposits but other players could face the crunch.

Another factor which has to be added is cost of printing these massive number of notes. This cost needs to be taken into account as well which also shrinks the balance sheet.

So lots of stories and linkages. What I have tried to do to best of my ability is to list these linkages. There could be some missing as well. The reality could be very different as seen in 1978. Moreover, what we have tried here is the accountancy angle. We could see no cash crunch at all due to several other known and unknown factors.

Things are different this time as Rs 500 and Rs 1000 notes with many people unlike 1977. How eventually people decide to exchange/deposit is what will matter.

I think I have only confused people more by this post. There are just no easy answers. Markets are dynamic in many ways and will move based on every bit of cue…

Is issuance of long term bonds sign of financial market maturity or destruction of the market economy?

November 8, 2016

Pick a macro or financial eco textbook and the standard narrative on bond market goes like this. Earlier, the governments just printed currency to finance deficits. This was called deficit financing which led to uninterrupted inflation. Then agreements were signed and this auto financing was stopped. The role of inflation management was given to central banks who started with monetary targeting and then gradually moved to inflation targeting.

One thing which developed due to this was the bond market. The governments needing money could not print currency so they started to issue bonds. Overtime, the governments issue bonds across time tenors to “manage the cashflows across time”. These bonds began to be traded and we eventually got an active yield curve. Then yield curve in turn becomes this public good which helps price other securities as well. So, if one is looking at pricing a security over a 10 years, then one uses the 10 year bond yield and so on. Thus, longer a yield curve it shows the markets are matured and so on. This leads to enormous literature on pricing financial securities across the yield curve and also figure whether it is efficient. There were later linkages of slope of yield curve to recessions etc.

This seems to be the standard narrative across most courses and books. However, most omit any criticism of  this standard narrative.

Joseph T. Salerno has a piece reflecting on the recent 70 year bond issue by Austria. He says bond issuance is the in thing given such low yields compressed artificially by the central banks. But a bigger question is why should govt issue bonds given they anyways issue fiat currency:

Nearly seven decades ago, Ludwig von Mises explained the seemingly irrational hunger among capitalists for long-term government bonds as based on an illusion. The illusion is that wealth once painstakingly accumulated in risky ventures can be removed from the competitive and uncertain sphere of the dynamic market process and preserved forever intact in a changeless realm of perfect certainty created by an imaginary political sovereign who is eternal, all-powerful, and unchanging.


The issue of government bonds is actually more insidious and destructive of the market economy than the issue of fiat money for two reasons.

First, politically, the issue of long-term bonds and the relentless piling up of government debt perversely bolsters and perpetuates the myth that the State is an eternal entity that somehow is not subject to the disturbances and uncertainties of human affairs.

And second, economically, the existence of government debt as a safe haven for wealth and an inexhaustible fount of income diverts capitalists and entrepreneurs from devoting all their attention and resources to their vital function of allocating scarce resources to the most urgent of the anticipated demands of consumers.

In fact, in an economic system burdened with fiat money, it would be preferable to ban government borrowing altogether. This would force the government to cover all of its deficits with irredeemable paper fiat money, which does not pay interest. There would be substantial benefits from this course of action. It would demystify the inflationary process for the average citizen. Instead of the Fed camouflaging its creation of money by the hocus pocus of “setting interest rates” via buying and selling bonds, financing government budget deficits would entail a completely transparent operation in which the Fed prints up money and directly hands it over to the U.S. Treasury.

Also the Fed would become a division of the Treasury and would no longer be involved in manipulating interest rates, which is the root cause of business cycles. And lastly, banks and other financial firms, which now hold vast quantities of government bonds and are a powerful constituency in favor of maintaining the political status quo in order to keep their interest payments flowing, would no longer be “a partner of the government which ruled people and exacted tribute from them.” Keynes infamously called for the “euthanasia of the rentier”; Mises’s theory of the public debt leads us to call for the euthanasia of the parasitic, government rentier.

Hmm. An argument which turns the standard narrative upside down. The standard narrative argues for bond markets to limit printing of currency. This one says bond market just covers the issue without really solving it. Central banks were issuing currency earlier now also they do the same but show it as a bond exercise.

These are issues which need to be debated at the foundation level but hardly any attention is paid. What we are taught as market economics in macro/finance texts is just a variant of the managed one which we are warned against.


Bank of England member joins HSBC…

November 4, 2016

There are several classes in the world. But I guess the highest class is that of top echelons in world of banking and money. It is just shocking to see how one on reaching this class continues to move from one organisation to the other with aplomb. It is as if the entire class takes care of you.

The crisis has exposed the ill-effects of this arrangement but it just does not end. One keeps moving from private bank to central bank/finance ministry and then back to the private world with amazing ease. Countries like Nepal are trying to put an end to the exercise but there is no such thing in the developed part of the world.

Infact, the whole thing is getting bolder. There seems to no cooling period whatsoever. How else does one explain this recent Bank of England revolving door? In this case, one Financial Policy Committee Member quits the central bank and the decision to appoint her at HSBC came in quick succession. Even worse is that newswires knew of the moves much in advance.

Just keeps getting worse..

Does Monetary Policy Have a Future?

November 3, 2016

Gerald P’Driscoll has a scathing piece on monetary policy and questions its utility:

I have chosen a provocative title, but it is fully justified. Fed officials are flying on autopilot, but the controls don’t work anymore, or at least not reliably. Fed watchers are largely clueless. The investment community and the economy may be collateral damage.


The Fed is now largely engaged in a futile exercise to control the economy. The massive expansion of its balance sheet flooded banks with excess reserves. “Operation Twist” robbed it of short-term assets. Its influence over short-term, market interest rates is attenuated at best. Nor does it seem able to control the money supply, though that is a more complicated issue (Jordan 2016).

What financial markets have feared the most, they in reality dare not hope for. The Federal Reserve is not positioned to raise short-term, market interest rates. If the feared spike in inflation materializes, the Fed is not positioned to contain it. Markets are expecting or fearing the Fed will do things it can no longer do. The misalignment between market expectations and Fed capabilities is very dangerous, and I fear it will not end well. Not an out-of-control central bank, but a not-in-control central bank is the problem markets must confront. The Fed is not positioned to control inflation when and if that becomes a problem.

There has been a lot of criticism of central banks in other pieces as well. Here is a piece from Kevin Dowd who also comes from the free banking school like P’Driscoll. Then there is another piece by Otmar Issing who was a career central banker.

Venezuela now weighs cash and Zimbabwe to introduce new currency..

November 2, 2016

These two countries Venezuela and Zimbabwe are classic cases of monetary mismanagement of this century.

In a recent article, Venezuela now weighs currency rather than count the same.

At a delicatessen counter in eastern Caracas, Humberto Gonzalez removes slices of salty white cheese from his scale and replaces them with a stack of bolivar notes handed over by his customer. The currency is so devalued and each purchase requires so many bills that instead of counting, he weighs them.

“It’s sad,” Gonzalez says. “At this point, I think the cheese is worth more.”

It’s also one of the clearest signs yet that hyperinflation could be taking hold in a country that refuses to publish consumer-price data on a regular basis. Cash-weighing isn’t seen everywhere but is increasing, echoing scenes from some of the past century’s most-chaotic hyperinflation episodes: Post-World War I Germany, Yugoslavia in the 1990s and Zimbabwe a decade ago.

 “When they start weighing cash, it’s a sign of runaway inflation,” said Jesus Casique, financial director of Capital Market Finance, a consulting firm. “But Venezuelans don’t know just how bad it is because the government refuses to publish figures.”

Zimbabwe on the other hand, plans to introduce a new currency.  It will be backed by a bond and trade at par with US Dollar:

Zimbabwe’s president has formalized a law allowing the introduction of a new currency this month.  The new bond notes, backed by a $200 million Afreximbank bond facility, will be regarded as legal tender for all local transactions.

 This southern African nation abandoned its own currency in 2009 after inflation hit 231 million per cent, according to government figures. It has been using a multi-currency system dominated by the US dollar since then.  
Severe cash shortages that the Reserve Bank of Zimbabwe attributes to low exports have hit this once-prosperous country in recent months. The bank says the bond notes to be introduced on an unspecified date this month will trade at par with the US dollar.
How difficult it has been to understand the basic lessons of money for some of the countries…

How culture (or lack of it) is becoming the major issue in finance….

October 28, 2016

Not too long ago, mention of culture in finance space was scoffed. It was seen as this soft issue which does not bring much value. Finance  was this hard subject all about numbers and jazz. This hard bit has taken a huge hit and has become really a soft target now. As a result, again people are going back to talking about the once soft things like culture, ethics etc in finance.

NY Fed has been organising conferences trying to figure the culture bit. The first was in 2014 and second in 2015.

In the 2016 edition, NY Fed chief William Dudley talks about things which central banks never thought they would – norms, ethics etc:

The evidence is pervasive that deep-seated cultural and ethical problems have plagued the financial services industry in recent years.  Bad conduct has occurred in both investment banking and securities market activities as well as in retail banking.2  This has eroded the industry’s trustworthiness.

This erosion impedes the ability of the financial services industry to do its job.  That job is financial intermediation—to facilitate the efficient transfer of resources from savers to borrowers, and to help customers manage the financial risks they face.  Verification—whether through regulation or internal controls—is an expensive substitute for trustworthiness.  Fines for bad behavior drain resources that could be better used to expand access and improve services, but billions of dollars in avoidable penalties are just the start.  The time spent handling a legal crisis is time not spent on more productive pursuits.  Moreover, I worry that, in the long term, an industry that develops a reputation for dubious ethics will not attract the best talent.3 

In contrast, a trustworthy financial services sector will be more productive and better able to support the economy.  Reliable financial intermediaries can help increase the flow of credit, promote economic growth and make the financial system more stable.  This is why restoring trustworthiness must be the ultimate goal of reforming culture. 

The industry’s shared norms—its culture—will not change by mere exhortation to the good, whether from me or from the industry’s CEOs.  In my experience, people respond far more to incentives and clear accountability than to statements of virtues and values.  The latter are worthy and necessary, but remain aspirational or even illusory unless they are tied to real consequences.4  What does it mean for a firm to profess to putting the customer first, if employees are compensated and promoted regardless of what’s good for customers?  Or, worse, if they are not held to account for activities that can harm customers?  If we focus on nothing else in today’s conference, let’s explore how best to structure incentives and reinforce accountability to align with core purposes and first principles.

To put it very simply, incentives drive behavior, and behavior establishes the social norms that drive culture.  If the incentives are wrong and accountability is weak, we will get bad behavior and cultures.  This implies a role for both firms and supervisors.  Firms need to continually assess their incentive regimes so that they are consistent with good conduct and culture.  When they are not consistent, the incentives need to be changed.

He says private sector should play the main role. But even the govt can help:

The primary responsibility for reforming culture—and changing incentives—belongs to the industry.  However, the industry does not act alone.  The public sector can play an important role as well.  I’ll discuss that issue this morning with my colleagues Norman Chan, chief executive of the Hong Kong Monetary Authority, and Minouche Shafik, deputy governor of the Bank of England.  Later this morning another panel will discuss the ways in which supervision can further contribute to improving bank culture.

Let’s also consider ways in which new laws or regulations might help—especially to overcome perennial collective action and first-mover problems that are common across the industry.  Two years ago I proposed solutions to two such obstacles to reforming culture.  First, there should be a database of banker misconduct to combat the problem of “rolling bad apples.”5  Second, a baseline assessment of culture is needed in order to measure progress.  I proposed an industry-wide survey, but there may be other good alternatives.  Once again, I invite the industry to take the initiative on these issues, and to look to the public sector for support.

I also hope that we will attend to issues that we may have overlooked in our earlier discussions.  Gillian Tett of the Financial Times argues in her new book, The Silo Effect, that the key to understanding any culture is identifying and explaining “social silences”—the issues that are not being discussed.

Database of banker misconduct…

There was a time when these databases only reported high salaries and bonuses of the sector. Now it is about misconduct..

Taking monetary policy to the people may be the only way for central banks to remain independent…

October 26, 2016

Howard Davies argues how central bank actions and need to be independent is  being increasingly questioned. More ironically. most of these pressures are coming in economies which have lectured the other world on need for central bank independence.

He says reaching out to people is one way to keep pressures off:

There is a powerful argument to be made that central banks, insulated from short-term political pressures, have been careful stewards of price stability, and have served the global economy well. It is not obvious that returning to politically administered interest rates would have any benefits beyond the immediate term.

Still, we must accept that central banks’ large-scale quantitative easing takes them into uncharted territory, where the boundary between monetary and fiscal policy is blurred. In the UK, for example, the Treasury decides on the level of economic intervention, while the BoE determines the timing and method of implementation. So, the central bank’s independence is not absolute.

Central bankers must demonstrate that they understand the political pressures and unusual circumstances that zero, or even negative, interest rates create. Savers are bitterly complaining that they are being penalized for their prudence; refusing to debate this and other implications of current monetary policies is not an acceptable response.

Independence demands higher degrees of accountability and transparency, whereby policies are explained to the public. To its credit, the BoE has been showing the way forward with a series of open forums around the UK. Taking monetary policy to the people is time-consuming, but it is essential if the necessary political consensus to sustain independence is to be maintained.

First central banks make policies which increasingly hurt people and then reach them to keep pressures from government at bay. But how much can public understand what is really going on? Monetary policy has become so technical that even experts find it difficult to explain what they are doing.

Bank of England open forums are welcome though. It has led to some interesting pieces of information especially on history. They have acted as a good fodder for this blog…

The significance of MPC and its first decision are overstated…

October 21, 2016

On one hand, hunger issues continue to be ignored despite its obvious importance. But on other things related to Indian central bank continue to be written and debated extensively without much importance.

EPW edit says much is written about recent monetary policy decision (sorry resolution).  But the overall gains are overstated and hyped:

The government, which has long sought a rate cut from the RBI but did not obtain one, is certainly pleased. Industrial capital, experts, and sections of the business press have also welcomed the reduction in the repo rate hoping that it will induce private sector investment. However, the risk of high inflation in the near future remains, from possible global increases in fuel prices as well as domestic demand surges following the roll-out of pay increases for government servants. However, the view that monetary policy will by itself affect inflation tendencies, or that it will induce investment in the economy is misplaced. Inflation is caused by many factors largely outside the RBI’s control, and investment is essentially a function of the state of long-term profit expectations, which is not promising at the present. To expect that the cut in the repo rate at this time will magically “restart the investment cycle” is excessively optimistic.

The MPC’s decision has pleased the government but to expect the committee to be a significant forum in which a democratically elected government can intervene in monetary policy is an overestimation of its role and importance. In its current form, the MPC is but an addition to the larger framework where an independent central bank focuses on targeting inflation within a certain range. The MPC is “entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.” It is to be held accountable for this role, and the minutes of its meetings will be made available to the public. Even as these moves for transparency are important international practices to adopt, the MPC’s mandate for which it is to be held accountable is itself a truncated one.

Inflation targeting is distinct from the multiple-indicator approach that was followed by the RBI earlier, which looked at not only inflation but various quantity and rate variables such as credit, output, and the exchange rate, among others. Inflation targeting has grown out of regulatory frameworks in economies with developed institutions and financial markets, and clear sources of inflation. These economies have sizeable financial markets and services. Earlier, such a single-target approach to monetary policy was not considered very useful in economies like India, where financial markets are far from developed, and inflation sources are vulnerable to food and fuel shocks, making it difficult to identify a “core” stable inflation to target. Two previous governors of the RBI—Y V Reddy and D Subbarao—were not in favour of switching to the inflation targeting approach. Yet this approach has been adopted.

Inflation targeting continues to be considered the “gold standard” of monetary policy in advanced economies. This is even after central banks following such a policy mechanism failed to diffuse asset price bubbles that led to the 2008 global financial crisis. It is largely this mainstream intellectual push in economic policy research that has aided the near universalisation of this rule-based approach to monetary policy in central banks worldwide. The Fiscal Responsibility and Budget Management Act, 2003 that targets low fiscal deficits is already constraining public expenditure on employment generation, food security, healthcare, and education. With inflation control as the primary target of the RBI, further constraints on provisioning of public goods and services are inevitable.

 This is a really old debate.

Should India have these developed world policy frameworks before becoming anywhere closed to developed? Or is it that these frameworks will lead to a developed economy?

History shows that though these ideas of monetary and fiscal rules/targets have been there for a while, countries have been really random at  implementing them. It is only post 1990s that both monetary and fiscal targets became not orthodoxy amidst economists but even policymakers. For most parts of their history, the developed world has spent and stimulated as per its wishes. Likes of Ha Joon Chang nicely call it as kicking the ladder.

There are merits and demerits on both sides. What should be followed is not blind aping of the western ideas. But to look at local contexts and make policies accordingly.

Fed’s rising focus on racial diversity and will it be reduced to an employment targeting central bank?

October 20, 2016

One has been so bored of reading FOMC statements that they are almost being ignored. The usual thing about inflation and unemployment is so much an overkill.

But Conor Sen points to this interesting new development. Fed is increasingly concerned about racial diversity in employment and reporting them as well. These are signs that Fed is going to be a more diverse place for employment as well:

The Federal Reserve gave two indications last week that one of its next structural pushes will be toward incorporating more diversity into how it conducts its business. For a variety of reasons, this evolution is likely to lead to a monetary policy with a more dovish bias than the institution has had in the past.

The first sign came in the release of the minutes from the September Fed meeting. For the third meeting in a row, the Fed commented on racial unemployment disparities, pointing out that “the unemployment rates for African Americans and Hispanics remained above the rate for whites.” The Fed also noted that for ages 25 to 64, the employment-to-population ratio was higher for whites than for blacks and Hispanics.

The second sign came in comments made by Minneapolis Fed President Neel Kashkari. “We cannot have confidence we are achieving maximum employment if we don’t understand what’s happening beneath the surface. … Understanding the composition of maximum employment is actually very important to us achieving the mandate that Congress has given us,” he said. Kashkari, whose parents immigrated to the U.S. from India, has previously said he will spend a day in the life of a struggling black family in order to better understand that experience.

This incorporation of demographic data in policy making isn’t the only way the Fed is looking to account for diversity. The Fed has increasingly been criticized by congressional Democrats for a lack of diversity on its staff. None of the Fed’s 12 regional branches has ever been led by a black or Hispanic president. Fed Chair Janet Yellen has pledged to increase diversity among the Fed’s ranks as it looks for a new Atlanta Fed president. With Louisiana, Mississippi, Alabama and Georgia, the Atlanta Fed branch includes four of the six states with the highest proportion of blacks in the country.


In the end, he says Fed is likely to look more at employment diversity than inflation as latter is hardly a concern now:

The future looks to be one with a more diverse Fed concerned more with achieving full employment in a variety of ways and less on elevated inflation, a focus that increasingly appears to be a relic of history.

This will be quite something if it happens.

And here in India, our central bank does not even think of regional representation in its overall policies. Though, in terms of employment Indian central bank could be more diversely employed given India’s affirmative policies. But the overall utility of this better representation can still be questioned. Does it really help address the wide regional and community differences in policies? On the face of it, it atleast does not seem to be the case..

250 years of the bond-equity correlation in UK – from positive to negative

October 20, 2016

The word correlation seems to have magical powers till you enter a statistics class. The class rubbishes the claim “correlation implies causation” and with it dies all the magic associated with the word. So whenever you read the word correlation, your reactions are mixed.

This post by Matt Roberts Sklar of BoE Blog Bank Underground shows 250 years of correlation between bonds and equities.  Interestingly, the correlation was positive till 1990s and has been negative ever since:

For most of the 18th-20th centuries, government bonds usually behaved like a risky asset. When equity prices fell, bond yields rose, i.e.  bond and equity returns were positively correlated (bond prices move inversely to yields). But since the mid-2000s, bond and equity returns have been negatively correlated, i.e. bonds became a hedge for risk. Before this, the last time this correlation was near zero for a prolonged period was the long depression in the late 19th century.

Bond-equity correlation

Source: Thomas and Dimsdale (2016) and author calculations.
Line shows ten year trailing correlation of monthly returns.

The change in the bond-equity correlation since the mid-2000s partly reflects investors being less worried about inflation risks. As well as demand-type shocks being more prevalent than supply-type shocks, the introduction of credible inflation targeting has helped anchor inflation expectations and reduced the likelihood of high inflation risks. Investors may also have become more focussed on bad states of the world.

At the same time, there has been a structural increase in demand for ‘safe assets’, with more investors demanding safe government bonds for reasons unrelated to their expected cashflows. This has been exacerbated during and since the financial crisis, with deterioration in risk sentiment leading to episodic ‘flight to safety’.  And the addition of QE and forward guidance to the monetary policy toolbox may mean long-term bonds react differently to previously.

The long historical perspective is interesting.

We usually think of stock and bond prices correlations like this. Say inflation goes up. Markets then expect central bank to increase rates and as a result bond yields go up and prices fall. In equity markets, the expectation is that valuation of firms will be lower in future down due to higher interest rates. So, the equity prices also decline. Thus, we see a positive correlation in the two assets.

But this monetary policy thing is recent development in 250 year history even if central banks are not. After all BoE came up in 1694, much before this data which is from 1750s. So to see this positive correlation even back in 1750s is interesting. Even more as during those times inflation was relatively stable due to commodity/gold standard. Prices hardly changed and inflation was hardly a risk. The shocks then mist be more around due to crop failures, sudden  rise in price of gold/silver , banking panics etc.

So say there is a banking panic this would have led both bond and stock investors shunning both and prices declining.

I would imagine this correlation has changed mainly due to increased central bank adventurism. In case of a shock people know central banks will infuse liquidity mainly via buying more bonds. Thus bonds are never really out of favor and only equities suffer.

There is a lot of interesting stuff in this one graph..


Mark Carney: Britain’s celebrity central banker

October 19, 2016

George Pickering student of economic history at the LSE and Mises University has an interesting piece. He talks about Mark Carney who has emerged as a big celebrity central banker:

An awed hush descended over the crowd, as the most powerful man in the British economy prepared to give his response. Sitting at the front of the room, Bank of England governor Mark Carney surveyed his audience, paused to consider the question for a moment, and then finally decided on his answer: “Pizza.”

The event in question took place last month, when Mr. Carney visited Whitley Academy in Coventry, a small provincial city in the English midlands, where he was questioned by a group of 12–18 year old pupils on everything from his favourite kinds of food (pizza, for the record) and chocolate, to his favourite television programmes, to whether he preferred dogs or cats. The event was part of the BBC’s “School Report” initiative, which aims to give young people a taste of what it’s like to work for Britain’s state-sponsored news and entertainment monolith. As well as Mr. Carney, BBC School Report has also allowed pupils to meet with celebrities such as Angelina Jolie. But even in such illustrious company, the pupils’ meeting with the man in charge of the world’s oldest central bank left them impressed with how “informal” and even “cool” he was.

They aren’t alone. Ever since he was appointed to the position in 2013, the personality and antics of the UK’s monetary policy czar have delighted and captivated the press. In the eyes of the British public, everything from his square jaw to the accent stemming from his far-off and exotic homeland of Canada, makes Mr. Carney appear closer to some sort of Hollywood celebrity than to the technocratic coterie of crumpled grey suits who preceded him in the post. Over the past year in particular, Mr. Carney has happily cultivated for himself a degree of national visibility from which many of his predecessors would have shied, even when the media’s adulation of the BoE governor seems to centre as much around personality as it does around policy. After he cut interest rates to their lowest level in history this summer, for example, the media were delighted to photograph him conspicuously attending a music festival just days later, replete with brightly coloured polo shirt and a “glitter tattoo” on his face. In the immediate aftermath of Britain’s vote to leave the European Union, which Carney loudly proclaimed to be the “toughest day” he’s ever faced as BoE governor, he was nevertheless sure to be photographed chatting with famous actors at Wimbledon. London’s Evening Standard even went so far as to call him “the biggest babe in banking,” on account of his “George Clooney good looks.”

As absurd and amusing as this all may be, it nevertheless represents a development which could provide clues to what the future of the British political landscape might look like. When placed in the context of the disarray and chaos engulfing Britain’s political system at present, Mark Carney’s self-conscious ascent into the elite club of “celebrity” central bankers, could have more to it than first meets the eye.

Ironically, Post Brexit it is these starry qualities which are keeping Britain at bay. But for how long will it last?

It is interesting how the fortunes of the two central banks – England and India- intertwined in 2013. The same piece could easily have been written for  India as well. I mean the Indian media reporting fawning was as atrocious and fawning as in British lands. Just that India has thankfully escaped but the torture and entertainment  continues even now..

Why was there a graveyard inside the Bank of England?

October 17, 2016

As central banks are getting highly predictable and laughable, they are turning to other ways to keep people ( and bloggers like me) interested. One way is to keep bringing some interesting trivia to people’s attention.

An example is this bit from Bank of England. Bank of Engalnd established in 1694 soon outgrew its original location. It then took up a graveyard nearby:

The Bank of England moved to its current site on Threadneedle Street in 1734.  We quickly outgrew our first building so to expand further we bought a church that was situated next-door.

The church was deconsecrated and demolished, but its graveyard was left in place.  This later became the Bank’s Garden Court..

There is then a story of a really tall employee who wanted to be buried in the same graveyard. His coffin was found later as the building was redone:

The Bank was completely rebuilt in the 1920s and ‘30s, and Jenkins’s coffin was found when the Garden Court was dug up.  Along with the other coffins found, it was moved to Nunhead Cemetery near Peckham, South London.  However, Jenkins’ coffin proved to be too long to fit in the vaults there, so arrangements were made for it to be placed in the catacombs..

So there are no longer any graves in or under our Garden Court today.  At least, not to our knowledge…

Scary stuff…
One can decide what is scarier. The Bank’s ever adventurous monetary policy or working late night at the Bank with your office being closer to the Garden Court…

Indian central bank cuts rates: Would expert reactions be same if govt appointed a Finance Ministry official as central bank chief?

October 4, 2016

Indian central bank threw a googly to most experts by cutting repo rate in today’s policy. Most experts/analysts expected a status quo for sometime but got a rate cut in the first meeting of the new Governor (This piece argues markets expected a rate cut!).

This was also the first time when we had an MPC deciding rates. So the statement was titled as: Resolution of the Monetary Policy Committee (MPC). Usually the word central banks use is decision but here it is resolution which means a firm decision. Interesting choice of word usage.

Then came the usual analysis. The only change was the decision, sorry resolution given by the committee:

Six members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published on October 18, 2016. The next meeting of the MPC is scheduled on December 6 and 7, 2016 and its resolution will be announced on December 7, 2016.

All central bank chiefs/committees want to create an impression of a hawk. They do not want to be seen as cutting rates in the first meeting itself of both the new chief and the new committee. But the new regime does not care for any such image.

Meanwhile, the Indian financial media and experts continues to spin stories on the Indian central bank. Calling it growth batting, dovish and so on. Just a while ago we were told how the new appointment would be a continuation of hawkish policies. It is amazing how there is no case of any introspection whatsoever.

One was just curious to ask this question. Given this decision, would media and experts reactions be same if govt appointed a Finance Ministry official as head of central bank? Or even if it appointed MPC members from finance ministry. It is highly unlikely as then talks of compromising independence etc would have started. The same news would have changed to Finmin insiders at RBI and so on.

It is less and less to do with economics per se. More and more is about the image management by the media.

One is also reading how this was the shortest media interaction ever. Some have pointed how the new chief just wanted to exit the conference hall asap. This is itself a dramatic turn around from the previous regime which had glamorised the whole thing way beyond imagination. This is a welcome development as things at central bank will hopefully be low key from hereon. But this means less noise for the media which just is so interested in central bank matters.

It is a case of mixed and confused signals really. The central bank will most likely try and minimise the noise around it but the media just wants to maximise given the hangover of the previous regime.

Interesting times..

Wells Fargo or the Federal Reserve: Who’s the Bigger Fraud?

October 4, 2016

It is interesting. Indian media jus

Ron Paul, the fierce Fed critic ups the ante against the institution. He cites the Alexander vs. Pirate story:


Mauritius’s long history of banking..

October 4, 2016

Nice speech by Mr. Rameswurlall Basant Roi of Central Bank of Mauritius. It is on occasion of Bank of China opening a branch in the island country.

He says Mauritius was a regional finance hub in 17th century:


Why study economics (and some lessons for Indian central bank?)

September 28, 2016

Stanley Fischer, Vice chair of FOMC gives a convocation speech at Howard University:


Using Behavioral insights in monetary policy…

September 26, 2016

Mark Calabria of Cato has a nice short paper reviewing the literature on the topic.


Bank of Japan to control the Japanese yield curve!!

September 22, 2016

One is completely fed up of the tactics being deployed by central bankers worldwide to keep controlling and planning the financial economy. I did read news of yield curve control by Bank of Japan here and there in the morning, But somehow thought it must be some rumor or one of those crazy suggestions to keep hings going.

But it is true. Bank of Japan indeed is going to control the yield curve!:


Indian financial media continues to spin stories on Indian central bank….

September 21, 2016

One does not like writing such posts but just can’t help it. There is only so much one can ignore.

The positive spinning of news on Indian central bank continues to be a big issue.  Despite central banking exposed widely across the world, we are continuously made to believe of godly powers of people at helm of Indian central bank.

Came across this recent piece which  again tries to spin a story. It argues how the new chief  has had the best start this century as far as bond markets are concerned.