Prof. Ajay Shah reviews the various measures taken in India’s currency defence of 2013. He looks at the impact of these measures on various markets and says it only led to more volatility.
Archive for the ‘Central Banks / Monetary Policy’ Category
A huge controversy has erupted ever since US Treasury Sec made this speech. There was a view that Alexander Hamilton will be removed from the note and be replaced by a Woman (who has done commendable work).
However, Treasury Sec did not really make this comment. He said we are exploring options and want to keep Hamilton on the note:
Bernanke responds to this (how the world’s most powerful econ has moved to a role of a blogger is amazing, this happens in US. In India all our central bank chiefs remain part of the system for eternity). He says removing Hamilton is not right. At best we should replace Andrew Jackson from the $20 note:
Hamilton also played a leading role in creating U.S. monetary and financial institutions. He founded the nation’s first major bank, the Bank of New York; and, as Chernow points out, Hamilton’s 1791 Report on the Mint set the basis for U.S. currency arrangements, which makes his demotion from the ten dollar bill all the more ironic. Importantly, over the objections of Thomas Jefferson and James Madison, Hamilton also oversaw the chartering in 1791 of the First Bank of the United States, which was to serve as a central bank and would be a precursor of the Federal Reserve System.
In the nineteenth century, a principal public role of central banks was to control banking panics, as the Bank of England would do quite successfully. Unfortunately, in large part because of populist opposition, neither the First Bank of the United States nor its successor, the Second Bank of the United States, would have their charters renewed. President Andrew Jackson led the opposition to the Second Bank, vetoing a bill passed by Congress to continue its operations. The expiration of the Second Bank’s charter in 1836 likely worsened the very severe Panic of 1837, which was followed by a prolonged economic depression. The United States would go on to suffer numerous banking panics that would hamper its economic and financial development over the rest of the century.
Hamilton’s demotion is intended to make room to honor a deserving woman on the face of our currency. That’s a fine idea, but it shouldn’t come at Hamilton’s expense. As many have pointed out, a better solution is available: Replace Andrew Jackson, a man of many unattractive qualities and a poor president, on the twenty dollar bill. Given his views on central banking, Jackson would probably be fine with having his image dropped from a Federal Reserve note. Another, less attractive, possibility is to circulate two versions of the ten dollar bill, one of which continues to feature Hamilton.
I was in government long enough to know that decisions like this have considerable bureaucratic inertia and are accordingly hard to reverse. But the Treasury Department should do everything within its power to defend the honor of Jack Lew’s most illustrious predecessor.
Mark Thornton of Mises, a leading advocate of free banking and no central bank reacts to Bernanke’s post:
Hamilton should get some credit for the Constitution and for being a policy maker. But the Constitution was an inferior form of government compared to the Articles of Confederation and his economic policy making was all geared toward bigger government and monetary nationalism, the two problems that are arguably the greatest threats to the American people, their prosperity, and their liberty. Bernanke then goes on to present a convoluted history of National Banks and bank panics during the 19th century. However, he does provide a suggestion for resolving the $10 bill controversy. Leave good old Hamilton on the $10 and take President Andrew Jackson off the $20 bill and replace him with a women.
This is probably the only idea of Ben Bernanke (removing the anti-central banking Jackson from the $20 bill) that I can agree with. And while you are at it take the image of Thomas Jefferson off the $2 bill and replace him with Paul Krugman or Ben Bernanke.
Both suggest to remove Jackson but for different reasons. Bernanke an advocate of central banking believes Jackson should not be there. Thornton an advocate of no central banking also believes Jackson should not be there as when we have private bank money, there is no need to put govt officials pictures on the notes. It is also interesting to see how central bankers are criticised in US. Here we just pray them..
Bank of England’s venture into blog had an interesting post on driverless cars. What does a central bank have to do with these kinds of cars? Well, a central bank is bothered about anything under the sun. But this post was on impact of insurance industry die to driverless cars. They will lose premiums on car insurance and so on.
George Selgin says we could do better by moving to driverless money as well:
Noah Smith has an article on this transition.Big data followers have always suggested that soon all your micro/macro theories will be history. All people will look at is evidence. As more and more data becomes available, we will get trends real time. If the data analysis matches the theory, the theory is lucky else the theory does not matter. The broad idea is earlier the onus was on data to match the theory as former was scarce. Now it will be the reverse – the theory has to match the data.
This is the kind of research we should be doing more often in India kind of places. Much of research on mon transmission focuses on formal financial sector whose reach is limited. We still do not know how mon pol effects informal financial sector.
Saibal Ghosh and Rakesh Kumar of RBI look at the issue and have interesting findings:
How times have changed. Earlier any mention of markets automatically meant it is real and good for the people. Not anymore.
Mark Carney of BoE (while releasing the Bank’s Fair and Effective Markets Review Releases Final Report) says we need to build such markets:
- the provision of liquidity to limit contagion;
- a recognition that clear, well-understood codes contribute to the greater good; and
- a belief that financial markets can solve real world problems.
From the coffee houses that served as meeting places for entrepreneurs and merchants; to the exchanges that supported the trading of financial claims; to a central bank that acted as lender of last resort: a rich infrastructure developed to support markets that served the UK and the world. As it grew into the world’s leading economic and trading power, the UK also became its centre of financial capitalism.
It is really surprising to see such reflections. For all you know, BoE and London were seen as the benchmarks for anything in finance.
What are real markets?
I guess our economic commentary is getting really extreme and dangerous. Now we will actually evaluate election outcomes on what it does to the central bank of all things?
So, it was really ironic to see an article like this. It says recent political uncertainty is a boon for its central bank:
ECB didn’t mention the word taper but EZ markets fear it. On the other side of Atlantic, investors in US compare the tapering fears in 2013 with today’s fears of Fed hike. How much economies and markets actually suffer from tantrums thrown by central banks.
First what explains untaper fears in EZ? No clear answers:
An insightful post by Prof George Selgin.
He picks a ppt from a Fed official who taught monetary economics to a school class. Prof Selgin says that the official tried to show how Fed is a superior system compared to the alternatives:
One of the chief goals of Cato’s Center for Monetary and Financial Alternatives is to make people aware of alternatives to conventional monetary systems—that is, systems managed by central bankers wielding considerable, if not unlimited, discretionary authority. The challenge isn’t just one of informing the general public: even professional monetary economists, with relatively few exceptions, are surprisingly ill-informed about such alternatives.
I recently came across a document that perfectly illustrates this last point: a power point presentation by a senior Federal Reserve Bank research economist, given at a conference aimed at school teachers specializing in economics.
I have no desire to single-out the economist in question, who I will therefore refer to simply as “our economist.” On the contrary: I offer his presentation as an example of the all-too common tendency for otherwise competent monetary economists (and our economist is in fact very accomplished) to misread the historical record regarding potential alternatives to central banking and to otherwise give such alternatives short shrift.
This unfortunate tendency rests in part on the fact that most economics graduate programs stopped teaching any sort of economic history decades ago (our economist earned his PhD in the early 1990s), while burdening their students with enough mathematics and statistics to all but guarantee that they never so much as crack open a book on the subject. But the trouble isn’t just that many monetary economists don’t know their monetary history: it’s that they know, and teach, monetary history that ain’t so. That’s what our economist did when he lectured a roomful of teachers on the merits of central banks and “Alternative Monetary Systems.”
Hmm.. Standard way to show how useful you are to the society.
It is frustrating how none of the real monetary history is taught to students. I mean one may disagree with free banking stuff, but atleast it should be taught.
Axel Weber, former head of Bundebank (who could have become ECB chief if he had not resigned) has this nice piece.
He says why CPI based inflation targeting is too narrow an objective. Above all, it does not even guarantee price stability:
Over the last two decades, inflation targeting has become the predominant monetary-policy framework. It has been essentially (though not explicitly) adopted by major central banks, including the US Federal Reserve, the European Central Bank, and the Swiss National Bank. But the 2008 global economic crisis, from which the world has yet to recover fully, has cast serious doubt on this approach.
The Bank for International Settlements has long argued that pure inflation targeting is not compatible with financial stability. It does not take into account the financial cycle, and thus produces excessively expansionary and asymmetric monetary policy. Moreover, a major argument in favor of inflation targeting – that it has contributed to a decline in inflation since the early 1990s – is questionable, at best. Disinflation actually began in the early 1980s – well before inflation targeting was invented – thanks to the concerted efforts of then-US Federal Reserve Board Chair Paul Volcker. And, from the 1990s on, globalization – in particular, China’s integration into the world economy – has probably been the main reason for the decline in global inflationary pressure.
A more recent indication that inflation targeting has not caused the disinflation seen since the 1990s is the unsuccessful effort by a growing number of central banks to reflate their economies. If central banks are unable to increase inflation, it stands to reason that they may not have been instrumental in reducing it.
The fact is that the original objective of central banks was not consumer-price stability; consumer-price indices did not even exist when most of them were founded. Central banks were established to provide war financing to governments. Later, their mission was expanded to include the role of lender of last resort. It was not until the excessive inflation of the 1970s that central banks discovered – or, in a sense, rediscovered – the desirability of keeping the value of money stable.
But how to measure the value of money? One approach centers on prices, with the consumer price index appearing to be the most obvious indicator. The problem is that the relationship between the money supply (which ultimately determines the value of money) and prices is an unstable one. For starters, the lag time between changes in the money supply and price movements is long, variable, and unpredictable. Given this, targeting consumer prices in the next 2-3 years will not guarantee that the value of money remains stable in the long term.
Moreover, different methods of collecting consumer prices yield different results, depending on how housing costs are treated and the hedonic adjustment applied. In short, monetary policy has been shaped by an imprecise, small, and shrinking subset of prices that exhibits long and variable lags vis-à-vis changes in the money supply. Unfortunately, monetary policymakers’ effort to operationalize the objective of ensuring that the value of money remains stable has taken on a life of its own. Today’s economics textbooks assume that a primary objective of central banks is to stabilize consumer prices, rather than the value of money.
Furthermore, economists now understand inflation as a rise in consumer prices, not as a decline in the value of money resulting from an excessive increase in the money supply. Making matters worse, central banks routinely deny responsibility for any prices other than consumer prices, ignoring that the value of money is reflected in all prices, including commodities, real estate, stocks, bonds, and, perhaps most important, exchange rates.
In short, while price stabilization through inflation targeting is a commendable objective, central banks’ narrow focus on consumer prices – within a relatively short time frame, no less – is inadequate to achieve it. This was highlighted by the surge in many countries’ housing prices in the run-up to the 2008 financial crisis, the steep decline in asset and commodity prices immediately after Lehman Brothers collapsed, the return to asset-price inflation since then, and recent large currency fluctuations. All are inconsistent with a stable value of money.
I mean all this has been so obvious but the obsession with IT continues.
Infact Weber says central banks need to look at multiple things:
Central banks’ exclusive focus on consumer prices may even be counterproductive. By undermining the efficient allocation of capital and fostering mal-investment, CPI-focused monetary policy is distorting economic structures, blocking growth-enhancing creative destruction, creating moral hazard, and sowing the seeds for future instability in the value of money.
Within a complex and constantly evolving economy, a simplistic inflation-targeting framework will not stabilize the value of money. Only an equally complex and highly adaptable monetary-policy approach – one that emphasizes risk management and reliance on policymakers’ judgment, rather than a clear-cut formula – can do that. Such an approach would be less predictable and eliminate forward guidance, thereby discouraging excessive risk-taking and reducing moral hazard.
History hints at what a stability-oriented framework could look like. In the last quarter of the twentieth century, many central banks used intermediate targets, including monetary aggregates. Such targets could potentially be applied to credit, interest rates, exchange rates, asset and commodity prices, risk premiums, and/or intermediate-goods prices.
Short-term consumer-price stability does not guarantee economic, financial, or monetary stability. It is time for central banks to accept this fact and adopt a comprehensive, long-term monetary-policy approach – even if it means that, in the short term, consumer-price inflation deviates from what is currently understood as “price stability.” Temporary fluctuations in a narrow and imprecisely measured CPI are a small price to pay to secure the long-term stability of money.
Indian central bank had exactly this kind of framework only to be rejected by the fashionable IT framework. Some IT central banks like say BoE, ECB, etc have atleast understood the limitations of IT game. They have missed the forest for the woods and continue to pay for their mistakes. But they still call them as IT central banks and have added the euphemism flexible to it.
Most fashionable economic ideas of today are only proved as duds in future. This is because we believe too much in scientification of economics. Some idea works in some time and we make a big deal of it and think it will work all the time. Soon the idea is projected as a big theory. The theory becomes even bugger if it comes from the hallowed schools of economics in US. And here is an idea whose limitations have been exposed in the crisi.s But it continues to remain.
There was a time when Mario Draghi was the most celebrated central banker of the world. His famous words “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” stirred European markets like nothing else could. Suddenly markets jumped and ECB ended up lowering yields without spending a penny. This was in 2012 and 2013 leading to several awards for the central banker.
And now we are in 2015, The same news sites which celebrated Draghi are wondering whether the central banker has lost his touch. One’s luck in central banking can only stretch so far. It is the usual story. The awards should instead be titled as the luckiest central banker of the year. Those central banks who claim that they are not cheerleaders of markets are living in utopia. The success of a central banker is just dependent on how markets perceive and cheer the monopolist leader. Most of these awards anyways are usually sponsored by the financial street directly or indirectly.
On to Draghi:
Stan Fisher sums up the lessons he has learnt over the years.
He misses the most important lesson – know the financial history and know it really well. Infact history is not even a word in the speech. Infact, if one follows history then you are unlikely to hype certain phases of economic and stock market growth as a new dawn or something. And then as the crisis enfolds, you know what you have to do. After all, there is nothing unique about having a crisis. History keeps you humble and grounded.
Another thing is how despite likes of Prof. Fisher wanting to be seen as market promoting economists, actually just talk about government and central bank interventions. These evry interventions end up sowing the seeds of the next crisis.
He starts with continued woes of Venezuela, and then gets to Ecuador:
Facing this inflationary theft, Venezuelan’s have voted with their wallets. Indeed, they have unofficially begun to dollarize the economy. But, the only way to establish the rule of law in the monetary sphere is to officially dollarize the economy by officially dumping the hapless bolivar and replacing it with the U.S. dollar.
Ecuador, where I served as the chief advisor to the Minister of Finance, when that country dollarized, offers some lessons that merit Caracas’ attention.
Ecuador represented a prime example of a country that was incapable of imposing the rule of law and safeguarding the value of its currency, the sucre. The Banco Central del Ecuador was established in 1927, with a sucre-U.S. dollar exchange rate of 5. Until the 1980s, the central bank periodically devalued the sucre against the dollar, violating the rule of law. In 1982, the central bank began to exercise its devaluation option with abandon. From 1982 until 2000, the sucre was devalued against the dollar each year. The sucre traded at 6,825 per dollar at the end of 1998, and by the end of 1999 the sucre-dollar rate was 20,243. During the first week of January 2000, the sucre rate soared to 28,000 per dollar.
In the case of Ecuador, the inability of the government to abide by the rule of law was, in part, a consequence of traditions and moral beliefs. Ecuadorian politics have traditionally been dominated by elites (interest groups) that are uninhibited in their predatory and parochial demands on the State. With the lack of virtually any moral inhibitions, special interest legislation was the order of the day. For example, during the rout of the sucre in 1999, laws were passed that allowed bankers to make loans to themselves. In addition, state guarantees for bank deposits were introduced. These proved to be a deadly cocktail, one that allowed for massive looting of the banking system’s deposit base. This, as well as the collapsing sucre, enraged most Ecuadorians.
With the rule of law (and the sucre) in shambles, President Mahuad announced on January 9, 2000 that Ecuador would abandon the sucre and officially dollarize the economy. The positive confidence shock was immediate. On January 11—even before a dollarization law had been enacted—the central bank lowered the rediscount rate from 200% a year to 20%. But, this newfound ray of hope was threatening to some, and during a 24-hour period (January 21–22), a coup d’état ensued. While the Mahuad government was toppled, the coup was a bungled affair and the former Vice President Gustavo Noboa assumed the Presidency. He honored Mahuad’s dollarization pledge. On February 29, the Congress passed the so-called Ley Trolebus, which contained dollarization provisions. It became law on March 13, and after a transition period in which the dollar replaced the sucre, Ecuador became the world’s most populous dollarized country on September 13.
With much the same enthusiasm as Ecuador’s coup plotters and the rigidity of a dogmatic cleric, the critics of dollarization condemned it as something akin to voodoo economics. Well, the critics have been predictably proven wrong.
The misery index is an objective measure of just how well dollarization has worked. The index is equal to the sum of the inflation rate (end of year), bank’s lending interest rates and unemployment rate, minus the actual percentage change in GDP per capita. Simply put, a high index means higher misery.
In Ecuador, prior to the implementation of dollarization in 2000, the country sustained a misery index of over 120. The public suffered greatly from inflation, but after dollarization was implemented, high inflation was stifled and misery drastically fell. The accompanying chart shows the direct link between dollarization and the immediate and sustained decrease in misery. From 2003 through 2014, the misery index in Ecuador has been remarkably constant at around 20 — one of the lowest in Latin America.
Interesting cases on monetary systems around the world..
Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as Decisive LeaderMay 27, 2015
This is the title of a recent book by Mark Toma and is reviewed here.
I mean Great Depression research still remains so relevant. More importantly, scholars are undoing whatever we have learnt about the depression. One such common lesson is role that Ben Strong of NY Fed could have played in resolving the depression if he was alive. After all it was Milton Friedman who made this idea popular.
Not anymore as it has been discussed in this book. AS the reviewer points out:
Mark Toma’s short, but dense Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as a Decisive Leader provides a revisionist history of the Benjamin Strong leadership years at the Fed leading up the Great Depression. Despite the title, the book focuses entirely on this period and doesn’t delve into the actual causes of the Great Depression. Rather than provide a casual explanation of the Great Depression per se, Toma’s project is to convince monetarist and Austrian economists that both of their accepted histories of the Great Depression are empirically unfounded. Thus, Toma argues that mismanaged monetary policy — tightening per the monetarist narrative or loosening per the Austrian narrative — can be ruled out as a causal factor of the Great Depression.
In questioning the Strong decisive leader theory — the theory that Benjamin Strong played a decisive role in the monetary policies of the 1920’s as the President of the influential New York Federal Reserve Bank and that his untimely death ultimately led to the wrong-headed policies that brought on the Great Depression — Toma does not stand alone. Temin (1989, 35), Wheelock (1992), and Brunner and Meltzer (1968) all question the strong leader hypothesis. However, Toma discredits each of their theories and forges a completely new explanation for why Strong’s leadership was not a decisive factor. Toma makes the case that the Fed operated as a self-regulating, decentralized system. According to Toma, this system operated effectively as intended, so the credit for Friedman and Schwartz’s (1963, Ch. 6) description of the 1921-1929 Fed era as the “high tide” of the Fed system should go to the founders of the Fed, not Benjamin Strong.
Overall, the book would have benefitted from a more thorough engagement with the modern literature. Instead of addressing modern developments and more nuanced and refined arguments in the monetarist and Austrian tradition, Toma sets up the book against the narratives of Rothbard (1975) and Friedman and Schwartz (1963).
Hmmm.. Have not read the book so no comments.
All I can say is we have this tendency to glorify certain individual and try and make him/her accountable for all goods/bads especially in an institutional setting. Reality is a lot different and one has to see a broader political picture. What matters more is how political systems have designed certain institutions and the structure therein. This is a much more important story and plays out for a longer period of time. Person based stories last only till the luck lasts..
It is also important to note how certain narratives remain despite them being proven wrong/right by subsequent scholars..