Archive for the ‘Central Banks / Monetary Policy’ Category

Split within RBI MPC flags flawed inflation model…A case of too soon?

August 10, 2017

Anirban Nag has a piece reflecting on the recent MPC split. He says the core problem behind split is the inflation model which is out of sync with Indian reality.

…the split raises questions on how much trust the MPC members place in the monetary authority’s forecasting model, which has consistently overestimated price pressures. 

The RBI’s inflation assessments have come under intense scrutiny after a slew of readings fell short of projections. Prime Minister Narendra Modi’s Chief Economic Adviser Arvind Subramanian criticized forecast errors that he said are “large and systematically one-sided in overstating inflation,” and called on policy makers to take a long, hard look at June’s record-low 1.5 percent reading.

where the RBI’s model is probably flawed is that it is structured around the concept of a small, open economy, according to Rohan Chinchwadkar, assistant professor of finance and accounting at the Indian Institute of Management at Tiruchirapalli in the southern state of Tamil Nadu. That would be akin to $300 billion Singapore, while India is a $2 trillion behemoth where almost half of gross domestic product is generated by an intricate web of unregistered networks that employ more than 90 percent of workers. 

“This might be one of the causes of disagreement within the RBI,” Chinchwadkar said. “There is no clear model understanding of the impact of monetary policy and shocks on India-specific features like the informal sector and shadow economy. So the position of MPC members depends on their own judgment and risk preference.” 

The central bank’s staff published a working paper in November in collaboration with the International Monetary Fund, aiming to “sketch out a model with India-specific features to capture the dynamics relevant to an emerging market economy.” It concluded that forecasting performance is improved by using the Bayesian statistical technique which assesses the probability of something happening based on observed data. 

The current model is based on the principles of New-Keynesian economics, which evolved from classical Keynesian economics but differs in terms of how quickly prices and wages adjust. It consists of four variables: the output gap, the Phillips curve which assesses the impact of unemployment, the Taylor rule for short-term interest rates that also guides several global central banks, and interest rate parity through exchange rates.

When India moved towards the new monetary policy framework recently, it was suggested that India joins the ranks of advanced countries. Gone are the days where policy was driven by experience and discretion and now is the era of rules and models…

Now we are told that the model does not reflect Indian reality and one has to go back to the drawing board.


A closer look at the Fed’s Balance Sheet accounting (applies to other central banks as well)…

August 4, 2017

There are two subjects apart from economics which are vital to understanding monetary policy: law and accounting. We have seen importance of law in India’s demonetisation and even advent of digital currency which has made us look at terms like legal tender, currency etc that have legal meanings. Knowledge of Accounting is crucial to understanding central bank accounts which tells us how central banks add or subtract reserve money which was also a big puzzle during demonetisation. Also, law has a lot to do with how accounting will be eventually done.

 have a nice post on accounting policies followed at Fed’s balance sheet. This applies to most central banks as well:

When a Reserve Bank purchases a Treasury security, it purchases an asset, typically from a bank or broker-dealer. It credits reserves (a liability of the Fed) to the reserve account of the seller (or the seller’s bank). The bank or broker-dealer may sell its own securities or may act as an agent on behalf of a client. As a holder of a Treasury security, a Reserve Bank has no special rights relative to other Treasury-holding entities. The Treasury security that the Fed has purchased is not “paid in full.” It remains an asset on the Fed’s balance sheet until the security matures or is redeemed by the Treasury in accordance with the terms of issuance. 

As the nation’s central bank, the Fed plays a number of important public policy roles, and monetary policy does indeed have fiscal implications. In trying to understand the effects of the Fed’s actions on public finances and debt, it can be convenient, in some cases, to think about a consolidated public sector balance sheet that sums together the respective assets and liabilities held by the Fed and the federal government. Nevertheless, as noted in an answer to a comment on our earlier post, the Federal Reserve Banks are independent entities, with their own balance sheets, separate from that of the Treasury. There is no authority to consolidate Reserve Bank and Treasury balance sheets. 

One might wonder whether the Fed could coordinate with the Treasury and agree to an accounting offset, so that every time the Fed buys a Treasury security, the security is considered “paid in full.” In fact, neither the Board of Governors nor any Reserve Bank is authorized under the Federal Reserve Act to fund the repayment or retirement of a Treasury security; only the Treasury can do so, and it can do so only under the terms under which it issued the security. 

Even if it could coordinate with the Treasury and agree to an accounting offset every time it buys a Treasury security, the Fed may prefer to hold on to these assets for future use. Indeed, just like any other entity with Treasury holdings, a Reserve Bank may resell or lend Treasury securities—as the New York Fed does—subject to the Section 14 open market limitation and FOMC directions. But again, a Reserve Bank does not have the authority to fund the payment or retirement of Treasury securities, which are obligations of the U.S. government. 


The role of political environments in the formation of Fed policy under Burns, Greenspan, and Bernanke…

August 4, 2017

Interesting paper by  Alexander William Salter of Texas Tech University  and Daniel J. Smith of Troy University.


The underpinnings of RBI monetary policy: Just mimicking models in US?

August 4, 2017

Indira Rajaraman has a nice piece on underpinnings of India’s monetary policy. Right at the beginning, she says the article is not the usual noise ones: how much rate cut, too little too late types. But instead analyses the process.

She says earlier worries were MPC members singing similar tunes (even at time of demon). Now the worry is over the divergent vote patterns as members are divided over inflation trajectory:


RBI’s proposal for a Public Credit Registry: A case of too many already..

August 3, 2017

RBI announced yday to set up a high level committee (whatever that means) to study public credit registry.

To address the information asymmetry between borrowers and lenders as well as to make the credit market more efficient, private Credit Bureaus and Public Credit Registry (PCR), generally operated by the central bank or a supervisory authority, work in tandem in most of the countries. In India, as of date, four credit bureaus or Credit Information Companies (viz. CIBIL, Equifax, Experian and CRIF Highmark) are running, which are regulated by RBI under Credit Information Companies (Regulation) Act, 2005 (CICRA 2005). Within RBI, Central Repository of Information on Large Credits (CRILC) has been created to cater to the supervisory needs by tracking large exposures. RBI also has a comprehensive Basic Statistical Return (BSR-1) database with granular account level information on credit.

A PCR can potentially help banks in credit assessment and pricing of credit as well as in making risk-based, dynamic and countercyclical provisioning. The PCR can also help the RBI in understanding if transmission of monetary policy is working, and if not, where are the bottlenecks. Further, it can help supervisors, regulators and banks in early intervention and effective restructuring of stressed bank credits.

In view of the above, it has been decided to constitute a High-level Task Force comprising experts as well as major stake-holders to (i) review the current availability of information on credit in India; (ii) assess the gaps that could be filled by a comprehensive PCR; (iii) study international practices; and, (iv) suggest a roadmap, including the priority areas, for developing a transparent, comprehensive and near-real-time PCR for India.

Prashanth Regy says what RBI says as well: there are 4 existing companies. How will another one help?


Will issuance of private currency help undermine government issued money?

August 3, 2017

J Fernández-Villaverde and D Sanches have a fairly technical paper looking at private players issuing their own currency along with central banks money. They summarise the findings:

 They say that Hayek’s idea of introducing private money will not lead to desired benefits.

Our analysis offers several valuable insights.

  • In general, a monetary equilibrium with private monies will not deliver price stability. When money is issued by a profit-maximising entrepreneur, that person will try to maximise the real value of seigniorage. There are many cost functions when minting money, so this maximisation does not imply that the entrepreneur delivers a stable currency. For example, if the cost function is strictly convex, entrepreneurs will always have an incentive to mint additional units of the currency. When Hayek conjectured that a system of private monies competing among themselves would provide a stable means of exchange, he was, in general, wrong. When money is issued by an automaton, there is no particular reason why the quantity of money will be compatible with price stability (except by coincidence). Bitcoin has already decided how many new units of currency will be issued in 2022, even though nobody knows what the demand for currency will be in that year.
  • Even when the cost function of minting money is such that we have an equilibrium with price stability, there is a continuum of equilibrium trajectories where the value of private monies monotonically converges to zero. The self-fulfilling inflationary episodes construed by Obstfeld and Rogoff (1983) and Lagos and Wright (2003) in economies with government-issued money are not an exclusive feature of public monies. Self-fulfilling inflationary episodes are, instead, the consequence of using intrinsically useless tokens (even if they are electronic and issued by private profit-maximising, long-lived entrepreneurs), whose valuation can change depending on expectations about the future.

But, as economists, we do not care about price stability per se. The goal of a well-behaved monetary system must be to achieve some efficiency goal. There is a third, and perhaps most important, result:

  • A purely private monetary system does not provide the socially optimum quantity of money even in the equilibrium with stable prices. Despite having entrepreneurs that take prices parametrically, competition cannot provide an optimal outcome because entrepreneurs do not internalise, by minting additional tokens, the pecuniary externalities they create in the market with trading frictions at the core of all essential models of money (Wallace 2001). These pecuniary externalities mean that, at a fundamental level, the market for currencies is very different from the market for goods such as wheat, and the forces that drive optimal outcomes under perfect competition in the market for wheat will fail in the market for money. The ‘price’ of money itself does not play a fully-allocative role: if one believes that money is used because there are frictions in transactions, one should not believe that the market can provide the right amount of money. (This argument slightly modifies the ideas in Friedman 1960.)

These three results cast serious doubts on Hayek’s proposal of currency competition. In most cases, a system of private monies will not deliver price stability and, even when it does, it will always be subject to self-fulfilling inflationary episodes, and it will supply a suboptimal amount of money. Currency competition works only sometimes, and partially.

But it will keep a check on government issued currency:

There is an important lesson here: the threat of competition from private monies imposes market discipline on any government that issues currency. If a central bank, for example, does not provide a sufficiently ‘good’ money, then it will have difficulties in implementing allocations. This may be the best feature of cryptocurrencies. In a world in which we can switch to Bitcoin or Ethereum, central banks need to provide, paraphrasing Adam Smith, a tolerable administration of money. Currency competition may have a large upside for human welfare after all.

The Free bankers will obviously disagree with the findings. There is a lot of history behind private vs government money..

RBI discloses more information related to voting behavior of MPC members

August 2, 2017

The much anticipated monetary policy decision was is in line with expectations: A 25 bps cut in Repo rates.

Much of the statement is the same old story with not much difference. Though, there was one difference.

In previous Resolution statements, RBI just said an X member was not in favor but did not tell what did the X member vote for. The details were released in MPC minutes. For instance, previous policy said:


The role of accountants in the process of economic development

August 1, 2017

Interesting speech by Mr Rameswurlall Basant Roi, Governor, Bank of Mauritius.

You rarely see a central banker speak about role of accountants and auditors. He says role of accountants as auditors is as crucial as any.

Thank you for having invited me to speak to an audience of accountants. It’s a first for me. On the occasion of this Forum organized by the Mauritius Institute of Professional Accountants (MIPA), it’s my pleasure to share with you some of my thoughts on the role of accountants in the process of economic development.  Let me at the very outset stress that contributions of accountants to the process of economic development are generally not direct. But their services as external auditors of financial institutions make direct contributions to the efficient functioning of financial markets which, in turn, allocate scarce resources to economic sectors and facilitate the process of economic development.

It is not just about importance of accountants but even importance accounting. Knowledge of basic accounting is really useful in economics to understand balance sheets and flow of funds. But the econ profession hardly pays any attention to teaching these basics.


It is even more ironical to see how Finance and Accounts professions have diverged in academia over the years. The Finance professors say they don’t know accounting and Accounting professor says they don’t know finance! We are just building more and more silos..

Why the quest for a single currency for West Africa won’t materialise soon

August 1, 2017

Interesting piece by Prof. Tahiru Azaaviele Liedong of University of Bath. One would imagine most monetary union projects would be stalled seeing the case of Europe, but not really.

Apparently there are 15 West African countries which want to form a monetary union. Of these 15, 8 are French colonies, 5 English and two are Portuguese. Of the 8 French colonies, 7 are already in a monetary union along with one of the Portuguese speaking nations (Guinea-Bissau). Their common currency is CFA Franc.


Why can’t the Government/RBI appoint Deputy Governors in time?

August 1, 2017

It has become a habit of late to keep key positions at RBI empty despite knowing the positions are going to be vacant due to retirement/rotation.

As big decisions like demonetisation were implemented with three Deputy Governors  and most Board positions being empty. We learnt later that of the three Deputy Governors, just two were present in the meeting.

Now, it has been known that one of the Deputy Governors-S.S. Mundhra- is going to retire on 31 July 2017. RBI even released an advertisement for the position which is a good practice compared to previous appointments whose process was not really known.  The ad was released on 24 May 2017, so there was ample time as well. Though, the open ad created controversy as there were allegations that RBI intends to appoint a banker from the private sector.

We were also told about people in the fray but they were to be interviewed on 29 July which was really close to the date of retirement of Mr Mundhra.

As there was no decision by 31 July or it was delayed, RBI had to shift responsibilities between the 3 DGs.Mr Mundhra handled following tasks:


RBI monetary policy trivia: Why policy has been announced mostly on Tuesdays?

July 31, 2017

I have been wanting to write this post for a long time but somehow keep forgetting.

I have been noticing for a while that RBI prefers to announce its monetary policy decision on mostly Tuesdays. So, just wanted to check whether the noticing matches with the facts. For most this will be just trivia and feel free to ignore.


Thomas Alva Edison too had a plan for monetary stability…

July 31, 2017

JP Koning is not just letting us know what economists have written on history of money and monetary system. He is also telling us about what experts from other fields have written about monetary systems. There was an earlier tweet on Copernicus writing about money.

Now there is another tweet which tells us Edison too had a solution for reinventing the US monetary system in 1920s. He suggested that instead of gold backed dollar, dollar should be backed by agri commodities like wheat, oats etc. Edison thought the gold backed dollar mainly favored the Eastern part of US economy. A crop backed Dollar would be beneficial to Southern and Western parts which had significant agri base.

The article says think of this as Bill Gates advocating similar standard and asking to dismantle the Federal Reserve.

The plan was that government would set up 12 warehouses across the country which will store 36 crops grown in the country. The farmers could store their crops and get a certificate against the same. This certificate will be equivalent to cash leading to monetisation of the crop. The farmer will hen take the certificate to a bank and get it exchanged for currency (50% of crop value and so on…).

The plan did not get much support from economists and the quality of responses (harsh language) led Edison to be disappointed and drop the idea. The plan was obviously ahead of its times and if not money, it is just like call option or warehouse financing of today.

There are more details in the article.

Superb stuff..

The Fed Ups: New Inflationists in town arguing for a higher inflation target…

July 28, 2017

Prof Larry White has a scathing piece on continued attempts by economists to push central banks into influencing real economy. Recently, several top US econs signed an open letter asking Fed to raise inflation target.

Prof White says these are the new Fed ups in town:


ECB continues to warn governments against war on cash…

July 27, 2017

Not all central banks have joined hands with their respective governments (rather bowed to governments’ pressure) on war on cash. ECB is one such central bank and its unique structure could be a reason for this. It is not answerable to any one country/government and can express itself much freely compared to others on the matter.

I had earlier pointed how it has asked two governments to go slow on war on cash. These were Portugal and Belgium.

Now it asks Bulgaria to go slow as well.  The Bulgarian Govt wants to lower transactions in cash:

The draft law seeks to gradually decrease the maximum limit for cash payments in Bulgaria from the current limit of BGN 10 000 to BGN 1 000 by 2019. The same maximum limit would apply to the payment of instalments in performance of a contractual obligation where the total amount is above
the maximum limit.
1.2 As in the currently applicable law, the maximum limit would apply both to payments in BGN, as well as payments in foreign currencies which are of equivalent amounts.

ECB says:

In particular, the decreasing limits on cash payments proposed by the draft law need to take into
account the advantages of having limits on cash payments in place and the potential
inconvenience thereof for citizens’ regular transactions in certain market segments. Setting the
limitation at these levels may make it difficult to implement the limit in practice. In this regard, it
should be noted that Directive (EU) 2015/849 of the European Parliament and of the Council14,
whilst confirming the vulnerability of large cash payments to money laundering and terrorist
financing, nevertheless applied customer due diligence measures to cash payments of EUR 10 000
or more. This implies that the draft law should establish a proportionate threshold for limits to cash
payments, taking into account the objectives of such limits.

2.11 Against this background, the ECB considers the lowering of the limit on cash payments to BGN
1000 (approximately EUR 500) by the 1st of January 2019 as disproportionate, in the light of the
potentially adverse impact on the cash payment system. In case the legislator wishes to pursue the
proposed cash payment limitations a higher threshold should be chosen and a degree of flexibility
should be introduced in the draft laws by, for example, allowing the delivery and receipt of cash
payments for compelling reasons or for reasons that are outside the individual’s control15, such as
where no payment service provider is available at the place or time of the payment. It might also be
advisable to allow cash transactions above the defined thresholds as long as the parties are able to
ensure that the payment is traceable by identifying the amount, the reason for the transaction and
the parties involved.

More importantly, it is putting all these discussions on its website for all to access. So unlike India, where we are moving from one rumor to another.


RBI stops printing Rs 2000 notes and focus printing on Rs 200 note?

July 26, 2017

The secret wars on banknotes continue in India. It was never clear from the RBI Board meeting when Rs 2000 was issued. Likewise, as news started doing the rounds of launch of Rs 200 note, there was no clarity again on whether and which Board meeting cleared the issue of Rs 200 note.

Both cases of issuance of Rs 2000 and Rs 200 notes, these were new denominations. Section 24 of RBI Act says:


Looking at the Stars while making economic policy…

July 26, 2017

John K Galbraith famously said: “The only function of economic forecasting is to make astrology look respectable.” 

Least did he know economists would take this seriously!

RBNZ Deputy Governor titles his speech: Looking at stars! Just that these stars are the unobserved variables which economists try along which economists shape the economy:


RBI MPC members to be paid much more per meeting than RBI Board members..

July 25, 2017

There was this recent news on compensation terms for RBI MPC members:


Linking usage of English language with monetary policy: Role of verbs in Central bank communications..

July 25, 2017

This is quite an interesting paper by Banca D’Italia economists – Maddalena Galardo and Cinzia Guerrieri.

They look at ECB policy statements and look at verb usage in them – will, expect etc. They use this to figure whether the verbs impact the money markets.

This paper has addressed a relevant question concerning central bank governance, i.e. whether and the extent which the verbal guidance has been effective in shaping the financial markets’ expectations on future short-term interest rates. The answer to this question crucially depends on the way central bank communication is measured. Despite the burgeoning literature on this topic, our paper has proposed a novel approach based on the frequency of future markers in monetary policy statements.

We have considered the European Central Bank communication strategy as a testing case. The main findings are as follows: (i) our verbal guidance index is able to capture the evolution towards explicit forward-looking statements, especially in the aftermath of the Global Financial Crisis and well before the forward guidance on key policy interest rates announced firstly on July 2013;

(ii) the results from the econometric analysis have showed that using a future tense that is perceived by the public as a commitment in pursuing a particular monetary policy stance is indeed effective in shaping future short-term interest rates expectations. In particular, the stronger is the surprise in speaking about future, the stronger is the effect on interest rates, especially for longer horizons.

To conclude, we have performed our analysis during a period characterized mostly by a dovish attitude, and thereof the results are valid in a context of
accommodative monetary policy stance. Although it is not possible to state if these implications hold in a hawkish context too, our results shed light on
the importance of the verbal tenses used to signal future actions.

In the middle of the paper, there is this really interesting discussion on English language and grammar rules which just make the paper quite interesting. It isn’t a typical mechanical paper on central bank communications but stresses on reading the policy statements carefully.

What is next? Role of adjectives?

What is Dictionary Money? When Governments can change value of unit of account almost at will..

July 24, 2017

Most books on monetary economics tell you there are three functions of money:

  • Store of value
  • Unit of account
  • Medium of exchange

All these are taught really mechanically and one is always struggling to figure the differences and meanings of the three terms. What we and our textbooks forget is that all these ideas have evolved historically and the story is hardly as linear.

The superb JP Koning in his new blogpost takes us through the history of unit of account idea. Earlier, we hardly had a fixed unit of account as today. Kings were free to announce and change value of the coins as and when. This was in a way like dictionary money where the meaning of money changed everyday:


Fintech: Is This Time Different?   A Framework for Assessing Risks  and Opportunities for Central  Banks 

July 24, 2017

Nice policy research paper by Bank of Canada economists:

Fintech is likely to increase competition and improve financial inclusiveness, which could reduce the cost of financial intermediation. If financial intermediation changes fundamentally, the traditional tool kit of central banks might be at risk. In this paper, we provide a framework to analyze the economics of various fintech solutions by focusing on the component technologies and underlying frictions that they solve. Moreover, we study the business models that some fintech firms are employing to understand which characteristics will likely lead to broad adoption of their technology. Our framework is meant to be general enough to use as fintech advances. Going forward, central banks and regulators will have to monitor whether these new technologies and business models are fundamentally changing money demand and the industrial organization of financial intermediation.

In this paper we focus mostly on banks and DLT. With respect to banks, we conclude that fintech firms will have incentives to either find new economies of scope or exploit the traditional economies of scope of banks by becoming regulated entities. Banks, on the other hand, will acquire or adopt the fintech innovations but might be hindered by their current business models. Lastly, we conclude that fintech might bring more change by creating new financial
intermediation applications than by changing the ones that exist today.

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