Archive for the ‘Central Banks / Monetary Policy’ Category

The recent surge in bond yields and the disconnect from fundamentals..

May 13, 2015

Despite easing policy stance, Indian govt bond yields jumped in India tracking MAT issue and global volatility. This led to certain corporates shelving plans to raise corporate bonds as well.

The rising yields have dampened the sentiment among investors. According to issue arrangers, Steel Authority of India (SAIL) and GIC Housing Finance are among companies that were planning to raise funds through private placement of bonds but have deferred the issuances after seeing the response. The yield on the 10-year benchmark government bond has hardened by 19 basis points in the last two weeks in line with global debt market yields, over concerns of rising oil prices. A weaker rupee and foreign fund outflows from the domestic share and debt markets have also been hurting.

“Due to the recent volatility of markets and upsurge in yields, companies are postponing their bond issuances. The appetite of investors has got impacted. GIC Housing Finance and SAIL postponed their issuances. Both were planning to raise three-year paper but they found the bid levels high for raising funds,” said Ajay Manglunia, senior vice-president (fixed income), Edelweiss Securities.

Similar trends are seen across some countries as well. Of all countries, Germnay has seen a jump in yields. The article says how stability breeds instability:

Central banks are getting a painful lesson in how their efforts to stabilize markets and boost their economies can, occasionally, do the opposite. The latest example is the brutal selloff in the German bond market. Yields on the 10-year German government bond, or “bund,” hit 0.67% Tuesday, up more than half a percentage point in just three weeks.

It’s hard to pinpoint a fundamental factor driving this. Yes, the European economy is doing better than expected, and Greece has, for now, avoided default or an exit from the euro as it wrangles further with its creditors over the terms of its bailout. Both factors have attenuated the “flight to safety” that made bunds so attractive.

But the main driving factor driving yields up is more technical than fundamental, and is in a strange way the result of central banks’ success in pushing yields down. Those efforts have led investors and traders to take on bigger positions, according to strategists atJ.P. Morgan. But when prices start to move against them, they respond by shrinking their positions, which can accelerate the movement in prices.

This is not the first time it’s happened. Last October, it was Treasurys, whose yields shot from 1.865% to 2.15% in a single day and eventually climbed to 2.4%. In the spring of 2013, something similar happened to Japanese government bonds.

What all three had in common, according to Nikolaos Panigirtzoglou and his colleagues at J.P. Morgan, is that all were driven by investors and traders using a risk management technique called “value at risk” (or VaR) that causes them to take on larger positions when volatility is low, because the steep price swings that inflict large losses are less likely.

Central banks have bought massive amounts of government bonds and used forward guidance to reassure investors that interest rates will remain near zero for a long time to come, a strategy aimed at lowering the cost of credit, encouraging investors and businesses to invest more, and raise inflation, which is now too low.

In the process, they have taken much of the guess work out of interest rates in recent years, causing bond market volatility to collapse. In that environment, VaR encourages traders to take on ever large positions. Markets are now heavily populated by VaR-sensitive investors: hedge funds, mutual fund managers, dealers and banks.When volatility ticks up, VaR also prods them to unwind those positions to avoid big losses, causing volatility to spike higher.

These movements are further exaggerated by the decline in bond market liquidity, i.e. the lack of dealers willing to take the other side of a client’s trade, due to a variety of structural and temporary factors. For example, dealers routinely “borrow” bonds from long-term holders such as insurance companies to facilitate their transactions. But German investors have become increasingly reluctant to lend out their precious bunds. Liquidity has been a particular problem for the futures contract on the 30-year bund, J.P. Morgan says.

“This volatility induced position cutting becomes self- reinforcing until yields reach a level that induces the participation of VaR-insensitive investors, such as pension funds, insurance companies or households,” Mr. Panigirtzoglou and his colleagues write. They refer to these episodes as “VaR shocks.”

VaR’s limitations are well known. By design it excludes or downplays rare episodes of extreme volatility. It is meant as a risk management tool, not a robotic buy or sell device. Yet VaR mimics the limitations of our own brains, which have trouble assuming circumstances that are at odds with those we have recently lived through.

Hmm.. Further:

Decades ago the late economist Hyman Minsky identified a similar phenomenon in the broader economy. A long period of steady growth with low inflation can persuade firms, workers and investors that recessions and crises are a thing of the past, and take on more risk as a result, for example by buying overvalued assets with debt.

“Stability is destabilizing,” Mr. Minsky said. He didn’t survive to see that prediction come true with a vengeance in 2008, an event Paul McCulley, then of Pimco, dubbed a “Minsky moment.”

Thus, in a larger sense, central banks’ efforts to hold down bond yields suffer from a similar shortcoming to their much bigger efforts to stabilize the economy, hold inflation low, and maximize employment. The more successful they are, the more they plant the seeds for a reversal of that success.

This is not a reason to abandon those efforts, because most of the time, they succeed (and are, in any event, better than the alternative, which is to do nothing). It is a reason to be aware of their limitations.

It also means central bankers need to be careful before assuming that market prices reflect fundamental developments. Many saw the big drop in German bond yields until mid-April as a ringing affirmation of the success of the European Central Bank’s bond-buying program. Similarly, some will see the recent selloff as evidence of failure. Neither sentiment is true.

Most of the time central banks only go wrong. The hubris they show over their control over economy only leads to huge failures later on. You keep going back to Austrians who have deplored all this rise of central banking and their interventions in economy..

Why budget and experts should not obsess over fiscal deficit target…

May 11, 2015

Sashi Sivramkrishna of NMIMS (Bengaluru) has written a much needed piece. Slightly late as Budget hype is over but nevertheless.

It says Budget should be about governance and other issues. Fiscal Deficit is an outcome dependent on many factors and is not really in control of the govt. All this obsession only leads to fiscal gimmikry as finance minister only tries to meet the target and ignores the rest.

Nations, unlike households, do not face budget constraints. Fiscal defi cit targets therefore cannot be the objective of macroeconomic policy. Instead, budget discussions must focus on governance, supply-side bottlenecks and on policies to raise aggregate demand.

….It is time that the Indian government recognises the immense policy space available to it as a sovereign nation and does not succumb to unnecessary constraints imposed on it by rating agencies and media hype. So why are myths about the need to balance budgets propagated by the economics community? One possible answer is what Samuelson once mentioned to Mark Blaug:

I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one  of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and ineffi ciency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in away that the long-run civilised life requires (qtd in Wray 2010).

This obsession over fiscal and inflation targets has all become so stupid really. It seems nothing else matters. Just like the west, we have moved macroeconomics to just these two numbers and two institutions (fin min and central bank) which has made us miss many a things.

HDFC Bank offers unsecured personal loans in just one minute..

May 7, 2015

This blog is really interested in the new products/technology offered by financial firms and banks.

Came to know of this loan  from HDFC Bank where you get a loan processed in just one minute.

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Common sense on the financial crisis – don’t blame financial markets

May 7, 2015
Patrick Minford of  Cardiff Univ has this piece:

Well, you get what you sow. Before the crisis there was tremendous hubris around what finance and monetary policy can do. The whole thing was to just deregulate finance and let central banks be free from govt (and be slave to finance). As both collapsed, they are all out to blame each other. The econ models may show one factor ruling over other (as is the case in this article), but we know such models have limitations. Just change a few equations and results could be very different.

The financial crisis was a combination of many things but above all it was hubris in economic and finance thinking which paved the way..

Flip flop over Indian central bank’s new roles/objectives..

May 7, 2015

Ever since the Budget 2015-16, there has been a lot of noise around Finance Bill which was to redefine Indian central bank’s new role. Actually the role isn’t anything new but was to become more precise and defined in form of inflation targeting.

Like all other IT central banks this would have meant RBI giving up all the powers to look at so called multiple indicators. The objective shall be just one – target inflation. Despite limitations of the IT framework which has been exposed during this crisis, we have gone ahead with the framework. Even the so called independence idea that IT central banks are more independent needs to be questioned.

But then we have gone ahead with these ideas (without much debate), so we should stick by it and make all the necessary changes required to make the framework consistent as explained here.

But  what is it that we see? The parts of Finance Bill which were to make this new policy consistent have been rolled back. Even worse is to see  experts who  hyped these changes have celebrated it as a victory of Indian central bank! They see that Indian central bank will continue to maintain its powers and not lose it to irresponsible govt. Really? This is just like the emperor’s new clothes story where the tail0r keeps fooling the king and public that there is something really fashionable the king is wearing but the reality was he was not wearing anything at all.

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Real meaning of central bank independence – independent from govts but slaves to financial markets

May 5, 2015

A nice rejoinder by Anantha Nageshwaran on the overhyped idea of central bank independence.  – http://tgs.nationalinterest.in/2015/05/05/central-bank-independence/

He says CBI means independent from govt but complete slaves to financial markets:

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History of India’s forex market..

May 5, 2015

Nice speech by G Padmanabhan, retiring ED of Indian central bank http://www.bis.org/review/r150410c.pdf

He handled the forex department and tells this useful story of evolution of Indian forex market. A good read..

 

Could machines put Central Bankers out of a job?

April 28, 2015

Interesting post reviewing  a paper by Prof. Randall Kroner. He says technology could make jobs of banks and central banks irrelevant. So what Milton Friedman espoused technology can achieve:

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Game of Thrones Economics: Why Doesn’t Westeros Have A Central Bank?

April 27, 2015

I have no idea about Game of thrones or Westeros.But this article on why there is co central bank in the game is interesting.

The Austrians would be happy seeing no such thing and attribute the success of the game for its absence. Whereas other schools might add that to spice the game, a central bank is a must…

Rethinking macroeconomic policy…

April 23, 2015

Oliver Blanchard sums up the views on macro policy at recently held IMF/WB meetings.

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Moving Towards Free-Market Money..

April 15, 2015

A good discussion at Cato Institute.

One of the discussants mentioned about making Fed chief completely irrelevant:

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Should monetary policy take into account risks to financial stability?

April 15, 2015

Blogger Bernanke does not think so. He says financial regulation is the best way to manage financial stability, even if it is limited in scope.

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Regulate the Carry Trade..

April 15, 2015

Harold James advocates the regulation of carry trade.

He says large volumes carry trade are distorting world economies:

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Who would mortgage their children?…Developed countries of all people?

April 14, 2015

Mr Norman T L Chan, Chief Executive of the Hong Kong Monetary Authority has this interesting speech on the topic.

He begins quoting from 1942 movie:

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A number of different institutional arrangements of monetary system..a discussion

April 13, 2015

Lucas M. Engelhardt has a nice discussion on this.

None of our textbooks discuss any of this and we are made to believe that current form of central banking is the best form. 

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Have long-term inflation expectations declined in US?

April 7, 2015

Nice paper by Fernanda Nechio of FRBSF.

The reading on inflation may have declined, but inflation exp remain anchored at 2%:

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The continuous media speculation over rifts between Indian finance ministry & central bank..

April 7, 2015

It is amusing to say the least how media continues to cook stories over rifts between Indian finance ministry and central bank. One day there is a rift and just the next day the rifts are bridged.

First and foremost, central bank independence is a very strong and wrong term. At best, one can talk about central bank autonomy like any other public sector organisation. The broad objectives are set by the government and central bank tries to work towards them. In terms of autonomy, the idea is that the govt does not interfere in day to day activity of the central bank and lets it function. When we say independence, the idea is the central bank is completely independent to do what it wishes to do which is just wrong. How can an organisation be completely independent when it is funded completely by the govt.? Moreover, all the senior appointments are made  by the govt just to provide credibility and in India’s case most are required to work at finance ministry before the central bank (and rejoin FinMin after the central bank stint to get to IMF/World Bank etc). So where is the case for independence as we mean by the term really?

Second, the word became fashionable after western economists who have tried to minimise the role of government and fiscal policy in whatever possible way. So we have lots of papers on the fancy word forgetting the basic structure of the central bank which has govt written all over it. The ignorance of central bank history has also played a major role. There is a feeling that this bank has suddenly sprung up and govt is trying to intervene in it. They forget that all central banks have been created by govt to give them control over currency and finance issues. It is nothing but a govt body. Monetary policy is much like subset of govt./fiscal policy in many ways. Those who forgot these lessons have learnt it the hard way in the recent crisis. So all this talk just creates media noise and nothing else. It is like a Principal-Agent relationship where there can be some disagreements between the two which is natural and healthy.

It is ironic (as Austrian school proponents suggest), that those who talk about independence wanting to limit govt.’s role in economy, should actually argue for a limited central bank (if at all). By taking Austrian economics out of books, we hardly discuss this aspect. We have highly overdone the control central banks have over macro variables even inflation. At best, central banks can regulated the banking system as they have a monopoly over currency/money matters.

Anyways, this continuous media focus reminds me of a joke. It is like this. There is a man who is once asked by another ” Sir are you a Chinese”? The man who is an Indian responds amusingly as no.  The question becomes a continuous one as the second man keeps asking the same question over and over again. The first man keep replying no with rising irritation. The questioning does not stop and the first man commits suicide in frustration. The second man follows him in heaven and asks again. The first man says “Yes I am Chinese. Now what”? The second man quips ” Well, you don’t look like one”..

In similar vein, media keeps cooking stories over differences between the two. Is there a rift? Both the govt and central bank say no. As the question becomes repetitive, the exasperated officials say yeah there is..now what? To this the media says does not look like and game goes on..

Autonomy is fine and every management need it but independence is a highly overdone term. It makes us think of central banks as some holy cow which they are not. They are actually a central planner which continue to determine prices (interest rates) of sector they regulate. No other regulator does it anymore. But thanks to the dominance of monetary policy thinking , no one even questions why should a central bank be setting interest rates for an economy? Why can’t banks change interest rates as per their financials?

Are we still paying for giving too much policy attention to monetarists?

April 1, 2015

Brad De Long takes on Friedman and his venerated monetarist ideas.

Ideas matter. That is the lesson of Hall of Mirrors, the American economist Barry Eichengreen’s chronicle of the two biggest economic crises of the past 100 years: the twentieth century’s Great Depression and the ongoing Great Recession, from which we are still struggling ineffectually to recover.

Eichengreen is my friend, teacher, and patron, and his book is to my mind the best explanation to date of why policymakers in Europe and the United States have reacted to the most dramatic economic collapse in almost four generations with half-hearted measures and half-finished interventions.

According to Eichengreen, the Great Depression and the Great Recession are related. The inadequate response to our current troubles can be traced to the triumph of the monetarist disciples of Milton Friedman over their Keynesian and Minskyite peers in describing the history of the Great Depression.

In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

This interpretation makes a certain kind of sense, but it relies on a critical assumption. Friedman and Schwartz’s prescription would have worked only if interest rates and what economists call the “velocity of money” – the rate at which money changes hands – were largely independent of one another.

What is more likely, however, is that the drop in interest rates resulting from the interventions needed to expand the country’s supply of money would have put a brake on the velocity of money, undermining the proposed cure. In that case, ending the Great Depression would have also required the fiscal expansion called for by John Maynard Keynes and the supportive credit-market policies prescribed by Hyman Minsky.

The debate over which interventions would be needed to put a halt to something like the Great Depression should have been a simple matter of analyzing the evidence. In economic hard times, did interest rates have little impact on the velocity of money, as Friedman suggested? Was Keynes correct when he described the concept of a liquidity trap, a situation in which easing monetary policy further proves ineffective? Is the stock of money in an economy an adequate predictor of total spending, as Friedman claimed, or is the smooth functioning of credit channels a more important factor, as Minsky argued?

This has always been the problem of economics. We hype certain individuals/ideas a bit too much. There is a lot of context, situation, local knowledge and above all luck for any policy to work. And here we do not even know whether monetarism would have worked in Great Depression. But we still bought the ideas as if they have delivered.

The dominance of Friedman’s ideas at the beginning of the Great Recession has less to do with the evidence supporting them than with the fact that the science of economics is all too often tainted by politics. In this case, the contamination was so bad that policymakers were unwilling to go beyond Friedman and apply Keynesian and Minskyite policies on a large enough scale to address the problems that the Great Recession presented.

Admitting that the monetarist cure was inadequate would have required mainstream economists to swim against the neoliberal currents of our age. It would have required acknowledging that the causes of the Great Depression ran much deeper than a technocratic failure to manage the money supply properly. And doing that would have been tantamount to admitting the merits of social democracy and recognizing that the failure of markets can sometimes be a greater danger than the inefficiency of governments.

The result was a host of policies based not on evidence, but on inadequately examined ideas. And we are still paying the price for that intellectual failure today.

The price is not just paid in US but across the world. All these ideas transmit quickly to rest of the world. What did not even work in the place where it was supposed to  work is expected to work in places where it is completely ill-suited.

David Glasner says it was not even Friedman but likes of Hawtrey and Cassel which had started the monetarism ideas. Even they did not look narrowly at interest rates alone but gave a more broader perspective saying going back to gold standard in 1920s was a really bad move. Points well taken. I mean how many of us really know the works of Cassel and Hawtrey.

All these ideas keep saying one thing – know your history…

Bernanke joins the econ blogging world..

March 31, 2015

Bernanke joins the quorum of econ bloggers, was bound to be a splashy event.

The blog is here. The introductory post says:

When I was at the Federal Reserve, I occasionally observed that monetary policy is 98 percent talk and only two percent action. The ability to shape market expectations of future policy through public statements is one of the most powerful tools the Fed has. The downside for policymakers, of course, is that the cost of sending the wrong message can be high. Presumably, that’s why my predecessor Alan Greenspan once told a Senate committee that, as a central banker, he had “learned to mumble with great incoherence.”

On January 31, 2014, I left the chairmanship of the Fed in the capable hands of Janet Yellen. Now that I’m a civilian again, I can once more comment on economic and financial issues without my words being put under the microscope by Fed watchers. I look forward to doing that—periodically, when the spirit moves me—in this blog. I hope to educate, and I hope to learn something as well. Needless to say, my opinions are my own and do not necessarily reflect the views of my former colleagues at the Fed.

Civilian again is an important lesson for Indian policymakers. They either remain policymakers forever or join some university in US remaining in the news circuit. Most keep coming back into some commission/report.

Anyways, the second post is on low interest rates:

Why are interest rates so low? Will they remain low? What are the implications for the economy of low interest rates?

If you asked the person in the street, “Why are interest rates so low?”, he or she would likely answer that the Fed is keeping them low. That’s true only in a very narrow sense. The Fed does, of course, set the benchmark nominal short-term interest rate. The Fed’s policies are also the primary determinant of inflation and inflation expectations over the longer term, and inflation trends affect interest rates, as the figure above shows. But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.

To understand why this is so, it helps to introduce the concept of the equilibrium real interest rate (sometimes called the Wicksellian interest rate, after the late-nineteenth- and early twentieth-century Swedish economist Knut Wicksell). The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment. Many factors affect the equilibrium rate, which can and does change over time. In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments. In a slowly growing or recessionary economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable. Government spending and taxation policies also affect the equilibrium real rate: Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment.

If the Fed wants to see full employment of capital and labor resources (which, of course, it does), then its task amounts to using its influence over market interest rates to push those rates toward levels consistent with the equilibrium rate, or—more realistically—its best estimate of the equilibrium rate, which is not directly observable. If the Fed were to try to keep market rates persistently too high, relative to the equilibrium rate, the economy would slow (perhaps falling into recession), because capital investments (and other long-lived purchases, like consumer durables) are unattractive when the cost of borrowing set by the Fed exceeds the potential return on those investments. Similarly, if the Fed were to push market rates too low, below the levels consistent with the equilibrium rate, the economy would eventually overheat, leading to inflation—also an unsustainable and undesirable situation. The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors. The Fed influences market rates but not in an unconstrained way; if it seeks a healthy economy, then it must try to push market rates toward levels consistent with the underlying equilibrium rate.

Lot of mumbo jumbo here. If markets determine so called real rates why does Fed intervene?

A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates “artificially low.” Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere. So where should that be? The best strategy for the Fed I can think of is to set rates at a level consistent with the healthy operation of the economy over the medium term, that is, at the (today, low) equilibrium rate. There is absolutely nothing artificial about that! Of course, it’s legitimate to argue about where the equilibrium rate actually is at a given time, a debate that Fed policymakers engage in at their every meeting. But that doesn’t seem to be the source of the criticism.

The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States. What features of the economic landscape are the ultimate sources of today’s low real rates? I’ll tackle that in later posts.

Being a historian, he would obviously know that things did work without Fed/central banks around. With central bank not even knowing what the rates are and just guessing their way, most of the time things only go wrong.

Interesting posts to follow. ..

Messed up macro..

March 25, 2015

A discerning friend retaliated strongly to yesterday’s post on the confusion amidst econs around Rupee valuation. The reaction was ” Do economists know value of anything? They are a highly overvalued commodity themselves”. :-)

TO add to the frustration, Robert Skidelsky has a piece on messed up macro:

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