Archive for the ‘Economist’ Category

The coming emerging-market debt squeeze

April 1, 2015

Andres Velasco warns about upcoming  debt squeeze in EMEs.

Consider the following scenario, one that has played out time and again in emerging-market countries. Local banks and firms go on a borrowing binge and pile up dollar-denominated debt – debt that pundits consider perfectly sustainable, as long as the local currency is strong. Suddenly, something (an increase in United States interest rates, a drop in commodity prices, a domestic political conflict) causes the local currency to drop in value against the dollar. The debt burden, measured in domestic currency, is now much higher. Some borrowers miss interest payments; others are unable to roll over principal. Financial mayhem ensues.

This is how the Latin American debt crisis of the 1980s, the Mexican Tequila crisis of 1994, the Asian debt crisis of 1997, and the Russian crisis of 1998 unfolded. It was also how the financial crisis of 2008-2009 transmitted itself to emerging markets. Every time, borrowers and lenders claimed to have learned their lesson.

Not only could it happen again today; it could happen on a much larger scale than in the past. Taking advantage of ultra-low interest rates in advanced countries, emerging-market banks and firms have been borrowing like never before. A recent paper by the Bank of International Settlements shows that since the global financial crisis, outstanding dollar credit to non-bank borrowers outside the US has risen by half, from $6 trillion to $9 trillion.

The bulk of that debt is in Asia, with China alone accounting for approximately $1 trillion. Other big dollar borrowers include Brazil (over $300 billion) and India ($125 billion). Countries such as Malaysia, South Africa, and Turkey, plus Latin America’s more financially open economies, also have rising foreign-currency debts.

This time is never different really ..

Dangers of not understanding economic concepts..

April 1, 2015

Jean Pisani Ferry writes about dangers of using potential output into economic policymaking.


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…

What’s the relationship between the economics blogosphere and academic economics?

March 31, 2015

A discussion on on the topic.

Alex Tabbrok of MR blog sums it up really well:


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. ..

A preview of Jammu & Kashmir budget

March 26, 2015

There is hardly any attention on State Budgets which needs to be corrected. State budgets matter more from its impact on local populations.

This blog has enjoyed several pieces written by Dr. Haseeb Drabu. Now he is the finance minister of the state (headed J&K bank as well), which is really interesting.

Here is a short article on the J&K budget presented recently:


Does a politician’s age matter for policy?

March 23, 2015

Alberto Alesina, Traviss Cassidy and Ugo Troiano think so.

We find that a politician’s age does matter for policy, though not always in the way conventional wisdom would suggest.


Student Loan Debt Is the Enemy of Meritocracy in the US

March 23, 2015

Thomas Piketty picks on highly elevated student debt levels in US. He says student debt is just the anathema of US idea of meritocracy:


Are low bond yields a problem?

March 23, 2015

Prof Shiller says based on his research so far low bond yields do not show a crisis. But never say never:

I have been thinking about the bond market for a long time. In fact, the long-term bond market was the subject of my 1972 PhD dissertation and my first-ever academic publication the following year, co-authored with my academic adviser, Franco Modigliani. Our work with data for the years 1952-1971 showed that the long-term bond market back then was pretty easy to describe. Long-term interest rates on any given date could be explained quite well as a certain weighted average of the last 18 quarters of inflation and the last 18 quarters of short-term real interest rates. When either inflation or short-term real interest rates went up, long-term rates rose. When either fell, so did long-term rates.

We now have more than 40 years of additional data, so I took a look to see if our theory still predicts well. It turns out that our estimates then, if applied to subsequent data, predicted long-term rates extremely well for the 20 years after we published; but then, in the mid-1990s, our theory started to overpredict. According to our model, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected.

But the explanation that we developed so long ago still fits well enough to encourage the belief that we will not see a crash in the bond market unless central banks tighten monetary policy very sharply (by hiking short-term interest rates) or there is a major spike in inflation.

Bond-market crashes have actually been relatively rare and mild. In the US, the biggest one-year drop in the Global Financial Data extension of Moody’s monthly total return index for 30-year corporate bonds (going back to 1857) was 12.5% in the 12 months ending in February 1980. Compare that to the stock market: According to the GFD monthly S&P 500 total return index, an annual loss of 67.8% occurred in the year ending in May 1932, during the Great Depression, and one-year losses have exceeded 12.5% in 23 separate episodes since 1900.

It is also worth noting what kind of event is needed to produce a 12.5% crash in the long-term bond market. The one-year drop in February 1980 came immediately after Paul Volcker took the helm of the Federal Reserve in 1979. A 1979 Gallup Poll had shown that 62% of Americans regarded inflation as the “most important problem facing the nation.” Volcker took radical steps to deal with it, hiking short-term interest rates so high that he created a major recession. He also created enemies (and even faced death threats). People wondered whether he would get away with it politically, or be impeached.

Regarding the stock market and the housing market, there may well be a major downward correction someday. But it probably will have little to do with a bond-market crash. That was the case with the biggest US stock-market corrections of the last century (after 1907, 1929, 1973, 2000, and 2007) and the biggest US housing-market corrections of all time (after 1979, 1989, and 2006).

It is true that extraordinarily low long-term bond yields put us outside the range of historical experience. But so would a scenario in which a sudden bond-market crash drags down prices of stocks and housing. When an event has never occurred, it cannot be predicted with any semblance of confidence.

Keep watching. We have seen many things in last few years which were least imagined in the fancy finance world..

Linking inequality to house analogy

March 23, 2015

James Kwak says wage inequality is just tip of iceberg. Real deal is wealth inequality.

Uses an analogy:


Financial inclusion – issues for central banks…

March 19, 2015


Macron Economics : A minor economic reform leads to panic in France.

March 19, 2015

For a moment, I thought there is some spelling error in the article. But it is not the case. Macron economics is basically an econ package proposed by French Economy Minister Emmanuel Macron (really young which is a surprise for French).

Theodore Darymple has an article on how even small changes proposed by Macron are finding opposition (which is so usual in France). First, how does France change? via violence:


How Italy’s Government enables the mafia…

March 18, 2015

Interesting piece by David Howden and Emilio Parodi of Mises Institute.


The Impossible Trinity: Where does India stand?

March 18, 2015

Rajeswari Sengupta of IGIDR has a paper on the topic.


Why is the history of economic thought not taught anymore?

March 14, 2015

T C A Srinivasa-Raghavan asks the question which troubles this blog the most and has looked at answering quite a few times. TCA picks the title of his article from the paper by Mark Blaug who also said  – No History of Ideas, Please, We’re Economists.

TCA’s friends advised him to look at the topic:


Adam Smith, Watch Prices, and the Industrial Revolution

March 13, 2015

Fascinating paper on econ history by Morgan Kelly and Cormac O’Grada.

Adam Smith mentions declining watch prices in Wealth of Nations as an evidence of tech progress. But how can we verify this claim? The authors show us how:


Do awards matter?

March 12, 2015

Bruno Frey & Jana Gallus on the topic.

Why Understanding Money Matters in Greece…(Issuing Tax anticipation notes)

March 10, 2015

Robert W. Parenteau and Marshall Auerback look at the real purpose of money and go into history for the same.

They says real purpose of fiat money is to allow govts to pay for its expenses:


Do Place-Based Policies Matter?

March 9, 2015

David Neumark and Helen Simpson reflect on place based policies. These policies favor a region/location for development.


Robots Are Us: Some Economics of Human Replacement

March 5, 2015

Interesting and a different kind of paper.

It says machines can indeed replace humans:

Will smart machines replace humans like the internal combustion engine replaced horses? If so, can putting people out of work, or at least out of good work, also put the economy out of business? Our model says yes. Under the right conditions, more supply produces, over time, less demand as the smart machines undermine their customer base. Highly tailored skill- and generation-specific redistribution policies can keep smart machines from immiserating humanity. But blunt policies, such as mandating open-source technology, can make matters worse.

It has an interesting historical discussion starting from Ned Ludd who destroyed two machines fearing new technology..


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