Archive for the ‘Financial Markets/ Finance’ Category

50 years of Bank Nationalisaton: Why Indira Gandhi Nationalised India’s Banks

July 12, 2019

It was 50 years ago on July 19, 1969 that then PM Indira Gandhi nationalised 14 of the largest private sector banks.

Bloomberg Quint is doing a series on 50 years of bank nationalisation. Mr DN Ghosh, one of the main persons who wrote the nationalisation legislation wrote the first piece saying: Bank Nationalisation the original sin?

In the second article,  yours truly explores the political economy of several factors which led to nationalisation.

 

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Cost-benefit Analysis of Leaning against the Wind

July 11, 2019

Should central banks increase policy rates to mitigate financial instability?

Trent Saunders and Peter Tulip of RBA look at the evidence from Australia:

Setting interest rates higher than macroeconomic conditions would warrant due to concerns about financial instability is called ‘leaning against the wind’. Many recent papers have attempted to quantify and evaluate the effects of this policy. This paper summarises this research and applies the approach to Australia.

The papers we survey see the benefit of leaning against the wind as avoiding financial crises, such as those that affected Australia in 1990 or other countries in 2008. Most of the international research finds that interest rates have too small an effect on the probability of a crisis for this benefit to be worth higher unemployment. Using Australian data, we find similar results. We estimate the costs of leaning against the wind to be three to eight times larger than the benefit of avoiding financial crises. However, research has not yet quantified the increased resilience of household balance sheets, which may be an extra benefit of leaning against the wind.

 

Safeguarding the euro in times of crisis: The inside story of the European Stability Mechanism (ESM)

July 10, 2019

In the backdrop of European sovereign debt crisis, the leaders first established European Financial Stability Facility in 2010 followed by European Stability Mechanism in 2012.

ESM has released a book (free pdf available) reflecting on the experiences of establishing the facility and so on:

Global financial leaders and ESM insiders provide a rich stock of perspectives and anecdotes that bring to life the urgency of the euro area crisis as well as the innovative solutions found to resolve it. As Europe strives to further strengthen its financial architecture, this books provides important lessons for future crisis management.
Should be a good read…

From optimal currency areas to digital currency areas..

July 10, 2019

Markus K Brunnermeier, Harold James and Jean-Pierre Landau envisage that we will have digital currency areas in future:

Global Dimensions of U.S. Monetary Policy

July 9, 2019

Maurice Obstfeld of Univ of California Berkeley in this research paper says there are 3 channels:

This paper is a partial exploration of mechanisms through which global factors influence the tradeoffs that U.S. monetary policy faces. It considers three main channels.

The first is the determination of domestic inflation in a context where international prices and global competition play a role, alongside domestic slack and inflation expectations.

The second channel is the determination of asset returns (including the natural real safe rate of interest, r*) and financial conditions, given integration with global financial markets.

The third channel, which is particular to the United States, is the potential spillback onto the U.S. economy from the disproportionate impact of U.S. monetary policy on the outside world.

In themselves, global factors need not undermine a central bank’s ability to control the price level over the long term — after all, it is the monopoly issuer of the numeraire in which domestic prices are measured. Over shorter horizons, however, global factors do change the tradeoff between price-level control and other goals such as low unemployment and financial stability, thereby affecting the policy cost of attaining a given price path.

 

Sea change in global economic outlook

July 8, 2019

Mark Carney in this speech points how global economic outlook has gone through a sea change from optimistic to pessimistic.  He quotes from who other but Shakespeare:

A sea change is a profound transformation. The term was originally coined by Shakespeare in The Tempest,
of which there are five productions across Dorset this summer.These productions will mix tragedy and comedy in a play whose themes range from magic and creation to betrayal and revenge.

My focus is more limited and prosaic – but also more immediately relevant to your work. In recent months, there has been a sea change in financial markets driven by growing concerns over the global economic outlook. I will assess these global developments before turning to what they may mean for the UK’s economic prospects.

A good account of economic conditions…

Decline of economist as a central banker

July 8, 2019

My new piece in Business Standard.

I reflect on the recent nomination of Christine Lagarde as head of European Central Bank. It is interesting how French dominate Germans, on the Bundesbank styled European Central Bank.

In recent months we have seen how governments worldwide are preferring non-economists to head the central banks. Lagarde is an addition to the list.

Though, it is a choice which would be seen as not really a good one. Lagarde is former French Minister of Finance and you do not want to see former Ministers heading central banks, atleast not in European Central Bank, which prides on independence and autonomy.

Much more in the piece.

 

Does Japan vindicate MMT?

July 5, 2019

Koichi Hamada, advisor to Shinzo Abe in this piece says Japanese economy has followed MMT but one has to be careful drawing lessons:

Some MMT advocates – including Stephanie Kelton, a former economic adviser to Sanders – point to Japanas proof that the approach works. Despite high public debt, its economy is steadily recovering, and standards of living are high.

Moreover, MMT advocates point out, Japan’s expansionary monetary policies – a central feature of Prime Minister Shinzo Abe’s economic-revitalization strategy, Abenomics – have not generated a much-feared surge in inflation. Even within Japan, some argue that there is no need for a consumption-tax hike to fund public spending.

But there is a serious problem with this logic: Japan’s government is not as heavily indebted as is generally believed. Though Japan’s gross debt-to-GDP ratio, at 240%, is the highest in the developed world, what really matters – for the government, just like for private firms – is the net debt-to-GDP ratio, which accounts for real and financial assets. And Japan’s public companies have very large real assets.

In fact, by this measure, Japan is about on par with the US, and doing much better than France and Germany, according to the International Monetary Fund’s October 2018 Fiscal Monitor report, “Managing Public Wealth.” Further challenging Kelton’s assessment, Japan’s primary balance has improved under Abenomics, thanks to its economic recovery.

This does not mean that MMT has no merit, in Japan or elsewhere. In its campaign to increase consumption taxes, Japan’s Ministry of Finance drilled into the public psyche the concept of “Ricardian equivalence”: a government cannot stimulate consumer demand with debt-financed spending, because people assume that whatever is gained now will be offset by higher taxes due in the future. (It was this campaign that drove the MOF constantly to advertise the 240% figure.)

MMT can challenge this strict Ricardian belief, drawing attention to the potential of deficit financing, say, to boost employment through targeted social spending. And, indeed, Olivier Blanchard and Takeshi Tashiro have already proposed using limited deficit financing to help bring Japan’s interest rates up to zero, at a time when the government’s borrowing costs are low and the effectiveness of monetary policy is weak.

Hmm….

MMT works but upto the point inflation comes back:

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Differences in Europe’s banking union and capital market union

July 4, 2019

A superb speech by Poul M. Thomsen of IMF.

He points that in order to understand differences between building banking union and capital market union, we need to look at key differences between bank based and market based finance:

Before getting to our concrete proposals for how to promote CMU, I want to define the issues a bit better by reminding you about some basic differences between bank-based and market-based finance.

Remember that the core funding base of banks is risk-averse depositors while that of the capital markets is yield-seeking investors. Through a long and bitter experience with financial panics we have developed a system where one fundamental difference between banking and the capital markets is the special privileges that banks enjoy under the public financial safety net.

This safety net has multiple strands. Banks enjoy the right to retail deposit insurance, backstopped by the state but funded by the industry. In addition, they enjoy the right to draw liquidity from the central bank against eligible collateral, and the right to place excess liquidity at the central bank—the safest counterparty in the land. All of this makes banks safer, but can also create moral hazard, meaning an incentive to take risk when one knows one is protected from some or all of the downside.

There is more. When banks fail—and fail they still do—the government’s promise to stand behind their retail deposits creates a natural role for government in their wind-up: this is why we have state-directed bank resolution, as distinct from private corporate insolvency. And, both to offset the moral hazard effects and to contain the financial stability risks arising from the mixing of leverage and maturity transformation, banks are prudentially regulated and supervised with the explicit mandate of reducing their probability of failure.

Contrast this with a relatively pure form of capital market intermediary: the mutual fund. Where banks focus on taking deposits with a promise to return them on demand and at face value, mutual funds take equity with the prospect of higher returns but also a disclaimer on potential losses. In the mutual fund industry, savers are exposed directly to the end-users of their funds with no public backstop; official oversight is mainly focused on ensuring transparency and good conduct by fund managers, with no explicit mandate to limit losses, and is often of an ex post nature, with a heavy emphasis on enforcement, contrary to ex anteprudential oversight in banking. Risk-taking here is modulated primarily by market forces.

One more point. Banks lend based on relationships and proprietary information. Given the relatively level playing field among banks—they all benefit from the same safety net—information gathering forms the essence of competition in banking. You collect as much data as you can on your borrowers, you nurture your customer relations in the pursuit of repeat business, and you never share your data with others. And information, of course, costs money—when we borrow from banks we pay for a broad range of overheads.

Mutual funds, in contrast, invest at arm’s-length. Here, the name of the game is reliable, comparable, publicly available information. The fund buys a tradable security after its managers have skimmed the prospectus—a much less costly endeavor than gathering bespoke information—and they don’t know much that other fund managers don’t also know. Here, success depends on wise investment choices, proper valuation practices, and portfolio diversification. For the recipients of mutual fund investments—the issuers of debt and equity securities—the benefit lies in being able to access savings with less margin taken by the middleman, and thus a lower cost of funds.

In view of these basic differences between banking and the capital markets, it is not surprising that plans for banking union have focused on the creation of a centralized supervisor of systemically important banks—the Single Supervisory Mechanism; a centralized bank resolution framework—the Single Resolution Mechanism, backed by a central fund soon to be backstopped by the European Stability Mechanism; and a common European Deposit Insurance Scheme—EDIS.

Thus, the two different forms of finance requires different approaches to development and regulations:

In contrast, the general principles that I just sketched suggest that the primary focus of efforts to create a CMU should be more on ensuring greater transparency; reducing variability in investor protection regulations; and improving insolvency regimes, both to improve recovery values and to facilitate smooth market exit. One key theme here is to facilitate market discipline, which requires an approach that is distinct from explicitly seeking to reduce the likelihood of failure through intrusive prudential supervision.

Really useful to think about several things in finance….

Before Thaler and Economic Survey, there was TMA Pai/Syndicate Bank

July 4, 2019

In the Economic Survey 2018-19 tabled today, there is a chapter on how Indian government is using behavioral economics/nudging to improve public policy.

Replugging (yet again) an old piece to show how How Dr T.M.A Pai nudged many decades before via Syndicate Bank, the bank he owed and developed over the years. Dr. Pai designed a savings product named Pigmy Deposits in 1928 which was nudged people into savings. It was based on similar principles developed much later by Prof Richard Thaler in 1990s.

The Economic Survey chapter discusses savings products designed elsewhere which resemble today’s Pigmy deposits but miss including Pigmy deposits in the list.

Facebook’s Libra Currency – Will it rewrite the crypto playbook?

July 3, 2019

My new piece on Moneycontrol on FB’s proposed currency Libra.

Macroprudential policy through the lens of Sherlock Holmes

July 2, 2019

Jens Weidmann of Bundesbank says macropru policy is much like investigation of Sherlock Holmes:

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Financial Gerontology: An emerging new sub-field in finance..

June 27, 2019

Haruhiko Kuroda, Governor, Bank of Japan in this speech talks about Financial inclusion in aging society:

As we get older, we all become physically weaker. Declining mobility means we can no longer take it for granted that we can easily visit bank branches. Deteriorating eyesight and hearing ability may impair our capacity to fill out a form or understand a face-to-face explanation. Declining cognitive ability may create difficulty in making financial decisions. Moreover, there is the risk that senior citizens will become victims of financial crime. In 2018, among all recorded cases of so-called special fraud in Japan — such as telephone-based identity deception — 78 percent of the victims were aged 65 and over.

Financial inclusion is therefore an extremely important social agenda in an aging society, as it ensures that senior citizens — who may have difficulty in visiting banks or making financial transactions due to age-related decline — can continue to use financial services with confidence and benefit as much as possible from these services.

In the field of what is known as “financial gerontology,” there has been discussion about ways to make the adult guardianship system more effective in order to protect the rights of senior citizens with cognitive decline. The use of innovative digital technologies has also been considered. For example, using biometric technology for identity verification and mobile payments will enable senior citizens to have secured access to financial services without actually visiting bank premises. Moreover, the use of speech recognition technology will enable financial transactions to be made without the need for physical writing or keyboard skills. Advances in technology may create increasingly comprehensive financial services that are better tailored to the needs of the individual senior citizen.

These new financial services for senior citizens can also be a great business opportunity for financial institutions. On the other hand, as technology advances, the risk of technology abuse will increase, and vigilance is therefore essential to maintain security.

Hmm..

Though, in India we hear the opposite. How these technologies have made it difficult for aged people to access their own deposited money.

As societies age across the world, financial gerontology is going to be an important are of study.

 

Non-performing loans in the euro area: How they were halved?

June 26, 2019

Nice speech by Andrea Enria, Chair of the Supervisory Board of the ECB:

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Twenty Years of the ECB’s monetary policy: Trial by Fire

June 26, 2019

Mario Draghi of ECB summarises the twenty years of monetary policy of ECB:

The euro was introduced twenty years ago in order to insulate the Single Market from exchange-rate crises and competitive devaluations that would threaten the sustainability of open markets. It was also a political project that, relying on the success of the Single Market, would lead to the greater integration of its Member States.

On both counts, the vision of our forefathers has scored relatively well. Imagine where the Single Market would be today, after the global financial crisis and rising protectionism, had all countries in Europe been free to adjust their exchange rates. Instead, our economies integrated, converged and coped with the most severe challenge since the Great Depression.

That leads me to four observations.

First, the integration of our economies and with it the convergence of our Member States has also greatly increased. Misalignments of real effective exchange rates between euro area countries are about a half those between advanced economies with flexible exchange-rates or countries linked by pegged exchange rates and they have fallen by around 20% in the second decade of EMU relative to the first.[20]

Second, the dispersion of growth rates across euro area countries, having fallen considerably since 1999, is since 2014 comparable to the dispersion across US states.

Third, this has been driven in large part by the deepening of European value chains, with EMU countries now significantly more integrated with each other than the United States or China are with the rest of the world.[21] Most EMU countries export more with each other than with the US, China or Russia. Fourth, employment in the euro area has reached record highs and in all euro area countries but one stands above its 1999 level.

But the remaining institutional weaknesses of our monetary union cannot be ignored at the cost of seriously damaging what has been achieved. Logic would suggest that the more integrated our economies become, the faster should be the completion of banking union and capital markets union, and the faster the transition from a rules-based system for fiscal policies to an institution-based fiscal capacity.

The journey towards greater integration that our citizens and firms started twenty years ago has been long, far from finished, and with broad but uneven success. But overall, it has strengthened the conviction of our peoples that it is only through more Europe that the implications of this integration can be managed. For some, that trust may lie in a genuine faith in our common destiny, for others it comes from the appreciation of the greater prosperity so far achieved, for yet others that trust may be forced by the increased and unavoidable closeness of our countries. Be that as it may, that trust it is now the bedrock upon which our leaders can and will build the next steps of our EMU.

Whatever the criticisms, EU polity continues to move ahead with the integration. People had questioned Euro right at inception and believed it would break down soon, but that has not happened.

Mixed reactions over Facebook’s Libra project..

June 21, 2019

Mixed reactions to the FB’s Libra project.

Mark Carney, Governor of Bank of England gives a cautious welcome:

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20 Years of European Economic and Monetary Union

June 20, 2019

The Annual European Central Bank Forum at Sintra, Portugal was held recently. The papers and videos are all on the website.

In particular, this speech by EC President Jean Claude Junker is interesting. He points to “six moments in time, six lessons in history that have shaped the euro and the European Union as we know it.”

Lesson 1: The euro is a political project for our grandchildren
Exchange Rate Mechanism Crisis 1992

Lesson 2: The rules do not need to be stupid
The Stability and Growth Pact crisis 2003

Lesson 3: The euro is a matter of common interest
Greece 2010

Lesson 4: The euro requires resolve
Mario Draghi’s ‘whatever it takes

Lesson 5: The euro is irreversible
Greece crisis July 2015

Lesson 6: The euro is a strategic asset in today’s world
The Iran nuclear deal and the international role of the euro

 

History of Australian equity market: 1917-79

June 19, 2019

Thomas Matthews of RBA in this paper:

This paper presents stylised facts about the historical Australian equity market, drawn from a new hand-collected unit record dataset on listed companies from 1917 to 1979. Among other things, I show that: i) dividends for the early 20th century were lower than previously believed; ii) the realised returns on equities has averaged about 4 percentage points above that on government bonds since 1917, somewhat lower than previous estimates; iii) the share of profits paid out as dividends increased substantially after the introduction of franking credits in the 1980s; iv) the current industry composition of the stock exchange is atypical relative to history, despite it being dominated by essentially the same companies for the past century; and v) price-to-earnings ratios are currently almost exactly at their very long-run average, in contrast with the experience of some other countries.

Good stuff!

Financial revolution in Republican China: 1900-1937 (rare case of finance being freed from State)

June 14, 2019

Nice research by Prof Debin Ma of LSE:

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Growing use of local currencies in Japanese trade with Asian countries

June 12, 2019

Takatoshi Ito, Satoshi Koibuchi, Kiyotaka Sato and Junko Shimizu in this research:

Japan exports to neither advanced nor Asian countries in yen, as would be expected. Using questionnaire data, this column shows why Japanese exporters tend to choose destination currencies in their exports to advanced countries and why the US dollar, rather than the yen, is more often used in their exports to Asia. It also presents new evidence that the share of local currency has recently increased markedly, while that of the US dollar has declined, in Japanese exports to Asia. 

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