Archive for the ‘Speech / Interviews’ Category

Assessing the risk of inverting yield curve in US…

December 22, 2017

Speech by James Bullard of St Louis Fed given on 1 Dec 2017.

He says based on current trends and future projections, US yield curve could begin to invert around late-2018:

• Let’s suppose that longer-term yields remain near the average since 2012.
• Let’s also suppose that the FOMC remains on track to raise the policy rate at the pace suggested in the SEP.
• Under this scenario, the U.S. nominal yield curve would invert in late 2018.
• This scenario would not play out if either (1) the FOMC does not raise the policy rate as aggressively as suggested by the SEP, or (2) longer-term rates begin to rise in tandem with the policy rate.

And then as we know, inverted yield curve is a great predictor of recessions.

We are back to full circle with so much monetary interventions and policies. It started with US yield curve inverting in 2007 whose signs were ignored. This was followed by failure of Lehman and AIG leading to all kinds of monetary interventions. And now 10 years later, we are again seeing signs of inverted yield curve…


Should Australia issue an e- Australian Dollar?

December 13, 2017

Just a few days ago, Riksbank chief Ingves spoke about whether and how Sweden should issue an e-krona.

On the speech, JP Koning rightly remarked that the speech does not talk about the need for e-krona to be anonymous. JP had earlier educated us about two key features which led to acceptance of paper money: anonymity and censorship.

Now, Australian central bank chief Philip Lowe speaks about whether Australia should issue an e- Australian Dollar (eAUD). He also looks at usual attributes of an e-AUD says that though cash usage is declining but cash is likely to remain, whether banks will be key to issuing this money and so on.


The economics of printing securities including banknotes…

December 5, 2017

Securities is a wider term which includes banknotes, tickets, stamps, cheques and  so on.

Lindsay Boulton, Assistant Governor of Reserve Bank of Australia gives a nice speech on printing securities which also discusses banknotes.  He discusses the trends in Asia:


History of 150 years of monetary policy in 7 sentences….

December 4, 2017

Missed this speech by John Williams of FRBSF which he gave on 16 Nov 2017.

The speech is on low r-star (natural rate of interest) in the developed world. Prof Phelps recently said: there is nothing natural about natural rate of unemployment, this should be extended to natural rate of interest as well.

As he discusses why we have low r-star and what to do about it, there is this bit on 150 years monetary history. He said ideally would have liked to sum the history in 140 characters but that will hardly cover anything. But how about summing the history in 7 sentences. Here are the 7 sentences:


How financial systems work: evidence from financial accounts (History of Funds Flow accounts..)

December 1, 2017

Bank of Italy is conducting a conference by the same title.

Here is the speech/opening remarks by  Luigi Federico Signorini, Deputy Governor of the central bank. He points to this interesting history of development of financial accounts, how central banks warmed up to these accounts, the decline of them in research and again their importance post-2008 crisis:


How to get rid of banking supervisors?

November 24, 2017

Central bankers are increasinly talking about culture, incentives etc. There have been two recent speeches which revisit these topics using bank supervision lens. First by Norman Chan of HKMA and second by Andreas Dombert of ECB.

Norman Chan of HKMA in this speech goes back to banking history when there were no banking supervisors:


When the definitive history of demonetisation is documented, RBI’s valiant defence of financial stability hopefully gets its due?

November 21, 2017

It is like when the kings force war onto its people and then saying look how well I defended you.

RBI Executive Director and MPC member Michael Patra in this speech reviews one year of RBI’s Monetary Policy Committee and comments:


Economics of prison in Australia…

October 31, 2017

This blog has written about economic of prison in US.

Here is a discussion and interview (mp3 format) on the economics of prison in Australia:

There are more than 41,000 daily full-time prisoners in Australia, according to the latest ABS data. Many of them are in private prisons – almost 20% of the prison population according to a 2014 Productivity Commission report.

But we don’t really know whether private prisons are more cost effective or produce better results. Private prison contracts are often “commercial in confidence”, and it’s hard to know what exactly we’ve paid for. All this means we have to rely on watchdogs to ensure taxpayers are getting value for money, and it’s tough for companies to really compete.

Prison job programs are often touted as a way to reduce prisoner recidivism, but again there is little evidence showing a positive impact. Joanne Wodak was a research assistant on a study in the Northern Territory. Despite positive feedback from both prisoners and employers, Wodak says these programs don’t address other, important factors affecting recidivism such as alcoholism and homelessness.

Technology could drastically change what a prison is and who is in them – through the use of algorithms that decide who gets bail, for instance. But as the University of Sydney’s Sandra Peter and Kai Riemer discuss, it’s unlikely to have an impact on the jobs prisoners themselves do. Low wages mean that prisoners provide an incredibly cheap source of labour, and the economics of this is unlikely to be drastically changed by technology.

So many different organisations and how economics differs across them…

President of India’s interesting speech on 60th anniversary of Karnataka’s Vidhan Souda…

October 26, 2017

In this environment of chaotic and acerbic political mudslinging across political parties, this speech is a welcome change (HT: qfint).

The President of India speaks on the occassion of the controversial 60th anniversary of Karnataka’s Vidhan Souda (seat of legislative assembly of the State). He talks about the 4 Ds that make the 5th D – Democracy (hope all political party members read it):

It is not just the 60th birthday of this building that we are marking. This is also the diamond jubilee of the debates and discussions in the two Houses, of legislations that have been passed and policies that have been shaped for the betterment of the lives of the people of Karnataka.

We are aware of the three D’s of the legislature, that it is a place to debate, dissent and finally decide. And if we add the fourth D, decency, only then does the fifth D, namely democracy, become a reality.The legislature is an embodiment of the will, aspirations and hopes of the people of Karnataka, irrespective of political belief, caste and religion, gender or language. It needs the collective wisdom of both Houses of the Legislature to fulfil the dreams of our people.

This spirit of debate and discussion, of inquiry and of service, is not limited to simply the Vidhan Soudha or to political life. It has existed in the soil of this great state. Karnataka has been known through history for spiritualism as much as science, for its farmers as much as its technologists. Its contribution to the intellectual and cultural – and ultimately democratic – heritage of our country has been enormous.

This is a land with ancient Jain and Buddhist traditions. Adi Shankaracharya founded the math in Sringeri in this very state. Gulbarga is a centre of Sufi culture. The reformist Lingayat movement under spiritual leaders such as Basavacharya was also located in Karnataka. In their own way, each of these currents has contributed to nation building.

Karnataka is a land of formidable soldiers. Krishnadeva Raya was the greatest ruler of the Vijayanagara Empire, and remains an inspiration for all Indians. Kempe Gowda was the founder of Bengaluru. Rani Chennamma of Kittur and Rani Abbakka led among the earliest battles against colonial powers.

Tipu Sultan died a heroic death fighting the British. He was also a pioneer in the development and use of Mysore rockets in warfare. This technology was later adopted by the Europeans. More recently, two of our finest army chiefs – Field Marshal K.M. Cariappa and General K.S. Thimayya – were sons of Karnataka.

This is also the seat of education, technology and science. The engineer-statesman M. Visvesvaraya was a builder of modern Karnataka and of modern India. He was responsible for major irrigation projects that continue to help farmers to this day. The Indian Institution of Science and the Indian Space Research Organisation are among so many of our crown jewel institutions that are based in Bengaluru. The dynamism of its entrepreneurs has made Bengaluru India’s IT capital. It is known the world over as the Silicon City.

As expected, people have only looked at his comments on Tipu Sultan whose role has been under a lot of scrutiny in recent times.

He goes on to explain who is a nation builder:

The opening of this building in 1956 coincided with the reorganisation of states and the creation of the boundaries of Karnataka state. In a sense, both these momentous happenings represented the sovereign will, the cultural and linguistic pride and the identity of the Kannadiga people. As such the people of this state are always the focal point of all our endeavours – and of all that is undertaken in this legislative building.

Having said that, Karnataka’s dreams are not for Karnataka alone; they are dreams for all of India. Karnataka is an engine of the Indian economy. It is a mini-India that draws – without losing its cultural and linguistic distinctiveness – youth from all over the country. They come here for knowledge and for jobs, and they give their labour and intellect. Everybody gains.

There was a time when Hampi, here in Karnataka, was one of the richest and greatest cities in the world. Today, as our country strives to regain its importance in the global economy and international system, once again we look to Karnataka to provide India with the enlightenment, the technology and unity of purpose to take us forward. And as representatives of the people of Karnataka, the members of the two Houses here have a special responsibility.

Legislators are both public servants as well as nation builders.

Indeed, anybody who performs his or her duties with honesty and dedication is a nation builder. Those who maintain this building are also nation builders. Those who provide it security are nation builders too. It is by the efforts of ordinary citizens, who diligently carry out everyday tasks, that nations are built. As you sit and work in this Vidhan Soudha, I am confident you will never forget this and will continue to draw inspiration from it.

Let us then make this diamond jubilee not just the celebration of a proud past – but a commitment to an even greater future. A great future for Karnataka and a great future for India!

There is a lot of talk on who is patriotic and who is not. President of India just sums it for us…

GST discussion: Public Finance view vs Legal view

October 17, 2017

Interesting set of views/interviews on GST on (or explainers as the forum calls it) .

I think this is how we should learn the subject as well from different perspectives..

History explains why Cameroon is at war with itself over language and culture

October 16, 2017

One had just blogged about how French is taught in South Africa without the usual colonial hangover.

However in Cameroon, the battles over Francophone and Anglophone continue like the Anglo-French battles of yesteryears.

In this interview, Prof. Verkijika G. Fanso of University of Yaounde explains:


“Most things that are urgent are not important. And most things that are important are not urgent”

October 12, 2017

The earlier times were something. Even government officials said something worth pondering on.

Mr Frank Elderson, Executive Director of the Netherlands Bank in this speech quotes American President Eisenhower:

I’m sure we’ve all been in this situation. You’ve got something really important to do, but it never makes it to the top of the agenda. Instead, there’s always something more urgent that comes along and takes up all your time. Something you need to deal with right away. Which means putting everything else on hold.

A wise man once said: “Most things that are urgent are not important. And most things that are important are not urgent”.

Today I’d like to present you with three pearls of wisdom from this man. You’ve just heard the first. I didn’t mention this because you don’t appreciate the urgency of financial inclusion, but because you so admirably manage to keep the subject constantly on the agenda.

The man I just quoted was a Republican President of the United States. Although the president I am referring to spoke these words in nineteen fifty-four, they form the basis for a time management technique which is still widely in use today. Unfortunately – among some young people – this historical figure is better known for this technique rather than for all his other achievements.

I am of course talking about Dwight D. Eisenhower. The man who was not only President of the United States, but before that was the general who played such a paramount role in liberating Europe from fascism, putting an end to the Second World War. 

The famous Eisenhower matrix..

He says to address financial inclusion is both important and urgent:

But today I’m not just going to draw on Eisenhower for inspiration. I’m also going to look to you for inspiration. Because you have succeeded in bringing a sense of urgency to a very important matter. 

And you have done this despite facing a deadline that’s a long way off, while also having to contend with a constant stream of other issues. Over the years you have taken great strides towards financial inclusion.

And you continue to seek further cooperation. This brings me to the second of Eisenhower’s maxims. He reiterated how cooperation is a critical success factor for every mission: ”Leaders need to work with others and build coalitions if they want to get things done.” He said.

What things do we want to get done? And why are we concerned with financial inclusion at De Nederlandsche Bank?

Financial inclusion relates directly to sustainable prosperity. And that’s definitely an area that concerns us at the central bank. Because contributing to sustainable prosperity is an issue at the top of our agenda. That is why, six years ago, we added the word ‘sustainable’ to our mission statement.
Although that’s just one word. It can make a big difference.

Our mission statement now reads: We seek to safeguard financial stability and thus contribute to sustainable prosperity in the Netherlands. We don’t just do this by focusing on ourselves, following the principles of corporate social responsibility, however important that is. We also focus on the outside world, considering how we can incorporate sustainability in our role as central bank and supervisor of the financial sector. This is what our stakeholders ask us to do: Use that influence, use your influence, your convening power, use the leverage that you have.


Economic Policy and the Need for Humility

October 11, 2017

Nice and much needed speech by Yves Mersch of ECB:


Opportune time for collaboration in blockchain technology between Andhra Pradesh and Singapore ….

October 11, 2017

As banks in India struggle with NPAs etc, other country banks are looking at opportunities here.

In this interesting speech, Ravi Menon of  Monetary Authority of Singapore pitches for collaboration between S’pore and Andhra Pradesh. More importantly, how banks of Singapore could provide blockchain technology solutions for the new AP State:

I am delighted to be here in Andhra Pradesh – the land of the Tiruppati temple, Carnatic music, Kuchipudi dance, and of course, the charming sea town of Vishakapatnam.  I am grateful to Chief Minister Chandrababu Naidu for his kind invitation to speak at this conference.

Andhra Pradesh and Singapore share in common a modern outlook. 

  • We both believe in the value of innovation for economic growth and harnessing the power of technology for the common good.
  • That Andhra Pradesh is organising a global conference on the topic of blockchains shows its progressive nature.
  • It is also a tribute to the vision of Chief Minister Chandrababu Naidu, who has inspired an IT revolution in Andhra Pradesh.

Little wonder that Andhra Pradesh and Singapore have forged good relations and have been working closely together.

  • The Andhra Pradesh government has appointed a Singapore consortium to develop the new capital city of Amaravati.
  • The Andhra Pradesh government and the Monetary Authority of Singapore (MAS) signed a FinTech cooperation agreement in October last year.
  • A delegation of more than 10 FinTech startups from Singapore attended the FinTech Valley Vizag Spring Conference in March this year.

He talks about blockchain tech and how it takes us from a centralised structure to a decentralised one. He points Singapore is open to using blockchain technology:

Project Ubin is a good example of such collaboration as well as challenging the status quo.

The problem statement is this: 

  • In a real-time gross settlement payment system, transactions typically go through a single trusted party, often the central bank.
  • The challenge MAS posed itself was: can we create a more efficient inter-bank payment and settlement system without MAS acting as the trusted party?

This began Project Ubin – a collaborative effort among MAS, the Singapore Exchange, ten banks, six technology companies, and six academic institutions. 

  • Over the course of the project, more than 150 people were trained in DLT.

Phase 1 of Project Ubin successfully demonstrated that banks are able to transact with one another on an Ethereum-based prototype without going through the MAS.

  • MAS issued a digital representation of the Singapore Dollar – a central bank digital currency – and placed it on the distributed ledger for domestic inter-bank settlement.

Phase 2 of Project Ubin – just recently concluded – successfully produced three software models that achieved decentralised netting of payments in a manner that preserved transactional privacy.

The next step in Project Ubin is to extend the application to cross-border payment and settlement. 

  • Cross-border payments today rely on a correspondent banking network. 
  • Banks hold balances with one another and settlement occurs through the adjustment of these relative balances.
  • There is counterparty risk, liquidity is split, and reconciliation is a major pain point.
  • In cases where multiple correspondent banks are involved, transactions may take days and at high cost to customers.

We are therefore exploring how Project Ubin can be linked up with other central bank DLT projects to facilitate cross-border payments.

  • If successful, it will help bring about significant improvements in efficiency, cost, speed, and risk management.
  • The grand vision is a DLT-based settlement system that paves the way for 24/7 operations and allows cross-border transactions to be settled instantly.

Fascinating. When most authorities are sweating over the blockchain tech and bitcoins, here is someone taking a different view.

In the end he pitches S’pore services to AP government issues:

DLT is a natural platform for collaboration.

  • With the strong trade flows between Singapore and India, there are good opportunities for FinTechs and financial institutions in Singapore and Andhra Pradesh to collaborate.
  • We can explore how our customs and trade platforms can be linked up to facilitate exchange of trade documents and advance the digitalisation of trade.
  • Our banks can work together on new models of cross-border payments to improve settlement time, allow for round the clock operations, and reduce settlement risk.

This is an opportune time for DLT collaboration, and more broadly FinTech collaboration, between Andhra Pradesh and Singapore.  I look forward to seeing FinTechs in Singapore developing solutions for use cases in Andhra Pradesh that will create value and opportunity for the people of this up-and-coming state.

Interesting space to watch out…

Geofinance: the impact of geography on the geometry of finance….

October 6, 2017

Interesting speech by Sam Woods of Bank of England:

Supervisors of the world’s leading international financial centre have always had to juggle domestic and global risks. In between them, however, is a dynamic which is fundamental to retail and wholesale finance in the modern economy. It is a dynamic at play in the cliff-edge risks from Brexit and the differences of view between countries over Basel 3 finalisation.

I am thinking of the impact of borders, location and distance on the shape of banks, insurers and financial regulation. Put simply: the impact of geography on the geometry of finance, a dynamic we might call geofinance.

Hmm…Geofinance…a new term…

Here, we try and figure whether banks have to be regulated by the local regulator or not. What is the periphery of financial regulation?


Learning about GST and SME issues….

September 26, 2017

Here is a superb interview Anil Bhardwaj, Secretary General of Federation of Indian Micro and Small and Medium Enterprise. He explains how GST has hit the SME sector.

More importantly,  he also tells you how these units actually function, the several constraints and challenges. This is something which most of us neither understand nor care to understand. Most of the articles dubs the SME sector as unorganised (which has come to mean corrupt of late) failing to realise that it forms 90% of economic activity in India (and other parts of the world as well). Most of our economic debates are for 10% of the Indian economy.

Weren’t there problems arising from the conception of GST itself?
One of the problems MSMEs [micro, small and medium enterprises] encountered pertained to those dealing with engineering items. In the B2B [business-to-business] sector, I get an advance, meaning that if you want me to customise a machinery costing, say, Rs 10 lakh, I will take an advance of Rs 2 lakh to Rs 3 lakh at the time you place the order for me. You will pay me another Rs 3 lakh at the next inspection and the remaining amount at the time of delivery.

The funny thing about GST is that you have to pay tax on an advance also. Most machines come under the 28% tax slab. So out of Rs 3 lakh paid as installment, 28% of it would go to the government. But I am not earning anything, I have to buy raw material to customise the machine you want. A little less than one-third of my working capital is gone.

What about the issue of reverse charges?
According to the reverse charge mechanism, if I am buying from a non-GST compliant entity, I have to prepare his invoice and pay the tax and then file yet another document to claim it back.

Though the charges are reversed next month, your capital is locked nevertheless.
You have hit the nail on the head. GST has put pressure on working capital. Typically, the payment schedule in the MSME [micro, small and medium enterprises] sector is two to three months. But I have to pay tax monthly. Big companies, unlike MSMEs, are in the B2C [business-to-consumer] sector. As soon as they supply to the distributor, they take a draft.

But those manufacturing machinery parts get their payments in two to three months. In GST, the moment I supply I have to create an invoice and pay tax. But I haven’t yet received my payment. I will receive it three months later. I am therefore paying the tax out of my working capital. And to think, the biggest problem of MSMEs is working capital.

Superb stuff. Lots of stuff in the entire interview…

Supporting central banks and local currencies in the Western Balkans

September 25, 2017

Central Bank of Bosnia and Herzegovania celebrated its 20th anniversary recently.

ECB Member Benoît Cœuré gave a speech on the occasion and touched on an issue we hardly think much about. It has been seen that in small countries the balance sheets are not in the local currencies but in currencies of a dominant currency.

Any shock hits these small countries which run on unofficial currency as we saw in South East Asian crisis. The loans were in US Dollars and as crisis hit and the local currency depreciated, the value of  these liabilities increased manifold.

Even  in Balkan countries most of the balance sheets are in Euro. It is called as unofficial Euroisation. Euro is not an official currency but what happens in Euroarea plays a major role in these economies.

How does one work around this issue?

Let me therefore spend a few minutes on the one recommendation that is specific to candidate and potential candidate countries, albeit not uniformly to all, namely that the use of local currencies be strengthened.

As you know, the high degree of unofficial euroisation is a striking feature of the banking systems in the Western Balkans. In the region as a whole, on average 56% of total loans and 52% of total deposits are denominated in, or indexed to, foreign currencies, in most cases the euro.[3] This phenomenon, also known as currency substitution, is driven by many factors, such as low confidence in the domestic currency, which is often the result of not-so-distant memories of monetary instability.

Another factor relates to the fact that the risk premium on loans in the domestic currency is higher, thereby providing an incentive to take out foreign currency loans. Lower funding costs, in turn, are often supported through strong integration with the euro area via trade and financial channels, but also via migration and remittances, which contribute to the holding of bank deposits in euro. All this is conducive to widespread unofficial “euroisation”.

But a high degree of foreign currency use also has serious drawbacks. For example, unofficial euroisation, while being a sign of trust in the euro as a stable store of value, constitutes a financial stability risk in the event of sudden and substantial exchange rate fluctuations. Households and firms may suddenly no longer be able to service their foreign currency-denominated debt, creating credit risk for banks. The same holds true for dollarisation in other parts of the world, as the Asian financial crisis vividly demonstrated.

Unofficial euroisation also impedes monetary policy transmission and may limit the overall room for manoeuvre of monetary policy. In Albania and Serbia, for instance, where central banks have adopted inflation-targeting frameworks, exchange rate flexibility remains relatively limited as policymakers are mindful of adverse balance sheet effects resulting from sudden and substantial exchange rate fluctuations. In countries that have opted to stabilise the exchange rate in the first place, such as Bosnia and Herzegovina, maintaining the credibility of the framework remains central to keeping financial stability risks contained.

Prospective EU countries that have their own legal tender and monetary policy have recognised these risks and constraints, and are thus making efforts to promote the use of the local currency, in line with the ECB’s recommendations. This is certainly not an easy task. Success crucially hinges upon the track record of the domestic monetary authority in maintaining monetary stability. To this end, central banks in the region have made laudable progress in recent years. Efforts need to be channelled towards extending this track record.

History teaches us that central banks’ success in sustainably maintaining confidence in the currency critically hinges on two elements: political independence and a clear mandate. The ECB was successfully built on these principles. Independence and a clear stability-oriented mandate ensure that central banks are not overburdened with pursuing other, potentially conflicting objectives, and that monetary policy makes the best possible contribution to growth and employment. They are therefore also a necessary condition for strengthening the use of local currencies.

Experience in other regions of the world – in Latin America, for example – suggests that targeted prudential measures as well as deeper local capital markets in domestic currency can reinforce the use of local currencies.[4] Such advances should ideally be embedded in a carefully designed comprehensive strategy involving all relevant stakeholders. Serbia adopted such strategies in 2012, and Albania has done so more recently, while other countries have started to put in place measures of this nature or are considering designing similar strategies.

So progress is clearly visible, in particular on the lending side, but more remains to be done. There are certainly no quick fixes, as currency substitution tends to be a sticky phenomenon. But the drawbacks of unofficial euroisation deserve policymakers’ attention. The expectation that countries will at some point join the EU, and eventually also the euro area, should not divert attention from such policy efforts.



Bundesbank at 60: each country gets the inflation it deserves…

September 19, 2017

I just wrote y’day about how much Bundesbank matters to ECB policy and yet no German central banker is primed for the top job at ECB.

Least did I realise that year 2017 happens to be 60th anniversary of Bundesbank. Jens Weidmann, the chief of the central bank pays tribute and shares some fascinating history:

The Bundesbank first saw the light of the world on 4 July 1957, the day on which Germany’s Bundestag adopted the Bundesbank Act – alongside the Antitrust Act. Writing at the time, the Frankfurter Allgemeine Zeitung newspaper remarked that this day had witnessed “the adoption of two crucially important pieces of basic legislation for our entire economic system”.

When the Bundesbank Act came into force on 1 August 1957, the Bank deutscher Länder, the Land Central Banks and the Berlin Central Bank were merged to form a single institution, the Deutsche Bundesbank.

This new institution took over the headquarters of the Bank deutscher Länder in Frankfurt am Main. I wonder if you are aware that it almost ended up being based in Hamburg. Back then, the British forces were pushing for the Bank deutscher Länder to make Hamburg its home. But as it turned out, the Americans got their way, and the institution was established in their preferred location of Frankfurt, inside the US occupation zone.

That marked a major turning point for Frankfurt. The city evolved into Germany’s financial centre and later also succeeded in attracting the European Central Bank. But I don’t think Hamburg lost out in any way – Hamburg is an appealing, vibrant and economically successful location as it is.

He says though location of Frankfurt has little to do with Bundesbank’s success:

One thing I am quite certain about is that the choice of location did not influence the Bundesbank’s success, which I think can be put down to three key factors:

  • Its narrow mandate to preserve price stability,
  • Its independence, which allows it to pursue this objective even against political influence, if need be, and
  • An appreciation of the need for stability throughout much of the German population, which gave the Bundesbank the popular backing it needed to pursue its monetary policy objectives.

Ladies and gentlemen, the fundamental problem facing monetary policymakers is that they are caught in a conflict of objectives. In the short run, staving off inflation can sap economic momentum and drag on employment. On the other hand, the central bank can temporarily dampen unemployment if it tolerates a higher rate of inflation. This phenomenon is what economists call the Phillips curve relationship. It is a concept which crops up in a famous remark uttered by Helmut Schmidt in the early 1970s, when he once said that “I would rather have 5% inflation than 5% unemployment”.

An inverse relationship exists between inflation and joblessness because an unexpected increase in inflation pushes down real wages, lowers the price of labour, and thus tends to lead to a drop in unemployment.

But that only happens in the short run. Because employees will push for the higher rate of inflation to be offset, thus moving real wages and unemployment back to where they were before. There is a shift in the Phillips curve.

And if the unions, fearing a further increase in the rate of inflation, push through even higher wage increases, unemployment will rise as a result.

Let me use an everyday situation to shed more light on how this principle works. Imagine a person who is habitually late for work. Now, their partner might be able to outsmart them once by moving the hands of the kitchen clock forward by five minutes. But in the long run, that person will get used to the new time, so the clock will have to be put forward even more to prevent that person from leaving the house late in future.

That’s exactly how it is with monetary policy. If you fire up the printing presses to fend off unemployment, you will end up mired in high inflation and high unemployment.

He brings some episodes from German history which affirmed this fight for price stability:

Bearing that in mind, it was undoubtedly crucial that the Bundesbank, just like its predecessor, the Bank deutscher Länder, had independence from political control. Because German post-war history also bears witness to a number of situations in which the Bank was forced to head off political demands to loosen monetary policy.

One such situation that springs to mind is the famous “Gürzenich speech” which Konrad Adenauer delivered shortly before the Bundesbank was established. At that time, the Bank deutscher Länder had switched to a tight monetary policy stance because there was a risk that the brisk external demand might cause Germany’s economy to overheat. Konrad Adenauer, speaking in 1956 at Cologne’s Gürzenich Hall, warned that the tight policy would be “disastrous … for the man on the street”. A year later, the SPIEGEL magazine looked back at these events and wrote: “What is more, the credit constraints later turned out to be absolutely correct; they came just in time to prevent the boom from morphing into an inflationary economic gallop.”

Another situation I can think of occurred in the year 1979, when the government drummed up sentiment against an increase in the discount and Lombard rates. Manfred Lahnstein, State Secretary in the Federal Ministry of Finance, presented his critique before the Central Bank Council and then went public with his misgivings. He expressed concerns that the policy rate hikes might endanger the economic upswing. As it turned out, the German economy expanded at a real rate of 4½% in 1979, even though policy rates were increased. The Bundesbank, then, did well to prevent the global inflationary tendencies from spilling over into Germany more strongly than they did.

Because the Bundesbank held its ground in both these cases and refused to be knocked off course, the Die Welt newspaper once dubbed it in retrospect the “bulwark on the Main”.

That was praise indeed for the Bundesbank, of course. For it had resisted the political pressure not because it was indifferent to the macroeconomic prospects, but it firmly believed, even back then, that monetary stability is the best contribution a central bank can make in the long run towards high levels of employment and sustained economic growth.

He also adds that what is also central to this is people’s appreciation of merits of stable currency.

But I am convinced that the Bundesbank only prevailed in its skirmishes with politicians because it could count on the general public’s appreciation of the merits of a stable currency. This brings me to the third of the key factors in the Bank’s success which I mentioned earlier on. A policy strictly geared to stability only stands a chance of success if the general public is sufficiently aware of the merits of stability. That’s because, in the long run, it is not right for democratic states to have a monetary policy which runs counter to public opinion.

On this topic, Otmar Issing once said that each country gets the inflation it deserves.

This is mainly due to German hyperinflation of 1920s continue to remain etched in people’s memories…

He then goes on to discuss current crisis and ECB’s role so far…

Superb throughout.


The policymakers also join the deflation chorus in India..

August 22, 2017

The deflation chorus keeps coming in India. A drop in inflation is termed as deflationary by media every now and then. Former ECB member Lorenzo Bini Smaghi had earlier warned that one should use the two D words – deflation and depression with caution. The reason is that both suggest really difficult times for both economy and policy. However, we seem to be using the word deflation with little caution.

For instance, this time around even Economic Survey says India suffers from deflationary impulses atleast in short term:

Optimism about the medium term and gathering anxiety about near-term deflationary impulses simultaneously reign over the Indian economy. Optimism stems from the launch of the historic Goods and Services Tax (GST), the decision in principle to privatize Air India; actions to address the Twin Balance Sheet (TBS) challenge; and growing confidence that macro-economic stability has become entrenched. Optimism, even exuberance,
is manifested in financial markets’ high and rising valuations of bonds, and especially stocks. At the same time, anxiety reigns because a series of deflationary impulses are weighing on an economy yet to gather its full momentum and still away from its potential. These include: stressed farm revenues, as non-cereal food prices have declined; farm loan waivers and the fiscal tightening they will entail; and declining profitability in the power
and telecommunication sectors, further exacerbating the TBS problem. For the year ahead, the structural reform agenda will be one of implementing actual and promised actions— GST, Air-India, and critically the TBS. The macro-economic challenge will be to counter the deflationary impulses through key monetary, fiscal, and agricultural policies. The opportunities created by the “sweet spot” that recent Economic Surveys have highlighted
must be seized and not allowed to recede.

Even in RBI MPC Minutes, both Governor and Deputy Governor mention deflation in food prices:

Statement by Dr. Viral V. Acharya

Inflation prints since the last policy have turned out even lower, though there are emerging signs that certain deflating food items are on a price rebound. 

Statement by Dr. Urjit R. Patel

…….An assessment of whether the recent deflation in food items is sustainable, despite a normal monsoon, would require more hard data going forward.

There is always this confusion when the term deflation is mentioned. What people perhaps mean is disinflation but they end up calling it deflation.

Robert Ophele, then Deputy GOvernor of Banque de France clarified:

Inflation refers to a sustained increase in the general price level in an economy. It is not an instantaneous shock limited to the prices of certain goods. It is a persistent and general process. Inflation is fuelled by expectations – when workers and companies expect prices to rise, they adjust upwards their prices and wages accordingly.

Conversely, deflation is a sustained decrease in the general price level in an economy. If only certain prices fall, it is not deflation. For example, the price of laptop computers or hi-fi equipment may decrease due to technological progress, but this is not deflation.

Disinflation is a reduction in the rate of inflation or a temporary decrease in the general price level in an economy. For example, if inflation falls from 3% to 1% per year, this is disinflation. If, however, the rate of inflation falls into negative territory, to 1% per year for example, and this decrease is expected to last, this is deflation.

In a recent piece Tandit Kandu of Mint clarifies the so called deflation only on account of fruits and veggies:

The second volume of the Economic Survey released a little over a week ago by the Union finance ministry warned that the Indian economy faces deflation risks owing to the problem of over-leveraged private sector balance sheetsand other headwinds such as GST and rural distress. Concerns over deflation risks are understandable, given the recent downward trend in retail price inflation.

However, a Mint analysis suggests that the sharp drop in inflation below the Reserve Bank of India’s (RBI’s) 4% target has been driven by only two items—pulses and vegetables. The analysis shows that consumer price index (CPI), excluding pulses and vegetables, rose at the rate of 3.8% in July, much higher than the official headline figure of 2.4% inflation for the month. The re-calculated CPI is based on adjusted weights after excluding pulses and vegetables from the basket of goods and services.


Thus, there does not seem to be any imminent threat of deflation in India. A more apt characterization of the recent trends in prices may be ‘disinflation’ (a fall in the inflation rate) rather than deflation (falling prices) given that overall inflation, excluding pulses and vegetables, is close to the RBI target of 4%.

This is pretty much the story each time deflation is mentioned in India. One or two items/categories lead to decline in inflation levels and we call it deflation in India and clamoring for monetary and fiscal stimulus.  Whereas deflation is persistent decline in most prices (if not all) and there is nothing of this sort happening here.

Comparing central banking to symphonies..

August 21, 2017

Nice speech by  Mr Nestor A Espenilla, Jr, Governor of Bangko Sentral ng Pilipinas.

He cites several awards given to the Philippines central bank recently and says it is all due to team work:


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