Monthly Archives: April 2016

Central Banks on Trial

Howard Davies is sympthatic about Central Bankers.

His article in PS.

He states that in this century Central bankers have gone from zero to hero and now back on trail again. Now doubt there role is now very much expanded:

Central banks’ balance sheets have expanded dramatically, and new laws have strengthened their hand enormously. In the United States, the Dodd-Frank Act has taken the Fed into areas of the financial system which it has never regulated, and given it powers to take over and resolve failing banks.

In the United Kingdom, bank regulation, which had been removed from the BoE in 1997, returned there in 2013, and the BoE also became for the first time the prudential supervisor of insurance companies – a big extension of its role. The ECB, meanwhile, is now the direct supervisor of more than 80% of the European Union’s banking sector.

In the last five years, central banking has become one of the fastest-growing industries in the Western world. The central banks seem to have turned the tables on their critics, emerging triumphant. Their innovative and sometimes controversial actions have helped the world economy recover.

But with great power comes great responsibilities:

There are two related dangers. The first is encapsulated in the title of Mohamed El-Erian’slatest book: The Only Game in Town. Central banks have been expected to shoulder the greater part of the burden of post-crisis adjustment. Their massive asset purchases are a life-support system for the financial economy. Yet they cannot, by themselves, resolve the underlying problems of global imbalances and the huge debt overhang. Indeed, they may be preventing the other adjustments, whether fiscal or structural, that are needed to resolve those impediments to economic recovery.

This is particularly true in Europe. While the ECB keeps the euro afloat by doing “whatever it takes” in ECB President Mario Draghi’s phrase, governments are doing little. Why take tough decisions if the ECB continues to administer heavier and heavier doses from its monetary drug cabinet?

The second danger is a version of what is sometimes called the “over-mighty citizen” problem. Have central banks been given too many powers for their own good?

Quantitative easing is a case in point. Because it blurs the line between monetary and fiscal policy – which must surely be the province of elected governments – unease has grown. We can see signs of this in Germany, where many now question whether the ECB is too powerful, independent, and unaccountable. Similar criticism motivates those in the US who want to “audit the Fed” – often code for subjecting monetary policy to Congressional oversight.

There are worries, too, about financial regulation, and especially central banks’ shiny new macroprudential instruments. In his new book The End of Alchemy, former BoE Governor Mervyn King argues that direct intervention in the mortgage market by restraining credit should be subject to political decision.

Others, notably Axel Weber, a former head of the Bundesbank, think it is dangerous for the central bank to supervise banks directly. Things go wrong in financial markets, and the supervisors are blamed. There is a risk of contagion, and a loss of confidence in monetary policy, if the central bank is in the front line.

So the role of CB where the distinction between fiscal and monetary policy burrs, there Central banker not being accountable to people( read legislative) is a double edged sword. Any stumbling of CB is going to subdue their autonomy, and hence so much positive spillover with it.

Whats wrong in negative rates

Joseph E. Stiglitz puts his views on negative rates in Project-Syndicate.

Bank, as we study in conventional economics are the intermediaries who transfers funds from savers to entrepreneurs. So what makes this transfer smooth. According to the contemporary practice, policy rates seems to be the most important lever you need to dial up or down to reach full employment.

And now we are in a zone where this dial down has breached the conventional boundary: Zero-Lower-Bound (ZLB). Along with BoJ and couple of others, now ECB also has decided to try the trick. Prof. Stiglitz argues that none of the economy adopting the negative rate policy has reached the full- employment, rather some of the lending rates have increased.

Prof Stiglitz further argues, that big business are sitting on the piles of cash, and 25 bps is not going to prompt them for some big capital investment. In fact investment in plants and equipments has only decreased. It is the SME’s who are not able to get the funds from the banks, so decrease in yield on T-bills do not affect them. Further they anyways do not have access to capital markets. So it is this group and more specifically the mechanism of credit that central banks should be worried about.

Egypt for Sale

A informative piece on Egypt by Barak Barfi in Project Syndicate.

  1. When Muhammad Ali defeated the British in 1807, Egypt became the first Arab country to gain de facto independence. But Ali’s grandson, Ismail, squandered that independence with profligate spending, establishing a dependency on external assistance that persists to this day.
  2. Egypt’s dependence on the British continued until Gamal Abdel-Nasser took power in 1952. He welcomed the Soviets, who provided sophisticated weapons in exchange for the same kinds of IOUs that doomed his predecessor. By the time Nasser died in 1970, the Soviet Navy had transformed the port of Alexandria into a virtual Soviet republic, with Russian spoken as a second language.
  3. Meanwhile, Nasser pursued costly populist economic policies. He expanded the bureaucracy by offering every college graduate a government sinecure; today, 24% of the workforce is employed by the state. He introduced subsidies for commodities, from bread to oil, that amounted to 8.1% of GDP in 2013-2014. In 2014-2015, 81% of the budget went to debt service, subsidies, and wages, crowding out education and other investments essential to long-term growth.
  4. Nasser’s successor, Anwar Sadat, attempted to revive Egypt by liberalizing the economy, making peace with Israel, and abandoning the alliance with the Soviets in favor of the US and Western Europe. He was rewarded with an aid package that averaged more than $2 billion per year. But, with Egypt’s population growing at an annual rate of 2.2%, even this was not enough
  5. Egyptians rarely hear about their country’s dire financial straits. Instead, the government-controlled press boasts about new bridges and increased industrial production, while highlighting Egypt’s role in regional affairs, such as the dormant Israeli-Palestinian peace process and the cobbling together of governments in Lebanon.
  6. Instead of delivering on these imperatives, Egyptian President Abdel Fattah el-Sisi has been forced to relinquish territory to the Saudis to secure the aid the country needs to stay afloat, facing considerable mockery in the process. In the zero-sum game that is Middle East politics, however, one party’s loss is another’s gain. And in the case of Egypt today, it is radical Islamists who are reaping the rewards of popular disillusionment with the government.
  7. The Islamists are offering their own narrative: The modern nation-state has failed Arabs and Muslims. This resonates with a population that is experiencing the state’s failure every day. Focusing on restoring past Islamic glory is becoming more appealing than resurrecting a regional power that could never even secure rights for Palestinians.
  8. Egypt’s leaders retain the legitimacy and strength needed to curtail this dangerous narrative. But, if they are to succeed, they will have to acknowledge what Egypt is – and what it is not. In a country where ancient artifacts are deeply cherished, the myth of regional greatness is one relic that should disappear soon.