Category Archives: MONETARY POLICY

RBI and its high interest rate

Prem Shankar Jha (the wire) blames RBI for low growth in India. He specifically put the blame on SubbaRao and Rajan for sticking to inflation target and bringing down the growth.

“The doctrine that both used to do this – Subba Rao implicitly, but Rajan explicitly – is “inflation targeting”, whose central tenet is that high inflation hurts economic growth, and lowering it automatically restores growth. Both therefore made the control of inflation the one-point agenda of the RBI. This doctrine was cock-eyed to start with, but by 2013 so complete was the RBI’s dominance over the ministry of finance, that no finance minister in Delhi (Arun Jaitley) has dared to take the RBI governor to task or challenge the theoretical basis of his addiction to high interest rates.”

He goes on to argue that inflation targeting was a tool devised by advanced economies to mooch of the saving of poor countries.


The truth is that inflation targeting is not an economic tool to foster growth but a political tool devised by the richest industrialised countries to enable them to continue living far beyond their shrinking means, by drawing, free of cost, upon the savings of less fortunate countries.

Inflation targeting attained the status of a doctrine – a one-stop cure for all developmental ailments – only when it was adopted by the industrialised countries in the 1990s. Its rationale developed out of Britain’s exchange rate crisis in 1992. Britain had been living way beyond its means, with an average inflation rate of 11% and a balance of payments deficit of 8% of the GDP for 20 years from the early seventies. Initially, this caused the pound to depreciate rapidly against the dollar. Then North Sea oil hit the market and the pound recovered till it was once more worth well over two dollars at the end of 1978.

Again I don’t agree with inflation going out of the control. The analysis of Jha is quite comprehensive.





Demonitization-Gurumurthy Take

Gurmurthy piece in The Hindu

His contention:

The balloon of HDN was expanding in dangerous proportions. This needed to be reined, otherwise Indian Economy was doomed by 2021. This was a reset.

The growth during UPA years was jobless growth powered by HDN, via high asset price and high private consumption.

Interestingly he faults Govt late introduction of Income declaration scheme late in the day, otherwise this could have fetched 2-3 lacs Cr in tax.

Now he states 45K Cr is black money is already unearthed and 2.9 lacs Cr in under scanner, the yield is far more than any earlier income declaration.

Following demonetisation, there are 56 lakh more assessees, advance tax receipts have gone up by 42% and self-assessment tax risen by 34%. It has also led to an attack on benami assets. Even as intelligence agencies note a 50% drop in hawala-related calls post demonetisation, nearly 2.24 lakh shell companies that have been used for hawala have been uncovered; 35,000 have been found laundering ₹17,000 crore; one of them, ₹2,484 crore.

Everyone has their numbers.



RBI consent in demonitization

In the present days of modern monetary system, independence of Central banks is given paramount importance. FED, ECB every single one has guarded this independence tooth and nail. Demonetization of 85% of currency takes some nerves, just too much risk is involved. Which raises question how much was the involvement of RBI in it. Media states on six people knew about it, RBI governor and ex-governor (erstwhile governor)  from RBI knew of it. Which means it never reached the board. This makes is much more murkier. Dr Rajan and Dr Subbarao put everything inline to protect this independence. I wonder how much is it now. It almost seems North Block is running RBI. Shaktikant Das is making all the announcement, Dr Urjit Patel is not be seen anywhere. Ex- Dy Director KC Chakrabarty spills the beans further. This was proposed during UPA-II time, but was rejected and did not reached the board state.

Why the money multiplier remains so low

George Selgin’s latest monetary policy primer was a very good explanation of the money multiplier in fractional reserve banking systems. He also suggested that a number of factors may be affecting the current surprisingly low level of the multiplier; a fact that prompted a number of endogenous money theorists to (wrongly) assert that the multiplier was ‘dead’.

In this post, I wish to elaborate on the reasons behind the low multiplier. And those reasons are, in my view, related to banking mechanics and regulatory dynamics.

Let’s first start with a little bit of history to put things in perspective. Some time ago, and following one of my blog posts on the topic, Levi Russel from the Farmer Hayek blog – who is much better than I am at manipulating FRED data – kindly sent me the following chart representing the M2 multiplier (‘MM’) since 1920:

Will Rajan get second term

AV Rajwade analyses Rajan’s record in BS.

  1. Arrested the slide of INR which was in free fall in Aug 13.
  2. CPI being the inflation anchor for RBI to target. Since WPI is 0 to negative for some while, where as CPI is moderate around 5%. HE complains that has WPI being the anchor, there would have been more room for rate cut. He also questions the efficacy of interest rate to inflation( basically challenging ” IS the most important lever CB have, any good?).
  3. Is single anchor approach effective. Employment should also be concern for RBI. I think this is where I would seriously disagree with author. Government should also be shouldering some weight. RBI mandate is inflation( now codified by law) and market stabilization. Both have been done excellently. As far as increase in NPA is concerned, it is more of namesake. He only made sure the criterion is adhered strictly, and we don,t live in a fools paradise.


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.

Chinaá Forex’s Follies

Prof. Barry Eichengreen has this nice piece in Project syndicate.

BERKELEY – On August 11, China devalued its currency by 2% and modestly reformed its exchange-rate system. This was no earth-shattering event, but financial markets responded as if a meteorite had struck them. The negative reaction is no mystery: China’s devaluation was a textbook example of how not to conduct exchange-rate policy.
If the intention of China is to depreciate the currency further there is no point in doing it in installment.

One of the government’s motivations was presumably to give a boost to China’s slowing economy. Although the service sector, which accounts for the majority of employment, is holding up relatively well, the country’s output of tradable goods, many of which are produced for export, is weakening sharply. Chinese exporters are caught between the pincers of weak foreign demand and rapidly rising domestic wages.

Devaluation is the tried and true remedy for such ills. But a 2% change in currency values is too little to make much of a difference, given that wages in Chinese manufacturing are rising at an annual rate of 10%.
It could be that Chinese policymakers regard the 2% devaluation as a down payment – the first in a succession of downward adjustments. But, in that case, they violated the first rule of exchange-rate management: Don’t cut off a cat’s tail in slices.

Next is there motive regarding the inclusion in SDR, which is of limited practical use.

Another interpretation of the August 11 move is that it paved the way for the renminbi’s inclusion in the basket of currencies that comprise the International Monetary Fund’s unit of account, Special Drawing Rights. In order to be included in the SDR basket, a currency must be widely used in international transactions. The renminbi is already widely used to invoice and settle international merchandise trade, notably other countries’ trade with China itself.

But it is less freely traded in global currency markets, ranking only 9th overall, according to the Bank for International Settlements. This relatively low standing partly reflects China’s maintenance of controls on capital flows, which make it hard for financial-market participants to get their hands on renminbi. But it is also a result of heavy-handed manipulation of the foreign-exchange market by the People’s Bank of China (PBOC), which makes changes in the price and availability of the renminbi opaque and uncertain.

The August 11 initiative may have been designed to alleviate this concern. In addition to devaluing, China announced that the opening “fix” – the price at which trading of the renminbi would commence each day – would be largely based on the previous day’s closing market price. Because the PBOC had been setting the opening fix pretty much wherever it wanted, this change could be seen as moving the renminbi toward a more market-determined exchange rate.

If so, it is at most a very modest move in that direction. The PBOC continues to intervene heavily once the market is open, thereby limiting fluctuations in the dollar-renminbi exchange rate to less than 2% a day.

In any case, gaining admission to the SDR club is a poor excuse for wrong-footing the markets. Given that the SDR, which the IMF uses to keep track of its own financial transactions, is of little practical importance, the Chinese authorities’ effort to add the renminbi to it amounts to little more than a vanity project. Inclusion would make no difference in terms of progress toward China’s goal of developing its currency into a first-class international and reserve currency widely used by private and official foreign investors.

If Chinese officials are serious about pursuing this goal, they should stop focusing on the SDR and start developing stable and liquid financial markets that are not subject to official manipulation. Only then will the international community embrace the renminbi as a proper international and reserve currency. The events of the last month suggest that China still has a long way to go.