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.
An excellent article on INET on present state of Macroeconomics and Macroeconomics models.
V Anantha Nageshwaran(mint) has very interesting take on economics law operating in India, albiet funny.
with olympics going and India about to win test, there is hardly any space for wonks. But tommorow’s Mon Policy statement will make headlines, but maybe totally as the Dr Rajan’s last Monetary Policy statement. So whats the state of economy:
- The Central Banks round the world has done the heavy lifting, FED Fund rates are close to 25bps, as is the case with ECB. The CBs in Countries like Japan and Switzerland have gone even to negative territory. So RBI better comply.
- IIP is languishing, IIP of Capital goods is infact negative for last seven months. Inspite of fiscical stimulas private investment is yet to pick up. Can interest rate entice the animal spirit.
- June inflation number are perilously close the 6%, the outer bound. The hard earned credibility should not be languished.
- Good Moonsoon, will bring cheers to agriculture sector, and should revive rural consumption. But its better to wait for the actual results.
- FED has not raise the rate this cycle. The commentry which followed is hardly conclusive. No point in cutting the rate now, and then raise it to arrest the capital flow.
Essentially this blog feels that there is little room for cutting rate this cycle.
Yesterday this blog shared the link for Prof Pulapare’s article reflecting on concerns regarding growth, while pursuing single point agenda for controlling inflation. Today BS pointed to one on the recent speech by Dr Rajan. Very wonderful analysis, convincing argument.
Prof Pulapre Balakishenin, The Hindu, has this very succient article regarding ” Should RBI be really focusing on “Inflation”. A very coherent article with strong argument.
By suggesting that inflation targeting be the sole objective of monetary policy in India, the government has also shut out of the reckoning an assault on India’s weak agricultural supply-side.
John Maynard Keynes was surely right to remark that the world is ruled by ideas and little else. But he may have been optimistic in believing that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil.” Actually, vested interests can ensure that ideas prevail even when they are meant to serve some sectional interests at the cost of others. To those convinced of the infallibility of the principles governing the creation of wealth, it must come as a surprise that some of what is often considered knowledge in the context may be contested on perfectly reasonable grounds or, worse still to their likely horror, merely reflects the interests of certain parties to the transaction, so to speak. This is certainly true of the reigning view of the role of the central bank. Central banks are pivotal to the economic system and all countries have them. Our own Reserve Bank of India (RBI) is widely admired as arguably the last institution standing up to the machinations of the political class. It has certainly helped that every Indian to have headed it has represented the highest traditions of public service and personal integrity. Persons apart, however, a certain degree of morphing of the RBI has occurred of late, some of it deliberately intended and some of it perhaps in the form of collateral damage.
The scope of inflation targeting
The Finance Bill, 2016 has finally succeeded in making inflation targeting the sole objective of monetary policy. As monetary policy is the central bank’s prerogative, the move may be welcomed as signalling a newly minted and wholehearted commitment to inflation control which is now privileged over all other objectives. It, however, overlooks two possibilities that are surely of relevance in the context. First, whether the focus on inflation may imply a loss in certain other areas of the economy. And, second, whether inflation is fully within the its control anyway. Each of these considerations poses substantial questions.
The issue germane to the first is whether focussing on inflation can lead to preventing a rise in employment. In economies with unemployed resources, an increase in aggregate demand may be expected to lead to a rise in output and a rise in prices if there is a shortage of some inputs into production. In India the rise in prices is usually that of food, some items which have been perennially in short supply, the case of pulses and vegetables coming to mind immediately. Note that the increase in output may be expected to lead to an increase in employment as goods require labour for their production. Thus we have an increase in output, employment and prices. In a situation of ongoing inflation, we may even witness a rise in its rate. The question now is how to deal with the rise in prices. This can be done via one of two approaches.
Under so-called inflation targeting the central bank raises the rate of interest. When this is passed on by the commercial banks, it reduces the demand for credit, lowers investment and output growth. There is a concomitant reduction in the demand for labour and the offending material inputs whose price rise constituted the inflation. Inflation is now likely to reduce. But notice the accompanying reduction in output. Supporters of inflation targeting argue that the initial spurt in output would not have been sustainable anyway as in the ‘long run’ workers will withdraw labour when they find that inflation has eroded the real value of their wages. This claim is sustained by ruling out involuntary employment, defined as a situation where workers are ready to work at the given money wage but do not find jobs. In its essence, the policy of inflation targeting assumes that the economy is always at full employment, or the ‘natural rate’ in the modern economist’s vocabulary. In this account fully-employed workers offer more labour as inflation rises only because they mistake an increase in their money wage for a rise in its purchasing power — that is, they are unaware of the inflation. This suggests a certain credulousness among workers who, one would imagine, visit the bazaar on their way home from work in the evenings. It is only by insisting that inflation always and everywhere reflects employment having overshot its natural rate that the claim of no loss in welfare due to tight monetary policy can be sustained.
Importance of supply position
It should be clear by now that inflation targeting by the central bank can stem inflation due to supply shortages only by restricting demand. This entails welfare loss as employment is thereby reduced. So, how are we to deal with the inflation of the type described above, which I suggest is typical of India today? It can only be tackled via an expansion of the supply shortfall through either imports or increased production. We would then have tackled inflation at source — that is, directly, not indirectly, by restricting aggregate demand, as under a policy of inflation targeting. As a defence of the latter is offered the idea that the central bank can influence inflation expectations by signalling its intent to lower inflation in the future. But why should agents buy this when they know that the bank cannot influence the food supply, which is the source of inflation? Their expectation of inflation is likely to remain high if they do not perceive in the offing a radical change in the supply position.
By suggesting via the Finance Bill now that inflation targeting becomes the sole objective of monetary policy in India, the Government of India has not just oversimplified the problem of inflation control, it has also shut out of the reckoning an assault on India’s weak agricultural supply-side. The importance of a strong supply position in combatting inflation can be seen from the history of the U.S. and the U.K. in the last four decades. Following the oil price hikes of the 1970s, these economies went into overdrive in reducing their dependence on imported oil, the price of which could be manipulated by a cartel such as OPEC. This was achieved through a combination of supply and demand-side measures. The U.K. was lucky in striking oil in the North Sea while the U.S. developed an alternative to crude oil from shale. What is less well known is that there has also been a concerted conservation drive, something that we have not seriously attempted as India’s politicians are reluctant to propose any form of belt-tightening.
Far from being an open-and-shut case then, the adoption of inflation targeting as the sole objective of the RBI is contestable in ways that have been indicated here. It also ignores a serious lesson from the recent global financial crisis, which is that an inflation-targeting central bank can lose control of the financial system. This, after all, was what had happened in the U.S. that had enjoyed a “great moderation” of inflation even as banks were generating toxic assets with the capacity of dragging the system down. It is not sufficiently recognised that at least some part of the present problem of non-performing assets in India is related to poor lending by the nationalised banking sector at a time when inflation was considered to be under control. If a central bank is to have responsibility for financial stability, and this was the original task assigned to it, its focus cannot be exclusively on inflation. In India the Financial Stability and Development Council has taken the task of financial regulation outside the RBI. This is unwise, as the interest rate mechanism can prove to be a double-edged sword. While it may curb inflation when raised, it may at the same time threaten financial stability by tipping indebted entities into insolvency. There is no case for monetary policy and financial regulation to be under the same authority.
Factor in the vested interests
But what about the vested interests that I started out talking about? They are present as follows. Inflation lowers the real value of fixed-income securities referred to as ‘bonds’. Bond holders thus face ‘inflation risk’. As the total value of these securities rises in an economy, a vested interest in keeping inflation low emerges. Wall Street in the U.S. is the archetype here. Its interests are not that of the American worker — that is, it only cares about the real value of the financial wealth it manages. It is also powerful, reflected by the revolving door between Wall Street and the U.S. Treasury, the equivalent of our Ministry of Finance. However, not even this has succeeded in turning the Federal Reserve into an inflation-targeting central bank. Its mandate includes “promoting maximum employment”. The Indian establishment, on the other hand, has shown itself to be amenable to cognitive capture.
Ten years back nobody would have believed that people in advanced economies, the evangilists of Globalisation and free trade with turn their backs on free trade. Then we are living in intresting times. This POTUS election, has be one such instances where candidates from both side of divide have pushed for same. NYT summerizes we in below article.
Democrats and Republicans agreed on almost nothing at their conventions this month, except this: Free trade, just a decade ago the bedrock of the economic agendas of both parties, is now a political pariah.
Protesters, many of whom supported Senator Bernie Sanders, swarmed into Philadelphia this week and heckled speakers, even President Obama, over the Trans-Pacific Partnership trade (TPP) deal that was finalised this year. Senator Tim Kaine of Virginia, who has tried to help Obama achieve this signature trade pact, renounced his support for the deal last week when he joined Hillary Clinton’s ticket.
Donald J Trump has made unravelling the Trans-Pacific Partnership, the largest regional trade accord in history, the centrepiece of his campaign, upending more than half a century of Republican orthodoxy.
The fragile pro-trade coalition on Capitol Hill once led by Republicans is also unspooling, and congressional approval of the Trans-Pacific Partnership, which would include 12 countries that together account for roughly 40 per cent of the global economy, seems increasingly unlikely during the Obama presidency. Republican leaders in both chambers are not planning to bring it up this year.
Opponents of multilateral trade agreements, convinced that they have unduly harmed American workers, have enjoyed a stunning success that may signal a long-term political and policy realignment in both parties.
Republicans, proponents of free trade for decades, have found their base this year expanding to include anti-trade voters from poor and working-class areas who have joined forces, if not voting habits, with the Democrats’ most liberal voters.
“The primaries created seismic changes,” said Senator Chuck Schumer, Democrat of New York. “It will never be the same again. Neither Republicans nor Democrats will ever again be unabashed advocates for trade.”
Candidates often turn against free trade only to embrace it as president, as Obama notably did. Clinton also changed her position on the Trans-Pacific Partnership during the campaign after championing it as secretary of state. Govenor Terry McAuliffe of Virginia suggested this week that Clinton would reverse as Obama did if elected, only to be strongly batted down by campaign officials. Trump’s criticism of the trade pact is far more frontal. In addition to tearing up the deal, he has said he would slap a 45 per cent tax on imports from China.
He believes he can attract liberal voters with this pitch, which he posted on Twitter this month, “To all the Bernie voters who want to stop bad trade deals & global special interests, we welcome you with open arms.”
In some ways, Trump is pulling Republicans back to their protectionist pre-war roots. They were the party of the ultimately disastrous Smoot-Hawley Tariff Act of 1930, which raised tariffs on imports, a position that was later reversed.
Democrats, with their deep ties to organised labour, have soured on trade deals in recent decades, especially in the wake of the North American Free Trade Agreement, which was signed into law by the Clinton administration.
They say the deals have cost manufacturing jobs and lowered wages, though global trade accounts for fewer lost jobs than automation and other technological advances. (The apparel and furniture sectors, which employed many of the workers now backing Trump, are exceptions.)
In surveys, most Americans typically say free trade on the whole is positive, a fact often cited by its supporters. But polls also show that people are less optimistic about trade’s effect on jobs at home. Americans are more likely to say that international trade diminishes wages more than it improves them, and that it results in jobs losses.
The anti-trade talk “resonates with people who have been on the short end of the stick,” said Jeffrey J Schott, a trade expert at the Peterson Institute for International Economics.
“There are a wide range of reasons why this segment of the population has been left behind,” he added. “Both the attacks on trade and on Clinton are a surrogate for concerns about globalisation.”
The shift was visible among Republicans early this year when the embattled incumbent Senator Rob Portman, Republican of Ohio and a former United States trade representative in the second Bush administration, came out against the Trans-Pacific Partnership.
Other Republicans have since remained quiet, or also pulled back. Portman, who is in a tough re-election fight against Ted Strickland, the former Ohio governor, recently received the endorsement of the Ohio Conference of Teamsters.
These are positions that worry the administration greatly. “Globalisation is a force, and trade agreements are how we shape globalisation,” said Michael B Froman, the United States trade representative who has been criticised on Capitol Hill all year from members of both parties. “There is a lot of rhetoric in the campaign that reflects real anger and concerns about changes in our economy, but the right prescription is not to get out of trade agreements.” Representative Kevin Brady, Republican of Texas and chairman of the House Ways and Means Committee, said “the White House is making progress, but it needs to pick up the pace and pick it up significantly.”
He added, “Congress has the final say on whether trade is good for our country and workers, and there are outstanding issues that have eroded that support.”
Sanders and Trump have relentlessly bashed the Trans-Pacific Partnership and multilateral trade deals throughout the campaign, pushing Clinton toward Sanders’s position and leaving Republicans largely scared into silence, or equivocating.
“It’s been a one-sided conversation in this race, which is unfortunate,” said Representative Ron Kind, Democrat of Wisconsin, who is a rare member of his party in the House who supports the Trans-Pacific Partnership.
Trade supporters are trying to counter the anti-trade crowd with local advertisements, posts on Twitter, op-ed articles and town-hall-style meetings.
“The current rhetoric about trade is in members’ minds,” Froman said, “but we are working hard to push back against misinformation that is out there.”
The White House is trying to allay concerns in Congress about when and how member countries will change their laws to adjust to the agreement and how the data of financial companies will be treated.
A fight over how intellectual property protections are managed for the biopharmaceutical industry has been sticky, and the topic has been the subject of discussions between the administration and Republicans in Congress.
Still, there is deep resistance to voting on the trade measure. “The chances are pretty slim that we’d be looking at that this year,” said Senator Mitch McConnell, Republican of Kentucky and the majority leader. House leaders are equally indifferent.
Clinton has expressed strong reservations to aspects of the deal, and it is not clear what she would do to move a trade pact forward as president. Even less is known about what Trump’s approach might be, other than his assertions that his deal-making prowess would achieve accords that are better for workers.
Even so, the long-term impacts on both parties seem inevitable.
“We are not going back to business as usual,” Schott said. “If Clinton wins, I think there are feasible ways for her to fix what is broken and make it better. If Trump wins, he wants to just break the china, and once he does that, you won’t be able to put the pieces together again.”
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:
Prof. Krugman(in NYT) takes a all together different view. And amazingly defends it.
On Thursday I weighed in on the short-term effects of Brexit, questioning the near-universal premise among economists that it will be a major negative shock to demand. I wasn’t trying to be counterintuitive for the sake of sounding clever, let alone trying to defend the Brexiteers. I was just genuinely puzzled about where this consensus came from, given that nothing in standard macroeconomic models says that a policy bad for the economy’s long-run supply side necessarily hurts its short-run demand side. And I worried that the apparent consensus among economists was in some sense political rather than analytical: free trade good, breaking from Europe bad, therefore you don’t have to be careful in your arguments about exactly why it’s bad.
I’ve received several thoughtful responses from economists I respect, all making a particular argument about the effects of Brexit-induced uncertainty. It goes like this: right now, firms don’t know how closely Britain will be tied to Europe, so it makes sense for them to postpone investments until the situation clarifies.
This is an interesting and defensible argument — basically, that the unclear shape of Brexit creates an option value to waiting. But I have three questions about it.
First, is this really the argument underlying all of these dire post-Brexit forecasts? My guess is that very few people reading news reports, or even briefing papers, about Brexit are hearing this; what they’re getting is much closer to the notion that uncertainty = increased probability of bad things. That is, this argument is a lot more nuanced and subtle than anything I previously heard in this discussion.
Second, doesn’t this argument imply a later investment boom once the uncertainty is resolved in either direction? That is, once Prime Minster Farage and President Le Pen have engineered the demise of the EU, there’s no reason to wait, and all the pent-up investment comes roaring back, right? But I haven’t heard anyone arguing that the contractionary effect of Brexit will be followed by a compensating boom once things settle down.
Third, doesn’t this argument suggest essentially the same effects from any policy negotiation whose end result isn’t known? Why don’t we say that the possibilities of TPP or TTIP are contractionary, because firms have an incentive to postpone investment decisions until they know whether these agreements actually happen? Somehow, though I’ve never heard anyone argue for the depressing effects of pending trade liberalization.
Again, I’m not trying to defend Brexit. But I worry that the urge to condemn it has led to a lowering of intellectual standards.
And let me also say that the narrative of disaster is coloring some (not all) financial reporting. On the whole, the market reaction looks pretty muted to me. It’s not just stocks: European bond spreads are about where they were a month ago. True, globally, rates are considerably lower; but we aren’t seeing the kind of financial disruption so widely predicted. Yet headlines about turmoil are everywhere.
Could I be wrong about all of this? Of course! But everyone really should ask where the consensus about Brexit macro is coming from.