Ars longa, vita brevis
Economics
Media Appearance: Mint
0I am quoted today in the Mint on inflation indexed bonds. I think there will be a market for IIBs in India given the way inflation has damaged purchasing power over the past decade. However there are a couple of key issues that need to be dealt with.
First, nominal yields in India have been very low and often below the consumer inflation rate. This is mainly due to forced investments in government bonds by large investors such as banks, insurance companies, pension & providend funds. Thus it is possible that the real rate on the new IIBs could be very low.
Second, coupons are subject to tax and after tax returns are possibly going to be lower than inflation. The annual coupon is calculated using the real yield times the inflation adjusted principal. Therefore it is possible that the tax rate on the new bonds is substantially lower than the rate on nominal bonds. Having said that the tax department may take the view that the increase in principal should also be taxed (just as zero coupon bonds are taxed at present).
Third, the new IIBs are indexed to the wholesale price index and not the consumer price index. Over time, the CPI based inflation has been much higher than the WPI based inflation. This can be “modeled” by increasing the spread (real yield). It is unclear how this will work in practice though.
Deepak Shenoy: Housing Bubble in India?
0Deepak Shenoy at Capital Mind blog has done some good work on house prices and transactions across major cities in India and asks the question: is there a housing bubble? His basic conclusion appears to be that different cities are at different stages of a housing cycle. The larger metros seem to be in a consolidation / early fall stage of the cycle.
Media Appearance: Financial Chronicle
0I was quoted in the Financial Chronicle on Saturday, May 4th [incidentally also Star Wars day]. Strangely for a piece on equity markets the two fund managers interviewed are both fixed income managers!
Bitcoins and free banking
0Good piece at the Ümlaut on the emergence of Bitcoin and how the lessons of free banking in America and Scotland may apply. Clearly the beneficiaries of seignorage are unhappy with the emergence of Bitcoin: witness the latest report that the US CFTC (the commodities / derivatives regulator) is looking into Bitcoin. Fundamentally seignorage occurs when the value of a currency is greater than the production cost. In the case of paper or digital currencies (like the US Dollar), the marginal cost of production is very close to zero. Thus there is significant seignorage to be earned. The emergence of an alternate currency is a threat to this free profit mechanism.
Euro break up, Cypriot Euro trading begins
0Well, effectively anyway. Via MR, a WSJ blog post on “distressed debt” type buyers willing to buy Cypriot bank deposits at a discount. This is the first step to arrive at an exchange rate between Cypriot and “core” euros. As I have said before, the imposition of capital controls and fear of a tax on deposits (equivalent to a change in the value of deposits in Cyprus banks vs. those elsewhere in the eurozone) have created a system where Cyprus has effectively left the eurozone. Not to mention the threat of end of TARGET2 participation which would have finally killed off the single currency. Now there appears to be the first steps towards trading Cypriot bank deposits. The legality of trading bank deposits is not clear. So this is still early days.
More on Reinhart/Rogoff
0A couple of new and comprehensive reports. One by Gavyn Davies at FT Alphaville and another by James Hamilton at Econbrowser. Both have the advantage that while they summarize the issue well, they also do it simply. The table below is taken from Prof. Hamilton’s page.
| 1945-2009 | ||||
|
RR AER (2010) |
HAP (2013) |
|||
| Debt/GDP | Mean | Median | Mean | Median |
| 0 to 30 | 4.1 | 4.2 | 4.2 | NA |
| 30 to 60 | 2.8 | 3.9 | 3.1 | NA |
| 60 to 90 | 2.8 | 2.9 | 3.2 | NA |
| Above 90 | -0.1 | 1.6 | 2.2 | NA |
| RR AER (2010) (Table 1) | ||||
| 1800-2009 | ||||
| 0 to 30 | 3.7 | 3.9 | NA | NA |
| 30 to 60 | 3.0 | 3.1 | NA | NA |
| 60 to 90 | 3.4 | 2.8 | NA | NA |
| Above 90 | 1.7 | 1.9 | NA | NA |
| RRR JEP (2012), | ||||
| 1800-2011 | Mean | |||
| Below 90 | 3.5 | |||
| Above 90 | 2.4 | |||
I took these points away as very important:
- The trend seen by RR is not changed by HAP (Thomas Herndon, Michael Ash and Robert Pollin). Both see drops in growth as Debt/GDP declines. But the sharp drop in the mean growth rate seen above Debt/GDP of 90% is not observed by HAP. Note that HAP have not published the median, which in RR shows a much more moderate decline.
- Causality is not established. RR themselves did not infer causality, though many others did.
- The Davies article above links to a paper that suggests that growth declines precede rise in debt ratios. Again no causality should be inferred1.
I think the fact that high debt and lower growth are correlated makes sense. If debt rises, there should be an expectation of future tax increases. This in turn should cause lower present consumption and consequently lower growth. The Keynesian story of lower growth (due for example to a shock or financial crisis) leading to higher debt as taxes decline is also plausible. Some commentators have taken to chest-thumping to say that this refutes the basis for fiscal austerity that the EU is prescribing to crisis countries in the eurozone. However they are choosing to ignore the fact that past fiscal profligacy has inflated past growth and the accumulated debt must be paid. If not fiscal austerity, what?
1 The article is a nice example of someone using post hoc ergo propter hoc. I haven’t seen it used since Sheldon Cooper used it in The Big Bang Theory.
Reinhart and Rogoff get pasted
0One of the better summaries of the entire mess comes from Josh Barro at Bloomberg. This really highlights the need for better analysis and critiquing before papers with such dramatic predictions get out. Two errors: one, in missing out one country, RR get to show a large cliff effect of high debt/GDP ratios, while adding that country back produces results that are not as obvious; two, RR’s original paper seemed to imply a causality between high debt and slowing growth. In the paper they do not make such a claim but their silence when so many others read that causality could have been avoided. Incidentally the small sample size is an issue (RR already acknowledge this).
The fact that the EU has been citing this paper (maybe indirectly) to support fiscal consolidation / austerity during this crisis shows the possibility that bad political decisions may have been made based on poor statistical analysis.
See also Andrew Gelman at this post. There are many good reports out there.
Well said, sir!
0John Mauldin writes:
I admit to being surprised by Cyprus. Oh, not the banking crisis or the sovereign debt crisis or the fact that its banks were eight times larger than the country itself or even the fact that the banks were bloated with Greek debt that had been written down. I wrote about all that a long time ago. What surprised me was that all the above was apparently a surprise to European leaders.
Go read the whole thing at Mauldin Economics.
“I pop a beautiful sentence into my mouth and suck it like a fruit drop.”
― Bohumil Hrabal (qotd, Good Reads)
Performance pay for teachers in India
0This does not seem to have gotten anywhere near the importance it deserves in the Indian press. Alex Tabarrok at Marginal Revolution has a follow-up story on a large randomized experiment on the effectiveness of performance based bonuses for teachers in primary schools in India. The study was on a large number of government-run primary schools in Andhra Pradesh and the paper reports some outstanding results:
Students who completed their full five years of primary school under the program performed significantly better than those in control schools by 0.54 and 0.35 standard deviations in math and language tests respectively. These students also scored 0.52 and 0.3 standard deviations higher in science and social studies tests even though there were no incentives on these subjects.
That is absolutely brilliant! As Alex says, “Shout it from the rooftops!”