What to read today: May 19


One and done. Bruegel has done the job for me by summarizing all the recent economic debates on whether the economy is self correcting.



What you should read today


Heard in the Hutong: The Chinese View of India

Benedict Evans on Apps versus the Web and why the future is mobile, except it isn’t.

Sanjeev Sanyal says the world population will top earlier and at a lower level than the World Bank believes.

And if you are in for an economics paper read, Roger Farmer’s Animal Spirits, Persistent Unemployment and the Belief Function is worth a good time slot (warning: pdf).

The European Centre for Medium Range Weather Forecasts is forecasting a super El Nino this year. Here is Bob Tisdale talking about it.




Unfair bond ruling


I wanted to link to this news article about a judge ruling that a municipality can choose to put pensioners ahead of bondholders in bankruptcy. The judge herself says that the ruling may be “unfair.”

California’s public retirement fund holds so much power over local officials that pension-bond investors can’t expect equal treatment when a city goes bankrupt, a judge said in a ruling that she acknowledged seems “unfair.”

U.S. Bankruptcy Judge Meredith Jury on Monday threw out a lawsuit in which investors had claimed their pension bonds must be paid off at the same rate as the California Public Employees’ Retirement System in the San Bernardino bankruptcy. The $304 billion fund is the biggest in the U.S.

Normally this has no impact on my life, but what an aptronym. I mean a Judge whose name is Jury!!!!

Ok. Bye.


US GDP reported

US GDP growth – not as weak as it seems


The headline is that US GDP growth in the first quarter of 2015 slowed to a 0.2% annualized rate down from the 2.2% rate in the December quarter. I believe that this hides the real growth in the economy. To be sure non residential investment would have fallen (thanks in large part due to oil related investments), but real incomes and consumption actually benefited from the fall in inflation. See also FT Alphaville – Another Winter of Discontent (registration required).

The problem with looking at quarter on quarter data is that we are dependent on the seasonal adjustment factor used. Using a year/year measure removes this “adjustment” but has issues with being dated, i.e. not representing current growth. Nevertheless when we look at the year-on-year numbers, the growth in Q1 was 3.0% compared to 2.4% y/y growth in December. In fact Q1 2015 has been one of the fastest growing quarters post-recession as shown in the chart:

US GDP Reported

Note the big divergence between the quarterly and annual rates of growth. Sharp eyed readers will note that the quarterly numbers for the March quarter in previous years too seem depressed (notably in 2014 and 2011). This should not be the case if we use seasonally adjusted numbers. The point of using seasonal adjustment is that this sort of seasonality is removed. Looking at the post recession period (2010 onwards), we see an interesting trend in the average for each quarter:

US GDP Average Quarterly

Consistently the Q1 number is low, while the variation in other quarters is limited. Note that the variation in y/y numbers is also small. Clearly there is a problem with the seasonal adjustment methodology used by the US commerce department. So I did a quick readjustment and calculated my own seasonally adjusted GDP series using the data in the post recession period and this is how it looks:

US GDP Revised

The number for Q1 2015 is a growth rate of 2.0%, and the y/y rate is (no change here) 3.0%. This is certainly a slowdown relative to the 4% growth that was seen in June and Sept 2014. The slowdown in December and March quarters in this series are also consistent with the strength in dollar leading to weak net export performance.

And the average growth rates for each quarter now:

US GDP Average Revised

The Q1 anomaly has disappeared in the new series as it should.

Bottom line:

Growth in the US is slower than before but a 2% growth rate is pretty decent. The Fed is right in dismissing the weak GDP print, but for the wrong reason. It is not transitory factors, but rather the seasonal adjustment methodology. By the time Q2 numbers roll out, we could be in for an upside surprise in growth. Note that the GDP series is also due for revision in July. Perhaps we may see some recalculation of the Q1 numbers.


Big disclaimer: This is just a rough and ready calculation. Please do not use this to make investment decisions. Also note this is a personal blog and a personal view. This does not necessarily represent the view of my employer.



This is why I follow Arnold Kling


From his post this weekend:

I take an outlier point of view, which is that the Fed is not important for the macro economy. Walrasian economists needed something to pin down the nominal price level, so they nominated the money supply. I instead take the view that money and inflation are largely social conventions. Extreme measures by the government can change these social conventions. Otherwise, in my view, the belief in the power of the Fed is a superstition. This superstition is best maintained if the Fed’s actions are mysterious. If the Fed were to follow a transparent rule, I think that the superstition would be exposed for what it is.

This is at the bottom of his take on the Neo-Fisherite (keeping rates low encourages low inflation) & market monetarist (target nominal market levels) thinking.


Hard a starboard?


Is the Indian electorate swinging right? I mean this economically not from a social/political point of view.

In 2009, there was a swing in favour of the Congress-led UPA government. Within the many narratives as to why I think there were a particular couple of factors at play:

1. Economically, the Congress/UPA had delivered a strong 5-year growth track record. Yes, inflation had risen, but it hadn’t reached the levels of the next five years. Real incomes rose sharply. The Rupee was on the rise (except during the financial crisis period). India was truly shining. Fiscal deficits ceased being a worry. We had survived the crisis intact. Government shrank, free markets prospered.

2. Politically, a big event in 2008 was the signing of the nuclear deal with the US and the Nuclear Suppliers’ Group. This led to a break between the UPA and the Left parties. The Left withdrew support and the government would have fallen except for the support extended from the outside by the Samajwadi Party.

The 2009 victory though was attributed to the success of the social programmes of the Congress, most notably the rural employment guarantee programme. Other commentators (such as Swaminathan Aiyar) have noted that the Congress did not win more seats in rural areas in 2009, rather it was the urban/semi-urban swing that it won. (See for example this article where he says:”In 2009, Sonia’s sycophants claimed that MNREGA had won her the election. In fact she swept the cities while the poorest states most in need of MNREGA voted for Opposition parties.”)

The mis-attribution resulted in a sharp left-ward swing in the next few years: large and expanding fiscal deficits, subsidies and handouts. Rising inflation, three periods of ever larger currency depreciation reaching near crisis levels in 2013.

The voters had not delivered a socialist mandate. Thus the electorate revolted. And handed the mandate to the only right-wing (economically speaking) party available. That this party was also right-wing politically (nationalist) was probably not what swung the result. Mr Modi was wise to use the development agenda as the mood of the nation was to punish the left-wingers.

As an additional point in support of this, I will note that 2004 was the peak for the Left movement with 53 seats between the CPI and CPI(M). That fell to 20 in 2009 and 10 in the current general election. If that is not a rejection of the left, I don’t know what is.

P Chidambaram – who understood this – said in a recent interview that they misread the 2009 mandate:

“While we got the largest chunk of seats from prosperous parts of the country, from urban India, we did not read the signs,” the FM said. While he suggested a pro-growth strategy as opposed to a more pro-distributive one was the way the party should have gone after 2009, power minister Jyotiraditya Scindia disagreed, saying rural India had given the Congress an equally powerful mandate.
Chidambaram pointed out that while the India of old was a ‘petitioner’ society, the current India was an ‘aspirational’ one. India’s political parties, he said, failed to understand the changes that were taking place in the mood of the country in 2010 and 2011 and that the government failed to anticipate the extent of anger that was building up.

Of course, he said this on 29 April after he had decided not to contest this election. So he had not much to lose in speaking the truth.

One can only hope the message gets across clear to the new government. The country is ready for free markets. This is a generation that has grown into adulthood after the economy was opened up. We like competition, we like globalization, we are ready to be counted in the assembly of nations.


A Neo-Fisherite Collection


Collecting for myself some blog posts on the Neo-Fisherite “rebellion” as Noah Smith calls it. I hope to come back to this later.

Starting with Smith’s own post which collects a lot of this.

First, the basic idea. The Fisher Relation says that nominal interest rates are the sum of real interest rates and inflation:

R = r + i

That’s not an assumption, that’s just a definition (actually it’s an approximation, but close enough). What I call the “Neo-Fisherite” assumption is that in the long term, r (the real interest rate) goes back to some equilibrium value, regardless of what the Fed does. So if the Fed holds R (the nominal interest rate) low for long enough, eventually inflation has to fall. This is exactly the opposite of the “monetarist” conclusion that if the Fed holds R very low for long enough, inflation will trend upward.

Scott Sumner’s response. He does not agree, though I see this bit as interesting:

Suppose a madman is put in change of the Fed who is committed to zero rates over the next 10 years, come hell or high water.  Then I might forecast an upward drift in inflation; indeed I think hyperinflation would be quite possible.  It depends on what else the madman did. But if you simply told me that rates would be low over the next 10 years under Janet Yellen, I’d assume that inflation would be low, and that low inflation is precisely the reason why Yellen held rates down.

Emphasis in original

Ryan Avent writes in Free Exchange blog for the Economist

Try this. Imagine the Fed sets the interest rate it pays on banks’ excess reserves to 20%. This would immediately cause the economy to fall into deep depression. Banks would liquidate their loan portfolios and raise deposit rates in order to maximise their excess reserves. Consumers would liquidate their asset holdings and put everything in bank deposits since, as Mr Smith notes, there are very few investments in an economy that can deliver a 20% return. It would be the mother of all credit crunches.

But after that, the Fed would be pumping money toward banks, and on to depositors, at a pretty rapid clip, in keeping with the 20% interest rate. Depositors would be getting richer much faster. Those that wandered into the smoking rubble of the economy would soon find prices rising, as this rapidly growing money supply competed for limited goods (even more limited than normal, since the destruction of the credit system would be a nasty supply shock). The Fed’s action would—eventually—deliver rapid inflation.

And Simon Wren-Lewis adds more with a specific focus on the Zero Lower Bound.

I wondered whether we could give the ZLB steady state a different interpretation? Suppose agents believe that is where inflation is heading because they do not think monetary (or any other) policy is capable of achieving the inflation target. Given current attitudes to fiscal policy, and a pessimistic view of the power of QE, this interpretation does not seem so farfetched for the US or UK. Economists sometimes worry about a deflationary spiral, where inflation just keeps falling into a bottomless pit. But maybe the ZLB steady state is like a ledge that can stop this descent.



Rajan on international monetary policy coordination


Or the lack of the same. What he calls the current “non-system.”

In a speech called Yesterday Once More (full title: Competitive Monetary Easing: Is it yesterday once more?), Dr. Rajan calls for greater international monetary cooperation. While he admits that this cannot be forced on anyone, just the acceptance of spillover effects by major central banks would improve overall decision making.

One important point he raises early on in the speech and expanded later is that unconventional monetary policies (balance sheet expansion at the zero bound) are not much different from competitive devaluation through exchange rate interventions, though the channels may be different. This is important because we see exchange interventions as “bad” while we bless quantitative easing (Rajan cites IMF in this). But the primary route that QE works is through market (asset) prices, including the most important price of all – the exchange rate.

At first non-QE countries don’t see QE as an implicit devaluation. But since you can’t keep everyone fooled forever, people eventually catch on. Thus other countries either counter the effects – witness China building reserves and Japan starting its own QE – or fail to counter the effects and suffer imbalances – witness the effects on India.

Rajan ends with two warnings: that in a world with inadequate aggregate demand, everyone is fighting for a larger share of the same demand; and that extreme monetary easing is more a cause of problems than a medicine.

My only quibble is that he should have used that most potent of terms, beggar thy neighbour, when describing QE. That is what it is.


Links to read


This election season has brought out some good journalism and insights. I am attempting to gather some interesting links here.

KP Nayar writes on JN Dixit, Natwar Singh and the disastrous foreign policy that we had in the last ten years. Singh came into office with a one-point agenda: to undo everything the Vajpayee government did before.

Prof. R Vaidyanathan (Finance, IIM Bangalore) writes on the competing economic models that we could have chosen: Rajaji vs. Mahalanobis. In the event the Bengali faction won as it was supported by Nehru and we went down the Soviet path. With the model imploding in 1991 and the Soviet Union itself collapsing, we need to revisit the model choice. The opportunity in 2009 was the nearest we got to cementing the change in the recent past. Had Manmohan Singh got his choice for Finance Minister (C Rangarajan), we would not have had to suffer the exploding deficit, inflation, currency weakness and financial instability of the last five years.



Monetary terms alphabet soup


There is a lot of confusion on what all these monetary terms mean. QE, OMO, TAF, LSAP, LTRO, Repo etc. This post tries to make sense of these monetary operations done by central banks.

Firstly it is important to understand what a central bank does. A central bank is a banker of banks, i.e. it provides banking services to normal commercial banks. In doing so it provides a deposit account where banks maintain balances called reserves (incidentally this is why central banks are also called reserve banks). These reserves are used by banks when they want to transfer funds to other banks.

If a bank has payments to another bank, it needs to find reserves. It can do so by borrowing in the market or by obtaining reserves from the central bank itself. It is the latter process that I want to talk about.

A bank may borrow from the central bank by providing collateral for the loan. This collateral is usually government bonds. This process is called repo (short for repurchase agreement – I agree to sell this bond to you and agree to repurchase it back tomorrow). In India the most common form of repo has been the overnight repo. In the last few months we have added term repos to the mix, where the tenor of the loan runs for multiple days and weeks.

The second source of liquidity is selling the government bond to the central bank without an agreement to buy it back. This is called an outright transaction.

Forms of repo:

Repo, Term Repo (India), Refinance Operations (US Fed), Refinance Operations and Long Term Refinance Operations (ECB).

Forms of outright transactions:

Open Market Operations (OMO, India), Large-Scale Asset Purchase (LSAP popularly called QE, US Fed) and Outright Monetary Transactions (OMT, ECB).

While both repo and outright transactions appear to be similar, in repo eventually the security returns to the borrower after the bank repays the loan to the central bank. Thus the risks associated with the bond belong to the bank and not to the central bank. In an outright transaction the future risk of the bond is with the central bank. This was brought to the fore in Europe in recent years thanks to the Greek default. The bonds which were held by the ECB in repo were returned to the borrowing banks and the banks took the losses not the ECB. In a future OMT purchase such a default would happen to the ECB.

Similarly in India in case of repo, the price risk of the bond remains with the borrowing bank while in OMO the price risk is with RBI.  This means that there is a qualitative difference in the way the market treats repo and OMO transactions, especially in longer dated bonds (where the price risk is large). The market sees the repo as just a means to add liquidity to the banking system while OMO is seen to have an impact on liquidity as well as providing a signal on yields – since OMO increases the price of the bond and reduces the yield. I wrote about the large OMO programme of RBI earlier here.

I hope that clarifies. Please comment here or on my twitter account if you need more clarity.

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