Nothing monetary about inflation

That was the provocative title of my piece in MINT for this week. So, when I saw stories in Bloomberg and Reuters with headlines that Federal Reserve officials urged a radical rethink of monetary policy framework, my heart jumped and even skipped a beat. When I read the stories in full, my heart sank. They do not seem to have learnt their lessons well.

The monetary policy framework rethink should focus on the following in my view:

(1) The usefulness of policy transparency, predictability, forward guidance, etc., for the real economy as opposed to financial market or the financial sector.

(2) Whether loose monetary policies, in the guise of helping the real economy, are only causing a divergence between asset markets and the real economy with the former soaring and the latter meandering along at best.

(3) Whether central banks have really any control over the inflation dynamics in the light of technological developments and the continued imbalance between labour and capital.

(4) Do central bankers have better success rate with causing asset price inflation rather than good and services price inflation?

After all, the monetary theory of inflation is a theory and not THE theory. Was it ever valid or, like all economic theories, it is valid under a given context or contexts?

Central bankers owe it to themselves, to their intellectual training and to future generations to ponder over the above and more rather than think of raising the inflation target or target nominal GDP or negative interest rates.

Not only should they remember that the road to hell is paved with good intentions and that the law of unintended consequences is an ever-present law in public policy but that many of us would be legitimate in questioning their intentions and their constituencies if they walk down such paths.


Central bankers in the dock

Today, central banks are under attack for all of these reasons: for missing their inflation targets, for failing to maintain financial stability, for failing to restore stability in transparent ways, and for not adequately taking into account the global repercussions of their policies. Dissatisfied by their performance, politicians are seeking to reassert control…..

….What central banks can do to head off threats to their independence is become more transparent. They can announce the votes of individual board members on all policy-relevant matters and release minutes without undue delay. They can hold more press conferences and be less platitudinous in explaining their policies. They can avoid pontificating on questions remote from their mandates. They can acknowledge the right of politicians to define the goals the central bank is tasked with achieving.

And to shape the views of those politicians, they can better explain why cooperation with fiscal authorities and foreign central banks is in the public interest. They can publish more detailed financial accounts, including on their individual security transactions and counterparties.

Above all, they can avoid intervening in parliamentary politics, as the European Central Bank did when it hastened the fall of Silvio Berlusconi’s government in Italy in 2011. Then they can keep their heads down and hope for the best. [Link]

That was from Barry Eichengreen in a recent (Nov. 10, 2017) piece for ‘Project Syndicate’. All emphasis mine.

Wait for my column coming Tuesday as well, for I am adding my voice to the attack on central bankers. Of course, my voice is not a recent addition to the chorus against the remit of central banks.

What is Ray Dalio saying here?

Average statistics camouflage what is happening in the economy, which could lead to dangerous miscalculations, most importantly by policy makers. For example, looking at average statistics could lead the Federal Reserve to judge the economy for the average man to be healthier than it really is and to misgauge the most important things that are going on with the economy, labor markets, inflation, capital formation, and productivity, rather than if the Fed were to use more granular statistics. That could lead the Fed to run an inappropriate monetary policy. Because the economic, social, and political consequences of an economic downturn would likely be severe, if I were running Fed policy, I would want to take this into consideration and keep an eye on the economy of the bottom 60%. [Link]

It is not clear to me as to what Mr. Ray Dalio is advocating here. Does he want the Federal Reserve not to try to normalise monetary policy. Honestly, they have been doing it so gingerly over the last four years that financial conditions have eased substantially since
they began their ever-so-glacial tightening in 2014.

If he documents the divide between the bottom 60% and the top 40% so eloquently, does he not know that Fed policy has played a big role in creating this chasm?


He wants the Federal Reserve not to reverse it because it would ‘hurt’ the bottom 60%!


Aswath on Bitcoin and other links

Aswath Damodaran provides an excellent tutorial while explaining what Bitcoin is all about.

Andy Mukherjee’s piece on Yes Bank having had to restate its NPA by a multiple of 4X is a MUST READ.

Billionnaires becoming richer thanks to QE. Surprising piece in FT. Hope FT Free Lunch journalist Martin Sandbu read it.

Good friend Srinivasan Varadarajan sent me this paper – speech by John Taylor, one of the candidates to replace the Federal Reserve chairperson, Janet Yellen, at the Conference on monetary policy hosted by the Federal Reserve Bank of Boston. My forthcoming column for MINT is based on this speech. I was underwhelmed.

The next Fed Chair

Newspapers and experts have had their share of speculation and critiques of the choices that President Trump has in nominating the next Chairperson of the Federal Reserve, including the incumbent Janet Yellen. Paul Krugman dissed Kevin Warsh, a favourite of this blogger.

In doing so, he thought he was criticising President Trump’s choice of personnel. But, read differently, he seemed to be taking a big dig at the Federal Reserve itself.

Now, I don’t know who Trump will actually pick to head the Federal Reserve. It might actually end up being someone smart, knowledgeable and honest. Hey, there’s a first time for everything. [Link]

Is he saying that, for the first time, the Federal Reserve might have someone smart, knowledgeable and honest? That is some Freudian slip.

Now, Noah Smith at Bloomberg has waded into John Taylor, who has also been tipped as a potential Chairman of the Federal Reserve. He says that John Taylor would have raised interest rates in 2011 and that that would have been a mistake. I have a few questions for him.

While he is right to chart the Employment-Population Ratio, the level of stock market volatility and the core consumer price inflation, is it possible for him to prove that the monetary policy of the Federal Reserve was responsible for these? Or, will they have happened regardless of what the Federal Reserve did or did not do? Second, is it not possible to argue that the low stock market volatility might be a case of mixed blessing now and could be a source of disaster later? Third, before the 2008 crisis happened, America’s monetary policy managers were vigorously patting themselves on the back for steering the economy and financial markets away from risks. It was somewhat similar to the praise that Noah Smith confers on them now. They did not wait a full cycle to judge themselves. It is quite possible that he is making the same mistake now.

I think America would be better served by either of these two gentlemen. A substantial portion of the blame for the accumulated problems in the advanced world over the last three decades could be laid at the doors of the Federal Reserve. It is time for a regime change and that has to start with the change of personnel who have all tended to think alike.

John Cochrane endorses his colleague John Taylor at Stanford University. The reasons he advances for endorsing John Taylor are sound.

But, I am doubtful if President Trump would really drain the monetary policy swamp.

Gold and Anhedonia and Culling and Darwin

An interesting piece in ‘Swarajya’ on October 6 on the role of Gold. Simply put, the author says that India, with its huge cache of private gold, is on a stronger wicket as and when paper currencies implode. He thinks they will. Not implausible but fairly extreme. Fiat currencies have not lasted forever. They eventually cause inflation and lose their currency (pun intended). Timing it is hard.

Good Edit in MINT on managing exchange rate volatility. To bat for intervention is practical and sensible. To ask the central bank and the government to choose the kind of flow it wants (debt or equity) is also correct. Both can be adjusted through a good and dynamic package of incentives and disincentives. They can keep changing, depending on the flows. The real elephant in the room is the big ‘CARRY TRADE’ flows that are due to interest rate imbalances in the developed world.

Niranjan’s piece on the potential growth estimate in India has an important warning. RBI, in its Monetary Policy Report released ten days ago showed a negative output gap. That is, actual growth is below potential growth. That is usually good news for inflation. There is slack and hence the economy could be stimulated (aggregate demand stimulation) without running the risk of inflation acceleration or other forms of overheating. That is theory. In India, it may not be so straightforward. It is a stagflation prone economy (my view) with its supply rigidities, inefficiencies and extremely fragmented production. If the negative gap closed, it could get worse for India. So, in that sense, Niranjan is right to warn of the potential for potential growth to shrink with all the structural reforms and their impact remaining permanent or long-term.

Monika Halan has a comprehensive interview with Adair Turner. He bats for much higher capital ratios for banks. He bats for higher capital weights for real estate loans. This blogger raises cheers for both. Alan Taylor has shown how real estate loans from banks exploded since the Eighties (in the West) after the risk weights on real estate loans were lowered in comparison to loans to businesses because real estate loans are collateralised.

He thinks helicopter money would work in some advanced countries because central banks are independent and cannot be manipulated to resort to them frequently for political reasons and that such a risk was higher in the developing world, such as in India, for example. May be. But, independence is not to be defined only with respect to the political executive but also with respect to financial sector and financial market interests. Developed nations, nearly a decade after introducing ultra-loose (or) unconventional monetary policies are unable to exit them. So, how ‘independent’ are they and ‘independent’ from what? Is it enough to be nominally independent from the executive arm of the government? What about habit persistence? Fear of withdrawal for an economy that has been made dependent on too low rates for too long? Big gaps in his observations, in my view. But, I am happy for the two things he had batted for, as I mentioned at the beginning.

Great blog post featured in ‘Zerohedge’ on Anhedonia. Spot on. Central banks in the West are used to seeing their consumer price indices rise lower than expected and much of it is due to subdued wage trends. A good chunk is also due to ‘hedonic’ pricing adjustments which adjusts prices downward for quality improvements. The article asks correctly if prices are adjusted for quality deterioration and goes on to point out many examples. Very correct and very interesting. (ht: Sampath Kumar)

Can banks relax provisioning norms for cases referred to the Bankruptcy courts? I am not sure it is correct for the eventual haircut could be much larger, once bankruptcy is determined and repayment ratio determined. It can only be a case-by-case decision. Other thoughts welcome.

Lastly, it was fascinating to read the comments under this article by R. Jagannathan on Modinomics. In terms of economic logic, it was mostly right. But, in terms of language – ‘cull’, ‘Darwinism’ – it attracted criticism. The comment by one ‘Jataayu’ was well made. But, I do not think Jaggi was for abandoning micro, nano and small businesses and let them toss in the wind. He was batting for productivity. The economy needs it because the small and the poor need it! An unproductive economy is always inflation prone and inflation hurts the poor more than anyone else because they spend a large portion of their income on essentials.