Fischer and the Fed

An interesting coincidence that barely hours after I had read an interesting critique of Stan Fischer’ remarks on the financial de-regulation proposals being considered by the Trump administration, came the announcement that he would step down. The critique was penned by Howard Davies, the first chairman of the United Kingdom’s Financial Services Authority (1997-2003) and currently the Chairman of the Royal Bank of Scotland. He was Director of the London School of Economics (2003-11) and served as Deputy Governor of the Bank of England and Director-General of the Confederation of British Industry.

His critique was that financial regulation, post-crisis, was a heavy-barrelled military tank and aspects of it needed to be amended. He called the Treasury’s discussion note on the topic of rolling back some regulations a thoughtful one.

The only concrete proposals to emerge from the administration so far are in a thoughtful paper published in June by the US Treasury. It is true that the paper’s title, “A Financial System that Creates Economic Opportunities,” has a political flavor; but the specific ideas it floats are not exactly those found on the wilder shores where “free banking” advocates roam….

…..It is, nonetheless, hard to see why this document should have so rudely disturbed Fischer’s equipoise. Perhaps he was giving us a glimpse of more fundamental disagreements on financial regulation at the heart of the administration….

….It would be unfortunate if the Fed’s opposition to change prevented a debate on whether, ten years on, every one of the changes made – often in a tearing hurry – make sense, both individually and collectively. [Link]

Reading the long interview of Stan Fischer with FT conducted in mid-August, it is not very clear that his departure could only have been due to his remarks on financial de-regulation. One gets the impression that his relationship with the Fed chairperson Janet Yellen might be (somewhat) fraught too.

I am not too disappinted by his departure. He has a formidable reputation but he is not a central banker who disturbs the cozy consensus on monetary policy that has prevailed since the crisis of 2008. To me, that is disappointing. In a piece written in October 2016, Howard Davies points to the limits of Central Banking independence and correctly notes that independence goes hand in hand with accountability.

Professor Fischer’s text book co-authored with Dornbusch and Startz is something that I have been using for the macro-economics course I have been teaching at the Singapore Management University for the last four years. I find it somewhat disappointing. It is too ‘consensual’ and does not challenge the students to think for themselves. Its loyalty towards monetary policy – which is set by unaccountable (largely) and unelected technocrats – over fiscal policy which is set by democratically elected and accountable politicians is too obvious and glaring and disappointing too.

The Treasury document that Davies refers to is here and I have not gone through it. An important omission on my part.

The Wall Street Journal reports that the President would not consider Gary Cohn anymore since he spoke out against the President’s remarks drawing equivalence between white supremacists and neo-Nazis who were supposedly protesting against the removal of Confederacy-era statues.  I do not have strong feelings for or against Gary Cohn. WSJ pays a tribute too to Stan Fischer.


ECB Meeting Minutes

The Minutes of the European Central Bank (ECB) meeting held in the first week of August were released on August 17. Members had expressed concern over the strength of the Euro, overshooting further.[1] That was a surprise. One thought that Germany would tolerate a stronger Euro in return for less pressure on its high current account surplus. Further, even for other countries (the Southern European or peripheral countries), the real effective exchange rate is not overvalued. The Eurozone enjoys a current account surplus, even if modest. Not just Germany.

Instead, the ECB Governing Council was worried that the strength of the Euro would undermine its progress towards a 2% inflation rate, from below.

In fact, the Minutes reiterated the need for continued monetary policy accommodation more than once. It stressed that interest rates could remain at the present levels well past the end of the asset purchase programme:

The Governing Council decided to keep the interest rates on the Eurosystem’s main refinancing operations, the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and ‑0.40% respectively. The Governing Council expected the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. [Link]

Vague concerns were expressed about the low volatility in financial markets. Other than that, the ECB Governing Council had nothing to say about its monetary policy distorting global asset prices. Not just the Euro, but the ECB monetary policy is another bubble that needs to burst for the world to return to normalcy.

They should read what Howard Marks had written about the low volatility in his recent newsletter. [Page 5 – Link]

RBI MPC Meeting Minutes – June 2017

Last week, the Reserve Bank of India (RBI) released the Minutes of its Monetary Policy Committee (MPC) Meeting held earlier in June. It made both for interesting and for sad reading. It was interesting because, for the first time, there was one dissent in the meeting. Prof. Ravindra Dholakia dissented. He presented a case for a rate cut for 50 basis points, rather eloquently and cogently. Cannot say the same of others.

Dr. Pami Dua, one has noticed, rather diligently tracks the Economic Cycle Research Institute in the US. One doubts if the U.S. Federal Reserve does that. ECRI’s recession warnings in this cycle have not materialised. In any case, to what extent they matter to India is unclear to me.

The excessive concern of many MPC members with farm loan waivers was disappointing. First, they are being spread over a few years.  Second, they are addressing a distress condition and that is not the same as as unprovoked fiscal give-aways. The latter is fiscal expansion. The former is merely about preventing the economy from sliding further into a slowdown and disinflation. Third and more importantly, as long as the States do not exceed their overall budget deficit, loan waivers cannot be incrementally fiscally expansionary. Dr. Ravindra Dholakia had done well to point that out. There are other reasons to object to loan waivers. But, an inflation risk is not one of them. Not this time. The farm loan waiver that UPA 1 government did in December 2007 deserves to be blamed for that and much more.

He also brought out an important point that if the unexpectedly low inflation rate seen in April was enough for RBI to revise its inflation forecast lower, then it should be good enough to cut rates too. One cannot have it both ways.

Also, it is a truism that one can always wait for more data. But, that is not going to solve the problem. In theory, with every passing month, one has more data. There is a trade-off between waiting for certainty and acting. Certainty will always be elusive in macro economics with uncertain lags. Judgement is inevitable. In the previous three months, actual inflation had undershot the central bank’s expectation.

So, a central bank that moved to a neutral stance in February has had enough time to observe the underlying behaviour of inflation and respond by June. It chose to wait again. That is somewhat inexplicable.

The following observation of the Deputy Governor, Viral Acharya was puzzling:

Accommodation in monetary policy during 2015-16 did not get transmitted to the corporate sector, and private investment remained weak then in spite of the monetary stance. The Treasury gains accruing to banks in this time, while not a direct concern for the monetary policy, only masked the true stress of their balance-sheets.

If the rate cut did not get transmitted in the form of loans but enabled bank balance sheets to get better, that is also a legitimate and justifiable reason for an easing of monetary policy. Banks, under pressure to make more provisions out of profits, were reluctant to do so because it would cause their net profits to decline and make the management look bad. But, if they found some extra gains from their bond holdings, wouldn’t that not make them more willing to recognise bad loans?

I wonder if the Deputy Governor has gotten his logic inside out or may be, I do not know something that he does. That is always possible.

In fact, a good friend pointed out a puzzling comment that the Deputy Governor had made in the February MPC Meeting. As per the Minutes,

The balanced budget, by focusing on fiscal stability and expenditure reorientation to rural and housing, seemed to exonerate the Committee from the burden of skewing rates to bridge the output gap and instead allowed the Committee to focus squarely on the inflation-targeting mandate. [Link]

Probably, he meant to say, ‘expansionary budget’. In that case, it does take the load off RBI of trying to orient monetary policy towards stimulating economic activity. A balanced budget does the opposite and, in fact, requires the central bank to offset fiscal prudence by loosening monetary policy.

In any case, for me, the budget for 2017-18 was pedestrian. Neither prudent nor expansionary nor balanced. It was a nothing budget.

Finally, it is somewhat worrying that the MPC did not discuss the uncertainty caused by government policies – for good or bad reasons. Their note-ban exercise, tax claims and pursuits, real estate regulation bill, benami bill, forthcoming Goods and Services Tax have induced uncertainty over and above the impact of stressed balance sheets.

RBI released the 77th round of Quarterly Industrial Outlook Survey on April 6th. Perhaps, the questionnaire was sent out in February or March. It should have included specific questions about higher or lower uncertainty arising out of note-ban and GST. It did not. I think they missed an opportunity.

I am also struck by the fact that it did not occur to any of the MPC members, if one went by the Minutes of the meeting.

In sum, on reading the Minutes of the June MPC meeting, one get the impression that, barring Dr. Dholakia, others seem to be in need of urgent acquaintance with the art of decision-making under uncertainty.

STCMA – 20th June 2017

Consistent with this blog’s tagline, Niall Ferguson raises an important question but does not provide an answer – he cannot – on whether political polarisation can induce more violence in America.

Public protests force HK Government to drop the arrest of a 75-year old woman who was hawking cardboard boxes without a hawker’s license.

Australian housing mess is about a decade later (or longer) than that of US housing. But, it is big or bigger? Two important articles from Bloomberg with useful charts. Here is the press release from Moody’s downgrading Australian banks. Key sentence:

The household sector’s resilience to weaker employment levels and/or rising interest rates has materially reduced.

MINT has some good charts on India’s declining computer services exports. Of course, that is not the same as IT Enabled Services.

A ‘European Central Bank’ working paper gives the ‘thumbs up’ to its Asset Purchase Programme. While one thought sclerosis was a European problem, in recent months, it has given way to hubris.

In an article purportedly about the effect of demonetisation on inequality, the author makes the breathtaking claim that unconventional monetary policies of advanced nations have reduced inequality. He cites no evidence. He cannot, because there isn’t any. Bank of England discussion paper, Andrew Haldane’s speeches, John Kay’s articles argue the opposite case and present evidence.

Sundeep Khanna offers a bizarre logic to resume cricket matches in Pakistan:

Terrorism looks constantly for the next soft target and if we keep on declaring every new target as out of bounds for normal life, very soon, we will be left with only the playing fields of Siberia. [Link]

Did ICC stop awarding cricket matches for Pakistan to host because it was a target of terrorism or because it was a hotbed of terrorism? In any case, what connection does it have with Pakistan’s victory in the Champion’s Trophy? Read my take on the Pakistan’s victory here.

Former HSBC Economist Stephen King has a new book out called, ‘Grave new world’. Interesting title. His conversation with BBC’s ‘Hard Talk’ is here. This book title has been used, it seems, before. I do not know if anyone would sue him for the title.

A response to Kashkari’s dissent at FOMC

The Federal Reserve Open Market Committee (FOMC) increased the Federal Funds rate by 25 basis points in June and still kept room for gradual increases. It made light of the fact that the inflation rate has been rather slow to rise. Nor have wages picked up. That is an amazing battle between the factors of production in which a central bank takes sides!

When wages rise, central banks tighten. Wages are costs and they feed through to prices. Therefore, it must be stopped. But, when asset prices rise, capitalists benefits and no rate increases! Why interfere? Of course, there is all about enterprise risk whereas labour can relocate if the enterprise fails. But, perhaps, it made sense in a world of unlimited partnerships and sole proprietors. In a world of limited liability, should labour and capital be treated differently, especially by a central bank?

In any case, Neel Kashkari, President of the Federal Reserve Bank of Minneapolis dissented against the rate increase and explained his stance in a lengthy post in My friend Praveen sent it to me.

We had some email exchanges. The emails I sent him formed the basis of my response to Neel Kashkari’s dissent. I have explained why I think he was wrong to dissent. You can read it here.

Raghuram Rajan has the last laugh

On Tuesday, in my regular weekly column, I had written that the GDP data for 2016-17 released on May 31 was a wake-up call for the Indian government and for the Reserve Bank of India. The decline in the ratio of of Gross Fixed Capital Formation to GDP to around 25.5% in the fourth quarter of 2016-17 in nominal terms was a shocker to me. This is not the stuff of a big-league economy.

What has gone wrong? There are several culprits and each one must do what they can do instead of arguing that someone else must act first and only then will their actions be meaningful. We do not know in economics with such precision. We act and hope for the best. That is the best that can be said about economic policymaking.

(1) The government: It has consistently underestimated the growth challenge in the Indian economy. It has swallowed its own propaganda of the ‘world’s fastest growing large economy’. It failed to understand and grasp the structural impediments that the economy was trapped under. It agreed to a pro-cyclical massive fiscal tightening in 2014-15 when it took office. The real fiscal deficit it inherited was close to 6.0% and it agreed for a target of 4.1% in 2014-15. That was in the backdrop of a failed monsoon. The collapse in the oil economy prevented its folly from becoming a big blunder.

Subsequently, it had also dilly-dallied on dealing with the non-performing loan (NPA) problem in the banking sector. Majority of the loans are held by banks in which it is the dominant shareholder. The top managements in these banks are its nominees. Its nominees sit on the Board of Directors.

Nothing prevented the government from calling an all-Party Meeting or two and then also knocking heads together with vigilance agencies to allow price discovery of these loans and their resolution from moving forward. Yes, all this takes time. But, I leave it to you to decide for yourself if 36 months was enough time or not.

Third, it has pursued a policy of targeting tax dodgers and other wrongdoers in the business community. Nothing wrong here. I am not even going into the question of whether the government had been selective or unbiased in these pursuits. It has done well to do this for it is never the case of this blogger that India’s private sector is an epitome of business ethics and virtues. Far from it.  India’s economy or capitalism always was in peril and is in peril from India’s capitalists with very few honourable exceptions. So, the pursuit was fine.

But, the government should have realised that it would have an impact on sentiment and on investment by businesses. It must have had a Plan B already. Large-scale privatisations (some trophy but chronic loss-making entities like AIR INDIA) either through strategic sale or though Further Placement Offering in capital markets (FPO) should have been contemplated to shore up sentiment and to create a mood of policy dynamism and progressive thinking, etc., especially in the context of what it did on 8th November 2016. It has done nothing of that sort.

The short-term contractionary impact of ‘note-ban’ decision exercise was not taken into consideration in the preparation of offsetting measures in the budget for 2017-18. The budget was a pedestrian document and it lacked imagination. Post-note-ban, the country needed an offsetting positive excitement. The budget ensured that it did not happen.

So, the government does have a large share of the blame for the current growth malaise in India.

(2) The Central Statistical Organisation: When the history of India’s economic cycles is written for this period, much of the blame must be and will be assigned to this organisation for creating a false perception of ‘all is well’ about the Indian economy. Its ‘no resemblance to reality’ growth prints of 7% or higher had robbed all of the sense of urgency, most of all in the Indian government. Further, it has done nothing to remove the suspicions that still linger over its methodology.

All that we receive, every now and then, from commentators is a reassurance that there is no mala fide in Indian economic growth numbers and that the CSO leadership scores high on integrity. That is not even an issue for discussion.

In fact, it is well known that it makes no sense to attribute malice to something that could be explained by incompetence.

That the Indian economy grew 6.4% in 2013-14 is no laughing matter. But, it is laughable. It is very hard to reconcile with lots of statistics – from mobile phone sales to airline traffic to rail freight traffic to cement production to current account deficit shrinkage, etc.  The growth rate was close to 4.0% then.

Similarly, with credit growth to industries contracting, with private capital formation rates shrinking, with production in infrastructure industries sluggish at best and contracting at worst, with demand for electricity not rising, it is hard to see that the economy is growing at 7.5%.

The CSO might have more data now on the corporate sector, etc., But, how the data are processed also matters. For outsiders, it remains a black box.

The CSO has played a very big role in inducing a perception of ‘all is normal and healthy in the economy’ in the government. Indeed, the biggest contribution that any one can make to any country is to induce a sense of crisis in policymakers. That is what leads to policy reforms and action. Where possible and realistic, patriotic citizens must ensure that the policymakers that have their ears are gripped by a sense of crisis.

The banking crisis, the falling investment rates and the credit off-take were perfect crisis ingredients in India. But, the CSO did a lot to remove the crisis-effect of these on the government. That is a very big disservice it has done to India. I hope historians would take note of it and record it with adequate prominence.

(3) The Reserve Bank of India (RBI):  The Indian central bank gets a free pass from the chattering classes, for the most part, especially from those based in Mumbai. It gets the benefit of doubt from them whereas the government in Delhi does not. Delhi is home to politicians who are not like us. Mumbai is home to the RBI which is led by people like us – elites, educated and thoughtful and therefore, it should be treated with respect and given the benefit of doubt, than not.

RBI adopted the inflation targeting regime when the rest of the world was having second thoughts on it. It is not a disaster, per se, even though much thought and discussion should have preceded it. That did not happen.

Even I was guilty of not being critical of its adoption because all of us were stung by the experience of five years of continuous annual double-digit inflation under the previous government from 2009 to 2014.

Further, its fiscal policy also undermined the independence of the central bank. Therefore, it is doubly unfortunate that the fiscal dominance of monetary policy and sustained annual double digit inflation for five years raised sympathies for an inflation targeting regime in India too.

But, in a social science subject like economics and policy framework based on a social science like economics, rules are guideposts and not millstones. It is what policymakers make of them. Creative interpretations have been made even in inflation targeting regimes. They can change the weights; they can creatively assume different lags (after all, they are long or short, variable or fixed as we like them).

For a creative reinterpretation of its mandate, ECB is enough example despite a Treaty-defined mandate only for inflation targeting. Not that I endorse what they do.

Yes, a framework does bind and can be an inconvenient one. Also, if someone stretched it once in one direction, on another occasion, another central banker can stretch it in another direction. But, that is an ever-present risk with all regimes.

The risk comes from the framework and from those who interpret and implement them.

A NPA situation bordering on 10% of GDP and a capital formation rate of 25% of GDP are outside the normal deviations that a creative interpretation of the inflation targeting regime was warranted, in my view, in the RBI policy meeting that concluded yesterday.

Hence, the central bank is guilty of being bookish.

Why should Raghuram Rajan have the last laugh? The title of the blog post is a reaction to the stories here and here. This government did an utterly foolish thing and made a spectacle of itself by the manner in which it had him leave office last year. There were far better ways of doing so. That was very bad karma and it is coming home to roost now.

Its current predicament and frustration with the current leadership of RBI are therefore well earned and well deserved.

Government and the RBI – Part 3

The first best world is that the government follows the letter of the Reserve Bank of India (RBI) Act, as amended. That is, it gives inputs in writing which are taken on record.

​The second best world is that there is a direct communication with the Governor formally, before very meeting and it is taken on record.

The third best world is that the RBI Act is amended – the sections pertaining to the Monetary Policy Committee (MPC) – and the Government formally has a non-voting voice in the MPC meetings.

This is third best because the MPC has just been formally launched and this might strike one as a panic and ad-hoc reaction. Basically, it is too soon to amend it. May be, after two years. That is why this is third best on my list.

The fourth best world is what is happening now : CEA+PEA+DEA Secy. meeting MPC non-RBI and not on record. They are government appointees. The appearance of free-will is important. That might be lost here. Indeed, even if they wish to cut rates on their own, it might not be seen that way but seen as succumbing to government pressure.

Look at the optics for the world of financial markets (fair or unfair is a different issue). This is how they would see it:

A new MPC has four meetings and it has not cut interest rates and has become even neutral to hawkish from being accommodative. The government therefore loses it and wants to interfere. It will have implications for the exchange rate, for funds flows, etc. The narrative about India might change for the worse, from the government point of view.

If the Government has to interact with RBI, it can be Finance Secy. and RBI Governor interacting formally. Perhaps, this was suggested and turned down.

In the final analysis, it boils down to 100 basis points of interest rates. Otherwise, I doubt if the Government would be so exercised about this. I really doubt if a rate cut of any magnitude would be so efficacious as to risk walking down a path a little bit without taking into account long-term consequences. Rate cuts in a balance sheet constrained environment are of little use. Even if the current real policy rate is 3.5%, is it too high for an economy that is supposedly growing at 7+%?

Further, given the experience in India with inflation, it is never easy to let down one’s guard on that. Sonal Varma has a nice piece in MINT today on why it is too soon to declare victory on inflation.

This would set a precedent for future governments to flout protocol and norms even more flagrantly. That is in the nature of the times we live in.

We have a stock market that is rich in valuation. It can go ballistic with 100-200 bp. of rate cuts while doing zilch to capital formation in the real economy. The costs are there for a rate cut of such magnitude.

It is not as though the RBI is missing a sure, riskless bet that would benefit the economy and therefore, the government has to step in.

So, I think that the government might have been better off retreating or doing it much more formally so that the personalities involved matter little.