Interest rates and growth

This article by Rohan Chinchwadkar of IIM Tiruchi made me happy for more than one reason:

  • It is from a faculty member from one of the newer IIMs
  • It is well and simply written. It does not try to overdo its point
  • It sources a recent piece of international research
  • It shows a faculty member who is in touch with contemporary reserach. Good for students
  • It was well timed – on the eve of the RBI Monetary policy meeting
  • It presented a paper that had turned conventional wisdom on its head

Not much can be asked of an op.-ed.

Kudos to MINT for publishing it.

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RBI dips into credibility balance

Quick off the blocks, Ms. Usha Thorat has written a good comment on the RBI monetary policy decision. Her last line was masterly.

As she points out in the first paragraph itself, RBI has increased the growth forecast, flagged fiscal policy risks and other inflation risks and yet, lowered the inflation forecast for the current financial year 2018-19. It is a tough one to explain away.

So, it is clear that they had set a goal for the policy meeting outcome today and worked backwards with the rationale. Of course, most human beings do that in most situations.

Frankly, there is so much uncertainty about both the growth and the inflation outcome right now for 2018-19 that one can pretty much justify any combination of projections.

Persnally, I would not set too much store by the recent uptick in some cyclical data. Hence, if I were in RBI, I would not have revised the growth projection higher.

Among the ‘forward looking’ surveys, the Consumer Confidence Survey must be a huge worry for the government. Together with inflation expectations, they present a double-whammy. Consumers are more pessimistic about their economic situation and expect inflation to be slightly higher as well! Would be a surprise if it is not reflected in the voting prefereences in the upcoming Assembly elections.

Consumer Confidence survey summary

Also, the Industrial Outlook survey (81st round) is not all that rosy. Check out Tables 15 and 16 on the availability of finance from banks and from foreign sources respectively.

Finally, one thought for the central bank’s credibility. The central bank sounded hawkish in February. Its Chief Economist keeps voting for rate increase. Suddenly, it turns soft on inflation forecast when all the logic (including faster GDP growth) points to the risk of a higher inflation rate.

But, financial markets do not call out the central bank for this ‘tangled web’ of projections. It takes them at face value and rallies! Mission accomplished! It does redound to the institution’s credibility that financial markets, instead of calling its bluff, lap up its projections and policy action.

What does it say about the financial markets, of course?  It continues to prove Eugene Fama wrong – day in and day out.

(Cheekily, I wonder if the decision,  the inflation projection, the growth projection and the dovish commentary are all a compensation for the Gandhi Nagar speech?)

Gross confusion here

At least, as reported by Reuters, Bill Gross appears to be all over the place. If global economies are leveraged to the hilt and if that means that intrest rates cannot go up without causing big dislocation/disruption/pain, then it risks adding to the pile of debt. This is a Catch-22 situation that Jerome Powell’s predecessors had landed him in. For the future of his country and for the future of the rest of the world too, some beginning has to be made somewhere.

If Powell is to be counselled against raising rates as indicated by him and his fellow FOMC members – 6 to 8 rate hikes of 25 basis points each in 2018 and in 2019 – then it is a counsel to allow more debt creation and a bigger eventual and inevitable pain.

This is what he had written, from which Reuters has written its report:

I write this – not in support of low interest rates and financial repression – indeed I have argued for the necessity of an eventual normal rebalancing if small savers and financial institutions such as pension funds and insurance companies are to continue to perform their critical capitalistic role. But I believe, as does Fed Governor Neel Kashkari, that our financial systems’ excesses cannot be expunged quickly by “liquidating assets” à la Andrew Mellon in the 1930’s, but by a mild and gradual re-entry back to privately influenced, as opposed to central bank suppressed, interest rates. 2% Fed Funds in a 2% inflationary world is the current limit in my opinion. [Link]

I am not sure I buy it fully. But, that does not mean that his point of view is any less valid than mine.

Powell’s seminal debut

After easing substantially during 2017, financial conditions in the United States have reversed some of that easing. At this point, we do not see these developments as weighing heavily on the outlook for economic activity, the labor market, and inflation.

The FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis. [Link]

Powell’s prepared remarks were rather brief but telling. He does not think that financial market volatility will have a big bearing on  economic activity.  We agree. One hopes that it is not just about current level of volatility but also reflects a structural attitude that assigns a lower weight to the goings-on in financial markets in terms of their impact on the real economy. Anna Cieslak and Annette-Vissing Jorgensen have documented this rather well. The Fed is more concerned about declines in financial asset prices than they ought to be. In reality, the impact is far lower than what Fed models assume.

His second statement is even more interesting. He is no longer talking about striking a balance between employment and inflation but between avoiding overheating and bringing inflation to 2% (from below). He is not going to be fixated on bringing inflation up to 2% from below. He will also keep an eye on overheating. Good for him!

Interesting times ahead.

Nearly three months ago, Gavyn Davies wrote a blog post for FT that Trump has the opportunity to shape the Federal Reserve Board this year in an unprecedented manner:

Including the promotion of Jerome Powell to Chair, six of the seven board members will have been nominated by the current administration when the process is completed next year. In addition, the President of the New York Fed will have been replaced by its own board. Such a root-and-branch upheaval in the Fed’s key personnel is unprecedented in its history.  [Link]

He predicted that the new Federal Reserve Board would likely display the following tendencies:

There may be more enthusiasm for expansionary fiscal policy, and greater belief in beneficial supply side effects from cuts in marginal tax rates;

There may be greater concern about possible instability from rising asset prices;

There may be greater willingness to reverse some of the regulatory restrictions in the Dodd Frank legislation;

There may be less emphasis on gradualism when it comes to raising interest rates;

There may be a greater eagerness to run down the balance sheet, especially in non-treasury assets;

There may be more emphasis on rules-based policy decisions, notably on the use of the Taylor Rule.

I like most of the above. In fact, I think Jerome Powell alluded to the second item in the above list when he spoke of balancing between overheating considerations and bringing inflation up to 2%.

I was surprised that many have not observed his comment about balancing between avoiding an overheating economy and bringing inflation to 2.0%. John Authers, here, notes that his message was not too different than that of Ms. Yellen but that he delivered the message in a business-like fashion. I disagree. The message too was different.

It is the first time in a long time that a Fed chair mentions overheating risks while trying to bring inflation back up to 2%!

In November 2017, Stephen King (formerly with HSBC) wrote a nice piece in FT suggesting that “central banks that focus on price stability alone may only be stoking the next financial bubble”.

We may have found a central banker who wants to put an end to that practice.

Weekend snippets

On the other hand, regulation remains a concern for many, with 75 percent of members continuing to feel foreign companies are less welcome in China than they have been in the past. Although down from 55 percent last year, some 46 percent feel foreign companies are treated unfairly compared to local companies and, for the third year running, respondents cited inconsistent regulatory interpretation/unclear laws and enforcement as the top challenge to doing business in China. For the first time, compliance and enforcement made the list of the top challenges companies expect to face in 2018. [Link]

(2) US Non-Farm payroll data for Jan. 2018 [Link]

(a) ​from Jan. 2017, unemployment rate for Whites has declined the most among races.

(b) In terms of education, unemployment rates for

high school or below and

high school but no college have declined the most.

Put (a) and (b) together, ​Trump has delivered for his constituency, I suppose.

(3) This Matthew Klein post in FT Alphaville might be from December 2014 but well worth a read on how Japan is far better placed than most think.

(4) A Chinese company lets go off the option of paying off a perpetual bond and has to raise the coupon by 3 percentage points. [Link]

(5) Dr. Manmohan Singh’s master class in fiscal indiscipline. Indeed! Who is better qualified than him to offer a master class in fiscal indiscipline?

(6) Academic economists close ranks on Janet Yellen as she departs but the last line attributed to Shiller restores a bit of a faith in their judgement [Link]

(7) An important read for financial market participants (aka investors) [Link]

(8) FT records the slump in U.S. stocks on Friday as the worst in the Trump era, leaving not much to the imagination of readers as to what message it wants them to take away.

Curious to know if the FT credited Trump when the stock market kept breaking records on the way up. It takes two to tango – the President would not take the blame for the fall even as he took credit for the ascent (both wrong). Similarly, the media would associate the decline in the stock market with him but not credit him for its ascent for one full year.  Both wrong, again. But, what gives the media folks the right to think that they are morally superior to the man that they love to hate?

(9) Vivek Kaul writes one of the most relevant comments on the Indian budget for 2018-19 [Link]

(10) A good piece on the challenges facing Jerome Powell as he takes office on Monday as the Chairman of the Federal Reserve.

Utterly confused lot

A quick glance through the blog posts in the website of the Economic Policy Institute (EPI) suggests that they are barking at inequality and yet baying for a loose monetary policy.

Loose monetary policy does zilch for good old inflation that they are hankering after. It does a lot for asset price inflation that contributes immensely to the inequality that they are opposed to.

She would, in short, be doing America’s working families a big favor. If she does decide to stay on after losing her chair position, we should all thank her. [Link]

The good folks at the EPI want Yellen to continue as a Governor in the Federal Reserve Board even if she were not the Chairperson! She supposedly tightened interest rates and financial conditions eased considerably, creating asset price inflation that favoured the rich and she had nothing to show for her efforts in generating inflation in goods and services.

EPI is doing a disservice to the workers whose cause it claims to espouse.

Trickle-down hypocrisy

The Keynesian Fed economists who were dismissive of Reagan’s trickle-down theory still don’t appear to see the irony in the fact that they applied trickle-down monetary policy in the hope that by giving a boost to asset prices they would create wealth that would trickle down to the bottom 50% of the US population or to Main Street. It didn’t. [Link]

Well said, John Mauldin. The link is almost two months old. Does not matter. The observation is very relevant even now.