India Equity Research (indiaer.blogspot.com): Oil & Gas (Vidyadhar Ginde, Akash Gupta) :: BofA ...
India Equity Research (indiaer.blogspot.com): Oil & Gas (Vidyadhar Ginde, Akash Gupta) :: BofA ...: Please Share:: India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� �� Oi...
Naman Jani: The Mother of all Bull Runs for India !!
Naman Jani: The Mother of all Bull Runs for India !!: Recently I compared the plots for Cumulative EPS Growth of Sensex-30 Stocks against the cumulative change in the Sensex Index level and trie...
F&C: How to manage Risk
F&C: How to manage Risk: "While one cannot completely avoid market risks, one can take a number of steps to manage and minimize them. Diversify: As in the case of ..."
Fiddling with Euro zone Burns
So the European Central Bank (ECB) has decided to follow through on its plans to tighten monetary policy this year. The ECB will begin by raising its benchmark interest rate next month. This is unbelievable. The Eurozone is under severe pressure that could ultimately lead to its breakup and yet the primary concern at the ECB is tightening monetary policy according to schedule. If followed through, the consequences of this are not only bad for the Eurozone, but for the rest of the global economy too. The slow-motion bank run now taking place in the Eurozone could easily turn into another severe global financial crisis.
So why then is the ECB pushing so hard for monetary policy tightening? From the New York Times we learn the answer:
With Germany, the euro zone’s largest economy, growing so quickly that some economists fear overheating, the E.C.B. has been trying to nudge interest rates back to levels that would be normal in an upturn.
Silly me, I thought the ECB’s mandate was for the entire Eurozone not just Germany. Now Germany is the largest economy in the Eurozone and so its economic conditions have a large influence on the the Eurozone aggregates that the ECB targets. So maybe I am being too hard on the ECB here. Still, if the ECB really desires to save the Eurozone in its current form then tightening monetary policy is a move in the wrong direction.
Here is why. If the ECB were to ease monetary policy, it would cause inflation to rise more in those parts of the Eurozone where there is less excess capacity. Currently, there is far less economic slack in the core countries, especially Germany. The price level, therefore, would increase more in Germany than in the troubled countries on the Eurozone periphery. Goods and services from the periphery then would be relatively cheaper. Thus, even though the fixed exchange rate among them would not change, there would be a relative change in their price levels. In other words, there would be a much needed real depreciation for the Eurozone periphery. This would make Greece, Portugal, Spain, and other periphery countries more externally competitive.
Again, the relative price level change would not be a permanent fix to the structural problems facing the Eurozone–it is not an optimal currency area and there needs to be debt restructuring–but it would provide more flexibility in addressing the problems. Tightening monetary policy, on the other hand, would only make matters worse. It would force all of the needed real depreciation for the periphery on wages and prices in the troubled countries. That only increases the pain for them and makes it more likely they will leave the Eurozone. This seems so obvious to me. Why isn’t it obvious to ECB officials? Why are ECB officials fiddling while the Eurozone burns?
P.S. See Kantoos latest idea for saving the Eurozone: apply countercyclical haircuts on bonds accepted by the ECB for refinacing (HT Matt Yglesias).
This post originally appeared at Macro and Other Market Musings and is reproduced here with permission.
http://www.economonitor.com/blog/2011/06/fiddling-while-the-eurozone-burns
So why then is the ECB pushing so hard for monetary policy tightening? From the New York Times we learn the answer:
With Germany, the euro zone’s largest economy, growing so quickly that some economists fear overheating, the E.C.B. has been trying to nudge interest rates back to levels that would be normal in an upturn.
Silly me, I thought the ECB’s mandate was for the entire Eurozone not just Germany. Now Germany is the largest economy in the Eurozone and so its economic conditions have a large influence on the the Eurozone aggregates that the ECB targets. So maybe I am being too hard on the ECB here. Still, if the ECB really desires to save the Eurozone in its current form then tightening monetary policy is a move in the wrong direction.
Here is why. If the ECB were to ease monetary policy, it would cause inflation to rise more in those parts of the Eurozone where there is less excess capacity. Currently, there is far less economic slack in the core countries, especially Germany. The price level, therefore, would increase more in Germany than in the troubled countries on the Eurozone periphery. Goods and services from the periphery then would be relatively cheaper. Thus, even though the fixed exchange rate among them would not change, there would be a relative change in their price levels. In other words, there would be a much needed real depreciation for the Eurozone periphery. This would make Greece, Portugal, Spain, and other periphery countries more externally competitive.
Again, the relative price level change would not be a permanent fix to the structural problems facing the Eurozone–it is not an optimal currency area and there needs to be debt restructuring–but it would provide more flexibility in addressing the problems. Tightening monetary policy, on the other hand, would only make matters worse. It would force all of the needed real depreciation for the periphery on wages and prices in the troubled countries. That only increases the pain for them and makes it more likely they will leave the Eurozone. This seems so obvious to me. Why isn’t it obvious to ECB officials? Why are ECB officials fiddling while the Eurozone burns?
P.S. See Kantoos latest idea for saving the Eurozone: apply countercyclical haircuts on bonds accepted by the ECB for refinacing (HT Matt Yglesias).
This post originally appeared at Macro and Other Market Musings and is reproduced here with permission.
http://www.economonitor.com/blog/2011/06/fiddling-while-the-eurozone-burns
Larry Rosenthal's Top 5 Reasons People Fail Financially in Retirement
Larry Rosenthal's Top 5 Reasons People Fail Financially in Retirement
1. Procrastination
• People take the path of least resistance. They wait to save and play and tell themselves that they have a long way to go. Most people have to fund for two colleges and then turn around the get ready for retirement shortly after that.
2. Failure to set clear financial goals
• People need to know their finish line. Some people can retire now and have no idea they can, while others are trying to force an early retirement on themselves and will struggle throughout their retirement years.
3. Failure to establish plans to meet their goals
• Everyone needs to develop a written financial plan. Most importantly, that plan needs to be monitored and reviewed each year.
4. Lack of understanding about what money can do for them
• Understanding compound interest and how to accumulate money with dollar cost averaging vs. market timing is important. In addition, it is vital to understand how to take money out during retirement to provide dependable streams of income from a reliable source.
5. Failure to understand and apply tax laws
• There are four different tax buckets: taxable; tax deductible and tax deferred; non-deductible and tax deferred; tax exempt or tax free. One of the most over looked tax advantages is the use of the Roth IRA. Take high income earners for example. Most of them think they cant make a contribution to the Roth. Heres how its done: Make a contribution to the non deductible IRA and then the next day convert it over to the Roth. One of the best kept secrets.
6. Unwise use of credit
7. Failure to prepare for the unexpected
8. Neglecting to plan their estates
9. Failure to develop a winning attitude
1. Procrastination
• People take the path of least resistance. They wait to save and play and tell themselves that they have a long way to go. Most people have to fund for two colleges and then turn around the get ready for retirement shortly after that.
2. Failure to set clear financial goals
• People need to know their finish line. Some people can retire now and have no idea they can, while others are trying to force an early retirement on themselves and will struggle throughout their retirement years.
3. Failure to establish plans to meet their goals
• Everyone needs to develop a written financial plan. Most importantly, that plan needs to be monitored and reviewed each year.
4. Lack of understanding about what money can do for them
• Understanding compound interest and how to accumulate money with dollar cost averaging vs. market timing is important. In addition, it is vital to understand how to take money out during retirement to provide dependable streams of income from a reliable source.
5. Failure to understand and apply tax laws
• There are four different tax buckets: taxable; tax deductible and tax deferred; non-deductible and tax deferred; tax exempt or tax free. One of the most over looked tax advantages is the use of the Roth IRA. Take high income earners for example. Most of them think they cant make a contribution to the Roth. Heres how its done: Make a contribution to the non deductible IRA and then the next day convert it over to the Roth. One of the best kept secrets.
6. Unwise use of credit
7. Failure to prepare for the unexpected
8. Neglecting to plan their estates
9. Failure to develop a winning attitude
Investment implications (Dr V. Anantha Nageswaran )
Build a portfolio that would stand volatility and insure (hope to) against downside risk in the next 24 months
Keep a small portfolio of high quality stocks
As for stock markets, Japan, Russia, Thailand make sense to us
Invest in no-default history Emerging Market bonds for coupons
Keep cash in three structurally sound sovereign bonds
Diversify into physical precious metals, agricultural commodities. Retain exposure to crude oil (Energy Fund or stocks)
Keep a sizeable portion in cash in a diversified portfolio of currencies
Take ‘known downside’ bets on over and undervalued currencies using cash portion as collateral
Convexity is what we are likely to see in the next two years
“It's easy to forget that responses to actions aren't linearly proportional to the force applied, that many situations have a convexity in which just a little more can make all the difference, and a little less does nothing.”
Some potential convexity areas:
“That China won't run into social trouble in the long run either, even though so far everything proceeds linearly towards growth without political freedom.
As for the US, sooner or later there will arise a successful popular nonlinear response to the linearly increasing concentration of economic power that isn't devoted to popular improvement
Insanity: doing the same thing over and over again and expecting different results
Only two things are infinite, the universe and human stupidity, and I'm not sure about the former.
Albert Einstein
Keep a small portfolio of high quality stocks
As for stock markets, Japan, Russia, Thailand make sense to us
Invest in no-default history Emerging Market bonds for coupons
Keep cash in three structurally sound sovereign bonds
Diversify into physical precious metals, agricultural commodities. Retain exposure to crude oil (Energy Fund or stocks)
Keep a sizeable portion in cash in a diversified portfolio of currencies
Take ‘known downside’ bets on over and undervalued currencies using cash portion as collateral
Convexity is what we are likely to see in the next two years
“It's easy to forget that responses to actions aren't linearly proportional to the force applied, that many situations have a convexity in which just a little more can make all the difference, and a little less does nothing.”
Some potential convexity areas:
“That China won't run into social trouble in the long run either, even though so far everything proceeds linearly towards growth without political freedom.
As for the US, sooner or later there will arise a successful popular nonlinear response to the linearly increasing concentration of economic power that isn't devoted to popular improvement
Insanity: doing the same thing over and over again and expecting different results
Only two things are infinite, the universe and human stupidity, and I'm not sure about the former.
Albert Einstein
Medi Claim could be denied
Health claims can be denied
Health insurance, popularly known as mediclaim, has become a modern day necessity. However, in the recent past, many policyholders have seen their claims being denied by insurance companies for one reason or another. Here is a low-down on things you need to keep in mind so that when the time comes to file a claim, the insurance company does not come up with reasons to deny it.
24 hours or more: Most health insurance policies reimburse expenses on hospitalization only if the policyholder has stayed in a hospital for 24 hours. That is well-known by now.
However, some insurance companies insist on the policyholder being in the hospital for more than 24 hours, i.e. for two consecutive nights. Other than this, a room rent for two days must be charged by the hospital, for the policyholder to make a claim.
Survival period: The policy should have been active for a certain period before any claim can be made. In case of most policies, this period is 30 days, but, for some, it can be as high as 60 days. Put simply, this means if the survival period of the policy is 30 days and a patient is admitted in the hospital 15 days after taking the policy, none of the claims will be reimbursed.
This is done to ensure that individuals who are expecting to be hospitalized do not take the policy and then get the insurance companies to pay their bills. In addition, any pre-existing diseases that an individual may have are not covered at the time of commencement of the policy and in most cases are covered only after four years. Other than this, certain diseases like sinusitis, cataracts, hernia, etc, are covered only after two years.
Original bills: Most insurance companies ask for original bills to be submitted while filing for a claim. So, maintaining a record of all the original bills that are generated during the course of hospitalization is very important. If a claim has to be split
between the two insurance companies, there can be a problem.
One needs to check with the insurance companies if attested or duplicate copies of the original bills would suffice. These days, some insurance companies have also been insisting on prescriptions of a physician when accepting bills for medicines.
Filing the claim: Filing the claim as soon as possible is of utmost importance. In case of most insurance policies, the claim has to be filed within 60 days of hospitalization. Waiting beyond that can create problems with the insurer dilly-dallying on the payments.
Post-hospitalization benefits: With competition among insurance companies hotting up, insurance companies have lately started offering post-hospitalization benefits as well.
These benefits are essentially for the treatment required after the individual is out of the hospital. However, things are not as simple as they sound. One of the policies offering post-hospitalization benefits insists that such benefits will be paid only if the individual has been in hospital for five days.
Type of disease: Lately, critical illness policies have become very popular. In case of these policies, a lump sum payment is made to the policyholder if he gets diseases like cancer or suffers from a heart attack.
However, the lump sum payment will made only if you suffer from a certain type of a particular disease. All forms of cancer are not covered under the policy. So, if a policyholder suffers from a form of cancer that is covered under the policy, only then does he get a lump sum payment.
The devil, as they say, always lies in the detail. Therefore, before committing yourself to any health insurance policy, please read the fine print.
Health insurance, popularly known as mediclaim, has become a modern day necessity. However, in the recent past, many policyholders have seen their claims being denied by insurance companies for one reason or another. Here is a low-down on things you need to keep in mind so that when the time comes to file a claim, the insurance company does not come up with reasons to deny it.
24 hours or more: Most health insurance policies reimburse expenses on hospitalization only if the policyholder has stayed in a hospital for 24 hours. That is well-known by now.
However, some insurance companies insist on the policyholder being in the hospital for more than 24 hours, i.e. for two consecutive nights. Other than this, a room rent for two days must be charged by the hospital, for the policyholder to make a claim.
Survival period: The policy should have been active for a certain period before any claim can be made. In case of most policies, this period is 30 days, but, for some, it can be as high as 60 days. Put simply, this means if the survival period of the policy is 30 days and a patient is admitted in the hospital 15 days after taking the policy, none of the claims will be reimbursed.
This is done to ensure that individuals who are expecting to be hospitalized do not take the policy and then get the insurance companies to pay their bills. In addition, any pre-existing diseases that an individual may have are not covered at the time of commencement of the policy and in most cases are covered only after four years. Other than this, certain diseases like sinusitis, cataracts, hernia, etc, are covered only after two years.
Original bills: Most insurance companies ask for original bills to be submitted while filing for a claim. So, maintaining a record of all the original bills that are generated during the course of hospitalization is very important. If a claim has to be split
between the two insurance companies, there can be a problem.
One needs to check with the insurance companies if attested or duplicate copies of the original bills would suffice. These days, some insurance companies have also been insisting on prescriptions of a physician when accepting bills for medicines.
Filing the claim: Filing the claim as soon as possible is of utmost importance. In case of most insurance policies, the claim has to be filed within 60 days of hospitalization. Waiting beyond that can create problems with the insurer dilly-dallying on the payments.
Post-hospitalization benefits: With competition among insurance companies hotting up, insurance companies have lately started offering post-hospitalization benefits as well.
These benefits are essentially for the treatment required after the individual is out of the hospital. However, things are not as simple as they sound. One of the policies offering post-hospitalization benefits insists that such benefits will be paid only if the individual has been in hospital for five days.
Type of disease: Lately, critical illness policies have become very popular. In case of these policies, a lump sum payment is made to the policyholder if he gets diseases like cancer or suffers from a heart attack.
However, the lump sum payment will made only if you suffer from a certain type of a particular disease. All forms of cancer are not covered under the policy. So, if a policyholder suffers from a form of cancer that is covered under the policy, only then does he get a lump sum payment.
The devil, as they say, always lies in the detail. Therefore, before committing yourself to any health insurance policy, please read the fine print.
What are the implications of rising commodity prices
What are the implications of rising commodity prices
for inflation and monetary policy?
by Charles L. Evans, president and chief executive officer, and Jonas D. M. Fisher, vice president and director of macroeconomic research
The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the
media. Clearly, higher prices of food and energy end up in the broadest measures
of consumer price inflation, such as the Consumer Price Index. Since the mid-1980s, however, sharp increases and decreases in commodity prices have had little, if any, impact on core inflation, the measure that excludes food and energy prices.
Chicago Fed Letter
ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 2011
OF CHICAGO NUMBER 286
We study the influence of
a credible inflation-fighting central bank by comparing responses of core inflation and the monetary policy
instrument in the pre- and post-Volcker periods.
Some economists argue that rising commodity prices are inflationary and, therefore, require a tightening of monetary policy.1 Others say rising commodity prices have sometimes led to inflation and sometimes not. Therefore, a monetary policy response may not be required.2 In this Chicago Fed Letter,3 we empirically assess these views by conducting a statistical analysis of quarterly data on commodity prices, inflation, and monetary policy since 1959. We find that since the mid-1980s, after the big oil shocks and the tenure of Paul Volcker as chairman of the Federal Open Market Committee (FOMC), the reactions of both core inflation and the federal funds rate (the monetary policy instrument) to shocks in oil and other commodity prices have been extremely modest. We use our estimates to assess the current stance of monetary policy.
Methodology
To assess inflationary pressures in the economy, we can look at many potential indicators of future inflation, such as rising commodity prices. But how do we determine the relative importance of these indicators? One objective approach is to include an indicator in an inflation-forecasting relationship and examine its contribution to improving forecasting performance. Using this approach, we find evidence from some single equation models that we track at the Chicago Fed that suggests commodity prices are poor predictors of changes in future core inflation. However, this might be because, as a credible inflation-fighting central bank, the Federal Reserve has historically tightened policy to eliminate the inflationary consequences of large changes in commodity prices. Accounting for such monetary policy reactions is an interesting and subtle issue, and there are several valid approaches. Here, we employ a reduced-form statistical framework.4 To identify the influence of monetary policy, we estimate the typical response of core inflation and the monetary policy instrument following an unexpected change in commodity prices. We study the influence of a credible inflation-fighting central bank by comparing responses in the pre- and post-Volcker periods.
We consider three distinct hypotheses:
• Weak central bank credibility hypothesis: If commodity prices have a substantial effect on actual inflation and the policy response is inadequate, we should see an increase in inflation
1. Responses to CRB price shocks
following a commodity price increase. Presumably, this evidence would be most apparent during the pre-Volcker period (1959–79).
• Strong central bank credibility hypothesis: If commodity prices have a substantial effect on inflation and the policy response is adequate, we should see no significant increase in inflation following a commodity price increase. However, we should see a response in the fed funds rate, reflecting the tightening of monetary policy. This might be apparent in the post-Volcker sample period (1982–2008).
• A generally uninformative indicator hypothesis: If commodity prices were truly uninformative for inflation,
they would generate insignificant
responses of both inflation and the policy instrument.
We estimate these hypotheses with the vector autoregressive (VAR) model that Bernanke, Gertler, and Watson used to study monetary policy and the effect of oil price shocks.5 We use quarterly data for core PCE inflation (personal consumption expenditures without food and energy), growth in real gross domestic product (GDP), growth of the Commodity Research Bureau’s (CRB) Commodity Price Index (which consists of commodities other than oil), growth of the Producer Price Index (PPI) for crude petroleum, and the federal funds rate (FFR).6 Following the literature, we assume the Fed (via the FFR) is able to respond contemporaneously to all the other variables in the model, but the other variables are affected by the funds rate only with a lag of one quarter. Inflation is assumed to depend on lags only. Under these assumptions, we examine how unanticipated changes in commodity prices influence inflation and monetary policy. We identify two commodity price shocks. The CRB shock is identified with the residuals from a regression of growth in the CRB price on four lags of itself and all the other variables in the system, plus current values of core inflation and GDP. The oil price shock is identified by a regression with the same conditioning variables, plus current CRB price growth. While we focus
Notes: The blue lines are 68% posterior probability bands. CRB indicates Commodity Research Bureau; PCE indicates personal consumption expenditures.
S
ource: Authors' calculations based on data from Haver Analytics.
A. Core PCE inflation, pre-Volcker
basis points
B. Federal funds rate, pre-Volcker
basis points
C. Core PCE inflation, post-Volcker (to 2008:Q4)
basis points
D. Federal funds rate, post-Volcker (to 2008:Q4)
basis points
2. Responses to oil price shocks
Notes: The blue lines are 68% posterior probability bands. CRB indicates Commodity Research Bureau; PCE indicates personal consumption expenditures.
S
ource: Authors' calculations based on data from Haver Analytics.
A. Core PCE inflation, pre-Volcker
basis points
B. Federal funds rate, pre-Volcker
basis points
C. Core PCE inflation, post-Volcker (to 2008:Q4)
basis points
D. Federal funds rate, post-Volcker (to 2008:Q4)
basis points
2
468101214161005075250–25–50–75–1002468101214161005075250–25–50–752468101214161005075250–25–50–752468101214161005075250–25–50–75–100–100–100100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416
Charles L. Evans, President ; Daniel G. Sullivan,
Executive Vice President and Director of Research;
Spencer Krane, Senior Vice President and Economic
Advisor ; David Marshall, Senior Vice President, financial
markets group ; Daniel Aaronson, Vice President,
microeconomic policy research; Jonas D. M. Fisher,
Vice President, macroeconomic policy research; Richard
Heckinger, Assistant Vice President, markets team;
Anna Paulson, Vice President, finance team; William A.
Testa, Vice President, regional programs, and Economics
Editor ; Helen O’D. Koshy and Han Y. Choi, Editors ;
Rita Molloy and Julia Baker, Production Editors ;
Sheila A. Mangler, Editorial Assistant.
Chicago Fed Letter is published by the Economic
Research Department of the Federal Reserve Bank
of Chicago. The views expressed are the authors’
and do not necessarily reflect the views of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2011 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Helen.Koshy@chi.frb.org. Chicago Fed
Letter and other Bank publications are available
at www.chicagofed.org.
ISSN 0895-0164
on a limited set of results, our findings
appear to be quite robust.7
Findings
The median dynamic responses of inflation and FFR to these identified shocks
are displayed in figures 1 and 2 for the
CRB shock and oil shock, respectively.
These plots display the predicted quarterly time paths of inflation and the FFR
following an unanticipated increase in
CRB prices of 3% and oil prices of 10%,
implied by our estimated VAR and identification
scheme.8 The blue lines represent 68% posterior probability bands,
a measure of our uncertainty in the
estimated paths. Panels A and B of the
figures show estimates based on the pre-
Volcker sample, 1959:Q1 to 1979:Q2,
and panels C and D show estimates based
on the post-Volcker sample, 1982:Q3 to
2008:Q4.
In the pre-Volcker period, core inflation
rises significantly following an unanticipated increase in CRB commodity prices
(figure 1, panel A). This occurs despite
a significant reaction of the FFR to the
same CRB shock (panel B). In the
post-Volcker period,
the same size CRB
shock leads to virtually
no change in inflation
(panel C). Whatever
is driving the nonresponse
of inflation
in the post-Volcker
period, it does not
appear to be an aggressive
response
of monetary policy—
the FFR response
(panel D) is a small
fraction of the reaction
in the earlier
period.
In figure 2, the responses
to the oil
shock follow a broadly
similar pattern. In the
pre-Volcker sample,
core inflation and the
FFR respond by a relatively
large amount
to the oil shock, although
the statistical
significance of the
FFR response is marginal. In the post-
Volcker period, the core inflation response
is virtually zero. Some case may
be made here that the non-response of
inflation is in part due to monetary
policy reacting to the oil shock (figure 2,
panel D). However, we discount this interpretation
because the magnitude of
the response is tiny—a surprise increase
in oil prices of 10% at best merits a rise
in the FFR of only 10 basis points.
In sum, figures 1 and 2 provide some
evidence for the “weak central bank
credibility” hypothesis during the pre-
Volcker period. In the post-Volcker era,
neither core inflation nor monetary
policy has been very sensitive to surprises
in commodity prices, consistent with the
“uninformative indicator” hypothesis.
Finally, we quantify the effects that recent
oil and CRB shocks should have
on policy according to the estimated
policy rules. The fact that we’ve been
constrained by the zero lower bound
(i.e., FFR close to zero) makes this
exercise problematic. The estimated
rules clearly do not hold in a period
when the bound comes into play. However,
to get at least a rough idea of the
importance of commodity prices for
monetary policy in the current period,
we conducted a dynamic simulation
of the post-Volcker rule, ignoring the
existence of the zero lower bound.9
Figure 3 shows the actual path of the
FFR since 2005:Q1 (blue line), along
with the values predicted by our estimated
post-Volcker monetary policy
rule for 2009:Q1 forward (black line)
and a version of this policy rule that
excludes commodity prices (light blue
line). The predicted values for FFR
are from simulations in which variables
other than FFR are set at their realized
values, but FFR is determined dynamically.
10 The last data point is for 2011:Q1,
and was fitted based on our own estimates
for GDP and core PCE inflation
and the commodity and oil prices in
that quarter.11
If we focus on the policy rule that includes commodity prices, after 2008:Q4
the fitted funds rate quickly goes negative, reaching as low as –2.66% in 2009,
whereas actual policy is constrained by
the zero lower bound. The predicted
policy rate gradually rises as data on
3. Recent monetary policy and commodity prices
Note: FFR indicates federal funds rate. Source: Authors' calculations based on data from Haver Analytics.
A. Actual FFR and predicted by post-Volcker rules
B. Recent oil and non-oil commodity prices
Actual With commodities Without commodities
Oil Other commodities
200
180
160
140
120
220
100
80
60
200
180
160
140
120
220
100
80
60
5
4
3
2
0
6
–1
–2
–3
1
5
4
3
2
0
6
–1
–2
1
2006 ’07’08’09’10
2006 ’07’08’09’10
GDP growth improved in late 2009 and 2010, reaching 1.15% for the current quarter. It is important to note that the policy rule depends on growth rates and contains no GDP or inflation gap variables. In this respect it is not a traditional Taylor rule.
The most important point to take away from figure 3 is that the difference between the policy rules with and without commodity prices is quite small, averaging only 40 basis points over the period. Even with the very large run-up in oil and CRB shown in the bottom panel of figure 3, estimated policy rules from the post-Volcker period do not suggest a large response of policy.
Conclusion
The modest dependence of policy on energy and other commodity prices implied by our analysis is not surprising. The shares of firm costs accounted for by energy and commodities are not large and, in fact, have fallen over time. Moreover, at least in the case of oil, price increases tend to slow the economy even without any policy rate increases. Of course, if commodity and energy prices were to lead to a general expectation of a broader increase in inflation, more substantial policy rate increases would be justified. But assuming there is a generally high degree of central-bank credibility, there is no reason for such expectations to develop—in fact, in the post-Volcker period, there have been no signs that they typically do.
1 See Allan H. Meltzer, 2011, “Ben Bernanke’s ’70s show,” Wall Street Journal, February 5, available at http://online.wsj.com/article/
SB10001424052748704709304576124033729197172.html.
2 For an elaboration of this view, see Laurence H. Meyer, 2011, “Inflated worries,” New York Times, March 24, available at www.nytimes.com/2011/03/25/opinion/ 25meyer.html?_r=2&ref=opinion.
3 We thank Helen Koshy, Spencer Krane, David Marshall, and Daniel Sullivan for improving this article.
4 One could also formulate a structural economic model. See Lawrence J. Christiano, Martin Eichenbaum, and Charles L. Evans, 2005, “Nominal rigidities and the dynamic effects of a shock to monetary policy,” Journal of Political Economy, Vol. 113, No. 1, February, pp. 1–45; and Alejandro Justiniano, Giorgio Primiceri, and Andrea Tambalotti, 2011, “Investment shocks and the relative price of investment,” Review of Economic Dynamics, Vol. 14, No. 1, January, pp. 101–121, for some of the challenges involved in proceeding with a structural model.
5 Ben S. Bernanke, Mark Gertler, Mark Watson, Christopher A. Sims, and Benjamin M. Friedman, 1997, “Systematic monetary policy and the effects of oil price shocks,” Brookings Papers on Economic Activity, Vol. 1997, No. 1, pp. 91–157.
6 The CRB Commodity Price Index and the federal funds rate are quarterly averages of monthly data. The PPI for crude petroleum is the quarterly average of monthly data. Core PCE inflation is measured as 400 times the log differences in the series levels. Growth rates are calculated as log first differences.
7 The results are robust to including various financial spreads and unemployment, including from two to eight lags, using levels or growth rates of the variables, and the ordering of the two commodity price
series in the VAR.
8 These shocks are roughly one standard deviation for the CRB shock in both samples and in the post-Volcker period for the oil shock. The standard deviation of the oil shock is about five times smaller in the pre-Volcker period, primarily because there is virtually no growth in the oil price over the first half of this sample.
9 In a figure available on our website, we show that the fitted values of the estimated policy rules with and without commodity prices track actual monetary policy very closely. The figure is located on the Other Resources page at www.chicagofed.org/webpages/people/fisher_jonas_d_m.cfm.
10 That is, from 2009:Q2 forward, the lagged predicted values of FFR are used to calculate the current- period fitted FFR.
11We assume annualized GDP growth, annualized core inflation, quarterly growth in CRB, and quarterly growth in oil prices of 3.3%, 1%, 16.2%, and 12.8%, respectively, during 2011:Q1.
for inflation and monetary policy?
by Charles L. Evans, president and chief executive officer, and Jonas D. M. Fisher, vice president and director of macroeconomic research
The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the
media. Clearly, higher prices of food and energy end up in the broadest measures
of consumer price inflation, such as the Consumer Price Index. Since the mid-1980s, however, sharp increases and decreases in commodity prices have had little, if any, impact on core inflation, the measure that excludes food and energy prices.
Chicago Fed Letter
ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 2011
OF CHICAGO NUMBER 286
We study the influence of
a credible inflation-fighting central bank by comparing responses of core inflation and the monetary policy
instrument in the pre- and post-Volcker periods.
Some economists argue that rising commodity prices are inflationary and, therefore, require a tightening of monetary policy.1 Others say rising commodity prices have sometimes led to inflation and sometimes not. Therefore, a monetary policy response may not be required.2 In this Chicago Fed Letter,3 we empirically assess these views by conducting a statistical analysis of quarterly data on commodity prices, inflation, and monetary policy since 1959. We find that since the mid-1980s, after the big oil shocks and the tenure of Paul Volcker as chairman of the Federal Open Market Committee (FOMC), the reactions of both core inflation and the federal funds rate (the monetary policy instrument) to shocks in oil and other commodity prices have been extremely modest. We use our estimates to assess the current stance of monetary policy.
Methodology
To assess inflationary pressures in the economy, we can look at many potential indicators of future inflation, such as rising commodity prices. But how do we determine the relative importance of these indicators? One objective approach is to include an indicator in an inflation-forecasting relationship and examine its contribution to improving forecasting performance. Using this approach, we find evidence from some single equation models that we track at the Chicago Fed that suggests commodity prices are poor predictors of changes in future core inflation. However, this might be because, as a credible inflation-fighting central bank, the Federal Reserve has historically tightened policy to eliminate the inflationary consequences of large changes in commodity prices. Accounting for such monetary policy reactions is an interesting and subtle issue, and there are several valid approaches. Here, we employ a reduced-form statistical framework.4 To identify the influence of monetary policy, we estimate the typical response of core inflation and the monetary policy instrument following an unexpected change in commodity prices. We study the influence of a credible inflation-fighting central bank by comparing responses in the pre- and post-Volcker periods.
We consider three distinct hypotheses:
• Weak central bank credibility hypothesis: If commodity prices have a substantial effect on actual inflation and the policy response is inadequate, we should see an increase in inflation
1. Responses to CRB price shocks
following a commodity price increase. Presumably, this evidence would be most apparent during the pre-Volcker period (1959–79).
• Strong central bank credibility hypothesis: If commodity prices have a substantial effect on inflation and the policy response is adequate, we should see no significant increase in inflation following a commodity price increase. However, we should see a response in the fed funds rate, reflecting the tightening of monetary policy. This might be apparent in the post-Volcker sample period (1982–2008).
• A generally uninformative indicator hypothesis: If commodity prices were truly uninformative for inflation,
they would generate insignificant
responses of both inflation and the policy instrument.
We estimate these hypotheses with the vector autoregressive (VAR) model that Bernanke, Gertler, and Watson used to study monetary policy and the effect of oil price shocks.5 We use quarterly data for core PCE inflation (personal consumption expenditures without food and energy), growth in real gross domestic product (GDP), growth of the Commodity Research Bureau’s (CRB) Commodity Price Index (which consists of commodities other than oil), growth of the Producer Price Index (PPI) for crude petroleum, and the federal funds rate (FFR).6 Following the literature, we assume the Fed (via the FFR) is able to respond contemporaneously to all the other variables in the model, but the other variables are affected by the funds rate only with a lag of one quarter. Inflation is assumed to depend on lags only. Under these assumptions, we examine how unanticipated changes in commodity prices influence inflation and monetary policy. We identify two commodity price shocks. The CRB shock is identified with the residuals from a regression of growth in the CRB price on four lags of itself and all the other variables in the system, plus current values of core inflation and GDP. The oil price shock is identified by a regression with the same conditioning variables, plus current CRB price growth. While we focus
Notes: The blue lines are 68% posterior probability bands. CRB indicates Commodity Research Bureau; PCE indicates personal consumption expenditures.
S
ource: Authors' calculations based on data from Haver Analytics.
A. Core PCE inflation, pre-Volcker
basis points
B. Federal funds rate, pre-Volcker
basis points
C. Core PCE inflation, post-Volcker (to 2008:Q4)
basis points
D. Federal funds rate, post-Volcker (to 2008:Q4)
basis points
2. Responses to oil price shocks
Notes: The blue lines are 68% posterior probability bands. CRB indicates Commodity Research Bureau; PCE indicates personal consumption expenditures.
S
ource: Authors' calculations based on data from Haver Analytics.
A. Core PCE inflation, pre-Volcker
basis points
B. Federal funds rate, pre-Volcker
basis points
C. Core PCE inflation, post-Volcker (to 2008:Q4)
basis points
D. Federal funds rate, post-Volcker (to 2008:Q4)
basis points
2
468101214161005075250–25–50–75–1002468101214161005075250–25–50–752468101214161005075250–25–50–752468101214161005075250–25–50–75–100–100–100100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416100500–50–100150–150–200–250246810121416
Charles L. Evans, President ; Daniel G. Sullivan,
Executive Vice President and Director of Research;
Spencer Krane, Senior Vice President and Economic
Advisor ; David Marshall, Senior Vice President, financial
markets group ; Daniel Aaronson, Vice President,
microeconomic policy research; Jonas D. M. Fisher,
Vice President, macroeconomic policy research; Richard
Heckinger, Assistant Vice President, markets team;
Anna Paulson, Vice President, finance team; William A.
Testa, Vice President, regional programs, and Economics
Editor ; Helen O’D. Koshy and Han Y. Choi, Editors ;
Rita Molloy and Julia Baker, Production Editors ;
Sheila A. Mangler, Editorial Assistant.
Chicago Fed Letter is published by the Economic
Research Department of the Federal Reserve Bank
of Chicago. The views expressed are the authors’
and do not necessarily reflect the views of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2011 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Helen.Koshy@chi.frb.org. Chicago Fed
Letter and other Bank publications are available
at www.chicagofed.org.
ISSN 0895-0164
on a limited set of results, our findings
appear to be quite robust.7
Findings
The median dynamic responses of inflation and FFR to these identified shocks
are displayed in figures 1 and 2 for the
CRB shock and oil shock, respectively.
These plots display the predicted quarterly time paths of inflation and the FFR
following an unanticipated increase in
CRB prices of 3% and oil prices of 10%,
implied by our estimated VAR and identification
scheme.8 The blue lines represent 68% posterior probability bands,
a measure of our uncertainty in the
estimated paths. Panels A and B of the
figures show estimates based on the pre-
Volcker sample, 1959:Q1 to 1979:Q2,
and panels C and D show estimates based
on the post-Volcker sample, 1982:Q3 to
2008:Q4.
In the pre-Volcker period, core inflation
rises significantly following an unanticipated increase in CRB commodity prices
(figure 1, panel A). This occurs despite
a significant reaction of the FFR to the
same CRB shock (panel B). In the
post-Volcker period,
the same size CRB
shock leads to virtually
no change in inflation
(panel C). Whatever
is driving the nonresponse
of inflation
in the post-Volcker
period, it does not
appear to be an aggressive
response
of monetary policy—
the FFR response
(panel D) is a small
fraction of the reaction
in the earlier
period.
In figure 2, the responses
to the oil
shock follow a broadly
similar pattern. In the
pre-Volcker sample,
core inflation and the
FFR respond by a relatively
large amount
to the oil shock, although
the statistical
significance of the
FFR response is marginal. In the post-
Volcker period, the core inflation response
is virtually zero. Some case may
be made here that the non-response of
inflation is in part due to monetary
policy reacting to the oil shock (figure 2,
panel D). However, we discount this interpretation
because the magnitude of
the response is tiny—a surprise increase
in oil prices of 10% at best merits a rise
in the FFR of only 10 basis points.
In sum, figures 1 and 2 provide some
evidence for the “weak central bank
credibility” hypothesis during the pre-
Volcker period. In the post-Volcker era,
neither core inflation nor monetary
policy has been very sensitive to surprises
in commodity prices, consistent with the
“uninformative indicator” hypothesis.
Finally, we quantify the effects that recent
oil and CRB shocks should have
on policy according to the estimated
policy rules. The fact that we’ve been
constrained by the zero lower bound
(i.e., FFR close to zero) makes this
exercise problematic. The estimated
rules clearly do not hold in a period
when the bound comes into play. However,
to get at least a rough idea of the
importance of commodity prices for
monetary policy in the current period,
we conducted a dynamic simulation
of the post-Volcker rule, ignoring the
existence of the zero lower bound.9
Figure 3 shows the actual path of the
FFR since 2005:Q1 (blue line), along
with the values predicted by our estimated
post-Volcker monetary policy
rule for 2009:Q1 forward (black line)
and a version of this policy rule that
excludes commodity prices (light blue
line). The predicted values for FFR
are from simulations in which variables
other than FFR are set at their realized
values, but FFR is determined dynamically.
10 The last data point is for 2011:Q1,
and was fitted based on our own estimates
for GDP and core PCE inflation
and the commodity and oil prices in
that quarter.11
If we focus on the policy rule that includes commodity prices, after 2008:Q4
the fitted funds rate quickly goes negative, reaching as low as –2.66% in 2009,
whereas actual policy is constrained by
the zero lower bound. The predicted
policy rate gradually rises as data on
3. Recent monetary policy and commodity prices
Note: FFR indicates federal funds rate. Source: Authors' calculations based on data from Haver Analytics.
A. Actual FFR and predicted by post-Volcker rules
B. Recent oil and non-oil commodity prices
Actual With commodities Without commodities
Oil Other commodities
200
180
160
140
120
220
100
80
60
200
180
160
140
120
220
100
80
60
5
4
3
2
0
6
–1
–2
–3
1
5
4
3
2
0
6
–1
–2
1
2006 ’07’08’09’10
2006 ’07’08’09’10
GDP growth improved in late 2009 and 2010, reaching 1.15% for the current quarter. It is important to note that the policy rule depends on growth rates and contains no GDP or inflation gap variables. In this respect it is not a traditional Taylor rule.
The most important point to take away from figure 3 is that the difference between the policy rules with and without commodity prices is quite small, averaging only 40 basis points over the period. Even with the very large run-up in oil and CRB shown in the bottom panel of figure 3, estimated policy rules from the post-Volcker period do not suggest a large response of policy.
Conclusion
The modest dependence of policy on energy and other commodity prices implied by our analysis is not surprising. The shares of firm costs accounted for by energy and commodities are not large and, in fact, have fallen over time. Moreover, at least in the case of oil, price increases tend to slow the economy even without any policy rate increases. Of course, if commodity and energy prices were to lead to a general expectation of a broader increase in inflation, more substantial policy rate increases would be justified. But assuming there is a generally high degree of central-bank credibility, there is no reason for such expectations to develop—in fact, in the post-Volcker period, there have been no signs that they typically do.
1 See Allan H. Meltzer, 2011, “Ben Bernanke’s ’70s show,” Wall Street Journal, February 5, available at http://online.wsj.com/article/
SB10001424052748704709304576124033729197172.html.
2 For an elaboration of this view, see Laurence H. Meyer, 2011, “Inflated worries,” New York Times, March 24, available at www.nytimes.com/2011/03/25/opinion/ 25meyer.html?_r=2&ref=opinion.
3 We thank Helen Koshy, Spencer Krane, David Marshall, and Daniel Sullivan for improving this article.
4 One could also formulate a structural economic model. See Lawrence J. Christiano, Martin Eichenbaum, and Charles L. Evans, 2005, “Nominal rigidities and the dynamic effects of a shock to monetary policy,” Journal of Political Economy, Vol. 113, No. 1, February, pp. 1–45; and Alejandro Justiniano, Giorgio Primiceri, and Andrea Tambalotti, 2011, “Investment shocks and the relative price of investment,” Review of Economic Dynamics, Vol. 14, No. 1, January, pp. 101–121, for some of the challenges involved in proceeding with a structural model.
5 Ben S. Bernanke, Mark Gertler, Mark Watson, Christopher A. Sims, and Benjamin M. Friedman, 1997, “Systematic monetary policy and the effects of oil price shocks,” Brookings Papers on Economic Activity, Vol. 1997, No. 1, pp. 91–157.
6 The CRB Commodity Price Index and the federal funds rate are quarterly averages of monthly data. The PPI for crude petroleum is the quarterly average of monthly data. Core PCE inflation is measured as 400 times the log differences in the series levels. Growth rates are calculated as log first differences.
7 The results are robust to including various financial spreads and unemployment, including from two to eight lags, using levels or growth rates of the variables, and the ordering of the two commodity price
series in the VAR.
8 These shocks are roughly one standard deviation for the CRB shock in both samples and in the post-Volcker period for the oil shock. The standard deviation of the oil shock is about five times smaller in the pre-Volcker period, primarily because there is virtually no growth in the oil price over the first half of this sample.
9 In a figure available on our website, we show that the fitted values of the estimated policy rules with and without commodity prices track actual monetary policy very closely. The figure is located on the Other Resources page at www.chicagofed.org/webpages/people/fisher_jonas_d_m.cfm.
10 That is, from 2009:Q2 forward, the lagged predicted values of FFR are used to calculate the current- period fitted FFR.
11We assume annualized GDP growth, annualized core inflation, quarterly growth in CRB, and quarterly growth in oil prices of 3.3%, 1%, 16.2%, and 12.8%, respectively, during 2011:Q1.
Open up the Rupee
PayPal, the company that pioneered payments and money transfers
on the internet, recently announced a change in the payment system
for Indian residents, by setting a limit of $500 per transaction.
Furthermore, users cannot use money credited to them to directly buy
goods or services—they will have to get the money paid into their bank
account first. PayPal said this change was made in order to comply with
Reserve Bank of India (RBI) regulations and, regrettably, did not give any
further details.
Many Indians use PayPal—shoppers who buy books or software
online, electronic retail entrepreneurs, and freelancers who are paid
online for ad hoc or small projects. Typically, they would receive and store
money at Paypal, and use it to pay for goods or services, or to make small
donations. With these new changes, they must withdraw any received
money immediately so the intermediation costs go up—users can still pay
others through PayPal with a credit card, but that means paying fees at
both ends of the transaction.
The limit of $500 per transaction hurts the bigger players who heavily
relied on PayPal as it is trusted by their US customers. Now they have to
tell customers to split transactions into chunks of $500—a process that is
tedious and appears unprofessional.
The new regulation was announced in a circular by RBI, which stated
that the Foreign Exchange Maintenance Act (FEMA) laws do not allow
for storing of export proceeds abroad. PayPal is therefore required to put
all such money into a pooled account at a “Category 1 I-Bank”, and then
transfer it to the exporter’s bank within seven days. The seven-day limit is
monetary policy
India’s currency policy is hurting its
economy
Photo: Jasleen Kaur
can finance more than three years’ worth of oil imports
(a far cry from just 15 days’ worth in 1992). Moreover,
India doesn’t need reserves against every single dollar
that India Inc. owes—very little of our government
borrowing is in dollars, and corporates can buy dollars
from the open market to pay back debt.
The rupee isn’t yet fully convertible. One thing
though—there is “current account” convertibility since
1994, so you can buy and sell goods abroad for “trade”
purposes. But you can’t buy assets abroad or transfer
dollars just as easily—that would be a “capital account”
transaction, which would cause you to jump through
several hoops. Indian nationals can buy certain assets
abroad, up to $200,000 per year. Foreign individuals
can’t own rupees at all, while foreign corporates and
institutions get near-unfettered access. Non-resident
Indians get a quasi-convertible regime with several
hurdles.
Why not just allow for full convertibility and get
rid of these restrictions?
Pros and cons of full convertibility
Full convertibility will restrict RBI control on the
rupee—but then, it won’t need to maintain reserves.
In panic situations, we won’t be able to protect our
currency quite as much—but we now know that is
a symptom, not the disease. Another concern is that
convertibility would cause too much volatility in
exchange rates. But the impact will be limited since we
already have large volumes being traded in both interbank
and exchange-traded futures markets.
The alternative—of locking down our dollars—
has an invisible and more damaging impact in terms
of lost opportunities. Simply put, we will grow a lot
more if the RBI and FEMA stopped being obsessed with
foreign exchange control.
More importantly, full convertibility would allow
our exporters to invoice trade partners in rupees. It
would allow us to trade with countries like Iran who
despise the dollar (Iran sells us a lot of oil for our
money). It will allow us to sell our country’s debt and
equity to foreign entities more easily—even individuals
will be able to buy our stocks and bonds. We will be
able to buy assets abroad, even if we needed to report
it, without needing permission.
Ajay Shah, professor at the National Institute
of Public Finance and Policy, goes one step further
and says that we must dilute reporting requirements
as well—you could create barriers from onerous
the RBI restriction, wherein interest needs to be paid
above that time (in addition, you have to be a bank);
PayPal is required to report in detail all transactions
over the $500 limit.
Storing virtual money owned by Indians—in a
holding system where you’re allowed to put money in
and take it out—is regulated by RBI under the Payment
and Settlement Systems Act, 2007. It specifically
requires that only banks can offer “open” systems
where you can deposit and withdraw funds—such as
credit and debit cards. Semi-closed instruments—
where you only buy a certain set of services—require
RBI approval, and can’t be converted to cash. These
are the restrictions that prevent the cashing in of gift
vouchers or converting credit card points to money.
Barter is okay, cash conversion is not.
It might seem like the best option is for PayPal to
become a bank. The question is, can PayPal become a
bank? Even if it wanted to, the RBI is unlikely to give
the company a license. Or, PayPal could register as a
“semi-closed” service, but that doesn’t allow them to
pay out money to end-users. The rules may appear to
be harsh, but they apply broadly to everyone in the
business—this is what stopped the Times Group from
offering a similar service earlier.
Having said all this, there is something we must
change.
Change the mindset, change the rules
FEMA—the act that dictates the $500 limits, restricts
storing money abroad—is unnecessary. It is an artefact
of the closed regulatory system that makes the Rupee
not fully convertible. After all, why should we care
if people hold their foreign currency abroad? If they
pay taxes on such income in India, it shouldn’t be a
problem.
The RBI or the government believes that India
needs the dollars—so you shouldn’t be allowed to
store it abroad, and must bring it home and convert it
to rupees. But we don’t need the dollars anymore—
with $300 billion in foreign exchange reserves, India
With $300 billion in reserves,
India doesn’t need dollars
anymore.
26 March 2011
reporting requirements while seeming to have full
convertibility.
Alongside all these measures, India must ease
restrictions on foreigners buying our rupee debt.
Apart from reducing interest rates, it will reduce the
amount banks, insurers and pension funds need to put
into government debt, and thereby help the fledgling
corporate bond market. We are a more fiscally
responsible country than most of the West, but we pay
three times their interest rates.
The PayPal issue cannot be sorted out for PayPal
alone—it has to comply with the rules of the land,
and if they want to pay out to Indian banks, they must
follow the RBI diktat. But the policy response should
be to open up our currency. We’ve been protected for
too long—and it seems—from ourselves. To quote
Tina Turner, we don’t need another hero; we don’t
need to know the way home.
for justice to get justice for their legitimate demand of
“one rank-one pension”. One rank-one pension is an
idea that must be implemented without further delay—
and without having to appoint any more committees of
bureaucrats to look into the issue. While a Department
of Ex-servicemen’s Welfare has been created in the
Ministry of Defence (MoD) in keeping with the UPA’s
Common Minimum Programme, there wasn’t a single
ex-Serviceman in it until recently. Such measures do
not generate confidence among serving soldiers and
retired veterans in the civilian leadership.
Finally—rather unbelievably—India does not
have a National War Memorial to date. Need we say
more?
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w does fiscal deficit impact inflation in
India?
JEEVAN KUMAR KHUNDRAKPAM and
SITIKANTHA PATTANAIK of RBI in a
paper (“Global Crisis, Fiscal Response and
Medium-term Risks to Inflation in India”)
explore the relationship between fiscal
deficit and inflation in India.
The authors frame their analysis against the
backdrop of the global financial crisis where
fiscal deficits (FD) have surged. They put
forth that the immediate impact of rise
in FD on inflation was limited as first it
replaced the declining private consumption
and investment. Second, there was no large
expansion in money growth as demand
for credit remained depressed. However,
going forward, FD has to be lowered as it
could lead to inflation, as both aggregate
and credit demand rise.
The authors study the relationship between
FD and inflation for the 1953-2009 period.
The finding is 1 percent rise in FD could
lead to a rise in 0.25 percent in inflation.
Though over a short-term, the relationship
is modest. The study also shows that FD
leads to rise in inflation and not the other
way round.
The paper concludes by saying that while
fiscal stimulus was appropriate in the
context of the global financial crisis, it may
have medium-term potential ramifications
for inflation situation. Hence, there is
a need to return to fiscal consolidation
path at the earliest. The key would be
to emphasise on the quality of fiscal
adjustment driven by expenditure rather
than revenue buoyancy.
Greece Crisis and Similarity to India
MICHAEL LEWIS in Vanity Fair (“Beware
of Greeks Bearing Bonds”) points to the
fallout of a monastery as the trigger of
the Greece crisis. Vatopaidi monastery,
a 1,000-year-old organisation was caught
in land scams with the Government. The
government had to step down amidst
public pressure; the new government
looked at the fiscal numbers and declared
that the deficit was much higher, leading
to a meltdown.
Lewis says that in the election year, the
tax collectors are pulled off the street!
There is a huge black economy in Greece
Amol Agrawal
Amol Agrawal blogs at Mostly Economics
(mostlyeconomics.blogspot.com)
with proceeds invested in real estate. To
avoid taxes, receipts/invoices are neither
given nor collected. It takes 10-15 years
for courts to give decisions leading to
few cases being filed. There are many
inefficient public sector enterprises, and
in some cases wage bills are much larger
than revenues earned. Its healthcare and
education systems are in very bad shape as
well.
While reading this, the parallels with India
cannot be missed—or ignored. India has
its own set of stories in public enterprises,
education and healthcare. India is a larger
economy than Greece, and hence much of
this is ignored. A larger economy works
both ways—it may delay the crisis, but the
fallout will be much larger. The hope is for
Indian policymakers to take some positive,
much needed lessons from Greece’s
governance crisis.
Mixing economics analysis with sports
TOBIAS MOSKOWITZ AND L. JON
WERTHEIM have written a book,
Scorecasting, where they mix economic
analysis with sports. Moskowitz shares his
findings with NYT Economix Blog.
There are two findings. One, they show
that for fans of Chicago Cubs, beer prices
matter more than the club’s win-loss
record. The stadium is the best place to
celebrate in Wrigley and people see it
more as an outing. Despite the club not
winning since the last 60 years or so, the
local attendance is as good as ever. This
is good for the stadium and earnings, but
works as a negative factor for the team as
there is no incentive to win.
The second finding is more controversial.
The authors say that the home advantage
is not because of knowledge of local
conditions, but because of umpires/
referees giving decisions that favour the
home team! In stadiums where umpires
knew that their decisions were being
monitored, the home bias did not intrude in
the decision. The authors think psychology
and behavioral science could explain the
reason why umpires sometimes give into
pressure from the home crowd.
The findings have interesting implications
for IPL/general Cricket. Though IPL
is relatively new, it will be interesting
to see whether fans in future will look
at the stadium than the team’s win-loss
record. The question of umpires favouring
home-teams is a oft-discussed issue in
cricket—with increase in technology,
this bias is mitigated, but the reviews are
limited. It will be interesting to know
about the history of umpires’ decisions as
well.
Four questions related to Japan’s
economy
Bank of Japan Governor MASAAKI
SHIRAKAWA gave a speech (“Toward a
Revitalization of Japan’s Economy”), in
which he dwelt on the four broad questions
he is asked in most meetings with press/
policymakers.
Why has Japan’s economy lost its vitality?
Reason is loss in productivity.
Japanese firms could not respond
to the changes in economic
environment after the 1990s.
Following that, consumption and
investment levels declined due to an
ageing population.
Why has deflation continued for a
prolonged period?
As growth continues to remain
positive, low price levels decline.
Lehman fall made the slump worse
for Japan, thereby prolonging
deflation. Yet, it is much lower
than deflation in 1930s and has not
resulted in a spiral.
Why are yields on JGBs have been stable
at low levels?
People believe Japan will continue to
grow and low inflation will remain.
However, one cannot take this for
granted, as fiscal imbalances can’t
run forever.
Can Japan’s economy regain its vitality?
Yes, it can—if the country can tackle
the problem of an ageing population,
raise productivity growth, create
markets where there is huge
demand like Asia, and improve fiscal
balances.
Shirakawa discusses the strengths of Japan
economy, which can help propel Japan’s
economy—its location in Asia, high level of
technological capabilities and soft power.
Economic history shows economies have
rebounded strongly from deep crisis in the
past like US and Korea—Japan could do so
as well.
Pareto
on the internet, recently announced a change in the payment system
for Indian residents, by setting a limit of $500 per transaction.
Furthermore, users cannot use money credited to them to directly buy
goods or services—they will have to get the money paid into their bank
account first. PayPal said this change was made in order to comply with
Reserve Bank of India (RBI) regulations and, regrettably, did not give any
further details.
Many Indians use PayPal—shoppers who buy books or software
online, electronic retail entrepreneurs, and freelancers who are paid
online for ad hoc or small projects. Typically, they would receive and store
money at Paypal, and use it to pay for goods or services, or to make small
donations. With these new changes, they must withdraw any received
money immediately so the intermediation costs go up—users can still pay
others through PayPal with a credit card, but that means paying fees at
both ends of the transaction.
The limit of $500 per transaction hurts the bigger players who heavily
relied on PayPal as it is trusted by their US customers. Now they have to
tell customers to split transactions into chunks of $500—a process that is
tedious and appears unprofessional.
The new regulation was announced in a circular by RBI, which stated
that the Foreign Exchange Maintenance Act (FEMA) laws do not allow
for storing of export proceeds abroad. PayPal is therefore required to put
all such money into a pooled account at a “Category 1 I-Bank”, and then
transfer it to the exporter’s bank within seven days. The seven-day limit is
monetary policy
India’s currency policy is hurting its
economy
Photo: Jasleen Kaur
can finance more than three years’ worth of oil imports
(a far cry from just 15 days’ worth in 1992). Moreover,
India doesn’t need reserves against every single dollar
that India Inc. owes—very little of our government
borrowing is in dollars, and corporates can buy dollars
from the open market to pay back debt.
The rupee isn’t yet fully convertible. One thing
though—there is “current account” convertibility since
1994, so you can buy and sell goods abroad for “trade”
purposes. But you can’t buy assets abroad or transfer
dollars just as easily—that would be a “capital account”
transaction, which would cause you to jump through
several hoops. Indian nationals can buy certain assets
abroad, up to $200,000 per year. Foreign individuals
can’t own rupees at all, while foreign corporates and
institutions get near-unfettered access. Non-resident
Indians get a quasi-convertible regime with several
hurdles.
Why not just allow for full convertibility and get
rid of these restrictions?
Pros and cons of full convertibility
Full convertibility will restrict RBI control on the
rupee—but then, it won’t need to maintain reserves.
In panic situations, we won’t be able to protect our
currency quite as much—but we now know that is
a symptom, not the disease. Another concern is that
convertibility would cause too much volatility in
exchange rates. But the impact will be limited since we
already have large volumes being traded in both interbank
and exchange-traded futures markets.
The alternative—of locking down our dollars—
has an invisible and more damaging impact in terms
of lost opportunities. Simply put, we will grow a lot
more if the RBI and FEMA stopped being obsessed with
foreign exchange control.
More importantly, full convertibility would allow
our exporters to invoice trade partners in rupees. It
would allow us to trade with countries like Iran who
despise the dollar (Iran sells us a lot of oil for our
money). It will allow us to sell our country’s debt and
equity to foreign entities more easily—even individuals
will be able to buy our stocks and bonds. We will be
able to buy assets abroad, even if we needed to report
it, without needing permission.
Ajay Shah, professor at the National Institute
of Public Finance and Policy, goes one step further
and says that we must dilute reporting requirements
as well—you could create barriers from onerous
the RBI restriction, wherein interest needs to be paid
above that time (in addition, you have to be a bank);
PayPal is required to report in detail all transactions
over the $500 limit.
Storing virtual money owned by Indians—in a
holding system where you’re allowed to put money in
and take it out—is regulated by RBI under the Payment
and Settlement Systems Act, 2007. It specifically
requires that only banks can offer “open” systems
where you can deposit and withdraw funds—such as
credit and debit cards. Semi-closed instruments—
where you only buy a certain set of services—require
RBI approval, and can’t be converted to cash. These
are the restrictions that prevent the cashing in of gift
vouchers or converting credit card points to money.
Barter is okay, cash conversion is not.
It might seem like the best option is for PayPal to
become a bank. The question is, can PayPal become a
bank? Even if it wanted to, the RBI is unlikely to give
the company a license. Or, PayPal could register as a
“semi-closed” service, but that doesn’t allow them to
pay out money to end-users. The rules may appear to
be harsh, but they apply broadly to everyone in the
business—this is what stopped the Times Group from
offering a similar service earlier.
Having said all this, there is something we must
change.
Change the mindset, change the rules
FEMA—the act that dictates the $500 limits, restricts
storing money abroad—is unnecessary. It is an artefact
of the closed regulatory system that makes the Rupee
not fully convertible. After all, why should we care
if people hold their foreign currency abroad? If they
pay taxes on such income in India, it shouldn’t be a
problem.
The RBI or the government believes that India
needs the dollars—so you shouldn’t be allowed to
store it abroad, and must bring it home and convert it
to rupees. But we don’t need the dollars anymore—
with $300 billion in foreign exchange reserves, India
With $300 billion in reserves,
India doesn’t need dollars
anymore.
26 March 2011
reporting requirements while seeming to have full
convertibility.
Alongside all these measures, India must ease
restrictions on foreigners buying our rupee debt.
Apart from reducing interest rates, it will reduce the
amount banks, insurers and pension funds need to put
into government debt, and thereby help the fledgling
corporate bond market. We are a more fiscally
responsible country than most of the West, but we pay
three times their interest rates.
The PayPal issue cannot be sorted out for PayPal
alone—it has to comply with the rules of the land,
and if they want to pay out to Indian banks, they must
follow the RBI diktat. But the policy response should
be to open up our currency. We’ve been protected for
too long—and it seems—from ourselves. To quote
Tina Turner, we don’t need another hero; we don’t
need to know the way home.
for justice to get justice for their legitimate demand of
“one rank-one pension”. One rank-one pension is an
idea that must be implemented without further delay—
and without having to appoint any more committees of
bureaucrats to look into the issue. While a Department
of Ex-servicemen’s Welfare has been created in the
Ministry of Defence (MoD) in keeping with the UPA’s
Common Minimum Programme, there wasn’t a single
ex-Serviceman in it until recently. Such measures do
not generate confidence among serving soldiers and
retired veterans in the civilian leadership.
Finally—rather unbelievably—India does not
have a National War Memorial to date. Need we say
more?
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w does fiscal deficit impact inflation in
India?
JEEVAN KUMAR KHUNDRAKPAM and
SITIKANTHA PATTANAIK of RBI in a
paper (“Global Crisis, Fiscal Response and
Medium-term Risks to Inflation in India”)
explore the relationship between fiscal
deficit and inflation in India.
The authors frame their analysis against the
backdrop of the global financial crisis where
fiscal deficits (FD) have surged. They put
forth that the immediate impact of rise
in FD on inflation was limited as first it
replaced the declining private consumption
and investment. Second, there was no large
expansion in money growth as demand
for credit remained depressed. However,
going forward, FD has to be lowered as it
could lead to inflation, as both aggregate
and credit demand rise.
The authors study the relationship between
FD and inflation for the 1953-2009 period.
The finding is 1 percent rise in FD could
lead to a rise in 0.25 percent in inflation.
Though over a short-term, the relationship
is modest. The study also shows that FD
leads to rise in inflation and not the other
way round.
The paper concludes by saying that while
fiscal stimulus was appropriate in the
context of the global financial crisis, it may
have medium-term potential ramifications
for inflation situation. Hence, there is
a need to return to fiscal consolidation
path at the earliest. The key would be
to emphasise on the quality of fiscal
adjustment driven by expenditure rather
than revenue buoyancy.
Greece Crisis and Similarity to India
MICHAEL LEWIS in Vanity Fair (“Beware
of Greeks Bearing Bonds”) points to the
fallout of a monastery as the trigger of
the Greece crisis. Vatopaidi monastery,
a 1,000-year-old organisation was caught
in land scams with the Government. The
government had to step down amidst
public pressure; the new government
looked at the fiscal numbers and declared
that the deficit was much higher, leading
to a meltdown.
Lewis says that in the election year, the
tax collectors are pulled off the street!
There is a huge black economy in Greece
Amol Agrawal
Amol Agrawal blogs at Mostly Economics
(mostlyeconomics.blogspot.com)
with proceeds invested in real estate. To
avoid taxes, receipts/invoices are neither
given nor collected. It takes 10-15 years
for courts to give decisions leading to
few cases being filed. There are many
inefficient public sector enterprises, and
in some cases wage bills are much larger
than revenues earned. Its healthcare and
education systems are in very bad shape as
well.
While reading this, the parallels with India
cannot be missed—or ignored. India has
its own set of stories in public enterprises,
education and healthcare. India is a larger
economy than Greece, and hence much of
this is ignored. A larger economy works
both ways—it may delay the crisis, but the
fallout will be much larger. The hope is for
Indian policymakers to take some positive,
much needed lessons from Greece’s
governance crisis.
Mixing economics analysis with sports
TOBIAS MOSKOWITZ AND L. JON
WERTHEIM have written a book,
Scorecasting, where they mix economic
analysis with sports. Moskowitz shares his
findings with NYT Economix Blog.
There are two findings. One, they show
that for fans of Chicago Cubs, beer prices
matter more than the club’s win-loss
record. The stadium is the best place to
celebrate in Wrigley and people see it
more as an outing. Despite the club not
winning since the last 60 years or so, the
local attendance is as good as ever. This
is good for the stadium and earnings, but
works as a negative factor for the team as
there is no incentive to win.
The second finding is more controversial.
The authors say that the home advantage
is not because of knowledge of local
conditions, but because of umpires/
referees giving decisions that favour the
home team! In stadiums where umpires
knew that their decisions were being
monitored, the home bias did not intrude in
the decision. The authors think psychology
and behavioral science could explain the
reason why umpires sometimes give into
pressure from the home crowd.
The findings have interesting implications
for IPL/general Cricket. Though IPL
is relatively new, it will be interesting
to see whether fans in future will look
at the stadium than the team’s win-loss
record. The question of umpires favouring
home-teams is a oft-discussed issue in
cricket—with increase in technology,
this bias is mitigated, but the reviews are
limited. It will be interesting to know
about the history of umpires’ decisions as
well.
Four questions related to Japan’s
economy
Bank of Japan Governor MASAAKI
SHIRAKAWA gave a speech (“Toward a
Revitalization of Japan’s Economy”), in
which he dwelt on the four broad questions
he is asked in most meetings with press/
policymakers.
Why has Japan’s economy lost its vitality?
Reason is loss in productivity.
Japanese firms could not respond
to the changes in economic
environment after the 1990s.
Following that, consumption and
investment levels declined due to an
ageing population.
Why has deflation continued for a
prolonged period?
As growth continues to remain
positive, low price levels decline.
Lehman fall made the slump worse
for Japan, thereby prolonging
deflation. Yet, it is much lower
than deflation in 1930s and has not
resulted in a spiral.
Why are yields on JGBs have been stable
at low levels?
People believe Japan will continue to
grow and low inflation will remain.
However, one cannot take this for
granted, as fiscal imbalances can’t
run forever.
Can Japan’s economy regain its vitality?
Yes, it can—if the country can tackle
the problem of an ageing population,
raise productivity growth, create
markets where there is huge
demand like Asia, and improve fiscal
balances.
Shirakawa discusses the strengths of Japan
economy, which can help propel Japan’s
economy—its location in Asia, high level of
technological capabilities and soft power.
Economic history shows economies have
rebounded strongly from deep crisis in the
past like US and Korea—Japan could do so
as well.
Pareto
The Seven Immutable Laws of Investing
In my previous missive I concluded that investors should stay true to the principles that have always guided (and
Should always guide) sensible investment, but I left readers hanging as to what I believe those principles might
Actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven
Immutable Laws of Investing.
They are as follows:
1. Always insist on a margin of safety
2. This time is never different
3. Be patient and wait for the fat pitch
4. Be contrarian
5. Risk is the permanent loss of capital, never a number
6. Be leery of leverage
7. Never invest in something you don’t understand
Should always guide) sensible investment, but I left readers hanging as to what I believe those principles might
Actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven
Immutable Laws of Investing.
They are as follows:
1. Always insist on a margin of safety
2. This time is never different
3. Be patient and wait for the fat pitch
4. Be contrarian
5. Risk is the permanent loss of capital, never a number
6. Be leery of leverage
7. Never invest in something you don’t understand
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