Saturday, July 31, 2010

Assessing the impact of TARP and ARRA

Alan Blinder and Mark Zandi have a new paper that seeks to estimate the impact of the various credit, monetary and fiscal policy stimulus programs in the US. Their assessment is conclusive, "We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0."

When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing—we estimate that the latter was substantially more powerful than the former. Nonetheless,

Their overall conclusion is that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5% lower this year. In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

They estimate the total direct cost of the recession at $1.6 trillion, and the total budgetary cost, after adding in nearly $750 billion in lost revenue from the weaker economy, at $2.35 trillion, or about 16% of GDP.

They conclude that the financial stabilization measures, TARP, have had a relatively greater impact than the stimulus program (ARRA). If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real GDP would have fallen 5% last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real GDP would have fallen nearly 4%, with 10 million jobs lost. They find that the fiscal stimulus alone raised 2010 real GDP by about 3.4%, held the unemployment rate about 1½ percentage points lower, and added almost 2.7 million jobs to US payrolls.

These findings are consistent with those made by CBO and other agencies. Earlier posts on the impacts of ARRA and TARP here, here, and here, point to much the same conclusions. Here is a summary of the findings of Zandi and Blinder.

The Federal Reserve undertook massive expansion of its balance sheet as part of unconventional moneatry policy response by acting as the lender, buyer and insurer of last resort...

... with the result that the battered financial markets recovered quickly and averted a full-fledged financial market melt-down...

The fiscal stimulus spending programs included transfers to states and local governments who experienced massive revenue declines and were forced into resultant spending cuts...

... the tax cuts propped up consumer spending to some extent atleast...

... and the cash for clunkers program was a runaway success.

Update 1 (4/8/2010)

Macroeconomic Advisers finds that
(pdf here), compared to an indefinite extension, impending expiration of numerous prior tax cuts would trim 2011 growth by 0.9 percentage points, while only allowing an increase in taxes for high-income individuals and families would trim growth 0.2 percentage points.

The graphic below show the unemployment rate changes under the three simulations - indefinite extension of the current tax code, full sunset of the earlier tax cuts as envisioned under current law, and the intermediate case of the MA forecast where only high-income individuals and families are assumed to see their taxes rise.

Update 1 (19/8/2010)

As the graphics below from CBPP shows, both GDP would have been lower and unemployment higher without the ARRA

Update 2 (25/8/2010)

CBO's latest assessment of the impact of ARRA on output and unemployment - raised the level of real (inflation-adjusted) GDP by between 1.7-4.5%; lowered the unemployment rate by between 0.7-1.8 percentage points; increased the number of people employed by between 1.4-3.3 million; and increased the number of full-time-equivalent (FTE) jobs by 2.0-4.8 million compared with what those amounts would have been otherwise. It also writes that the effects of ARRA on output and employment are expected to gradually diminish during the second half of 2010 and beyond.

Update 3 (16/10/2010)

Simon Johnson puts the magnitude of the ARRA fiscal stimulus in the US in perspective. The lions share of the increase in debt due to fiscal stimulus came from automatic stabilizers and not discretionary fiscal stimulus spending (only 17% of the increase in public debt).

Update 4 (4/11/2010)

A San Francisco Fed study finds that the ARRA spending created or saved about 2.0million jobs, or 1.5% of pre-ARRA employment, in the total nonfarm sector by early 2010, though its impact tapered off quickly to essentially zero by August 2010. David Leonhardt writes that "judging the stimulus by jobs data reveals success".

Update 5 (2/12/2010)

The Fed released papers revealing the true extent of its involvement under the TARP. From December 2008 until March 2009, the Fed purchased some $1.7 trillion in mortgage-related assets and Treasury securities to lower long-term interest rates. From March 2008 to May 2009, the central bank extended a cumulative total of nearly $9 trillion in short-term loans to 18 different financial firms — under a program called the Primary Dealer Credit Facility. The ECB and nie other central banks (Australia, Britain, Denmark, Japan, Mexico, Norway, South Korea, Sweden and Switzerland) drew on the Fed’s currency swap lines to support dollar-financed money markets in Europe.

See also this excellent assessment of the TARP and other financial bailouts by Gretchen Morgenson.

Update 6 (24/2/2011)

The CBO's latest estimates (pdf here) show that ARRA’s policies had the following effects in the fourth quarter of calendar year 2010 - raised real (inflation-adjusted) gross domestic product by between 1.1-3.5%; lowered the unemployment rate by between 0.7-1.9 percentage points; increased the number of people employed by between 1.3-3.5 million; increased the number of full-time-equivalent (FTE) jobs by 1.8-5 million compared with what would have occurred otherwise.

Update 7 (30/5/2011)

The latest CBO estimate of the impact of ARRA (blue line showing the actual real GDP while the red line shows what would have happened in the absence of the ARRA).

Update 8 (4/2/2012)

CBPP has the latest estimate of the impact of ARRA. The CBO estimates that GDP in the fourth quarter of 2011 was between 0.2 and 1.5 percent larger than it would have been without the Recovery Act.

The Congressional Budget Office estimated that because of the Recovery Act, the unemployment rate in the fourth quarter of 2011 was 0.2 to 1.1 percentage points lower than it otherwise would have been and payroll employment was between 0.3 million and 2.0 million jobs greater than it otherwise would have been.
Update 9 (14/4/2012)

Excellent set of graphics from the US Treasury that highlights the response to the financial crisis and recession.

Update 10 (8/7/2012)

find that those states that increased per-capita expenditures the most experienced the smallest rises in unemployment rates, while those that increased expenditures the least experienced the largest rises in unemployment. Much of the increased state spending was financed by the ARRA. 

Update 11 (9/8/2012)

Dylan Matthews has this nice listing of all studies assessing the impact of the fiscal spending measures. The overwhelming evidence is that the stimulus measures have worked.

Burgernomics says yuan needs to rise 48%?

The latest version of the Economist's Big Mac Index is out. The index, which is based on the premise that in the long run exchange rates should move to equalize the price of an identical basket of goods (n this case one Big Mac) between two countries, seeks to arrive at a light-hearted measure of how far currencies are from their fair value (in relation to dollar).

The index would suggest that a fair value dollar-yuan exchange rate should be 3.54 yuan to the dollar, compared with the current rate of 6.78, or the yuan is undervalued by 48%. In fact, its broader message would have it that emerging economy currencies are under-valued.

India is not covered under the index. But interestingly, even though the Big Mac is the cheapest in India (at around $1.22), it is amongst those where it is slowest earned (it takes almost 61 minutes of work to earn enough to buy a Big Mac Mumbai).

Friday, July 30, 2010

Nudging to keep restaurants clean?

In an interesting experiment, drawing on insights from behavioral psychology, and whose outcome will be widely watched, New York city public health department has launched a program to grade all the 24000-odd restaurants across the city A, B or C on their respective cleanliness.

The officials hope that issuing restaurant letter grades will help consumers make informed choices about where to eat out and the resultant consumer awareness would create a powerful new incentive for restaurants to maintain the highest food safety standards. In the language of behavioural economics, the grading system, by generating public pressure, is expected to nudge the restaurants into improving their cleanliness.

Restaurateurs will be required to to post the 8-by-10-inch placards prominently on a front window, door or exterior wall within five feet of the main street entrance, from four to six feet in height. Failure to do so will be punishable by a $1,000 fine, with additional penalties for counterfeiting.

The ratings will be phased in, with only the A grade restaurants required to post their grades. Restaurants that receive a lower grade will automatically be inspected again at a later date and their grades reviewed, and if they are still unhappy with their grade, they have the right to seek an administrative hearing. A black-and-white "grade pending" sign will be posted in restaurants that are appealing their scores.

Incidentally a number-based grading system, based on points for violation of specified parameters, is already in place and the grades are displayed on the health and mental hygiene department website. Now the blue A card will correspond to 0 to 13 points under the old system, while the green B will designate a less sanitary 14 to 27 points, and an orange C will represent 28 points or more.

Inspections are unannounced and done atleast once a year. An inspector, equipped with hand-held computers to fill and calculate scores, examines the establishment’s sanitary conditions and then give the operator a printed report listing the violations observed, the points for each violation, and the total number of points.

Expectedly, the decision has evoked strong opposition from the restaurant owners and the New York State Restaurant Association has already sent a letter to some 3,500 eating establishments, rallying opposition and raising money for a possible legal challenge.

The challenge to replicating this experiment in countries like India would, apart from the political opposition it would invariably provoke, be in maintaining the purity/sanctity of the grading system. Though, to some extent more objective measures of hotel-cleanliness and food-safety can help address this problem, a large element of subjectivity will continue to remain. The likelihood of the administrative machinery being subverted to dilute the grading system will be very high.

A comparison of the supervisory bureaucracy in New York and a typical Indian city is instructive. In New York, the department is adding 23 more inspectors to its existing 157 to conduct annual visits that are now expected to rise by more than one-third, to 85,000 from 60,000. This translates to almost 130-150 restaurants for each inspector and 450-500 inspection visits each inspector in an year.

In comparison, a similarly large city like Delhi would have more than a lakh restaurants whose regulation is monitored by a handful of food inspectors. It becomes practically impossible for even a food inspector working exclusively on monitoring grading (they typically have a host of other activities) to just visit all the restaurants in his jurisdiction once a year.

An alternative would be to have grading agencies, similar to the ISO certification firms, who can be entrusted the task of evaluating restaurants on a few clearly defined parameters. While this too is vulnerable to being subverted, it stands a more realistic chance of succeeding than any government run certification and grading arrangement.

Thursday, July 29, 2010

Labor market in the Great Recession

Arguably the biggest immediate economic challenge facing developed economies is that of lowering their unemployment rates. In the US, despite the unexpectedly strong economic recovery, equity market rise, and surges in corporate profits, unemployment rate has been stubbornly sticky.

In fact, in his semi-annual monetary policy report testimony to the Congress, Fed Chairman Ben Bernanke even opined that it will take at least three or four years for employment to return to its long-run sustainable level and the economy to recover the 8.5 million jobs lost in 2008 and 2009.

Assuming that the recession in the US officially ended in the summer of 2009, after adjusting for inflation, the economy grew 2.2% in 2009 Q3, 5.6% in 2009 Q4, and 2.7% in 2010 Q1. However, despite three quarters of output growth, the unemployment rate has remained stubbornly high, rising from 9.5% in June 2009, to 10.1% in October 2009, before falling back to 9.5% in June 2010, identical to the rate when growth restarted 12 months earlier.

Admittedly, the well-established lag between output growth and rise in job-hirings is a partial explanation for this stickiness. In the circumstances, there has been an interesting debate about the surprising rigidities in the labor market that are delaying labor market adjustments in the aftermath of the Great Recession.

Conservatives had attributed the persistently high unemployment rates among many European economies through much of the last two decades to the moral hazard induced incentive distortions generated by the continental economies' generous social welfare nets. It was argued that those out of jobs found it more convenient to live-off benefits than search for jobs.

However, the same argument can be hardly applied to the US economy, with its bare-minimum of social security benefits and flexible labor markets. In fact, the US Congress even voted early this month to not continue unemployment insurance benefits to long-term unemployed beyond 52 weeks (originally, it was 26 weeks but was extended once). However, early this week the Senate approved the extension of unemployment benefits for those out of work for more than 26 weeks for another six months till November 2010.

In the US, the search for structural causes for the persistent high unemployment rate has received much attention. They include skills mismatch, workers geographically "stuck" in place by negative housing equity, and the reduced employability of the long-term unemployed.

Automation and off-shoring has meant that it becomes possible for employers to lay-off workers performing manufacturing and low-end mangerial jobs and certain high-skill service sector jobs. As Daron Acemoglu argues, this along with the reluctance of men previously performing relatively well-paying manual tasks, manufacturing jobs and lower-end managerial jobs being unwilling to take lower paying service jobs means that structural unemployment will remain high for some time, atleast till recovery takes firmer roots and/or expectations of the workforce about job propsects change.

In other words, as Gilles Saint Paul writes, unemployment will persist "because of the reduced employability and job search intensity of the long term unemployed". He also cautions against "political hysteresis", or the possibility of those who have kept their jobs (the insiders) supporting tighter labour regulations (once the recession is past) that would increase their bargaining power in order to take advantage of the recovery to get higher wages, at the expense of new hires.

However, the search for explanations for the high unemployment in structural causes may be a red-herring. For a start, structural unemployment refers to those long-term unemployed that would be without jobs even if aggregate demand was on target, an extremely dubious assumption now. As Scott Sumner points out, the decline in nominal GDP has been so large (in 2009 nominal GDP in the US fell at the fastest rate since 1938) that "there is nothing at all surprising about the steep rise in unemployment during 2008-09". And after the ARRA expired, since nothing really effective is being done to nullify the effects of the lingering nominal GDP shock, the high rate of unemployment persists. He writes that the focus on structural causes "takes the pressure off policymakers to deliver adequate nominal GDP growth".

Richard Koo tool feels that the search for structural causes is diverting attention from attending to the real problem of reviving depressed aggregate demand. He argues that in a balance sheet recession the private sector minimizes its debt instead of maximising profits so as to repair their battered balance sheets. In the circumstances, governments need to step in and fill the deficit or risk letting the economy dip into a deflationary spiral with persistent and rising unemployment rates. He writes,

"When the deficit hawks manage to remove the fiscal stimulus while the private sector is still deleveraging, the economy collapses and re-enters the deflationary spiral. That weakness, in turn, prompts another fiscal stimulus, only to see it removed again by the deficit hawks once the economy stabilises. This unfortunate cycle can go on for years if the experience of post-1990 Japan is any guide. The net result is that the economy remains in the doldrums for years, and many unemployed workers will never find jobs in what appears to be structural unemployment even though there is nothing structural about their predicament. Japan took 15 years to come out of its balance sheet recession because of this unfortunate cycle where the necessary medicine was applied only intermittently."

Paul Krugman points to the interesting differences in the labor market outcomes in the recessions before nineties, which were due to real economy shocks and resultant macroeconomic policy actions, and those in the nineties and beyond, which have been induced by financial market crashes. He points to the variations in productivity across recessions in these two periods and writes

"(B)efore 1990, recessions were generally accompanied by a fall in productivity, mainly because businesses would hang on to workers, so as to be prepared to ramp up production quickly once recovery got underway. After 1990, this 'labor hoarding' effect basically vanished; if anything, productivity growth seemed to accelerate in times of weak demand. Partly this may have reflected structural changes in the economy; it might also reflect the (correct) perception that recovery from financial-crisis-induced recessions is much slower than recovery from recessions created by tight money, imposed by the Fed to control inflation."

In a much discussed recent post, Tyler Cowen felt inclined towards the view that "many previously employed workers simply have a current marginal product pretty close to zero". His reasoning is based on the fact that the economy produces much the same amount of goods with the reduced number of labor, without any major new technological breakthroughs. In other words, since a lesser number of workers are now producing more than earlier, the marginal product of those now laid-off workers had to be zero. See also Arnold Kling here.

Further, examination of the US labor market reveals that the unemployment rate is very low for highly-educated workers but very high for those at the other end of the spectrum (in the US, 34.7% of the labor force is college graduate and above, whereas their share of the long-term unemployed, more than six months, was just 18.7%). Similarly, lower-income Americans are affected greatly by the current recession while people at the top of the pyramid have almost negligible unemployment rates.

However, among the long-term unemployed, those with more education tend to have longer length of unemployment, while those with less education are more likely to find another quickly. This is understandable given the fact that more educated are more likely to wait for an appropriate opening before they re-join the labor market, whereas those at the other end are most likley to join the first opportunity that comes their way.

Greg Mankiw points to the steep rise in the median duration of unemployment and feels that traditional unemployment-output-inflation relationships like Okun's law, Phillips Curve, NAIRU etc may be due for revision.

On the shift in NAIRU, he also points to recent research findings that the "long-term unemployed put less downward pressure on inflation" and argues that therefore "the increase in long-term unemployment may mean that we will see less deflationary pressure than we might have expected from the high rate of unemployment".

Interestingly, Paul Krugman draws attention to a paper by Laurence Ball who points to the strong tendency of high unemployment to become permanent. Those out of work for a long enough period become permanently unemployable (or atleast less productive and less competitive in the job market), both psychologically and in terms of their skill-erosion. Ball provides compelling evidence that weak policy responses to high unemployment tend to raise the level of structural unemployment, so that inflation tends to rise at much higher unemployment rates than before.

Krugman also points to the possibility that the Beveridge curve — the relationship between job vacancies and the unemployment rate — already seems to have shifted out dramatically, signaling a worsening of the NAIRU. David Altig writes that the "most tempting explanation for the seeming shift in the Beveridge curve relationship is a problem with the mismatch between skills required in the jobs that are available and skills possessed by the pool of workers available to take those jobs".

Heidi Shierholz explains away the falsehood in the five big unemployment myths - unemployment benefits make people less likely to find jobs (since there are now roughly five unemployed workers for every available job, simply searching for jobs won't help you find one!); unemployment insurance doesn't contribute to economic recovery (see this); we can't afford to do this right now (see this, primary causes of US long-run deficits are rising health-care costs and low revenues and the stimulus is responsible for no more than 1 to 2% of US's long-run fiscal gap); private sector can take care of unemployment on its own (to get down to the pre-recession unemployment rate within five years, the labor market would have to add an average of roughly 280,000 jobs every single month between now and then); and unemployment rate gives us a good sense of how many people are affected by the downturn (the underemployment rate which includes jobless people who have given up looking for work and people who are working part time but want full-time jobs stands at 16.5%).

Tim Duy has this excellent summary of the debate in the blogosphere about the possibility of NAIRU having risen.

Update 1 (1/8/2010)
Minneapolis Fed has a series of superb graphics that highlights the magnitude of the Great Recession in relation to previous ones in terms of changes is employment and output.

Update 2 (8/8/2010)
Mark Thoma argues that irrespective of whether the unemployment is structural or cyclical, governments have a major role to play in lowering it, especially in deep recessions like the current one. Mark Thoma also argues that governments should intervene with fiscal support even with structural unemployment.

Update 3 (1/9/2010)

During the 2007-09 recession, middle income jobs were the worst hit, while lower paying jobs have been recovering faster than higher paying ones.

David Autor of the MIT also writes that from 2007 to 2009, the paper said, there was relatively little net change in total employment for both high-skill and low-skill occupations, while employment plummeted in so-called middle-skill occupations.

Update 4 (20/9/2010)

Mike Konczal (also this) and Paul Krugman point to evidence that it is weak aggregate demand and not skills mismatch that is driving the high unemployment rates in the US.

Update 5 (11/11/2010)

A San Francisco Fed working paper questions the structural reasons are causing high unemployment hypothesis. They write that "analysis of data on employment growth and jobless rates across industries, occupations, and states suggests only a limited increase in structural unemployment, indicating that cyclical factors account for most of the rise in the unemployment rate".

Update 6 (5/12/2010)

The structural or skills-mismatch hypotheisis of Kocherlakota et al (with its attendant claim that government cannot do anything) is not borne out by the across-the-board nature of job losses. As Matt Yglesias points out, it looks like a "massive and largely avoidable plague of idless in which the country is producing far fewer goods and services than it is capable of producing".

Update 7 (12/3/2011)

Economix (from Cleveland Fed report) points to an excellent graphic that highlights how "America’s most educated workers have been blessed with significantly lower unemployment rates and higher wages gains than their less-educated counterparts".

Wednesday, July 28, 2010

Explaining India's inflation story

Just as unemployment is the defining macroeconomic challenge of the era across developed economies like the US, persistently high inflation has assumed centerstage as the central economic policy challenge in India. Worryingly, inflation in India has been following a trend different from other emerging economies where, as the graphic below indicates, inflation rates have moderated.

Standard explanations of India's inflation story has focussed mostly on foodgrain prices and specific supply and policy shocks. Besides conventional monetary policy responses, the immediate prescriptions to the problem have revolved around government buffer-stock operations, increasing imports and other efforts to increase foodgrain supplies. However, I have blogged earlier here and here that India's inflation story may be far more complex and go beyond these issues.

In this context, the RBI has used the occasion of its first quarter monetary policy review to expectedly hike the repo and reverse repo rates by 25 and 50 basis points, respectively, to soften persistent inflationary pressures in the economy. The fourth hike in the key policy rates in the current calendar year will increase the repo rate to 5.75% and reverse repo rate to 4.50%, while the CRR will remain at 6%. In a deficit liquidity mode, the repo rate under LAF (Liquidity Adjustment Facility) is the effective operating policy rate. See this and this excellent posts by Amol Agarwal.

The larger hike in the reverse repo rate was to narrow the corridor for short-term money market rates and thereby reduce interest rate volatility. Since the WPI-based inflation, recorded at 10.6% for June, has been in double-digits since February and was getting generalized across sectors, the RBI has raised the baseline projection for WPI inflation to 6% for FY 2011 from 5.5% earlier. Primary article (basically food, minerals and non-food crops) prices rose by 16.3% in June, fuels by 14.3% and manufactured goods by 6.7%.

The quarterly policy review document points to the demand-side pressures (increased pricing power) and capacity constraints generating inflationary forces and elevating inflation expectations. Non-food items like fuel products, iron ore and electricity contributed 70% to the WPI inflation in June compared with nil last November, indicating that food was no longer the dominant factor for speeding the rate.

In what is surely the most convincing analysis of India's stubbornly persistent inflation scenario I have come across, Arvind Subramanian draws attention to fundamental structural issues - overheating and cost-push inflation induced by rising land prices - that may satisfactorily explain India's inflation problem.

He does not subscribe to the standard explanations like weak monsoons and resultant fall in agriculture production or policy-shocks like fuel price and MSP hikes. He also doubts the utility of conventional monetary policy tools in addressing this inflation challenge.

Instead he feels that "the economy’s current growth rate of 7-8 per cent is above its potential or trend growth rate" and is causing the economy to overheat. Exacerbating the problem is weak agriculture productivity growth and increased purchasing power due to programs like NREGS. In particular, the unintended stimulative impact of NREGS on aggregate demand in rural India may be one of the under-appreciated contributors to inflationary pressures. He argues that the supply capacity of the economy is simply unable to match the demands on that capacity,

"We do not know for sure what the bottlenecks are in the rest of the economy. They could be inadequate investment in infrastructure, inadequate supplies of skilled labour (always a possibility in India because its growth model is so skills-reliant), slow total factor productivity growth or some combination of all the three."

There is no official measure of potential output levels for the Indian economy. Though, accurate approximations of potential output growth rate is difficult, the RBI research itself estimates the potential output growth rates in the 6.8-7.4% range for the 2000s decade. In fact, in view of the infrastructure bottle-necks that seriously constrain the capacity of the economy to meet the much faster growth in aggregate demand, a liberal approximation of the potential output will be in the range of 8-8.5%.

In a recent article in the Economic Times, B Kapali raised much the same issue while pointing to the persistent underlying inflationary pressures in the Indian economy over the past decade,

"A wide range of goods, services and assets have experienced some of the sharpest price increases we have seen in recent memory. Very high inflationary pressures have been built into the overall macro economy in the past 7 or 8 years even as real growth shifted into a higher gear. Between 2000 and 2010, while real GDP rose 100%, nominal GDP increased 260%. This indicates that prices have risen close to 300% in this period — a CAGR of nearly 12%. (This is the price level increase in overall GDP including services)...

After a decade of rapid output growth but equally rapid (or even larger) increases in prices, the basic questions (going beyond the tyranny of the present) are: what is the Indian economy’s potential growth rate? Has monetary policy been too accommodative in the past 10 years in relation to the level of potential output?"

The other causal factor mentioned by Arvind Subramanian is the increased activity in the real estate market on the back of strong economic recovery. The resultant surge in capital inflows into real estate and housing has led to sudden increases in the price of land and related inputs, raising the cost of production in the economy as a whole. He writes,

"A whole range of services, such as retail, construction, entertainment, education and finance — which account for progressively larger shares of the economy — use significant amounts of land as an input, a fact that gets overlooked in inflation discussions, which tend to focus on agriculture and manufacturing... Generalised cost-push inflation could then be a natural consequence with the push resulting from the interaction between a pre-existing microeconomic distortion and a macroeconomic factor that serves to aggravate this distortion, converting a price-level effect into an inflation effect."

He proposes taking immediate steps to eliminate the land market distortions and dampening credit flows, both external and domestic, into the real estate sector. This would help contain the real-estate driven cost-push inflation pressures. While it may be possible to take immediate steps to address this challenge more effectively, the expansion of the production possibility frontier of the economy would surely take time.

Neither of these causes can be directly addressed with standard monetary policy tools and would require resolving more fundamental structural challenges being faced by the Indian economy. In other words, the persistently large inflation is the most immediate and salient question mark on India's ability to sustain near double digit rates of economic growth. Does this also mean that Indian economy looks will face consistently high inflation rates alongside high economic growth rates for atleast the foreseeable future?

Update 1 (4/8/2010)

Niranjan has this op-ed pointing to the over-heating story.

Monday, July 26, 2010

How can foodgrains be "off-loaded"?

The persistently high food inflation has triggered off calls for more aggressive and direct government intervention in the foodgrain markets, especially by off-loading some share of the massive buffer stocks, in order to increase the supply and thereby lower prices.

Adding weight to this are reports that more than 10 mt of rice and wheat, stored in the open across the country by the Food Corporation of India (FCI), are at risk of (or already are) rotting. Of the 59 mt of grain stored by FCI and state agencies across India, 42 mt is in covered buildings, while the remaining 17.8 mt is stored in the open under tarpaulins.

Now, assuming the government decides to off-load these stocks, what are the channels to do so without any major market distortions? Unlike conventional open-market operations of the government in the financial markets, it is not possible to simply off-load massive stocks of food grains directly into the market, even accepting the distortion effect on the market prices. In the absence of trading in rice and wheat futures, the commodities market too lose relevance (it is a moot point as to whether manipulating this market can translate into lower market prices).

The only available channel for the government to off-load such massive quantities of stocks is the existing public distribution system (PDS). Here too, it can be done either by improving the efficiency of drawls (given the dysfunctional nature of the PDS in many North Indian states) or by increasing the allocations itself. Any improvements in the efficiency of PDS system is too complex an issue to be addressed immediately, which leaves increasing allocations as the only alternative. In fact, the proposal under the Food Security Act to distribute atleast 35 kgs of rice or wheat to BPL families at Rs 3 per kg in 150 of India’s poorest districts, is a good place to start.

But such actions would only cause small quantities to be released into the market and would not make any meaningful dent on rotting stocks or the larger issue of lowering prices. Further, it would take care of only food grains like rice and wheat, and still leave the major contributors to food inflation like pulses, oil-seeds, vegetables, etc unaddressed.

In this context, food-for-work programs, dove-tailed to the NREGS program (with some share of the wages given as food stamps), can be the most effective channel to off-load the massive food stocks and thereby bring down prices. This would enable the expansion of the scope of NREGS to more explicitly include infrastructure asset creation, besides wage employment assurance. Many much-needed infrastructure/community asset works that would other-wise have not been done, can now be covered under this. Moreover, from the experience of previous food-for-work programs, it can also have a depressing effect on food grain prices.

Another alternative would be to issue time-dated food vouchers, especially in rural areas. These vouchers could be redeemed through the regular PDS shops and other pre-defined/certified retail outlets. Though this would certainly carry the risk of market incentive distortions, if structured carefully and done in sufficiently large enough quantities it can achieve both the stock-disposal and price lowering objectives. And finally, there is the option of helicopter drops!

Sunday, July 25, 2010

Social empowerment and economic growth

More evidence in support of the argument that economic growth is the most sustainable route to social empowerment comes from the example of women working in the growing garment industry in Bangladesh.

This Economix post points to how "by giving women an independent source of livelihood, Bangladesh’s garment industry has changed this conservative Muslim country’s society in immeasurable ways". An yet to be released study finds that "a doubling of garment jobs causes a 6.71% increase in the probability that a 5-year-old girl is in school". It has also been found that girls who live in villages with garment factories tend to marry later and have children later than the girls who grow up in villages.

More than 80% of the three million people who work in the industry are girls, who migrate to cities to work in these factories when they are in the 16-19 age group. Bangladesh with annual garment exports worth $ 7.1 bn, is already the world's second largest garment exporter. With the lowest factory wages in the world, the country is slowly emerging as the preferred outsourcing location for western apparel retailers and brands, who are exiting China due to rising wages there.

In this context, a study of the software industry in India by Emily Oster and M. Bryce Millett has found that the introduction of one ITES center increases school enrollment by 5.7% in its surroundings, an effect driven almost entirely by English language schools.

The results from the software and the garment industry are consistent with the claim that social empowerment impacts are driven by changes (or perception of changes) in returns to schooling. Such inherent incentives-driven forces have to complement (and beyond some level - say, secondary and tertiary education - even dominate) the role of government welfare interventions in achieving social goals like education.

They also underline the fact that the most effective - in terms of sustainability, ease of implementation, and most importantly, magnitude of the impact - means of social empowerment and poverty reduction is through economic growth.

Targeted welfare programs and focused poverty-reduction initiatives like micro-finance and SHGs, while important, have serious limitations in their ability to translate destitution-support led social empowerment into meaningful long-term economic empowerment. If there is any more evidence required, just look northwards to China!

Saturday, July 24, 2010

Where is the evidence of inflation?

While following the debate on exiting fiscal expansion in the US, I thought of listing out all available graphics on inflation based on different types of indices and expectations to see where does the evidence point to. As can be seen below, all of them point unmistakably southwards.

The 12-month percentage change in core inflation has been going downhill...

... as is the CPI for all urban consumers stripped off food and energy components. Core inflation has fallen from more than 2 percent to less than 1 percent.

David Beckworth shows thee steeply declining trend in inflation expectations as reflected in the difference between 5 year treasury yields and 5 year TIPS for the
January 4, 2010 - July 15, 2010 period.

Menzie Chinn
finds no signs of inflation with either annualized 3 month changes in price indices...

... inflation expectations from either Survey of Profession Forecasters...

... or from market-based measures of inflation expectations.

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.69%, or in other words, the public currently expects the inflation rate to be less than 2% on average over the next decade. This is borne out by the expected inflation yield curve.

On a historical perspective too nothing appears to have badly unsettled the inflation trend.

Paul Krugman points
to the 10 year TIPS spreads (difference between the interest rate on ordinary government bonds and bonds indexed to inflation), which is a measure of the inflation rate, and finds much the same declining inflation trend

And Rebecca Wider finds that the trend is global, atleast among the developed economies. She illustrates using the respective inflation-indexed bond markets that the 10-yr break-even expected inflation rates for the UK, Germany, Canada, Italy, and the US are falling.

See also this and this by James Hamilton.

Update 1 (1/8/2010)
More evidence from Free Exchange which points to the continuously declining trend on the interest rates on 10 year US government debt.

Update 2 (3/8/2010)
University of Michigan estimates (survey-based) of inflation expectations appear to indicate that they are currently well anchored. Indeed, except the early 1980's which experienced a period of rapid disinflationary expectations, expectations have been relatively stable.

Financial market inflation expectations, as manifested in the difference between 5 year Treasuries and 5 year TIPS fell slightly in recent months, but nothing like the clear taste of deflationary expectations at the end of 2008. It too appears to be well anchored.

Update 3 (4/8/2010)
David Beckworth has a series of graphs on falling inflation expectations.

Update 4 (10/8/2010)
Menzie Chinn finds that over certain horizons, we already have deflation; and for certain segments of the population, inflation has been at zero for a year already.

US economic situation in graphics

Mark Zandi's testimony before the House Budget Committee contains several superb graphics that can be used to nicely reconstruct the state of the US economy today.

The LIBOR-Treasury spreads clearly reflect the strains experienced by the US economy over the past three years.

The federal debt-to-GDP ratio, while not alarming when seen in historical perspective, is estimated to reach its highest level in more than half-a-century.

As the recession deepened, state and local government revenues have fallen precipitously.

The impact of ARRA spending will disappear from the third quarter, leaving the corporate sector to shoulder the burden.

Stripped off the census hirings, the labor market shows no signs of any recovery despite the recession getting over.

A reflection of the deep uncertainty about economic prospects is the anemic job hirings in the private sector, which has acted to amplify the unemployment problem.

Despite a surge in corporate profits, jobs have been hard to come by, as most of the profits have been saved or used to pay-off debts.

Consumer sentiment is stuck at a low plateau.

Business confidence, like consumer confidence, is at its lowest level in the last three decades.

Despite the rebound in equity markets and bottoming of the real estate market, foreclosures show no signs of falling.

The spectacular de-leveraging by households and financial and non-financial firms has driven down the credit markets and there is no evidence of any recovery.

The news from Europe is not encouraging as the sovereign debt spreads (with respect to 10 year German government bonds) remain high.

Update 1 (19/8/2010)

Superb series of graphics on the US economic situation.