Contracting civic services

In recent years there has been a widespread trend wherein cities have been weighing the choice between delivering specific civic services with their own employees or by contracting with private or public sector providers. Jonathan Levin and Steven Tadelis have a working paper that develops a model of the "make-or-buy" choice that highlights the "trade-off between productive efficiency and the costs of contract administration" from a dataset of service provision choices by US cities. Their findings include

1. Services that are characterized by high "transactions costs" of contracting and those that are widely provided by cities or are ranked high by city managers in terms of resident sensitivity to quality are privatized less frequently.



This explains why majority of the efforts at outsourcing or privatizing water, sewerage and solid waste have failed in India. All of these have high contract management costs, have considerable public interface and carry high salience in civic services delivery. In each of them too, it may be more appropriate to outsource or privatize the upstream activities like sewerage, water, and solid-waste treatment facilities rather than downstream, citizen-interfaced activities like management of the water distribution, sewerage collection and solid waste collection and transportation.

2. Contracting to other public agencies appears to be largely a substitute for in-house provision, rather than an analogue of privatization. In any case, in developing countries there are very few specialized civic service providers in the government sector.

3. There exists a substantial degree of heterogeneity across cities in terms of their contracting practices - large cities and recently incorporated cities, and cities governed by an appointed city manager rather than an elected mayor do more private contracting and their choices exhibit a closer match to the trade-offs identified in the model.

It is natural that larger cities which enjoy economies of scale (and therefore attractive for service providers), have the resources and personnel to manage contracts, and are likely to have more private service providers, take the lead in opening up the market for such services. Unfortunately, in the Indian context, the smaller (second tier) cities, with all their inherent dis-advantages have been more pioneering with contracting civic services and the balance sheet has understandably been not very encouraging. The larger cities, where contracting stands greater chance of succeeding, have been less forthcoming, especially for political reasons.

4. There is some evidence of spillovers in contracting practices within a given city, so that privatizing one service may make it more likely to do further privatization.

The danger and reality with most of our cities is just the opposite - negative externalities associated with failed contracting interventions. A large part of this is inevitable given the nascent and under-developed nature of both sides of the market. However, such failures impose substantial barriers that come in the way of development of the market - the private sellers demand a "credibility premium" for the services and the local government buyers develop "risk aversion".

The services found commonly outsourced/privatized, in view of the relative ease of their contracting, include - vehicle towing, solid waste collection, tree trimming, streets cleaning, buildings maintenance etc. In contrast, crime prevention, elderly care and other welfare programs, inspections and code enforcement, libraries, emergency medical services are found to be difficult to contract and accordingly done in-house. Interestingly, services like street cleaning, utility meter reading, collection of delinquent taxes, operation of parking lots and maintenance of parks, and even water and sewerage treatment, while relative easy to contract, have not taken off in the out-sourcing market.

This data is reflective of the trends in India too, though the frequency of such contracting is on a much smaller scale.

Clean technologies in power generation

I have blogged earlier about how entrenched ideological positions on important public issues comes in the way of achieving even the "second-best" solutions, leave alone the "best". The best becomes the enemy of the good!

Gregg Easterbrook points to another example of this in the context of clean technologies for power generation.

"Companies including General Electric have already perfected technology to reduce emissions substantially, called 'integrated gasification combined cycle' power. Current coal-fired power plants burn pulverized coal using a combustion process that hasn’t changed in a half a century. The new approach turns coal into a gas similar to natural gas, which runs through a device similar to a jet engine. Such plants can achieve near-zero emissions of toxic material and chemicals that form smog, and they require about a third less coal than regular coal-fired power plants to produce an equal amount of energy, which means about a third lower greenhouse gases.

Beyond that, the promising technology of 'sequestering' carbon dioxide — pumping it back into the ground to keep it out of atmosphere — appears for technical reasons to be impractical for conventional pulverized-coal power plants. But gasification plants have technical characteristics that should make 'sequestration' of carbon feasible. A gasification power plant with sequestration would have around two-thirds lower greenhouse gases than a conventional coal-fired generating station. The first commercial gasification power plant, designed by General Electric for Duke Energy, is being built in Indiana."

Absurdly enough, this technology continues to languish at the margins. Power generation companies are deterred by the higher up-front cost of a gasification plant and environmentalists reject any coal-based power generation solution. As Easterbrook writes, "Much of the environmental movement clings to a fairyland notion that coal combustion can soon be eliminated, and therefore no coal-fired power plant of any kind, even an advanced plant, should be built... We have two choices: do nothing and wait while coal-caused carbon emissions continue unabated; or start building improved coal-fired plants that reduce the problem."

Governments can make such technologies attractive for generation utilities by making the power generated from conventional coal-based plants expensive. This can be achieved by either imposing carbon emission caps and/or taxing the carbon emissions. The Waxman-Markey Climate Change Bill, with all its flaws, passed by the US Congress recently, after resisting such restrictions for over twenty years, is a step in this direction. At the heart of the legislation is a cap-and-trade system that sets a limit on overall emissions of heat-trapping gases while allowing utilities, manufacturers and other emitters to trade pollution permits, or allowances, among themselves. The cap would grow tighter over the years, pushing up the price of emissions and presumably driving industry to find cleaner ways of making energy.

The challenge of getting Asians to spend

This blog has written extensively about how the global macroeconomic imbalances have contributed to the ongoing economic crisis, and the need for fundamental structural shifts in the global economic attitudes and patterns to remedy these imbalances. For the emerging economies, especially those of Asia Pacific, this means sharply increasing their domestic consumption and deepening and widening their domestic financial markets. The former will ensure that they spend more and save a little less, and also consume more of what they produce instead of just exporting them. The latter will provide the required breadth and depth to provide safe, liquid and remunerative investment opportunities at home for their massive domestic savings.

In this context, the graphic below captures the massive scope for increasing domestic private consumption in these economies. Compared to global average of 61% of GDP (and 72% of GDP in the US), the household consumption expenditure among the East Asian economies range between 40% to 50% of GDP, with China coming in at a shockingly low 33% and Japan at a slightly higher 57%. India too has a low figure of 54%. The scope for boosting domestic consumption is therefore considerable, especially in China.



However, many challenges lie ahead if these objectives are to be achieved. The deep uncertainty about their economic prospects and low consumer confidence makes households in these Asian economies culturally inclined to save more so as to secure the economic future of themselves and their children. The ongoing economic crisis, with its impact on exports and decline in jobs in export-oriented sectors, may only reinforce the resolve of people in these economies to save more and consume less, thereby deepening the paradox of thrift.

Interestingly, the poorer nations of South Asia (excluding India) has a higher than global average in household consumption expenditure. Similarly, the household consumption expenditures are high among all the second generation of East Asian tigers - Vietnam, Cambodia, Philippines, and Indonesia. The high share of private consumption in these economies can be partially explained by the relatively smaller disposable incomes with their citizens. This in turn means smaller amount of savings to draw for both private business and government spending and investments. However, as national incomes rise, their savings rates are more likely to converge upward towards those of their richer neighbours. In case of the more advanced East Asian economies, the higher net incomes and resultant increased disposable incomes are saved (instead of consumed) at the margins.

The cultural and contextual inclination towards savings and reflected in their frugal consumption habits cannot be overcome easily. It can only be hoped that as a new generation of consumers come up, relatively free from the entrenched cultural legacy of their parents and with less uncertainties about their economic future, the aforementioned habits give way to those more suited for the modern capitalist economy.

This process can be facilitated by the development of vibrant financial markets that enable consumers and citizens to hedge their risks, smoothen their consumption needs, and invest their savings in safer and liquid investments. Development of a vibrant market in consumer finance and housing mortgage loans, and other measures to facilitate easier access to credit, will facilitate consumption. Lower interest rates, besides lowering the cost of capital for businesses, also expedites the development of a consumer finance market. Refraining from currency manipulation (to keep exports competitive) will help by keeping imports cheaper and more attractive for domestic consumers.

Update 1
In an NBER working paper, Shang-Jin Wei and Xiaobo Zhang trace the high and increasing savings rate in China during 1990-2007 to competitive savings motive "as the country experiences a rising sex ratio imbalance, the increased competition in the marriage market has induced the Chinese, especially parents with a son, to postpone consumption in favor of wealth accumulation. The pressure on savings spills over to other households through higher costs of house purchases."

Update 2
Economist explores the possibility fo Asian consumers replacing Americans as engines of global economic growth.

Wealth effect and the savings patterns

Over two decades of unprecedented increases in asset (homes, bonds and equities) values, with their resultant "wealth effect" (use the assets like ATMs to draw down cash), coupled with historically low interest rates and a booming economy, had driven Americans to spend as though there were no tomorrow. Now, battered by a collapsing housing market, asset values that have plummetted to their depths (wiping out household net worth at an alarming rate), and an economy in deep recession, Americans appear to have dusted up their piggy banks and resumed the long forgotten habit of saving for the rainy day.

Latest figures indicate that household savings in the US touched 6.9% of their after-tax income in May 2009, up from minum 2.5% in 2005. Impressive as it sounds, this is only about equal to the average savings rate of the last 50 years. However, as Nouriel Roubini predicts, the household savings rate may touch 11% by next year.



Comparing patterns in household savings as a share of disposable incomes in US, UK, Canada and Germany, and finding similarities in the same, Rebecca Wilder feels that "wealth effect", more than "de-leveraging" (propensity to reduce debt burdens), may be the dominant determinant of savings patterns. First, though, Canadian and German households did not experience the bubble in debt accumulation as did the US and UK households, saving rates are rising across the board.



Second, as a comparison of the ratio of net-worth (nominal wealth) to disposable income in the US and Canada shows, the wealth effect (reflected in the much steeper declines in the ratio as the asset values boomed) is much more pronounced in the US. Despite this, the savings rate have been climbing in both countries.



Both these trends taken together lends credence to the view that wealth effect is the more important determinant of household savings and the effect of high debt burdens may be more marginal than conventional wisdom would have it. By implication, as Wilder writes, this view also means that "the second the labor market starts to improve, and credit standards loosen up further, US households (may) start spending again. All that is needed is a little income growth to generate some consumption growth alongside constant debt payments."

Financial crisis timeline

Economix draws attention to two excellent interactive timelines on the financial crisis by the Federal Bank of New York. The first one compares events in the US - Fed policy actions, market events, and other policy actions over the June 2007-June 2009 period. The second one maps the international responses to the crisis in terms of various financial market interventions - bank liability guarantee, liquidity and rescue interventions, and other market interventions.

The turning point that was 1979!

Freakonomics points to a superb article by Christian Caryl on the year 1979 that saw Ayatollah Khomeini's ascent to power and the rise of militant Islamic nationalism in the Middle East (aided by the Soviet invasion of Afghanistan and the infamous Iran hostage crisis), Margaret Thatcher leading the Conservative Party to power in the UK and setting the stage for three decades of liberal free-market orthodoxy as the ruling ideology of the world economy, Pope John Paul II's pilgrimage to communist Poland that sowed the first seeds of the backlash that swept away communism, and the start of Deng Xioaping's experiment with capitalism in China that has today dramatically reversed the global economic balance of power.



He writes that 1979 (and not 1968 or 1989) was the definitive turning point in the "politicized religion, post-communist globalization, and laissez-faire economics" that has defined our modern era.

The market for vocational skills

Sample this from Louis Uchitelle in NYT about the professions that have bucked the trend druing the recession,

"Welder is one... critical care nurse is another. Electrical lineman is yet another, particularly those skilled in stringing high-voltage wires across the landscape. Special education teachers are in demand. So are geotechnical engineers, trained in geology as well as engineering, a combination sought for oil field work. Respiratory therapists, who help the ill breathe, are not easily found... And with infrastructure spending now on the rise, civil engineers are in demand to supervise the work."

The recession may have taken its toll with many well paying, high-skilled, knowledge-based jobs being lost over the past few months. However, as the NYT report indicates, demand for skilled labour with experience appears to be immune from the vagaries of the business cycle. The market evidently puts a premium on specialized technical (or vocational) skills honed to near-perfection through years of experience.

The cycle-proof nature of such vocational skills stems from the inelastic nature of the demand for these jobs. Plumbers, carpenters, electricians, and those offering specialized engineering (environmental, transport, hydraulics, structural, marine etc) and para-professional services have a well established and more or less invariant market in any economy, irrespective of the conditions. Add in experience to the basic set of occupational skills, and their market demand increases considerably.

And in economies like India, where infrastructure driven construction activities will play a dominant role in the economy for the foreseeable future, the demand for such occupational skills will be insatiable. And among them too, those with experience will command a very high premium, far out of proportion to their basic educational qualifications.

Since these jobs do not require long duration and expensive college degrees, and can be attained by attending specialized vocational tranining institutes (it is an altogether different matter that there is dire shortage of such institutions in the country) for shorter duration courses, there is a clear case in favor of more students embracing careers involving such occupational skills. The market forces, manifested in the ever increasing demand for such professionals and their wages, will in due course of time incentivize more and more people to venture into such careers. The demand for experienced professionals will continue to remain uncleared for such time till large enough numbers of those joining such careers gathers adequate experience over the next decade or so.

Free Exchange points to a "rigidity premium" associated with such professions, since workers who entrench themselves in these specialized skills find it difficult to find alternative employment opportunities in the unforeseen event of a disruptive change that undermines their professions. It writes that this is "a strong disincentive to attempt to develop the experience that is now so valued... employers of experienced workers... have to compensate their employees for the fact that their skills do not readily translate into alternative employment options".

Bar Code turns 35

The Bar Code, with its 12 digits and 30 black and 29 white lines to convey 95 bits of data in binary code, and scanned more than 10 billion times a day around the world, turned 35 early this week. NYT has this nice illustration of a bar code.

Pricing water supply in India

In a recent study on water scarcity in India, consultancy firm Grail Research have found that unless the government makes serious changes to the way it prices and manages water, increased consumption by the nation’s farms, factories and growing population will push drinking water supplies to critical limits by 2050. Its recommendations include increasing desalination and rainwater harvesting, improving watershed management, and use of public-private partnerships for water treatment and distribution.

The report points to the stark difference in prices between supply in Indian cities and elsewhere. The tariff per cubic meter of water, in US dollars (derived by multiplying the tariff per cubic meter in U.S. dollars by the exchange rate as of July 1, 2008, and dividing by the 2005 purchasing power parity rate), adjusted for purchasing power parity, for various cities was in the range of $0.25-0.33 for Indian cities, whereas it was $1.94 in Ankara, Turkey; $4.53 in Manchester, Britain; $2.77 in Cape Town, South Africa; $2.84 in Kathmandu, Nepal; and $2.80 in Boston, Mass.; and $1.39 in Omaha, Nebraska.

The low nominal prices for municipal water supplies in our cities glosses over the high actual cost incurred by the consumers in accessing piped water
1. Large segments of the population don’t have access to piped-in water and are forced to buy it from water vendors at exorbitant prices.
2. The Transparency International's Global Corruption Report for 2008 notes that 40%of water customers in India had made multiple small payments in the previous six months to falsify meter readings so as to lower their bills.
3. Customers also reported that they had paid bribes to speed up repair work (33% of respondents) or expedite new water and sanitation connections (12% of respondents).
4. Other opportunity costs associated with accessing piped water supply in Indian cities are discussed here and here.

Jobless growth?

I had blogged earlier about Michael Mandel's claim that the innovation driven growth of the last three decades has been accompanied by weak job growth. Now Mandel has three graphs that captures the shockingly anemic job growth in the private sector and appears to clearly indicate that "without a decade of growing government support from rising health and education spending and soaring budget deficits, the labor market would have been flat on its back". In the May 1999 to May 2009 period, employment in the private sector sector only rose by 1.1%, by far the lowest 10-year increase in the post-depression period.



Over the same period, the dominant private sector has generated a total of roughly 1.1 million additional jobs, whereas the public sector created about 2.4 million jobs.



Most of the industries which had positive job growth over the past ten years were in the government health and education (HealthEdGov) sectors. In fact, financial job growth was nearly nonexistent once we take out the health insurers.

In defense of EMH

The sub-prime mortgage crisis may have battered many reputations, and questioned many of the fundamental tenets of modern finance like the Efficient Market Hypothesis (EMH) and Modern Portfolio Theory (MPT). However, in an excellent post, Edward Glaeser argues that bubbles and market irrationality doesn’t mean that markets are inefficient (prices do not reflect all relevant information and shares are under- or over-valued) and thereby abound with easy arbitrage opportunities.

He makes the distinction between "inefficiency" and "irrationality" and points to an old paper by Brad DeLong, Andrei Shleifer, Larry Summers and Robert Waldmann which showed that less-than-rational (or irrational) "noise traders" could move markets even when rational traders have arbitraged away all the free lunches. He writes,

"The market may be buffeted by strange forces, but those people who claim to be able to earn fortunes by understanding those forces are more likely to be charlatans than those who argue for the continuing relevance of the EMH. Still, recognizing the occasional madness of markets can provide a bit of investment guidance. The difficulty inherent in finding free lunches means that buyers can’t just buy a house, or a mortgage-backed security or a stock, trusting that the market has priced things correctly. A house doesn’t become a good buy just because some other idiot paid a fortune for a similar home down the street. A similar fool may not be around when you are looking to sell."

Update 1
Jeremy Siegel writes in defence of EMH (prices of securities reflect all known information that impacts their value), "The hypothesis does not claim that the market price is always right. On the contrary, it implies that the prices in the market are mostly wrong, but at any given moment it is not at all easy to say whether they are too high or too low... CEOs of the failed financial firms or the regulators who did not see the risks that subprime mortgage-backed securities posed to the financial stability of the economy. Regulators wrongly believed that financial firms were offsetting their credit risks, while the banks and credit rating agencies were fooled by faulty models that underestimated the risk in real estate."

Update 2
Rajiv Sethi argues that though it is possible to detect bubbles it is difficult to make money using that information - "the eventual size of the bubble and the timing of the crash are unpredictable. Selling short too soon can result in huge losses if one is unable to continue meeting margin calls as the bubble expands. Trying to ride the bubble for a while can be disastrous if one doesn't get out of the market soon enough".

He goes along with Richard Thaler in claiming that EMH may be only partially correct. While recent events have reinforced the claim that you can’t always beat the market or atleast can't do so without taking on more risk, it may not be correct to argue that "the market price is always right", especially given the widespread evidence of bubbles (despite Fama's denial).

Nick Rowe's take on EMH is very incisive and reflective of how differently academics and traders view EMH, "From the Econ Dept perspective, watching the players play, the Efficient Market Hypothesis makes a lot of sense. From the Biz Skool perspective, as one of the players playing, the EMH makes much less sense."

Update 3
Mark Thoma writes, "There are two versions of the efficient markets hypothesis, a strong version and a weak version. According to the strong version prices accurately reflect the underlying intrinsic value of financial assets, but the weak version only requires that prices be unpredictable, they don't have to accurately reflect fundamental values. The strong version is, well, too strong and it seems clear that this condition is not satisfied in asset markets, at least not on a continuous basis. The weak version, however, does have support (though even here there is not universal agreement). The distinction between the strong and weak versions, and the assertion that the weak version holds even if the strong version does not, is often used as a defense of the efficient markets hypothesis."

In light of this, Rajiv Sethi rephrases EMH as Invincible Market Hypothesis.

Negative inflation in India in perspective

The annual WPI-based inflation India has fallen into negative terrritory for the first time in over three decades last week, reporting at minus 1.61% for the week ended June 6, 2009. The base effect from the corresponding period last year, when prices were on their way up, and relative declines in fuel and power prices, and and not any deflationary trap, is being held responsible for this trend.



The drop in aggregate prices conceals large variations within categories. Primary Articles group inflation increased to 5.8%, up from 5.7% last week, whereas "food articles" inflation remained at a high 8.7%, with cereals, pulses, vegetables, milk and spices recording a high rate of inflation. The price rise translated into retail prices is much higher, as indicated by the graphic of food prices from the Price Monitoring Cell of the Department of Consumer Affairs.



The sharp variations in foodgrain and energy prices apart, the prices of manufactured goods, a more accurate reflection of the underlying prices trends (core inflation), have been remarkably benign, remaining at very modest, even stagnant, levels for months now. As the Financial Express notes, "the weak demand for manufactured products has even caused a free fall in prices of important investment goods like machinery and intermediate products like chemicals in the last few weeks... The revival of demand across the broad industrial spectrum calls for the supply of credit at reasonable cost, something that the monetary authorities have chosen to ignore for too long, but cannot afford to anymore, given that inflation is certainly less of an issue, and that firm recovery remains elusive."

A more definitive indication of the global trend of declining inflation, even for food items, is captured in the graphic below. As compared to the high food price inflation in the year ended February 2009, the price changes for the last three months have been relatively modest, even negative.



As has been argued in earlier posts here, here, and here, the sharp disconnect between the WPI inflation levels and the price rise seen at the retail level is a measure of the distortions and market imperfections, especially at the downstream side, in the market for each of the commodities.

Update 1
WPI comprises three major groups, namely primary articles, manufactured items, and fuel, light, power and lubricants, contributing 22.02%, 63.75% and 14.23%, respectively to overall inflation. See this article on proposals to change over to a monthly WPI with 2004-05 base year and a larger basket of items with different weights.

And now a W-shaped recovery?

In the last three months, green shoots have been sprouting across the global economic landscape - equity markets are looking up and volatility is down; commodity prices are rising; corporate credit spreads (the difference between the yield of corporate and government bonds) have narrowed dramatically, as government-bond yields have increased sharply; and the dollar has weakened as demand for safe dollar assets has abated.

Nouriel Roubini, whose forecasts are a bell-wether for the world economy, feels that this upturn is driven by excessively optimistic expectations of a rapid recovery of growth toward its potential level and by a liquidity bubble that is raising oil prices and equities too fast too soon. He feels that "extremely loose monetary policies (zero interest rates, quantitative easing, new credit facilities, emissions of government bonds and purchases of illiquid and risky private assets), together with the huge sums spent to stabilize the financial system, may be causing a new liquidity-driven asset bubble in financial and commodity markets", as in the case of Chinese state-owned enterprises which have been buying equities and stockpiling commodities well beyond their productive needs using the huge amounts of easy money and credit they gained access to. He writes,

"Recent data from the US and other advanced economies suggest that the recession may last through the end of the year. Worse, the recovery is likely to be anemic and sub-par — well below potential for a couple of years, if not longer — as the burden of debts and leverage of the private sector combine with rising public sector debts to limit the ability of households, financial firms and corporations to lend, borrow, spend, consume and invest.

This more challenging scenario of anemic recovery undermines hopes for a V-shaped recovery, as low growth and deflationary pressures constrain earnings and profit margins and as unemployment rates above 10% in most advanced economies cause financial shocks to re-emerge, owing to mounting losses for banks’ and financial institutions’ portfolios of loans and toxic assets. At the same time, financial crises in a number of emerging markets could prove contagious, placing additional stress on global financial markets.

The increase in some asset prices may, moreover, lead to a W-shaped, double-dip recession. In particular, thanks to massive liquidity, energy prices are now rising too high too soon. The role that high oil prices played last summer in tipping the global economy into recession should not be underestimated. Oil above US$140 a barrel was the last straw — coming on top of the housing busts and financial shocks — for the global economy, as it represented a massive supply shock for the US, Europe, Japan, China and other net importers of oil.

Meanwhile, rising fiscal deficits in most economies are now pushing up the yields of long-term government bonds. Some of the rise in long rates is a necessary correction, as investors are now pricing a global recovery. But some of this increase is driven by more worrisome factors: the effects of large budget deficits and debt on sovereign risk, and thus on real interest rates; and concerns that the incentive to monetize these large deficits will lead to high inflation after the global economy recovers from next year to 2011 and deflationary forces abate. The crowding out of private demand, owing to higher government-bond yields — and the ensuing increase in mortgage rates and other private yields — could in turn endanger the recovery.

As a result, one cannot rule out that by late next year or 2011, a perfect storm of oil above US$100 a barrel, rising government-bond yields and tax increases (as governments seek to avoid debt-refinancing risks) may lead to a renewed growth slowdown, if not an outright double-dip recession."

Update 1
A primer on V-, L-, W-, and U-shaped recessions.

The debate about electronic voting

The Madras High Court is hearing a Public Interest Litigation (PIL) seeking a ban on the use of Electronic Voting Machines (EVMs) in bye-elections and to direct that elections be conducted using ballot papers. This comes in the wake of doubts raised by some parties about the reliability of these machines.

And now in the US House of Representatives, a bill has been introduced by Rush Holt that would ban paperless electronic voting in all federal elections from November 2010. Mr. Holt’s bill would help prod election officials toward the best of the currently available technologies - optical-scan voting. With optical scans, voters fill out a paper ballot that is then read by computer — much like a standardized tests the votes are counted quickly and efficiently by computer, but the paper ballot remains the official vote, which can then be recounted by hand. The bill would also require the states to conduct random hand recounts of paper ballots in 3 percent of the precincts in federal elections, and more in very close races.

An NYT op-ed has argued that "electronic voting machines that do not produce a paper record of every vote cast cannot be trusted... there is no way to be sure that a glitch or intentional vote theft — by malicious software or computer hacking — did not change the outcome. If there is a close election, there is also no way of conducting a meaningful recount."


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Exit strategies for Central Banks

This crisis has been marked by Central Banks resorting to unconventional monetary policy responses to both ease the frozen credit markets and bail out the beleaguered banks. Over the last few months, through its unconventional monetary policy actions, the Fed in the US has dramatically inflated (through purchases of even private financial assets, keeping liquidity windows open by lending against an expanded category of assets, and equity injections) the reserves available (over and above the statutory reserve requirements) with the banks (so as to enable them to make more loans). In fact, the Fed even started paying interest on these reserve deposits in excess of the statutory reserves. Banks now have huge amounts of excess reserves, enabling them to make lots of net new loans. At the end of 2007, reserve balances at Federal Reserve stood at about $8 billion, whereas currently they are closer to $900 billion.

Banks are required to hold a certain fraction of their liabilities - demand deposits and other checkable deposits - in reserves held at the Fed (on which the Fed pays no interest) or in vault cash. Banks are constrained in the amount they can lend by the statutory reserve requirements (like Cash Reserve Ratio, CRR, in India) and the actual reserves available with them. The bursting of the sub-prime bubble had severely depleted their deposits and consequently the reserves available to leverage for lending.

Federal funds rate (in the US) or the call money rate (in India) is the interest rate at which private depository institutions (mostly banks) with reserve balances in excess of reserve requirements, lend their excess reserves (available at the Federal Reserve or the Central Bank) overnight to other depository institutions with reserve deficiencies. In other words, it is the interest rate banks charge each other for loans, and is now touching the zero bound in many countries.

A Central Bank repo operation temporarily buys permitted securities in exchange for reserves, while a reverse repo temporarily sells Fed-owned securities in exchange for reserves. A repo is an asset on the Central Bank balance sheet that is matched by an increase in reserves on the liabilities side of the borrowing bank. In contrast, a reverse repo is a Central Bank liability that is matched by a decrease in reserves for the lending bank.

Alan Blinder has an excellent discussion about the build-up of excess bank reserves, what it means during such exceptional times when the credit markets are frozen, and the problems with exit strategies. He writes that "providing frightened banks with the reserves they demand will fuel neither money nor credit growth — and is therefore not inflationary".

As Brad DeLong points out, the recent actions of the Fed in buying a melange of financial assets has been funded by expanding the monetary base, which in turn has increased its liabilities. The Fed has increased the private-sector willingness to hold this monetary base by paying interest on reserve deposits it holds. This has added a fourth motive, profit, to the three traditional motives for holding reserve deposits at the Fed - the transactions demand, the emergency liquidity demand, and the speculative demand. With risk-free returns assured, the banks therefore naturally have little incentive to expand their lending operations (nor wind down their excess reserves) as long as the credit markets remain uncertain and frozen.

John Robertson at the Atlanta Fed feels that "if the federal funds rate target is going to be raised at some point in the future (as inflation threatens or recovery starts) then either the Fed needs to be able to simultaneously keep demand for reserves at a high level or it has to reduce the amount of reserves available in order to drive the market rate higher. In other words, a positive interest rate would require eliminating a large portion of the excess reserves or elevating the demand for reserves in a way that is consistent with the market rate near the desired (target) level."

Here are five possible alternatives for Central Banks to control the reserves and thereby keep a lid on inflationary pressures.

1. Economists like Arthur Laffer have argued that the Fed should "contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion. Fed can reduce bank reserves and also reduce the overall size of the Fed's balance sheet by the same amount by outright sales of assets — Treasury securities, agency debt, and agency mortgage-backed securities — held in the Fed's portfolio." This would suck out atleast some part of the monetary base from the system, including the excess reserves with the banks.

However, Arthur Laffer cautions that a reduction in the monetary base by $1 trillion, which would require selling a net $1 trillion in bonds, "would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds."

2. In the absence of a major contraction in the monetary base, the Fed can increase reserve requirements on member banks to absorb the excess reserves. Given that banks are now paid interest on their reserves and short-term rates are very low, raising reserve requirements should not exact too much of a penalty on the banking system, and the long-term gains of the lessened inflation would many times over warrant whatever short-term costs there might be.

3. Another possibility is to have the demand for excess reserves at a high level, with the interest rate paid on reserves being the primary lever for the implementation of monetary policy. In other words, the interest rates paid on excess reserves could be adjusted to incentivize banks to maintain the demand for these reserves. Accordingly, in recent times, the US banks have foregone their overnight call money market lending and preferred maintaining (interest bearing) reserve deposits. Similarly, in New Zealand, a large level of bank reserves have replaced the central bank daylight overdraft facilities for the purposes of meeting payment system needs. However, as John Robertson points out, "it remains an open question as to whether market rates could be controlled satisfactorily by adjusting the interest rate paid on excess reserves alone given the size and complexity of the US banking system".

4. The Central Bank can undertake reverse repo transactions (temporarily selling Fed-owned securities in exchange for reserves) to mop up the extra reserves available with banks. While a reverse repo does not reduce the size of the Central Bank balance sheet, it does reduce the amount of reserves available with banks.

5. The Central Bank could issue its own unsecured debt, which be similar in effect to a reverse repo — replacing reserves with interest-bearing Fed obligations, but these obligations would not be backed by Fed-owned collateral. During the peak of the 2008, sterling bills and reserve bank bills have been used in the United Kingdom and New Zealand, respectively, as the primary means of draining reserves when reserves were created as a result of short-term liquidity facilities.

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There is an interesting discussion about the merits of having separate interest rate (to maintain overall macroeconomic stability) and bank reserve polices (to address financial market objectives). It is argued that linking the policy rate to the interest rate paid on reserve balances means that a change in the interest rate does not require changing the supply of reserves. More on this is also discussed here.

John Robertson points to a hypothetical scenario when this could be useful, "Suppose the Fed needed to keep bank reserves at a high level because of lingering demand for liquidity in financial markets that is not being provided by the private sector. Now, suppose the Fed also wanted to tighten monetary policy because of separate macroeconomic stability concerns. Interest on reserves provides a tool to meet both a financial stability objective (by helping the functioning of credit markets) and a macroeconomic stability objective (by influencing banks’ willingness to lend to private borrowers)."

The football transfers market

The first half of this month saw the two most expensive football transfer deals ever, as first the Brazilian playmaker Kaka and then Portuguese Cristiano Ronaldo moved from AC Milan and Manchester United to Real Madrid for 56 million and 80 million pounds respectively.

As Gideon Rachman writes, these high cost purchases by Real Madrid, reminiscent of their deals in the early part of this decade involving Zidane, Figo, Ronaldo and Beckham, is part of an astute commercial strategy (the galacticos business model) that has seen Real becoming the highest revenue earning club in the world, despite not so encouraging performance during the period (not even entering a final since 2001-02).



The graphic above highlights a few interesting things
1. Apart from the parsimonious Bundesliga teams, the recession appears to have had no effect on player wages, as its share of revenues has been on the way up in all the other four major European leagues - England, Italy, Spain, and France. Maybe, it has something to do with the generally observed fact that economic downturns leaves the popular sources of entertainment unscathed and even gives them a boost.

2. Further incresases in wages does not appear to have much co-relation with performance. English Premier League teams, not known for extravagant spending, have done remarkably well over the past five seasons, having representation in each of the five Champions League finals and winning two of them. Similarly, AC Milan too, with mostly home talent and no superstar signings, have done relatively well in recent years. In contrast, the extravagantly spending Real Madrid's stars have failed to set the Santiago Bernabeu alight in recent years.

3. As Gopal Muttu writes, there is an element of the stock picking strategy of relevance to purchasing a football player. In the equity markets, the timing is important, for we have purchase when the market is at its bottom and sell at its peak, so as to maximize the returns. Manchester United bought a then promising, but relatively unheralded Ronaldo for £12.24m after the 2002-2003 season and have now sold him for £80m at what appears to be his peak, thereby making handsome profit from brand and player Ronaldo. On the contrary, for Real, buying a Ronaldo at his prime, means that he may well cost more than at almost any time in his career. But then, as with all such equity purchases, player Ronaldo may be on his way up and below his peak, and Real Madrid may yet benefit.

Global oil reserves

BP feels that the world has enough oil reserves to meet the demand for the next four decades with no further exploration discoveries.

Why fiscal and monetary expansion should not be prematurely closed?

In an Economist article, Christina Romer, the chairwoman of Barack Obama's Council of Economic Advisers, has cautions against cutting back on fiscal stimulus and tightening monetary policy on the grounds that "green shoots" have appeared on the economic landscape. She draws attention to the similar "recession-within-recession" situation that developed during the recovery from the Great Depression as the Treasury (by withdrawing the stimulus and raising social security taxes) and the Fed (by raising reserve requirements) switched over to contractionary policies in 1936 to address the growing deficits and ward off inflationary pressures.

She argues in favor of resisting the urge to cut back on stimulus spending till "the economy is again approaching full employment" and private demand increases by enough to fill the output gap. She also advocates granting the Fed additional tools like authorization to issue debt, so as to enhance its ability to withdraw excess cash from the financial system, and thereby help its balance-sheet contract once the economy has recovered. Much the same has been endorsed by Paul Samuelson here and here.

However, Allan Meltzer strikes a note of caution, by writing, "yes, stimulate now to reduce unemployment, but avoid creating a big inflation in a year or two", and finds issue with the focus of the stimulus program on tax cuts to boost consumption and prefers investments to increase productivity. While accepting the need to stimulate now to reduce unemployment, he feels that it is equally important to avoid creating a big inflation in a year or two. And accordingly, he advocates that the Fed and Treasury announce in advance how they propose to reduce the high money growth rate and the excessive deficits.

Brad De Long argues that the Obama stimulus is on the lower side by a substantial margin; the federal-level fiscal expansion is offset and neutralised by state-level fiscal contraction by lowering spending and cutting taxes; the massive expansion in the Fed balance sheet and the possibility of dollar sliding from its perch of pre-eminence, leaves the Fed vulnerable to the "mother of all bank runs", combating which would require giving the Fed the option to borrow in time-deposits (as opposed to demand-deposits) and the power to issue its own bonds; and that if it is the long-run budget you are worried about, ending the stimulus package, say, six months or a year earlier makes little difference to the (already very bleak)long-term budget outlook.

Barry Eichengreen cautions against reading too much into the hardening bond yields and rising commodity prices, and exiting from the stimulative policies, since, coincidentally enough, both these were the primary triggers for the relapse of 1936-37. The propensity of investors, battered by the shocks to the financial system, to keep their investments in short-term, liquid form is (and was) the primary cause of the hardening of yields. Further, as as evidence of green shoots began to accumulate, traders had bid up the prices of tin, rubber, wool and wheat, only for these speculative positions to quickly collapse and pull back commodity prices.

Mark Thoma provides a behavioural explanation for the reluctance to intervene until the economy is well into a deep recession and the inclination to draw back at the first signs of green shoots. He feels that the dangers of withdrawing the stimulus too soon (a severe depression) are far more devastating than that of continuing with the expansionary policies for a little longer (inflation and a slightly slower gorwoth for some time).

Carmen M Reinhart draws a "distinction between the appropriate time to begin withdrawing stimulus and the appropriate time to begin reassuring the public that a plan for such an exit has been developed". She calls for making public both "how the Federal Reserve will slim its balance sheet and how the administration will put the federal budget balance on a sustainable path". She draws attention to her studies with Ken Rogoff where they find that financial crises tend to last several years and significant additional real resources will have to be provided to fill the capital hole of firms at the centre of the global financial system.

Tyler Cowen points to the important fact that the current downturn isn't just a "business cycle", but it may herald a fundamental reset for many sectors of the economy, and an economic recovery won’t restore a lot of these sectors to what were once normal conditions. The full debate is available here.

Update 1
Economix has an analysis of the latest data on the CBO's projections of the budget deficit. See also David Leonhardt here.

Update 2
James Suroweicki argues against premature celeberation that the housing market crisis is over.

Obama's financial market regulation plan

In order to redress and turn back "a culture of irresponsibility (that) took root from Wall Street to Washington to Main Street", the Obama administration has finally unveiled the draft of its much awaited financial market regulation plan that would broadly expand the scope (to include "other large firms that pose a risk to the entire economy in the event of failure") of the Federal Reserve to regulate financial risk. The draft plan includes proposals for raising the amount of the financial cushion that institutions must hold against losses, setting new conflict of interest rules for credit rating agencies, imposing new requirements that banks hold on their own books a percentage of the mortgages they issue to discourage the marketing of abusive or ill-suited loans, besides a new institutional framework.



The plan identifies many regulatory failures - capital and liquidity requirements did not require firms to hold sufficient capital to cover trading assets, high-risk loans, and off-balance sheet commitments, or to hold increased capital during good times to prepare for bad times; regulators did not take into account the harm that large, interconnected, and highly leveraged institutions could inflict on the financial system and on the economy if they failed; the responsibility for supervising the consolidated operations of large financial firms was split among various federal agencies, and even allowed owners of banks and other insured depository institutions to shop for the regulator of their choice; investment banks operated with insufficient government oversight, money market mutual funds were vulnerable to runs, and hedge funds and other private pools of capital operated completely outside of the supervisory framework.

It therefore proposes five key objectives (also here)

1. Promote robust supervision and regulation of financial firms. It is proposed to have a Financial Services Oversight Council of financial regulators to identify emerging systemic risks and improve interagency cooperation; authority for the Federal Reserve to supervise all firms that could pose a threat to financial stability, even those that do not own banks; stronger capital and other prudential standards for all financial firms, and even higher standards for large, interconnected firms; National Bank Supervisor to supervise all federally chartered banks; elimination of the federal thrift charter and other loopholes that allowed some depository institutions to avoid bank holding company regulation by the Federal Reserve; registration of advisers of hedge funds and other private pools of capital with the SEC.

2. Establish comprehensive supervision of financial markets to withstand both system-wide stress and the failure of one or more large institutions. It is proposed to have enhanced regulation of securitization markets (which supply roughly two-thirds of the credit in the economy, with banks providing the rest, through loans), including new requirements for market transparency, stronger regulation of credit rating agencies, and a requirement that issuers and originators retain a financial interest (amounting to atleast 5% of loans packaged) in securitized loans; comprehensive regulation of all over-the-counter derivatives; a new authority for the Federal Reserve to oversee payment, clearing, and settlement systems.

3. Protect consumers and investors from financial abuse. It is proposed to have a new Consumer Financial Protection Agency to protect consumers across the financial sector from unfair, deceptive, and abusive practices; stronger regulations to improve the transparency, fairness, and appropriateness of consumer and investor products and services; a level playing field and higher standards for providers of consumer financial products and services, whether or not they are part of a bank.

4. Provide the government with the tools it needs to manage financial crises. It is proposed to have a new regime to resolve non-bank financial institutions whose failure could have serious systemic effects; revisions to the Federal Reserve’s emergency lending authority to improve accountability.

5. Raise international regulatory standards and improve international cooperation. It is proposed to promote international reforms to support our efforts at home, including strengthening the capital framework; improving oversight of global financial markets; coordinating supervision of internationally active firms; and enhancing crisis management tools.

However, the plan does not contain any proposals for drastic overhaul of rating agencies, whose conflicts of interest were at the heart of the financial market crisis. It does not alter the issuer-pay model, whereby the companies selling securities pay to have them rated, nor does it encourage competitors to enter the industry, which many regard as an oligopoly. The reforms proposed are restricted to regulators relying on more independent analysis, and calls on them to reduce their reliance on agency ratings when deciding whether structured investments are safe enough for banks, insurance companies, pension funds and money market mutual fund investors. The plan is also silent on what steps are required to better align executive compensation practices of financial firms with long-term shareholder value.

Apart from imposing the 5% retention of loans (the adequacy of which is itself questionable) on the issuers balance sheet for securitization of assets and setting up a clearinghouse for "bespoke" derivatives (customized, one-of-a-kind products that generated enormous profits for institutions), so that their price and trading activity can be more readily seen, the plan does not contain anything aimed at specific categories of derivative assets like CDS or CDOs. In the absence of standardization, and atleast some form of homogenity, customized (and thereby illiquid products with opacity in price discovery, irrespective of what clearinghouse prices indicate) products will continue to play a major role in the financial markets, with all their attendant risk quantification problems.

The highest risk, "too big to fail" financial institutions, labeled "Tier 1 Financial Holding Companies" in the draft plan, will continue to exist and grow. Only, they are proposed to be regulated more "robustly". There is little in the plan about "how the government will eliminate systemic risks posed by financial firms that aren’t allowed to fail because they’re simply too big or to interconnected to other important economic players here and abroad". As Eric Dash asks rhetorically, "If It’s Too Big to Fail, Is It Too Big to Exist?". But the Obama plan has answered in the negative and proposed greater oversight and regulation of such institutions. Quoting the work of Edward J. Kane, Gretchen Morgenson argues that such regulatory oversight only means "expanding the universe of companies eligible for taxpayer support if another mess arose".

Simon Johnson feels that intense lobbying by the finance industry has meant that the "reform process appears to be have been captured at an early stage". He writes that many of the proposals are mere re-iterations of the existing arrangements and inspire little confidence of success. Paul Krugman feels that the only redeeming feature of the draft plan is in bringing the shadow banking system under the regulatory architecture and giving the government the authority to seize such institutions if they appear insolvent.

Reactions to the draft plan are available here, here, and here. Though the plan is hosrt on details, as Joe Nocera rightly points out, there is nothing dramatic about the plan - "additional regulation on the margin, but nothing that amounts to a true overhaul".

Update 1
Thomas Frank critiques the Obama Plan on the grounds that it does not address the issue of regulatory capture. Mark Thoma argues that while most markets function well with minimal regulation, and that a hands off approach is generally best, financial markets are not among the markets for which this is true.

Martin Wolf drives home the importance of changing incentives so as to discourage traders and bankers from taking on too much risk and refers to the role of executive compensation in causing the crisis, as brought out by Lucian Bebchuk and Holger Spamann.

Update 2
On the controversial issue of regulating derivatives, the Plan proposes that complicated, illiquid derivatives should require higher margins from customers and that as much derivative trading as possible be pushed into standardized (instead of illiquid customized products), exchange-traded contracts.

Richard Bookstaber, one of the pioneers with financial engineering in the Wall Street, has described derivatives as providing "a means for obtaining a leveraged position without explicit financing or capital outlay and for taking risk off-balance sheet, where it is not as readily observed and monitored... Viewed in an uncharitable light, derivatives and swaps can be thought of as vehicles for gambling; they are, after all, side bets on the market". They let institutions dodge taxes and accounting rules and take side bets that could destabilize the markets.

Further, contrary to conventional wisdom that claimed derivatives as allowing risks to be transferred to those better able to bear them, experience had shown that "derivatives allow risk to be shifted from those who understand it a little to those who do not understand it at all" (the risks of bad mortgage loans were transferred from those who made the loans to those who bought troubled collateralized debt obligations).

Update 3
Simon Johnson too feels that "too big to fail" is "oo big to exist" and feels that the Obama Plan does little to alleviate this fear. Also see the Senate hearings video on "too big to fail" institutions.

Update 4
Douglas Elliot of the Brookings Institution reviews the Regulation proposals.

Update 5
Alan Blinder weighs in arguing that the Federal Reserve should be the systemic risk regulator, to serve as an early-warning-and-prevention system, on the prowl for looming risks that extend across traditional boundaries and are becoming large enough to have systemic consequences. Alice Rivlin and Mark Thoma too support much the same.

Update 6
Two excellent posts, here and here, in Baseline Scenario about financial market regulaiton.

Update 7
Alan Blinder points to five reasons for the inertia against financial market regulation. He also identifies three important financial market regulation proposals - a systemic risk monitor or regulator (and he favors Fed); a new mechanism to euthanize or rehabilitate giant financial institutions whose failure could threaten the whole system; and do something serious to tame, though not to destroy, the derivatives markets.

Mark Thoma too feels that as time passes the resolve to pass strong enough regulation proposals will fade away.

Update 8
The Obama Plan passes the House of Reps and moves to the Senate. The House Bill’s principal provisions establish a process for dismantling large, failing financial institutions; set up a council to identify and regulate firms that are so big, interconnected or risky that they need heightened supervision to keep them from bringing down the whole financial system; create a new consumer financial-protection agency to squelch unfair and abusive practices; and for the first time, regulate over-the-counter derivatives markets. The bill also contains provisions on executive pay, investor protection, credit ratings, hedge funds and insurance.

Climate change - classic negative externality

For sometime now, it has been widely acknowledged that while the developed economies, led by the US, have been the chief culprits of climate change, its major brunt has been borne by the poorer nations. The Lancet has an excellent density equalizing illustration of the source and victims of climate change for the 1950-2000 period.



The top map illustrates which countries are considered more responsible for climate change - that is "undepleted cumulative CO2 emissions" - and the bottom map shows the countries that will be most harmed by climate change — that is, "the regional distribution of four climate-sensitive health consequences (malaria, malnutrition, diarrhea, and inland flood-related fatalities)".

As the map shows, while the US, W Europe and China are the overwhelmingly biggest culprits, Africa and South Asia bear almost all of the burden. Interestingly, the effect on US, W Europe (and even China) is minuscule as to be almost irrelevant.

Judging by the locations of cause and effect, one could easily describe climate change as the "mother of all externalities" and the classic negative externality. In the absence of any arrangement to internalize these costs, the developed economies have gained at the expense of their developing country counterparts. The Lancet study appears to indicate that the costs on the poorer nations have been far out of proportion by any yardstick.

It would be instructive for someone to study the subsidy reaped by the developed economies by not paying for the costs of their climate change producing actions, and the cost inflicted on the developing countries due to the climate change producing activities of the richer nations. In other words, for the past half a century, the poorer nations may have been paying a "climate change tax" to the richer nations, which they can ill-afford.

(HT: Economix)

Message from the crisis to third world

Joseph Stiglitz has an excellent essay (full here) on the demise of the neo-liberal moment in history, and how the failed experiment may have discredited the concepts of capitalist market economy and liberal democracy, especially in the developing countries. He writes, "We have given critics who opposed America’s licentious form of capitalism ample ammunition to preach a broader anti-market philosophy... The economic crisis, created largely by America’s behavior, has done more damage to these fundamental values than any totalitarian regime ever could have."

Graphical summary of the inflation debate

The great inflation debate gets shriller. The ballooning US deficits (current account and fiscal) and hardening of long term US Government Treasury bond yields in recent weeks has triggered off alarm bells about an inflationary spiral ready to go off. Historian Niall Ferguson (and here) sees the debts and deficits as portends of inflation down the road and the fiscal and monetary expansion becoming contractionary.

Paul Krugman has differed arguing that the US is facing a liquidity trap - interest rates touching the zero-bound and counter-party risks forcing banks to shut their lending taps - and though the world is awash with a savings glut, appetite for borrowing remains constrained. In the circumstances, government is the only agency capable of borrowing and deploying this excess liquidity.

Over the past two decades, household and financial sector debt has sky-rocketed, while non-financial sector debt and government too have risen



Thanks to the fiscal stimulus and the credit expansion through unconventional monetary policy responses, the budget deficit projections have gone over the roof.



All this, as Arthur Laffer points out, has dramatically expanded the monetary base - comprised of currency in circulation, member bank reserves held at the Fed (which has exploded, as banks have been shored up with equity injections), and vault cash - in an unprecedented manner and money supply has exploded.



Further, long term yields on US Treasury Bonds have been hardening in recent weeks, reflecting fears of inflation lurking round the corner.



But history shows that during stag-deflations, the expansion in monetary base does not automatically translate into inflation. Figures from the Great Depression...



... and then with Japan in the nineties shows that inflation has remained reined in despite the expansion in monetary base during the recessions.



Even the experience in the US from the last half century, shows that expansion of monetary base does not automatically translate into bank loan growth.



Further, increase in government borrowing, while huge, has not quite offset a huge plunge in private borrowing.



And, the spare capacity of US industry has now reached a 40-year high, with companies churning out just 68.3% of their potential output, the lowest since the data series collection started in 1967. To put this in perspective, the average capacity utilization between 1972 and 2008 was 80.9%. As Christopher Swann blogs, "clearly American industry has huge amounts of slack to deploy when the recovery comes. With unemployment at 9.4 percent, companies will also have a huge pool of workers to draw upon before they start bidding up the price of labor. This will give policy makers plenty of time to withdraw their stimulus before inflation becomes a problem."

And Andy Harless identifies 15 requirements (from output stabilizing to firms raising wages faster than trend productivity growth) before wage pressure reverses and becomes inflationary, and feels that we have some distance to traverse before inflation takes hold.

Update 1
Alan Blinder is the latest to cast doubts on the inflation danger.

Update 2
Greg Mankiw has this nice explanation as to why an increase in monetary base does not automatically translate into higher inflation. As he writes, unlike in normal times, the Fed is now paying interest on excess reserves, and as long as the interest rate on reserves is high enough, banks should be happy to hold onto those excess reserves, which in turn will prevent a surge in the monetary base from being inflationary.