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Thursday, March 15, 2012

Insights from the Economic Survey 2011–12-Micro-foundations of Macroeconomic Policy

The newspaper editions of tomorrow and dayafter will be filled with analysis and insights as people try to decipher the numbers and read the tea leaves, for both the Economic Survey and the Union Budget. However, this blogpost aims to capture the nuggets mentioned in the 14 chapters of the budget(which I did read today!), and does not claim to be exhaustive given the huge data overload! Anyways, here goes for Chapter II(normal text is from the survey, bold text is mine) which can be read at this link http://indiabudget.nic.in/es2011-12/echap-02.pdf
  1. With what to compare:- This is a somewhat curious situation because how we evaluate these numbers depends critically on the analyst’s perch. Given the global despondency, and steadily deteriorating global growth scenario, these numbers look good rather than bad, especially if one’s perch were to be in Europe. However, compared to how India has fared since 2003 and, especially, since 2005, they are disappointing. Ironically, this issue is with all comparables even in management MD&As of corporate reporting, where they prefer an easier benchmark! However, the economic planners are aware of this and state that Lest we fall into the trap of complacency, it is better for Indian policymakers to use the latter perspective as the benchmark and ask what caused the slowdown
  2. Importance to implementation and behavioural considerations In India,when policies have failed, they have done so more often because of faulty implementation and fault lines in the detail rather than in the broad conception. The error has usually been in misreading the incentives and behavioural traits of the individuals who are to benefit from the policies and those who are supposed to carry out their day-to-day functioning. Fortunately,this is beginning to change both in the discipline of economics as well as in the design of policies in India
  3. Repo rate lags WPI but the correlation is slender and research needed using VAR If we take the data underlying the graphs and subject these to careful statistical analysis by putting in lags, we will see that the policy instruments do have an impact on inflation with a lag. They hope that someone will use vector autoregression (VAR), developed by Christopher Sims on Indian data, to tease out the causal links between macroeconomic policy variables and inflation, something that to the naked eye looks quite hopeless since macroeconomic data come with so much white noise. 
  4.  Two different approaches to measuring poverty when economists measure poverty there can be two very different motivating factors One is to see how the level of poverty is changing over time and the other is to identify the poor in order to direct benefits. When tracking the level of poverty over time we have to hold the poverty line constant (subject to corrections for the changing value of the rupee). This is for the same reason that we use the same standard over time to see if there is
    global warming occurring. To change the standard would make inter-temporal comparison quite meaningless. However, to decide on whom to direct subsidies, we have reason to use different standards for measuring poverty. We could think of measures which change as society becomes better off and is able to service the poor better. One criterion in this spirit is the quintile income measure, which assesses society in terms of how its poorest 20 per cent population fares. 
  5. Inflated enrolment at primary school level(something which we trumpet proudly!) : Currently the primary education system in our country faces a serious problem of inflated enrolment at school level. This results in significant leakages and serious implementation problems. Leakages occur in various areas, including mid-day meals, books, scholarships, provision of uniforms and bicycles
  6. Game theory in currency intervention by central bank Box 2.4-Typically, a central bank is acutely aware of the fact that big private players try to game the central bank. What has not been explored adequately is the possibility of the central bank, in turn, using strategic moves in the market to its own advantage. the central bank enters the market directly or through its agent bank not with a lump sum buy or sell order but with a full schedule of how to behave, conditional on what the exchange rate is. It is possible to design interventions so that the RBI can influence the
    exchange rate without running down or building up reserves
  7. Why bond market needs a nudge-multiple equilibria and self fulfilling prophecy  Consider a situation where the bond market is small. If you buy bonds and later wish to sell these off, you anticipate difficulty. Since the bond market is not active, you may not easily be able to sell the bonds you hold simply because you cannot find a buyer. Hence, this may lead to your not buying the bonds in the first place. If everybody reasons like this, the bond market remains thin. Hence, the need is for a push that nudges the market to another equilibrium, where people readily buy bonds because they know that they can easily sell these off and this becomes a self-fulfilling prophesy and sustains the large bond market.
  8. some depreciation of the rupee was quite natural-India has been facing high inflation for two years now, whereas inflation in the United States has been negligible. If the nominal exchange rate remained stable, this would mean that in terms of the real exchange rate the rupee was appreciating. Indeed, this is what was happening for several months. S & P’s downgrading of the United States was like a gentle nudge to a golf ball which then sheds its inertia and moves to the more natural resting place. It is true that the exchange rate had depreciated abnormally but subsequent partial correction means that it is now at a more realistic level
  9. When you don't like your rating, devise another metric-the 'comparative rating index for sovereigns’ or, in brief, CRIS developed by Ministry of Finance Box 2.6- The precise mathematical formula for the CRIS, and hence the paper  is confidential. The researchers settled on Moody’s foreign currency credit ratings and the International Monetary Fund’s (IMF) GDP statistics, with no purchasing power parity (PPP) correction. Each nation’s CRIS is constructed using these two sets of numbers. Among the important mathematical properties of the CRIS are the following. (1) If nation i’s sovereign credit rating is constant, and all other nations’ Moody’s ratings rise, then nation i’s CRIS will decline. (2) The weighted average of the CRIS for all nations is constant. Hence, one nation’s improvement in CRIS is invariably accompanied by worsening of the CRIS for some other nation or nations. (3) The CRIS has been constructed so as to register diminishing marginal returns to improvements in the absolute ratings. This is that rare analytical innovation coming out of Indian economics, and so should be commended.  The CRIS table is reproduced below in part till India's score, PIIGS countries and Egypt score among lowest for obvious reasons! Lots of work needed to decipher this though!
  10. Joint probability(!)/coordination issue reason to give a coordinated big push to a cluster of
    infrastructural projects by guarantees! very interesting points made here
    suppose there are three projects, pertaining to a road, a township, and a power project. Each entails an initial cost of 100. If the project succeeds, it yields 150; if it fails, the entire initial cost goes unrecovered. If all three projects are undertaken, each project is more likely to succeed, because of the kind of positive externality mentioned.  Suppose now government gives a guarantee to only one project. Assuming that the other projects are not undertaken under the circumstances, there is an expected loss of 50 units of money to the government, since the probability of failure is half and in the event of a failure government has to pay the investor 100. Hence, the expected fiscal deficit rises by 50. for a nation on the verge of take-off, and with complementarities between projects, the calculus of guarantees and fiscal deficits is not as simple as may seem at first
  11. A subtle argument maybe targeted at Lokpal is made in Box 2.8(risks of over regulation)-smart policy design needs to be distinguished from mere procedural tightening and bureaucratic expansion, which can lead to ‘passive waste’ which does not benefit public officials. It can, for instance, arise from onerous regulations which increase the price the public body pays.. While we need to ruthlessly crack down on corruption, it must, at the same time, be recognized that the fear of a large and cumbersome anti-corruption bureaucracy can be detrimental to risk taking and may hamper legitimate activities in public institutions. This is highlighted in the case of the Indian banking sector in a paper by Banerjee, Cole, and Duflo which indicates that loan officers of public banks are reluctant to lend to growing firms for profitable opportunities, and accounts from the loan officers that cite fear of prosecution for corruption as one reason, the authors study the impact of vigilance activities on lending. They find that vigilance activities result in reduced lending in the affected branch as well as neighbouring branches and the effect persists for around two years. Risk taking also declines in the aftermath of a vigilance event.
  12. Making fuel prices really market based-In a market where all dominant players are
    public-sector companies, ‘market price’ is not a very meaningful concept. It is easy for government to control state-owned companies through nods and winks. So what really needs to be done as a first step is to put petrol pricing on a transparent formula—if the price of crude is x and the exchange rate y, then every month or fortnight, government announces a maximum price of petrol, which anybody can work out from the x and the y.y. The rule has to be worked out to make sure that the oilmarketing companies can, in general, cover their costs=>private players renter
  13. The importance of civil society-in talking about a nation’s economic progress, all attention, including both praise and criticism, is usually focused on the government. It is, however, important to recognize that much also depends on civil society, the firms, the farmers, and ordinary citizens. While self-interest is a major driver of economic growth, it is important to recognize that honesty, integrity, and trustworthiness constitute the cement that binds society..

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