Session​ ​1​ ​–​ ​National​ ​Income​ ​&​ ​Product​ ​Accounts

#1​ ​India​ ​at​ ​a​ ​glance

GNI​ ​per​ ​capita $1,420

GNI $1.766​ ​trillion

GDP $1.8728​ ​trillion

Exports​ ​have​ ​gone​ ​up​ ​from​ ​8.3%​ ​to​ ​23.9%​ ​of​ ​GDP​ ​in​ ​20​ ​years.

%​ ​of​ ​GDP Growth

Agriculture 17.5% 3.6%

Industry 26.7% 3.5%

​ ​ ​-​ ​Mfg 14.4% 2.7%

Services 55.7% 8.2%

Total​ ​exports $450.777​ ​billion

Total​ ​imports $576.439​ ​billion

#2​ ​Output,​ ​prices​ ​and​ ​jobs

India​ ​has​ ​one​ ​of​ ​the​ ​higher​ ​growth​ ​rates,​ ​but​ ​also​ ​high​ ​inflation​ ​(highest​ ​after​ ​Venezuela
and​ ​Egypt).​ ​China​ ​has​ ​very​ ​low​ ​inflation​ ​even​ ​with​ ​very​ ​low​ ​unemployment​ ​rate​ ​and
highest​ ​growth​ ​rate.​ ​Indian​ ​unemployment​ ​rate​ ​is​ ​lower​ ​than​ ​the​ ​Euro​ ​region!

#3,​ ​#4:​ ​ ​Lies,​ ​damned​ ​lies​ ​and​ ​Greek​ ​statistics;​ ​don’t​ ​lie​ ​to​ ​me,​ ​Argentina

● Govt​ ​have​ ​an​ ​incentive​ ​to​ ​fudge​ ​stats,​ ​but​ ​an​ ​independent​ ​body​ ​is​ ​needed​ ​for​ ​econ​ ​stats,
otherwise​ ​credibility​ ​is​ ​hurt​ ​in​ ​international​ ​markets​ ​leading​ ​to​ ​long​ ​term​ ​problems.

#5:​ ​ ​The​ ​Economics​ ​of​ ​Happiness

● The​ ​common​ ​measures​ ​of​ ​economic​ ​wellbeing​ ​of​ ​a​ ​country​ ​(GDP)​ ​doesn’t​ ​equate​ ​directly
to​ ​the​ ​wellbeing,​ ​happiness,​ ​life​ ​satisfaction​ ​of​ ​its​ ​people.
● The​ ​correlation​ ​is​ ​definitely​ ​positive​ ​and​ ​observable​ ​–​ ​countries​ ​with​ ​higher​ ​GDP​ ​have
more​ ​resources​ ​to​ ​medical​ ​care,​ ​good​ ​nutrition,​ ​hence​ ​rich​ ​countries​ ​have​ ​higher​ ​life
expectancies,​ ​lower​ ​mortality​ ​rates,​ ​and​ ​generally​ ​better​ ​health​ ​indicators.​ ​Cleaner
environments,​ ​more​ ​leisure​ ​time,​ ​higher​ ​education​ ​levels,​ ​greater​ ​ability​ ​to​ ​travel,​ ​more
funding​ ​for​ ​arts​ ​&​ ​culture.
● There​ ​is​ ​certainly​ ​a​ ​direct​ ​correlation,​ ​but​ ​after​ ​a​ ​point,​ ​higher​ ​metrics​ ​do​ ​not​ ​translate
to​ ​happier​ ​or​ ​more​ ​satisfied​ ​people.​ ​Easterlin​ ​paradox​:​ ​People​ ​in​ ​rich​ ​countries​ ​don’t
report​ ​much​ ​greater​ ​happiness​ ​than​ ​those​ ​in​ ​lower-income​ ​countries​ ​–​ ​even​ ​though,​ ​in
 any​ ​given​ ​country,​ ​the​ ​rich​ ​say​ ​they​ ​are​ ​happier​ ​than​ ​the​ ​poor​ ​do.
● Easterlin’s​ ​view:​ ​people’s​ ​happiness​ ​depends​ ​less​ ​on​ ​absolute​ ​wealth​ ​than​ ​on​ ​their
wealth​ ​compared​ ​to​ ​others​ ​around​ ​them.
● The​ ​key​ ​is​ ​Adam​ ​Smith’s​ ​observation:​ ​“The​ ​mind​ ​of​ ​every​ ​man,​ ​in​ ​a​ ​longer​ ​or​ ​shorter
time,​ ​returns​ ​to​ ​its​ ​natural​ ​and​ ​usual​ ​state​ ​of​ ​tranquility.​ ​In​ ​prosperity,​ ​after​ ​a​ ​certain
time,​ ​it​ ​falls​ ​back​ ​to​ ​that​ ​state;​ ​in​ ​adversity,​ ​after​ ​a​ ​certain​ ​time,​ ​it​ ​rises​ ​up​ ​to​ ​it.”
● Congress’​ ​mandated​ ​objectives​ ​for​ ​the​ ​Federal​ ​Reserve:​ ​price​ ​stability​ ​and​ ​maximum
employment
● Happy​ ​people​ ​tend​ ​to​ ​spend​ ​time​ ​with​ ​friends​ ​and​ ​family​ ​and​ ​put​ ​emphasis​ ​on​ ​social​ ​and
community​ ​relationships.​ ​Another​ ​factor​ ​is​ ​based​ ​on​ ​concept​ ​of​ ​“flow”.​ ​Thirdly,​ ​happy
people​ ​feel​ ​in​ ​control​ ​of​ ​their​ ​own​ ​lives.​ ​Finally,​ ​happiness​ ​can​ ​be​ ​promoted​ ​by​ ​fighting
the​ ​natural​ ​human​ ​tendency​ ​to​ ​become​ ​entirely​ ​adapted​ ​to​ ​your​ ​circumstances.
● [[Not​ ​in​ ​article]]​ ​Bhutan’s​ ​Gross​ ​Happiness​ ​Index

#6:​ ​ ​The​ ​Roots​ ​of​ ​Hardship​ ​-​ ​Why​ ​Nations​ ​Fail

● Institutions​ ​determine​ ​the​ ​fate​ ​of​ ​nations

● When​ ​political​ ​and​ ​economic​ ​institutions​ ​are​ ​inclusive​ ​and​ ​pluralistic,​ ​incentives​ ​for
everyone​ ​to​ ​invest​ ​in​ ​future​ ​leads​ ​to​ ​success
● Nations​ ​fail​ ​when​ ​institutions​ ​are​ ​extractive​ ​–​ ​protecting​ ​the​ ​political​ ​and​ ​economic
power​ ​of​ ​only​ ​a​ ​small​ ​elite​ ​that​ ​takes​ ​income​ ​from​ ​everyone​ ​else.​ ​[[Anti-trust​ ​policies
prevent​ ​extractive​ ​power!?]]
● “The​ ​spectacular​ ​growth​ ​rates​ ​in​ ​China​ ​will​ ​slowly​ ​evaporate”​ ​as​ ​Chinese​ ​institutions​ ​are
extractive.

#6:​ ​ ​Not​ ​by​ ​bread​ ​alone

● HDI​ ​(Human​ ​Development​ ​Index)​ ​vs.​ ​GDP;​ ​HDI​ ​includes​ ​social​ ​indicators​ ​as​ ​well​ ​(e.g.,
health​ ​&​ ​education).
● Most​ ​of​ ​the​ ​countries​ ​in​ ​top​ ​15​ ​on​ ​HDI​ ​scale​ ​did​ ​not​ ​have​ ​outstanding​ ​growth​ ​rates​ ​on
GDP.
● Best​ ​performers​ ​on​ ​HDI​ ​also​ ​have​ ​most​ ​energetic​ ​social​ ​policies​ ​and​ ​most​ ​also​ ​increased
the​ ​share​ ​of​ ​trade​ ​in​ ​their​ ​economies.

#7:​ ​ ​Where​ ​was​ ​China?

● Stagnation​ ​bad.​ ​Innovation​ ​good!

Session​ ​2​ ​–​ ​Production​ ​&​ ​Economic​ ​Growth

 #1​ ​Secret​ ​Sauce

● Productivity​ ​Growth​ ​is​ ​the​ ​single​ ​most​ ​important​ ​gauge​ ​of​ ​economy’s​ ​health.
● Productivity​ G ​ rowth​ ​could​ ​be​ ​due​ ​to​ ​simply​ ​labor​ ​productivity​ ​growth​ ​which​ ​in​ ​turn
could​ ​be​ ​due​ ​to​ ​capital​ ​investment.
● Total​ ​Factor​ ​Productivity​ ​measure​ ​might​ ​be​ ​better​ ​–​ ​tries​ ​to​ ​assess​ ​the​ ​efficiency​ ​with
which​ ​both​ ​capita​ ​and​ ​labor​ ​are​ ​used.
● Once​ ​a​ ​country’s​ ​labor​ ​force​ ​stops​ ​growing​ ​and​ ​increasing​ ​capital​ ​stock​ ​causes​ ​the
return​ ​on​ ​new​ ​investment​ ​to​ ​decline,​ ​TFP​ ​is​ ​the​ ​main​ ​source​ ​of​ ​future​ ​economic​ ​growth
● TFP​ ​=​ ​%​ ​increase​ ​in​ ​output​ ​not​ ​accounted​ ​for​ ​by​ ​changes​ ​in​ ​volume​ ​of​ ​inputs​ ​of​ ​capital
and​ ​labor
● China​ ​also​ ​has​ ​high​ ​TFP​ ​@​ ​4%,​ ​followed​ ​by​ ​India​ ​@​ ​just​ ​under​ ​3%.
● Rate​ ​of​ ​adoption​ ​of​ ​existing​ ​and​ ​new​ ​tech,​ ​pace​ ​of​ ​domestic​ ​scientific​ ​innovation​ ​and
changes​ ​in​ ​organ​ ​of​ ​production.​ ​Depend​ ​on​ ​openness​ ​of​ ​an​ ​economy​ ​to​ ​FDI​ ​and​ ​trade,
education​ ​and​ ​flexibility​ ​of​ ​labor​ ​markets.
● Rate​ ​of​ ​increase​ ​in​ ​an​ ​economy’s​ ​technological​ ​progress​ ​proportional​ ​to​ ​TFP.
● Financial​ ​health​ ​of​ ​firms​ ​and​ ​govts​ ​also​ ​matter​ ​for​ ​Prod​ ​growth.​ ​Weak​ ​balance​ ​sheets​ ​è
no​ ​investments​ ​in​ ​tech​ ​è​ ​lower​ ​TFP.
● China’s​ ​prod​ ​growth​ ​is​ ​likely​ ​to​ ​slow​ ​unless​ ​the​ ​govt​ ​pushes​ ​ahead​ ​with​ ​bolder​ ​reforms.

#2​ ​the​ ​Poor​ ​Half​ ​Billion

● Increasing​ ​number​ ​of​ ​poor:​ ​economic​ ​growth​ ​reduced​ ​poverty​ ​rate,​ ​but​ ​not​ ​fallen​ ​fast
enough​ ​to​ ​reduce​ ​the​ ​total​ ​number​ ​of​ ​poor.
● 595​ ​million​ ​in​ ​South​ ​Asia,​ ​India​ ​has​ ​¾​ ​of​ ​these​ ​–​ ​455​ ​million​ ​in​ ​2005.
● Spatial​ ​Disparities:​ ​Bangalore​ ​vs.​ ​Bihar​ ​(started​ ​to​ ​improve).​ ​Issues​ ​concentrated​ ​in
lagging​ ​regions.
● Policy​ ​interventions​ ​are​ ​needed​ ​–​ ​reduce​ ​human​ ​misery,​ ​in​ ​turn​ ​sparks​ ​growth.
● Pro-poor​ ​fiscal​ ​transfers​ ​to​ ​lagging​ ​regions​ ​to​ ​achieve​ ​equity.​ ​Complemented​ ​with
improvement​ ​in​ ​capacity,​ ​accountability,​ ​and​ ​participation​ ​at​ ​local​ ​level
● Mobility/Migration​ ​increases​ ​with​ ​level​ ​of​ ​education:​ ​Remove​ ​barriers​ ​to​ ​human
mobility​ ​–​ ​labor​ ​laws,​ ​state-specific​ ​welfare​ ​programs​ ​and​ ​housing​ ​market​ ​distortions
● Recast​ ​agriculture​ ​in​ ​the​ ​global​ ​context
● Convergence​ ​of​ ​incomes​ ​between​ ​leading​ ​and​ ​lagging​ ​regions​ ​is​ ​neither​ ​necessary​ ​nor
sufficient​ ​to​ ​achieve​ ​poverty​ ​and​ ​social​ ​convergence.

#3​ ​Rural​ ​India​ ​enjoys​ ​consumption​ ​boom

● Rural​ ​India​ ​is​ ​having​ ​a​ ​higher​ ​rate​ ​of​ ​growth​ ​than​ ​urban.
● Rural​ e​ conomy​ ​accounts​ ​for​ ​20%​ ​of​ ​country’s​ ​–​ ​grew​ ​on​ ​average​ ​of​ ​17%.​ ​Per-capita
income​ ​rise​ ​of​ ​12%.
● Biggest​ ​driver​ ​of​ ​growth​ ​are​ ​govt​ ​schemes,​ ​incl​ ​subsidies​ ​for​ ​energy,​ ​fertilizers​ ​and​ ​food,
loan​ ​cancellation​ ​programs,​ ​non-farming​ ​job​ ​programs,​ ​MNREGA.​ ​Schemes​ ​cost​ ​2.9%​ ​of
GDP.
● Boosted​ ​purchasing​ ​power​ ​of​ ​rural​ ​areas​ ​–​ ​no​ ​longer​ ​only​ ​food.​ ​Non-food​ ​spending​ ​now
46%!
● Appliances,​ ​and​ ​two-wheelers​ ​saw​ ​growth​ ​of​ ​50%​ ​since​ ​2006,​ ​tractors,​ ​30%
 #4​ ​Dream​ ​On?

● Crisis​ ​hit​ ​lot​ ​of​ ​Asian​ ​countries​ ​between​ ​1997-2002.​ ​Next​ ​decade​ ​was​ ​a​ ​dream!
● Economies​ ​expanded​ ​in​ ​records!​ ​Global​ ​capital​ ​markets​ ​welcomed​ ​them​ ​back,​ ​even
backing​ ​local​ ​currencies.​ ​They​ ​built​ ​up​ ​reserves​ ​for​ ​protection
● Now​ ​they​ ​are​ ​struggling.​ ​None​ ​are​ ​in​ ​trouble​ ​like​ ​Americas​ ​or​ ​Europe,​ ​but​ ​prospects​ ​are
downhill.
● MSCI​ ​emerging​ ​market​ ​index​ ​is​ ​flat​ ​for​ ​year​ ​and​ ​down​ ​30%​ ​from​ ​2007​ ​peak
● Some​ ​Reasons:​ ​Europe’s​ ​pain​ ​has​ ​spread​ ​–​ ​EU​ ​is​ ​biggest​ ​market​ ​for​ ​many​ ​economies;
govt​ ​orchestrations​ ​nervous​ ​about​ ​price​ ​pressures​ ​or​ ​bubbles
● But​ ​underlying​​ ​“rate​ ​of​ ​sustainable​ ​growth”​ ​may​ ​be​ ​less​ ​impressive​ ​than​ ​thought.
● High​ ​commodity​ ​prices​ ​boosted​ ​some​ ​emerging​ ​economies,​ ​rapid​ ​credit​ ​growth​ ​also
contributed​ ​in​ ​some​ ​countries.
● Rising​ ​credit​ ​ratio​ ​(credit​ ​as​ ​%​ ​of​ ​GDP)​ ​may​ ​represent​ ​healthy​ ​“financial​ ​deepening”,​ ​as
household​ ​savings​ ​are​ ​reallocated​ ​to​ ​best​ ​use.
● But​ ​may​ ​also​ ​reflect​ ​potentially​ ​destabilizing​ ​“financial​ ​cycle”​ ​–​ ​upswing​ ​in​ ​credit​ ​and
other​ ​financial​ ​variables​ ​overlays​ ​and​ ​outlasts​ ​swings​ ​in​ ​GDP​ ​and​ ​inflation.
● Financial​ ​cycle​ ​upturn​ ​may​ ​flatter​ ​growth​ ​thru​ ​easy​ ​credit​ ​(spending,​ ​speculation)​ ​–​ ​may
give​ ​impression​ ​that​ ​economies​ ​can​ ​grow​ ​faster​ ​than​ ​they​ ​really​ ​can.
● Of​ ​99​ ​credit​ ​balloons​ ​(episodes​ ​of​ ​fast​ ​credit​ ​growth)​ ​over​ ​50​ ​years​ ​in​ ​rich​ ​&​ ​emerging
economies,​ ​44​ ​popped​ ​badly​ ​(banking​ ​and/or​ ​currency​ ​crisis)​ ​and​ ​13​ ​popped​ ​very​ ​badly
(9%​ ​contraction​ ​of​ ​GDP).
● External​ ​factors​ ​explain​ ​only​ ​16%​ ​of​ ​variation​ ​in​ ​credit​ ​growth​ ​in​ ​Asia.
● Imposing​ ​curbs​ ​on​ ​domestic​ ​credit​ ​and​ ​allowing​ ​greater​ ​flexibility​ ​in​ ​currencies,
economies​ ​can​ ​regain​ ​control
● By​ ​2010,​ ​combined​ ​GDP​ ​of​ ​BRICs​ ​was​ ​already​ ​75%​ ​bigger​ ​than​ ​forecasted​ ​in​ ​2003.​ ​India
and​ ​China​ ​might​ ​still​ ​fulfill​ ​the​ ​high​ ​growth​ ​estimates​ ​of​ ​6%+

#5​ ​Autocracy​ ​or​ ​Democracy?

● Does​ ​economic​ ​growth​ ​go​ ​hand-in-hand​ ​with​ ​democracy?​ ​Not​ ​necessarily.​ ​Correlation,
but​ ​not​ ​causation
● There​ ​is​ ​growth-induced​ ​democracy​ ​in​ ​East​ ​Asia;​ ​democracy​ ​did​ ​not​ ​lead​ ​to​ ​growth!
(South​ ​Korea’s​ ​better​ ​institutions​ ​developed​ ​due​ ​to​ ​dictators’​ ​policy​ ​choices)
● Extractive​ ​institutions​ ​sometimes​ ​lead​ ​to​ ​growth​ ​when​ ​elite​ ​find​ ​it​ ​in​ ​their​ ​best​ ​interests
to​ ​allow​ ​new​ ​tech​ ​and​ ​institutional​ ​changes​ ​for​ ​economic​ ​growth​ ​as​ ​they​ ​feel​ ​more
secure​ ​and​ ​seek​ ​their​ ​own​ ​ends.
● In​ ​ethnically​ ​diverse​ ​societies,​ ​only​ ​democracies​ ​can​ ​work​ ​for​ ​growth​ ​(India).​ ​However
China​ ​is​ ​an​ ​exception​ ​–​ ​more​ ​like​ ​several​ ​small​ ​and​ ​tightly​ ​controlled​ ​states.
● India’s​ ​growth​ ​was​ ​services​ ​led.​ ​Chinese​ ​was​ ​industry​ ​based​ ​and​ ​owed​ ​to​ ​state​ ​policy.
● Economic​ ​freedoms​ ​lead​ ​to​ ​political​ ​freedoms​ ​(South​ ​Korea).​ ​China’s​ ​politburo​ ​will
likely​ ​face​ ​a​ ​challenge.
● Prosperity​ ​tends​ ​to​ ​inspire​ ​democracy.
● China’s​ ​growth​ ​strategy​ ​may​ ​be​ ​doomed​ ​to​ ​failure​ ​in​ ​the​ ​long-term.

#6​ ​A​ ​five-star​ ​problem

● “Part​ ​of​ ​currency​ ​slump​ ​is​ ​a​ ​natural​ ​correction​ ​to​ ​reflect​ ​high​ ​inflation”,​ ​but​ ​“Foreign
exchange​ ​markets​ ​have​ ​a​ ​notorious​ ​history​ ​of​ ​overshooting”.
● Vote​ ​against​ ​military​ ​action​ ​against​ ​Syria​ ​helped​ ​push​ ​down​ ​oil​ ​prices​ ​–​ ​helped​ ​India​ ​and
rupee​ ​made​ ​some​ ​recovery.
● Central​ ​bank​ ​would​ ​provide​ ​$s​ ​directly​ ​to​ ​oil​ ​importing​ ​firms​ ​–​ ​stops​ ​them​ ​from​ ​selling
rupees​ ​in​ ​the​ ​spot​ ​market.​ ​Reserves​ ​are​ ​used​ ​to​ ​support​ ​exchange​ ​rate.
● Fed​ ​may​ ​stop​ ​buying​ ​bonds​ ​–​ ​Great​ ​Exit​ ​of​ ​FDI​ ​may​ ​continue;​ ​other​ ​countries​ ​have
higher​ ​interest​ ​rates.
● Credit​ ​crunch​ ​is​ ​still​ ​pronounced​ ​–​ ​most​ ​measures​ ​of​ ​stress​ ​in​ ​the​ ​financial​ ​system​ ​are
still​ ​flashing​ ​red,​ ​reflecting​ ​Indian​ ​banks’​ ​bad​ ​debt​ ​problem.
● 3​ ​options​ ​–​ ​allow​ ​the​ ​rupee​ ​to​ ​fall​ ​further:​ ​would​ ​boost​ ​exports​ ​and​ ​help​ ​close​ ​current
account​ ​deficit.​ ​But​ ​turnaround​ ​could​ ​take​ ​time​ ​as​ ​mfging​ ​is​ ​not​ ​strong​ ​and​ ​takes​ ​time​ ​to
ramp​ ​up.​ ​May​ ​destabilize​ ​domestic​ ​economy​ ​by​ ​adding​ ​to​ ​inflation​ ​and​ ​increasing​ ​govt
subsidies​ ​on​ ​fuel​ ​and​ ​thus​ ​its​ ​borrowing
● Second​ ​is​ ​to​ ​increase​ ​interest​ ​rates​ ​to​ ​increase​ ​FDI.​ ​Further​ ​hammers​ ​Indian​ ​industry,
and​ ​increase​ ​bad​ ​debts​ ​at​ ​bank.​ ​Equity​ ​investors​ ​may​ ​panic​ ​and​ ​pull​ ​out.
● Finally,​ ​lower​ ​govt​ ​borrowing.​ ​Now​ ​at​ ​7%​ ​of​ ​GDP.​ ​Central​ ​govt​ ​expenditure​ ​is​ ​at​ ​15%​ ​of
GDP.​ ​Hence​ ​can’t​ ​balance​ ​budget​ ​with​ ​spending​ ​cuts.
● Needs​ ​more​ ​tax​ ​revenue?​ ​Only​ ​3%​ ​pay​ ​income​ ​taxes.

#7​ ​America​ ​Faces​ ​the​ ​Shock​ ​of​ ​the​ ​Old

● Innovation​ ​is​ ​the​ ​secret​ ​sauce​ ​of​ ​growth.

● Argument​ ​that​ ​innovation​ ​is​ ​slowing​ ​down​ ​in​ ​US
● Counter​ ​argument​ ​is​ ​that​ ​innovation​ ​is​ ​accelerating​ ​with​ ​AI​ ​etc.
● Prices​ ​of​ ​equipment​ ​are​ ​not​ ​dropping​ ​as​ ​fast​ ​as​ ​they​ ​used​ ​to​ ​–​ ​means​ ​the​ ​tech​ ​is​ ​not
advancing​ ​as​ ​fast
● Counter​ ​argument​ ​is​ ​that​ ​open​ ​source​ ​and​ ​crowd​ ​sourcing​ ​doesn’t​ ​figure​ ​into​ ​formal
economy​ ​hence​ ​are​ ​not​ ​captured​ ​correctly.
● Spending​ ​on​ ​US​ ​tech​ ​has​ ​slowed​ ​–​ ​decade​ ​ended​ ​2011,​ ​IT​ ​spend​ ​rose​ ​at​ ​its​ ​slowest​ ​pace
since​ ​1940s.​ ​If​ ​firms​ ​aren’t​ ​as​ ​willing​ ​to​ ​buy​ ​into​ ​innovation,​ ​there​ ​is​ ​less​ ​incentive​ ​to
innovate.

Session​ ​3​ ​–​ ​Labor​ ​Market

#1​ ​Labor​ ​Productivity

● Global​ ​labor​ ​productivity​ ​growth​ ​is​ ​sluggish.

● In​ ​some​ c​ ountries,​ ​improvements​ ​in​ ​productivity​ ​may​ ​be​ ​reflection​ ​of​ ​a​ ​faltering
economy​ ​–​ ​as​ ​employment​ ​falls,​ ​fewer​ ​people​ ​are​ ​doing​ ​the​ ​work.
● When​ ​economy​ ​starts​ ​to​ ​recover,​ ​companies​ ​get​ ​more​ ​work​ ​done​ ​with​ ​existing
employees​ ​rather​ ​than​ ​start​ ​hiring​ ​quickly,​ ​so​ ​productivity​ ​growth​ ​may​ ​be​ ​temporary
due​ ​to​ ​business​ ​cycle.
 #2​ ​Virtual​ ​Working​ ​takes​ ​off​ ​in​ ​EMs

● Crowd​ ​sourcing​ ​is​ ​becoming​ ​big​ ​in​ ​emerging​ ​markets.

● Market​ ​on​ ​track​ ​to​ ​be​ ​worth​ ​$1bn​ ​by​ ​2012.​ ​By​ ​2020,​ ​1/3​ ​could​ ​be​ ​hired​ ​online
● By​ ​2011,​ ​workers​ ​on​ ​oDesk​ ​were​ ​earning​ ​$225​ ​mil,​ ​up​ ​from​ ​$10mil​ ​in​ ​2007.
● You​ ​bypass​ ​physical​ ​migration!
● Mass​ ​fast​ ​speed​ ​internet​ ​has​ ​become​ ​accessible​ ​in​ ​many​ ​EMs​ ​only​ ​recently.
● Many​ ​established​ ​BPO​ ​companies​ ​might​ ​find​ ​themselves​ ​getting​ ​squeezed.

#3​ ​China​ ​approaching​ ​the​ ​turning​ ​point

● Lewis​ ​Turning​ ​Point:​ ​First​ ​you​ ​can​ ​grow​ ​very​ ​fast​ ​by​ ​importing​ ​foreign​ ​tech​ ​and
employing​ ​capital​ ​and​ ​cheap​ ​labor;​ ​but​ ​as​ ​wages​ ​rise​ ​and​ ​becomes​ ​unprofitable,​ ​they
have​ ​to​ ​come​ ​up​ ​with​ ​their​ ​own​ ​tech​ ​to​ ​keep​ ​growing.​ ​This​ ​shift​ ​is​ ​Lewis​ ​Turning​ ​Point.
● China​ ​is​ ​not​ ​there​ ​yet.​ ​But​ ​glut​ ​of​ ​labor​ ​peaked​ ​in​ ​2010,​ ​and​ ​population​ ​is​ ​aging.​ ​China
will​ ​reach​ ​LTP​ ​between​ ​2020-2025.
● China​ ​cannot​ ​sustain​ ​its​ ​growth​ ​rate;​ ​question​ ​is​ ​whether​ ​it​ ​will​ ​slow​ ​before​ ​incomes
have​ ​attained​ ​rich​ ​world​ ​levels.
● Model​ ​relies​ ​on​ ​continuous​ ​improvements​ ​in​ ​living​ ​standards.​ ​If​ ​it​ ​stops,​ ​there​ ​might​ ​be
social​ ​unrest.

#4​ ​Trickle-up​ ​economies

● Federal​ ​minimum​ ​wage​ ​hike​ ​benefits​ ​15mil​ ​workers.

● Low​ ​by​ i​ ntl​ ​standards​ ​–​ ​38%​ ​of​ ​median​ ​wage.
● Pros:​ ​reduce​ ​poverty​ ​and​ ​raise​ ​spending​ ​power​ ​of​ ​poorest;​ ​boosts​ ​economy​ ​since​ ​the
poorest​ ​workers​ ​spend​ ​all​ ​the​ ​additional​ ​money;​ ​reduce​ ​costly​ ​turnover,​ ​reducing
incentives​ ​to​ ​lay​ ​workers​ ​off.
● Cons:​ ​reduce​ ​jobs​ ​available​ ​for​ ​low​ ​skilled-workers.​ ​Hurts​ ​those​ ​who​ ​lose​ ​jobs,​ ​helps
those​ ​who​ ​keep​ ​them.​ ​Disagree​ ​with​ ​the​ ​economy-boost​ ​argument.

#5​ ​Wasting​ ​Time

● India​ ​is​ ​squandering​ ​its​ ​demographic​ ​opportunity.

● India​ ​needs​ ​to​ ​create​ ​about​ ​100mil​ ​jobs​ ​over​ ​the​ ​coming​ ​decade
● Quality​ ​of​ ​jobs​ ​matter​ ​too.
● One​ ​problem​ ​is​ ​manufacturing​ ​sector​ ​(and​ ​number​ ​of​ ​jobs​ ​in​ ​mfging)​ ​is​ ​not​ ​very​ ​large
compared​ ​to​ ​other​ ​developing​ ​nations
● Many​ ​firms​ ​are​ ​also​ ​preferring​ ​to​ ​setup​ ​plants​ ​abroad
● Tricky​ ​labor​ ​relations​ ​are​ ​a​ ​problem,​ ​red​ ​tape,​ ​erratic​ ​electricity,​ ​lack​ ​of​ ​land,​ ​bad​ ​roads,
busy​ ​ports,​ ​cost​ ​of​ ​logistics
● The​ ​lack​ ​of​ ​political​ ​resolve,​ ​and​ ​of​ ​a​ ​clear​ ​signal​ ​from​ ​voters​ ​means​ ​India​ ​is​ ​unlikely​ ​to
summon​ ​up​ ​the​ ​single-minded​ ​dedication​ ​with​ ​which​ ​South​ ​Korea,​ ​Taiwan​ ​and​ ​China
created​ ​industrial​ ​jobs.
 Session​ ​4​ ​–​ ​International​ ​Capital​ ​Flows
#1​ ​China​ ​to​ ​unveil​ ​its​ ​strategy​ ​to​ ​rebalance​ ​robust​ ​economy

· China’s​ ​latest​ ​5-year​ ​plan​ ​calls​ ​for​ ​a​ ​shift​ ​away​ ​from​ ​an​ ​economy​ ​based​ ​on​ ​exports​ ​and
public​ ​works​ ​projects​ ​to​ ​one​ ​powered​ ​by​ ​consumer​ ​spending

· Crucial​ ​to​ ​sustain​ ​economic​ ​growth​ ​and​ ​party’s​ ​rule​ ​internally.​ ​Rebalance​ ​global​ ​trade
externally

· Growth​ ​has​ ​enriched​ ​eastern​ ​coast​ ​and​ ​cities,​ ​but​ ​left​ ​behind​ ​rural​ ​areas

· Trade​ ​surpluses​ ​are​ ​a​ ​source​ ​of​ ​friction​ ​with​ ​US​ ​and​ ​others

· Settle​ ​for​ ​7%​ ​growth​ ​and​ ​divert​ ​billions​ ​spending​ ​on​ ​construction​ ​and​ ​corporate
subsidies​ ​towards​ ​increasing​ ​household​ ​incomes

· Raise​ ​the​ ​minimum​ ​threshold​ ​for​ ​personal​ ​income​ ​tax

#2​ ​Shifting​ ​Sands

· As​ ​Western​ ​economies’​ ​prospects​ ​look​ ​sunnier​ ​and​ ​American​ ​consumer​ ​confidence​ ​has
rebounded,​ ​money​ ​is​ ​flowing​ ​out​ ​of​ ​Emerging​ ​markets

· After​ ​2008,​ ​money​ ​came​ ​back​ ​into​ ​emerging​ ​markets​ ​in​ ​records​ ​going​ ​out​ ​again​ ​in​ ​2011

· Inflation​ ​in​ ​EM​ ​is​ ​another​ ​reason​ ​money​ ​may​ ​be​ ​flowing​ ​out

· Worry​ ​that​ ​policy​ ​makers​ ​will​ ​respond​ ​to​ ​higher​ ​prices​ ​not​ ​with​ ​free-market​ ​reforms
but​ ​with​ ​subsidies​ ​and​ ​price​ ​controls

· Optimists​ ​argue​ ​that​ ​EM’s​ ​fiscal​ ​health,​ ​maturing​ ​infrastructure​ ​and​ ​middle​ ​class​ ​boom
are​ ​good​ ​indicators

· Also​ ​valuations​ ​of​ ​EM’s​ ​markets​ ​are​ ​not​ ​high​ ​–​ ​2x​ ​book​ ​value.

· Also,​ ​investors​ ​are​ ​becoming​ ​more​ ​discerning​ ​–​ ​pulling​ ​out​ ​of​ ​broad​ ​EM​ ​funds​ ​and
entering​ ​country​ ​specific​ ​ones.

#3​ ​Emerging​ ​appetites

· The​ ​market​ ​is​ ​very​ ​good​ ​for​ ​EM’s​ ​private​ ​firm​ ​issued​ ​debt.

· Yields​ ​in​ ​developed​ ​countries​ ​are​ ​very​ ​low​ ​due​ ​to​ ​low​ ​interest​ ​rates.​ ​Hence​ ​investors​ ​are
flocking​ ​to​ ​private​ ​debt​ ​in​ ​EM.​ ​Not​ ​good​ ​for​ ​small​ ​and​ ​medium​ ​sized​ ​companies​ ​in​ ​the
rich​ ​world​ ​–​ ​unable​ ​to​ ​raise​ ​money.

· Is​ ​this​ ​a​ ​bubble?​ ​(Like​ ​the​ ​American​ ​housing​ ​bubble?)​ ​–​ ​Debt-to-GDP​ ​ratio​ ​of​ ​the​ ​average
EM​ ​country​ ​is​ ​lower​ ​than​ ​that​ ​of​ ​an​ ​average​ ​country​ ​in​ ​the​ ​developed​ ​world.
· Investors​ ​wanting​ ​to​ ​diversify​ ​out​ ​of​ ​the​ ​developed​ ​world​ ​is​ ​not​ ​new​ ​–​ ​since​ ​1900s.

· Global​ ​capital​ ​flows​ ​to​ ​countries​ ​that​ ​need​ ​to​ ​fund​ ​development​ ​and​ ​offer​ ​the​ ​most
attractive​ ​growth​ ​opportunities.

· Asian​ ​crisis​ ​of​ ​the​ ​late​ ​1990s​ ​pushed​ ​the​ ​global​ ​capital​ ​the​ ​wrong​ ​way​ ​towards​ ​safety​ ​of
American​ ​debt,​ ​but​ ​trend​ ​is​ ​correcting​ ​itself.​ ​Better​ ​to​ ​own​ ​Petro​ ​bras​ ​debt​ ​at​ ​high​ ​yields
that​ ​British​ ​govt​ ​100​ ​year​ ​debt​ ​at​ ​low​ ​yield.

#4​ ​A​ ​troubled​ ​island​ ​story

· Cyprus​ ​–​ ​bailout​ ​is​ ​unpopular.

Session​ ​5​ ​–​ ​International​ ​Trade​ ​&​ ​Globalization

#1​ ​Opening​ ​the​ ​floodgates

· Imports​ ​can​ ​be​ ​as​ ​useful​ ​as​ ​exports​ ​are!

· Imports​ ​allow​ ​firms​ ​to​ ​imports​ ​things​ ​they​ ​want,​ ​so​ ​product​ ​mix,​ ​production​ ​processes
can​ ​all​ ​be​ ​improved

· India​ ​is​ ​a​ ​great​ ​case​ ​study​ ​after​ ​1989.​ ​Output​ ​grew​ ​over​ ​50%,​ ​rise​ ​in​ ​intermediate​ ​goods
imports​ ​was​ ​227%,​ ​compared​ ​to​ ​90%​ ​growth​ ​in​ ​consumer​ ​goods​ ​imports​ ​until​ ​2000.
Average​ ​firm​ ​made​ ​2.3​ ​products​ ​(compared​ ​to​ ​1.4​ ​products)​ ​and​ ​new​ ​products​ ​were
responsible​ ​for​ ​25%​ ​growth​ ​in​ ​output​ ​between​ ​91​ ​and​ ​97.

#2​ ​The​ ​other​ ​conclave

· Is​ ​WTO​ ​irrelevant?

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Global​ ​trade​ ​is​ ​is​ ​more​ ​than​ ​the​ ​2010​ ​output.​ ​WTO​ ​role​ ​has​ ​become​ ​more
significant​ ​to​ ​monitor​ ​agreements​ ​or​ ​settling​ ​disputes

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Doha​ ​talks​ ​failure​ ​due​ ​to​ ​mistrust​ ​between​ ​emerging​ ​and​ ​rich​ ​countries.
Emerging​ ​markets​ ​view​ ​cannot​ ​be​ ​ignored.​ ​Most​ ​of​ ​the​ ​candidates​ ​for​ ​WTO​ ​top
position​ ​are​ ​from​ ​emerging​ ​economies

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Rich​ ​countries​ ​fear​ ​cheap​ ​china​ ​imports

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Regional​ ​trade​ ​agreements​ ​are​ ​thriving​ ​since​ ​multi-lateral​ ​trade​ ​talks​ ​are​ ​going
nowhere.​ ​“Nothing​ ​is​ ​agreed​ ​until​ ​everything​ ​is​ ​agreed”​ ​delays​ ​getting​ ​anything
done.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Fundamental​ ​source​ ​of​ ​strain​ ​on​ ​the​ ​multi-lateral​ ​system​ ​is​ ​the​ ​shifting​ ​economic
 balance​ ​of​ ​power​ ​from​ ​developed​ ​countries​ ​to​ ​EMs.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Despite​ ​decades​ ​of​ ​fast​ ​growth,​ ​EMs​ ​are​ ​reluctant​ ​to​ ​abandon​ ​the​ ​trade​ ​safeguards.
They​ ​reject​ ​unappealing​ ​rich​ ​world​ ​offers.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Emerging​ ​markets​ ​fear​ ​that​ ​rich​ ​countries​ ​would​ ​get​ ​what​ ​they​ ​want​ ​and​ ​leave​ ​them
in​ ​tail​ ​spin.​ ​WTO​ ​chief’s​ ​has​ ​greater​ ​role​ ​to​ ​bring​ ​back​ ​Doha​ ​talks​ ​and​ ​bring​ ​some
new​ ​novelty​ ​in​ ​to​ ​thought​ ​process.

#3​ ​Trade​ ​with​ ​the​ ​world

· China​ ​has​ ​eclipsed​ ​US​ ​as​ ​the​ ​world’s​ ​largest​ ​trader​ ​$3.87​ ​trillion​ ​in​ ​goods.​ ​If​ ​services​ ​are
also​ ​considered,​ ​US​ ​still​ ​leads.

· 124​ ​countries​ ​consider​ ​China​ ​as​ ​their​ ​largest​ ​trading​ ​partner.

#4​ ​Why​ ​did​ ​The​ ​Economist​ ​favor​ ​free​ ​trade?

· James​ ​Wilson​ ​founded​ ​The​ ​Economist​ ​in​ ​1843​ ​to​ ​campaign​ ​for​ ​free​ ​trade.​ ​Supported​ ​free
trade​ ​views​ ​with​ ​remarkable​ ​completeness​ ​and​ ​consistency.

· Free​ ​trade​ ​produced​ ​abundance​ ​and​ ​employment​ ​–​ ​appropriate​ ​for​ ​economies​ ​where​ ​a
large​ ​proportion​ ​of​ ​the​ ​population​ ​and​ ​property​ ​depended​ ​on​ ​commerce​ ​and​ ​industry
alone.

· Protection​ ​is​ ​not​ ​appropriate​ ​for​ ​mature​ ​economies.

· Consumers​ ​(Adam​ ​Smith/Wealth​ ​of​ ​Nations)​ ​should​ ​buy​ ​products​ ​from​ ​where​ ​they​ ​are
cheapest.​ ​Protection​ ​creates​ ​monopolies,​ ​which​ ​are​ ​a​ ​great​ ​enemy​ ​to​ ​good
management...

· Ricardo:​ ​All​ ​countries​ ​benefit​ ​from​ ​free​ ​trade,​ ​producing​ ​what​ ​they​ ​were​ ​best​ ​at​ ​relative
to​ ​other​ ​countries.

· Some​ ​economists​ ​including​ ​Keynes,​ ​argue​ ​that​ ​tariff​ ​policies​ ​work​ ​in​ ​specific​ ​or
temporary​ ​situations,​ ​e.g.,​ ​to​ ​bring​ ​Britain​ ​out​ ​of​ ​Great​ ​Depression​ ​in​ ​1931.​ ​But​ ​may
have​ ​damaged​ ​long​ ​term​ ​economic​ ​growth​ ​in​ ​1950-73​ ​boom.

· Persistence​ ​in​ ​economic​ ​history​ ​of​ ​the​ ​idea​ ​that​ ​free​ ​trade​ ​provides​ ​the​ ​optimal​ ​long-run
conditions​ ​for​ ​growth.

Session​ ​6​ ​–​ ​Fiscal​ ​Policy​ ​and​ ​Government​ ​Debt

#1​ ​Sorry,​ ​but​ ​Europe’s​ ​Economic​ ​Crisis​ ​is​ ​not​ ​over
· Financial​ ​conditions​ ​are​ ​improving.​ ​Bond​ ​yields​ ​are​ ​falling​ ​to​ ​supportable​ ​levels​ ​even​ ​in
Govts​ ​that​ ​were​ ​on​ ​the​ ​brink​ ​of​ ​bankruptcy.

· IMF’s​ ​forecasters​ ​have​ ​marked​ ​down​ ​Europe’s​ ​prospects​ ​again.

· Due​ ​to​ ​the​ ​single​ ​currency,​ ​there​ ​isn’t​ ​a​ ​lot​ ​that​ ​monetary​ ​policy​ ​can​ ​do​ ​to​ ​lift​ ​the
region’s​ ​struggling​ ​economies.​ ​Fiscal​ ​policy​ ​continues​ ​to​ ​widen​ ​rather​ ​than​ ​narrow
intra-Europe’s​ ​disparities.

· Weak​ ​economies​ ​are​ ​trying​ ​to​ ​curb​ ​public​ ​spending​ ​and​ ​raise​ ​revenue,​ ​which​ ​adds​ ​to
contraction

· Europe​ ​suffered​ ​a​ ​worse​ ​decline​ ​in​ ​output,​ ​sharper​ ​rise​ ​in​ ​unemployment,​ ​milder
monetary​ ​policy​ ​response,​ ​counter-productive​ ​fiscal​ ​policy​ ​response,​ ​and​ ​severe
country-specific​ ​setbacks​ ​compared​ ​to​ ​US.​ ​National​ ​boundaries​ ​still​ ​inhibit​ ​the​ ​ability​ ​of
the​ ​economy’s​ ​supply​ ​side​ ​to​ ​bounce​ ​back​ ​–​ ​e.g.,​ ​impeding​ ​labor​ ​mobility.

· Needed:​ ​Fiscal​ ​transfers​ ​from​ ​strong​ ​to​ ​weak​ ​economies,​ ​more​ ​flexible​ ​labor​ ​markets,
proposed​ ​banking​ ​union,​ ​with​ ​better​ ​regulation.

· Re-launch​ ​of​ ​the​ ​Euro​ ​gave​ ​the​ ​leaders​ ​breathing​ ​space.

#2​ ​Keynes​ ​v​ ​Hayek​ ​in​ ​China

· Keynes​ ​worried​ ​about​ ​inadequate​ ​investment​ ​(too​ ​little​ ​entrepreneurial​ ​spending​ ​to
keep​ ​everyone​ ​employed).​ ​Hayek​ ​argued​ ​that​ ​with​ ​overinvestment​ ​comes
mal-investment,​ ​which​ ​should​ ​be​ ​avoided.

· China​ ​is​ ​an​ ​example​ ​of​ ​over-investment​ ​leading​ ​to​ ​bad-investments:​ ​over​ ​ambitious
projects,​ ​which​ ​will​ ​never​ ​be​ ​successful.​ ​Ghost​ ​cities,​ ​bridges,​ ​roads,​ ​housing​ ​projects
that​ ​will​ ​never​ ​be​ ​occupied​ ​etc.

· In​ ​2009,​ ​China’s​ ​banks​ ​increased​ ​their​ ​lending​ ​by​ ​$1.5​ ​trillion,​ ​which​ ​is​ ​twice​ ​the​ ​size​ ​of
Indian​ ​banking​ ​system.​ ​(They​ ​added​ ​2​ ​India’s​ ​to​ ​their​ ​books​ ​in​ ​the​ ​space​ ​of​ ​1​ ​year).

· Krugman​ ​critiques​ ​hangover​ ​theory​ ​of​ ​recessions​ ​–​ ​why​ ​should​ ​bad​ ​investments​ ​in​ ​the
past​ ​lead​ ​to​ ​unemployment​ ​in​ ​the​ ​present.

· Hayek’s​ ​supporters​ ​argue​ ​that​ ​economies​ ​take​ ​time​ ​to​ ​reorganize​ ​themselves​ ​after​ ​bad
investments​ ​are​ ​exposed.

· Boom-time​ ​mal-investments​ ​are​ ​responsible​ ​for​ ​subsequent​ ​bust,​ ​much​ ​as

binge-drinking​ ​is​ ​responsible​ ​for​ ​the​ ​next​ ​morning’s​ ​hangover.

· Government​ ​will​ ​most​ ​probably​ ​step​ ​in​ ​and​ ​finish​ ​projects

#4​ ​A​ ​walk​ ​on​ ​the​ ​wild​ ​side

· India​ ​has​ ​never​ ​been​ ​able​ ​to​ ​balance​ ​budget.​ ​Deficit​ ​has​ ​been​ ​running​ ​at​ ​8-10%​ ​of​ ​GDP
(5-6.5%​ ​by​ ​Central​ ​Gov).

· 2003’s​ ​Fiscal​ ​Responsibility​ ​Act​ ​has​ ​been​ ​ignored​ ​by​ ​the​ ​Center.
· Indian​ ​Govt​ ​revenues​ ​should​ ​be​ ​25%​ ​of​ ​GDP​ ​–​ ​currently​ ​@​ ​18%.

· Complexity​ ​discourages​ ​people​ ​from​ ​joining​ ​the​ ​formal​ ​economy.​ ​GST​ ​has​ ​been​ ​in​ ​the
works​ ​to​ ​simplify​ ​and​ ​consolidate.

#5​ ​Foreign​ ​Central​ ​banks’​ ​US​ ​debt​ ​holdings​ ​fall:​ ​Fed

· China​ ​and​ ​Japan​ ​are​ ​the​ ​biggest​ ​foreign​ ​holders​ ​of​ ​US​ ​treasuries

· Fed’s​ ​holdings​ ​of​ ​US​ ​securities​ ​kept​ ​for​ ​overseas​ ​central​ ​banks​ ​stand​ ​at​ ​$3.3​ ​tril.

#6​ ​KrugTron​ ​the​ ​Invincible?

· Krugman​ ​has​ ​been​ ​outspoken​ ​that​ ​austerity​ ​has​ ​failed​ ​and​ ​Keynesian​ ​economics​ ​has
won.

· Keynesian​ ​theory​ ​–​ ​idea​ ​that​ ​in​ ​a​ ​recession,​ ​govt​ ​should​ ​spend​ ​money​ ​in​ ​order​ ​to​ ​prop
up​ ​aggregate​ ​demand.

· Economists​ ​use​ ​austerity​ ​to​ ​mean​ ​the​ ​measures​ ​implemented​ ​by​ ​govt​ ​to​ ​reduce​ ​the
debt-to-GDP​ ​ratio.​ ​It​ ​can​ ​take​ ​different​ ​forms​ ​such​ ​as​ ​cutting​ ​spending,​ ​raising​ ​taxes​ ​or​ ​a
mix​ ​of​ ​both.

· Fiscal​ ​adjustments​ ​made​ ​up​ ​of​ ​spending​ ​cuts​ ​are​ ​more​ ​likely​ ​to​ ​lead​ ​to​ ​lasting​ ​debt
reduction​ ​than​ ​those​ ​made​ ​of​ ​tax​ ​increases

· Europe​ ​mostly​ ​hiked​ ​taxes​ ​as​ ​austerity​ ​measures​ ​and​ ​this​ ​is​ ​against​ ​Keynes’​ ​theories.
According​ ​to​ ​Keynes,​ ​during​ ​recession,​ ​govt​ ​should​ ​hike​ ​spending​ ​and​ ​cut​ ​taxes

· Large​ ​tax​ ​increases​ ​as​ ​austerity​ ​measures​ ​devastated​ ​Europe.

India​ ​in​ ​Trouble​ ​-​ ​The​ ​Reckoning

What​ ​happened​ ​in​ ​Financial​ ​Market?

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Rupee​ ​sank,​ ​stock​ ​market​ ​tumbled,​ ​money​ ​market​ ​rates​ ​rose​ ​(making​ ​loans​ ​costly)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Bank​ ​had​ ​lot​ ​of​ ​bad​ ​loans

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Made​ ​worse​ ​further​ ​when​ ​capital​ ​flight​ ​introduced​ ​–​ ​residents​ ​and​ ​firms​ ​allowed​ ​to
take​ ​less​ ​money​ ​out

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Foreign​ ​investors​ ​feared​ ​that​ ​they​ ​would​ ​be​ ​affected​ ​(Ex​ ​Malaysia​ ​did​ ​in​ ​1998)
although​ ​India​ ​said​ ​they​ ​would​ ​not​ ​impose​ ​control​ ​on​ ​foreign​ ​capital

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​In​ ​response​ ​RBI​ ​said​ ​that​ ​they​ ​would​ ​intervene​ ​and​ ​claim​ ​bond​ ​yields

Why​ ​this​ ​happened

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​US​ ​Fed​ ​reserve​ ​slowed​ ​down​ ​their​ ​pace​ ​of​ ​asset​ ​purchases.​ ​So​ ​no​ ​ultra-cheap​ ​loans

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Funds​ ​taken​ ​from​ ​emerging​ ​markets

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Bond​ ​yields​ ​rose​ ​from​ ​Brazil​ ​to​ ​Thailand.​ ​Indonesia​ ​raised​ ​interest​ ​rate​ ​to​ ​bolster​ ​its
currency

Effect​ ​on​ ​India

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Growth​ ​falling​ ​to​ ​4-5%​ ​(half​ ​seen​ ​during​ ​economic​ ​boom​ ​in​ ​2003-2008)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​rates​ ​10%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Packages​ ​of​ ​reforms​ ​and​ ​free​ ​big​ ​industrial​ ​projects​ ​from​ ​red​ ​tape​ ​by​ ​FM​ ​did​ ​not
work

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Uncertainty​ ​due​ ​to​ ​elections

Dependence​ ​on​ ​Foreign​ ​Money

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​High​ ​dependence​ ​due​ ​to​ ​CAD​ ​7%​ ​(Although​ ​expected​ ​to​ ​be​ ​at​ ​4-5%)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​External​ ​borrowing​ ​stable​ ​at​ ​21%​ ​of​ ​gdp

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Short​ ​term​ ​debt​ ​raised​ ​and​ ​hence​ ​the​ ​risk

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Total​ ​financial​ ​needs​ ​$​ ​250B​ ​and​ ​India​ ​reserve​ ​$​ ​279B​ ​(this​ ​has​ ​fallen​ ​from​ ​400%​ ​in
2005​ ​to​ ​100%​ ​in​ ​2013)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Foreign​ ​investors​ ​hold​ ​$​ ​200B​ ​in​ ​equity​ ​at​ ​current​ ​prices.​ ​If​ ​he​ ​exit,​ ​India​ ​has​ ​no
defense

History

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​India​ ​had​ ​fixed​ ​exchange​ ​rate​ ​earlier.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Trying​ ​to​ ​protect​ ​the​ ​rate,​ ​India​ ​took​ ​huge​ ​loan​ ​from​ ​Bank​ ​of​ ​England​ ​with​ ​gold​ ​as
deposit

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Today​ ​India​ ​has​ ​floating​ ​so​ ​no​ ​foreign​ ​currency​ ​debt​ ​for​ ​government.​ ​So​ ​no
insolvency​ ​for​ ​government

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Pain​ ​to​ ​private​ ​investor​ ​who​ ​own​ ​foreign​ ​debt.​ ​With​ ​higher​ ​interest​ ​rates,​ ​liquidity
would​ ​squeeze

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​India​ ​state​ ​owned​ ​bank​ ​have​ ​sour​ ​loans​ ​for​ ​10-12%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Cost​ ​of​ ​subsidy​ ​on​ ​imported​ ​fuel​ ​gets​ ​bigger

Measures​ ​on​ ​Aug​ ​19​th

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Banned​ ​TV​ ​imports,​ ​raised​ ​duties​ ​on​ ​gold​ ​import,​ ​persuade​ ​supreme​ ​court​ ​to​ ​lift
iron​ ​ore​ ​export,​ ​may​ ​also​ ​cut​ ​fuel​ ​subsidies

​ ​Long​ ​run​ ​solutions

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Ramp​ ​up​ ​manufacturing​ ​sector​ ​and​ ​industrial​ ​export​ ​(how​ ​much​ ​India​ ​can​ ​attract
foreign​ ​firms)

Questions

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Can​ ​India​ ​have​ ​policies​ ​that​ ​can​ ​be​ ​less​ ​vulnerable​ ​to​ ​outside​ ​world

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Recovery​ ​from​ ​slump​ ​in​ ​rupee​ ​made​ ​growth​ ​even​ ​harder.​ ​How​ ​to​ ​manage?

Horns​ ​of​ ​a​ ​Trilemma

Background

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Asian​ ​currencies​ ​depreciated​ ​since​ ​May​ ​2013​ ​(India,​ ​Indonesia,​ ​Turkey)

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Blamed​ ​rich​ ​monetary​ ​experiments​ ​affect​ ​developing​ ​economies

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Studies​ ​confirms​ ​the​ ​point​ ​where​ ​the​ ​foreign​ ​investment​ ​in​ ​developing​ ​economies
soar​ ​when​ ​S​ ​&​ ​P​ ​is​ ​low

Traditional​ ​Trio​ ​(can​ ​choose​ ​only​ ​2​ ​out​ ​of​ ​3)

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Free​ ​capital​ ​flows

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Fixed​ ​exchange​ ​rates

-​​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Autonomous​ ​monetary​ ​policy

Example​ ​–​ ​Open​ ​economy​ ​and​ ​fixed​ ​exchange​ ​rate​ ​work​ ​when​ ​you​ ​subjugate​ ​monetary
policy​ ​by​ ​increasing​ ​interest​ ​rates​ ​when​ ​capital​ ​outflow​ ​put​ ​pressure​ ​on​ ​currency

Also​ ​free​ ​economy​ ​and​ ​independent​ ​monetary​ ​policy​ ​but​ ​giving​ ​up​ ​the​ ​fixed​ ​exchange
rate

Emerging​ ​markets​ ​abandoned​ ​fixed​ ​exchange​ ​rates​ ​during​ ​Asian​ ​crises.​ ​Reserve​ ​bank
partially​ ​neutralize​ ​hot​ ​money​ ​by​ ​intervention.​ ​Footloose​ ​capital​ ​create​ ​credit​ ​boom
when​ ​advance​ ​economy​ ​eased​ ​their​ ​monetary​ ​policy.​ ​Brazil​ ​imposed​ ​capital​ ​controls​ ​to
stop​ ​the​ ​plight​ ​of​ ​capital

IMF​ ​suggested​ ​that​ ​limited​ ​coordinated​ ​policies​ ​to​ ​temper​ ​flows​ ​could​ ​be​ ​warranted
especially​ ​in​ ​underdeveloped​ ​financial​ ​systems.​ ​Maurice​ ​who​ ​is​ ​the​ ​architect​ ​of
impossible​ ​trio​ ​noted​ ​that​ ​financial​ ​institutions​ ​are​ ​ill​ ​prepared​ ​for​ ​world​ ​of​ ​outsized
financial​ ​outflows.​ ​New​ ​industrial​ ​Asian​ ​economies​ ​have​ ​foreign​ ​investment​ ​position​ ​up
to​ ​200%​ ​of​ ​their​ ​GDP.

Rey​ ​from​ ​LBS​ ​states​ ​that​ ​impossible​ ​trio​ ​is​ ​obsolete​ ​and​ ​government​ ​face​ ​dilemma​ ​on
free​ ​capital​ ​flow​ ​means​ ​loss​ ​of​ ​monetary​ ​policy​ ​independence

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Risky​ ​assets​ ​ ​(equity​ ​and​ ​corporate​ ​bonds)​ ​move​ ​across​ ​global​ ​economy​ ​irrespective
of​ ​exchange​ ​rates

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Links​ ​moves​ ​to​ ​VIX​ ​(index​ ​of​ ​market​ ​volatility​ ​derived​ ​from​ ​S​ ​&​ ​P​ ​500​ ​stock​ ​option
prices)​ ​which​ ​correlates​ ​to​ ​capital​ ​growth​ ​and​ ​credit​ ​flows.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Central​ ​bank​ ​in​ ​one​ ​country​ ​cannot​ ​lean​ ​against​ ​investments​ ​coming​ ​from​ ​another
side

Drop​ ​in​ ​interest​ ​rate​ ​by​ ​Fed​ ​starts​ ​the​ ​cycle​ ​by​ ​increasing​ ​appetite​ ​for​ ​market​ ​risk.​ ​This
creates​ ​credit​ ​and​ ​capital​ ​flows​ ​to​ ​risky​ ​assets.​ ​On​ ​the​ ​flip​ ​side​ ​decreasing​ ​interest​ ​rates
can​ ​send​ ​dynamic​ ​to​ ​reverse

Fed​ ​alone​ ​is​ ​not​ ​the​ ​villain​ ​but​ ​variation​ ​on​ ​interest​ ​rates​ ​account​ ​for​ ​most​ ​of​ ​the
fluctuations

Americans​ ​are​ ​unlikely​ ​to​ ​welcome​ ​higher​ ​unemployment​ ​to​ ​calm​ ​asset​ ​prices​ ​abroad.

Some​ ​measures​ ​to​ ​dampen​ ​easy​ ​money​ ​across​ ​borders.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Link​ ​bank​ ​loan​ ​to​ ​value​ ​ratios

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Leverage​ ​limits​ ​to​ ​economic​ ​conditions

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Capital​ ​controls​ ​(like​ ​china)

India​ ​tried​ ​its​ ​capital​ ​controls​ ​by​ ​limiting​ ​individuals​ ​to​ ​they​ ​can​ ​remit​ ​abroad.​ ​Not​ ​a
time​ ​to​ ​test​ ​which​ ​will​ ​scare​ ​foreign​ ​investors​ ​but​ ​it’s​ ​a​ ​tempting​ ​trade​ ​off​ ​to​ ​secure
monetary​ ​policy​ ​independence.

Six​ ​Years​ ​of​ ​Low​ ​Interest​ ​Rate​ ​in​ ​search

of​ ​some​ ​growth

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Lower​ ​interest​ ​rates​ ​prevalent​ ​in​ ​US,​ ​Britain,​ ​Eurozone,​ ​japan​ ​and​ ​Switzerland.​ ​This
has​ ​become​ ​norm​ ​now

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Companies​ ​taken​ ​advantage​ ​and​ ​locked​ ​in​ ​for​ ​cheaper​ ​financing​ ​for​ ​years​ ​to​ ​come.
But​ ​not​ ​invested​ ​much​ ​as​ ​expected

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Purchase​ ​manager​ ​index​ ​showed​ ​further​ ​fall​ ​and​ ​unemployment​ ​reached​ ​12%​ ​in
euro​ ​zone

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Lower​ ​interest​ ​rates​ ​has​ ​its​ ​own​ ​benefits.

o​​ ​ ​ ​ ​Has​ ​triggered​ ​people​ ​to​ ​buy​ ​homes​ ​and​ ​refinance​ ​existing​ ​ones.

o​​ ​ ​ ​ ​Car​ ​sales​ ​has​ ​increased.​ ​People​ ​employed​ ​in​ ​processing​ ​credit​ ​has​ ​also​ ​increased

o​​ ​ ​ ​ ​Share​ ​prices​ ​has​ ​been​ ​posted​ ​as​ ​people​ ​are​ ​willing​ ​to​ ​spend

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Excessive​ ​low​ ​rates​ ​would​ ​result​ ​in​ ​property​ ​bubble​ ​which​ ​was​ ​seen​ ​in​ ​Thailand,
Spain​ ​and​ ​Ireland

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Low​ ​rates​ ​would​ ​take​ ​interest​ ​from​ ​the​ ​risk​ ​equation​ ​and​ ​people​ ​would​ ​be​ ​waiting
for​ ​capital​ ​gain​ ​to​ ​realize.​ ​If​ ​bubbles​ ​emerge,​ ​it​ ​would​ ​take​ ​more​ ​time​ ​to​ ​have​ ​normal
monetary​ ​policy

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​In​ ​Japan​ ​nominal​ ​interest​ ​rate​ ​is​ ​near​ ​zero​ ​although​ ​real​ ​interest​ ​rate​ ​is​ ​positive.​ ​Not
only​ ​govt​ ​bonds​ ​yield​ ​low,​ ​higher​ ​debt​ ​to​ ​gdp​ ​ratio​ ​is​ ​not​ ​safe.​ ​So​ ​prolonged​ ​lower
interest​ ​rate​ ​is​ ​not​ ​safe​ ​at​ ​all.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Many​ ​multinationals​ ​can​ ​get​ ​loan​ ​cheaper​ ​than​ ​European​ ​countries.​ ​They​ ​have
substituted​ ​debt​ ​for​ ​equity​ ​and​ ​proceed​ ​to​ ​make​ ​bigger​ ​buy​ ​back

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​With​ ​easy​ ​money​ ​M​ ​&​ ​A​ ​has​ ​also​ ​increased​ ​big​ ​time.​ ​Through​ ​increased​ ​M​ ​&​ ​A
corporates​ ​are​ ​looking​ ​to​ ​increase​ ​profits

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​In​ ​US,​ ​car​ ​and​ ​home​ ​loan​ ​are​ ​packaged​ ​and​ ​sold​ ​as​ ​securities​ ​to​ ​the​ ​outside​ ​world.​ ​In
2008​ ​nobody​ ​thought​ ​that​ ​all​ ​loans​ ​would​ ​be​ ​defaulted.​ ​However​ ​subprime​ ​credit
standards​ ​made​ ​default​ ​more​ ​likely.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Commercial​ ​backed​ ​security​ ​is​ ​gaining​ ​importance.​ ​Typically​ ​property​ ​performs​ ​well
when​ ​rental​ ​income​ ​is​ ​more​ ​than​ ​interest​ ​income.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Companies​ ​have​ ​cash​ ​but​ ​not​ ​certain​ ​about​ ​the​ ​return​ ​they​ ​would​ ​get​ ​from​ ​the
investment​ ​due​ ​to​ ​sluggish​ ​demand.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Companies​ ​need​ ​to​ ​consider​ ​lot​ ​of​ ​factors​ ​–​ ​supply​ ​and​ ​demand,​ ​regulatory​ ​and
political​ ​back​ ​drop,​ ​availability​ ​of​ ​skilled​ ​employees.​ ​Interest​ ​cost​ ​is​ ​now​ ​very​ ​little.
Business​ ​do​ ​not​ ​invest​ ​because​ ​economy​ ​is​ ​weak.​ ​Economy​ ​is​ ​weak​ ​as​ ​business​ ​do​ ​not
invest

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Small​ ​and​ ​medium​ ​business​ ​find​ ​it​ ​difficult​ ​to​ ​get​ ​cash.​ ​Developing​ ​economies​ ​have
been​ ​promising​ ​on​ ​the​ ​growth.
 Phony​ ​Currency​ ​Wars
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​G​ ​20​ ​bankers​ ​worry​ ​that​ ​peer​ ​might​ ​devalue​ ​currencies​ ​to​ ​boost​ ​exports​ ​at​ ​neighbor
expense

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Brazil​ ​accused​ ​US​ ​when​ ​government​ ​bought​ ​bonds​ ​which​ ​made​ ​investors​ ​move​ ​to
emerging​ ​markets​ ​to​ ​seek​ ​better​ ​returns,​ ​lifting​ ​their​ ​exchange​ ​rates​ ​(made​ ​dollar
cheaper)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Shinbo​ ​Abe​ ​wants​ ​weaker​ ​yen​ ​(yen​ ​fell​ ​by​ ​16%​ ​against​ ​dollar​ ​and​ ​19%​ ​against​ ​euro)
and​ ​to​ ​increase​ ​inflation.

Turning​ ​sword​ ​in​ ​to​ ​printing​ ​press

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Central​ ​banks​ ​exhausted​ ​their​ ​monetary​ ​policies​ ​when​ ​they​ ​brought​ ​their​ ​interest
rate​ ​to​ ​zero​ ​and​ ​now​ ​they​ ​are​ ​resorting​ ​to​ ​quantum​ ​easing​ ​(QE)​ ​which​ ​will​ ​increase
inflation

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​This​ ​is​ ​done​ ​to​ ​stimulate​ ​domestic​ ​spending​ ​and​ ​investment.​ ​This​ ​in​ ​turn​ ​weakens
the​ ​currency​ ​and​ ​depress​ ​imports.​ ​If​ ​it​ ​revives​ ​local​ ​demand​ ​it​ ​will​ ​also​ ​lead​ ​to​ ​higher
imports

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Aggressive​ ​monetary​ ​expansion​ ​in​ ​developed​ ​economies​ ​is​ ​good​ ​for​ ​rest​ ​of​ ​the
world.​ ​Trading​ ​partner​ ​output​ ​increased​ ​by​ ​.3%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Due​ ​to​ ​dollar​ ​weakening,​ ​yen​ ​started​ ​the​ ​assault​ ​on​ ​its​ ​deflation.​ ​Both​ ​Japan​ ​and​ ​US
policies​ ​boosted​ ​investor​ ​confidence

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Euro​ ​got​ ​worried​ ​and​ ​caught​ ​in​ ​cross​ ​fire​ ​between​ ​yen​ ​and​ ​dollar.​ ​They​ ​started
managing​ ​euro.​ ​Rather​ ​they​ ​should​ ​do​ ​quantum​ ​easing.​ ​This​ ​will​ ​combat​ ​recession.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​This​ ​may​ ​not​ ​work​ ​for​ ​brazil​ ​where​ ​inflation​ ​is​ ​high​ ​and​ ​they​ ​should​ ​resort​ ​to​ ​capital
controls​ ​to​ ​control​ ​hot​ ​money​ ​inflow

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​If​ ​Japan​ ​actually​ ​intervene​ ​in​ ​the​ ​market​ ​they​ ​rest​ ​of​ ​the​ ​world​ ​should​ ​bother.​ ​Until
then​ ​countries​ ​should​ ​not​ ​resort​ ​to​ ​currency​ ​war​ ​rather​ ​they​ ​should​ ​fight​ ​stagnation.
Why​ ​Large​ ​movements​ ​in​ ​exchange​ ​rates
have​ ​small​ ​effects​ ​on​ ​International
prices

Introduction

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Exchange​ ​rates​ ​has​ ​little​ ​impact​ ​on​ ​prices.​ ​This​ ​disconnect​ ​is​ ​a​ ​central​ ​puzzle​ ​to
international​ ​economists.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Change​ ​in​ ​relative​ ​prices​ ​shift​ ​expenditure​ ​towards​ ​countries​ ​whose​ ​currency​ ​are
depreciated.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​If​ ​price​ ​do​ ​not​ ​respond,​ ​neither​ ​quantity​ ​does.​ ​So​ ​expenditure​ ​switching​ ​role​ ​of
exchange​ ​rates​ ​is​ ​diminished

New​ ​research

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Large​ ​exporters​ ​are​ ​also​ ​large​ ​importers

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​If​ ​they​ ​face​ ​shock​ ​in​ ​destination​ ​market​ ​then​ ​they​ ​face​ ​compensating​ ​movement​ ​in
marginal​ ​costs​ ​if​ ​they​ ​are​ ​importing​ ​their​ ​intermediary​ ​inputs

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Example​ ​euro​ ​appreciation​ ​would​ ​lower​ ​sourcing​ ​of​ ​intermediate​ ​inputs.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Value​ ​of​ ​the​ ​currency​ ​are​ ​normally​ ​co​ ​related​ ​to​ ​their​ ​strongest​ ​trading​ ​partner

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​So​ ​this​ ​natural​ ​hedge​ ​reduce​ ​the​ ​need​ ​for​ ​exporters​ ​to​ ​adjust​ ​the​ ​export​ ​market
prices

Empirical​ ​analysis

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​High​ ​importers​ ​also​ ​enjoy​ ​high​ ​export​ ​market​ ​share​ ​with​ ​high​ ​mark​ ​up.​ ​Actively
move​ ​them​ ​to​ ​offset​ ​the​ ​change​ ​in​ ​marginal​ ​costs​ ​on​ ​export​ ​prices.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​This​ ​is​ ​a​ ​second​ ​channel​ ​to​ ​limit​ ​pass​ ​thorough​ ​of​ ​exchange​ ​rate​ ​shocks

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Small​ ​importer​ ​will​ ​pass​ ​through​ ​100%​ ​but​ ​large​ ​importer​ ​just​ ​above​ ​50%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​This​ ​is​ ​due​ ​to​ ​offsetting​ ​movements​ ​in​ ​mark-up​ ​and​ ​marginal​ ​cost​ ​due​ ​to​ ​imported
inputs

New​ ​understanding​ ​of​ ​exporters​ ​and​ ​importers

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Exporters​ ​are​ ​bigger,​ ​more​ ​productive,​ ​pay​ ​wage​ ​premium

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Within​ ​exporters​ ​high​ ​import​ ​intensive​ ​exporters​ ​are​ ​2.5​ ​times​ ​larger​ ​than​ ​low
import​ ​intensive​ ​exporters
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Similar​ ​ranking​ ​exist​ ​for​ ​productivity,​ ​material​ ​costs​ ​and​ ​wages

Three​ ​major​ ​results

1)​​ ​ ​ ​ ​Higher​ ​market​ ​share​ ​and​ ​import​ ​intensity​ ​are​ ​key​ ​determinants​ ​to​ ​explain​ ​variation
in​ ​exchange​ ​rate​ ​pass​ ​through

a)​​ ​ ​ ​ ​Data​ ​grouped​ ​by​ ​low​ ​and​ ​high​ ​import​ ​intensity​ ​and​ ​low​ ​and​ ​high​ ​market​ ​share​ ​in​ ​a
matrix​ ​form​ ​suggest​ ​that​ ​firm​ ​with​ ​below​ ​median​ ​market​ ​share​ ​and​ ​import​ ​intensity​ ​has
high​ ​pass​ ​through​ ​coefficient​ ​of​ ​.89​ ​compared​ ​to​ ​high​ ​market​ ​share​ ​and​ ​high​ ​import
intensity​ ​which​ ​is​ ​.61

2)​​ ​ ​ ​ ​Decomposed​ ​incomplete​ ​pass​ ​through​ ​in​ ​marginal​ ​cost​ ​channel​ ​and​ ​mark​ ​up
channel.​ ​Two​ ​channel​ ​contribute​ ​equally​ ​to​ ​variation​ ​in​ ​to​ ​pass​ ​through​ ​across​ ​firms

a)​​ ​ ​ ​ ​Half​ ​of​ ​variation​ ​due​ ​to​ ​offsetting​ ​effects​ ​on​ ​marginal​ ​cost​ ​(due​ ​to​ ​stronger​ ​exchange
rates)

b)​​ ​ ​ ​ ​Other​ ​half​ ​is​ ​firms​ ​with​ ​large​ ​market​ ​share​ ​adjust​ ​their​ ​mark​ ​up​ ​more​ ​than​ ​small
firms​ ​in​ ​response​ ​to​ ​cost​ ​shocks

3)​​ ​ ​ ​ ​These​ ​results​ ​have​ ​implication​ ​of​ ​aggregate​ ​pass​ ​through

a)​​ ​ ​ ​ ​High​ ​import​ ​intensive,​ ​high​ ​market​ ​share​ ​exporters​ ​account​ ​for​ ​30%​ ​of​ ​the​ ​bin​ ​and
60%​ ​of​ ​the​ ​total​ ​exports​ ​pass​ ​through​ ​only​ ​.61​ ​of​ ​the​ ​cost.​ ​This​ ​explains​ ​for​ ​low
aggregate​ ​pass​ ​through

b)​​ ​ ​ ​ ​They​ ​are​ ​partially​ ​linked​ ​to​ ​domestic​ ​market​ ​conditions

c)​​ ​ ​ ​ ​Result​ ​–​ ​they​ ​are​ ​hedged​ ​against​ ​exchange​ ​rate​ ​fluctuations​ ​and​ ​do​ ​not​ ​need​ ​to​ ​fully
adjust​ ​the​ ​prices.

d)​​ ​ ​ ​ ​They​ ​are​ ​strong​ ​market​ ​power​ ​firms,​ ​setting​ ​high​ ​mark​ ​ups​ ​and​ ​actively​ ​vary​ ​them​ ​to
accommodate​ ​cost​ ​shocks.

Conclusion

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​International​ ​competitiveness​ ​due​ ​to​ ​euro​ ​devaluation​ ​are​ ​likely​ ​to​ ​be​ ​modest​ ​given
extensive​ ​international​ ​sourcing​ ​by​ ​major​ ​exporters.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Weak​ ​euro​ ​less​ ​impact​ ​on​ ​prices​ ​and​ ​quantities.​ ​Changes​ ​visible​ ​only​ ​in​ ​profit
margins
 BIG​ ​MAC​ ​INDEX​ ​–​ ​VALUE​ ​MEAL

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Fed​ ​decision​ ​to​ ​stop​ ​asset​ ​purchase​ ​had​ ​big​ ​impact​ ​on​ ​emerging​ ​market​ ​currency’s
slide​ ​and​ ​bullish​ ​bet​ ​on​ ​dollar​ ​grows

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Big​ ​mac​ ​Index​ ​–​ ​based​ ​on​ ​theory​ ​of​ ​purchase​ ​power​ ​parity,​ ​states​ ​long​ ​run​ ​exchange
rates​ ​should​ ​adjust​ ​to​ ​prices​ ​of​ ​identical​ ​basket​ ​of​ ​goods​ ​and​ ​services​ ​across​ ​borders

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Big​ ​mac​ ​in​ ​Norway​ ​is​ ​$​ ​7.48​ ​against​ ​US​ ​$​ ​4.56.​ ​This​ ​means​ ​that​ ​Norway​ ​krone​ ​is​ ​65%
overvalued​ ​(higher​ ​local​ ​currency​ ​depreciation)

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​USD​ ​could​ ​buy​ ​more​ ​burgers​ ​in​ ​India,​ ​Southafirca,​ ​china,​ ​Thailand​ ​etc.​ ​which
denotes​ ​these​ ​currencies​ ​are​ ​undervalued​ ​(although​ ​the​ ​labor​ ​cost​ ​is​ ​cheaper)

Currency​ ​disunion​ ​–​ ​Why​ ​Europe​ ​leader

should​ ​think​ ​the​ ​unthinkable

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Founders​ ​of​ ​Euro​ ​in​ ​thoughts​ ​of​ ​forging​ ​rival​ ​to​ ​USD,​ ​created​ ​a​ ​version​ ​of​ ​gold
standard​ ​which​ ​was​ ​abandoned​ ​long​ ​ago

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Unable​ ​to​ ​devalue,​ ​struggling​ ​countries​ ​trying​ ​to​ ​regain​ ​competitiveness​ ​by​ ​internal
devaluation​ ​(pushing​ ​wages​ ​down​ ​and​ ​prices).​ ​Result​ ​is​ ​unemployment

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Why​ ​not​ ​break​ ​up​ ​Euro.​ ​France​ ​and​ ​Germany​ ​threatened​ ​to​ ​release​ ​Greece​ ​from
Euro​ ​zone​ ​last​ ​year

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Why​ ​euro​ ​not​ ​breaking​ ​up

o​​ ​ ​ ​ ​Fear​ ​of​ ​creating​ ​economic​ ​and​ ​financial​ ​chaos​ ​on​ ​unprecedented​ ​scale

o​​ ​ ​ ​ ​Defend​ ​decade​ ​long​ ​political​ ​investment​ ​in​ ​European​ ​project

o​​ ​ ​ ​ ​Euro​ ​defense​ ​wall​ ​of​ ​euro​ ​800B​ ​would​ ​only​ ​realize​ ​500B
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Entrants​ ​to​ ​Euro​ ​break​ ​up​ ​contests

o​​ ​ ​ ​ ​One​ ​entrant​ ​–​ ​leaving​ ​euro​ ​would​ ​help​ ​troubled​ ​countries​ ​to​ ​recover​ ​quickly.​ ​Greece
can​ ​exit​ ​the​ ​euro​ ​by​ ​redenominating​ ​all​ ​deposits​ ​to​ ​drachmas,​ ​capital​ ​controls​ ​imposed,
new​ ​notes​ ​circulated,​ ​border​ ​checks​ ​and​ ​financial​ ​institution​ ​given​ ​time​ ​to​ ​update
software.​ ​Devaluation​ ​of​ ​euro​ ​for​ ​Greece​ ​would​ ​increase​ ​euro​ ​denominated​ ​debt.​ ​His
formula​ ​was​ ​depart,​ ​default​ ​and​ ​devalue.

o​​ ​ ​ ​ ​Another​ ​entrant​ ​–​ ​abolish​ ​euro​ ​as​ ​soon​ ​as​ ​Germany​ ​leaves​ ​and​ ​invalidate​ ​euro
contracts.​ ​Not​ ​to​ ​be​ ​done​ ​under​ ​secrecy,​ ​all​ ​euro​ ​contracts​ ​to​ ​be​ ​modified​ ​to​ ​new
European​ ​currency​ ​unit​ ​which​ ​is​ ​basket​ ​of​ ​national​ ​currencies

o​​ ​ ​ ​ ​Another​ ​entrant​ ​–​ ​split​ ​euro​ ​in​ ​to​ ​yolk​ ​and​ ​white​ ​(strong).​ ​Overtime​ ​yolk​ ​will
devaluated​ ​against​ ​strong​ ​white

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Conclusion​ ​is​ ​plan​ ​for​ ​worst​ ​and​ ​orderly​ ​process​ ​may​ ​salvage​ ​Europe​ ​integration
with​ ​single​ ​market.

Asia​ ​Double​ ​Hedge​ ​Currency​ ​sword

o​​ ​ ​ ​ ​Asian​ ​policy​ ​makers​ ​in​ ​dilemma​ ​over​ ​how​ ​to​ ​smooth​ ​out​ ​forex​ ​volatility.​ ​If​ ​currency​ ​is
strong,​ ​exports​ ​are​ ​affected​ ​and​ ​if​ ​its​ ​weak,​ ​would​ ​import​ ​inflation​ ​and​ ​domestic​ ​buying
power​ ​fades

o​​ ​ ​ ​ ​Singapore​ ​and​ ​South​ ​Korea​ ​had​ ​high​ ​inflation​ ​despite​ ​curbs​ ​in​ ​exports​ ​and​ ​slow
growth.​ ​Both​ ​currencies​ ​depreciated​ ​against​ ​USD​ ​in​ ​2011

o​​ ​ ​ ​ ​Japan​ ​which​ ​is​ ​reeling​ ​under​ ​deflation​ ​entered​ ​in​ ​to​ ​market​ ​to​ ​weaken​ ​the​ ​yen​ ​which
attracted​ ​attention​ ​from​ ​US.​ ​They​ ​advised​ ​Japan​ ​to​ ​improve​ ​domestic​ ​demand

o​​ ​ ​ ​ ​For​ ​US​ ​trade​ ​imbalance​ ​with​ ​Japan​ ​and​ ​china​ ​is​ ​greater​ ​concern.​ ​US​ ​can​ ​call​ ​on​ ​IMF​ ​to
impose​ ​realignment​ ​if​ ​any​ ​country​ ​manipulate​ ​the​ ​currencies.

o​​ ​ ​ ​ ​US​ ​argues​ ​that​ ​it’s​ ​in​ ​best​ ​interest​ ​for​ ​china​ ​to​ ​appreciate​ ​the​ ​currencies​ ​so​ ​that​ ​it
stops​ ​inflation​ ​and​ ​improve​ ​domestic​ ​spending​ ​power

o​​ ​ ​ ​ ​China​ ​central​ ​bank​ ​marks​ ​daily​ ​mid-point​ ​and​ ​allows​ ​variation​ ​of​ ​only​ ​1.5%​ ​variation
on​ ​either​ ​side.​ ​China​ ​intervened​ ​and​ ​depreciated​ ​renminbi​ ​even​ ​though​ ​export​ ​was
going​ ​down.

o​​ ​ ​ ​ ​Another​ ​reason​ ​is​ ​the​ ​increase​ ​in​ ​oil​ ​prices.​ ​With​ ​weaker​ ​renminbi​ ​domestic​ ​demand
for​ ​oil​ ​for​ ​would​ ​be​ ​very​ ​costly.

Switzerland​ ​abandons​ ​floating​ ​exchange

rate​ ​in​ ​dramatic​ ​currency​ ​war​ ​twist
o​​ ​ ​ ​Switz​ ​bank​ ​stated​ ​that​ ​they​ ​can​ ​no​ ​longer​ ​tolerate​ ​overvalued​ ​franc​ ​that​ ​pose​ ​threat​ ​to
Swiss​ ​economy​ ​and​ ​carry​ ​risk​ ​of​ ​deflationary​ ​development

o​​ ​ ​ ​Switz​ ​plummeted​ ​against​ ​all​ ​major​ ​currencies​ ​while​ ​yen​ ​appreciated​ ​which​ ​threatens
exporters​ ​and​ ​tip​ ​country​ ​in​ ​too​ ​deep​ ​deflation

o​​ ​ ​ ​Currency​ ​wars​ ​in​ ​cards​ ​and​ ​gold​ ​only​ ​safe​ ​haven​ ​since​ ​there​ ​would​ ​not​ ​be​ ​QE,​ ​put
capital​ ​controls

o​​ ​ ​ ​Swiss​ ​wants​ ​to​ ​buy​ ​only​ ​French​ ​and​ ​German​ ​bonds​ ​which​ ​is​ ​considered​ ​safe​ ​and
moving​ ​out​ ​of​ ​southern​ ​and​ ​northern​ ​Europe

o​​ ​ ​ ​Japan​ ​states​ ​they​ ​would​ ​intervene​ ​if​ ​US​ ​does​ ​QE.​ ​Britain​ ​is​ ​next​ ​in​ ​line​ ​to​ ​do​ ​QE

o​​ ​ ​ ​Once​ ​hedge​ ​covers​ ​expires,​ ​exporters​ ​would​ ​be​ ​exposed​ ​to​ ​weaker​ ​exchange​ ​rates​ ​in
Switzerland

o​​ ​ ​ ​Switz​ ​tried​ ​the​ ​floor​ ​strategy​ ​in​ ​1978​ ​and​ ​pad​ ​hefty​ ​price​ ​to​ ​stabilize​ ​franc

o​​ ​ ​ ​The​ ​flood​ ​of​ ​liquidity​ ​from​ ​various​ ​sources​ ​increased​ ​inflation​ ​to​ ​over​ ​7​ ​%

Default​ ​Lines
o​​ ​ ​ ​In​ ​1978,​ ​New​ ​York​ ​City​ ​came​ ​to​ ​brink​ ​of​ ​insolvency.​ ​Finally​ ​Government​ ​bailed​ ​out​ ​as
default​ ​would​ ​hurt​ ​other​ ​cities,​ ​and​ ​US

o​​ ​ ​ ​New​ ​York​ ​has​ ​to​ ​react​ ​more​ ​aggressively​ ​by​ ​imposing​ ​taxes,​ ​shedding​ ​employments,
cutting​ ​public​ ​expenditure​ ​extra​ ​and​ ​paid​ ​huge​ ​interest​ ​to​ ​federal​ ​bank

o​​ ​ ​ ​Similar​ ​question​ ​arises​ ​in​ ​euro​ ​zone​ ​as​ ​to​ ​who​ ​will​ ​assume​ ​Greece​ ​debts.​ ​Would
Greece​ ​allowed​ ​to​ ​exit,​ ​can​ ​Greece​ ​make​ ​it​ ​their​ ​own​ ​monetary​ ​system

o​​ ​ ​ ​Greece​ ​raised​ ​7,5B​ ​euros​ ​by​ ​offer​ ​coupon​ ​rate​ ​of​ ​6%

o​​ ​ ​ ​Euro​ ​zone​ ​countries​ ​has​ ​high​ ​wages​ ​and​ ​poor​ ​wage​ ​competitiveness.​ ​It’s​ ​harder​ ​to
grow​ ​and​ ​generate​ ​tax​ ​revenue

o​​ ​ ​ ​Euro​ ​cannot​ ​be​ ​devalued​ ​since​ ​it’s​ ​not​ ​an​ ​option​ ​for​ ​euro​ ​zone

o​​ ​ ​ ​Italy​ ​debt​ ​is​ ​lower​ ​than​ ​euro​ ​area​ ​average​ ​and​ ​refrained​ ​from​ ​using​ ​fiscal​ ​controls.
Ireland​ ​had​ ​tighter​ ​fiscal​ ​policy.​ ​Spain​ ​is​ ​increasing​ ​its​ ​vat.​ ​Prices​ ​are​ ​falling​ ​faster​ ​which
is​ ​sign​ ​of​ ​improving​ ​competitiveness

o​​ ​ ​ ​Even​ ​in​ ​good​ ​times​ ​Greece​ ​has​ ​unprecedented​ ​public​ ​deficit.​ ​Greece​ ​is​ ​targeting​ ​9.1%
but​ ​euro​ ​zone​ ​wants​ ​more.

o​​ ​ ​ ​Euro​ ​zone​ ​charter​ ​states​ ​that​ ​another​ ​member​ ​will​ ​not​ ​bear​ ​deficit​ ​of​ ​one.

o​​ ​ ​ ​It’s​ ​hard​ ​to​ ​imagine​ ​New​ ​York​ ​type​ ​bailout​ ​in​ ​Eurozone​ ​if​ ​it​ ​runs​ ​out​ ​of​ ​cash.​ ​Trouble
may​ ​quickly​ ​spread​ ​to​ ​other​ ​big​ ​country​ ​and​ ​fear​ ​of​ ​cut​ ​from​ ​external​ ​finance​ ​unless​ ​the
interest​ ​rate​ ​is​ ​high

o​​ ​ ​ ​Germany​ ​does​ ​not​ ​want​ ​to​ ​act​ ​alone​ ​to​ ​bail​ ​out​ ​nor​ ​does​ ​France

o​​ ​ ​ ​If​ ​strong​ ​euro​ ​is​ ​an​ ​issue,​ ​even​ ​half​ ​tarnished​ ​devalued​ ​euro​ ​would​ ​be​ ​welcomed​ ​by
people

Hide,​ ​wide​ ​and​ ​handsome

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​hawks​ ​watch​ ​the​ ​impact​ ​of​ ​QE​ ​for​ ​price​ ​stability.​ ​Central​ ​bankers
closely​ ​monitor​ ​for​ ​inflation​ ​as​ ​well.​ ​The​ ​uncertainty​ ​of​ ​the​ ​inflation​ ​is​ ​dangerous
rather​ ​than​ ​real​ ​increase​ ​itself

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Harms​ ​of​ ​inflation​ ​–​ ​bond​ ​price​ ​would​ ​increase,​ ​workers​ ​demand​ ​high​ ​wages.
Cannot​ ​reduce​ ​cost​ ​without​ ​unemployment

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Wages​ ​set​ ​annually​ ​but​ ​price​ ​of​ ​goods​ ​more​ ​fluid.​ ​Bonds​ ​and​ ​loans​ ​have​ ​fixed
in​ ​nominal​ ​terms​ ​whereas​ ​commodities​ ​and​ ​buildings​ ​prices​ ​move​ ​with​ ​inflation.
Lenders​ ​would​ ​demand​ ​premium​ ​for​ ​increasing​ ​cost.​ ​Investment​ ​and​ ​growth
would​ ​suffer

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Ways​ ​to​ ​measure​ ​inflation​ ​expectations

o​​ ​ ​ ​Customer​ ​survey​ ​–​ ​depicts​ ​uncertainty​ ​in​ ​future.

o​​ ​ ​ ​Assets​ ​that​ ​provide​ ​inflation​ ​protections.​ ​Example​ ​inflation​ ​linked​ ​government
bonds.​ ​They​ ​pay​ ​real​ ​interest​ ​and​ ​compensate​ ​for​ ​insurance​ ​at​ ​the​ ​end​ ​of​ ​the​ ​bond
term.​ ​Nominal​ ​bonds​ ​are​ ​easy​ ​to​ ​sell.​ ​If​ ​inflation​ ​increases​ ​customer​ ​would​ ​expect
higher​ ​return.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Latest​ ​survey​ ​indicated​ ​that​ ​inflation​ ​risk​ ​premium​ ​kept​ ​on​ ​increasing
showcasing​ ​uncertainty

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Hedges​ ​cover​ ​investor​ ​for​ ​inflation​ ​where​ ​seller​ ​promises​ ​investor​ ​to​ ​pay​ ​%​ ​if
inflation​ ​move​ ​above​ ​certain​ ​level.​ ​Inflation​ ​floors​ ​are​ ​mirror​ ​image​ ​of​ ​this
contract.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Information​ ​on​ ​the​ ​contract​ ​shows​ ​how​ ​much​ ​investor​ ​willing​ ​to​ ​pay​ ​to​ ​avoid
inflation​ ​and​ ​how​ ​much​ ​seller​ ​willing​ ​to​ ​accept​ ​the​ ​risk.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​2008​ ​inflation​ ​in​ ​Britain​ ​was​ ​3%.​ ​2008​ ​options​ ​pointed​ ​with​ ​90%​ ​chance​ ​that
inflation​ ​would​ ​like​ ​between​ ​1.8%​ ​and​ ​5%.​ ​In​ ​reality​ ​the​ ​range​ ​was​ ​-2.2​ ​%​ ​and
7.7%.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​The​ ​less​ ​certainty​ ​about​ ​where​ ​prices​ ​are​ ​leading​ ​is​ ​worrying​ ​factor
Inflation​ ​in​ ​India​ ​–​ ​who​ ​cares​ ​about
price​ ​of​ ​onions?

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​India​ ​has​ ​impressive​ ​record​ ​of​ ​managing​ ​inflation.​ ​Between​ ​1947​ ​and​ ​2000​ ​inflation
rose​ ​to​ ​two​ ​digits​ ​only​ ​during​ ​oil​ ​shocks​ ​in​ ​1970.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Since​ ​2009​ ​inflation​ ​was​ ​in​ ​double​ ​digits​ ​but​ ​now​ ​heading​ ​down.​ ​Whole​ ​some​ ​price
rose​ ​by​ ​6.9%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Core​ ​inflation​ ​which​ ​excludes​ ​food​ ​has​ ​been​ ​5-6%.​ ​RBI​ ​targets​ ​5%

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Industrialist​ ​and​ ​politicians​ ​cry​ ​for​ ​lower​ ​interest​ ​rate.​ ​Growth​ ​was​ ​about​ ​5%​ ​and
private​ ​investment​ ​has​ ​dried​ ​up.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Obsessed​ ​with​ ​low​ ​inflation,​ ​RBI​ ​can​ ​now​ ​slash​ ​interest​ ​rates​ ​to​ ​kick​ ​start​ ​growth

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​However​ ​RBI​ ​worried​ ​about​ ​inflation.​ ​Food​ ​prices​ ​would​ ​raise.​ ​With​ ​creeping​ ​oil
prices,​ ​it​ ​has​ ​impact​ ​on​ ​electricity​ ​tariffs.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Suppressed​ ​inflation,​ ​thanks​ ​to​ ​fuel​ ​subsidy​ ​is​ ​running​ ​at​ ​2-3​ ​%​ ​low

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​If​ ​govt​ ​wants​ ​to​ ​clean​ ​up​ ​its​ ​financials,​ ​it​ ​has​ ​to​ ​cut​ ​subsidy,​ ​which​ ​will​ ​push​ ​prices
up.​ ​RBI​ ​believes​ ​real​ ​interest​ ​rates​ ​are​ ​not​ ​that​ ​high​ ​which​ ​explains​ ​slump​ ​in
investments.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Congress​ ​government​ ​wants​ ​looser​ ​monetary​ ​policies.​ ​FM​ ​asking​ ​banks​ ​to​ ​cut
interest​ ​rate​ ​to​ ​revive​ ​demand

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Studies​ ​reveal​ ​that​ ​people​ ​are​ ​not​ ​averse​ ​for​ ​inflation​ ​but​ ​worried​ ​about​ ​slow
growth.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​With​ ​latest​ ​anti-corruption​ ​movements,​ ​public​ ​outcry​ ​on​ ​higher​ ​inflation​ ​is​ ​lowered.
The​ ​death​ ​of​ ​Inflation​ ​Targeting
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​targeting​ ​overtook​ ​exchange​ ​rate​ ​targeting​ ​during​ ​currency​ ​crises​ ​in​ ​1990.
Pegged​ ​exchange​ ​rate​ ​succumbed​ ​to​ ​speculative​ ​attacks​ ​in​ ​many​ ​countries

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Earlier​ ​to​ ​that​ ​money​ ​supply​ ​targeting​ ​was​ ​familiar​ ​however​ ​succumbed​ ​to​ ​violent
money​ ​demand​ ​shocks

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​targeting​ ​means​ ​setting​ ​target​ ​range​ ​for​ ​yearly​ ​change​ ​in​ ​CPI.​ ​Target​ ​core
inflation​ ​rate

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Set​ ​back​ ​happened​ ​in​ ​sep​ ​2008​ ​when​ ​it​ ​became​ ​clear​ ​central​ ​banking​ ​was​ ​not​ ​paying
attention​ ​to​ ​asset​ ​bubble​ ​instead​ ​over​ ​relied​ ​on​ ​IT

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​When​ ​global​ ​crisis​ ​hit,​ ​monetary​ ​policy​ ​was​ ​loose​ ​during​ ​2003-2006​ ​and​ ​it​ ​neither
preceded​ ​or​ ​followed​ ​by​ ​increase​ ​in​ ​inflation

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​IT​ ​did​ ​not​ ​respond​ ​well​ ​to​ ​asset​ ​market​ ​bubbles​ ​but​ ​neither​ ​responded​ ​to​ ​supply
shocks​ ​and​ ​terms​ ​of​ ​trade​ ​shocks.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​CPIT​ ​target​ ​tell​ ​central​ ​bank​ ​to​ ​appreciate​ ​in​ ​response​ ​to​ ​increase​ ​in​ ​world​ ​price
which​ ​is​ ​opposite​ ​of​ ​adverse​ ​shift​ ​to​ ​terms​ ​of​ ​trade.​ ​European​ ​central​ ​bank​ ​increase
rates​ ​in​ ​July​ ​2008​ ​to​ ​circumvent​ ​oil​ ​price​ ​increase​ ​rather​ ​to​ ​manage​ ​recession

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Nominal​ ​gdp​ ​targeting​ ​is​ ​favorite​ ​candidate​ ​to​ ​takeover​ ​IT.​ ​Unlike​ ​IT,​ ​it​ ​will​ ​not
result​ ​in​ ​excessive​ ​tightening​ ​in​ ​response​ ​to​ ​adverse​ ​supply​ ​shocks.​ ​Rather​ ​it​ ​will
stabilize​ ​demand.​ ​ ​Adverse​ ​supply​ ​shock​ ​is​ ​divided​ ​in​ ​to​ ​inflation​ ​and​ ​real​ ​gdp.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Nominal​ ​gdp​ ​also​ ​helps​ ​to​ ​achieve​ ​monetary​ ​expansion​ ​that​ ​is​ ​much​ ​needed

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​It’s​ ​not​ ​strong​ ​enough​ ​to​ ​bring​ ​unemployment​ ​down​ ​or​ ​restore​ ​output​ ​to​ ​potential
Inflation​ ​solution
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​considered​ ​as​ ​obstacle​ ​to​ ​investment​ ​and​ ​tax​ ​on​ ​thrifty

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​If​ ​central​ ​bank​ ​target​ ​high​ ​inflation​ ​rate​ ​it​ ​would​ ​cut​ ​real​ ​interest​ ​rates.​ ​Allowing
prices​ ​to​ ​raise​ ​has​ ​costs​ ​and​ ​benefits

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Low​ ​inflation​ ​may​ ​do​ ​more​ ​harm​ ​than​ ​good.​ ​4%​ ​inflation​ ​target​ ​would​ ​allow
aggressive​ ​monetary​ ​policy​ ​to​ ​economic​ ​shocks.​ ​If​ ​expected​ ​inflation​ ​raise​ ​by​ ​2%​ ​then
wage​ ​and​ ​interest​ ​rates​ ​would​ ​shift​ ​to​ ​match​ ​it.​ ​Higher​ ​rates​ ​required​ ​so​ ​that​ ​cuts​ ​are
possible​ ​during​ ​slumps

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Inflation​ ​creases​ ​wheels​ ​of​ ​economy.​ ​Higher​ ​inflation​ ​allows​ ​for​ ​cut​ ​in​ ​real​ ​wages.
ECB​ ​has​ ​higher​ ​inflation​ ​target​ ​then​ ​Greece​ ​and​ ​Ireland​ ​would​ ​gain​ ​competitiveness​ ​and
avoid​ ​unpopular​ ​nominal​ ​wage​ ​cuts

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Burst​ ​in​ ​inflation​ ​allows​ ​to​ ​real​ ​value​ ​of​ ​the​ ​mortgages​ ​to​ ​erode.​ ​It​ ​works​ ​on​ ​same
magic​ ​on​ ​government​ ​debt.​ ​Inflation​ ​pushes​ ​tax​ ​payers​ ​to​ ​higher​ ​limits​ ​and​ ​hefty​ ​tax
rates

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​In​ ​reality​ ​it​ ​could​ ​work​ ​different.​ ​Government​ ​debt​ ​in​ ​US​ ​reduced​ ​partially​ ​due​ ​to
inflation​ ​but​ ​primarily​ ​due​ ​to​ ​strong​ ​gdp​ ​growth​ ​and​ ​budget​ ​surplus

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Government​ ​had​ ​incentive​ ​to​ ​keep​ ​inflation​ ​low​ ​and​ ​thus​ ​bond​ ​yields​ ​and​ ​issue​ ​new
bonds​ ​to​ ​cover​ ​deficits.​ ​But​ ​it​ ​does​ ​not​ ​work​ ​in​ ​the​ ​present

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Bond​ ​holders​ ​now​ ​demand​ ​for​ ​higher​ ​rate​ ​to​ ​compensate​ ​the​ ​uncertainty​ ​in​ ​the
prices​ ​and​ ​demand​ ​for​ ​more​ ​variable​ ​returns.​ ​Health​ ​care​ ​and​ ​social​ ​security​ ​in​ ​linked​ ​to
prices​ ​so​ ​this​ ​will​ ​drive​ ​higher​ ​public​ ​spending

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​You​ ​can​ ​use​ ​inflation​ ​to​ ​transfer​ ​wealth​ ​from​ ​savers​ ​to​ ​debtors​ ​to​ ​boost​ ​spending
but​ ​there​ ​are​ ​limits.​ ​In​ ​Britain​ ​savings​ ​and​ ​mortgages​ ​are​ ​linked​ ​to​ ​short​ ​term​ ​interest
rates.​ ​Though​ ​it​ ​reduces​ ​the​ ​debt​ ​burden,​ ​it​ ​will​ ​increase​ ​the​ ​interest​ ​rates​ ​quickly​ ​and​ ​it
would​ ​not​ ​be​ ​politically​ ​popular

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Central​ ​bank​ ​worry​ ​would​ ​be​ ​how​ ​to​ ​keep​ ​bond​ ​holder​ ​calm​ ​with​ ​slight​ ​rise​ ​in
inflation.​ ​Best​ ​is​ ​to​ ​talk​ ​tough​ ​on​ ​inflation​ ​and​ ​keep​ ​interest​ ​rates​ ​low​ ​as​ ​long​ ​as​ ​possible.
Bernake​ ​is​ ​the​ ​best​ ​stimulus​ ​right​ ​now
·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​FED​ ​lowering​ ​interest​ ​rates​ ​is​ ​welcome​ ​move​ ​but​ ​with​ ​rates​ ​close​ ​to​ ​zero​ ​how​ ​far
the​ ​monetary​ ​policy​ ​can​ ​reach.​ ​Ben​ ​statement​ ​that​ ​he​ ​would​ ​do​ ​all​ ​he​ ​can​ ​to​ ​take​ ​actions
to​ ​stimulate​ ​spending

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Fed​ ​injected​ ​about​ ​$​ ​600b​ ​in​ ​to​ ​private​ ​sector​ ​to​ ​stimulate​ ​spending.​ ​But​ ​people
wanted​ ​to​ ​stick​ ​to​ ​safe​ ​assets​ ​like​ ​government​ ​issued​ ​bonds​ ​and​ ​banks​ ​reluctant​ ​to​ ​give
loans​ ​to​ ​avoid​ ​2008​ ​level​ ​issues

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​Individuals​ ​convert​ ​other​ ​securities​ ​to​ ​government​ ​issued​ ​debt​ ​and​ ​this​ ​drives​ ​the
other​ ​assets​ ​down.​ ​People​ ​not​ ​spending​ ​is​ ​the​ ​main​ ​reason​ ​for​ ​recession

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​During​ ​normal​ ​time​ ​to​ ​stimulate​ ​spending,​ ​government​ ​would​ ​by​ ​treasury​ ​bills.​ ​But
rates​ ​reaching​ ​zero​ ​treasury​ ​bills​ ​are​ ​equivalent​ ​to​ ​cash.​ ​Is​ ​it​ ​a​ ​zero​ ​sum​ ​game?​ ​Certainly
not.​ ​Fed​ ​used​ ​QE​ ​to​ ​buy​ ​other​ ​risky​ ​assets​ ​and​ ​this​ ​is​ ​what​ ​happened​ ​with​ ​$​ ​600B.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​There​ ​are​ ​different​ ​interest​ ​rates.​ ​Yield​ ​on​ ​short​ ​term​ ​government​ ​and​ ​privately
issued​ ​bonds​ ​are​ ​large​ ​at​ ​maturities.​ ​Many​ ​are​ ​eager​ ​to​ ​trade​ ​private​ ​paper​ ​for
non-interest​ ​bearing​ ​reserves​ ​and​ ​this​ ​is​ ​what​ ​FED​ ​is​ ​helping​ ​them​ ​to​ ​do

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​$​ ​600B​ ​is​ ​can​ ​be​ ​called​ ​bail​ ​out.​ ​Fed​ ​is​ ​taking​ ​all​ ​bad​ ​quality​ ​assets​ ​from​ ​the​ ​market
and​ ​providing​ ​liquidity.

·​​ ​ ​ ​ ​ ​ ​ ​ ​ ​This​ ​method​ ​is​ ​fast​ ​and​ ​flexible.​ ​In​ ​no​ ​way​ ​Ben​ ​could​ ​have​ ​put​ ​$​ ​600B​ ​in​ ​the​ ​market
in​ ​such​ ​short​ ​period.​ ​It​ ​can​ ​also​ ​be​ ​taken​ ​out​ ​faster​ ​if​ ​necessary​ ​which​ ​can​ ​come​ ​in​ ​form
of​ ​loans.