The RBI and memories of the 2008/9 central bankers panic

This is from Reuters:

The Indian rupee rallied sharply to sub 67 per dollar levels on Thursday after the central bank said it would supply dollars to oil companies through a separate window in its latest attempt to shore up the currency.

I am sure that the Reserve Bank of India is pleased with the results of their latest actions. However, it is also clear that the RBI is now conducting monetary policy on a minute by minute basis. It is pure firefighting. It is totally discretionary. The RBI has no monetary rule it follows and monetary policy target. But one thing is certain – this is monetary tightening and the result most likely will be a sharp drop in nominal and real GDP growth.  If India enters a recession (I am not forecasting that…) then you would have to blame it on the desperate tightening of India monetary policy to prop up the rupee.

The increasingly desperate actions of the Reserve Bank of India bring back memories to me of what we saw in Central and Eastern Europe in early 2009.

As the crisis was unfolding in late 2008 and early 2009 investors were scrambling for US dollars and investors were basically selling all other currencies in the universe. This was also the case for the Central and Eastern European currencies, which came under massive selling pressures as the crisis escalated.

The Latvian crisis was caused by a monetary shock

At that time most countries in Central and Eastern Europe were running sizable current account deficits. For example in the case of Latvia a current account deficit was in excess of 20% of GDP and for many other countries in the region the C/A deficits were in the range of 5-10% of GDP.

As the crisis escalated the CEE countries were basically facing a sudden stop to the funding of the current account deficits. In that situation you have to choose between either allowing your currency to drop until it is cheap enough to attract currency inflow again or you tighten monetary policy until domestic demand has dropped enough to basically close the current account gap (through a collapse in imports).

The countries operating fixed exchange rate policies – particularly the Baltic States and Bulgaria – thought desperately to maintain their pegged exchange rate regimes. They “succeed” and avoided devaluation. However, the result was a massive monetary tightening and a collapse in domestic demand. In the case of Latvia real GDP dropped in the magnitude of 30% and the crisis caused banking crisis and the country had to be bailed out by the EU and IMF. The peg was saved but the cost to the economy was enormous. Five years later the Latvian economy has still not recovered from the shock.

The 2008-9 CEE Central bankers panic

However, it was not only the countries operating fixed exchange rate regimes in Central and Eastern Europe, which panicked. In fact the central banks of Poland, Hungary, the Czech Republic and Romania also went into full-scale panic even though the officially had floating exchange rates.

A dreadful example was the Hungarian central bank’s desperate rate hike of 300bp from 8.50% to 11.50%. At the time I commented on the actions:

“Will other countries in the region follow suit and hike rates to defend their currencies? This is clearly a possibility, but we would stress that rate hikes not only have a negative impact on growth, but also on the funding costs for banks in the region – which is of course a serious problem in the present situation with a credit crunch.”

I was not impressed then and the desperate actions of the Central and Eastern European central banks in 2008 and 2009 are something I will never forget. They CEE central banks were completely focused on their sharply depreciating currencies – despite of the fact that many of these central banks officially operated floating exchange rate regime. There was a distinct fear-of-floating that caused the them to take desperate and hugely counterproductive actions.

The most shocking event (in Central and Eastern Europe in 2008/9) – in the sense of revealing central bankers incompetence – was probably the decision of the central banks of Poland, the Czech Republic, Hungary and Romania to issue a statement (actually numerous) statements that the four central banks would cooperate to to curb the weakening of the four countries’ currencies on February 23 2009.

As far as remember the whole thing was kicked off when Romanian central bank governor Mugur Isarescu  at a press conference said that the four CEE central banks would acted in coordinated fashion to curb the sell-off in the Central and Eastern Europe currencies. Within hours the Polish, the Hungarian and the Czech central banks issued similar statements.

However, there was a major problem. The statements from the four central banks had been extremely badly coordinated so the wording in the statements from the different central banks didn’t really say the same thing. In fact it seemed like particularly the Polish and the Czech central banks really didn’t think that the Hungarian and Romanian central banks were part of the deal. Hence, within hours it became clear that there really wasn’t any coordination between the four central banks other than about issuing statements that they didn’t like weaker currencies. Needless to say within 24 hours the sell-off in the four CEE currencies continued.

There is no doubt that the actions of the Central and Eastern European central banks in 2008 and 2009 to a very large extent were driven by shear panic. At the core of this panic in my view was the lack of clear commitment among the CEE central banks to a clear rule-based monetary policy. Instead of focusing on their stated nominal targets (inflation targeting and floating exchange rtes).

The Hungarian central bank’s desperate rate hike and the failed attempt at coordinated FX intervention were a clear testimony to the failures of discretionary monetary policy. The actions did not stabilise Central and Eastern European markets. They increased volatility and undermined central bank credibility and worse probably deep the economic crisis in all of the countries.

The RBI should end the stop-go policies

This should be a lesson for the Reserve Bank of India. It should forget about trying to prop up the rupee and allow it to float completely freely. Instead the RBI needs to focus on a clear and well-defined nominal target. I would prefer an NGDP target, but even a strict inflation target or a price level target would be much preferable to the RBI’s present stop-go policies.

And in that regard it should be noted that the Reserve Bank of Australia recently has allowed the Australian dollar to weaken as worries over the Asian economies have increased. The result of this strict non-intervention policy is very likely to be that the Australian economy will come through this shock much better than any of the Asian economies where central banks desperately are trying to prop their currencies.

PS Within the last 24 hours both the Brazil and the Indonesian central banks have hiked interest rates to prop up their currencies. It is discretionary monetary tightening, which will only accomplish to deepen the crisis in these countries. I am not too impressed by central bankers in Emerging Markets at the moment. I would, however, notice that the South African Reserve Bank (SARB) under the leadership of Gill Marcus is one of the few EM central banks which has not panicked in reaction to currency weakness. Good job Gill Marcus.


Prediction markets and UK monetary policy

I have long argued that central banks should utilise prediction markets for macroeconomic forecasting and for the implementation of monetary policy.

In today’s edition of the UK business daily City AM I have an oped on this topic and about how the Bank of England should have a closer look at prediction markets. See here:

IN HIS first major speech since becoming governor of the Bank of England, Mark Carney is today likely to defend a policy that has come to be described as the “Carney rule”. Also known as forward guidance, the rule effectively promises that interest rates will stay at present levels until unemployment drops below 7 per cent, so long as the Bank’s inflation forecast does not top 2.5 per cent.
This kind of forward guidance is welcome news for the financial markets. We will now at least have some sort of map to navigate monetary policy, instead of relying on insinuations from the lips of the wise men on the Monetary Policy Committee (MPC).
But this still leaves markets at the mercy of the Bank of England’s internal forecasters, whose credibility can certainly be questioned. The Bank doesn’t need to be biased to consistently predict that it will hit its inflation target, for example (though what institution would forecast that it will fail?). Even with the best incentives, it cannot possibly bring together all the private knowledge spread across investors, firms and households.
It is this inability of elite central planners to gather such a wide source of information that led even committed Marxist GA Cohen to agree that markets may be necessary for a rational economic system. No individual, however intelligent, can know enough about the economy to make a really reliable prediction about it.
And it’s not just the dragging-together of information from thousands of different sources that makes market predictions more accurate than those made by small elite groups. Investors betting in markets have skin in the game; they have an extremely strong incentive to get their bets right, since they will lose money for bad (inaccurate) bets and win money for good (accurate) ones.
Read the rest of the piece here.
And Mark Carney is lucky that he now in fact has a prediction market to look at. This is from a press release from the Adam Smith Institute:

Today we’ve launched two betting markets to try to use the ‘wisdom of crowds’ to beat government economic forecasters….The Bank of England’s economic forecasts have been wrong again and again. To counter this, the free market Adam Smith Institute is today (Wednesday 28th August) launching two betting markets where members of the public can bet on UK inflation and unemployment rates, taking the government’s experts on at their own game. The markets are designed to aggregate individual predictions about the economy’s prospects to use the ‘wisdom of crowds’ to beat the predictions of government experts.

The launch coincides with Mark Carney’s first major speech as governor of the Bank of England and follows his announcement earlier this month that the Bank will consider both inflation and unemployment when deciding monetary policy.
Read more here.
It will extremely interesting to follow how this prediction market will work and it will obviously be very interesting to see how it will impact the monetary policy debate in the UK. My hope certainly is that it will help the case for market-driven monetary policy implementation and also help “police” the Bank of England’s forecasts.

The Danish Centre for Military Studies on Syria

If I were to write a blog post on Syria I would write about the law of unintended consequences, but I am not going to do that. Instead have a look at this paper from the Danish Centre for Military Studies on “Syria’s Military Capabilities and Options for Military Intervention”.

Here is the abstract:

Centre for Military Studies presents this background paper on Syrian military capabilities, the implications for potential military intervention by other states, as well as scenarios for potential Danish military contributions.

The purpose of this paper is to briefly describe military capabilities and options in order to provide a factual background for the ongoing discussion on possible military intervention in the Syrian conflict and Denmark’s possible participation in such a conflict.

This background paper includes a short description of Syria, to set the grounds for understanding the population and military context. The paper argues that Syria is in many ways similar to Iraq and Libya, where the international community has intervened in various ways. To understand the Syrian military and its capabilities and what kind of military a possible intervention force might face, this paper summarizes its structure and capabilities, by taking a closer look at all three branches of the Syrian Military and paramilitary.

On the basis of this summary, the paper proposes two distinct scenarios for military intervention by state coalitions;

1. Operation Thunderstorm: Military intervention based on an intensive air campaign and the use of technologically superior air power, which will reduce the adversary factor to between 1:2 – 1:4,

2. Operation Dust Storm: Military intervention based on a two-step approach, this being a land and amphibious invasion with corps-level units sent from naval task forces and bases in Turkey, preceded by an intensive air campaign.

The paper concludes with a short summary of the possible options for Danish support from all three branches of the military.

The Danger of an All-Powerful central bank – against macroprudential policies

I have often disagreed with the views of University of Chicago Professor John Cochrane over the paste five years. However, his latest oped in the Wall Street Journal is spot on.

In the oped Cochrane questions the rational for the increasingly common view that central banks should pursue “macroprudential” policies to reduce the risks in the financial sector.

This is Cochrane:

Interest rates make the headlines, but the Federal Reserve’s most important role is going to be the gargantuan systemic financial regulator. The really big question is whether and how the Fed will pursue a “macroprudential” policy. This is the emerging notion that central banks should intensively monitor the whole financial system and actively intervene in a broad range of markets toward a wide range of goals including financial and economic stability.

For example, the Fed is urged to spot developing “bubbles,” “speculative excesses” and “overheated” markets, and then stop them—as Fed Governor Sarah Bloom Raskin explained in a speech last month, by “restraining financial institutions from excessively extending credit.” How? “Some of the significant regulatory tools for addressing asset bubbles—both those in widespread use and those on the frontier of regulatory thought—are capital regulation, liquidity regulation, regulation of margins and haircuts in securities funding transactions, and restrictions on credit underwriting.” 

This is not traditional regulation—stable, predictable rules that financial institutions live by to reduce the chance and severity of financial crises. It is active, discretionary micromanagement of the whole financial system. A firm’s managers may follow all the rules but still be told how to conduct their business, whenever the Fed thinks the firm’s customers are contributing to booms or busts the Fed disapproves of.
I completely agree with Cochrane.

Macroprudential policies might very well develop into ad hoc and completely discretionary policies rather than a rule based monetary and financial policy regime. That is certainly not the direction we would like to see monetary policy move.

Cochrane continues:

Macroprudential policy explicitly mixes the Fed’s macroeconomic and financial stability roles. Interest-rate policy will be used to manipulate a broad array of asset prices, and financial regulation will be used to stimulate or cool the economy.

I think this is an extremely important point to make. The purpose of monetary policy is to provide nominal stability – either in the form of an inflation target, a price level target or an NGDP target and fundamentally the central bank basically only have one instrument to hit that – increasing or decreasing the money base. It is the Tinbergen rule – one policy instrument, one policy target. It is Econ101.

If the central bank starts to take into account macroprudential “targets” then it would have to put aside other targets. A good example of this kind of “mixed message” in monetary policy has been the conduct of monetary policy in Sweden in the last couple of years where the Riksbank increasingly has focused on macroprudential indicators – for example property prices and household debt – in the conduct of monetary policy.

The result has been that Swedish monetary policy has been tighter than it otherwise would have been if the Riksbank had only focused on it’s official inflation target. The result has likely been that Swedish unemployment is higher than it would have been if the Riksbank consistently pursued its official inflation target and there is very little – if any – evidence that the Riksbank’s policy has increased financial stability in Sweden.

In fact in a recent paper former Riksbank deputy governor Lars E. O. Svensson shows “that a higher policy rate leads to a higher debt ratio, not a lower one. This result may be surprising to some, at least at the Riksbank, which has apparently made a sign error in its assumptions. The result is actually quite easy to understand once one carefully considers how debt, GDP and inflation are affected by a higher policy rate.”

I think Svensson’s paper quite clearly shows the dangers of having macroprudential policy dominating monetary policy making.

Central banks have a lousy track-record on detecting “bubbles”

Back to Cochrane:

It’s easy enough to point out that central banks don’t have a great track record of diagnosing what they later considered “bubbles” and “systemic” risks. The Fed didn’t act on the tech bubble of the 1990s or the real-estate bubble of the last decade. European bank regulators didn’t notice that sovereign debts might pose a problem. Also, during the housing boom, regulators pressured banks to lend in depressed areas and to less creditworthy customers. That didn’t pan out so well.

Yes, markets are often wrong, but there is very little (no) evidence that central bankers are better at diagnosing “bubbles” and “systemic” risks. Hence, it is not a question whether markets are good or bad at forecasting bubbles. The question is whether regulators better than market participants in spotting bubbles?

It is also correct that moral hazard problems might mean that private investors will ignore or downplay risks and that is an argument for certain regulations of the financial sector. However, my own personal experience is that regulators often are extremely reluctant to utilize their regulatory powers when it is “obvious” that there is a bubble of some kind.

In 2006 I co-authored a paper forecasting a major macroeconomic and financial crisis in Iceland and in a number of papers in 2007 I made similar warnings about the risks to the Baltic economies. Unfortunately the warnings turned out to be correct. The “crash” predictions were essentially based on macroprudential analysis and in that sense one can of course say that this shows the effectiveness of macroprudential analysis. Macroprudential analysis have long also indicated that something could go badly wrong in India – however, the Reserve Bank of India has done little if anything to act to avoid these risks neither has the Indian government.

Even though I thought it was quite obvious that both the Icelandic and the Baltic economies were heading for a major crash the local regulators in both Iceland and the Baltic States were extremely hostile towards these warnings and they completely failed to act before it was too late. In fact the regulators in more than one case acted as “cheerleaders of the boom” rather than defenders of financial and macroeconomic stability. This of course added to the feeling among investors that nothing could go wrong.

Hence, even if macroprudential analysis can in fact diagnose “bubbles” and systemic risks it is in no way given that that will lead regulators to take the right actions (never forget the Iron Law of Public Choice). The Icelandic crash is sad testimony to that. So is the Baltic crisis.

Cochrane’s policy advice  

Cochrane has good policy advice:

First lesson: Humility. Fine-tuning a poorly understood system goes quickly awry. The science of “bubble” management is, so far, imaginary.

Consider the idea that low interest rates spark asset-price “bubbles.” Standard economics denies this connection; the level of interest rates and risk premiums are separate phenomena. Historically, risk premiums have been high in recessions, when interest rates have been low.

…Second lesson: Follow rules. Monetary policy works a lot better when it is transparent, predictable and keeps to well-established traditions and limitations, than if the Fed shoots from the hip following the passions of the day. The economy does not react mechanically to policy but feeds on expectations and moral hazards. The Fed sneezed that bond buying might not last forever and markets swooned. As it comes to examine every market and targets every single asset price, the Fed can induce wild instability as markets guess the next anti-bubble decree.

Third lesson: Limited power is the price of political independence. Once the Fed manipulates prices and credit flows throughout the financial system, it will be whipsawed by interest groups and their representatives.

Hear, hear…Cochrane is right – central banks need to return to rule based monetary policies. Macroprudential policies on the other hand might risk moving us away from rule based policies and towards a regime where central bankers become firefighters.

PS I am not arguing that macroprudential analysis cannot be useful. It can be a good tool for market participants and (non-central bank) regulators, but monetary policy should focus on ensuring nominal stability. Nothing else.

PPS If central bankers really need a good macroprudential indicators then the best indicator might be to look at the growth and level of nominal GDP.

The Angell rule – a market approach to monetary policy

I have for some time had the idea that Federal Reserve thinking in the second half of the 1980s and the early part of the 1990s was dominated by a view that in many ways resembles Market Monetarist thinking. Here especially Wayne Angell and  Manuel “Manley” Johnson played an important role. Johnson was on the Fed’s Board of Governors from 1986 to 1990, while Angell served on the Board of Governors from 1986 until 1994. Both had been appointed by President Reagan. You can think of them as the original Supply Side Monetarists.

Like Market Monetarists Angell and Johnson believed (and still do as far as I can judge) that the best way to judge the monetary policy stance is by observing the price action in financial markets. Angell particularly stressed commodity prices as an indicator of monetary policy, while Johnson advocated looking at a broader range of financial markets – ranging from commodity and equity prices to the exchange rate and the yield curve.

Johnson explained his unique take on monetary policy in his excellent book Monetary Policy, A Market Price Approach, which he co-authored with Robert Keleher. See more on Keleher’s and Johnson’s thinking here.

The Angell rule

A couple of days ago I came across an interesting paper by Wayne Angell from 1991. In the paper – “Commodity Prices and Monetary Policy – What Have we Learned?” from 1991. In the paper Angell spells out his thinking about commodity prices as forward-looking indicators of the monetary policy stance. Angell is quite clear that both interest rates and monetary aggregates are quite imperfect indicators of the monetary policy stance.

While reading the paper I got the idea that Angell not only spelled out an idea about how to conduct monetary policy, but maybe he was also describing actual US monetary policy during the years while he was at the Fed. In his paper Angell basically is saying that the Fed should ensure price stability and to achieve that should use commodity prices (among other things) as an indicator of future price pressures.

Hence, effectively Angell was suggesting that the Fed should follow a rule for the money base where the money base is increased or decreased dependent on the development in commodity prices.

Looking at the development in the money base during the time Angell was at the Fed it surely looks like this is effectively was the policy the Fed actually followed. Just take a look at the graph below.

Angell rule

You don’t need advanced econometric studies to see that there is a pretty clear relationship.

As commodity prices (the CRB Index) drop the Fed reacts within some quarters by expanding the growth rate of the money base. This is for example the case from 1984 to 1987 and again from 1989 to 1993.

Hence, the Fed de facto seems to have changed the monetary policy stance based on the signals from financial market data. This is pretty much in line with general Market Monetarist recommendations. However, it should of course be remembered that while Market Monetarists advocate NGDP level targeting Angell effectively favours Price Level Targeting (“Price Stability”).

Furthermore, this is also the period in Fed history where the Fed move toward what Bob Hetzel has termed a Lean-Against-the-Wind with credibility policy. Angell again and again has stressed the need for a rule based monetary policy rather than a discretionary monetary policy.

The lesson we should learn from the Angell rule is not that we should reintroduce the the Angell rule – at least not in the sense that we should use only commodity prices as an indicator of the monetary policy (Angell never argued that), but that market prices are excellent indicators of the monetary policy stance. This is of course also why we need a proper NGDP futures markets, which the Fed could utilize in the conduct of monetary policy.

Maybe the Brazilian central bank should give Mike Belongia a call

Central banks from India to Turkey and Brazil these days seem to completely have lost track of their objectives – jumping from one objective (inflation targeting) to another (exchange rate targeting) and back. Confusion rules.

Maybe they should take a bit of advice from Mike Belongia. This is Mike in a piece from Public Choice in 2007:

“Transparency,” as it applies to the conduct of monetary policy in the United States, appears to be like pornography in the sense that it defies objective definition. In general, however, a transparent framework would include at least these elements: A well-defined statement of monetary policy’s goals, the enunciation of an economic model by which the central bank’s ultimate goal variable(s) is determined and the announcement of which policy levers (instruments) the Federal Reserve has chosen to manipulate in its pursuit of a policy objective(s). With an understanding of these three components of monetary policy, it can be argued, the public would have a clear idea of what the Fed is trying to accomplish and how it intends to achieve the goal(s) it has identified. In the absence of information about any of these of three components of monetary policy, however, the Fed becomes less a policy institution that serves the public and more like a Wizard of Oz figure who operates behind a curtain of secrecy and asks the public to trust it with blind optimism.

It is not more complicated than that. Unfortunately 7 years later the Fed has still not really defined its policy objective or its policy instrument and I am beginning to doubt that the central banks of India, Turkey and Brazil even know what they are trying to achieve with the use of multiple odd instruments. It is depressing…

The Bird fight – Yellen vs Summers

I have co-authored a paper on Yellen versus Summers with my Danske Bank colleagues Signe Roed-Frederiksen, Kristoffer Kjær Lomholt and Mikael Olai Milhøj. This is the abstract:

Fed chairman Ben Bernanke’s second four-year term expires on 31 January 2014 and his successor needs to be vetted by Congress before then. Although a dark horse cannot be ruled out, there are two clear candidates: Lawrence Summers and Janet Yellen. The debate of who is the most suited successor to Big Ben has been surprisingly little about the candidate’s economic views and the level of innuendo has been a US presidential campaign worthy. The US economy is on the path to recovery and it is now as important as ever how the new chairman plans to run future US monetary policy. This paper discusses the differences in economic policy of Yellen and Summers and in particular if it is fair to call Yellen the most dovish of the two.

Our conclusions are as follows. We believe that the characterisation by the media of Lawrence Summers as being more hawkish than Janet Yellen is too simplistic. In fact we argue that Summers and Yellen are equally dovish when economic conditions improve, since they both have a very strong aversion to unemployment relative to inflation. It is first when the US is hit by a negative demand shock while interest rates are at the zero lower bound that Summers is likely to be more hawkish than Yellen. This is due to Summers’s open scepticism towards alternative monetary stimulus instruments such as QE – a scepticism not shared by Yellen.

We point out the importance of a transparent Fed and we believe that Yellen would support this transparency. On the other hand, Summers’s flamboyant personality together with his comments that he will be a fire-fighting Fed chairman indicate that the Fed would become less transparent if he was to be chosen by Obama.

Read the rest of the paper here.

Helmut Reisen on the “China as monetary superpower” hypothesis

I have in a number of blog posts argued that China is a global or at least an Asian monetary superpower, which is exporting monetary tightening across Asia.

In a new very good blog post the former head of research at the OECD’s Development Centre Helmut Reisen discusses this hypothesis:

Usually, the current travails in emerging markets are blamed on expectations of slowing open market purchases by the US Federal Reserve System. Lars Christensen, head of emerging market research at Danske Bank, however, blames China´s monetary tightening as at least as important as the expected US Fed ´tapering´.  I have myself, with former colleagues, pointed to the growing impact that China´s growth has exerted since the last decade on GDP growth in middle- and low-income countries[1], pointing to the growing raw material, trade and production links of increasingly China centric emerging countries. So I shall have a lot of sympathy for Lars Christensen’s earlier proposition that China has also grown into a monetary superpower in a Sino monetary transmission mechanism with the rest of Asia. China´s monetary tightening, however, can hardly explain the current slump in Asian markets, on closer inspection.

So I nearly got Helmut convinced, but not quite. Here is Helmut again:

First, let us consider  the expected monetary stance in the US and in China. Graph 1 clearly shows that the market has formed expectations since May that the Fed would not continue open market purchases at the pace witnessed over the last years, partly fueled by Bernanke´s taper talk that month to US Congress. China´s monetary tightening, by contrast, occurred during late 2010 to early 2012 from when the Bank of China[2]. Since then, minimum reserve requirements were repeatedly reduced. Further, the PBC reduced its benchmark deposit and loan rates in June 2012. In addition, the PBC has also used a mix of monetary policy instruments to appropriately increase market liquidity. Even considering huge time lags, the current turmoil of Asia stock and bond markets cannot be blamed on China´s monetary tightening.

Hence, Helmut’s argument is that this is mostly caused by the Fed rather than by the People’s Bank of China. I do not disagree that the discussion of Fed tapering is having a negative impact on market sentiment in Asia. My view is just that that is not the whole story. China remains very important.

Furthermore, this is a good illustration of the Market Monetarist view of how to “measure” the monetary policy stance. While Helmut stresses that the PBoC has cut reserve requirements and interest rates recently Market Monetarists would instead focus on what markets are telling us about the monetary policy stance.

This discussion of course is similar to what happened in the euro zone and the US in 2008. Did the Fed ease or tighten monetary policy? Well, despite cutting nominal interest rates inflation expectations plummeted as did expectations for NGDP growth. That was indeed monetary tightening. And if we had good indicators for NGDP growth or inflation in China I would expect them to indicate a continued tightening of the Chinese monetary policy stance did the cut in official interest rates and reserve requirements.  The best market indicators for Chinese NGDP growth are probably copper and the Aussie dollar – and the Chinese stock market.

Hence, judging from for example the Chinese stock market monetary conditions have not become easier. Rather the opposite. And if the PBoC really had eased monetary conditions the Renminbi would have weakened significantly – it has not.

Furthermore, I would argue that communication about future changes in the money base is at least – in fact more – important than present changes to for example reserve requirements or interest rates. Hence, the communication from the Chinese authorities over the last couple of months has been decisively hawkish and if one wants to forecast the future path of the money base or the money supply in China one surely would have to conclude that the PBoC now plans a much slower rate of growth in the money supply than market participants had expected only a few months ago.

Furthermore, the PBoC’s rather clumsy handling of money market distress back in May-June left the impression that the Chinese authorities were quite happy about the impact it had on parts of the Chinese banking sector. In fact the turmoil gave reason to question that the PBoC really would act as lender-of-last-resort. That in my view was a very clear signal that the PBoC was quite happy with monetary conditions becoming tighter.

So yes, the PBoC has eased reserve requirements and cut official interest rates, but given the PBoC’s continued hawkish rhetoric market participants are not seeing the PBoC’s monetary policy stance becoming more accommodative – rather the opposite and judging from market pricing monetary contraction continues in China. That is having a clearly negative impact on the financial market sentiment across Asia.

That of course does not mean that Fed tapering is not important for what is going on in Asia at the moment. I think it is very important and it is for example clear that the sell-off in the Asian markets accelerated further this morning after the release yesterday of minutes from the latest FOMC meeting.

My point is just that the Fed is not the only monetary superpower in the world. The PBoC is also tremendously important. And on that I think Helmut and I are in total agreement.

Reserve Bank of India and the Tinbergen rule: Please end the stop-go policies!

It is hard to keep track of the direction of monetary policy in India. This is from Bloomberg this morning:

Indian (SENSEX) stocks climbed for the first time in four days, led by the biggest rally in financial shares since 2009, after the central bank said it will buy government bonds to combat surging borrowing costs.

So now the Reserve Bank of India (RBI) is effectively doing quantitative easing. Meanwhile this is also from Bloomberg not long ago:

The Reserve Bank of India on July 22 made it mandatory for importers to set aside 20 percent for re-exports as jewelry. The measures to moderate demand boosted the premium that jewelers pay to importers to about $10 an ounce over the London spot price from as low as $4 a week earlier, according to the the All India Gems & Jewelry Trade Federation.

Hence, RBI stepped in to curb the buying of gold by Indians to stop the sell-off in the rupee. That of course was monetary tightening.

The truth is that RBI is trying to do everything at the same time—ease monetary policy to push down yields, tighten monetary policy to curb the sell-off in the rupee, while at the same time trying to curb inflation by tightening monetary policy and easing monetary policy to spur growth. Confused? Not as much as the RBI…

It is about time that somebody reminds the RBI about the Tinbergen Rule: For each and every policy target there must be at least one policy tool. If there are fewer tools than targets, then some policy goals will not be achieved.

The only thing RBI fundamentally can do is to control the money base to hit one nominal target. Therefore, it is also about time that RBI comes clean on this.

RBI can only hit one target (with one instrument). That target in my view should be a nominal gross domestic product (GDP) target, but the most important thing now is that RBI just announces one nominal target—be it an inflation target, a price level target or a nominal GDP target.

RBI should immediately end the attempts to distort financial prices—whether in the fixed income or the currency market. Leave it to the markets to determine the prices in the fixed income markets and the currency markets.

If RBI is concerned about the heightened volatility in the Indian financial markets it should at least stop creating volatility on its own. The best way of doing this of course is to announce a clear rule-based monetary policy.

There is only so much monetary policy can do. Monetary policy is extremely effective when it comes to hitting a nominal target, but monetary policy cannot do much about India’s other problems—for example the major public finance problems. The Indian government has to take care of that problem.

PS One can of course fear that RBI will not give up on trying to hit more than one target. Then it, however, will need more policy instruments. Normally this would be capital and currency controls. God forbid the RBI will venture down that road.

This post has also been publlished at

The Second Asian Crisis? Feeling the impact of Chinese monetary tightening

This is from Bloomberg this morning:

Asian stocks fell for a fourth day after U.S. Treasury yields reached a two-year high. Currencies from Malaysia to Thailand declined amid an emerging market exodus that’s seen investors withdraw $8.4 billion from exchange-traded funds this year.

…Indonesia’s Jakarta Composite Index dropped 3 percent, taking a four-day rout beyond 10 percent…Malaysia’s ringgit decreased for a seventh day, and the Thai baht fell 0.8 percent.

…Asian economies are struggling to ignite growth.

…Five stocks fell for every three that gained on the Asia-Pacific index. Real estate and construction firms led declines in Jakarta where the benchmark index tumbled as much as 20 percent from a high in May.

China’s economy, No. 2 in the world, has been slowing for the past two quarters. Indonesian shares led declines in emerging Asian markets yesterday, sliding 5.6 percent, after data showed the current-account deficit widened to a record last quarter. A report this month also showed the economy grew less than 6 percent for the first time since 2010 in the second quarter.

…Foreigners sold a net $3 billion of Indian stocks and bonds in July amid the slowest growth in a decade in Asia’s third-largest economy, according to data compiled by Bloomberg. The rupee slid to a record low yesterday and 30-day volatility on the CNX Nifty Index touched the highest level since April 2012.

…Thailand’s SET Index dropped 3.3 percent yesterday, the most in two months, after a report showed the economy unexpectedly shrank in the second quarter, pushing the country into a recession. The government also cut its growth forecast.

It is hard to feel optimistic about growth in Asia when you read this kind of thing.

In the article the market turmoil is blamed in Fed “tapering”, but I would suggest that Chinese monetary tightening is at least as important. Hence, China is as I have argued earlier the monetary superpower of Asia and Chinese monetary tightening weigh heavily on the Emerging Asian currencies. If the “local” central banks try to fight the currency sell-off then they are automatically importing monetary tightening from China causing growth to slump. The slump in the local stock markets is an indication that this is in fact what is partly happening.

The good news is that we are in fact seeing currencies weaken across Asia – that is softening the blow from the “China shock” . The bad news is that Asian central banks in general has been fighting the currency sell-off by hiking interest rates, intervening in the FX markets and by introducing all kinds of draconian currency controls. All that is likely hit growth across the region. And yes, I am quite nervous about new cases of monetary policy failure, where local policy makers in their attempts to curb the currency sell-off end up doing more bad than good. Just take a look at stop-go policies of Bank Indonesia and the Reserve Bank of India over the past two months.

The best way to shield the Asian economies from the negative impact of Chinese monetary tightening and fed tapering is to let currencies float completely freely and to the extent necessary letting the currencies weakening. Trying to fight the currency sell-off with monetary tightening is the recipe for setting of the Second Asian Crisis. As long as the impact of the Chinese monetary tightening continues Asian policy makers have the choice between weaker currencies or lower growth.  You cannot have both in the present situation.

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