India’s fiscal mess

The Economic Times has a depressing story on the state of public finances in India:

…Expecting the fiscal deficit to come in at 4.1% of GDP for the whole of 2014-15 was widely predicted to be unrealistic, but the speed at which the gap between actual numbers and the projected figure has closed has exceeded earlier years. Last year, for instance, the fiscal deficit was around a third of the budgeted amount in the first two months of the year.

Essentially, what the government did was roll over, to the next year, payments which would have ideally come in towards the end of the previous financial year. The petroleum ministry, for instance, saw its expenditure for the first two months of this year coming in at 39% of its annual budget. In the same months of last year, the petroleum ministry had spent virtually nothing. Effectively what the government had done was delay payments of the fuel subsidy to oil companies till 2014-15. This way, it didn’t have to account for the expenditure in the previous year, resulting in a lower deficit. This way, it didn’t have to account for the expenditure in the previous year, resulting in a lower deficit. “The government left a number of expenditures uncovered,” points out Rajiv Kumar, senior fellow at the Centre for Policy Research.

Kumar points to the interesting fact that the fiscal deficit for the month of March last year was actually negative — in other words, the government received more funds into its coffers than was paid out of them for that month. “There was sharp fiscal compression in that month — more so than in earlier years,” he says, alluding to the fact that the government did not spend as much as it usually did.

March is an unusual month for government spending as the cement sector is well aware. Every March, cement consumption across the country spikes sharply. In recent years, that spike has been anywhere between 10% and 13%, but it’s followed in the subsequent month by a sharp fall. The spike is often because government departments would like to use up their budgets before the end of the financial year and binge on construction activity which was originally budgeted but failed to take off.

In contrast, in the early months of the new financial year, construction activity is slow as government budgets take time to be approved. Indeed government expenditure in March is regularly in excess of 15% of the budgeted amount for the year. In other months, the spending averages around 7-8%. In 2013 and 2014, though, the effect was more muted.

This, along with rolling over subsidy payments to the next year, helped the government push the fiscal deficit into negative territory. On the revenue side, dividend payments were sharply higher than originally budgeted for 2013-14 — by as much as 44%. “Notice also that the budgeted dividend payments by public sector undertakings [PSUs] for 2014-15 are much lower than earned in 2013-14,” says Sabnavis. Effectively the government asked PSUs to pay up higher amounts in dividends the previous financial year, with the sweetener that they wouldn’t be forced to do so again next year.

Then there is the tactic to give rosy estimates for the coming year, in order to give the markets and economists something to cheer about. Total subsidies for 2014-15 were pegged in the interim budget at just about 0.3% higher than the revised estimates for 2013-14. The government’s previous track record in managing subsidies gave little reason to believe this.

Last year, for instance, revised estimates were higher than their original budgeted amounts by 11%. Despite that experience, budget estimates were pegged at a lower level than a year before. At the same time, expectations of tax revenues are pegged at overly optimistic levels as well. All this means little fiscal room for Arun Jaitley when he presents his first budget next week.

India has enormous potential, but this story is yet another example of why India continues to fail to live up to her potential. I hope Premier Minister Narendra Modi’s new government will deliver on the promised reforms. Unfortunately given the historical experience it is hard to be optimistic.


Airport musings on India, Danish efficiency and Larry Summers

I am writing this while I am sitting in London’s Heathrow Airport (Terminal 5) after having spent a couple of days in London.

To be quite frank I think I have been suffering from a bit of writer’s block in the past couple of weeks – maybe because I have been too busy with other things, but also because I have been a bit uncertain what stories I really wanted to tell. I could of course blame Paul Krugman – after all his writings on Milton Friedman greatly upset me and I wanted to respond to Krugman’s posts on Friedman, but on the other hand I didn’t really want Krugman to dictate what I was going to blog about. So enough said about Krugman.

So now I am trying to get over the writer’s block with another round of musings.

The most interesting story – India. Unfortunately it is not positive

Since May the Indian rupee has more or less been in a free fall to the great concern of Indian policy makers who are trying hard to curb the sell-off. Anybody who has read and understood Milton Friedman’s classic article “The Case for Flexible Exchange Rates” will be able to realize that the Reserve Bank of India (RBI) is making a serious policy mistake when it is trying to curb the weakening of the rupee.

The sell-off in the rupee has likely been triggered by market fears of Fed tapering, general Emerging Markets gloom and spill-over from the Chinese growth slowdown. However, it is also clear that India is suffering from serious structural problems which have resulted in a double deficit – sizable current account and public finance deficits.

All this easily explains and justifies the weakening of the rupee. Hence, the sell-off is a natural reaction to external shocks and imbalances in the Indian economy. The Indian authorities should therefore fundamentally welcome the drop in the rupee as a natural adjustment. An adjustment that will be a lot smoother than if India had had a fixed exchange rate regime.

However, the RBI’s insistence on trying to curb the sell-off in the rupee is fundamentally an abrupt monetary policy tightening and the likely result is that Indian growth is going to take a beating.

One can of course argue that the RBI long ago should have moved to tighten monetary policy – NGDP growth clearly was excessive in 2008-10. However, the fundamental problem is the RBI’s lack of commitment to a clear and transparent monetary policy rule. The RBI’s continued extremely discretionary stop-go policies are a serious problem in terms of both macroeconomic and financial stability.

In my view the RBI should implement an NGDP targeting regime targeting 7 or 8% NGDP growth going forward (see more on that suggestion here). That would be a “tighter” monetary policy than what we have seen in recent years, but it would likely be “expansionary” in the sense that it would provide a lot more stability for the Indian economy, which likely would help boost long-term real GDP growth. Furthermore, a clear and transparent monetary policy would provide the necessary nominal stability for the Indian government to start serious structural reforms to reduce India’s large public budget deficit and to boost long-term trend growth.

Ashok Rao has a couple of very good posts on India. Ashok provides some justification for the RBI’s attempts to curb the sell-off in the rupee and he also provides some arguments why we should not become too negative on the Indian economy. I disagree with some of what Ashok is saying, but he has good arguments. Take a look for yourself (here and here).

Denmark is the most efficient economy in the world (at least in terms of airport security)

Thursday morning when I was flying to London from Copenhagen I noticed a billboard saying that Copenhagen Airport has been voted the most efficient airport in the world when it comes to airport security by something called Skytrax. I have earlier argued that efficiency in airport security is a good indicator of the overall level of regulation/efficiency in an economy.

So I guess if Skytrax is right then there might be some reason to argue that Denmark indeed is the most efficient/competitive economy in the world or at least the least regulated economy in the world. If we look at different competitive and regulation indicators Denmark actually is on the very top in the world – whether you look at the Heritage Foundation’s Economic Freedom Index, the World’s Ease of Doing Business index or the World Economic Forum’s Global Competitiveness Report.

I haven’t had time to look more at the Skytrax data, but I am pretty convinced that the Skytrax rating of airport security efficiency will be highly correlated with other measures of economic efficiency/competitiveness. Maybe, maybe one of these days I will write more on this…

Summers is not more hawkish than Yellen, but he will be massively more partisan

I have been trying to write a blog post on Summers vs Yellen, but now I will instead just state some of the conclusions here.

It is normally assumed that Larry Summers will be a more hawkish Fed chairman than Janet Yellen because he dislikes quantitative easing (as many other paleo-Keynesians). However, I think it is important to note that Summers’ preferences in terms of unemployment versus inflation certainly are not hawkish. Rather the opposite. He just thinks that fiscal policy rather than monetary policy should be used to boost aggregate demand.

Therefore, in a world where the Fed is moving toward “tapering” and in a couple of years rate hikes there is likely not a big difference between Yellen and Summers. It is only if additional “stimulus” is needed – due to for example a new negative shock – that Summers will be more hawkish than Yellen.

Furthermore, Summers is a Democrat and part of the Clinton “family”. Therefore I am fairly convinced that he will do anything to help Hillary Clinton get elected US president in 2016. Yellen on the other hand is much less likely to act as a partisan Fed chairwoman.

Now some might say that Market Monetarists have been screaming about the need for monetary easing for years so we should be happy if Summers becomes Fed chairman and actually steps up monetary easing toward the 2016 presidential elections.

That, however, would completely miss the point Market Monetarists have been making. We want a clear monetary policy rule. We don’t care about discussing monetary policy in terms of hawks and doves. We need the Fed to follow a monetary policy rule. Both Yellen and Summers are likely to be tempted to continue the Fed’s unfortunate discretionary policies.

Summers famously was on the “committee to save the world” when he with Rubin and Greenspan “saved” the world from disaster during the Asian crisis in 1997. I am extremely critical about about Summers’ abilities as a firefighter. In fact I am extremely critical about the very concept that central bankers should act as firefighters.

Central bankers should instead stop starting fires. However, I am afraid that 2014 might very well be the year where Chairman Summers will be trying to save the world from the Second Asian Crisis. Yes, I have some very deep concerns about how things will play out in Asia – with both China and India likely to make new serious policy mistakes.

PS I most of this article was written in Heathrow airport on Friday. I am now happily back home in Denmark.


Indian superstar economists, Egyptian (not so liberal!) dictators, the Great Deceleration and Taliban banking regulation – Some more unfocused musings

While the vacation is over for the Christensen family I have decided to continue with my unfocused musings. I am not sure how much I will do of this kind of thing in the future, but it means that I will write a bit more about other things than just monetary issues. My blog will still primarily be about money, but my readers seem to be happy that I venture into other areas as well from time to time. So that is what I will do.

Two elderly Indian economists and the most interesting debate in economics today

In recent weeks an very interesting war of words has been playing out between the two giants of Indian economic thinking – Jagdish Bhagwati and Amartya Sen. While I don’t really think that they two giants have been behaving themselves in a gentlemanly fashion the debate it is nonetheless an extremely interesting and the topic the are debate – how to increase the growth potential of the Indian economy – is highly relevant not only for India but also for other Emerging Markets that seem to have entered a “Great Deceleration” (see below).

While Bhagwati has been arguing in favour of a free market model Sen seems to want a more “Scandinavian” development model for India with bigger government involvement in the economy. I think my readers know that I tend to agree with Bhagwati here and in that regard I will also remind the readers that the high level of income AND the high level of equality in Scandinavia were created during a period where all of the Scandinavian countries had rather small public sectors. In fact until the mid-1960s the role of government in Scandinavia was more limited than even in the US at the same time.

Anyway, I would recommend to anybody interested in economic development to follow the Bhagwati-Sen debate.
Nupur Acharya has a good summery of the debate so and provides some useful links. See here.

By the way this is Bhagwati’s new book – co-authored with Arvind Panagariya.


The Economics of Superstar Economists

Both Bhagwati and Sen are what we call Superstar economists. Other superstar economists are people like Tyler Cowen and Paul Krugman. Often these economists are also bloggers. I could also mention Nouriel Roubini as a superstar economist.

I have been thinking about this concept for a while  and have come to the conclusion that superstar economists is the real deal and are extremely important in today’s public debate about economics. They may or may not be academics, but the important feature is that they have an extremely high public profile and are very well-paid for sharing their views on everything – even on topics they do not necessarily have much real professional insight about (yes, Krugman comes to mind).

In 1981 Sherwin Rosen wrote an extremely interesting article on the topic of The Economic of Superstars. Rosen’s thesis is that superstars – whether in sports, cultural, media or the economics profession for that matter earn a disproportional high income relative to their skills. While, economists or actors with skills just moderately below the superstar level earn significantly less than the superstars.

I think this phenomenon is increasingly important in the economics profession. That is not to say that there has not been economic superstars before – Cassel and Keynes surely were superstars of their time and so was Milton Friedman, but I doubt that they were able to make the same kind of money that Paul Krugman is today.  What do you think?

The Great Deceleration – 50% structural, 50% monetary

The front page of The Economist rarely disappoints. This week is no exception. The front page headline (on the European edition) is “The Great Deceleration” and it is about the slowdown in the BRIC economies.

I think the headline is very suiting for a trend playing out in the global economy today – the fact that many or actually most Emerging Markets economies are loosing speed – decelerating. While the signs of continued recovery in the developed economies particularly the US and Japan are clear.

The Economist rightly asks the question whether the slowdown is temporary or more permanent. The answer from The Economist is that it is a bit of both. And I agree.

There is no doubt that particularly monetary tightening in China is an extremely important factor in the continued slowdown in Emerging Markets growth – and as I have argued before China’s role as monetary superpower is rather important.

However, it is also clear that many Emerging Markets are facing structural headwinds – such as negative demographics (China, Russia and most of the rest of Central and Eastern Europe), renewed “Regime Uncertainty” (Egypt, Turkey and partly South Africa) and old well-known structural problems (for example the protectionism of India and Brazil).  Maybe it would be an idea for policy makers in Emerging Markets to read Bhagwati and Panagariya’s new book or even better Hernando de Soto’s “The Mystery of Capital – Why Capitalism Triumphs in the West and Fails Everywhere Else”

Egypt – so much for “liberal dictators”

While vacationing I wrote a bit Hayek’s concept of the “liberal dictator” and how that relates to events in Egypt (see here and here). While I certainly think that the concept a liberal dictatorship is oxymoronic to say the least I do acknowledge that there are examples in history of dictators pursuing classical liberal economic reforms – Pinochet in Chile is probably the best known example – but in general I think the idea that a man in uniform ever are going to push through liberal reforms is pretty far-fetched. That is certainly also the impression one gets by following events in Egypt. Just see this from AFP:

With tensions already running high three weeks after the military ousted president Mohamed Morsi, General Abdel Fattah al-Sisi’s call for demonstrations raises the prospect of further deadly violence.

…Sisi made his unprecedented move in a speech broadcast live on state television.

“Next Friday, all honourable Egyptians must take to the street to give me a mandate and command to end terrorism and violence,” said the general, wearing dark sunglasses as he addressed a military graduation ceremony near Alexandria.

You can judge for yourself, but I am pretty skeptical that this is going to lead to anything good – and certainly not to (classical) liberal reforms.

Just take a look at this guy – is that the picture of a reformer? I think not.


Banking regulation and the Taliban

Vince Cable undoubtedly is one of the most outspoken and colourful ministers in the UK government. This is what he earlier this week had to say in an interview with Finance Times about Bank of England and banking regulation:

“One of the anxieties in the business community is that the so called ‘capital Taliban’ in the Bank of England are imposing restrictions which at this delicate stage of recovery actually make it more difficult for companies to operate and expand.”

While one can certainly question Mr. Cable’s wording it is hard to disagree that the aggressive tightening of capital requirements by the Bank of England is hampering UK growth. Or rather if one looks at tighter capital requirements on banks then it is effectively an tax on production of “private” money. In that sense tighter capital requirements are counteracting the effects of the quantitative easing undertaken by the BoE. Said in another way – the tight capital requirements the more quantitative easing is needed to hit the BoE’s nominal targets.

That is not to say that there are not arguments for tighter capital requirements particularly if one fears that banks that get into trouble in the future “automatically” will be bailed out by the taxpayers and the system so to speak is prone to moral hazard. Hence, higher capital requirements in that since is a “second best” to a strict no-bailout regime.

However, the tightening of capital requirements clearly is badly timed given the stile very fragile recovery in the UK economy. Therefore, I think that the Bank of England – if it wants to go ahead with tightening capital requirements – should link this the performance of the UK economy. Hence, the BoE should pre-annonce that mandatory capital and liquidity ratios for UK banks and financial institutions in general will dependent on the level of nominal GDP. So as the economy recovers capital and liquidity ratios are gradually increased and if there is a new setback in economy capital and liquidity ratios will automatically be reduced. This would put banking regulation in sync with the broader monetary policy objectives in the UK.


Too easy AND too tight – the RBI’s counterproductive stop-go policies

Only a couple of days ago I was complaining that the Turkish (and the Polish) central bank(s) have been intervening in the currency markets. My complains of the Turkish central bank’s fear-of-floating and what seemed to be politically motivated monetary operations were then followed by the Brazilian central bank that hiked interest rates – officially to curb inflationary pressures, but what to me very much looked like an effort to prop up the Brazilian real.

It indeed seems like there is a pattern emerging in particularly in Emerging Markets. The latest central bank to jump on the FX intervention bandwagon is the Reserve Bank of India (RBI). This is from Reuters:

“The Reserve Bank of India (RBI) announced measures late on Monday to curb the rupee’s decline by tightening liquidity and making it costlier for banks to access funds from the central bank.

The RBI raised the Marginal Standing Facility (MSF) rate and Bank Rate each by 200 basis points to 10.25 percent, capped the amount up to which banks can borrow or lend under its daily liquidity window and announced a sale of government securities through an open market operation.

The RBI said total funds available under its repo window will be capped at 1 percent of banks’ deposits – roughly 750 billion rupees – from Wednesday. It announced a 120 billion rupee sale of government bonds for Thursday.

The central bank does not set a target for the rupee, which hit a record low of 61.21 to the dollar last week, but it does take measures to manage volatility”

It is very hard to be impressed by the RBI’s de facto currency targeting as there is hardly any economic arguments for  the RBI’s actions, but we can safely conclude whatever motivated the RBI have just implemented significant monetary tightening.

Too easy AND too tight – it’s called stop-go monetary policy

I have earlier argued that there might be arguments for tightening monetary policy in India. Hence, since 2009 nominal GDP has risen much sharper than the earlier NGDP-trend of around 12% NGDP growth.  The graph below illustrates this.

NGDP India July 2013Furthermore, there is there is nothing “optimal” about a 12% NGDP growth path. In fact I believe that the RBI if anything rather should target an NGDP growth path around 7-8% (as I have argued earlier).

The problem with the RBI’s recent actions is not necessarily the decision to tighten monetary policy per se, but rather the in fashion it is done.

The RBI’s decision has clearly not been based on a transparent and rule based monetary framework.

Hence, after years of high NGDP growth and high inflation the RBI suddenly slams the brakes. And mind you not to hit an NGDP level target or an inflation target for that matter, but to “stabilize” the currency.

The result of this currency “stabilization” might be that the RBI will be able to curb the sell-off in the rupee (I doubt it), but we can be pretty sure that the cost of this “operation” will likely be a fairly sharp slowdown in Indian real (and nominal) GDP growth. You have to choose – either you have a “stable” currency or stable macroeconomic conditions. I fear that the RBI has just sacrificed macroeconomic stability in a ill-fated attempt to stabilize the currency – at least if the RBI insist to continue the policy of FX intervention.

In a sense the RBI has been pursuing both too easy monetary policies – too high NGDP growth and inflation – and at the same time too tight monetary policy in the sense of an abrupt monetary contraction to prop up the rupee. This is the core of the problem – the RBI’s counterproductive stop-go policies.

The way forward – a completely freely floating rupee and 8% NGDP target 

In my view the RBI urgently needs give up its policy of fiddling with the currency and instead let the rupee float completely freely and instead announce an target on the nominal GDP level.

In my view the historical trend of 12% NGDP growth is too high and a lower NGDP growth target of 8% seems to be more appropriate. The RBI should hence announce that it gradually will slow NGDP growth to 8% over a five period. It is important that this should be a level target. Hence, if growth is faster than 11% in 2014 then it is important that NGDP growth will have to be even slower in the next four years. That is exactly the idea with a level target – you should not allow bygones-to-be-bygones. After 2018 the RBI will keep NGDP on 8% growth path.

Such a policy will ensure a lot more nominal stability than historically has been the case and therefore also very likely significantly increase macroeconomic stability.

Furthermore, a side effect will that the rupee likely will be more stable and predictable than under the present stop-go regime as FX volatility to a very large extent tend to be a result of monetary disorder.

A serious need for kick-starting economic reforms

There is no doubt that India seriously needs nominal stability, but there also is also a massive need for structural reforms in India. I think this story (quoted from Bloomberg) tells you everything you need to know about the extent of harmful and unnecessary government intervention in the Indian economy:

“For more than 100 years across the 19th and 20th centuries, its gnomic messages, worked into Morse code and out into language again, then delivered by postmen, connected human beings in faraway places. It announced births, marriages and deaths; called soldiers home from war or announced their demises to their families (or changed the course of the war itself); confirmed job offers or remittances to anxious and impatient souls. The voice of history whenever it was in haste, it was stoic by nature — concealing waves of emotion under its impassive, attenuated syntax — and easily available to rich and poor, in city and village.

In India, it was installed by the British as a way of administratively and militarily linking up the vast reaches of the subcontinent. But it became one of the engines of the freedom movement, a way for the Indian migrant to keep up a tenuous link to the world he had left far behind. The Indian word for it was “taar,” or wire, invoking an image more concrete than the English “telegraph.” (The “wire,” in English, was claimed by news media services.) Long after the rest of the world had moved on to more advanced technologies, the humble telegraph continued to enjoy great currency in India, before the onset of the digital revolution began to chip away at its hegemony. But the end has been in sight for some years now.

With the explosion of the mobile-phone revolution in the last decade (described recently in “The Great Indian Phone Book“), the telegraph service began for the first time to appear anachronistic. Text messages sent from mobile phones began to make the taar service seem quaint, even to rural users. This weekend, Bharat Sanchar Nigam Ltd, the state-run company that runs the system, is finally set to wind down its telegraph service for good, just as Western Union decided in 2006 that it was over for its telegrams in the U.S. Almost 16 decades after a member of the Indian public sent a telegram for the first time in 1855, the telegram will finally give up the ghost in one of its last surviving redoubts.

The Indian telegraph service still processes about 5,000 telegrams each day (most of them government notifications).

It is truly bizarre that a developing country like India until this day has continued to have a government run telegraph company, but I think it tells you a lot about how extreme the level of government intervention in the Indian economy still is.

In the 1990s growth was kick-started by a number of supply side reforms. However, over the past decade speed of reforms have been much more slower and in some area reforms have even been scaled back.

In this regard it should be noted that inflation has been stubbornly high – around 7-8% (GDP deflator) – since 2009. But at the same nominal GDP growth has slowed. This to me is an indication that while monetary policy has indeed become tighter India has also at the same time seen a deterioration of supply side conditions. The result has been a fairly sharp slowdown in real GDP growth in the same period.

I think it is quite unclear what is potential real GDP growth in India, but I think it likely is closer to 5-6% than to 8-10%. This would seems to be a quite low trend-growth given the low level of GDP/capita in India and India’s trend-growth seems to be somewhat lower than that of China.

Concluding, while a monetary regime change certainly is needed in India serious structural reforms are certainly also needed. The best place to start would be to get rid of India’s insanely high trade tariffs and generally opening up the economy significantly.

Update: s shorter edition of this blog post has also been published at See here.

India needs Market Monetarism

There is no doubt that the popularity of NGDP level targeting is increasing and with that partly also the popularity of Market Monetarism. However, as the popularity is growing so is the misunderstandings about both.

First, I would stress that while Market Monetarists advocate NGDP level targeting the two things should not be seen as the same thing. NGDP level targeting is a monetary policy advocated by Market Monetarists, but also by others – such as certain New Keynesian economists such as Christina Romer and Michael Woodford. Market Monetarism on the other is an economic school – or said in another way – it is a way to think about monetary policy and monetary theory.

Today I came across an interesting article by Niranjan Rajadhyaksha with the intriguing headline “India does not need market monetarism” that illustrates some of the misunderstandings about Market Monetarism and NGDP level targeting.

Here is from the article:

The Bank of Japan said on Tuesday that it would try to push up inflation as part of a new strategy to stimulate the economy. Such an attempt would have been met with gasps of disbelief a few years ago, when low inflation was the central quest of monetary policy. A higher inflation target is now becoming an important part of the ongoing policy debate, at least in the developed countries that are still struggling to recover from the economic effects of the financial crisis.

What has just happened in Japan is another victory for a group of economists called market monetarists, who have argued over several years that policymakers should target the nominal gross domestic product (NGDP), which is a combination of real output and inflation. Targeting nominal GDP can be contrasted with what the two main schools of macroeconomics suggest: the traditional monetarists look at money supply and the new Keynesians look at interest rate.

Well, yes it is a victory in the sense that the Bank of Japan now finally is clear on what the central bank is targeting (2% inflation). However, Market Monetarists would certainly have preferred an NGDP level target to an inflation target.

Niranjan continues:

The market monetarists once tried to be heard from the sidelines. They have since gained popularity and are now an important voice in the corridors of power. The US Fed has not yet embraced nominal GDP targeting, but there are signs that market monetarism is getting heard in that institution. Chicago Federal Reserve president Charles Evans is one important convert.

The new Bank of England governor Mark Carney is known to be sympathetic to the market monetarist cause. Japanese Prime Minister Shinzo Abe has also been talking about pushing up Japanese nominal GDP, and his influence in evident in the new Bank of Japan policy statement. All implicitly believe that a higher inflation target will goad rational consumers to spend before prices go up, thus boosting economic activity

So far so good, but again an higher inflation target in Japan is not an NGDP level target, but certainly better than the non-target the BoJ has effectively been practicing for the past 15 years.

But then it goes wrong for Niranjan:

The situation in India is very different. It is unwise to use higher inflation as an important part of any strategy for economic recovery, though there has been loose talk of allowing the Reserve Bank of India to let its unofficial inflation target rise. India already suffers from structurally high inflation. Inflation expectations seem to have drifted up in recent years. These will damage the economy in the long run.

Yet the Indian government has been following a perverse variant of nominal GDP targeting. High inflation has led to robust nominal GDP growth despite the slowdown in real output, which in turn has ensured that the burden of public debt in India has not expanded despite large fiscal deficits. Look at the numbers. Nominal growth in fiscal 2011 was 17.5%, the highest in 20 years. Nominal GDP growth has been growing faster in the four years after the global financial crisis than in the four years that preceded it. In other words, the Indian government has been inflating away its old debts, most of which are held by Indian households through the banking system.

Market monetarism and nominal GDP targeting may make sense in economies that have persistent negative output gaps and interest rates at the lower bound. India is in a different situation. It needs lower inflation to get its economy back on track.

Niranjan seems to equate Market Monetarism and NGDP level targeting with a desire for higher inflation. The fact is, however, that Market Monetarists don’t advocate higher inflation. We advocate a higher level of NGDP for countries such as the US or the euro zone where the level of NGDP is well below the pre-crisis trend level. We don’t concern ourselves with the “split” between real GDP and the price level – the only thing we concern ourselves with is the NGDP level.

Furthermore and much more importantly we are advocating a rule based monetary policy – so we are not advocating the central bank should jump from one stance of policy to another in a discretionary fashion.

In addition Market Monetarists are not “hawks” or “doves”. We are doves when the actual level of NGDP is below the targeted level of NGDP and hawks when the opposite is the case. So yes, for the US or the euro zone we might sound as “doves” in the sense that we (the Market Monetarist bloggers) have been advocating easier monetary policy to bring back NGDP “on track”. What we are arguing is not “stimulus” in a discretionary fashion, but rather a return to a rule based monetary policy.

But what about India?

From 2000 and until the outbreak of the Great Recession in 2008 Indian NGDP grew by around 12% a year. There is is obviously nothing “optimal” about that number, but lets as a starting point see that as our benchmark.

The graph below shows the actual level of Indian NGDP and a 12% growth path for NGDP starting in 2000.

NGDP India
The graph is pretty clear – actually NGDP has been running well above the 12% path in recent years. So if the Reserve Bank of India (RBI) had targeted a 12% NGDP level path then it would certainly had kept a tighter monetary stance in recent years than what actually have been the case.

Hence, the Market Monetarist advise to the RBI would be to tighten monetary policy – rather than the opposite.This illustrates that Market Monetarism is not about being “hawkish” or “dovish”. It is about advocating a rule based monetary policy and at the moment a 12% NGDP level target for India would mean that the RBI should tighten – rather than ease . monetary policy.

Therefore, Niranjan is certainly right when he is arguing that India does not need monetary easing, but that is exactly the conclusion you would reach as a Market Monetarist!

In fact I think that most Market Monetarists would think that a 12% NGDP level target for India is too high and I would personally think a long-term NGDP level target path should be around 7-8% rather than 12%.

Concluding, if the RBI had an NGDP targeting rule it would have kept monetary policy significantly tighter in recent years. The actual conduct of monetary policy in India has nothing to do with Market Monetarism. The only difference between the ECB and the RBI is that the ECB failed on the “tight side” while RBI failed on the “easy side”.

So Niranjan, you are right to worry about the RBI’s overly easy monetary policy, but don’t blame Market Monetarism. You should rather endorse it. We are with you – the RBI has failed exactly because it has not conducted monetary policy within a rule based framework and the RBI should tighten monetary policy sooner than later. And of course introduce an NGDP targeting rule asap.


PS a major advantage of NGDP level targeting compared to inflation targeting is that NGDP level targeting would “ignore” supply shocks. This is very important for an Emerging Market economy like India where headline inflation often is driven by supply shocks in the form of changes in food and energy prices.

Hence, it is well-known that most of the short-term variation in Indian inflation is driven by food prices. A strict inflation targeting central bank would react to higher inflation by tightening monetary policy – this is of course the ECB style inflation targeting regime. Contrary to this an NGDP level targeting central bank would not react to supply shock and instead just keep NGDP on track.

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