Zombie Economics:How Dead Ideas Still Walk Among Us
By John Quiggin
Princeton University Press
Economist John Maynard Keynes said ideas of economists, when they are right or wrong, are more powerful than is commonly understood, “indeed the world is ruled by little else”. Quite prophetic. And John Quiggin will have you believe the same in Zombie Economics. He shows how these incorrect ideas or the proverbial ‘zombies’ keep getting resurrected to outlive their originators. Which are these ideas? The great moderation, efficient-market hypothesis, concept of dynamic stochastic general equilibrium (DSGE), trickle-down theory and privatisation are the esoteric ideas that had dominated our cerebrum for years and need to be discarded given the havoc they caused. They come under different garbs — Thatcherism, Reaganism or simply market liberalism. But they have been unequivocally inappropriate solutions.
In the light of the recent financial crisis, Quiggin indulges in some exfoliation of their logic with impunity, which is largely entertaining, though one-sided. The reader may not agree with him as, at times, his examples are selective.
The great moderation, made popular by Ben Bernanke, currently chairman of the US Federal Reserve, was an eyewash, which created a delusion that the business cycle was dead and growth was there to stay. Policies were formulated to support this feeling. It led to Ponzis being created by making capital cheap. When momentum was created, they came in as those deadly, exotic derivative products.
Quiggin is even harsher when it comes to the efficient markets hypothesis, where prices embed all possible information in a perfect manner. As this can never be so, markets have to be inefficient. But then all other fancy models such as the Black-Scholes pricing of options or capital asset pricing model are based on premises that turned catastrophic. With a wry twist of humour, he talks a lot on the concept of the ‘Greenspan put’, named after Alan Greenspan, which is an interesting ‘option’ where markets are bailed out in case of financial failure.
The third zombie idea is the DSGE model. Quiggin takes us through vintage theory from Say’s law to new classical economics, which is déjà vu stuff. His contention, however, is we cannot elevate micro-economic theories to the macro level. The DSGE models did not quite provide solutions and every crisis invariably had us turn back to Keynes for a solution as they understated the crisis until it hit us hard.
The trickle-down theory, another bastion of economic liberalism, is a mirage, and we should not be carried away by the goodies that are accessible to the poor. Theory says if we concentrate on efficiency, equity would automatically follow in the long run. But taxes fall on wage earners as the rich do not consume all their income and consumption taxes are high. While the rich benefit from zero or low capital taxes, the poor lag in healthcare, education and social cohesion as governments spend less. Not unsurprisingly, income inequality has increased in the past four decades with the income of the top echelons multiplying several times, while those below have witnessed only marginal increases.
Privatisation is the last zombie, which was part of Thatcherism in the 1980s. The idea was to collect funds by selling government companies on grounds of efficiency. Government’s role was relegated to being a provider of public services and the fall of the Soviet bloc and the beginning of the Washington Consensus only supported this zombie idea. This served everybody; public servants got better-paid jobs, while private entrepreneurs are able to buy cheap and then sell dear. Quiggin calls it a policy in search of a rationale. The ultimate irony was when the financial crisis led to the re-nationalisation of capitalist enterprises such as Citigroup, Bank of America and General Motors.
How then do we put these pieces together? The book works on the premise that risk managed by financial markets under economic liberalism outperforms the government, leading to optimal solutions that create the illusion of great moderation. This had the DSGE models inbuilt, which was supported at the micro level by the efficient-markets hypothesis. Privatisation was at the heart of this ideology where the entire model was reinforced by the trickle-down theory. Alas, the financial crisis dealt a big blow to this structure, and it is time for us to review it, and probably go back to the government and Keynes.
Sunday, May 1, 2011
Not for the 9th time: Financial Express: 29th April 2011
Ever since we embarked on the path of fine tuning monetary policy last year, meaning eight such announcements, a lot has been said every time about what RBI should or should not do. Fiscal year 2011 was quite unique in the sense that it has thrown up a lot of surprises. Inflation has been an enigma that we just could not understand and several theories that popped up did not stand the test of time. We spoke of food
inflation but agricultural production has reached a peak this year. We are now talking of core inflation rising, i.e., non-food and -fuel inflation. But aren’t commodity prices, such as those of metals, moving up increasing the prices of manufactured goods? And if core inflation is the issue, then we should be seeing excess demand forces somewhere. But, is this visible?
This is critical because the policy to be announced on May 3, 2011, is for the year, and RBI will be giving direction on both GDP and inflation targets. While these are not sacrosanct numbers, they would indicate to a large extent the course of likely action by RBI during the year, which is more important. An inflation target of, say, 5%, which has been the convention so far, will mean that RBI will keep increasing interest rates until such time that the number comes down to this level. On the other hand, if it is in the region of 6-7%, then maybe we can expect a pause as the present inflation number will come down gradually.
The other issue is, of course, GDP growth. Normally, the targeted range has been between 8-9% and given that the Planning Commission is looking at higher numbers from FY13
onwards, RBI will have to strike a balance between such optimism and the pessimistic numbers rolled out by private agencies, which are looking at the range of 7-8%.
Therefore, the announcements made in this credit policy will be crucial as it will once again be all about interest rates. RBI has increased rates eight times since last March but the impact on inflation has been limited (Chart 1). The prices of primary products have shown an uneven trend, while those of manufactured goods have increased in the last few months. Higher interest rates have certainly maintained the level of ‘real interest rates’ and protected deposit holders and other returns on debt instruments quite well. The question is whether we have reached an inflection point after which further rate hikes will impede growth. This is pertinent because if increasing interest rates has not helped to temper inflation, are we chasing the incorrect shadow?
There are already signs that investment decisions may be getting deferred today in the current environment. This holds especially for capital intensive and infrastructure projects where funds will be locked in at higher rates of, say, 13-15% for an extended period of time. The internal rate of return so
calculated may not justify these high borrowing rates. The SME segment, which may be confronting even higher rates, may not find it feasible to expand further at this stage. Chart 2 shows that in the last three years, there are signs of the rate of fixed capital formation coming down, which is certainly not good news for growth prospects.
So what should RBI be looking at? As the controller of monetary policy, RBI has to choose between the Keynesian and Monetarist hats. Chart 3 juxtaposes growth in GDP with bank credit and money supply. Growth in money supply has been lower this year while growth in credit has been commensurate with higher GDP growth, which is still lower than that in FY07 and FY08. Clearly, growth in credit (which will be lower if an adjustment is made for the R1 lakh crore outflows on account of 3G auctions that have been locked with the government during FY11) has not shown signs of going overboard. If we are looking to control inflation, then the question is whether there are demand pull inflationary forces in the economy that can support the argument.
Looking at the GDP numbers of the CSO, we see that there are three elements there. Consumption growth has been steady, with the higher value of consumption being more on account of protecting existing consumption. Chart 4 shows that consumption as a proportion of GDP has actually been coming down over the years. Therefore, it cannot be argued that households are borrowing money to meet their growing consumption requirements. The second element, capital formation, as mentioned earlier, has shown signs of slippage and will be on the radar of RBI.
The third important element is growth in government expenditure which is captured by the community,
social and personal services in the GDP numbers. The quarterly growth numbers provided by the CSO, again, show a continued slowdown in this number. This was a conscious act of the government to roll back on the fiscal stimulus (Chart 5).
Therefore, there are two fairly unequivocal observations that stand out. The first is that interest rate hikes have not really had an impact on inflation, with the prices of primary products showing double digit growth. The second is that there is reason to believe that growth can slow down in case there is further monetary policy action. Therefore, a modified Keynesian approach of deferring a rate hike and, hence, taking a pause can be argued for under these circumstances.
inflation but agricultural production has reached a peak this year. We are now talking of core inflation rising, i.e., non-food and -fuel inflation. But aren’t commodity prices, such as those of metals, moving up increasing the prices of manufactured goods? And if core inflation is the issue, then we should be seeing excess demand forces somewhere. But, is this visible?
This is critical because the policy to be announced on May 3, 2011, is for the year, and RBI will be giving direction on both GDP and inflation targets. While these are not sacrosanct numbers, they would indicate to a large extent the course of likely action by RBI during the year, which is more important. An inflation target of, say, 5%, which has been the convention so far, will mean that RBI will keep increasing interest rates until such time that the number comes down to this level. On the other hand, if it is in the region of 6-7%, then maybe we can expect a pause as the present inflation number will come down gradually.
The other issue is, of course, GDP growth. Normally, the targeted range has been between 8-9% and given that the Planning Commission is looking at higher numbers from FY13
onwards, RBI will have to strike a balance between such optimism and the pessimistic numbers rolled out by private agencies, which are looking at the range of 7-8%.
Therefore, the announcements made in this credit policy will be crucial as it will once again be all about interest rates. RBI has increased rates eight times since last March but the impact on inflation has been limited (Chart 1). The prices of primary products have shown an uneven trend, while those of manufactured goods have increased in the last few months. Higher interest rates have certainly maintained the level of ‘real interest rates’ and protected deposit holders and other returns on debt instruments quite well. The question is whether we have reached an inflection point after which further rate hikes will impede growth. This is pertinent because if increasing interest rates has not helped to temper inflation, are we chasing the incorrect shadow?
There are already signs that investment decisions may be getting deferred today in the current environment. This holds especially for capital intensive and infrastructure projects where funds will be locked in at higher rates of, say, 13-15% for an extended period of time. The internal rate of return so
calculated may not justify these high borrowing rates. The SME segment, which may be confronting even higher rates, may not find it feasible to expand further at this stage. Chart 2 shows that in the last three years, there are signs of the rate of fixed capital formation coming down, which is certainly not good news for growth prospects.
So what should RBI be looking at? As the controller of monetary policy, RBI has to choose between the Keynesian and Monetarist hats. Chart 3 juxtaposes growth in GDP with bank credit and money supply. Growth in money supply has been lower this year while growth in credit has been commensurate with higher GDP growth, which is still lower than that in FY07 and FY08. Clearly, growth in credit (which will be lower if an adjustment is made for the R1 lakh crore outflows on account of 3G auctions that have been locked with the government during FY11) has not shown signs of going overboard. If we are looking to control inflation, then the question is whether there are demand pull inflationary forces in the economy that can support the argument.
Looking at the GDP numbers of the CSO, we see that there are three elements there. Consumption growth has been steady, with the higher value of consumption being more on account of protecting existing consumption. Chart 4 shows that consumption as a proportion of GDP has actually been coming down over the years. Therefore, it cannot be argued that households are borrowing money to meet their growing consumption requirements. The second element, capital formation, as mentioned earlier, has shown signs of slippage and will be on the radar of RBI.
The third important element is growth in government expenditure which is captured by the community,
social and personal services in the GDP numbers. The quarterly growth numbers provided by the CSO, again, show a continued slowdown in this number. This was a conscious act of the government to roll back on the fiscal stimulus (Chart 5).
Therefore, there are two fairly unequivocal observations that stand out. The first is that interest rate hikes have not really had an impact on inflation, with the prices of primary products showing double digit growth. The second is that there is reason to believe that growth can slow down in case there is further monetary policy action. Therefore, a modified Keynesian approach of deferring a rate hike and, hence, taking a pause can be argued for under these circumstances.
Don’t ban our futures: Financial Express 22nd April 2011
The growth of the commodity futures markets has been quite amazing in the last few years. Forward Markets Commission (FMC) data shows that volumes have been around Rs 120 lakh crore in FY11, which is almost 1.5 times India’s GDP at current market prices. Does this mean that commodity futures trading has finally arrived?
Let’s go back to the basics. When futures trading were revived in 2003, the idea was to bring in a price discovery mechanism that would finally help the farmers get higher prices for their produce. But for these prices to be determined, we needed to have active trading to generate the requisite liquidity. Therefore, we required the arbitrager, investor and speculator to take contrary positions.
The market has been mired in controversy as every bout of inflation has been associated with futures trading. The conundrum is that futures prices are supposed to tell us what lies ahead, in case the market is efficient. However, when futures prices of, say, tur or urad or wheat indicated a crop failure, these price signals were taken to be proof of futures’ role in fuelling inflation, leading to a ban. The banning of futures products and their subsequent reintroduction has not really helped as traders are wary of future bans. It is not surprising that contracts in wheat and sugar, which were extremely robust before the ban, are quite muted after their reintroduction.
The question now is, how can we evaluate the market as it stands today? The first is that the share of farm products in total volume traded has come down to a low of 12.2% in FY11. These are the only products where price discovery takes place within the country and hence add value to the pricing system. The canvas is limited with noteworthy volumes in soybean, soy oil, mustard and chana, and some of the spices during the season besides guar, which is traded more as a proxy for weather.
The second issue is whether the farmers are gaining from such trading. The answer is yes and no. No, because they do not trade. Yes, because the price information is available to a large cross-section of the community, thanks to the development role taken on by the FMC and the exchanges in price dissemination. The Indore oilseeds mandi or the Delhi chana markets commence daily trade based on the National Commodity & Derivatives Exchange (NCDEX) futures prices. Therefore, futures prices do get used in the spot market.
The third is whether there has been any use of futures trading in metals and energy, which constitute around 88% of volumes, especially when there is virtually no price discovery taking place in India and where deliveries are non-existent. Crude prices are determined on the New York Mercantile Exchange (NYMEX) or Intercontinental Exchange (ICE), bullion on the Commodities Exchange (COMEX) and copper on the London Metal Exchange (LME). The answer is that these commodities have now become alternative investment classes and offer opportunities to investors. While there is no direct value for the economy, investors can diversify their portfolio as these commodities do not have a relationship with stocks or interest rates. Regulation must change so that the retail investor can harness these benefits through commodity funds where the mutual fund can invest in these products. Currently, regulatory overlap does not permit such an option.
The fourth is whether the market needs multiple exchanges when most of the terms of operation are fixed by FMC. Today, FMC data shows that there are 21 operating exchanges. However, the Multi Commodity Exchange of India (MCX) has a market share of over 80% and NCDEX a little over 10%. The National Multi Commodity Exchange of India (NMCE) is the third while the Indian Commodity Exchange (ICEX), the Ahmedabad Commodity Exchange (ACE) and the National Board of Trade (NBOT) are players around the fringe. The broader issue is what is being done to revive the age-old exchanges. While two of the new exchanges are operating and one more is on the anvil, will these exchanges really survive? This is important because anecdotal experience shows that liquidity gravitates towards an exchange and then gets stuck to it. Moving liquidity away is a challenge and exchanges are natural monopolies. This being the case with a firm demarcation between the original electronic exchanges (besides NBOT, which has its own loyal members), there is a need to reconsider making the system well knit. In the stock market, only two exchanges dominate, and a similar picture appears to have emerged here. The FMC needs to work towards consolidation or enabling measures like market-making to ensure that they survive.
So what does this all mean? It is hard to think of futures trading changing the architecture of farming in the context of what has transpired in the last few years. Trading in farm futures will continue to remain on the periphery as it can no longer be pursued as a goal by exchanges that have to return a profit to their shareholders. It will evolve to be analogous to the equity market as a platform for investors who look at non-farm products. Here, it will be a challenge to the FMC to get in end-user and retail participants so that a wider audience can draw benefits from this investment alternative. Along the way, the market, too, will attain more respectability.
Let’s go back to the basics. When futures trading were revived in 2003, the idea was to bring in a price discovery mechanism that would finally help the farmers get higher prices for their produce. But for these prices to be determined, we needed to have active trading to generate the requisite liquidity. Therefore, we required the arbitrager, investor and speculator to take contrary positions.
The market has been mired in controversy as every bout of inflation has been associated with futures trading. The conundrum is that futures prices are supposed to tell us what lies ahead, in case the market is efficient. However, when futures prices of, say, tur or urad or wheat indicated a crop failure, these price signals were taken to be proof of futures’ role in fuelling inflation, leading to a ban. The banning of futures products and their subsequent reintroduction has not really helped as traders are wary of future bans. It is not surprising that contracts in wheat and sugar, which were extremely robust before the ban, are quite muted after their reintroduction.
The question now is, how can we evaluate the market as it stands today? The first is that the share of farm products in total volume traded has come down to a low of 12.2% in FY11. These are the only products where price discovery takes place within the country and hence add value to the pricing system. The canvas is limited with noteworthy volumes in soybean, soy oil, mustard and chana, and some of the spices during the season besides guar, which is traded more as a proxy for weather.
The second issue is whether the farmers are gaining from such trading. The answer is yes and no. No, because they do not trade. Yes, because the price information is available to a large cross-section of the community, thanks to the development role taken on by the FMC and the exchanges in price dissemination. The Indore oilseeds mandi or the Delhi chana markets commence daily trade based on the National Commodity & Derivatives Exchange (NCDEX) futures prices. Therefore, futures prices do get used in the spot market.
The third is whether there has been any use of futures trading in metals and energy, which constitute around 88% of volumes, especially when there is virtually no price discovery taking place in India and where deliveries are non-existent. Crude prices are determined on the New York Mercantile Exchange (NYMEX) or Intercontinental Exchange (ICE), bullion on the Commodities Exchange (COMEX) and copper on the London Metal Exchange (LME). The answer is that these commodities have now become alternative investment classes and offer opportunities to investors. While there is no direct value for the economy, investors can diversify their portfolio as these commodities do not have a relationship with stocks or interest rates. Regulation must change so that the retail investor can harness these benefits through commodity funds where the mutual fund can invest in these products. Currently, regulatory overlap does not permit such an option.
The fourth is whether the market needs multiple exchanges when most of the terms of operation are fixed by FMC. Today, FMC data shows that there are 21 operating exchanges. However, the Multi Commodity Exchange of India (MCX) has a market share of over 80% and NCDEX a little over 10%. The National Multi Commodity Exchange of India (NMCE) is the third while the Indian Commodity Exchange (ICEX), the Ahmedabad Commodity Exchange (ACE) and the National Board of Trade (NBOT) are players around the fringe. The broader issue is what is being done to revive the age-old exchanges. While two of the new exchanges are operating and one more is on the anvil, will these exchanges really survive? This is important because anecdotal experience shows that liquidity gravitates towards an exchange and then gets stuck to it. Moving liquidity away is a challenge and exchanges are natural monopolies. This being the case with a firm demarcation between the original electronic exchanges (besides NBOT, which has its own loyal members), there is a need to reconsider making the system well knit. In the stock market, only two exchanges dominate, and a similar picture appears to have emerged here. The FMC needs to work towards consolidation or enabling measures like market-making to ensure that they survive.
So what does this all mean? It is hard to think of futures trading changing the architecture of farming in the context of what has transpired in the last few years. Trading in farm futures will continue to remain on the periphery as it can no longer be pursued as a goal by exchanges that have to return a profit to their shareholders. It will evolve to be analogous to the equity market as a platform for investors who look at non-farm products. Here, it will be a challenge to the FMC to get in end-user and retail participants so that a wider audience can draw benefits from this investment alternative. Along the way, the market, too, will attain more respectability.
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