Chidamabaram also stated in his Statement that the Committee has observed that the demand for funds and special attention of different States will be more than adequately met by the twin recommendations of the basic allocation of 0. Chidamabaram informed that t he Prime Minister has approved the proposal to place the report of the Committee in the public domain. Chidamabaram further informed that the Prime Minister has also directed that the recommendations of the Committee may be examined and necessary action in this behalf may be taken.
The Ministry of Finance, Department of Economic Affairs has been asked to examine the report and take necessary action, the Finance Minister added.
The Firm comprises of a team of Corporate Lawyers and Company Secretaries with in-depth subject matter knowledge and participative industry experience of over 15 years. This is what the Fed calls forward guidance. Second, buy long term bonds thus creating more appetite for the remaining ones in public hands, thus pushing down the long rate.
The Fed aims to use its Large Scale Asset Purchase LSAP program to take long bonds out of private portfolios with the hope that as they rebalance their portfolios , the price of long bonds and other assets will rise and yields will fall. One could ask whether these policies should work even theoretically. Forward guidance relies on the central bank being willing to hold down policy rates way into the future below what would otherwise be appropriate - below, for example, that suggested by the Taylor Rule.
But what ensures such commitment? Will the fear of breaking a prior transparent explicit promise say to hold policy rates at zero so long as unemployment is above 6.
Or will they fudge their way out when the time comes by saying that long term expectations have become less well anchored? Some argue that the source of commitment will be the LSAP itself. The central bank may fear losing value on its bond holdings if it raises rates too early. However, one could equally well argue that it could fear a rise in inflationary expectations if it stays on hold too long, which in turn could decimate the value of its bond holdings.
The bottom line is that it is not clear what makes forward guidance credible theoretically, and the matter becomes an empirical one. And then we have the asset purchase program. If markets are not segmented, a version of the Modigliani Miller Theorem or Ricardian Equivalence suggests that the Fed cannot alter interest rates by buying bonds. Essentially, the representative agent will see through the Fed's purchases. Since the aggregate portfolio that has to be held by the economy does not change, pricing will not change.
Alternatively, households will undo what the Fed does. Alternatively, the market must not internalize the Fed's portfolio holdings. As with forward guidance, the effectiveness of LSAPs is an empirical question. Much of the evidence on the effectiveness of asset purchase programs comes from the first Fed LSAP, which involved buying agency and mortgage backed securities in the midst of the crisis.
Fed purchases restored some confidence to those markets including by signaling that the government stood behind agency debt , and this had large effects on the yields. Event studies document the effects on yields in the following rounds of LSAPs were much smaller. Regardless of the effect Fed purchases may have had on the way in, speculation in May that it would start tapering its asset purchases led to significant increases in Treasury yields and large effects on the prices of risky assets and cross-border capital flows.
This is surprising given the theory, because what matters to the portfolio balance argument is the stock of long term assets in the Fed's portfolio, not the flow. So long as the Fed can be trusted to hold on to the stock, the price of risky assets should hold up. Yet the market seems to have reacted to news about the possible tapering of Fed flows into the market, which one would have thought would have small effect on the expected stock.
Either the market believes that Fed implicit promises about holding on to the stock of assets it has bought are not credible, or it believed that flows would continue for much longer than seems reasonable before it was disabused, or we do not understand as much about how LSAPs work as we should!
Given that long term nominal bond yields in Japan are already low, the Bank of Japan's focus has been more directly on enhancing inflationary expectations than on pushing down nominal yields. One of the benefits of the enormous firepower that a central bank can bring to bear is the ability to unsettle entrenched expectations. The shock and awe generated by the Bank of Japan's quantitative and qualitative easing program may have been what was needed to dislodge entrenched deflationary expectations.
The BOJ hopes to reshape expectations more favorably. Direct monetary financing of the large fiscal deficit will raise inflationary expectations. A collateral effect as the currency depreciates is inflation imported through exchange rate depreciation.
Nevertheless, the BOJ's task is not easy. If it is too successful in raising inflationary expectations, nominal bond yields will rise rapidly and bond prices will tank. So to avoid roiling bond investors, it has to raise inflationary expectations just enough to bring the long term real rate down to what is consistent with equilibrium without altering nominal bond yields too much.
And given that we really do not know what the neutral or equilibrium real rate is, how much inflationary expectation to generate is a matter of guesswork. The bottom line is that unconventional monetary policies that move away from repairing markets or institutions to changing prices and inflationary expectations seem to be a step into the dark.
Of course, central bankers could argue that their bread and butter business is to change asset prices and alter inflationary expectations. However, unconventional policies are assumed to work through different channels. We cannot be sure of their value, even leaving aside the theoretical questions I raised earlier about pushing down the real rate to ultra-low levels as a way to full employment.
Let us now turn to their unintended side effects. If effective, the combination of the "low for long" policy for short term policy rates coupled with quantitative easing tends to depress yields across the yield curve for fixed income securities. Fixed income investors with minimum nominal return needs then migrate to riskier instruments such as junk bonds, emerging market bonds, or commodity ETFs, with some of the capital outflow coming back into government securities via foreign central banks accumulating reserves.
Other investors migrate to stocks. To some extent, this reach for yield is precisely one of the intended consequences of unconventional monetary policy. The hope is that as the price of risk is reduced, corporations faced with a lower cost of capital will have greater incentive to make real investments, thereby creating jobs and enhancing growth.
There are two ways these calculations can go wrong. First, financial risk taking may stay just that, without translating into real investment. For instance, the price of junk debt or homes may be bid up unduly, increasing the risk of a crash, without new capital goods being bought or homes being built. This is especially likely if key supports to investment such as a functioning and well capitalized banking system, or policy certainty, are missing. A number of authors point out the financial risk taking incentives engendered by very accommodative or unconventional monetary policy, with Stein providing a comprehensive view of the associated economic downsides.
Second, and probably a lesser worry, accommodative policies may reduce the cost of capital for firms so much that they prefer labor-saving capital investment to hiring labor. The falling share of labor in recent years is consistent with a low cost of capital, though there are other explanations. Excessive labor-saving capital investment may defeat the very purpose of unconventional policies, that is, greater employment. Relatedly, by changing asset prices and distorting price signals, unconventional monetary policy may cause overinvestment in areas where asset prices or credit are particularly sensitive to low interest rates and unanchored by factors such as international competition.
For instance, the economy may get too many buildings and too few machines, a consequence that is all too recent to forget. The spillovers from easy global liquidity conditions to cross-border gross banking flows, exchange rate appreciation, stock market appreciation, and asset price and credit booms in capital receiving countries - and eventual overextension, current account deficits, and asset price busts has been documented elsewhere, both for pre-crisis Europe and post-crisis emerging markets.
When this occurs cross-border, exchange rate appreciation in the receiving country is an additional factor that makes lending appear safer. The mechanism Andrew Crockett laid out has played repeatedly. For the receiving country, it is unclear whether monetary policy should tighten and attract more inflows, or be accommodative and fuel the credit boom.
Tighter fiscal policy is a textbook solution to contain aggregate demand, but it is politically difficult to tighten when revenues are booming, for the boom masks weakness, and the lack of obvious problems makes countermeasures politically difficult. Put differently, as I will argue later, industrial country central bankers justify unconventional policies because politicians are not taking the necessary decisions in their own countries - unconventional policies are the only game in town.
At the same time, however, they expect receiving countries to follow textbook reactions to capital inflows, without acknowledging that these too may be politically difficult. Prudential measures, including capital controls, to contain credit expansion is the new received wisdom, but their effectiveness against the "wall of capital inflows" has yet to be established.
Spain's countercyclical provisioning norms may have prevented worse outcomes, but could not prevent the damage that the credit and construction boom did to Spain. Even if the unconventional monetary policies that focus on lowering interest rates across the term structure have limited effects on interest rates in the large, liquid, sending country Treasury markets, the volume of flows they generate could swamp the more illiquid receiving country markets, thus creating large price and volume effects.
The reality may be that the wall of capital dispatched by sending countries may far outweigh the puny defenses that most receiving countries have to offset its effects. What may work theoretically may not be of the right magnitude in practice to offset pro-cyclical effects, and even if it is of the right magnitude, may not be politically feasible.
As leverage in the receiving country builds up, vulnerabilities mount, and these are quickly exposed when markets sense an end to the unconventional policies and reverse the flows.
The important concern during the Great Depression was competitive devaluation. While receiving countries have complained about "currency wars" in the recent past, and both China and South Korea seem affected by the sizeable Japanese depreciation after the Bank of Japan embarked on quantitative and qualitative easing though they benefited earlier when the yen was appreciating the more worrisome effect of unconventional monetary policies may well be competitive asset price inflation.
We have seen credit and asset price inflation circle around the globe. While industrial countries suffered from excessive credit expansion as their central banks accommodated the global savings glut after the Dot-Com bust, emerging markets have been the recipients of search-for-yield flows following the global financial crisis.
This time around, because of the collapse of export markets, they have been far more willing to follow accommodative policies themselves, as a result of which they have experienced credit and asset price booms.
Countries like Brazil and India that were close to external balance have started running large current account deficits. Unsustainable demand has traveled full circle, back to emerging markets, and emerging markets are being forced to adjust. Will they be able to put their house in order in time? What should be done? How do we prevent the monetary reaction to asset price busts from becoming the genesis of asset price booms elsewhere?
In a world integrated by massive capital flows, monetary policy in large countries serves as a common accelerator pedal for the globe. One's car might languish in a deep ditch even when the accelerator pedal is pressed fully down, but the rest of the world might be pushed way beyond the speed limit. If there is little way for countries across the globe to avoid the spillover effects of unconventional policies emanating from the large central banks, should the large central banks internalize these spillovers?
And will it be politically feasible? Central bankers do get aggrieved when questioned about their uncharacteristic role as innovators. But that may well be the problem. When the central banker offers himself as the only game in town, in an environment where politicians only have choices between the bad and the worse, he becomes the only game in town.
Everyone cedes the stage to the central banker, who cannot admit that his tools are untried and of unknown efficacy. The central banker has to be confidant, and will constantly refer to the many bullets he still has even if he has very few. But that very public confidence traps him because the public wants to know why he is not doing more. The dilemma for central bankers is particularly acute when the immediate prospect of a terrible economic crisis is necessary for politicians to obtain the room to do the unpleasant but right thing.
For instance, repeated crises forced politicians in the Euro area to the bargaining table as they accepted what was domestically unpopular, for they could sell it to their constituents as necessary to avert the worse outcome of an immediate Euro break-up.
The jury is still out on whether the OMT announced by the ECB, essentially as a fulfillment of the pledge to do what it takes to protect and preserve the Euro, bought the time necessary for politicians to undertake difficult institutional reform or whether it allowed narrow domestic concerns to take center stage again.
And finally, there is the issue of moral hazard. Clearly, when the system is about to collapse, it is hard to argue that it should be allowed to collapse to teach posterity a lesson. Not only can the loss of institutional capital be very hard for the economy to rebuild, the cost of the collapse may ensure that no future central banker ever contemplates "disciplining" the system. And clearly, few central bankers would like to be known for allowing the collapse on their watch.
But equally clearly, the knowledge that the central bank will intervene in tail outcomes gives private bankers an incentive to ignore such outcomes and hold too little liquidity or move with the herd. Less clear is what to do about it, especially because it is still not obvious whether bankers flirt with tail risks because they expect to be bailed out or because they are ignorant of the risks.
Once again, we do not know. Having experienced the side-effects of unconventional monetary policies on "entry", many now worry about exit from those policies.
The problem is that while "entry" may take a long time as the central bank needs to build credibility about its future policies to have effect, "exit" may not require central bank credibility, may be anticipated, and its consequences brought forward by the market. Asset prices are unlikely to remain stable if the key intent of entry was to move asset prices from equilibrium.
What is held down must bounce up. One might think that countries that have complained about unconventional monetary policies in industrial countries should be happy with exit. The key complication is leverage. If asset prices simply went up and down, the withdrawal of unconventional policies should restore status quo ante.
However, leverage built up in sectors with hitherto rising asset prices can bring down firms, financiers, and even whole economies when they fall. As Andrew Crockett put it in his speech, "financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle.
Countries around the world have to prepare themselves, especially with adequate supplies of liquidity. Exiting central bankers have to be prepared to "enter" again if the consequences of exit are too abrupt.
Will exit occur smoothly, or in fits and starts, or abruptly? This is yet another aspect of unconventional monetary policies that we know little about. Churchill could well have said on the subject of unconventional monetary policy, "Never in the field of economic policy has so much been spent, with so little evidence, by so few".
Unconventional monetary policy has truly been a step in the dark. But this does raise the question of why central bankers have departed from their usual conservatism - after all, "innovative" is usually an epithet for a central banker. A view from emerging markets is that, in the past, crises have typically occurred in countries that did not have the depth of economic thinking that the United States or Europe have.
When emerging market policymakers were faced with orthodox economic advice that suggested many years of austerity and unemployment as well as widespread bank closures were needed to cleanse the economy after a crisis, they did not protest.
Poorly timed report. Shankar Acharya: The Rajan report on finance. Surjit S Bhalla: No appreciable impact. Strong report, weak foundations. Rajan Panel could be more ambitious.
Single market regulator still a long way off: FMC. Macro framework for financial reforms. The next big step in banking reforms. Broadening access to finance. Suman Bery: On dealing with external shocks.
Financial Sector Reforms - I. Truly Bold. Equity boom hardly enough to offset effete bond market. India C-bank sees supportive role in consolidation. Why an Inflation Objective? Innovation for Inclusion.
RBI view sought for local banks. Dissecting the Rajan Report.
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