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As published in Dawn on July 27th, 2012. There has been lots of talk lately of Pakistan’s massive and largely untapped mineral potential. More specifically, Imran Khan, chairman of the Pakistan Tehreek-e-Insaf, has hinted at various rallies and forums that Pakistan’s future economic growth could … Continue reading

Should states offer debt relief to their poor farmers?

A new paper from Martin Kanz tries to test the long run impact of the debt relief program in India for small and marginal farmers- and the results offer a cautionary tale. Here’s a sneak peek into the findings:

Debt relief leads to short run improvements for the recipient households, however they tend to accumulate new debt fairly quickly after the settlement.

It doesn’t lead to investment and productivity gains for the recipient households.

Finally, the debt relief doesn’t improve recipient households’ access to bank credit lines.

The full paper is here.

Does austerity leads to violence?

In the wake of the shocking riots in Britain, I’ve come across a very instructive CEPR paper which attempts to explore the historical causation between extreme fiscal tightening and social unrest.

Here is an abstract of the paper:

Does fiscal consolidation lead to social unrest? From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble cross-country evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyze interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

Read the full paper here.

The Debt Paranoia!

It is astonishing to me how the carnage in the stock market this past week was completely misrepresented and misattributed to the debt downgrade by the S&P. There is a critical distinction that is being missed by the pundits on CNBC and other business networks. The reaction of the stock market earlier this week was NOT due to the concerns about the US solvency but more about the economy’s poor growth-prospects.

US 10-Year Bond Yield

Just to recap a bit: S&P downgraded the US bond rating- raising doubts about the credit worthiness of the country. However, rather than shedding US bonds, investors are crowding into US debt. This sudden rise in the appetite for the US debt has drove down the 10-year treasury interest rate to 2.24 percent (the higher the demand for bonds, the lower the interest rates on them). This indicates the markets’ complete repudiation of the diagnosis offered by the S&P. For the investors, the US remains a safe haven for their investments.

So, the real worry in the market is not the US’s inability to service and payoff its debt, but rather the pockets of stress that remain in the economy. The shortfalls in private investment and aggregate demand, anemic job-growth, stress in the housing market, etc. continue to impair the growth potential of the economy. Until we successfully ameliorate these problems, the stock market would remain volatile and extremely sensitive to the news headlines.

Italian 10-Year Bond Yield

Spanish 10-Year Bond Yield

So, why is the US 10-year rate at a record low despite the downgrade? One word: Europe. The sovereign debt contagion has spread from the periphery economies like Greece, Portugal, etc. to major economies like Italy and Spain. Above are the 10-year rates on Italian and Spanish bonds. Both are hovering between 4.99 to 5.2 percent. These problems in  Europe have forced the investors to pull their savings out from the EU and pile into the US bonds. So, thanks to the tepid steps taken by the European Central Bank and Brussels, the US debt continues to retain its status as the safest security to invest in.

NOTE:  A 10-year bond rate above (>) 5 percent signals impending debt crisis leading to a possible speculative attack.


Um, okay. I recently came across this statement by Steve Wynn, a Las Vegas entrepreneur, who called President Obama “the greatest wet blanket to business…”. These kind of  statements are being copiously repeated in the conservative echo chamber. So, I decided to do some quick research and discovered this gem of a graph below.

Click to make it bigger

The trend-line above illustrates the corporate profits after taxes (CP) for the past 10 years.  The shaded region in the graph indicates the recessionary period where the corporate profits took a plunge. However, what has happened since then has taken even me by surprise. Subsequent to the recession (at least in technical terms), the corporate profits have risen to the highest level in the past decade. Now, this is maybe a positive symptom for the administration, but there is an important silver lining in it. The rise in corporate profits is not accompanied by job-creation. This is especially disconcerting because it indicates that despite growth in worker productivity and overall output, the job-growth has remained anemic.

This whole episode takes me back to my undergrad History of Econ. Thought class where we studied about a Polish economist named Michel Kalecki. Mr. Kalecki argued that recessions were extremely sympathetic to the elites and corporations because they create a surplus labor supply and forces the existing workers to work even harder to save their jobs– this ends up raising  the rate of relative surplus-value for a corporation.

To sum it up, this is bad, real bad.

FED is not printing money

It was is common to colloquially refer to  quantitative easing by the Fed – specifically, QE2 – as “printing money”. However, that’s not exactly right.  So what exactly did the Fed do? Well, instead of printing the green paperbacks, the Fed credited the accounts of the banks that are members of the Federal Reserve system. This- in econ talk- is also known as expanding  the Fed’s reserve balances. These reserves are different from printing money because they’re are loaned out to the banks and do not create new money, or M1 in the short-run. With that said, any bank who’s a recipient of such credits could at any time redeem them for real currency. Via FRED, I’ve sketched a composite graph illustrating money in circulation (blue) and reserve balances of the Fed (red). The graph clearly shows a precipitous rise in reserve balances in the 2nd-half of 2008, accompanies by a sober rise in money supply. These two variables essentially offset each other. Note: The rise in reserves during 2011 is attributed to QE2.


Money in circulation (blue) & Reserves (red)

To understand this distinction better, we need to look at the past 10 years. Prior to 2008, the interest rate on excess reserves was virtually zero; this forced the banks to do two things to make a little profit off these reserves: (1) cash withdrawals OR (2) exchange them with other banks i.e. interbank transfers for a small profit margin. This all came undone once the Great Recession hit. After the bail-outs and averting systemic risk, the Fed introduced interest rates on excess reserves to incentivize the banks to hold on to the reserves, and in effect cushion themselves against the forthcoming period of economic uncertainty. Unlike pre-2008, in the present system as the graph shows, the banks are earning financial rate of returns on their reserves and have no desire to redeem these reserves for actual currency. This consequently has created a huge lag in the overall money supply.

GOP and the myth of fiscal conservatism

I’m always surprised when folks on the right tout the GOP as a party of small and limited government. This runs counter to the historical time-series data.  Via Matias Vernengo at the Naked Keynesianism blog, I have imported a noteworthy chart below which attempts to put everything in perspective. The chart indicates that the federal outlays (expenditures) as a % of GDP have consistently gone up during the Republican administrations and reversed under the Democrats. The only exception is the first two years of the Obama admin., where the spending grew during 2008-2009 due to the shortfall in revenue, up-tick in automatic stabilizers, i.e. unemployment insurance, etc., and of course the stimulus.  However, this preliminary growth in spending fell in 2010 (despite the continuation of the two wars, the Libya campaign and the offshore wars in Pakistan and Yemen). However, this raises a red flag:  At a time when we require ambitious deficit spending to offset the shortfalls in private investment and spur aggregate demand, the chart shows that the Obama administration has succumbed to the deficit hawks.

Also note, the exponential rise in defense spending during the Republican administrations and an unchecked rise in the healthcare spending due to the healthcare cost inflation. If the Republicans and Democrats are serious about retiring the nation’s debt, I hope they’re ready to tame the costs of defense and healthcare. We need to scale back our foreign ambitions, and make important patches to the healthcare law that would insure more discipline in the health-care market.