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March 7, 2011

Pareto

How does fiscal deficit impact inflation in India?
JEEVAN KUMAR KHUNDRAKPAM and SITIKANTHA PATTANAIK of RBI in a paper (“Global Crisis, Fiscal Response and Medium-term Risks to Inflation in India”) explore the relationship between fiscal deficit and inflation in India.

The authors frame their analysis against the backdrop of the global financial crisis where fiscal deficits (FD) have surged. They put forth that the immediate impact of rise in FD on inflation was limited as first it replaced the declining private consumption and investment. Second, there was no large expansion in money growth as demand for credit remained depressed. However, going forward, FD has to be lowered as it could lead to inflation, as both aggregate and credit demand rise.

The authors study the relationship between FD and inflation for the 1953-2009 period. The finding is 1 per cent rise in FD could lead to a rise in 0.25 per cent in inflation. Though over a short-term, the relationship is modest. The study also shows that FD leads to rise in inflation and not the other way round.

The paper concludes by saying that while fiscal stimulus was appropriate in the context of the global financial crisis, it may have medium-term potential ramifications for inflation situation. Hence, there is a need to return to fiscal consolidation path at the earliest. The key would be to emphasise on the quality of fiscal adjustment driven by expenditure rather than revenue buoyancy.

Greece Crisis and Similarity to India
MICHAEL LEWIS in Vanity Fair (“Beware of Greeks Bearing Bonds”) points to the fallout of a monastery as the trigger of the Greece crisis. Vatopaidi monastery, a 1,000-year-old organisation was caught in land scams with the Government. The government had to step down amidst public pressure; the new government looked at the fiscal numbers and declared that the deficit was much higher, leading to a meltdown.

Lewis says that in the election year, the tax collectors are pulled off the street! There is a huge black economy in Greece with proceeds invested in real estate. To avoid taxes, receipts/invoices are neither given nor collected. It takes 10-15 years for courts to give decisions leading to few cases being filed. There are many inefficient public sector enterprises, and in some cases wage bills are much larger than revenues earned. Its healthcare and education systems are in very bad shape as well.

While reading this, the parallels with India cannot be missed—or ignored. India has its own set of stories in public enterprises, education and healthcare. India is a larger economy than Greece, and hence much of this is ignored. A larger economy works both ways—it may delay the crisis, but the fallout will be much larger. The hope is for Indian policymakers to take some positive, much needed lessons from Greece’s governance crisis.

Mixing economics analysis with sports
TOBIAS MOSKOWITZ & L. JON WERTHEIM have written a book, Scorecasting, where they mix economic analysis with sports. Moskowitz shares his findings with NYT Economix Blog.

There are two findings. One, they show that for fans of Chicago Cubs, beer prices matter more than the club’s win-loss record. The stadium is the best place to celebrate in Wrigley and people see it more as an outing. Despite the club not winning since the last 60 years or so, the local attendance is as good as ever. This is good for the stadium and earnings, but works as a negative factor for the team as there is no incentive to win.

The second finding is more controversial. The authors say that the home advantage is not because of knowledge of local conditions, but because of umpires/referees giving decisions that favour the home team! In stadiums where umpires knew that their decisions were being monitored, the home bias did not intrude in the decision. The authors think psychology and behavioral science could explain the reason why umpires sometimes give into pressure from the home crowd.

The findings have interesting implications for IPL/general Cricket. Though IPL is relatively new, it will be interesting to see whether fans in future will look at the stadium than the team’s win-loss record. The question of umpires favouring home-teams is a oft-discussed issue in cricket—with increase in technology, this bias is mitigated, but the reviews are limited. It will be interesting to know about the history of umpires’ decisions as well.

Four questions related to Japan’s economy
Bank of Japan Governor MASAAKI SHIRAKAWA gave a speech (“Toward a Revitalization of Japan’s Economy”), in which he dwelt on the four broad questions he is asked in most meetings with press/policymakers.

  • Why has Japan’s economy lost its vitality? Reason is loss in productivity. Japanese firms could not respond to the changes in economic environment after the 1990s. Following that, consumption and investment levels declined due to an ageing population.
  • Why has deflation continued for a prolonged period? As growth continues to remain positive, low price levels decline. Lehman fall made the slump worse for Japan, thereby prolonging deflation. Yet, it is much lower than deflation in 1930s and has not resulted in a spiral.
  • Why are yields on JGBs have been stable at low levels? People believe Japan will continue to grow and low inflation will remain. However, one cannot take this for granted, as fiscal imbalances can’t run forever.
  • Can Japan’s economy regain its vitality? Yes, it can—if the country can tackle the problem of an ageing population, raise productivity growth, create markets where there is huge demand like Asia, and improve fiscal balances.

Shirakawa discusses the strengths of Japan economy, which can help propel Japan’s economy—its location in Asia, high level of technological capabilities and soft power. Economic history shows economies have rebounded strongly from deep crisis in the past like US and Korea—Japan could do so as well.


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