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November 12, 2011

Pareto

What if Swiss National Bank (SNB) has negative equity?
SNB shocked markets by deciding to peg its currency against Euro. SNB is buying foreign currency to defend the peg leading to rise in its forex reserves. Meanwhile SNB has also been shifting its forex reserve portfolio from USD to EUR and faced losses in 2010 as EUR depreciated. What if the scenario occurs again and SNB has a negative capital base?

SNB’s Vice-Chairman Thomas Jordan clarifies that a central bank is not like a private firm/bank (Does the Swiss National Bank need equity?). A central bank cannot become illiquid and chances of its capital turning negative are remote. Even if it has negative equity, it does not constrain the central bank as it has banknote-issuing privilege. Moreover, they generate surplus income over the long term. Thus over time, a central bank like the SNB can usually rebuild its equity level all on its own after a loss.

This speech tells you a lot about central banking operations and why it is a special entity. Apart from its magical powers to create money out of nothing its cost of creating money is very low and hence it only makes gains over a period of time. We have seen this case in Fed’s case which has made profits from its bailouts and investments in financial firms at the peak of the crisis.

Getting an institutional perspective of EMU economies
Amidst the Euro bashing, comes a nice paper from Marion Salines, Gabriel Glöckler, Zbigniew Truchlewski and Paola del Favero of ECB (Beyond the economics of the euro – analysing the institutional evolution of EMU 1999-2010). The paper examines how and why the institutional framework governing EMU has evolved since the creation of the euro. More interestingly, the paper gives a nice typology by which one can understand changes in institutions:

  • Layering is an institutional change which happens when new institutional elements are added to existing ones. In context of EMU examples are addition of institutions such as the EFSM/EFSF, creation of the Lisbon agenda etc.
  • Displacement takes place when an element of the institutional structure becomes more salient over time as in the case of ECB.
  • Redirection occurs when objectives of institutions are changed or reorientated. Like Stability and Growth Pact has changed from a mere disciplinarian device to determining fiscal rules in EMU economies.
  • Drift happens when institutional structures are overwhelmed by external developments as seen in discrepancy between financial integration in EMU countries.
  • Depletion happens when institutions experience a gradual breakdown over time. The authors say this hardly applies to EMU as it is a young institution. Most economists would not agree and call EMU a fundamentally flawed institution to begin with.

One could use this typology to analyse changes in other institutions as well.

How the crisis shaped Iceland’s new constitution..
Thorvaldur Gylfason writes on this fascinating set of events in Iceland (From crisis to constitution, voxeu.org). We have seen political crisis leading to new (or change in) constitutions as seen during collapse of communism in 1989. It is rare to see economic crises as triggers of constitutional change. Even Great Depression did not prompt the Americans to change their constitution with laws like Glass-Steagall Act deemed as sufficient.

In Iceland’s case the history is slightly different. After separating from Denmark in 1944, the Iceland leaders promised a new constitution but failed to deliver on their promises barring some new rules. The crisis in Iceland in 2008 started from a revolution to protest against financial crisis but led to a bigger movement to form a new constitution.
The process to create the new constitution was very interesting. First constitutional committee was appointed by parliament consisting of a thousand citizens drawn at random from the national registry. The committee discussed the matters and then organised a nation-wide election in Nov-10 where 522 candidates stood for 25 seats. This 25 member team formed the constitutional assembly/council (CAC) which worked on the proposals in detail and presented their bill with Parliament on 29-Jul-11.

The key highlights of the new constitution are: One person, one vote, Protection of Natural resources, Iceland’s nature and environment, Right to information, Appointment of public officials and Independent state agencies.

Explaining the resilience of India’s services sector
Abhijit Das, Rashmi Banga, and Dinesh Kumar explain the resilience of India’s services sector (Global Economic Crisis: Impact and Restructuring of the Services Sector in India). Though the paper focuses on services sector in 2008-09 crisis period, it has broader lessons for India’s thriving services sector.

There are two main findings:

India’s income elasticity of services exports is high (around 3, for software it is 6). Meaning if foreign incomes go down by 1 unit, our services exports go down by 3 units and vice versa. The price elasticity of services exports is low (inelastic). This means if prices of services exports decline, it does not lead to any major rise in services exports. Hence there is not much which can be done via the pricing route

More importantly, India’s services are mainly consumed by domestic sources. In services, exports form around 6% of services till 2000-01 and has risen to 15% by 2008-09 which is still a low figure. So services growth might decline post a global shock but still remains resilient thanks to a much larger domestic demand for services.

What is the way ahead? It looks at productivity levels in three sectors: retail/wholesale trade, software services, and banking. It says there is a scope of improvement in all three and govt. should make its policies boosting growth in these three sectors.


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