Guillermo Calvo is one of my favorite economists. But — you know there had to be a but — I just don’t buy his latest missive. Still, it’s important that we have this debate: something awesome is happening to oil and other commodities, and figuring out what it means is crucial
Saudi Arabia’s central bank governor on Tuesday called on the government to fight inflation by curbing public expenditure, warning that economic policies in the kingdom faced “a critical situation”.
The call by Hamad al-Sayari followed a government announcement that it would invest in agricultural and livestock projects in foreign countries to ensure food security and control commodity prices....
Saudi Arabia’s oil-fuelled boom is producing massive investment in infrastructure projects but is also leading to growing social pressure as inflation spirals, reaching 9.6 per cent in March year on year. Although lower than in Qatar and the United Arab Emirates, the inflation rate is tormenting a country accustomed to near zero inflation.
Insisting that inflation is driven by domestic factors – mainly housing and foodstuffs – the central bank has resisted calls to drop the riyal’s peg to the dollar, thus limiting its ability to use monetary policy.
“Powerful and contradictory factors put economic policymakers before difficult choices,” said Mr Sayari at a Euromoney conference, pointing to the need to promote economic growth but also the burden inflation was putting on low-income families.
“The Saudi Arabian Monetary Agency [the central bank] has taken steps to reduce domestic liquidity by raising the statutory reserve requirement several times. Given the dominance of fiscal policies on the economy, it is necessary to reprioritise spending and programme it to fit the absorptive capacity of the national economy,” Mr Sayari added.
A Royal Order was issued on 28/11/1428H (8/12/2007) granting a subsidy of SR1,000 per ton on imported rice, and increasing the flat subsidy on baby milk from SR2 to SR12 per kilo.
In Mogadishu, the price of a kilogram (2.2 pounds) of corn meal has gone from 12 cents in January to 25 cents. Another staple, rice, has risen in that time from $26 to $47.50 for a sack of 50 kilograms (110 pounds).
Food prices also have been affected by the plummeting Somali shilling, which lost nearly half its value this year, tumbling from 17,000 shillings to about 30,000 to the U.S. dollar amid growing insecurity and a market clogged with millions of counterfeit notes printed in bulk locally.
"We have to put our money where our mouth is now so that we can put food into hungry mouths. It's as stark as that."- Bob Zoellick
The Government believes that the policies set forth in the attached Memorandum of Economic and Financial Policies (MEFP) are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Haiti will consult with the IMF on the adoption of these measures, and in advance of any revision to the policies contained in the MEFP, in accordance with the fund’s policies on such consultation...
The program envisages attaining an inflation rate of 9.0 percent by end-September 2008. This rate slightly exceeds the FY2007 outcome, as a result of higher international prices for food and petrol. To ensure that these increases do not translate into broader inflationary pressures, base money growth will be kept slightly below that of nominal GDP, with an indicative target for the year of 9.6 percent. The bulk of monetary expansion will come from an increase in net international reserves, with a program floor of US$40 million. This will boost gross reserves coverage to 2.7 months’ worth of imports. Recognizing that appreciation of the real exchange rate is a reflection mainly of changing fundamentals, the BRH will maintain exchange rate flexibility, limiting interventions to purchases for the achievement of the program NIR target and temporary smoothing of excessive market volatility...
Building on the cessation of non-essential activities in the first program year, we will strengthen the institutional foundation for our monetary policy framework through further reinforcement of the independence of the BRH, including through strengthening its balance sheet. A strategy to divest the BRH’s interest in the state telephone company, Teleco, is currently being prepared (PC for end-March 2008), with support from the IFC. Taking into account the expected proceeds from that operation, the BRH will, together with the MEF, devise a plan for the recapitalization of the central bank (PC for end-March 2008). The plan will contain steps to revert the BRH’s quasi-fiscal losses, and put its balance sheet on a sound financial footing.
First, Federal Reserve policy easing in the last five months of last year seemed to be constrained by concerns about inflation. Judging from the longer-term projections included in the minutes of the October 2007 and January 2008 meetings, Federal Reserve policy makers seem to have an informal goal for PCE inflation (excluding food and energy) or something less than 2 percent. Was that goal reining in their response to the weakening of spending in 2007, and will it constrain their actions their actions over the remainder of this year?
Second, policy actions this year suggest that the Federal Reserve has abandoned the practice of gradually responding to economic events that marked the experience of the prior two decades. Will this phase of post-gradualism apply symmetrically later this year if evidence accumulates that inflation expectations are on the rise?
Third, Chairman Bernanke and his predecessors have previously argued that Federal Reserve involvement in the supervision of financial institutions is important in making both the conduct of supervision and monetary policy better. But the past few years apparently witnessed multiple regulatory lapses. Supervisors failed to caution depositories offering potential borrowers unsuitable mortgages. They also acquiesced as complicated structures were booked off the balance sheet, even though, in the event, they were not treated as such by corporate headquarters at the first sign of stress. At the same time, it is hard to read the hesitant easing of late 2007 as evidence that monetary policy makers were receiving useful insights from their supervisory colleagues. Does Chairman Bernanke still view supervision and regulation as an appropriate responsibility of the Federal Reserve?
Volcker was skeptical that inflation targeting, a device for anchoring inflation expectations embraced by Bernanke, would be helpful.
``That's a little too precise for me,'' he said. ``The inflation rate is bound to go up and down a little bit and it should go up and down a little bit. But I would like to see stability as the target.''
He suggested that Bernanke, who has championed better communication through transparency at the central bank, may be communicating too much.
``It's kind of ironic,'' said Volcker. ``Mr. Bernanke seems to be criticized for a little too much transparency.''
Arvind Gupta, Lead Financial Sector Specialist at the World Bank, introduced the main speaker, Guy Caruso, noting the many different perspectives Caruso brings to the topic of oil price volatility. Caruso, an Administrator in the Energy Information Administration (EIA) of the United States Energy Department, stated that the EIA periodically publishes reports on the subject on the state of the world oil market and provides analysis for hypothetical policy scenarios.
Caruso talked about the main drivers behind the prices of oil, stating that this is still explained by the fundamental principles of supply, demand, inventories, and productive capacity. He also cited the decisions made by the Organization of Petroleum Exporting Countries (OPEC) last year to reduce oil production as a factor that will continue to influence the market through 2008. Caruso noted the recent uncertainty about oil supply and demand due to geopolitical events, unprecedented global economic growth in the last 4 or 5 years, and even extreme weather events. In the short term, he said, these factors will ensure that oil prices stay high.
Caruso went on to cite the most recent report produced by the EIA, which indicates that in the coming years, there is a strong likelihood that prices will come down slightly. However he acknowledged that the present volatility of the market may lead to variations in these predictions. Caruso returned to the subject of OPEC, noting the reduction of the production of oil in 2006. In the last few months he explained, this production is again rising to meet growing demand.
Caruso pointed out that another fundamental driver of world oil prices in the last five years is the sharp reduction in spare productive capacity as a result of strong growth in the global economy, particularly in China. This, he said, has limited the ability of the world market to react to changes in supply or demand. The fact that spare productive capacity is now increasing might be one of the factors leading to a small decline in oil prices in the coming months. Caruso also explained the impact of the weakness of the US dollar. This, he said, is creating a widening gap in the price of oil for those who are paying with the stronger currencies relative to the dollar based countries.
Caruso noted the multiple sources of uncertainty in the world oil market, particularly the tensions with Iran and Venezuela and the state of the US economy. He also mentioned that while the continued inflow of money from hedge funds perhaps plays a role in the volatility, he does not believe it to be the main driver of prices. Caruso concluded by explaining the different projections outlined in the latest EIA report, pointing out that all the information is available to the public online.
In the question and answer session, audience members asked about what the prices in graphs meant in real terms, about the motivation behind OPEC’s interest in keeping prices of oil high, how prediction scenarios are estimated, and whether there are underlying assumptions of existing reserves in these predictions.
He told CBS Charlie Rose show: “We have seen the Federal Reserve take more extreme measures in some respects than any that have been taken in the past to deal with a financial crisis.”
He said the decision to lend cash to Bear Stearns and make emergency fin-ance available to other primary dealers was “understandable” but raised “real questions” as to the appropriate division of labour between US authorities.
The former Fed chief said the US central bank had not been thought of as a place “where you put in bad assets, possibly bad assets” – an apparent reference to the collateral backing the $30bn credit line extended by the Fed as part of the Bear rescue takeover deal.
“At some point the government, in my view, ought to be taking responsibility for that kind of action, not the Federal Reserve,” Mr Volcker said.
He added that the Fed’s latest move “stretches their authority to the limit”. The problem of what to do with bad housing loans was “basically a governmental responsibility”.
He urged the government to channel funds into the market through Fannie Mae and Freddie Mac, the government-sponsored agencies – possibly by activating a longstanding Treasury credit line to these institutions.
Echoing the message from the Fed this week, which cut interest rates by less than the market had expected and highlighted concern about inflation, Mr Volcker said “there are limits to how much you can reduce interest rates”.
He warned that the threat of resurgent inflation was “lurking not very far in the background”. That would be “the ultimate destructive result of this”, he said. “We just must not let that happen.”
The former Fed chief also said the administration’s strong dollar rhetoric had “become meaningless”.
He said a weak dollar allowed the US to increase exports and reduce its reliance on foreign savings but “begins to raise questions” as to its role as a world currency.
Second, the more commitments made by the Fed, the more we lose the (quasi) independence of our central bank; for a large commitment Treasury sign-off is needed. The realignment of the regulatory universe will eventually emerge as a big story from the current crisis, though it is hardly commanding much attention right now.
One lesson is that trouble is all too common. Most members of the IMF have undergone at least some distress since the late 1970s. Crises in poorer countries tend to be deeper and more costly, often because they are twinned with collapsing currencies. According to a 1996 survey of insolvencies by economists at the World Bank, the bail-out of Argentina's banking system in the early 1980s cost a stunning 55% of GDP to fix.
The rich world's banking troubles have not been cheap either. The bill for bolstering Finland's banks in the early 1990s came to 8% of GDP; Sweden's bail-out was scarcely less dear. America spent more than 3% of GDP cleaning up the savings-and-loan crisis, its priciest to date. That suggests that the possible cost of today's troubles, though alarming, is not off the charts. The best, though still highly uncertain, estimate of prospective lending losses is around $1.1 billion, less than half of which would be borne in America by banks, investors and in forgone taxes: $460 billion is equivalent to about 3% of last year's GDP.
It always seemed to me that there is a kind of commonsense view that inflation is too much money chasing too few goods. You could oversimplify it and say that inflation is just a monetary phenomenon. There are decades, hundreds of years, of economic thinking relating the money supply to inflation, and people to some extent have that in their bones. So I think we could explain what we had to do to stop inflation better that way than simply by saying that we've got to raise interest rates. It was also true that we had no other good benchmark for how much to raise interest rates in the midst of a volatile inflationary situation.
At least as important was the idea to discipline ourselves. People in the Federal Reserve don't like to raise interest rates. So the danger is you're always too little too late. I think that would apply to the current situation [April 2000]. So, when inflation really had the upper hand, it was, I think, very important to put something out there so you could discipline yourself. For that kind of a commitment, you've got to know what's at stake, and it does make some broad sense if you have that much inflation [pp. 178-179].
What really propelled me to make the change was when we raised the discount rate for the second time, when I was first down there. The vote was 4-3. I thought it was a reasonably strong move and we'd get a favorable reaction in the market, but we didn't. The response was, "Well, gee, the Federal Reserve is behind the curve anyway, the vote was 4-3, and that's the last increase of the discount rate we'll see." So the market reacted very badly, which surprised me. I guess I was a little naive. I remember very clearly, I didn't bend over backwards to try to twist the arms of the three people who voted the other way. I knew I had four votes. If we had to increase the discount rate again, we'd have another 4-3 vote. But that's not the way the market read it. Then I realized that we had this credibility problem worse than I thought. That got me off and really thinking operationally about the other approach [basing policy on target growth for the monetary aggregates]. But when it was sprung on them, everybody was very much in favor, even those who were voting against the increases in interest rates [pp. 178-179].
The cost of protecting the senior debt of the 25 European banks in the iTraxx Financials index has fallen 44bp this week, or about 28 per cent. It now costs an average of €114,000 per year to insure €10m of the banks' debt against default over five years, €44,000 less than it did on Friday.
So central banks, including the Fed, should stand ready to act as market maker of last resort, accepting a wide range of private securities as collateral in repos (or purchasing such securities outright) from a wide range of counterparties at a wide range of maturities. Likewise, individual systemically important financial institutions should have recourse to lender of last resort facilities, including the discount window.
The Fed has recently extended access to its discount window to the 20 (or is that now 19?) primary dealers. Other non-deposit-taking institutions will no doubt be granted the same privilige before long. The restriction of the new PDCF to overnight finance only should also be lifted. The same terms as those available to deposit-taking institutions (up to 90 days) should be available. Provided the collateral is priced appropriately (which means the prompt abandonment of the approach outlined on the Fed’s website that “…the pledged collateral will be valued by the clearing banks used by the primary dealers to access the new facility, based on a range of pricing services.” - an invitation to stuff the Fed with fools’ gold priced as bullion), this will stop the unavoidable and fundamentally warranted solvency problems of a number of households and financial institutions from triggering a system-wide liquidity crisis and a system-wide fundamentally unwarranted solvency problem, and will do so with minimal damage in terms of moral hazard.
“If anything goes awry, these dominos fall very fast,” said Charles R. Morris, a former banker who tells the story of the crisis in a new book, “The Trillion Dollar Meltdown.”
This toxic combination — the ubiquity of bad investments and their potential to mushroom — has shocked Wall Street into a state of deep conservatism. The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
Summary: Much of the information communicated by central banks is noisy or imperfect. This paper considers the potential benefits and limitations of central bank communications in a model of imperfect knowledge and learning. It is shown that the value of communicating imperfect information is ambiguous. There is a risk that the central bank can distract the public; this means that the central bank may prefer to focus its communication policies on the information it knows most about. Indeed, conveying more certain information may improve the public's understanding to the extent that it "crowds out" a role for communicating imperfect information.
