Month: January 2007

On Inflation Targeting

The rate of Inflation is of great concern to the Central Bank of a country as well as to its Government.

This concern of the authorities is what makes ‘inflation targeting’ important. But should it be the only concern’

What is ‘Inflation targeting”

Inflation targeting is a framework for operating monetary policy. The first authority to formulate it was the Reserve Bank of New Zealand in the early 1990s. It is undertaken by the monetary authorities and it tries to keep the price stable without adversely affecting output and employment. [Khatkhate 2006]

On Phillips curve

The Phillips curve represents the relationship between the rate of inflation and the unemployment rate. Although several people had made similar observations before him, A. W. H. Phillips published a study in 1958 that represented a milestone in the development of macroeconomics. Phillips discovered that there was a consistent inverse, or negative, relationship between the rate of wage inflation and the rate of unemployment in the United Kingdom from 1861 to 1957. When unemployment was high, wages increased slowly; when unemployment was low, wages rose rapidly. [Hoover]

Inflation targeting has gained a lot of importance, mainly owing to the downward slope of the Phillips curve.

On NAIRU

NAIRU or Non-accelerating inflation rate of unemployment was introduced by Milton Friedman and Edmund Phelps during the 1970s.

NAIRU is a steady state unemployment rate above which inflation would fall and below which inflation would rise.

The natural rate of unemployment is a key concept in modern macroeconomics. Its use originated with Milton Friedman’s 1968 Presidential Address to the American Economic Association in which he argued that there is no long-run trade-off between inflation and unemployment: As the economy adjusts to any average rate of inflation, unemployment returns to its “natural” rate. Higher inflation brings no benefit in terms of lower average unemployment, nor does lower inflation involve any cost in terms of higher average unemployment. A second important unemployment rate is the “Non-Accelerating Inflation Rate of Unemployment,” or NAIRU. This is the unemployment rate consistent with maintaining stable inflation. According to the standard macroeconomic theory enshrined in most undergraduate textbooks, inflation will tend to rise if the unemployment rate falls below the natural rate. Conversely, when the unemployment rate rises above the natural rate, inflation tends to fall. Thus, the natural rate and the NAIRU are often viewed as two names for the same thing, providing an important benchmark for gauging the state of the business cycle, the outlook for future inflation, and the appropriate stance of monetary policy. [FRBSF Economic Letter 1998]

A digression

I am digressing from ‘inflation targeting’ and am going to talk about a welcome proposal by the Indian Government.

In a bid to obtain a `true picture’ of the effect of price changes on the economy, the Union Finance Ministry has proposed the inclusion of services in the Wholesale Price Index (WPI) which is used to measure point-to-point inflation. In India, the services sector accounted for 54 per cent of the GDP during the previous fiscal year. [The Hindu 2007]

In an earlier post of mine, I had argued for a restructuring of the WPI.

Conclusion

Giving too much significance to the ‘Inflation rate’ without adequate and corresponding developments in food supply, public distribution systems, etc will not help combat the problems of unemployment. Thus the fiscal and monetary authorities must ensure that such areas are targeted during a ‘rise in inflation’.

Increasing interest rates and importing food grains so as to bring down inflation rates will not succeed as the ‘inflation’ is basically caused by distributional inefficiencies.

References

1) Deena Khatkhate, Inflation Targeting, Dec 9 2006, EPW.

2) Kevin D. Hoover, The Concise Encyclopedia of Economics.

””’ 3) Federal Reserve Bank of San Francisco, The Natural Rate, NAIRU, and Monetary Policy, 1998.

Further Reading

1) The Phillips curve by Bradford DeLong.

2) The NAIRU by Bradford DeLong.

3) History and Theory of the NAIRU: A Critical Review by Espinosa and Russell.

””’ 4) Why inflation still matters, Frontline, Jayati Ghosh, 2006.

The Political Economy of Singapore

 

The Political Economy of Social Control in Singapore
Christopher Tremewan
1996

Excerpts

‘Singapore has been widely seen as an economic miracle, a veritable and contentment.’

‘The Singapore state is the exclusive or major provider of infrastructure (utilities, communications, media, industrial estates, port and airport services) and of social services (housing, health and education). It is the country’s largest employer, it sets wage levels, regulates labour supply and controls all unions. It is the main actor in the domestic capital market, runs giant state enterprises, a trading company and joint ventures with foreign capital. It also directs the apparatus of state coercion: the police and the internal security organizations, the courts and the prisons and a large military force.’

‘..many people are constantly aware of the political limits on personal behaviour imposed by the state.’

‘..the singular characteristic of social control in Singapore is its success in producing political loyalty and cooperation among the majority of the population.’

‘The wealthiest ten per cent of Singapore households take approximately 30 per cent of total income, while the poorest 10 per cent are left with 2 or 3 per cent of total income.’

‘Neither the inequality nor the comprehensive system of social control in Singapore are obvious to the casual observer.’

‘The increased consumption of the services and consumer goods has had the ideological effect of Singaporeans believing that they have more control over their lives rather than less.’

‘the main political effect of the housing policy was the production of a working class dependent on wage labour to pay for it. The former was achieved through the physical destruction of all other forms of cheap housing and through forced settlement.’

Conclusion

Though Singapore has achieved great growth rates, I wonder if there is ‘freedom’ in that country. Or are high growth rates alone sufficient’ Read this book to know more.

Further Reading

1) Singapore Diary-Part 3 By E Pradeep

2)On Singapore-Binu Ninan

The Economics of Remittances

Definition

According to Wikipedia, Remittances are transfers of money by foreign workers to their home countries. Remittances (also known as current transfers) include worker’s remittances and other private transfers on the current account. [Gupta 2006]

 

The Indian scenario

Remittances to India have increased at about 13 per cent a year since 1991, making India one of the largest recipients of remittances in the world. They have been the most stable type of external flows in India. They have been crucial in improving the current account and in the consequent build-up of foreign exchange in the last few years.

 

The effect of remittances on output and employment generation would depend on the end-use of the transfers. The effect would be larger if remittances are geared more toward investment expenditure.

 

In terms of percentage of GDP, remittances equaled about 3 per cent in 2003.

 

[These are excerpts from Poonam Gupta’s ‘Macroeconomic Determinants of Remittances‘ which came in the EPW.]

 

The Kerala scene

 

The great exodus of Keralites to the Gulf Countries during the 1970s oil boom was to a large extent possible because of the benefits these workers had gained from growing up in Kerala (better health and education, and more awareness of opportunities beyond their state). The money they send back today makes up 25% of the state budget, and one third of all remittances to India. It has not only helped to stimulate consumption levels in Kerala, which are among the highest in country, but it has also kick-started the boom in the tertiary (or service) sector of industry ‘IT, tourism, banking, private health care, etc. ‘ that has been the driving force behind Kerala’s economic growth spurt. While neither the manufacturing industry nor agriculture has experienced any significant growth over the past decade, the service sector now makes up something like 65% of the state economy, and has since 1986 until today gone from a growth rate of 3.25% to 7.5%. The remittances also probably served to underestimate Kerala’s economy throughout the financial dark ages, since they do not count directly towards the GDP. [Blomqvist 2006]

 

Reasons

Obviously, the most common motivation to remit is simply that migrants care of those left behind: spouses, children, parents, and members of larger kinship and social circles. First of all, remittances may just ‘buy’ a wide range of services such as taking care of the migrant’s assets and relatives at home, with the likelihood and size of remittances depending on whether and when the migrant intends to return. Secondly, it is clear that migration is primarily (but not only) driven by wage differentials, implying that people are ready to incur substantial moving costs in order to access to international migration. [Rapoport and Docquier 2005]

The main results established in the literature are: remittances are motivated more by an altruistic motive than by an investment motive; remittances are counter-cyclical, i.e., higher under adverse economic outcomes in the native country; they are used more for consumption than for investment; and they do not respond much to relative rates of return on investment in the home country. [Gupta 2006] This result is supported by The Hindu Business Line which says that ‘Unlike the capital flows, interest rate differentials are not found to be significant in determining the workers remittances, thus underlining the stable nature of these flows.’

 

A trade off’

Migration to other countries take place mainly when there are better employment avenues abroad. This usually takes place after the individual has completed his education. Large scale migration has been criticized by imposing on them the ‘brain drain’ stamp.

 

Thus when migration takes place, the home country is losing a significant chunk of its educated labour force. In developing countries like India, there is much to be done; but since the addition to labour force happens at a faster rate than the increase in employment opportunities, this ‘migration’ tends to become inevitable.

 

A trade off is evident between ‘brain drain’ and ‘remittances’. Though ‘brain drain’ is said to have a considerable pressure on the home economy (By withdrawing educated labour force) remittances tend to improve standard of living in the home country. But usually remittances better the standard of living of the ‘dependent population’. They do not affect or increase the productive capacity of the Indian economy directly, but they affect it indirectly through increased consumption.

 

Illegal flows

Unofficial remittances are sent through friends or migrants themselves or through traditional networks, known in some countries as hawala or chiti, which allow money deposited with a trader in one country to be paid out by a partner in the recipient country. [Mutume 2005]

 

Hawala is an informal banking system in which funds are transferred internationally, without being moved physically. Hawala brokers, whose relationships are based in part on trust, maintain running accounts with one another. Once a sender deposits funds with a hawala broker, the broker contacts another hawala broker in the relevant location and requests the dispersal of funds to the recipient. Hawala brokers employ fast methods of communication, such as phone or fax. The main users of the hawala system reside in the developed world and transfer funds to recipients in the developing world. [Fugfugosh 2006]

 

Conclusion

The increased inflow of remittances is what is fuelling the ‘consumption boom’ in India. The fact that the SENSEX is bullish and the real estate markets are booming are proof to this. (There has not been any proportionate increase in the intrinsic values. They might be a bubble which is financed almost to a large extent by remittances.) Adequate studies should be targeted at such interrelationships between remittances and various markets in the home country, so that the small investors do not incur huge losses.

 

Since, these remittances are relatively stable, this consumption boom will tend to sustain for longer periods. Moreover, these remittances are said to be one of the main reasons for lowering poverty. For example, remittances enhanced the standard of living of the people in Kerala. They also contributed to development in African countries.

 

The government is trying to improve the investment benefits accruing to the expatriates with a hope of increasing the flow of remittances. There is no doubt that remittances are beneficial to the receiving country.

 

Recipients spend these funds (remittances) in various ways: for some, remittances are their lifeline, without which they do not eat, as in Somalia; for others, remittances are transferred home specifically to be invested in savings schemes with attractive incentives, as in India. In Cape Verde, migrant remittances contributed to political change of the oppressive island government while for people from other countries, remittances are directed to community infrastructure development, such as collective projects in Mexico. These illustrations convey the message that in all corners of the globe, remittances are a precious tool for every single recipient and that the secure flow of remittances must be assured. [Fugfugosh 2006]

 

Thus for countries like India where additions to employment opportunities take place at a slow pace, migration will take place. Providing better investment avenues for these expatriates will help, although not significantly in bettering the flow of remittances. Moreover, by making such inflows easy and transparent, the unofficial inflows will reduce. Targeting these remittances and channeling them to socially productive investment avenues such as education and health will improve the condition of the Indian populace.

 

References

1) Steady rise in NRI remittances, The Hindu Business Line, 29th January 2004.

2) The Economics of Migrants’ Remittances, Hillel Rapoport and Fr’d’ric Docquier, March 2005.

3) Welfare and banana leaf thalis ‘ a foreign student’s take on Kerala, Part 1, Olof Blomqvist, 2006.

4) Informal Remittance Flows and Their Implications for Global Security, Miriam Ahmed Fugfugosh, 2006.

5) Workers’ remittances: a boon to development, Gumisai Mutume, 2005.