You might want to read Monday and Tuesday’s post before you begin in on this one.
In today’s post, we conclude by thinking through the section titled “Making Space While The Sun Shines“
- I’ve used the analogy of a human body throughout this little series, and I’ll press the point a little further here.
One major problem that crops up when treating a seriously ill patient is about both the strength and the duration of the dosage. How much should the dose be per day, and for how many days should the patient take the medicine?
- Similarly, when it comes to fiscal policy, how much is enough? What if you give too little of a push? Then the recovery is anemic. What if you nudge a little bit too much? We’re back in 2011-2014 territory – and please do read The Lost Decade!
- Which is where this section of the article becomes really important: there is no model, anywhere in the world, that tell you what to do now. That is a strong way to put it, but let me be clear: there is no model anywhere in the world that will tell you what to do now. The cause of this current crisis, the crossroads at which the Indian economy found itself before this crisis, the uncertainty about how this crisis will play out and eventually end, and the uncoordinated global response(s) to this crisis all put together mean that we economists don’t know for sure how much fiscal policy is too much. We don’t know for how long we should keep the fiscal stimulus going. We’re, as it were, flying blind.
- What Sajjid Chinoy is saying, however, is this: whenever you cross a certain threshold of the vaccination drive, you need to start the process of unwinding the stimulus. That is what this excerpt means:
“Counter cyclicality must be symmetrical: supporting activity in times of a shock, but then quickly retreating to create space when vaccinations reach a critical mass and the recovery becomes more entrenched.”
Will this actually happen? For India’s sake, let us hope so. Our track record is less than encouraging in this regard.
- Familiarize yourselves with the great r>g debates. In this decade, they’re going to matter.
- Familiarize yourselves with the meaning and the importance of the primary deficit.
- Familiarize yourselves with the what the phrase “dual mandate” means when it comes to monetary policy.
- Pts. 5 through 8 are hopefully going to be areas that you will cut your teeth on if you join the market as a macroeconomist over the next five years. Hopefully because if we are still on pts. 2-4 until that point of time, this pandemic will obviously still be with us.
- But if it has gone by then, (god, I hope so!), managing the recovery and its aftermath will the macroeconomic challenge of this decade.
This post should be read as a continuation of yesterday’s post.
What are the things to keep in mind when talking about fiscal policy for India in 2021? Sajjid Chinoy mentions two, and we’ll deal with the first of these in today’s post. It is called “Recalibrating To New Realities“
- Sajjid Chinoy first points out the fiscal deficit situation. Please, whether you are an economics student or otherwise, familiarize yourself with the budget at a glance document. My take on the fiscal deficit for the FY21-22 is that there is no way on earth we’re going to be able to stick to the budgeted 6.8%. Tax revenues will be lower, borrowing will be higher, and I’m not buying the INR 1,75,000 crores disinvestment target. I hope I am wrong!
- He recommends not cutting expenditures even if budgeted revenues don’t materialize, and expanding MNREGA funding – and I completely agree.
We’re getting into the weeds a little bit, but he also speaks about cash transfers instead of MNREGA given the pandemic, and I agree there too. Effectively, he is saying that people might not choose to apply for work because of the fear of getting infected, so drop the cash for work requirement: just transfer.
- “Double down on achieving budgeted asset sales targets, because this will provide space for more debt-free spending.” is one of his recommendations. I agree with the message, but find myself to be (very) cynical about the likelihood of this happening. We haven’t managed to meet these targets even once, and were off by an impossibly large magnitude this year, so I don’t see this happening. Again, I hope I am wrong.
- I’m paraphrasing over here, but the implicit request by the author is to keep capital expenditure sacrosanct (because of the multiplier effect). The implicit bit is the corollary: if sacrifices must be made, it is in revenue expenditure. The cynic in me needs to be reined in, but I’ll say it anyway: good luck with that.
- Finally, he makes a request of monetary policy, that is acts as a complement to what is written above. That is, monetary policy should not worry about inflation too much this year. It is more complicated than that, of course, but that’s a separate blogpost in it’s own right.
I wrote this last week on the basis of this write-up by Sajjid Chinoy. The sequel came out last week, so let’s read through it together.
First things first:
- During times of a crisis, such as the one we are going through, it may be helpful to think of the economy as a sick person. That would make us economists and policymakers the diagnosticians and doctors respectively.
- Us diagnosticians often like to think about why the person got sick. Was it because of some previously administered medicine? Was it because of some external factor? Maybe both? That is, we identify the disease, and the cause of the disease.
In this case, the economy is struggling because of the lockdowns and the uncertainty about (at least) the near future. Those are the symptoms. The cause is, of course, the virus.
- The doctors – that is, the policymakers – will want to remove the cause behind the economy’s illness first. That is what Sajjid Chinoy means when he says: “With a health crisis at the genesis of the current situation, it’s tautological to say that ramping up vaccinations is the “first-best” solution to tackling the crisis.” That is the cause of the crisis, and removing the thing that causes the crisis is of paramount importance.
The “how to do this best” question has troubled all of us, and continues to trouble us, and it is worth your time to keep tracking this issue. And it is a great way to learn about how to think about public policy.
- But treating the symptoms (and the manifestations) of the cause is equally important. Job losses, reduced investment, reverse migration, subdued demand, rising inequality, reduced incomes, the exacerbated lack of social safety nets are all symptoms and manifestations of the crisis. How to treat the symptoms? That is where Sajjid Chinoy’s second article comes into play.
There are two courses of treatments available to us diagnosticians and doctors: fiscal policy and monetary policy. Sajjid Chinoy argues (and in my opinion, does so convincingly) that monetary policy has done all the heavy lifting it could in 2020, and there’s not much left in the RBI’s arsenal.
Monetary policy was the prime mover last year and markets will inevitably clamour for that pedal to be pressed even harder. But quite apart from the fact that monetary conditions are already very accommodative and core inflation has averaged 5 per cent since the start of 2020, what’s less appreciated is the reduced efficacy of monetary policy in periods of elevated uncertainty. That’s because monetary policy ultimately relies on economic agents (households, businesses, banks) to act on the impulses it imparts. But when agents are faced with acute health, income and macroeconomic uncertainty, they often freeze into inaction (“the paradox of thrift”). So households don’t borrow, businesses don’t invest and banks don’t lend. This is evident in the evolution of bank credit over the last year in India. Despite negative real policy rates and falling real bank lending rates, credit growth has continued to slow all year long, likely reflecting these uncertainties.https://www.business-standard.com/article/opinion/fiscal-vs-monetary-policy-under-uncertainty-121052401432_1.html
Homework: What is core inflation? Where is this data to be gotten from? Where do we get data on the evolution of bank credit from? What are negative real policy rates? What are falling real bank lending rates? Where do we get that data from? What is credit growth? Where do we get that data from?
Which means we must now think about how to best deploy fiscal policy.
The baton must, therefore, pass to fiscal policy. While fiscal policy cannot mitigate the health uncertainties it can help alleviate income and macroeconomic uncertainties. Stronger spending will not only boost activity but, in so doing, will reduce demand uncertainties for firms. Furthermore, income support (in cash or kind) along with public-investment-induced-job-creation can alleviate income uncertainties for households and thereby help catalyse the private sector.https://www.business-standard.com/article/opinion/fiscal-vs-monetary-policy-under-uncertainty-121052401432_1.html
Sajjid Chinoy highlights two broad areas to think about in his article:
- Recalibrating To New Realities
- Making Space While The Sun Shines
There is much to agree with (and add to) in each of these cases, and I’ll do so in the next two blogposts.
But the bottomline across both articles, for students of macroeconomics, is this:
- Think of the economy as a human body. Like the human body, the economy is impossibly complex, and all of its underlying connections, mechanisms and responses aren’t entirely clear.
- Like a good diagnostician, it is important to keep tabs on a variety of different metrics on an ongoing basis. That’s what Sajjid Chinoy’s first article should mean to you – and therefore this blogpost is homework you really should do.
- Once you have enough data about the patient, a good doctor should be able to recommend potential cures. As with the human body, so with the economy: different doctors will recommend different treatments, and for many (mostly good) reasons. This is the part that gets really tricky.
- Sajjid Chinoy’s recommended course of treatment is his second article. As a student, you must try and understand why he recommends this course of treatment and no other, and ask yourself to what extent you agree with him. If you disagree with him (which is fine!), you should be able to tell yourself why – from a theoretical viewpoint.
- For example, you may disagree with him and say that India can still effectively deploy monetary policy. Maybe so, but you must have theoretically valid reasons for saying so.
- In fact, as a student, my advice to you would be to read an article willing yourself to disagree with the author. “How might this person be wrong?” is a great way to learn while reading. It is also a great way to keep yourself awake in class, trust me.
Human evolution produced gossip. Cultural anthropology sees gossip as an informal way of enforcing group norms. It is effective in small groups. But gossip is not the search for truth. It is a search for approval by attacking the perceived flaws of others.http://www.arnoldkling.com/blog/gossip-at-scale/
Arnold Kling writes an excellent essay about gossip and (as he puts it), the ISS. That, to be clear, stands for Internet, Smart Phones and Social Media. Excellent essay, well worth your time.
Low level of CRAR not only hampers bank health but also restricts smooth transmission of monetary policy. Injection of capital by the Government of India in public sector banks is likely to increase the credit flow to the real sector and help in smoother transmission of monetary policy.https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIWPS12.PDF
How much of this paper is signaling/laying the groundwork, and how much of it is a genuine addition to what we already know about monetary policy? The link comes via Amol Agarwal
This is exactly why I am so pleased to see how narrowly focused the Justice Department’s lawsuit is: instead of trying to argue that Google should not make search results better, the Justice Department is arguing that Google, given its inherent advantages as a monopoly, should have to win on the merits of its product, not the inevitably larger size of its revenue share agreements. In other words, Google can enjoy the natural fruits of being an Aggregator, it just can’t use artificial means — in this case contracts — to extend that inherent advantage.https://stratechery.com/2020/united-states-v-google
The concluding paragraph from this blog post by Ben Thompson is even better, and I was tempted to go with it, but this works too! Please read the whole thing – excellent writing, as always.
If you’re looking to get an iPad right now and can afford it, the new $599 iPad Air is the best tablet for most people. Apple has taken the design from the more expensive iPad Pro and brought it down to a more reasonable price point. It’s $100 more than it was last year, but in return this year’s iPad Air has a bigger, better screen and a faster (and very intriguing) processor.https://www.theverge.com/21525780/apple-ipad-air-2020-review
Dieter Bohn’s review of the iPad Air (2020). If I could, I would!
Miniature paintings are among the most beautiful, most technically-advanced and most sophisticated art forms in Indian culture. Though compact (about the same size as a small book), they typically tackle profound themes such as love, power and faith. Using technologies like machine learning, augmented reality and high-definition robotic cameras, Google Arts & Culture has partnered with the National Museum in New Delhi to showcase these special works of art in a magical new way.https://blog.google/around-the-globe/google-asia/india-miniature-masterpieces
This is a must have app on your phone. I mean, it was always a must-have app on your phone, this latest collection only makes the argument stronger!
A reader sends in this question:
“What do governments actually mean when they say that we’re going to announce a 1 trillion dollar economic stimulus package? Does it mean that they’re going to spend that much money? Or they’re just going to give it to the industries? (if so what does that entail?)”
Keep the following in mind:
- I’m going to assume that the person who asked the question hasn’t learnt macroeconomics in a formal setting just yet, and will therefore answer the question accordingly
- I will describe a macroeconomic model using words, and keep it fairly simple
- I will use examples from earlier crises
- Let’s get started!
- Think of the Indian economy as a patient, and think of monetary and fiscal policies as medicines that are going to be administered by doctors. The RBI governor is a doctor to this patient, as is the Finance Minister.
- Any move pertaining to regulation of banks (allowing banks to ask for EMI’s later, reduction of interest rates, forbearance of loans) is medicine administered by the RBI.
- Any move pertaining to reduction of taxes, introduction of subsidies, amnesty schemes for taxes due in the past, spending on specific projects (construction of roads bridges etc), changes to government employees salaries/pensions, payouts to firms or individuals (literally giving them money) is medicine administered by the finance minister.
- Under normal circumstances, one doctor is plenty enough. In fact, macroeconomists often end up saying that if fiscal policy is going to provide the medicine, monetary policy should stand ready to counteract any excesses.
There is a dilemma as to whether these two policies are complementary, or act as substitutes to each other for achieving macroeconomic goals. Policy makers are viewed as interacting as strategic substitutes when one policy maker’s expansionary (contractionary) policies are countered by another policy maker’s contractionary (expansionary) policies. For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa. If they behave as strategic complements, then an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of the other.
- But when the patient is as ill as is the case now (and is going to get sicker in the days to come!), well then monetary and fiscal policy are not substitutes: both need to be at play at the same time.
- For example, in the 2008 recession, American policymakers resorted to both monetary and fiscal policy measures (all countries did, to be clear. I’m just using the American example because its data is easier to find and present)
- The monetary policymakers announced, among other things, TARP. By the way, astute readers might want to point out that this seems to have been run by the Treasury Department, not the Federal Reserve. True, not arguing with that. It’s complicated! Also, watch this movie.
- And, among other things, the American government also announced ARRA. The original website is no longer up, but you can see this, or read this.
Now, all that being said, we’re going to take a look at fiscal policy alone from here on in. It is not that monetary policy isn’t important (oh dear lord, it is!) but the question is more focused on fiscal policies.
To understand the answer to this question, let’s go back to an earlier post of mine, and quote from it:
Let’s break this tweet by Paul Krugman down.
- The government has decided that it will give away money. Ergo, fiscal policy.
- To whom should it give the money? It can give the money to firms, or to households.
- If it gives the money to households (in India for example, this would have been through Direct Benefits Transfer), might that help people more?
- Or should it give the money to firms instead?
- Payroll taxes, which is what is being spoken about in the tweet, is tax paid on behalf of employees to the government, by firms. Here’s Wikipedia:
Payroll taxes are taxes imposed on employers or employees, and are usually calculated as a percentage of the salaries that employers pay their staff. Payroll taxes generally fall into two categories: deductions from an employee’s wages, and taxes paid by the employer based on the employee’s wages. The first kind are taxes that employers are required to withhold from employees’ wages, also known as withholding tax, pay-as-you-earn tax (PAYE), or pay-as-you-go tax (PAYG) and often covering advance payment of income tax, social security contributions, and various insurances (e.g., unemployment and disability). The second kind is a tax that is paid from the employer’s own funds and that is directly related to employing a worker. These can consist of fixed charges or be proportionally linked to an employee’s pay. The charges paid by the employer usually cover the employer’s funding of the social security system, Medicare, and other insurance programs. It is sometimes claimed that the economic burden of the payroll tax falls almost entirely on the worker, regardless of whether the tax is remitted by the employer or the employee, as the employers’ share of payroll taxes is passed on to employees in the form of lower wages that would otherwise be paid.
- So when there is a payroll tax holiday, firms no longer have to pay these taxes. So who is benefiting here? Firms or the employees of firms? To the extent that the firm no longer has to pay these taxes, it has more money with itself. It can either keep this money and use it for other things, or it can pass on this money to the employees. What will actually happen is tricky to predict, and trickier still to measure!
- For example, imagine the Indian government says to the Gokhale Institute of Politics and Economics (GIPE) that the Tax Deducted at Source (TDS) from the professors salaries need no longer be given over to the government. (To people who know their macro, I know it is not the same thing. Treat this as an illustrative example)
- If GIPE was due to pay me a 100 rupees every month, it would deduct 10 (that’s the TDS) and pass it on to the government. That need be done no longer.
- But the government doesn’t say that this money should be given to the professors instead – GIPE can do with it whatever it wishes.
- Will (should) GIPE pass on this money to the professors? Or use this to pay other people employed by GIPE? Or just keep it with GIPE (who knows when the college will reopen, hoarding cash may be a good idea). Or… anything else you can think of, really!
- So “giving” to industries really can mean a variety of things. And it really depends on what industry chooses to do with this money. You could apply conditionalities and say you will only get the money if:
- It’s passed on to employees
- You qualify because your firm falls in an important sector (employs a lot of people, is important from a social viewpoint, is critical to combat the virus etc)
- Anything else you can think of
- Or the government could spend the money itself! Build roads, bridges, dams, employ thousands more teachers, temporary employees – but all of this is assuming we can control the spread of the virus, of course. Without that, all of this is difficult, if not impossible to achieve.
So the correct answer to the question that the reader asks is: all of the above. At this point in time, a good fiscal policy move will be to spend, and give tax benefits to firms and households. This is roll out the big guns territory, no half measures will do.
A useful exercise to do: go through the fiscal stimulus announced by our government, and try and pinpoint which parts are directly in the hands of the people, which in the hands of the firms, and which is spending by government on building out infrastructure etc. Here’s one article to help you along.
Homework Part Deux:
Are we Rawlsian?
Homework Part Trois:
Are we Rawlsian enough?
Dr. Parchure is the officiating director at the Gokhale Institute of Politics and Economics, where I work. He was also my guide during my PhD saga (there is no other word for it), and has forgotten more macroeconomics than I will ever learn.
Tomorrow, at some point of time, I and Dr. Parchure will be sitting down – at our respective homes, of course – for a chat about what India can do when it comes to macroeconomic policy after the worst of the corona virus lock-down is over.
First things first: health comes first, and that’s a non-negotiable. There’s no version of this story in which we can discuss trade-offs about “getting things back to normal” so that “the economy isn’t destroyed”.
As Russ Roberts puts it:
So we’ll be talking tomorrow about an as yet unspecified date in the future, where India might not be as mobile and social as she was before, but not as locked-down as she is right now. But when that day comes, what should macroeconomic policy look like?
Here are two articles that I will be basing this discussion on:
- Ira Dugal’s take on India’s monetary policy.
- Ananth Narayan’s take on India’s fiscal policy.
Please read both, and don’t worry if you don’t get some details. Just power through both write-ups regardless.
Here are some aspects that I will definitely be asking questions about tomorrow:
- The advisability of giving a monetary and fiscal stimulus: everybody seems to be taking it as a given (myself included). But is there a case to be made for limiting it, if at all?
- That out of the way, should both fiscal and monetary policy be wheeled out simultaneously? Either ways, why?
- What are the major tools in the monetary policy toolbox? Which of them will give the most bang for the buck? Which should we be holding back for later, and why? What mistakes should we be guarding against?
- Ditto for fiscal policy.
- What would Keynes have advised? I have this book in mind when I ask this question.
- What episodes, in 20th century macroeconomic history, have parallels we can learn from? If there are none, are current macroeconomic models good enough to handle such scenario? If not, how might they be updated?
- If you, Dr. Parchure, were in charge of things – interpret that as you being given carte blanche to handle India’s economy, no questions asked – what would you do? What are the political realities that in reality will stop some of these solutions from being implemented?
I’ll be sharing this blog post with Dr. Parchure, but in the meantime, if you have any questions that I have missed, please let me know in the comments, or email me.
The conversation will be up on YouTube tomorrow at some point of time.
Stay home, stay safe!