Understanding Fiscal Policy (3/3)

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

  1. 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?
  2. 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!
  3. 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.
  4. 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.
  5. Familiarize yourselves with the great r>g debates. In this decade, they’re going to matter.
  6. Familiarize yourselves with the meaning and the importance of the primary deficit.
  7. Familiarize yourselves with the what the phrase “dual mandate” means when it comes to monetary policy.
  8. 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.
  9. But if it has gone by then, (god, I hope so!), managing the recovery and its aftermath will the macroeconomic challenge of this decade.

Understanding Fiscal Policy (2/3)

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


  1. 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!
  2. 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.
  3. “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.
  4. 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.1
  5. 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.
  1. Let me be clear, I agree! I just don’t see it happening, that’s all[]

Understanding Fiscal Policy (1/3)

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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?1


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:

  1. Recalibrating To New Realities
  2. 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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  1. Not all of the links will give you the exact answers, and that is deliberate. The last two questions being “unlinked” is also deliberate. If you are a student looking to work or study further in areas relating to macroeconomics, start building out a file with your answers to these questions (and many more!), and update the data on a regular basis.[]

A Summer Spent Doing Macroeconomics

Say you’re a student, and you’ve just finished learning a fair bit about macroeconomics. You’ve read and not understood Keynes, you’ve read and think you’ve understood Friedman, and you don’t have the faintest idea what folks in macro have been up to since Robert Lucas.

OK, all that is fine, but how should a budding macroeconomist spend her summer this year?

You could do a lot worse than reading this article, and asking yourself some simple questions.

Such as, do I hear you say? Read on!


Google mobility, for instance, is down more than 40 per cent since the start of April and currently at levels seen a year ago, when the national lockdown was in effect. This dynamic is also visible in the cross-section: states that forced down mobility more strongly have, in general, also seen a larger drop in positivity rates.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

What is Google Mobility? What does the data for India look like? How does this data correlate with statewise Covid-19 numbers? Can I create simple tables and charts in, say, Google Sheets that show a link between the two? And write up a blog about how I did it? Or maybe create YouTube tutorials that show how I did it?


That said, there’s growing evidence the impact will not be trivial even if not of the same scale as the first wave. By the middle of May, power demand was down 13 per cent and vehicle registrations were down 70 per cent compared to the start of the quarter, while e-way bills in the first half of the month were at 40 per cent of where they should be. A broader composite index would suggest activity is tracking a 6-7 per cent sequential decline this quarter and, while this is much shallower than the 25 per cent sequential contraction witnessed last year this time, the fact that it comes on the heels of the first shock, and can potentially trigger more hysteresis, remains a source of concern.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

Where does the data for power demand come from? Where does the data for vehicle registration come from? Where does GST data come from? What does the phrase “tracking a 6-7 percent sequential decline” mean? What is hysteresis?


Household income uncertainty and precautionary savings can be expected to rise. Even before the second wave, households had signalled caution about future spending (manifested in the RBI Consumer Confidence Survey) likely reflecting both an income hit and a precautionary savings motive. This behaviour is consistent with labour market dynamics wherein the unemployment rate, once adjusted for reduced labour force participation, had increased meaningfully even before the second wave.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

What is the RBI Consumer Confidence Survey? How is it calculated (see Annexure A in this document)? Where do we get unemployment data from?


Private investment could also take time to pick up. Even before the second wave, utilisation rates were in the mid-60 per cent range, much lower than needed to jumpstart investment.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

What is OBICUS? It stands for Order Book, Inventory and Capacity Utilization Survey. How else do we track capacity utilization?


We have previously found a strong elasticity of India’s exports to global growth and, if that holds, this should drive a strong export rebound in India. Some of this is already visible in the data with manufacturing exports surging in recent months, and currently 18 per cent (in nominal dollar terms) above pre-pandemic levels.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

Where might that paper/research be, the one that talks about the strong elasticity of India’s exports to global growth? What does it tell us? What is different between the time that paper was written and today? Is that to India’s advantage or not? How do we tell?


If crude prices average close to $70 this fiscal year, as is expected, that would constitute a 50 per cent increase over last year and serve as a negative terms of trade shock that impinges on household purchasing power and firm margins — a process already underway.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

EIA? Or something else? Should we take lagged data? If yes, with what lag? If no, why not? Where do we get information on firm margins? Bloomberg/Reuters? If yes, do we have access to a terminal? If no, whom do we ask for a favor?


When all is said and done, the completeness of an economy’s recovery from Covid-19 — and therefore the level of scarring — is assessed by comparing its post-Covid-19 path of the level of GDP with the path forecasted pre-Covid-19. If the aforementioned forecasts fructify, the level of quarterly GDP at the end of this year would be about almost 8 per cent below the level forecasted pre-pandemic. To be sure, India will not be the only emerging market to be below its pre-pandemic path. In fact, among the large economies, only the US and China will surpass it. But that said, an 8 per cent shortfall is meaningful.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

What is the level of GDP, and how is it different from the growth rate of GDP? Which should one use, and how does the answer change depending on the context? Where do we get data on GDP of all countries at one time? Which one of these measures should we use for comparison, and why?


Macro is hard, and in many different ways. Understanding the theory is hard, but piecing together parts of the puzzle from disparate (and at lest in India, gloriously unfriendly) data sources is perhaps harder still. But if you want to “do” macro for a living, being familiar with the answers to these questions is table stakes.

That is, getting familiar with the answers to the questions I have asked here gets you the right to sit at the table. Playing the game better than the others once you’re in is a whole different story. And playing the game means using this data with your knowledge of theory to try and take a stab at the really important questions:

The question, therefore, is how should economic policy respond to this second shock? With fiscal and monetary policy already quite expansive, is there space to respond further? We assess policy options and tradeoffs in a companion piece tomorrow.

https://www.business-standard.com/article/opinion/a-recovery-interrupted-121052300845_1.html

Trust me, macro is hard.