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How India can reduce the size of its black economy

Here is the link to my article, “How India can reduce the size of its black economy” in

It is partially based on an earlier blogpost on the same topic.

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Picking on Piketty!

So like many other fellow bloggers, amateur economists, savant economists, and Nobel laureate Paul Krugman, I have my copy of Capital. This time the author is Thomas Piketty and not Mr. Marx though. I am yet to read the book- not sure if I will ever get to it amidst semester ending, grading and fulfilling research requirements. So I wanted to get a quick take on what macroeconomists have to say about the book. Not surprisingly, Steve Williamson had a post- but he was yet to read the book. So I guess we will have to wait for his critical comments or not as he is more into figuring out what Fed should be doing! Meanwhile this following comment by Tony on Steve’s post¬†provides a good critical view:

Piketty’s book does not contain explicit references (to the best of my knowledge) to the two-decade-old body of work on macroeconomics and inequality beginning with Huggett and Aiyagari. Neither does the book’s online appendix, but if you follow the links provided in this appendix to other papers that Piketty and co-authors have written you will find references to some of this work. (That does not count as a citation in my book but it shows at least that Piketty is evidently aware of some of this work.) But for reasons that are unclear to me Piketty does not seem persuaded by papers like Castaneda, Diaz-Gimenez, and Rios-Rull (JPE, 2003) which match most of the facts about U.S. income and wealth inequality with parameters calibrated more-or-less reasonably. Instead in his book (which I have still not yet finished) and in a very recent paper (April 2014) with Zucman he seems to favor fairly mechanical models with multiplicative shocks to individual wealth accumulation. These models generate power laws for the upper tails with coefficients that evidently depend on the now-infamous “r-g” (i.e., the difference between the interest rate and the growth rate). But he does not make much of an attempt to calibrate them as do Benhabib et al (Econometrica et al, 2011). My overall impression so far is that Piketty does not really engage the existing literature on income and wealth inequality. Maybe this is because he focuses almost exclusively on the upper upper right tail of the wealth distribution (not just the top 1% but the top 0.1%). Krusell and Smith and Castaneda et al and others do a pretty good job of matching the top 1% but perhaps (and I am not sure about this) less well on the top 0.1%. But then in his book he makes bizarre statements like “the profession [has an] undue enthusiasm for simplistic mathematical models based on so-called representative agents”. He knows this is not true! (He was even a discussant for Quadrini and Rios-Rull’s forthcoming chapter on “Inequality in Macroeconomics” in the Handbook of Income Distribution.) Inexcusable.

There is also this article from 2012 on VOX that might interest you. And as the famous econblogger Noah Smith once tweeted: stop spelling Piketty as Picketty ūüėČ

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Unconventional Monetary Policy in an Interconnected World

I came across this news item from CNBC about Bernanke and Rajan face-off and that was enough to break the long blogging hiatus! ¬†Rajan raises an important question that should be addressed given today’s closely connected economic systems. In the context of unconventional monetary policies, he asks¬†“If the policy hurts the rest of the world more than it helps the United States, should this policy be pursued?” ¬†This question is important because there has been a lot of debate about the domestic impact of Fed’s QE policies , but not much has been said about¬†the effects of such policies on emerging market economies. In fact, Rajan puts it quite bluntly when he criticizes “the Fed for failing to mention turmoil in emerging economies in its January 2014 policy statement, sending ‚Äúthe probably unintended message that those markets were on their own,‚ÄĚ a sentiment reinforced by public comments by regional Fed bank presidents.” (Source)

While some macroeconomists and even the new Fed Chairman continue to argue about the favorable effects of QE and the eventual low interest rate regime, there has been a convincing argument against it made by New Monetarists like Stephen Williamson here¬†and more informally here. ¬†The infromal argument in short goes somewhat like this: if money competes as means of payments with other assets playing similar role (shadow banking) and if QE is increasing their prices, then the only way money can retain value is if inflation goes down. So we have an imminent danger of Japaneese style stagnation as the lowering of interest rates and increase in value of money creates a liquidity trap. ¬†This is quite apparent in the data and hence quite surprising that Fed continues to neglect it when it comes to policy making. Thus, given that the benefits of QE for the US itself are circumspect¬†or unclear at best, Rajan’s criticism seems valid and timely.¬†Of course, Bernanke did not take it well- he does not want any blemish on his legacy! Not sure what to think of his argument about QE being demand augmenting as suggested by required exchange rate intervention.

Notwithstanding this face-off between two first rate scholar central bankers, something definitely needs to be thought about policy making in an interconnected world economy-especially in case of the US who supplies the world’s most prominent reserve currency and the general shortage of safe assets as argued by Caballero. It looks like there was some talk about this in Kansas City Fed in 2012, the Jackson Hole symposium in 2013, and very recently at the IMF. Rajan’s proposal in this regard seems interesting and worth researching. He sees “merit in assigning the International Monetary Fund or a similar institution the responsibility of assessing the spillover effects of major central banks policies ‚Äď much as the World Trade Organization does with trade rules ‚Äď but acknowledged this isn‚Äôt politically viable.”¬†

Whether, such a solution is possible or not, the argument against activist monetary policy favoring low interest rates has never been stronger than now. As James Bullard suggests here, there is a strong evidence that low interest rates may have prolonged the recession that started in August 2007, when firms speculated in the international oil markets using the abundantly available cheap funds and literally engineered an oil price shock! Of course, real data available to Fed at that time did not reflect this and significantly understated the extent of actual recession. Talk about lags in policy making eh!


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Must be right- Krugman says it!

A couple of students from UMass Amherst find a fault in the results by Ken Rogoff and Carmen Reinhart weakening their claim about the proportion of debt to GDP and its deleterious effects. It seems, now that this link appears to be tenuous, the case for austerity in case of many debt ridden EU countries is significantly weakened and finally the Keynesians of the world win the intellectual battle. Certainly, Paul Krugman seems to think that in successive blogposts on the Rogoff affair!

So is the case for austerity for these debt ridden EU countries really that tenuous? Should they be allowed to continue to inflate their way out? I do not think so. A clear picture of what plagues EU can be found here. The theoretical and empirical evidence against government spending as a way out of economic problems is overwhelmingly in support of austerity. Empirical work by Barro clearly shows that even with huge government spending shocks, the expenditure multiplier tends to just a little over or equal to 1. Moreover, theory tells us that polices that alter the incentives people face will tend to work far better in stimulating the economy in the desired direction. Even if there is deficient private demand, just filling in the gap will just do that- plug the hole. It does not affect the behavior of private sector in the long run. For example we know that the 2008 tax rebate did not move current consumption at all. Savings went up and people paid down the debt that was accumulated in the past. Sometimes even seemingly well intentioned policies can have opposite effects. Casey Mulligan makes an interesting case for this in his latest book, “The Redistribution Recession”.

There might be some case for government spending or inflation tax in developing countries. The presence of a substantial informal sector and significant positive returns on investment in public infrastructure are the cases in point. But you cannot have the same prescription for every country, and hence the Keynesians or Left thinkers especially in developing¬†countries¬†should not take shortcomings in Rogoff and Reinhart’s work as their victory. ¬†Increased government expenditure on employee salaries is still unproductive and deficient private demand (if present at all) may still not be corrected with it. And that replication of results should be still taken seriously before we base policy prescriptions on them.

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Perils of using PennWorld Data

Seems like results from a lot of published papers will have to be revisited:

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Top 20 AER articles of the century!

The February 2011 issue is the 100th anniversary issue of the American Economic Review. Taking this opportunity, the first article lists top 20 articles published in AER since its inception. There was a committee set up to pick these articles which used a more informal process to select 20 admirable and important articles. Click here to find out who made it to top 20!

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India-US Nuclear Deal

This controversial deal for trade in nuclear reactors targeted for civilian use has finally come through. All the downside apart, it will be great to have the energy problem solved in a much cleaner way. Read the coverage in the Financial Times for details.

However, given that the nuclear deal is for non military purposes, there is nothing ironic about it coming through on October 2, as FT would like us to believe!

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Pollution Concerns

Well, people say there is always some environmental cost of development. But in case of India these costs turn catastrophic becasue of tragedy of commons, corruption and citizens, who dont give a damn. If you are not convinced, this article should be an eye opener.

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Land Reforms

If any body has been even near CESP, JNU, he or she cannot miss one simple prognosis for almost all of India’s economic ills- lack of land reforms! I think Tim Besley & Robin Burgess definitely did not miss it. In a very interesting article, they undertake the task of econometrically investigating the relationship between land reforms, poverty and growth in India. They find a robust link between land reform and poverty reduction. However, they argue that a closer scrutiny reveals that, in an Indian context, this is due primarily to land reforms that change the terms of land contracts rather than actually redistributing land.
Some points worth noting:

  1. In an IV regression, they find that Congress and soft left decrease the probability of enacting land reform legislation, while hard left exerts a positive influence and Hindu parties are insignificant. If you think this is a cudos for left governments, note that the overall positive influence of hard left parties seems to originate principally through strong positive effect on the passage of land ceiling legislation and the authors do not find any evidence that such land reforms reduce poverty.
  2. Land reforms have a positive significant effect on agricultural wages, though this effect primarily comes from abolition of intermediaries.
  3. Tenancy reform has negative impact on agricultural output while land consolidation has the opposite effect.

Thus, according to the authors, although the effects on poverty are likely to have been greater if large scale redistribution of land had been achieved, the results are interesting as they suggest that partial, second best reforms which mainly affect production relations in agriculture can play a significant role in reducing rural poverty. Comparing the effect of land reforms on poverty with effect of changes in per capita income, the authors find that implementing a land reform has a similar effect on poverty reduction to a 10 percent increase in per capita income, or around four to five years growth at all-India average growth rate over period (1958-1992).

The article also has a good summary of the kind of land reforms undertaken by various states till now.

Besley Timothy & Burgess Robin (2000), Land Reform, Poverty Reduction, and Growth: Evidence from India, The Quarterly Journal of Economics, May.

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I always wondered what keeps the movements like the Narmada Bachao Andolan going, especially in the face of claims made that they might have hindered the possibility of the displaced being well compensated. However, this article was an eye opener. It also showed something more than that- the innovative use of an instrumental variable strategy in order to asses the impact of dams on rural poor.

It seems intuitive enough that dams will have a differential impact on down stream districts than the upstream districts or the district where the dam was built. This accords well with the engineering fact that dam construction requires some gradient for the river, a low but a non zero one more suited for irrigation dams. The authors exploit variation in dam construction induced by differences in river gradient across districts within Indian states to obtain IV estimates.

The main findings of the paper are as follows:

  1. Dam construction leads to a significant increase in irrigated area and agricultural production in districts located down stream and they also provide insurance against the rainfall shock in these districts. However, in the own district a dam induces something like a mean preserving spread in agricultural production.
  2. Each dam is associated with a significant poverty increase of 0.77 percent in its own district. However, poverty reduction in the down stream district is significantly lower than that. As per the authors there are 1.75 districts down steam and thus the poverty reduction in down stream districts is insufficient to compensate for the increase in poverty in upstream districts.
  3. The poverty impact of dam construction is accentuated in districts with a history of relatively more extractive institutions (as captured by their historical land tenure system). This is in accordance with Banerjee and Iyer (2000) who show that the ability of of the population to organize themselves and obtain public goods exhibited marked differences across regions with different historical land tenure legacies (as mentioned on pp. 637).

Ever wonder why the displaced choose to stay in their village than move else where? The answer lies in the relation between income and risk aversion. Risk aversion decreases with income. So if dams increase poverty in the own district, it means in absence of credit and insurance markets, the affected will not choose to migrate. Does that seem too much out of line?

This article is definitely a good read and all those who are interested in the economics of public policy should definitely browse through.


Duflo E & Pande R, (2007), Dams, The Quarterly Journal of Economics, May, pp: 601-646.

Banarjee A & Iyer L, (2005), History, Institutions and Economic Performance: The Legacy of Colonial Land Tenure Systems in India, American Economic Review, XCV (4), 1190-1213.

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