One example: Another article in the same issue of Finance & Development, written by IMF economists, argues that “heavy inflows of remittances impair a country’s ability to conduct monetary policy”. The argument is that large remittance inflows impair monetary policy transmission because they “expand bank balance sheets by providing a stable and essentially costless source of deposits — because they are largely insensitive to interest rates”. While remittances are broadly insensitive to interest rates, I am unable to understand how they necessarily expand bank balance sheets in a costless way. India itself is a large recipient of external remittances, of the order of 3.5/4 per cent of gross domestic product. Indians working outside India remit the money to support their families in India. If the recipient does not need the money immediately, she would surely invest it in fixed deposits or other investment instruments — or real estate. Surely, remittances do not provide a costless source of deposits?
I also found the arguments in the article about bank lending confusing. For one thing, it seems that banks in developing countries “lack... complete information about the dependability of borrowers”. (Does anybody — even the US banks about mortgage borrowers?) This causes “banks to accumulate excess liquidity rather than expand private sector credit beyond their well-known borrowers”. In the same paragraph, the article emphasises the need for reduction in fiscal deficits to “free up resources to finance the credit-strapped private sector”. If the first argument is true, how will lower fiscal deficits help increase bank credit to the private sector?
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As for exchange rates, most economists in the IMF are PhDs from US universities. And, “in a number doctoral programmes (in the US) a student can specialise in macroeconomics without knowing what an exchange rate is, much less an emerging market economy” (Olivier Blanchard, IMF’s former economic counsellor and head of research, in Finance & Development, September 2014). Are these some of the economists trying to improve the knowledge base of illiterates like me in the developing world on exchange rates and monetary policy transmission?
The reality on the ground seems to be totally different from the kind of macroeconomic theory the IMF has believed in for decades. One example is the argument that an increase in money supply fuels inflation. If this were true, surely the inflation rate in the advanced economies, which have continuously expanded money supply and reduced interest rates for the last eight years, would have skyrocketed? Today, their central banks are struggling to bring it up to two per cent. And, as for the virtues of fiscal austerity to free up resources for the private sector, the central banks — and the IMF itself — are now urging governments to increase deficits for investment in infrastructure, taking advantage of the low cost of even 50-year capital. As for the liberal capital account and market-determined exchange rates, these not only do not lead to balanced trade, which is one of the IMF’s objectives, but also benefit only the financial economy at the cost of the real economy. The IMF has recently learned that a liberal capital account and fiscal austerity lead to lower growth and increase income inequality; that the fiscal compression ratio is altogether different from its earlier estimates.
After the 2008 crisis, Her Majesty the Queen, on a visit to the London School of Economics, asked a commonsensical question: Why did nobody predict it? One part of the answer is the kind of assumptions on which all the mathematical models used by economists are based; the second is that economics remains a social science — however “rigorous” and “elegant” the mathematics used it will never become physics. As Nobel Laureate physicist Richard Feynman said, “Imagine how much harder physics would be if electrons had feelings”; “electrons” of economics are human beings who do have feelings and emotions — and ideology. In economics, the questions remain the same — but answers keep changing. Economists should perhaps be modest like dentists, as Keynes advised them to be. The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com