The Hindu Business Line : Sadly, economics is typically explained so badly

THE Reserve Bank of India Governor, Dr Yaga Venugopal Reddy, is different from the usual economists, because he communicates to the common man. To check, you may see his recent speech titled, `Monetary Policy: An Outline', posted on www.rbi.org.in. He begins by listing the three basic constituents of monetary policy framework, Objectives, Analytics, and Operating procedures, and goes on to explain each of these.

"Traditionally, central banks have pursued the twin objectives of price stability and growth," says Dr Reddy about the first constituent; he then reasons how central banks end up pursuing multiple goals such as financial stability, exchange rate management, and maximum employment.

What are analytics? These refer to `monetary transmission mechanism' or "the process through which changes in the monetary policy get transmitted to the ultimate objectives like inflation or growth."

If that goes above your head, Dr Reddy explains disarmingly: "Interestingly, economists often refer to the channels of `monetary transmission' as a black box — implying that we know that monetary policy does influence output and inflation but we do not know for certain how precisely it does so."

The third, that is, `operating procedure,' refers to the day-to-day implementation of monetary policy by central banks through various instruments, direct and indirect.

"Direct instruments include required cash and/or liquidity reserve ratios, directed credit and administered interest rates," elaborates Dr Reddy, and among the indirect ones is repo that figured prominently in the latest Credit Policy Statement.

"Conduct of monetary policy is complex," he concedes, and describes his challenge "to balance the various choices into a coherent whole and to formulate a policy as an art of the possible." To most of us, however, economics is just impossible.

"Sadly, economics has typically been explained so badly that people either dismiss it as impenetrable gobbledygook or stand falsely in awe of it," writes Sean Masaki Flynn in Economics for Dummies, from Wiley (www.wiley.com).

The book is aimed at making one understand more about people, the government, international relations, business, global warming and endangered species (which, I guess, should include plain-speaking economists too for they're in terrible short supply!).

A chapter is on `Measuring the macroeconomy' to explain `how economists keep track of everything'.

They use `a huge accounting apparatus' called the National Income and Product Accounts (NIPA) to measure economic activity, writes Flynn, a Ph.D. in economics at the University of California, Berkeley, and a student of Nobel laureates George Akerlof and Daniel McFadden.

Normally accountants shun economics, but it seems economists are wiser; the author points out that knowing accounting is indispensable because "it's the basis for all the mathematical models that economists use to understand and predict things like the business cycle, inflation, economic growth, and both monetary and fiscal policy."

For instance, you have to tally up what numbers you get by counting incomes, and then totalling all expenditure.

"If your calculations are correct, both methods give you the same value for GDP." A simple diagram shows the circular flow between firms and households; "firms buy or rent the factors of production from the households and use them to produce goods and services, which are then sold back to the households."

A detailed diagram shows how savings and taxes move from households to financial markets and the government, respectively, and also positions markets between households and firms — both for factors of production and goods/services. When countries move from agrarian structure to market economy, "where nearly everything produced is sold for money," you may find that gross domestic product or GDP rises. That is because a lot of output is being counted for the first time, explains the author.

More the GDP the better, but remember that the value of leisure does not get counted in the statistic.

"Many of my favourite times have been when I was neither producing nor consuming anything that would count in GDP — sitting on the beach, climbing a mountain, taking a walk, working out with friends," says Flynn.

But leisure is a high-growth service sector that counts in GDP. For instance, "the tourist sector of the Dominican Republic generated $3.4 billion worth of revenues last year, up 5 per cent from 2003," informs www.cubaxp.com. And on the Theme Parks & Fun Centres Show 2005 — West Asia's `largest and exclusive trade event for the amusement & leisure Industry'— www.ameinfo.com talks of "mega projects such as the $3 billion, Attractions & Experience World, part of Dubailand in Dubai, Durrat al-Arus in Saudi Arabia, the third largest recreational city in the world; and Iceberg Towers at Bahrain at a cost of $175 million."

Yet Flynn has a point that "an increase in GDP often comes at the price of sacrificing these leisure activities — meaning that when you see an increase in GDP, overall well-being or happiness hasn't necessarily improved."

Similarly, `more money isn't always a good thing,' as a chapter on `Inflation frustration' explains.

Do you know that Hitler was voted to power because he tried to fix the damaged caused by "history's most infamous hyperinflation" that hit Germany in the 1920s?

It was 100 per cent per month and 6,000 per cent by the end of 1922! "Prices went up 1,300,000,000,000 times (this is not a misprint) in 1923," recounts Flynn. "That year, Germans paid 200,000 marks for a loaf of bread and 2 million marks for a pound of meat.

Prices rose so rapidly that waiters at restaurants had to pencil in new prices on menus several times a day. And if you ate slowly, you were sometimes charged twice what was printed on the menu because prices had gone up so much while you were eating!"

How refreshing, therefore, to read Dr Reddy's recent communiqué and find that our consumer price inflation apologetically "firmed up to 4.4 per cent in January 2005 mainly due to increase in the prices of fish, meat, sugar, kerosene oil and housing, before decelerating to 4.2 per cent in February 2005," as if in atonement.

Prescribed read before you let other economists launch their assault!

Economics@TheHindu.co.in

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Sadly, economics is typically explained so badly