Institutional Economics: ‘Light Reading It’s Not’

The RBA and Expectations Management

The RBA’s decision to leave the OCR unchanged at its February Board meeting is the subject of a lengthy discussion by Adrian Rollins in yesterday’s AFR. The discussion centres on whether the surprise decision was a failure by the market to interpret the signals being sent by the RBA, or whether it was a failure on the part of the RBA to appropriately condition market expectations. This is a joint problem, but one made worse because the RBA is not very good at communicating in a consistent, systematic and structured way.

This is an issue that is more serious than just wrong-footing the market over the outcome of a given Board meeting. Expectations for the future real official cash rate are critical to the transmission of monetary policy and are probably more important to the stance of policy than the actual cash rate. Changes in these expectations can even substitute for changes in the actual policy rate. Poor communication can lead to the effective stance of policy being easier or tighter than the Bank intends, requiring a more activist approach to changes in the OCR than would otherwise be necessary.

For example, it was not unusual for the market to periodically price in a new easing cycle during the 2002-2008 tightening episode. This de facto easing in policy contributed to inflation getting out of control and increased the amount of tightening ultimately required. It is thus very much in the RBA’s interests to ensure that market expectations align with its views.

posted on 05 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

How to Kill Animal Spirits: Banking Banana Skins

The PWC/CSFI Survey of Bank Risk, aka Banking Banana Skins 2010, finds political interference is the number one risk facing the banking industry:

Having bailed the banks out, governments are pushing them to keep lending through the recession, against their better judgment. A director at a large UK bank said that “political meddling in the financial sector is almost universally contradictory and negative. One can’t lend more to support the economy and build up capital bases at the same time”. A credit analyst at a large Japanese bank said that “political interference in both banking and regulation is likely to lead to a mis-allocation of resources, which will probably increase, not decrease, the risk profile of the system”.

In 2005 and 2006, ‘too much regulation’ topped the list of concerns and is still the main concern in the Asia-Pacific region.

Here is another banking banana skin.

posted on 02 February 2010 by skirchner in Economics, Financial Markets

No Free Lunch for Credit Conditions

The RBA has surprised the punditocracy by leaving the official cash rate unchanged, although financial markets had not fully priced a tightening. The RBA’s decision is consistent with comments made by Deputy Governor Ric Battellino late last year noting that credit conditions had tightened by 100 basis points relative to changes in the official cash rate over the last two years. He also noted that the tightening in lending margins had largely been in the area of business lending, not housing.

Today’s decision puts the bank-bashing by the government and others into proper perspective. The RBA discounts lending margins in its setting of the official cash rate. There are those who persist in believing that there is an interest rate free lunch to be had, if only the banking sector could be made more competitive. Today’s decision shows that monetary policy is so carefully calibrated to prevailing credit conditions that any exogenous easing through increased bank competition would be quickly taken back via the official cash rate. The RBA said so explicitly at the time of its August 2006 interest rate decision:

Compression of lending margins over recent years has contributed to a lowering of borrowing costs relative to the cash rate. This has meant that although the cash rate has recently been slightly above its average for the low-inflation period since 1993, interest rates paid by borrowers have remained below average.

Even Peter Martin is giving Westpac some love, so the message must be slowly sinking in.

posted on 02 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

RBA Tightening Expected on Tuesday

Financial market economists are unanimous in expecting a 25 bp tightening from the RBA at Tuesday’s Board meeting, according to a Reuters poll taken today. February inter-bank futures are giving a 69% probability to a 25 bp tightening, while iPredict has an implied probability of 87%. Markets seem to be underpricing a tightening relative to the punditocracy, perhaps reflecting the same concerns driving weakness in equity markets.

posted on 29 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Australian House Prices Post 11% Gain in 2009

The RP Data-Rismark national capital city hedonic home price index for December shows a modest fall of 0.3% for the month, but up 2.1% for the quarter and 11.1% for the calendar year. This follows modest declines of 2-3% in 2008, which was the worst performance in history on this measure.

posted on 29 January 2010 by skirchner in Economics, House Prices

Sentences You Won’t Read from the Reserve Bank of Australia

From today’s Reserve Bank of New Zealand intra-quarter policy review:

As growth becomes self sustaining, fiscal consolidation would help reduce the work that monetary policy might otherwise need to do.

This is more the RBA’s style (see if you can guess when the RBA said it before clicking here):

The purpose of my answer was to explain why it was wrong to claim that rises in interest rates were due to the stance of fiscal policy.

My answer in no way constituted an attack on the Government’s fiscal policy.

Governor Macfarlane was right to argue that fiscal policy was then irrelevant to inflation and interest rates. But more recently, Governor Stevens has argued that fiscal stimulus has supported economic activity and that there is a trade-off between monetary and fiscal stimulus. Just don’t expect him to spell out the implications of that logic in a policy announcement as candid as that from the RBNZ.

posted on 27 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

The Underrated Inflation Hedge

Fama and French discuss the relative merits of TIPS versus cash as inflation hedges. Cash is an effective inflation hedge because short-term interest rates offer compensation for actual and expected inflation, with very low risk. As French notes:

Because the one-month T-bill rate changes to accommodate changes in expected inflation, unexpected inflation does not have the compounding effect that it has with longer-term bonds.

Of course, this assumes that short-term interest rates remain market-determined rather than set by regulation.

posted on 27 January 2010 by skirchner in Economics, Financial Markets

Wisdom of Crowds: Fiscal Stimulus Edition

Americans are far from sold on fiscal stimulus:

A CNN/Opinion Research Corporation survey released Monday morning also indicates that 63 percent of the public thinks that projects in the plan were included for purely political reasons and will have no economic benefit, with 36 percent saying those projects will benefit the economy.

Twenty-one percent of people questioned in the poll say nearly all the money in the stimulus has been wasted, with 24 percent feeling that most money has been wasted and an additional 29 percent saying that about half has been wasted. Twenty-one percent say only a little has been wasted and 4 percent think that no stimulus dollars have been wasted.

posted on 26 January 2010 by skirchner in Economics, Fiscal Policy, Opinion Polls

Core Inflation

The December quarter CPI to be released on Wednesday is seen at 0.4% q/q and 2% y/y, according to Friday’s Reuters poll. This is somewhat higher than the 0.1% q/q and 1.7% y/y implied by the TD-MI inflation gauge.

The trimmed mean is seen at 0.6% q/q and a steady 3.2% y/y. The weighted median is seen at 0.6% q/q and 3.5% y/y, down from 3.8% y/y in the previous quarter. It is noteworthy that despite a near two percentage point increase in the unemployment rate, core inflation was not reduced to an annual rate consistent with the RBA’s 2-3% target range during the recent economic downturn.

posted on 25 January 2010 by skirchner in CPI, Economics, Financial Markets, Monetary Policy

Steve Keen They Hardly Knew You: Consumer House Price Expectations

The January Westpac-Melbourne Institute Consumer Sentiment survey finds that 84% expect house prices to increase over the next 12 months, with 21% expecting gains of over 10%.

posted on 22 January 2010 by skirchner in Economics, House Prices

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RBA’s Kraehe Highlights Supply-Side Constraints

RBA Board member Graham Kraehe highlights the capacity constraints driving monetary policy tightening:

Asked if there was a risk of too much policy tightening choking off recovery, Mr Kraehe said the focus should be on price rises rather than supporting demand.

“The risk is more to cost pressure and inflation than it is to the demand side,“ he said.

“Our unemployment has clearly now peaked. We’ve got increasing and continuing demand for employment in the resources sector that will put pressure on wages,“ said Mr Kraehe, who is also chairman of Bluescope Steel.

“As an economy, one of the issues for us will be our ability on the supply side, whether it be on housing or the labour market, to supply enough resources to be able to take some of the pressure off cost inflation. Wages is one thing, housing another,“ Mr Kraehe said.

posted on 21 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

It’s Not the Imbalances, It’s What You Do With Them

I have an op-ed in today’s Australian on the subject of global imbalances, arguing that it is distortions to capital allocation that make current account ‘imbalances’ problematic:

China will need to liberalise its capital account and domestic financial markets, moving its economy away from forced saving and unproductive, state-driven investment to a more market-driven system of capital allocation.

In this respect, China and the US have more in common than many Americans would like to think.

The US government will also need to extricate itself from its disastrous politicisation of housing finance and its post-crisis role in the US financial system.

In this regard, the US congress is likely to prove just as resistant to change as the Chinese Communist Party.

A less distorted system of capital allocation in both China and the US would have resulted in the more efficient use of global saving than was evident in the run-up to the global financial crisis. But it is unlikely to make much difference to the forces of globalisation driving persistent global imbalances.

posted on 21 January 2010 by skirchner in Economics, Financial Markets

Inflation for the Long-Run

Jim Hamilton points to his Phillips curve relation, which is forecasting deflation over the near-term. For the long-run, he suggests we should look to the fiscal theory of the price level:

The value of the new Federal Reserve liabilities ultimately will be determined by the long-term fiscal soundness of the U.S. government….Inflation is not something you should be afraid of for 2010. But what we need is a convincing commitment from the government to both near-term stimulus and longer-term fiscal responsibility in order to be assured that it’s not a concern over the next decade.

And that’s not what I’m seeing from the U.S. Congress.

Meanwhile, Thomas Frank contemplates an evil plot to stick it to the gold bugs: putting Fort Knox on eBay. Not that it would work, but there is a certain irony in those who fear inflation taking refuge in the one real asset that is potentially the most vulnerable to a surge in supply from central banks and governments.

posted on 21 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Gold, Monetary Policy

Transparency Policy in Practice

The federal government often references IMF reports in support of its policies, but is none too keen on facilitating interactions between Fund staff and the media. The IMF’s Independent Evaluation Office report on interactions with Fund members notes that:

the authorities of some advanced economies that had been major proponents of the Fund’s transparency policy in practice resisted the timely disclosure and dissemination of mission findings.

That would be us:

Press conferences/calls associated with the publication of the Public Information Notice and the Staff Report took place in the remaining countries, with the exceptions of Australia and New Zealand.

More from David Uren.

posted on 20 January 2010 by skirchner in Economics, Financial Markets, Media

The Bronze Medal for Economic Freedom

Australia maintains its third place in the Heritage Foundation-Wall Street Journal Index of Economic Freedom for 2010, once again trailing Hong Kong and Singapore. The US crash-dives to 8th place, behind Canada.

The index does not purport to measure political freedom. Australia’s political institutions are at least as free as any other country, and certainly more free than those in Hong Kong and Singapore. Australia could thus make a plausible case for being the world’s freest country after giving sufficient weight to the political as well as the economic dimensions of freedom, at least as measured by Heritage.

CIS will be holding an event on ‘Valuing and Measuring Economic Freedom’ on 28 January at which I will be speaking. Details here.

posted on 20 January 2010 by skirchner in Economics

Did the US Treasury See the Inflation Nutters Coming?

I have a column in today’s Business Spectator arguing that the global debate about whether monetary and fiscal stimulus will prove inflationary reflects poorly on the credibility of policymakers. One of the lasting effects of the discretionary policy responses to the global financial crisis may be the damage it will do to the credibility of monetary and fiscal policy frameworks.

David Merkel has updated the inflation expectations implied by US Treasuries, noting that ‘rapidly rising long-term inflation expectations indicate that the average investor does not trust monetary policy to succeed over the next 20+ years’. At the same time, Merkel argues that since this outcome is already priced, it may be time to short US Treasury Inflation Protected Securities (TIPS). The US Treasury may well be taking the inflation nutters for a ride:

there is a lot of demand for long TIPS. If the US Treasury thinks it can get things under control, the rational thing to do is to stuff the long TIPS buyers with as much product as they can gulp before it becomes obvious that low inflation will continue because the government will soon balance the budget and pay down debt, as they did after WWII.

But Merkel also concedes that:

I don’t know which direction the US Government and Fed intend to go with policy. They likely have no idea as well…if the US Treasury can’t get things under control, the long TIPS buyers will do well, as they have the most sensitivity to rising forward inflation expectations.

The enormous uncertainty created by the discretionary policy responses of governments to the crisis will weigh on economic activity, regardless of how these issues are ultimately resolved.

posted on 19 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

More on the ‘Bubble’ Drones at The Economist Magazine

Scott Sumner responds to the ‘bubble’ drones at The Economist’s Free Exchange blog. Like Scott, we can only laugh at the evidence The Economist offers for its claim that ‘many people did correctly identify the bubble years before it imploded, including writers at The Economist’. This is what they said in 2003:

A SURVEY in The Economist in May predicted that house prices would fall by 10% in America over the next four years, and by 20-30% in Australia, Britain, Ireland, the Netherlands and Spain. Prices have since continued to rise…

It’s a bit like ‘predicting’ that tech stock prices would crash…in 1996. The article was headed ‘What goes up…’, which pretty much sums up The Economist’s model of asset price determination.

posted on 19 January 2010 by skirchner in Economics, Financial Markets, House Prices

A Turning Point for Inflation?

The TD Securities – Melbourne Institute Monthly Inflation Gauge rose by 0.3% in December, following a 0.3% rise in November. In the twelve months to December, the Inflation Gauge rose by 2.6%. This is a fairly rapid acceleration from the October low of 1.2% y/y, which may well have been a turning point for CPI inflation. According to the Melbourne Institute, the gauge points to an increase in the December quarter CPI of 0.1%, yielding an annual inflation rate of 1.7%, a pick-up on the 1.3% annual rate seen in the September quarter. The December quarter CPI is released on 27 January.

posted on 18 January 2010 by skirchner in CPI, Economics, Financial Markets, Monetary Policy

Why Gene Fama Cancelled His Subscription to The Economist Magazine

…and why you should too. From John Cassidy’s terrific series of interviews with Chicago economists in The New Yorker:

JC: In the past, I think you have been quoted as saying that you don’t even believe in the possibility of bubbles.

EF: I never said that. I want people to use the term in a consistent way. For example, I didn’t renew my subscription to The Economist because they use the word bubble three times on every page. Any time prices went up and down—I guess that is what they call a bubble. People have become entirely sloppy.

See also Cassidy’s interview with John Cochrane:

JC: So you take the Greenspan view that bubbles can’t be identified except in retrospect? In 2005, you didn’t think there was a housing bubble?

Cochrane: I think most people mean by a “bubble” just, “Prices were high and I wish I sold yesterday.” The efficient markets (hypothesis) never told you that wasn’t going to happen. What efficient markets says is that prices today contain the available information about the future. Why? Because there’s competition. If you think it’s going to go up tomorrow, you can put your money where your mouth is, and your doing it sends (the price) up today. Efficient markets are not clairvoyant markets. People say, “nobody foresaw saw the market crash.” Well, that’s exactly what an efficient market is—it’s one in which nobody can tell you where it’s going to go. Efficient markets doesn’t say markets will never crash. It certainly doesn’t say markets are clairvoyant. It just says that, at that moment, there are just as many people saying its undervalued as overvalued. That certainly seems to be the case.

Ok, now you know what “efficient markets” means. What is there about recent events that would lead you to say that markets are inefficient? The market crashed, to which I would say, we had the events last September in which the President gets on television and says the financial markets are near collapse. On what planet do markets not crash after that?

posted on 14 January 2010 by skirchner in Economics, Financial Markets

US Dollar Bulls Who Can’t Get Enough

Follow the ETF money:

Some ETF investors appear to be positioning hedging against a continually rising dollar in 2010, based on the surging popularity of PowerShares DB U.S. Dollar Index Bullish Fund (UUP), which holds nearly $3 billion in assets.

The fund follows the movement of the U.S. dollar against a basket of six major currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. As its name suggests, the ETF profits when the dollar strengthens against global currencies.

The fund has been such a hot seller that, twice in late 2009, it was forced to halt the creation of new shares when it ran out and awaited regulatory clearance to issue more shares.

Its mirror image, the PowerShares DB U.S. Dollar Index Bearish Fund (UDN), is geared to make money from a weakening dollar. It is much smaller with just under $300 million in total assets.

posted on 13 January 2010 by skirchner in Economics, Financial Markets

Taking the Myth Out of The Myth of the Rational of the Market

Justin Fox tells me that the UK-Australian edition of his The Myth of the Rational Market is out this month. My review of the US edition can be found over the fold.

posted on 12 January 2010 by skirchner in Economics, Financial Markets

Endless Oil

The technology driving oil production.

posted on 11 January 2010 by skirchner in Economics, Oil

Prediction Market in US Monthly Unemployment Rate

Contracts on the monthly US unemployment rate make a welcome return at Intrade. There was a time when Intrade offered contracts on all US economic data releases, including non-farm payrolls, but the market-makers gave up on these contracts due to an insufficient number of noise traders. Economic derivatives markets have a poor track record of success in the US, with the CME shutting down its economic derivatives in 2007.

Perhaps the most successful economic derivatives market is iPredict in New Zealand, which also offers contracts on Australian economic data and the RBA’s official cash rate.

posted on 11 January 2010 by skirchner in Economics, Financial Markets

Stocks for the Long-Run

Jeremy Siegel still likes equities:

All indications are that the world economy has successfully dodged the depression bullet, and I believe economic activity will surprise on the upside. This means stronger than expected stock returns and weaker than expected bond returns.

While Jim Chanos is shorting China:

Mr. Chanos declined to be interviewed, citing his continuing research on China. But he has already been spreading the view that the China miracle is blinding investors to the risk that the country is producing far too much.

“The Chinese,” he warned in an interview in November with Politico.com, “are in danger of producing huge quantities of goods and products that they will be unable to sell.”

posted on 09 January 2010 by skirchner in Economics, Financial Markets

Blogometrics: Top Economic Bloggers by Scholarly Impact

An article in the Eastern Economics Journal ranks economics bloggers according to their scholarly impact. This blog is ranked 78th.

posted on 08 January 2010 by skirchner in Economics

Non-Predictions for 2010

Macro Man’s non-predictions for 2010, here and here. MM’s 2009 performance is scored here.

posted on 07 January 2010 by skirchner in Economics, Financial Markets

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Bernanke on Monetary Policy and the Housing ‘Bubble’

Reporting on Fed Chair Ben Bernanke’s speech to the American Economic Association has focused on his suggestion that ‘we must remain open to using monetary policy as a supplementary tool for addressing those risks’ associated with asset price inflation. However, the rest of his speech makes clear that Bernanke views this as very much a second-best option. His speech contains a review of the evidence against the notion that monetary policy was the main cause of the housing ‘bubble’ in the US and elsewhere.

The WSJ quotes Dale Jorgenson on what was missing from Bernanke’s speech:

a Harvard professor who served as Mr Bernanke’s thesis adviser at MIT in the 1970s, said the Fed chairman made a “pretty convincing” argument that low rates were not the driving force of the housing bubble.

But he said Mr Bernanke should have laid more blame at the feet of Congress for encouraging reckless mortgage lending with its support of Fannie Mae and Freddie Mac and other policies meant to increase home ownership.

“I didn’t hear any word with regard to going back to Congress about changing housing policy,“ he said.

Leaving aside that fact that his reconfirmation is pending before Congress, one suspects that Bernanke knows a lost cause when he sees one. As the WSJ notes in another article:

In today’s Washington, we suppose, it only makes sense that the companies that did the most to cause the meltdown are being kept alive to lose even more money. The politicians have used the panic as an excuse to reform everything but themselves.

posted on 04 January 2010 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

Economists as Cheapskates

The WSJ examines the idea that economists are chronic cheapskates, citing both survey and anecdotal evidence. Given that economics proceeds from the notion of opportunity cost, this reputation is not hard to explain. The relative reluctance of economists to donate to charity may not be motivated by a lack of philanthropy, but by a better understanding of incentives or the unintended consequences of such generosity.

According to the WSJ:

Stanford University economist Robert Hall, incoming president of the American Economic Association, values his time so highly that his wife, economist Susan Woodward, occasionally puts her foot down. “Bob doesn’t see why we can’t just hire people to trim the Christmas tree,“ she says. “I tell him that’s not what it’s supposed to be about.“

Hall has probably realised that the only genuinely scarce resource is the amount of attention an individual has to devote to their life-time activities. Shirley Conran had the same idea when she declared that life was too short to stuff a mushroom.

posted on 02 January 2010 by skirchner in Economics

New Year’s Links

Peter Wallison on the biggest public policy disaster in US history.

Henry Ergas on the unacknowledged efficiency costs of an ETS.

The welfare costs of government playing Santa.

posted on 01 January 2010 by skirchner in Economics

Fairfax Self-Parody Alert

The Sydney Morning Herald runs an op-ed by Fidel Castro, titled ‘The Truth About Copenhagen’. You can also read it in the Tehran Times.

posted on 22 December 2009 by skirchner in Media

Pre-Christmas Linkfest

Crowding-out in the face of a rising supply price of foreign capital.

How EMU promotes anarchist violence.

How Kevin Rudd sold Australia down the river in Copenhagen.

International Economy symposium on targeting assets prices with monetary policy.

My final op-ed for the noughties: (NZ) Labour Should Not Take its Eyes Off the Target.

posted on 21 December 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

The Gruen Transfer

Henry Ergas responds to David Gruen’s defence of the indefensible:

Gruen says the infrastructure spending is justified because it adds to productive capacity.

But this is true only if the benefits from that spending exceed its costs. If they don’t (think national broadband network or pink batts), then the community loses twice: from the waste, as scarce capital is diverted from better uses; and from the distortions caused by the higher taxes needed to cover the projects’ costs.

As a result, far from expanding productive capacity, projects such as these cause it to shrink. This used to be part of Treasury religion; it is startling that there is no mention of it in Gruen’s speech.

posted on 19 December 2009 by skirchner in Economics, Fiscal Policy

(Not So) Outrageous Predictions for 2010

Saxo Bank has released its outrageous predictions for 2010, which are actually not outrageous at all. But how did they go with their outrageous predictions for 2009? My comments in square brackets.

1) There will be severe social unrest in Iran as lower oil prices mean that the government will not be able to uphold the supply of basic necessities. [IE: yes, but not because of oil, half marks]

2) Crude will trade at $25 as demand slows due to the worst global economic contraction since the great Depression. [IE: WTI bottomed out at $33.22 in mid-January].

3) S&P will hit 500 in 2009 because of falling earnings, vaporizing housing equity and increased cost of funds in the corporate sector. [IE: S&P 500 made lows at the even more ominous sounding level of 666].

4) The EU is likely to crack down on excessive government budget deficits in several member states, and Italy could live up to previous threats and leave the ERM completely. [IE: if only!]

5) The AUDJPY will drop to 40. The decline in the commodities markets will affect the Australian economy. [IE: AUD-JPY actually bottomed in October 2008. Lows for 2009 were 55.55. Australian economy outperformed ROW]

6) EURUSD will fall to 0.95 and then go to 1.30 as European bank balances are under tremendous pressure because of exposure to the faltering Eastern European markets and intra‐European economic tensions. [IE: EUR-USD made lows at 1.2459 and highs at 1.5144 YTD, but half marks for European bank stress].

7) Chinese GDP growth drops to zero. The export driven sectors in the Chinese economy will be hurt significantly by the free‐fall economic activity in the Global Trade and especially of the US. [IE: growth forecast wrong, no marks for stating the obvious implications of global recession already in evidence]

8) Pre‐In’s First Out. Several of the Eastern European currencies currently pegged or semi‐pegged to the EUR will be under increasing pressure due to capital outflows in 2009. [IE: Full marks, although fixed exchange rates spell macro trouble by definition]

9) Reuters/ Jefferies CRB Index to drop to 30% to 150. The Commodity bubble is bursting, with speculative excesses so large they have skewed the demand and supply statistics. [IE: see comments on Australia]

10) 2009 will see the first Asian currencies to be pegged to CNY. Asian economies will increasingly look towards China to find new trade partners and scale down their hitherto US‐centric agenda. [IE: wrong on first part, second part hardly unique to 2009]

So score 2/10 for Saxo in 2009, which is a whole lot better than Nouriel Roubini.

posted on 17 December 2009 by skirchner in Economics, Financial Markets

3.75 is the New 4.75

So says Deputy Governor Ric Battellino of the RBA’s official cash rate. Battellino’s speech once again highlights the fact that the RBA calibrates changes in the official cash rate to changes in actual borrowing rates. Battellino also notes that:

The margin on variable housing loans is much the same today as it was at the start of the crisis.

All this makes the whole political pantomime of bank-bashing rather pointless. It is also the case that the RBA will probably discount the implications of tighter bank capital regulation for retail borrowing rates in its future setting of the official cash rate. The equilibrium official cash rate may shift even lower as a result.

posted on 16 December 2009 by skirchner in Economics, Financial Markets, Monetary Policy

Big Government Fails Treasury’s ‘Wellbeing’ Test

I have an op-ed in today’s Australian taking Treasury Secretary Ken Henry to task for resigning Australia to a permanent expansion in the size of government. I argue that the expansion in the size of government since Gough Whitlam fails the criteria set by the Treasury’s ‘wellbeing’ framework for public policy.

Note that the Oz has an unfortunate habit of leaving out quotation marks. There should be quote marks around ‘25 per cent as the maximum tolerable proportion of taxation’. The quote is from a letter Keynes wrote to Colin Clark.

posted on 15 December 2009 by skirchner in Economics, Fiscal Policy

Crowding-Out in a Small Open Economy (That Would Be Us!)

Tony Makin makes the case for a crowding-out effect from fiscal stimulus via the exchange rate and net exports. Last week’s September quarter balance of payments implied a 1.8 percentage point subtraction from growth on the part of net exports, which is consistent with this story. Indeed, despite a positive contribution in the first half of 2009, export volumes made no contribution to measured GDP growth for the year-ended in June. A 13.1% decline in import volumes, by contrast, made a 3.3 percentage point contribution to growth over the same period.

Remarkably, the Australian dollar-US dollar exchange rate bottomed out in October 2008, the same month as the first stimulus package, before rising 57% from its lows around 0.6000 to its recent highs around 0.9400.

I made a similar case for crowding-out via the exchange rate and net exports in this op-ed following the May Budget.

posted on 15 December 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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How the US Government Funds Mortgage Fraud

The Centre for Public Integrity and the Washington Post investigate Ginnie Mae:

The trouble signs surrounding Lend America had been building for years. A top executive was convicted of mortgage fraud but still helped run the company. Home loans made by its headquarters were defaulting at an extremely high rate. Federal prosecutors alleged in a civil suit that the company falsified loan documents and committed fraud.

Yet despite these red flags, a little-known federal agency continued giving its blessing to Lend America, allowing it to do business in the name of the U.S. government. The Government National Mortgage Association, known as Ginnie Mae, authorized the firm to bundle its mortgages into securities and sell them to investors around the world—all backed by U.S. taxpayer money.

posted on 14 December 2009 by skirchner in Economics, Financial Markets

Markets in Everything: Autographed P J O’Rourke Promotional Banners

CIS is auctioning three 3m x 1.5m promotional banners autographed by P J O’Rourke as part of his Australia and New Zealand tour earlier this year. Images of the banners and bidding instructions can be found here.

UPDATE (14 December 16:35 AEDT):

The highest bids received to date for the personally autographed PJ O’Rourke banners are as follows:

Banner 2 $300.00 “Government does not cause affluence. Citizens of totalitarian countries have plenty of government and nothing of anything else.“

Banner 3 $120.00 “The free market is a bathroom scale. You may hate what you see when you step on the scale. ‘Jeeze, 230 pounds!‘ But you can’t pass a law making yourself weigh 185.“

No bids have been received for banner 1 as yet. “Bringing the government in to run Wall Street is like saying, ‘Dad burned the dinner, let’s get the dog to cook.‘“

If you would like to place a bid, please visit the link below and follow the instructions. Note: If you are outbid, you will receive notification so that you have the opportunity to place a counter-bid.

posted on 11 December 2009 by skirchner in CIS

Will Australian FDI Policy Be Any More Comprehensible in Chinese?

Treasurer Wayne Swan has announced an expansion of the Foreign Investment Review Board and a review of the communication of FDI policy in a speech to the Global Foundation. The government’s first initiative will be to:

release an easy-to-read version of the foreign investment review framework for prospective investors, which will be made available in other languages, including Chinese, Japanese and Bahasa.

One would of thought that such documentation already existed. The problem is that Australian FDI policy is not going to be any less confusing in a foreign language than it already is in English. No amount of explanation can eliminate the fundamental source of confusion and uncertainty, which is the sweeping discretion available to the Minister and FIRB under the Foreign Acquisitions and Takeovers Act.

The debacle of the Patrick Colmer speech demonstrated that the basic communication problem stems from the government’s lack of a clear policy framework for the exercise of this discretion. Foreign investors cannot be expected to understand a policy that the government itself cannot articulate.

UPDATE:The Patrick Colmer saga continues:

JOURNALIST:

Do you endorse the guidelines put out by Colmer from the FIRB two weeks ago?

TREASURER:

Mr Colmer didn’t put out any guidelines two weeks ago, and you know that.

JOURNALIST:

About the 15, 50 per cent and the…

TREASURER:

Mr Colmer was asked a theoretical question to which he gave a theoretical answer, which I believe has been taken out of context.

Maybe the Chinese translation will be clearer.

posted on 10 December 2009 by skirchner in Economics, Foreign Investment

Why Do Banks Pay Political Protection Money?

With the government, the opposition and the media all heavily engaged in gratuitous bank-bashing, few people have given much attention to the implications of tighter capital adequacy regulation for the cost of borrowing to consumers. RBA Governor Glenn Stevens was remarkably frank about the implications of increased regulation in a speech this week:

on the assumption that most of these regulatory changes go ahead, one effect will presumably be to make the process of financial intermediation more costly. The intention, after all, is that lenders will operate with more capital against the risks they are taking. But capital is not free; shareholders have to be induced to supply it, and it will have to be paid for. High-quality liquid assets typically carry lower yields too, so mandating higher liquidity will have some (modest) cost as well. Admittedly it can be argued that shareholders of financial institutions will have a less risky investment and so should be prepared to accept lower returns. But customers of financial institutions – depositors and borrowers – will also pay via higher spreads between what lenders pay for funds and what they charge for loans. That is, they will pay more ex ante to use a safer financial system, as opposed to taxpayers having to pay large costs ex post to re-capitalise a riskier system that runs into trouble.

Stevens’ posited trade-off between a safer financial system that is more expensive and one that is cheaper and riskier may only hold up to a point. His assumption that a more tightly regulated financial system is less likely to be bailed-out by taxpayers may not hold at all. As Stevens notes, careful attention needs to be given to whether the additional costs imposed by increased regulation will yield the desired benefits.

The increase in funding costs being passed on by the banks to their borrowers as a result of the financial crisis is not something we can do much about ex post, especially given that Australia is a price-taker in global capital markets. But we can do something about the future of bank capital regulation. Bashing the banks, while giving the government a free pass to tighten the regulation of capital without due attention to costs and benefits is perverse.

Perhaps even more perverse is the way the banks continue to fund the politicians who are actively seeking to damage their franchise. The AEC’s web site shows that the big four banks are all major donors to political parties (see, eg, Westpac’s return). No doubt the banks fear things would be even worse if they didn’t pay their political protection money, but it’s hard to see how.

posted on 09 December 2009 by skirchner in Economics, Financial Markets, Politics

How to Reduce the Budget Deficit, Without Really Trying

The Australian economy just got bigger, thanks to the adoption of the new national accounting standard SNA08. The revised data raise the level of nominal GDP by 4.4% for 2007-08. As the government was quick to point out, this reduces the estimated budget deficit for 2009-10 from 4.7% to 4.5% of GDP, as well as the expected net debt to GDP ratio.

posted on 09 December 2009 by skirchner in Economics, Fiscal Policy

Clive Hamilton as Reactionary Conservative

True socialists don’t support reactionary conservatives like Clive Hamilton:

it’s a sign of the decline of Left politics that a reactionary, pro-censorship sexual moraliser who hates the idea of working people enjoying a higher material standard of living could ever be considered left-wing…

It’s time that left-wingers stood up for their beliefs, rejected reactionaries like Hamilton and once again proudly said that we support industrial civilisation, the modern world, and more freedom and more material wealth for the working class. Any left-winger voting in the Higgins by-election this Saturday would do well to put Hamilton where he belongs: at the bottom of their preferences.

posted on 03 December 2009 by skirchner in Politics

Abbott and McKibbin Need to Talk

Michael Stutchbury makes the case for Liberal leader Tony Abbott to adopt Warwick McKibbin’s hybrid ETS-cabon tax as a counter to Labor’s ETS. Former opposition leader Malcolm Turnbull was once sold on the McKibbin model when in government, but couldn’t be bothered making the case from opposition.

posted on 03 December 2009 by skirchner in Economics, Politics

Turning Off Turnbull

With Malcolm Turnbull’s political career seemingly all but over, his only significant legacy may be bad lighting:

The importation of General Lighting Service (GLS) Electric Filament Lamps will be prohibited under the Customs (Prohibited Imports) Regulations 1956 (the Regulations) from 1 February 2009…

The maximum penalty for importing these goods without import approval is a fine not exceeding $110,000 or 5 times the value of the goods, whichever is the greater.

Meanwhile, Tony Abbott is already breaking left-wing hearts.

posted on 02 December 2009 by skirchner in Economics, Politics

Once a Leaker, Always a Leaker

The following observation from a London-based hedge fund trader is perhaps representative of offshore perceptions of monetary policy in Australia:

The RBA hiked rates again overnight, in line with leaks yesterday but contrary to some speculation at the height of the Dubai panic.

I don’t think there were any leaks on this occasion. Friday’s Reuters poll had all but one respondent expecting a 25 bp tightening, despite Dubai. But it shows that the perception that the RBA is a leaker is well entrenched in financial markets.

posted on 01 December 2009 by skirchner in Economics, Financial Markets, Monetary Policy