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RBA Transparency and Accountability: You Can’t Keep a Good Issue Down

Too many journalists are preoccupied with personalities and outcomes at the expense of processes when it comes to reporting on macroeconomic policy.  John Garnaut deserves some kudos for keeping the issue of RBA transparency and accountability alive, using the monthly board meeting as a hook:

The lack of Reserve Bank transparency has been cited as a factor in recent market volatility, with interest rate expectations swinging from rate cuts in January to rate rises six weeks ago and back to rate cuts last week.

“If they had a post-meeting statement … the market wouldn’t have run and priced rate cuts at the end of last year and January, the Reserve Bank wouldn’t have had to issue such a one-sided, unbalanced statement in February, and it wouldn’t have seemed inconsistent for not moving in April,” said Deutsche Bank’s chief economist, Tony Meer.

The central bank’s board issues a statement when it adjusts interest rates but stays silent when it leaves rates on hold.

Graeme Thompson, who sat on the board as one of two deputy governors until 1998, said there was no obvious argument for not releasing a monthly statement. “I don’t quite see the argument against issuing some sort of statement every month for why the board came to a decision.”

Professor Adrian Pagan, a board member until 2001, also supports improved communications, including a statement each month.

It is also good to see some market economists chiming in on this for once.  Many market economists come from RBA and Treasury backgrounds and consequently tend to be rather uncritical of instituional framework for macro policy in Australia.

posted on 05 May 2005 by skirchner in Economics

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Mankiw on Bush, Social Security and More

Russ Roberts interviews Greg Mankiw over at Econlib.

posted on 04 May 2005 by skirchner in Economics

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Libertarian-Conservative Monetary Policy Doves

Alan Reynolds joins other libertarian and conservative commentators in calling into question the Fed’s tightening bias:

I have avoided complaining about the Fed being too tight since co-authoring a Wall Street Journal article to that effect in October 2000 (and before that, only in mid-1982 and 1984). If asked today if the Fed should again raise interest rates anytime soon, however, my answer is no. The domestic and global economic risks of raising dollar interest rates are real—the inflation scare is not.

There has been an interesting role reversal for libertarian and conservative think-tanks in relation to monetary policy over the last 15 years or so.  Whereas their commentary once focussed on the inflationary bias of central banks, the Fed would now appear to be a good deal more hawkish than they would like. 

The Shadow Open Market Committee now focuses much of its effort on encouraging reform of the institutional framework for US monetary policy.  This is the correct focus for debate, since improvements in this framework should generally lead to improved policy outcomes.

posted on 03 May 2005 by skirchner in Economics

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Institutional Origins of Global Imbalances: Don’t Dump on the Anglo-American Model

The argument that global imbalances are attributable to excess consumption in the Anglo-American economies is increasingly being discredited in US policy circles.  Ben Bernanke has already identified the role of forced saving in East Asia as a major driver of these imbalances.  Glenn Hubbard (free version here) extends Bernanke’s global saving glut thesis, by considering the role of dysfunctional capital market institutions in the emerging economies as a key driver of forced saving:

Key emerging-market economies like China need to absorb more of their domestic savings. Arithmetic makes a powerful case here. Last year, if reserves-rich emerging-market economies had run current account deficits equal to their inflows of foreign direct investment, the aggregate swing in their current account position would have eliminated much of the U.S. current account deficit. And given the spotlight now being cast on China, it is worth noting that such a shift for China alone would have offset about one-sixth of the U.S. current account deficits.

But economics is more than arithmetic. To increase domestic spending in a way consistent with long-term growth, domestic financial systems must be able to allocate capital to its most valued use, improving consumers’ ability to borrow and the efficiency of business investment. Such capital-market efficiency cannot be taken for granted. Consider Japan’s decade-long struggle with nonperforming loans and its current battle over cross-border M&A and the privatization of the slumbering Japan Post. More to the present situation, consider China’s massive and mounting nonperforming loan problem, as state-owned enterprises devour credit better used by entrepreneurs.

Herein lies a clue to the puzzle. If capital markets around the world matched the effectiveness of those in the U.S., one would expect capital to flow on balance from the U.S. and Europe to emerging economies like China. That flow, of course, is not materializing. In a recent economic study, Charles Himmelberg, Inessa Love and I found that weak institutions and capital-market imperfections in emerging economies can lead to very high costs of capital for productive investment at home. In this context, using American leadership to focus on exchange rates alone misses a bigger opportunity—to tackle the much larger need for financial reform that will permit imbalances to ease.

Those who blame global imbalances on Anglo-American consumption are implicitly punishing a successful economic model and endorsing failed institutional arrangements in other parts of the world.  It is a sad fact that a large part of economics-oriented blogosphere is now heavily invested in this bankrupt view of the world.

posted on 02 May 2005 by skirchner in Economics

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The May Budget and the Future Fund: Attack of the Stone

Former Treasury Secretary John Stone is unimpressed with the likely content of the May Budget and the Future Fund:

Can it really be that, apart from new spending on its welfare reforms, the Government is simply proposing to hang on to these huge surpluses quite deliberately? To lend some verisimilitude to this otherwise indefensible policy, it has devised a so-called future fund, into which it will pay these surpluses (plus most of the proceeds from Telstra and other future asset sales) to fund, over time, the present large public service superannuation accounts deficit.

It has always been hard to take the future-fund notion seriously. When it first surfaced as a broader inter-generational fund, the secretary to the Treasury, Ken Henry, was openly, and rightly, scathing about it. Now that ministers have decided to erect this nonsense on stilts at the apex of this and future budgets, he has understandably fallen silent.

Unfortunately, it is no longer the case that major tax and spending decisions are made in the context of the annual Budget.  These decisions are increasingly being tied to the political rather than the Budget cycle.  While the conventional wisdom is that the first Budget after an election is the best from the point of view of expenditure restraint, on this occasion, the government shows little interest in reducing spending.  This effectively rules out any meaningful reduction in the overall tax burden.

posted on 02 May 2005 by skirchner in Economics

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The Neutral Fed Funds Rate and the Bond Yield ‘Conundrum’

One of the main problems with the dominant neo-Wicksellian paradigm for monetary policy is that it is organised around a latent variable: the neutral or equilibrium real interest rate.  There is currently a debate as to whether the neutral real interest rate for the US has declined, implying that US monetary policy is now rather closer to neutral than past experience would suggest.  The AEI’s resident monetary policy dove, John Makin, makes an argument along these lines.

I don’t have a strong view on this, but given the role of expectations for the Fed funds rate in determining the yield curve, this strikes me as a plausible explanation for the so-called bond yield ‘conundrum.’  If the market takes the view that monetary policy settings are already neutral, while at the same time pricing further increases in the Fed funds rate, then it makes perfect sense for the market to also price a flat yield curve in the expectation that growth and inflation will moderate in the future.  In effect, the market is saying that it expects the Fed to overshoot neutral.

This is certainly a more compelling explanation for the ‘conundrum’ than the standard cop-out that bonds are experiencing a ‘bubble,’ a term now so overused as to be bereft of any analytical content.  Obviously, the Fed thinks differently, otherwise it would not be expressing puzzlement over currently observed bond yields. 

Australia is in a similar situation, with the RBA’s official cash rate still below its previous cyclical peak and with the yield curve already seeing a modest inversion.  In Australia, the market is moderating its tightening expectations, partly on the basis that an inverse yield curve implies a restrictive policy stance.

One of the ways we discover the equilibrium real rate is by either under or overshooting it.  The resulting boom or recession reveals the otherwise unobservable equilibrium rate.  Central bankers face a knowledge problem every bit as acute as that faced by any other central planner trying to fix an equilibrium price.

posted on 29 April 2005 by skirchner in Economics

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The Future Fund

The May Federal Budget should contain details of the government’s ‘Future Fund,’ which is meant to serve as a repository for the proceeds from the privatisation of the rest of Telstra and for the government’s budget surpluses, now that there is precious little Commonwealth government debt to retire.

The government is rationalising the Fund in part by arguing that it needs to provide for currently unfunded liabilities in relation to public service superannuation.  If the government were serious about this logic, then it would start provisioning for all of its unfunded contingent liabilities.  New Zealand is also attempting something similar with its inter-generational fund, although this is more a reflection of the fact that NZ actually takes public sector accounting principles seriously.

In reality, the Future Fund is just a form of revenue hoarding by a government that has more money than it knows what to do with.  Alan Wood notes that the Prime Minister’s recent comments on the Fund suggest it will be little different in practice from consolidated revenue.  Even if the government had the right intentions now, the Fund would be subject to a time inconsistency problem, by which the temptation to abuse the fund would grow in line with its assets.

If the government were serious about reducing future demands on Commonwealth government spending, it could simply take the proceeds from the privatisation of Telstra and its budget surpluses and make one-off contributions to the private superannuation accounts that every working Australian already owns, where these funds would steadily and safely compound until retirement.  By economically empowering individuals, we would reduce their future dependence on the state and protect these funds from abuse by the current or future governments.  This would also prevent the many problems that are bound to arise from the Commonwealth government managing a very large asset portfolio.

posted on 28 April 2005 by skirchner in Economics

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The Bond Yield ‘Conundrum’ and Global Saving

John Quiggin sent the following comment, which is relevant to several of my previous posts on this topic:

A general comment on why so few economists trust the market on bubbles. It’s obvious that low interest rates are crucial, and that your whole argument makes sense if and only if sustained low interest rates are a market-driven response to changes in the real economy.

But in an environment with near-zero savings in the English-speaking countries, and large unfunded state obligations in the rest of the developed world, interest rates should be high, not low.

The proximate cause of low interest rates is the willingness of Asian countries to run large current account surpluses (that is, capital account deficits), but there is no convincing micro story as to why people in poor countries should want to save massive amounts to lend to fund consumption in rich countries.

The leading optimist on all this is Bernanke, but he sees the surpluses as the product of macro policy, governments building up reserves in reaction to the crises of the 1990s. This source of surpluses presumably won’t be sustained, since the countries concerned are incurring huge unrealised losses on their US dollar holdings. So the ‘global savings glut’ is a temporary one, and is being squandered by borrower nations in high levels of consumption.

I do not buy the argument that the interest rates currently observed in the US are due to purchases of US Treasuries by Asian central banks, for the simple reason that the flow of such purchases is small relative to the total market turnover in these instruments.  Foreign exchange market interventions by central banks are usually ineffective except in the very short-term for the same reason: they are simply swamped by the multi-trillion dollar turnover we see daily in these markets.  Needless to say, I don’t think the US dollar depends much on these purchases either.

I agree with John that it is perverse that we should see developing countries saving to fund investment in rich countries, but this is due to forced saving via managed exchange rate regimes.  It is indeed ridiculous that China is issuing domestic debt to fund purchases of US debt instruments, as Deepak Lal has noted, but symptomatic of its mercantilist development strategy.  I agree that this will not be sustained because fixed exchange rate regimes always come unstuck, but I see this as being more of an issue for China than for the US or Australia.  The subsidy to US and Australian consumption from China’s fixed exchange rate regime is too small relative to the overall contribution that the emergence of China is making to the expansion of our consumption possibilities.

I agree that low bond yields in the face of massive unfunded contingent liabilities associated with unsustainable welfare-statism is something of a puzzle, but this is not new.  There is not a strong cross-country empirical relationship between government budget deficits and interest rates, as many were keen to point out during the last Australian federal election campaign.  Japan has the most serious fiscal problems of the developed countries and yet also the lowest bond yields.  My view is that Japan’s low bond yields reflect the overcapitalisation of its economy due to excess saving in previous years, a legacy of its own mercantilist development strategy which has landed it with excess industrial capacity.  China risks the same fate. 

Asset prices do not follow neat linear relationships with a few simple fundamentals.  If they did, we would not need markets to tell us what prices these assets should trade at.  When market pricing disagrees with our view of fundamentals, it is tempting to assume a ‘bubble,’ but then one must come up with a persuasive case for market failure.  I am willing to concede that there are some relevant market distortions in this case, but they do not constitute a ‘bubble.’  They are instead an alternative fundamental story that needs to be taken seriously.

posted on 25 April 2005 by skirchner in Economics

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Fever Swamp Austrians versus the Fed

The Austrians of Auburn Alabama have always had a rather mono-causal view of the business cycle.  Through much of the current cycle, they have been ranting about easy monetary policy fuelling commodity and asset price inflation, while paying little attention to non-monetary fundamentals.  For devotees of free markets, they have little respect for actual market outcomes in relation to growth in credit aggregates and asset prices.

Former Federal Reserve Board member Wayne Angell makes the case for recalibrating our assumptions about what constitutes easy monetary policy:

many have not accepted the reality of lower interest rates that accompany an economy of abundance—and we seem to be not much better at this than Japan in the 1980s. Lower interest rates mean an upward adjustment to asset prices. The present value of houses, land, and capital goods is increased as the flow of rents and dividends are discounted at lower interest rates. The erroneous reaction was to think that higher asset prices spelled out easy money.

Price increases and decreases are the most important motivator and regulator in a market economy. In an economy without inflation, higher price motivates consumers to consume less while motivating business to produce more. High prices are somewhat short-lived as supply-side and demand-side price rationing soon returns the price to a normal level.

The introduction of market-economic growth to China and India added so much to the demand for commodities that their prices had to adjust upward to a new level. At a 9% annual growth rate, China doubles its use of resources every eight years. There is no global inflation consequence as China and India are adding workers to global production, and commodity prices only go up to set off a realignment of global resources producing more of the commodities with higher prices. Yet most observers interpreted rising commodity prices as easy money which they suspected would lead to inflation. That is wrong. If inflationary forces were evident, the supply and demand responses would be blunted by an understanding that prices have not gone up, but that, instead, the value of money has gone down.

posted on 23 April 2005 by skirchner in Economics

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In Defence of Speculative Capital Markets

Vernon Smith’s Inaugural Pope Lecture on globalisation contains a great defence of the role of speculative bubbles in capital markets:

Market efficiency does not require large numbers, complete information, economic understanding or sophistication…

stock markets…are inherently far more uncertain than markets for commodities and services because stock markets must anticipate innovations—the new commodities and services of the future. At the time of new innovations the extent of their subsequent economic success is inherently unpredictable.

If you limit people’s decisions to make risky investments in an attempt to keep them from harming themselves, how much will that reduce our capacity to achieve major technological advancements? The hope of great gain by individuals fuels thousands of experiments in an environment of great uncertainty as to which experiment, which combinations of management and technology will be successful. The failure of the many may be a crucial part of the cost of sorting out the few that will succeed. After a wave of innovation, and a bubble bursts managers know a lot about what did not work, and even a little about what did work.

posted on 22 April 2005 by skirchner in Economics

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‘They’re Commies?!’ An Australia-China Free Trade Agreement

In an episode of The Simpsons in which Homer goes to China, he expresses his disbelief that the Chinese are communists: ‘then how come I’m seeing rudimentary free markets?’  In reality, there is nothing rudimentary about them.  China’s industrial prices are overwhelmingly market-determined.  The Australian government is being criticised for conceding market economy status (MES) to China at the outset of the negotiations for an Australia-China Free Trade Agreement.  We are in fact doing ourselves a favour by making this ‘concession,’ since it potentially reduces the scope for Australian producers to take anti-dumping actions against Chinese imports.  As Peter Gallagher notes, Australia does not have much more to offer in terms of Chinese access to Australian markets.  MES is a small ‘price’ to pay for bringing China to the table.

posted on 20 April 2005 by skirchner in Economics

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Oil Doesn’t Make You Rich

Some controversial ads on Australian television have been berating us for supposedly giving East Timor a rough deal on the proceeds from the oil fields of the Timor Gap.  I suspect part of the motivation for this campaign stems from the popular view that national wealth is a function of resource endowments.  It is easy to refute this proposition by pointing to resource-rich countries that are poor, like Russia, and resource-poor countries that are rich, like Singapore, Hong Kong and Japan.

Oil endowments are no exception, as Tom Palmer has been explaining to the Iraqis.  There are obvious reasons why oil has not made Iraq rich (yet).  However, it is also less obviously true of some developed countries that do not have Iraq’s problems as an excuse.  This American ex pat in Norway observes that local living standards do not quite match its reputation as the world’s richest country:

After I moved here six years ago, I quickly noticed that Norwegians live more frugally than Americans do. They hang on to old appliances and furniture that we would throw out. And they drive around in wrecks. In 2003, when my partner and I took his teenage brother to New York - his first trip outside of Europe - he stared boggle-eyed at the cars in the Newark Airport parking lot, as mesmerized as Robin Williams in a New York grocery store in “Moscow on the Hudson.”

There is also evidence to suggest that overdependence on a single resource encourages rent-seeking behaviour and corruption.  East Timor’s share of the Timor Gap oil revenue by itself will do little to ameliorate its problems and could even make them worse.

posted on 18 April 2005 by skirchner in Economics

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So I’m a Tory After All

Not that I put much store in tests like this, but here is my score:

Conservative +51
Labour -6
Lib-Dem -66
UKIP +24
Green +3

What I thought interesting about these results is they suggest I should be close to neutral on Labour and the Greens.  My anti-EU responses are no doubt responsible for the high Conservative and UKIP scores, since these parties would not have benefited from my responses to most of the other questions.  One election I am glad I don’t get to vote in!

posted on 16 April 2005 by skirchner in Politics

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Wireless Broadband in Sydney

A temporary lapse into tech blogging.  I recently decided to try wireless broadband with Unwired, mainly because I want to encourage the process of disintermediating traditional telcos from broadband distribution.  I can’t say I have been overly impressed.  The problem is not necessarily that the signal is weak, but highly variable, even though I am well within the notional coverage area and in a reasonably elevated position.  Using Unwired’s own diagnostics, the signal strength bounces around anywhere from 1-6 out of 10 from the best location in the house.  Drop outs are frequent enough to be annoying, and even though only very brief, they can be enough to require a manual refresh of the connection and generally slow things down to a crawl.

Unwired are not lying when they say that the best place for the modem is parallel to a window.  I find the modem will only work reliably right up against the window.  A few centimetres inside and signal strength deteriorates rapidly.  The best place for the modem is actually outside.  This is obviously a widespread problem, because I have found one Sydney company that already produces dedicated kits to house the Unwired modem externally.

Unwired offer only a very narrow 14 day window in which to trial the service.  Unless you are getting a very reliable signal in the first few days, my suggestion would be to cancel the service immediately.

The university’s wireless broadband service is also flaky, from my very limited experience of it, but then again so is mobile reception (I had to get a CDMA mobile to get a signal at my UNSW office).  Perhaps it is due to Sydney’s undulating topography.  In any event, it’s back to ADSL for me.

posted on 15 April 2005 by skirchner in Misc

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The UK General Election as Lose-Lose

David Frum on why the UK general election outcome is a no-win deal for conservatives.

The Intrade contract for Labour winning the most seats in the Commons has managed to rally from levels that were already pricing this outcome as a near certainty.  Even in the absence of an outright Commons majority, this outcome would see Labour well placed to form government.  The market is not giving much credence to the scenario in which enough Labour voters stay home or vote Lib-Dem to hand the Tories the largest number of seats, yet I would have thought this was a non-negligible risk.  Never underestimate the left’s capacity for spite!

posted on 14 April 2005 by skirchner in Economics

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