Working Papers

Outsourcing Financial Market Journalism

Reuters has notoriously been shifting financial market journalism jobs to Bangalore at the expense of other centres, which says a lot about the commodification of financial market reporting.  For example, its Australian economic consensus forecasts are now compiled by its Bangalore Polling Unit. 

While I am all in favour of outsouring, basic knowledge of local conditions can sometimes be important, as Bloomberg found last week:

Just one of the many things that could have gone wrong and did was the Bloomberg newswire flash at 8.30am last Wednesday stating that the RBA had held interest rates steady at 5.5 per cent.

The bank was not due to announce its decision for another hour. Had Bloomberg got hold of a leak?

As traders reached for their phones, it emerged that the Bloomberg update was managed from South Korea, where an operator had failed to take account of the end of daylight saving, and gone to the RBA website where the old rate was still posted.

posted on 11 April 2005 by skirchner in Economics

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The Reserve Bank and Transparency

The RBA’s on-going problems with transparency are highlighted in this story:

The bank spent the week fighting communications battles. The most serious have been allegations in the market that an American analyst received a selective briefing of the RBA’s thinking before the board meeting last Tuesday.

The RBA is emphatic that the analyst, Regina Schleiger from Medley Global Advisers, has not visited the bank recently and that the bank’s policy of not talking to anyone in the lead-up to board meetings has been strictly kept.

The concern that confidentiality had been breached was created by the US advisory firm switching its recommendation on the direction of Australian interest rates late in the week before the board meeting.

Clients, who pay in excess of $100,000 a year to subscribe to the Medley service, were told late last week that the organisation was 100 per cent certain that Australian rates would not be raised.

The firm had previously argued that the RBA would raise rates at least twice more, so the change in view captured attention. One of the clients said Medley had been trying to build its international profile and was trying to impress US clients that it had good contacts in Australia.

“You had to believe they had the good oil,” he says.

The organisation would not have exposed its reputation by basing such advice on a hunch, according to market operators.
The market responded immediately. Before the newsletter, the market estimated that there was a 70 per cent likelihood of the RBA raising rates. This fell to a 50-50 probability afterwards. A trader with 1000 futures contracts on the Australian cash rate would have made $250,000 overnight, and many did.

The willingness of the market to believe that a private advisory firm had been backgrounded by the RBA is understandable, since it is well known that the RBA backgrounds selected economics writers.  In meetings with financial market clients, I am often asked if I have ‘contacts’ within the Bank.  While I know quite a few people at the RBA, and my discussions with them are often helpful in understanding monetary policy developments in a very general way, I would never expect to receive specific information about the outcome of a Board meeting, or information about the Bank’s policy bias that was not already public knowledge.  When I explain this to clients, they often look disappointed, but anyone who tells them otherwise is not to be believed.  I have also sometimes been accused of ‘sour grapes’ in arguing that the RBA needs to clean-up its act on transparency issues, as if my real complaint is that I am not an ‘insider’ myself.

Most of these supposed insider relationships only exist in the fevered minds of financial market participants, but these perceptions highlight the fact that the RBA has a big problem with communication and transparency.  The Bank would make life a lot easier for itself if it formalised processes for disclosing its policy bias and Board deliberations.

Incidentally, you did not have to pay $100,000 to Medley to know that the RBA would keep rates steady last week.  You just needed to be a client of Action Economics!

posted on 11 April 2005 by skirchner in Economics

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The Reserve Bank and the Electoral Commission

Yesterday’s SMH story turns out to have been something of a beat-up, with the RBA having now released some of its correspondence in relation to the matter.  Today Peter Hartcher tries to give it legs with a comment piece that seems to consist almost entirely of inference on his part (no sources are quoted).

The Secretary of the RBA wrote to a minor Liberal Party figure in response to a complaint from the public and asked the official to desist distributing a brochure that cited the RBA as a source for some of its claims.  My own recollection is that much of the Liberal Party’s campaign material cited the RBA as a source, something the press gallery did not make much of at the time.  This is technically defensible, since presumably they were offering the RBA as the source for the historical data on interest rates cited in their brochures.  Obviously, the Liberal Party would not have been too upset if people inferred more than this, but would the campaign have been less effective if the brochures cited Bloomberg or Reuters or even offered no source at all?  It was the electorate’s historical memory of rates that made the campaign effective.

The RBA is still not completely off the hook in this matter.  The fact that members of the public complained to the RBA shows that the electorate are quite capable of forming their own views about the material.  The RBA certainly had no business telling a political party to stop distributing an election brochure, whatever the content, even if only to mollify an irate member of the public.

UPDATE:  It all comes down to a missing asterisk.  Australia’s first punctuation-induced political crisis!  As silly beat-ups go, this one is hard to beat.

posted on 09 April 2005 by skirchner in Economics

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The Reserve Bank as Political Trade Practices Commission

This story makes the extraordinary claim that the RBA referred some of the Coalition’s advertising material to the Australian Electoral Commission during the last federal election campaign:

the central bank believed that some of the material in the Coalition’s campaign leaflets was exaggerated and that some was factually wrong, the officials said.

However, the bank concluded that it was the role of the electoral commission to police election campaigns.

Reserve Bank officials referred the Coalition’s leaflets to the commission during the six-week campaign and asked whether they breached any regulations.

The commission responded that it was unable to take action to halt a political party making policy claims or predictions even where they might be false and misleading, the officials said.

The bank decided that it would have to allow the Coalition’s claims to be contested by other political parties, and that it could not intervene without provoking headlines saying “Reserve says PM wrong,” a senior official said.

The bank was anxious to avoid this because it would make the bank itself the centrepiece of the campaign, the official said.

The Bank’s second decision (‘that it would have to allow the Coalition’s claims to be contested by other political parties’) was the correct one.  The fact that the AEC took no action shows that the RBA was grossly mistaken in thinking either it or the AEC had a role in arbitrating political truth.  Politicians make all sorts of ridiculous economic claims during election campaigns and the RBA could make a full-time job out of correcting them.  That the RBA would even contemplate setting itself up as some sort of political Trades Practices Commission is symptomatic of its paternalistic mistrust of markets, in this case, the political marketplace.

posted on 08 April 2005 by skirchner in Economics

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Breaking the RBA’s Cone of Silence

RBA Board members Jillian Broadbent and Warick McKibbin seemingly break with convention to comment on yesterday’s interest rate decision, with Broadbent quick to reassure us that the decision was unanimous.  Far from heralding a new age of RBA transparency, my suspicion is that the Bank was keen to pre-empt any speculation about dissent on the RBA Board or that the Bank’s senior officers had been rolled.  Broadbent and McKibbin were given the job of putting the word out.

One can understand the RBA’s desire to quash such speculation, because the media always turn any hint of conflict on the Board into something more than a legitimate difference of opinion.  Yet the reason for this lack of maturity on the part of the media is precisely that they have never been given the opportunity to treat dissent on the Board as a normal and routine part of the policymaking process.  This will only occur when the RBA formalises procedures for disclosing its deliberations in a systematic way.  Ad hoc revelation of the Board’s deliberations only when it suits the convenience of the Bank’s senior officers is a poor substitute for the transparency and accountability mechanisms that are now the norm among the industrialised world’s central banks.

posted on 07 April 2005 by skirchner in Economics

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More on Australia’s Terms of Trade

We have often highlighted the impressive growth in Australia’s terms of trade and the fact that volume-based measures of GDP do not adequately capture its contribution to national welfare.

The RBA’s Christian Gillitzer and Jonathan Kearns have examined Australia’s terms of trade over the last 135 years and reach some interesting conclusions:

Since Australia predominantly exports commodities and imports manufactures, the Prebisch-Singer hypothesis suggests that there should be a negative trend in the terms of trade. But the trend is no more than -0.1 per cent per annum, less than the trend decline in world commodity prices relative to manufactured goods prices. The weaker trend appears to be the result of Australia exporting, and importantly diversifying toward, commodities with faster price growth. Extending the sample using projections for the terms of trade for the two years to 2005/06 based on commodity price movements to date, the apparent downward trend disappears. Indeed, based on these projections, the terms of trade will have increased by around 50 per cent over the period 1987–2006, unwinding the decline over the preceding 30 years.

The RBA has previously pointed to the long-run relationship between the terms of trade and the Australian dollar.  Together, these results suggest that the secular decline in the AUD is over.  Recent developments in the terms of trade also serve to discredit the many advocates of ‘strategic’ industry and trade policy, especially in relation to the ICT sector.

posted on 06 April 2005 by skirchner in Economics

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Rational Choice Theory and the Papal Conclave

Can rational choice theory be used to divine the Will of God?  You bet.

Intrade is running both successor and country of origin markets for the next Pope.  The latter market suggests that the Italians have it.

posted on 05 April 2005 by skirchner in Economics

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China’s Voodoo Accounting

China Economic Quarterly editor Joe Studwell claims:

Beijing has raided tens of billions of dollars of foreign exchange reserves to shore up banks’ capital.

Those who argue that liberalising China’s foreign exchange rate regime would destabilise its financial system may have things exactly backwards.  If what Studwell says is true, then China’s managed exchange rate regime may in fact be perpetuating the systemic problems in its financial system.  Supporting China’s peg to the USD on financial stability grounds could well be a circular argument.

posted on 04 April 2005 by skirchner in Economics

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Debunking ‘Low’ Saving in the US

Bear Sterns chief economist David Malpass rubbishes the notion that the US does not save enough:

Not only are we not running out of household savings, it is growing fast both in terms of the annual additions and the cumulative buildup of American-owned savings. Household net worth, one good measure of savings, reached $48.5 trillion in 2004. Time deposits and savings accounts alone total a staggering $4.3 trillion, versus slow-growing credit-card debt of $800 billion. True, the U.S. is the world’s biggest debtor, but it is building assets faster than debt. Even if household assets took a hard fall, the remaining net worth would still dwarf other countries’. On a per capita basis, counting mortgages but not houses, net financial assets total $89,800 in the U.S. versus $76,900 in No. 2 saver, Japan. Of course, some households don’t have nearly this average, creating risks for them and burdens on others in the event of a downturn. This is an appropriate policy concern, but the macroeconomic issue is aggregate savings, of which the U.S. has an abundance.

According to the Federal Reserve’s flow of funds data, the 2004 additions to household financial assets were a net $590 billion. This was 6.8% of personal disposable income, providing a meaningful measure of the cash flow going into new financial savings. This increased the household’s financial net worth to $26.1 trillion, way above any other country’s savings and plenty to fund profitable domestic investments. If the 2004 appreciation in the value of homes and equities were also counted, the 2004 saving rate was 46% of disposable income. Foreign savings invested in the U.S., the counterpart of the widely criticized current account deficit, is additive to our own large store of savings.

Rather than a “dependence” on foreign savings, the U.S. is an effective user of it, profiting by growing faster than the interest cost of foreign saving. The combination of large domestic and foreign savings allows heavy investment in the U.S. decade after decade, part of the explanation for our fast growth and the world’s highest employment levels. Meanwhile, foreigners are actually losing ownership share in the U.S. despite the $2.6 trillion net debtor position, since U.S. assets are growing faster than foreign savings in the U.S.

A similar analysis would apply in the Australian context.  Malpass also highlights the real dangers associated with the ‘low’ saving view:

However, the bigger harm is not that we expose ourselves to a collapse, but that we allow ourselves and foreigners to underestimate, even mock, our economic system. We apologize for our “low savings rate” and “dependence on foreigners,” turn our foreign economic policy over to the International Monetary Fund’s economic gurus, and contemplate consumption tax increases, forced saving, protectionism, and a weaker dollar (with the consequent increase in inflation). Instead, while working hard to improve our system, we should encourage others to emulate its freedom, flexibility and prosperity.

posted on 02 April 2005 by skirchner in Economics

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The Reserve Bank as ‘Benign Autocracy’

John Garnaut uses next week’s Reserve Bank Board meeting as a hook to consider Australia’s 1920s model of monetary policy governance (Ross Gittins is obviously on leave!):

Professor Adrian Pagan, an economist at the Australian National University, sat on the Reserve’s board for five years to 2001.

Pagan says the bank is a “benign autocracy” where good policy outcomes have obscured the need to look more closely at rules and processes.

By the time of the 1990 recession, the rules that empowered and governed the bank had barely changed in 40 years. Fifteen years later and those rules and structures still have not changed.

“I think that once you become independent, it’s appropriate that you do change the governance structure,” he says. “Most others have changed, it’s unusual that we haven’t.”

Pagan’s reform agenda includes the publication of board meeting minutes, transparent risk-control processes for currency trading and, most importantly, restructuring the board.

The Reserve Bank board structure was established 80 years ago and remains almost unique among central banks.

Representing the institution are Macfarlane and his deputy, Glenn Stevens. Henry, secretary of the Treasury, represents the Government - although Macfarlane has said he still doesn’t know whether the Treasury secretary speaks for the Treasury or the Treasurer.

Five positions have been reserved for business people for most of the period since 1924. Not all have been praised for their contributions.

“They are very non-expert - to very high degree,” [former Board member Professor Bob] Gregory says. “I found that surprising.”

I make similar criticisms of Reserve Bank governance here.

posted on 02 April 2005 by skirchner in Economics

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The UK Election, Liberalism and Strategic Voting

Samuel Brittan recently wrote about his intention to vote for the Lib-Dems in the forthcoming UK election, having voted for the Labour Party in 2001:

In going for the Lib-Dems I am under no illusion that they are the party of Gladstone and John Stuart Mill. But at least they are different from Labour and Conservative; and there is nothing wrong in voting for negative reasons. In the past I have shrunk from supporting them because they looked too much like the unreconstructed Old Labour of the 1980s. But since Gordon Brown’s large increases in public service spending, they have found less mileage in that direction; and the recent Orange Book from the still-too-small free market wing of the party suggests a move in the right direction, as does the appointment of the eminently sensible Vincent Cable as their shadow chancellor.

There is no avoiding tactical voting in our present electoral system; and if your main objective is to keep out either Labour or the Conservatives at all costs then there are only a few constituencies where voting Lib-Dem would make sense. But if you believe that two terms of Labour are long enough and you would not mind a hung House of Commons then feel free to go for the Lib-Dems.

It says a lot about the Tories that one of Britain’s most prominent classical liberal commentators cannot bring himself to vote for them.  But the fact that he has turned his back on the Labour Party is also telling.  The prediction markets are implying a Labour victory is a near certainty, but I suspect this is one election the prediction markets will get wrong.  With the Tory campaign now being run by the same campaigners who made John Howard Australia’s second longest serving Prime Minister and with Tony Blair on the nose with the anti-war left, the Labour Party will have their work cut out for them.

posted on 01 April 2005 by skirchner in Politics

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The Growing Chorus for Tax Reform

Ross Garnaut joins the growing chorus for tax reform:

The most urgent task is to reduce considerably the effective marginal tax rates for social security recipients, the high levels of which contribute to relatively low labour force participation and high levels of part-time employment.

High taxation rates are also significant elements in labour force participation and the attraction and retention of skilled personnel at higher levels—and probably at all but the highest levels of the incomes range.

A reform of taxation rates that established a flat 30 per cent marginal effective tax rate for all corporate and personal income, including capital gains, would be most advantageous for people at the bottom of the income range, and most disadvantageous for Australians on the highest incomes and with the greatest wealth. Contrary to popular perception, it would be progressive, as well as being highly advantageous to incentives for greater labour force participation. It would have the additional advantage of removing the gains from conversion of personal into corporate income. Raising the rate of taxation on capital gains (it would need to be on real rather than nominal gains) would have the incidental effect of greatly reducing the distortions in capital allocation that have spurred the housing and associated consumption boom.

Needless to say, I disagree with Garnaut on capital gains tax and its supposed effects, but a flat 30/30/30 system for personal, corporate and capital gains tax has some appeal and should be readily achievable.  Unfortunately, the government still shows no sign of taking tax and spending reform seriously.

posted on 31 March 2005 by skirchner in Economics

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Disappointing Think Tanks on the Left and Right

The AEI’s John Makin confidently declares housing to be in a ‘bubble’ and lays it all at the feet of Alan Greenspan.  Makin argues that the Fed should toughen up its rhetoric and tighten by 50 bps in June.  This is somewhat at odds with the position Makin held as recently as October last year, when he called for a halt to further rate increases because of what he saw as the risk of recession in 2005.  The AEI has been more dovish and interventionist on monetary and exchange rate policy than many left-liberal think tanks, making any criticism of Greenspan for presiding over a ‘second bubble’ more than a bit rich.

Frank Lowy is to be commended for his philanthropy in establishing the Lowy Institute, but one has to wonder whether he is getting value for money.  The Lowy Institute would seem to be promoting ideas that are already over-represented within academia and among the Labor Party’s foreign policy establishment-in-internal-exile.  As Greg Sheridan notes:

The Lowy Institute, devoted as it is to Australian foreign policy, is a good thing. It’s full of conscientious folk doing useful work. Unfortunately, it does not look like it’s going to inject any fresh thinking into Australian foreign policy or generate any new voices. Rather it will reinforce the sadly quite narrow range of opinions held among professional academic and quasi-academic foreign policy commentators.

The same narrow views that led the Labor Party into a catastrophic abandonment of bipartisanship on foreign and defence policy ahead of the last election.

posted on 29 March 2005 by skirchner in Economics

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The US Current Account and Globalisation

Diana Farrell at the McKinsey Global Institute has been doing some excellent work highlighting the growing irrelevance of a residency-based view of trade, which ignores the increased importance of cross-border ownership of equity capital in driving current account balances.  Farrell estimates that one-third of the US current account deficit is attributable to trade with US-owned foreign subsidiaries.  Moreover, 

For at least the next decade, we would expect foreign investment by US multinationals to go on adding to the current-account deficit as it is currently measured. After all, globalization is in its infancy.

Record current account deficits should not be a surprise in this context, since globalisation should bring about a structural deterioration in the measured current account balance.  Insofar as this deterioration is symptomatic of globalisation, it should be welcomed rather than feared.  Farrell suggests moving to an ownership-based measure of trade balances, which might help defuse current account deficit angst.

posted on 25 March 2005 by skirchner in Economics

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It is now increasingly common to set up a blog to accompany the release of a new book.  Steve Levitt and Dubner have done this for their new book Freakonomics.  One of their first posts deals with why real estate agents are like the Ku Klux Klan.

I think the title of the book is unfortunate, because while Levitt’s interests are unconventional for an economist, he often explores issues that are of wider social interest and importance.  Too often economists are engaged in work that is of only limited interest, even to other economists.  I often get invited to economics conferences where I cannot find a single interesting paper on the conference program. 

Hopefully, this effort by the two Steves will help popularise econometric approaches to social and other issues that are often neglected by economists, leaving debate dominated by those from other disciplines that do not have a coherent theory of human behaviour and have limited interest in empirical testing.

posted on 23 March 2005 by skirchner in Economics

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