Institutional Economics: ‘Light Reading It’s Not’

The Official Lies that Underpin the Euro

Der Spiegel on the official lies that underpin European Monetary Union:

Since joining the euro zone, the 16 euro countries have violated the deficit rule, under which net new debt cannot exceed 3 percent of GDP, 43 times. Most of the infractions have occurred in the last two years. Greece is at the top of the list of violators. Only once did the country manage to push its deficit rate below the magic limit, and only with an extremely creative trick: The Greeks sugarcoated their statistics by including prostitution, black-market trade and gambling in the calculation of economic output. As a result, GDP rose by a stunning 25 percent in 2006, and the deficit dropped to 2.9 percent.

While this is a remarkable story coming from Der Spiegel, the authors still can’t quite come to terms with giving up on the euro, suggesting that its problems could be solved through a common financial policy and an IMF-like European Monetary Fund. Still, as Anne Appbaum notes, opinion in Germany is shifting.

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

Mid-Week Linkfest

1. Roubini wrong again and again.

2. Cash for Corfu.

3. Axel Weber and Philipp Hildebrand versus Olivier Blanchard. See also Phil Lowe for further Blanchard repudiation.

4. Bill Emmott and Wolfgang Munchau as bumptious prats.

5. Hayek’s lessons for Kevin Rudd.

posted on 09 March 2010 by skirchner in Economics, Misc

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Nice Hedge Fund You’ve Got There, Shame if Something Were to Happen to It

Governments may sometimes feel threatened by hedge funds (and properly so), but no one beats the US Justice Department when it comes to bureaucratic intimidation and standover tactics:

The Justice Department has launched an investigation into whether hedge funds might have banded together to drive down the value of the euro, people familiar with the matter say.

In a letter last week, the department has asked hedge funds including SAC Capital Advisors LP, Greenlight Capital Inc., Soros Fund Management LLC and Paulson & Co. to retain trading records and emails relating to the euro, say people who have seen the letter.

The letter was dated Feb. 26, the same day a page-one article in The Wall Street Journal outlined a large bet being made in recent weeks by heavyweight hedge funds against the euro, in moves that are reminiscent of the trading action at the height of the financial crisis like bets against Lehman Brothers and other troubled firms…

The Justice Department’s letter said the antitrust division “has opened an investigation into agreements among various hedge funds that trade euro contracts,“ including contracts to trade euros in the “cash or the derivatives market,“ a person familiar with the matter says.

The letter requested that the funds “preserve all documents” and electronic communications relating to agreements to trade the euro or communications about agreements to trade currencies, the person says.

As the article notes, the US authorities have a dismal track record in bringing successful prosecutions in these matters, suggesting that bureaucratic intimidation has become an end in itself.

posted on 04 March 2010 by skirchner in Economics, Financial Markets, Rule of Law

Mid-Week Linkfest

Peter Wallison on why financial sector reform is stalled.

Electronic Frontiers Australia on Facebook police.

The documentary that asks why parents aren’t rioting in the streets.

posted on 02 March 2010 by skirchner in Misc

Betting on the RBA

Someone was betting big on the outcome of today’s RBA Board meeting:

a Centrebet regular, has staked just short of $30,000 on the Reserve Bank sitting on its hands.

If at 2.30pm the bank announces its board has decided to keep rates on hold, he will walk away with a profit of $21,000. If it puts rates up, he will say goodbye to $29,500.

‘'He is very confident. He placed four separate bets, continuing to pile in as the odds went down,‘’ said Centrebet’s Neil Evans.

‘'Another punter staked $5000 on there being no change, another $3500.

‘'It’s the house against the punters. I am hoping they don’t know something I don’t.‘’

They didn’t.

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

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The CPI and the RBA’s Backward-Looking Bias

I have an op-ed in today’s Canberra Times arguing for a monthly CPI for Australia (full text below the fold):

This lack of timeliness in compiling and releasing inflation data gives monetary policy a backward-looking bias. Around 45 per cent of the changes in the official interest rate since 1990 have been announced at the Board meeting immediately following the quarterly CPI release. During the 2002-08 tightening episode, 67 per cent of rate hikes followed this pattern, including every one of the six tightenings between May 2006 and February 2008.

Today saw the release of the TD Securities-Melbourne Institute Monthly Inflation Gauge, which rose by 0.1% in February, following a 0.8% rise in January and a 0.3% rise in December 2009. In the twelve months to February, the Inflation Gauge rose by 1.9%. The trimmed mean measure rose by 0.1%, to be 2.0% higher than a year ago. The gauge points to a 1% rise in the March quarter CPI for an annual rate of 3%.

As I note in the op-ed, the Melbourne Institute has stopped publishing the index numbers for the gauge, limiting its usefulness and going very much against the spirit of its creators and sponsors. However, for those who need it, Annette Beacher advises the index number for February is 123.45.

posted on 01 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

Divergent Pricing for March RBA Board Meeting

Friday’s Reuters poll has 12 of 18 financial market economists expecting a 25 bps tightening, with the balance looking for steady rates. March inter-bank futures are giving only a 49% chance to a 25 bp tightening, while iPredict is pricing a 67% chance of a rate hike. I suspect interbank futures are closer to the mark.

I will be talking on Australian monetary policy on Bloomberg TV Tuesday morning AEDT.

posted on 26 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

Youngest ever guest lecturer.

Child Labour at Stanford

posted on 25 February 2010 by skirchner in Economics

The Future of Money

New innovations in payment systems, including:

dynamic invoices that pay themselves — that constantly monitor exchange rates, say, or the price of lumber, and then automatically send out an order to withdraw funds or to make a purchase just when the price is cheapest.

posted on 25 February 2010 by skirchner in Economics, Financial Markets

Mid-Week Linkfest

Phil Levy and Robert Barro on the first anniversary of the US fiscal stimulus.

Peter Wallison on zombie GSEs.

Joye versus Keen Cage Match. Two economists enter. Only one can leave. UPDATE: You can view Joye’s presentation here.

posted on 23 February 2010 by skirchner in

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The Road Not Taken

The New Yorker on the tragedy that is Paul Krugman:

When the Times approached him about writing a column, he was torn. “His friends said, ‘This is a waste of your time,’ ” Wells says. “We economists thought that we were doing substantive work and the rest of the world was dross.” Krugman cared about his academic reputation more than anything else. If he started writing for a newspaper, would his colleagues think he’d become a pseudo-economist, a former economist, a vapid policy entrepreneur like Lester Thurow?

The rest is history.

posted on 22 February 2010 by skirchner in Economics

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The RBA and the Media

RBA Governor Stevens’ appearance before the House Economics Committee on Friday included this exchange with the federal member for Mayo:

Mr BRIGGS—Just on a slightly different track: On 2 November last year there was an article on the Lateline Business program about suggestions that the Reserve Bank executive selectively leaks the likely outcome of the board meeting prior to the board meeting. I guess the presenter summarised it best:

Certainly, there’s disquiet among market economists that the Reserve Bank is selectively briefing certain journalists in the lead-up to rate decisions. Many argue the practice undermines the board process.

I am just interested—did you see the report, and do you have a comment?

Mr Stevens—I did see the report. Apparently there were not too many selective leaks in February, because everybody was surprised, so I am not sure what to make of all this.

Mr BRIGGS—So, you—

Mr Stevens—No, people do not leak the outcome. For a start, the staff do not take calls from the media after the relevant internal meetings where we have come to the view of what we are going to recommend. That is usually on the Thursday morning; the papers go that night. Secondly, we cannot be certain that the board will do what we recommend. It is a board of nine people, and I can assure you they are all of independent mind. People do not leak that information; in my experience the Reserve Bank never has leaked and, if I can help it, it never will.

Stevens is probably correct to argue that the outcome of the Board meeting has never been leaked outright, but that was not what the Lateline Business story was about. The issue raised was whether the RBA backgrounded journalists to the point where they were much better informed about the RBA’s policy bias and therefore better able to call the likely outcome of the Board meeting.

There is evidence on the public record for the view that the RBA has engaged in this practice. In a profile of former Governor Ian Macfarlane published in the AFR Magazine in 2001, a former RBA official is quoted as follows:

The Bank uses newspapers to manage expectations. It’s a game the Bank manages very well. Senior people talk to a small handful of the economics writers from the major papers on a strictly non-attributable basis. I think it’s right to do this from the bank’s point of view, but not necessarily from a public policy view: accountability and a critical press are very important in this system.

That last sentence is the key issue in a nutshell. My sense is that the RBA has now been subjected to sufficient heat over the issue that we won’t see another episode of this in future. The test for the RBA will be whether there is a future recurrence of market speculation about RBA media backgrounding, despite the Governor’s denial.

posted on 20 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

Yes, We Have Patrick Colmer Speeches (for the ‘Merely Curious’)

Using Freedom of Information legislation, I have obtained a copy of a speech given by Patrick Colmer, Executive Director of the Foreign Investment Review Board, to the Australian-China Investment Forum on 24 September last year. The background to the speech and the FOI process are discussed in an op-ed in today’s Australian.

posted on 18 February 2010 by skirchner in Economics, Foreign Investment

Endogenising the Inflation Forecast

RBA Assistant Governor Phil Lowe highlights an important change in the RBA’s technical forecasting assumptions:

For some years, it had been our practice to produce forecasts assuming that the cash rate remained unchanged throughout the forecast horizon. This approach had the obvious advantage of simplicity, but when the cash rate is a long way from its normal level, it is not particularly realistic.

So, in August last year we changed our approach. Since then, we have prepared our forecasts on the technical assumption that the cash rate returns towards a more normal setting over time. Our overall objective here is to provide the community with a general sense of how we think the economy is likely to evolve over the next few years and to do this we need to make realistic assumptions. Broadly speaking, the paths the staff have used have been similar to those implied by market interest rates at the time the forecasts were prepared. It is important to stress that this neither implies a commitment by the Board to the particular path used nor an endorsement by the Bank of the market pricing.

This is a welcome change. It makes more sense for an inflation targeting central bank to forecast its own policy rate or to incorporate a market forecast for the policy rate and then base the inflation forecast on this projection. This makes it more explicit that inflation outcomes are not exogenous under an inflation targeting regime.

There was also this endorsement of the macroeconomic benefits of increased labour market flexibility:

The good news is that this flexibility in employment relationships worked in limiting job losses in the economy. This has had obvious social benefits as well as supporting overall confidence in the community. Without this flexibility, it is likely that the outcomes would not have been as favourable.

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

iPredict Contract on Australian Federal Election Date

This Friday, iPredict launches a host of new contracts with full market-maker liquidity, including a contract on the Australian federal election date and the outcome of the March RBA Board meeting.

posted on 17 February 2010 by skirchner in Economics, Financial Markets

Steve Keen’s Latest Media Stunt

In an attempt to snatch victory from the jaws of defeat in his wager with Rory Robertson, Steve Keen seeks to lead a lemming-like march of housing doomers up the slopes of Mt. Kosciuszko:

rather than accept the victory of his more bullish opponent, it appears the professor is trying to muster the biggest gathering of market bears in Australian economic history. He has already coined the event ‘'Walking Against Australia’s Property Mania.‘’

Keen will start his 224-kilometre walk from Parliament House in Canberra on April 15, and aside from a documentary crew, his girlfriend and a masseuse, he hopes to be accompanied by some of the 3000-odd members of his Debtwatch blog.

The other side of the bet is unimpressed:

“Betting the house on an economist’s forecast typically is not a smart move. Unfortunately, Dr Keen recklessly encouraged everyday Australians to sell their homes at what turned out to be the peak of the global financial crisis, and the trough in local house prices,“ Rory Robertson responded.

“That’s why he’s getting set to walk from Canberra to Mt Kosciuszko wearing a t-shirt saying, ‘I was hopelessly wrong on house prices. Ask me how!‘“

posted on 16 February 2010 by skirchner in Economics, House Prices

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Consumers as Interest Rate Hawks

The February Westpac-Melbourne Institute Consumer Sentiment survey finds respondents expecting increases in mortgage interest rates in excess of 100 bp over the next 12 months. While this is somewhat in excess of the tightening in official interest rates recently priced into the inter-bank futures strip, it is not necessarily inconsistent with market pricing. Consumers are by now well aware that the official cash rate is not the only determinant of mortgage interest rates and that there is a trade-off between changes in mortgage interest rates and the official cash rate.

Treasurer Wayne Swan continues to maintain that there is ‘no excuse’ for interest rate movements in excess of movements in the official cash rate. If lenders were to have followed this advice in the past, then none of the benefits of lower funding costs from mortgage securitisation would have been passed on to borrowers before the onset of the credit crisis. Moreover, any future improvement in capital market conditions could not be passed on to consumers, but would instead be hoarded by lenders with the Treasurer’s implicit blessing.

posted on 11 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

The RBA’s 50th Anniversary Symposium

Today I attended the RBA’s 50th anniversary symposium. The proceedings were not for attribution, but the papers have been published on the RBA’s web site. The session on supply-side issues was a particularly welcome contribution to an area too often neglected by central banks, but one that is inescapably linked to the conduct of monetary policy.

posted on 09 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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

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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

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

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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

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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

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