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ECB to Adopt QE in H2 2014

I have an op-ed in Business Spectator arguing that the ECB will likely resort to QE in the second half of this year. This will be a vindication of the long-standing criticisms of ECB monetary policy made by the new market monetarists. Inflation outcomes, nominal GDP and the euro exchange rate are all consistent with monetary policy having been too tight rather than too easy. The emerging divergence between ECB/BoJ and Fed monetary policy should set the stage for broad-based USD outperformance.

posted on 11 April 2014 by skirchner in Economics, Financial Markets, Monetary Policy

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De-Risking the RBA

I had an op-ed in the AFR over the break on the federal government’s injection of funds into the RBA’s Reserve Fund. The article notes that the public policy issue is not the subtraction from the budget bottom line from the injection, but whether the benefits of holding foreign exchange reserves are worth the risk of potential valuation losses and forgone income on higher yielding domestic assets. Foreign exchange reserves are not necessary for the effective conduct of monetary and exchange rate policy in Australia. An alternative policy approach is to hold smaller reserves. Full text below the fold (may differ slightly from published AFR text).

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posted on 12 January 2014 by skirchner in Economics, Financial Markets, Monetary Policy

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The 30th Anniversary of the Floating of the Australian Dollar

I have an op-ed in today’s AFR on the occasion of the 30th anniversary of the decision to float the Australian dollar. This year also marks the 20th anniversary of the adoption of implicit inflation targeting by the Reserve Bank, although a formal inflation target was not adopted until August 1996. As I note in the op-ed, the combination of these two macroeconomic institutions fundamentally changed the role of fiscal policy in the economy. Yet much of our macroeconomic policy debate remains stuck in the pre-float era. Full text below the fold (may differ somewhat from edited AFR text).

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posted on 08 December 2013 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Credit Controls Won’t Fix Housing

I have an op-ed in the AFR making the case against macro-prudential regulation in relation to lending for housing. Text below the fold (may differ slightly from published version).

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posted on 02 October 2013 by skirchner in Economics, House Prices, Monetary Policy

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Why the Fiscal Policy Multiplier is Zero

Scott Sumner has a new paper published by the Mercatus Centre, Why the Fiscal Multiplier is Roughly Zero. The argument will be familiar to regular readers of his blog, but the paper serves as a nice summary of what has become known as the Sumner critique. As Scott would be the first to concede, this is not a new or unconventional idea, but somehow the economics profession lost sight of this basic insight into monetary-fiscal interactions during the global financial crisis.

The Sumner critique is particularly relevant to a small open economy like Australia, where the entire institutional framework for macroeconomic policy is arguably built around this insight. With a floating exchange rate and an inflation targeting monetary policy, the change in the budget balance as a share of GDP from one year to the next is a macroeconomic irrelevance by design. This allows fiscal policy to focus on microeconomic and supply-side issues.

In testimony before various parliamentary committees, former Treasury Secretary Ken Henry and RBA Governor Glenn Stevens explicitly acknowledged monetary offset in the context of the 2008-09 fiscal ‘stimulus’, but resorted to the argument that it was better to rely on a mix of macroeconomic instruments rather than monetary policy alone, citing alleged adverse side-effects from very low interest rates. In the US context, Sumner notes the real reason for such arguments: politically, the monetary authority cannot be seen to be explicitly undermining the efforts of the fiscal authority.

In Australia, it is often argued that the government should not cut government spending or return the budget to surplus because it would supposedly be contractionary for the economy. This not only ignores the role of fiscal policy within Australia’s macroeconomic policy framework. As Scott notes, the assumed underlying ‘estimates of fiscal multipliers become little more than forecasts of central bank incompetence.’

posted on 13 September 2013 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Scott Sumner Enjoyed His Time in Australia

Scott Sumner enjoyed his time in Australia, presenting at the Centre for Independent Studies’ Consilium conference on the Gold Coast and the Economic Society of Australia (New South Wales) in Sydney. You can read Scott’s account here.

Scott’s presentation covered similar ground to his article in the Winter issue of our journal Policy. I did a video interview with Scott that should be available soon. Watch this space.

Scott says some nice things about the Centre for Independent Studies in the post linked above. Many potential overseas speakers are reluctant to make what is admittedly a long trip to Australia. But take it from Scott, if you come to Australia, we will show you a good time!

One thing I learned as a result of my presentation at Consilium was that then Treasurer Jim Cairns offered the RBA Governorship to Charles Goodhart in the early 1970s (who wisely turned it down). This was quite possibly the only good idea Jim Cairns ever had. So there is at least some historical precedent for my long-standing suggestion for an internationally competitive process for filling senior positions at the RBA.

posted on 29 August 2013 by skirchner in Economics, Monetary Policy

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Scott Sumner in Australia

Scott Sumner will be in Australia next month as a guest of the Centre for Independent Studies. He will be attending our Consilium conference on the Gold Coast, but will also be doing a seminar with the Economic Society of Australia (NSW) in Sydney.

Scott has written an article in the latest issue of our journal Policy, ‘A New View of the Great Recession.’ It is an excellent introduction to some of the ideas informing what Lars Christensen has dubbed ‘the new market monetarism.’

I’m also pleased to read that Scott will be attending next year’s Mont Pelerin Society meeting, where he will be on a panel on The Coming Threat of Inflation. As Scott notes on his blog:

The 500 classical liberals in the audience will be surprised to learn that the threat is that inflation will be too low over the next 5 years.

In fact, MPS includes quite a few market monetarists, especially among the younger members (I’m young by MPS standards!) This should not be surprising since the new market monetarism is firmly in the orthodox monetarist tradition of Milton Friedman, one of the Society’s founding members. Unfortunately, many of the older MPS members are still wedded to fighting the inflation battles of the 1970s. They need to move on!

posted on 22 July 2013 by skirchner in Classical Liberalism, Economics, Monetary Policy

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Australia as Poster Child for the New Market Monetarism? (March Quarter Edition)

The national accounts were out yesterday, so time to update our graph of the (log) level of nominal GDP relative to its low inflation period trend. The Australian economy still sits 4% below the NGDP level stabilisation benchmark suggested by the new market monetarists, implying that monetary policy has been too tight:

The new market monetarists argue Australia was a poster child for NGDP stabilisation during the financial crisis, but I interpret things differently. Prior to the onset of the financial crisis, inflation was out of control (CPI inflation running at 5%) and nominal GDP growth was running in the double-digits. The financial crisis saved the RBA from having to induce a domestic recession to bring inflation under control. The RBA was most successful when international conditions were doing the work for them.

Lest this look like the luxury of hindsight, I was arguing much the same thing in August 2008.

posted on 06 June 2013 by skirchner in Economics, Financial Markets, Monetary Policy

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Foreign Exchange Market Intervention a Risk to Taxpayers

I have an op-ed in the Business Spectator arguing that foreign exchange market intervention is a risk to taxpayers who would be better served if the RBA matched its foreign currency assets and liabilities. I also debunk the notion that Australia is a victim of a ‘currency war’:

It has been argued that Australia is somehow a victim of a ‘currency war’ being waged between foreign central banks engaged in quantitative easing. Yet there is nothing unusual about the effects of quantitative easing on exchange rates.

Quantitative easing is simply a change in the operating instrument of the central bank, from a price variable (the official interest rate) to a quantity variable (base money).

In itself, quantitative easing tell us nothing about whether central bank policy is easy or tight. Low inflation and low interest rates in countries like Japan and the United States imply policy settings are if anything too tight, not too easy.

The exchange rate is just one of the channels through which a change in monetary policy is transmitted to the rest of the economy and quantitative easing does not fundamentally alter this transmission mechanism.

In previous decades, Australians worried about a low exchange rate and capital flight. In the current international environment, foreign capital inflows are an affirmation of our relatively sound economic fundamentals and not a bad problem to have.

posted on 18 April 2013 by skirchner in Economics, Financial Markets, Foreign Investment, Monetary Policy

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Why US Monetary Policy is Too Tight

An excellent op-ed by Doug Irwin on why US monetary policy is too tight:

The Divisia M3 and M4 figures for the US money supply, calculated by the Center for Financial Stability, show that the money supply is no higher today than in early 2008. For all the fretting about the Fed’s accommodative policy, the money supply has barely increased and is way off its previous trend. This represents a very tight policy compared to Friedman’s rule that growth in the money supply should be limited to a constant percentage. The lack of growth in the money supply is an important reason why US inflation and inflationary expectations remain under control. The Federal Reserve Bank of Cleveland’s latest market-based estimate of the 10-year expected inflation rate is 1.32 per cent.

posted on 16 October 2012 by skirchner in Economics, Financial Markets, Monetary Policy

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Do Australians Make Better Central Bankers?

Does Glenn Stevens know something Ben Bernanke does not? Matt Yglesias seems to think so:

if it’s true that Australia has recession-proofed itself through sound monetary policy, there are lessons that larger countries could be learning here. Heck, we could even be hiring some Australian central bankers to ply their trade in England, Japan, the United States, or wherever.

It is of course very implausible that being Australian in itself makes one a better central banker or the RBA has hit upon a secret formula for conducting monetary policy unknown to the rest of the world (not least because Australian central bankers mostly trained in North America). It is equally implausible that foreign central banks are incapable of observing and learning from the Australian experience.

Nor is that experience as good as Matt suggests. Australia went into the financial crisis with an inflation rate of 5%. In the absence of a severe global economic downturn, the RBA would have been forced to engineer a local one to have much hope of bringing inflation back down to the 2-3% target range. I argued back in August 2008 that monetary policy had been too easy in previous years. The subsequent financial crisis does not change that judgement in any way if you accept that it was an event that could not be forecast.

Glenn Stevens and Ben Bernanke both assumed their respective roles in 2006. Had they swapped roles, would monetary policy and macroeconomic outcomes have been any different in Australia or the US? I think not.

posted on 04 October 2012 by skirchner in Economics, Monetary Policy

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Another Shadow RBA Board

Jessica Irvine has rounded-up another Shadow RBA Board, including yours truly. Like the overlapping ANU Shadow Board, the News Ltd version makes normative rather than positive predictions, ie, what the RBA ‘should’ do rather than what it ‘will’ do.

This distinction probably isn’t very meaningful if the starting point for each month’s normative forecast is the existing cash rate. If the starting point re-sets every month, the Shadow rate track cannot deviate far enough or long enough from the actual rate to be economically significant. A Shadow Board needs to take its previous decisions as the starting point and develop an independent interest rate path. Even then, the difference between the Shadow and actual rate tracks may not amount to very much.

The US Shadow Open Market Committee and the UK’s Shadow Monetary Policy Committee were established specifically to critique current policy from a monetarist perspective, as well as advocating reform of existing monetary institutions. This has not prevented significant differences of opinion on these bodies. For example, the Shadow MPC includes supporters and opponents of QE for the UK. As I have argued here previously, QE is an entirely orthodox monetarist policy prescription. It represents no more than a change in operating instrument and QE in itself does not indicate whether policy is easy or tight. Monetary conditions could still be too tight even in the presence of large scale outright bond purchases by the central bank if money demand is strong enough.

We were also asked where we would like to see the official cash rate in 12 months time. My expectation is 100 bp lower than the current rate, but I do not think this will be a particularly easy monetary policy stance. There is a good case to be made that that the world equilibrium real interest rate and potential output have declined as a result of the bad public policy decisions taken globally during and after the financial crisis and now reflected in record low bond yields. How much of this is cyclical and how much becomes permanent depends on where public policy goes from here.

Monetary policy will need to reflect this, but will not do much to address what are ultimately supply-side problems.

posted on 01 October 2012 by skirchner in Economics, Financial Markets, Monetary Policy

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Peter Costello and Reserve Bank Transparency

Peter Costello in 2012:

The RBA… as a public institution it must be subject to public scrutiny.

Peter Costello in 2004:

The Reserve Bank of Australia has used powers given to it by Treasurer Peter Costello to issue a “conclusive certificate” to prevent publication of the RBA board’s minutes, saying their release is not in the public interest.

The Reserve Bank’s action on Thursday 25 November came just three days before the start of a hearing in the Administrative Appeals Tribunal in which The Weekend Australian newspaper was set to challenge the RBA’s decision under the Freedom of Information Act not to release the minutes of its meetings and voting records for 2003/04.

posted on 23 August 2012 by skirchner in Economics, Monetary Policy

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Euro Crisis Vindicates Friedman’s Big Idea

I have an op-ed in today’s Business Spectator arguing that the euro crisis should be viewed primarily as a vindication of Milton Friedman’s pioneering 1953 essay, ‘The Case for Flexible Exchange Rates.’

Not mentioned in the op-ed, but Friedman’s essay had its origins in a 1950 memo he wrote as a consultant to the Office of Special Representative for Europe, United States Economic Cooperation Administration. The essay references many of the problems with exchange rate regimes in Europe at that time.

posted on 21 May 2012 by skirchner in Economics, Financial Markets, Monetary Policy

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Good and Bad Reasons for a Budget Surplus

The government’s stated motivation for returning the budget to surplus next financial year is to give the Reserve Bank ‘maximum room to move’ on interest rates. Yet a fiscal contraction is no more effective in restraining the economy than a fiscal expansion is effective in stimulating it. In an open economy with a floating exchange rate and an inflation-targeting central bank, changes in fiscal policy do not have significant macroeconomic implications. That is why the reaction of financial markets to budget statements is so negligible. The Reserve Bank’s statements also make clear that fiscal policy is a very minor consideration in its decision-making.

During the financial crisis, the government tried to have it both ways, arguing that its fiscal stimulus saved us from recession, but had no implications for interest rates. The second part of the argument was correct, but not the first. If the first part had any truth, then monetary policy must have been much tighter during the financial crisis as a result of the government’s stimulus spending.

The government should have no concern over the macroeconomic implications of changes in the budget balance, so long as it is balancing its budget over time and conducting fiscal policy in a sustainable manner. This should free the government to focus on what fiscal policy can do effectively, namely, changing microeconomic incentives to work, save and invest.

The government and opposition’s mistaken belief in a trade-off between fiscal and monetary policy is dangerous, because it leads to fiscal policy decisions that are more about window-dressing the budget balance and claiming credit for reductions in official interest rates that would have happened anyway, rather than improving incentives. For example, the mistaken belief that tax cuts stimulate demand and lead to higher interest rates can prevent sensible tax reform that has positive implications for the supply-side of the economy. Similarly, the fiscal stimulus of 2008-09 was bad primarily because it misallocated resources. Take away the macroeconomic rationale and the stimulus measures look indefensible on microeconomic grounds, even if the spending had been administered perfectly (which it was not).

A budget surplus target can be defended as a fiscal rule designed to impose additional discipline on government decision-making that might otherwise be absent. But there is no reason to subordinate fiscal policy to monetary policy and fiscal targets should not be pursued at the expense of the microeconomic incentives that are the ultimate source of both economic growth and long-term fiscal sustainability.

posted on 09 May 2012 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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