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The Financial System Inquiry and Macro-Pru

I have an op-ed in Business Spectator endorsing the sceptical approach to macro-prudential regulation taken in the Murray inquiry’s interim report:

Macro-prudential policies are seen as providing policymakers with a more targeted set of policy instruments that might complement or even substitute for changes in official interest rates. However, these instruments also implicate policymakers in making much finer judgements about risks to financial stability as well as the more traditional concern of monetary policy with price stability.

A blunt instrument like monetary policy encourages caution in making such judgements. By contrast, more targeted counter-cyclical quantitative controls are a standing invitation to micro-manage credit allocation, but do not in themselves improve the ability of policymakers to make appropriate judgements about the implications of such policies. It can also create a false impression that a central bank’s price stability mandate has been subordinated to other objectives, such as house price inflation.

Macro-prudential policies are also more politically fraught than traditional monetary policy. Quantitative controls designed to be selective in impact are more likely to provoke opposition. In Britain, macro-prudential policies are at cross-purposes with the government’s ‘Help to Buy’ mortgage guarantee scheme. Macro-prudential regulation is often a second-best approach to dealing with the inflationary implications of supply-side rigidities in housing markets. It may also push borrowing and lending activities outside the regulatory perimeter altogether.

posted on 25 July 2014 by skirchner in Economics, Financial Markets

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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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Do Financial Markets Care About the G20?

An ECB Working Paper looks at the impact of G20 meetings on financial markets:

In this paper we run an event study to test whether G20 meetings at ministerial and Leaders level have had an impact on global financial markets. We focus on the period from 2007 to 2013, looking at equity returns, bond yields and measures of market risk such as implied volatility, skewness and kurtosis. Our main finding is that G20 summits have not had a strong, consistent and durable effect on any of the markets that we consider, suggesting that the information and decision content of G20 summits is of limited relevance for market participants.

That won’t stop the Australian federal government spending $500 million on a process markets have deemed an irrelevance.

posted on 05 April 2014 by skirchner in Economics, Financial Markets

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Bob Shiller, Ex-Ante and Ex-Post

Scott Sumner has a nice comparison of Robert Shiller’s investment advice with that from one of my favourite supply-side economists, Alan Reynolds. Loyal readers of this blog will not be surprised to see that Scott’s post has my name all over it.

Scott asks, ‘Can people find me the dates where Shiller recommended people buy stocks?’

Sure. In his 2009 book with George Ackerlof, Shiller wrote: ‘there has been one way, at least in the past, in which almost everyone could become at least moderately rich … Invest it for the long term in the stock market, where the rate of return after adjustment for inflation has been 7% per year’ (p. 117).

Unfortunately, Shiller’s ex-post observations on stock market returns in 2009 do not sit well with his ex-ante prediction in 1996: ‘long run investors should stay out of the market for the next decade.’

posted on 25 March 2014 by skirchner in Economics, Financial Markets

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‘Australian of the Year’ as Contrarian Sell Signal

In January 2010, The Australian named then Prime Minister Kevin Rudd as ‘Australian of the Year’ ‘because of the way he dealt with the global financial crisis’. From affiliate EWI’s 2014 State of the Global Markets Report:

We correctly called the award a sell signal for Australian stocks - the All Ords would make no net progress for the next three-and-a-half years.

posted on 30 January 2014 by skirchner in Financial Markets

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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).

continue reading

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

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Bob Shiller Still Can’t Define a ‘Bubble’

John Cochrane reviews Bob Shiller’s Nobel lecture and notes that he still can’t define the idea for which he is most well known. Moreover:

In an entire lecture, Bob did not give a single concrete example of how “listening to psychologists” produces one concrete positive step to understanding “bubbles.”

Cochrane then tries to rehabilitate Shiller by suggesting he is doing something terribly profound:

I realized just how deep and audacious Bob’s project is. He is telling us to abandon the “scientific” pretense. He wants us to adopt a literary style, where we look at the world, are inspired by psychology, and write interpretive prose as he has done.  When he says that the definition of a a bubble is a fad, he isn’t being sneaky and avoiding the argument. He means exactly what he says and wants us to think and write this way too. A bubble, to Bob, is defined as any time a time that he, writing about it, informed by psychology, and reading newspapers, thinks a “fad” is going on. And he invites us to think and write like that too. A model is, to Bob, wrapped up in one person’s judgement and not an objective machine. If I complain that this is ex-post story telling, he might say sure, stop pretending to be physics, write ex-post stories. If I complain that there are no rules and that this is no better than “the gods are angry,” he might say, no, read psychology not ancient theology, and the rules are you have to couch your story telling in their terms. He does not want us to try to construct models, either psychological or rational, that make quantitative predictions.

This is consistent with my observation that much of Shiller’s work is simply assertion rather than science. It is audacious, but not in a good way. While Cochrane means to praise Shiller, I think he effectively buries him.

posted on 19 December 2013 by skirchner in Economics, Financial Markets

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Debt Limits and Fiscal Rules

This week’s abolition of the local federal debt limit is a welcome development, but only because a debt limit in absolute dollar terms is not a well specified fiscal rule and was never intended to serve as such. The US debt limit, from which Australia’s took its inspiration, was also never intended to be a binding constraint on government borrowing, although threatened to become one on the back of poor fiscal outturns.

The US debt ceiling was first put in place in the 1930s. Its purpose was to alleviate the US Treasury from having to seek Congressional authorisation for each individual debt issue. Instead, Treasury was given discretion to issue debt within the overall limit specified by Congress, but not in the expectation that it would serve as a binding constraint on government borrowing. Since 1960, the US debt limit has been amended by Congress 78 times. More recently, the US debt limit has been politicised and used a proxy fiscal rule, but is unfit for this purpose. Government borrowing is ultimately a product of government spending in excess of revenue and it is government spending that needs to be controlled.

A net debt limit specified as a share of GDP rather than in absolute dollar terms is a better specification and a useful addition to a suite of fiscal rules designed to impose fiscal discipline, as I have argued elsewhere.

A traditional objection to fiscal rules is that they might force a fiscal consolidation or prevent the operation of automatic stabilisers so that fiscal policy becomes pro- rather than counter-cyclical. However, as argued in my AFR op-ed Monday, this is only a problem in the absence of an independent monetary and exchange rate policy. An inflation targeting central bank and a floating exchange rate allows fiscal policy to focus on supply-side issues and long-run fiscal sustainability without being pre-occupied by aggregate demand management and macroeconomic stabilisation.

posted on 09 December 2013 by skirchner in Economics, Financial Markets, Fiscal 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).

continue reading

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

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The Financial System Inquiry – Dealing RBA Governance Back In

I participated in a roundtable discussion on the Financial System Inquiry’s draft terms of reference organised by federal Treasury. Item 7 of the draft terms of reference states that:

In reaching its conclusions, the Inquiry will take account of, but not make recommendations on the objectives and procedures of the Reserve Bank in its conduct of monetary policy.

This can be read a number of ways. I think the intent is to take RBA independence and inflation targeting off the table, but it can also be read as shutting down any consideration of RBA governance. The RBA is internationally anomalous in failing to separate monetary policy decision-making from the overall governance of the bank. This puts the board in the position of oversighting itself in the conduct of monetary policy, the bank’s most important function.

As I argue in this paper, external board members are also conflicted in being notionally appointed to represent particular interests and perspectives, but their role as monetary policy decision-makers requires them to put aside these interests in favour of the public interest. This results in the contributions of individual board members to monetary policy deliberations being suppressed, reducing transparency and accountability in the conduct of monetary policy. The RBA is also exceptional in affording a government representative voting rights (as opposed to non-voting representation) in setting monetary policy.

I also argued at the roundtable, consistent with my article in yesterday’s AFR, that the role of both the Foreign Acquisitions and Takeovers Act and the Foreign Investment Review Board needed to be explicitly included in the terms of reference because of their implications for the cost of capital and the financial system’s international integration with global capital markets. I briefly canvass reform options for the regulation of foreign direct investment in this article in the December issue of Infinance.

My concern is that unless RBA governance, the role of FATA and the FIRB are explicitly raised in the final terms of reference, these issues will not be adequately examined by the Inquiry.

Submissions on the draft terms of reference close Thursday 5 December. If you think these are important issues, it is not too late to put in a submission.

posted on 04 December 2013 by skirchner in Economics, Financial Markets

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Does Compulsory Super Increasing Saving?

I have an op-ed in the Business Spectator discussing a recent CPA Australia report and its claim that “nothing has been saved during the 20 years of compulsory superannuation contributions”:

The CPA report argues that households anticipate the tax-free benefit they will receive from their superannuation account balance on retirement by increasing their current levels of borrowing and consumption. This increased borrowing is claimed to have fully offset the increased saving via compulsory superannuation contributions. Hence the report’s conclusion that “superannuation savings minus household debt effectively equals zero”.

This surprising result reflects a questionable feature of the report’s methodology. The report counts borrowing for housing on the liabilities side of household balance sheets, but does not count housing equity on the assets side. The report defines household saving as household financial wealth less debt, including housing debt.

The report defends this approach on the basis that few retirees access housing equity to fund their retirement, whether through reverse mortgages, downsizing or relocating the family home. As the report notes, the means test for the age pension encourages the movement of financial assets into the home rather than taking equity out of the home. Stamp duty on property transactions is another factor discouraging the realisation of housing equity.  Whereas mortgage debt in retirement needs to be serviced, the value of the family home does not directly affect the cost of living in retirement.

In fact, it is always possible to change the incentives that currently discourage households from realising housing equity for the purposes of funding retirement.  In principle at least, housing equity is available to fund retirement, even if this is not a popular choice. We should not completely discount the role of housing equity as a source of retirement saving when it is such an important part of household net worth.

posted on 24 September 2013 by skirchner in Economics, Financial Markets

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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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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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Sovereign Wealth Funds and Fiscal Responsibility

The Future Fund’s creator, former Treasurer Peter Costello, does not have much faith in the ability of sovereign wealth funds to promote fiscal responsibility:

Now I put aside $60 billion in the Future Fund. People say “oh well you could have put aside 70 or $80 billion or something like that.” But I make this point. If we’d put aside more they’d probably just have borrowed more.

posted on 30 April 2013 by skirchner in Economics, Financial Markets, Fiscal 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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