Working Papers

2007 09

‘The Opposite of the Greenspan Put’

Allan Meltzer, speaking from the Jackson Hole symposium, on why the Fed won’t cut the Fed Funds rate.

posted on 01 September 2007 by skirchner in Economics, Financial Markets

(1) Comments | Permalink | Main

| More

At the Treasurer’s Convenience

Next week’s Q2 national accounts release has been moved to Tuesday, to avoid clashing with APEC:

I have requested the Australian Statistician release the June quarter 2007 National Accounts one day early on Tuesday, 4 September 2007, in view of the fact that meetings surrounding the APEC Summit will be occurring on Wednesday 5 September.

The acting Australian Statistician has agreed to this request and indicated that he will release the June quarter 2007 National Accounts one day earlier, on Tuesday 4 September 2007, at 11.30 am.

The usual Treasurer’s press conference will occur in Canberra on that day.

This is not the first time that the national accounts release has been re-scheduled to suit the Treasurer’s schedule.  On a previous occasion, the national accounts were released earlier simply because the Treasurer wanted to go overseas.  The willingness of the ABS to accommodate ministerial requests to re-schedule data releases to suit the Treasurer’s schedule is not a good look for an independent authority.

The Treasurer has also been busy instructing the ABS to maintain secrecy on the Future Fund’s transactions:

During the June quarter, the Future Fund commenced investment activity. The Future Fund has been classified as a General Government unit and thus the investment activity and associated holdings of assets are recorded as part of the General Government sector. In order to maximise the availability of information about the activities of the General Government sector, ABS legislation allows the publication of identifiable information about this sector except where a request for confidentiality has been received from the relevant Minister. A request has been received and the relevant estimates have been confidentialised in this publication. The estimates will remain confidentialised in all releases published up to and including 30 June 2008.

The secrecy around the Future Fund’s investment activities is a tacit admission of the capacity of the Fund to distort financial market prices.

posted on 30 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

The Use and Abuse of ‘Liquidity’

The notion of ‘liquidity’ is routinely invoked as a driver of the business cycle and asset prices, yet few analysts bother to define what it is they mean by liquidity.  More often than not, ‘liquidity’ is discussed in a way that is simply synonymous with monetary policy.  To that extent, there is nothing remarkable about the idea that monetary policy might be important for business cycle and asset price dynamics.  Many of the analysts who invoke liquidity intend the term to mean something more than monetary policy, defined narrowly as changes in official interest rates.  In particular, the notion of liquidity is often employed to denote growth in monetary and credit aggregates, which may have only a tenuous relationship with monetary policy and may be dominated by private choice. 

Then there are those who conflate liquidity with saving.  The idea of glut of global saving has led some to claim that the world is ‘awash in liquidity.’  But as Alex Pollock notes ‘if liquidity were substantive, there could not have been plenty of it a few weeks ago and a shortage now.’  Pollock argues instead that:

“liquidity” is a figure of speech, describing the following situation:

• A is ready and able to buy an asset from B on short notice
• At a price B considers reasonable
• Which usually means C has to be willing to lend money to A
• Which means C believes A is solvent and the asset is good collateral
• And if A is a dealer, A and C both have to believe that the asset could be readily sold to D
• Which means they both have to believe that there is an E willing to lend money to D.

In short, liquidity is about group belief in the solvency of counterparties and the reliability of prices, reminding us that “credit” and “credo” have the same root. When no one is sure who is broke, and there is high uncertainty about prices, we will discover that liquidity has vanished, however plentiful it may recently have seemed.


posted on 29 August 2007 by skirchner in Culture & Society, Financial Markets

(1) Comments | Permalink | Main

| More

Who Took the Behavioural Out of Behavioural Finance?

Robert Shiller sounds increasingly like the anti-modernist Clive Hamilton:

As we all try to adjust to a rapidly growing and increasingly capitalist world, we have been trying to discover who we are and how we fit into it. This has meant an enormous change in values.

Many people feel that they have discovered their true inner genius as investors and have relished the new self-expression and excitement. Investors across the world have been thinking that they are winners — not recognizing that much of their success is only a result of a boom. Declines in asset prices endanger this very self-esteem.

That is why it is so hard to turn around investor attitudes once a downward psychology sets in. The Fed and other central banks do not have lithium or Prozac in their bag of remedies, and so cannot control it.

This is actually identical to the arguments used by market technicians like Robert Prechter, who resort to market psychology as an explanation for the behaviour of asset prices.  Prechter would argue that causality runs from sentiment to prices, with sentiment being exogenous.  Shiller seems to allow for bilateral causality, but the turning point in market sentiment is still effectively exogenous.  In other words, what is missing from Shiller’s behavioural finance is an actual behavioural model.

posted on 28 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Central Bank Open Market Operations

RBA Deputy Governor Ric Battellino addresses some of the misconceptions around recent central bank open market operations:

none of these measures was intended as a change in monetary policy settings and no central bank has reduced its interest rate target. Neither should these measures be seen as an attempt to ‘bail out’ banks or markets. Rather, the measures have been technical operations aimed at breaking up the log jams in money markets and encouraging funds to flow again, in order to prevent monetary conditions becoming tighter than the settings that had been determined by the central bank monetary policy committees and boards in the various countries.

posted on 27 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

More Commonwealth Revenue Hoarding

The Federal Treasurer has announced the 2006-07 Budget outcome on a preliminary basis.  The underlying cash surplus came in higher than expected at $17.3 billion or 1.7% of GDP, which (ominously enough) matches that seen at the peak of the last cycle in the late 1980s.  Revenue collections continue to exceed Treasury forecasts, backing former RBA Governor Macfarlane’s observation that the tax system is now much more income elastic than ever intended.  The Commonwealth will put $7 billion in the Future Fund, which, together with the proceeds from T3, means the Future Fund should be able to realise its objective of funding outstanding public sector superannuation liabilities by 2020, without further government contributions.

This still leaves the government with the political problem of what to do with the other revenue it doesn’t need to cover recurrent expenditures.  So the government has been busy creating more lock-boxes in which to warehouse the surplus: the Higher Education Endowment Fund announced in this year’s budget; and the new Health and Medical Investment Fund, which will also be the repository for the proceeds from the sale of Medibank Private. 

With the Prime Minister undertaking to maintain surpluses of around 1% of GDP, the government will need to be increasingly creative in its efforts to keep these surpluses out of the hands of taxpayers.  The government is seeking to window-dress the surplus, by making it appear that it is being devoted to the supposedly worthy causes of higher education and health, but without doing anything new to address the long-term structural issues in these portfolio areas.  The question is whether this will actually ease future pressures on the budget.  It is just as likely that these funds will be used by future governments to avoid taking difficult fiscal policy decisions.

The Intergenerational Report suggests that current government spending programs are not sustainable.  But it is also pretty clear that these issues are not going to be meaningfully addressed on the expenditure side.  Whether future expenditures are meet out of current or future revenue is less important than the issue of the overall tax burden being created by current government spending programs.

posted on 22 August 2007 by skirchner in Economics, Financial Markets

(3) Comments | Permalink | Main

| More

Meltzer and Malpass on the Fed’s Discount Window Action

A Bloomberg podcast, featuring Allan Meltzer and David Malpass on the Fed’s discount window action.

posted on 20 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Cullen Rejects the Consensus – Or Does the Consensus Reject Him?

In recent years, we have documented the steady erosion of the RBNZ’s once pioneering approach to monetary policy governance under Treasurer Cullen and Governor Bollard.  In a speech to Ernst & Young, Cullen expresses his misgivings about the fundamental basis for a monetary policy focused on long-run price stability:

The accepted consensus has been that our monetary policy framework doesn’t have an impact on long run growth. In other words, monetary policy helps keep the economy stable by moderating economic cycles, without impacting on the sustainable rate of growth of the economy.

My overriding concern is that this view no longer holds…

So I think we need to look seriously at the monetary policy framework and whether it can be made more effective at curing the inflation disease without killing the patient in the process.

We should not be afraid of exploring new ideas and openly debating them.

Unfortunately, this process is more likely to dredge-up some very old and bad ideas, rather than new ones.

posted on 18 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Glenn Stevens’ Declaration of Independence

RBA Governor Glenn Stevens, in his testimony before the House Economics committee on Friday, gave the clearest indication yet that the upcoming federal election need not to stand in the way of further monetary policy tightening.  Stevens told the committee that:

If it’s clear that something needs to be done, I don’t know what explanation we can offer to the Australian public for not doing it.  I don’t think there’s any case for the Reserve Bank board to cease doing its work in the month the election is going to be.  I doubt that members of the public would see that as appropriate.

Last week, we suggested that the RBA might still be reluctant to raise rates in the period between the formal calling of an election and the election date.  Taken literally, Stevens’ comments imply no such reluctance.  Indeed, as we noted last week, to delay taking policy action in this context would be an act every bit as political as a decision to change policy.  The right approach for an independent central bank would be to do as Stevens suggests.

Further policy tightening will likely be required by November to maintain a target-consistent medium-term inflation forecast.  There is thus a strong chance that the RBA will be contemplating further tightening in the context of the federal election campaign.  A mid-campaign tightening would be a welcome display of institutional independence on the part of the Reserve Bank.


posted on 17 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

The Harvard Education You Could Do Without

Harvard Magazine interviews some of its leading lights on international economic and financial issues and uncovers a morass of closed economy macro, mercantilism and doomsday cultism:

The global imbalances created by this dynamic of American borrowing and foreign lending appear stable for now, but if they slip suddenly, that could pose serious dangers for middle- and working-class Americans through soaring interest rates, a crash in the housing market, and sharply higher prices for anything no longer made domestically. Harvard economists and political scientists see possible threats to globalization (the opening of markets and trade that has made the economy a world phenomenon): the risk of rising protectionism; the potential for a world recession if market forces unwind the imbalances too quickly; and even the possibility that political considerations could trump shared economic interests, causing nations to use their international financial positions as weapons.

At least they interviewed Richard Cooper:

But what if our current account deficit is a side effect of globalization that is not going to go away? Richard Cooper, Boas professor of international economics, takes a much more relaxed view about this possibility than his colleagues do. In theory, he says, the deficit could persist forever, as long as it eventually stops increasing as a percent of the U.S. GDP.

Cooper, who was undersecretary of state for economic affairs from 1977 to 1981, and chair of the Federal Reserve Bank of Boston from 1990 to 1992, sees global imbalances as a natural consequence of a decline in investment “home bias.” “What do we mean by globalization?” he asks. “What we mean is that everyone around the world thinks beyond [his or her own] national boundaries when it comes to allocating their savings.” Americans used to invest almost 100 percent in the United States, but now allocate a portion of their portfolios abroad. “That is a process that is going on worldwide: foreigners are investing more abroad, too, but foreigners save more than Americans do.” Because the United States is 30 percent of the world economy, a world with no home bias would see foreigners investing 30 percent of their savings in the United States and Americans investing 70 percent of their savings outside the country. “If you apply those two numbers to actual savings levels,” Cooper says, “you get a $1.1 trillion current account deficit in the year 2005, with foreigners investing $2.3 trillion in the U.S. on savings of over $8 trillion, and Americans investing $1.2 trillion abroad. The difference between those two is $1.2 trillion.” International diversification of investments, in other words, causes the current account gap.

posted on 14 August 2007 by skirchner in Economics, Financial Markets

(2) Comments | Permalink | Main

| More

Election Timing and Interest Rates

Terry McCrann suggests the government might choose an election date to pre-empt not just the November RBA Board meeting, but the Q3 CPI outcome at the end of October as well:

The CPI is released on Wednesday, October 24. It would be a ‘courageous’ prime minister who risked a high CPI number and a tsunami of media and market comment on the certainty of another rate rise.

Depending on where we were in the actual election cycle and how Stevens and the RBA board played their hand—we would literally be in virgin monetary policy territory—two alternatives would be possible.

We actually got a rate rise on the day after the Melbourne Cup, as we did last year. Ironically, the first with Stevens as governor. Or a decision was taken to hike but with implementation postponed.

It is difficult to know which, with associated commentary and market speculation, would be worse for the government. Again presumably, so close to a—still, coming—election.

posted on 13 August 2007 by skirchner

(0) Comments | Permalink | Main

| More

Sovereign Wealth Funds

The Peterson Institute’s Ed Truman reviews some of the issues surrounding the growth of sovereign wealth funds, including Australia’s Future Fund, noting that:

Large cross-border holdings in official hands are at sharp variance with today’s general conception of a market-based global economy and financial system in which decision making is largely in the hands of numerous private agents pursuing commercial objectives.

posted on 10 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Did the RBA Break with Convention Yesterday?

Did the RBA break with convention yesterday by raising interest rates in an election year? Andrew Leigh thinks so:

For two decades, it has been an unwritten rule that rates do not rise in an election year. While yesterday’s decision broke that rule, the alternative may well have been worse. In the face of an overheating economy, should we expect the RBA to wait for a non-election year before taking action? Just because of our ridiculously short three-year election cycles, it’s hard to see why an independent central bank should be forced to put monetary policy on ice one-third of the time.

By definition, there is no direct evidence for an unwritten rule and Leigh effectively argues against such a rule in endorsing the view put by Governor Glenn Stevens that it would be unrealistic for the RBA to be out of action for one year in three.

A more plausible explanation for the lack of interest rate rises in election years is that the electoral and interest rates cycles have simply not coincided in this way.  The 1990 and 1993 elections were both held against the back drop of an extended easing cycle.  The 1996 election fell in a long period of steady rates between December 1994 and July 1996 and heading into a new easing cycle.  The 1998 election was held against the backdrop of the same easing cycle begun in 1996, with the 2001 election coinciding with the next easing cycle after that.  The 2004 election was held in another extended period of steady rates between December 2003 and March 2005 while in the midst of current tightening episode.

Since politicians in Australia have some control over election timing and also some influence over economic conditions, we would expect some endogenity between the electoral and interest rate cycles, which may help explain why politicians have been able to avoid holding elections in close proximity to interest rate rises, but luck has probably played an even bigger role.

posted on 09 August 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

The RBNZ’s First Month in the Proprietary Trading Business

The RBNZ’s foreign currency liabilities and assets show that the RBNZ held a net long foreign currency position valued at NZD 702m in June, compared a net short position of NZD 58m in May under the old arrangements whereby the Bank sought to match foreign currency assets and liabilities.  The RBNZ sold a net NZD 736m over the month. 

The RBNZ would be approximately breaking even on these positions at current levels for the NZD, although would have been underwater for most of July.  The RBNZ is operating under self-imposed limits agreed with the government in relation to its intervention activities.

The RBNZ’s intervention is notable for how little impact it has had on the exchange rate.  With the exception of the announced intervention on June 11, traders would be hard pressed to say whether the RBNZ had been intervening on a given day.

Given the depth and liquidity of foreign exchange markets, with daily turnover in the trillions, this result should not be surprising.  There is little reason to believe that changes in the composition of official reserve assets are significant in exchange rate determination in the context of floating exchange rates. 

posted on 06 August 2007 by skirchner in Economics, Financial Markets

(2) Comments | Permalink | Main

| More

Follow insteconomics on Twitter