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2011 11

Not that 70s Show: Why This Boom is Different

Treasury’s David Gruen highlights the role of Australia’s macroeconomic policy framework in sustaining the boom:

The Federal Governments of the 1970s were in direct control of all arms of macroeconomic policy, including the value of the exchange rate. When commodity prices were rising strongly, generating boom conditions in parts of the economy, it proved extremely difficult for governments of either political persuasion to impose sufficient restraint on other parts to deliver an appropriate outcome for the economy overall.

By contrast, the current macroeconomic framework has several elements that together represent a crucial improvement on the framework of the 1970s. These elements are: a market-determined exchange rate, a medium-term inflation target implemented by the Reserve Bank, a medium-term fiscal framework implemented by the Federal Government, and largely decentralised wage-setting arrangements.

A consequence of the current framework is that when commodity prices are high, the floating exchange rate is likely to have appreciated sharply, acting as a shock absorber, and reducing the expansionary effects of the terms of trade rise on the overall economy. As a consequence, there is a smaller role for ‘activist’ macroeconomic management - simply because much of the necessary restraint is imposed by the exchange rate.

The exchange rate plays its shock-absorber role primarily by imposing significant restraint on those parts of the traded sector, including parts of the manufacturing sector, which are not experiencing strongly rising prices for their output or are not directly exposed to the booming sectors of the economy…

In the longer term, the increasing numbers of people in the Asian middle classes, with disposable incomes to match, will generate rising demand for a range of Australian goods and services - whether they be a range of foodstuffs, Australian tourist destinations, or educational, financial and other professional services in which Australia has a proven track record. Indeed, this process is well underway.

posted on 29 November 2011 by skirchner in Commodity Prices, Economics, Monetary Policy

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My Review of Paul Cleary’s ‘Too Much Luck’

My review of Paul Cleary’s book ‘Too Much Luck’ is up at The Conversation. The original review included a discussion of the role of the exchange rate which unfortunately hit the cutting room floor, but can be found below the fold. The review draws on a monograph by Robert Carling and I making the case against a sovereign wealth fund for Australia that will be published by CIS in the New Year.

Paul has been offered the opportunity to respond.

continue reading

posted on 21 November 2011 by skirchner in Commodity Prices, Economics, Foreign Investment, Media

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Did Nudge Kill Keynes? Behavioural Economics and the Stimulus

Business Week reports:

The design of Making Work Pay plays off of mental accounting. One of Thaler’s findings is that people are more likely to spend money that they have filed in their “current income” mental account rather than their “assets” mental account—in other words, they measure their spending against the size of their paycheck instead of the size of their bank account. A lump-sum tax rebate feels like an increase in wealth and is more likely to be saved. A series of slightly bigger paychecks feels like an increase in income and is more likely to be spent.

That’s not what happened in practice, according to Sahm, Slemrod, and Shapiro. In a study of the 2009 stimulus, based on 500 telephone interviews, the authors found that only 13 percent of Making Work Pay recipients reported that the tax credit would lead them to increase spending. This was just half of the 25 percent spend rate the researchers found for the traditional lump-sum tax rebate in President Bush’s 2008 stimulus. Of course, 2009 was a worse economic climate than 2008, and that might have played a role in the change. To control for this, the researchers looked at one-time stimulus payments that went to retirees at the same time that Making Work Pay was going to working households. The retirees, too, reported much higher spending rates than the Making Work Pay households, who got their money in a steady drip.

The authors can only guess at what’s behind their results.

There are plenty of conventional and straightforward explanations for why MWP didn’t work that do not require any resort to behaviouralism. The problem with behavioural economics is that it is really anti-behavioural. Behaviouralists will resort to any ad hoc theory, except the one behavioural theory we already know that actually works: self-interested rational choice.

posted on 13 November 2011 by skirchner in Economics, Fiscal Policy

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De-Occupying Greg Mankiw

At the beginning of my first Economics I lecture at ANU in 1986, the lecturer told us that for the next three years we would be studying neo-classical economics. He helpfully suggested if we were interested in other schools of economic thought, we might want to enrol at another university. He went on to point out the significant earnings premium that ANU economics graduates then earned in the labour market. The implication was that these two facts were not unrelated. Not that we needed to be told. This is exactly what many of us had signed-up for. The subject had a 45% failure rate.

If the idea was to indoctrinate students, it failed in my case. I don’t consider myself a neo-classical economist, more a heterodox institutionalist, although I accept many fundamental neo-classical insights. You first have to study neo-classical economics to understand what you reject and why. Too many dismiss neo-classical economics without ever having understood it other than as a caricature.

This would seem to be the case with those students who staged a walk-out from Greg Mankiw’s class at Harvard, judging by their very silly open letter. Having taught from Mankiw’s introductory and intermediate texts, I can vouch for the fact that they are very balanced in their approach, as a good textbook should be. I teach from Cowen and Tabarrok’s principles text, which is more Hayekian than neo-classical, yet still very balanced. For example, it makes a conditional case for activist fiscal policy I would reject, but it is important that students understand the thinking behind such policy.

It is far from clear what Mankiw’s critics want taught instead, but I suspect it is not economics.

posted on 04 November 2011 by skirchner in Economics

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Zero Bubble: A Theory of Asset Price Booms and Busts

The Philly Fed’s Business Review has a good article by Satyajit Chatterjee on why asset price booms and busts are a rational response to the uncertain return to innovation.

posted on 01 November 2011 by skirchner in Economics, Financial Markets

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