Working Papers

2013 12

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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Strengthening Australia’s Fiscal Institutions

I have a new paper in the CIS Target 30 series, Strengthening Australia’s Fiscal Institutions, that re-states the case for legislated fiscal rules to be monitored and enforced by an independent statutory Fiscal Commission.

It is often argued that fiscal rules are unlikely to serve as an effective discipline on fiscal policy in the absence of political will. This is undoubtedly true, but fiscal rules can be seen as a mechanism through which the political will to tackle issues in relation to long-run fiscal sustainability can find more effective expression. If politicians are unwilling to put into law what they say they are committed to doing, then it is less likely that they will deliver on these commitments. The willingness to adopt fiscal rules can thus be seen as a test of the degree of political commitment.

Measures to strengthen Australia’s fiscal institutions should be a key recommendation of the Abbott government’s Commission of Audit.

posted on 11 December 2013 by skirchner in Economics, Fiscal Policy

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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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