The Official Lies that Underpin the Euro

Der Spiegel on the official lies that underpin European Monetary Union:

Since joining the euro zone, the 16 euro countries have violated the deficit rule, under which net new debt cannot exceed 3 percent of GDP, 43 times. Most of the infractions have occurred in the last two years. Greece is at the top of the list of violators. Only once did the country manage to push its deficit rate below the magic limit, and only with an extremely creative trick: The Greeks sugarcoated their statistics by including prostitution, black-market trade and gambling in the calculation of economic output. As a result, GDP rose by a stunning 25 percent in 2006, and the deficit dropped to 2.9 percent.

While this is a remarkable story coming from Der Spiegel, the authors still can’t quite come to terms with giving up on the euro, suggesting that its problems could be solved through a common financial policy and an IMF-like European Monetary Fund.  Still, as Anne Appbaum notes, opinion in Germany is shifting.

posted on 11 March 2010 by skirchner in Economics, Financial Markets

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Mid-Week Linkfest

1. Roubini wrong again and again.

2. Cash for Corfu.

3. Axel Weber and Philipp Hildebrand versus Olivier Blanchard.  See also Phil Lowe for further Blanchard repudiation.

4. Bill Emmott and Wolfgang Munchau as bumptious prats.

5. Hayek’s lessons for Kevin Rudd.

posted on 09 March 2010 by skirchner in Economics, Misc

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Nice Hedge Fund You’ve Got There, Shame if Something Were to Happen to It

Governments may sometimes feel threatened by hedge funds (and properly so), but no one beats the US Justice Department when it comes to bureaucratic intimidation and standover tactics:

The Justice Department has launched an investigation into whether hedge funds might have banded together to drive down the value of the euro, people familiar with the matter say.

In a letter last week, the department has asked hedge funds including SAC Capital Advisors LP, Greenlight Capital Inc., Soros Fund Management LLC and Paulson & Co. to retain trading records and emails relating to the euro, say people who have seen the letter.

The letter was dated Feb. 26, the same day a page-one article in The Wall Street Journal outlined a large bet being made in recent weeks by heavyweight hedge funds against the euro, in moves that are reminiscent of the trading action at the height of the financial crisis like bets against Lehman Brothers and other troubled firms…

The Justice Department’s letter said the antitrust division “has opened an investigation into agreements among various hedge funds that trade euro contracts,“ including contracts to trade euros in the “cash or the derivatives market,“ a person familiar with the matter says.

The letter requested that the funds “preserve all documents” and electronic communications relating to agreements to trade the euro or communications about agreements to trade currencies, the person says.

As the article notes, the US authorities have a dismal track record in bringing successful prosecutions in these matters, suggesting that bureaucratic intimidation has become an end in itself.

posted on 04 March 2010 by skirchner in Economics, Financial Markets, Rule of Law

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Mid-Week Linkfest

Peter Wallison on why financial sector reform is stalled.

Electronic Frontiers Australia on Facebook police.

The documentary that asks why parents aren’t rioting in the streets.

posted on 02 March 2010 by skirchner in Misc

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Betting on the RBA

Someone was betting big on the outcome of today’s RBA Board meeting:

a Centrebet regular, has staked just short of $30,000 on the Reserve Bank sitting on its hands.

If at 2.30pm the bank announces its board has decided to keep rates on hold, he will walk away with a profit of $21,000. If it puts rates up, he will say goodbye to $29,500.

‘'He is very confident. He placed four separate bets, continuing to pile in as the odds went down,‘’ said Centrebet’s Neil Evans.

‘'Another punter staked $5000 on there being no change, another $3500.

‘'It’s the house against the punters. I am hoping they don’t know something I don’t.‘’

They didn’t.

posted on 02 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The CPI and the RBA’s Backward-Looking Bias

I have an op-ed in today’s Canberra Times arguing for a monthly CPI for Australia (full text below the fold):

This lack of timeliness in compiling and releasing inflation data gives monetary policy a backward-looking bias.  Around 45 per cent of the changes in the official interest rate since 1990 have been announced at the Board meeting immediately following the quarterly CPI release.  During the 2002-08 tightening episode, 67 per cent of rate hikes followed this pattern, including every one of the six tightenings between May 2006 and February 2008.

Today saw the release of the TD Securities-Melbourne Institute Monthly Inflation Gauge, which rose by 0.1% in February, following a 0.8% rise in January and a 0.3%  rise in December 2009. In the twelve months to February, the Inflation Gauge rose by 1.9%. The trimmed mean measure rose by 0.1%, to be 2.0% higher than a year ago.  The gauge points to a 1% rise in the March quarter CPI for an annual rate of 3%.

As I note in the op-ed, the Melbourne Institute has stopped publishing the index numbers for the gauge, limiting its usefulness and going very much against the spirit of its creators and sponsors.  However, for those who need it, Annette Beacher advises the index number for February is 123.45.

* * *

Timely information is crucial to the conduct of monetary policy.  Yet the single most important input into the decision-making process of the Reserve Bank Board, the consumer price index (CPI), is also one of the least timely by international standards.  Australia shares with New Zealand the distinction of being one of the few countries to release its inflation data at a quarterly rather than a monthly frequency.  Even New Zealand publishes a monthly food price index, a useful series for forecasting the quarterly CPI inflation rate.

This lack of timeliness in compiling and releasing inflation data gives monetary policy a backward-looking bias.  Around 45 per cent of the changes in the official interest rate since 1990 have been announced at the Board meeting immediately following the quarterly CPI release.  During the 2002-08 tightening episode, 67 per cent of rate hikes followed this pattern, including every one of the six tightenings between May 2006 and February 2008.

This suggests that the Reserve Bank may sometimes delay policy action by one or two months while it waits for the latest inflation data.  This goes against what the RBA tells us is good policy practice, which is to be pre-emptive and forward-looking.  It is also potentially confusing to the public, implying that the Reserve Bank is passively responding to past inflation outcomes rather than actively targeting the future path of inflation. 

A monthly CPI release would ensure that each Reserve Bank Board meeting had the benefit of an update on the inflation rate, which also serves as the baseline for the Bank’s inflation forecast.  The RBA would no longer have a bias to changing interest rates in the wake of the quarterly CPI release.  The Bank and financial markets could more quickly identify potential turning points in the inflation rate and the economy more generally.

It is considered desirable for central banks to smooth changes in interest rates over time, to minimise the risk of policy errors.  This argues for a gradualist approach to policy.  However, more timely policy action could facilitate this gradual approach by reducing the need for future changes in interest rates.  A monthly CPI that results in more timely policy action would not necessarily lead to an increase in policy activism whereby the Reserve Bank engages in unnecessary fine-tuning.

While the Reserve Bank and financial markets would welcome a monthly CPI, the Australian Bureau of Statistics (ABS) has traditionally resisted the idea.  The ABS argues that the increased cost of collecting the data at a monthly frequency would outweigh any additional benefits to users.  But this is based on a very narrow reading of the benefits side of the equation.  If a higher frequency CPI leads to more timely monetary policy action, the economy-wide benefits could be very large.  Most other developed countries have apparently decided that a monthly CPI is worth the cost.  It would be surprising if the costs and benefits in Australia were substantially different.

Funding has been an issue for the ABS in recent years.  This has seen the ABS implement saving measures that resulted in less reliable labour force and retail trade data, decisions that were subsequently reversed.  However, savings could potentially be made by reducing the frequency of other data, such as the monthly labour force release.  These data are very noisy at a monthly frequency.  They are good for generating newspaper headlines, but add relatively little new information at this frequency.  Monthly readings on the labour market can be left to private sector surveys, such as the ANZ job advertisements series.  Most analysts welcomed the demise of the volatile and revision-prone monthly current account data in 1997 in favour of a quarterly release.

Stephen Koukoulas of TD Securities and Professor Don Harding, formerly at the Melbourne Institute and now at La Trobe University, teamed-up to create a monthly inflation gauge that has a low tracking error with the official CPI, showing what can be done with even limited resources.  Their inflation gauge has been a valuable source of more timely readings on the inflation rate, while also helping to better forecast the official data.  Unfortunately, the Melbourne Institute recently discontinued publishing the index numbers with the monthly release, which has reduced the usefulness of this series to analysts. 

The ABS is currently conducting its five-yearly review of the CPI.  The review is canvassing options including the release of higher frequency data on consumer prices.  Public submissions can be made before 12 March, with the outcome of the review to be announced in December.  It is to be hoped that the review leads Australia to match its developed country peers in the frequency of its official data on consumer price inflation.

Dr Stephen Kirchner is a Research Fellow at the Centre for Independent Studies.

posted on 01 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Divergent Pricing for March RBA Board Meeting

Friday’s Reuters poll has 12 of 18 financial market economists expecting a 25 bps tightening, with the balance looking for steady rates.  March inter-bank futures are giving only a 49% chance to a 25 bp tightening, while iPredict is pricing a 67% chance of a rate hike.  I suspect interbank futures are closer to the mark.

I will be talking on Australian monetary policy on Bloomberg TV Tuesday morning AEDT.

posted on 26 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Child Labour at Stanford

Youngest ever guest lecturer.

posted on 25 February 2010 by skirchner in Economics

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The Future of Money

New innovations in payment systems, including:

dynamic invoices that pay themselves — that constantly monitor exchange rates, say, or the price of lumber, and then automatically send out an order to withdraw funds or to make a purchase just when the price is cheapest.

posted on 25 February 2010 by skirchner in Economics, Financial Markets

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Mid-Week Linkfest

Phil Levy and Robert Barro on the first anniversary of the US fiscal stimulus.

Peter Wallison on zombie GSEs.

Joye versus Keen Cage Match.  Two economists enter.  Only one can leave.  UPDATE: You can view Joye’s presentation here.

posted on 23 February 2010 by skirchner

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The Road Not Taken

The New Yorker on the tragedy that is Paul Krugman:

When the Times approached him about writing a column, he was torn. “His friends said, ‘This is a waste of your time,’ ” Wells says. “We economists thought that we were doing substantive work and the rest of the world was dross.” Krugman cared about his academic reputation more than anything else. If he started writing for a newspaper, would his colleagues think he’d become a pseudo-economist, a former economist, a vapid policy entrepreneur like Lester Thurow?

The rest is history.

posted on 22 February 2010 by skirchner in Economics

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The RBA and the Media

RBA Governor Stevens’ appearance before the House Economics Committee on Friday included this exchange with the federal member for Mayo:

Mr BRIGGS—Just on a slightly different track: On 2 November last year there was an article on the Lateline Business program about suggestions that the Reserve Bank executive selectively leaks the likely outcome of the board meeting prior to the board meeting. I guess the presenter summarised it best:

Certainly, there’s disquiet among market economists that the Reserve Bank is selectively briefing certain journalists in the lead-up to rate decisions. Many argue the practice undermines the board process.

I am just interested—did you see the report, and do you have a comment?

Mr Stevens—I did see the report. Apparently there were not too many selective leaks in February, because everybody was surprised, so I am not sure what to make of all this.

Mr BRIGGS—So, you—

Mr Stevens—No, people do not leak the outcome. For a start, the staff do not take calls from the media after the relevant internal meetings where we have come to the view of what we are going to recommend. That is usually on the Thursday morning; the papers go that night.  Secondly, we cannot be certain that the board will do what we recommend. It is a board of nine people, and I can assure you they are all of independent mind. People do not leak that information; in my experience the Reserve Bank never has leaked and, if I can help it, it never will.

Stevens is probably correct to argue that the outcome of the Board meeting has never been leaked outright, but that was not what the Lateline Business story was about.  The issue raised was whether the RBA backgrounded journalists to the point where they were much better informed about the RBA’s policy bias and therefore better able to call the likely outcome of the Board meeting.

There is evidence on the public record for the view that the RBA has engaged in this practice.  In a profile of former Governor Ian Macfarlane published in the AFR Magazine in 2001, a former RBA official is quoted as follows:

The Bank uses newspapers to manage expectations.  It’s a game the Bank manages very well.  Senior people talk to a small handful of the economics writers from the major papers on a strictly non-attributable basis.  I think it’s right to do this from the bank’s point of view, but not necessarily from a public policy view: accountability and a critical press are very important in this system.

That last sentence is the key issue in a nutshell.  My sense is that the RBA has now been subjected to sufficient heat over the issue that we won’t see another episode of this in future.  The test for the RBA will be whether there is a future recurrence of market speculation about RBA media backgrounding, despite the Governor’s denial.

posted on 20 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Yes, We Have Patrick Colmer Speeches (for the ‘Merely Curious’)

Using Freedom of Information legislation, I have obtained a copy of a speech given by Patrick Colmer, Executive Director of the Foreign Investment Review Board, to the Australian-China Investment Forum on 24 September last year.  The background to the speech and the FOI process are discussed in an op-ed in today’s Australian.

posted on 18 February 2010 by skirchner in Economics, Foreign Investment

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Endogenising the Inflation Forecast

RBA Assistant Governor Phil Lowe highlights an important change in the RBA’s technical forecasting assumptions:

For some years, it had been our practice to produce forecasts assuming that the cash rate remained unchanged throughout the forecast horizon. This approach had the obvious advantage of simplicity, but when the cash rate is a long way from its normal level, it is not particularly realistic.

So, in August last year we changed our approach. Since then, we have prepared our forecasts on the technical assumption that the cash rate returns towards a more normal setting over time. Our overall objective here is to provide the community with a general sense of how we think the economy is likely to evolve over the next few years and to do this we need to make realistic assumptions. Broadly speaking, the paths the staff have used have been similar to those implied by market interest rates at the time the forecasts were prepared. It is important to stress that this neither implies a commitment by the Board to the particular path used nor an endorsement by the Bank of the market pricing.

This is a welcome change.  It makes more sense for an inflation targeting central bank to forecast its own policy rate or to incorporate a market forecast for the policy rate and then base the inflation forecast on this projection.  This makes it more explicit that inflation outcomes are not exogenous under an inflation targeting regime.

There was also this endorsement of the macroeconomic benefits of increased labour market flexibility:

The good news is that this flexibility in employment relationships worked in limiting job losses in the economy. This has had obvious social benefits as well as supporting overall confidence in the community. Without this flexibility, it is likely that the outcomes would not have been as favourable.

posted on 18 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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iPredict Contract on Australian Federal Election Date

This Friday, iPredict launches a host of new contracts with full market-maker liquidity, including a contract on the Australian federal election date and the outcome of the March RBA Board meeting.

posted on 17 February 2010 by skirchner in Economics, Financial Markets

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Steve Keen’s Latest Media Stunt

In an attempt to snatch victory from the jaws of defeat in his wager with Rory Robertson, Steve Keen seeks to lead a lemming-like march of housing doomers up the slopes of Mt. Kosciuszko:

rather than accept the victory of his more bullish opponent, it appears the professor is trying to muster the biggest gathering of market bears in Australian economic history. He has already coined the event ‘'Walking Against Australia’s Property Mania.‘’

Keen will start his 224-kilometre walk from Parliament House in Canberra on April 15, and aside from a documentary crew, his girlfriend and a masseuse, he hopes to be accompanied by some of the 3000-odd members of his Debtwatch blog.

The other side of the bet is unimpressed:

“Betting the house on an economist’s forecast typically is not a smart move. Unfortunately, Dr Keen recklessly encouraged everyday Australians to sell their homes at what turned out to be the peak of the global financial crisis, and the trough in local house prices,“ Rory Robertson responded.

“That’s why he’s getting set to walk from Canberra to Mt Kosciuszko wearing a t-shirt saying, ‘I was hopelessly wrong on house prices. Ask me how!‘“

posted on 16 February 2010 by skirchner in Economics, House Prices

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Consumers as Interest Rate Hawks

The February Westpac-Melbourne Institute Consumer Sentiment survey finds respondents expecting increases in mortgage interest rates in excess of 100 bp over the next 12 months.  While this is somewhat in excess of the tightening in official interest rates recently priced into the inter-bank futures strip, it is not necessarily inconsistent with market pricing.  Consumers are by now well aware that the official cash rate is not the only determinant of mortgage interest rates and that there is a trade-off between changes in mortgage interest rates and the official cash rate. 

Treasurer Wayne Swan continues to maintain that there is ‘no excuse’ for interest rate movements in excess of movements in the official cash rate.  If lenders were to have followed this advice in the past, then none of the benefits of lower funding costs from mortgage securitisation would have been passed on to borrowers before the onset of the credit crisis.  Moreover, any future improvement in capital market conditions could not be passed on to consumers, but would instead be hoarded by lenders with the Treasurer’s implicit blessing. 

posted on 11 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA’s 50th Anniversary Symposium

Today I attended the RBA’s 50th anniversary symposium.  The proceedings were not for attribution, but the papers have been published on the RBA’s web site.  The session on supply-side issues was a particularly welcome contribution to an area too often neglected by central banks, but one that is inescapably linked to the conduct of monetary policy.

posted on 09 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA and Expectations Management

The RBA’s decision to leave the OCR unchanged at its February Board meeting is the subject of a lengthy discussion by Adrian Rollins in yesterday’s AFR.  The discussion centres on whether the surprise decision was a failure by the market to interpret the signals being sent by the RBA, or whether it was a failure on the part of the RBA to appropriately condition market expectations.  This is a joint problem, but one made worse because the RBA is not very good at communicating in a consistent, systematic and structured way.

This is an issue that is more serious than just wrong-footing the market over the outcome of a given Board meeting.  Expectations for the future real official cash rate are critical to the transmission of monetary policy and are probably more important to the stance of policy than the actual cash rate.  Changes in these expectations can even substitute for changes in the actual policy rate.  Poor communication can lead to the effective stance of policy being easier or tighter than the Bank intends, requiring a more activist approach to changes in the OCR than would otherwise be necessary. 

For example, it was not unusual for the market to periodically price in a new easing cycle during the 2002-2008 tightening episode.  This de facto easing in policy contributed to inflation getting out of control and increased the amount of tightening ultimately required.  It is thus very much in the RBA’s interests to ensure that market expectations align with its views. 

posted on 05 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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How to Kill Animal Spirits: Banking Banana Skins

The PWC/CSFI Survey of Bank Risk, aka Banking Banana Skins 2010, finds political interference is the number one risk facing the banking industry:

Having bailed the banks out, governments are pushing them to keep lending through the recession, against their better judgment. A director at a large UK bank said that “political meddling in the financial sector is almost universally contradictory and negative. One can’t lend more to support the economy and build up capital bases at the same time”. A credit analyst at a large Japanese bank said that “political interference in both banking and regulation is likely to lead to a mis-allocation of resources, which will probably increase, not decrease, the risk profile of the system”.

In 2005 and 2006, ‘too much regulation’ topped the list of concerns and is still the main concern in the Asia-Pacific region. 

Here is another banking banana skin.

posted on 02 February 2010 by skirchner in Economics, Financial Markets

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