Working Papers

Op-Eds - 2018

‘Donald Trump has a chance to shape US monetary policy for years’, Australian Financial Review, 14 February 2018.

posted on 13 February 2018 by skirchner

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Donald Trump has a chance to shape US monetary policy for years

I have an op-ed in today’s AFR on how Obama’s neglect gives Trump the chance to own the leadership of the Federal Reserve Board. Full text below the fold (may differ slightly from published version).

Obama’s neglect of the Fed an opportunity for Trump

Incoming Chairs of the US Federal Reserve Board often find themselves stepping straight into trouble.

Alan Greenspan took up the role two months before the 1987 stock market crash.

Ben Bernanke assumed the office in February 2006 just as US house prices were peaking ahead of the financial crisis of 2008.

Jerome Powell was sworn in at the beginning of this month only to face a sharp sell-off in US equities his first day on the job. Powell will inevitably face similar challenges to his predecessors, perhaps the most important being how the Fed balances its inflation and financial stability mandates.

The change at the top of the Fed is the start of what promises to be a compete remaking of the membership of the Federal Reserve Board under President Trump.

The current President has the opportunity to appoint six of the seven Board members who determine US monetary policy, alongside five of the regional Federal Reserve Bank presidents on a rotating basis.

This opportunity arises in part because of the Obama Administration’s neglect of the governance of this important economic institution, leaving Federal Reserve Board positions vacant for extended periods.
Board Governors notionally serve a term of 14 years, with one term beginning every two years on the first of February of even numbered years. 

In recent years, Board members have served for significantly less than their full terms, in some cases, as little as two years. This places an increased burden on the executive branch of government to ensure that the Board is fully staffed.

The Obama Administration failed to meet that burden, not because of Senate obstruction of Fed appointments, although the Senate did reject one Obama nominee in 2010, but due to the failure to even nominate candidates for the positions.

There were two vacancies on the Board when Trump assumed office, but the departure of former Chair Janet Yellen, former Vice Chair Stanley Fischer and Daniel Tarullo, together with Trump-appointed Randal Quarles’s partial term that ended on 31 January, gives Trump and the Republican-dominated US Senate enormous influence over the leadership of the Fed.

The Board vacancies change the balance of power on the Federal Open Market Committee (FOMC) that sets monetary policy. Whereas the seven Board members notionally outnumber the rotating regional Bank presidents by seven to five, the regional bank presidents have come to outnumber the Board members.

Obama’s lack of interest in the Fed perhaps reflected his view, rather indelicately expressed to the incoming Chair of his Council of Economic Advisers Christina Romer, that ‘monetary policy has shot its wad.’
Romer disagreed and, perhaps reflecting her exchange with Obama, published an article in 2013 with David Romer titled ‘The Most Dangerous Idea in Federal Reserve History: Monetary Policy Doesn’t Matter.’

Since taking office, Trump passed on the opportunity to reappoint Yellen as Chair in favour of Jerome Powell. While there was some disappointment that Yellen was not reappointed, Powell’s appointment was otherwise widely view as a conventional one. Trump has yet to nominate a Vice Chair.

In additional to Randal Quarles, Trump has nominated Marvin Goodfriend, a noted monetarist, to fill one Board vacancy. Goodfriend is a firm believer in the efficacy of monetary policy and is committed to meeting the Fed’s inflation target.

It is ironic that while neither Ben Bernanke nor Janet Yellen were considered particularly hawkish on inflation before taking office, their focus on official interest rates as the main indicator of the stance of policy and belief in an effective trade-off between the unemployment rate and the inflation rate led them to deliver a monetary policy stance that was much tighter than they likely intended.

The Fed has systematically undershot its inflation target in recent years, calling its credibility into question. The Fed has blamed various one-off and non-monetary factors, but such a sustained undershooting can only be attributed to the conduct of monetary policy.

Janet Yellen described low inflation as a ‘mystery,’ while former Board member Daniel Tarullo, who resigned in April last year, claimed the Fed did not have a ‘theory of inflation dynamics that works.’ These were extraordinary statements coming from those charged with setting the inflation rate.

Trump should waste no time bringing the Board up to strength with appointees willing to serve a full term. A full strength Board is essential in enabling the Fed to effectively discharge its numerous statutory responsibilities, quite apart from monetary policy, as well as restoring the traditional balance of power with the regional bank presidents on the FOMC.

Trump should also ensure that future Fed appointees believe in the effectiveness of monetary policy and understand that inflation and nominal spending are the product of that policy.

Anyone who thinks differently has no business making monetary policy.

Wednesday sees the first reading on US inflation for 2018 and will be closely watched. With inflation still below target, the Fed will need to proceed cautiously in raising interest rates. Based on recent history, market fears that the Fed will overdo it are entirely justified.

Dr Stephen Kirchner is Program Director, Trade and Investment, at the United States Studies Centre, University of Sydney.

posted on 13 February 2018 by skirchner in Economics, Financial Markets, Monetary Policy

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The Man Who Knew

The Man Who Knew: The Life and Times of Alan Greenspan.

posted on 28 March 2017 by skirchner

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My Review of Sebastian Mallaby’s Bio of Alan Greenspan

The latest issue of CIS Policy includes my review of Sebastian Mallaby’s biography of Alan Greenspan. Here is a sample:

Far from being a tragedy, Greenspan’s tenure at the Fed was a spectacular success, as Mallaby for the most part acknowledges. This is not to say that US monetary policy could not have been improved by a more rules-based and transparent approach. Mallaby briefly mentions nominal gross domestic product targeting as an alternative to inflation targeting, but does not elaborate on its significance. Greenspan could have moved the Fed in these directions at the expense of his own authority and influence. While one can fault Greenspan’s highly discretionary approach to monetary policy on procedural and other grounds, the results were far better than could reasonably be expected and this is in no small part due to Greenspan’s judgement, which was spectacularly right more often than not. Had Greenspan gone against his own free market instincts and sought to second-guess financial markets on asset prices, as Mallaby suggests, the results would almost certainly have been disastrous and his biography would relate a different type of tragedy. The counter-factual in which someone other than Greenspan was Fed Chair (and we largely know who the alternatives might have been) is one that is worth contemplating.

Full article here.

posted on 28 March 2017 by skirchner in Economics, Financial Markets

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On Fiscal Rules and Avoiding Public Debt Crises

‘On Fiscal Rules and Avoiding Public Debt Crises’, in Jan Libich (ed.) Real-World Economic Policy: Insights from Leading Australian Economists, Cengage Learning Australia, 2015.

posted on 08 December 2016 by skirchner

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The G20 and Global Governance

The latest issue of The Cato Journal includes my article on The G20 and Global Governance, a critique of state-sponsored global governance scholarship.

posted on 26 September 2016 by skirchner in Economics

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High Frequency Trading: Fact & Fiction

The latest issue of the CIS journal Policy includes my article on High Frequency Trading: Fact and Fiction.

posted on 14 March 2016 by skirchner in Centre for Independent Studies, Economics, Financial Markets

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Op-eds - 2016

‘Economy’s engine room right size for job’, The Australian Financial Review, 11 January 2016.

posted on 10 January 2016 by skirchner

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Too Much Finance?

I have an op-ed in the AFR looking at the long-run relationship between financial sector size and living standards that addresses the ‘too much finance’ critique. Full text below the fold.

Economy’s engine room right size for job

The government’s response to David Murray’s financial system inquiry has highlighted the centrality of the financial services sector to the national economy.

The financial services sector is the largest industry in the Australian economy, with a share of gross domestic product about 10 per cent, narrowly edging out mining.

In addition to its direct contribution to output, the financial sector plays an essential role in determining the quantity and quality of investment. This in turn is a driver of long-run growth in productivity and the living standards all Australians enjoy.

The financial services share of the economy tends to increase along with incomes. As living standards rise, consumers and businesses demand more sophisticated financial services. The relative size of the financial sector and the depth of financial markets is a measure of economic development.

The rising share of financial services in national income is a global phenomenon that is likely to continue as long as living standards continue to rise.

While these relationships are well understood, some have questioned whether the financial sector can become too large.

In particular, recent papers by the Bank for International Settlements and the International Monetary Fund say measures of financial depth such as the bank credit to gross domestic product ratio could reach levels at which they begin to subtract from economic growth.


A difficulty in studying these relationships is that advanced economies like Australia experience slower growth rates as they approach the global frontier of productivity and living standards. Because measures of financial sector size and depth are positively correlated with living standards, this slowdown can be falsely blamed on financial sector growth.

The Peterson Institute’s Bill Cline shows that the same statistical approach underpinning findings that the financial sector might become inefficiently large could also be applied to the number of doctors, fixed-line telephones, and research and development technicians. Of course, few would suggest that any of these are bad for economic growth.

In the context of 2015’s financial system inquiry, some submissions argued that the Australian financial system had become less efficient at supporting capital formation.

However, it is the quality and not the quantity of investment that matters most for productivity and economic growth. Indeed, an important function of financial markets is to generate the price signals that prevent over-investment.

The investment share of the Australian economy has in recent years been very high by historical and international standards. While the mining boom played an important role in this outcome, there is little evidence to support the view that the financial system has inhibited capital formation.

Another criticism of the financial system is that it facilitates turnover in existing assets at the expense of creating new ones. But these two functions are closely linked.


The ease of buying and selling assets in secondary markets and asset market turnover lowers the cost of capital and is positively correlated with investment, productivity, economic growth and equity market returns.

Liquid asset markets tend to be less volatile and more efficient at price discovery, directing capital to more valuable uses.

The growth of bank credit has also been singled out for facilitating turnover in established housing at the expense of new dwellings and other investment. But turnover in Australia’s housing stock is still inefficiently low because of the taxes imposed on real estate transactions, such as stamp duty and capital gains tax, that lock up supply.

Also, the supply of residential land and new housing is largely determined by regulation, suggesting the prominence of established dwellings relative to new housing being financed is a sign of housing market inefficiency rather than an issue with financial intermediation.

These misconceptions lead to the view that there is “too much finance” and cause some to advocate policies that would ultimately suppress the financial markets, such as financial transaction taxes. Such policies would serve only to damage the liquidity that is essential to well-functioning financial markets and the economic benefits they generate for all Australians.

Dr Stephen Kirchner is an economist with the Australian Financial Markets Association

posted on 10 January 2016 by skirchner in Economics, Financial Markets

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Taxing Consumption, Not Saving: New Zealand’s Rejection of a Comprehensive Capital Gains Tax

‘Taxing Consumption, Not Saving: New Zealand’s Rejection of a Comprehensive Capital Gains Tax,’ in Capital Gains Tax Reform in Canada: Lessons from Abroad, edited by Charles Lammam and Jason Clemens, Fraser Institute, November 2014.

posted on 06 November 2014 by skirchner

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Capital Gains Tax Reform in Canada: Lessons from Abroad

The Fraser Institute has released a new volume on international experience with capital gains taxes. I wrote the chapter on New Zealand, with some reference to Australia. Australia was deemed too similar to Canada to warrant a chapter in its own right.

posted on 06 November 2014 by skirchner in Economics

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I am leaving CIS and returning to financial markets

This is my last week at CIS. I will be returning to financial markets from whence I came back in 2008. Thanks to Greg Lindsay for giving me a platform to participate in the public policy debate over the last few years. Thanks also to those who contributed to Policy while I was editor over the last 18 months. Policy will continue under a new editor.

My new employer won’t be paying me to blog or tweet during business hours, so you will be hearing even less from me on what is already a very low frequency blog. I will still post material here from time to time and link to what I am doing when appropriate. Needless to say, nothing on this web site should be attributed to current or previous employers.

This blog has followed me around in various roles since 2003, back when economics blogs were a rarity. The economics blogosphere is now a very over-crowded space. Since 2009, Scott Sumner has been saying much of what I wanted to say, only better. It is more efficient for me to send him a link and have him blog on it than to do it myself. So go read him if you don’t already.

posted on 28 August 2014 by skirchner in Centre for Independent Studies, Economics, Financial Markets

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Scott Sumner

posted on 25 August 2014 by skirchner in Blogs

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Wayne Swan on Monetary Offset and the GFC

Former Treasurer Wayne Swan is releasing some of his briefing notes from the GFC ahead of the launch of his upcoming memoir, The Good Fight. The first instalment from a meeting at the Prime Minister’s residence with the Prime Minister, Treasury Secretary and other senior officials on 4 August 2008 is remarkable for its acknowledgement of monetary offset. Indeed, the notes could just as easily have been written by Scott Sumner:

There are three broad considerations the Government would need to keep in mind in taking a decision to engage in discretionary [fiscal] action:

• The Reserve Bank through its control over interest rates, determines the overall level of aggregate demand in the economy, and the Bank would likely take account of any fiscal stimulus in its monetary decisions – that is, more spending would keep interest rates higher than otherwise…

The bottom line is that in the event of a shallow downturn, discretionary [fiscal] action may not achieve any noticeable outcomes in terms of growth and unemployment, but would leave rates higher, erode the [budget] surplus and put at risk the Government’s fiscal credibility.

These costs of course need to be weighed against the potential political costs of being seen to do nothing…

Needless to say, the ‘political costs’ argument won in the end, with the first discretionary fiscal stimulus announced in October 2008.

posted on 11 August 2014 by skirchner in Economics, Fiscal Policy, Monetary Policy

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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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Rent or Buy: Does it Matter?

A RBA Research Discussion Paper on whether Australian housing is over-valued attracted considerable media attention. The (unsurprising) bottom-line was that Australian housing is currently fairly valued based on the user-cost approach, but that the average household might be better off renting now if, ‘as many observers have suggested,’ future real house price growth is less than the historical annual average rate of around 2.5% since 1955.

As it turns out, the ‘many observers’ actually referenced in the paper are the RBA itself, which makes one wonder whether the RDP’s conclusion is part of the RBA’s broader jaw-boning effort directed at expectations for future house price appreciation.

In fact, the RBA’s RDP makes an excellent case for the view that we should be indifferent between renting or buying ex ante. The user costs of owner-occupation and renting are subject to a long-run equilibrium relationship. The RBA’s RDP shows how close this relationship has been historically using matched data on house prices and rents, despite some short-run volatility. In principle, one could use deviations from this equilibrium relationship to profitably arbitrage the user cost of owner-occupation and renting, but it is likely that these deviations reflect the transaction costs associated with buying/selling and moving. The deviations arise precisely because this arbitrage is difficult in practice.

So don’t sweat on the rent-buy decision.

posted on 17 July 2014 by skirchner in Economics, House Prices

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Eight Housing Affordability Myths

Eight Housing Affordability Myths, Issue Analysis 146, Centre for Independent Studies, Sydney, July 2014.

posted on 10 July 2014 by skirchner

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Eight Housing Affordability Myths

I have published a new Issue Analysis with the Centre for Independent Studies, Eight Housing Affordability Myths. In the paper, I show how a number of highly persistent myths about the nature of housing markets, the dynamics of house prices and the drivers of housing affordability condition public policy to focus on excessively on housing demand at the expense of housing supply.

posted on 09 July 2014 by skirchner in Centre for Independent Studies, Economics, Foreign Investment, House Prices

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Is John Edwards a Ricardian?

John Edwards’ ‘Beyond the Boom’ is a welcome follow-up to his 2006 ‘Quiet Boom’, which I reviewed at the time in conjunction with Ian Macfarlane’s Boyer Lectures.

I agree with the argument that economic reform should not be sold on the basis of a faux crisis or economic failure narrative. If proposed reforms are worth doing they are worth doing regardless of where we sit in relation to the business cycle or the budget outlook.

John notes that households saved the Howard government’s tax cuts and that household saving would have been lower in their absence. This is an important observation, because it demonstrates the private saving offset to changes in public saving. Possibly to spare his readers the jargon, John didn’t mention this as an example of Ricardian equivalence, but it is clearly relevant here. I made much the same argument at the time.

It is perhaps worth noting that John was rather more sympathetic to tax cuts in ‘Quiet Boom,’ where he says that:

It may well be worthwhile to reduce the top marginal income tax rate, or to encourage more workforce participation by older Australians or to increase the incentives to move from social security support to paid employment.

Those arguments remain valid, regardless of the state of the budget. While balancing the budget over time is important, this should not come at the cost of reducing incentives for labour market participation.

John also notes that during the financial crisis, the increase in private sector saving more than offset the decrease in public sector saving from the fiscal stimulus. He doesn’t mention that this is at odds with the dominant narrative around the stimulus, which is that it worked because we ‘went early, went large and went households.’ If the stimulus worked, John’s analysis implies that it was not through household consumption spending. I would like to have seen John spell out these implications in more detail (my take is here).

John maintains we should limit the current account deficit to 3.3% of GDP to contain growth in external liabilities. This is close to the average since 1960 and so is certainly achievable based on historical experience. However, in ‘Quiet Boom’ John shows how conditioning macro policy on a view about the appropriate size of the current account deficit got us into a lot of trouble. Tim Geithner’s attempt to get the G20 to sign up to a 4% of GDP limit on current account imbalances was similarly mistaken in my view. We cannot know in advance the appropriate rates of saving and investment, from which it follows that the appropriate current account deficit is also unknown.

John maintains that the government has a revenue rather than a spending problem, but this is necessarily a joint problem. The normative issue is to define what government should be doing and raise revenue accordingly.  In that sense, the expenditure side is analytically prior to the revenue side, regardless of what is driving changes in the budget balance over any given period. The test both revenue and expenditure measures need to pass is whether they improve incentives to work, save and invest. Higher average tax rates do not pass that test and would be at odds with the aims of the tax reform process and raising labour force participation. Balancing the budget is important, but should not come at the expense of microeconomic incentives. Balancing the budget and stabilising net debt as a share of GDP will be a somewhat hollow achievement if it comes at the expense of a smaller economy that yields less revenue for government in absolute terms.

John is spot on in arguing that Australia’s economic future lies in integration with Asia through trade in services. I would add that there are even larger gains to be had through increased trade in capital and labour. Regional free trade agreements will be important in defining the parameters of our engagement and deserve close attention from policymakers. The G20 would do well to focus on the successful conclusion of regional and multilateral trade deals.

Alex Tabarrok says the Reserve Bank deserves a lot of credit, but I do not think we can attribute Australia’s relative economic outperformance to the conduct of monetary policy. Australia adopted inflation targeting along with the rest of the world. Australia’s senior central bankers largely trained in north America and think much like Ben Bernanke. It cannot be said Australia followed a different intellectual approach or that we know something foreign central bankers do not.

At the onset of the crisis, CPI inflation was running at an annual rate of 5%, nominal GDP at 11% and inflation expectations were coming unhinged. In the absence of a global downturn, the RBA would probably have needed to engineer a severe domestic slowdown to bring inflation back to target. In that sense, the downturn in the world economy did the RBA a favour. Monetary policy is neutral in the long-run, so I don’t think we can give the central bank too much credit for a 23 year expansion.

posted on 03 July 2014 by skirchner in Economics, Monetary Policy

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The 2014 Budget and Monetary Offset

The 2014 Budget is notable for its explicit rejection of monetary offset. According to the government’s fiscal strategy, ‘the pace of fiscal consolidation balances the need for structural fiscal repair with the shorter term impact on the economy.’ Yes, the government still thinks it is in the business of aggregate demand management.

As I have argued in more detail here, this misunderstands the role of fiscal policy in the economy. With an inflation targeting central bank and a floating exchange rate, fiscal policy need not concern itself with demand management. Interest rates and the exchange rates can carry most of the required adjustment to reduced government spending.

The Abbott government proposes a four percentage point turnaround in the budget balance over 10 years.

By way of comparison, the Hawke government’s ‘trilogy’ of fiscal rules led to a fiscal consolidation of similar magnitude in five years during the mid- to late-1980s. The combined efforts of the Keating and Howard governments turned a deficit of 4% of GDP in 1993-94 into a balanced budget by 1997-98 (using today’s measures). These turnarounds were as much cyclical as discretionary, but this only serves to demonstrate that the economy is more important for the budget than the budget is for the economy.

The US has seen a sharp turnaround in its budget deficit from 10% to 4% of GDP over four years, including the sharpest decrease in federal spending since World War Two, without inducing an economic slowdown, because of accommodative monetary policy. As Scott Sumner has argued, it is hard to conceive a better test of monetary offset.

The Abbott government has thus conditioned its fiscal strategy on the same mistaken understanding of the role fiscal policy in the economy that informed the Rudd government’s fiscal stimulus of 2008-09.

posted on 14 May 2014 by skirchner

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