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Trump Administration Divided on Trade Policy

I have an op-ed in the AFR noting the contradictions in US international economic policy. Full text below the fold (may differ slightly from edited AFR version).

The joint United States-China communique on trade issues released over the weekend has been flagged by US Treasury Secretary Steven Mnuchin as a ceasefire in the trade war between the two economies.

Yet the communique suggests the two countries remain far apart on key issues. The statement contained little of substance and at best serves as a placeholder for further negotiations.

Perhaps the biggest stumbling block is the US insistence on trying to negotiate specific trade outcomes rather than over the rules of trade.

Ironically, this is pushing China even further in the direction of managed trade as it attempts to satisfy US demands. Complaints about Chinese mercantilism ring hollow when the US is pursuing a mercantilist policy of its own.

Media reports note that the US Agriculture Department is looking into how to expand production of key agricultural products that China could then buy in an eerie echo of communist central planning.

The key US demand that China reduce the size of its bilateral trade surplus by increasing purchases of US goods and services is unrealistic and makes no economic sense.

The trade balance is an arbitrary construct, calculated on the basis of goods crossing lines on a map, with little regard to the location of value-added or the associated cross-border investment that balances the overall economic relationship between the two economies.

Even if China were to somehow increase its purchases of US goods and services, the increased demand for US dollars to make those purchases would tend to put upward pressure on the US dollar foreign exchange rate, making the US less competitive.

An expansionary US fiscal policy is already inducing foreign capital inflows and putting upward pressure on the US dollar exchange rate, crowding-out US net exports.

This is one reason why the US Federal Reserve has little reason to fear expansionary fiscal policy. The US dollar will do much of the work of tightening monetary conditions.

The US current account deficit is ultimately the product of its own imbalance between domestic saving and investment.

As Australia learned from policy mistakes in the 1980s and 90s, a current account deficit and corresponding capital account surplus is an indication of economic strength, not weakness.

China’s former current account surplus, which turned to a deficit in the first quarter of this year, says more about the defects of its economy than its strengths, in particular, the suppression and distortion of its domestic capital markets.

US economic and trade policy under Trump are fundamentally incoherent. By all accounts, the US negotiating team is itself divided on key issues and China is at a loss to work out what the US wants and how to satisfy US demands.

At the same time that the US is looking to strike a superficial deal on managed trade with China, time is running out to re-negotiate the North American Free Trade Agreement (NAFTA). Having already walked away from another high quality trade agreement in the Trans-Pacific Partnership, the failure of the NAFTA negotiations would be another blow to the US economy as well as to US allies.

By focusing on specific outcomes on trade, the US is losing sight of the more important rules of the game that ensure trade and cross-border investment are conducted in a fair and reciprocal manner.

Donald Trump’s offer at the instigation of the Chinese to relax restrictions on Chinese telecoms company ZTE as part of the effort to secure Chinese concessions illustrates how attempts to manage trade internationally can undermine the rule of law domestically.

The rule of law is one of the great strengths of the US economy, the foundation stone of its capital markets and itself an important export to the rest of the world that consumes US financial services.

Even if China and the US were to flesh out their weekend communique with a more specific deal on trade, it is unlikely to prove robust to the inherently dynamic nature of the world economy.

Financial markets, including exchange rates, will effectively discount the substance of any agreement and the other incoherent elements of US economic policy.

The laws of economics will continue to work, even if President Trump does not believe in them.

The US Administration will find itself fighting a losing war against economic fundamentals. It will also find very few partners willing to enter into bilateral agreements to replace the multilateral agreements it has walked away from.

Those looking for a resolution of US and Chinese trade tensions in the weekend communique are sure to be disappointed. With the Trump Administration focused on arbitrary and economically irrelevant measures of trade performance, a lasting peace in its self-imposed trade war with the rest of the world will be impossible to achieve.

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

posted on 23 May 2018 by skirchner in Free Trade & Protectionism

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Don’t Sacrifice the Inflation Target on the Altar of Financial Stability

I have an op-ed at The Conversation on what happens when the RBA sacrifices its inflation target on the altar of financial stability.

posted on 16 May 2018 by skirchner in Monetary Policy

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Trump pursuing the wrong strategy against China

I have an op-ed in the AFR arguing President Trump is pursuing the wrong trade policy strategy against China. Full text below the fold.

President Trump has proposed an additional $US 100 billion in tariffs on Chinese imports, on top of the 25 per cent tariffs on $US 50 billion of imports already mooted as retaliation for China’s forced technology transfers and intellectual property rights violations. The US has also initiated a WTO dispute with China over its increasingly discriminatory technology regulations.

The latest tariff measures are a response to genuine violations of international trade law by China, unlike the recent tariffs on steel and aluminium, which were based on a bad faith invocation of the national security provisions of US trade law.

However, the Administration’s proposed tariffs are the wrong remedy, inconsistent with its domestic and international legal obligations and will be ineffective in changing Chinese practices.

Instead of implementing new tariffs, the US should instead broaden its WTO dispute with China to cover the full range of intellectual property issues and discriminatory technology regulations.

Foreign firms operating in China have long complained about forced intellectual property transfer as a condition for entry into the Chinese market and as part of joint venture arrangements with Chinese firms.
China’s new National Cybersecurity Law and the National Security Law require that information, communications and technology (ICT) products must be “secure and controllable.” This vague standard provides a legal mechanism through which China can engage in ICT protectionism and extract trade secrets and intellectual property such as source code from foreign firms.

Foreign companies operating in China are subject to multiple security reviews administered by multiple agencies, including a new cybersecurity review regime. China is imposing data localisation requirements that potentially interfere with the ability of both foreign and Chinese firms to operate global ecommerce and other platforms.

China is also erecting barriers to competition in cloud computing, with foreign cloud service providers requiring a local partner.

These measures reflect China’s desire to control the internet and ICT goods as part of its apparatus of social and political repression, as well as to foster indigenous technological innovation through state intervention and protectionism. China seeks to become a global technology leader through self-sufficiency in the production and consumption of all technology goods and services. China’s mercantilist approach to technology innovation threatens to fragment the internet and ICT product development globally.

China’s ICT protectionism violates both the WTO Agreement on Trade Related Intellectual Property Rights and China’s WTO Accession Protocol. China is vulnerable to a WTO challenge over its intellectual property rights violations. Indeed, the US has previously brought successful WTO actions against China in this area which led China to voluntarily eliminate the offending practices.

The US could initiate a broader action at the WTO in concert with other countries with good prospects for success. The US and other countries supported China’s accession to the WTO in 2001 so they could exercise this leverage over China.

By pursuing unilateral tariff measures outside the WTO, the Trump Administration transforms the US from trade victim to trade villain. China is well within its rights to challenge the US measures as a violation of US obligations and impose proportionate retaliatory measures. The WTO could rule that the relevant provisions of US trade law are inconsistent with WTO rules, authorising Chinese retaliation, a perverse outcome.

Trump has engineered a situation in which China can turn the WTO against the United States over an issue where China is ultimately at fault.

Trump’s latest tariffs are also vulnerable to domestic legal challenge. The measures fall outside his legislative authority under section 301 of the Trade Act, which authorises the US Trade Representative (USTR) to take action only in respect of foreign trade barriers that fall outside the scope of WTO rules. US law requires the USTR to invoke WTO dispute settlement procedures where applicable. Trump is abusing both domestic and international law.

Unilateral tariffs by the United States are unlikely to change Chinese policy and China’s retaliatory tariffs will compound the self-inflicted harm to the US economy.                                                                                                                                                             

The US should instead be leading concerted action through the WTO to change Chinese policy and protect the internet and global ICT standards from further fragmentation at the hands of China.

The Trans-Pacific Partnership was potentially a vehicle through which the US could have enlisted other countries to pushback against China’s ICT protectionism and state-led capitalism, but US withdrawal from the TPP means that is now a missed opportunity.

It is incumbent upon the Republican-led Congress to reign in the Trump Administration’s anti-trade policies. There is historical precedent for Congress overturning Presidential tariff measures. Congress should go further and legislate to remove some of the President’s Cold War-era discretionary powers over trade policy.

If Congress does not act to reign in the Trump Presidency over trade, the damage that will be inflicted on the US and world economy will only compound that from China’s mercantilist policies.

posted on 09 April 2018 by skirchner in Free Trade & Protectionism

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Making America 1930 Again

I have an op-ed in the AFR on Trump’s latest tariff measures. Full text below the fold.

Steel tariffs make America 1930 again

The Trump Administration’s decision to impose global tariffs of 25% on imported steel and 10% on aluminium will come as a disappointment to Australia and other US allies who hoped to be carved out of the measures. While there may still be scope for Australian exports to be excluded from the tariffs, Trump has told US industry executives he wants no exceptions.

The tariffs are to be imposed under Section 232 of the US Trade Expansion Act of 1962, which authorises the Secretary of Commerce to investigate whether imports are harming US national security and to propose remedies to the President.

This provision was designed to guard against a situation in which the US might become dependent on unfriendly countries for imports critical to national security. It was last used by President Reagan in 1986.

Yet in the case of steel imports, there is no such dependence. Most US steel imports come from allies such as Canada, Europe, South Korea and Australia. China and Russia have a small share of overall imports. The defence sector consumes a trivial share of US domestic steel output. The measures will harm US allies more than its strategic competitors.

A stronger although still flawed national security case can be made for aluminium, where Russia and China have a larger share of imports. The US has only one aluminium smelter that produces aerospace-grade product. 
But the aluminium tariff is much smaller than the steel tariff, so the proposed remedies are not proportional to the alleged threat. This suggests the real motivation is protectionism not national security.

As well as harming US allies, the tariffs will increase costs for the US defence sector. The measures as proposed were opposed by the Pentagon, in part because of the harm to US allies like Australia. The consumers of US steel across a wide range of industries and US exports will be hit. The tariffs will also increase the cost of President Trump’s proposed infrastructure program.

The measures are an abuse of US trade law. By all accounts, the Commerce Department’s investigation into the matter was perfunctory, with little regard for proper process. Trump has complete discretion over the form and duration of the measures.  They are so sweeping it will almost certainly be necessary to introduce exclusions in future, from which Australia may or may not benefit.

Affected countries will retaliate and the measures could be the subject of disputes before the World Trade Organisation. Whether the WTO upholds the national security justification will be a key issue.

If it does, this will set a dangerous precedent for other countries to abuse similar provisions in domestic and international trade rules. If it does not, the Administration may ignore the WTO ruling or, worse, withdraw from the WTO. The latter outcome would be the biggest blow to the rules-based international trading system since the 1930s.

The WTO dispute settlement process is already being actively undermined by the Trump Administration, which is blocking appointments to the appellate body that adjudicates trade disputes.

The tariffs follow the safeguard measures imposed earlier this year on solar panels and washing machines. The Administration is also expected to pursue major retaliatory action in response to Chinese intellectual property rights violations. These measures will almost certainly violate WTO rules. If challenged by China, the WTO could rule against the US and declare the relevant provisions of US trade law inconsistent with WTO obligations.

Collectively, these actions amount to a massive assault on free trade that will harm the US economy more than other countries. It suggests the anti-free trade forces in Trump’s Administration are in the ascendant. The adverse financial market reaction to the latest tariffs only hints at the damage that could be done to the world economy.

While some in the Administration continue to hold the door open to the US re-joining the Trans-Pacific Partnership, as the Australian government hopes, Trump’s policy actions demonstrate this is an increasingly remote prospect.

While Australia will be disappointed with the latest tariffs, it does not come to this issue with clean hands. Australia is an increasingly aggressive user of anti-dumping actions, including duties on steel imports. Ironically, Australian producers are now being hit by these duties as they need to import product to meet demand in excess of domestic production.

Changes to Australia’s anti-dumping regime under the Abbott and Turnbull governments have made it easier for local producers to abuse the anti-dumping system for protectionist purposes.
Successive Australian governments have ignored advice going back as far as the 1989 Garnaut Report that they should abandon or curtail the use of anti-dumping measures.

Australia’s lobbying effort on US steel tariffs might have resonated more strongly in Washington if we were not also playing the protectionist game.

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

posted on 04 March 2018 by skirchner in Economics, Free Trade & Protectionism

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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.

FALSELY BLAMED

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.

LOWERS COST OF CAPITAL

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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