Institutional Economics: ‘Light Reading It’s Not’

Hockey’s Hindsight Heroes

Opposition Treasurer Joe Hockey has problems staying on message:

Mr Hockey’s most controversial remarks were suggesting that the Rudd government would have been justified in cancelling this year’s tax cuts.

“The honest answer is there would have been a legitimate justification for the government to say our debt, our recovery, our economic recovery will be slower if we are running a big deficit and I think it should’ve been considered as part of the mix.“

Mr Hockey noted that it would have been hard for the Liberal Party to support the removal of the tax cuts. Earlier this year, Mr Hockey had argued for the government to bring forward tax cuts.

There is, of course, a case for not proceeding with the tax cuts. Because they are unfunded, the tax cuts are equivalent to a future tax increase and subject to the same Ricardian equivalence critique as discretionary government spending. However, one suspects that this is not the case Hockey has in mind. Instead, Hockey is an unreconstructed, Costello-style revenue-hoarder:

Mr Hockey said that, if he had his time again, he would have better explained the Future Fund, which Mr Costello regarded as one of his crowning achievements. “I would have set up the other funds earlier: the higher education funds for infrastructure and the health and hospitals fund,“ he said.

Like Costello, Hockey does not seem to understand that these funds are simply deferred government spending.

posted on 01 July 2009 by skirchner in Economics, Fiscal Policy

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Ricardian Equivalence, with a Vengeance

Dave Rosenberg, on the effectiveness of US fiscal stimulus efforts:

In April, total stimulus from the federal government to the personal sector, in the form of tax reduction and increased benefits, came to $121 billion at an annual rate. But that month, in nominal terms, consumer spending rose the grand total of $1 billion. Then we found out on Friday that in May, the total stimulus from the Obama economics team came to $163 billion at an annual rate, and consumer spending increased by a measly $25 billion (again at an annual rate). The big story is that the personal savings rate surged again to a new 16-year high of 6.9% from 5.6% in April and 4.3% in March. This is a repeat of the fiscal impact from the tax relief a year ago when the savings rate jumped from 0.2% in March 2008 to 4.8% in May 2008. This is what economists refer to as “Ricardian equivalence” — the money from Uncle Sam goes into the coffee can instead of being used to buy more coffee.

So let’s get this straight, the future taxpayer is being asked to contribute to a policy today that is aimed at perpetuating a consumer cycle — and yet for every dollar that is coming out of Washington to support a 70% consumption/GDP ratio, it is getting barely more than 8 cents worth of new spending activity. In real terms, as was the case with the tax rebates of just over a year ago, the real impact is on the savings rate, and it is very clear that not even the most aggressive monetary and fiscal policy since the 1930s is going to stop consumer spending in volume terms from rolling over in the second quarter.

posted on 30 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

When Behaviouralists Attack

Scientific American notes the penetration of the Obama Administration by behavioural economics:

The arrival of the Obama administration marks a growing acceptance of the discipline. A group of leading behavioural scientists provided guidance on ways to motivate voters and campaign contributors during the presidential campaign. Cass Sunstein, a constitutional scholar who wrote the well-regarded book Nudge, which President Barack Obama has reportedly read, was appointed head of the Office of Information and Regulatory Affairs, which reviews federal regulations. Other officials who are either behavioral economists or aficionados of the discipline are now populating the White House.

Alan Wolfe comments on the reactionary and anti-Enlightenment foundations of behaviouralism in this podcast with Russ Roberts.

Meanwhile, Chris Dillow uncovers a ‘heartbreaking work of staggering genius, a brilliant illumination of class relations, post-modernism and the crisis of the left.’

posted on 29 June 2009 by skirchner in Economics, Financial Markets

Greenspan on the Political Allocation of Capital

Alan Greenspan, on the quantitative channel for crowding-out:

Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt. Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.

posted on 26 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

Are Americans All Keynesians Now?

While policymakers around the world may be sold on the effectiveness of discretionary fiscal stimulus, the public remain more skeptical. The disconnect between official and public sentiment is important, because confidence is meant to be one of the channels through which stimulus spending works to support economic activity. We have previously pointed to US survey data on consumers’ evaluation of macroeconomic policy, which calls into question the effectiveness of fiscal stimulus efforts.

A WaPo-ABC News poll directly asks whether economic stimulus has or will help the economy. A net 52% see stimulus as helpful to the economy, while 46% view stimulus as not helping, either currently or prospectively. At the same time, 87% of respondents were ‘very’ or ‘somewhat concerned’ about the federal budget deficit. A majority (54%) also favour ‘smaller government, fewer services’ to ‘larger government, more services.’ The majority view expressed in these polls is consistent with a Ricardian interpretation of the effectiveness of fiscal policy. The poll also sheds light on why President Obama remains popular. Most respondents still see Obama as ‘a new-style Democrat who will be careful with the public’s money’ rather than ‘an old-style, tax-and-spend Democrat.’

posted on 25 June 2009 by skirchner in Economics, Fiscal Policy

More Anti-‘Bubble’ Popping

BoE chief economist Spencer Dale, on the evils of ‘bubble’ popping:

Short-term interest rates are a blunt instrument best deployed maintaining a broad balance between nominal demand and supply. They are not well suited to the task of managing asset price bubbles and economic imbalances. They may be wholly ineffective in addressing some types of imbalances, particularly those with an international dimension. And, even for domestic imbalances, short-term interest rates would probably need to be held substantially higher for a persistent period in order to suppress rapid rises in asset prices or growing imbalances. Such policy actions could generate significant economic costs.

The practical difficulty of implementing a policy of “leaning against the wind”, where the main policy instrument is short-term interest rates, should not be underestimated. If, as policymakers, we were successful in preventing a bubble from inflating, it might appear as if we were responding to phantom concerns. The bubble or imbalance would be nowhere to be seen, but interest rates would be higher, inflation would undershoot the inflation target and we would appear to have inflicted unnecessary economic hardship. That could undermine public faith and support in both the inflation target and the MPC.

posted on 24 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy

The Long and the Short of Housing Wealth and Consumption

Charles Calomiris, Stanley Longhofer and William Miles, on why there is no wealth effect on consumption from changes in house prices:

any decrease in house prices hurts only those who are net “long” in housing, that is, those who own more housing than they plan to consume. This might include, for instance, “empty-nesters” who are planning on selling their current houses and downsizing. On the other hand, the decline in home values helps those who are not yet homeowners but plan to buy. Most homeowners, however, are neither net long nor net short to any significant degree; they own roughly what they intend to consume in housing services. For these households, there should be no net wealth effect from house price change. And when one thinks about the economy as a whole (which is a combination of all three types of households) the aggregate change in net housing wealth in response to house price change should be nearly zero; changes in house prices should affect the distribution of net housing wealth, but have little effect on aggregate net housing wealth. Thus any effect from net housing wealth change on aggregate consumption spending should be similarly small.

Put differently, an increase in house prices raises the value of the typical homeowner’s asset, but such a price increase is also an equivalent increase in the cost of providing oneself housing consumption. In the aggregate, changes in house prices will have offsetting effects on value gain and costs of housing services, and leave nothing left over to spend on non-housing consumption.

The authors also debunk the work of Karl Case, John Quigley and Robert Shiller.

posted on 23 June 2009 by skirchner in Economics, Financial Markets, House Prices

Fiscal Stimulus, Interest Rates and Crowding-Out

I have an article in the Weekend Australian arguing that the government’s discretionary fiscal stimulus measures will undermine Australia’s long-run growth prospects, citing the Australian edition of a widely used undergraduate textbook:

“When the government reduces national saving by running a budget deficit, the interest rate rises and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.“ So says Joshua Gans in his Principles of Macroeconomics text. Yet Gans was also one of the 21 economists who recently signed a letter defending the government’s deficit spending.

An increase in the stock of government debt reduces the amount of capital available for private investment, although this crowding-out effect may be offset by increased private saving and foreign capital inflows. In a small and open economy such as Australia, crowding out occurs not so much because interest rates rise, but because it induces foreign capital inflows that put upward pressure on the exchange rate, lowering net exports and reducing aggregate demand, which offsets the increase in government spending.

I also have an article in Business Spectator, noting that recent market-led increases in retail borrowing rates are just a taste of things to come:

Whatever the cause of rising global bond yields, these increases in interest rates will inevitably be passed on to Australian borrowers. It would be a sign of political maturity if Australian politicians were to acknowledge this reality, rather than taking refuge in the shameless populism of bank-bashing.

UPDATE: Joshua complains about ‘selective extracting’ and an ‘unwillingness to deal with economic complexity’ in my Weekend Australian piece. The point of highlighting the very good discussion of these issues in Joshua’s textbook was precisely to show that the 21 economists were being selective and incomplete in their analysis, by not acknowledging the many arguments against discretionary fiscal stimulus. I would certainly encourage people to read Principles of Macroeconomics in coming to a considered view of the merits of discretionary fiscal policy.

posted on 21 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

Lu Kewen Thought ‘Shallow and Crude’

A Chinese economist rejects Lu Kewen Thought:

KEVIN Rudd has been accused by a leading Chinese economist of being “either short of economic knowledge or misleading his readers” in his famous essay attacking neoliberalism.

In a scathing assessment, Xu Xaonian, economics professor at China Europe International Business School in Shanghai, lambasts the essay, now translated and published in China, as “shallow and crude”.

Dr Xu says “Lu Kewen” - Mr Rudd’s Chinese name - made a “big, big mistake” in forming his “confident opinions” based on “the observation that the crisis came as a result of neoliberalism and the absence of supervision”.

Dr Xu, one of China’s leading liberal economists, has savaged the Rudd essay in the weekly Chinese newspaper The Economic Observer after the Prime Minister’s work was translated and reprinted in China’s leading business magazine, Caijing.

Dr Xu, who has a doctorate from the University of California and was formerly managing director of the country’s biggest investment bank, says it is not time to resurrect Keynesianism, as Mr Rudd proposes.

“Instead, it’s time to announce Keynesianism’s failure, time to announce the emperor Lord Keynes has no clothes.“

He says the Prime Minister “has used electioneering-style tactics to brand neoliberalism as dogmatic, to paint a clownish portrait of it, seeking to pioneer popular antipathy to this artificial enemy, casting a moral verdict without seeming to care about truth or logic”.

posted on 19 June 2009 by skirchner in Economics, Politics

Government Policy, the Business Cycle & Consumer Confidence

Claims about the effectiveness of fiscal stimulus in the US do not quite square with evidence from surveys of consumer confidence. The University of Michigan survey asks respondents “As to the economic policy of the government—I mean steps taken to fight inflation or unemployment—would you say the government is doing a good job, only fair, or a poor job?“ According to secondary sources, this measure posted its equal sharpest decline on record in June to 93 from 108 in May. The chart below the fold shows the history of this series until November 2008, after which the data disappeared behind a Thomson-Reuters paywall (if anyone has the intervening data, feel free to flick it my way). Clearly, consumers did not think much of the Bush Administration’s fiscal stimulus measures (although there is a rally around the flag effect in relation to policies pursued after September 11 2001). The change in Administration since November last year benefited this series, but the political honeymoon now seems to be wearing off.

This series is clearly cyclical, suggesting consumers blame economic conditions on government policy. While consumers might be overrating the importance of government policy to economic outcomes, they are also effectively calling into question the effectiveness of the usual counter-cyclical policy responses, including fiscal stimulus.

posted on 18 June 2009 by skirchner in Economics, Fiscal Policy

‘Bubble’ Popping at Treasury and the BoE

The Australian Treasury’s David Gruen on monetary policy and asset prices:

Some have suggested that, rather than simply being a contributing factor, expansionary US monetary policy in the early 2000s was the main cause of the crisis.

Expansionary US monetary policy undoubtedly contributed to rising US asset prices, including house prices, at the time. Indeed, that is the point of the policy – rising asset prices constitute one of the ways that expansionary monetary policy works.

But I have less sympathy with the argument that monetary policy should explicitly ‘lean against the wind’ of a suspected inflating asset price bubble, which is implicit in the criticism of US monetary policy at that time.

In my view, to lean against the wind and do more good than harm requires a level of understanding about the likely future path of a suspected asset bubble that is simply unrealistic. Without that understanding, attempting to use monetary policy to lean against the wind is as likely to be destabilising for the wider economy as it is to be stabilising.

It is good to see that Adam Posen, author of one of the better social democratic critiques of ‘bubble’ popping, has just been appointed to the BoE’s MPC.

posted on 17 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy

Breathtaking Hyperbole

David Burchell reads Peter Hartcher’s purple prose, so you don’t have to:

At times the prose reaches for the clouds and we are treated to extended literary metaphors, such as the credulity-stretching parable of John Howard as Herman Melville’s Ahab, forlornly chasing the White Whale of political immortality…

Indeed, a good deal of what Hartcher presents as grand political drama is simply over-cooked. The description of Howard’s secret offer to resign in the face of disastrous polling as “a breathtakingly grand example of subterfuge” is simply florid, while the accompanying accusations of disingenuousness and “breathtaking chutzpah” become emptily repetitious.

posted on 17 June 2009 by skirchner in Politics

Stimulus Watch

The Australian looks behind the photo-op spin of politicians in hard hats and fluro safety vests to give stimulus spending the scrutiny it deserves. The results are not pretty.

You can report stimulus waste to online-at-theaustralian.com.au.

posted on 16 June 2009 by skirchner in Economics, Fiscal Policy

The Rio-Chinalco Counter-Factual

John Garnaut challenges the widespread assumption that the Rio-Chinalco deal fell-over for commercial rather than political reasons:

The Economist reported that Rudd wanted the deal to go through. That may well be a message Rudd’s office would like the outside world to have but it is not consistent with dealings I have had with any of Rudd’s ministers, staffers or advisers, and certainly not from the companies involved.

In the normal course of events we would never find out what went on inside FIRB. On this occasion, Rio chairman Jan du Plessis hinted after he walked away from the Chinalco deal just over a week ago and Chinalco president Xiong Weiping more clearly indicated at his press conference on Thursday, that the original deal would have been killed in Canberra without substantial amendments.

“During our engagement and communication with FIRB we received advice in principle in terms of how the transaction should be modified,“ said Xiong. And, unusually, Rudd ministers publicly lent against the deal from the start.

My own understanding, from Australian and Chinese sources, is that FIRB expressed its intense displeasure at almost every substantial aspect of the Chinalco deal but never spelt out what it would take for the deal to pass.

FIRB’s displeasure and the range of its concerns increased as time progressed — in correlation with the improving commodities, stock and debt markets — reaching critical levels early last month.

Xiong hoped his large concessions would be enough for Canberra. In fact he had no idea. Would Canberra have allowed him to accept a seat on the Rio Tinto board? He and we will never know.

Rudd may have been right in assuring China and the world that the Chinalco-Rio deal failed for “entirely commercial reasons”. But Australia’s China-like investment review process means we will never know the counter-factual.

Without the delay and uncertainty injected by the political process, which strengthened BHP’s negotiating arm vis-a-vis Chinalco, how would those two parallel commercial negotiations have panned out?

For all the ink spilled on the Rio-Chinalco deal, Garnaut is one of the few journalists to identify the real public policy issue in this debate: Australia’s Whitlam-era, Chinese-style regulatory regime for FDI. Once again, that regime has been tested and found seriously wanting. The collapse of the deal only adds to the uncertainty facing prospective foreign investors and the vendors of domestic equity capital.

posted on 16 June 2009 by skirchner in Economics, Financial Markets, Foreign Investment

Fiscal Stimulus and Retail Trade

Ashton de Silva and Sinclair Davidson demolish the myth that fiscal stimulus has led to above trend growth in retail sales. The authors note that:

the media has been full of articles indicating that individuals have increased spending on poker machines and plasma televisions. Some individuals told reporters that they intended to get tattoos or spend the money on prostitutes. That type of spending does not undermine the policy objective. The policy objective is to stimulate increased spending in the economy irrespective of what the spending actually entails.

This sort of media commentary should also be rejected because it supports the elitist notion that people cannot be trusted to make consumption choices in their own interests.

posted on 12 June 2009 by skirchner in Economics, Fiscal Policy

Free Trade Snitch

Dob-in a protectionist. You know you want to.

posted on 12 June 2009 by skirchner in Economics, Free Trade & Protectionism

Australia and the World Economy

I have a column in the Business Spectator, arguing that the transmission mechanism from the world to the Australian economy is mainly via financial markets rather than cross-border trade in goods and services:

While it may seem surprising that export volumes are holding up in the context of a global economic downturn, it highlights the fact that the transmission mechanism from the world to the Australian economy is somewhat different to the one many people assume.

There has been a much closer relationship between the world and Australian economy since the early 1980s, as lower trade barriers have resulted in closer ties with world markets and a larger traded goods sector. However, it is difficult to account for the strength of this relationship based purely on trade linkages.

A more important transmission mechanism from the world to the Australian economy comes from our increased integration with global financial markets following financial market liberalisation and deregulation in the early 1980s. Changes in global interest rates and other asset prices are transmitted directly to the Australian economy via global financial markets.

This has a more powerful and immediate impact on the Australian economy than international trade in goods and services and has been particularly important in the context of the recent global financial crisis.

It helps explain why domestic demand has contracted, even while external demand has proven resilient.

As I note in the column, this has important implications for the effectiveness of domestic policy interventions.

posted on 11 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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When Gold Bugs and Reality Meet

A Wired story on the rise and fall of E-Gold:

In a sparsely decorated office suite two floors above a neighborhood of strip malls and car dealerships, former oncologist Douglas Jackson is struggling to resuscitate a dying dream.

Jackson, 51, is the maverick founder of E-Gold, the first-of-its-kind digital currency that was once used by millions of people in more than a hundred countries. Today the currency is barely alive.

Stacks of cardboard evidence boxes in the office, marked “U.S. Secret Service,” help explain why, as does the pager-sized black box strapped to Jackson’s ankle: a tracking device that tells his probation officer whenever he leaves or enters his home.

“It’s supposed to be jail,” he says. “Only it’s self-administered.”

There are some remarkable parallels between this story and the Paypal Wars. Contrary to the hopes of the cypherpunk and cryptoanarchist movements, on-line payments systems have not been able to effectively challenge the power of the state. I would agree with Richard Timberlake’s assessment (quoted in the linked article) of the original intentions behind E-Gold.

posted on 11 June 2009 by skirchner in Economics, Financial Markets, Gold, Monetary Policy

Velocity is Not an Independent Variable

Among certain economic commentators, it has been suggested that we should watch for a recovery in velocity (nominal GDP divided by some monetary aggregate) as an indication that economic conditions are improving. Brian Wesbury goes so far as to argue that the US recesssion was ‘caused by a dramatic slowdown in monetary velocity’. While an increase in velocity might be symptomatic of economic recovery, it would be wrong to think of velocity as an independent variable. Milton Friedman is often caricatured as claiming that velocity is constant. Rather, he claimed velocity is a stable function of other variables.

A better way to think about velocity is in terms of its inverse, or money demand. Money demand is typically viewed as some function of nominal GDP, an interest rate (the opportunity cost of holding money balances) and financial technology. The latter usually goes unmodelled, but conceptually at least, we can distinguish between permanent and temporary changes in financial technology. Permanent changes in financial technology are probably the main driver of long-run trends in velocity. Velocity trends lower in the early stages of economic development, as money facilitates a growing division of labour, before declining again as new forms of financial instrument take over some of the functions previously performed by money, giving rise to a classic U-shape.

Short-run changes in money demand are likely to reflect temporary changes in financial technology or financial shocks, as well as cyclical variations in nominal GDP and interest rates. From the foregoing, it should be apparent that short-term movements in velocity are unlikely to tell us anything we don’t already know about current and prospective business cycle conditions. Against the backdrop of a shock to financial technology of unknown duration, interpretation becomes even more difficult.

posted on 09 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy

Debunking Bad Narratives on Stimulus

Henry Ergas responds to the 21 economists rounded-up by Nic Gruen to defend the federal government’s stimulus measures (as if the government were not big and ugly enough to defend itself):

The open letter 21 highly respected Australian economists published earlier this week in The Australian Financial Review strikingly illustrates the trend. Endorsing the “too much rather than too little” approach, that letter claims “there is no more effective way to stimulate the economy” than cash handouts.

In reality, the efficacy of that spending is far from established. Rather, much as economic theory would predict, the striking fact is just how smooth the path of consumption has been, despite a substantial spike in income associated with the Government’s cash splash.

Sinclair Davidson makes similar points in The Age:

It would be surprising indeed if the 21 economists were prepared to defend any of the $800 million in ‘community infrastructure’ boondoggles listed here.

RBA Governor Glenn Stevens has also been out highlighting the limits of macro policy stimulus:

Macroeconomic policies have not been able to prevent an economic downturn. They rarely can, especially in the face of a global recession of this magnitude. Indeed, attempts to do so have as often as not run into trouble by stoking up bigger problems a few years down the track.

posted on 05 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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By How Much Did the Australian Economy Outperform?

Updating our earlier model of Australian GDP growth for yesterday’s data revisions yields a forecast for the March quarter of -0.5% q/q compared to an actual result of 0.4% q/q. So growth was 0.9 percentage points stronger than a forecast based solely on US GDP growth. This outperformance is even larger if we believe the expenditure measure of GDP (1.1% q/q), but turns into underperformance if we believe the conceptually equivalent production measure, which came in at -0.9% q/q.

Of all the country-specific factors that might account for this outperformance, discretionary fiscal policy is likely to have been the least of them.

posted on 04 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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World’s Most Expensive Narrative

Vince Reinhart, on the high cost of bad narratives:

The most expensive stage of a financial crisis is not the initiating economic loss—in our case, an unsustainable boom in residential construction that left too many houses and a mountain of debt. Nor are the largest losses racked up as investors withdraw from risk, markets freeze, and balance sheets implode. Policy missteps, including the continuing confusion of solvency problems for liquidity ones, no doubt add to the tab. These costs, while they may be big, pale to insignificance compared to what follows.

The most expensive stage of a financial crisis occurs when society tries to explain to itself what just happened. The resulting narrative is not the product of one person or institution. Rather, it gets written in the tell-all “tick-tocks” of major newspapers, the inside accounts in bestsellers, the speeches of leading officials, and the punch lines of late-night comedians. The narrative determines our attitudes toward the actors and events of the crisis. It also identifies the structural problems thought suitable for legislative and regulatory remedy.

posted on 03 June 2009 by skirchner in Economics, Financial Markets

A Simple Test for the Effectiveness of Macro Policy Stimulus in Australia

A simple test for the effectiveness of macro policy stimulus in Australia is to model quarterly Australian GDP growth as a function of contemporaneous and lagged US GDP growth and a constant. The model makes the reasonable assumption that causality runs from US growth to Australian growth, since Australia is too small to influence the US economy. US stimulus measures could benefit Australian GDP based on this model, but Australian policy stimulus should not influence US GDP growth (even allowing for those stimulus cheques to ex-pats). Domestic policy is historically correlated with US GDP growth, but presumably works in a counter-cyclical direction. The estimated relationship implies that domestic policy can do only so much to offset the influence of US or world growth on domestic activity.

The model’s static forecast for Australian March quarter GDP is -0.8% q/q, with a standard error of 0.6, so we would expect March quarter GDP growth to lie in the range of -0.2% q/q to -1.4% q/q. The median forecast of market economists is -0.2% q/q, based on Friday’s Reuters poll*, implying that the Australian economy is modestly outperforming what we might expect based solely on US growth. Both domestic monetary and fiscal policy could thus be given some credit in offsetting the effect of the decline in world growth. But even if we generously assume that discretionary fiscal policy measures account for most of this outperformance, it is a very small return on what has been called ‘the greatest mobilisation of resources in Australia’s peacetime history.’ The lesson is that for a small open economy like Australia, there is only so much domestic policy can do when confronted with a global economic downturn.

Model details over the fold.

* Update: Latest Reuters poll median is +0.2% q/q, following Tuesday’s release of net exports for the March quarter.

posted on 02 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

Meltzer versus Battellino on Central Bank Credibility

Allan Meltzer doesn’t share Ric Battellino’s optimism that central banks will re-tighten monetary policy in a timely fashion:

Does the Federal Reserve have the technical ability to prevent inflation? Certainly! Will the Federal Reserve show the political stomach in the face of a sluggish recovery and almost certain cries of alarm from Chairman Barney Frank, the administration, the business community, the labor unions, and Krugman? Certainly not!

posted on 01 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy

Bankruptcy and the Rule of Law in the US

James Glassman on the decline of the rule of law in the United States:

I head a nonprofit group that encourages developing nations to adopt policies that will lead to prosperity — starting with transparency and the rule of law — and hold up America as a model. Yet in its high-handed dealings with Chrysler and G.M., the Obama administration reminds me of an irresponsible third-world regime, skirting the law and handing economic prizes to political cronies…

What lesson does federal favoritism toward Chrysler and G.M. teach other businesses that play by the rules? How will our trade negotiators keep a straight face when complaining about subsidies to Airbus or Chinese steel makers? The government should have stepped aside earlier and allowed a normal bankruptcy that would have treated the union and the debt-holders fairly.

As P J O’Rourke notes, bankruptcy is the norm rather than the exception for the US car industry:

American cars have been manufactured mostly by romantic fools. David Buick, Ransom E. Olds, Louis Chevrolet, Robert and Louis Hupp of the Hupmobile, the Dodge brothers, the Studebaker brothers, the Packard brothers, the Duesenberg brothers, Charles W. Nash, E. L. Cord, John North Willys, Preston Tucker and William H. Murphy, whose Cadillac cars were designed by the young Henry Ford, all went broke making cars. The man who founded General Motors in 1908, William Crapo (really) Durant, went broke twice. Henry Ford, of course, did not go broke, nor was he a romantic, but judging by his opinions he certainly was a fool.

posted on 31 May 2009 by skirchner in Economics

The Quiggin-Caplan Wager: I’m with Quiggin

Bryan Caplan and John Quiggin take a 10-year bet on the average of the US-EU15 unemployment rate differential. On this bet, I have to say I’m with Quiggin. The reason: the US is thinking more and more like Quiggin and less like Caplan. Public policy in the EU is not appreciably worse than it has been in the past, but the rate of deterioration in the US implies that their respective structural unemployment rates should converge via a faster rate of deterioration in the US. The capital allocation process in the US is now so deeply compromised by political intervention that there is little reason to believe in the continued structural outperformance of the US economy. Differences in labour market institutions won’t matter much in this context. Caplan himself puts his chances of winning at only 60%.

David Goldman put it well in perhaps the most disturbing metaphor for the crowding-out effect on US economy:

The moment the zombie pulls on his chain, rates rise, consumption falls, and the zombie gets less oxygen.

posted on 29 May 2009 by skirchner in Economics, Financial Markets

More Bubble Wrap

Alan Wood discusses the debate on the relationship between monetary policy and asset prices, referencing my CIS Policy Monograph Bubble Poppers. Wood writes:

Central bankers have always taken asset prices into account in setting monetary policy and in Australia’s case successfully intervened in the housing market via both interest rates and jawboning by then governor Ian Macfarlane and head of Australian Prudential Regulation Authority, John Laker, a former Reserve banker, to cool off reckless lending and overheating in housing prices.

Kirchner dismisses this episode as unsuccessful, and the Howard government certainly didn’t like it. But the ratio of house prices to income fell markedly after 2003, when the RBA raised rates by 0.5 percentage points in two back-to-back hits. And Australia has so far not suffered anything like the housing price collapses in the US and Britain.

To be clear, my argument was that the RBA’s talk was not backed by policy action. Like the rest of the world, monetary policy in Australia was accommodative in 2003 and the RBA had an explicit easing bias in June of that year. As I noted in this op-ed, the nominal official cash rate did not reach a neutral level until 2005 and the real cash rate struggled to stay above neutral as inflation increasingly got away on the RBA. Unfortunately, most media commentators mistake increases in the nominal cash rate for a tightening in policy, ignoring what is happening with real or expected interest rates. It is this confusion that gave rise to the myth that the RBA presided over a successful bubble popping episode in 2002-03.

As the commodity price boom took off in 2003, population and income was sucked out of the south-eastern property markets and flowed into the resource-rich states. As the RBA has noted, this saw renewed convergence in capital city house prices, as the heat was taken out of the south-east and shifted to the north-west. This sub-national variation in house prices cannot be explained with reference to monetary policy, as much as the bubble poppers might like us to believe otherwise. It had a clear basis in sub-national differences in economic performance.

posted on 29 May 2009 by skirchner in Economics, Monetary Policy

Convenience Shopping for Gold Bugs

Gold vending machines.

posted on 28 May 2009 by skirchner in Economics, Financial Markets, Gold

Why Monetary Easing Need Not be Inflationary

RBA Deputy Governor Ric Battellino, on why monetary easing need not be inflationary:

The other side of the debate – that the measures will result in higher inflation – implicitly assumes that the measures will be effective in stimulating the economy, since money does not miraculously transform into inflation without affecting economic and financial activity. Rather, their argument is that central banks will be too slow to reverse the various measures.

As there are no technical factors that would prevent or slow the reversal of recent measures – they can be reversed simultaneously or in any sequence – the argument must rest on central banks making incorrect policy judgments. This is always a possibility. But, the high state of awareness that currently exists about the risk of being too slow to reverse recent exceptional measures should limit the probability of such a mistake being made.

Unfortunately, a high state of awareness does not in itself guarantee timely policy action, as the RBA’s own track record would suggest.

posted on 28 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy

Cameron Frye’s House for Sale

Ferrari not included.

posted on 28 May 2009 by skirchner in Misc

Steve Keen, They Hardly Knew You: Consumer House Price Expectations

The most recent Westpac-MI Consumer Sentiment survey included a question on expectations for house prices over the next 12 months. Expectations were close to balanced nationally, with those expecting declines slightly outnumbering those expecting falls. However, there was considerable sub-national variation. Most pessimistic are the resource states of Queensland and WA, while the south-eastern states are relatively upbeat. No change was the single most common expectation in every state, except NSW, where the single most common expectation was for a rise of 0-10%.

posted on 27 May 2009 by skirchner in Economics, House Prices

Boondoggle Nation

RBA Board member Warwick McKibbin, on the effectiveness of activist fiscal policy:

“Most fiscal policy doesn’t do anything except switch spending from one period to another,“ the RBA director said.

“When you change fiscal policy, all you do is stimulate the economy today out of future possible growth.“

Stimulus spending had to be paid for either with higher future taxes or reduced opportunities for the private sector so that the public sector could be financed.

“The only exceptions are infrastructure and similar spending, which raises the return to private activities,“ Professor McKibbin said.

“The most sustainable way of reducing a fiscal deficit is through strong productivity growth in the private sector.“

He said that in mature economies, it was hard to engineer productivity growth.

Whether public infrastructure spending increases private sector productivity is a case-by-case judgement. As the rest of the story makes clear, much of the government’s stimulus spending consists of little more than electoral boondoggles such as swimming pools and sports stands.

posted on 25 May 2009 by skirchner in Economics, Fiscal Policy

The Monthly Labour Force Lottery

Centrebet is now running a book on the unemployment rate, as published in the monthly ABS Labour Force release. A rate of 5.6%-5.7% is currently favoured for May following 5.4% in April.

The quoted range begs the question as to whether they would pay on a rounded estimate published at 5.6% or 5.7% that was actually outside this range on an unrounded basis.

posted on 25 May 2009 by skirchner in Economics, Financial Markets

Crowding-Out Gets Crowded-Out

I have an op-ed in today’s Age, noting that it is the crowding-out effect and not the short-run multipliers that will determine the long-run economic effects of the government’s discretionary fiscal policy actions:

In the 366 pages of Budget Paper No. 1, where the Government outlines its fiscal strategy, crowding out isn’t mentioned once.

It wasn’t always this way. The budget papers released in the second half of the 1990s were full of references to the contribution federal budget surpluses were making to national saving and investment. One of the advantages of budget surpluses, Treasury informed us, was that the government would no longer make a net call on capital markets. Instead of crowding out private capital and investment spending, budget surpluses would crowd them back in.

All this was said when the economy was still well short of full employment.

Treasury Secretary Ken Henry’s “secret” speech to Treasury officers in March 2007 drew heavily on the idea of crowding out to explain why government intervention in an economy at full employment was counter-productive, resulting in a misallocation of resources and reduced output. Only by augmenting the supply side of the economy, he noted, could Australia increase national income.

When the public sector saves less, all else being equal, national saving is also reduced, reducing future growth in national income. This crowding-out effect can occur even if there is no change in interest rates and the economy is below its full employment level of output.

posted on 22 May 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

Kevin Rudd as Neo-Liberal

My CIS colleague, Oliver Hartwich, in Neo-Liberalism: The Genesis of a Political Swear Word, demonstrates that when Kevin Rudd attacks neo-liberalism, he is unconsciously attacking his own intellectual heritage and heroes.

posted on 21 May 2009 by skirchner in Classical Liberalism

Is the RBA Still Agnostic on Bubble Popping?

In contrast to the cautious agnosticism of his boss on the question of bubble-popping, RBA Assistant Governor Guy Debelle is remarkably clear on the issue:

the current episode vindicates the position that monetary policy, narrowly defined as the setting of the policy interest rate, should be confined to targeting inflation. Set interest rates primarily to achieve the inflation goal as that, in itself, contributes to sizeable social gains. A departure from that runs the risk of losing the nominal anchor that the inflation target provides.

But other tools, most notably the much-touted (although not clearly defined) macro-prudential instruments, should be used to address asset price and credit imbalances. I do not think that a slightly tighter setting of interest rates would have prevented the development of the imbalances that have led to the current financial crisis. When human psychology is such that optimism about asset price rises is at the fore, then an excessively stringent setting of interest rates would be required to suppress the optimism. The Australian and Scandinavian experience in the late 1980s shows the sort of interest rate settings required to achieve such an outcome. In that example, a credit boom and bubble-like asset price dynamics took hold and only a very high setting of real interest rates ultimately curtailed that, but at the cost of a historically high level of unemployment.

I do not think it would be socially acceptable or desirable to endure the level of unemployment that would come with the high interest rates necessary to pop the bubble. It is asking too much of the single monetary policy instrument, namely, the targeted short-term interest rate to target both financial excesses and inflation.

Nor do I believe there is much to be achieved by ‘leaning against the wind’. The wind that is blowing in most episodes of credit booms is generally at least gale force. Setting interest rates a bit higher in such circumstances is likely to be close to futile when such credit dynamics take hold. Again, what would be the point of undershooting the CPI inflation target and enduring a higher than desirable level of unemployment with little to be gained. How would such actions be explained to the public?

posted on 21 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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The Ken Henry Speech that Time Forgot

Treasury Secretary Ken Henry, speaking to the Sydney Institute in 2005:

By the 1990s, however, a consensus had emerged, in Australia and elsewhere, that fiscal activism had to be limited. Fiscal policy had to be given a medium-term anchor. At the same time, a view emerged that macro stabilisation should be primarily the responsibility of monetary policy. But monetary policy, too, had to have a medium-term anchor….

The last of these observations is particularly striking for a student of post-war economic history: one has to wonder whether the policy debate in this country is not the sort of thing that one might have hoped to see in a ‘classical’ economy of the sort that economists thought existed before the Great Depression and the ensuing Keynesian revolution; a debate about the factors that influence our productive capacity rather than the factors that influence our demand for it…

It might be worth asking the question whether, because of the reform efforts of the past, we should not now consider ourselves to be most often in a ‘classical’ world in which the economy naturally trends toward, and in fact spends most of its time quite close to, its productive capacity, or supply potential, without the need of continuous macro policy stimulus.

Answering this question in the affirmative would not imply a view that we have eliminated the business cycle. There will be future economic downturns. And when we see evidence of one we should not be afraid of responding with activist expansionary macroeconomic policy. Rather, an affirmative answer implies some conditioning of the exercise of macro policy activism – an acceptance that large swings in macro instruments are to be implemented (only) in extremis…

let me say something about the emerging pressure for increased infrastructure spending. This pressure is mostly well-intentioned – more spending on infrastructure will indeed tend to increase the productive potential of the economy. And, with long-term interest rates and therefore the cost of capital at a cyclical low at the moment, both the public and private sectors are in a relatively strong position to undertake additional spending.

But without appropriate price signals, quality investment decisions will not be made. And present price signals are far from appropriate. The risks of making large infrastructure investment decisions in such an information-poor environment are very great.

posted on 20 May 2009 by skirchner in Economics, Fiscal Policy

Wisdom of Crowds: Budget Edition

Only 30% of Newspoll respondents believe the federal budget will be back in surplus within six years. There is a sharp partisan divide on this issue, although surplus skepticism increases with age and income. It is interesting that the most well received federal budget since 1993 was also the Howard government’s last.

posted on 19 May 2009 by skirchner in Economics, Fiscal Policy, Politics

Peter Costello is Shovel-Ready

Liberal backbencher and former Treasurer Peter Costello channels Rex Connor:

Yesterday he continued the attack on the Rudd Government’s cash handouts, saying the $20billion would have been far better spent on infrastructure.

“You could have drought-proofed Victoria for that…for $20 billion you could have built a channel from Northern Australia down to Victoria…“

posted on 19 May 2009 by skirchner in Economics, Politics

The Myth of an Independent Treasury

My CIS colleague and former Treasury official Robert Carling has an op-ed on page 21 of today’s Australian (no link, but see text below the fold) noting that neither Treasury nor the Budget papers are independent of the federal government.

The claim that Treasury is an institution independent of government fundamentally misconstrues the relationship between the federal government and the Commonwealth public service. While it is not surprising to see politicians fail Economics 101, it is more surprising to see them also failing Political Science 101. The government now routinely hides behind Treasury and RBA independence and the federal opposition is increasingly accommodating this behaviour through their unwillingness to challenge official sector views.

While the RBA is more independent than Treasury, this independence is limited in scope. At its most basic, RBA independence means that it is free to set interest rates without the approval of the Treasurer, what is often called ‘operational independence.’ This independence in no sense precludes the government or opposition from taking a different view on monetary policy to the RBA or being publicly critical of central bank policy actions, statements and forecasts. The RBA has been made progressively more independent of government precisely in order to facilitate differences of opinion with government. Under the Reserve Bank Amendment (Enhanced Independence) Bill, it is almost impossible to remove the RBA Governor, so public criticism could hardly be viewed as a threat to the Governor’s position. By the same token, the RBA would not be compromising its independence by speaking out on issues relating to its statutory responsibilities, provided it does so in a non-partisan fashion.

Mistaken notions of Treasury and RBA independence are being used to suppress public debate over economic policy, not least by the current government. That the federal opposition and media are accommodating this behaviour on the part of the government can only undermine the robustness of public debate and democratic accountability.

posted on 16 May 2009 by skirchner in Economics, Fiscal Policy, Media, Monetary Policy, Politics

Government Bonds to Underperform?

Jeremy Siegel, on the poor prospects for returns on government bonds:

40 years ago [US] treasury bonds were yielding over 6.3 percent, about twice their yield today. It is mathematically impossible for government bonds to come close to matching those 12 percent returns in future decades. Stocks, on the contrary, can easily repeat their returns over the past four decades, since those returns were near their historical average…

For the 55-year period from December 1925, when the well-known Ibbotson stock and bond series begins, through January 1982, total real government bond returns were negative. This means that, by rolling over in long-term government bonds, reinvesting all the coupons, and thereby taking no income, investors’ bond portfolios were sinking in value.

Most strikingly, for the 40-year period from 1941 through 1981, government bond investors lost a whopping 62 percent of their value after inflation. A loss in purchasing power over this long a period has never happened in stocks. There has never even been a 20-year period when real returns in stocks have been negative. In fact, the worst 30-year real return for stocks is plus 2.6 percent per year, just slightly below the average real return investors earn with government bonds.

Looking at today’s markets, the forward-looking prospects for government bonds are very poor. Yields on 30-year inflation-protected bonds are 2.3 percent, and yields are only 4 percent on 30-year Treasuries. In contrast, after stocks have fallen 50 percent from their previous high, as they did in March of this year, their subsequent 30-year real returns have always been in excess of 10 percent per year.

The 40-year outperformance of government bonds over large stocks has ended.

posted on 15 May 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

Big Government Will Hinder Growth

I have an op-ed in today’s Australian on the ‘economic conservatives’ who have turned into the biggest spending government since Gough Whitlam:

THE 2009 budget forecasts the biggest expansion in federal government spending since Gough Whitlam. While the budget deficit is being sold as a necessary response to the worst global economic downturn since the Depression, government spending will hinder growth long after Australia’s recession is over.

The Government has made much of the reduction in revenue flowing from the global downturn and the resulting domestic recession. But this is only one side of the budget deficit equation. The unprecedented deterioration in the budget balance is also driven by the biggest increase in government spending in a generation.

The federal government spending share of gross domestic product will increase by 2.6 percentage points this financial year, with a further increase of two percentage points forecast for next financial year, the biggest increases since the early 1970s. Government spending will reach 28.6per cent of GDP in 2009-10, a figure unprecedented in peacetime.

It is appropriate that the Government should allow the automatic stabilisers to work in response to an economic downturn.

However, the deterioration in the budget balance has been made worse by discretionary fiscal stimulus packages of doubtful effectiveness.

posted on 14 May 2009 by skirchner in Economics, Fiscal Policy

The Contradictions of FDI Protectionism

The ‘chairman’ of Hancock Prospecting, Gina Rinehart, argues against a Rio-Chinalco tie-up:

We cannot wish or assume that Rio-Chinalco (without investment conditions) will then invest in high-cost Australia.

What do India or Africa offer Rio and other mining companies? Massive and high-quality ore reserves and labour costs massively cheaper than in Australia.

What happens when Rio, perhaps enlivened with Chinese assistance, develops these massive projects in Africa and/or India?

Those projects offshore will compete against Australian mines and interests for many decades to come.

How will this help us to create more jobs? How will this help us to repay our growing debt? How will this help us maintain or grow standards of living?

Rinehart views FDI policy in protectionist terms, but her claim that Australian mining projects cannot compete with those in emerging markets is at odds with those who oppose the tie-up on the grounds that Chincalco would over-develop Australian resources with a view to lowering prices. The opposition to Chinese FDI in the Australian mining industry is fundamentally incoherent.

In sharp contrast to Gina Rinehart, Peter Gallagher has an excellent post responding to Malcolm Turnbull’s concerns about the proposed Chinalco-Rio tie-up.

posted on 13 May 2009 by skirchner in Economics, Foreign Investment

Nothing Has Changed

Unlike Richard Posner and all the other capitulationists, Bryan Caplan is conceding nothing:

Nothing that happened in the last two years should have significantly revised the general macroeconomic views of anyone who is (a) familiar with the last two centuries of global economic history, and (b) reasonable….

if you claim that 2008 overthrew everything you thought you knew about economics, I’ve got to wonder what you knew in the first place.

posted on 12 May 2009 by skirchner in Economics

One Survey, Two Headlines

The Australian:

Readers not averse to paying for online content

A GLOBAL survey has found that readers could be willing to pay almost as much for some high-quality online newspapers as they do for print versions, particularly in specialist news areas.

The SMH:

Readers reluctant to pay for online news

Rupert Murdoch’s aim to have readers pay for access to newspapers online has been called into question by a global survey that found readers are unlikely to pay for general news they can get elsewhere free.

posted on 11 May 2009 by skirchner in Media

More FDI Protectionism from Treasurer Swan

Not content with micro-managing foreign direct investment in Australia, the Rudd government’s latest approval under the Foreign Acquisitions and Takeovers Act also seeks to micro-manage Australian FDI in China:

My approval under the Foreign Acquisitions and Takeovers Act 1975 is conditional upon Ansteel supporting the wider development of infrastructure in the Mid West, and maintaining agreed levels of Australian participation in a greenfields joint venture in China’s Liaoning Province.

Using the FATA to obtain leverage for Australian FDI in China sets a dangerous precedent and ignores the basic reality that Australia benefits from Chinese FDI even in the absence of Chinese reciprocity. The answer to Chinese FDI restrictiveness is not to make our system more like China’s.

As with other recent FDI approvals, the Treasurer has once again made explicit the protectionist intent behind the exercise of his discretionary powers under the Act:

These undertakings support Australian mining jobs, and protect Australia’s investment participation in the Chinese resources market.

The FIRB and Treasury are going to be kept very busy if the Rudd government is going to micro-manage every FDI proposal coming out of China in coming years.

posted on 09 May 2009 by skirchner in Economics, Foreign Investment

Are Opinion Polls Consistent with Ricardian Equivalence?

The latest Newspoll finds 44% of respondents want the government to go ahead with the next round of legislated tax cuts, while 47% want the tax cuts cancelled ‘to help reduce the budget deficit.’ Given that the planned tax cuts are unfunded, respondents should be indifferent between these two choices. Today’s unfunded tax cut is tomorrow’s tax increase. All else being equal, the only reason why taxpayers should want a reduction in disposable income for the sake of a lower budget deficit is because they recognise the government’s inter-temporal budget constraint. The near even split on this question suggests your average punter is a good deal smarter than the commentariat.

posted on 05 May 2009 by skirchner in Economics, Fiscal Policy

Bruno Does Austrian Economics

Austrian economics, Bruno-style:

The search for fame leads him to Ron Paul’s door. Brüno attempts to seduce him after being told that featuring in a sex tape will help his celebrity stock to rise…Ron Paul didn’t twig…that a TV interview that was supposed to be about Austrian economics might end in a candle-lit hotel bedroom, where a blond male journalist would proffer cheap champagne before attempting to seduce him. Never, in his wildest dreams, could the 73-year-old hero [sic] of the Republican right have envisioned that a predatory homosexual would have the gall to suddenly drop his trousers. That’s why Paul ran away shouting: “This is ENDED!“

posted on 04 May 2009 by skirchner in Austrian School