Working Papers

2006 02

Harvard’s Russia Scandal

Institutional Investor has a special report on Andrei Schleifer and Harvard’s Russia scandal, which played a role in the recent resignation of Harvard President Larry Summers:

Since being named president of Harvard University in 2001, former U.S. Treasury secretary Lawrence Summers has sparked a series of controversies that have grabbed headlines…Then, in quiet contrast, there is the case of economics professor Andrei Shleifer, who in the mid-1990s led a Harvard advisory program in Russia that collapsed in disgrace. In August, after years of litigation, Harvard, Shleifer and others agreed to pay at least $31 million to settle a lawsuit brought by the U.S. government. Harvard had been charged with breach of contract, Shleifer and an associate, Jonathan Hay, with conspiracy to defraud the U.S. government.

Some might see a certain irony in the fact that Schleifer is a big name in behavioural economics, particularly as author of papers such as ‘Does Competition Destroy Ethical Behavior?’

posted on 28 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

PIMCO’s McCulley: Gimme that Old Time Regulation

The always bizarre PIMCO crew hark for the good old days of regulation:

This transformation of the central banking game has been evolutionary over the last twenty-five years, starting with the repeal of Regulation Q in 1980. 

Prior to that, central banking really was child’s play, as monetary policy worked its magic through a highly regulated, bank- and thrift-centric, essentially-closed domestic financial system. Regulation Q capped the interest rate that banks could pay on deposits, while capping the interest rate that thrifts could pay one-quarter percentage point higher. In return for that un-level playing field,  thrifts were required to deploy the lion’s share of their deposits into long-term, fixed rate mortgages.

It was an ideal world for banks and thrifts, as well as the Federal Reserve. It was a world of regulated competition, with the Fed having colossal power to impact the pricing, availability and terms of credit creation. The set up was particularly well suited to the Fed counter cyclically fine tuning the housing cycle (and, thus, the business cycle!).

And what a bang-up job they did of counter-cyclical fine-tuning in the 1970s!  In fact, the 1980s and the 1990s have seen a secular decline in the volatility of real GDP growth, inflation and interest rates that owes an enormous debt to the financial de-regulation of the early 1980s, as does PIMCO itself.

posted on 28 February 2006 by skirchner in Economics

(1) Comments | Permalink | Main

| More

Bringing Currency Competition to the Euro Zone

John Gillingham, speaking at an Open Europe seminar on his book, A Design for a New Europe:

I propose in my book an idea that has considerable circulation within the City and which was at one point on the Treasury agenda in Britain. That is changing the euro, not destroying it, but changing its operating mechanism from being the sole currency in a single economic area to a parallel currency that finds its market value in competition to reissued national currencies.

It does two things: first of all I believe that it is technically credible and sensible because it allows the currencies to adjust against one another on a daily basis. It eliminates the life of the major shock that the euro could still face once it becomes apparent that a currency that was designed for a political goal, that is to be a step towards a closer economic and political union, has been organised for a country that will never exist…

I think that the currencies of the euroland should be reissued and any attempt to regulate the values of the currencies by an overall single monetary and fiscal straight jacket should be dropped. The values of the currencies will depend on the strength of the individual national economies. The euro is a good “numéraire” because the EU can’t run a deficit. So it can be a depositary bridge and has a real value to discipline governments.

Hayek would approve.

posted on 28 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

Peter Costello’s International Tax Beauty Contest

Treasurer Costello has instituted a study to ‘internationally benchmark’ Australia’s taxation system to those found in other countries.  The inquiry will report in April, just before the May Budget.  The Treasurer has already indicated that he thinks that Australia’s tax system compares favourably to other OECD countries.  While this is almost certainly true, it is also completely irrelevant. 

The most obvious benchmark for Australia is the US.  The US is itself the scene of a major debate about tax reform, reflecting what many regard as fundamentals flaws in their tax system (for one contribution to the US debate, see here).  To say that Australia compares favourably to other countries is simply to highlight the woeful state of revenue raising systems throughout the OECD.  This reflects the simple reality that taxation is an area of public policy that is particularly vulnerable to corruption via rent-seeking and, once corrupted, becomes very difficult to reform.

Costello will almost certainly use the report’s findings to re-assert his authority over the tax debate, while at the same time seeking to counter demands for a renewed tax reform effort in Australia.  It confirms Costello’s position as the most conservative politician in Australia, in the non-political sense of the term.

posted on 27 February 2006 by skirchner in Economics

(1) Comments | Permalink | Main

| More

Self-Censorship at SBS

The supposedly fearless SBS ‘defers’ an episode of South Park.  As Cartman would say, weeeak!

UPDATE: Matt Stone’s father, Gerald Stone is an economist and U of Kentucky graduate students (such as Hypothetical Bias creator, Whitehead) from the mid to late 80s know him from the principles text, Byrns and Stone.

posted on 25 February 2006 by skirchner in Culture & Society

(1) Comments | Permalink | Main

| More

Fundamentals of House Price Inflation: Single Eye for the (Straight) Melbourne Guy Edition

Previous posts have noted the convergence in capital city house prices with those in Sydney and suggested, as has RBA Governor Macfarlane, that internal migration is one of the equilibrating factors at work.  The latest ABS release on regional population growth is consistent with this view, as reported in The Australian:

SYDNEY’S population growth is lagging behind that of Brisbane and Melbourne, with fresh evidence people are abandoning the nation’s largest city to escape inflated property prices and reduced job opportunities.

Australian Bureau of Statistics figures released yesterday show Melbourne and Brisbane outstripped Sydney’s population growth rate last financial year.

The figures are further evidence the NSW economy has slowed, with Melbourne attracting a net 41,300 people last year, a growth rate of 1.1 per cent, compared with Sydney’s 29,800, or 0.7 per cent.

Brisbane remains the fastest-growing city, with a growth rate of 1.9 per cent, while coastal regions continued to lure those in search of a sea change…

The lower growth rate came despite 37,000 migrants arriving in NSW during 2004-05.

However, 26,000 people left NSW for another state during the same period.

ABS statistician Andrew Howe said Melbourne had been growing faster than Sydney since 2001.

The figures show southeast Queensland continues to boom, growing by 53,300 people, or more than 1000 a week.

The Australian report (channeling the tabloid style of the SMH), goes for this supposedly illustrative vox pop:

Management consultant Janet Martin is among those making the shift south. Having lived in Sydney for 10 years, Ms Martin decided six months ago to move from Annandale in Sydney’s inner west to South Yarra in Melbourne’s inner east in search of a more vibrant culture and cheaper housing.

Ms Martin, 34, said the increased proportion of single men in the city had proved an added bonus. She had spent the last year and a half in Sydney single, but found a boyfriend within two months of moving to Melbourne.

“All I know is now I have a boyfriend who’s my age, who has two cats and wants to make babies,” Ms Martin said.

Increased proportion of straight men perhaps!  For the record, the median Sydney house price actually rose 1% in Q4, consistent with the argument I made some time ago that Sydney house price growth would bottom relative to trend by the middle of 2006.  But as the ABS release shows, it is the differences in annual growth rates among the capital cities that are the more interesting story.

posted on 24 February 2006 by skirchner in Economics

(5) Comments | Permalink | Main

| More

Who Spiked the Drinks at the BIS?

A report in the Torygraph pointed me in the direction of this BIS Working Paper.  As the Torygraph and the author himself note, the arguments presented are a significant departure from what might be considered the current orthodoxy in favour of inflation targeting.  Indeed, they are a bizarre mix of Bretton Woods era economics and fever swamp Austrianism (note the use of the vague Mises quote at the beginning of the paper, which in my experience usually signals that some abuse of the Austrian tradition is about to follow).

Although the author is somewhat vague when it comes to policy prescriptions, his main claim is that the absence of Bretton Woods-type arrangements is responsible for the supposed problem of global imbalances:

The underlying problem is that we no longer have a coherent system that somehow forces countries to alter their relative degrees of domestic absorption, and associated exchange rates, so as to reduce external imbalances in an orderly way…While it is logically possible that policy measures consistent with resolving domestic imbalances might resolve external imbalances as well, this should not be assumed. In any event, it is not likely to happen. This leads on to the question of whether there are institutional changes that might be recommended to strengthen the international adjustment process.

The reason Bretton Woods institutions were largely dispensed with in the early 1970s (with the exception of the IMF, which somehow managed to survive its redundancy), was precisely because external imbalances were a serious problem under fixed exchange rate regimes.  The move to floating exchanging rates and open capital accounts solved this problem and eliminated the external balance constraint on growth, with enormous benefits for those economies that liberalised along these lines.  It is therefore nothing short of bizarre to suggest that global imbalances now argue for a return to Bretton Woods-type institutions. 

What the author, and many others who see global ‘imbalances’ as a problem, are effectively saying is that the Anglo-American economies should stop outperforming the rest the world and instead try and look more like everyone else.  Those who argue that this outperformance is built on debt and asset prices have things exactly the wrong way around.  Rising debt levels and asset prices are merely symptomatic of expectations for continued strong economic growth.  To argue otherwise is to implicitly attack the institutional foundations of Anglo-American economic success.

The author favours a consolidation in the number of currencies.  As Hayek would argue, we need more currencies, not less.  For the author to invoke the Austrian tradition on behalf of proposals for a global macro regulatory framework and reduced currency competition is a travesty of that tradition.

posted on 23 February 2006 by skirchner in Economics

(1) Comments | Permalink | Main

| More

Bernanke, Warsh, Inflation Targeting and the Fed

Brian Wesbury on the internal politics of the Fed:

Issues with the press and internal Fed battles are much more complicated, as well as interrelated. For example, last week’s public attacks on Kevin Warsh—a key White House staffer and one of President Bush’s recent nominees for Federal Reserve Board governor—appear to be part of this nexus.

These attacks violated an unwritten rule that former Fed members do not publicly disagree with the Fed or its chairman. They were orchestrated by a retired Fed governor who claimed that Mr. Warsh was not qualified to be on the Fed as he was not trained by academics to be an economist. Instead, he is a lawyer with extensive Wall Street experience and knowledge of the capital markets. Given that Mr. Bernanke worked with him in the White House, and likely had veto power, we can assume he supported the nominee. So someone else inside the Fed may have encouraged the attacks in order to send a warning shot about any moves toward inflation targeting that might be made by the new chairman and his newest colleagues. Like any D.C. institution, the Fed abhors change and accountability, and inflation targeting would force both.

posted on 22 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

The Benign View of Global Imbalances

RBA Governor Macfarlane has long taken a benign view of global ‘imbalances.’  Fortunately, it would seem that this perspective is shared by his Deputy, Glenn Stevens, widely tipped to take over from Macfarlane when his current term expires in September:

it is common for observers to warn against the risk that the ‘imbalances’ may unwind in a disruptive fashion. Often this is not spelled out. What is sometimes meant, I think, is that those currently accumulating dollar-denominated claims suddenly change their minds, precipitating abrupt movements in exchange rates and interest rates. Such developments might, in this view, lead to a pronounced weakening of domestic demand in countries like the US if long-term interest rates rose abruptly, while a big decline in the dollar might affect the ability of areas like Europe to export.

One can never rule out the possibility that financial markets will suffer a sudden and dramatic loss of confidence. But it is not as though markets are unaware of the various ‘imbalances’ or the associated risks – they read about them on a daily basis. Yet the actual pricing for risk in markets apparently suggests an assessment that risks in general are of relatively little concern at present.

In the event that there is some market discontinuity, I suspect that it is more likely to be sparked by some sort of credit event that prompts a change in appetite for risk in general, than by reactions to current account positions per se. It is not obvious that US interest rates would rise, or the dollar fall, in the face of such an event.

posted on 22 February 2006 by skirchner in Economics

(5) Comments | Permalink | Main

| More

Kirchner the ‘Cornucopian’

Via my server stats, I found this rather amusing link to Institutional Economics:

Skirchner seems well-educated, a good writer, and glowingly optimistic. Yet within the span of a few posts, beginning with his January 24th “The Doomsday Cult Comes to Reno,” Skirchner says “Warren Buffet is sounding more and more ridiculous,” “Stephen Roach is having trouble getting his colleagues and clients to take him seriously,” “PIMCO’s Bill Gross [is] keeping the doomsday cult alive,” and “The Economist has a tired and predictable piece on Greenspan’s legacy.” All of this, and likely more on his blog pretty much contradicts all of what I post here.

So what gives? How is it that Skirchner can be so optimistic and me so pessimistic? Does he see more than I? Less? Do we both see pretty much the same stuff, yet draw radically different conclusions as to what is and what might come? I dont’ know.

Maybe Skirchner and others can help me to see the world differently, or at least to better understand how those I call “Cornucopians” can be so glowingly optimistic.

I’m here to help!  But if Bretton Woods era economics is really more your thing, you can always go check out Brad and Nouriel, the Stadler and Waldorf of international macro.

As far as the contrarian optimist versus doomsday cult scorecard goes, Kevin Hassett notes that Q1 GDP growth in the US is shaping up as a boomer (and yes, I know about the weather.)

posted on 22 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

Two New Australian Academic Economist Blogs

I have been remiss in not linking earlier to two new blogs by Australian academic economists: Joshua Gans and Harry Clarke.  You can still count on one hand the number of Australian academic economists who blog (I would even exclude myself from the list, since I do not hold a full-time academic position).  This is in sharp contrast to the economics faculty at George Mason University, most of whom seemingly engage in blogging in one form or another.  This is indicative of the fact that the GMU faculty are among the world’s most interesting academic economists. 

Gans constructs a purchasing power parity index based on iTunes prices, which confirms what many Australian iTunes users probably already suspect:

apart from Canada, iTunes songs are priced at a premium in other music stores. This echoes my observations about the Australian iTunes music store in The Age (4th November, 2005) where I noted the substantially higher prices for all iTunes products (if they were available) in Australia as compared with the US.

It is amazing that for all the talk about globalisation, such price discrimination remains viable, exploiting simple things like the lack of effective cross-border markets in retail financial services.  Many of the things that are commonly assumed to be thoroughly globalised are anything but.

posted on 21 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

The Ultimate in ‘Downshifting’

Proving that you can make anything fashionable in the name of environmental awareness, the neo-socialist Australia Institute identifies the latest in inner-city environmental trends, ‘skip-dipping:’

IT IS supposed to be the domain of the destitute and desperate, but scavenging through other people’s rubbish is emerging as a favourite pastime of well-heeled city dwellers.

Research by the Australia Institute suggests the practice of searching through bins for unused food, clothing and household goods, known as “skip dipping”, is becoming popular among well-educated professionals sick of contributing to increasing landfill.

Interviews by the Australia Institute conducted between December and February revealed that people of all ages and from all walks of life, including computer programmers, designers, public servants and retirees, do their shopping in other people’s bins.

Scavenging through other people’s garbage is a logical extension of the ‘downshifting’ to a less affluent lifestyle favoured by the Australia Institute.  Indeed, if the Institute were ever to get its way, many more people could look forward to living out of garbage bins, although more out of necessity than environmental awareness. 

(via Catallaxy)

posted on 18 February 2006 by skirchner in Economics

(6) Comments | Permalink | Main

| More

The RBA’s Policy Bias

In a rare display of insight on the part of a member of the House Economics Committee, Craig Emerson questioned RBA Governor Macfarlane on differences in the Bank’s presentation of its policy bias in his prepared testimony to the Committee compared to the Statement on Monetary Policy earlier in the week.  Macfarlane denied there was any difference, arguing that the two presentations were intended to be the same, although he also noted that the statements had two different authors.  Financial markets took a different view, with the Australian dollar rallying and bond futures selling-off after the delivery of his Committee testimony, implying that the market thought there was a change in emphasis.

This episode confirms my view that the RBA does not give as much thought as it should to the presentation of its policy bias and its statements are over-interpreted relative to the thought the Bank puts into them.  It seems incredible to me that a backbencher could discern a key difference in presentation that was not apparently discernable to the Governor of the Bank.  Consistency in communication has never been the Bank’s strong point.  The Statement on Monetary Policy is a misnomer, since most of the document studiously avoids any discussion of the policy outlook.

posted on 17 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

Sydney and the Rest: Convergence in House Prices

Yesterday’s RBA Statement on Monetary Policy included the following chart, showing the ratio of Sydney to other capital city house prices, using the composition-adjusted APM series:


The chart suggests the possibility of a long-run equilibrium relationship between capital city house prices.  Note that the adjustment is coming from both sides:  Sydney house prices are falling, while those in other capital cities are still rising, in some cases quite strongly.  As noted previously, those capital cities benefiting most from the commodity price boom are still experiencing strong house price growth.  Since the boom in commodity prices is exogenous to the Australian economy, this implies that it is broader economic developments that are driving house prices, not the other way around.  Internal migration is also likely to be a factor in driving convergence.

Previously, we have also noted that the global price shock to residential property as an asset class invalidated attempts to explain national house prices with reference to country-specific factors, such as changes in capital gains tax.  This chart also implies that these simplistic mono-causal explanations are also invalidated from the bottom-up.  The national story obscures what is happening on a state-by-state basis.

posted on 14 February 2006 by skirchner in Economics

(6) Comments | Permalink | Main

| More

Why Central Banks Should Not Burst ‘Bubbles’

An IIE Working Paper by Adam Posen, arguing that monetary policy should not seek to burst asset price ‘bubbles.’  While I would reject Posen’s assumption that markets can be meaningfully characterised as experiencing ‘bubbles’ (and Posen himself notes some of the real factors that give rise to so-called bubble behaviour), his bottom-line is essentially correct:

Bubbles generally arise out of some combination of irrational exuberance, jumps forward in technology, and financial deregulation (with more of the second in equity price bubbles and more of the third in real estate booms). Accordingly, the connection between monetary conditions and the rise of bubbles is rather tenuous, and by raising interest rates a central bank is unlikely to achieve what is needed—i.e., persuading investors that the bubble is ill-founded and/or that they will not find some greater fool to sell to in time. More important, the cost of bubbles bursting largely depends upon the structure and fragility of the economy’s financial system. A properly supervised and regulated financial system—or one with more securitized and liquid markets than bank-dependent—will not suffer much in real terms from a bubble expanding and bursting. If the financial system is fragile or improperly supervised, then monetary tightening will be even more costly in real economic terms, but such tightening in no way substitutes for directly dealing with the underlying financial problems.

The lack of monetary tightening’s effectiveness to pop bubbles or to respond to financial fragility and the far greater cost of inducing recessions than riding bubbles out are structural factors characteristic of modern financial systems and bubbles. The cost-benefit analysis inherently goes against popping bubbles and in favor of monetary easing after busts because there is an asymmetry in the way investors and financial intermediaries behave in the two situations. In the end, no amount of monetary discipline can substitute for lack of proper financial regulation and supervision.

posted on 12 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

De-Monetisation of Copper

Never mind the supposed ‘re-monetisation’ of gold, what about the de-monetisation of copper.  The price of copper is now so high that the copper content of small denomination coins may now exceed their face value.  Larry White points to the case of Korea, which is suffering from reverse seignorage:

The production cost of a W10 coin is about W40, W14 of that for copper and zinc alone.

Australian coins are 75-92% copper, although we wisely took smaller denomination coins out of circulation years ago.

posted on 10 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

Meta Prediction Markets

A prediction market in prediction markets.

posted on 08 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

More Gold Buggery

One of the reasons why it is hard to take gold bugs seriously is that much of the hype around gold seems to be linked to the selling of gold stocks.  A number of people have pointed me in the direction of this report from the Cheuvreux broking house, which contains this rather bullish forecast under the heading ‘Remonetisation of Gold: Start Hoarding’:

We also believe that there is a reasonable chance that we could see the gold price
spike up much further, possibly to USD2,000/oz or even higher.

The report is a good summary of the gold bugs’ rather conspiratorial worldview, but I find very little of it convincing, for reasons articulated in previous posts.  Remarkably, the report argues that both inflation and deflation are good for the gold price, so gold seemingly can’t lose.  It is also quite possibly the longest buy recommendation for a gold stock (specifically, Anglo-American) ever penned.

posted on 07 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

What Does the Gold Price Tell Us?

The 25 year highs in the nominal gold price have seen the gold bugs out in force.  It is often claimed that gold has special properties, either as a leading indicator of inflation or the stance of monetary policy.  Yet gold’s correlation with commodity prices in general suggests that it has no special properties in this regard.  The following chart shows the USD gold price, alongside an index of base metal prices in USD terms:


The most that could be said for gold is that there have been episodes where the gold price has led base metal prices.  As an indicator of the business cycle and inflation pressures, base metal prices would seem to be a better coincident indicator, which follows logically from their use in a much wider range of industrial applications.  Even gold’s role as a store of value is not entirely unique, since base metals are also subject to inventory cycles and inter-temporal arbitrage. 

The next chart shows gold alongside the Fed funds rate:


Again, gold would seem to lead Fed funds, although one could just as easily argue that the Fed funds rate is a lagging indicator of the business cycle!  If we are to take gold seriously as an indicator of the stance of monetary policy, then we would have to argue that policy was too tight from the mid-1990s through to the early 2000s, contrary to what is indicated by base metals prices.  This would argue against the notion that monetary policy was accommodative during the late 1990s equity market boom. 

There are of course those who argue that the gold price was being artificially suppressed by official sector gold sales during the late 1990s and early 2000s.  If one thinks that a market price is being manipulated in this way, then this is an even stronger argument for not using it as an indicator.

posted on 04 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

There Are Worse Things than Debt

The AEI’s John Makin has an interesting discussion of low bond yields that attempts to put the ‘condundrum’ in a structural setting.  His discussion of the relevant fundamentals argues against any ‘bubble’ characterisation, but Makin can’t help throwing this non-explanation into the mix as well, ‘bubbles’ being an all-purpose theory of everything and nothing in relation to asset prices.

Makin argues that bond yields are now so low, that governments should start looking to debt financed tax cuts, on the grounds that the welfare costs of current marginal rates are so high as to make debt finance look cheap by comparison:

Imaginative treasury secretaries and finance ministers should take note of another opportunity offered by the extraordinarily low borrowing cost that can be obtained by issuing long-maturity inflation-indexed debt. Governments should consider a debt-financed investment in a transition to lower and more uniform marginal tax rates that many studies have shown would result in an increase in long-term growth rates of up to one half of 1 percent. For a $12 trillion economy like the United States, one half of 1 percent is $60 billion a year, measured in current dollars. The present value, again measured in current dollars, of $60 billion per year given a 2 percent real interest rate used as a discount rate, is $3 trillion. Therefore, even if a move to lower and more uniform marginal tax rates entailed transitional costs of several hundred billion dollars, it could still constitute a good investment for most governments.

This does not account for any negative wealth effect associated with a higher future tax burden, which is why I think it is preferable to finance tax cuts out of current government spending.  But Makin’s suggestion highlights the extent to which conservative and libertarian think-tanks have changed their tune in recent years.  In the 1970s and 1980s, these think-tanks spent much of their time criticising lax fiscal and monetary policy.  These days, the same think-tanks are much more forgiving.  Although Makin seems to have difficulty deciding whether he is a monetary policy hawk or dove from one month to the next, it is now commonplace for those at conservative and libertarian think-tanks to fret over the possibility that the Fed is overdoing its tightening effort.  It shows what a different world Greenspan leaves behind compared to the one he started with.

posted on 01 February 2006 by skirchner in Economics

(0) Comments | Permalink | Main

| More

Follow insteconomics on Twitter