Working Papers

2007 05

Do Markets Care Who Chairs the Central Bank?

According to this paper by Kuttner and Posen, they do.  Once again, the RBA, or more specifically, former Governor Bernie Fraser, serves as an influential observation in this study:

One puzzling result involving the bond yield is that there is a significant market reaction for the non-newsworthy subsample, which is meant to consist only of appointments that were widely anticipated ahead of time. At first glance, this seems to contradict the proposition that the market should respond only to new information. An inspection of the individual responses in table 2 reveals that this anomalous response can be traced to two observations: Australia’s 1989 appointment of Bernie Fraser and Norway’s 1996 appointment of Kjell Storvik. Both of these were classified as anticipated appointments, based on the press reports, and yet, both were associated with pronounced bond market responses.  Yields rose 15 basis points (two standard deviations) on Fraser’s announcement and fell 19 basis points (over four standard deviations) on Storvik’s.

In Fraser’s case, the reason for the unusual reaction is relatively clear. The likely choice of Fraser, the sitting Secretary of the Treasury, had been criticized in the weeks prior to the announcement as an appointment that would predispose the Reserve Bank of Australia (RBA) to yield to political pressure for more accommodative monetary policy. And, while Fraser was widely viewed as the clear front-runner for the job, there was some speculation that Bob Hawke’s government would back away from its preferred candidate and appoint instead one of several viable candidates from within the RBA. Thus, the adverse market reaction provoked by the announcement suggests Fraser’s appointment was not thought to be entirely certain. Reclassifying the appointment as newsworthy along these lines would make the bond market’s reaction significant at the five percent level for newsworthy events and not significant for non-newsworthy events, thus eliminating one minor anomaly in the results.

posted on 31 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Australian Economists Repudiate Kyoto

The latest media stunt by the anti-modernist Australia Institute has backfired, with Warwick McKibbin noting on ABC Radio that only 10% of those eligible to sign the economists’ petition in support of Kyoto actually did so.  McKibbin was a particularly notable non-signatory, given his expertise in climate change policy. 

UPDATE:  Damien Eldridge explains his reasons for not signing.

posted on 28 May 2007 by skirchner in Culture & Society, Economics, Politics

(0) Comments | Permalink | Main

| More

Sad, But Probably True

Justin Wolfers, quoted in American.com:

I could do the same work I’m doing now for an Australian institution, and the truth is, no one would listen.

posted on 26 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

The Economy and the Polls: A Rational Choice Perspective

Australia’s incumbent federal Coalition government is struggling in the opinion polls ahead of this year’s federal election, despite some of the strongest economic conditions in the post-war period.  Treasurer Peter Costello likes to boast of his role in ‘managing a trillion dollar economy.’  As Andrew Leigh notes, we must have all missed Australia’s transition from a market to a planned economy!  It is likely that voters are aware of this distinction, even if Peter Costello is not. 

There is some evidence to suggest that economic data has predictive power for the incumbent two-party preferred vote share at the federal level.  Yet rational choice theory would also lead us to expect the two main parties to fully endogenise the preferences of the median voter ahead of the federal election.  The modifications that both parties have made to their industrial relations policies in recent weeks are consistent with the predictions of the median voter model.  Opposition leader Kevin Rudd’s claim to be a ‘fiscal conservative’ is similarly an attempt to endogenise the preferences of the median voter.  Rudd’s political skill lies largely in not differentiating himself from the federal government, unlike former leader Mark Latham, who actively sought to differentiate himself on issues such as school funding and health.

This model still fails to explain why the opposition should enjoy such a strong lead in the polls, since the model is more consistent with voter indifference, with actual election outcomes a random walk.  However, it is noteworthy that betting and prediction market pricing of the election seems closer than that suggested by the opinion polls.  As Bryan Palmer notes:

The book makers are saying that if the same 2007 Federal election were repeated 20 times, John Howard would expect to win 9 elections and Kevin Rudd would expect to win 11. It is still a close contest.

As Andrew Leigh’s research has found, markets such as these may have better predictive power for election outcomes than opinion polls and economic data. 

From the perspective of a rational voter, there are few substantial differences between the Coalition and Labor on monetary and fiscal policy and a diminishing amount of product differentiation on industrial relations.  Since the last federal election, it is also likely that voters have learned that international and cyclical influences are more significant in the determination of interest rates than anything the government might do with the federal budget balance.

posted on 24 May 2007 by skirchner in Economics, Financial Markets, Politics

(1) Comments | Permalink | Main

| More

China’s Monetary and Exchange Rate Policy

Ahead of the US-China Strategic Economic Dialogue, Matthew Slaughter explains why the preoccupation with China’s managed exchange rate regime is misplaced:

Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows.

Like all other central banks, the People’s Bank of China uses its monopoly power over minting its money to control one nominal price. Since 1994 the PBOC has chosen to closely target the dollar-yuan price. In recent times, maintaining this target has required the PBOC to print yuan to buy dollars and thereby accumulate dollar-denominated assets on its balance sheet…

In a counter-factual world where over the past decade China allowed the yuan to float against the dollar, the U.S. would still have run a large and growing trade deficit with China. The real economic forces of comparative advantage that drive trade flows operate regardless of which nominal prices central banks choose to fix.

As this paper from the Bank of Japan explains in detail, China’s money market operations are largely subordinate to the requirements of its managed exchange rate regime.


posted on 22 May 2007 by skirchner in Economics, Financial Markets

(1) Comments | Permalink | Main

| More

The Politicisation of the Future Fund

The Future Fund has barely invested a single cent and yet it is already the target of rent-seeking in relation to its basic administrative arrangements, such as its choice of custodian.  The Future Fund’s investment decisions will be the subject of even greater scrutiny, especially following Chairman David Murray’s recent suggestion that the Fund would seek to invest in private equity.  This scrutiny will necessarily be after the fact, given the lack of transparency around the Fund’s investment process.  By creating an asset portfolio subject to public ownership and control, the Future Fund will increasingly become a focus for distributional conflict and rent-seeking.

posted on 22 May 2007 by skirchner in Economics, Financial Markets

(1) Comments | Permalink | Main

| More

The World Bank is the Scandal, Not Wolfowitz

A Bloomberg podcast interview with CMU’s Adam Lerrick on the World Bank.

posted on 19 May 2007 by skirchner in Economics, Financial Markets

(2) Comments | Permalink | Main

| More

More Currency Speculation from Warren Buffett

Warren Buffett is back making currency bets, although this time is saving himself the embarrassment of revealing what they are:

Warren Buffett, perhaps the world’s most influential investor, sent the foreign exchange markets scrambling this week after revealing that he had made a “surprising” new bet on the currency markets.

Mr Buffett added to the intrigue by indicating he was only actively buying one currency. “We will tell you about it next year,” he said.

At first glance, the Sage of Omaha is not taking his own advice.  “The cemetery for seers has a huge section set aside for macro-forecasters,” he once said…

Mr Buffett’s Berkshire Hathaway did make more than $2bn overall on a $20bn-plus bet against the dollar that began in 2002, even after the market moved against him to the tune of $1bn in 2005. But he has phased out most of the direct bet – which had started to cost money to hold – in favour of investments in companies with sales in other currencies…

Perhaps the most surprising call for him would be to reverse his bearish stance on the dollar.

Paul Mackel, currency strategist at HSBC, says it is possible that Mr Buffett thinks that US economic growth could accelerate, and has bought the currency.

Ultimately, though, Mr Mackel says that Mr Buffett’s views on currencies are unlikely to carry as much weight as his views on companies.

“His currency calls do generate a lot of headlines, but I’m not sure quite how seriously people take it,” adds Mr Mackel.


posted on 19 May 2007 by skirchner in Economics, Financial Markets

(1) Comments | Permalink | Main

| More

Another Wooden Spoon for the Reserve Bank

The Reserve Bank of Australia typically scores poorly in cross-country rankings of central bank transparency and accountability.  It can now add to its collection of wooden spoon awards bottom place in JP Morgan’s index of central bank communication.  Indeed, the RBA is such an outlier that it single-handedly establishes a significant relationship between the JP Morgan index of central bank communication and at least one of their measures of interest rate forecast errors. 

Of course, the fact that the RBA serves as an influential observation in this study only serves to highlight the more general conclusion from this and other studies, that there is typically not a robust relationship between measures of central bank transparency and measured market volatility.  This does not, however, negate the purely procedural case for increased transparency and accountability on the part of the RBA.

posted on 17 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Peter Costello as ‘Old-Fashioned Christian Socialist’

At the same time that Treasurer Peter Costello has been branding opposition leader Kevin Rudd a socialist, Jennifer Hewett finds that Peter Costello is not above a bit of old-fashioned Christian socialist resentment either:

An aggrieved Peter Costello certainly won’t be breaking out the champagne to celebrate with Allan Moss or Nicholas Moore.

Their $30 million-plus salaries will fuel the Treasurer’s anger with what he regards as a culture of greed and arrogance at the multi-multi-millionaires factory.

Costello doesn’t like investment bankers much in general. But the uber-bankers at Macquarie, in particular, represent all that most irritates him.

How, he wonders, can these guys justify earning so much while giving so little back?

Those who know the Treasurer well have learned to expect a private tirade of vitriol about Macquarie whenever the bank’s name comes up.

“He sees people benefiting from his hard work on the economy, enjoying the fruits of the Government’s labour and earning obscene amounts of money that he could never earn,” says one insider.

It’s not so much that Costello wants to earn or spend such vast sums of money himself. His Baptist upbringing in Melbourne has moulded him as much as it has his brother Tim, chief executive of World Vision Australia.

Even if their careers have gone in different directions, Peter Costello still finds personal excess distasteful, rather gross. And it’s not just a matter of disliking Sydney glitz.

What really rankles the Treasurer is what he regards as the sheer and grotesque imbalance in the money equation, given how hard he believes government ministers work. None more so than himself….

Another problem is that the Treasurer sees investment bankers as not actually producing anything.

...unlike politicians.

posted on 16 May 2007 by skirchner in Culture & Society, Economics, Politics

(0) Comments | Permalink | Main

| More

Ken Henry’s Supply-Side Economics

Treasury Secretary Ken Henry has previously argued that the Australian economy is operating in a classical world and his emphasis on the supply-side of the economy puts him squarely within the classical tradition.  This is why analysis of the federal budget in terms of Keynesian demand-management is so misplaced.  The ‘tax cuts lead to higher interest rates’ brigade simply fail to understand what is driving fiscal policy.   

Henry’s traditional post-Budget address to Australian Business Economists reiterated some of the main themes in the Budget papers, including this analysis of the supply-enhancing implications of the government’s tax cuts:

The Treasury’s participation modelling project has the capability to assess the impact on labour supply (or potential labour utilisation) of tax-transfer policy changes in particular.  We have run last week’s tax cuts through our version of the Melbourne Institute Tax and Transfer Simulator (MITTS).  Most of the positive impact on labour supply comes from the increase in the 30 per cent threshold from $25,000 to $30,000 – including the labour supply response of many secondary earners.  The increases in LITO and the 40 per cent and 45 per cent thresholds are also positive for labour supply, though smaller.  And the increase in the dependent spouse rebate is estimated to produce a very small negative impact on labour supply.

Overall, we calculate that the Budget tax cuts might increase labour supply by about 0.1 hours per week.  If this additional supply is fully employed, the increase in labour utilisation will lift the employment ratio by about a third of a percentage point. 

But there is another way of looking at this.  The increase in labour supply expands potential GDP in the same way as a cut in the NAIRU does.  As a rough approximation, an increase in labour supply of 0.1 hours a week would have about the same impact on potential GDP as a cut in the NAIRU of half of a percentage point – quite a significant amount.

The package of tax cuts announced in last year’s budget, and in particular the increase in the 30 per cent threshold from $21,600 to $25,000, would have added about another 0.1 hours a week to labour supply.  Thus, over two budgets, the increase in this threshold could have an impact on potential GDP broadly equivalent to a one percentage point cut in the NAIRU.

Changes to child care arrangements announced in last week’s budget can also be expected to make a positive contribution to labour supply.  Coming on top of the earlier welfare-to-work measures and the superannuation changes announced in last year’s budget, we have had quite a significant policy-induced boost to the economy’s supply capacity.


posted on 15 May 2007 by skirchner in Economics, Financial Markets

(2) Comments | Permalink | Main

| More

The Anti-Capitalist Origins of the Foundational ‘Bubble’ Myth

A review of Anne Goldgar’s Tulipmania: Money, Honor, and Knowledge in the Dutch Golden Age, which discusses the anti-capitalist origins of the foundational ‘bubble’ myth:

Some contemporary pamphleteers attacked the trade, baffled by what one Englishman called the “incredible prices for tulip rootes”, and disquieted by the godless materialism of it all. They feared, wrongly, that the trade subverted the social order by making poor people rich. As almost no other contemporaries wrote about tulipmania, these biased pamphlets informed most later accounts.

Most tulip tales we know, scolds Goldgar, “are based on one or two contemporary pieces of propaganda and a prodigious amount of plagiarism”.


posted on 13 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Pop! Why Bubbles Are Great for the Economy

Dan Gross presents a summary of his book, Pop! Why Bubbles Are Great for the Economy.  Jason Potts does a much better job making much the same argument here, locating the case for ‘bubbles’ squarely within the Austrian market process tradition. 

I would argue that the term ‘bubble’ has no analytical content.  More often than not, it is used tautologically as a description of asset price behaviour, while offering no insight into the process by which asset prices are determined.  Peter Garber’s Famous First Bubbles shows how the idea of ‘bubbles’ in asset markets rests on very shaky historical and intellectual foundations that drive the widespread popular misuse of the term today.

posted on 10 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Tax Cuts & Interest Rates: Round Up the Usual Suspects

Actually, there are very few members of the economic commentariat arguing that tax cuts will lead to higher interest rates in response to this year’s federal budget.  Even Wowser Ross was forced to concede that the budget would not put upward pressure on interest rates, while Brian Toohey in the AFR (unlinkable) argued that ‘at least the tax cuts can be seen as having some incentive effect.’ 

Part of the reason is that in the Budget papers, the Treasury makes explicit the links between tax cuts and increased labour supply, going so far as to quantify the expected impact of the tax cuts on labour force participation.  This puts the commentariat in the position of having to argue against Treasury numbers, something few of them are brave enough to do.  Since many of the economics writers in the mainstream press rely on wholesale recycling of Treasury speeches and other research as the basis for their columns, they are not about to start arguing with one of their favourite sources.  The fact that the tax cuts are aimed at low income earners also helps, since few are prepared to argue against tax cuts for the low paid.  Tax cuts for the ‘rich’ would have been a different story.

The fiscal impulse between 2006-07 and 2007-08 is a small 0.3% of nominal GDP.  Some will make the argument that the timing of budget measures makes the short-run stimulus larger, but this misses the point of what has been happening with the budget balance in recent years.  The main problem faced by the government has been to avoid what would have been a large fiscal contraction induced by above forecast revenue collections.  Recent budgets have largely been aimed at keeping the fiscal impulse steady, by returning some of this increased revenue in the form of tax cuts and increased spending.  This is a phenomenon the RBA has also noted, which is one of reasons it has not been bothered by fiscal policy in recent years.

The most salient aspect of fiscal policy is that the government has been raising much more revenue that it needs to fund recurrent expenditure.  This government is in the process of accumulating a large negative net debt position, to the tune of nearly 5% of GDP by 2010-11.  Hence the advent of the Future Fund to manage these assets.  The Future Fund concept has now been extended to include a higher education endowment. 

We know from the prospective fiscal gap identified in the most recent Intergenerational Report that, on a no policy change basis, federal spending will eventually outstrip revenue.  The solution to this problem is not to hoard revenue now, but to grow the economy faster today, while restructuring federal tax and spending programs to put them on a more sustainable long-term footing.  This is the basis on which fiscal policy should be assessed, not its largely imaginary implications for interest rates.

posted on 09 May 2007 by skirchner in Economics, Financial Markets

(4) Comments | Permalink | Main

| More

No, Virginia, Tax Cuts Don’t Cause Higher Interest Rates

The Federal government will hand down its 2007-08 Budget next Tuesday facing an all too familiar embarrassment of riches.  On a no policy change basis, the 2006-07 underlying cash surplus could easily exceed $16 billion compared to a MYEFO estimate of $11.8 billion, with the 2007-08 surplus likely to be in excess of $10 billion. 

The actual surplus will then depend on how the government allocates the surplus among new spending, tax cuts and the Future Fund.  The challenge for the government in recent budgets has been to hold the fiscal impulse neutral, by keeping the change in the budget balance broadly steady as a share of GDP, in the face of what would otherwise have been a sharp fiscal contraction brought about by revenue growth that has consistently exceeded previous estimates.  This is consistent with the view that fiscal policy should be focused on microeconomic objectives and not demand management, with the latter task being best left to monetary policy. 

Among financial market economists, there is nonetheless a widely held view that the government should somehow assist the RBA in its demand management task, by favouring the accumulation of surpluses in the Future Fund over tax cuts to avoid putting upward pressure on inflation and interest rates.  The same argument is rarely made against new spending measures, even though ‘crowding out’ is a much more serious problem in relation to new spending than tax cuts.

continue reading

posted on 04 May 2007 by skirchner in Economics, Financial Markets

(2) Comments | Permalink | Main

| More

The Return of the Perfect Latin American Idiot

Alvaro Vargas Llosa on the Return of the Perfect Latin American Idiot.

posted on 02 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

The Andy Xie Club

Andy ‘These Western People Didn’t Know What They Were Talking About’ Xie is back on the loose:

Xie told Reuters that he plans to set up an “investment club” that would be open only to people he knows. The club would invest in unlisted firms, would have total funds of $200 to $300 million and would be focused solely on China.

“I’m looking for backers who know me, so there’s a trust element involved and that would make decisions much easier,” he added.

Xie—who worked at Morgan Stanley for nine years and spent five years as an economist with the World Bank—resigned from the U.S. investment bank after an email with disparaging comments about Singapore’s economic policy was leaked to the public.

His email was written shortly after the IMF/World Bank meetings in Singapore in September.

Xie declined to elaborate on his departure, but said he was already considering resigning from the bank before then.

He added that he would not join another firm again and does not rule out heading his own fund in future. He sees himself traveling around China, dispensing economic advice.

posted on 02 May 2007 by skirchner in Economics, Financial Markets

(0) Comments | Permalink | Main

| More

Follow insteconomics on Twitter