Working Papers

2007 09

The Credit Crunch that Wasn’t

If Australia is suffering a tightening in credit market conditions, it was far from apparent in the financial aggregates for August released today.  Private sector credit rose 1.5% m/m and 16.2% y/y, the strongest growth since September 1989.  Housing credit, including securitisations, rose 0.9% m/m and 12.4% y/y.  Business credit rose a stunning 2.7% m/m and 22.4% y/y, the strongest annual rate since January 1989.  M3 rose 17.9% y/y, while broad money expanded 16.6% y/y, growth rates also not seen since the end of 1989. 

These data are all the more remarkable considering that the late 1980s were an era of much higher rates of inflation.  While growth in credit aggregates have explanatory power for the business cycle, it should be recalled that credit has also been growing as a share of GDP, as financial deregulation and innovations gradually release the household and business sectors from the borrowing constraints of the past.  As RBA Deputy Governor Ric Battellino indicated in a speech this week, there is no reason to believe that household sector debt will not continue to rise as a share of GDP, as the benefits of financial innovation are diffused to a broader range of households.  Given the growing likelihood that the current positive terms of trade shock is going to be permanent, it also makes sense for the household and business sectors to start borrowing against this permanent increase in national income.

posted on 28 September 2007 by skirchner in Economics, Financial Markets

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‘Force Interest Rates Down’

One of the Labor Party’s Google Ads that have popped up to the right of this post:

Interest Rates in 2007.  Families Today Are Carrying Record Debt.  Labor Will Force Rates Down.

Clicking on to Kevin07.com.au, I could not find how Labor proposed to ‘force’ rates down, but it’s an interesting verb choice.  Even the government’s claims about interest rates in the 2004 campaign did not go that far.

You would think Labor might have learned from the government’s experience that there is no point in making the claim that a government can lower interest rates.  The direction of Australian interest rates is determined by business cycle and international influences over which the government (and even the RBA) have very little effective control.

posted on 28 September 2007 by skirchner in Economics, Financial Markets, Politics

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Bretton Woods Revivalism in the WSJ

More tiresome hard money ratbaggery in the WSJ, this time from Bretton Woods revivalist, Judy Shelton:

The massive currency swings that reign between the dollar, the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc wreak havoc on demand-and-supply outcomes for goods traded across borders. The New York Board of Trade’s U.S. Dollar Index, which tracks the dollar’s value relative to a basket of those six other currencies, has tumbled 34% since its July 2001 peak. Why pontificate about the importance of eliminating tariffs to promote open markets when the impact of a gyrating dollar is far more devastating, far more protectionist in its effect on global free trade?

It is time for the U.S. to acknowledge what we have tried to wave off under the pretense of allowing free markets to decree the value of our currency.

If we truly believe in a global marketplace where outcomes are determined by competition and competence, not localized monetary policies, we need a global monetary unit of measure. We need a meaningful global currency.

Bretton Woods broke down precisely because fixed exchange rates wrecked havoc by transmitting economic shocks, including monetary and fiscal policy mistakes, around the world.

posted on 27 September 2007 by skirchner in Economics, Financial Markets

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Sustainable Household Sector Debt Levels

RBA Deputy Governor Ric Battellino’s observations on recent financial trends:

I don’t think anybody knows what the sustainable level of gearing is for the household sector in aggregate, but given that there are still large sections of the household sector with no debt, it is likely to be higher than current levels.

posted on 25 September 2007 by skirchner in Economics, Financial Markets

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101 Uses for Alan Greenspan’s Memoir

Fidel Castro uses Greenspan’s memoir as proof of life:

Castro noted that the euro was trading at $1.41 and that the price of petroleum is $84 a barrel, proof that the interview was recorded earlier Friday.

During the interview, Castro displayed several thick books that he indicated he had been reading, including former Federal Reserve Chairman Alan Greenspan’s just-published “The Age of Turbulence”…

In another show of ability, Castro also read lengthy passages aloud from the Greenspan book, but he didn’t use the actual book. Instead, he read from a separately prepared printout with easier-to-read type.

posted on 24 September 2007 by skirchner in Economics, Financial Markets

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Greenspan and Coincident Indicators

Robert Krulwich recalls Greenspan’s fondness for unusual coincident indicators of economic activity:

He once told me that if you think about all the garments in the household, the garment that is most private is the male underpant, because nobody sees it except people like in the locker room, and who cares? Your children need clothes. Your wife needs clothes that have to change. The children grow. You need clothes on the outside. But, the last purchase that you don’t have to make is underpants. … If you look at the sales of men’s underpants, it’s just pretty much a flat line, it hardly ever changes. But on those few occasions where it dips, that means that men are so pinched that they are deciding not to replace underpants. And he said that is almost always a sort of foreshadow of ‘here comes trouble.’

Of course, Greenspan also has a very well-developed sense of humour.


posted on 21 September 2007 by skirchner in Economics, Financial Markets

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Greenspan on The Daily Show

Alan Greenspan’s appearance on Jon Stewart’s The Daily Show, where he answers the question, ‘Why do we have a Fed? Why do we have someone adjusting the rates if we’re a free-market society?’ 

Greenspan’s answer to that question has changed somewhat over the years.

posted on 20 September 2007 by skirchner in Economics, Financial Markets

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Mortgages and Monetary Policy

More US recession skepticism, this time from Nobel laureate, Robert Lucas:

In this situation, it is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. They could be right—who really knows?—and in any case we may not know enough to prove them wrong.

So I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.

To me, inflation targeting at its best is an application of Milton Friedman’s maxim that “inflation is always and everywhere a monetary phenomenon,” and its corollary that monetary policy should concentrate on the one thing it can do well—control inflation. It can be hard to keep this in mind in financially chaotic times, but I think it is worth a try.

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

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Greenspan on Australia

Australia features in Greenspan’s memoir, The Age of Turbulence:

Australia has always fascinated me as a microcosm of the United States in many ways. It is a land with vast open spaces, similar in many respects to the American West.  I know I can’t generalise on the basis of a few years of observations, but I nonetheless found myself during my tenure at the Fed looking to Australia as the leading indicator of many aspects of US economic performance.  I continually monitor Australia’s current account deficit, which has persisted far longer than that of the United States with no evident significant micro-economic impact other than large increasing foreign ownership of Australian corporate assets.

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

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The Median Darlinghurst Voter

Federal Liberal MHR Malcolm Turnbull has been out endogenising the preferences of the median Darlinghurst voter ahead of the federal election.  His latest newsletter to Darlinghurst and Paddington residents in his seat of Wentworth includes the following headings: Supporting the Gay and Lesbian Community; Whales – Think Globally, Act Locally; Solar Panels and Green Vouchers; and Supporting Good Urban Design.

posted on 18 September 2007 by skirchner in Economics, Politics

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The BoE’s MPC 10 Years On

The UK parliament’s Treasury Select Committee has released its report on the Monetary Policy Committee of the Bank of England: 10 Years On.  Despite having one of the world’s best frameworks for monetary policy governance, the Committee does not believe the BoE should be resting on its laurels:

We recommend changes to enhance the transparency of the MPC, including immediate publication of a record of the votes of each MPC member after MPC decisions are released, greater transparency of individual MPC members’ positions in the minutes of the MPC, and further work on improving the public’s understanding of monetary policy.

The contrast with the very low standards of transparency and public accountability demanded of the RBA by the Australian parliament could not be more stark.  On these issues, the Australian House of Representatives Standing Committee on Economics is at best indifferent.  It is to be hoped that an incoming Labor Government (not a federal election prediction) will conduct a similar review the operation of the current framework for monetary policy governance in Australia.  There is no reason why responsibility for Australian monetary policy should reside with the RBA Board.  The governance of the Bank as an institution should be separated from monetary policy making.

posted on 18 September 2007 by skirchner in Economics, Financial Markets

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Bubble Denialism

Some refreshing bubble skepticism from Peter Gordon:

I still do not know what asset price “bubbles” are. If I did, then I would also know what the “correct” prices are.

There is plenty of talk about prices that cannot be justified by “fundamentals” but most of that is in hindsight. The latest of many such discussions from The Economist clarifies nothing.

The current credit problems are prompted by house price declines that, in turn, further crimp liquidity. But this is not the implosion of the “house price bubble” that was the talk for so long.

This evening’s 60-Minutes interview with Alan Greenspan shows him saying that he had no idea that there would be a sub-prime credit contraction—or that there would be a serious problem.

Good for his candor and good for his helping to unravel the current problem from all of the media herd housing bubble chorus.

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

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The Case Against a Fed Easing

Allan Meltzer argues against a Fed easing, referencing the arguments of Martin Feldstein:

Mr. Feldstein and others offer a scenario for the unfolding of recent credit and housing problems that ends in a deep recession. He calls for a one percentage point reduction in the federal funds rate to partly overcome the disaster he foresees. Much of his analysis depends on forecasts or guesses about declines in house prices and failures of credit markets that are outside the range of past experience. But it is not difficult to find an alternative forecast that is far less gloomy. Many economists, including many at the Fed, foresee a more benign outcome—a slow growth rate for a few quarters but no recession. Only time will tell which is correct. At present, markets seem to accept the more favorable outcome.

Intrade’s 2007 US recession contract is pricing around a 10% chance of recession, while the probability for 2008 is around 60%.  If recession is seen as mainly a risk for 2008 rather than 2007, this gives Fed policy a substantial lead on any downturn.  There is remarkably little conviction behind the near-term recession trade.  Intrade’s Q4 2007 GDP growth contraction contract has not even traded, with what little market depth there is lined-up mainly on the short side.

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

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How to Announce a Steady Interest Rate Decision

The RBNZ is now webcasting Governor Bollard’s Monetary Policy Statement press conferences (you can see a replay by following the link), a further enhancement in the transparency of NZ monetary policy.

These press conferences make a sharp contrast to the almost non-existent public profile of the RBA Governor.  There are good reasons why the RBA Governor should be required to hold a press conference after each Board meeting and following each quarterly Statement on Monetary Policy. 

Quite apart from the increased public scrutiny of monetary policy this would provide, it would also change the character of electronic reporting of monetary policy.  As things stand, the electronic media in Australia report interest rate decisions from banks’ dealing rooms, which provide the colour and movement they need to illustrate the story.  The story then becomes centered around financial market reaction.

The Treasurer is the only responsible public official who makes a media appearance in the wake of monetary policy decisions, which contributes to the peculiar and undesirable Australian habit of interpreting interest rates decisions almost exclusively through the prism of political competition.  This is partly a hang over from the bad old days before 1996, when interest rate decisions were jointly announced by the RBA and the Treasurer, but it still heavily skews the electronic reporting of Australian monetary policy.  Having the RBA Governor front the media could significantly change this dynamic and would help serve to educate the public about how monetary policy is determined.

The RBA protests that it would not have anything to talk about when rates were left unchanged.  As Bollard’s press conference shows, there is always plenty to talk about, even when interest rates are left unchanged.  The RBA just doesn’t want the scrutiny.

If I were opposition Treasury spokesman Wayne Swan, one of my first acts on becoming Treasurer would be to request that Governor Stevens front the media after every Board meeting.  I would then get to work re-writing the RBA Act to remove responsibility for monetary policy from the RBA Board and put it in the hands of a dedicated Monetary Policy Committee, on which the Bank’s senior officers would be a minority.  The rest would be made up of appointees from outside the Bank.

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

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‘Part and Parcel of Being a Central Bank’

The RBA records a large unrealised valuation loss on its long foreign exchange position:

The Bank’s financial results for 2006/07 were affected by the rise in the exchange rate of the Australian dollar. As previous annual reports of the Bank have explained in some detail, and as this report again outlines, central banks which hold their nations’ foreign currency reserves on their balance sheet are exposed to considerable currency risk. When the Australian dollar exchange rate appreciates, the accounts record a fall in the value of foreign assets. In 2006/07, the rising Australian dollar meant that the Bank experienced a substantial unrealised valuation loss on its financial assets, which exceeded the flow of income from its assets during the year.  Therefore, the Bank recorded a loss in 2006/07, as measured by Australian equivalents to International Financial Reporting Standards.

This is not the first such loss – the Reserve Bank last experienced one on an AIFRS basis in 1993/94 – and it is unlikely to be the last. The reason is that there is very little scope for a central bank to manage foreign currency risk without compromising its policy obligations. Foreign assets cannot be hedged back to Australian dollars because that would defeat the purpose of holding them. This risk has to be accepted as part and parcel of being a central bank. In some years very large valuation gains will be observed. But on some other occasions, the Bank can expect to record a valuation loss.

Something for the RBNZ to look forward to.

posted on 12 September 2007 by skirchner in Economics, Financial Markets

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UK Conservatives Channel Clive Hamilton

UK Conservatives reach for the Australia Institute playbook:

THE Conservatives will propose banning plasma screens and other energy-guzzling electrical goods in a report to be unveiled next week.

The proposals target white goods like fridges and freezers, as well as TVs, personal computers and DVD players that use too much energy or operate on stand-by.

The ideas come from a Conservative group set up by David Cameron to develop policies to protect the environment and although the measures to make household electrical appliances more energy efficient are not binding on Mr Cameron, they are thought likely to be warmly received by the Tory leader.

The group will also suggest scrapping Gross Domestic Product (GDP) as a measure of the nation’s success in favour of a model that measures people’s happiness drawn up up by Friends of the Earth.

See also Brendan O’Neill on David Cameron’s promotion of carbon bondage.


posted on 11 September 2007 by skirchner in Culture & Society, Economics

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Monetary Policy is Not a Morality Play

Tyler Cowen argues against the urge to resort to simple monetary policy narratives in the current environment:

Colorful interpretations of recent monetary policy abound, from both commentators and politicians. Depending on the storyteller, the policy reflects the triumph of the rich over the poor, an atonement for the sins of the Bush administration, a long-awaited comeuppance for the American economy, a continuing hangover from the dot-com bubble, or an inability of the professor (Ben S. Bernanke) to handle a real-world job (running the Fed).

Journalists are especially likely to embrace narratives, if only because their editors and their readers clamor for them. Of course, if there are enough competing stories, some of them will fit or predict some real-world events, if only because of random luck.

Perhaps the most seductive of these narratives is Austrian business cycle theory, because it can be made to fit almost any set of business cycle facts. 

In view of the weak US August employment report, the Fed will now probably ease policy on September 18.

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

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The Adam Smith Institute Celebrates Big Government Conservatism

A rather bizarre post at the Adam Smith Institute blog, which (I suspect unwittingly) seeks to defend Treasurer Costello against his classical liberal critics in Australia:

Ahead of the upcoming general election (in about two months time) journalists have claimed that the coalition government of John Howard has turned to big government. However, his Treasurer, Peter Costello, in a blog-style response, crushed this sophisticated distortion of facts and demonstrated that the opposite is true: government spending as a proportion of GDP has actually gone down from 26.1 percent to 25.2 percent over the last ten years. According to him the main factor is the reduction of interest payments for government debts, which the political writers try to belittle.

Not just journalists or political writers.  The main criticisms of Costello’s fiscal policy have in fact come from classical liberals, who rightly point out that the numbers quoted by Costello are all but meaningless.  Costello’s article was a rather lame response to an article in previous edition of Policy.  See also Andrew Norton’s subsequent response to Costello. 

Treasurer Costello can’t be too proud of his government’s record on fiscal policy, given his willingness to shirk cabinet responsibility and attack the Prime Minister over the government’s spending record.

posted on 07 September 2007 by skirchner in Economics

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‘The Opposite of the Greenspan Put’

Allan Meltzer, speaking from the Jackson Hole symposium, on why the Fed won’t cut the Fed Funds rate.

posted on 01 September 2007 by skirchner in Economics, Financial Markets

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