Working Papers

2007 12

China’s Credit Crunch II

China continues to rely on quantitative lending controls to address the inflationary implications of its peg to the USD:

China will limit next year’s commercial bank loan growth to 15 percent and has urged banks to adhere to quarterly lending targets or risk punishment, the official Shanghai Securities News reported on Friday.

The government also urged lenders to spread new loans more evenly through 2008 and indicated they should lend out 35 percent of the full-year quota in the first quarter, 30 percent in the second, 25 percent in the third and 10 percent in the fourth, the newspaper said, citing unnamed banking sources.

Those that lend more excessively than told may face administrative penalties, be issued with central bank bills at below-market interest rates or be ordered to set aside more deposits at the central bank as reserves, the newspaper said.

Meanwhile, Morgan Stanley gets a capital infusion from Chi-com sovereign wealth fund, China Investment Corp.  As Macro Man notes, all those years of sucking-up by Morgan’s resident Sinophile, Stephen Roach, have finally paid-off.

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

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The Euro’s Day Will Not Come

Adam Posen, on why recent strength in the euro does not herald its rise to greater international status:

So a strengthening of the euro against the dollar, even for several months in a row, is not indicative of a decline in the dollar’s global role and usage, or for that matter much of anything else. People started talking about a move away from the dollar in the 1970s when US long-term economic prospects were far more uncertain relative to Europe and Japan than they are now compared even to China—and nothing happened in terms of a decline in the dollar’s global role…

No one should read too much into exchange rate swings, including the recent decline of the dollar against the euro. It takes much more than such a depreciation to cause a shift in reserve currency status. The euro may someday play a global role beyond its current use, but until the eurozone’s financial markets integrate, its sustainable growth rate rises, and its willingness to import increases, that day will not come.

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

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Greenspan: A Lifelong Libertarian Republican

Alan Greenspan’s memoir was released the day before his successor as Federal Reserve Chairman presided over a reduction in US interest rates of 0.50 percentage points, the first easing in US monetary policy since 2003.  Many have argued that the current economic problems in the US are attributable to Greenspan’s legacy as Fed Chairman.  Greenspan defends the policy actions of the Federal Open Market Committee (FOMC) during his tenure, but does not fully engage with his critics.  This is unfortunate, because Greenspan’s book could have served as a much needed corrective to those who argue that monetary policy is the principal driver of the business cycle and asset price dynamics.  This view has almost no empirical support, but has popular appeal as a simple, mono-causal explanation for economic developments that are not otherwise well understood.  Under Greenspan and his predecessor, Paul Volcker, US monetary policy focused more successfully on anchoring the long-run price level of the US economy than had been the case in earlier decades.  Greenspan and the other members of the FOMC did not and could not aim to eliminate the business cycle or asset price inflations and deflations, which are a normal part of the functioning of the economy and financial markets.  Those who argue otherwise are effectively calling for a kind of central planning via monetary policy that is likely to be far more destabilising than the current focus on long-run inflation control.

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posted on 16 December 2007 by skirchner in Economics, Financial Markets

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Collective Responsibility and RBA Board Secrecy

RBA Governor Stevens has elaborated on the rationale for the RBA’s new transparency regime in a speech to the Sydney Institute.  Stevens was careful to disassociate the new measures from the change in government, saying that the RBA had ‘reflected on this for some time this year,’ and that he ‘was very pleased to learn when I met the new Treasurer a couple of weeks ago that he supported the changes.’  It is likely that the new measures have as much to do with the change at the top of the RBA last year as the change in government this year, although their announcement at the first Board meeting after the federal election is surely not entirely coincidental.

Much of the speech is given over to the ‘limits of transparency,’ with Stevens arguing that:

The nature of the Reserve Bank Board – a majority of whom are part-time members, drawn from various parts of the Australian community, but seeking to make decisions in the national interest as opposed to any industry, geographical or sectional interest – needs to be considered when thinking about disclosure practices…

Readers will also observe that the pattern of votes of individuals is not recorded [in the new minutes], only the outcome. That is a point of difference with other central banks which publish minutes. But in those cases the decision-makers are full-time appointees, in some cases in systems with expressly individual, as opposed to collective, responsibility for their decisions. That is not the system Australia operates, and our pattern of disclosure reflects the institutional arrangements.

Stevens’ argument about collective responsibility is an embellishment of the RBA’s traditional argument for Board secrecy, which is that the backgrounds of the external Board members would subject them to undue external pressure if their behaviour on the Board in relation to monetary policy became known.  Stevens is smart enough not to make explicit what is really being argued here: that some of the external Board members are too conflicted to discharge their responsibilities in relation to monetary policy in a transparent fashion.  In any other setting, this argument would be considered absurd.  Indeed, the potential for such conflicts argues if anything for more transparency, not less.  More fundamentally, it is an argument for the removal of responsibility for monetary policy from the RBA Board.

Stevens says that the Bank of England ‘MPC’s culture is expressly, by the intention of its creators, one of individual accountability.’  The implication is that the RBA has a different institutional make-up and culture, so that ‘it would not make sense to “cherry pick” the high transparency aspects of every other system and assume that they should simply be grafted onto the Australian system.’  But this is exactly why more fundamental statutory reform of monetary policy governance is required.  The RBA Board and its statutory responsibilities date back to 1960, and are little changed on the central banking arrangements of the 1930s.  The RBA’s governance structures as they are currently constituted are simply incompatible with a fully transparent monetary policy regime. 

Stevens also cites the fact that the ECB does not publish minutes: ‘it is argued, not unreasonably, that publication of minutes and voting might prejudice the capacity of the national governors to take a euro area, rather than national, perspective.’  This is just one of many arguments against European Monetary Union rather than a valid defence of a lack of transparency in the conduct of monetary policy.

We argued in the previous post that the new statutory protections for the RBA Governor and Deputy Governor and the new appointments process for external Board members runs the risk of entrenching bureaucratic influence over monetary policy at the expense of the increased external participation and scrutiny that could be expected from a Bank of England MPC-type arrangement.  Indeed, the new arrangements substantially diminish accountability for monetary policy, in that there is no mechanism for the removal of the Governor or Deputy Governor for non-performance, which remains poorly benchmarked in any event.  Overlaying this with a doctrine of collective responsibility for monetary policy decision-making means that the new arrangements may actually serve to detract from transparency and accountability in the conduct of monetary policy.  The RBA has put in place many of the trappings of transparency, but without the substance that would ensure genuine accountability for decision-making.

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

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A New Era of RBA Independence or the Bureaucratisation of Monetary Policy?

The RBA Governor and Treasurer have announced a new Joint Statement on the Conduct of Monetary Policy, which Treasurer Swan has hailed as a ‘new era’ of central bank independence.  The Statement maintains the existing inflation target of 2-3% on average over the economic cycle.  The main change is that the positions of the Governor and Deputy Governor will have their level of statutory independence raised to be equal to that of the Commissioner of Taxation and the Australian Statistician. Their appointments will be made by the Governor-General in Council, and could be terminated only with the approval of each House of the Parliament in the same session of Parliament. 

In relation to appointments of external members to the RBA Board, the Secretary to the Treasury and the RBA Governor will maintain a register of ‘eminent’ candidates of the ‘highest integrity,’ from which the Treasurer will make new appointments to the Reserve Bank Board.

The improvements to the statutory independence of the Governor and Deputy Governor are welcome in that they serve to augment the existing provisions of the RBA Act that have always given the RBA Governor a high degree of independence from the government of the day.  Contrary to the myth propagated by former Treasurer Peter Costello, RBA independence did not begin in August 1996 with the first Joint Statement.  But these measures are unlikely to afford the Governor and Deputy Governor much additional independence in practice.  The best protection for the Governor and Deputy Governor is their own reputation, which would make any politically-motivated dismissal very damaging for the government of the day.  International capital markets could also be expected to punish any government that sought to overtly compromise the independence of the Bank.

The changes in relation to the external Board appointments are designed to remedy the situation by which these appointments have been used for political patronage, most recklessly in the case of former Treasurer Peter Costello’s appointment of Robert Gerard.  This may protect the appointments process from undue political influence, but creates a new problem in that it will effectively limit Board appointments to those who meet with approval from the official family of RBA and Treasury.  This is a backward step, which will work against promoting a diversity of viewpoints in the policymaking process. 

Under the former government, bureaucratic capture of the executive was just as big a problem as executive politicisation of the bureaucracy.  In the Treasury portfolio for example, Peter Costello was the subject of aggressive bureaucratic capture in relation to a broad-range of policy areas, from international tax harmonisation to the G20, allowing Treasury to promote its own interests.  The new appointments process for external Board members risks entrenching the influence of the RBA’s senior officers over the monetary policy decision-making process, at the expense of those who have been critical of past or current policy.  Given that the RBA is currently presiding over an inflation rate in breach of its mandate, this seems an odd time to be further entrenching bureaucratic influence over policy.

The involvement of the Treasury in this process is also at odds with international trends in central bank reform, which generally seek to increase the degree of separation between monetary policy and the fiscal authority.  The new register will serve to increase the influence of Treasury over policy.  The Treasury Secretary should be excluded from a direct role in monetary policy, with either no representation on the RBA Board, or non-voting representation only.  The Treasury should play no role in the appointments process for the RBA Board.

Ultimately, politics cannot be completely removed from the appointments process for both the Bank’s senior officers and the external Board members.  The RBA is a government creation and must at some level be answerable to the government of the day.  The best protection for the integrity of monetary policy is an extremely high level of transparency in monetary policy decision-making.  Unfortunately, the new arrangements for the release of the Board minutes will still keep secret the decisions of individual Board members in relation to monetary policy.  Coupled with the effective internalisation of the appointments process to those approved by the Treasury-RBA official family, the new arrangements may serve to entrench the de facto monopoly that the RBA’s senior officers enjoy over decision-making and minimise effective external participation in, and scrutiny over, monetary policy.

posted on 06 December 2007 by skirchner in Economics, Financial Markets, Politics

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Climate Change and Monetary Policy

The new Australian government has been quick to ratify Kyoto, but this does not necessarily sit comfortably with its other policy commitment to keep downward pressure on interest rates.  The RBNZ’s latest Monetary Policy Statement discusses the monetary policy implications of the proposed Emission Trading Scheme in New Zealand:

Another recent Government announcement that could have significant implications for the medium-term inflation outlook is the intention to introduce an emissions trading scheme as part of New Zealand’s Kyoto Protocol obligations… it is likely that the emissions trading scheme will have very significant direct and indirect effects on CPI inflation by affecting fuel and electricity prices. It will also affect inflation expectations and supply and demand in the economy….

It is likely that incorporating the effects of the emissions trading scheme… would result in interest rates being held higher for even longer than assumed here…

to the extent that the gradual phasing in of the scheme adversely affects the medium-term path of inflation, policy will need to lean against this.

The RBNZ assumes an emissions price of NZD 21/tonne, which could prove overly optimistic. 

On another subject, the RBNZ seems oblivious to the glaring contradiction in this statement:

New Zealand is one of the few developed countries in which the government now has net financial assets. The government’s very strong overall balance sheet, achieved as a result of a series of fiscal choices over the past 20 years, is undoubtedly helping to keep the long-term average level of interest rates in New Zealand lower than it would otherwise be.

New Zealand is also notorious for having the highest interest rates in the developed world, which rather argues against the importance of fiscal policy as a determinant of interest rates.

posted on 06 December 2007 by skirchner in Economics, Financial Markets

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Not Only in Norway

Anders Åslund of the Peterson Institute, with some observations on sovereign wealth funds that former Treasurer Peter Costello should have taken to heart:

Since the Norwegian fund was established in 1990, every incumbent government has lost elections because the opposition has promised all kinds of popular expenditures from the abundant fund. Democratically, it is difficult to defend an excessive public reserve fund.

Åslund also notes that SWFs are profoundly anti-democratic:

They reflect a paternalistic—and economically illiterate—notion that the ruler knows best while citizens are so irresponsible that they cannot be entrusted with their own savings. It would be more economical and democratic to cut taxes and let citizens save and invest themselves.

posted on 06 December 2007 by skirchner in Economics, Financial Markets

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Never Let the RBA Minutes Get in the Way of a Beat-Up

The RBA may now be releasing minutes of its deliberations, but that won’t stop the media from reading their own views into the RBA’s public comments.  Under the headline ‘Reserve Bank was “not happy John,”’ Colin Brinsden writes:

THE Reserve Bank of Australia was none too happy with the Howard government’s election spend-fest, the minutes from its November board meeting suggest.

The minutes contain no such implication and Brinsden conveniently refrains from quoting the bottom-line of the RBA’s discussion:

This meant that fiscal policy was roughly neutral in its overall effect on growth as conventionally measured.


posted on 05 December 2007 by skirchner in Economics, Financial Markets

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Has the RBA Pre-Empted Labor on Reform?

The RBA has announced new arrangements for communicating with the public.  The RBA will now release a statement following each monthly Board meeting, even when policy is left unchanged.  The Board’s decision on interest rates will be announced at 2:30pm on the day of the meeting, rather than the following day.  The RBA will now also release minutes of the monthly Board meetings, with a two week lag.

The RBA said that it has been reviewing its communications practices ‘for some months.’  To that extent, the new measures can be seen as independent of the change in government.  However, it is likely that the RBA has been working on these measures in anticipation of demands for increased transparency and accountability from the incoming Labor government.  The measures may well be a pre-emptive strike against demands for more meaningful reform, designed to ensure that any changes are made on the RBA’s own terms and preserve the effective monopoly that the Bank’s senior officers enjoy over monetary policy decision-making. 

The new measures will certainly be an improvement.  The statement accompanying today’s steady interest rate decision saw a rally in bond futures and a weaker Australian dollar, implying that the statement conveyed new information to the market, resulting in more efficient pricing of financial instruments.

The minutes of the November meeting released today are largely descriptive and backward-looking in their discussion of economic conditions, a problem which also afflicts the quarterly Statements on Monetary Policy.  This is in contrast to the more forward-looking statements released by the Bank of England and the RBNZ.  The section on ‘considerations for monetary policy’ has the potential to be more informative, but it appears as though the RBA will be presenting only the consensus view, with the views of individual Board members not discussed. 

There will be no record of any vote taken. It is likely that what little dissent there is on the Board will be suppressed in the minutes.  The RBA has long argued that identifying the views of individual members would subject them to external pressures, given the numerous potential conflicts of interest of the external Board members.  This highlights the continued incompatibility of the current Board arrangements with increased transparency and accountability. 

This conflict can only be resolved by separating monetary policymaking from the Bank’s Board and placing it in the hands of an independent, professional Monetary Policy Committee, with substantial external representation and excluding the Treasury Secretary, who may serve as a vector for political influence on monetary policy. 

The votes of the Committee should then be made public immediately following each meeting, ensuring increased transparency and accountability for decision-making and protecting the integrity of the monetary policy process.  It would also end the RBA’s de facto monopoly on decision-making, by ensuring that members of the Committee had the expertise and experience to challenge the views of the RBA’s senior officers.

Today’s measures are an attempt by the Bank to give the appearance of increased transparency and accountability, but without seriously challenging the status quo.  Most rankings of central bank transparency and accountability are based on check-lists of factors that are quantitative rather than qualitative in nature.  The changes will thus have the effect of lifting the RBA from its current position at the bottom of international rankings of central bank transparency and accountability.  Qualitatively, however, the RBA will continue to lag world’s best practice in monetary policy governance.

posted on 05 December 2007 by skirchner in Economics, Financial Markets

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RBA Reform Under Rudd?

RBA Governor Glenn Stevens speaks to the Sydney Institute on the subject of central bank communication next week and David Uren suggests that this might be the occasion for Stevens to unveil improved RBA transparency and accountability measures.  Uren notes that a new Joint Statement on the Conduct of Monetary Policy is also expected later this week.

After more than a decade of neglect under former Treasurer Peter Costello, it remains to be seen whether the new government is serious about reforming RBA governance, which has left the RBA as one of the developed world’s least accountable and transparent central banks.

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

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The Euro as Ultimate Sub-Prime Victim

Liam Halligan argues that the euro may be the ultimate victim of the current problems in global credit markets:

sceptics like me have always said the operational viability of the single currency won’t be known until the system is tested by a serious downturn. That moment may now come soon.

Interest rate spreads between government bonds in France, Spain, Germany and Italy have lately got wider and wider. In other words, believe it or not, the markets are increasingly betting on the eurozone breaking up – as political tensions rise, and the needs of inflation-averse nations like Germany can’t be reconciled with much weaker debt-driven members like Ireland and Spain.

Could it happen? Why not? Every other currency union in the history of man has broken up – unless, like the US and UK, it has been preceded by generations of political union, and held together with a federal tax system.

It sounds far-fetched, I know. But the ultimate victim of this sub-prime crisis could be nothing less than the single currency’s existence.


posted on 03 December 2007 by skirchner in Economics, Financial Markets

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The Opinion Polls Costello Forgot

As Peter Costello steps-up martyrdom operations against John Howard, Greg Sheridan reminds Costello of his culpability in the Coalition’s defeat:

It is very difficult to find an interpretation of the facts over the past few years that does not indicate that Peter Costello was the one who played the wrecking, and the dishonourable, role in the Liberal Party.

At least 30 per cent of the Government’s problems came from Costello and his party supporters repeatedly briefing the press and others against Howard. There are numerous public examples of this, such as the bitter comments Costello made to Howard’s biographers, or the famously leaked dinner with senior Canberra reporters during which Costello detailed how he would destroy Howard.

Similarly, Costello’s party lieutenants for years briefed journalists on leadership challenge timetables and why Howard must go.

All of this had two perverse consequences. First, more than any other factor it crippled Howard as a medium-term leader. It forced him to make the leadership compromise commitment that he would hand over to Costello midway through the next term.

This minimised the government’s freedom to manoeuvre. It diminished Howard and was a drag on the Liberal vote. Two non-political members of my extended family told me they would vote Labor because they didn’t want Costello to become prime minister. Costello, you see, was always unpopular.

If Roy Morgan is to be believed, Costello would have had a devastating impact on the Coalition:

Electors were also asked who they would vote for if Peter Costello or Malcolm Turnbull were Prime Minister: neither Costello nor Turnbull lifted the L-NP vote beyond the result Howard achieved. 

Primary support for the L-NP if Peter Costello were leader is a low 31.5% (down 3.5% from the Howard result), while ALP support rose 4.5% to 52.5%.  The ALP’s two-party preferred lead went from 18% with Howard as leader to 26% with Costello as leader (63% cf. 37%).

Malcolm Turnbull fared better with L-NP primary support remaining at the same level as Howard (35%), while ALP support increased 1.5% to 49.5%.  Turnbull achieved the same two-party preferred lead as Howard (ALP 59%, L-NP 41%).


posted on 01 December 2007 by skirchner in Politics

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