Working Papers

2008 02

Saved Not Spent II

An opinion poll finds that a slim majority would prefer tax cuts to be paid into superannuation accounts:

The survey was based on interviews with 800 Queenslanders and found 55 per cent of respondents would prefer the proposed tax cuts to be delivered as extra payments to their superannuation fund. This included a majority of Labor and Coalition supporters.

Only 38 per cent of people wanted the money upfront through lower taxes.

This is an interesting result, because there is nothing to prevent people from putting their tax cuts into super voluntarily.  The only reason to favour having the choice made for you would be as a solution to an imagined collective action problem: I might save my tax cut, but if others don’t, the consequences could be inflationary, so a policy that is also binding on others is to be preferred.  This policy preference is likely the result of a cognitive bias: the belief that other people are less prudent than ourselves (I’m sure Andrew Norton would have hard data on the extent of this belief).  In reality, if we think saving a tax cut is a good thing, then others probably see it that way too.


posted on 29 February 2008 by skirchner in Economics, Financial Markets, Politics

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The Futureless Future Fund

It says a lot about the Future Fund that our first real insights into its investment strategy and performance should come via a Senate Estimates Committee hearing.  As we have noted previously, the Future Fund’s ranking in international comparisons of sovereign wealth fund transparency and accountability lies somewhere between that of the State Oil Fund of the Republic of Azerbaijan and the National Oil Fund of Kazakhstan. 

Given recent market conditions, it should not come as a huge surprise to learn that the Fund remains around 75% invested in cash.  This is little different from leaving the funds on deposit with the RBA, the more traditional home of budget surpluses.  This did not stop the headline writers (‘Future Fund’s $700m hit’; ‘Future Fund Flounders’) and Coalition Senators from making hay out of the Fund’s few non-cash investments.  As we predicted here, the Future Fund’s investments will inevitably become a political football and today’s headlines are just a taste of what we will see as the Fund expands the scope of its investments.

Unfortunately for the Coalition, the Future Fund is very much a creature of its own making and in many ways emblematic of the political and intellectual exhaustion that led to the former government’s defeat.  This effectively lets the new government off the hook in relation to the Fund’s future performance under its current mandate

The new government is promising to hoard any increase in the budget surplus over and above the forward estimates. The government could very quickly notch-up budget surpluses of around 2% of GDP without any real effort, adding more than $20 billion annually to the Fund’s assets.  With the Fund already set to meet its original mandate to provide for public sector super liabilities, Coalition Senators could make themselves useful by asking what further contributions to the Future Fund are actually for.

posted on 28 February 2008 by skirchner in Economics, Financial Markets, Politics

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Saved Not Spent

Finance Minister Lindsay Tanner launches a robust defence of the government’s tax cuts:

“To the extent that there is a stimulatory impact ... it is actually far less than some people have been presenting.”…

“Everybody ... assumes that every last dollar that every citizen gets in a tax cut will be spent and not saved - that’s a false assumption,” Mr Tanner said.

I make many of the same arguments here.


posted on 27 February 2008 by skirchner in Economics, Financial Markets, Politics

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Business Spectator Column

This week’s Business Spectator column.  If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list.  Email info at institutional-economics dot com.

posted on 23 February 2008 by skirchner in Economics, Financial Markets

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Real Prices or Relative Prices? The Dow-Gold Ratio

Robert Prechter’s January Elliott Wave Theorist (you can sign-up for a free copy here) presents one of Bob’s favourite charts, namely the Dow-gold ratio.  The ratio is currently around 13, down from a peak around 44.12 in the late 1990s.  Prechter argues that this ratio represents the Dow denominated in real terms.  This is true only if you think the gold price benchmarks real purchasing power.  We could equally measure the Dow in terms of any other commodity (as Prechter sometimes does with oil).  Since commodity prices are typically more volatile than consumer prices, they are a poor benchmark for consumer purchasing power, which is best measured with respect to the CPI.

Rather than a real price, the Dow-gold ratio is better viewed as a relative price.  The ratio tell us that equity prices have recently underperformed commodity prices.  This should not come as a surprise, since equities typically underperform in an inflationary environment.  The Great Inflation of the 1970s was notoriously associated with a rolling multi-year bear market in stocks.

While Prechter is notoriously bearish equities, he has also been bearish gold, so his case for gold is based on relative performance.  But the implication to be drawn from the Dow-gold ratio is that equities as an asset class are becoming cheaper relative to commodities as an asset class.  Relative value is thus increasingly on the side of equities, not commodities.

posted on 22 February 2008 by skirchner in Economics, Financial Markets

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Consumers Don’t Cause Recessions

Adam Posen, on why consumers don’t cause recessions:

When forecasting the US economy, what happens to the business sector and investment is far more salient than what happens to consumption. While private consumption makes up 70 percent of the economy, it fluctuates over a far smaller range than investment or net exports (which makes sense, since what households purchase does not vary all that much with the business cycle). A decline in consumption commensurate with the decline in housing prices, and thus households’ perceived wealth, would be on the order of 1.25 percent of GDP, based on how they increased spending as house prices went up. That estimate is essentially what the forecast slowdown in the US economy over the next couple of quarters amounts to—it is not in itself enough to cause a persistent recession. And since at least 1945, the United States has never had a consumer-driven recession, precisely because consumers behave this way.

posted on 21 February 2008 by skirchner in Economics, Financial Markets

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The Macro Policy Division of Labour

The Treasury’s David Gruen reminds Senators who is responsible for demand management and inflation control:

Dr Gruen said the RBA strategy of raising interest rates was the most effective method of bringing inflation under control, but budget cuts proposed by the Rudd Government would help.

“Monetary policy responds quickly, and for that reason is our primary tool around demand management,” he said.

posted on 21 February 2008 by skirchner in Economics, Financial Markets

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What is the NAIRU for Australia?

Opposition Treasury spokesman Malcolm Turnbull sought to put Treasurer Swan on the spot yesterday, asking him to nominate Australia’s non-accelerating inflation rate of unemployment (NAIRU).  The question was specifically designed not to get an answer.  I dare say Malcolm can’t answer this question either.  If he can, he has chosen the wrong profession.

The NAIRU is one of those latent variables that is inherently unobservable and likely changes over time.  The concept is thus not very useful in the real-time conduct of macroeconomic policy.  The more important focus for policymakers is to ease the NAIRU constraint on growth, by lowering the structural or non-cyclical component of unemployment.

By way of comparison, New Zealand also currently enjoys a record low unemployment rate of 3.4% compared to Australia’s 4.1%.  Recent inflation outcomes suggest that both economies are likely facing the NAIRU constraint.  Yet on some measures (eg, non-tradeables inflation) Australia’s inflation performance is currently worse than that of New Zealand, despite its higher unemployment rate.  We can reasonably infer that New Zealand’s NAIRU is somewhat below that of Australia.  The 0.7 percentage point differential in the unemployment rate between the two countries reflects the additional structural unemployment Australian policymakers have been willing to accept in their choice of labour market institutions compared to those favoured in New Zealand.

posted on 19 February 2008 by skirchner in Economics, Financial Markets, Politics

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What Does RBA Tightening Do to the Economy?

David Uren writes:

WHAT does a 0.25 per cent rate rise do to the economy?...

The Reserve Bank, like other central banks around the world, keeps its own estimate of the effect of its actions a secret.

In fact, the RBA’s published research on this question is reasonably explicit.  The latest iteration of the RBA’s policy simulation model estimates the long-run elasticity of the output gap with respect to a sustained increase in the real cash rate of 100 basis points at 1.0 (ie, real output 1% below potential output), with most of the impact seen within three years.  Significantly, the real cash rate enters the model as a deviation from an assumed neutral real cash rate of 3%.  As we have noted previously, the real cash rate has only recently moved significantly above neutral based on headline inflation.  To that extent, it is only recently that monetary policy has been exercising any restraint at all on the economy.  Much of the tightening in the nominal cash rate in recent years has simply been offset by rising inflation.

posted on 18 February 2008 by skirchner in Economics, Financial Markets

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Business Spectator Column

Readers may have noticed that I have an occasional weekend column over at The Business Spectator

If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list.  Email info at institutional-economics dot com.

posted on 16 February 2008 by skirchner in Economics, Financial Markets

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None Dare Call it Conspiracy II

Terry McCrann remains hard on the case of the AFR’s resident conspiracy theorists:

Now Harris’s substantive assertion was that Treasury had unexpectedly cut the inflation forecasts from the previous year’s 2.9 per cent.

That was wrong. He did not tell readers that Treasury had actually increased its CPI inflation forecasts. From 2.5 per cent in both years in the May budget to 2.75 per cent for both years in the MYEFO/PEFO.

Crucially, those are for year average - all of 2007-08 over 2006-07 and the same for 2008-09. They were exactly consistent with the-then latest inflation forecasts from the Reserve Bank.

It should hardly be surprising that the Treasury and the Reserve Bank are mostly in agreement on the inflation outlook.  Since the Treasury Secretary is an ex-officio member of the Reserve Bank Board, he notionally presides over both sets of inflation forecasts.  A Treasury forecast that deviated too far from the RBA’s forecast might be seen as an implicit criticism of the Reserve Bank and its Board.  If Treasury were to forecast inflation outside the target range, it would effectively be accusing the RBA of presiding over a monetary policy error, one in which the Treasury Secretary was necessarily implicated.  It should also be pointed out that the Treasury and RBA forecasts are not strictly comparable, if only because the forecasts are made at different points in time.  If a week is a long time in politics, it is also a long time in the forecasting business.

According to Governor Stevens, the Board operates under a doctrine of collective responsibility.  If there were any substance to this doctrine, then a Board member who takes a different view on inflation to the one publicly endorsed by the Bank needs to either reconcile himself to the Board’s majority view, or resign.  Since the Treasury Secretary is a member of the Board by statute, the latter is not exactly an option.

Rather than looking for non existent conspiracies, the AFR might instead go in search of the rather more obvious conflict of interest.  The Treasury Secretary should not be a member of the RBA Board.

posted on 16 February 2008 by skirchner in Economics, Financial Markets, Politics

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Zero ‘Bubble’

Some refreshing ‘bubble’ skepticism from Alex Tabarrok:

So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.

But what has actually happened?  House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension).

In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.


posted on 14 February 2008 by skirchner in Economics, Financial Markets

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Which is Tighter, Monetary or Fiscal Policy?

Every time RBA Governor Glenn Stevens opens the newspaper these days, he must give thanks for having such a tame press.  On his own forecasts, both headline and underlying inflation in Australia will have a three in front of it for the rest of this decade and the first half of 2010.  Yet with the honourable exceptions of Terry McCrann and Alan Wood, Australia’s economic commentators are near unanimous in arguing that it’s all the fault of fiscal policy (meaning tax cuts).

This view misunderstands Australia’s macro policy framework, which assigns the job of demand management and inflation control to the Reserve Bank.  Those who are opposed to further tax cuts are effectively arguing that the government should engineer a taxpayer-funded bail-out of monetary policy.  Needless to say, this strategy won’t work, because higher taxes would simply add to supply-side constraints in the labour market. 

It also ignores the obvious conclusion to be drawn from two very simple metrics that can be applied to assess the stance of monetary and fiscal policy.  The Commonwealth’s 2005-06 and 2006-07 underlying cash surpluses were at their highest as a share of GDP in nearly 20 years.  Fiscal policy is thus unambiguously tight, even after all the previous tax cuts that the commentariat have for the most part opposed.

The same cannot be said for the real official cash rate, the best measure of the stance of monetary policy.  With underlying inflation at 3.6% in Q4, the ex-post real cash rate was a mere 3.15% taking the year-ended official cash rate of 6.75% and 3.4% using the current official cash rate of 7.00%.  According to the RBA’s own policy simulation model, Australia’s neutral real cash rate is 3%.  So when the RBA’s Statement on Monetary Policy says that monetary policy is ‘on the restrictive side of neutral,’ it is talking about less than 50 basis points.  With the RBA’s own inflation forecasts having a three in front for as far as the eye can see, the ex-ante real interest rate is at best 4% (assuming steady policy). 

As the following chart shows, the ex-post real cash rate only moved to the restrictive side of neutral at the beginning of last year.  Monetary policy has been too easy for too long.  Hence the inflation problem.


posted on 13 February 2008 by skirchner in Economics, Financial Markets, Politics

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No Malcolm, Wayne Swan is Not Making this Up

One of the referees for an article I have forthcoming on Australian monetary policy queried my assertion that Australia’s inflation target is poorly defined, although subsequently came around to my view that the Statement on the Conduct of Monetary Policy makes this less than clear.  The Statement refers to ‘consumer price inflation,’ but is otherwise silent on which of many possible measures of consumer price inflation could be used in determining whether the inflation target has been met.

The confusion this causes was nicely illustrated by Shadow Treasurer Malcolm Turnbull in an interview over the weekend, in which he accused Treasurer Swan of making up the inflation figures:

BARRIE CASSIDY: But what was it in the December quarter though, what was the figure in the December quarter? The one that this Government inherited? 3.6 per cent. A 16-year high.

MALCOLM TURNBULL: No it wasn’t. Ok, now that is a complete untruth. Now Wayne Swan keeps on saying that. I challenge you, invite all of your viewers to go to the Reserve Bank website. You’ll see there that the headline CPI (consumer price index) which is the one that is the inflation targeting is benchmarked against as recently - emphasised again - as recently as December 6 by Wayne Swan himself. That was 3 per cent. In fact, it was 2.96 per cent. The other measurers of inflation, so-called “underlying inflations”, which are statistical adjustments are ... none of them were 3.6 per cent, not one. So, where the 3.6 per cent comes from, I could make a guess but it is not one that was published by the RBA.

The 3.6% figure is an average of the two statistical measures of underlying inflation, the weighted median and the trimmed mean, now published by the ABS rather than the RBA.  The RBA references this average in the underlying inflation forecasts contained in the quarterly Statements on Monetary Policy.  But unless you are an avid reader of the footnotes to these Statements, you could be forgiven for missing it.  The RBA uses this measure because it captures the persistent component of inflation that is of most concern for policy purposes.

Turnbull’s comments reflect a larger problem, which is that this definition of underlying inflation has never been properly announced by the RBA or explicitly endorsed by the current government.  Those of us in financial markets first discovered the RBA was using it only by a process of educated guesswork.  The May 2006 increase in interest rates caught financial markets by surprise, because markets were then accustomed to looking at a different measure of underlying inflation.  It was only when the RBA characterised ‘underlying consumer price inflation’ as being ‘around 2¾ per cent’ in the statement accompanying the May 2006 increase in interest rates that it became apparent what measure the RBA was using, but even this inference was only possible by a process of elimination. 

An inflation targeting regime works largely by conditioning inflation expectations.  But if even the Shadow Treasurer doesn’t know or doesn’t accept the RBA’s working definition of underlying inflation, we should not be surprised that we have an inflation problem.

posted on 11 February 2008 by skirchner in Economics, Financial Markets, Politics

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Tax Cuts Cause Recessions!

If you think tax cuts lead to higher interest rates, then I guess it follows that you would also believe that tax cuts cause recessions.  From someone who should know better:

This is no joke: Kevin Rudd’s tax cuts will increase the risk of a recession in the second year of his first term.

posted on 09 February 2008 by skirchner in Economics, Financial Markets

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None Dare Call it Conspiracy

Terry McCrann on the AFR’s conspiracy theorists:

Despite the “best” efforts of The Australian Financial Review during the week to concoct an absurd conspiracy out of the Treasurer and Prime Minister’s “shock discovery” of an inflation problem.

Did anyone down at the Fin notice that the Reserve Bank increased the official interest rate smack in the middle of the election campaign? Something that it had never previously done, and was regarded by many as something it would never - or even should - do?

That sorta, kinda, suggested someone in the official family was worried about inflation. Worried enough that it couldn’t wait a couple of weeks until the election was out of the way.

The very strong suggestion from some quarters that that was exactly what the RBA should do, so as not to “politicise” rates, provides an interesting counterpoint to the Fin’s (completely untrue and quite outrageous) slur.

Surely for the RBA to have postponed its rate rise would have been to engage in exactly the subterfuge about inflation becoming a problem that the Fin accused Treasury and in particular Treasury head Ken Henry of doing.

There was no conspiracy, there was no inflation surprise. Treasury upped its inflation forecasts even before seeing the all-important September quarter CPI numbers. And it was those CPI numbers that set inflation alarm bells ringing all over town, and especially above Martin Place in Sydney.

Self-evidently. There was no official rate rise in September or in October. But there had been in August; again a pointer to the beginning of concern.

posted on 09 February 2008 by skirchner in Economics, Financial Markets

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Peak Oilers in Simon-Ehrlich Wager

A group of Peak Oilers put their money where their mouth is:

Reveling in the role of the fly tweaking the elephant, a group of peak-oil proponents has challenged prominent oil-industry consultancy Cambridge Energy Research Associates to a not-so-friendly wager.

If CERA proves correct in its prediction that global oil production will rise by 20 million barrels per day by 2017, then the challengers, the Association for the Study of Peak Oil & Gas, will hand CERA a check for $100,000 nine years hence. If oil production falls short of CERA’s projection, as the group known as ASPO projects, ASPO will get the bragging rights and the check – and donate the money to charity.

CERA, the Boston-based company headed by prominent consultant Daniel Yergin, forecasts that global oil-production capacity could rise to 112 million barrels per day in 2017. Today, according to CERA, capacity is about 91 million barrels.

“That’s a vision in search of reality,” Steve Andrews, co-founder of ASPO’s U.S. branch, said in a statement it sent out yesterday. Who knows whether ASPO’s finances will peak before then. But along with its press release, ASPO sent a copy of what it said is a bank letter of credit guaranteeing its $100,000 bet.

While it’s scary to think the peak oilers have this much money to throw around, their willingness to back their view with an Ehrlich-Simon type bet is praiseworthy.  Having said that, the criticism of peak oil does not necessarily turn on specific outcomes for oil production, but on whether a prospective peak in production has any long-term relevance.


posted on 08 February 2008 by skirchner in Economics, Financial Markets

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The Revenge of the Revenue Hoarders

The legislation to implement the government’s promised tax cuts will be introduced to parliament next week, but like a zombie army immune to intelligent argument, the advocates of increased Commonwealth revenue hoarding are not beaten yet:

WAYNE Swan has called an end to the Howard government policy of returning excess budget surpluses as tax cuts, saying the Reserve Bank had been allowed to shoulder too much responsibility for controlling inflation with interest rate rises.

The Treasurer said that under the Rudd Government, any windfall revenue would be allowed to mount up as a larger budget surplus and would be quarantined, either with the Reserve Bank or the Future Fund.

“We will be banking any upward revisions to revenue, if they occur,” he told The Australian.

Mr Swan said the previous government placed too much emphasis on the use of interest rates - or monetary policy - to control inflation, and did not do enough to control the budget with fiscal policy.

“Monetary policy is a blunt instrument and that is why it is really important that fiscal policy plays a bigger role,” he said.

This has things exactly backwards.  It is fiscal policy that is the blunt and unwieldy policy instrument and Australia’s current inflation problem is first and foremost a failure of monetary not fiscal policy.

Increased Commonwealth revenue hoarding also runs counter to Treasury advice, which points to the positive implications for labour supply and potential output of lower taxes.  If the previous government had not cut taxes, labour market constraints would be an even greater threat to inflation and interest rates than they are now.  By contrast, Commonwealth revenue hoarding has no pay-off in augmenting the supply-side of the economy.

posted on 08 February 2008 by skirchner in Economics, Financial Markets

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Australia’s Fiscal Gang Problem

Finance Minister Lindsay Tanner says ‘Australia has a gang problem, and I’m part of it.’  He is referring, of course, to the ‘razor gang.’  Tanner was announcing a ‘modest down payment’ of $643m in budget cuts, ahead of larger cuts to be announced in the May Budget.  No doubt the aim of this announcement is to be seen to be doing something about inflation in the week of an increase in official interest rates.  Among the causalities are some of the former government’s more outrageous pork-barrelling projects, including the Fishing Hall of Fame and the National Rugby Academy. 

The more significant cuts will take longer to put together, but the returns to what has supposedly been a line-by-line examination of government spending programs are already looking rather paltry.  They are also small relative to the enormous amount of political capital the government has available to spend in the wake of its election victory.  One suspects that the legendary Lu Kewen could literally spit on some voters at the moment and still have them come away thinking it was a religious experience.  When it comes to cutting spending, there is no time like the present. 

We previously noted that the new Labor government’s target for the underlying cash surplus of 1.5% of GDP for 2008-09 was not exactly ambitious, merely maintaining the status quo on recent budget outcomes and representing only a small contractionary impulse on forward estimates that probably would have been bettered anyway.  The ugly reality for the government is that Commonwealth fiscal policy is already the tightest it’s been in two decades and further spending cuts of the magnitude being contemplated by the government will not put a dent in inflation or interest rates.

posted on 07 February 2008 by skirchner in Economics, Financial Markets, Politics

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Hot Ladies Talk Money with Bald Dudes

Jon Stewart’s take on financial TV.

posted on 07 February 2008 by skirchner in Economics, Financial Markets

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Another Own Goal in the ‘War on Inflation’

Fighting inflation – with higher tariffs:

The Rudd Government is looking at the possibility of a tariff freeze, in a bid to protect Australia’s remaining car makers, after Mitsubishi confirmed the closure of it’s Australian manufacturing operations with the loss of 930 jobs, according to media reports.

The automaker’s departure is expected to prompt the federal government to carry out a review of subsidies allocated to the industry, as players left in the local automotive sector struggle to cope with increased global competition and a shrinking share of the market.

Car industry tariffs are due to be cut from 10 per cent to 5 per cent by 2010, but manufacturers have asked the government to maintain the current protection and boost funding for the industry.


posted on 06 February 2008 by skirchner in Economics, Politics

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Building Approvals, House Price Inflation and Rents

If you thought the double-digit annual growth rates for established house prices in the December quarter were impressive, then you should be even more impressed with the December building approvals release.  Private house approvals fell off a cliff, with the overall level of approvals at its lowest since September 2005. 

In financial markets, it is common to give the building approvals release a demand-side interpretation, but the supply-side implications are more compelling in the current environment.  The strong increases in dwelling rents, a direct contribution to CPI inflation, and house prices are symptomatic of a national shortage of dwelling stock which, on these numbers, is not about to be eased any time soon.  Of course, rising rents and house prices should eventually induce an increase in approvals and supply.  The November release seemed to herald exactly that, but those gains and more were given away in December. It remains to be seen how much of this is just one-off month on month volatility.  The fact that Christmas fell on a Tuesday may have been a factor.  There would not have been many people working Monday and, knowing council workers, it is hard to imagine too many hanging around on the previous Friday afternoon either, so there may be a trading day effect that is not picked-up by the usual seasonal adjustment process.

In any event, together with yesterday’s increase in official interest rates, the implications for housing affordability are fairly dire.  During the previous boom in house prices earlier this decade, many people decried the tax breaks on investment property and predicted massive over-supply and a subsequent crash in property prices.  Yet at best we saw a flattening in prices at the national level, suggesting that the national housing market was never seriously oversupplied.  In the absence of the augmentation of the housing stock that we saw as a result of the previous boom and the concessional tax treatment of capital gains on investment property after 1999, the supply situation, housing affordability and inflation outcomes may have turned out even worse than they are now.

posted on 06 February 2008 by skirchner in Economics, Financial Markets

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Better Late than Never

From today’s RBA statement on official interest rates:

In future meetings, the Board will continue to evaluate whether the stance of policy will be sufficiently restrictive to return inflation to the 2-3 per cent target.

One would have hoped that the RBA might have performed this evaluation properly before inflation moved outside the target range.

posted on 05 February 2008 by skirchner in Economics, Financial Markets

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In Bed with Sharon Burrow

What do opposition Treasury spokesman Malcolm Turnbull and ACTU President Sharon Burrow have in common? 

Mr Turnbull:

“I have said before and I will repeat again that I think there are powerful reasons for the Reserve Bank to hold its hand at this meeting.

“There is a lot going on in the international markets and we have inflation running at around that 3 per cent mark at the moment in Australia.”

Ms Burrow:

“It should wait and see on interest rates until the effect of the turmoil in the United States caused by the sub-prime housing market is clearer,” Ms Burrow said.

It is of course precisely the lack of interest rate rises from the RBA that has been the main cause of Australia’s inflation problem.

posted on 05 February 2008 by skirchner in Economics, Financial Markets, Politics

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An Own Goal in the ‘War on Inflation’

The Rudd government seeks to fight inflation and promote housing affordability – by giving people more money to spend on housing.  This is good news for incumbent property owners, who will see the increase demand for housing capitalised into house prices, but will only worsen housing affordability. 

According to the government:

First Home Saver Accounts are also part of the Rudd Government’s five point plan to win the war on inflation, encouraging private savings [sic] and helping put downward pressure on inflation and interest rates.

This initiative will help boost national savings [sic], with the accounts anticipated to hold around $4 billion in savings [sic] after four years.

It is more likely the scheme will simply see substitution between different types of private saving, with households diverting funds from other types of saving to take advantage of the government co-contribution, with no gain to overall private or national saving.  As we argue here, the level of domestic and national saving is only a minor influence on interest rates in a small open economy like Australia.

posted on 04 February 2008 by skirchner in Economics

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Australian versus US House Prices

The December quarter ABS established house price index saw the weighted average for capital cities rise 3.2% q/q and 12.3% y/y.  Perth once again underperformed the other capital cities, with growth of 0.9% q/q and 1.1% y/y, coming down off the massive near 50% y/y growth rate seen for the year-ended in September 2006.  Sydney rose 2.4% q/q and 8% y/y, giving a very respectable 5% y/y real return after headline inflation.  All the other capitals recorded double-digit annual percentage gains in house prices, with house price growth in Melbourne, Brisbane and Adelaide standing around 20% annually.

For all the talk of a house price bust in Australia a few years ago, Sydney was the only state capital to record an outright decline in house prices at an annual rate, although Melbourne got close with a modest 0.4% y/y rate in the year to December 2004.  Many of Australia’s capital cities did, however, experience house price disinflations that were far more dramatic than anything experienced in the US as part of its so-called housing ‘bubble.’

This raises the obvious question as to why house price swings in the US that are relatively modest by Australian standards have had much more adverse macroeconomic consequences in the US.  The answer most probably lies in the distinctive features of the US mortgage market.  The Australian market is much better conditioned to pronounced cycles in house prices, inflation and interest rates.  The lesson is that dramatic house price disinflations or deflations in themselves need not be a serious macroeconomic problem.  The more important issue is how these swings interact with, and get propagated through, the financial system.

Australia is a price-taker in global capital markets.  The US is an effective price-maker, which means it has the capacity to export financial shocks that have their origins in the non-traded goods sector of the US economy.  There has been some pass through of this shock to Australian retail lending rates, as Australian borrowers compete with the rest of the world for scarce liquidity.  But this shock to retail lending rates can be traded-off against changes in official interest rates.  It has long been argued that Australia’s negative net international investment position left it vulnerable to negative external financial shocks, but the current episode suggests that Australia’s vulnerability to international credit shocks has been greatly exaggerated.

posted on 04 February 2008 by skirchner in Economics, Financial Markets

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The Legendary Lu Kewen

First, there was Rudd Commands Your Vote.  Now, in a case of life imitating art, we have the legendary Lu Kewen:

“This book will fully interpret the legendary life of Lu Kewen. How he was born in a poor family in 1957, how he stepped into the palace of success through endeavour and effort, how he fought in the political waves and stepped proudly through the tide.”


posted on 02 February 2008 by skirchner in Politics

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posted on 01 February 2008 by skirchner in Culture & Society, Economics, Financial Markets, Foreign Affairs & Defence, Higher Education, Misc, Politics

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