Working Papers

2009 01

‘Neo-Liberalism’ Triumphed in 1978.  Who Knew?

Prime Minister Kevin Rudd has produced a 7,700 word essay on The Global Financial Crisis.  Only the first 1,500 words are currently available on-line.  Until I have seen the rest, I’ll refrain from commenting on the substance, such as there is.  If any readers have a samizdat copy, please send it through.

However, if the first 1,500 hundred words are any guide, we can safely comment on the Prime Minister’s style.  Kevin Rudd is notorious for the mind-numbing emptiness of his public utterances.  Rudd’s most overused phrase is ‘for the future’, so it was no surprise that this made it into the first 1,500 words, along with such awful clichés as ‘throw the baby out with the bathwater.’

As with his ‘Between Hayek and Brezhnev’ speech to CIS in August last year, Rudd posits two straw men and then places himself in the reasonable centre.  Rudd’s approach to argument is thus very similar to his approach to politics.  His strategy is to minimise points of disagreement.  But what works well as political strategy won’t fly as serious argument.

posted on 31 January 2009 by skirchner in Economics, Politics

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Rudd Bank versus AussieMac

A curious feature of the debate surrounding the so-called Rudd Bank (see previous post) and AussieMac is that the same people have taken different positions on the two interventions.  Opposition leader Malcolm Turnbull supported the government’s intervention in the RMBS market, but opposes Rudd Bank.  In The Australian today, Christopher Joye criticises Ian Harper for supporting Rudd Bank while opposing the RMBS intervention.  Joye supports the RMBS intervention and (at least on a relative basis) opposes Rudd Bank.

In my op-ed for the AFR on Rudd Bank yesterday, I deliberately linked the two interventions, because I see them as suffering from similar problems.  Both interventions implicate the government in favouring specific industries and firms, on the assumption that this will prevent wider adverse economic outcomes.  This overlooks the fact that those sectors deemed most worthy of assistance may also be those most in need of adjustment and may see low relative returns on government resources compared to alternative policies.  Both interventions rely on a rather stretched transmission mechanism from the government’s balance sheet, via the balance sheets of business, to the wider public.

One of the advantages of generalised tax cuts as a stimulus measure is that they are relatively neutral from the standpoint of resource allocation.  Tax cuts may also have other supply-side benefits through easing distortions and disincentives flowing from the operation of the tax system.  From a demand management perspective, unfunded tax cuts are subject to the same Ricardian equivalence critique as unfunded spending measures, but from a supply-side perspective, they have a distinct advantage.

From a political perspective, however, the advantage of Rudd Bank and the RMBS intervention is that they can be written up as loans and investments rather than outright spending.  The fiscal transfers involved are therefore much less transparent.  One could say the same of the provision of term funding to banks via the Future Fund, although at least this is at arms length from the government of the day and may not differ significantly from the market-based outcomes that would prevail if the Future Fund did not exist.

posted on 29 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Rudd Bank Puts Taxpayers Last

I have an op-ed in today’s AFR on the so-called ‘Rudd Bank.’  Text below the fold (may differ slightly from edited AFR version).

Henry Ergas made related arguments in The Australian yesterday.

continue reading

posted on 28 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Right Forecast, Wrong Trade II

Mike Shedlock is far from impressed with Peter Schiff.

posted on 27 January 2009 by skirchner in Economics, Financial Markets

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US Government Debt Default – It’s Happened Before

Alex Pollock reviews the US government’s 1933 decision to repudiate its gold clause obligations:

The United States quite clearly and overtly defaulted on its debt as an expediency in 1933, the first year of Franklin Roosevelt’s presidency. This was an intentional repudiation of its obligations, supported by a resolution of Congress and later upheld by the Supreme Court.

Granted, the circumstances were somewhat different in those days, since government finance still had a real tie to gold. In particular, U.S. bonds, including those issued to finance the American participation in the First World War, provided the holders of the bonds with an unambiguous promise that the U.S. government would give them the option to be repaid in gold coin.

Nobody doubted the clarity of this “gold clause” provision or the intent of both the debtor, the U.S. Treasury, and the creditors, the bond buyers, that the bondholders be protected against the depreciation of paper currency by the government.

Unfortunately for the bondholders, when President Roosevelt and the Congress decided that it was a good idea to depreciate the currency in the economic crisis of the time, they also decided not to honor their unambiguous obligation to pay in gold.

The fact that the US defaulted on these obligations demonstrates that a gold standard is only a very weak constraint on government once the decision is made to go off it.  The gold standard fails an important test that all monetary institutions should satisfy, namely that they be politically robust.  It is noteworthy that private and public debt defaults are often associated with the failure of fixed exchange rate regimes, because those who borrow in foreign currencies at the former parity can face a sudden increase in their debt burden.

A floating exchange rate regime, by contrast, is much less likely to give rise to the need for default on debt obligations.  In the case of the US, the ability to borrow in its own currency shifts exchange rate risk to its creditors.  Although this currency risk might be reflected in interest rates, in practice, this seems to be a relatively minor influence on interest rates.  For countries like Australia that are also heavily dependent on foreign borrowing, the exchange rate risk is typically swapped out.  The exchange rate can then carry most of the adjustment to an external shock, without causing significant problems for domestic borrowers.

posted on 27 January 2009 by skirchner in Economics, Financial Markets, Gold

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An Offer Über Dollar Bears Cannot Refuse

David Henderson offers to ease the worries of US dollar bears:

please contact the publisher for my address and send me all of your bills with pictures of dead presidents on them, especially the ones with pictures of Ulysses S. Grant. (I will even accept the ones with pictures of Benjamin Franklin, although he was not a president.) In return, I will send you an equal weight of blank paper. I promise.

posted on 25 January 2009 by skirchner in Economics, Financial Markets

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The Terms of Trade: Not Dead Yet

The December quarter trade prices release saw the largest quarterly and annual increases in export prices since the current series began in the September quarter 1974, at 15.9% q/q and 54.9% y/y.  Import prices were up 10.8% q/q and 21.1% y/y, the largest annual increase since the December quarter 1985.  The merchandise terms of trade are up nearly 30% on a year ago.

How did Australia pull-off a further gain in the terms of trade against the backdrop of collapsing world commodity prices?  The depreciation in the Australian dollar over the quarter, which supported Australian dollar commodity prices.  This is a very good illustration of the role of a floating exchange rate in insulating the economy against external shocks. 

Given the magnitude of the external shock now confronting the Australian economy, the appropriate exchange rate response is massive depreciation.  In this context, US dollar strength is perfectly explicable, because weakness in the US economy is an external shock for the rest of the world. 

Unfortunately, this may see pressures for competitive devaluations and foreign exchange market intervention, not least on the part of the new US Administration.  This would be in sharp contrast to the highly principled stance the Bush Administration took against intervention in foreign exchange markets.  The new US Treasury Secretary, Tim Geithner, was a protégé of former Treasury Secretary Robert Rubin, who presided over massive intervention in foreign exchange markets.

posted on 24 January 2009 by skirchner in Economics, Financial Markets

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The Multiplier Equals Zero

Robert Barro makes the case for a zero multiplier from fiscal stimulus:

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP—consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.

This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.

What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II. The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.

I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports—personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses—there was a dampener, rather than a multiplier.

posted on 22 January 2009 by skirchner in Economics, Fiscal Policy

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The Failure of US Fiscal Policy

When it comes to activist fiscal policy, it seems that nothing succeeds like failure.  The failure of the economy to respond to previous stimulus measures is always seen as an argument for yet more stimulus, rather than supporting the more obvious conclusion that activist fiscal policy doesn’t work.  As Philip Levy notes, if the existing US budget deficit won’t budge its economy, there is nothing the Obama Administration can add that is likely to make a difference:

The Congressional Budget Office projected last week that even without a stimulus package, the federal budget deficit will hit $1.2 trillion this year. That’s 8.3% of gross domestic product. Followers of the late John Maynard Keynes should be thrilled. Such a gap between government spending and taxes was just what he prescribed to stimulate a slumping economy.

And yet the stimulus enthusiasts seem unsatisfied. President-elect Barack Obama argues that this level of stimulus would leave us with shattered dreams and long-lasting torpor. Our only chance is to adopt his plan of $800 billion in additional stimulus spending over the next two years. So $1.2 trillion in deficit spending leaves us in despair, but $1.6 trillion in deficit spending brings prosperity…

there is very little science behind arguments that an additional $800 billion stimulus should do the trick.

Unfortunately, the political imperative is for governments to be seen to be doing something, regardless of whether it works or not.

posted on 15 January 2009 by skirchner in Economics, Fiscal Policy

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Is Australia the Freest Country on Earth?

Australia moves up to third place in the Heritage Foundation-Wall Street Journal Index of Economic Freedom for 2009, behind only Hong Kong and Singapore.  The construction of the score for Australia contains some questionable elements.  For example, Australia loses five points from its monetary freedom score because ‘retail gas and electricity prices are regulated.’  Yet these regulations are a relatively minor infringement of economic liberty, while ignoring other more serious price controls (ask Andrew Norton about price controls in higher education, which limit freedom to invest in human capital).  The statement on ‘investment freedom’ is self-contradictory:  ‘Foreign and domestic investors receive equal treatment… Foreign investment in media, banking, airlines, airports, shipping, real estate, and telecommunications is subject to limitations. Foreign investors may own land, subject to a number of restrictions.’

The index does not purport to measure political freedom.  But since Australia’s political institutions are at least as free as any other country, and certainly more free than those in Hong Kong and Singapore, Australia could make a plausible case for being the world’s freest country if sufficient weight were given to the political as well as the economic dimensions of freedom (at least as measured by Heritage).

posted on 14 January 2009 by skirchner

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Thrift is No Paradox

I have an op-ed in today’s AFR refuting the paradox of thrift as a rationale for short-term fiscal stimulus measures.  In particular, I highlight the origins of the idea in the discredited ‘secular stagnation’ hypothesis of the1930s.  Text over the fold (may differ slightly from edited AFR version).

Greg Mankiw makes related arguments in the US context.

continue reading

posted on 13 January 2009 by skirchner in Economics, Fiscal Policy

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Does ‘Peak Oil’ Cause Oil Prices or Do Oil Prices Cause ‘Peak Oil’?

‘Peak oil’ is meant to drive a secular increase in oil prices.  But what if the cyclical behaviour of oil prices actually drove belief in peak oil?  Matthew Kahn notes that traffic at the peak oil blog The Oil Drum is closely correlated with oil prices.  The direction of causality is fairly unambiguous:

I don’t believe that the Oil Drum blog causes gas price dynamics. The causality runs from oil price dynamics causing interest or declines in interest in the Oil Drum blog.

posted on 10 January 2009 by skirchner in Economics, Oil

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Life Imitates Art: Atlas Shrugged Edition

Stephen Moore argues ‘the current economic strategy is right out of “Atlas Shrugged”’…

“We don’t need to make a movie out of the book,” Mr. [David] Kelley jokes. “We are living it right now.” 


posted on 10 January 2009 by skirchner in Economics, Rand

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Bailouts Gone Wild: The Welfare Economics of Porn

With what I assume is tongue firmly in cheek, Larry Flynt petitions Congress for a bailout:

LOS ANGELES, Jan 07, 2009 /PRNewswire via COMTEX/—As the 2009 AVN Adult Expo opens in Las Vegas this week, Girls Gone Wild CEO Joe Francis and HUSTLER magazine publisher Larry Flynt are petitioning the newly convened 111th Congress to provide a financial bailout for the adult entertainment industry along the lines of what is being sought by the Big Three automakers, a spokesperson for Francis announced today.

Adult industry leaders Flynt and Francis sent a joint request to Congress asking for $5 billion in federal assistance, “Just to see us through hard times,” Francis said. “Congress seems willing to help shore up our nation’s most important businesses, we feel we deserve the same consideration. In difficult economic times, Americans turn to entertainment for relief. More and more, the kind of entertainment they turn to is adult entertainment.”

But according to Flynt the recession has acted like a national cold shower. “People are too depressed to be sexually active,” Flynt says, “This is very unhealthy as a nation. Americans can do without cars and such but they cannot do without sex.”

As the Tax Foundation notes, they probably have a stronger case than the auto industry:

is “adult entertainment” a public good?  Like all intellectual property, porno is non-rivalrous: once a Girls Gone Wild video is produced, the content can be endlessly distributed and redistributed.  And with the advance of the Internet and peer-to-peer file sharing, it is increasingly non-excludable: as noted in the bailout press release, a key driver behind reduced porn revenues is the illegal reproduction and sharing of porn content.

Pornography might have even greater public good characteristics if its benefits extend beyond its direct consumers.  For example, pornography may have educational value that benefits not only its direct consumers but also those consumers’ sex partners.  Under Coasean analysis, this does not necessarily make porn a public good: those sex partners could bear the cost of their indirect porn consumption, perhaps by paying a “porn surcharge” to their better-educated partners.  However, the Coase theorem only applies when transaction costs are low, and given well-established social norms against the combination of sexual activity and financial transactions, it is likely that there is a market failure leading to porn underconsumption.

This is not to say that Congress should give money to the adult entertainment industry.  However, these characteristics do make the providers of pornography a more attractive bailout recipient than, say, the auto industry, which produces goods that are clearly both excludable and rivalrous.

Chris Dillow, channelling Bastiat’s candlemakers’ petition, notes that the industry is also subject to unfair competition:

The need for a subsidy is especially pressing because the industry is under threat not just from the availability of free porn on the web, but also competition from another source - women giving it away for free. Both of these can be seen as a form of predatory pricing, or dumping. Many policy-makers believe it’s acceptable to protect industries from this.


posted on 09 January 2009 by skirchner in Economics

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Credit Default Swap Myths

Peter Wallison tackles the many myths surrounding the role of credit default swaps in the financial crisis:

One conventional explanation for the Bear rescue has been that CDSs made the financial markets highly “interconnected.” It is in the nature of credit markets to be interconnected, however: that is the way money moves from where it is less useful to where it is most useful, and that is why financial institutions are called “intermediaries.” Moreover, there is very little evidence that Bear was bailed out because of its involvement with CDSs—and some good evidence to refute that idea. First, if the government rescued Bear because of CDSs, why did it not also rescue Lehman? If the Treasury Department and the Federal Reserve really believed that Bear had to be rescued because the market was interconnected through CDSs, they would never have allowed Lehman—a much bigger player in CDSs than Bear—to fail. In addition, although Lehman was a major dealer in CDSs—and a borrower on which many CDSs had been written—when it failed there was no discernible effect on its counterparties. Within a month after the Lehman bankruptcy, the swaps in which Lehman was an intermediary dealer were settled bilaterally, and the swaps written on Lehman itself ($72 billion notionally) were settled by the Depository Trust and Clearing Corporation (DTCC). The settlement was completed without incident, with a total cash exchange among all counterparties of $5.2 billion. There is no indication that the Lehman failure caused any systemic risk arising out of its CDS obligations—either as one of the major CDS dealers or as a failed company on which $72 billion in notional CDSs had been written.

posted on 08 January 2009 by skirchner in Economics, Financial Markets

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Macro Non-Predictions for 2009

Macro Man’s non-predictions for 2009

Macro Man’s strike rate for 2008: 7/10.

posted on 08 January 2009 by skirchner in Economics, Financial Markets

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Commodity Prices and the Australian Economy: Trends versus Cycles

I have an article in the latest issue of Policy examining trends and cycles in commodity prices.  In the article, I highlight the difficulty of isolating longer-run trends from the pronounced multi-year cycles in commodity prices.  I also argue that commodities are not nearly as important to the Australian economy as commonly assumed.

posted on 07 January 2009 by skirchner in Commodity Prices, Economics

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What is Seen and What is Not Seen: Cow Candy Edition

From the office of the Treasurer, Wayne Swan:

Today I visited the Biocane Mill at Bli Bli on Queensland’s Sunshine Coast and announced the reinstatement of a $1 million funding grant to help complete the construction of a factory at the site.

The company, Biocane Ltd, will use the factory to manufacture stock feed from sugar cane using technology pioneered in Australia that produces a dry sweet fodder, known as ‘Cow Candy’, which is exported to cattle feedlots in East Asia…

The Minister took an active interest investigating this issue because he understands how important it is to support local businesses and has now reinstated the funding.

Biocane Ltd has advised that it will employ 32 people at the Bli Bli plant to complete the construction and upon completion about 18 permanent jobs will be created initially at the mill, as well as flow-on employment for sugar cane farmers and their employees.

Having grown up at Nambour I know first hand how important this funding will be to the sugar cane industry and the economy of the Sunshine Coast region.

Pity they didn’t teach Bastiat at Nambour High:

But the disadvantage that the taxpayers try to free themselves from is what is not seen, and the distress that results from it for the merchants who supply them is something further that is not seen, although it should stand out plainly enough to be seen intellectually.

When a government official spends on his own behalf one hundred sous more, this implies that a taxpayer spends on his own behalf one hundred sous the less. But the spending of the government official is seen, because it is done; while that of the taxpayer is not seen, because—alas!—he is prevented from doing it.


posted on 06 January 2009 by skirchner in Economics

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Blame Oil, Not Housing

Amid the GFC of 2008, it was easy to forget that 2008 also saw a major oil price shock.  In a series of posts, James Hamilton argues that the oil price shock largely accounts for the downturn in the auto sector.  He also presents evidence to suggest that the oil price shock was critical in exacerbating the downturn in the housing sector.

Hamilton concludes that ‘if gasoline prices had stayed at $2.50 a gallon through 2008, the NBER Business Cycle Dating Committee would not have declared that the current recession began in December 2007.’

posted on 04 January 2009 by skirchner in Economics, Oil

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Right Forecast, Wrong Trade

The WSJ profiles ‘doomsayers who got it right’ – well, almost:

[Peter Shiff] has been wrong on significant parts of his argument. Many detractors point out that two of his core beliefs—a longstanding prediction that the dollar would collapse and that foreign stocks would outperform U.S. shares—have been well off the mark in this crisis. A rush into the safety of the greenback sent the dollar soaring against other currencies and, as a side effect, helped undermine shares of stocks around the world.

Mr. Schiff acknowledges that he wasn’t expecting that to happen. But he says his worries aren’t misplaced: A dollar dive and foreign-stock outperformance are still in the cards.

posted on 02 January 2009 by skirchner in Economics, Financial Markets

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In Search of the Real Austrian School

Time magazine’s economics columnist Justin Fox goes in search of the real Austrian School:

People in the U.S. who self-identify as believers in Austrian economics, though, tend to follow a much narrower path, that of Mises and his American disciple Murray Rothbard. They are extremely libertarian (at the first meeting of the Mont Pelerin Society, a libertarian group organized by Hayek in 1947, Mises stormed out saying “You’re a bunch of socialists”). They yearn for a return to the gold standard. Many possess a near-religious conviction that their beliefs are correct and that all other economic theories are pure folly. Some of them—I’m thinking here mainly of the crowd around Lew Rockwell—combine these beliefs with far loopier stuff. Others—such as financial pundits Peter Schiff and Michael Shedlock—often let their rabid Austrian leanings overpower (and, to my taste, ruin) otherwise trenchant economic analyses. Am I going to go to these people for perspective on the business cycle or Austrian economics? No, I don’t think so.

On the other hand, I’m not going to do like Krugman and dismiss Austrian economics as “about as worthy of serious study as the phlogiston theory of fire.” Just because something is outside the mainstream doesn’t mean it’s wrong. I guess the best thing for me to do would be for me to read more of the source material myself. I’ve dabbled in Hayek and Schumpeter and even Rothbard. If I devoured all of Menger’s Grundsätze der Volkswirtschaftslehre, in German, that ought to give me a certain authority, right?

That’s not going to happen anytime soon, so I’ll keep relying on Tyler Cowen. I will also try to follow Ransom’s advice, though. Roger Garrison of Auburn and Steve Horwitz of St. Lawrence University, the two modern Austrian-school economists he recommends, seem on first examination to be more interesting than loopy or strident, so I’ll start looking out for their writings. First step, adding the Austrian Economists blog, to which Horwitz contributes, to my feed reader.

posted on 02 January 2009 by skirchner in Austrian School, Economics

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