Working Papers

2009 05

The Quiggin-Caplan Wager: I’m with Quiggin

Bryan Caplan and John Quiggin take a 10-year bet on the average of the US-EU15 unemployment rate differential.  On this bet, I have to say I’m with Quiggin.  The reason: the US is thinking more and more like Quiggin and less like Caplan.  Public policy in the EU is not appreciably worse than it has been in the past, but the rate of deterioration in the US implies that their respective structural unemployment rates should converge via a faster rate of deterioration in the US.  The capital allocation process in the US is now so deeply compromised by political intervention that there is little reason to believe in the continued structural outperformance of the US economy.  Differences in labour market institutions won’t matter much in this context.  Caplan himself puts his chances of winning at only 60%.

David Goldman put it well in perhaps the most disturbing metaphor for the crowding-out effect on US economy:

The moment the zombie pulls on his chain, rates rise, consumption falls, and the zombie gets less oxygen.

posted on 29 May 2009 by skirchner in Economics, Financial Markets

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More Bubble Wrap

Alan Wood discusses the debate on the relationship between monetary policy and asset prices, referencing my CIS Policy Monograph Bubble Poppers.  Wood writes:

Central bankers have always taken asset prices into account in setting monetary policy and in Australia’s case successfully intervened in the housing market via both interest rates and jawboning by then governor Ian Macfarlane and head of Australian Prudential Regulation Authority, John Laker, a former Reserve banker, to cool off reckless lending and overheating in housing prices.

Kirchner dismisses this episode as unsuccessful, and the Howard government certainly didn’t like it. But the ratio of house prices to income fell markedly after 2003, when the RBA raised rates by 0.5 percentage points in two back-to-back hits. And Australia has so far not suffered anything like the housing price collapses in the US and Britain.

To be clear, my argument was that the RBA’s talk was not backed by policy action.  Like the rest of the world, monetary policy in Australia was accommodative in 2003 and the RBA had an explicit easing bias in June of that year.  As I noted in this op-ed, the nominal official cash rate did not reach a neutral level until 2005 and the real cash rate struggled to stay above neutral as inflation increasingly got away on the RBA.  Unfortunately, most media commentators mistake increases in the nominal cash rate for a tightening in policy, ignoring what is happening with real or expected interest rates.  It is this confusion that gave rise to the myth that the RBA presided over a successful bubble popping episode in 2002-03.

As the commodity price boom took off in 2003, population and income was sucked out of the south-eastern property markets and flowed into the resource-rich states.  As the RBA has noted, this saw renewed convergence in capital city house prices, as the heat was taken out of the south-east and shifted to the north-west.  This sub-national variation in house prices cannot be explained with reference to monetary policy, as much as the bubble poppers might like us to believe otherwise. It had a clear basis in sub-national differences in economic performance.

posted on 29 May 2009 by skirchner in Economics, Monetary Policy

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Convenience Shopping for Gold Bugs

Gold vending machines.

posted on 29 May 2009 by skirchner in Economics, Financial Markets, Gold

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Why Monetary Easing Need Not be Inflationary

RBA Deputy Governor Ric Battellino, on why monetary easing need not be inflationary:

The other side of the debate – that the measures will result in higher inflation – implicitly assumes that the measures will be effective in stimulating the economy, since money does not miraculously transform into inflation without affecting economic and financial activity. Rather, their argument is that central banks will be too slow to reverse the various measures.

As there are no technical factors that would prevent or slow the reversal of recent measures – they can be reversed simultaneously or in any sequence – the argument must rest on central banks making incorrect policy judgments. This is always a possibility. But, the high state of awareness that currently exists about the risk of being too slow to reverse recent exceptional measures should limit the probability of such a mistake being made.

Unfortunately, a high state of awareness does not in itself guarantee timely policy action, as the RBA’s own track record would suggest.

posted on 28 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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Cameron Frye’s House for Sale

Ferrari not included.

posted on 28 May 2009 by skirchner in Misc

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Steve Keen, They Hardly Knew You: Consumer House Price Expectations

The most recent Westpac-MI Consumer Sentiment survey included a question on expectations for house prices over the next 12 months.  Expectations were close to balanced nationally, with those expecting declines slightly outnumbering those expecting falls.  However, there was considerable sub-national variation.  Most pessimistic are the resource states of Queensland and WA, while the south-eastern states are relatively upbeat.  No change was the single most common expectation in every state, except NSW, where the single most common expectation was for a rise of 0-10%.

posted on 27 May 2009 by skirchner in Economics, House Prices

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Boondoggle Nation

RBA Board member Warwick McKibbin, on the effectiveness of activist fiscal policy:

“Most fiscal policy doesn’t do anything except switch spending from one period to another,” the RBA director said.

“When you change fiscal policy, all you do is stimulate the economy today out of future possible growth.”

Stimulus spending had to be paid for either with higher future taxes or reduced opportunities for the private sector so that the public sector could be financed.

“The only exceptions are infrastructure and similar spending, which raises the return to private activities,” Professor McKibbin said.

“The most sustainable way of reducing a fiscal deficit is through strong productivity growth in the private sector.”

He said that in mature economies, it was hard to engineer productivity growth.

Whether public infrastructure spending increases private sector productivity is a case-by-case judgement.  As the rest of the story makes clear, much of the government’s stimulus spending consists of little more than electoral boondoggles such as swimming pools and sports stands.


posted on 26 May 2009 by skirchner in Economics, Fiscal Policy

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The Monthly Labour Force Lottery

Centrebet is now running a book on the unemployment rate, as published in the monthly ABS Labour Force release.  A rate of 5.6%-5.7% is currently favoured for May following 5.4% in April. 

The quoted range begs the question as to whether they would pay on a rounded estimate published at 5.6% or 5.7% that was actually outside this range on an unrounded basis.

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

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Crowding-Out Gets Crowded-Out

I have an op-ed in today’s Age, noting that it is the crowding-out effect and not the short-run multipliers that will determine the long-run economic effects of the government’s discretionary fiscal policy actions:

In the 366 pages of Budget Paper No. 1, where the Government outlines its fiscal strategy, crowding out isn’t mentioned once.

It wasn’t always this way. The budget papers released in the second half of the 1990s were full of references to the contribution federal budget surpluses were making to national saving and investment. One of the advantages of budget surpluses, Treasury informed us, was that the government would no longer make a net call on capital markets. Instead of crowding out private capital and investment spending, budget surpluses would crowd them back in.

All this was said when the economy was still well short of full employment.

Treasury Secretary Ken Henry’s “secret” speech to Treasury officers in March 2007 drew heavily on the idea of crowding out to explain why government intervention in an economy at full employment was counter-productive, resulting in a misallocation of resources and reduced output. Only by augmenting the supply side of the economy, he noted, could Australia increase national income.

When the public sector saves less, all else being equal, national saving is also reduced, reducing future growth in national income. This crowding-out effect can occur even if there is no change in interest rates and the economy is below its full employment level of output.

posted on 22 May 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Kevin Rudd as Neo-Liberal

My CIS colleague, Oliver Hartwich, in Neo-Liberalism: The Genesis of a Political Swear Word, demonstrates that when Kevin Rudd attacks neo-liberalism, he is unconsciously attacking his own intellectual heritage and heroes.

posted on 21 May 2009 by skirchner in Classical Liberalism

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Is the RBA Still Agnostic on Bubble Popping?

In contrast to the cautious agnosticism of his boss on the question of bubble-popping, RBA Assistant Governor Guy Debelle is remarkably clear on the issue:

the current episode vindicates the position that monetary policy, narrowly defined as the setting of the policy interest rate, should be confined to targeting inflation. Set interest rates primarily to achieve the inflation goal as that, in itself, contributes to sizeable social gains. A departure from that runs the risk of losing the nominal anchor that the inflation target provides.

But other tools, most notably the much-touted (although not clearly defined) macro-prudential instruments, should be used to address asset price and credit imbalances. I do not think that a slightly tighter setting of interest rates would have prevented the development of the imbalances that have led to the current financial crisis. When human psychology is such that optimism about asset price rises is at the fore, then an excessively stringent setting of interest rates would be required to suppress the optimism. The Australian and Scandinavian experience in the late 1980s shows the sort of interest rate settings required to achieve such an outcome. In that example, a credit boom and bubble-like asset price dynamics took hold and only a very high setting of real interest rates ultimately curtailed that, but at the cost of a historically high level of unemployment.

I do not think it would be socially acceptable or desirable to endure the level of unemployment that would come with the high interest rates necessary to pop the bubble. It is asking too much of the single monetary policy instrument, namely, the targeted short-term interest rate to target both financial excesses and inflation.

Nor do I believe there is much to be achieved by ‘leaning against the wind’. The wind that is blowing in most episodes of credit booms is generally at least gale force. Setting interest rates a bit higher in such circumstances is likely to be close to futile when such credit dynamics take hold. Again, what would be the point of undershooting the CPI inflation target and enduring a higher than desirable level of unemployment with little to be gained. How would such actions be explained to the public?


posted on 21 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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The Ken Henry Speech that Time Forgot

Treasury Secretary Ken Henry, speaking to the Sydney Institute in 2005:

By the 1990s, however, a consensus had emerged, in Australia and elsewhere, that fiscal activism had to be limited. Fiscal policy had to be given a medium-term anchor. At the same time, a view emerged that macro stabilisation should be primarily the responsibility of monetary policy. But monetary policy, too, had to have a medium-term anchor….

The last of these observations is particularly striking for a student of post-war economic history: one has to wonder whether the policy debate in this country is not the sort of thing that one might have hoped to see in a ‘classical’ economy of the sort that economists thought existed before the Great Depression and the ensuing Keynesian revolution; a debate about the factors that influence our productive capacity rather than the factors that influence our demand for it…

It might be worth asking the question whether, because of the reform efforts of the past, we should not now consider ourselves to be most often in a ‘classical’ world in which the economy naturally trends toward, and in fact spends most of its time quite close to, its productive capacity, or supply potential, without the need of continuous macro policy stimulus.

Answering this question in the affirmative would not imply a view that we have eliminated the business cycle. There will be future economic downturns. And when we see evidence of one we should not be afraid of responding with activist expansionary macroeconomic policy.  Rather, an affirmative answer implies some conditioning of the exercise of macro policy activism – an acceptance that large swings in macro instruments are to be implemented (only) in extremis…

let me say something about the emerging pressure for increased infrastructure spending. This pressure is mostly well-intentioned – more spending on infrastructure will indeed tend to increase the productive potential of the economy. And, with long-term interest rates and therefore the cost of capital at a cyclical low at the moment, both the public and private sectors are in a relatively strong position to undertake additional spending.

But without appropriate price signals, quality investment decisions will not be made. And present price signals are far from appropriate. The risks of making large infrastructure investment decisions in such an information-poor environment are very great.

posted on 20 May 2009 by skirchner in Economics, Fiscal Policy

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Wisdom of Crowds: Budget Edition

Only 30% of Newspoll respondents believe the federal budget will be back in surplus within six years.  There is a sharp partisan divide on this issue, although surplus skepticism increases with age and income.  It is interesting that the most well received federal budget since 1993 was also the Howard government’s last.

posted on 19 May 2009 by skirchner in Economics, Fiscal Policy, Politics

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Peter Costello is Shovel-Ready

Liberal backbencher and former Treasurer Peter Costello channels Rex Connor:

Yesterday he continued the attack on the Rudd Government’s cash handouts, saying the $20billion would have been far better spent on infrastructure.

“You could have drought-proofed Victoria for that…for $20 billion you could have built a channel from Northern Australia down to Victoria…”


posted on 19 May 2009 by skirchner in Economics, Politics

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The Myth of an Independent Treasury

My CIS colleague and former Treasury official Robert Carling has an op-ed on page 21 of today’s Australian (no link, but see text below the fold) noting that neither Treasury nor the Budget papers are independent of the federal government. 

The claim that Treasury is an institution independent of government fundamentally misconstrues the relationship between the federal government and the Commonwealth public service.  While it is not surprising to see politicians fail Economics 101, it is more surprising to see them also failing Political Science 101. The government now routinely hides behind Treasury and RBA independence and the federal opposition is increasingly accommodating this behaviour through their unwillingness to challenge official sector views.

While the RBA is more independent than Treasury, this independence is limited in scope.  At its most basic, RBA independence means that it is free to set interest rates without the approval of the Treasurer, what is often called ‘operational independence.’  This independence in no sense precludes the government or opposition from taking a different view on monetary policy to the RBA or being publicly critical of central bank policy actions, statements and forecasts.  The RBA has been made progressively more independent of government precisely in order to facilitate differences of opinion with government.  Under the Reserve Bank Amendment (Enhanced Independence) Bill, it is almost impossible to remove the RBA Governor, so public criticism could hardly be viewed as a threat to the Governor’s position.  By the same token, the RBA would not be compromising its independence by speaking out on issues relating to its statutory responsibilities, provided it does so in a non-partisan fashion.

Mistaken notions of Treasury and RBA independence are being used to suppress public debate over economic policy, not least by the current government.  That the federal opposition and media are accommodating this behaviour on the part of the government can only undermine the robustness of public debate and democratic accountability. 

continue reading

posted on 16 May 2009 by skirchner in Economics, Fiscal Policy, Media, Monetary Policy, Politics

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Government Bonds to Underperform?

Jeremy Siegel, on the poor prospects for returns on government bonds:

40 years ago [US] treasury bonds were yielding over 6.3 percent, about twice their yield today. It is mathematically impossible for government bonds to come close to matching those 12 percent returns in future decades. Stocks, on the contrary, can easily repeat their returns over the past four decades, since those returns were near their historical average…

For the 55-year period from December 1925, when the well-known Ibbotson stock and bond series begins, through January 1982, total real government bond returns were negative. This means that, by rolling over in long-term government bonds, reinvesting all the coupons, and thereby taking no income, investors’ bond portfolios were sinking in value.

Most strikingly, for the 40-year period from 1941 through 1981, government bond investors lost a whopping 62 percent of their value after inflation. A loss in purchasing power over this long a period has never happened in stocks. There has never even been a 20-year period when real returns in stocks have been negative. In fact, the worst 30-year real return for stocks is plus 2.6 percent per year, just slightly below the average real return investors earn with government bonds.

Looking at today’s markets, the forward-looking prospects for government bonds are very poor. Yields on 30-year inflation-protected bonds are 2.3 percent, and yields are only 4 percent on 30-year Treasuries. In contrast, after stocks have fallen 50 percent from their previous high, as they did in March of this year, their subsequent 30-year real returns have always been in excess of 10 percent per year.

The 40-year outperformance of government bonds over large stocks has ended.


posted on 15 May 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Big Government Will Hinder Growth

I have an op-ed in today’s Australian on the ‘economic conservatives’ who have turned into the biggest spending government since Gough Whitlam:

THE 2009 budget forecasts the biggest expansion in federal government spending since Gough Whitlam. While the budget deficit is being sold as a necessary response to the worst global economic downturn since the Depression, government spending will hinder growth long after Australia’s recession is over.

The Government has made much of the reduction in revenue flowing from the global downturn and the resulting domestic recession. But this is only one side of the budget deficit equation. The unprecedented deterioration in the budget balance is also driven by the biggest increase in government spending in a generation.

The federal government spending share of gross domestic product will increase by 2.6 percentage points this financial year, with a further increase of two percentage points forecast for next financial year, the biggest increases since the early 1970s. Government spending will reach 28.6per cent of GDP in 2009-10, a figure unprecedented in peacetime.

It is appropriate that the Government should allow the automatic stabilisers to work in response to an economic downturn.

However, the deterioration in the budget balance has been made worse by discretionary fiscal stimulus packages of doubtful effectiveness.


posted on 14 May 2009 by skirchner in Economics, Fiscal Policy

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The Contradictions of FDI Protectionism

The ‘chairman’ of Hancock Prospecting, Gina Rinehart, argues against a Rio-Chinalco tie-up:

We cannot wish or assume that Rio-Chinalco (without investment conditions) will then invest in high-cost Australia.

What do India or Africa offer Rio and other mining companies? Massive and high-quality ore reserves and labour costs massively cheaper than in Australia.

What happens when Rio, perhaps enlivened with Chinese assistance, develops these massive projects in Africa and/or India?

Those projects offshore will compete against Australian mines and interests for many decades to come.

How will this help us to create more jobs? How will this help us to repay our growing debt? How will this help us maintain or grow standards of living?

Rinehart views FDI policy in protectionist terms, but her claim that Australian mining projects cannot compete with those in emerging markets is at odds with those who oppose the tie-up on the grounds that Chincalco would over-develop Australian resources with a view to lowering prices.  The opposition to Chinese FDI in the Australian mining industry is fundamentally incoherent.

In sharp contrast to Gina Rinehart, Peter Gallagher has an excellent post responding to Malcolm Turnbull’s concerns about the proposed Chinalco-Rio tie-up.

posted on 13 May 2009 by skirchner in Economics, Foreign Investment

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Nothing Has Changed

Unlike Richard Posner and all the other capitulationists, Bryan Caplan is conceding nothing:

Nothing that happened in the last two years should have significantly revised the general macroeconomic views of anyone who is (a) familiar with the last two centuries of global economic history, and (b) reasonable….

if you claim that 2008 overthrew everything you thought you knew about economics, I’ve got to wonder what you knew in the first place.

posted on 12 May 2009 by skirchner in Economics

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One Survey, Two Headlines

The Australian:

Readers not averse to paying for online content

A GLOBAL survey has found that readers could be willing to pay almost as much for some high-quality online newspapers as they do for print versions, particularly in specialist news areas.

The SMH:

Readers reluctant to pay for online news

Rupert Murdoch’s aim to have readers pay for access to newspapers online has been called into question by a global survey that found readers are unlikely to pay for general news they can get elsewhere free.


posted on 12 May 2009 by skirchner in Media

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More FDI Protectionism from Treasurer Swan

Not content with micro-managing foreign direct investment in Australia, the Rudd government’s latest approval under the Foreign Acquisitions and Takeovers Act also seeks to micro-manage Australian FDI in China:

My approval under the Foreign Acquisitions and Takeovers Act 1975 is conditional upon Ansteel supporting the wider development of infrastructure in the Mid West, and maintaining agreed levels of Australian participation in a greenfields joint venture in China’s Liaoning Province.

Using the FATA to obtain leverage for Australian FDI in China sets a dangerous precedent and ignores the basic reality that Australia benefits from Chinese FDI even in the absence of Chinese reciprocity.  The answer to Chinese FDI restrictiveness is not to make our system more like China’s. 

As with other recent FDI approvals, the Treasurer has once again made explicit the protectionist intent behind the exercise of his discretionary powers under the Act:

These undertakings support Australian mining jobs, and protect Australia’s investment participation in the Chinese resources market.

The FIRB and Treasury are going to be kept very busy if the Rudd government is going to micro-manage every FDI proposal coming out of China in coming years.

posted on 09 May 2009 by skirchner in Economics, Foreign Investment

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Are Opinion Polls Consistent with Ricardian Equivalence?

The latest Newspoll finds 44% of respondents want the government to go ahead with the next round of legislated tax cuts, while 47% want the tax cuts cancelled ‘to help reduce the budget deficit.’  Given that the planned tax cuts are unfunded, respondents should be indifferent between these two choices.  Today’s unfunded tax cut is tomorrow’s tax increase.  All else being equal, the only reason why taxpayers should want a reduction in disposable income for the sake of a lower budget deficit is because they recognise the government’s inter-temporal budget constraint.  The near even split on this question suggests your average punter is a good deal smarter than the commentariat.

posted on 05 May 2009 by skirchner in Economics, Fiscal Policy

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Bruno Does Austrian Economics

Austrian economics, Bruno-style:

The search for fame leads him to Ron Paul’s door. Brüno attempts to seduce him after being told that featuring in a sex tape will help his celebrity stock to rise…Ron Paul didn’t twig…that a TV interview that was supposed to be about Austrian economics might end in a candle-lit hotel bedroom, where a blond male journalist would proffer cheap champagne before attempting to seduce him. Never, in his wildest dreams, could the 73-year-old hero [sic] of the Republican right have envisioned that a predatory homosexual would have the gall to suddenly drop his trousers. That’s why Paul ran away shouting: “This is ENDED!”


posted on 04 May 2009 by skirchner in Austrian School

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