Working Papers

2010 08

Fiscal Policy After the Election

Tony Makin argues in The Australian that:

Whichever side forms government, it will have to live with the legacy of the fiscal extravagance since October 2008. Just as present budgetary actions have implications for future economic activity, past actions have economic implications for the present and the near future.

Questions that will most likely arise during the term of the next government include the following: Why are long-term interest rates and the cost of obtaining funds from abroad continuing to rise? Why is private investment not improving as expected? Why is future economic growth now likely to be lower than otherwise? Why are inflationary pressures continuing to build?

The answer to each of these questions is the same. It’s either mostly, or partly, due to the excessive fiscal stimulus of the past two years.

My view is that activist fiscal policy in Australia and abroad will have negative consequences through a rather different channel: a negative wealth effect from increased government debt that will weigh on economic growth and consequently lower rather than raise long-term interest rates globally. I made this argument in a recent op-ed. Recent developments in global long-term interest rates have been consistent with this view.

For those interested, I will be discussing these issues as part of a panel at this year’s Australian Conference of Economists on the topic of ‘Monetary-Fiscal Interactions: How to Improve Policy Outcomes.’ Other panellists include Don Brash (ex-RBNZ), Jacopo Cimadomo (ECB), Carl Wash (UCSC) and Jan Libich (La Trobe).


posted on 30 August 2010 by skirchner in Economics, Financial Markets, Fiscal Policy

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Political Insiders and Anti-Gaming Wowsers

There are calls to ban political insiders from election betting markets. Apart from the usual anti-gaming wowsers like Nick Xenophon, I suspect this is motivated by the same mistaken notion of fairness that supports anti-insider trading laws in relation to equity securities. As Henry Manne’s work has shown, anti-insider trading laws are based on a fundamental misunderstanding of the role of markets. Simon Jackman notes that a ban on political insiders would be impractical, but this is no less true of anti-insider trading laws in general.

It is interesting to note that for all the reports of trading by political insiders, prediction markets got the election outcome ‘wrong’ in an ex post sense. While the betting market odds bounced around with the polls, they consistently gave a strong probability to a Labor win, while the polls suggested a tighter contest.

This is not necessarily anomalous, because they measure different things. Polls measure vote shares, but these translate only very loosely into seats won and the ability to form government, so betting markets can quite reasonably imply results that are not obviously supported by the polls. Still, the polls were a better guide to the overall result than the prediction markets on this occasion (have not looked at individual seat markets).

My guess is that political insiders are little better than noise traders. We should be happy to let the market professionals milk them for all their worth.

posted on 26 August 2010 by skirchner in Economics, Financial Markets, Politics

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Low Expectations: Why Financial Markets Didn’t Care About the Election Result

Financial markets usually take federal election outcomes in their stride, an indication that the result is either not a surprise or makes very little difference to expected economic and financial outcomes.

The fact that markets have been just as sanguine when faced with the prospect of a hung parliament for the first time since 1940 implies that markets do not expect public policy outcomes to be appreciably worse under the various options for a minority or (small ‘c’) coalition government than under a majority government. One can only conclude that markets had very low expectations for the public policy outcomes from any majority government and those expectations have not in any way been disappointed by a hung parliament.

posted on 24 August 2010 by skirchner in Economics, Financial Markets, Politics

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The Future of US Housing Finance

Peter Wallison’s gloomy thoughts.

posted on 24 August 2010 by skirchner in Economics, Financial Markets

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Bonfire of Kevin Rudd’s Vanity

Whoever forms government in the wake of Saturday’s federal election, the result is as comprehensive a repudiation of Kevin Rudd and his legacy as one could reasonably hope for. Any suggestion that Kevin Rudd’s liquidation as Prime Minister in June was a net negative for the ALP withstands little scrutiny. It is ill-advised for members of the conservative side of politics to suggest otherwise or confect sympathy over the manner of Rudd’s demise. We should always be thankful to the ALP caucus for taking the action they did in removing a dysfunctional central planner from office. Perhaps the highlight of last night’s election coverage was the ABC’s decision to cut Kevin Rudd off mid-speech as the producers realised that amid the usual profusion of words coming out of his mouth, he had nothing to say. Rudd suffered a 9% primary swing against him in his own seat.

The election result is one that Malcolm Turnbull said could never happen if the Coalition failed to join a bipartisan policy cartel behind Kevin Rudd’s ETS. Malcolm’s stand undoubtedly helped him in Wentworth, where he now sits on a massive 60% of the primary vote. What Malcolm never understood and what Tony Abbott demonstrated was that public opinion on the ETS was not independent of the opposition’s stand on the issue. Ironically, Rudd dropped the ETS for the same reason Malcolm supported it: neither of them wanted to fight an election on the issue.

Any new government will now be hostage to some combination of Greens and rural protectionists. Unfortunately, both have a common interest in frustrating economic and other reforms. While there is now little prospect of good legislation coming out of any new government, it will also be difficult to push bad legislation through such a finely balanced legislative process. Legislative and policy paralysis are underrated as political outcomes and could even set the stage for new elections in which real policy issues might actually be at stake.

posted on 22 August 2010 by skirchner in Politics

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Sydney: Too Many People in 1912?

I have an op-ed in today’s Australian referencing an article in the Sydney Morning Herald from 1912 about how Sydney’s then transport system supposedly could not cope with a population of 700,000.

The text below the fold is a slightly longer version that went out on Friday in the Ideas@TheCentre series. You can subscribe to Ideas@TheCentre here.

continue reading

posted on 19 August 2010 by skirchner in Economics, Population & Migration

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The $389 Billion Third Rail of American Politics

The US Treasury Department convened a conference on the vexed issue of housing finance reform. Remarkably, even the New York Times saw straight through the politics of GSE reform in its reporting on proceedings:

The consensus was that neither Democrats nor Republicans wanted to touch an issue that would dredge up decisions made by both parties over the last decade that looked bad in light of the financial crisis. Fannie and Freddie was now the third rail of American politics.

‘Looked bad’ doesn’t even begin to cover what has been a catastrophic failure of America’s political institutions for which there has been little or no accountability.

The de facto nationalisation of US housing finance through its Congressional-mandated GSEs may have been a catastrophe for the US, yet for PIMCO’s Bill Gross, nothing succeeds like failure:

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said the U.S. should consider “full nationalization” of the mortgage- finance system…

“To suggest that there’s a large place for private financing in the future of housing finance is unrealistic,” Gross said today at a U.S. Treasury Department conference in Washington. “Government is part of our future. We need a government balance sheet. To suggest that the private market come back in is simply impractical. It won’t work.”

Gross conveniently ignores the fact that the housing GSEs have effectively been on the books of the US government for their entire existence.


posted on 18 August 2010 by skirchner in Economics, Financial Markets

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Rudd’s Way: Working with Australia’s Most Dysfunctional Central Planner

Graeme Dobell reviews Rudd’s Way:

While this column needed a three-part series last year to grapple with the dysfunctional nature of the Rudd experience, Stuart nails it in one paragraph:

‘Rudd appeared unable to delegate. His office was nicknamed the ‘black hole’, because briefs would vanish and nothing would emerge. The government’s agenda appeared to swing suddenly and wildly. One moment there would be frenzied progress on an issue until, if it seemed intractable, it would simply be left in limbo.’

As a columnist for The Canberra Times and author of two previous books on The Kevin, Nick Stuart is an experienced journalist who is a known part of the Canberra milieu. Thus, he could quietly gather the quotes and insights that light up Rudd’s Way. Here’s the acid judgement of a senior public servant on Rudd’s mode of operation:

‘The man’s output is negligible. He gets wound up around the detail, and loses the plot. You’d be concerned if a dep sec (deputy secretary) was working like this, but because he’s PM, he can get away with it.’

Or consider this from a Labor minister, not long after taking office, as the polls were still soaring. The minister complained that Rudd was ‘a bloody perfectionist micro-manager’ who, more seriously, ‘couldn’t give a rat’s about what the party’s policy actually is.’ Then the minister paused for a long moment before concluding: ‘Thank goodness he’s no good at it; otherwise we’d really be up the creek.’…

Consider this line last Friday from Verona Burgess, who has spent more years than she wants to remember writing on the machinations and machinery of the Canberra public service: ‘It is difficult to explain to people outside the capital just how loathed Kevin Rudd had become among large sections of the Australian Public Service (let alone the caucus) and why.’


posted on 18 August 2010 by skirchner in Politics

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What Did They Know and When Did They Know It: Ex-Ante Views on US Housing

Looking through all the after-the-fact wisdom and hand-wringing, a Boston Fed discussion paper examines the ex ante views of economists in relation to the US housing market:

From our review of the pre-crisis housing literature from the early-to-mid-2000s, it is apparent that well-trained and well-respected economists with the best of motives could and did look at the same data and come to vastly different conclusions about the future trajectory of U.S. housing prices. This is not such a surprising observation once one realizes that the state-of-the-art tools of economic science were not capable of predicting with any degree of certainty the collapse of U.S. house prices that started in 2006.

The paper has mostly fatal implications for the idea that the authorities can actively manage cycles in house prices.


posted on 17 August 2010 by skirchner in Economics, Financial Markets, House Prices

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Australian Equities: A Century of Outperformance

Australian equities offered the highest return and second lowest risk of 19 major markets between 1900 and 2009, according to Credit Suisse.

posted on 15 August 2010 by skirchner in Economics, Financial Markets

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The Making of Dick Smith’s Population Puzzle

In February this year, I was contacted by Dick Smith’s researcher Sarah Gilbert to provide some background for his anti-population growth documentary, Dick Smith’s Population Puzzle. She mentioned a column by Paul Sheehan, which had quoted me making the point that faster population growth required faster economic growth to maintain living standards. No doubt they saw this as a bad thing, but must have finally twigged that I thought it wasn’t, because I heard no more from them, even though Dick and the production crew were on campus a few weeks later and could have easily dropped in to see me. They did interview my UTS colleague Jock Collins, but they obviously didn’t like what he had to say either, because it was not included in the final cut.

Dick later wrote to me taking exception to an op-ed I had written for The Australian, in which I called some of his arguments absurd. I took the opportunity to try and steer Dick in the right direction by referring him to some books by Julian Simon, but he gave no indication he ever bothered to read them.

The documentary screened on the ABC last night. Dick gave significant air time to only one pro-growth advocate, Bernard Salt, but could not help impugning his expertise and motivation. There may be plenty of things wrong with Bernard Salt, but being a historian and working with KPMG are not among them. If Salt is as unqualified as Dick would have us believe, why include him in the documentary? Because Dick has a completely closed-mind on the issue and is uninterested in giving the other side of the argument a fair go.

posted on 13 August 2010 by skirchner in Economics, Population & Migration

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What’s Not to Love About Dutch Disease?

Judith Sloan wants to know. I make similar arguments here.

posted on 12 August 2010 by skirchner in Economics, Financial Markets, Fiscal Policy

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Teaching With Cowen and Tabarrok’s Modern Principles of Economics

I have been using Tyler Cowen and Alex Tabarrok’s Modern Principles of Economics to teach an introductory course in economics to MBA students. Many if not most students study economics as part of vocationally-oriented degrees, without any intention of working as economists or completing further study in economics. Unfortunately, most textbooks are not designed with this in mind. Robert Frank has argued that many courses in economics do the equivalent of teaching language students the pluperfect tense at the expense of basic conversational fluency. Students consequently come away from their economics subjects with the sense that it is an arcane discipline of little real-world relevance, damaging the standing of economics in the community.

By contrast, Cowen and Tabarrok’s textbook is well suited to students who may be studying economics not only for the first time, but also for the last time. It imparts the essential economic insights, without over-burdening students with derivation and optimisation. It is the only text I know of that gives students an appreciation of the coordinating role of markets. The macro part of the text emphasises the role of shocks and real factors in driving the business cycle. Aggregate demand is derived from quantity theory relations rather than aggregate expenditure concepts. It also stresses the limitations of macroeconomic policy instruments.

With the exception of the chapters on monetary and fiscal policy, the text avoids being overly US-centric, reflecting the cosmopolitan sensibility of its authors. The first chapter begins with an Australian example, which is a nice point of entry for Australian students.

Australian faculty can contact Helen Boyd at Palgrave Macmillan (Helen.Boyd [at] macmillan.com.au) for examination copies of the text.

posted on 09 August 2010 by skirchner in Economics

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Penny Dreadful Spec Stock of the Week

Day traders love Fannie Mae:

The big money has ceded the marketplace to individuals who are bold enough, or perhaps foolish enough, to gamble on these stocks for a few hours.

Just don’t hold Fannie Mae too long, Mr. George advised. He predicted the stock would eventually fall to zero. It is difficult to know what other analysts think, since Mr. George is just about the only one who still covers Fannie Mae’s stock. His recommendation is an understated “underperform” — Wall Street code for sell.

“It’s not really a stock anymore — everyone knows this is going to zero,” he said.


posted on 06 August 2010 by skirchner in Economics, Financial Markets

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When Krugman No Longer Feels the Love

Fred Douglass argues that Krugman has lost his battle with those who comment on his blog:

Krugman had also had enough. On July 23, Krugman showed that he was clearly no longer “in love” with his commenters. Now he called them “ranters” and “trolls.” On July 28, Krugman changed his comment moderation policy. Claiming that “ranters ... say the same thing every time,” Krugman announced that he was going to throw away posts longer than “three inches.” His thinking must have been thus: Three inches are sufficient to write “Krugman is brilliant,” but not sufficient to present a documented and persuasive rebuttal to whichever of Krugman’s standard arguments he was peddling that day.

(HT: Sinclair Davidson)

posted on 06 August 2010 by skirchner in Economics

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Below-the-Line Senate Voting Tool

For those who like to make the major parties work for their vote, here is a handy web site that lets you create customised below-the-line Senate voting tickets that you can print-out and take with you on polling day (just don’t use it as a ballot paper, it won’t count!)

posted on 04 August 2010 by skirchner in Politics

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Did Cheap Credit Fuel the US Housing Boom?

No, according to Ed Glaeser and his co-authors:

Interest rates do influence house prices, but they cannot provide anything close to a complete explanation of the great housing market gyrations between 1996 and 2010. Over the long 1996-2006 boom, they cannot account for more than one-fifth of the rise in house prices. Their biggest predictive influence is during the 2000-2005 period, when long rates fell by almost 200 basis points. That can account for about 45% of the run-up in home values nationally during that half-decade span. However, if one is going to cherry-pick time periods, it also must be noted that falling real rates during the 2006-2008 price bust simply cannot account for the 10% decline in FHFA indexes those years. There is no convincing evidence from the data that approval rates or down payment requirements can explain most or all of the movement in house prices either.

The authors also note that Robert Shiller’s ‘irrational exuberance’ is a non-explanation:

even if Case and Shiller are correct, and over-optimism was critical, this merely pushes the puzzle back a step. Why were buyers so overly optimistic about prices? Why did that optimism show up during the early years of the past decade and why did it show up in some markets but not others? Irrational expectations are clearly not exogenous, so what explains them? This seems like a pressing topic for future research. Moreover, since we do not understand the process that creates and sustains irrational beliefs, we cannot be confident that a different interest rate policy wouldn’t have stopped the bubble at some earlier stage. It is certainly conceivable that a sharp rise in interest rates in 2004 would have let the air out of the bubble. But this is mere speculation that only highlights the need for further research focusing on the interplay between bubbles, beliefs and credit market conditions.

A more fruitful line of inquiry would be to investigate fundamental factors such as the role of US housing GSEs in distorting the allocation of global capital.

posted on 04 August 2010 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

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Federal Election Betting Market Probabilities

Simon Jackman provides a handy update on federal election outcome probabilities derived from Centrebet and updated daily at 9am AEST. Along with iPredict, Centrebet is showing a sharp decline in the probability of a Labor win, reflecting recent opinion polls, but also (perfectly legal) inside information:

SENIOR Labor figures have placed significant bets on the outcome of the federal election, with some punting against their own party. A major betting agency said bets had been placed on members of the opposing team to win marginal seats in NSW and Queensland.

Centrebet primary analyst Neil Evans said: ‘‘I can’t tell you who but I can tell you this: these are people very high up betting on some of the critical seats and I can tell you they don’t always stay faithful to their party - they swap sides.

‘‘They are well-known Labor figures and associates that are punting on these seats. A lot of Labor-connected money has been backing a Coalition win in marginal seats and, to a lesser extent, the Coalition has been doing the reverse.’‘

The Sun-Herald understands the figures include parliamentary staffers, advisers and senior party officials.

posted on 01 August 2010 by skirchner in Financial Markets, Politics

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