Working Papers

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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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. 

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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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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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‘Whatever it Takes’: A Wicked Idea

Jamie Whyte, on the long-term damage wrought by fiscal stimulus measures:

So, despite near universal agreement that governments must do “whatever it takes” to avoid a severe recession, this is an absurd idea. Perhaps even a wicked idea. The important question about the kind of actions most governments are now taking – “bailing out” failed companies and massively increasing government spending – is what their long-term effects will be.

Those few commentators who worry about long-term effects tend to focus on the debt burden created by stimulus packages. But this is a trivial and short(ish)-term issue. If there is no structural damage to the economy, servicing these debts will be reasonably easy. A stimulus package would simply transfer wealth from the nation’s future citizens to its present citizens. And that does not constitute a net loss to the population.

Indeed, if the stimulators are right about the effects of their proposals on long-term GDP, even future citizens who bear the debt burden might be grateful for the transfer. Better to be rich with big but manageable debts than to be poor. These future citizens would be like people who had borrowed to get a medical degree.

The serious question about stimulus packages concerns not the short-term accountancy, not the details of jobs today and debt tomorrow, but the structural effects on economies. Are stimulus packages really like borrowing to get a medical degree or are they more like taking brain-damaging drugs to eliminate an acute headache?

Chris Berg looks for method in the madness of fiscal stimulus efforts in Australia and decides the government is just making it up:

Sure, it seems fun watching the Government conjure up jobs and prosperity out of nowhere, but in retrospect, after none of those jobs appear, the economy keeps going down the toilet, and bureaucrats have eventually admitted they made it all up — it’s actually quite depressing.

posted on 17 April 2009 by skirchner in Economics, Fiscal Policy

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Keynes and the G20

Tony Aspromourgos and I debate ‘Should Keynes Have a Seat at the G20 Table’ in today’s AFR.  Text below the fold (may differ slightly from edited AFR version).

As if to help my case about the political imperatives driving fiscal stimulus, the AFR’s Smart Money section includes a feature called ‘The Great Australian Giveaway’:

Everybody loves a freebie, especially when money is tight and there are plenty of rebates, subsidies and handouts available from all levels of government, if you know where to look and what to ask for…

The free-for-all is not restricted to the working families beloved of politicians.

As Bastiat said, ‘government is the great fiction through which everybody endeavors to live at the expense of everybody else.’

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posted on 28 March 2009 by skirchner in Economics, Fiscal Policy

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Ricardian Backlash to Fiscal Stimulus

The government has hailed the latest data on retail trade volumes as evidence of the success of its fiscal stimulus packages.  As we have argued previously, much of this retail spending will leak into imports, which is one of the reasons stimulus is even less effective in a small open economy like Australia compared to a large and relatively closed economy like the US.  But the boost to retail spending is feeble relative to gains in household disposable income.  Westpac does the numbers:

the Q4 retail figures suggest a muted initial response from consumers to what has been a significant policy injection to disposable incomes. We estimate that the Govt’s $8.7bn in fiscal payments to households and the substantial easing in interest rates (275bps in Q4) effectively added over $10bn to household disposable incomes in the last quarter of 2008. The Q4 increase in nominal retail sales amounted to just $974mn.  While this is only a portion of total consumer spending, the result suggests households saved about 80% of the cash injection.  Clearly some of the stimulus cash will be spent in the months ahead – many recipients will no doubt have held off spending just to take advantage of post-Xmas sales. However, the general indication so far is of a decidedly underwhelming spending response.

Households are clearly trying to rebuild their net worth in response to declining asset prices through increased saving.  Public sector dissaving through unfunded fiscal stimulus packages simply adds to this saving task by increasing the future tax burden on households.  Fiscal stimulus is at war with itself.

So what should households do with an $8 witholding tax credit?  Ask 16 economists and you will get 16 different answers.  I like Adam Posen’s suggestion of investing in your own human capital, although possibly for different reasons.  My reasons: human capital is mobile, hard for governments to directly tax and you only have yourself to blame if the investment goes south.

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

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Five Reasons Why Fiscal Stimulus Won’t Work

From Henry Ergas:

the expectation of future deficits may have immediate, adverse consequences for confidence and output. However, the Government’s announcement merely sets a vague commitment to return to surplus through future reductions in spending growth. It does not say how great the cuts in spending will need to be or where those cuts will be made, and it ignores the obvious point that if there is wasteful spending that can be cut tomorrow, it ought to be cut today.

While fiscal stimulus is assumed to be popular, opinion polling is remarkably divided on the issue:

According to the Newspoll survey, 57 per cent of voters believe the economic stimulus package, which includes $12 billion in short-term cash giveaways to boost retail spending, will be good for the economy. Almost half those surveyed, 48 per cent, believe they would be personally better off as a result of the package.

posted on 09 February 2009 by skirchner in Economics, Fiscal Policy

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‘Attacking Iran is a Shovel-Ready Project’

Robert Barro interviewed in The Atlantic.

On Obama’s fiscal stimulus bill:

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much.

On Paul Krugman:

He just says whatever is convenient for his political argument. He doesn’t behave like an economist.

On war as stimulus:

I think the best evidence for expanding GDP comes from the temporary military spending that usually accompanies wars—wars that don’t destroy a lot of stuff, at least in the US experience. Even there I don’t think it’s one for one, so if you don’t value the war itself it’s not a good idea. You know, attacking Iran is a shovel-ready project. But I wouldn’t recommend it.

posted on 06 February 2009 by skirchner in Economics, Fiscal Policy

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‘The Last Little Timber from a Sunken Boat of Ideas’

Prime Minister Kevin Rudd proudly declared himself to be a Keynesian in his essay for The Monthly and now has a massive fiscal stimulus package to prove it.  John Cochrane, Professor of Finance at the University of Chicago Booth School of Business, highlights the extent to which Keynesianism has been thoroughly discredited within modern macroeconomics:

Am I some sort of radical? No, in fact economics, as written in professional journals, taught to graduate students and summarized in their textbooks, abandoned fiscal stimulus long ago.

Keynesians gave up by the 1970s. They saw that fiscal programs took too long to implement. They especially disparaged temporary measures, which would not stimulate the consumption that classic Keynesians thought was important to stimulus.  Every undergraduate text has repeated these conclusions for at least 40 years. I learned this view from Dornbusch and Fisher’s undergraduate text, taught by Bob Solow, in the 1970s…

The equilibrium tradition which took over professional academic economics in the mid-1970s has even less room for fiscal stimulus. Some “equilibrium” analyses do say fiscal stimulus can increase output – but by making us feel poorer, work harder at lower wages, and consume less. That’s not what advocates have in mind! A large fiscal program can affect prices, wages, and interest rates with all sorts of interesting general-equilibrium implications, but these analyses haven’t really converged on anything solid, much less the large “multipliers” necessary to make traditional fiscal stimulus attractive.

More deeply, macroeconomics was revolutionized starting in the 1950s, by the realization that what people think about the future is crucial to understanding how policies work today. Milton Friedman started this, pointing out that consumption does not depend statically on today’s income, but on what people expect of the future. People who learn that their jobs are on the line will consume less and save more, even though today’s income may still be good. As I have emphasized, the effects fiscal stimulus will have now depends crucially on whether people expect the new spending to be paid back by future taxes or whether they expect it to be quickly monetized. Classic Keynesian analysis analyzed policies and each time point in isolation. We do not have to agree if expectations are formed “rationally,” all we have to agree is that expectations of the future matter crucially for how people behave today, and the classic Keynesian analysis of fiscal stimulus falls apart.

In textbooks and graduate curriculums across the country, stimulus is presented at best as quaint “history of thought” with no coherent defense that one should believe it in the context of modern economics.  (For example, David Romer’s classic graduate text Advanced Macroeconomics) At worst, it is presented as a classic fallacy. (My view of the treatment in Tom Sargent’s Dynamic Macroeconomic Theory and Sargent and Ljungqvist’s Recursive Macroeconomic Theory).

“New-Keynesian” thought is devoted to defending the importance of monetary policy, and incorporating specific frictions in the equilibrium tradition, not to rescuing the ancient view that fiscal stimulus is important and abandoning that tradition.  Mike Woodford’s magisterial New-Keynesian opus, Interest and Prices, has no mention at all of fiscal stimulus.  More deeply, new-Keynesian economics is completely devoted to the proposition that expectations of the future matter centrally for how the economy behaves today.  Its central thesis is that central bankers must manage expectations, not manage “demand.”  It has no room at all for the sort of analysis in which one adds up “consumption” “investment” and “government” demands, without considering alternatives for those demands or expectations of the future, to determine output.

These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said “we’re all Keynesians now” just as Keynesian policy led to the inflation and economic dislocation of the 1970s, unexpected by Keynesians but dramatically foretold by Milton Friedman’s 1968 AEA address. Keynes disdained investment, where we now all realize that saving and investment are vital to long run growth. Keynes did not think at all about the incentives effects of taxes. He favored planning, and wrote before Hayek reminded us how modern economies cannot function without price signals.  Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience.

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

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So Much for ‘Liquidity Enhancement’

Australian Office of Financial Management head Neil Hyden gives the game away on the government’s expanded bond issuance program:

“The bonds we’re issuing, the proceeds are all going to be needed for government expenditures…”

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

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Ken Henry on Activist Fiscal Policy

Treasury Secretary Ken Henry, addressing Australian Business Economists in May this year:

activist counter-cyclical fiscal policy might be frustrated by lags of recognition, implementation and transmission. And its effectiveness might be compromised by Ricardian equivalence, the permanent income hypothesis or import leakages. I noted that these lags and questions of effectiveness pose real challenges for the use of counter-cyclical fiscal policy. But I also noted that they do not rule out such use.

On the issue of import leakages, much is being made of the alleged contribution of the government’s previous stimulus package to December retail trade:

Greg Smith, the managing director of household goods store Clive Peeters, said wide-screen televisions, DVD players, digital cameras and laptop computers had begun walking out of the company’s stores from the day the Government’s first economic package reached the public.

Since all of the mentioned items are imported, this expenditure is a subtraction from Australian gross domestic product.  One of the problems with activist fiscal policy is that, to the extent that there is any boost to domestic demand, much of it will spillover into imports, which might stimulate the Chinese and other economies, but will do very little for economic growth in Australia.  Retail sales are inappropriate as a gauge of the effectiveness of fiscal policy in stimulating domestic production.

Westpac note that the increase in retail sales was disappointing given gains in disposable income:

More importantly the December retail sales figure points to an even sharper run-up in household savings than previously anticipated. Indeed, it points to a spike in the savings rate to over 8% in Q4 from basically zero in the final quarter of 2007. This would mark the sharpest rise in saving on history back to 1960 by a very long way – effectively double any surge in household saving ever seen before.

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

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Obama’s Fiscal Stimulus versus the University of Chicago

Professors John Huizinga, Robert Lucas and Kevin Murphy speak at an Initiative on Global Markets Forum at the University of Chicago Booth School of Business on Obama’s fiscal stimulus package.  All of their arguments translate directly into the Australian context.

posted on 04 February 2009 by skirchner in Economics, Fiscal Policy

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A $42 Billion Future Tax Increase: Immiseration Not Stimulation

I have an op-ed in The Australian, arguing that the government has just announced a $42 billion future tax increase.  In reality, it’s worse than that because of the interest bill on the $42 billion in unfunded spending, plus the future welfare costs associated with an increased tax burden and the government’s diversion of resources away from potentially more highly valued uses.  The package will immiserate rather than stimulate.

In the statement accompanying yesterday’s 100 basis point cut in the official cash rate, the Reserve Bank said that ‘the Board took into account the package of measures announced by the Government earlier today.’  If the RBA shares the Treasury’s Keynesian assumptions about the implications of the package for short-term economic growth, then it is entirely possible that yesterday’s rate cut was smaller than it might have been in the absence of the latest fiscal stimulus package.  While fiscal policy has been irrelevant to monetary policy in recent years due to a steady fiscal impulse, it is less likely the RBA will ignore the massive turnaround in the budget balance we have seen since May last year.  Those ‘free’ pink batts are likely to have come at the cost of a higher mortgage interest rate.

posted on 04 February 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

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