Working Papers

Sentences You Won’t Read from the Reserve Bank of Australia

From today’s Reserve Bank of New Zealand intra-quarter policy review:

As growth becomes self sustaining, fiscal consolidation would help reduce the work that monetary policy might otherwise need to do.

This is more the RBA’s style (see if you can guess when the RBA said it before clicking here):

The purpose of my answer was to explain why it was wrong to claim that rises in interest rates were due to the stance of fiscal policy.

My answer in no way constituted an attack on the Government’s fiscal policy.

Governor Macfarlane was right to argue that fiscal policy was then irrelevant to inflation and interest rates.  But more recently, Governor Stevens has argued that fiscal stimulus has supported economic activity and that there is a trade-off between monetary and fiscal stimulus.  Just don’t expect him to spell out the implications of that logic in a policy announcement as candid as that from the RBNZ.


posted on 28 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Wisdom of Crowds: Fiscal Stimulus Edition

Americans are far from sold on fiscal stimulus:

A CNN/Opinion Research Corporation survey released Monday morning also indicates that 63 percent of the public thinks that projects in the plan were included for purely political reasons and will have no economic benefit, with 36 percent saying those projects will benefit the economy.

Twenty-one percent of people questioned in the poll say nearly all the money in the stimulus has been wasted, with 24 percent feeling that most money has been wasted and an additional 29 percent saying that about half has been wasted. Twenty-one percent say only a little has been wasted and 4 percent think that no stimulus dollars have been wasted.

posted on 26 January 2010 by skirchner in Economics, Fiscal Policy, Opinion Polls

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Inflation for the Long-Run

Jim Hamilton points to his Phillips curve relation, which is forecasting deflation over the near-term.  For the long-run, he suggests we should look to the fiscal theory of the price level:

The value of the new Federal Reserve liabilities ultimately will be determined by the long-term fiscal soundness of the U.S. government….Inflation is not something you should be afraid of for 2010. But what we need is a convincing commitment from the government to both near-term stimulus and longer-term fiscal responsibility in order to be assured that it’s not a concern over the next decade.

And that’s not what I’m seeing from the U.S. Congress.

Meanwhile, Thomas Frank contemplates an evil plot to stick it to the gold bugs: putting Fort Knox on eBay.  Not that it would work, but there is a certain irony in those who fear inflation taking refuge in the one real asset that is potentially the most vulnerable to a surge in supply from central banks and governments.

posted on 21 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Gold, Monetary Policy

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Did the US Treasury See the Inflation Nutters Coming?

I have a column in today’s Business Spectator arguing that the global debate about whether monetary and fiscal stimulus will prove inflationary reflects poorly on the credibility of policymakers.  One of the lasting effects of the discretionary policy responses to the global financial crisis may be the damage it will do to the credibility of monetary and fiscal policy frameworks.

David Merkel has updated the inflation expectations implied by US Treasuries, noting that ‘rapidly rising long-term inflation expectations indicate that the average investor does not trust monetary policy to succeed over the next 20+ years’.  At the same time, Merkel argues that since this outcome is already priced, it may be time to short US Treasury Inflation Protected Securities (TIPS).  The US Treasury may well be taking the inflation nutters for a ride:

there is a lot of demand for long TIPS.  If the US Treasury thinks it can get things under control, the rational thing to do is to stuff the long TIPS buyers with as much product as they can gulp before it becomes obvious that low inflation will continue because the government will soon balance the budget and pay down debt, as they did after WWII.

But Merkel also concedes that:

I don’t know which direction the US Government and Fed intend to go with policy.  They likely have no idea as well…if the US Treasury can’t get things under control, the long TIPS buyers will do well, as they have the most sensitivity to rising forward inflation expectations.

The enormous uncertainty created by the discretionary policy responses of governments to the crisis will weigh on economic activity, regardless of how these issues are ultimately resolved.

posted on 20 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Pre-Christmas Linkfest

Crowding-out in the face of a rising supply price of foreign capital.

How EMU promotes anarchist violence.

How Kevin Rudd sold Australia down the river in Copenhagen.

International Economy symposium on targeting assets prices with monetary policy. 

My final op-ed for the noughties: (NZ) Labour Should Not Take its Eyes Off the Target.

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

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The Gruen Transfer

Henry Ergas responds to David Gruen’s defence of the indefensible:

Gruen says the infrastructure spending is justified because it adds to productive capacity.

But this is true only if the benefits from that spending exceed its costs. If they don’t (think national broadband network or pink batts), then the community loses twice: from the waste, as scarce capital is diverted from better uses; and from the distortions caused by the higher taxes needed to cover the projects’ costs.

As a result, far from expanding productive capacity, projects such as these cause it to shrink. This used to be part of Treasury religion; it is startling that there is no mention of it in Gruen’s speech.

posted on 19 December 2009 by skirchner in Economics, Fiscal Policy

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Big Government Fails Treasury’s ‘Wellbeing’ Test

I have an op-ed in today’s Australian taking Treasury Secretary Ken Henry to task for resigning Australia to a permanent expansion in the size of government.  I argue that the expansion in the size of government since Gough Whitlam fails the criteria set by the Treasury’s ‘wellbeing’ framework for public policy.

Note that the Oz has an unfortunate habit of leaving out quotation marks.  There should be quote marks around ‘25 per cent as the maximum tolerable proportion of taxation’.  The quote is from a letter Keynes wrote to Colin Clark.

posted on 16 December 2009 by skirchner in Economics, Fiscal Policy

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Crowding-Out in a Small Open Economy (That Would Be Us!)

Tony Makin makes the case for a crowding-out effect from fiscal stimulus via the exchange rate and net exports.  Last week’s September quarter balance of payments implied a 1.8 percentage point subtraction from growth on the part of net exports, which is consistent with this story.  Indeed, despite a positive contribution in the first half of 2009, export volumes made no contribution to measured GDP growth for the year-ended in June.  A 13.1% decline in import volumes, by contrast, made a 3.3 percentage point contribution to growth over the same period. 

Remarkably, the Australian dollar-US dollar exchange rate bottomed out in October 2008, the same month as the first stimulus package, before rising 57% from its lows around 0.6000 to its recent highs around 0.9400. 

I made a similar case for crowding-out via the exchange rate and net exports in this op-ed following the May Budget.

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

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How to Reduce the Budget Deficit, Without Really Trying

The Australian economy just got bigger, thanks to the adoption of the new national accounting standard SNA08.  The revised data raise the level of nominal GDP by 4.4% for 2007-08.  As the government was quick to point out, this reduces the estimated budget deficit for 2009-10 from 4.7% to 4.5% of GDP, as well as the expected net debt to GDP ratio.

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

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Capital Gains Tax Myths and Realities

The CIS have released my Policy Monograph on Reforming Capital Gains Tax: The Myths and Realities Behind Australia’s Most Misunderstood Tax.  There is an op-ed version in today’s Australian.

The 2004 Productivity Commission inquiry into first home ownership noted that ‘changes to the capital gains tax regime coupled with longstanding negative-gearing arrangements were seen to have contributed to higher prices through encouraging greater investment in housing’, but the commission did not model the effects of the tax changes. If increased investment is putting upward pressure on prices, this is an argument for easing supply-side constraints, not for discouraging investment with a CGT. CGT is a tax on transactions that would reduce turnover in owner-occupied housing and lead to a less efficient allocation of that stock.

Some mistakenly see a CGT on the family home as a way of soaking the rich. Yet a CGT on owner-occupied housing would most likely be accompanied by tax deductibility for mortgage interest payments, as in the US, offsetting any increase in revenue from a CGT.

In conjunction with negative gearing, the Ralph reforms were blamed for the housing boom in Australia in the early part of this decade. In reality, the boom was caused by the inability of housing supply to respond flexibly to the increased debt-servicing capacity of households in a low inflation, low interest rate environment.

The boom in house prices also occurred in the context of a bear market in equities between 2001 and 2003. It is not surprising demand for housing increased when prices of a competing asset class were declining. House price inflation was a global phenomenon, arguing against country-specific factors as the main cause.

Rather than increasing the tax burden on housing, policymakers need to tackle the impediments to new housing supply to improve affordability.


posted on 12 November 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, House Prices

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Tens of Billions Lost

RBA Board member Warwick McKibbin, on the resource cost of fiscal stimulus:

RESERVE Bank director Warwick McKibbin has publicly questioned whether the Rudd government dumped him from the Prime Minister’s science council as payback for saying its fiscal stimulus package was “too big”.

Speaking yesterday after Wayne Swan said the RBA was “entirely comfortable with our fiscal policy”, Professor McKibbin said he had no doubt history would show that the Rudd government had overdone the stimulus.

Professor McKibbin also revealed that part of the motivation behind establishing a new council of eminent economists to debate policy issues was to encourage academics to speak out.

“I think when people look through the entrails of this, they will find billions, if not tens of billions, that was just lost,” he told The Australian.

A few weeks after he suggested that the second part of the stimulus package was too large while giving evidence at a Senate inquiry in May, he was dumped from a government advisory role on the Prime Minister’s Science and Innovation Council, Professor McKibbin said.

posted on 09 November 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Politics

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Tax Competition and the Future Fund

Australia’s sovereign wealth fund, the Future Fund, does not pay tax, which would be pointless, but it is not too keen on paying foreign taxes either.  The Fund’s 2008-09 Annual Report shows five Cayman Islands subsidiaries.  As the report notes ‘the Fund seeks to maximise after tax returns and, where it is legitimate to use a structure which protects the claim to sovereign immunity, this path has been taken.’  The Australian government has been an enthusiastic participant in international efforts to crack-down on so-called ‘harmful’ tax competition, but is not averse to having its own proprietary trading operation take advantage of these opportunities.  To be clear, this is meant as a criticism of the government’s participation in such efforts and not the Future Fund.

The Fund saw a real rate of return of -5.7% (ex-Telstra), which is pretty poor compensation for the tax cuts forgone as a result of the Fund’s creation.  The Fund remains 41.1% invested in cash (ex-Telstra), down from 62.1% at the end of the previous financial year.  The government could have achieved a better return with less risk and at lower cost simply leaving the funds on deposit with the Reserve Bank.

posted on 30 October 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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What If You Got Pink Bats and a School Hall for Christmas?

Scroogenomics author Joel Waldfogel, on the welfare costs of poorly chosen Christmas gifts:

My favorite way to do it is to compare what would you be willing pay for stuff that you receive as a gift per dollar spent versus what would you be willing to pay for stuff you bought for yourself per dollar spent. The surveys converge on the idea that it is about 20% less. U.S. holiday spending per year is conservatively about $65 billion. So about 20% of that, something like $13 billion a year, is what’s destroyed through gift giving in the U.S. But it turns out it is by no means limited to the U.S.

You see the same pattern of spending in almost every major western economy, with a big bump in spending in December. You don’t see it in China and you don’t see it in Israel. But you see it in every country that is predominantly Christian, and some that aren’t. Japan also has it in a big way. If you add up that spending in the other major OECD economies you get, instead of $65 billion alone for the U.S., $130 billion (in holiday spending). There’s every reason to believe the dead weight loss is as big elsewhere. That would get you to $25 billion a year around the world in value destroyed through gift giving.

An almost perfectly analogous argument can be made against fiscal stimulus of the non-cash variety, except that the government has even less knowledge about your preferences, has even less of an incentive to satisfy them and you get sent a tax bill for the gifts you didn’t want.  The rush to push stimulus dollars out the door is similar to the mad rush to buy presents before Christmas, resulting in poor quality spending decisions.  The political Santa Claus also has a rather more selective view of who has been ‘naughty’ and who has been ‘nice’. 

Fiscal stimulus spending is often viewed as valuable in its own right, as if it doesn’t matter what the government spends money on.  When asked whether his proposal for less Christmas gift-giving would be bad for the economy, Waldfogel notes:

I’m not against spending, I’m just against spending done ignorantly by others… Although George Bush said go out and spend and other folks have exhorted us to spend at times, spending is not really a measure of success or satisfaction… When we say it is good for the economy, we can’t just look at the amount of spending, we want to think about the amount of satisfaction that we’re getting from the spending.

While Waldfogel’s argument is less applicable to so-called ‘cash splashes’, last year’s cash hand-outs were strategically timed just before Christmas.  We will never know just how much of last year’s pre-Christmas cash splash ended-up in the great national stockpile of unwearable socks and ties.

posted on 19 October 2009 by skirchner in Economics, Fiscal Policy

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Fiscal Stimulus and Monetary Policy

RBA Governor Glenn Stevens, making the case for tightening monetary policy yesterday:

If we were prepared to cut rates rapidly, to a very low level, in response to a threat but then were too timid to lessen that stimulus in a timely way when the threat had passed, we would have a bias in our monetary policy framework. Experience here and elsewhere counsels against that approach.

The same argument can be made in relation to fiscal policy, but not because it will make the RBA’s job any easier.  The main argument for winding back the fiscal stimulus at a faster pace is to avoid the long-run costs from crowding-out and resource misallocation rather to contribute to short-run demand management.  There is no necessary contradiction in arguing that fiscal stimulus has been ineffective and that it should now be wound back, as some have suggested. 

Standard New Keynesian models would predict that fiscal stimulus in a small open economy will induce capital inflows, put upward pressure on the exchange rate and crowd-out net exports, rendering discretionary fiscal policy wholly ineffective in stimulating aggregate demand.  Treasury have argued that this does not apply in the context of a concerted global fiscal expansion.  The problem with the Treasury’s argument is that Australia’s fiscal stimulus is one of the world’s largest as a share of GDP and we now have the exchange rate appreciation to show for it. 

Despite the downturn, underlying inflation as measured by the RBA’s statistical core series remains above the upper-bound of the RBA’s 2-3% medium-term target range.  The Bank’s forecast that underlying inflation will return to the middle of the target range by June 2010 is based on economic forecasts that look overly pessimistic.  Little wonder that the inter-bank futures market is pricing an aggressive tightening cycle, with a further 50 basis points of tightening more than fully priced before the end of the year.

posted on 16 October 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Policymakers Sold Australia Short

I have an op-ed in today’s AFR arguing that the budget economic forecasts are the wrong benchmark to use in evaluating the effectiveness of fiscal stimulus.  Full text below the fold (may differ slightly from edited AFR text).

Alan Mitchell’s column on the facing page is worth reading for its discussion of the relationship between the Rudd government and the Treasury Secretary.  Mitchell argues that ambiguity about the nature of this relationship is undermining accountability for government policy.

continue reading

posted on 14 October 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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