Working Papers

Hockey’s Hindsight Heroes

Opposition Treasurer Joe Hockey has problems staying on message:

Mr Hockey’s most controversial remarks were suggesting that the Rudd government would have been justified in cancelling this year’s tax cuts.

“The honest answer is there would have been a legitimate justification for the government to say our debt, our recovery, our economic recovery will be slower if we are running a big deficit and I think it should’ve been considered as part of the mix.”

Mr Hockey noted that it would have been hard for the Liberal Party to support the removal of the tax cuts. Earlier this year, Mr Hockey had argued for the government to bring forward tax cuts.

There is, of course, a case for not proceeding with the tax cuts.  Because they are unfunded, the tax cuts are equivalent to a future tax increase and subject to the same Ricardian equivalence critique as discretionary government spending.  However, one suspects that this is not the case Hockey has in mind.  Instead, Hockey is an unreconstructed, Costello-style revenue-hoarder:

Mr Hockey said that, if he had his time again, he would have better explained the Future Fund, which Mr Costello regarded as one of his crowning achievements. “I would have set up the other funds earlier: the higher education funds for infrastructure and the health and hospitals fund,” he said.

Like Costello, Hockey does not seem to understand that these funds are simply deferred government spending.

posted on 01 July 2009 by skirchner in Economics, Fiscal Policy

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Ricardian Equivalence, with a Vengeance

Dave Rosenberg, on the effectiveness of US fiscal stimulus efforts:

In April, total stimulus from the federal government to the personal sector, in the form of tax reduction and increased benefits, came to $121 billion at an annual rate. But that month, in nominal terms, consumer spending rose the grand total of $1 billion. Then we found out on Friday that in May, the total stimulus from the Obama economics team came to $163 billion at an annual rate, and consumer spending increased by a measly $25 billion (again at an annual rate). The big story is that the personal savings rate surged again to a new 16-year high of 6.9% from 5.6% in April and 4.3% in March. This is a repeat of the fiscal impact from the tax relief a year ago when the savings rate jumped from 0.2% in March 2008 to 4.8% in May 2008. This is what economists refer to as “Ricardian equivalence” — the money from Uncle Sam goes into the coffee can instead of being used to buy more coffee.

So let’s get this straight, the future taxpayer is being asked to contribute to a policy today that is aimed at perpetuating a consumer cycle — and yet for every dollar that is coming out of Washington to support a 70% consumption/GDP ratio, it is getting barely more than 8 cents worth of new spending activity. In real terms, as was the case with the tax rebates of just over a year ago, the real impact is on the savings rate, and it is very clear that not even the most aggressive monetary and fiscal policy since the 1930s is going to stop consumer spending in volume terms from rolling over in the second quarter.

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

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Greenspan on the Political Allocation of Capital

Alan Greenspan, on the quantitative channel for crowding-out:

Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt. Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.

posted on 26 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

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Are Americans All Keynesians Now?

While policymakers around the world may be sold on the effectiveness of discretionary fiscal stimulus, the public remain more skeptical.  The disconnect between official and public sentiment is important, because confidence is meant to be one of the channels through which stimulus spending works to support economic activity.  We have previously pointed to US survey data on consumers’ evaluation of macroeconomic policy, which calls into question the effectiveness of fiscal stimulus efforts. 

A WaPo-ABC News poll directly asks whether economic stimulus has or will help the economy.  A net 52% see stimulus as helpful to the economy, while 46% view stimulus as not helping, either currently or prospectively.  At the same time, 87% of respondents were ‘very’ or ‘somewhat concerned’ about the federal budget deficit.  A majority (54%) also favour ‘smaller government, fewer services’ to ‘larger government, more services.’  The majority view expressed in these polls is consistent with a Ricardian interpretation of the effectiveness of fiscal policy.  The poll also sheds light on why President Obama remains popular.  Most respondents still see Obama as ‘a new-style Democrat who will be careful with the public’s money’ rather than ‘an old-style, tax-and-spend Democrat.’

posted on 25 June 2009 by skirchner in Economics, Fiscal Policy

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Fiscal Stimulus, Interest Rates and Crowding-Out

I have an article in the Weekend Australian arguing that the government’s discretionary fiscal stimulus measures will undermine Australia’s long-run growth prospects, citing the Australian edition of a widely used undergraduate textbook:

“When the government reduces national saving by running a budget deficit, the interest rate rises and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.” So says Joshua Gans in his Principles of Macroeconomics text. Yet Gans was also one of the 21 economists who recently signed a letter defending the government’s deficit spending.

An increase in the stock of government debt reduces the amount of capital available for private investment, although this crowding-out effect may be offset by increased private saving and foreign capital inflows. In a small and open economy such as Australia, crowding out occurs not so much because interest rates rise, but because it induces foreign capital inflows that put upward pressure on the exchange rate, lowering net exports and reducing aggregate demand, which offsets the increase in government spending.

I also have an article in Business Spectator, noting that recent market-led increases in retail borrowing rates are just a taste of things to come:

Whatever the cause of rising global bond yields, these increases in interest rates will inevitably be passed on to Australian borrowers. It would be a sign of political maturity if Australian politicians were to acknowledge this reality, rather than taking refuge in the shameless populism of bank-bashing.

UPDATE: Joshua complains about ‘selective extracting’ and an ‘unwillingness to deal with economic complexity’ in my Weekend Australian piece.  The point of highlighting the very good discussion of these issues in Joshua’s textbook was precisely to show that the 21 economists were being selective and incomplete in their analysis, by not acknowledging the many arguments against discretionary fiscal stimulus.  I would certainly encourage people to read Principles of Macroeconomics in coming to a considered view of the merits of discretionary fiscal policy.

posted on 21 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

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Government Policy, the Business Cycle & Consumer Confidence

Claims about the effectiveness of fiscal stimulus in the US do not quite square with evidence from surveys of consumer confidence.  The University of Michigan survey asks respondents “As to the economic policy of the government—I mean steps taken to fight inflation or unemployment—would you say the government is doing a good job, only fair, or a poor job?”  According to secondary sources, this measure posted its equal sharpest decline on record in June to 93 from 108 in May.  The chart below the fold shows the history of this series until November 2008, after which the data disappeared behind a Thomson-Reuters paywall (if anyone has the intervening data, feel free to flick it my way).  Clearly, consumers did not think much of the Bush Administration’s fiscal stimulus measures (although there is a rally around the flag effect in relation to policies pursued after September 11 2001).  The change in Administration since November last year benefited this series, but the political honeymoon now seems to be wearing off. 

This series is clearly cyclical, suggesting consumers blame economic conditions on government policy.  While consumers might be overrating the importance of government policy to economic outcomes, they are also effectively calling into question the effectiveness of the usual counter-cyclical policy responses, including fiscal stimulus. 

continue reading

posted on 18 June 2009 by skirchner in Economics, Fiscal Policy

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Stimulus Watch

The Australian looks behind the photo-op spin of politicians in hard hats and fluro safety vests to give stimulus spending the scrutiny it deserves.  The results are not pretty.

You can report stimulus waste to online-at-theaustralian.com.au.

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

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Fiscal Stimulus and Retail Trade

Ashton de Silva and Sinclair Davidson demolish the myth that fiscal stimulus has led to above trend growth in retail sales.  The authors note that:

the media has been full of articles indicating that individuals have increased spending on poker machines and plasma televisions. Some individuals told reporters that they intended to get tattoos or spend the money on prostitutes. That type of spending does not undermine the policy objective. The policy objective is to stimulate increased spending in the economy irrespective of what the spending actually entails.

This sort of media commentary should also be rejected because it supports the elitist notion that people cannot be trusted to make consumption choices in their own interests.

posted on 12 June 2009 by skirchner in Economics, Fiscal Policy

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Australia and the World Economy

I have a column in the Business Spectator, arguing that the transmission mechanism from the world to the Australian economy is mainly via financial markets rather than cross-border trade in goods and services:

While it may seem surprising that export volumes are holding up in the context of a global economic downturn, it highlights the fact that the transmission mechanism from the world to the Australian economy is somewhat different to the one many people assume.

There has been a much closer relationship between the world and Australian economy since the early 1980s, as lower trade barriers have resulted in closer ties with world markets and a larger traded goods sector. However, it is difficult to account for the strength of this relationship based purely on trade linkages.

A more important transmission mechanism from the world to the Australian economy comes from our increased integration with global financial markets following financial market liberalisation and deregulation in the early 1980s. Changes in global interest rates and other asset prices are transmitted directly to the Australian economy via global financial markets.

This has a more powerful and immediate impact on the Australian economy than international trade in goods and services and has been particularly important in the context of the recent global financial crisis.

It helps explain why domestic demand has contracted, even while external demand has proven resilient.

As I note in the column, this has important implications for the effectiveness of domestic policy interventions.

posted on 11 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Debunking Bad Narratives on Stimulus

Henry Ergas responds to the 21 economists rounded-up by Nic Gruen to defend the federal government’s stimulus measures (as if the government were not big and ugly enough to defend itself):

The open letter 21 highly respected Australian economists published earlier this week in The Australian Financial Review strikingly illustrates the trend. Endorsing the “too much rather than too little” approach, that letter claims “there is no more effective way to stimulate the economy” than cash handouts.

In reality, the efficacy of that spending is far from established. Rather, much as economic theory would predict, the striking fact is just how smooth the path of consumption has been, despite a substantial spike in income associated with the Government’s cash splash.

Sinclair Davidson makes similar points in The Age:

It would be surprising indeed if the 21 economists were prepared to defend any of the $800 million in ‘community infrastructure’ boondoggles listed here

RBA Governor Glenn Stevens has also been out highlighting the limits of macro policy stimulus:

Macroeconomic policies have not been able to prevent an economic downturn. They rarely can, especially in the face of a global recession of this magnitude. Indeed, attempts to do so have as often as not run into trouble by stoking up bigger problems a few years down the track.

posted on 05 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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By How Much Did the Australian Economy Outperform?

Updating our earlier model of Australian GDP growth for yesterday’s data revisions yields a forecast for the March quarter of -0.5% q/q compared to an actual result of 0.4% q/q.  So growth was 0.9 percentage points stronger than a forecast based solely on US GDP growth.  This outperformance is even larger if we believe the expenditure measure of GDP (1.1% q/q), but turns into underperformance if we believe the conceptually equivalent production measure, which came in at -0.9% q/q.

Of all the country-specific factors that might account for this outperformance, discretionary fiscal policy is likely to have been the least of them.

posted on 04 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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A Simple Test for the Effectiveness of Macro Policy Stimulus in Australia

A simple test for the effectiveness of macro policy stimulus in Australia is to model quarterly Australian GDP growth as a function of contemporaneous and lagged US GDP growth and a constant.  The model makes the reasonable assumption that causality runs from US growth to Australian growth, since Australia is too small to influence the US economy.  US stimulus measures could benefit Australian GDP based on this model, but Australian policy stimulus should not influence US GDP growth (even allowing for those stimulus cheques to ex-pats).  Domestic policy is historically correlated with US GDP growth, but presumably works in a counter-cyclical direction.  The estimated relationship implies that domestic policy can do only so much to offset the influence of US or world growth on domestic activity.

The model’s static forecast for Australian March quarter GDP is -0.8% q/q, with a standard error of 0.6, so we would expect March quarter GDP growth to lie in the range of -0.2% q/q to -1.4% q/q.  The median forecast of market economists is -0.2% q/q, based on Friday’s Reuters poll*, implying that the Australian economy is modestly outperforming what we might expect based solely on US growth.  Both domestic monetary and fiscal policy could thus be given some credit in offsetting the effect of the decline in world growth.  But even if we generously assume that discretionary fiscal policy measures account for most of this outperformance, it is a very small return on what has been called ‘the greatest mobilisation of resources in Australia’s peacetime history.’  The lesson is that for a small open economy like Australia, there is only so much domestic policy can do when confronted with a global economic downturn.

Model details over the fold.

* Update: Latest Reuters poll median is +0.2% q/q, following Tuesday’s release of net exports for the March quarter.

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posted on 02 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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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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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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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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