Working Papers

Consumers as Interest Rate Hawks

The February Westpac-Melbourne Institute Consumer Sentiment survey finds respondents expecting increases in mortgage interest rates in excess of 100 bp over the next 12 months.  While this is somewhat in excess of the tightening in official interest rates recently priced into the inter-bank futures strip, it is not necessarily inconsistent with market pricing.  Consumers are by now well aware that the official cash rate is not the only determinant of mortgage interest rates and that there is a trade-off between changes in mortgage interest rates and the official cash rate. 

Treasurer Wayne Swan continues to maintain that there is ‘no excuse’ for interest rate movements in excess of movements in the official cash rate.  If lenders were to have followed this advice in the past, then none of the benefits of lower funding costs from mortgage securitisation would have been passed on to borrowers before the onset of the credit crisis.  Moreover, any future improvement in capital market conditions could not be passed on to consumers, but would instead be hoarded by lenders with the Treasurer’s implicit blessing. 

posted on 11 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA’s 50th Anniversary Symposium

Today I attended the RBA’s 50th anniversary symposium.  The proceedings were not for attribution, but the papers have been published on the RBA’s web site.  The session on supply-side issues was a particularly welcome contribution to an area too often neglected by central banks, but one that is inescapably linked to the conduct of monetary policy.

posted on 09 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA and Expectations Management

The RBA’s decision to leave the OCR unchanged at its February Board meeting is the subject of a lengthy discussion by Adrian Rollins in yesterday’s AFR.  The discussion centres on whether the surprise decision was a failure by the market to interpret the signals being sent by the RBA, or whether it was a failure on the part of the RBA to appropriately condition market expectations.  This is a joint problem, but one made worse because the RBA is not very good at communicating in a consistent, systematic and structured way.

This is an issue that is more serious than just wrong-footing the market over the outcome of a given Board meeting.  Expectations for the future real official cash rate are critical to the transmission of monetary policy and are probably more important to the stance of policy than the actual cash rate.  Changes in these expectations can even substitute for changes in the actual policy rate.  Poor communication can lead to the effective stance of policy being easier or tighter than the Bank intends, requiring a more activist approach to changes in the OCR than would otherwise be necessary. 

For example, it was not unusual for the market to periodically price in a new easing cycle during the 2002-2008 tightening episode.  This de facto easing in policy contributed to inflation getting out of control and increased the amount of tightening ultimately required.  It is thus very much in the RBA’s interests to ensure that market expectations align with its views.

posted on 05 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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No Free Lunch for Credit Conditions

The RBA has surprised the punditocracy by leaving the official cash rate unchanged, although financial markets had not fully priced a tightening.  The RBA’s decision is consistent with comments made by Deputy Governor Ric Battellino late last year noting that credit conditions had tightened by 100 basis points relative to changes in the official cash rate over the last two years.  He also noted that the tightening in lending margins had largely been in the area of business lending, not housing.

Today’s decision puts the bank-bashing by the government and others into proper perspective.  The RBA discounts lending margins in its setting of the official cash rate.  There are those who persist in believing that there is an interest rate free lunch to be had, if only the banking sector could be made more competitive.  Today’s decision shows that monetary policy is so carefully calibrated to prevailing credit conditions that any exogenous easing through increased bank competition would be quickly taken back via the official cash rate.  The RBA said so explicitly at the time of its August 2006 interest rate decision:

Compression of lending margins over recent years has contributed to a lowering of borrowing costs relative to the cash rate. This has meant that although the cash rate has recently been slightly above its average for the low-inflation period since 1993, interest rates paid by borrowers have remained below average.

Even Peter Martin is giving Westpac some love, so the message must be slowly sinking in.

posted on 02 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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RBA Tightening Expected on Tuesday

Financial market economists are unanimous in expecting a 25 bp tightening from the RBA at Tuesday’s Board meeting, according to a Reuters poll taken today.  February inter-bank futures are giving a 69% probability to a 25 bp tightening, while iPredict has an implied probability of 87%.  Markets seem to be underpricing a tightening relative to the punditocracy, perhaps reflecting the same concerns driving weakness in equity markets.

posted on 29 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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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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Core Inflation

The December quarter CPI to be released on Wednesday is seen at 0.4% q/q and 2% y/y, according to Friday’s Reuters poll.  This is somewhat higher than the 0.1% q/q and 1.7% y/y implied by the TD-MI inflation gauge. 

The trimmed mean is seen at 0.6% q/q and a steady 3.2% y/y.  The weighted median is seen at 0.6% q/q and 3.5% y/y, down from 3.8% y/y in the previous quarter.  It is noteworthy that despite a near two percentage point increase in the unemployment rate, core inflation was not reduced to an annual rate consistent with the RBA’s 2-3% target range during the recent economic downturn.

posted on 25 January 2010 by skirchner in CPI, Economics, Financial Markets, Monetary Policy

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RBA’s Kraehe Highlights Supply-Side Constraints

RBA Board member Graham Kraehe highlights the capacity constraints driving monetary policy tightening:

Asked if there was a risk of too much policy tightening choking off recovery, Mr Kraehe said the focus should be on price rises rather than supporting demand.

“The risk is more to cost pressure and inflation than it is to the demand side,” he said.

“Our unemployment has clearly now peaked. We’ve got increasing and continuing demand for employment in the resources sector that will put pressure on wages,” said Mr Kraehe, who is also chairman of Bluescope Steel.

“As an economy, one of the issues for us will be our ability on the supply side, whether it be on housing or the labour market, to supply enough resources to be able to take some of the pressure off cost inflation. Wages is one thing, housing another,” Mr Kraehe said.

posted on 22 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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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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A Turning Point for Inflation?

The TD Securities – Melbourne Institute Monthly Inflation Gauge rose by 0.3% in December, following a 0.3% rise in November. In the twelve months to December, the Inflation Gauge rose by 2.6%.  This is a fairly rapid acceleration from the October low of 1.2% y/y, which may well have been a turning point for CPI inflation.  According to the Melbourne Institute, the gauge points to an increase in the December quarter CPI of 0.1%, yielding an annual inflation rate of 1.7%, a pick-up on the 1.3% annual rate seen in the September quarter.  The December quarter CPI is released on 27 January.

posted on 18 January 2010 by skirchner in CPI, Economics, Financial Markets, Monetary Policy

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Bernanke on Monetary Policy and the Housing ‘Bubble’

Reporting on Fed Chair Ben Bernanke’s speech to the American Economic Association has focused on his suggestion that ‘we must remain open to using monetary policy as a supplementary tool for addressing those risks’ associated with asset price inflation.  However, the rest of his speech makes clear that Bernanke views this as very much a second-best option.  His speech contains a review of the evidence against the notion that monetary policy was the main cause of the housing ‘bubble’ in the US and elsewhere.

The WSJ quotes Dale Jorgenson on what was missing from Bernanke’s speech:

a Harvard professor who served as Mr Bernanke’s thesis adviser at MIT in the 1970s, said the Fed chairman made a “pretty convincing” argument that low rates were not the driving force of the housing bubble.

But he said Mr Bernanke should have laid more blame at the feet of Congress for encouraging reckless mortgage lending with its support of Fannie Mae and Freddie Mac and other policies meant to increase home ownership.

“I didn’t hear any word with regard to going back to Congress about changing housing policy,” he said.

Leaving aside that fact that his reconfirmation is pending before Congress, one suspects that Bernanke knows a lost cause when he sees one.  As the WSJ notes in another article:

In today’s Washington, we suppose, it only makes sense that the companies that did the most to cause the meltdown are being kept alive to lose even more money. The politicians have used the panic as an excuse to reform everything but themselves.


posted on 04 January 2010 by skirchner in Economics, Financial Markets, House Prices, 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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3.75 is the New 4.75

So says Deputy Governor Ric Battellino of the RBA’s official cash rate.  Battellino’s speech once again highlights the fact that the RBA calibrates changes in the official cash rate to changes in actual borrowing rates.  Battellino also notes that:

The margin on variable housing loans is much the same today as it was at the start of the crisis.

All this makes the whole political pantomime of bank-bashing rather pointless.  It is also the case that the RBA will probably discount the implications of tighter bank capital regulation for retail borrowing rates in its future setting of the official cash rate.  The equilibrium official cash rate may shift even lower as a result.

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

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Once a Leaker, Always a Leaker

The following observation from a London-based hedge fund trader is perhaps representative of offshore perceptions of monetary policy in Australia:

The RBA hiked rates again overnight, in line with leaks yesterday but contrary to some speculation at the height of the Dubai panic.

I don’t think there were any leaks on this occasion.  Friday’s Reuters poll had all but one respondent expecting a 25 bp tightening, despite Dubai.  But it shows that the perception that the RBA is a leaker is well entrenched in financial markets.


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

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