Working Papers

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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NZ Labour Loses its Way on Inflation

The Wall Street Journal has been running a series of articles on the impact of US dollar weakness on Asia-Pacific economies.  In today’s edition, I write about New Zealand Labour’s abandonment of the consensus on inflation targeting:

Mr. Goff’s criticism of this dynamic misses the important benefits inflation targeting and its effects on the exchange rate bring to New Zealand. The dollar’s fluctuations help insulate the economy from external shocks, not least during the recent global financial crisis. When demand weakens in the rest of the world, the New Zealand dollar depreciates, making New Zealand’s exports more competitive. When external demand is strong, the currency rises, moderating export prices in New Zealand-dollar terms and restraining import price inflation. New Zealand’s floating exchange rate thus smoothes external demand and economic activity, making the central bank’s job of controlling inflation much easier.

Many exporters resent the role of the exchange rate in moderating New Zealand’s economic cycle, viewing their competitiveness as being sacrificed on the altar of inflation control. But the idea that New Zealand can ignore inflation and grow faster through easy money and a lower exchange rate is a short-sighted view, no matter how tempting. It ignores the fact that higher domestic prices resulting from inflation would ultimately undermine rather than promote international competitiveness. Economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.

Sinclair Davidson made similar arguments in relation to the Australian dollar in an earlier op-ed in the series.


posted on 23 November 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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The End of Inflation Targeting?

The leader of the opposition New Zealand Labour Party, Phil Goff, has announced the abandonment of his party’s support for inflation targeting by the Reserve Bank of New Zealand.

It was a Labour government that introduced the Reserve Bank of New Zealand Act in 1989, making New Zealand a global pioneer in the practice of inflation targeting.

I have long suspected that the global trend towards increased central bank independence and inflation targeting would eventually be reversed.  As I noted in my Bubble Poppers monograph, even the central banking community is increasingly divided on the issue. 

If the bipartisan consensus in favour of inflation targeting can be shattered in New Zealand, it can happen anywhere.

posted on 19 November 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA and the Media Revisited

I featured in a Lateline Business story last night on Reserve Bank media backgrounding in relation to monetary policy.  Lateline Business supervising producer Richard Lindell deserves considerable credit for pursuing this story in the face of both official and unofficial stonewalling.  Credit is also due to Alan Kohler, Adam Carr and Christopher Joye, who have all spoken out on this issue.  Some of the people who originally agreed to appear on camera for the story were prevented from doing so by their employers.  As I said to Richard Lindell, ‘now you know why market economists don’t criticise fiscal stimulus.’

A 2001 AFR Magazine profile of then RBA Governor Ian Macfarlane by Peter Hartcher quoted a former RBA official as saying:

The Bank uses newspapers to manage expectations.  It’s a game the Bank manages very well.  Senior people talk to a small handful of the economics writers from the major papers on a strictly non-attributable basis.

The quote was re-produced in Stephen Bell’s 2004 book on the Reserve Bank, Australia’s Money Mandarins (see my review).  Journalists and academics should be the standard-bearers for due process, procedural fairness and public accountability.  Yet many commentators view the RBA’s manipulation of the media as simply a clever use of power. 

The practice is a legacy of a less transparent era at the Reserve Bank.  With so many open channels of communication now available to the Bank, there is no longer any excuse for it to continue.

There is more on Reserve Bank governance here.

posted on 03 November 2009 by skirchner in Economics, Financial Markets, Monetary 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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Does the RBA Still Feed the Media Chooks?

Speculation about RBA media backgrounding in relation to future interest rate decisions is back again.  Even if no such backgrounding has taken place, the perception that this still occurs is very damaging, not only for the integrity of financial markets, but also for the supposed beneficiaries of the backgrounding.  It is well understood that politicians engage in selective leaks in order to control journalists.  There is nothing more damaging to the credibility of a press gallery journalist than to be seen as the mouthpiece for a politician.  The relationship between the RBA and journalists should not be viewed any differently.

The RBA could put a stop to the speculation by denying that the practice takes place or at least foreswearing its use in future.  Not only would this benefit the integrity of financial markets, it would also give us more confidence that the rather generous treatment the RBA receives from many in the media was actually deserved.

posted on 07 October 2009 by skirchner in Economics, Financial Markets, Media, Monetary Policy

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Minsky Remembered

Eric Falkenstein recalls Hyman Minsky:

I was Minsky’s TA while a senior at Washington University in St.Louis in 1987, and took a couple of his advanced classes, which regardless of the official name, were all just classes in Minskyism. He was a maverick, but perhaps a bit too much, being a little too dismissive of others, as he hated the traditional Samuelson/Solow Keynesians as much as the Friedmanite Monetarists. He always thought a market collapse was just around the corner…

Most articles celebrating Minsky have a strong subtext, kind of like Krugman’s wistful remembrance of his undergraduate macro based on the General Theory, that if we only go back to the days when Nixon famously said ‘we are all Keynesians now’, we would have more faith in government top-down solutions. That was when Federal spending was 30% of GDP. Now it’s 40%. Economists did not abandon Keynesianism because they are capitalist dupes, rather, it was inconsistent, generated poor models of economic growth, and it neglected the micro economic factors that make all the difference between a North Korea and South Korea: free markets, property rights, decentralized incentives. A Keynesian thought he could steer the economy via two controls, the budget deficit and the Fed Funds rate, and indeed in the short run these are very powerful tools, but in the longer run, rather unimportant.

It is reassuring that the critics of mainstream macro have nothing better than Minsky to turn to, but still no less excusable.

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

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Vindicating Fightback

I join the history wars with an op-ed in today’s Australian taking issue with Paul Kelly’s claim that ‘the defeat of Dr Hewson’s policy [of Reserve Bank reform] laid the basis for the successful monetary policy of the Keating-Howard era.’  I make the case that:

Far from being a repudiation of Fightback, as Kelly suggests, subsequent developments have largely vindicated its vision for monetary policy reform.


continue reading

posted on 15 September 2009 by skirchner in Economics, Financial Markets, Monetary Policy, Politics

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Resolving Equity and Bond Market Divergence

Richard Cookson suggests two scenarios for the resolution of the current episode of equity and bond market divergence:

The benign argument for bond yields (and equities) revolves around supply.  Many pundits and investors have been in a lather about the vast quantities of debt that governments have to issue. But if an unexpected mountain of supply raises the risk premium that investors demand for holding longer dated paper, the opposite is also true: supply that becomes less Everest-like than feared would reduce it.

So the benign explanation for why bond yields have been falling even as equity markets have been rallying is that worries about the surge in government bond issuance are lessening as signs of recovery mount.

That in turn should lead to a fall in government issuance and thus long-term yields, especially since inflationary pressures (apart perhaps from the UK) are so muted and yield curves so steep by historical standards.

And if that’s right, lower government bond yields would increase the appeal of riskier assets, equities included.

Effectively, the ex ante equity-risk premium would be driven higher because the long-term risk-free rate, but not the growth rate, would be lower.

Sadly, there’s also an altogether more malign explanation. Much as was the case in Japan in the 1990s, it could be that low government bond yields are telling you that this recovery is unsustainable once the monetary and fiscal medicine wears off.

It could be saying that, thanks to the required private sector deleveraging, especially in the US and UK, the long-term potential growth rate of the developed world is much lower than it was. That would lead to a sharply lower ex ante equity risk premium and thus  potentially dreadful returns from equities.

Unfortunately, another lesson from Japan in the 1990s is that the world’s lowest bond yields can co-exist with the world’s worst fiscal policy outcomes.  This makes the first of Cookson’s scenarios less plausible.  We are more likely to end up with whatever is behind door number two.

posted on 01 September 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Anchoring Fiscal Expectations

Eric Leeper argues that expectations for fiscal policy are as important as those for monetary policy.  Leeper points to ‘an egregious example of non-transparent fiscal policy’:

the recent $787 billion American fiscal stimulus plan. Leading up to the introduction and passage of the American Recovery and Reinvestment Act, the entire economic rationale for thestimulus package consisted of the job creation prediction in a document by Romer and Bernstein (2009).  The document claims it “suggests a methodology for ensuring the package contains enough stimulus. . . [to] create sufficient jobs to meet the Presidentelect’s goals [p. 2].” An appendix reports multipliers for a permanent increase in government spending and decrease in taxes of 1 percent of GDP. Four years after the initial stimulus, government purchases raise GDP by 1.55 percent, while tax cuts raise GDP by 0.98 percent. Sources for these numbers are reported as the Federal Reserve’s FRB/US model and “a leading private forecast firm.”

To assess how this rationale for stimulus measures up in terms of transparency, I raise some questions that are not addressed in the Romer-Bernstein document, but are important for anchoring fiscal expectations:

• What are the economic models underlying the multiplier numbers and are those numbers reproducible?
• Why consider permanent changes in fiscal variables when the Act makes transitory changes?
• What are the consequences of the stimulus for government debt?
• What are the repercussions of significantly higher government debt?
• Will the debt run-up be sustained or retired?
• How will policies adjust in the future to either sustain or retire the debt?
• What “methodology” does this document suggest for gauging the necessary size of fiscal stimulus?

Some might accuse me of finding a straw man to ridicule. But this is an important example because of its potential impact on the world economy.

The same questions could be asked in the Australian context.

Robert Carling and I make a similar case for rules-based fiscal policy here.

posted on 25 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Demand is Not Supply

Asked about the effectiveness of discretionary fiscal stimulus measures, RBA Governor Stevens told the House Economics Committee on Friday that:

we believe that the fiscal measures have supported demand and, therefore, at least to some extent, output.

The distinction was probably lost on members of the Committee, but is nonetheless an important one.  Demand can be met out of imports and inventories, without boosting domestic production.  This is why indicators like retail sales are entirely inappropriate as a measure of the effectiveness of fiscal policy.

Some remarkably good questioning from Liberal MHR Scott Morrison also flushed out some more of the Governor’s position on using monetary policy to target asset prices:

One view, the Alan Greenspan view, is you cannot know it is a bubble until it has burst, so you should not do anything much, and then you should clean up the mess once it has burst… I personally would not want to commit to saying, ‘We’re definitely never going to pay attention to asset prices and totally ignore them.’  That has been shown to be a mistake, basically. But nor do I think it is our brief to aggressively chase down asset things that pop up here and there that we might personally find hard to accept or agree with, at the expense of other things that we have as our objectives. So I think that, into the future, it is going to be a matter of judicious, careful use of our instrument in trying to meet all these worthy goals—keeping in mind as well that there is a whole separate debate about other tools that might be applied to booms and busts and asset prices. That is a whole separate section of this debate—what tools could be used by the supervisory authority to rein in the lending.

In fact, no one has ever suggested that asset prices should be completely ignored.  Greenspan explicitly rejected this proposition in his 1996 ‘irrational exuberance’ speech.  The issue is whether asset prices should have a weighting in the central bank’s reaction function that is independent of the inflation forecast.

Stevens can at least be thankful he does not have to appear before the US Congress:

Far from deference, Mr. Bernanke’s recent testimonies have been treated with all the delicacy usually reserved for a mob boss.

posted on 17 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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The Wizards of Oz: Behind the Curtain

The always interesting Scott Sumner (who is right on most things) falls into the grass-is-always-greener trap that seems to afflict many Americans when it comes to monetary policy:

Earlier I said Australia is very similar to the US.  The main difference is that the wizards who run monetary policy in Australia don’t listen to Puritans who insist we must suffer high unemployment for our sins. 

Scott is impressed with Australia’s high rates of nominal GDP growth, which he attributes to superior monetary policy.  But as Scott himself notes, Australia has had a high average growth rate for nearly 20 years.  Real growth has also averaged at or near the top of the OECD.  In other words, this outperformance is structural rather than cyclical and has little to do with short-run demand management.  The fact that Australia has continued to outperform in the context of a global economic downturn lends further weight to the view that this outperformance has been structural rather than cyclical.

Scott fails to consider the downside of this high rate of nominal GDP growth: a high rate of inflation.  While Australia’s headline inflation rate has moderated recently, the statistical core series that capture the persistent component of inflation are still running well above the upper bound of the RBA’s 2-3% target range, even after a nearly two percentage point increase in the unemployment rate.  Australia consequently also has some of the highest nominal interest rates of any developed country.  As Friedman noted, high nominal rates are often indicative of monetary policy that is too loose due to a high inflation premium. 

The RBA’s inflation target range has a mid-point above the 2% widely considered to be consistent with price stability in the rest of the world.  Australia has thus institutionalised a relatively high rate inflation.  If the central bank’s primary responsibility is long-run inflation and price stability rather than nominal income growth, then Australia’s monetary policy performance does not compare favourably to the US.  What is considered to be an acceptable inflation rate in Australia would be considered a policy failure in the US.

posted on 10 August 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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It’s Not Easy Being a Supply-Sider

From RBA Governor Glenn Stevens’ speech yesterday:

A very real challenge in the near term is the following: how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices. Given the circumstances – the economy moving to a position of less than full employment, with labour shortages lessening and reduced pressure on prices for raw material inputs – this ought to be the time when we can add to the dwelling stock without a major run up in prices. If we fail to do that – if all we end up with is higher prices and not many more dwellings – then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over leverage and asset price deflation down the track.

Much of the commentary on Stevens’ speech suggested that he was warning of a housing ‘bubble’, but the text makes clear that his real concern was the supply-side rigidities that amplify asset price cycles.  Stevens’ speech is the lead story in much of today’s media, but Google News finds only three stories that directly quoted ‘serious supply-side impediments’.  It is indicative of how difficult it is to interest the media in structural as opposed to cyclical stories.

posted on 29 July 2009 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

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Central Bank Transparency and Accountability in Action

Federal Reserve Chairman Ben Bernanke’s appearance at a town hall meeting at the Federal Reserve Bank of Kansas City can be seen here (transcript here). 

As I lamented in an AFR op-ed last week, this kind of public scrutiny is notably absent in Australia.

posted on 28 July 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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