Working Papers

Why Central Banks Should Not Lean Against the Wind

The Cato Institute held its 28th Annual Monetary Policy Conference on the theme of ‘Is Monetary Policy Responsible for Bubbles?’ Adam Posen (a social democrat rather than a classical liberal) presented a paper titled ‘Do We Know What We need to Know in Order to Lean Against the Wind?’ This was his conclusion:

even the seemingly least controversial assumption required for leaning against the wind to succeed – that central banks can discern destabilizing booms with sufficient notice to pre-empt them – will be invalid. Since this argument is solely about the ability of monetary policymakers to recognize and react to asset price booms, and not about the viability of their means to affect asset prices, this should concern advocates of discretionary macroprudential policymaking as well, even when using non-monetary tools.

Posen wrote an even more thorough critique of using monetary policy to manage asset prices that can be found here. My own effort in this regard can be found here.

posted on 23 November 2010 by skirchner in Economics, Monetary Policy

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The QE Bunnies Meet Jim Hamilton

The non-cartoon version of QE.

posted on 23 November 2010 by skirchner in Economics, Monetary Policy

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Another Small Catch from the FOI Desk at the Oz

Another fishing expedition from the FOI desk at The Australian turned up this, with the following sub-editorial spin:

THE Reserve Bank deliberately intervened in the political debate over the property boom to stop governments releasing more land.

While I’m certainly not above using the FOI process to get a headline, a little more context would have been appropriate for this story. Luci Ellis wrote an RBA RDP in 2006 that argued that it was the combination of a demand-side shock from increased household sector leverage in a low inflation-low interest rate environment and an inflexible supply-side that gave rise to the early 2000s house price boom.

I agree with Chris Joye that the RBA had it wrong in the early 2000s and has now changed its tune. The RBA’s fingering of negative gearing in its 2004 submission to the Productivity Commission inquiry was possibly an attempt to set the government up as a scapegoat in case the early 2000s housing boom had ended badly in the context of a monetary policy tightening cycle. The RBA’s then jaw-boning of a supposedly over-heated market now looks rather quaint.

There has been a change in leadership at the RBA since then. Glenn Stevens’ more recent comments about ‘serious supply-side constraints’ in housing are pretty brave by the standards of an Australian central banker (imagine the reaction to Stevens making an even vaguely critical remark about the NBN and you will see what I mean). They are a damning criticism of policy at all levels of government. The only reason it hasn’t been written up that way is that many in the media simply don’t believe that housing affordability is a supply-side problem requiring supply-side solutions.

posted on 22 November 2010 by skirchner in Economics, House Prices, Monetary Policy

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The Downside of China’s Managed Exchange Rate

Inflation and price controls.  As we have often noted, China’s managed exchange rate is a much bigger problem for them than it is for the rest of the world. Former RBA Governor Ian Macfarlane told the Chinese as much in 2005, when he compared China to Australia in the 1970s:

surpluses may be more difficult to sustain in the long run than deficits are for some other countries. I speak from experience here as Australia faced this problem in the early 1970s and did not handle it successfully. At that time, Australia briefly experienced a current account surplus and also became a favourable destination for capital flows. As the money poured in from both these sources it had to be sterilised or it would flow directly into the banking system and through that into money and credit aggregates, with obvious inflationary results.

The problem we found was that in order to sell the official paper in sufficient volumes to soak up the inflow, interest rates had to be raised, and this induced further inflow. In the end, the monetary aggregates grew too quickly and inflation soon rose to an unacceptable rate. We came to the conclusion then that it was not possible to restrain an over-exuberant and inflation-prone economy only by domestic tightening. Exchange rate adjustment was required in order to take away the ‘one way bet’ aspect of the exchange rate. We eventually did this, but we were too slow and the inflation had already become entrenched.

So far, China has made a much better job of handling this situation than we in Australia did 30 years ago. And, of course, it is made easier by the fact that it is occurring in a world environment of low and stable inflation rather than the rising inflation of 30 years ago. But, ultimately, I think the point will be reached where domestic restraint has to be augmented by action on the exchange rate.

Five years on, Macfarlane’s speech remains highly relevant. He could usefully give the same speech in Washington today.


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

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One More Time, for the Dummies

RBA Deputy Governor Ric Battellino says it again for the hard of hearing:

“People feel there is, or there should be, a rule that says banks can’t actually set any rates more than the official interest rates set by the Reserve Bank,” Mr Battellino said.

“That rule doesn’t exist, it has never existed, and it would be quite risky for the financial system to have such a rule.”...

Mr Battellino said bank margins had not changed in six years, remaining between 2.25 per cent and 2.5 per cent.


posted on 19 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Don’t Blame Ben

Charlie Gasparino defends Ben Bernanke:

what’s happening to Bernanke now isn’t accountability, it’s a feeding frenzy. And for the good of the country, it should stop.

Classical liberal and conservative critics of Bernanke would do well to read this speech, in which Bernanke pays tribute to Milton Friedman:

Friedman’s monetary framework has been so influential that, in its broad outlines at least, it has nearly become identical with modern monetary theory and practice.

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

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Profitable Banks, Unprofitable Politics

I have an op-ed in today’s WSJ arguing that the government and opposition’s attacks on the banks are a pointless diversion. Saul Eslake makes similar arguments in today’s Age. After yesterday’s RBA Board minutes destroyed the politicians’ case against the banks, the best Joe Hockey can come up with is this:

Mr Hockey said the minutes had contemplated the banks going further than the official rise but didn’t contemplate the banks going as far as they did.

UPDATE: I have another op-ed in the Business section of The Australian.


posted on 17 November 2010 by skirchner in Economics, Monetary Policy, Politics

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Maybe the Banks Just Don’t Want Your Business

The big four banks have now set their post-November RBA tightening mortgage interest rates. Amid the shameful public vilification of the banks by politicians and others who should know better, almost no one has considered the possibility that, at least at the margin, the banks probably don’t want our business. People in the banking industry tell me that Westpac and CBA in particular have full mortgage books and don’t want to take on additional exposure to housing. Not surprisingly, they have the highest mortgage rates on offer. Notice too how ANZ and NAB are much more aggressive in their advertising? In any other business, using price signals to manage excess demand would be viewed as completely unexceptional.

Far from being greedy, the banks are being prudent, while the government tries to induce them into taking on additional risk. Of course, we could always go back to the days of regulated interest rates and non-price credit rationing, when getting money from the bank was a beauty contest that saw housing credit go only to the rich.

posted on 12 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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A Daily CPI

Never mind a monthly CPI. How about a daily one:

Economists Roberto Rigobon and Alberto Cavallo at the Massachusetts Institute of Technology’s Sloan School of Management have come up with a method to scour the Internet for online prices on millions of items and then use them to calculate inflation statistics for a dozen countries on a daily basis. The two have been collecting data for the project for more than three years, but only made their results public this week…

Two days after the September 2008 collapse of Lehman Brothers, for example, the economists’ price index for the U.S. started to fall, and by the end of the month it was down a full percentage point, as desperate companies slashed prices amid slowing sales. It wasn’t until mid-November—when the Labor Department released its average monthly consumer price figures for October—that government data began to catch up.

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

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What Would Friedman Do II?

Allan Meltzer claims Friedman would not support QE, but undermines his argument when he says:

Friedman made an exception to his rule about steady-state monetary policy in case of deflation. When prices fell, as they had during the Great Depression or in Japan in the 1990s, he urged the central bank to increase money growth. I served as one of two honorary advisers to the Bank of Japan in the 1990s. With short-term rates close to zero, I gave the same advice, urging the bank several times to buy long-term bonds or foreign exchange to increase money growth until deflation ended.

All this is not relevant now, since there is no sign of deflation in the United States. The Fed’s claim that there is a risk of deflation should embarrass it.

That last paragraph is unavoidably a judgement call. Meltzer may be right in his judgement, but he has all but conceded the point that if deflation is a significant risk, then QE is the right response. Here are my reasons for thinking that it is.


posted on 04 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Political Thuggery and the Banks

Saul Eslake notes the long history of ministerial thuggery directed at the banks, not to mention bureaucratic intimidation by the ACCC. As Saul reminds us:

the whole debate about whether the banks have some obligation to tie the timing and magnitude of movements in their lending rates to changes in the RBA’s cash rate entirely misses the crucial point that the RBA is now targeting the interest rates that borrowers actually pay when it sets the cash rate, and thus takes into account any change in the spread between the cash rate and the rates that borrowers pay.

If banks raised lending rates by an average of, say, 50 basis points, following yesterday’s 25-basis point rise in the cash rate, the RBA would remove one of the series of further 25-basis point increases in the cash rate it is clearly contemplating between now and the peak of the current mining boom.

Preventing banks raising their rates by more than the cash rate would not result in borrowers paying lower interest rates. All it would do is alter the distribution of the stream of interest payments made by borrowers between bank shareholders, bank depositors, and other sources of bank funds. And why that should be the subject of government intervention - especially by those who generally favour less rather than more government intervention in business decision-making - continues to elude me.

What eludes me is why the banks make donations to political parties that are actively seeking to damage their franchise (see, eg, CBA’s donations). These donations are clearly not buying the banks much in terms of influence. Shareholders should demand that the banks stop paying political protection money, sending a message to politicians that their shameless populism has consequences.

posted on 03 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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US T-Bills Versus Tuna

James Hamilton on the implications of negative real interest rates:

You’re better off storing a can of tuna for a year than messing with T-bills at the moment. But there’s only so much tuna you can use, and many expenditures you might want to save for can’t really be stored in your closet for the next year. It’s perfectly plausible from the point of view of more realistic economic models that we could see negative real interest rates, at least for a while.

Even so, within those models, there’s an incentive to buy and hold those goods that are storable. And in terms of the historical experience, episodes of negative real interest rates have usually been associated with rapidly rising commodity prices.


posted on 28 October 2010 by skirchner in Commodity Prices, Economics, Financial Markets, Monetary Policy

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Sell the Gold Stock, Burn the Gold Bugs

Ed Truman makes the case for the US Treasury to follow the IMF and offload its gold stock:

the US Treasury holds 261.5 million fine troy ounces of gold. The government has been sitting on that gold since the Great Depression, receiving no return. At the current market price of $1,300 per ounce, the US gold stock is worth $340 billion. The Treasury secretary, with the approval of the president, has the power to sell (and buy) gold on terms that the secretary considers most beneficial to the public interest. Revenues from sales must be used to reduce the national debt.

If the United States were to sell its entire gold stock at the current market price, it would reduce the gross government debt by 2.25 percent of gross domestic product. Based on the average interest cost from 2005 to 2008, this reduction in debt would trim the budget deficit by $15 billion annually. Thus, the Obama administration would be doing something about the US fiscal debt and deficit without reducing near-term support for the ailing economy.

This would of course be incredibly lazy public policy, but should nonetheless give gold bugs pause. As I have noted previously, there is a certain irony in people who fear an over-supply of money taking refuge in an asset in which governments hold substantial stocks and for which the price is arguably in a stock rather than a flow equilibrium.


posted on 22 October 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Gold, Monetary Policy

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What Would Friedman Do? Support Ben Bernanke

David Beckworth and William Ruger argue that Friedman would support Ben Bernanke. I often point to this op-ed, in which Friedman argued in favour of quantitative easing for Japan in the late 1990s in circumstances not unlike those in the US today. While I doubt Friedman would see quantitative easing as a panacea (it certainly wasn’t for Japan from 2001-2006), he would surely argue that monetary policy should be as accommodating as possible.

In the classical liberal circles in which I travel, mindless criticism of quantitative easing is all too common, but this only highlights the lack of knowledge of the classical liberal tradition in monetary economics among many people who should know better.

posted on 22 October 2010 by skirchner in Economics, Monetary Policy

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Part-Time Work at the RBA Board

The so-called part-time members of the RBA Board were even more part-time than usual in October:

The minutes of the October board meeting, released yesterday, reveal that only three of the six independent board members attended the meeting, with the key voices on the health of retailing, manufacturing and the global economy absent. It was the lowest board meeting attendance in the four years that the Reserve Bank has been releasing its minutes.

The chairman of Bluescope Steel and Brambles, Graham Kraehe, former Woolworths chief executive Roger Corbett, who is also a director of US retailer Walmart and chairman of Fairfax, and the board’s resident academic economist, Warwick McKibbin, all had other commitments.

It only takes five of the nine members to form a quorum.

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

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