Working Papers

Did Cheap Credit Fuel the US Housing Boom?

No, according to Ed Glaeser and his co-authors:

Interest rates do influence house prices, but they cannot provide anything close to a complete explanation of the great housing market gyrations between 1996 and 2010. Over the long 1996-2006 boom, they cannot account for more than one-fifth of the rise in house prices. Their biggest predictive influence is during the 2000-2005 period, when long rates fell by almost 200 basis points. That can account for about 45% of the run-up in home values nationally during that half-decade span. However, if one is going to cherry-pick time periods, it also must be noted that falling real rates during the 2006-2008 price bust simply cannot account for the 10% decline in FHFA indexes those years. There is no convincing evidence from the data that approval rates or down payment requirements can explain most or all of the movement in house prices either.

The authors also note that Robert Shiller’s ‘irrational exuberance’ is a non-explanation:

even if Case and Shiller are correct, and over-optimism was critical, this merely pushes the puzzle back a step. Why were buyers so overly optimistic about prices? Why did that optimism show up during the early years of the past decade and why did it show up in some markets but not others? Irrational expectations are clearly not exogenous, so what explains them? This seems like a pressing topic for future research. Moreover, since we do not understand the process that creates and sustains irrational beliefs, we cannot be confident that a different interest rate policy wouldn’t have stopped the bubble at some earlier stage. It is certainly conceivable that a sharp rise in interest rates in 2004 would have let the air out of the bubble. But this is mere speculation that only highlights the need for further research focusing on the interplay between bubbles, beliefs and credit market conditions.

A more fruitful line of inquiry would be to investigate fundamental factors such as the role of US housing GSEs in distorting the allocation of global capital.

posted on 04 August 2010 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

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An Unlikely RBA Research Discussion Paper

Imagine if you will the RBA publishing a Research Discussion Paper that reached the following conclusions:

despite a relatively stable total fiscal impulse the effectiveness of spending shocks in stimulating economic activity has decreased over time. Short-run spending multipliers increased until the late 1980s when they reached values above unity, but they started to decline afterwards to values closer to 0.5 in the current decade. Long-term multipliers show a more than two-fold decline since the 1980s. These results suggest that other components of aggregate demand are increasingly being crowded out by spending based fiscal expansions. In particular, the response of private consumption to government spending shocks has become substantially weaker over time.

rising government debt is the main reason for declining spending multipliers at longer horizons, and thus increasingly negative long-run consequences of fiscal expansions. We interpret this finding as an indication that further accumulating debt after a spending shock leads to rising concerns on the sustainability of public finances, such that agents may expect a larger fiscal consolidation in the future which depresses private demand and output. We also find that a stronger response of the short-term nominal interest rate goes along with declining spending multipliers. This result is consistent with an increasingly offsetting reaction of monetary policy to the expansionary fiscal shock.

The extract is from a European Central Bank Working Paper and the conclusions reached are in relation to the euro area. Don’t hold your breath waiting for the RBA to publish a similar study of activist fiscal policy in Australia.

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

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The Money Supply Growth that Isn’t

Bob McTeer debunks the inflation fears of fever-swamp Austrians:

What am I missing? I keep hearing people on financial TV say things like “The Fed keeps pumping out the dollars,” “The Fed keeps monetizing the debt.”

Then I go look up money-growth charts. I can’t find all this excessive money creation that is monetizing the debt and is about to create a breakout in inflation. Not M1; not M2…

To repeat the obvious, because others won’t, money growth is almost flat. Flat money growth does not cause inflation—especially when we have enormous slack in the economy along with rapid productivity growth and declining unit labor cost. We may get inflation in the next few years, but, if so, it will be based on money growth yet to happen. It hasn’t happened yet.


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

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Abusing the 2004 FOMC Minutes

Vince Reinhart on the abuse of the March 2004 FOMC minutes to attack Alan Greenspan:

Greenspan was noting that letting the world know that top Fed officials were considering an issue would draw attention to that issue, which might sometimes be uncomfortable. This is a debatable proposition, to be sure, but not one that sounds conspiratorial.

That is, unless you have the imagination of Ryan Grim, who linked this obviously general discussion of the timing of the release of the minutes to the specific mention of housing prices 45 pages (and four hours in real time) earlier. To do so, Grim also had to elevate a mention about real-estate speculation by the president of the Federal Reserve Bank of Atlanta, Jack Guynn, into Cassandra’s warning.

posted on 05 May 2010 by skirchner in Economics, Monetary Policy

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The Market Believes the RBA is Targeting House Prices

The weighted average of capital city established house prices rose a Steve Keen-busting 4.8% q/q and 20% y/y for the March quarter, with gains in Sydney and Melbourne in excess of 20% y/y. This saw three-year bond futures savaged by around 7 basis points and the implied probability of a 25 basis points tightening from the RBA tomorrow surge from around 50% to around 65% on iPredict. The ugly 3.4% annualised result for the trimmed mean of the TD-MI inflation gauge released an hour earlier should be more important for the RBA’s deliberations, but it is house prices that are grabbing the market’s attention.

posted on 03 May 2010 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

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The RBA’s Perception Problem

Regardless of whether the RBA still backgrounds journalists on the monetary policy outlook, the perception that it does so remains alive and well in financial markets. Yesterday’s column by Terry McCrann confidently declared that ‘the Reserve Bank is all-but certain to deliver its third successive interest rate increase next Tuesday.’  At the same time, the implied probability of a 25 bp tightening priced into inter-bank futures rose from around 32% Wednesday to around 48% Thursday.  There was a similar increase in the probability of a tightening on iPredict

This suggests that the market doesn’t believe RBA Governor Glenn Stevens’ denial that the RBA leaks, although that denial was couched in very narrow terms. Of course, current pricing also implies that the market doesn’t have complete confidence in Terry McCrann either, but the change in market pricing is still significant.

Chris Joye speculates that this might be part of a RBA sting operation designed to finally put to rest the idea that the RBA leaks. Yet even if the punditocracy is deliberately wrong-footed on this occasion, it may not be enough to change market perceptions.  When I worked in financial markets, I was often asked by clients whether I had ‘contacts’ at the RBA, with the clear implication that anyone who did was more likely to have the inside running on monetary policy. I always thought these clients had a greatly exaggerated view of the extent to which any such contacts might be useful in calling the interest rate outlook and the amount of media and other backgrounding that actually takes place. But that perception, even if exaggerated, is still a problem for the integrity of monetary policy.

UPDATE: Friday’s Reuters poll has the median financial market economist giving a 60% chance to a 25 bp tightening on Tuesday. Not quite the ‘all-but’ certainty expressed by McCrann.

posted on 30 April 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Robert Barro’s Great Depression Reading List

Robert Barro’s reading list on the economics of the Great Depression.  I would add that there is a shorter version of Friedman and Schwartz’s A Monetary History of the United States dealing specifically with the Depression: The Great Contraction, 1929-33, recently re-published by PUP.

Barro on stimulus:

There’s a strong tendency for the economy to recover on its own, as long as it’s not subject to further new shocks, so a likely scenario is that that is what will happen today as well. And then the Obama administration will say that it’s because of our policy that things recovered, and there won’t be any way to prove whether that’s right or wrong.


posted on 16 April 2010 by skirchner in Economics, Fiscal Policy, Monetary Policy

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ASIC Shuts Down Betting on RBA Board Meetings and the ASX 200

ASIC is seeking to prevent Centrebet from offering betting markets on the outcome of RBA Board meetings and the ASX 200 index, on the grounds that the bets are derivatives within the meaning of the Corporations Act.  Sinclair Davidson and Ian Ramsay both suspect regulatory protectionism is at work:

Professor Ramsay said ASIC may have turned its attention to the bookmaker following a complaint from a competitor after it set up a market on the ASX200 share price index in March.

This will simply divert betting interest to offshore markets like iPredict, which enjoys the support of the Reserve Bank of New Zealand.


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

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Glenn Stevens Goes Where Ian Macfarlane Feared to Tread

Former RBA Governor Ian Macfarlane took pride in never having given an on-the-record media interview in his 10 years in office.  Macfarlane’s public appearances were about as common as those for your average thylacine.  Macfarlane only drew attention to the problem by engaging in a post-retirement media blitz that sought to set the record straight on all the issues where he claimed to have been misquoted or misrepresented while Governor. 

Stevens has more than doubled the annual number of public speeches that Macfarlane gave in his last full year as Governor.  If the last two months are anything to go by, Stevens will double his own record this year.  His senior officers have also been considerably more active in terms of public appearances.

In a further break with the RBA’s secretive past, Governor Stevens has even put in an appearance on the Sunrise program.  David Koch is not exactly Kerry O’Brien or Tony Jones, but the program’s reach is much greater.  It sets an important precedent, but could be taken further.  As I have argued previously, the RBA Governor should be made to front a media conference after every Board meeting and CPI release.  A Treasurer with half a brain would insist on it.

The Governor’s comments on house prices during the program were somewhat risky, in that they could easily give the impression that house prices are a target rather than merely one of many indicators for monetary policy.  If the public think Stevens is targeting house prices, then the Bank will end up owning them (figuratively, not literally, as with the US Fed).  A better strategy would be to go on highlighting the supply-side constraints on the housing market.  The public is smart enough to figure out who is to blame for those.

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

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The Irrelevance of Bank Interest Rate Margins

At least one journalist gets the irrelevance of bank interest rate margins when the Reserve Bank is explicitly targeting credit conditions:

This means that the Reserve Bank, rather than bank gouging, is effectively targeting and setting the interest rate charged to mortgage borrowers because this is what influences the demand for credit. If the 20-25 basis point increase in the banks’ net interest margin suddenly disappeared, the Reserve Bank would simply hike its cash rate by the same amount so as to return mortgage lending rates back toward their more normal 7 per cent-plus levels.

As Stutchbury notes, bank bashing is little more than an attempt by politicians to divert attention from the implications of their own policies for interest rates.  At least one bank is privately telling its shareholders to brace for more political thuggery:

Westpac is under financial pressure to raise its interest rates but fears a political backlash, chief executive Gail Kelly has reportedly told a private shareholder briefing.

Mrs Kelly told the briefing political pressure from Canberra could make it tough for the bank to increase home and business loan interest rates ahead of the federal election, due later this year

Mrs Kelly might also care to explain to Westpac shareholders why it is donating money to political parties that are actively seeking to damage the bank’s franchise.



posted on 23 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Betting on the RBA

Someone was betting big on the outcome of today’s RBA Board meeting:

a Centrebet regular, has staked just short of $30,000 on the Reserve Bank sitting on its hands.

If at 2.30pm the bank announces its board has decided to keep rates on hold, he will walk away with a profit of $21,000. If it puts rates up, he will say goodbye to $29,500.

‘‘He is very confident. He placed four separate bets, continuing to pile in as the odds went down,’’ said Centrebet’s Neil Evans.

‘‘Another punter staked $5000 on there being no change, another $3500.

‘‘It’s the house against the punters. I am hoping they don’t know something I don’t.’‘

They didn’t.

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

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The CPI and the RBA’s Backward-Looking Bias

I have an op-ed in today’s Canberra Times arguing for a monthly CPI for Australia (full text below the fold):

This lack of timeliness in compiling and releasing inflation data gives monetary policy a backward-looking bias.  Around 45 per cent of the changes in the official interest rate since 1990 have been announced at the Board meeting immediately following the quarterly CPI release.  During the 2002-08 tightening episode, 67 per cent of rate hikes followed this pattern, including every one of the six tightenings between May 2006 and February 2008.

Today saw the release of the TD Securities-Melbourne Institute Monthly Inflation Gauge, which rose by 0.1% in February, following a 0.8% rise in January and a 0.3%  rise in December 2009. In the twelve months to February, the Inflation Gauge rose by 1.9%. The trimmed mean measure rose by 0.1%, to be 2.0% higher than a year ago.  The gauge points to a 1% rise in the March quarter CPI for an annual rate of 3%.

As I note in the op-ed, the Melbourne Institute has stopped publishing the index numbers for the gauge, limiting its usefulness and going very much against the spirit of its creators and sponsors.  However, for those who need it, Annette Beacher advises the index number for February is 123.45.


continue reading

posted on 01 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Divergent Pricing for March RBA Board Meeting

Friday’s Reuters poll has 12 of 18 financial market economists expecting a 25 bps tightening, with the balance looking for steady rates.  March inter-bank futures are giving only a 49% chance to a 25 bp tightening, while iPredict is pricing a 67% chance of a rate hike.  I suspect interbank futures are closer to the mark.

I will be talking on Australian monetary policy on Bloomberg TV Tuesday morning AEDT.

posted on 26 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA and the Media

RBA Governor Stevens’ appearance before the House Economics Committee on Friday included this exchange with the federal member for Mayo:

Mr BRIGGS—Just on a slightly different track: On 2 November last year there was an article on the Lateline Business program about suggestions that the Reserve Bank executive selectively leaks the likely outcome of the board meeting prior to the board meeting. I guess the presenter summarised it best:

Certainly, there’s disquiet among market economists that the Reserve Bank is selectively briefing certain journalists in the lead-up to rate decisions. Many argue the practice undermines the board process.

I am just interested—did you see the report, and do you have a comment?

Mr Stevens—I did see the report. Apparently there were not too many selective leaks in February, because everybody was surprised, so I am not sure what to make of all this.

Mr BRIGGS—So, you—

Mr Stevens—No, people do not leak the outcome. For a start, the staff do not take calls from the media after the relevant internal meetings where we have come to the view of what we are going to recommend. That is usually on the Thursday morning; the papers go that night.  Secondly, we cannot be certain that the board will do what we recommend. It is a board of nine people, and I can assure you they are all of independent mind. People do not leak that information; in my experience the Reserve Bank never has leaked and, if I can help it, it never will.

Stevens is probably correct to argue that the outcome of the Board meeting has never been leaked outright, but that was not what the Lateline Business story was about.  The issue raised was whether the RBA backgrounded journalists to the point where they were much better informed about the RBA’s policy bias and therefore better able to call the likely outcome of the Board meeting.

There is evidence on the public record for the view that the RBA has engaged in this practice.  In a profile of former Governor Ian Macfarlane published in the AFR Magazine in 2001, a former RBA official is quoted as follows:

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.  I think it’s right to do this from the bank’s point of view, but not necessarily from a public policy view: accountability and a critical press are very important in this system.

That last sentence is the key issue in a nutshell.  My sense is that the RBA has now been subjected to sufficient heat over the issue that we won’t see another episode of this in future.  The test for the RBA will be whether there is a future recurrence of market speculation about RBA media backgrounding, despite the Governor’s denial.

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

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Endogenising the Inflation Forecast

RBA Assistant Governor Phil Lowe highlights an important change in the RBA’s technical forecasting assumptions:

For some years, it had been our practice to produce forecasts assuming that the cash rate remained unchanged throughout the forecast horizon. This approach had the obvious advantage of simplicity, but when the cash rate is a long way from its normal level, it is not particularly realistic.

So, in August last year we changed our approach. Since then, we have prepared our forecasts on the technical assumption that the cash rate returns towards a more normal setting over time. Our overall objective here is to provide the community with a general sense of how we think the economy is likely to evolve over the next few years and to do this we need to make realistic assumptions. Broadly speaking, the paths the staff have used have been similar to those implied by market interest rates at the time the forecasts were prepared. It is important to stress that this neither implies a commitment by the Board to the particular path used nor an endorsement by the Bank of the market pricing.

This is a welcome change.  It makes more sense for an inflation targeting central bank to forecast its own policy rate or to incorporate a market forecast for the policy rate and then base the inflation forecast on this projection.  This makes it more explicit that inflation outcomes are not exogenous under an inflation targeting regime.

There was also this endorsement of the macroeconomic benefits of increased labour market flexibility:

The good news is that this flexibility in employment relationships worked in limiting job losses in the economy. This has had obvious social benefits as well as supporting overall confidence in the community. Without this flexibility, it is likely that the outcomes would not have been as favourable.

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

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