The End of America
If people are most bearish near the bottom of the cycle, it is probably a good sign that Slate has been running an interactive feature on The End of America: How It Will Happen. It is even more encouraging that of the top five apocalyptic scenarios most favoured by Slate readers, two are economic crankery deserving little serious consideration: ‘peak oil’ and ‘China Unloads U.S. Treasurys’ [sic].
There are more prosaic reasons for considering the ‘end of America’, at least as we once knew it, as suggested in David Goldman’s Top Ten Reasons Why the Recession Will Last Forever:
1. Barack Obama. Bill Clinton, the last Democratic president, thought in effect, “Let’s get economic growth so I can tax it and pay for all my toys and games.” That was the “New Democrat” approach. Obama knows that if the economy crumbles and he’s the only one left with a checkbook, then everyone has to come to him. Where is the independent base of entrepreneurial business to which the Republicans might turn to raise money against Obama? The banks, the hedge funds, the manufacturers, the municipalities, in fact everyone who is left standing in the economy is beholden to Obama. This is Chicago city politics writ large. Leave aside all of the individual things that Obama is doing that harm economic growth: Obama is the first American president (with the possible exception of FDR) to actually benefit from economic weakness.
posted on 11 August 2009 by skirchner in Economics, Financial Markets
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The Efficient Markets Hypothesis as Meta Predictor
Bill Easterly answers Her Majesty’s questions on the role of economists in the financial crisis:
We correctly predicted that we would not be able to predict it.
Robert Lucas spells out the obvious implications:
The main lesson we should take away from the EMH for policymaking purposes is the futility of trying to deal with crises and recessions by finding central bankers and regulators who can identify and puncture bubbles. If these people exist, we will not be able to afford them.
posted on 11 August 2009 by skirchner in Economics, Financial Markets
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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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Open Australia
Open Australia is providing a useful service making information about federal parliament available on-line. This volunteer effort often provides better information than parliament itself, as this story notes.
Most notably, the volunteers have scanned the 1500-odd pages of the Register of Members’ Interests and made them available on-line. Previously, this information was available only in hard copy in binders kept in Parliament House, Canberra, making it a costly exercise for members of the public to examine the Register. It says a lot about the willingness of politicians to subject themselves to the same levels of disclosure and transparency they routinely demand of the private sector.
Unfortunately, the Register does not contain enough information to perform a study like this, showing how US Senators’ shareholdings significantly outperform the market.
posted on 30 July 2009 by skirchner in Economics, Financial Markets, Politics
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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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No Time for a Media-Shy Central Banker
I have an op-ed in today’s Australian Financial Review, comparing the level of media scrutiny applied to central bankers in Australia and the rest of the world. Full text below the fold (may differ slightly from edited AFR text).
continue reading
posted on 24 July 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Monetary versus Fiscal Stimulus
Tony Makin, on the relative effectiveness of monetary and fiscal stimulus:
dramatically easier monetary policy has probably done more for the Australian economy than fiscal policy. A less modest, or perhaps more independent, Reserve Bank would take more credit for this.
Tony makes an important point. The RBA’s very low public profile relative to the very noisy fiscal stimulus efforts of politicians is skewing perceptions of the relative importance of these two arms of macro policy.
It was not that long ago that many economic commentators were talking of a direct trade-off between fiscal and monetary policy. Tax cuts and smaller budget surpluses, we were told, would lead to higher inflation and interest rates. This argument never had much merit, not least because the actual (as opposed to the forecast) fiscal impulse was simply too small to matter very much for the economy. The former government put in place some of the tightest fiscal policy settings since the early 1970s.
By contrast, the current government has put in place an unprecedented fiscal easing of 4.4% of GDP in a single financial year. The RBA’s statements on monetary policy suggest that it believes that fiscal stimulus is supporting economic activity (in sharp contrast to previous years, in which fiscal policy was rarely even mentioned). This would argue against reductions in interest rates at the margin, even if it is based on an exaggerated view of the effectiveness of fiscal policy. The proponents of discretionary fiscal policy can’t have it both ways. If activist fiscal policy is thought to be effective, there is less work for monetary policy to do in supporting activity and official interest rates will be higher than in the absence of a discretionary fiscal easing.
posted on 14 July 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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Productivity and House Prices
In Bubble Poppers, I followed Peter Garber in arguing that claims about ‘bubbles’ in asset prices are a substitute for fundamental analysis, a non-explanation for events that people are otherwise unable or too lazy to explain. In contrast to the dominant non-explanation for innovations in house prices in the United States, James Kahn argues that there is a strong relationship between house prices and productivity growth that explains the recent US housing boom and bust:
The housing boom and bust of the last decade, often attributed to “bubbles” and credit market irregularities, may owe much to shifts in economic fundamentals. A resurgence in productivity that began in the mid-1990s contributed to a sense of optimism about future income that likely encouraged many consumers to pay high prices for housing. The optimism continued until 2007, when accumulating evidence of a slowdown in productivity helped dash expectations of further income growth and stifle the boom in residential real estate.
posted on 10 July 2009 by skirchner in Economics, Financial Markets, House Prices
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Market, Regulatory or Business Model Failure?
Yet another open letter from the usual suspects, this time calling for a new financial system inquiry. However, their call proceeds from a mistaken premise:
SINCE the severe market failures in Australia’s securitisation industry were identified in 2008, we have been concerned that these problems were partly attributable to more fundamental flaws in Australia’s ageing regulatory architecture and the inadequately defined role of government in dealing with such crises.
The authors cannot seem to make up their mind about the relative importance of market failure and regulatory failure, but a more basic issue is business model failure. The mortgage securitisation industry was overly dependent on a particular financial technology. When that technology was new and working well, the industry was able to capture market share from the banks. The industry was not complaining about either market or regulatory failure then. From a consumer standpoint, the success or failure of particular business models is irrelevant, not least because the RBA’s setting of the official cash rate explicitly discounts the impact of shocks to financial technology on overall credit conditions. I discuss these issues in more detail in this paper.
posted on 08 July 2009 by skirchner in Economics, Financial Markets
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Too Much Hand Wringing, Not Enough Hand Raising
The Australian’s FoI desk has another stab at the decision-making processes of the RBA Board, this time seeking voting records, but comes up empty-handed:
“There are no records as the board seeks to achieve a consensus without the need for formal voting,” the board’s secretary, David Emanuel, wrote in response to The Australian’s request.
“The board now seeks to make decisions by consensus and only the consensus decisions are recorded.”
This remarkable unanimity implies that the RBA Board is little more than a rubber stamp for decisions made by the RBA’s senior officers. Now that the RBA and Treasury effectively control the appointments process to the Board, there is little chance that this bureaucratic monopoly over monetary policy decision-making will ever be effectively challenged. I make the case for an alternative model of RBA governance in this article.
posted on 07 July 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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When Interventions Collide
Christopher Joye notes how the government’s bank guarantees have undermined its $8 billion intervention in the market for residential mortgage-backed securities:
while the $8 billion has directly helped out the lenders who have benefited from the capital, it has had no effect at all on the overall cost of RMBS funding (or the so-called ‘spreads’) because it is being undermined by the government guarantees of bank debt, which have massively increased the supply of AAA-rated securities and created two-tiers of investment – those AAA assets with and without a government guarantee (RMBS and CMBS obviously fall into the latter category). Indeed, as the RBA (in its Statement of Monetary Policy) and the Treasury’s David Gruen have recently observed with some bewilderment, RMBS spreads have actually increased markedly to more than 200 basis points over the swap rate since the AOFM started investing its money notwithstanding their incredibly low default rates (again because of the dysfunction indirectly introduced by the government guarantees of bank debt). In the ten years prior to the advent of the GFC, Aussie RMBS spreads averaged 20-30 basis points over. And today, the 90 day mortgage default rate sits at about 15 per cent and 25 per cent of US and UK levels, respectively, or roughly 0.6 per cent.
As I argue in this paper, the idea that government intervention in the RMBS market can engineer an exogenous easing in credit conditions is mistaken, because the RBA fully discounts these conditions in its conduct of monetary policy. Even if such an easing were possible, it would be capitalised into house prices, with no benefit to home borrowers.
posted on 02 July 2009 by skirchner in Economics, Financial Markets, Monetary 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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When Behaviouralists Attack
Scientific American notes the penetration of the Obama Administration by behavioural economics:
The arrival of the Obama administration marks a growing acceptance of the discipline. A group of leading behavioural scientists provided guidance on ways to motivate voters and campaign contributors during the presidential campaign. Cass Sunstein, a constitutional scholar who wrote the well-regarded book Nudge, which President Barack Obama has reportedly read, was appointed head of the Office of Information and Regulatory Affairs, which reviews federal regulations. Other officials who are either behavioral economists or aficionados of the discipline are now populating the White House.
Alan Wolfe comments on the reactionary and anti-Enlightenment foundations of behaviouralism in this podcast with Russ Roberts.
Meanwhile, Chris Dillow uncovers a ‘heartbreaking work of staggering genius, a brilliant illumination of class relations, post-modernism and the crisis of the left.’
posted on 29 June 2009 by skirchner in Economics, Financial Markets
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More Anti-‘Bubble’ Popping
BoE chief economist Spencer Dale, on the evils of ‘bubble’ popping:
Short-term interest rates are a blunt instrument best deployed maintaining a broad balance between nominal demand and supply. They are not well suited to the task of managing asset price bubbles and economic imbalances. They may be wholly ineffective in addressing some types of imbalances, particularly those with an international dimension. And, even for domestic imbalances, short-term interest rates would probably need to be held substantially higher for a persistent period in order to suppress rapid rises in asset prices or growing imbalances. Such policy actions could generate significant economic costs.
The practical difficulty of implementing a policy of “leaning against the wind”, where the main policy instrument is short-term interest rates, should not be underestimated. If, as policymakers, we were successful in preventing a bubble from inflating, it might appear as if we were responding to phantom concerns. The bubble or imbalance would be nowhere to be seen, but interest rates would be higher, inflation would undershoot the inflation target and we would appear to have inflicted unnecessary economic hardship. That could undermine public faith and support in both the inflation target and the MPC.
posted on 24 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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