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Remember those 20-30% declines in house prices that were meant to have thrown Australia into recession by now? Neither do I. The ABS median established house price index rose 3.1% q/q and 6.4% y/y for the June quarter, based on a weighted average of capital cities. The weighted average once again concealed considerable variation between capital cities, ranging from a 0.5% y/y decline in Sydney to a 35.4% y/y increase in Perth.
The ABS has been doing a lot of work trying to improve the quality of its data on house prices, partly in response to RBA demands for a more timely series that is less prone to compositional distortions. The latest data suggest that the trough in the weighted average of capital city house prices was seen in the March quarter of 2005, when house prices were essentially flat compared to the March quarter 2004. This coincided with the peak decline in Sydney house prices of -5.9% y/y. This was enough for Robert Shiller to pronounce that Australia had suffered a burst housing ‘bubble,’ yet with the exception of Sydney and Canberra, none of the other capital cities recorded a decline in nominal house prices at an annual rate. Melbourne got down to +0.4% y/y at the end of 2004, one quarter ahead of the Sydney trough. Cities like Perth never even managed a decline over a quarter, much less a year.
The upswing in global commodity prices that began in 2002 explains much of this regional variation, adding to incomes in the resource-rich states and driving the inter-state migration flows that the RBA has identified as an important source of weakness in Sydney house prices, which have now largely converged back to the same ratio to other capital cities seen in the early 1990s. While many people have argued that, but for the commodities boom, the rest of Australia would look like Sydney, it is more plausible to argue that Sydney is only as weak as it is because the commodities boom has drawn people away from Australia’s largest city. What many analysts saw as a prospective national house price bust emanating from Sydney that would wreck the Australian economy was in fact just one aspect of an exogenous commodity price boom that has been anything but harmful.
posted on 24 August 2006 by skirchner in Economics
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More of the stuff that hits the cutting room floor at Doomsday Cult Central, from my associates at Action Economics:
A surprising array of major U.S. macro indicators continue to defy expectations of a slowdown, beyond pocketed weakness in the housing. Indeed, even here, construction activity remains solid despite housing due to robust business and public sector growth. Consumers are spending, factories are humming, profits are booming, and trade is turning the corner. Even the labor market clearly remains tight, despite the seemingly meaningful yet notably isolated restraint in monthly payroll growth.
The most important discrepancy between expectations and outcomes has come from the consumer, where nearly all economists projected some pull-back this year, even though spending strength has remained unwavering. As is evident below, nominal consumer spending growth was solid in both Q1 and Q2, and has actually gained steam in Q3. The “real” spending figures were hit in Q2 from soaring gasoline prices, but the hit was temporary. Since consumption accounts for 2/3rds of GDP, this steady growth is providing an important driver of economic growth.
posted on 23 August 2006 by skirchner in Economics, Financial Markets
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RBA Assistant Governor Ric Battellino tackles some of the myths around household sector saving in a speech on Developments in Australian Retail Finance:
the popular representation of Australian household finances is that they are in poor shape. In particular, three facts are usually put forward:
• household debt levels are rising relative to household incomes;
• household debt servicing costs, relative to incomes, are at record levels; and
• the household saving rate is low, and in fact negative of late.
There are, however, grounds for believing that household finances are in better shape than suggested by this depiction.
First, rising ratios of debt to income are not necessarily a sign that something is amiss. The evidence I showed earlier suggested that it is quite normal in a growing economy for the level of debt outstanding to rise relative to income. Financial variables typically rise faster than GDP…
households’ financial assets have increased by substantially more than their debt. There has been only one year during the past decade when they have not done so. As a result, even though household debt has increased, the net financial position of households has improved noticeably….
The often-stated fact that Australian households have now become net payers of interest is only true because households have shifted their financial assets from bank deposits (on which they earned interest) to equities and superannuation where returns accrue largely in non-interest forms. Taking account of interest, dividends and capital gains, the net investment returns of households, though variable from year to year, on average have remained strong…
The key point is that conventional measures of saving do not take into account capital gains. This has a particular bearing on Australian households because, as noted, they now hold a high proportion of their financial assets in investments such as shares and superannuation on which a significant part of the return is in the form of capital gains. In the May 2006 Statement on Monetary Policy, we showed that once allowance is made for capital gains, the saving rate of Australian households (broadly defined) is neither low nor falling.
posted on 22 August 2006 by skirchner in Economics
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In his appearance before the House Economics Committee on Friday, RBA Governor Macfarlane complained that some of his remarks before a previous Committee hearing had been taken out of context. In an interview in today’s SMH, Macfarlane also complains about the way the issue of interest rates was handled during the last federal election campaign, saying that:
we thought that the independence of the Reserve Bank was already so well established that that argument would not be a plausible argument.
Yet in the same interview, Macfarlane takes pride in his almost non-existent public profile during his 10 years as Governor:
He went the length of his term without giving an on-the-record interview to any Australian media outlet, or appearing once on TV or radio, a matter of considerable pride to him. “I’ve never been able to see how that could possibly be in the interests of the Reserve Bank. As far as I could see it would probably trivialise things. You have to be honest and forthright but you don’t have to be constantly pontificating. You’re not an economic commentator.”
He says there is a difference between transparency and self-promotion, “and I don’t think it would be a good idea to go into self-promotion”. There is an implied rebuke here to others, such as Greenspan, who have allowed their own personality cults to overshadow their institutions.
The comparison with the Fed is appropriate, because it shows what an absurd argument it is to suggest that the Governor of the Reserve Bank should not be an active participant in economic debate. The Fed Chairman, the Federal Reserve Board Governors and Federal Reserve Bank Presidents who serve on the Federal Open Market Committee have high public profiles, routinely speak out on a wide range of economic issues and are often critical of the government on issues such as fiscal policy.
Macfarlane was understandably reluctant not to have the Bank drawn into partisan political debate and it would certainly be inappropriate for the Bank to have adjudicated on competing claims about interest rates during the last federal election. Yet it is the Bank’s more general absence from public debate that makes it more likely that issues surrounding the determination of official interest rates will be misrepresented.
While Macfarlane would see himself as upholding the independence of the Bank, the fact that he felt unable to speak out as Governor for fear of coming into conflict with the Treasurer speaks volumes about the nature of the RBA’s independence. For all the hype surrounding the August 1996 Joint Statement on the Conduct of Monetary Policy, it amounted to little more than a codification of existing practice and left the statutory basis for RBA independence unchanged. A central bank governor who feels unable to publicly criticise the government of the day is lacking independence, not upholding it.
It should also be said that Macfarlane’s public reticence also extended to his areas of direct responsibility. In his appearance before the House Economics Committee on Friday, Macfarlane sounded positively put upon when asked to express an opinion on the direction of interest rates, having studiously avoided any discussion of the issue in his prepared statement. While Macfarlane did then venture an opinion, it was one the Bank did not bother to include in its Statement on Monetary Policy only two week’s previously. This was a repeat performance of the February hearings, when Macfarlane also offered a view on the direction of interest rates that was more explicit than the preceding SOMP. What this shows is that Bank often has a view on the direction of interest rates that it is not willing to share with the public, except on an ad hoc basis in response to questions from a Committee before which the Governor appears only twice per year.
Macfarlane can hardly complain about the course of public debate when he was so obviously unwilling to participate in it.
posted on 19 August 2006 by skirchner in Economics, Financial Markets
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The most recent increase in official interest rates had a predictably negative impact on consumer confidence, as measured by the Westpac-Melbourne Institute survey. There was a similarly large fall after the March 2005 rate hike.
RBA research suggests that the consumer confidence survey in question tells us very little that we don’t already know from contemporaneous activity data. In other words, it is economic activity that drives sentiment, not the other way around.
Interestingly enough, the break-down by respondent shows that the fall in confidence in August was more pronounced on the part of people who own their homes outright, as opposed to those who are mortgagees. This suggests that there was more to the fall in confidence than just interest rates.
Another possible explanation for this is that those with mortgages are in fact better placed to smooth their consumption over time than those without them. Mortgage products have become more flexible in recent years, adding much greater flexibility to overall household balance sheets. High levels of household sector gearing may well result in smoother rather than more volatile consumption patterns, by easing liquidity constraints.
Prior to the mid-1990s, the household sector in Australia was a net lender rather than borrower, but this was probably a sub-optimal situation driven by a lack of financial innovation in retail lending. The shift to a net debtor position on the part of the household sector in recent years is probably a more accurate reflection of household balance sheet preferences.
posted on 17 August 2006 by skirchner in Economics
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Late last year, I had occasion to review Peter Hartcher’s Bubble Man. For some reason, the book is only now receiving critical scrutiny in the US. Daniel Drezner reviews the book in the WaPo, although notes on his blog that:
It was difficult, in the space allotted, to list all the reasons I thought this book sucked eggs.
Dan also links to Steven Mufson’s review in The Washington Monthly:
By overemphasizing the damage done in the market and economic downturn in 2000-2001, Hartcher skews the answer to the question of whether Greenspan or any other Fed chairman ought to use the powers of his office to protect investors from bubbles given the Fed’s other, arguably bigger, responsibilities. The hot economy of the late 1990s had real benefits for many workers, especially those lower down on the income scale who didn’t have any stock portfolios. And while a disproportionate chunk of economic gains flowed to America’s wealthy, some job gains among middle- and lower-class Americans were real and a surprising number survived the recession.
posted on 14 August 2006 by skirchner in Economics, Financial Markets
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RBA Governor Macfarlane is interviewed by The Australian ahead of his departure from the top job next month. Macfarlane made precious few public appearances during his term as Governor and the interview gives some insight into why this is the case:
Macfarlane says the relationship between the governor and the Treasurer is a critical one - one which he has had no intention of jeopardising by getting up on a soap box on all sorts of issues.” We have been entrusted or delegated with independence,” he says. “It is a very valuable thing. I think it would be very foolish to jeopardise it by deciding you want to pontificate on subjects that are not relevant to your field.”
This degree of timidity is unwarranted. Both former Fed Chair Alan Greenspan and former RBNZ Governor Don Brash were quite outspoken on a wide range of issues, without compromising the independence of their respective central banks. Brash subsequently became leader of the opposition New Zealand National Party. Central bank independence does not mean being uncritical of government, it requires only that such criticism be expressed in a non-partisan fashion. To stay silent on issues which have a bearing on inflation and interest rate outcomes so as not to embarrass the government of the day is potentially even more compromising to the independence of a central bank.
Macfarlane is nonetheless correct in dismissing the notion that fiscal policy has had a material influence on monetary policy outcomes in recent years:
Macfarlane rejects suggestions that the last budget was highly expansionary, putting more pressure on the bank to raise rates.
“In the lead-up to the last budget, the Treasurer was under intense pressure to give massive tax cuts which he resisted and gave rather modest ones,” he says.
Macfarlane argues it is too soon to tell whether the tax cuts of the May budget will be stimulatory - particularly given the propensity of the Government to be on the receiving end of larger than expected tax revenues.
“The rather modest tax cuts he gave mainly consisted of returning the excess tax collections to the public,” he says. “Taxes may still come in faster than expected.”
Macfarlane goes on to defend the RBA’s antiquated governance framework, making this rather extraordinary argument in favour of not revealing minutes of the RBA Board’s proceedings:
He says board members who come from different interest groups need to be able to freely discuss their views without feeling they have to be publicly accountable. He says board members “have to be able to overcome their allegiances”.
“They wouldn’t be able to if it (their vote at board meetings) was relayed back to the sectors from which they came.
“If their votes were recorded it would be very hard for them at times to make decisions from the national perspective.”
Macfarlane is effectively conceding that the non-ex officio members of the Board are conflicted in their role as monetary policymakers. The notion that these conflicts of interest can be eliminated by cloaking them in a veil of secrecy would not be accepted in any other context and it is amazing that journalists - of all people - should continue to uncritically buy this argument from the Bank.
Meanwhile, opposition leader Kim Beazley has trouble telling one Ian Macfarlane from another.
posted on 12 August 2006 by skirchner in Economics
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My associates at Action Economics take on the emerging bearish consensus:
Despite the market’s nearly uniform belief that a significant economic “slowdown” is underway, today’s retail sales, trade price, and inventory data join our reference yesterday to the litany of indicators that are refusing to cooperate with the consensus view.
For the record, we are seeing virtually no signs of a slowdown in consumer spending as we enter the second month of Q3, As gauged by today’s retail sales report as well as nearly all the consumer confidence and income statistics. The surge in July tax receipts revealed late yesterday, combined with the solid growth trajectory of hours-worked through the month from last Friday’s payroll report, ensures that income posted another round of solid growth on the month.
In addition, all the major factory sector indicators suggest continued solid growth in this bellwether sector, and industrial production to be released next Wednesday will reveal a big 0.6% July gain that follows the even bigger 0.8% June increase. In addition, as noted yesterday, both exports and imports entered Q3 on a robust growth path as signaled in the June trade report. And, the construction sector is continuing to post solid growth despite housing sector fears thanks to a booming commercial and public sector, as signaled by continued strength in building material prices, alongside steady 9%-13% y/y growth in sales of building materials that received a big boost from the 1.8% July sales surge. Inventories posted solid gains through Q2, though the ratio of inventories to sales remains remarkably lean.
We continue to believe that economic growth is moderating in these middle years of the expansion by about 0.5 percentage points, from a 3.7% clip over the last thirteen quarters to about a 3.2% rate, as Fed policy moves to neutral from accommodative. But this slowdown in real growth will be hard to see in many of the volatile monthly reports that the markets watch, and larger price gains in the second half of the expansion may diminish the effects of this moderation on the reports that are not inflation adjusted, like retail sales, or inventories.
For today’s data, note that retail sales grew at a solid 7.6% rate in Q2 despite a market focus on the “draining” effect of surging gasoline prices on the “real” spending component in the last quarter, which is an “above trend” growth clip despite notions in the market that the slowdown began with the consumer in Q2. In Q3, retail sales are on track to grow at a 7% rate, and with less of the gasoline “drain” on the real figures that will leave real consumption growing at a 3.3% Q3 rate that is right in line with our 3.0% Q3 GDP forecast.
posted on 12 August 2006 by skirchner in Economics, Financial Markets
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Alan Reynolds on that recent WSJ editorial:
That editorial rebukes the Fed for drifting “back to the era of the Phillips Curve,” which blamed inflation on “wage push” resulting from low unemployment. Yet the same editorial enthusiastically embraced the Phillips Curve, fretting that “unit labor costs are now 3.2 percent higher than a year ago; that’s the fastest increase since 2000, when monetary policy was considerably tighter than it is now.”…
The Phillips Curve notion that increases in unit labor costs predict or cause higher inflation was debunked in studies from the Federal Reserve Banks of Richmond (Yash Mehra), Dallas (Kenneth Emery and Chich-Ping Chang) and Cleveland. The latter paper, by Gregory Hess and Mark Schweitzer, found “little systematic evidence that ... unit labor costs are helpful for predicting inflation.”
A March 2005 study for the Bureau of Labor Statistics by Anirvan Banerji found that “upturns in unit labor cost growth actually lag upturns in CPI inflation 80 percent of the time.”
The Fed is right this time, for a change. I regret to say that their toughest critics, including many of my oldest and best friends, are wrong.
The Reserve Bank of Australia’s model of inflation is a mark-up model based in part on unit labour costs. The RBA are the first to concede that the data reject their model. They impose it anyway and ask if it predicts inflation. It does, which makes this approach defensible, but still not very satisfying.
posted on 11 August 2006 by skirchner in Economics, Financial Markets
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RBA rate hike probabilities implied by 30 day inter-bank futures have surged after yet another strong employment report that sent the unemployment rate to new multi-decade lows of 4.8% in July. Early employment of Census workers probably contributed to the increase in employment in July, with another 10,000 addition to employment from the Census likely in August. Of course Census workers are no more to blame for higher interest rates than bananas.
Every three months, the Australian and New Zealand employment reports coincide. The two reports show the price Australia pays for a less liberal approach to labour market reform, with NZ’s unemployment rate re-visiting the record lows from last year at 3.6% in the June quarter. NZ also has an official cash rate of 7.25% compared to Australia’s 6.0%. This underscores a point we made previously: the sort of economic growth that drives unemployment rates to multi-decade lows is not going to give you low interest rates. Higher interest rates reflect good economic news, not bad.
By the way, weren’t Australia and NZ supposed to be in some sort of currency and financial crisis by now? Yet another failed Roubini forecast.
posted on 10 August 2006 by skirchner in Economics, Financial Markets
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U2’s Bono is not averse to a little international tax arbitrage:
The rock band U2 came under criticism yesterday after reports that it has moved a portion of its multi-million-pound business empire out of Ireland for tax reasons.
The band, fronted by Bono, the anti-poverty campaigner, has reportedly transferred some of its publishing company to Holland.
Based in Dublin, U2 have long benefited from the artists’ tax exemption introduced by Charles Haughey, the late prime minister. It is reported that the band’s move has been made in response to a £170,000 cap on the tax-free incomes introduced in the last Irish budget.
Bono is also apparently a founder and partner in a USD 1.9 billion private equity fund that has just taken a stake in Forbes media. Perhaps he is just following Lang Hancock’s dictum that the best way to help the poor is not to become one of them.
posted on 09 August 2006 by skirchner in Economics
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The WSJ, channelling gold bugs and fever swamp Austrians, frets over the August Fed pause:
Mr. Bernanke no doubt hopes that yesterday’s pause is one that refreshes; we fear it has only postponed the ultimate day of reckoning.
James Hamilton instead offers a timely warning:
There are those who will doubtless never surrender their conviction that Ben Bernanke is in reality a bird, with the latest FOMC statement confirming him as a member of the family Columbidae. To those pundits I repeat my previous warning—if you invest based on that misunderstanding of Bernanke, you’re going to get whacked down by reality.
posted on 09 August 2006 by skirchner in Economics, Financial Markets
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Nouriel Roubini has engaged in a furious linking frenzy over at Doomsday Cult Central in support of his US recession call. Nouriel seems oblivious to the paradox that makes recession forecasting so difficult. Recessions are inherently difficult to predict, because if they could be forecast with reasonably accuracy, policymakers would take action to avert them and the public would change their behaviour in ways that would mitigate their effects. The news and data flow that Nouriel points to in support of his recession call is the same information that the Fed will be responding to when it (more than likely) decides to pause its tightening cycle in August. Nouriel now acknowledges this possibility in his latest post, but argues that a new Fed easing cycle will be too little, too late to avert recession.
All this conveniently ignores the fact that Nouriel has been prominent in arguing that monetary policy should respond to asset price ‘bubbles,’ particularly the supposed US housing ‘bubble.’ If the Fed had taken Nouriel’s advice, US interest rates would presumably be even higher than they are now, greatly increasing the risk of the recession Nouriel claims is now imminent. Indeed, the central bank that has most explicitly targeted house prices in its official explanation of policy, the Reserve Bank of New Zealand, had a narrow brush with recession in the second half of 2005.
Nouriel is not alone in trying to have his monetary policy cake and eat it too. Even conservative commentators who should know better, like Des Lachman of the AEI, have sought to argue that the Fed both failed to ease quickly enough in the wake of the tech ‘bubble’ and then eased too much to prevent the housing ‘bubble.’ Lachman and Roubini are effectively claiming that they know of some alternative path for Fed policy that would have better smoothed both asset prices and the real economy, leading to better macro outcomes. This is nothing but after the fact hubris. Adam Posen has presented a definitive debunking of Nouriel’s arguments in favour of central banks targeting asset prices. I make similar arguments here against those who argue that the Fed could and should have prevented the US tech ‘bubble’ of the late 1990s.
Nouriel was spectacularly wrong in his structural bear call on the US dollar in 2005, not because the USD failed to collapse as he predicted, but because even if it had, it would have had none of the consequences he predicted (remember that this too was meant to have caused a recession!) It is not enough simply to be a permabear and then wait for the cycle to finally deliver vindication. You have to be right for the right reasons.
posted on 06 August 2006 by skirchner in Economics, Financial Markets
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The Economist asks why economists blog. I’ve always thought the opportunity to make fun of The Economist magazine was reason enough, but that’s just me! The Economist raises the obvious question about the opportunity cost of blogging. The most frequent question I get asked about blogging is ‘where do you find the time?’ but I have never found blogging particularly time consuming. I put this down to the fact that my blogging is more often than not an extension of work I am already doing. Leveraging this into a blog post is not particularly demanding.
In some respects, economics blogging is a return to an older tradition in economics that had a much stronger public orientation and interest in substantive issues. This tradition has been lost as the discipline has become increasingly consumed by technique. Dan Klein has written eloquently about this in What Do Economists Contribute? It is no accident that the economics faculty at George Mason University are such active bloggers. They are some of the best representatives of this older tradition and among the most interesting academic economists in the world today.
posted on 04 August 2006 by skirchner in Economics
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Once every three months, financial markets turn to the RBA’s quarterly Statement on Monetary Policy for guidance on the monetary policy outlook. More often than not, they are disappointed. It’s not hard to see why. The quarterly Statements are scheduled after the Board meeting that follows each quarterly CPI release, so they typically serve as vehicles for the ex post rationalisation of existing policy moves, while studiously avoiding any explicit discussion of the policy outlook. The broad-brush inflation forecasts contained in the Statements have taken on an increasingly endogenous character, being left largely unchanged from one Statement to the next because of intervening policy moves. It is unlikely that the RBA would forecast underlying inflation outside the target range, since this would beg the question as to why policy action had not already been taken to pre-empt it. The Bank would essentially be admitting that it was in the process of making a policy error.
Instead of persisting with the fiction that inflation is an exogenous variable, the RBA should move to formally endogenise its forecasting process to a published projection for the official cash rate that it believes is likely to be consistent with maintaining inflation within the target range. This would help ensure the credibility of its medium-term inflation target, by making it more explicit that inflation is not an exogenous variable under an inflation targeting regime, as well as giving clearer guidance on the monetary policy outlook.
posted on 04 August 2006 by skirchner in Economics, Financial Markets
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