Central Bank Governors Gone Wild: Don Brash Was Never Like This, Part II

Previously, we highlighted the unprecedented tightening in monetary conditions presided over by RBNZ Governor Bollard.  The RBNZ’s March Monetary Policy Statement has now ruled out any easing in official cash rate during 2006. 

This can be partly justified by an inflation target breach, but the RBNZ’s discussion of the inflation outlook has recently been dominated by its views on the housing sector and the supposedly ‘unsustainable’ domestic saving-investment and current account imbalance.  In the March MPS, Governor Bollard says ‘the other key inflation risk over the next two years remains the housing market.  We need to see this market continue to slow, so that consumption moderates and helps to reduce inflation pressures.’

Governor Bollard is implying that causality runs from housing to consumption to overall economic growth to inflation.  But if this causal reasoning is wrong, or even if there is bilateral causality between housing and activity more broadly, then the New Zealand economy is in serious trouble.  The risk is that by the time the housing market cracks, New Zealand will already be in recession, particularly given the slow transmission from changes in the official cash rate to effective mortgage interest rates in NZ.  Indeed, the yield curve inversion driven by RBNZ tightening is even facilitating longer-term fixed rate borrowing, while encouraging capital inflow that makes the current account deficit even worse.

Just like Australia in the early 1990s, the authorities will probably argue that any subsequent recession was necessary to correct these imbalances, substantiating their view about their ‘unsustainability.’  The real lesson from Australia’s experience in the late 1980s and early 1990s is that the monetary authority has no business targeting private saving-investment and current account imbalances or the housing market.

posted on 09 March 2006 by skirchner in Economics

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The Prediction Market Oscars

‘Chris Masse still doesn’t get it.’  Chris Masse’s 2005 Prediction Market Awards…in 2006.  More prediction market links than you can poke a stick at.

posted on 08 March 2006 by skirchner in Economics

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Busting the Myth of the UK Housing ‘Bubble’

A reader has pointed me in the direction of this speech by the BoE MPC’s Stephen Nickell, which is a thorough de-bunking of the myths in relation to the role of housing and household debt in the UK economy.  This piece is remarkable because of its very close fit with the arguments I have been running on the same issues in the Australian context.  Nickell summarises his argument as follows:

there has not been a spending boom, the non-spending boom was not credit-fuelled and there has probably not been a house price bubble…what we have seen is first, the average quarterly growth rate of real consumption over the period 2000-2003 has been almost exactly equal to the average growth rate over the last twenty five years, so there was no consumption boom.  Second, from 1998 to 2003 the proportion of their post-tax income which has been consumed by households has been stable, despite the fact that mortgage equity withdrawal plus unsecured credit has grown from 2 per cent of post-tax income to nearly 10 per cent of post-tax income over the same period. Third, these two apparently inconsistent facts are reconciled by the fact that since 1998, the increasing rate of accumulation of debt by households has been closely matched by the increasing rate of accumulation of financial assets. Furthermore, this is not an accident. There are good reasons why aggregate secured debt accumulation and aggregate financial asset accumulation might be related, particularly in a period of rapidly rising house prices. Finally, therefore, there is no strong relationship between aggregate consumption growth and aggregate debt accumulation.

Nickell also presents an inventory of busted house price predictions for the UK.  The point of this is not to make fun of other people’s failed forecasts (as I am sometimes accused of doing). As Nickell notes, the serious point is that:

commentators (either implicitly or explicitly) disagreed significantly on the long-run equilibrium level of house prices, on where house prices were heading and on the extent to which there was a misalignment or bubble.

In other words, the ‘bubble’ identification problem is so serious as to render the notion of a ‘bubble’ useless as a framework for analysis.

posted on 07 March 2006 by skirchner in Economics

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Warren Buffett’s Expensive Convictions

Warren Buffett, on the high price of his doomsday cultism:

My views on America’s long-term problem in respect to trade imbalances, which I have laid out in previous reports, remain unchanged. My conviction, however, cost Berkshire $955 million pre-tax in 2005.

Buffett is seeking supposedly less costly ways of shorting the US dollar, via apparently unhedged acquisitions of foreign equity capital:

We reduced our direct position in currencies somewhat during 2005. We partially offset this
change, however, by purchasing equities whose prices are denominated in a variety of foreign currencies and that earn a large part of their profits internationally. Charlie and I prefer this method of acquiring nondollar exposure. That’s largely because of changes in interest rates: As U.S. rates have risen relative to those of the rest of the world, holding most foreign currencies now involves a significant negative “carry.”  The carry aspect of our direct currency position indeed cost us money in 2005 and is likely to do so again in 2006. In contrast, the ownership of foreign equities is likely, over time, to create a positive carry – perhaps a substantial one.

...and turning equity bets into currency plays.

posted on 06 March 2006 by skirchner in Economics

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Guilt Trip

Lonely Planet makes its readers feel good about air travel:

the founders of the Rough Guides and the Lonely Planet books, troubled that they have helped spread a casual attitude to air travel that could trigger devastating climate change, are uniting to urge tourists to fly less…

From next month warnings will appear in all new editions of their guides about the impact of flying on global warming alongside alternative ways of reaching certain destinations.

In fact, aircraft contrails may contribute to ‘global dimming,’ thought to be a significant offset to global warming.

posted on 06 March 2006 by skirchner in Culture & Society

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RBA Governor Macfarlane on Doomsday Cultism

RBA Governor Macfarlane, interviewed in the WSJ:

“I have been in so many meetings, from the late ‘90s onwards, where the participants at the meeting identified the U.S. current account as a serious imbalance that had to be remedied, and that if it wasn’t remedied, the U.S. dollar would go into some sort of free fall and people would stop buying U.S. assets,” he wearily responds. “Clearly, it wasn’t happening. Just as it didn’t happen in Australia.”

posted on 04 March 2006 by skirchner in Economics

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Rusted Not Busted: Australian House Prices

Yesterday’s speech by RBA head of economic analysis Tony Richards included this chart of the various series for Australian house prices.  Looking at the level rather than the growth rate of house prices drives home the point that national house prices have been holding their own (although as previous posts have stressed, this conceals important differences between the capital cities). 

Needless to say, this is a very different outcome to the doomsday scenarios that were floated not very long ago, which promised national economic ruin on the back of a collapse in house prices (scenarios that are still getting a run in the US context).  While the Q4 national accounts were painted as soft on the back of the headline numbers, real household consumption expenditure rose nearly 3% y/y, gross national expenditure rose 4.4% y/y and real gross domestic income rose a stunning 5.2% y/y.

posted on 03 March 2006 by skirchner in Economics

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Peter Costello: The Heir Unapparent

The 10th anniversary of John Howard’s ascent to the Prime Ministership has not surprisingly seen increased scrutiny of his Deputy, Peter Costello.  In part, Costello has drawn this attention to himself, with the announcement of his international tax beauty contest, as well as a recent foray outside his portfolio responsibilities.  The punditocracy was unimpressed with both efforts.  His speech on citizenship has drawn this response from Greg Sheridan (or at least the sub-editor’s paraphrase):

This shallow, lazy, lucky and opportunistic Treasurer does not deserve to run the country.

On tax, Sinclair Davidson notes:

Apart from some tinkering at the margins, he has done nothing…The top marginal tax rate of 47 per cent has remained unchanged since Paul Keating was treasurer…By calling for a review of the basic facts of the tax system, Costello has shown himself to be years out of date and uninformed.  Costello has relied on three arguments to stymie tax reform. First, that Australian tax rates aren’t that high; second, that the tax take is small; and third, that tax reform would only benefit a small number of Australians. Each of these arguments is false.

Alan Wood, by contrast, attempts this rather lame defence of Costello:

this time Australia has avoided the boom’s inflationary consequences, and “there are grounds for optimism it can avoid a subsequent bust”.

If we do, it will be because of the better economic policy framework Costello has played an important role in putting in place.

Peter Costello has cited ‘Reserve Bank independence’ as one of his greatest achievements as Treasurer.  The August 1996 exchange of letters between the Treasurer and RBA Governor was in fact a mere codification of existing practice.  In 1996, the RBA was already doing what the Treasurer now claims credit for.  This fell well short of the comprehensive statutory reform of central banking institutions seen in other countries during the 1990s.  Along with the US Fed, this has left Australia with one of the most antiquated frameworks for monetary policy governance among the major industrialised countries.

posted on 02 March 2006 by skirchner in Politics

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BlogAds Political Blog Reader Demographics Survey

BlogAds is conducting a survey of political blog readers.  BlogAds will break-out the results obtained from this blog and pass them on to me (make sure you mention Institutional Economics in question 23).  If the sample is large enough, I will post the results, which will give you a better picture of your fellow Institutional Economics readers.

You might wonder why this blog is being included in the survey, even though it is not mainly concerned with politics.  This is due to the fact that I classified the blog as ‘libertarian’ when I signed-up for BlogAds.  While my own politics should be fairly obvious to regular readers, it has never been my intention to run an overtly political blog.  The most successful blogs in terms of traffic are strongly partisan, but these sites serve mainly to confirm rather than challenge readers’ views.  I have always aimed to appeal to a more diverse readership and I’m hoping this is reflected in the survey results.

posted on 01 March 2006 by skirchner in Misc

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Black Economy Pole Dancers

I would have thought the headline for this story goes without saying:

‘Underground economy baffles Tax Office’

The Tax Office told the Auditor-General it was impossible to assess the size of the cash economy because conclusions would be too imprecise, too costly and the burden on taxpayers would be too intrusive.

“We don’t attempt to estimate it because of the time and cost involved,” a spokeswoman for the Tax Office told the Herald yesterday.

The ATO did, however, find time for this:

The Australian National Audit Office has revealed in its cash economy report that tax investigators contacted more than 50 pole dancing clubs “with a sample receiving unannounced visits”.

Tough job, but someone’s got to do it.

posted on 01 March 2006 by skirchner in Economics

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Harvard’s Russia Scandal

Institutional Investor has a special report on Andrei Schleifer and Harvard’s Russia scandal, which played a role in the recent resignation of Harvard President Larry Summers:

Since being named president of Harvard University in 2001, former U.S. Treasury secretary Lawrence Summers has sparked a series of controversies that have grabbed headlines…Then, in quiet contrast, there is the case of economics professor Andrei Shleifer, who in the mid-1990s led a Harvard advisory program in Russia that collapsed in disgrace. In August, after years of litigation, Harvard, Shleifer and others agreed to pay at least $31 million to settle a lawsuit brought by the U.S. government. Harvard had been charged with breach of contract, Shleifer and an associate, Jonathan Hay, with conspiracy to defraud the U.S. government.

Some might see a certain irony in the fact that Schleifer is a big name in behavioural economics, particularly as author of papers such as ‘Does Competition Destroy Ethical Behavior?’

posted on 28 February 2006 by skirchner in Economics

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PIMCO’s McCulley: Gimme that Old Time Regulation

The always bizarre PIMCO crew hark for the good old days of regulation:

This transformation of the central banking game has been evolutionary over the last twenty-five years, starting with the repeal of Regulation Q in 1980. 

Prior to that, central banking really was child’s play, as monetary policy worked its magic through a highly regulated, bank- and thrift-centric, essentially-closed domestic financial system. Regulation Q capped the interest rate that banks could pay on deposits, while capping the interest rate that thrifts could pay one-quarter percentage point higher. In return for that un-level playing field,  thrifts were required to deploy the lion’s share of their deposits into long-term, fixed rate mortgages.

It was an ideal world for banks and thrifts, as well as the Federal Reserve. It was a world of regulated competition, with the Fed having colossal power to impact the pricing, availability and terms of credit creation. The set up was particularly well suited to the Fed counter cyclically fine tuning the housing cycle (and, thus, the business cycle!).

And what a bang-up job they did of counter-cyclical fine-tuning in the 1970s!  In fact, the 1980s and the 1990s have seen a secular decline in the volatility of real GDP growth, inflation and interest rates that owes an enormous debt to the financial de-regulation of the early 1980s, as does PIMCO itself.

posted on 28 February 2006 by skirchner in Economics

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Bringing Currency Competition to the Euro Zone

John Gillingham, speaking at an Open Europe seminar on his book, A Design for a New Europe:

I propose in my book an idea that has considerable circulation within the City and which was at one point on the Treasury agenda in Britain. That is changing the euro, not destroying it, but changing its operating mechanism from being the sole currency in a single economic area to a parallel currency that finds its market value in competition to reissued national currencies.

Hayek would approve.

posted on 28 February 2006 by skirchner in Economics

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Peter Costello’s International Tax Beauty Contest

Treasurer Costello has instituted a study to ‘internationally benchmark’ Australia’s taxation system to those found in other countries.  The inquiry will report in April, just before the May Budget.  The Treasurer has already indicated that he thinks that Australia’s tax system compares favourably to other OECD countries.  While this is almost certainly true, it is also completely irrelevant. 

The most obvious benchmark for Australia is the US.  The US is itself the scene of a major debate about tax reform, reflecting what many regard as fundamentals flaws in their tax system (for one contribution to the US debate, see here).  To say that Australia compares favourably to other countries is simply to highlight the woeful state of revenue raising systems throughout the OECD.  This reflects the simple reality that taxation is an area of public policy that is particularly vulnerable to corruption via rent-seeking and, once corrupted, becomes very difficult to reform.

Costello will almost certainly use the report’s findings to re-assert his authority over the tax debate, while at the same time seeking to counter demands for a renewed tax reform effort in Australia.  It confirms Costello’s position as the most conservative politician in Australia, in the non-political sense of the term.

posted on 27 February 2006 by skirchner in Economics

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Self-Censorship at SBS

The supposedly fearless SBS ‘defers’ an episode of South Park.  As Cartman would say, weeeak!

UPDATE: Matt Stone’s father, Gerald Stone is an economist and U of Kentucky graduate students (such as Hypothetical Bias creator, Whitehead) from the mid to late 80s know him from the principles text, Byrns and Stone.

posted on 25 February 2006 by skirchner in Culture & Society

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