Saved Not Spent
Finance Minister Lindsay Tanner launches a robust defence of the government’s tax cuts:
“To the extent that there is a stimulatory impact ... it is actually far less than some people have been presenting.”…
“Everybody ... assumes that every last dollar that every citizen gets in a tax cut will be spent and not saved - that’s a false assumption,” Mr Tanner said.
I make many of the same arguments here.
posted on 27 February 2008 by skirchner in Economics, Financial Markets, Politics
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What is the NAIRU for Australia?
Opposition Treasury spokesman Malcolm Turnbull sought to put Treasurer Swan on the spot yesterday, asking him to nominate Australia’s non-accelerating inflation rate of unemployment (NAIRU). The question was specifically designed not to get an answer. I dare say Malcolm can’t answer this question either. If he can, he has chosen the wrong profession.
The NAIRU is one of those latent variables that is inherently unobservable and likely changes over time. The concept is thus not very useful in the real-time conduct of macroeconomic policy. The more important focus for policymakers is to ease the NAIRU constraint on growth, by lowering the structural or non-cyclical component of unemployment.
By way of comparison, New Zealand also currently enjoys a record low unemployment rate of 3.4% compared to Australia’s 4.1%. Recent inflation outcomes suggest that both economies are likely facing the NAIRU constraint. Yet on some measures (eg, non-tradeables inflation) Australia’s inflation performance is currently worse than that of New Zealand, despite its higher unemployment rate. We can reasonably infer that New Zealand’s NAIRU is somewhat below that of Australia. The 0.7 percentage point differential in the unemployment rate between the two countries reflects the additional structural unemployment Australian policymakers have been willing to accept in their choice of labour market institutions compared to those favoured in New Zealand.
posted on 19 February 2008 by skirchner in Economics, Financial Markets, Politics
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None Dare Call it Conspiracy II
Terry McCrann remains hard on the case of the AFR’s resident conspiracy theorists:
Now Harris’s substantive assertion was that Treasury had unexpectedly cut the inflation forecasts from the previous year’s 2.9 per cent.
That was wrong. He did not tell readers that Treasury had actually increased its CPI inflation forecasts. From 2.5 per cent in both years in the May budget to 2.75 per cent for both years in the MYEFO/PEFO.
Crucially, those are for year average - all of 2007-08 over 2006-07 and the same for 2008-09. They were exactly consistent with the-then latest inflation forecasts from the Reserve Bank.
It should hardly be surprising that the Treasury and the Reserve Bank are mostly in agreement on the inflation outlook. Since the Treasury Secretary is an ex-officio member of the Reserve Bank Board, he notionally presides over both sets of inflation forecasts. A Treasury forecast that deviated too far from the RBA’s forecast might be seen as an implicit criticism of the Reserve Bank and its Board. If Treasury were to forecast inflation outside the target range, it would effectively be accusing the RBA of presiding over a monetary policy error, one in which the Treasury Secretary was necessarily implicated. It should also be pointed out that the Treasury and RBA forecasts are not strictly comparable, if only because the forecasts are made at different points in time. If a week is a long time in politics, it is also a long time in the forecasting business.
According to Governor Stevens, the Board operates under a doctrine of collective responsibility. If there were any substance to this doctrine, then a Board member who takes a different view on inflation to the one publicly endorsed by the Bank needs to either reconcile himself to the Board’s majority view, or resign. Since the Treasury Secretary is a member of the Board by statute, the latter is not exactly an option.
Rather than looking for non existent conspiracies, the AFR might instead go in search of the rather more obvious conflict of interest. The Treasury Secretary should not be a member of the RBA Board.
posted on 16 February 2008 by skirchner in Economics, Financial Markets, Politics
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Which is Tighter, Monetary or Fiscal Policy?
Every time RBA Governor Glenn Stevens opens the newspaper these days, he must give thanks for having such a tame press. On his own forecasts, both headline and underlying inflation in Australia will have a three in front of it for the rest of this decade and the first half of 2010. Yet with the honourable exceptions of Terry McCrann and Alan Wood, Australia’s economic commentators are near unanimous in arguing that it’s all the fault of fiscal policy (meaning tax cuts).
This view misunderstands Australia’s macro policy framework, which assigns the job of demand management and inflation control to the Reserve Bank. Those who are opposed to further tax cuts are effectively arguing that the government should engineer a taxpayer-funded bail-out of monetary policy. Needless to say, this strategy won’t work, because higher taxes would simply add to supply-side constraints in the labour market.
It also ignores the obvious conclusion to be drawn from two very simple metrics that can be applied to assess the stance of monetary and fiscal policy. The Commonwealth’s 2005-06 and 2006-07 underlying cash surpluses were at their highest as a share of GDP in nearly 20 years. Fiscal policy is thus unambiguously tight, even after all the previous tax cuts that the commentariat have for the most part opposed.
The same cannot be said for the real official cash rate, the best measure of the stance of monetary policy. With underlying inflation at 3.6% in Q4, the ex-post real cash rate was a mere 3.15% taking the year-ended official cash rate of 6.75% and 3.4% using the current official cash rate of 7.00%. According to the RBA’s own policy simulation model, Australia’s neutral real cash rate is 3%. So when the RBA’s Statement on Monetary Policy says that monetary policy is ‘on the restrictive side of neutral,’ it is talking about less than 50 basis points. With the RBA’s own inflation forecasts having a three in front for as far as the eye can see, the ex-ante real interest rate is at best 4% (assuming steady policy).
As the following chart shows, the ex-post real cash rate only moved to the restrictive side of neutral at the beginning of last year. Monetary policy has been too easy for too long. Hence the inflation problem.
posted on 13 February 2008 by skirchner in Economics, Financial Markets, Politics
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No Malcolm, Wayne Swan is Not Making this Up
One of the referees for an article I have forthcoming on Australian monetary policy queried my assertion that Australia’s inflation target is poorly defined, although subsequently came around to my view that the Statement on the Conduct of Monetary Policy makes this less than clear. The Statement refers to ‘consumer price inflation,’ but is otherwise silent on which of many possible measures of consumer price inflation could be used in determining whether the inflation target has been met.
The confusion this causes was nicely illustrated by Shadow Treasurer Malcolm Turnbull in an interview over the weekend, in which he accused Treasurer Swan of making up the inflation figures:
BARRIE CASSIDY: But what was it in the December quarter though, what was the figure in the December quarter? The one that this Government inherited? 3.6 per cent. A 16-year high.
MALCOLM TURNBULL: No it wasn’t. Ok, now that is a complete untruth. Now Wayne Swan keeps on saying that. I challenge you, invite all of your viewers to go to the Reserve Bank website. You’ll see there that the headline CPI (consumer price index) which is the one that is the inflation targeting is benchmarked against as recently - emphasised again - as recently as December 6 by Wayne Swan himself. That was 3 per cent. In fact, it was 2.96 per cent. The other measurers of inflation, so-called “underlying inflations”, which are statistical adjustments are ... none of them were 3.6 per cent, not one. So, where the 3.6 per cent comes from, I could make a guess but it is not one that was published by the RBA.
The 3.6% figure is an average of the two statistical measures of underlying inflation, the weighted median and the trimmed mean, now published by the ABS rather than the RBA. The RBA references this average in the underlying inflation forecasts contained in the quarterly Statements on Monetary Policy. But unless you are an avid reader of the footnotes to these Statements, you could be forgiven for missing it. The RBA uses this measure because it captures the persistent component of inflation that is of most concern for policy purposes.
Turnbull’s comments reflect a larger problem, which is that this definition of underlying inflation has never been properly announced by the RBA or explicitly endorsed by the current government. Those of us in financial markets first discovered the RBA was using it only by a process of educated guesswork. The May 2006 increase in interest rates caught financial markets by surprise, because markets were then accustomed to looking at a different measure of underlying inflation. It was only when the RBA characterised ‘underlying consumer price inflation’ as being ‘around 2¾ per cent’ in the statement accompanying the May 2006 increase in interest rates that it became apparent what measure the RBA was using, but even this inference was only possible by a process of elimination.
An inflation targeting regime works largely by conditioning inflation expectations. But if even the Shadow Treasurer doesn’t know or doesn’t accept the RBA’s working definition of underlying inflation, we should not be surprised that we have an inflation problem.
posted on 11 February 2008 by skirchner in Economics, Financial Markets, Politics
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Australia’s Fiscal Gang Problem
Finance Minister Lindsay Tanner says ‘Australia has a gang problem, and I’m part of it.’ He is referring, of course, to the ‘razor gang.’ Tanner was announcing a ‘modest down payment’ of $643m in budget cuts, ahead of larger cuts to be announced in the May Budget. No doubt the aim of this announcement is to be seen to be doing something about inflation in the week of an increase in official interest rates. Among the causalities are some of the former government’s more outrageous pork-barrelling projects, including the Fishing Hall of Fame and the National Rugby Academy.
The more significant cuts will take longer to put together, but the returns to what has supposedly been a line-by-line examination of government spending programs are already looking rather paltry. They are also small relative to the enormous amount of political capital the government has available to spend in the wake of its election victory. One suspects that the legendary Lu Kewen could literally spit on some voters at the moment and still have them come away thinking it was a religious experience. When it comes to cutting spending, there is no time like the present.
We previously noted that the new Labor government’s target for the underlying cash surplus of 1.5% of GDP for 2008-09 was not exactly ambitious, merely maintaining the status quo on recent budget outcomes and representing only a small contractionary impulse on forward estimates that probably would have been bettered anyway. The ugly reality for the government is that Commonwealth fiscal policy is already the tightest it’s been in two decades and further spending cuts of the magnitude being contemplated by the government will not put a dent in inflation or interest rates.
posted on 07 February 2008 by skirchner in Economics, Financial Markets, Politics
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Another Own Goal in the ‘War on Inflation’
Fighting inflation – with higher tariffs:
The Rudd Government is looking at the possibility of a tariff freeze, in a bid to protect Australia’s remaining car makers, after Mitsubishi confirmed the closure of it’s Australian manufacturing operations with the loss of 930 jobs, according to media reports.
The automaker’s departure is expected to prompt the federal government to carry out a review of subsidies allocated to the industry, as players left in the local automotive sector struggle to cope with increased global competition and a shrinking share of the market.
Car industry tariffs are due to be cut from 10 per cent to 5 per cent by 2010, but manufacturers have asked the government to maintain the current protection and boost funding for the industry.
posted on 06 February 2008 by skirchner in Economics, Politics
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In Bed with Sharon Burrow
What do opposition Treasury spokesman Malcolm Turnbull and ACTU President Sharon Burrow have in common?
Mr Turnbull:
“I have said before and I will repeat again that I think there are powerful reasons for the Reserve Bank to hold its hand at this meeting.
“There is a lot going on in the international markets and we have inflation running at around that 3 per cent mark at the moment in Australia.”
Ms Burrow:
“It should wait and see on interest rates until the effect of the turmoil in the United States caused by the sub-prime housing market is clearer,” Ms Burrow said.
It is of course precisely the lack of interest rate rises from the RBA that has been the main cause of Australia’s inflation problem.
posted on 05 February 2008 by skirchner in Economics, Financial Markets, Politics
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The Legendary Lu Kewen
First, there was Rudd Commands Your Vote. Now, in a case of life imitating art, we have the legendary Lu Kewen:
“This book will fully interpret the legendary life of Lu Kewen. How he was born in a poor family in 1957, how he stepped into the palace of success through endeavour and effort, how he fought in the political waves and stepped proudly through the tide.”
posted on 02 February 2008 by skirchner in Politics
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‘Unrepentant’
posted on 01 February 2008 by skirchner in Culture & Society, Economics, Financial Markets, Foreign Affairs & Defence, Higher Education, Misc, Politics
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‘Fiscal Conservatism’ for All
Seems not everyone got the memo on ‘fiscal conservatism’:
KEVIN Rudd faces intensifying pressure from community groups for billions of dollars of new government spending, despite his promise of an austerity budget designed to ease pressure on inflation and interest rates.
As the Prime Minister told a business breakfast in Perth yesterday of his plans to cut spending in the 2008-09 budget, to be delivered in May, his office was being flooded with requests for more than $7 billion in spending on health, infrastructure and climate change.
posted on 22 January 2008 by skirchner in Economics, Financial Markets, Politics
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How to be a ‘Fiscal Conservative,’ Without Really Trying
Prime Minister Kevin Rudd is promising budget surpluses of 1.5% of GDP, as part of the government’s ‘war on inflation.’ Relative to the forward estimates contained in the previous government’s Mid-Year Economic and Fiscal Outlook, this represents a fiscal contraction of a mere 0.2% of GDP.
Contrary to popular perception, Commonwealth fiscal policy is already the tightest it’s been in two decades. Looking at actual budget outcomes, as opposed to the forward estimates or the arbitrary counterfactuals the commentariat love to play with, the fiscal impulse (ie, the change in the budget balance as a share of GDP) has been either neutral or contractionary for the entire period since 2001-02. The underlying cash surplus has ranged between 1.5-1.6% of GDP since 2004-05, a GDP share not seen since the peak of the last cycle in the late 1980s. The automatic stabilisers would probably cough-up another surplus of 1.5% of GDP anyway, regardless of any contribution from discretionary policy actions.
The fiscal impulse has been largely irrelevant to inflation and interest rate outcomes in recent years. Today’s announcement suggests that is not about to change.
posted on 21 January 2008 by skirchner in Economics, Financial Markets, Politics
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Yet Another ‘New Era’?
Having promised a ‘new era’ of Reserve Bank independence, the government is now promising the Reserve Bank a ‘new era of fiscal discipline’:
KEVIN Rudd and Wayne Swan have personally told the Reserve Bank of their determination to cut budget spending to reduce the need for further interest rate rises.
Following their meeting at the Reserve Bank’s Sydney headquarters with deputy governor Ric Battellino and Treasury secretary Ken Henry, Mr Swan said they had “flagged a new era of fiscal discipline”.
“It’s critical we demonstrate restraint as we frame our first budget, because that sends a clear message to the Reserve Bank,” Mr Swan said.
For reasons argued here, demand management is the wrong focus for fiscal policy and is not likely to have much impact on interest rates in any event. Rising interest rates are in fact symptomatic of economic strength, not weakness. What the government should fear most is that the RBA should start cutting interest rates, since that will be one of the first signs that the Australian economy has succumbed to the deteriorating global growth outlook. Rising interest rates should be the least of the government’s worries.
This is not to deny that Australia has an inflation problem, but all the finger-pointing between the government and the opposition misses the point that there is only one public institution in Australia with an explicit mandate to control the cyclical component of inflation, and that’s the Reserve Bank. Next week’s Q4 CPI release will likely show underlying inflation running above the RBA’s 2-3% medium-term target range. Given the lags between changes in official interest rates and inflation outcomes, this tells us that the RBA was not doing its job properly 12-18 months ago. The newly elected Labor government has inherited an inflation problem from the Reserve Bank, not the former Coalition government.
posted on 16 January 2008 by skirchner in Economics, Financial Markets, Politics
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Douglas Holtz-Eakin on John McCain
Douglas Holtz-Eakin, economic policy adviser to Republican presidential candidate John McCain, talks to Bloomberg’s Tom Keene (mp3) about why McCain is the only candidate he has ever worked for.
posted on 15 January 2008 by skirchner in Economics, Politics
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Aspirational Leadership
When it comes to the leadership of the federal parliamentary Liberal Party, Peter Costello remains all aspiration, no application:
Mr Costello is considering whether to remain in politics as a backbencher until Dr Nelson is deposed, then lead the Liberal Party to the next election with Malcolm Turnbull as his treasurer.
posted on 14 January 2008 by skirchner in Politics
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