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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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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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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Fundamentals of House Price Inflation: Single Eye for the (Straight) Melbourne Guy Edition

Previous posts have noted the convergence in capital city house prices with those in Sydney and suggested, as has RBA Governor Macfarlane, that internal migration is one of the equilibrating factors at work.  The latest ABS release on regional population growth is consistent with this view, as reported in The Australian:

SYDNEY’S population growth is lagging behind that of Brisbane and Melbourne, with fresh evidence people are abandoning the nation’s largest city to escape inflated property prices and reduced job opportunities.

The figures show southeast Queensland continues to boom, growing by 53,300 people, or more than 1000 a week.

The Australian report (channeling the tabloid style of the SMH), goes for this supposedly illustrative vox pop:

Management consultant Janet Martin is among those making the shift south. Having lived in Sydney for 10 years, Ms Martin decided six months ago to move from Annandale in Sydney’s inner west to South Yarra in Melbourne’s inner east in search of a more vibrant culture and cheaper housing.

“All I know is now I have a boyfriend who’s my age, who has two cats and wants to make babies,” Ms Martin said.

Increased proportion of straight men perhaps!  For the record, the median Sydney house price actually rose 1% in Q4, consistent with the argument I made some time ago that Sydney house price growth would bottom relative to trend by the middle of 2006.  But as the ABS release shows, it is the differences in annual growth rates among the capital cities that are the more interesting story.

posted on 24 February 2006 by skirchner in Economics

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Who Spiked the Drinks at the BIS?

A report in the Torygraph pointed me in the direction of this BIS Working Paper.  As the Torygraph and the author himself note, the arguments presented are a significant departure from what might be considered the current orthodoxy in favour of inflation targeting.  Indeed, they are a bizarre mix of Bretton Woods era economics and fever swamp Austrianism (note the use of the vague Mises quote at the beginning of the paper, which in my experience usually signals that some abuse of the Austrian tradition is about to follow).

Although the author is somewhat vague when it comes to policy prescriptions, his main claim is that the absence of Bretton Woods-type arrangements is responsible for the supposed problem of global imbalances:

The underlying problem is that we no longer have a coherent system that somehow forces countries to alter their relative degrees of domestic absorption, and associated exchange rates, so as to reduce external imbalances in an orderly way…While it is logically possible that policy measures consistent with resolving domestic imbalances might resolve external imbalances as well, this should not be assumed. In any event, it is not likely to happen. This leads on to the question of whether there are institutional changes that might be recommended to strengthen the international adjustment process.

The reason Bretton Woods institutions were largely dispensed with in the early 1970s (with the exception of the IMF, which somehow managed to survive its redundancy), was precisely because external imbalances were a serious problem under fixed exchange rate regimes.  The move to floating exchanging rates and open capital accounts solved this problem and eliminated the external balance constraint on growth, with enormous benefits for those economies that liberalised along these lines.  It is therefore nothing short of bizarre to suggest that global imbalances now argue for a return to Bretton Woods-type institutions. 

What the author, and many others who see global ‘imbalances’ as a problem, are effectively saying is that the Anglo-American economies should stop outperforming the rest the world and instead try and look more like everyone else.  Those who argue that this outperformance is built on debt and asset prices have things exactly the wrong way around.  Rising debt levels and asset prices are merely symptomatic of expectations for continued strong economic growth.  To argue otherwise is to implicitly attack the institutional foundations of Anglo-American economic success.

The author favours a consolidation in the number of currencies.  As Hayek would argue, we need more currencies, not less.  For the author to invoke the Austrian tradition on behalf of proposals for a global macro regulatory framework and reduced currency competition is a travesty of that tradition.

posted on 23 February 2006 by skirchner in Economics

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Bernanke, Warsh, Inflation Targeting and the Fed

Brian Wesbury on the internal politics of the Fed:

Issues with the press and internal Fed battles are much more complicated, as well as interrelated. For example, last week’s public attacks on Kevin Warsh—a key White House staffer and one of President Bush’s recent nominees for Federal Reserve Board governor—appear to be part of this nexus.

These attacks violated an unwritten rule that former Fed members do not publicly disagree with the Fed or its chairman. They were orchestrated by a retired Fed governor who claimed that Mr. Warsh was not qualified to be on the Fed as he was not trained by academics to be an economist. Instead, he is a lawyer with extensive Wall Street experience and knowledge of the capital markets. Given that Mr. Bernanke worked with him in the White House, and likely had veto power, we can assume he supported the nominee. So someone else inside the Fed may have encouraged the attacks in order to send a warning shot about any moves toward inflation targeting that might be made by the new chairman and his newest colleagues. Like any D.C. institution, the Fed abhors change and accountability, and inflation targeting would force both.

posted on 22 February 2006 by skirchner in Economics

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The Benign View of Global Imbalances

RBA Governor Macfarlane has long taken a benign view of global ‘imbalances.’  Fortunately, it would seem that this perspective is shared by his Deputy, Glenn Stevens, widely tipped to take over from Macfarlane when his current term expires in September:

it is common for observers to warn against the risk that the ‘imbalances’ may unwind in a disruptive fashion. Often this is not spelled out. What is sometimes meant, I think, is that those currently accumulating dollar-denominated claims suddenly change their minds, precipitating abrupt movements in exchange rates and interest rates. Such developments might, in this view, lead to a pronounced weakening of domestic demand in countries like the US if long-term interest rates rose abruptly, while a big decline in the dollar might affect the ability of areas like Europe to export.

In the event that there is some market discontinuity, I suspect that it is more likely to be sparked by some sort of credit event that prompts a change in appetite for risk in general, than by reactions to current account positions per se. It is not obvious that US interest rates would rise, or the dollar fall, in the face of such an event.

posted on 22 February 2006 by skirchner in Economics

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