Deflating Australia’s Housing ‘Bubble:’ Lessons for the Fed
Another article in the global press noting Australia’s experience with house price inflation, this time by Bloomberg columnist William Pesek in the IHT, who credits Australia’s ‘soft landing’ with deft monetary policy action by the RBA. The emerging conventional wisdom is that the RBA has successfully deflated a housing ‘bubble’ through some well timed increases in interest rates. The current tightening cycle, which began back in mid-2002, has in fact been remarkably restrained compared to previous cycles, leaving the official cash rate 75 bps below its previous cycle peak and not far from what is widely regarded as a neutral setting for the official cash rate. So policy settings remain accommodative relative to the standards of previous cycles in Australia, partly because the increase in the net debtor status of the household sector has made monetary policy more potent relative to previous cycles.
What is not widely appreciated is that the RBA has generally disavowed the practice of directly targeting asset prices with monetary policy. For example, this is what RBA Governor Macfarlane had to say last year in relation to housing-related credit growth:
In essence, monetary policy has one instrument – it can set the path of short-term interest rates. Over the past dozen years or so, it has set a path which has achieved the outcomes for inflation, growth and employment which I have just outlined.
What would have happened if, instead, we had aimed our monetary policy at one of the other objectives put forward, say a substantially lower growth of credit. I am not sure whether we would have been able to achieve this, but I do know that the attempt to do so would have required setting a path of interest rates which was significantly higher than the one we did. This, in turn, would have meant that the outcomes for inflation and economic growth would have been lower than we actually achieved. I do not think this would have been a good economic result, and it certainly would have violated the letter and the spirit of our agreement on accountability. As I said earlier, a central bank cannot be accountable for everything, and our monetary regime recognises this, while at the same time choosing the right objective to be accountable for.
While the RBA deserves considerable credit for its handling of monetary policy, it has conducted interest rate policy in an entirely conventional way. The lesson from Australia’s experience is not that monetary policy should target house prices (which as Macfarlane notes, would not be consistent with its mandate), but that a well formulated inflation targeting regime is a good general framework for policy. This is the lesson the Fed should take away from Australia’s experience.
posted on 18 August 2005 by skirchner in Economics
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Does the Composition of Foreign Securities Purchases Really Matter?
Every month, we see certain economics bloggers pouring over the data on net foreign securities purchases for the US, trying to discern implications for strength or otherwise in the financing of the US current account deficit. In fact, the current account deficit must be financed by definition, so the absolute amount of financing is never in question, yet many analysts persist in approaching these data as though the financial account tail wags the current account dog.
For a given domestic saving-investment imbalance, asset prices adjust to ensure that the resulting current account deficit is financed. Shifts in the asset composition of the financial account are likely to reflect changes in relative asset prices, but the absolute value of this financing is essentially pre-determined for a given current account deficit. Only the prices these assets trade at is in question, and these reflect the influence of all market participants, not just those foreigners looking to recycle surplus USD receipts because of systemic problems in their own domestic capital markets, which renders their funding of the US current account deficit non-discretionary. US asset pricing has of course remained remarkably robust throughout the recent deterioration in the current account, as many US bond and dollar bears have discovered at great cost.
As RBA Governor Macfarlane has argued persuasively before a Chinese audience, countries with open capital markets and floating exchange rates do not face an external financing constraint. Countries with managed exchange rate regimes and closed capital markets have the bigger problem.
posted on 17 August 2005 by skirchner in Economics
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Skilled Migrants or Guest Workers?
The Federal government has launched a campaign to fill 20,000 new places in the skilled migration program. This comes after Federal Treasurer Peter Costello ruled out the use of ‘guest workers’ as being ‘inconsistent with Australian values,’ despite being an obvious way of meeting both skilled and unskilled labour shortages and an effective form of development assistance for source countries. Of course, we already have a de facto guest worker scheme in the form of European backpackers on working holiday visas, so a new guest worker visa category is not such a great leap.
What surprises me is that very few people see the guest worker concept as also being an obvious solution to the high cost of child care and the work-family balance issue. Creating a special visa category for live-in amahs from South East Asia could dramatically lower the cost of child care and domestic help and promote higher labour force participation rates.
posted on 16 August 2005 by skirchner in Economics
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The Fed Succession: When Supply-Siders Attack
The WSJ surveys US economists on their preferred replacement for Alan Greenspan, with CEA Chair Ben Bernanke commanding a plurality of support at 30%. Bernanke is also still the favourite on Intrade, although the Bernanke contract has suffered recently in the wake of a Lawrence Lindsay rally (dare I suggest ‘bubble’?) on the strength of a favourable mention in another WSJ story. Perhaps the biggest uncertainty about each of the candidates is whether they actually want the job. Bernanke would make a fine Fed Chairman, although I think Martin Feldstein is the stronger prospect.
We previously noted Bryan Caplan’s defence of Bernanke against the attack of the fever swamp Austrians. Leading free banking theorist Larry White also offers a partial defence of Bernanke against a rather strange and ill-considered attack from the National Review’s knee-jerk supply-siders. As someone who is also partial to free banking (albeit of the Yeager-Greenfield BFH variety), I have very few reservations about Bernanke. Indeed, some of Bernanke’s recent work is consistent with the views of pre-rational expectations, old school monetarism, a departure from the neo-Wicksellian paradigm that dominates contemporary thinking about monetary policy.
The WSJ story quotes at least one analyst saying:
financial markets have become overly complacent about the succession question. He says any successor, no matter how sound, will be selected at some cost to the markets.
“Nobody can replace Greenspan’s reputation,” Mr. Harris says. “His reputation helps keep low risk premiums in the markets. That will be lost on the day he retires. It can be re-earned by the next chairman, but there will be some loss.”
One of the costs associated with the highly discretionary approach to monetary policy personified by Alan Greenspan is the failure to institutionalise the Fed’s credibility. Hopefully, the next Fed Chair will begin the task of formalising an inflation targeting framework for US monetary policy.
posted on 13 August 2005 by skirchner in Economics
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RBA Governor Macfarlane: Economic Myth Buster
RBA Governor Macfarlane’s appearances before the House Economics Committee see some woeful displays of economic ignorance and ham-fisted attempts at political point-scoring on the part of Committee members. Most of their questions consist of wildly partisan statements with which they then invite the Governor to agree, as if Macfarlane is not smart enough to see them coming. In what is invariably a very classy performance, Macfarlane and his senior officers patiently listen to these questions and elevate the proceedings by turning them into some much needed education for Committee members and the public.
Particularly interesting were Deputy Governor Stevens’ remarks on the results of the RBA’s current research into home equity withdrawal. Stevens said that the early results point to something this blog has been arguing for some time, that very little of this is going into consumption, but instead into other financial assets. As Stevens pointed out, if home equity withdrawal had all been going into consumption, we would have already seen a massive boom and bust in consumption and this is not remotely supported by the data. When this research is finally published, it will almost certainly make a lot of commentary on this subject look very silly.
Macfarlane noted that the boom and subsequent correction in Sydney house prices closely matched what was happening with population growth in NSW and suggested that the recent decline in house prices was attributable to net emigration from the state, which in turn is driven by housing affordability. In other words, there are some sound fundamental reasons for the observed behaviour of Sydney house prices, with feedback from house prices to population growth as falling housing affordability drives people out of the state. Macfarlane did lapse into using the term ‘bubble,’ but I think this was just a concession to popular usage that is belied by what he had to say on the subject.
Macfarlane also agued, consistent with the consenting adults view, that none of us can know what the ‘right’ net foreign debt to GDP or private debt ratios should be, and also noted that fiscal policy has not had a major impact on monetary policy in the last seven years.
Perhaps the funniest moment was when a Committee member tried to argue against the privatisation of Telstra, on the grounds that consumption would suffer as people bought newly issued Telstra stock. Deputy Governor Stevens suggested that the impact on consumption would be zero ‘as a first approximation.’ The member in question probably still does not realise how stupid this made him look.
The Hansard transcript of proceedings should eventually appear on the RBA web site, for those who are interested.
posted on 12 August 2005 by skirchner in Economics
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Economics Blogs Lead Wall Street
The WSJ profiles economic blogs:
While many investors continue to take their cues from traditional outlets, the real news junkies—including those who aim to get a trading idea before they hear about it from their broker—have bookmarked the blogs, or Web logs. Even Wall Street itself is paying heed.
“It’s all about the ‘memes,’ ” says Stan Jonas, head of interest rate strategy at Fimat USA in New York, employing a word that describes ideas that spread quickly by word of mouth—or Web. “Those guys say it and about a week or two later, the guys on Wall Street pick it up.”
posted on 12 August 2005 by skirchner in Economics
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Bubble Triple Jump
Glenn Rudebusch suggests a few hurdles that need to be satisfied before monetary policy responds to ‘bubbles:’
The decision tree for choosing a Bubble Policy poses a daunting triple jump. For example, consider the run-up in the stock market in 1999 and 2000, when there was widespread suspicion that an equity price bubble existed and people worried that it could result in capital misallocation and financial instability. Still, those worries did not spur a Bubble Policy, in large part because it appeared unlikely that monetary policy could have deflated the equity price bubble without substantial costs to the economy. After the fact, of course, the macroeconomic consequences from the apparent boom and bust in equity prices arguably have been manageable.
However, the decision tree does not provide a blanket prohibition on bubble reduction, and as yet, there is no bottom line on the appropriate policy response to asset price bubbles. Those who oppose a Bubble Policy stress the steep informational prerequisites for success, while those who favor it note that policymakers often must act on the basis of incomplete knowledge.
posted on 11 August 2005 by skirchner in Economics
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Stalked by the ‘Bubble’ Brigade
Housing ‘bubble’ stalkers.
posted on 10 August 2005 by skirchner in Economics
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Allan Fels as Next OECD Secretary-General?
Place your bets here.
posted on 10 August 2005 by skirchner in Economics
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Review of Bubble Man: Alan Greenspan & the Missing 7 Trillion Dollars
My review of Peter Hartcher’s (2005) Bubble Man: Alan Greenspan & the Missing 7 Trillion Dollars. Black Inc: Melbourne.
continue reading
posted on 10 August 2005 by skirchner in Economics
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Australian House Price Developments
The RBA’s quarterly Statement on Monetary Policy includes a useful discussion of recent house price developments. One of the major problems with existing house price data is that the majority of the measured variation is attributable to compositional distortions, so the RBA has developed an index which adjusts for these shifts, giving a more reliable and less volatile series for house prices.
The RBA seems to have come around to a rather benign view of the role of recent house price developments in the economy, consistent with the view I have been arguing for some time:
The correction in the housing market appears so far to have proceeded reasonably smoothly, and the prospect of an excessive and unwelcome slowing in domestic demand has been reduced by the boost to national incomes coming from the favourable terms of trade.
posted on 08 August 2005 by skirchner in Economics
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Australia-Japan Economic Outlook Conference
Manuel Panagiotopoulos of Australian-Japan Economic Intelligence has once again staged an excellent Australia-Japan Economic Outlook Conference. HSBC chief economist John Edwards gave a presentation on the Australian economy, which ran through a host of macroeconomic indicators showing their best performance in 30 to 50 years and a housing downturn that is shaping up as the most modest in 20 years. Proving that there is no market for good news, this had at least one conference participant demanding to know when it would all end. While nobody is arguing that the business cycle has been abolished, the many who predicted disaster on the back of the downturn in house prices have been thoroughly discredited. John Edwards has been one of the few to have argued consistently against this view. US pundits, take note!
There was also some impromptu ridicule heaped on The Economist magazine (and with absolutely no prompting from me!) Edwards said that he found The Economist ‘unnecessarily somber,’ a more polite version of the critique of the magazine we have been running here. While there was also some positive comment about the magazine’s recent coverage of oil prices, this was presented as the exception rather than the rule. As The Economist’s circulation breaks new records, it seems to be taken less and less seriously in circles where it once commanded considerable respect.
posted on 04 August 2005 by skirchner in Economics
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Implausible Headline of the Week
‘Nationals Put Sense into VSU.’
posted on 03 August 2005 by skirchner in Economics
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Forbes on Economics Blogs, Mark II
Forbes has updated its story on economics blogs from March 2003 and rather kindly suggests that ‘the depth of Kirchner’s discussions…isn’t matched in many other blogs.’ However, the author of the story concludes that ‘if you don’t know the difference between demand-pull inflation and dividend imputation, this probably isn’t the blog for you.’ One of the main motivations behind this blog has been my disappointment at the dumbing-down of economics and financial market reporting in the mainstream press. There seems to be a working assumption, even in the ‘quality’ press, that you should avoid challenging your readers. If this blog were not challenging, then I would be wasting my time writing it and there would be no point in you reading it.
The Forbes story also suggests that the blog’s ‘worst feature’ is being ‘Aussie-centric.’ The author of the story is perhaps unaware that one of the other eight economics bloggers profiled is a former resident of Australia. My other objective in writing this blog has in fact been to challenge the parochialism that sometimes afflicts discussion of public policy issues. An excellent example of this has been the attempt to frame debates about the US and Australian current account deficits and house price inflation in country-specific terms. Yet clearly there is a much bigger story here involving changes in the saving-investment preferences and financial technology of the Anglo-American economies. The cross-national perspective offered in this blog is hopefully a useful corrective to the more parochial perspective often found in the mainstream media, which still depends on a predominately local rather than global audience.
posted on 03 August 2005 by skirchner in Economics
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Foreign Official Sector Asset Purchases and Bond Markets
Brad Setser asks ‘Can China add close to $300 b to its reserves a year and have no impact on the bond market?’ I think the answer to this question is yes, although I would agree with him that the small size of the RMB revaluation means that it is not a good test of this proposition one way or the other. It is generally agreed that central bank intervention in foreign exchange markets is ineffective, because the size of these interventions are trivial in relation to the multi-trillion dollar daily turnover in these markets. Yes, central banks can peg their exchange rate below its equilibrium level, because there is no theoretical limit on the ability of a central bank to devalue its own currency by issuing more of its own liabilities, but as China has found, the sustainability of such a policy is limited in practice. Pegging the exchange rate above its equilibrium value is even more problematic because, as many countries have found, foreign exchange reserves can be quickly exhausted in attempts to defend fixed exchange rates against the weight of the market.
I would suggest that the same argument can be made in relation to central bank purchases of debt securities. It is very difficult to determine total turnover in global bond markets, because of the lack of centralisation in bond trading compared to foreign exchange markets. However, even the relatively small Australian bond market had an annual turnover of AUD 1 trillion in the mid-1990s. The totality of East Asian central bank purchases of USD denominated assets would have at best a marginal impact on markets with the depth and liquidity of US Treasuries and the US dollar.
posted on 02 August 2005 by skirchner in Economics
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