The Demise of the Euro
Back in 1999, I gave the euro five years at most. My prediction might have worked out if the goal posts, in particular, the Stability and Growth Pact, had not been shifted. Milton Friedman gave himself more wriggle room by forecasting the euro’s demise within ten years. The euro project is now being seriously questioned, and its possible demise actively canvassed, as Joachim Fels notes:
A full-blown political union in Europe is not only unlikely, it is also undesirable. Europe’s cultural, political and institutional diversity should be seen as a strength rather than a weakness because it encourages institutional competition for ideas and for mobile capital…
The euro’s founding fathers assumed that monetary union would over time quasi-automatically lead to political union and thus didn’t spend much time worrying about the long-run viability of the euro. But their assumption is clearly no longer valid…
As long as all euro members agree that higher inflation and fiscal deficits are desirable or at least unavoidable, this does not yet put the euro at risk. Each euro would merely buy less domestic and foreign goods and services. However, some member states’ tolerance for inflation and fiscal deficits is likely to be lower than that of others, especially if the euro would turn into a mini-lira. In this case, the more stability minded members might decide to introduce a harder currency. Needless to say, a break-up of EMU would be economically very costly for all parties involved. But that doesn’t mean it cannot happen.
These costs need to be balanced against the reduction in macroeconomic policy risk that would occur with the demise of the euro, in particular, the risk of serious monetary policy mistake by the ECB being propagated across the euro zone.
posted on 07 July 2005 by skirchner in Economics
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The Rise and Fall of Monetary Targeting in Australia
My review of Simon Guttmann’s (2005) The Rise and Fall of Monetary Targeting in Australia.
continue reading
posted on 06 July 2005 by skirchner in Economics
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The Economics of On-Line Dating
Hal Varian reports on some research into on-line dating in the US, including an interesting application of the Gale-Shapley algorithm:
There was a strong Lake Wobegon effect in the data, with only 1 percent of the population admitting to having “less than average” looks. Even so, only a third actually posted a photo. The reported weights of the women were substantially less than national averages and about 30 percent were blonde. The reported weights of the men were consistent with national averages and only about 12 percent were blond…
Having a lot of money is good for attracting e-mail messages, at least for men. Those men reporting incomes in excess of $250,000 received 156 percent more e-mail messages than those with incomes below $50,000…
I would guess that none of these findings are terribly surprising. Everyone knows you can’t be too rich or too thin.
Call me romantic, but I suspect these results grossly overstate the importance of money. Income probably proxies for a broad range of other characteristics that are desirable in their own right, not least the ability to write a literate and appealing profile, something which might not otherwise be captured in the data.
posted on 05 July 2005 by skirchner in Economics
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RBA Governor Macfarlane on Global Imbalances
An excellent speech given by RBA Governor Macfarlane in China, which argues that the sustainability of current account surpluses under fixed exchange rate regimes is much more questionable than the sustainability of current account deficits under floating exchange rate regimes:
there is a belief that current account deficits are unsustainable, whereas surpluses could go on forever. This was a reasonable assumption for most of the post-war period, particularly under the Bretton Woods system, but may no longer be so. In a world of floating exchange rates and mobile international capital, the old rules may no longer apply. The discipline applied by the international market place on developed countries with current account deficits now may be very weak.
Even under earlier monetary regimes, there are examples of countries that have maintained current account deficits for long periods. The United States in the nineteenth century is a good example, as is Australia in the twentieth. In the 1970s, Singapore ran a current account deficit which averaged 15 per cent for a decade. For developed countries with deep financial markets and little or no foreign currency exposure in their borrowing, current account deficits are not the problem they once were…
the scenario whereby world financial markets react to the US current account deficit by withdrawing funding has disappointed those who thought it would come into play. It may happen yet, but people have been predicting it for a long time and yet it seems no closer. A large part of the reason for this is that investors who want to get out of US dollars have to run up their holdings of another currency – they cannot get out of US dollars into nothing. They have to take the risks involved in holding some other currency, possibly at an historically high exchange rate, and they may well be reluctant to do so.
Macfarlane reproduces a quote of his own from 1998, which shows him to have been remarkably prescient on the rise of East Asian mercantilism in relation to official reserve assets.
posted on 29 June 2005 by skirchner in Economics
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Krugman Makes New Lows
Alex Tabarrok points to Paul Krugman’s continuing intellectual implosion.
posted on 29 June 2005 by skirchner in Economics
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Border Security or Tariff Police?
It is an interesting sign of the times that one of the better rating shows on Australian television is Border Security, which goes behind the scenes to document the activities of the Australian Customs Service and Immigration. For anyone with classical liberal sensibilities, it makes uncomfortable viewing, not least because of the enormous effort that goes into enforcing bad laws.
An example from a few weeks ago was the two Indian shoe salesmen, who were carrying with them 150 shoe samples. The fact that the shoes were unpaired was not enough to convince Customs that these were samples. As a Customs officer explained, the other shoes could be brought in separately and then re-paired for local sale! So the hapless shoe salesmen were required to destroy each shoe by drilling a hole in them.
The real problem was that the two merchants had not completed the right paperwork, but one Customs officer explained that part of their job was to protect Australian industry from damage that might be inflicted by foreign goods. We can all sleep easier at night knowing that we have been kept safe from 300 Indian shoes that might have otherwise found their way on to the feet of unsuspecting Australian consumers.
posted on 28 June 2005 by skirchner in Economics
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Econometrics in the City
At least one person is hoping econometrics will help him pick up.
(via Freakonomics)
posted on 25 June 2005 by skirchner in Economics
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Housing ‘Bubbles,’ Financial Intermediation and Moral Hazard
More refreshing housing ‘bubble’ scepticism from James Hamilton, invoking a ‘consenting adults’ view of financial intermediation in relation to housing:
even if you readily believe that large numbers of home buyers are fully capable of just such miscalculation, there’s another issue you’d have to come to grips with before concluding that the current situation represents a bubble rather than a response to market fundamentals. And that is the question, why are banks making loans to people who aren’t going to be able to pay them back? Maybe your neighbor doesn’t have the good sense not to burn his own money, but is the same also true of his bank?
If you want to come up with an answer more sophisticated than “banks are stupid, too,” I think you’re ultimately led to look for the real roots of the housing bubble, if you think there is one, in some kind of moral hazard argument explaining why the equity capital of lending institutions is insufficient to cover the risk in the mortgage loans they issue or hold.
I earlier mentioned deposit insurance as one story that could be told along these lines, while Greg Hess and the Chicagoboyz some time back argued that Fannie Mae could be playing such a role. But it’s not obvious what changed recently along these lines to only now be producing a housing bubble.
Astute readers will notice this is the same argument we have been making in relation to current account deficits.
posted on 25 June 2005 by skirchner in Economics
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Putting Your Money Where Brad DeLong’s Mouth Is
One of my frequent complaints about those who indulge in ‘bubble’ talk is that they rarely put their money where their mouth is. Most people are probably correct in thinking that they have made prudent decisions in relation to their own finances, but they are equally ready to assume that everyone else is being imprudent (inconsistencies of this sort are a common result in behavioural economics/finance). What amuses me most about those who worry about the current account deficit is that many would have personal balance sheets that are little different in substance from the current account deficit and, indeed, make a direct contribution to it, but few would perceive themselves as part of the ‘problem.’
Mark Kleiman would appear to be a notable exception, selling his house for speculative reasons, or as he says, putting his money where Brad DeLong’s mouth is. Unfortunately, his reasoning is little more than a tautology, combined with Bush Derangement Syndrome:
If the current fiscal and trade deficits are unsustainable, especially with national economic policy run by the cast of a clown show, then they won’t sustain themselves forever.
While I think this is incredibly silly, Kleiman gets full marks for consistency. He is certain to suffer for his beliefs.
posted on 23 June 2005 by skirchner in Economics
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Demographic Underpinnings of US Potential Growth
A very good critical review of some of the demographic-panic literature in the US, including this observation:
the US is exceptional. Our birthrates have fallen, and thus the average age of our people has increased, but it has happened more gradually than elsewhere. What’s more, our population is projected to keep growing. This is not only because of immigration, as Wattenberg suggests, but because of higher fertility among native-born women; even college-educated, non-Hispanic white women have a total fertility rate of 1.7 children, higher than the overall rates of Canada, Britain, or Australia, not to mention the even lower rates of Japan, Germany, Italy, and Spain.
Within the context of falling birthrates worldwide caused by urbanization, education, and the rest, Americans, as both a more religious and more optimistic people, simply choose to have more children. In fact, the only Census Bureau scenario that foresees a declining U.S. population in this century is based on the highly unlikely assumptions that, first, the fertility of American women will fall to European levels, and second, immigration will be reduced to levels below even what most restrictionist organizations call for. Barring catastrophe, then, the population of the US will not decline during the lifetime of anyone reading this article.
posted on 22 June 2005 by skirchner in Economics
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Austrian School or Austrian Schooled?
An editorial in New Zealand’s National Business Review refers to me as ‘Australia’s Austrian school economist.’ NBR must be the only mainstream media publication in the world that doesn’t have to explain ‘Austrian school’ to its readers. Only in New Zealand!
As careful readers of this blog will have noticed, I am very sympathetic to most Austrian School insights, and I’m a disequilibrium rather than a general equilibrium theorist. As the article implies, that is partly why I’m a ‘bubble’ sceptic, but it is also what sets me apart from most people who call themselves ‘Austrian,’ especially the fever swamp Austrians of Auburn Alabama. These people are all too ready to run with ‘bubble’ talk, because it ties in with their naïve, mono-causal explanation of the business and asset price cycle as being entirely attributable to fiat money supply errors.
An authentic interpretation of the Austrian tradition would see asset price inflation and deflation as a necessary part of the market discovery process, which would emerge under a variety of plausible monetary regimes, including whatever model of free banking one might prefer. My only reservation about the Austrian School label is the dubious company it has increasingly come to keep. It’s high time authentic Austrians drained the fever swamp!
posted on 21 June 2005 by skirchner in Economics
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Ken Henry and the Classics
The Secretary of the Treasury calls for a return to classical economics as the basis for macroeconomic policy:
one has to wonder whether the policy debate in this country is not the sort of thing that one might have hoped to see in a ‘classical’ economy of the sort that economists thought existed before the Great Depression and the ensuing Keynesian revolution; a debate about the factors that influence our productive capacity rather than the factors that influence our demand for it.
This shift in policy attention – from pre-occupation with the management of effective demand to an interest in the things that affect aggregate supply – is timely since, especially for demographic reasons, the principal macroeconomic issue of the very near future will be inadequate participation, not unemployment – a problem of too few people wanting a job, not too many…
It might be worth asking the question whether, because of the reform efforts of the past, we should not now consider ourselves to be most often in a ‘classical’ world in which the economy naturally trends toward, and in fact spends most of its time quite close to, its productive capacity, or supply potential, without the need of continuous macro policy stimulus.
Answering this question in the affirmative would not imply a view that we have eliminated the business cycle. There will be future economic downturns. And when we see evidence of one we should not be afraid of responding with activist expansionary macroeconomic policy. Rather, an affirmative answer implies some conditioning of the exercise of macro policy activism – an acceptance that large swings in macro instruments are to be implemented (only) in extremis.
posted on 21 June 2005 by skirchner in Economics
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Greenspan, Monetary Policy and Asset Prices
The SMH has been running extracts from Peter Hartcher’s forthcoming book Bubble Man: Alan Greenspan & the Missing 7 Trillion Dollars. I will post a full review in due course, but the extracts highlight numerous problems with Hartcher’s argument. Hartcher notes:
And the research by the Fed’s own economists is also at odds with the chairman’s contention. By demonstrating that surprise changes in official interest rates have a “multiplier” effect on stock prices of between three and six times, their work simply affirms what market strategists already knew - the Fed can make a powerful difference. And a tightening would certainly introduce an element of risk for speculators and interrupt the one-way bet that generates speculative momentum.
This is very selective, ignoring an extensive body of Federal Reserve Board and other research which suggests that targeting asset prices with monetary policy would be a disaster.
Hartcher’s conclusion is almost pure hyperbole:
We are left with the conclusion that, because of acts of omission as well as acts of commission, Alan Greenspan was not prepared to contain or manage in any way one of the most deluded and dangerous market manias in four centuries of financial capitalism until it had assumed such vast proportions that recession was inevitable.
This is a good illustration of how careless talk about ‘bubbles’ promotes the belief that asset prices can be centrally planned by monetary policy. It is the asset market equivalent of the socialist calculation debate of the 1930s. If you think the tech stock boom and bust was manic, wait and see what markets look like when central banks start second-guessing the market on asset prices. If monetary policy is as powerful as Hartcher would have us believe, and the Fed Chairman as prone to error as Hartcher suggests, then surely this is a strong argument against activist monetary policy, particularly where asset prices are concerned.
posted on 20 June 2005 by skirchner in Economics
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More Housing ‘Bubble’ Scepticism
In case you haven’t noticed, James Hamilton is now blogging. He suggests some simple fundamentals underpinning gains in house prices:
This simple calculation helps us to understand that if a community experiences a change in its growth rate, property values can increase a great deal over a short time. For the above example, going from 2% to 3% growth would cause the property values to double overnight. It’s noteworthy that over the last 5 years, the three states with the highest population growth rates as reported by the Census Bureau—Nevada, Arizona, and Florida—have also been among the locations that saw the biggest increase in home prices. Forces such as these, rather than a random distribution of irrational exuberance, seem a more natural explanation for why some communities got bubbled and others didn’t.
posted on 19 June 2005 by skirchner in Economics
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The Current Account, Foreign Exchange and Interest Rate Risk
Alan Wood highlights some widely underappreciated facts about Australia’s lack of exposure to foreign exchange and interest rate risk in relation to its foreign borrowings:
In 2001 [the RBA] asked the Australian Bureau of Statistics to do a survey on the issue. It found that once the banks’ off balance sheet activities in derivatives were taken into account, their foreign exchange exposure was negligible - their borrowings were all effectively in Australian dollars.
This is still the case, so a fall in the dollar won’t lead to a banking crisis. And it is not just the banking system. The ABS found that Australia as a whole was long on foreign currencies - assets exceeded liabilities.
This means that Australia as a whole is not vulnerable to changes in currency valuations caused by even large falls in the exchange rate. A fall in the dollar would actually be a financial gain, not a loss. This is also still true.
And then there is refunding risk. What if foreign investors become worried about our current account deficits and high debt levels? They will push down the exchange rate and push up interest rates, making it too expensive for banks to go on funding offshore.
When they come back onshore to borrow it will push up interest rates, won’t it? Only marginally, according to the RBA. Banks borrow mainly at the short end of the yield curve, where it sets the rates, and it is not going to respond to a fall in the dollar by pushing up official rates.
posted on 18 June 2005 by skirchner in Economics
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