2008 05
This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 31 May 2008 by skirchner in Economics, Financial Markets
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Bill Easterly on the World Bank’s Growth Commission:
The report of the World Bank Growth Commission, led by Nobel laureate Michael Spence, was published last week. After two years of work by the commission of 21 world leaders and experts, an 11- member working group, 300 academic experts, 12 workshops, 13 consultations, and a budget of $4m, the experts’ answer to the question of how to attain high growth was roughly: we do not know, but trust experts to figure it out.
This conclusion is fleshed out with statements such as: “It is hard to know how the economy will respond to a policy, and the right answer in the present moment may not apply in the future.” Growth should be directed by markets, except when it should be directed by governments.
My students at New York University would have been happy to supply statements like these to the World Bank for a lot less than $4m.
Why should we care about the debacle of a World Bank report? Because this report represents the final collapse of the “development expert” paradigm that has governed the west’s approach to poor countries since the second world war. All this time, we have hoped a small group of elite thinkers can figure out how to raise the growth rate of a whole economy. If there was something for “development experts” to say about attaining high growth, this talented group would have said it.
posted on 30 May 2008 by skirchner in Economics
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New Zealand Institute of Economic Research economist Trinh Le on the KiwiSaver scheme (HT: Matt Nolan):
KiwiSaver is merely a money-go-round. Over half of the savings are funded by taxpayers, in the form of the $1000 kick-start subsidy, matching contributions of up to $1040 per year and foregone tax revenue from ESCT (employer superannuation contribution tax) exemption. Most of the remaining savings are employers’ contributions and money that members would have saved in other forms.
Only 9-19 per cent of KiwiSaver balances are estimated to be from reduction in consumption.
That much “new” saving is hardly enough to cover the administration and compliance costs of implementing the scheme, and the deadweight loss due to taxation…
More on KiwiSaver from Phil Rennie at CIS.
posted on 26 May 2008 by skirchner in Economics, Financial Markets
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This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 24 May 2008 by skirchner in Economics
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Looks like budget cuts may have finally ended Australia’s role in the European Bank for Reconstruction and Development:
A reality check comes from Down Under. Speaking at the Kiev meeting, Peter Reith, EBRD director for Australia and New Zealand, said that “the EBRD has achieved a great deal in its 17 years.” “It is in this context of a job well done,” he announced, “that the Australian government intends to withdraw from the bank by 2010.”
Australia has given the EBRD €52.5 million since the bank’s founding, about a quarter of the €200 million it originally committed. The EBRD’s biggest shareholder, the U.S., committed €2 billion and has so far paid in €525 million. David McCormick, Treasury Undersecretary for International Affairs, says the bank is at a “crossroads,” but that the U.S. “remains a strong supporter.” Australia looks smarter.
Australia was none too smart to sign-up for the EBRD in the first place, especially given its focus on a region far removed from Australia’s interests. I recall researching the institution when the capitalisation bill came before parliament in the early 1990s and was appalled at what I found. It was apparent even then that this would be another scandal-ridden multilateral development bank.
As the WSJ article notes, the EBRD suffers from the same problem as all the other multilateral development banks. Redundancy has bred mission creep:
At its annual meeting in Kiev this week, the European Bank for Reconstruction and Development—founded in 1991 to assist the former Soviet bloc states—confirmed that, among other things, it wants to explore projects in Turkey.
That’s an odd idea for a bank whose mission is to “foster the transition towards open market-oriented economies and to promote private and entrepreneurial initiative in the Central and Eastern European countries committed to and applying the principles of multiparty democracy, pluralism and market economics.” Turkey is a democracy, has an open market, and isn’t in Central or Eastern Europe…
In recent years, the bank has moved south and east as Soviet bloc countries have grown richer. Fully 42% of its investments last year went to Russia. Never mind that Russia is rolling in oil revenues and also receives subsidized capital from the International Finance Corporation, an arm of the World Bank. EBRD President Thomas Mirow, who took office on Monday, says he supports Turkey’s request to have the EBRD invest there.
posted on 23 May 2008 by skirchner in Economics
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The government’s budget cuts may not amount to much, but they certainly range widely:
Plans for a $5 million national bilby centre in south-western Queensland have been shelved, after the Federal Government pulled out of a funding deal.
However, the bilby lobby seem to understand the political economy of government spending all too well:
Manager Jane Morgan says that money was to be used to build a new observatory, but those plans have also now been shelved with the funding cut.
“Yes we are a little bit disappointed, but it’s not as if they’ve said ‘forever and a day there will be no more grant programs in this area’,” she said.
“This is the looking at Government expenditure that they went through and it is disappointing because we had some great plans, but we’re not going to put those plans away.
“We’re just going to put them on a shelf which is easily reached and pull them out again.”
CORRECTION: The quote is actually not from the bilby people, but from those involved with another project that got cut. Same point applies, however.
posted on 21 May 2008 by skirchner in Economics
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Treasury Secretary Ken Henry, in his traditional post-Budget address to ABE, points to the correct interpretation of the role of the budget in demand management:
activist counter-cyclical fiscal policy might be frustrated by lags of recognition, implementation and transmission. And its effectiveness might be compromised by Ricardian equivalence, the permanent income hypothesis or import leakages. I noted that these lags and questions of effectiveness pose real challenges for the use of counter-cyclical fiscal policy. But I also noted that they do not rule out such use.
And, obviously, they do not rule out allowing the so-called automatic stabilisers to work. That’s probably how the fiscal stance contained in this budget should be interpreted. With respect to the current year, 2007-08, the Pre-Election Economic and Fiscal Outlook (PEFO) published in the November 2007 election period estimated an underlying cash surplus of 1.3 per cent of GDP. Last week’s budget reveals parameter and other variations since PEFO that would have added $5.2 billion, or about 0.5 per cent of GDP, to the underlying cash balance. Of this, more than 0.3 per cent of GDP is additional tax revenue. Most of that upward revision to tax revenue has been ‘saved’, to achieve a 2007-08 surplus estimated now to be 1.5 per cent of GDP. For the budget year, 2008-09, the government has targeted an underlying cash balance excluding tax revenue revisions of the same proportion of GDP – that is, 1.5 per cent. Adding the revisions to tax revenue since PEFO, the estimated surplus for 2008-09 is 1.8 per cent of GDP.
See the end of Henry’s remarks for a swipe at opposition Senators.
posted on 20 May 2008 by skirchner in Economics, Financial Markets
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I will be speaking at the Sovereign Wealth Funds Summit on 26 June on the subject of ‘Sovereign Wealth Funds and Financial Markets: A Stabilising Force?’ Summit details and registration can be found here.
posted on 19 May 2008 by skirchner in Economics, Financial Markets
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This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 17 May 2008 by skirchner in Economics, Financial Markets
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RBA Governor Glenn Stevens revisits the economics of the 1970s:
“There is much less inclination than there once was to use fiscal policy as a counter-cyclical stabilisation tool,” he told alumni of the Sydney University economics faculty last night.
Mr Stevens and his predecessor Ian Macfarlane have set little store by the use of the budget to influence inflation or rates.
Mr Stevens earlier this year said the budget should be judged for the value of the measures it contained and the sustainability of government finances.
“It shouldn’t be judged through the narrow prism of what might it mean for the overnight cash rate,” he said in January.
This does not stop the commentariat and Access Economics from living in a 1970s time-warp.
posted on 16 May 2008 by skirchner in Economics, Financial Markets
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There is something about the Future Fund that brings out the latent statism of the commentariat. Here’s Alan Kohler, praising the growing amount of revenue being hoarded by the Australian government:
Sometime next year Australia will have its own $US100 billion sovereign wealth fund (SWF) and the Government will have a positive net worth for the first time.
…it finally puts Australia on the right side of global decoupling, as one of the world’s resource rich nations building wealth for the future. It’s been that for a while, except the proceeds have been frittered over the past few years.
We still have the Anglo-Saxon west’s propensity for lots of personal and household debt, but at least the Government will be entirely debt-free (including [sic] pension obligations) and building real wealth.
What Kohler doesn’t seem to understand is that the Future Fund and its sister funds announced in this week’s Budget are simply holding vehicles for future government spending. If the government were spending all of these funds today, Kohler would likely deem it irresponsible. But it makes no difference whether future government spending is paid for out of current or future taxes (the investment returns on the Fund are simply compensation for the opportunity cost of not spending the money today). It is far more likely that these funds will be ‘frittered away’ by government than by taxpayers. All the Future Fund does is ensure that current taxpayers are now paying for the government frittering of the future, as well as the present.
The ‘real wealth’ being ‘built’ in the Future Fund is no such thing. It comes entirely at the expense of the current wealth-generating capabilities of the private sector.
posted on 15 May 2008 by skirchner in Economics, Financial Markets
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The Labor government’s first budget had more in common with those of its predecessor than it would care to admit. The chief fiscal problem confronting policymakers is not fighting inflation, but finding a home for the revenue growth that continues to exceed Treasury forecasts and for which the government has no current use after delivering on its election tax cuts and other commitments. At 1.8% of GDP, the underlying budget surplus is larger than at any time since 1999-00, but still a trivial tightening on the 1.5% of GDP seen in 2007-08. The Commonwealth has now been running surpluses of 1% of GDP or more since 2002-03 and at least 1.5% of GDP since 2004-05. As Alan Wood notes ‘The cynicism born of many budget lock-ups says that this is a remarkably convenient pattern of surpluses.’
Peter Costello’s solution to the problem was a combination of tax cuts and hoarding revenue in the Future Fund, which is much the same approach taken by Labor with its Building Australia Fund and revamped higher education fund. Whether revenue is better used buying financial assets or invested in as yet unspecified infrastructure is far from clear. If infrastructure needs were so pressing, the government would not need a body like Infrastructure Australia to go in search of suitable projects and would instead have no problem drawing up a list and timetable of projects in the Budget itself. Investment spending has been at post-war record highs as a share of GDP, so there is no shortage of investment on the part of the private sector. The danger is that the BAF becomes a public sector white elephant fund.
At the same time, Labor has still not fully funded the ‘aspirational’ part of its election tax cuts, which aim to reduce the existing four tax scales to three by 2013: 15%, 30% and 40%. These aspirational tax cut commitments would have more credibility if they had been fully funded in the budget and could conceivably even have immediate supply-side benefits if the public were convinced they would be delivered. The failure to fully fund them suggests that the ‘aspirational’ part of the tax cuts will remain just that. Social democrats like John Quiggin are openly looking forward to the inflation tax that will claw back the tax cuts.
Ross Gittins and Chris Richardson still seem to think that the main role of the Budget is to save RBA Governor Stevens from having to do any work. According to Gittins:
Even if further interest-rate increases don’t prove necessary, the budget does nothing to bring forward the day when the Reserve Bank is able to start cutting rates.
Just as predictably, Chris Richardson said that:
Tax cuts are clearly inflationary and clearly dangerous in an economy that is still at full stretch. Much of them will be spent.
The budget has no relevance for inflation and interest rate outcomes, but even if it did, why would we prefer restraint in demand to come from higher taxes than higher interest rates? On political economy grounds, we should prefer higher interest rates. The interest rate cycle will eventually turn, whereas the expansion of government probably won’t. The real agenda of those who oppose tax cuts is to support the secular expansion of the state.
posted on 14 May 2008 by skirchner in Economics, Financial Markets
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David Uren highlights the private sector offset to increased public sector saving:
there is a good body of academic research showing that savings decisions by government and individuals are inversely related—that increases in government surpluses are financed, at least in part, by consumers running down their savings.
The superannuation industry, which has doubled its contribution to tax revenue to $10 billion in the past five years, has always argued that the Government’s surpluses are based upon sequestering the savings of households.
Research conducted by the OECD shows that for Australia, every additional dollar saved by the public sector results in a fall in private savings of about 50c. This is in line with the international average.
The OECD study looked at the savings performance of government and individuals in 21 countries, including Australia, over a 30-year period.
It suggested that the trade-off between individual and public sector saving would be greatest at times when public sector debt was low and private sector debt was high, as is the case now in Australia.
I review similar evidence here. This is just one of the reasons why budget surpluses don’t put downward pressure on interest rates, because dissaving by the private sector offsets the government contribution to national saving. In any event, the domestic saving-investment balance does not determine domestic interest rates given an open capital account.
posted on 12 May 2008 by skirchner in Economics, Financial Markets
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Terry McCrann poses some questions to Chris ‘Rainy Day’ Richardson:
What would have been - dangerously - fiscally irresponsible is to have not had the cuts each year. If Costello had listened to the twitterings of Access Economics, which opposed every single one of the yearly cuts, the budget would be groaning under surpluses of $70 billion a year or more.
Ceteris paribus - all other things being equal - as the economists like to say. When, of course, they wouldn’t have been, either in terms of the impact on the economy or the political process.
It was hard enough keeping the hands of his cabinet colleagues, from the prime minister down, off even the tax cut-reduced surpluses.
Even the team at Access would - should be forced to - concede the literal impossibility of letting those surpluses mount ever higher. But perhaps Access’s Chris Richardson could say when over the last five years and how such huge surpluses would have been spent.
And/or how they would be dispersed today and tomorrow. He objects to the current $31 billion of tax cuts over the next four years, at the supposed cost of higher interest rates.
I doubt, though, that he would be endorsing cuts of $100 billion over that time frame. Just to take the last three years of Costello’s tax cuts.
posted on 10 May 2008 by skirchner in Economics, Financial Markets
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This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 10 May 2008 by skirchner in Economics, Financial Markets
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The RBA’s quarterly Statement on Monetary Policy contained an inflation forecast consistent with the 2-3% medium-term target range, assuming you don’t mind waiting until Christmas 2010 to get it. This was achieved largely by way of a dramatically lower economic growth forecast. Non-farm GDP is now expected to slow to 1.75% by the end of this year, compared to the 2.75% forecast in the February Statement. This is an annual growth rate not seen since 2001 in the wake of the recession in domestic final demand that followed the introduction of the GST in the second half of 2000. In effect, the RBA has dramatically raised the bar on the weakness we will have to see in the activity data this year for the RBA not to further raise interest rates. The RBA’s forecasts highlight the growth sacrifice that will now need to be made to tame inflation. Even then, inflation will still be sitting at the upper-end of the target range.
posted on 09 May 2008 by skirchner in Economics, Financial Markets
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Gerard Baker on the Great Depression that wasn’t:
I don’t know about you but I feel a bit cheated. There we all were, led to believe by so many commentators that the sub-prime crisis was going to force the United States into a new era of dust bowls and breadlines, a slump that would call into question the very functioning of the capitalist system in the world’s largest economy. Carried away on the surging wave of their own economically dubious verbosity, the pundits even speculated that this unavoidable calamity might presage some 1930s-style global political cataclysm to match.
Well, it’s early days, to be fair, but so far the Great Depression 2008 is shaping up to be a Great Disappointment. Not so much The Grapes of Wrath as Raisins of Mild Inconvenience.
posted on 07 May 2008 by skirchner in Economics, Financial Markets
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Traxis Partners MD Cyril Moulle-Berteaux argues the US housing downturn is all but over:
In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.
The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in “months of supply” terms. That’s the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.
Inventories are declining because construction activity has been falling for such a long time that home completions are now just about undershooting new home sales. In a few months, completions of new homes for sale could be undershooting new home sales by 50,000-100,000 annually.
Inventories will drop even faster to 400,000 – or seven months of supply – by the end of 2008. This shift in inventories will have a significant impact on prices, although house prices won’t stop falling entirely until inventories reach five months of supply sometime in 2009. A five-month supply has historically signaled tightness in the housing market.
posted on 06 May 2008 by skirchner in Economics, Financial Markets
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Once-were-inflation-warrior turned inflation capitulationist ‘Henry Thornton’ concedes:
if wages begin to surge, all bets will be off and the bank will need to hit the economy with additional rate rises until people demanding wage increases get the message.
If you like record-breaking growth rates in the labour price index, then you are probably going to love next week’s March quarter release.
Meanwhile, over in Imagination Land:
BRENDAN NELSON will today challenge Labor’s first budget a week before its release by claiming there was no need for spending cuts because Australia’s inflation crisis was “imaginary” and “a complete charade”.
posted on 06 May 2008 by skirchner in Economics, Financial Markets, Politics
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Regular readers will not be surprised to learn I’m in furious agreement with Don Harding:
The most egregious error occurs when people argue that the Reserve Bank has aggressively tightened monetary policy. It has done nothing of the sort. The relevant measure for assessing whether the RBA has tightened monetary policy is the real (inflation-adjusted) cash rate, which stood at 3.1 per cent in March 2005 and now stands at 3.0 per cent. The seven increases in the nominal cash rate over this period have just kept pace with inflation and do not represent a tightening of policy…
The danger is that if I am right and inflation accelerates because the RBA’s approach is too soft, then the RBA will need to move aggressively and hike rates several times.
We got the first bottom-up look at June quarter inflation today, with the release of Don Harding’s inflation gauge for April. It was a shocker at 0.5% m/m and 4.3% y/y, the strongest annual growth rate on record for this series. Core inflation (ex-volatile items) rose 0.5% m/m and 3.9% y/y compared to 3.3% y/y in March. The trimmed mean, which proxies for the RBA’s preferred measures of underlying inflation, rose 0.6% m/m and 4.3% y/y compared to 3.8% y/y in March.
posted on 05 May 2008 by skirchner in Economics, Financial Markets
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This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 03 May 2008 by skirchner in Economics, Financial Markets
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Alan Wood on the Gans-Joye proposal to harness government guarantees to under-write mortgage lending:
The creation of a government - that is, taxpayer - subsidised institution, largely for the benefit of non-bank mortgage lenders, would need to be justified either by the existence of a long-term structural problem in the provision of housing finance in Australia, or evidence of a short-term collapse in the availability of home loans.
Neither problem is evident, and in any case it would take too long to set up such a body for it to be of any use in the current credit crisis. Nor is it warranted as a hedge against future crises.
Interestingly, in his upbeat press release, Greg Medcalf was obliged to include the following sentence: “While the proposal has received encouraging feedback, Mr Medcalf said there was some concern the enhancements were addressing a short-term market issue that did not require a long-term fix”. Just so.
posted on 03 May 2008 by skirchner in Economics, Financial Markets
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James Hamilton updates his recession indicator index following the advance Q1 GDP release:
Recent sluggish growth rates bring our recession indicator index for the fourth quarter of 2007 up to 26.9%. That’s its highest value since the 2001 recession, but still well short of the 65% reading that we require in order to make a declaration that the U.S. economy had entered a recession as of 2007:Q4.
The numbers are reminding us that if, for example, the tax rebates were to keep GDP growth positive in the second quarter, we would end up characterizing the most recent experience as a period of slow growth rather than a typical economic contraction.
Fed funds futures now imply a 78% chance the FOMC will leave the Fed funds rate unchanged at its June 25 meeting.
posted on 01 May 2008 by skirchner in Economics, Financial Markets
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