Inflation Targeting and Fed Governance

Greg Mankiw echoes some of this blog’s arguments for reform of Fed governance:

Some recent news reports have suggested that inflation targeting would mean a big change in policy from the Greenspan era. That is not right. Starting where we are today, a switch to inflation targeting is not so much a change in monetary policy as it is a change in the way the Fed communicates about monetary policy. To a large extent, Mr. Greenspan’s policy can be described as “covert inflation targeting.” He has never announced a target inflation rate, but there is little doubt about his goals. As former Fed governor Laurence Meyer pointed out, anyone who doesn’t know that Mr. Greenspan is aiming for a measured inflation rate of about 1% to 2% is just not paying attention…

Alan Greenspan is a rock star, at least by the standards of the American Economic Association… The most negative assessment I have ever heard about Ben Bernanke, from one of my colleagues, is that he is “a bit boring.” For an economist, boring is an occupational hazard. For a central banker, however, it is just the ticket. The central bank’s job is to create stability, not excitement. Ben Bernanke would do well to increase public confidence in the institution of the Federal Reserve: The institution matters more than the individual who happens to be leading it at the moment. It would be ideal if, after a long, successful tenure, Mr. Bernanke’s retirement as Fed chairman were a less momentous event than his arrival.

UPDATE:  Free version here.

posted on 28 October 2005 by skirchner in Economics

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RBNZ Governor Bollard Has Lost the Plot

Former RBNZ Governor (now National Party leader) Don Brash got a lot of bad press for his conduct of monetary policy, most of it undeserved.  But his successor as Governor, Alan Bollard, deserves criticism following today’s decision to raise the official cash rate to a record 7%.  The problem is not the rate increase as such.  A case can be made for further tightening, even if this partly reflects Bollard’s mistake in lowering the cash rate in 2003.  Rather, the problem is Bollard’s rationalisation for the latest tightening, which is contradictory to say the least.  According to Bollard:

The most serious risk to medium term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending.  Significant dis-saving by the household sector is showing through in a worsening current account deficit, now 8 per cent of GDP. Borrowers and lenders alike need to recognise that the current rate of debt accumulation is unsustainable. The correction of these imbalances and associated inflation pressures will require a slowdown in housing, credit growth and domestic spending. We also expect a significantly lower exchange rate. The longer these adjustments in behaviour and asset prices are deferred, the more disruptive they are likely to be.

This is not only a mischaracterisation of the risks to inflation, it is also contradictory.  Raising the official cash rate will only attract further capital inflow, already very strong, putting further upward pressure on the exchange rate and making the current account deficit even worse.  This is exactly the policy mistake the RBA made in the late 1980s, when it sought to target the current account deficit with tighter monetary policy, resulting in a recession in the early 1990s.  Both Governor Bollard and the Finance Minister have been trying to talk the NZD lower, yet monetary policy has been driving it higher.  This can only cause credibility problems for the Bank.  If anything, Bollard should be talking up the exchange rate. 

The credibility problem is made worse by the fact that the RBNZ recently sought an increase in its capitalisation to facilitate intervention in foreign exchange markets, yet it seems unwilling to back its exchange rate overvaluation rhetoric with actual intervention.  This is just as well, because we would then have a situation in which interest rate and exchange rate policy were at cross purposes, but it highlights the contradiction between what the RBNZ and the government say about the exchange rate and what the RBNZ is actually doing with monetary policy.

Before the current government watered down the RBNZ’s inflation targeting regime, the current rate of inflation might have already seen the RBNZ Board meet to decide whether to recommend dismissal of the Governor to the Minister, although the contribution to inflation from higher oil prices would fall under the caveats to the Policy Targets Agreement.  This is now much harder to do, because the inflation target has been re-defined in such a way as to accommodate a much wider range of outcomes.  By the Bank’s own admission, there is little scope for inflation to return to the target range before 2007.

posted on 27 October 2005 by skirchner in Economics

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Blog Capitalisation

Who said blogging doesn’t pay?

(via Barry Ritholtz)

posted on 27 October 2005 by skirchner in Economics

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The Dark Side of the Confirmation Process

Some of the charming search terms that are showing in my site stats: ‘bernanke cannabis,’ ‘dirt on bernanke,’ ‘bernanke family origins’ etc. 

This is more stupid than sinister.  Do these people honestly think the background checks conducted for the White House would miss something on the internet?

posted on 26 October 2005 by skirchner in Economics

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The Real Ben Bernanke

The market reaction to Ben Bernanke’s nomination as Fed Chair has been disappointing.  The implication that Bernanke is somehow more inflation friendly than Greenspan reveals profound ignorance about Bernanke’s thinking.  This view largely stems from two speeches given during the 2002-2003 deflation scare, in which Bernanke canvassed various quantitative approaches to monetary policy that might be used as an alternative to the Fed funds rate should the zero bound become a binding constraint.  Bernanke’s willingness to canvass unconventional approaches to monetary policy should if anything be welcomed.  I suspect very few of the people who derisively refer to ‘printing press Ben’ have bothered to even read these speeches, much less understood their significance or context.  It is interesting that Bernanke’s nomination has attracted endorsement from libertarian economists like Tyler Cowen, Bryan Caplan and even qualified support from an arch free banker like Larry White.  Those on the libertarian right who have criticised Bernanke do so largely out of ignorance, but it seems these silly prejudices against Bernanke have wider currency given the market reaction to his nomination.

The negative market reaction to Bernanke’s nomination is also disappointing in the sense that it shows that the credibility of the Fed resides largely in the position of Chairman, not the institution itself.  This is the unfortunate legacy of Greenspan’s highly discretionary approach to Fed policy and hostility to inflation targeting.  I suspect that reform of Fed governance is high on Bernanke’s agenda.  Bernanke’s interest in inflation targeting is particularly promising in this regard.  The WSJ’s reference to a ‘Bernanke Standard’ misses an important point: Bernanke may well end up presiding over the de-personalisation of US monetary policy, elevating process above personality.

Finally, it should be noted that Bernanke’s nomination is another event the prediction markets got ‘right,’ in the sense that the Bernanke contract was consistently the highest priced contract for next Fed Chair on Intrade.

posted on 25 October 2005 by skirchner in Economics

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Misguided Monetarism: Tim Congdon’s Money and Asset Prices in Boom and Bust

My review of Tim Congdon’s (2005) Money and Asset Prices in Boom and Bust, London: Institute of Economic Affairs.

Tim Congdon is perhaps best know for his former role as head of Lombard Street Research and his membership of the IEA’s Shadow Monetary Policy Committee, which is loosely modelled on the monetarist Shadow Open Market Committee in the US.  Money and Asset Prices seeks to motivate a role for broad measures of the money supply in the determination of asset prices.  Congdon subscribes to the ‘active money’ paradigm, which is at odds with the mainstream academic view that money plays an essentially passive role in an economy because it is endogenous to the determination of official interest rates and money demand.  The ‘active’ money view is, however, probably closer to popular conceptions of how monetary policy works.  Popular commentary on monetary policy is often framed in terms of some vaguely defined notion of ‘liquidity,’ even though monetary aggregates play only an incidental role in the determination of official interest rates.

continue reading

posted on 24 October 2005 by skirchner in Economics

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Serious Tax Reform

Finance Minister Nick Minchin on tax reform:

“Serious, sustainable and responsible income tax reductions can only be delivered by reducing government expenditures,” the minister told the Liberal Party’s South Australian state council last night.

“Those who want further substantial income tax cuts should tell us all where they think the Government can and should reduce its expenditure to pay for their cuts.”

If Minchin isn’t willing to volunteer these cuts himself, doesn’t it follow that he is not interested in ‘serious, sustainable and responsible’ tax reform?

posted on 22 October 2005 by skirchner in Economics

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Housing Equity and Consumption: Myth Busted

The RBA has released the results of its survey on housing equity withdrawal.  As we predicted when the survey was first announced, the results effectively demolish one of the most pernicious myths about the Australian economy in recent years: that strong economic growth was largely driven by a housing equity fuelled consumption boom:

Around two-thirds of equity withdrawn in 2004 was invested in other assets or used to pay down other loans. In contrast, only a relatively small proportion of equity withdrawn was used to fund consumption. This implies that swings in housing equity withdrawal in recent years are likely to have had a smaller impact on aggregate household consumption than the raw figures on aggregate net household equity withdrawal would suggest…

the results suggest that swings in recent years in the amount of equity withdrawn or injected by the household sector probably did not result in swings of a corresponding magnitude in consumption growth. To a significant extent, the changes in the amounts withdrawn or injected are likely to have been the result of changes in turnover in the property market and the longer-term growth in prices. The results of the survey indicate that withdrawals of equity through transactions were not typically used for consumption but were instead used to accumulate other assets.

posted on 21 October 2005 by skirchner in Economics

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Brad Setser (Almost) Gets It

In the wake of the August TIC data showing strong net foreign inflows into US assets, Brad Setser shows signs of capitulating to the consenting adults view of current account deficits:

Why not run a bigger trade deficit?  After all, the market seems willing to finance one!

As we have argued previously, the financing of the US current account deficit is essentially pre-determined for given US and foreign saving-investment imbalances.  Only the asset composition of this financing and prices at which assets change hands is actually in question, yet many analysts persist in analysing this data as though it were some incredible surprise that foreigners are still buying US assets.  Setser nonetheless persists in his view that:

it would be a mistake, I think, to conclude from the TIC data that the US is no longer dependent on foreign central bank support.

As this research suggests, even in the very unlikely event that foreign official sector purchases disappeared entirely, the implications for US interest rates would be small.  In other words, there is no such US ‘dependence.’  Furthermore, as Setser notes, US accounts were net sellers of foreign assets, suggesting that there are not many net buyers of the doomsday cult trade.  With the USD index testing its highs for the year, those who ignored the purveyors of doomsday cultism have been appropriately rewarded.

posted on 19 October 2005 by skirchner in Economics

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How Important Are Foreign Official Reserve Asset Purchases?

Federal Reserve Board research examines the implications of foreign purchases for yields on US debt securities:

foreign official purchases of U.S. Treasury bonds skyrocketed in 2003 and 2004, but these were only a small subset of foreign flows into all types of U.S. bonds—Treasury, corporate, and agency bonds. At their peak in the summer of 2004, foreign official inflows amounted to 2.5 percent of GDP, far below the overall foreign purchases of U.S. bonds of 7 percent…

if foreigners did not accumulate U.S. bonds over the twelve months ending May 2005, our model suggests that the 10-year Treasury yield would currently be 150 basis points higher.  But even if the United States experienced only average inflows of 2 percent of GDP, our point estimate suggests that U.S. rates would be 95 basis points higher… had foreign official flows been zero over the last twelve months, long rates would currently be 60 basis points higher.

While 60 bps is not trivial, it is very small relative to the enormous importance many commentators have attached to foreign official sector asset purchases by East Asian central banks as drivers of US interest rates.  Since foreign official sector demand is largely determined by managed exchange rate regimes, this demand is not discretionary under current exchange rate regimes. 

Even the 150 bps attributable to overall foreign purchases needs to be placed in context:

with U.S. bonds comprising roughly half the global bond market, other international investors—be they speculators or institutions such as pension funds—are not likely to completely abandon the U.S. market. Indeed, zero net inflows into U.S. bonds over a sustained period has not occurred in at least 20 years. Even during the 1990-1991 recession, when the U.S. current account was temporarily balanced (and thus net capital inflows were not required), annual foreign purchases of U.S. bonds still totaled about one percent of GDP (compared to the current record annual bond inflows of roughly 6 percent of GDP). This is not to say that a retreat could not occur, just that a complete and sustained retreat is unlikely.

posted on 14 October 2005 by skirchner in Economics

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The Flat Tax Costello Rejects

The 30% flat tax plan Treasurer Peter Costello rejected:

WHEN Treasurer Peter Costello left Canberra for his Christmas break last year, he had before him modelling for the most radical reform to income tax in 60 years.

Only those privy to the Treasurer’s thinking know why the plan was dropped, but it may have been because of an analysis Treasury prepared on who would be the winners. Although nobody would be worse off as a result of the changes, only 20 per cent of taxpayers would be better off.

A more plausible explanation is that Costello is rationing tax cuts to fit with his leadership timetable.

posted on 14 October 2005 by skirchner in Economics

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An Australian Congressional Budget Office?

Simon Banks, formerly of the Chifley Research Centre, argues for an independent fiscal policy institute to improve the quality of public debate about fiscal policy.  This is an excellent proposal and ties in with earlier work by the CRC on fiscal policy rules by Ric Simes.  The current arrangements under the Charter of Budget Honesty are inadequate, with the process still dominated by partisan political considerations and ministerial direction.  Costings done privately by hired guns like Access Economics do not carry much authority, since the client is assumed to get what they pay for, and it is very simple for Treasury to pick holes in these analyses, distracting attention from the substance of the policy proposal. 

Unfortunately, while oppositions get very excited about reforming fiscal and monetary policy rules, they quickly lose interest in the subject when in government.  When I worked for the federal opposition in the early 1990s, there was a determination on the part of the Coalition to reform both the RBA Act and institute fiscal responsibility legislation that would prevent what we saw as abuses of process by the then Labor Government.  What subsequently emerged in government fell well short of what many of us would like to have seen implemented.  We can only hope that the Labor Party doesn’t forget what it was like to be in opposition quite as quickly as the Coalition did.

posted on 13 October 2005 by skirchner in Economics

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Johan Norberg in Sydney

The Centre for Independent Studies has been playing host to Johan Norberg this week.  I attended the launch of the Australasian edition of his book In Defence of Global Capitalism on Monday and his John Bonython Lecture last night, an op-ed rendition of which can be found here.  Norberg’s theme of the cognitive biases that motivate anti-globalisation sentiment is remarkably consistent with some of the arguments run on this blog in relation to financial markets and asset prices. 

Norberg’s book is perhaps the most accessible and persuasive defence of globalisation in print.  The book is much more faithful to the classical liberal tradition than the books on globalisation by Jagdish Bhagwati and Martin Wolf.  Both Bhagwati and Wolf concede way too much to globalisation’s critics and have probably done the cause more harm than good, particularly in the case of Bhagwati’s hostility to international capital mobility.

posted on 12 October 2005 by skirchner in Economics

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When Costello Attacks

Treasury costings of Liberal MHR Malcolm Turnbull’s tax reform proposals purport to show a greater cost than allowed for in Turnbull’s discussion paper.  This analysis somewhat misses the point that meaningful tax reform should come at a cost to revenue.  That these costs might be greater than assumed by Turnbull is not in itself an argument against the proposed reforms.  Analysis by the Melbourne Institute shows an expected increase in labour force participation from the tax reform proposals of both Turnbull and Labor MHR Craig Emerson.  Increased labour force participation is meant to be a key objective of government economic policy and yet the Treasurer shows no interest in tax reforms that might be helpful in realising this goal. Hiding behind Treasury costings does not conceal the fact that Treasurer Costello remains a policy-free zone when it comes to tax.

Perhaps the biggest mistake the tax reform debate has made to date has been to assume that tax cuts can only be funded out of the surplus, rather than through net reductions in government spending, particularly the welfare churn that sees many middle-income households paying no net tax.

posted on 11 October 2005 by skirchner in Economics

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The Doomsday Cult Takes a Bath, III

The WSJ weighs in and declares a winner:

For a couple of years now, we’ve been watching a debate, generally speaking, between two economic factions. The first and largest group has routinely predicted slower growth, if not recession, almost as a rite of spring and sometimes autumn too. This crowd has included the most prominent economists on Wall Street, and most of those you see quoted in the media. In this view, inflation was nowhere to be seen, and for many of them the real danger was the budget and trade deficits. The Fed could stop raising rates at any time, the sooner the better.

Well, the evidence is mostly in, and the second group looks to be the winner.

posted on 10 October 2005 by skirchner in Economics

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