More Anti-‘Bubble’ Popping
BoE chief economist Spencer Dale, on the evils of ‘bubble’ popping:
Short-term interest rates are a blunt instrument best deployed maintaining a broad balance between nominal demand and supply. They are not well suited to the task of managing asset price bubbles and economic imbalances. They may be wholly ineffective in addressing some types of imbalances, particularly those with an international dimension. And, even for domestic imbalances, short-term interest rates would probably need to be held substantially higher for a persistent period in order to suppress rapid rises in asset prices or growing imbalances. Such policy actions could generate significant economic costs.
The practical difficulty of implementing a policy of “leaning against the wind”, where the main policy instrument is short-term interest rates, should not be underestimated. If, as policymakers, we were successful in preventing a bubble from inflating, it might appear as if we were responding to phantom concerns. The bubble or imbalance would be nowhere to be seen, but interest rates would be higher, inflation would undershoot the inflation target and we would appear to have inflicted unnecessary economic hardship. That could undermine public faith and support in both the inflation target and the MPC.
posted on 24 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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The Long and the Short of Housing Wealth and Consumption
Charles Calomiris, Stanley Longhofer and William Miles, on why there is no wealth effect on consumption from changes in house prices:
any decrease in house prices hurts only those who are net “long” in housing, that is, those who own more housing than they plan to consume. This might include, for instance, “empty-nesters” who are planning on selling their current houses and downsizing. On the other hand, the decline in home values helps those who are not yet homeowners but plan to buy. Most homeowners, however, are neither net long nor net short to any significant degree; they own roughly what they intend to consume in housing services. For these households, there should be no net wealth effect from house price change. And when one thinks about the economy as a whole (which is a combination of all three types of households) the aggregate change in net housing wealth in response to house price change should be nearly zero; changes in house prices should affect the distribution of net housing wealth, but have little effect on aggregate net housing wealth. Thus any effect from net housing wealth change on aggregate consumption spending should be similarly small.
Put differently, an increase in house prices raises the value of the typical homeowner’s asset, but such a price increase is also an equivalent increase in the cost of providing oneself housing consumption. In the aggregate, changes in house prices will have offsetting effects on value gain and costs of housing services, and leave nothing left over to spend on non-housing consumption.
The authors also debunk the work of Karl Case, John Quigley and Robert Shiller.
posted on 23 June 2009 by skirchner in Economics, Financial Markets, House Prices
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Fiscal Stimulus, Interest Rates and Crowding-Out
I have an article in the Weekend Australian arguing that the government’s discretionary fiscal stimulus measures will undermine Australia’s long-run growth prospects, citing the Australian edition of a widely used undergraduate textbook:
“When the government reduces national saving by running a budget deficit, the interest rate rises and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.” So says Joshua Gans in his Principles of Macroeconomics text. Yet Gans was also one of the 21 economists who recently signed a letter defending the government’s deficit spending.
An increase in the stock of government debt reduces the amount of capital available for private investment, although this crowding-out effect may be offset by increased private saving and foreign capital inflows. In a small and open economy such as Australia, crowding out occurs not so much because interest rates rise, but because it induces foreign capital inflows that put upward pressure on the exchange rate, lowering net exports and reducing aggregate demand, which offsets the increase in government spending.
I also have an article in Business Spectator, noting that recent market-led increases in retail borrowing rates are just a taste of things to come:
Whatever the cause of rising global bond yields, these increases in interest rates will inevitably be passed on to Australian borrowers. It would be a sign of political maturity if Australian politicians were to acknowledge this reality, rather than taking refuge in the shameless populism of bank-bashing.
UPDATE: Joshua complains about ‘selective extracting’ and an ‘unwillingness to deal with economic complexity’ in my Weekend Australian piece. The point of highlighting the very good discussion of these issues in Joshua’s textbook was precisely to show that the 21 economists were being selective and incomplete in their analysis, by not acknowledging the many arguments against discretionary fiscal stimulus. I would certainly encourage people to read Principles of Macroeconomics in coming to a considered view of the merits of discretionary fiscal policy.
posted on 21 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy
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Lu Kewen Thought ‘Shallow and Crude’
A Chinese economist rejects Lu Kewen Thought:
KEVIN Rudd has been accused by a leading Chinese economist of being “either short of economic knowledge or misleading his readers” in his famous essay attacking neoliberalism.
In a scathing assessment, Xu Xaonian, economics professor at China Europe International Business School in Shanghai, lambasts the essay, now translated and published in China, as “shallow and crude”.
Dr Xu says “Lu Kewen” - Mr Rudd’s Chinese name - made a “big, big mistake” in forming his “confident opinions” based on “the observation that the crisis came as a result of neoliberalism and the absence of supervision”.
Dr Xu, one of China’s leading liberal economists, has savaged the Rudd essay in the weekly Chinese newspaper The Economic Observer after the Prime Minister’s work was translated and reprinted in China’s leading business magazine, Caijing.
Dr Xu, who has a doctorate from the University of California and was formerly managing director of the country’s biggest investment bank, says it is not time to resurrect Keynesianism, as Mr Rudd proposes.
“Instead, it’s time to announce Keynesianism’s failure, time to announce the emperor Lord Keynes has no clothes.”
He says the Prime Minister “has used electioneering-style tactics to brand neoliberalism as dogmatic, to paint a clownish portrait of it, seeking to pioneer popular antipathy to this artificial enemy, casting a moral verdict without seeming to care about truth or logic”.
posted on 19 June 2009 by skirchner in Economics, Politics
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Government Policy, the Business Cycle & Consumer Confidence
Claims about the effectiveness of fiscal stimulus in the US do not quite square with evidence from surveys of consumer confidence. The University of Michigan survey asks respondents “As to the economic policy of the government—I mean steps taken to fight inflation or unemployment—would you say the government is doing a good job, only fair, or a poor job?” According to secondary sources, this measure posted its equal sharpest decline on record in June to 93 from 108 in May. The chart below the fold shows the history of this series until November 2008, after which the data disappeared behind a Thomson-Reuters paywall (if anyone has the intervening data, feel free to flick it my way). Clearly, consumers did not think much of the Bush Administration’s fiscal stimulus measures (although there is a rally around the flag effect in relation to policies pursued after September 11 2001). The change in Administration since November last year benefited this series, but the political honeymoon now seems to be wearing off.
This series is clearly cyclical, suggesting consumers blame economic conditions on government policy. While consumers might be overrating the importance of government policy to economic outcomes, they are also effectively calling into question the effectiveness of the usual counter-cyclical policy responses, including fiscal stimulus.
continue reading
posted on 18 June 2009 by skirchner in Economics, Fiscal Policy
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‘Bubble’ Popping at Treasury and the BoE
The Australian Treasury’s David Gruen on monetary policy and asset prices:
Some have suggested that, rather than simply being a contributing factor, expansionary US monetary policy in the early 2000s was the main cause of the crisis.
Expansionary US monetary policy undoubtedly contributed to rising US asset prices, including house prices, at the time. Indeed, that is the point of the policy – rising asset prices constitute one of the ways that expansionary monetary policy works.
But I have less sympathy with the argument that monetary policy should explicitly ‘lean against the wind’ of a suspected inflating asset price bubble, which is implicit in the criticism of US monetary policy at that time.
In my view, to lean against the wind and do more good than harm requires a level of understanding about the likely future path of a suspected asset bubble that is simply unrealistic. Without that understanding, attempting to use monetary policy to lean against the wind is as likely to be destabilising for the wider economy as it is to be stabilising.
It is good to see that Adam Posen, author of one of the better social democratic critiques of ‘bubble’ popping, has just been appointed to the BoE’s MPC.
posted on 17 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Stimulus Watch
The Australian looks behind the photo-op spin of politicians in hard hats and fluro safety vests to give stimulus spending the scrutiny it deserves. The results are not pretty.
You can report stimulus waste to online-at-theaustralian.com.au.
posted on 16 June 2009 by skirchner in Economics, Fiscal Policy
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The Rio-Chinalco Counter-Factual
John Garnaut challenges the widespread assumption that the Rio-Chinalco deal fell-over for commercial rather than political reasons:
The Economist reported that Rudd wanted the deal to go through. That may well be a message Rudd’s office would like the outside world to have but it is not consistent with dealings I have had with any of Rudd’s ministers, staffers or advisers, and certainly not from the companies involved.
In the normal course of events we would never find out what went on inside FIRB. On this occasion, Rio chairman Jan du Plessis hinted after he walked away from the Chinalco deal just over a week ago and Chinalco president Xiong Weiping more clearly indicated at his press conference on Thursday, that the original deal would have been killed in Canberra without substantial amendments.
“During our engagement and communication with FIRB we received advice in principle in terms of how the transaction should be modified,” said Xiong. And, unusually, Rudd ministers publicly lent against the deal from the start.
My own understanding, from Australian and Chinese sources, is that FIRB expressed its intense displeasure at almost every substantial aspect of the Chinalco deal but never spelt out what it would take for the deal to pass.
FIRB’s displeasure and the range of its concerns increased as time progressed — in correlation with the improving commodities, stock and debt markets — reaching critical levels early last month.
Xiong hoped his large concessions would be enough for Canberra. In fact he had no idea. Would Canberra have allowed him to accept a seat on the Rio Tinto board? He and we will never know.
Rudd may have been right in assuring China and the world that the Chinalco-Rio deal failed for “entirely commercial reasons”. But Australia’s China-like investment review process means we will never know the counter-factual.
Without the delay and uncertainty injected by the political process, which strengthened BHP’s negotiating arm vis-a-vis Chinalco, how would those two parallel commercial negotiations have panned out?
For all the ink spilled on the Rio-Chinalco deal, Garnaut is one of the few journalists to identify the real public policy issue in this debate: Australia’s Whitlam-era, Chinese-style regulatory regime for FDI. Once again, that regime has been tested and found seriously wanting. The collapse of the deal only adds to the uncertainty facing prospective foreign investors and the vendors of domestic equity capital.
posted on 16 June 2009 by skirchner in Economics, Financial Markets, Foreign Investment
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Fiscal Stimulus and Retail Trade
Ashton de Silva and Sinclair Davidson demolish the myth that fiscal stimulus has led to above trend growth in retail sales. The authors note that:
the media has been full of articles indicating that individuals have increased spending on poker machines and plasma televisions. Some individuals told reporters that they intended to get tattoos or spend the money on prostitutes. That type of spending does not undermine the policy objective. The policy objective is to stimulate increased spending in the economy irrespective of what the spending actually entails.
This sort of media commentary should also be rejected because it supports the elitist notion that people cannot be trusted to make consumption choices in their own interests.
posted on 12 June 2009 by skirchner in Economics, Fiscal Policy
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Free Trade Snitch
Dob-in a protectionist. You know you want to.
posted on 12 June 2009 by skirchner in Economics, Free Trade & Protectionism
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Australia and the World Economy
I have a column in the Business Spectator, arguing that the transmission mechanism from the world to the Australian economy is mainly via financial markets rather than cross-border trade in goods and services:
While it may seem surprising that export volumes are holding up in the context of a global economic downturn, it highlights the fact that the transmission mechanism from the world to the Australian economy is somewhat different to the one many people assume.
There has been a much closer relationship between the world and Australian economy since the early 1980s, as lower trade barriers have resulted in closer ties with world markets and a larger traded goods sector. However, it is difficult to account for the strength of this relationship based purely on trade linkages.
A more important transmission mechanism from the world to the Australian economy comes from our increased integration with global financial markets following financial market liberalisation and deregulation in the early 1980s. Changes in global interest rates and other asset prices are transmitted directly to the Australian economy via global financial markets.
This has a more powerful and immediate impact on the Australian economy than international trade in goods and services and has been particularly important in the context of the recent global financial crisis.
It helps explain why domestic demand has contracted, even while external demand has proven resilient.
As I note in the column, this has important implications for the effectiveness of domestic policy interventions.
posted on 11 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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When Gold Bugs and Reality Meet
A Wired story on the rise and fall of E-Gold:
In a sparsely decorated office suite two floors above a neighborhood of strip malls and car dealerships, former oncologist Douglas Jackson is struggling to resuscitate a dying dream.
Jackson, 51, is the maverick founder of E-Gold, the first-of-its-kind digital currency that was once used by millions of people in more than a hundred countries. Today the currency is barely alive.
Stacks of cardboard evidence boxes in the office, marked “U.S. Secret Service,” help explain why, as does the pager-sized black box strapped to Jackson’s ankle: a tracking device that tells his probation officer whenever he leaves or enters his home.
“It’s supposed to be jail,” he says. “Only it’s self-administered.”
There are some remarkable parallels between this story and the Paypal Wars. Contrary to the hopes of the cypherpunk and cryptoanarchist movements, on-line payments systems have not been able to effectively challenge the power of the state. I would agree with Richard Timberlake’s assessment (quoted in the linked article) of the original intentions behind E-Gold.
posted on 11 June 2009 by skirchner in Economics, Financial Markets, Gold, Monetary Policy
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Velocity is Not an Independent Variable
Among certain economic commentators, it has been suggested that we should watch for a recovery in velocity (nominal GDP divided by some monetary aggregate) as an indication that economic conditions are improving. Brian Wesbury goes so far as to argue that the US recesssion was ‘caused by a dramatic slowdown in monetary velocity’. While an increase in velocity might be symptomatic of economic recovery, it would be wrong to think of velocity as an independent variable. Milton Friedman is often caricatured as claiming that velocity is constant. Rather, he claimed velocity is a stable function of other variables.
A better way to think about velocity is in terms of its inverse, or money demand. Money demand is typically viewed as some function of nominal GDP, an interest rate (the opportunity cost of holding money balances) and financial technology. The latter usually goes unmodelled, but conceptually at least, we can distinguish between permanent and temporary changes in financial technology. Permanent changes in financial technology are probably the main driver of long-run trends in velocity. Velocity trends lower in the early stages of economic development, as money facilitates a growing division of labour, before declining again as new forms of financial instrument take over some of the functions previously performed by money, giving rise to a classic U-shape.
Short-run changes in money demand are likely to reflect temporary changes in financial technology or financial shocks, as well as cyclical variations in nominal GDP and interest rates. From the foregoing, it should be apparent that short-term movements in velocity are unlikely to tell us anything we don’t already know about current and prospective business cycle conditions. Against the backdrop of a shock to financial technology of unknown duration, interpretation becomes even more difficult.
posted on 09 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Debunking Bad Narratives on Stimulus
Henry Ergas responds to the 21 economists rounded-up by Nic Gruen to defend the federal government’s stimulus measures (as if the government were not big and ugly enough to defend itself):
The open letter 21 highly respected Australian economists published earlier this week in The Australian Financial Review strikingly illustrates the trend. Endorsing the “too much rather than too little” approach, that letter claims “there is no more effective way to stimulate the economy” than cash handouts.
In reality, the efficacy of that spending is far from established. Rather, much as economic theory would predict, the striking fact is just how smooth the path of consumption has been, despite a substantial spike in income associated with the Government’s cash splash.
Sinclair Davidson makes similar points in The Age:
It would be surprising indeed if the 21 economists were prepared to defend any of the $800 million in ‘community infrastructure’ boondoggles listed here.
RBA Governor Glenn Stevens has also been out highlighting the limits of macro policy stimulus:
Macroeconomic policies have not been able to prevent an economic downturn. They rarely can, especially in the face of a global recession of this magnitude. Indeed, attempts to do so have as often as not run into trouble by stoking up bigger problems a few years down the track.
posted on 05 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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By How Much Did the Australian Economy Outperform?
Updating our earlier model of Australian GDP growth for yesterday’s data revisions yields a forecast for the March quarter of -0.5% q/q compared to an actual result of 0.4% q/q. So growth was 0.9 percentage points stronger than a forecast based solely on US GDP growth. This outperformance is even larger if we believe the expenditure measure of GDP (1.1% q/q), but turns into underperformance if we believe the conceptually equivalent production measure, which came in at -0.9% q/q.
Of all the country-specific factors that might account for this outperformance, discretionary fiscal policy is likely to have been the least of them.
posted on 04 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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