Climate Change and Monetary Policy
The new Australian government has been quick to ratify Kyoto, but this does not necessarily sit comfortably with its other policy commitment to keep downward pressure on interest rates. The RBNZ’s latest Monetary Policy Statement discusses the monetary policy implications of the proposed Emission Trading Scheme in New Zealand:
Another recent Government announcement that could have significant implications for the medium-term inflation outlook is the intention to introduce an emissions trading scheme as part of New Zealand’s Kyoto Protocol obligations… it is likely that the emissions trading scheme will have very significant direct and indirect effects on CPI inflation by affecting fuel and electricity prices. It will also affect inflation expectations and supply and demand in the economy….
It is likely that incorporating the effects of the emissions trading scheme… would result in interest rates being held higher for even longer than assumed here…
to the extent that the gradual phasing in of the scheme adversely affects the medium-term path of inflation, policy will need to lean against this.
The RBNZ assumes an emissions price of NZD 21/tonne, which could prove overly optimistic.
On another subject, the RBNZ seems oblivious to the glaring contradiction in this statement:
New Zealand is one of the few developed countries in which the government now has net financial assets. The government’s very strong overall balance sheet, achieved as a result of a series of fiscal choices over the past 20 years, is undoubtedly helping to keep the long-term average level of interest rates in New Zealand lower than it would otherwise be.
New Zealand is also notorious for having the highest interest rates in the developed world, which rather argues against the importance of fiscal policy as a determinant of interest rates.
posted on 06 December 2007 by skirchner in Economics, Financial Markets
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Not Only in Norway
Anders Åslund of the Peterson Institute, with some observations on sovereign wealth funds that former Treasurer Peter Costello should have taken to heart:
Since the Norwegian fund was established in 1990, every incumbent government has lost elections because the opposition has promised all kinds of popular expenditures from the abundant fund. Democratically, it is difficult to defend an excessive public reserve fund.
Åslund also notes that SWFs are profoundly anti-democratic:
They reflect a paternalistic—and economically illiterate—notion that the ruler knows best while citizens are so irresponsible that they cannot be entrusted with their own savings. It would be more economical and democratic to cut taxes and let citizens save and invest themselves.
posted on 06 December 2007 by skirchner in Economics, Financial Markets
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Never Let the RBA Minutes Get in the Way of a Beat-Up
The RBA may now be releasing minutes of its deliberations, but that won’t stop the media from reading their own views into the RBA’s public comments. Under the headline ‘Reserve Bank was “not happy John,”’ Colin Brinsden writes:
THE Reserve Bank of Australia was none too happy with the Howard government’s election spend-fest, the minutes from its November board meeting suggest.
The minutes contain no such implication and Brinsden conveniently refrains from quoting the bottom-line of the RBA’s discussion:
This meant that fiscal policy was roughly neutral in its overall effect on growth as conventionally measured.
posted on 05 December 2007 by skirchner in Economics, Financial Markets
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Has the RBA Pre-Empted Labor on Reform?
The RBA has announced new arrangements for communicating with the public. The RBA will now release a statement following each monthly Board meeting, even when policy is left unchanged. The Board’s decision on interest rates will be announced at 2:30pm on the day of the meeting, rather than the following day. The RBA will now also release minutes of the monthly Board meetings, with a two week lag.
The RBA said that it has been reviewing its communications practices ‘for some months.’ To that extent, the new measures can be seen as independent of the change in government. However, it is likely that the RBA has been working on these measures in anticipation of demands for increased transparency and accountability from the incoming Labor government. The measures may well be a pre-emptive strike against demands for more meaningful reform, designed to ensure that any changes are made on the RBA’s own terms and preserve the effective monopoly that the Bank’s senior officers enjoy over monetary policy decision-making.
The new measures will certainly be an improvement. The statement accompanying today’s steady interest rate decision saw a rally in bond futures and a weaker Australian dollar, implying that the statement conveyed new information to the market, resulting in more efficient pricing of financial instruments.
The minutes of the November meeting released today are largely descriptive and backward-looking in their discussion of economic conditions, a problem which also afflicts the quarterly Statements on Monetary Policy. This is in contrast to the more forward-looking statements released by the Bank of England and the RBNZ. The section on ‘considerations for monetary policy’ has the potential to be more informative, but it appears as though the RBA will be presenting only the consensus view, with the views of individual Board members not discussed.
There will be no record of any vote taken. It is likely that what little dissent there is on the Board will be suppressed in the minutes. The RBA has long argued that identifying the views of individual members would subject them to external pressures, given the numerous potential conflicts of interest of the external Board members. This highlights the continued incompatibility of the current Board arrangements with increased transparency and accountability.
This conflict can only be resolved by separating monetary policymaking from the Bank’s Board and placing it in the hands of an independent, professional Monetary Policy Committee, with substantial external representation and excluding the Treasury Secretary, who may serve as a vector for political influence on monetary policy.
The votes of the Committee should then be made public immediately following each meeting, ensuring increased transparency and accountability for decision-making and protecting the integrity of the monetary policy process. It would also end the RBA’s de facto monopoly on decision-making, by ensuring that members of the Committee had the expertise and experience to challenge the views of the RBA’s senior officers.
Today’s measures are an attempt by the Bank to give the appearance of increased transparency and accountability, but without seriously challenging the status quo. Most rankings of central bank transparency and accountability are based on check-lists of factors that are quantitative rather than qualitative in nature. The changes will thus have the effect of lifting the RBA from its current position at the bottom of international rankings of central bank transparency and accountability. Qualitatively, however, the RBA will continue to lag world’s best practice in monetary policy governance.
posted on 05 December 2007 by skirchner in Economics, Financial Markets
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RBA Reform Under Rudd?
RBA Governor Glenn Stevens speaks to the Sydney Institute on the subject of central bank communication next week and David Uren suggests that this might be the occasion for Stevens to unveil improved RBA transparency and accountability measures. Uren notes that a new Joint Statement on the Conduct of Monetary Policy is also expected later this week.
After more than a decade of neglect under former Treasurer Peter Costello, it remains to be seen whether the new government is serious about reforming RBA governance, which has left the RBA as one of the developed world’s least accountable and transparent central banks.
posted on 04 December 2007 by skirchner in Economics, Financial Markets
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The Euro as Ultimate Sub-Prime Victim
Liam Halligan argues that the euro may be the ultimate victim of the current problems in global credit markets:
sceptics like me have always said the operational viability of the single currency won’t be known until the system is tested by a serious downturn. That moment may now come soon.
Interest rate spreads between government bonds in France, Spain, Germany and Italy have lately got wider and wider. In other words, believe it or not, the markets are increasingly betting on the eurozone breaking up – as political tensions rise, and the needs of inflation-averse nations like Germany can’t be reconciled with much weaker debt-driven members like Ireland and Spain.
Could it happen? Why not? Every other currency union in the history of man has broken up – unless, like the US and UK, it has been preceded by generations of political union, and held together with a federal tax system.
It sounds far-fetched, I know. But the ultimate victim of this sub-prime crisis could be nothing less than the single currency’s existence.
posted on 03 December 2007 by skirchner in Economics, Financial Markets
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Microeconomic Reform Under Rudd
I think the last time I heard an Australian politician mention microeconomic reform was circa 1993. Now this from our new social-democratic overlord:
KERRY O’BRIEN: You’ve talked about a central role for Treasury, what do you mean by that?
KEVIN RUDD: … I think Treasury by instinct, this goes back to the earlier Labor period, is a reforming department. It actually has a whole bunch of people within it who want to advance the cause of micro-economic reform. I think that reform agenda has not had any political impetus for a long, long time during the latter period of the Howard government and I think there is a lot of enthusiasm there for us embracing a reform agenda because if you cease reforming this economy, you start to strangle long-term productivity growth. We don’t intend to do that.
Who knew?
posted on 28 November 2007 by skirchner in Economics, Politics
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Operation Sunlight
More reasons to welcome our new social-democratic overlords:
INCOMING finance minister Lindsay Tanner is planning far-reaching reform of the budget to improve transparency. He will overhaul the Charter of Budget Honesty, introduced by Peter Costello in 1996 to govern budget disclosure and Opposition rights to financial information during elections.
Mr Tanner, who held meetings with Finance Department officials yesterday, is expected to take time to implement all of Labor’s proposed budget reforms, but there are likely to be some changes before its first budget in May.
Under the proposals, new government programs that could be influenced by demographic shifts will have to be accompanied by five-year forecasts of their costs.
The International Monetary Fund was critical of the Howard government’s failure to include any long-term assessment of the cost of its decision to make superannuation benefits tax-free for people aged over 60.
Labor intends to include in the budget a statement explaining how welfare, health and education benefits are distributed among different income groups, and the taxes paid by those groups. The idea is to help in the assessment of the merits of government spending and tax levels.
Labor wants the budget papers to contain more information about what individual government departments are spending.
At present, the main budget papers list spending by broad function, so spending on housing might include programs run by the transport and regional services department, defence and family and community services. Although each department publishes its own portfolio budget, these do not include more than one year’s forecasts and do not match the main budget papers.
Labor’s reforms follow an extensive consultation that resulted in the publication of a policy paper, called Operation Sunlight, last year…
The Labor government will expect the Treasury and finance departments to provide continuous disclosure, posting major changes in the budget position on their websites and providing quarterly updates on the size of the surplus. There will be fixed dates for mid-year budget updates and monthly financial reports.
The finance department has not posted a monthly budget report since June.
It may sound like a trivial matter, but the fixed dates for the budget updates will be a great improvement. Outgoing Treasurer Peter Costello would fling these documents out at his own convenience, often with as little as a few hours notice. I still shudder at the amount of my time that was wasted trying to find out when these things would be released and obtaining copies of the documentation in a timely manner.
posted on 27 November 2007 by skirchner in Economics, Financial Markets, Politics
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Financial Markets Judge Peter Costello
For all the former government’s claims to superior economic management, financial markets have greeted the change in government with indifference. The Australian dollar is firmer against the USD this morning, as well as against those currencies with which it is traditionally correlated such as NZD and EUR. This may partly reflect relief at a decisive election outcome compared to the possibility of a hung parliament or minority government, but firmer commodity prices would also be playing a role. The NZD had to contend with a wider than expected October trade deficit this morning
December 10-year bond futures are around 6 bp weaker in price, but this largely reflects a similar weakening in US Treasuries Friday.
The S&P/ASX 200 is up 1.4% in early trade, but this reflects similar gains in US stocks Friday and the improvement in commodity prices.
Financial markets are effectively saying that there is no difference between the Coalition and Labor in terms of Australia’s economic prospects. This is as much a condemnation of the Coalition as an endorsement of Labor. Outgoing Treasurer Peter Costello would do well to reflect on the financial market reaction to the dismissal of New Zealand’s reformist Finance Minister, Sir Roger Douglas, in December 1988, when the NZD fell off a cliff. That is the measure of an effective Treasurer.
Financial markets will be looking to the content of the new Joint Statement on the Conduct of Monetary Policy between the new Treasurer and RBA Governor Stevens. It is likely the new agreement will be little changed, although there is always the possibility the ALP will surprise us with a more comprehensive attempt at reforming Australia’s monetary policy governance, to bring it into line with world’s best practice after a decade of neglect under Peter Costello.
posted on 26 November 2007 by skirchner in Economics, Financial Markets
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‘I for one welcome our new social-democratic overlords…’
Australia’s federal election has seen a change of government, with the Labor Party set to win 86 seats in the House of Representatives against the incumbent conservative Coalition’s 62 seats. The Labor Party secured a two-party preferred swing of around 6%, to win its largest two-party preferred vote share in the post-war period of around 54%. It is likely that incumbent Prime Minister John Howard will lose his seat in parliament. The Coalition will also lose its majority in the Senate. The decisive nature of the Labor win should minimise any negative implications for financial markets that might have arisen from the possibility of a hung parliament or minority government.
The change in government opens up a number of possibilities for positive change. There is a good chance the Labor Party will finally address the Coalition’s legacy of failure in relation to statutory reform of central bank governance, which has left the Reserve Bank of Australia as one of the developed world’s least accountable and transparent central banks. Outgoing Treasurer Peter Costello cites central bank reform as one of his greatest achievements when it is in fact one of his many failures as Treasurer.
Costello’s other great failing as Treasurer was to withhold the benefits of national prosperity from the Australian people, by hoarding Commonwealth revenue on an unprecedented scale. Rather than continuing to nationalise private equity capital and other assets via the Future Fund, it is to be hoped that the ALP will lower the record federal tax burden Peter Costello inflicted on the Australian people.
Malcolm Turnbull has held on to the seat of Wentworth against the odds, almost securing a majority in his own right on the primary vote. The anti-pulp mill left were repudiated, despite a massive campaign against Turnbull. The Labor Party’s George Newhouse was literally bitch-slapped. The result gives Turnbull ample authority to contest the leadership of the federal parliamentary Liberal Party. Turnbull is the Liberal Party’s best chance for renewal.
Perhaps the worst aspect of the federal election is that the balance of power in the Senate will be held either by anti-gaming wowser Nick Xenophon in combination with Family First’s Steve Fielding or the Greens. It is hard to know which of these two possibilities is least friendly to our liberties.
UPDATE: As we predicted back in June, Costello does not have the stomach to lead.
UPDATE II: Turnbull declares!
posted on 25 November 2007 by skirchner in Economics, Financial Markets, Politics
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‘Beyond Insane’
Terry McCrann continues to do battle with those who favour more Commonwealth revenue hoarding:
Imagine if Costello was handing Swan a $60 billion annual surplus—close to a quarter of a trillion dollars over the next four years. The same Swan who is absolutely dedicated to keeping “downward pressure on interest rates”.
Now, of course, we cannot assume either the Mandate of Heaven or the dollars it bestows are already “in the bank” for even the next four years. Further, we still face the fundamental uncertainty of whatever comes out of the US over the next year or so.
This, though, does not validate the depressingly ubiquitous demand from too many economists that such surpluses should be “banked” to allow the “automatic budget stabilisers” to work and/or to target lower or stable interest rates.
The idea of running a “flexible fiscal policy” to target a stable interest rate is beyond insane. And which rate would be appropriate? An official rate of 7 per cent, 6 per cent, 5 per cent?
When we have experienced a structural (upward) shift in budget revenues, the money has to be spent. The only question is whether in tax cuts or in service delivery or infrastructure…
The increases in official rates over the past few years have only succeeded in getting rates back to a sensible level, commensurate with an economy growing at 7 per cent-plus in nominal terms.
posted on 24 November 2007 by skirchner in Economics, Financial Markets
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Election Eve Round-Up
David Uren blames Paul Romer for Ruddonomics:
Rudd is influenced by the new growth theory of Californian economist Paul Romer. Where traditional economics says economic growth results from the forces of labour and capital coming together, assisted by the fortuitous development of new technology, Romer argues that investment in knowledge is a measurable input and part of the growth process. New technology doesn’t appear like manna from heaven but requires investment in education.
Labor’s take on Romer’s work is that investment in education will produce long-term dividends in economic growth. Its election promises such as the tax rebate for education equipment and funds for school computers are tokens of its new approach and could be expected to be followed, if elected, by a more substantial shift of budget priorities towards education.
Econtalk has a superb interview with Paul Romer, in which Romer is very careful to disassociate himself from some of the many abuses of endogenous growth theory.
Sinclair Davidson and Alex Robson calculate the tax cuts that could have been financed out of the election spending promises of Labor and the Coalition:
According to the Coalition’s own calculations of the size of its and Labor’s tax cut and spending commitments, the average taxpayer earning approximately $60,000 per annum would receive a benefit after four years of $65 per week under the Coalition’s plans and $52 per week under the ALP’s plans—if each party’s tax policy was implemented and if the amount each party promised in new spending was instead devoted to tax cuts. If the Sunday Telegraph’s calculations were used these figures would be $58 per week under the Coalition’s plans and $47 per week under the ALP’s plan. Using the estimates of The Age/SMH and The Australian after four years the average taxpayer would be $94 per week better off under the Coalition, and $66 per week better off under Labor.
It can be said therefore, that regardless of who’s figures are believed the average taxpayer would be better off after four years by at least $58 per week under the Coalition and $47 per week under Labor, Labor, if tax cuts were delivered instead of spending increases.
The Intrade federal election contract is giving an 88% chance to a Labor win, although there is actually more market depth on the short-side of the Labor contract, suggesting that at least some people are looking to take advantage of Labor being over-priced.
posted on 23 November 2007 by skirchner in Economics, Financial Markets, Politics
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That 1969 Feeling
Matthew Johnson argues that financial markets should be getting nervous ahead of this weekend’s federal election in Australia:
It’s starting to feel a little bit like Florida 2000 to me. It’s perfectly possible for the Coalition to win in court (Newhouse’s invalid nomination) and to do so with a minority of the vote. Given this risk, I’d sooner not go home long AUD or Aussie equities on Friday – no decision creates complications in all sorts of places (FIRB for example), and it’d be a clear ‘sell Australia’ signal.
Instead, I would suggest it is starting to feel like 1969, when the Labor Party secured its largest post-war two-party preferred swing of 7.1% and a majority of the national two-party preferred vote, yet failed to secure a majority in the House of Representatives. Indeed, 21% of post-war elections have been won on a minority of the two-party preferred vote (1954, 1961, 1969, 1990 and 1998).
Amid broad-based USD weakness, the Australian dollar has been a notable underperformer in the run-up to the election. Recent AUD weakness reflects flight from currencies with negative net international investment positions in favour of the Japanese yen. But the AUD has also underperformed those currencies with which it is traditionally highly correlated. AUD-EUR has broken below multi-year trendline support from the October 1998 monthly lows. AUD is also underperforming its commodity bloc peers NZD and CAD, with AUD-NZD slipping to lows of 1.1529, levels not seen since late August, while AUD-CAD fell to a low of 0.8540, below the highs for the year at 0.9512. Weakness in base metals prices is the most likely explanation for the underperformance of AUD. But this weekend’s federal election and the risk of a hung parliament may also be playing a role.
posted on 22 November 2007 by skirchner in Economics, Financial Markets, Politics
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The Dynamic Benefits of Tax Cuts
Alan Wood, on why fiscal policy should not be used for demand management:
fiscal policy has a higher purpose than keeping interest rates at politically comfortable levels. Would we really be better off, as the Government’s critics suggest, with budget surpluses of 3 per cent, 4 per cent, or 5 per cent of gross domestic product and lower interest rates?
The answer is no. The appropriate role of fiscal policy is to redistribute the revenue windfall from the China boom in economically productive ways, and tax cuts meet this criterion admirably. If this leads to higher interest rates than otherwise, so what?
At worst the contribution is marginal compared with the other forces at work on the economic cycle, and the dynamic economic benefits exceed the costs. For most of the past five years, according to the RBA, fiscal policy has had no impact on monetary policy.
And according to analysis by IPAC’s Johnson, even under the extreme assumption that the tax cuts were entirely responsible for the interest rate rises that did take place, the economy-wide benefits exceeded the cost by several billion dollars.
Howard and Costello’s mistake has not been their tax cuts, but the fact they didn’t deliver more vigorous tax reform earlier in the economic cycle, before the economy ran up against capacity constraints.
As we noted at the beginning of the election campaign, Federal government revenue hoarding has also been bad political strategy. The government’s campaign promises in relation to further tax cuts would have been much more credible had they been announced in the May Budget and legislated ahead of the election campaign. As things stand, the tax cuts were a one day wonder, long since forgotten amid all the election campaign trivia.
posted on 21 November 2007 by skirchner in Economics, Financial Markets, Politics
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China’s Credit Crunch
The Chinese authorities are resorting to administrative window guidance in order to control the inflationary implications of the exchange rate peg to the US dollar, according to the WSJ:
In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals.
A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don’t exceed the total outstanding on Oct. 31. The official described the request as “guidance aimed at supporting the macro-control measures being implemented.”…
Bankers say they will honor the lending edict, partly because it comes with threats of financial penalties for noncompliance. “Which commercial bank would dare not obey this?” says Liu Haibin, chairman of the supervisory committee of Shanghai Pudong Development Bank Co.
posted on 19 November 2007 by skirchner in Economics, Financial Markets
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