Fiscal Policy and Interest Rates in Australia
Alan Wood mentions my Policy article on fiscal policy and interest rates in his column in today’s Australian:
The very large (potential) budget surpluses of recent years tells us Australia has a structure of tax rates that is excessively high and major tax reform is needed.
It just has to be done in a way that doesn’t add to inflationary pressure—that is, it needs to be offset by spending cuts or spread over future budgets.
Yet it is quite clear from the run of huge budget surpluses the Howard Government has enjoyed that structurally, Australia’s tax rates are excessive.
This is no time to take serious tax reform off the economic agenda.
posted on 13 October 2007 by skirchner in Economics, Financial Markets
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Not a Minsky Moment
If you read only one paper on recent developments in credit markets, this should be it:
the correct application of the Minsky model to the current data indicates that the financial system may be able to absorb the subprime mortgage and securitization technology shocks in an orderly fashion, without a large “financial accelerator” effect. The financial system has suffered a significant liquidity shock, and it is not over yet. But the worrying turmoil does not necessarily mean that the turmoil resulting from this shock should be viewed, as some have labeled it, as a “Minsky moment” – that is, the beginning of a severe economic decline produced by a collapse of credit, which would magnify adverse aggregate demand shocks. Such collapses of credit, in the Minsky framework, tend to occur in reaction to asset price collapses, which are themselves partly a result of the widespread overleveraging of consumers and firms. At the moment, however, it is not obvious that housing or other asset prices are collapsing, or that leverage is unsustainably large for most firms or consumers. That is not to say that the economy will avoid a slowdown, or possibly even a recession.
posted on 11 October 2007 by skirchner in Economics, Financial Markets
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Lunch with Kevin Rudd
Federal opposition leader Kevin Rudd addressed an Australian Business Economists’ lunch last week. John Edwards’ observations on the event go a long way to explaining why a booming economy is providing the government with little or no political traction:
Rudd ranged widely over Australia’s recent economic record and what he planned to do if elected to government. He then took questions. There were just three, none of them memorable. Given that the polls show Mr. Rudd will highly likely be Prime Minister within eight weeks or so and that Labor has been out of office for over a decade, this was a remarkably small number of questions from what might be expected to be a well informed, concerned and not particularly sympathetic audience…Mr. Rudd wasn’t asked many questions, because there isn’t much worth asking.
Edwards’ goes on to note the near complete bipartisanship between the government and opposition on economic policy and says:
for all its vaunted political brilliance [the government has] an amazing inability to shape the economic debate.
posted on 10 October 2007 by skirchner in Economics, Financial Markets, Politics
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The Credit Crunch that Wasn’t II
We previously noted that there was little sign of a credit crunch in Australia’s financial aggregates for the month of August. My associates at Action Economics reach similar conclusions in relation to the US:
What if Wall Street throws a panic, and nobody shows up? Some players became so caught-up in the pass-through scenario of credit market disruption to reduced economic growth that it seemed a fait accompli. Yet, the events of August were better described as market turmoil than a credit crunch, and the difference is important for the economy, inflation, and the Fed…
In total, the use of the term “credit crunch” to describe the events of August may prove a misnomer with real implications for risk assessments as we enter Q4. Though turmoil for financial market participants was substantial, there is widespread evidence that the large majority of the borrowing public both ignored the events and experienced little effect. To most U.S. borrowers, the period has only been associated with declining interest rates, a falling dollar, surging stock and commodity prices, and rapid loan, money, and reserve growth. Such patterns usually define a period of easy money and rising inflation rather than a “credit crunch.” Even if some borrowers on the margin are now unable to obtain credit, and there is no doubt that credit conditions have tightened for some borrowers, expanded borrowing by everyone else may more than offset the difference.
posted on 10 October 2007 by skirchner in Economics, Financial Markets
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Bryan Caplan’s The Myth of the Rational Voter
Bryan Caplan’s The Myth of the Rational Voter turns on the distinction he draws between the familiar rational choice theory concept of rational ignorance and what he calls rational irrationality: the idea that there are weak or no incentives to behave rationally in the political arena. This runs counter to standard public choice theory, but Caplan argues that this explains the failure of political behavior to parallel market behaviour.
I’m not sure that Caplan’s attempt to distinguish between rational ignorance and rational irrationality succeeds in the end. It mostly just relocates the standard cost-benefit analysis of rational choice theory from the costs and benefits of acquiring information to the costs and benefits of holding and indulging irrational beliefs in the political arena. Caplan notes that to the extent that standard rational choice theory wrongly emphasises the former, ‘this is a failure of economists rather than a failure of economics.’
Caplan suggests that one way of raising the economic literacy of the median voter is plural voting for the well-educated and eliminating efforts to increase voter turnout. Caplan’s view implies that political-economic outcomes should be decidedly worse in a country with compulsory voting like Australia than in a country like the US, where voting is voluntary and electoral participation is correlated with education. Australian and US economic literacy levels are likely to be very similar, but the economic literacy of the median Australian voter should be lower than that for the median US voter. Yet as a generalization, the two political systems produce qualitatively similar public policy outcomes. Indeed, in some policy areas, such as regulation of the financial system and retirement incomes policy, the Australian political system has produced decidedly better outcomes than in the US. For a book that aims to explain ‘Why Democracies Choose Bad Policies,’ I think this is a significant problem.
Caplan’s book includes a nice dig at the fever swamp Austrians of the Mises Institute. Caplan argues against the caricature of economists as market fundamentalists, noting that only the Mises Institute crew comes close to giving substance to the caricature:
Both Mises and Rothbard have passed away, but their outlook – including Ph.D.s who subscribe to it – lives on in the Ludwig von Mises Institute. But groups like these have basically given up on mainstream economics; members mostly talk to each other and publish in their own journals. The closest thing to market fundamentalists are not merely outside the mainstream of the economics profession. They are way outside.
posted on 06 October 2007 by skirchner in Economics, Politics
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The Fall in Employment that Wasn’t
The James Hamilton emoticon indicator turns from frowny face to neutral.
posted on 06 October 2007 by skirchner in Economics, Financial Markets
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A November RBA Tightening
Terry McCrann continues to highlight the risk of an increase in the RBA’s official cash rate in November:
The only thing that could stay the RBA’s hand on the rate lever on Cup Day is a mild September quarter CPI inflation figure.
And it would now have to be milder than a tobacco-free cigarette. And/or some sort of utter disaster in the US.
But even if so, almost nothing can save the governor . . . from hiking early next year.
posted on 04 October 2007 by skirchner in Economics, Financial Markets
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Fiscal Policy and Interest Rates in Australia
The latest issue of Policy includes my article on Fiscal Policy and Interest Rates in Australia.
posted on 04 October 2007 by skirchner in Economics, Financial Markets
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The ALP, Interest Rates and Truth in Advertising
The Labor Party has pulled the on-line advertisement we highlighted late last week:
LABOR has had to withdraw an online advertisement which said a Kevin Rudd government would cut interest rates.
The ad was a tougher version of ALP policy, which is to keep “downward pressure” on interest rates.
A party spokesman said the ad was not properly authorised.
Labor’s Google advertisement headed “Interest Rates in 2007” read: “Families today are carrying record debt. Labor will force rates down.”
posted on 03 October 2007 by skirchner in Economics, Financial Markets, Politics
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Another Redundant International Financial Institution
Bill Easterly on the Asian Development Bank:
Given all the economic success stories in today’s Asia, you’d think the ADB could pat itself on the back for a job well done and then pack up and go home. But not so fast, says the ADB, which is desperately trying to find new things to do with its 2,000 employees and $6 billion of annual lending.
To that end, the ADB is working on a Long Term Strategic Framework 2020, a project best read as bureaucratic jargon for the ADB’s promise to keep producing bureaucratic jargon through the year 2020. For help with the framework, the ADB commissioned an Eminent Persons Group to tell it what to do with itself. The learned committee was chaired by Supachai Panitchpakdi, Secretary-General of the United Nations Conference on Trade and Development, a body that has long distinguished itself by promoting all the bad ideas that stifle both trade and development. The end result was a report called “Toward a New Asian Development Bank in a New Asia.” The eminences have pointed out to the ADB what should be obvious to anyone who reads this newspaper: The ADB’s original raison d’etre of providing capital is obsolete in a capital-surplus region with a large excess of saving over investment.
Australia is the fifth largest shareholder in the ADB.
posted on 02 October 2007 by skirchner in Economics, Financial Markets
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Running the CPI-Interest Rate Gauntlet
The failure of the Prime Minister to visit Yarralumla over the weekend means that he chosen to run the gauntlet of the Q3 CPI at the end of October and the November meeting of the RBA Board. Terry McCrann has been highlighting the implications:
JOHN Howard has ignored the ‘message’ from Reserve Bank governor Glenn Stevens, first ‘revealed’ in these columns on August 14.
That he should consider, seriously consider, holding the election on October 20.
After ‘sitting out’ a trip to Government House in Canberra on Sunday, literally at Telstra stadium in Sydney, the earliest practically the election can now be held is November 10.
Why should he have considered that Saturday in October? Because it came before the next official inflation figures, released on Wednesday October 24.
And Stevens had made it absolutely crystal clear in the RBA’s quarterly monetary statement in mid-August that if it was a bad inflation number, the RBA would lift rates again in November.
Here is what Glenn Stevens said on the subject at his last appearance before the House Economics Committee:
If it’s clear that something needs to be done, I don’t know what explanation we can offer to the Australian public for not doing it. I don’t think there’s any case for the Reserve Bank board to cease doing its work in the month the election is going to be. I doubt that members of the public would see that as appropriate.
Of course, it is by no means obvious that having interest rates front and centre in an election campaign is a negative for the government. But having decided to run the gauntlet, the risk of an interest rate rise argues for an election at the end rather than the beginning of November.
posted on 02 October 2007 by skirchner in Economics, Financial Markets, Politics
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Household Sector Debt and Wealth Accumulation
Steve Burrell highlights the extent to which household sector borrowings underpin the accumulation of financial and other assets:
we are taking on more debt to accumulate wealth and this leveraging has paid off handsomely. Figures earlier this year showed Australians on average had debts of just over $25,000. Not only is that dwarfed by the value of assets they hold, but the ratio of wealth to debt was the highest in nine years.
Last Friday’s figures showed that, overall, net household financial wealth in the June quarter was up by 23.3 per cent on a year ago to $1208 billion.
That means that, after allowing for borrowings, every Australian has a record $57,400 in net financial assets - up more than 21 per cent in a year and by 48.6 per cent in the last two years, the largest jump on record.
And that’s before we take into account the wealth tied up in homes. Other recent figures show the value of Australian dwellings rose by almost 10 per cent over the past year to stand at $3.3 trillion at the end of June. The latest figures on overall wealth show the average Australian worth nearly $400,000 at the end of March, a record high and a doubling in the past five years.
posted on 02 October 2007 by skirchner in Economics, Financial Markets
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The Credit Crunch that Wasn’t
If Australia is suffering a tightening in credit market conditions, it was far from apparent in the financial aggregates for August released today. Private sector credit rose 1.5% m/m and 16.2% y/y, the strongest growth since September 1989. Housing credit, including securitisations, rose 0.9% m/m and 12.4% y/y. Business credit rose a stunning 2.7% m/m and 22.4% y/y, the strongest annual rate since January 1989. M3 rose 17.9% y/y, while broad money expanded 16.6% y/y, growth rates also not seen since the end of 1989.
These data are all the more remarkable considering that the late 1980s were an era of much higher rates of inflation. While growth in credit aggregates have explanatory power for the business cycle, it should be recalled that credit has also been growing as a share of GDP, as financial deregulation and innovations gradually release the household and business sectors from the borrowing constraints of the past. As RBA Deputy Governor Ric Battellino indicated in a speech this week, there is no reason to believe that household sector debt will not continue to rise as a share of GDP, as the benefits of financial innovation are diffused to a broader range of households. Given the growing likelihood that the current positive terms of trade shock is going to be permanent, it also makes sense for the household and business sectors to start borrowing against this permanent increase in national income.
posted on 28 September 2007 by skirchner in Economics, Financial Markets
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‘Force Interest Rates Down’
One of the Labor Party’s Google Ads that have popped up to the right of this post:
Interest Rates in 2007. Families Today Are Carrying Record Debt. Labor Will Force Rates Down.
Clicking on to Kevin07.com.au, I could not find how Labor proposed to ‘force’ rates down, but it’s an interesting verb choice. Even the government’s claims about interest rates in the 2004 campaign did not go that far.
You would think Labor might have learned from the government’s experience that there is no point in making the claim that a government can lower interest rates. The direction of Australian interest rates is determined by business cycle and international influences over which the government (and even the RBA) have very little effective control.
posted on 28 September 2007 by skirchner in Economics, Financial Markets, Politics
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Bretton Woods Revivalism in the WSJ
More tiresome hard money ratbaggery in the WSJ, this time from Bretton Woods revivalist, Judy Shelton:
The massive currency swings that reign between the dollar, the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc wreak havoc on demand-and-supply outcomes for goods traded across borders. The New York Board of Trade’s U.S. Dollar Index, which tracks the dollar’s value relative to a basket of those six other currencies, has tumbled 34% since its July 2001 peak. Why pontificate about the importance of eliminating tariffs to promote open markets when the impact of a gyrating dollar is far more devastating, far more protectionist in its effect on global free trade?
It is time for the U.S. to acknowledge what we have tried to wave off under the pretense of allowing free markets to decree the value of our currency.
If we truly believe in a global marketplace where outcomes are determined by competition and competence, not localized monetary policies, we need a global monetary unit of measure. We need a meaningful global currency.
Bretton Woods broke down precisely because fixed exchange rates wrecked havoc by transmitting economic shocks, including monetary and fiscal policy mistakes, around the world.
posted on 27 September 2007 by skirchner in Economics, Financial Markets
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