Austrianism or Agnosticism at the BIS?
The WSJ’s Greg Ip claims that:
Although the concluding chapter of the BIS’s latest annual report, released Sunday, never mentions the Austrian school, it is suffused with its influence.
My own reading of it would suggest that it is studiously agnostic on most issues. We have previously had occasion to ridicule the notion of the BIS as a home of Austrian School thinking. Greg Ip says that:
The BIS’s leading “Austrian” is a Canadian, William White, the head of the bank’s monetary and economic department and sometimes-rumored successor to retiring Bank of Canada governor David Dodge. In a 2006 paper Mr. White wrote that under Austrian theory, “credit creation need not lead to overt inflation. Rather…. the financial system … create[s] credit which encourages investments that, in the end, fail to prove profitable.” This leads to an “an eventual crisis whose magnitude would reflect the size of the real imbalances that preceded it [because] the capital goods produced in the upswing are not fungible, but they are durable. Mistakes then take a long time to work off.” He argued that in recent decades, “financial liberalisation has increased the likelihood of boom-bust cycles of the Austrian sort.”
As we noted when it was released, White’s paper was little more than Bretton Woods revivalism dressed-up in Austrian clothes. The notion that Austrian business cycle theory provides a basis for a revival of Bretton Woods institutions and central bank targeting of asset prices is absurd, but it is not hard to understand why these conclusions might appeal to a central banker.
There is little evidence to support Austrian business cycle theory as even a stylised account of business cycle and financial market dynamics, at least under current central bank operating procedures in the major industrialised countries, which have been dominated by interest rate and inflation targeting for at least the last 10 years.
The Taylor rule and related literature shows that it is much easier to explain monetary policy with reference to the economy than it is to explain the economy with reference to monetary policy. This is just another way of saying that monetary policy for the most part responds endogenously to economic developments and the exogenous component of monetary policy is very small. Anyone who has tried to motivate a role for official interest rates in standard economic models (the sort of empirical work that few would-be Austrians are prepared to undertake) knows what a problematic exercise this can be. Growth in money and credit aggregates can be given a similar endogenous interpretation.
This makes the claim that, but for the supposed monetary policy errors of central banks, the amplitude of business and asset price cycles would be greatly reduced extremely implausible, at least under contemporary interest rate/inflation targeting regimes. Indeed, we know that under the gold standard, the preferred monetary regime for many Austrians, volatility was more pronounced, with inflexibility in prices and exchange rates simply forcing any adjustment on to the real side of the economy.
The increased prominence of Austrian business cycle theory in popular discourse actually has profoundly anti-market implications, because it leads people to believe that there is something wrong with macroeconomic and financial market outcomes that are in fact largely market-determined and have very little to do with either monetary policy or asset price ‘bubbles.’
posted on 26 June 2007 by skirchner in Economics, Financial Markets
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Depression Era Exchange Rate Regimes
Amity Shlaes, on exchange rate policy under Roosevelt:
At some points Roosevelt seemed to understand the need to counter deflation. But his method for doing so generated a whole new set of uncertainties. Roosevelt personally experimented with the currency—one day, in bed, he raised the gold price by 21 cents. When Henry Morgenthau, who would shortly become Treasury Secretary, asked him why, Roosevelt said that “it’s a lucky number, because it’s three times seven.” Morgenthau wrote later: “If anybody ever knew how we set the gold price through a combination of lucky numbers, etc., I think they would be frightened.”
You can hear Amity talk about her new book, The Forgotten Man: A New History of the Great Depression, in this podcast.
posted on 25 June 2007 by skirchner in Economics
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Gordon Brown Wants You for the BoE MPC
Outgoing Chancellor of the Exchequer Gordon Brown wants to advertise for new members for the Bank of England’s Monetary Policy Committee:
Gordon Brown yesterday bowed to pressure to reduce the secrecy surrounding appointments to the Bank of England’s rate-setting body by pledging to advertise the positions.
Making his final appearance before the Treasury select committee as chancellor, the prime minister-elect said he would invite “expressions of interest’’ from economists and other experts for the four outside appointments to the nine-member monetary policy committee.
The advertisements would be more specific about the criteria and skills the Treasury was looking for than under current rules, he said, amid fears that under-qualified people might be appointed.
Last year, four former MPC members raised concerns that Mr Brown might have received advice to appoint a non-economist to replace Stephen Nickell, an economics professor who now heads Nuffield College, Oxford.
The House of Lords’ economic affairs committee last year described the appointments process as one which was “shrouded in mystery and may not always recommend the most suitable candidates”.
Mr Brown also pledged to lay out a timetable for appointments. Mervyn King, Bank governor, has criticised the Treasury for a “very informal” approach resulting in appointments being made “very much at the last minute” instead of in a “timely” fashion.
In Australia, we know all about timely appointments of qualified persons to the Board of the Reserve Bank.
posted on 18 June 2007 by skirchner in Economics, Financial Markets
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How to Beat Warren Buffett
It’s as easy as investing in Australian banks:
Research from global consulting firm Stern Stewart, commissioned by The Australian, shows the banks beat Buffett in terms of total shareholder return (share price growth plus dividends) over one, three, five, 10 and 15 years.
posted on 16 June 2007 by skirchner in Economics, Financial Markets
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Never Mind the Incandescent Light Bulbs
From RBA Governor Glenn Stevens’ speech in Brisbane today:
One recent study suggests that, based on the experience of most other countries which have made that transition, the number of motor vehicles owned in China would be expected to rise from 20 million in 2002 to almost 400 million by 2030. That would be equivalent to nearly 50 per cent of the vehicles in the world today.
posted on 14 June 2007 by skirchner in Economics
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Fertility and the Exchange Rate
Fertility has been a long-standing preoccupation of the authorities in Singapore, so it is perhaps not surprising that the Monetary Authority of Singapore should examine the links between fertility and the exchange rate:
We use a quinquennial data set covering 87 countries between 1975 and 2005 to investigate the relationship between fertility and the real effective exchange rate. Theoretically a country experiencing a decline in its fertility rate can be expected to have higher savings, lower investment, a current account surplus, and accordingly a real depreciation. We test and confirm this hypothesis, controlling for a host of potential determinants such as PPP deviations and the Balassa-Samuelson effect. We find a statistically significant and robust link between fertility and the exchange rate. Our point-estimate is that a decline in the fertility rate of one child per woman is associated with a depreciation of approximately .15% in the real effective exchange rate.
The number of births in Australia in the year-ended December 2006 was the highest in 35 years, while the real effective exchange rate in Q4 2006 was the highest since Q1 1985.
posted on 13 June 2007 by skirchner in Economics, Financial Markets
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RBNZ Monetary Policy Now Formally at War with Itself
The Reserve Bank of New Zealand today went from the sublime to the ridiculous, intervening in foreign exchange markets to sell the NZ dollar. On Friday, NZD-USD reached its highest level since May 1982 at 0.7640, following last week’s decision by the RBNZ to raise official interest rates to 8.00%. RBNZ Governor Bollard said that:
As stated in our June Monetary Policy Statement, we regard current levels of the exchange rate as exceptional and unjustified in terms of the economic fundamentals. This action does not prejudge the future direction of monetary policy, which as always will remain dependent on emerging economic trends. The action is consistent with clause 4(b) of the Policy Targets Agreement, which requires monetary policy to avoid unnecessary instability in the exchange rate.
The claim that the NZD is over-valued in the current environment only makes sense if one believes that there is a much broader misalignment in multilateral exchange rates. The NZD’s dollar bloc peers, the Australian and Canadian dollars, are also making 18 and 30-year highs respectively. The NZD is in fact responding to fundamentals largely of the RBNZ’s own making. The exchange rate is “exceptional by historical standards” because the RBNZ’s official cash rate is also at record highs and threatens to go higher.
RBNZ monetary and exchange rate policy are now formally working at cross-purposes, with the RBNZ raising interest rates on the one hand, while seeking to offset the implications of higher interest rates through intervention in foreign exchange markets on the other.
The RBNZ has historically taken a laissez-faire approach to the exchange rate. But after Bollard became Governor, he sought a re-capitalisation of the Bank to facilitate intervention in foreign exchange markets. So far, the intervention has been a failure, with NZD-USD still holding above levels that prevailed before last week’s tightening. This is despite the intervention being timed to capitalise on thin market conditions brought about by a public holiday in Australia. While there is no technical limit on the ability of a central bank to weaken its own currency, this is only possible when monetary and exchange rate policy work together. When monetary and exchange rate policy are at cross-purposes, it is monetary policy that invariably wins.
Far from reducing volatility in the exchange rate, RBNZ intervention in the foreign exchange market will only serve to increase it. In recent years, NZ monetary policy has become increasingly incoherent. The RBNZ’s Statements on Monetary Policy, once a model for central banks around the world, increasingly have an Alice in Wonderland quality, with the RBNZ making key operating assumptions about the exchange rate and its relationship with monetary policy that simply have no credibility.
posted on 11 June 2007 by skirchner in Economics, Financial Markets
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Mundell’s Long View on the US Dollar
Nobel laureate Robert Mundell’s long view on the big dollar:
HONG KONG—As the audience at the Asia Society’s May gala dinner here sips their coffee, the moderator allows one more question from the audience for Nobel economics laureate Robert Mundell. A Chinese gentleman stands to ask how much longer the U.S. dollar would remain the world’s reserve currency. The query seems like the perfect set-up for the world’s foremost expert on monetary policy and a well-known “friend of China” to predict the rise to pre-eminence of China’s currency.
Instead, Mr. Mundell says that China is still far behind the U.S. in economic strength and stability. “I think the dollar era is going to last a long time . . . perhaps another hundred years.”
Nouriel Roubini’s worst nightmare.
posted on 09 June 2007 by skirchner in Economics, Financial Markets
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Deregulating Prediction Markets
Andrew Leigh and Justin Wolfers call for the deregulation of prediction markets in their Melbourne Review article:
In Australia, the legal environment has prevented prediction markets from establishing themselves in most States. In addition, there is a concern that, for major bookmakers such as Centrebet, trading on economic derivatives would bring them into conflict with the Australian Stock Exchange and the Australian Futures Exchange. Since Australian betting agencies already handle significant sums of money for elections and major sporting events, relaxation of the regulation governing such markets would bring little risk but a significant public benefit.
Unfortunately, the (now merged) ASX and SFE would probably resist the expansion of prediction markets. Given the SFE’s failure to generate interest in many of the futures contracts it offers, it is hard to imagine it being very enthusiastic about increased competition from new prediction markets offering new products. As in the US, incumbent exchanges and gaming interests, as well as restrictions on cross-border financial transactions, are likely to stand in the way of further development of prediction markets.
posted on 08 June 2007 by skirchner in Economics, Financial Markets
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Do Markets Care Who Chairs the Central Bank?
According to this paper by Kuttner and Posen, they do. Once again, the RBA, or more specifically, former Governor Bernie Fraser, serves as an influential observation in this study:
One puzzling result involving the bond yield is that there is a significant market reaction for the non-newsworthy subsample, which is meant to consist only of appointments that were widely anticipated ahead of time. At first glance, this seems to contradict the proposition that the market should respond only to new information. An inspection of the individual responses in table 2 reveals that this anomalous response can be traced to two observations: Australia’s 1989 appointment of Bernie Fraser and Norway’s 1996 appointment of Kjell Storvik. Both of these were classified as anticipated appointments, based on the press reports, and yet, both were associated with pronounced bond market responses. Yields rose 15 basis points (two standard deviations) on Fraser’s announcement and fell 19 basis points (over four standard deviations) on Storvik’s.
In Fraser’s case, the reason for the unusual reaction is relatively clear. The likely choice of Fraser, the sitting Secretary of the Treasury, had been criticized in the weeks prior to the announcement as an appointment that would predispose the Reserve Bank of Australia (RBA) to yield to political pressure for more accommodative monetary policy. And, while Fraser was widely viewed as the clear front-runner for the job, there was some speculation that Bob Hawke’s government would back away from its preferred candidate and appoint instead one of several viable candidates from within the RBA. Thus, the adverse market reaction provoked by the announcement suggests Fraser’s appointment was not thought to be entirely certain. Reclassifying the appointment as newsworthy along these lines would make the bond market’s reaction significant at the five percent level for newsworthy events and not significant for non-newsworthy events, thus eliminating one minor anomaly in the results.
posted on 31 May 2007 by skirchner in Economics, Financial Markets
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Australian Economists Repudiate Kyoto
The latest media stunt by the anti-modernist Australia Institute has backfired, with Warwick McKibbin noting on ABC Radio that only 10% of those eligible to sign the economists’ petition in support of Kyoto actually did so. McKibbin was a particularly notable non-signatory, given his expertise in climate change policy.
UPDATE: Damien Eldridge explains his reasons for not signing.
posted on 28 May 2007 by skirchner in Culture & Society, Economics, Politics
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Sad, But Probably True
Justin Wolfers, quoted in American.com:
I could do the same work I’m doing now for an Australian institution, and the truth is, no one would listen.
posted on 26 May 2007 by skirchner in Economics, Financial Markets
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The Economy and the Polls: A Rational Choice Perspective
Australia’s incumbent federal Coalition government is struggling in the opinion polls ahead of this year’s federal election, despite some of the strongest economic conditions in the post-war period. Treasurer Peter Costello likes to boast of his role in ‘managing a trillion dollar economy.’ As Andrew Leigh notes, we must have all missed Australia’s transition from a market to a planned economy! It is likely that voters are aware of this distinction, even if Peter Costello is not.
There is some evidence to suggest that economic data has predictive power for the incumbent two-party preferred vote share at the federal level. Yet rational choice theory would also lead us to expect the two main parties to fully endogenise the preferences of the median voter ahead of the federal election. The modifications that both parties have made to their industrial relations policies in recent weeks are consistent with the predictions of the median voter model. Opposition leader Kevin Rudd’s claim to be a ‘fiscal conservative’ is similarly an attempt to endogenise the preferences of the median voter. Rudd’s political skill lies largely in not differentiating himself from the federal government, unlike former leader Mark Latham, who actively sought to differentiate himself on issues such as school funding and health.
This model still fails to explain why the opposition should enjoy such a strong lead in the polls, since the model is more consistent with voter indifference, with actual election outcomes a random walk. However, it is noteworthy that betting and prediction market pricing of the election seems closer than that suggested by the opinion polls. As Bryan Palmer notes:
The book makers are saying that if the same 2007 Federal election were repeated 20 times, John Howard would expect to win 9 elections and Kevin Rudd would expect to win 11. It is still a close contest.
As Andrew Leigh’s research has found, markets such as these may have better predictive power for election outcomes than opinion polls and economic data.
From the perspective of a rational voter, there are few substantial differences between the Coalition and Labor on monetary and fiscal policy and a diminishing amount of product differentiation on industrial relations. Since the last federal election, it is also likely that voters have learned that international and cyclical influences are more significant in the determination of interest rates than anything the government might do with the federal budget balance.
posted on 24 May 2007 by skirchner in Economics, Financial Markets, Politics
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China’s Monetary and Exchange Rate Policy
Ahead of the US-China Strategic Economic Dialogue, Matthew Slaughter explains why the preoccupation with China’s managed exchange rate regime is misplaced:
Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows.
Like all other central banks, the People’s Bank of China uses its monopoly power over minting its money to control one nominal price. Since 1994 the PBOC has chosen to closely target the dollar-yuan price. In recent times, maintaining this target has required the PBOC to print yuan to buy dollars and thereby accumulate dollar-denominated assets on its balance sheet…
In a counter-factual world where over the past decade China allowed the yuan to float against the dollar, the U.S. would still have run a large and growing trade deficit with China. The real economic forces of comparative advantage that drive trade flows operate regardless of which nominal prices central banks choose to fix.
As this paper from the Bank of Japan explains in detail, China’s money market operations are largely subordinate to the requirements of its managed exchange rate regime.
posted on 22 May 2007 by skirchner in Economics, Financial Markets
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The Politicisation of the Future Fund
The Future Fund has barely invested a single cent and yet it is already the target of rent-seeking in relation to its basic administrative arrangements, such as its choice of custodian. The Future Fund’s investment decisions will be the subject of even greater scrutiny, especially following Chairman David Murray’s recent suggestion that the Fund would seek to invest in private equity. This scrutiny will necessarily be after the fact, given the lack of transparency around the Fund’s investment process. By creating an asset portfolio subject to public ownership and control, the Future Fund will increasingly become a focus for distributional conflict and rent-seeking.
posted on 22 May 2007 by skirchner in Economics, Financial Markets
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