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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‘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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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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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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World’s Most Expensive Narrative
Vince Reinhart, on the high cost of bad narratives:
The most expensive stage of a financial crisis is not the initiating economic loss—in our case, an unsustainable boom in residential construction that left too many houses and a mountain of debt. Nor are the largest losses racked up as investors withdraw from risk, markets freeze, and balance sheets implode. Policy missteps, including the continuing confusion of solvency problems for liquidity ones, no doubt add to the tab. These costs, while they may be big, pale to insignificance compared to what follows.
The most expensive stage of a financial crisis occurs when society tries to explain to itself what just happened. The resulting narrative is not the product of one person or institution. Rather, it gets written in the tell-all “tick-tocks” of major newspapers, the inside accounts in bestsellers, the speeches of leading officials, and the punch lines of late-night comedians. The narrative determines our attitudes toward the actors and events of the crisis. It also identifies the structural problems thought suitable for legislative and regulatory remedy.
posted on 03 June 2009 by skirchner in Economics, Financial Markets
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A Simple Test for the Effectiveness of Macro Policy Stimulus in Australia
A simple test for the effectiveness of macro policy stimulus in Australia is to model quarterly Australian GDP growth as a function of contemporaneous and lagged US GDP growth and a constant. The model makes the reasonable assumption that causality runs from US growth to Australian growth, since Australia is too small to influence the US economy. US stimulus measures could benefit Australian GDP based on this model, but Australian policy stimulus should not influence US GDP growth (even allowing for those stimulus cheques to ex-pats). Domestic policy is historically correlated with US GDP growth, but presumably works in a counter-cyclical direction. The estimated relationship implies that domestic policy can do only so much to offset the influence of US or world growth on domestic activity.
The model’s static forecast for Australian March quarter GDP is -0.8% q/q, with a standard error of 0.6, so we would expect March quarter GDP growth to lie in the range of -0.2% q/q to -1.4% q/q. The median forecast of market economists is -0.2% q/q, based on Friday’s Reuters poll*, implying that the Australian economy is modestly outperforming what we might expect based solely on US growth. Both domestic monetary and fiscal policy could thus be given some credit in offsetting the effect of the decline in world growth. But even if we generously assume that discretionary fiscal policy measures account for most of this outperformance, it is a very small return on what has been called ‘the greatest mobilisation of resources in Australia’s peacetime history.’ The lesson is that for a small open economy like Australia, there is only so much domestic policy can do when confronted with a global economic downturn.
Model details over the fold.
* Update: Latest Reuters poll median is +0.2% q/q, following Tuesday’s release of net exports for the March quarter.
continue reading
posted on 02 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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Meltzer versus Battellino on Central Bank Credibility
Allan Meltzer doesn’t share Ric Battellino’s optimism that central banks will re-tighten monetary policy in a timely fashion:
Does the Federal Reserve have the technical ability to prevent inflation? Certainly! Will the Federal Reserve show the political stomach in the face of a sluggish recovery and almost certain cries of alarm from Chairman Barney Frank, the administration, the business community, the labor unions, and Krugman? Certainly not!
posted on 02 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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The Quiggin-Caplan Wager: I’m with Quiggin
Bryan Caplan and John Quiggin take a 10-year bet on the average of the US-EU15 unemployment rate differential. On this bet, I have to say I’m with Quiggin. The reason: the US is thinking more and more like Quiggin and less like Caplan. Public policy in the EU is not appreciably worse than it has been in the past, but the rate of deterioration in the US implies that their respective structural unemployment rates should converge via a faster rate of deterioration in the US. The capital allocation process in the US is now so deeply compromised by political intervention that there is little reason to believe in the continued structural outperformance of the US economy. Differences in labour market institutions won’t matter much in this context. Caplan himself puts his chances of winning at only 60%.
David Goldman put it well in perhaps the most disturbing metaphor for the crowding-out effect on US economy:
The moment the zombie pulls on his chain, rates rise, consumption falls, and the zombie gets less oxygen.
posted on 29 May 2009 by skirchner in Economics, Financial Markets
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Convenience Shopping for Gold Bugs
Gold vending machines.
posted on 29 May 2009 by skirchner in Economics, Financial Markets, Gold
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Why Monetary Easing Need Not be Inflationary
RBA Deputy Governor Ric Battellino, on why monetary easing need not be inflationary:
The other side of the debate – that the measures will result in higher inflation – implicitly assumes that the measures will be effective in stimulating the economy, since money does not miraculously transform into inflation without affecting economic and financial activity. Rather, their argument is that central banks will be too slow to reverse the various measures.
As there are no technical factors that would prevent or slow the reversal of recent measures – they can be reversed simultaneously or in any sequence – the argument must rest on central banks making incorrect policy judgments. This is always a possibility. But, the high state of awareness that currently exists about the risk of being too slow to reverse recent exceptional measures should limit the probability of such a mistake being made.
Unfortunately, a high state of awareness does not in itself guarantee timely policy action, as the RBA’s own track record would suggest.
posted on 28 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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The Monthly Labour Force Lottery
Centrebet is now running a book on the unemployment rate, as published in the monthly ABS Labour Force release. A rate of 5.6%-5.7% is currently favoured for May following 5.4% in April.
The quoted range begs the question as to whether they would pay on a rounded estimate published at 5.6% or 5.7% that was actually outside this range on an unrounded basis.
posted on 25 May 2009 by skirchner in Economics, Financial Markets
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