A ‘New Era’ for the Reserve Bank?
I have an op-ed in today’s Age on the proposed Reserve Bank Amendment (Enhanced Independence) Bill, which is a brief summary of a more detailed article that will be forthcoming in Policy. The op-ed concludes:
While formally enhancing the independence of the RBA, the new arrangements leave it operating under an outdated and internationally anomalous governance structure that is incompatible with modern demands for central bank transparency and accountability.
UPDATE: Full article can be found here.
posted on 27 March 2008 by skirchner in Economics, Financial Markets
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Central Banking for Monarchists
From the not-always-reliable Real Time Economics blog:
and the exception, the Royal Bank of Australia, which has been raising rates lately to fight inflation in the commodity-rich economy, to boost its key rate from 7.25% to 7.5% later this year.
posted on 21 March 2008 by skirchner in Economics, Financial Markets
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Business Spectator Column
This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 15 March 2008 by skirchner in Economics, Financial Markets
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Stevens on Monetary & Fiscal Policy
RBA Governor Stevens, speaking to Treasury officers Wednesday, remained decidedly agnostic on the appropriate mix of monetary and fiscal policy in controlling inflation:
It strikes me that in the popular discussion about fiscal policy, many participants talk past each other because they are looking at different time dimensions. It is not unreasonable to say that if the budget is perpetually in surplus, there is no debt to speak of and no other looming large unfunded liability, taxes should probably, over some long run horizon, be lower. This, it seems to me, is the economic case for structural reductions in taxes, which some observers articulate. Others argue that such reductions should be delayed, for cyclical reasons, given that demand needs to slow to contain inflation. So there is a structural case for taxes to fall, and a cyclical case for them not to. It is no doubt difficult for any government to reconcile these two, equally valid, points of view, the more so if the same tension persists for a number of consecutive years…
If it is accepted, on the other hand, that inflation is sufficiently general that overall demand has to slow, the amount of slowing has to be the same regardless of whether it comes via monetary policy or fiscal policy. It would be somewhat differently distributed across sectors and regions, as the impact of interest rate and exchange rate effects obviously would not overlap exactly with the tax or spending measures that would occur in their place. I would hazard a guess, though, that a good many people who are today paying higher interest rates would instead pay higher taxes in a world where fiscal policy was used more actively to manage the business cycle.
posted on 14 March 2008 by skirchner in Economics, Financial Markets
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Chinese Inflation
Jonathan Anderson is relaxed about Chinese inflation:
All the evidence suggests that the current spike in prices will prove to be temporary, likely fading away by the second half of 2008, and as it does the prevailing furor over the inflation issue will subside as well…
We agree that money growth is a fundamental force behind inflation in China, and there is a clear and tight correlation between the two over time. But the salient point is that monetary factors drive underlying inflation, and not every short-term twist and turn in CPI along the way. During the deflationary period 1997-2003, the measure of broad money, M2, grew at an average annual rate of 16.4%. What was the comparable pace for the second half of 2007? Around 17.6% year on year—in other words, only slightly higher.
Base money growth has been much lower still, with sharply falling commercial bank excess liquidity ratios in the process. So while it’s easy to argue that money growth may have been nudging core inflation upward, it certainly can’t explain a seven percentage point rise in the headline rate.
posted on 11 March 2008 by skirchner in Economics, Financial Markets
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Business Spectator Column
This week’s Business Spectator column (which updates interbank pricing referenced in the previous post). If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 08 March 2008 by skirchner in Economics, Financial Markets
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Rate Cuts by Christmas? Good Luck with That!
If you believe the interbank futures market, then there is a small chance the RBA will be cutting the official cash rate by November this year. This is partly based on the market’s reading of the statement accompanying yesterday’s increase in official interest rates, in which the RBA focused on the expected moderation in domestic demand and inflation. This is simply a reiteration of the RBA’s February SOMP forecasts, but these forecasts look increasingly aspirational.
Today’s December quarter national accounts confirmed headline and non-farm GDP growth were both running above the RBA’s forecasting assumptions. Domestic demand, far from slowing, accelerated over the December quarter to 1.6% q/q and 5.7% y/y in real terms. The first bottom-up estimates for March quarter CPI inflation point to an increase of 1.3% q/q and 4.2% y/y. With a nominal official cash rate of 7.25%, this points to a real cash rate of only 3.05%, although market-determined rates are significantly higher.
This is not the first time this tightening cycle that financial markets have priced in future reductions in interest rates. Markets condition their view in large part on what the RBA says, or more importantly, what it does not say. Yesterday’s statement gave no explicit forward policy guidance, but neither did the February tightening statement. It was not until the February SOMP and Board minutes were released that the RBA bothered to mention its view that further significant increases in official interest rates would be required.
While an easing by Christmas is not impossible, this leaves markets grossly underpricing the risk of further intervening increases in official interest rates.
posted on 05 March 2008 by skirchner in Economics, Financial Markets
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Oil Aplenty: Debunking the Peakniks
Nansen Saleri, former head of reservoir management for Saudi Aramco, debunks the peakniks in the WSJ:
The world is not running out of oil anytime soon. A gradual transitioning on the global scale away from a fossil-based energy system may in fact happen during the 21st century. The root causes, however, will most likely have less to do with lack of supplies and far more with superior alternatives. The overused observation that “the Stone Age did not end due to a lack of stones” may in fact find its match.
The solutions to global energy needs require an intelligent integration of environmental, geopolitical and technical perspectives each with its own subsets of complexity. On one of these—the oil supply component—the news is positive. Sufficient liquid crude supplies do exist to sustain production rates at or near 100 million barrels per day almost to the end of this century.
Technology matters. The benefits of scientific advancement observable in the production of better mobile phones, TVs and life-extending pharmaceuticals will not, somehow, bypass the extraction of usable oil resources.
posted on 04 March 2008 by skirchner in Economics, Financial Markets
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The Need for a More Timely CPI
If you like your inflation with a ‘four’ in front, then the February TD-MI inflation gauge has good news for you. Their proxy for CPI inflation was running at 4% y/y in February, matching the previous record high for this series in May 2006. The trimmed mean, which proxies for the RBA’s preferred measure of underlying inflation, rose 0.3% m/m and 4.1% y/y, a new record high for this series. The February inflation gauge points to an official Q1 headline CPI outcome of 1.3% q/q and 4.2% y/y compared to 3% y/y previously, well outside the RBA’s 2-3% medium-term target range.
Australia shares with New Zealand an anomalous position among developed countries in publishing its official CPI at a quarterly rather than a monthly frequency. The ABS has traditionally defended this practice on the grounds that the additional costs of publishing at a higher frequency outweighed the benefits. One suspects that this assessment has more to do with the costs and benefits for the ABS, rather than society more generally. If a higher frequency CPI reduces the risk of a macroeconomic policy error, then the benefits from a more timely CPI release could be very large indeed.
It has been widely noted that most of the Reserve Bank’s increases in official interest rates this cycle have been announced at the Board meeting immediately following the release of the quarterly CPI. This strongly suggests that the RBA Board is looking to these quarterly releases for confirmation of the direction of inflation before taking policy action. This gives monetary policy a backward-looking bias, one that is exacerbated by a low frequency CPI.
Moving to a monthly CPI release has the potential to significantly change the dynamics of monetary policy decision-making. Each monthly Board meeting would have the benefit of an updated reading on inflation, eliminating the current bias to take policy action at a quarterly frequency. This could result in more timely monetary policy action than has been evident from the RBA this cycle, leading to better inflation outcomes.
posted on 03 March 2008 by skirchner in Economics, Financial Markets
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Saved Not Spent II
An opinion poll finds that a slim majority would prefer tax cuts to be paid into superannuation accounts:
The survey was based on interviews with 800 Queenslanders and found 55 per cent of respondents would prefer the proposed tax cuts to be delivered as extra payments to their superannuation fund. This included a majority of Labor and Coalition supporters.
Only 38 per cent of people wanted the money upfront through lower taxes.
This is an interesting result, because there is nothing to prevent people from putting their tax cuts into super voluntarily. The only reason to favour having the choice made for you would be as a solution to an imagined collective action problem: I might save my tax cut, but if others don’t, the consequences could be inflationary, so a policy that is also binding on others is to be preferred. This policy preference is likely the result of a cognitive bias: the belief that other people are less prudent than ourselves (I’m sure Andrew Norton would have hard data on the extent of this belief). In reality, if we think saving a tax cut is a good thing, then others probably see it that way too.
posted on 29 February 2008 by skirchner in Economics, Financial Markets, Politics
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The Futureless Future Fund
It says a lot about the Future Fund that our first real insights into its investment strategy and performance should come via a Senate Estimates Committee hearing. As we have noted previously, the Future Fund’s ranking in international comparisons of sovereign wealth fund transparency and accountability lies somewhere between that of the State Oil Fund of the Republic of Azerbaijan and the National Oil Fund of Kazakhstan.
Given recent market conditions, it should not come as a huge surprise to learn that the Fund remains around 75% invested in cash. This is little different from leaving the funds on deposit with the RBA, the more traditional home of budget surpluses. This did not stop the headline writers (‘Future Fund’s $700m hit’; ‘Future Fund Flounders’) and Coalition Senators from making hay out of the Fund’s few non-cash investments. As we predicted here, the Future Fund’s investments will inevitably become a political football and today’s headlines are just a taste of what we will see as the Fund expands the scope of its investments.
Unfortunately for the Coalition, the Future Fund is very much a creature of its own making and in many ways emblematic of the political and intellectual exhaustion that led to the former government’s defeat. This effectively lets the new government off the hook in relation to the Fund’s future performance under its current mandate
The new government is promising to hoard any increase in the budget surplus over and above the forward estimates. The government could very quickly notch-up budget surpluses of around 2% of GDP without any real effort, adding more than $20 billion annually to the Fund’s assets. With the Fund already set to meet its original mandate to provide for public sector super liabilities, Coalition Senators could make themselves useful by asking what further contributions to the Future Fund are actually for.
posted on 28 February 2008 by skirchner in Economics, Financial Markets, Politics
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Saved Not Spent
Finance Minister Lindsay Tanner launches a robust defence of the government’s tax cuts:
“To the extent that there is a stimulatory impact ... it is actually far less than some people have been presenting.”…
“Everybody ... assumes that every last dollar that every citizen gets in a tax cut will be spent and not saved - that’s a false assumption,” Mr Tanner said.
I make many of the same arguments here.
posted on 27 February 2008 by skirchner in Economics, Financial Markets, Politics
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Business Spectator Column
This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 23 February 2008 by skirchner in Economics, Financial Markets
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Real Prices or Relative Prices? The Dow-Gold Ratio
Robert Prechter’s January Elliott Wave Theorist (you can sign-up for a free copy here) presents one of Bob’s favourite charts, namely the Dow-gold ratio. The ratio is currently around 13, down from a peak around 44.12 in the late 1990s. Prechter argues that this ratio represents the Dow denominated in real terms. This is true only if you think the gold price benchmarks real purchasing power. We could equally measure the Dow in terms of any other commodity (as Prechter sometimes does with oil). Since commodity prices are typically more volatile than consumer prices, they are a poor benchmark for consumer purchasing power, which is best measured with respect to the CPI.
Rather than a real price, the Dow-gold ratio is better viewed as a relative price. The ratio tell us that equity prices have recently underperformed commodity prices. This should not come as a surprise, since equities typically underperform in an inflationary environment. The Great Inflation of the 1970s was notoriously associated with a rolling multi-year bear market in stocks.
While Prechter is notoriously bearish equities, he has also been bearish gold, so his case for gold is based on relative performance. But the implication to be drawn from the Dow-gold ratio is that equities as an asset class are becoming cheaper relative to commodities as an asset class. Relative value is thus increasingly on the side of equities, not commodities.
posted on 22 February 2008 by skirchner in Economics, Financial Markets
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Consumers Don’t Cause Recessions
Adam Posen, on why consumers don’t cause recessions:
When forecasting the US economy, what happens to the business sector and investment is far more salient than what happens to consumption. While private consumption makes up 70 percent of the economy, it fluctuates over a far smaller range than investment or net exports (which makes sense, since what households purchase does not vary all that much with the business cycle). A decline in consumption commensurate with the decline in housing prices, and thus households’ perceived wealth, would be on the order of 1.25 percent of GDP, based on how they increased spending as house prices went up. That estimate is essentially what the forecast slowdown in the US economy over the next couple of quarters amounts to—it is not in itself enough to cause a persistent recession. And since at least 1945, the United States has never had a consumer-driven recession, precisely because consumers behave this way.
posted on 21 February 2008 by skirchner in Economics, Financial Markets
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