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.
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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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More Bubble Wrap
Alan Wood discusses the debate on the relationship between monetary policy and asset prices, referencing my CIS Policy Monograph Bubble Poppers. Wood writes:
Central bankers have always taken asset prices into account in setting monetary policy and in Australia’s case successfully intervened in the housing market via both interest rates and jawboning by then governor Ian Macfarlane and head of Australian Prudential Regulation Authority, John Laker, a former Reserve banker, to cool off reckless lending and overheating in housing prices.
Kirchner dismisses this episode as unsuccessful, and the Howard government certainly didn’t like it. But the ratio of house prices to income fell markedly after 2003, when the RBA raised rates by 0.5 percentage points in two back-to-back hits. And Australia has so far not suffered anything like the housing price collapses in the US and Britain.
To be clear, my argument was that the RBA’s talk was not backed by policy action. Like the rest of the world, monetary policy in Australia was accommodative in 2003 and the RBA had an explicit easing bias in June of that year. As I noted in this op-ed, the nominal official cash rate did not reach a neutral level until 2005 and the real cash rate struggled to stay above neutral as inflation increasingly got away on the RBA. Unfortunately, most media commentators mistake increases in the nominal cash rate for a tightening in policy, ignoring what is happening with real or expected interest rates. It is this confusion that gave rise to the myth that the RBA presided over a successful bubble popping episode in 2002-03.
As the commodity price boom took off in 2003, population and income was sucked out of the south-eastern property markets and flowed into the resource-rich states. As the RBA has noted, this saw renewed convergence in capital city house prices, as the heat was taken out of the south-east and shifted to the north-west. This sub-national variation in house prices cannot be explained with reference to monetary policy, as much as the bubble poppers might like us to believe otherwise. It had a clear basis in sub-national differences in economic performance.
posted on 29 May 2009 by skirchner in Economics, Monetary Policy
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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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Is the RBA Still Agnostic on Bubble Popping?
In contrast to the cautious agnosticism of his boss on the question of bubble-popping, RBA Assistant Governor Guy Debelle is remarkably clear on the issue:
the current episode vindicates the position that monetary policy, narrowly defined as the setting of the policy interest rate, should be confined to targeting inflation. Set interest rates primarily to achieve the inflation goal as that, in itself, contributes to sizeable social gains. A departure from that runs the risk of losing the nominal anchor that the inflation target provides.
But other tools, most notably the much-touted (although not clearly defined) macro-prudential instruments, should be used to address asset price and credit imbalances. I do not think that a slightly tighter setting of interest rates would have prevented the development of the imbalances that have led to the current financial crisis. When human psychology is such that optimism about asset price rises is at the fore, then an excessively stringent setting of interest rates would be required to suppress the optimism. The Australian and Scandinavian experience in the late 1980s shows the sort of interest rate settings required to achieve such an outcome. In that example, a credit boom and bubble-like asset price dynamics took hold and only a very high setting of real interest rates ultimately curtailed that, but at the cost of a historically high level of unemployment.
I do not think it would be socially acceptable or desirable to endure the level of unemployment that would come with the high interest rates necessary to pop the bubble. It is asking too much of the single monetary policy instrument, namely, the targeted short-term interest rate to target both financial excesses and inflation.
Nor do I believe there is much to be achieved by ‘leaning against the wind’. The wind that is blowing in most episodes of credit booms is generally at least gale force. Setting interest rates a bit higher in such circumstances is likely to be close to futile when such credit dynamics take hold. Again, what would be the point of undershooting the CPI inflation target and enduring a higher than desirable level of unemployment with little to be gained. How would such actions be explained to the public?
posted on 21 May 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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The Myth of an Independent Treasury
My CIS colleague and former Treasury official Robert Carling has an op-ed on page 21 of today’s Australian (no link, but see text below the fold) noting that neither Treasury nor the Budget papers are independent of the federal government.
The claim that Treasury is an institution independent of government fundamentally misconstrues the relationship between the federal government and the Commonwealth public service. While it is not surprising to see politicians fail Economics 101, it is more surprising to see them also failing Political Science 101. The government now routinely hides behind Treasury and RBA independence and the federal opposition is increasingly accommodating this behaviour through their unwillingness to challenge official sector views.
While the RBA is more independent than Treasury, this independence is limited in scope. At its most basic, RBA independence means that it is free to set interest rates without the approval of the Treasurer, what is often called ‘operational independence.’ This independence in no sense precludes the government or opposition from taking a different view on monetary policy to the RBA or being publicly critical of central bank policy actions, statements and forecasts. The RBA has been made progressively more independent of government precisely in order to facilitate differences of opinion with government. Under the Reserve Bank Amendment (Enhanced Independence) Bill, it is almost impossible to remove the RBA Governor, so public criticism could hardly be viewed as a threat to the Governor’s position. By the same token, the RBA would not be compromising its independence by speaking out on issues relating to its statutory responsibilities, provided it does so in a non-partisan fashion.
Mistaken notions of Treasury and RBA independence are being used to suppress public debate over economic policy, not least by the current government. That the federal opposition and media are accommodating this behaviour on the part of the government can only undermine the robustness of public debate and democratic accountability.
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posted on 16 May 2009 by skirchner in Economics, Fiscal Policy, Media, Monetary Policy, Politics
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Should We Use Monetary Policy to Regulate Human Nature?
Writing in the letters page of today’s AFR (no link), Des Moore says:
Whether or not a targeting of asset prices warrants more attention, any review of policy surely needs to address the difficult issue of changes over time in human nature…
There is a long history of swings in attitudes from optimism to pessimism, often “inspired” by governments, that result in changes in risk behaviour: our most recent swing of optimism was reflected in the boom in investment in commodity production.
If monetary policy does not pay sufficient regard to such swings, it is very likely that we will end up with a “bust” - and high unemployment. That is what happened in the 1980s and what is happening now…
The idea that human nature is variable at business cycle frequencies is highly questionable, as is the assumption that the monetary authorities are somehow immune to these ‘swings of attitude’. Des falls into the classic trap identified by public choice theorists of assuming that human nature changes when we relocate people from the private to the public sector.
In arguing that the recent boom in commodity investment was a ‘reflection’ of ‘our most recent swing in optimism’, Des Moore identifies himself with behavioralists like Robert Shiller, who maintain that sentiment drives economic activity, rather than the other way around. But as I argue in Bubble Poppers, the more asset prices are thought to be disconnected from the real economy, the weaker the case for using monetary policy to regulate asset prices via the real economy.
posted on 06 April 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Bubble Wrap
Reactions to my Bubble Poppers monograph, here and here.
posted on 31 March 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Bubble Poppers: Monetary Policy and the Myth of ‘Bubbles’ in Asset Prices
CIS has released my Policy Monograph, Bubble Poppers: Monetary Policy and the Myth of ‘Bubbles’ in Asset Prices. The text was finalised before Greenspan published a defence of his record in the WSJ, but takes a similar position to the former Fed Chair.
The monograph is partly devoted to debunking the concept of a ‘bubble’ in asset prices. It argues that if the idea of ‘bubbles’ in asset prices cannot be given analytical or empirical substance, then monetary policy should not attempt to actively manage asset price cycles.
There is a shorter version in the latest issue of Policy and an even shorter version in today’s Age.
posted on 19 March 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Greenspan versus Taylor
Former Federal Reserve Chairman Alan Greenspan defends the Fed’s record against criticism from John Taylor:
However, starting in mid-2007, history began to be rewritten, in large part by my good friend and former colleague, Stanford University Professor John Taylor, with whom I have rarely disagreed. Yet writing in these pages last month, Mr. Taylor unequivocally claimed that had the Federal Reserve from 2003-2005 kept short-term interest rates at the levels implied by his “Taylor Rule,” “it would have prevented this housing boom and bust. “This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom.
Aside from the inappropriate use of short-term rates to explain the value of long-term assets, his statistical indictment of Federal Reserve policy in the period 2003-2005 fails to address the aforementioned extraordinary structural developments in the global economy. His statistical analysis carries empirical relationships of earlier decades into the most recent period where they no longer apply.
Moreover, while I believe the “Taylor Rule” is a useful first approximation to the path of monetary policy, its parameters and predictions derive from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.
Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. All things considered, I personally prefer Milton Friedman’s performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: “There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind.”
Proving that great minds think alike, I will shortly be releasing a CIS policy monograph making much the same argument in the context of a broader discussion of the relationship between monetary policy and asset prices. I discussed the issue with John Taylor at the New York MPS meeting, but could not bring him around to my point of view.
posted on 12 March 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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The Greenspan Counter-Factual
Alan Greenspan on the counter-factual to the Fed’s 2001-2004 easing cycle:
“If we tried to suppress the expansion of the subprime market, do you think that would have gone over very well with the Congress?” Mr. Greenspan said. “When it looked as though we were dealing with a major increase in home ownership, which is of unquestioned value to this society — would we have been able to do that? I doubt it.”
Mr. Greenspan said that if he had taken steps to prevent the crisis, the outcome would have been painful.
“We could have basically clamped down on the American economy, generated a 10 percent unemployment rate,” he said. “And I will guarantee we would not have had a housing boom, a stock market boom or indeed a particularly good economy either.”
posted on 13 February 2009 by skirchner in Economics, Monetary Policy
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A $42 Billion Future Tax Increase: Immiseration Not Stimulation
I have an op-ed in The Australian, arguing that the government has just announced a $42 billion future tax increase. In reality, it’s worse than that because of the interest bill on the $42 billion in unfunded spending, plus the future welfare costs associated with an increased tax burden and the government’s diversion of resources away from potentially more highly valued uses. The package will immiserate rather than stimulate.
In the statement accompanying yesterday’s 100 basis point cut in the official cash rate, the Reserve Bank said that ‘the Board took into account the package of measures announced by the Government earlier today.’ If the RBA shares the Treasury’s Keynesian assumptions about the implications of the package for short-term economic growth, then it is entirely possible that yesterday’s rate cut was smaller than it might have been in the absence of the latest fiscal stimulus package. While fiscal policy has been irrelevant to monetary policy in recent years due to a steady fiscal impulse, it is less likely the RBA will ignore the massive turnaround in the budget balance we have seen since May last year. Those ‘free’ pink batts are likely to have come at the cost of a higher mortgage interest rate.
posted on 04 February 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy
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Monetary and Fiscal Policy Effectiveness in a Globalised World
Alan Greenspan, interviewed in Die Zeit, on the effectiveness of monetary and fiscal policy:
Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates…
The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.
The way it should be.
posted on 22 December 2008 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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One Speech, Two Stories
The Australian:
RESERVE Bank governor Glenn Stevens last night flagged further interest rate cuts to help shore up the economy.
The AFR:
Reserve Bank Governor Glenn Stevens has signalled the bank’s unprecedented series of deep interest rate cuts may have come to an end.
Both papers fell victim to the view that every time the Governor speaks, he must be sending a signal on interest rates and if there is no explicit signal, then there must be an implied one. In fact, the RBA very rarely signals its policy intentions, not least because its view on the future direction of policy is not very strongly held. Unlike the rest of us, the RBA doesn’t need to anticipate its own actions, putting more value on policy flexibility than policy predictability.
posted on 10 December 2008 by skirchner in Economics, Financial Markets, Monetary Policy
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