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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The Macro Policy Division of Labour
The Treasury’s David Gruen reminds Senators who is responsible for demand management and inflation control:
Dr Gruen said the RBA strategy of raising interest rates was the most effective method of bringing inflation under control, but budget cuts proposed by the Rudd Government would help.
“Monetary policy responds quickly, and for that reason is our primary tool around demand management,” he said.
posted on 21 February 2008 by skirchner in Economics, Financial Markets
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What is the NAIRU for Australia?
Opposition Treasury spokesman Malcolm Turnbull sought to put Treasurer Swan on the spot yesterday, asking him to nominate Australia’s non-accelerating inflation rate of unemployment (NAIRU). The question was specifically designed not to get an answer. I dare say Malcolm can’t answer this question either. If he can, he has chosen the wrong profession.
The NAIRU is one of those latent variables that is inherently unobservable and likely changes over time. The concept is thus not very useful in the real-time conduct of macroeconomic policy. The more important focus for policymakers is to ease the NAIRU constraint on growth, by lowering the structural or non-cyclical component of unemployment.
By way of comparison, New Zealand also currently enjoys a record low unemployment rate of 3.4% compared to Australia’s 4.1%. Recent inflation outcomes suggest that both economies are likely facing the NAIRU constraint. Yet on some measures (eg, non-tradeables inflation) Australia’s inflation performance is currently worse than that of New Zealand, despite its higher unemployment rate. We can reasonably infer that New Zealand’s NAIRU is somewhat below that of Australia. The 0.7 percentage point differential in the unemployment rate between the two countries reflects the additional structural unemployment Australian policymakers have been willing to accept in their choice of labour market institutions compared to those favoured in New Zealand.
posted on 19 February 2008 by skirchner in Economics, Financial Markets, Politics
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What Does RBA Tightening Do to the Economy?
David Uren writes:
WHAT does a 0.25 per cent rate rise do to the economy?...
The Reserve Bank, like other central banks around the world, keeps its own estimate of the effect of its actions a secret.
In fact, the RBA’s published research on this question is reasonably explicit. The latest iteration of the RBA’s policy simulation model estimates the long-run elasticity of the output gap with respect to a sustained increase in the real cash rate of 100 basis points at 1.0 (ie, real output 1% below potential output), with most of the impact seen within three years. Significantly, the real cash rate enters the model as a deviation from an assumed neutral real cash rate of 3%. As we have noted previously, the real cash rate has only recently moved significantly above neutral based on headline inflation. To that extent, it is only recently that monetary policy has been exercising any restraint at all on the economy. Much of the tightening in the nominal cash rate in recent years has simply been offset by rising inflation.
posted on 18 February 2008 by skirchner in Economics, Financial Markets
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Business Spectator Column
Readers may have noticed that I have an occasional weekend column over at The Business Spectator.
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 16 February 2008 by skirchner in Economics, Financial Markets
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None Dare Call it Conspiracy II
Terry McCrann remains hard on the case of the AFR’s resident conspiracy theorists:
Now Harris’s substantive assertion was that Treasury had unexpectedly cut the inflation forecasts from the previous year’s 2.9 per cent.
That was wrong. He did not tell readers that Treasury had actually increased its CPI inflation forecasts. From 2.5 per cent in both years in the May budget to 2.75 per cent for both years in the MYEFO/PEFO.
Crucially, those are for year average - all of 2007-08 over 2006-07 and the same for 2008-09. They were exactly consistent with the-then latest inflation forecasts from the Reserve Bank.
It should hardly be surprising that the Treasury and the Reserve Bank are mostly in agreement on the inflation outlook. Since the Treasury Secretary is an ex-officio member of the Reserve Bank Board, he notionally presides over both sets of inflation forecasts. A Treasury forecast that deviated too far from the RBA’s forecast might be seen as an implicit criticism of the Reserve Bank and its Board. If Treasury were to forecast inflation outside the target range, it would effectively be accusing the RBA of presiding over a monetary policy error, one in which the Treasury Secretary was necessarily implicated. It should also be pointed out that the Treasury and RBA forecasts are not strictly comparable, if only because the forecasts are made at different points in time. If a week is a long time in politics, it is also a long time in the forecasting business.
According to Governor Stevens, the Board operates under a doctrine of collective responsibility. If there were any substance to this doctrine, then a Board member who takes a different view on inflation to the one publicly endorsed by the Bank needs to either reconcile himself to the Board’s majority view, or resign. Since the Treasury Secretary is a member of the Board by statute, the latter is not exactly an option.
Rather than looking for non existent conspiracies, the AFR might instead go in search of the rather more obvious conflict of interest. The Treasury Secretary should not be a member of the RBA Board.
posted on 16 February 2008 by skirchner in Economics, Financial Markets, Politics
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Zero ‘Bubble’
Some refreshing ‘bubble’ skepticism from Alex Tabarrok:
So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.
But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension).
In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.
posted on 14 February 2008 by skirchner in Economics, Financial Markets
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Which is Tighter, Monetary or Fiscal Policy?
Every time RBA Governor Glenn Stevens opens the newspaper these days, he must give thanks for having such a tame press. On his own forecasts, both headline and underlying inflation in Australia will have a three in front of it for the rest of this decade and the first half of 2010. Yet with the honourable exceptions of Terry McCrann and Alan Wood, Australia’s economic commentators are near unanimous in arguing that it’s all the fault of fiscal policy (meaning tax cuts).
This view misunderstands Australia’s macro policy framework, which assigns the job of demand management and inflation control to the Reserve Bank. Those who are opposed to further tax cuts are effectively arguing that the government should engineer a taxpayer-funded bail-out of monetary policy. Needless to say, this strategy won’t work, because higher taxes would simply add to supply-side constraints in the labour market.
It also ignores the obvious conclusion to be drawn from two very simple metrics that can be applied to assess the stance of monetary and fiscal policy. The Commonwealth’s 2005-06 and 2006-07 underlying cash surpluses were at their highest as a share of GDP in nearly 20 years. Fiscal policy is thus unambiguously tight, even after all the previous tax cuts that the commentariat have for the most part opposed.
The same cannot be said for the real official cash rate, the best measure of the stance of monetary policy. With underlying inflation at 3.6% in Q4, the ex-post real cash rate was a mere 3.15% taking the year-ended official cash rate of 6.75% and 3.4% using the current official cash rate of 7.00%. According to the RBA’s own policy simulation model, Australia’s neutral real cash rate is 3%. So when the RBA’s Statement on Monetary Policy says that monetary policy is ‘on the restrictive side of neutral,’ it is talking about less than 50 basis points. With the RBA’s own inflation forecasts having a three in front for as far as the eye can see, the ex-ante real interest rate is at best 4% (assuming steady policy).
As the following chart shows, the ex-post real cash rate only moved to the restrictive side of neutral at the beginning of last year. Monetary policy has been too easy for too long. Hence the inflation problem.
posted on 13 February 2008 by skirchner in Economics, Financial Markets, Politics
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No Malcolm, Wayne Swan is Not Making this Up
One of the referees for an article I have forthcoming on Australian monetary policy queried my assertion that Australia’s inflation target is poorly defined, although subsequently came around to my view that the Statement on the Conduct of Monetary Policy makes this less than clear. The Statement refers to ‘consumer price inflation,’ but is otherwise silent on which of many possible measures of consumer price inflation could be used in determining whether the inflation target has been met.
The confusion this causes was nicely illustrated by Shadow Treasurer Malcolm Turnbull in an interview over the weekend, in which he accused Treasurer Swan of making up the inflation figures:
BARRIE CASSIDY: But what was it in the December quarter though, what was the figure in the December quarter? The one that this Government inherited? 3.6 per cent. A 16-year high.
MALCOLM TURNBULL: No it wasn’t. Ok, now that is a complete untruth. Now Wayne Swan keeps on saying that. I challenge you, invite all of your viewers to go to the Reserve Bank website. You’ll see there that the headline CPI (consumer price index) which is the one that is the inflation targeting is benchmarked against as recently - emphasised again - as recently as December 6 by Wayne Swan himself. That was 3 per cent. In fact, it was 2.96 per cent. The other measurers of inflation, so-called “underlying inflations”, which are statistical adjustments are ... none of them were 3.6 per cent, not one. So, where the 3.6 per cent comes from, I could make a guess but it is not one that was published by the RBA.
The 3.6% figure is an average of the two statistical measures of underlying inflation, the weighted median and the trimmed mean, now published by the ABS rather than the RBA. The RBA references this average in the underlying inflation forecasts contained in the quarterly Statements on Monetary Policy. But unless you are an avid reader of the footnotes to these Statements, you could be forgiven for missing it. The RBA uses this measure because it captures the persistent component of inflation that is of most concern for policy purposes.
Turnbull’s comments reflect a larger problem, which is that this definition of underlying inflation has never been properly announced by the RBA or explicitly endorsed by the current government. Those of us in financial markets first discovered the RBA was using it only by a process of educated guesswork. The May 2006 increase in interest rates caught financial markets by surprise, because markets were then accustomed to looking at a different measure of underlying inflation. It was only when the RBA characterised ‘underlying consumer price inflation’ as being ‘around 2¾ per cent’ in the statement accompanying the May 2006 increase in interest rates that it became apparent what measure the RBA was using, but even this inference was only possible by a process of elimination.
An inflation targeting regime works largely by conditioning inflation expectations. But if even the Shadow Treasurer doesn’t know or doesn’t accept the RBA’s working definition of underlying inflation, we should not be surprised that we have an inflation problem.
posted on 11 February 2008 by skirchner in Economics, Financial Markets, Politics
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