When Interventions Collide
Christopher Joye notes how the government’s bank guarantees have undermined its $8 billion intervention in the market for residential mortgage-backed securities:
while the $8 billion has directly helped out the lenders who have benefited from the capital, it has had no effect at all on the overall cost of RMBS funding (or the so-called ‘spreads’) because it is being undermined by the government guarantees of bank debt, which have massively increased the supply of AAA-rated securities and created two-tiers of investment – those AAA assets with and without a government guarantee (RMBS and CMBS obviously fall into the latter category). Indeed, as the RBA (in its Statement of Monetary Policy) and the Treasury’s David Gruen have recently observed with some bewilderment, RMBS spreads have actually increased markedly to more than 200 basis points over the swap rate since the AOFM started investing its money notwithstanding their incredibly low default rates (again because of the dysfunction indirectly introduced by the government guarantees of bank debt). In the ten years prior to the advent of the GFC, Aussie RMBS spreads averaged 20-30 basis points over. And today, the 90 day mortgage default rate sits at about 15 per cent and 25 per cent of US and UK levels, respectively, or roughly 0.6 per cent.
As I argue in this paper, the idea that government intervention in the RMBS market can engineer an exogenous easing in credit conditions is mistaken, because the RBA fully discounts these conditions in its conduct of monetary policy. Even if such an easing were possible, it would be capitalised into house prices, with no benefit to home borrowers.
posted on 02 July 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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Hockey’s Hindsight Heroes
Opposition Treasurer Joe Hockey has problems staying on message:
Mr Hockey’s most controversial remarks were suggesting that the Rudd government would have been justified in cancelling this year’s tax cuts.
“The honest answer is there would have been a legitimate justification for the government to say our debt, our recovery, our economic recovery will be slower if we are running a big deficit and I think it should’ve been considered as part of the mix.”
Mr Hockey noted that it would have been hard for the Liberal Party to support the removal of the tax cuts. Earlier this year, Mr Hockey had argued for the government to bring forward tax cuts.
There is, of course, a case for not proceeding with the tax cuts. Because they are unfunded, the tax cuts are equivalent to a future tax increase and subject to the same Ricardian equivalence critique as discretionary government spending. However, one suspects that this is not the case Hockey has in mind. Instead, Hockey is an unreconstructed, Costello-style revenue-hoarder:
Mr Hockey said that, if he had his time again, he would have better explained the Future Fund, which Mr Costello regarded as one of his crowning achievements. “I would have set up the other funds earlier: the higher education funds for infrastructure and the health and hospitals fund,” he said.
Like Costello, Hockey does not seem to understand that these funds are simply deferred government spending.
posted on 01 July 2009 by skirchner in Economics, Fiscal Policy
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Ricardian Equivalence, with a Vengeance
Dave Rosenberg, on the effectiveness of US fiscal stimulus efforts:
In April, total stimulus from the federal government to the personal sector, in the form of tax reduction and increased benefits, came to $121 billion at an annual rate. But that month, in nominal terms, consumer spending rose the grand total of $1 billion. Then we found out on Friday that in May, the total stimulus from the Obama economics team came to $163 billion at an annual rate, and consumer spending increased by a measly $25 billion (again at an annual rate). The big story is that the personal savings rate surged again to a new 16-year high of 6.9% from 5.6% in April and 4.3% in March. This is a repeat of the fiscal impact from the tax relief a year ago when the savings rate jumped from 0.2% in March 2008 to 4.8% in May 2008. This is what economists refer to as “Ricardian equivalence” — the money from Uncle Sam goes into the coffee can instead of being used to buy more coffee.
So let’s get this straight, the future taxpayer is being asked to contribute to a policy today that is aimed at perpetuating a consumer cycle — and yet for every dollar that is coming out of Washington to support a 70% consumption/GDP ratio, it is getting barely more than 8 cents worth of new spending activity. In real terms, as was the case with the tax rebates of just over a year ago, the real impact is on the savings rate, and it is very clear that not even the most aggressive monetary and fiscal policy since the 1930s is going to stop consumer spending in volume terms from rolling over in the second quarter.
posted on 30 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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When Behaviouralists Attack
Scientific American notes the penetration of the Obama Administration by behavioural economics:
The arrival of the Obama administration marks a growing acceptance of the discipline. A group of leading behavioural scientists provided guidance on ways to motivate voters and campaign contributors during the presidential campaign. Cass Sunstein, a constitutional scholar who wrote the well-regarded book Nudge, which President Barack Obama has reportedly read, was appointed head of the Office of Information and Regulatory Affairs, which reviews federal regulations. Other officials who are either behavioral economists or aficionados of the discipline are now populating the White House.
Alan Wolfe comments on the reactionary and anti-Enlightenment foundations of behaviouralism in this podcast with Russ Roberts.
Meanwhile, Chris Dillow uncovers a ‘heartbreaking work of staggering genius, a brilliant illumination of class relations, post-modernism and the crisis of the left.’
posted on 29 June 2009 by skirchner in Economics, Financial Markets
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Greenspan on the Political Allocation of Capital
Alan Greenspan, on the quantitative channel for crowding-out:
Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt. Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.
posted on 26 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy
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Are Americans All Keynesians Now?
While policymakers around the world may be sold on the effectiveness of discretionary fiscal stimulus, the public remain more skeptical. The disconnect between official and public sentiment is important, because confidence is meant to be one of the channels through which stimulus spending works to support economic activity. We have previously pointed to US survey data on consumers’ evaluation of macroeconomic policy, which calls into question the effectiveness of fiscal stimulus efforts.
A WaPo-ABC News poll directly asks whether economic stimulus has or will help the economy. A net 52% see stimulus as helpful to the economy, while 46% view stimulus as not helping, either currently or prospectively. At the same time, 87% of respondents were ‘very’ or ‘somewhat concerned’ about the federal budget deficit. A majority (54%) also favour ‘smaller government, fewer services’ to ‘larger government, more services.’ The majority view expressed in these polls is consistent with a Ricardian interpretation of the effectiveness of fiscal policy. The poll also sheds light on why President Obama remains popular. Most respondents still see Obama as ‘a new-style Democrat who will be careful with the public’s money’ rather than ‘an old-style, tax-and-spend Democrat.’
posted on 25 June 2009 by skirchner in Economics, Fiscal Policy
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More Anti-‘Bubble’ Popping
BoE chief economist Spencer Dale, on the evils of ‘bubble’ popping:
Short-term interest rates are a blunt instrument best deployed maintaining a broad balance between nominal demand and supply. They are not well suited to the task of managing asset price bubbles and economic imbalances. They may be wholly ineffective in addressing some types of imbalances, particularly those with an international dimension. And, even for domestic imbalances, short-term interest rates would probably need to be held substantially higher for a persistent period in order to suppress rapid rises in asset prices or growing imbalances. Such policy actions could generate significant economic costs.
The practical difficulty of implementing a policy of “leaning against the wind”, where the main policy instrument is short-term interest rates, should not be underestimated. If, as policymakers, we were successful in preventing a bubble from inflating, it might appear as if we were responding to phantom concerns. The bubble or imbalance would be nowhere to be seen, but interest rates would be higher, inflation would undershoot the inflation target and we would appear to have inflicted unnecessary economic hardship. That could undermine public faith and support in both the inflation target and the MPC.
posted on 24 June 2009 by skirchner in Economics, Financial Markets, Monetary Policy
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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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Fiscal Stimulus, Interest Rates and Crowding-Out
I have an article in the Weekend Australian arguing that the government’s discretionary fiscal stimulus measures will undermine Australia’s long-run growth prospects, citing the Australian edition of a widely used undergraduate textbook:
“When the government reduces national saving by running a budget deficit, the interest rate rises and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.” So says Joshua Gans in his Principles of Macroeconomics text. Yet Gans was also one of the 21 economists who recently signed a letter defending the government’s deficit spending.
An increase in the stock of government debt reduces the amount of capital available for private investment, although this crowding-out effect may be offset by increased private saving and foreign capital inflows. In a small and open economy such as Australia, crowding out occurs not so much because interest rates rise, but because it induces foreign capital inflows that put upward pressure on the exchange rate, lowering net exports and reducing aggregate demand, which offsets the increase in government spending.
I also have an article in Business Spectator, noting that recent market-led increases in retail borrowing rates are just a taste of things to come:
Whatever the cause of rising global bond yields, these increases in interest rates will inevitably be passed on to Australian borrowers. It would be a sign of political maturity if Australian politicians were to acknowledge this reality, rather than taking refuge in the shameless populism of bank-bashing.
UPDATE: Joshua complains about ‘selective extracting’ and an ‘unwillingness to deal with economic complexity’ in my Weekend Australian piece. The point of highlighting the very good discussion of these issues in Joshua’s textbook was precisely to show that the 21 economists were being selective and incomplete in their analysis, by not acknowledging the many arguments against discretionary fiscal stimulus. I would certainly encourage people to read Principles of Macroeconomics in coming to a considered view of the merits of discretionary fiscal policy.
posted on 21 June 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy
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Lu Kewen Thought ‘Shallow and Crude’
A Chinese economist rejects Lu Kewen Thought:
KEVIN Rudd has been accused by a leading Chinese economist of being “either short of economic knowledge or misleading his readers” in his famous essay attacking neoliberalism.
In a scathing assessment, Xu Xaonian, economics professor at China Europe International Business School in Shanghai, lambasts the essay, now translated and published in China, as “shallow and crude”.
Dr Xu says “Lu Kewen” - Mr Rudd’s Chinese name - made a “big, big mistake” in forming his “confident opinions” based on “the observation that the crisis came as a result of neoliberalism and the absence of supervision”.
Dr Xu, one of China’s leading liberal economists, has savaged the Rudd essay in the weekly Chinese newspaper The Economic Observer after the Prime Minister’s work was translated and reprinted in China’s leading business magazine, Caijing.
Dr Xu, who has a doctorate from the University of California and was formerly managing director of the country’s biggest investment bank, says it is not time to resurrect Keynesianism, as Mr Rudd proposes.
“Instead, it’s time to announce Keynesianism’s failure, time to announce the emperor Lord Keynes has no clothes.”
He says the Prime Minister “has used electioneering-style tactics to brand neoliberalism as dogmatic, to paint a clownish portrait of it, seeking to pioneer popular antipathy to this artificial enemy, casting a moral verdict without seeming to care about truth or logic”.
posted on 19 June 2009 by skirchner in Economics, Politics
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Government Policy, the Business Cycle & Consumer Confidence
Claims about the effectiveness of fiscal stimulus in the US do not quite square with evidence from surveys of consumer confidence. The University of Michigan survey asks respondents “As to the economic policy of the government—I mean steps taken to fight inflation or unemployment—would you say the government is doing a good job, only fair, or a poor job?” According to secondary sources, this measure posted its equal sharpest decline on record in June to 93 from 108 in May. The chart below the fold shows the history of this series until November 2008, after which the data disappeared behind a Thomson-Reuters paywall (if anyone has the intervening data, feel free to flick it my way). Clearly, consumers did not think much of the Bush Administration’s fiscal stimulus measures (although there is a rally around the flag effect in relation to policies pursued after September 11 2001). The change in Administration since November last year benefited this series, but the political honeymoon now seems to be wearing off.
This series is clearly cyclical, suggesting consumers blame economic conditions on government policy. While consumers might be overrating the importance of government policy to economic outcomes, they are also effectively calling into question the effectiveness of the usual counter-cyclical policy responses, including fiscal stimulus.
continue reading
posted on 18 June 2009 by skirchner in Economics, Fiscal Policy
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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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Breathtaking Hyperbole
David Burchell reads Peter Hartcher’s purple prose, so you don’t have to:
At times the prose reaches for the clouds and we are treated to extended literary metaphors, such as the credulity-stretching parable of John Howard as Herman Melville’s Ahab, forlornly chasing the White Whale of political immortality…
Indeed, a good deal of what Hartcher presents as grand political drama is simply over-cooked. The description of Howard’s secret offer to resign in the face of disastrous polling as “a breathtakingly grand example of subterfuge” is simply florid, while the accompanying accusations of disingenuousness and “breathtaking chutzpah” become emptily repetitious.
posted on 17 June 2009 by skirchner in Politics
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Stimulus Watch
The Australian looks behind the photo-op spin of politicians in hard hats and fluro safety vests to give stimulus spending the scrutiny it deserves. The results are not pretty.
You can report stimulus waste to online-at-theaustralian.com.au.
posted on 16 June 2009 by skirchner in Economics, Fiscal 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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