The QE Bunnies Meet Jim Hamilton
The non-cartoon version of QE.
posted on 23 November 2010 by skirchner in Economics, Monetary Policy
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Another Small Catch from the FOI Desk at the Oz
Another fishing expedition from the FOI desk at The Australian turned up this, with the following sub-editorial spin:
THE Reserve Bank deliberately intervened in the political debate over the property boom to stop governments releasing more land.
While I’m certainly not above using the FOI process to get a headline, a little more context would have been appropriate for this story. Luci Ellis wrote an RBA RDP in 2006 that argued that it was the combination of a demand-side shock from increased household sector leverage in a low inflation-low interest rate environment and an inflexible supply-side that gave rise to the early 2000s house price boom.
I agree with Chris Joye that the RBA had it wrong in the early 2000s and has now changed its tune. The RBA’s fingering of negative gearing in its 2004 submission to the Productivity Commission inquiry was possibly an attempt to set the government up as a scapegoat in case the early 2000s housing boom had ended badly in the context of a monetary policy tightening cycle. The RBA’s then jaw-boning of a supposedly over-heated market now looks rather quaint.
There has been a change in leadership at the RBA since then. Glenn Stevens’ more recent comments about ‘serious supply-side constraints’ in housing are pretty brave by the standards of an Australian central banker (imagine the reaction to Stevens making an even vaguely critical remark about the NBN and you will see what I mean). They are a damning criticism of policy at all levels of government. The only reason it hasn’t been written up that way is that many in the media simply don’t believe that housing affordability is a supply-side problem requiring supply-side solutions.
posted on 22 November 2010 by skirchner in Economics, House Prices, Monetary Policy
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The Downside of China’s Managed Exchange Rate
Inflation and price controls. As we have often noted, China’s managed exchange rate is a much bigger problem for them than it is for the rest of the world. Former RBA Governor Ian Macfarlane told the Chinese as much in 2005, when he compared China to Australia in the 1970s:
surpluses may be more difficult to sustain in the long run than deficits are for some other countries. I speak from experience here as Australia faced this problem in the early 1970s and did not handle it successfully. At that time, Australia briefly experienced a current account surplus and also became a favourable destination for capital flows. As the money poured in from both these sources it had to be sterilised or it would flow directly into the banking system and through that into money and credit aggregates, with obvious inflationary results.
The problem we found was that in order to sell the official paper in sufficient volumes to soak up the inflow, interest rates had to be raised, and this induced further inflow. In the end, the monetary aggregates grew too quickly and inflation soon rose to an unacceptable rate. We came to the conclusion then that it was not possible to restrain an over-exuberant and inflation-prone economy only by domestic tightening. Exchange rate adjustment was required in order to take away the ‘one way bet’ aspect of the exchange rate. We eventually did this, but we were too slow and the inflation had already become entrenched.
So far, China has made a much better job of handling this situation than we in Australia did 30 years ago. And, of course, it is made easier by the fact that it is occurring in a world environment of low and stable inflation rather than the rising inflation of 30 years ago. But, ultimately, I think the point will be reached where domestic restraint has to be augmented by action on the exchange rate.
Five years on, Macfarlane’s speech remains highly relevant. He could usefully give the same speech in Washington today.
posted on 22 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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Treasury Hand-Wringing on House Prices
The FOI desk at The Australian uncovered the following, which it then beats-up into ‘Treasury warning on home bubble’:
Phil Garton, the manager of Treasury’s Macro Financial Linkages Unit, sent colleagues a draft paper on the rise in household debt, prospects for further growth in the debt-to-income ratio and the potential implications of slower household debt growth.
His email prompted an exchange with Steve Morling, currently the general manager of the Domestic Economy Division, who argued the paper should “make a bit more about the risks”.
“The elephant in the room is house prices or more specifically the risk of a precipitous drop in them, perhaps from an external shock [SK: didn’t we just have one of those?] or perhaps from their own internal dynamics when affordability constraints or capacity debt levels see prices and expectations of house prices start to move in the opposite direction,” Mr Morling wrote on June 15.
“(I) know there are very supportive fundamentals, but prices rose by 50-60 per cent in three to four years in the early part of this decade, with largely unchanged fundamentals, so they can have a life of their own.
“And given what’s happened elsewhere I’m far less sanguine about this - and the interplay with debt - than in the past.”
Mr Garton agreed that there would be risks if the fundamentals of low interest rates, unemployment, and financial deregulation “reversed significantly”. But he maintained the price growth in the early 2000s was based on a “lagged response” to improvements in the fundamentals, and questioned how Australia could have maintained a bubble for more than six years.
Mr Morling said other bubbles had lasted that long, and the fundamentals were often used to justify price rises - including in Britain where a debate over lack of supply drove property prices higher “before the British property bubble burst”.
“(I) think price expectations can take over from the fundamental drivers that you have identified for extended periods, including generating house price falls,” he wrote.
The only remarkable thing about this analysis is how pedestrian it is. It’s not much better than the kind of hand-wringing you would expect from the writers at left-wing scandal sheet Crikey, who have long viewed the Australian housing market as an anti-capitalist morality play that can only have one ending.
Asked for reaction, the Treasurer’s office had this to say:
it is the considered position of the Treasurer and the Treasury that our housing market reflects the fundamentals of supply and demand and not a bubble - specifically that Australia is simply not building enough new houses.
Not that they will do anything about it.
posted on 20 November 2010 by skirchner in Economics, House Prices
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One More Time, for the Dummies
RBA Deputy Governor Ric Battellino says it again for the hard of hearing:
“People feel there is, or there should be, a rule that says banks can’t actually set any rates more than the official interest rates set by the Reserve Bank,” Mr Battellino said.
“That rule doesn’t exist, it has never existed, and it would be quite risky for the financial system to have such a rule.”...
Mr Battellino said bank margins had not changed in six years, remaining between 2.25 per cent and 2.5 per cent.
posted on 19 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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Don’t Blame Ben
Charlie Gasparino defends Ben Bernanke:
what’s happening to Bernanke now isn’t accountability, it’s a feeding frenzy. And for the good of the country, it should stop.
Classical liberal and conservative critics of Bernanke would do well to read this speech, in which Bernanke pays tribute to Milton Friedman:
Friedman’s monetary framework has been so influential that, in its broad outlines at least, it has nearly become identical with modern monetary theory and practice.
posted on 18 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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Profitable Banks, Unprofitable Politics
I have an op-ed in today’s WSJ arguing that the government and opposition’s attacks on the banks are a pointless diversion. Saul Eslake makes similar arguments in today’s Age. After yesterday’s RBA Board minutes destroyed the politicians’ case against the banks, the best Joe Hockey can come up with is this:
Mr Hockey said the minutes had contemplated the banks going further than the official rise but didn’t contemplate the banks going as far as they did.
UPDATE: I have another op-ed in the Business section of The Australian.
posted on 17 November 2010 by skirchner in Economics, Monetary Policy, Politics
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The G20 and ‘Balanced’ Trade
I have a column at the ABC’s Drum Unleashed arguing that the G20 is doing more harm than good:
The G20 is still saddled with the same mercantilist thinking that underpinned these earlier episodes of international policy coordination. That thinking mistakenly blames the global financial crisis on cross-border capital flows, rather than the role of America’s government-sponsored enterprises in misdirecting these capital flows. The Obama administration’s call for the G20 to set numerical targets for trade ‘imbalances’ would do more to threaten free trade and global economic growth than to sustain it.
Since the early 1990s, Australian policymakers have embraced the ‘capitalist acts between consenting adults’ view of current account imbalances, not least because Australia’s economic success has been built on the global trade in saving and investment that the Obama administration now wants to constrain through the G20.
More recently, however, Treasury has seemingly re-embraced mercantilist notions of ‘balanced’ trade. Treasurer Swan called the Obama administration’s proposal “constructive”. Yet the 4 per cent limit on current account imbalances proposed by US treasury secretary Geithner would condemn Australia to permanently slower economic growth and lower living standards.
posted on 16 November 2010 by skirchner in Economics, Financial Markets
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America’s Third World Politics
America’s gerrymandered electoral system makes it very difficult to unseat incumbents. As John Sides notes, the November mid-term elections barely put a dent in incumbents, who enjoyed an 86% re-election rate. The number of contests with no incumbent running also remained little changed. This basic lack of contestability in the US political system explains a lot about the US.
In Australia, we can be thankful for the independence of the Australian Electoral Commission, which routinely unseats incumbents through electoral redistributions and ensures that the political system as a whole remains contestable. Had an Australian political party done to Australia what Congress has done to the US, we can be fairly confident that not only would many of their MPs lose their seats, but the party responsible would probably never govern again.
posted on 13 November 2010 by skirchner in Politics
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Maybe the Banks Just Don’t Want Your Business
The big four banks have now set their post-November RBA tightening mortgage interest rates. Amid the shameful public vilification of the banks by politicians and others who should know better, almost no one has considered the possibility that, at least at the margin, the banks probably don’t want our business. People in the banking industry tell me that Westpac and CBA in particular have full mortgage books and don’t want to take on additional exposure to housing. Not surprisingly, they have the highest mortgage rates on offer. Notice too how ANZ and NAB are much more aggressive in their advertising? In any other business, using price signals to manage excess demand would be viewed as completely unexceptional.
Far from being greedy, the banks are being prudent, while the government tries to induce them into taking on additional risk. Of course, we could always go back to the days of regulated interest rates and non-price credit rationing, when getting money from the bank was a beauty contest that saw housing credit go only to the rich.
posted on 12 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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The ‘Chinese Demand’ that Isn’t
Chinese demand is our demand.
posted on 12 November 2010 by skirchner in Commodity Prices, Economics
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A Daily CPI
Never mind a monthly CPI. How about a daily one:
Economists Roberto Rigobon and Alberto Cavallo at the Massachusetts Institute of Technology’s Sloan School of Management have come up with a method to scour the Internet for online prices on millions of items and then use them to calculate inflation statistics for a dozen countries on a daily basis. The two have been collecting data for the project for more than three years, but only made their results public this week…
Two days after the September 2008 collapse of Lehman Brothers, for example, the economists’ price index for the U.S. started to fall, and by the end of the month it was down a full percentage point, as desperate companies slashed prices amid slowing sales. It wasn’t until mid-November—when the Labor Department released its average monthly consumer price figures for October—that government data began to catch up.
posted on 11 November 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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How to Shut Down Freddie and Fannie
Withhold approval for new debt issuance:
the Treasury doesn’t need Congress or an academic assessment in order to tackle the most important reform goal: eliminating the GSEs and moving their activities to the private sector. Mr. Geithner himself can immediately reshape the mortgage markets—by withholding his approval of new debt issuances by the GSEs. That’s the best way to begin curtailing the GSEs, and it can be done unilaterally.
Congress chartered the GSEs and in their charters required that the Treasury secretary approve all of their new debt. For decades, the Treasury exercised this duty, and the GSEs submitted each new debt issuance to the department for prior approval.
But the Clinton administration found this process cumbersome and a strain on Treasury staff. It established a new process that weakened the administrative approval process for GSE securities offerings. This hands-off approach represented an abdication of Treasury’s essential oversight powers.
The bloating and strategic drift of the GSEs began soon thereafter.
posted on 11 November 2010 by skirchner in Economics, Financial Markets
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What the Critics Don’t Get About Modern Macro
Tom Sargent defends modern macro in a very good interview for the Minneapolis Fed:
The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised. These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.
By the way, participants within both the real business cycle and new Keynesian traditions have been stern and constructive critics of their own works and have done valuable creative work pushing forward the ability of these models to match important properties of aggregate fluctuations. The authors of papers in this literature usually have made it clear what the models are designed to do and what they are not. Again, they are not designed to be theories of financial crises.
it is just wrong to say that this financial crisis caught modern macroeconomists by surprise. That statement does a disservice to an important body of research to which responsible economists ought to be directing public attention. Researchers have systematically organized empirical evidence about past financial and exchange crises in the United States and abroad. Enlightened by those data, researchers have constructed first-rate dynamic models of the causes of financial crises and government policies that can arrest them or ignite them. The evidence and some of the models are well summarized and extended, for example, in Franklin Allen and Douglas Gale’s 2007 book Understanding Financial Crises. Please note that this work was available well before the U.S. financial crisis that began in 2007.
(HT: Falkenblog)
posted on 11 November 2010 by skirchner in Economics, Financial Markets
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Rismark Offers Jeremy Grantham a $100m Bet on Aussie Housing
Rismark’s Chris Joye offers Jeremy Grantham the mother of all house price wagers:
Rismark believes it can facilitate a transaction whereby Mr Grantham will be able to invest $100 million into a short position over the RP Data-Rismark Australian capital cities dwelling price index, which is universally regarded as the most accurate and timely house price benchmark in the market.
Following a torrent a criticism, Mr Grantham appears to have placed tentative conditions on his extraordinary assertions, opining that, “In Australia’s case, the timing and speed of the decline is very uncertain, but the outcome is inevitable.”
Recognising Mr Grantham’s equivocality, we will give him lots of time—three years, in fact. That is, he would be able to invest his $100 million for a three year horizon against RP Data-Rismark’s Australian capital cities dwelling price index.
Mr Grantham’s investment would be structured as a very simple “delta-one” transaction: for every 1 per cent fall in the index, Mr Grantham would receive $1 million. Conversely, for every 1 per cent rise in the index, Mr Grantham would pay $1 million away. The trade would be settled at the end of three years with monthly margining to manage credit risk.
Beats sending the guy up a mountain wearing a funny t-shirt.
posted on 05 November 2010 by skirchner in Economics, House Prices
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