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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Rudd in Wonderland II
Michael Stutchbury writes from Davos on that essay:
There’s so many straw men in there, it’s a fire hazard.
At the same time, the WSJ writes on ‘neo-socialism Down Under’:
he’s manufacturing a philosophy to justify his actions.
posted on 03 February 2009 by skirchner in Economics, Politics
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Rudd in Wonderland
David Burchell attempts to deconstruct Rudd’s bizarre work of political speculative fiction:
It’s hard to accept that the flesh and blood Kevin Rudd who lives in the Lodge really believes any of these things. While it’s true that governments around the world have been more inclined to expose national economies to international competition, and to facilitate the flow of capital across national borders, there’s no clear evidence of a general shrinkage of the size or role of governments over the past 30 years, regardless of the ideological presuppositions of specific administrations. The neo-liberal ghoul is just that, a ghoul. And the fantasy that sets states and markets on a path of mortal combat resembles the imaginations of those medieval mystics who saw Christ and the devil locked in struggle across this vale of tears.
This is where the several other authorial Rudds come in. One of them - we’ll call him Rudd 2 - is the dutiful policy technocrat, eager to reassure us about the practical measures necessary to stabilise world finance. But since few of these measures are disputed by orthodox economists, it’s not clear how they toll the death-knell of neo-liberalism. Rudd 3, in turn, is that familiar figure in ministers’ offices, the instinctual party loyalist who wants to spin the fable of neo-liberalism into a partisan account of Labor governments (good) and conservatives (bad). Yet this third Rudd seems equally discordant with the first, given that - as the Old Testament critics of economic rationalism have been instructing us tirelessly since the early 1990s - the Hawke-Keating governments were our neo-liberal pioneers, the unleashers of the locust plague, the vandals of our nation-building state.
What I have seen of Rudd’s essay reads almost like a cyber-punk novel, with the action set in a speculative ‘neo-liberal’ dystopia (Brutopia?), and where the social democratic hero (guess who?) saves the day.
posted on 02 February 2009 by skirchner in Economics, Politics
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‘Neo-Liberalism’ Triumphed in 1978. Who Knew?
Prime Minister Kevin Rudd has produced a 7,700 word essay on The Global Financial Crisis. Only the first 1,500 words are currently available on-line. Until I have seen the rest, I’ll refrain from commenting on the substance, such as there is. If any readers have a samizdat copy, please send it through.
However, if the first 1,500 hundred words are any guide, we can safely comment on the Prime Minister’s style. Kevin Rudd is notorious for the mind-numbing emptiness of his public utterances. Rudd’s most overused phrase is ‘for the future’, so it was no surprise that this made it into the first 1,500 words, along with such awful clichés as ‘throw the baby out with the bathwater.’
As with his ‘Between Hayek and Brezhnev’ speech to CIS in August last year, Rudd posits two straw men and then places himself in the reasonable centre. Rudd’s approach to argument is thus very similar to his approach to politics. His strategy is to minimise points of disagreement. But what works well as political strategy won’t fly as serious argument.
posted on 31 January 2009 by skirchner in Economics, Politics
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Rudd Bank versus AussieMac
A curious feature of the debate surrounding the so-called Rudd Bank (see previous post) and AussieMac is that the same people have taken different positions on the two interventions. Opposition leader Malcolm Turnbull supported the government’s intervention in the RMBS market, but opposes Rudd Bank. In The Australian today, Christopher Joye criticises Ian Harper for supporting Rudd Bank while opposing the RMBS intervention. Joye supports the RMBS intervention and (at least on a relative basis) opposes Rudd Bank.
In my op-ed for the AFR on Rudd Bank yesterday, I deliberately linked the two interventions, because I see them as suffering from similar problems. Both interventions implicate the government in favouring specific industries and firms, on the assumption that this will prevent wider adverse economic outcomes. This overlooks the fact that those sectors deemed most worthy of assistance may also be those most in need of adjustment and may see low relative returns on government resources compared to alternative policies. Both interventions rely on a rather stretched transmission mechanism from the government’s balance sheet, via the balance sheets of business, to the wider public.
One of the advantages of generalised tax cuts as a stimulus measure is that they are relatively neutral from the standpoint of resource allocation. Tax cuts may also have other supply-side benefits through easing distortions and disincentives flowing from the operation of the tax system. From a demand management perspective, unfunded tax cuts are subject to the same Ricardian equivalence critique as unfunded spending measures, but from a supply-side perspective, they have a distinct advantage.
From a political perspective, however, the advantage of Rudd Bank and the RMBS intervention is that they can be written up as loans and investments rather than outright spending. The fiscal transfers involved are therefore much less transparent. One could say the same of the provision of term funding to banks via the Future Fund, although at least this is at arms length from the government of the day and may not differ significantly from the market-based outcomes that would prevail if the Future Fund did not exist.
posted on 29 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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Rudd Bank Puts Taxpayers Last
I have an op-ed in today’s AFR on the so-called ‘Rudd Bank.’ Text below the fold (may differ slightly from edited AFR version).
Henry Ergas made related arguments in The Australian yesterday.
continue reading
posted on 28 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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Right Forecast, Wrong Trade II
Mike Shedlock is far from impressed with Peter Schiff.
posted on 27 January 2009 by skirchner in Economics, Financial Markets
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US Government Debt Default – It’s Happened Before
Alex Pollock reviews the US government’s 1933 decision to repudiate its gold clause obligations:
The United States quite clearly and overtly defaulted on its debt as an expediency in 1933, the first year of Franklin Roosevelt’s presidency. This was an intentional repudiation of its obligations, supported by a resolution of Congress and later upheld by the Supreme Court.
Granted, the circumstances were somewhat different in those days, since government finance still had a real tie to gold. In particular, U.S. bonds, including those issued to finance the American participation in the First World War, provided the holders of the bonds with an unambiguous promise that the U.S. government would give them the option to be repaid in gold coin.
Nobody doubted the clarity of this “gold clause” provision or the intent of both the debtor, the U.S. Treasury, and the creditors, the bond buyers, that the bondholders be protected against the depreciation of paper currency by the government.
Unfortunately for the bondholders, when President Roosevelt and the Congress decided that it was a good idea to depreciate the currency in the economic crisis of the time, they also decided not to honor their unambiguous obligation to pay in gold.
The fact that the US defaulted on these obligations demonstrates that a gold standard is only a very weak constraint on government once the decision is made to go off it. The gold standard fails an important test that all monetary institutions should satisfy, namely that they be politically robust. It is noteworthy that private and public debt defaults are often associated with the failure of fixed exchange rate regimes, because those who borrow in foreign currencies at the former parity can face a sudden increase in their debt burden.
A floating exchange rate regime, by contrast, is much less likely to give rise to the need for default on debt obligations. In the case of the US, the ability to borrow in its own currency shifts exchange rate risk to its creditors. Although this currency risk might be reflected in interest rates, in practice, this seems to be a relatively minor influence on interest rates. For countries like Australia that are also heavily dependent on foreign borrowing, the exchange rate risk is typically swapped out. The exchange rate can then carry most of the adjustment to an external shock, without causing significant problems for domestic borrowers.
posted on 27 January 2009 by skirchner in Economics, Financial Markets, Gold
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An Offer Über Dollar Bears Cannot Refuse
David Henderson offers to ease the worries of US dollar bears:
please contact the publisher for my address and send me all of your bills with pictures of dead presidents on them, especially the ones with pictures of Ulysses S. Grant. (I will even accept the ones with pictures of Benjamin Franklin, although he was not a president.) In return, I will send you an equal weight of blank paper. I promise.
posted on 25 January 2009 by skirchner in Economics, Financial Markets
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The Terms of Trade: Not Dead Yet
The December quarter trade prices release saw the largest quarterly and annual increases in export prices since the current series began in the September quarter 1974, at 15.9% q/q and 54.9% y/y. Import prices were up 10.8% q/q and 21.1% y/y, the largest annual increase since the December quarter 1985. The merchandise terms of trade are up nearly 30% on a year ago.
How did Australia pull-off a further gain in the terms of trade against the backdrop of collapsing world commodity prices? The depreciation in the Australian dollar over the quarter, which supported Australian dollar commodity prices. This is a very good illustration of the role of a floating exchange rate in insulating the economy against external shocks.
Given the magnitude of the external shock now confronting the Australian economy, the appropriate exchange rate response is massive depreciation. In this context, US dollar strength is perfectly explicable, because weakness in the US economy is an external shock for the rest of the world.
Unfortunately, this may see pressures for competitive devaluations and foreign exchange market intervention, not least on the part of the new US Administration. This would be in sharp contrast to the highly principled stance the Bush Administration took against intervention in foreign exchange markets. The new US Treasury Secretary, Tim Geithner, was a protégé of former Treasury Secretary Robert Rubin, who presided over massive intervention in foreign exchange markets.
posted on 24 January 2009 by skirchner in Economics, Financial Markets
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The Multiplier Equals Zero
Robert Barro makes the case for a zero multiplier from fiscal stimulus:
A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP—consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.
This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.
What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II. The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.
I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports—personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses—there was a dampener, rather than a multiplier.
posted on 22 January 2009 by skirchner in Economics, Fiscal Policy
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The Failure of US Fiscal Policy
When it comes to activist fiscal policy, it seems that nothing succeeds like failure. The failure of the economy to respond to previous stimulus measures is always seen as an argument for yet more stimulus, rather than supporting the more obvious conclusion that activist fiscal policy doesn’t work. As Philip Levy notes, if the existing US budget deficit won’t budge its economy, there is nothing the Obama Administration can add that is likely to make a difference:
The Congressional Budget Office projected last week that even without a stimulus package, the federal budget deficit will hit $1.2 trillion this year. That’s 8.3% of gross domestic product. Followers of the late John Maynard Keynes should be thrilled. Such a gap between government spending and taxes was just what he prescribed to stimulate a slumping economy.
And yet the stimulus enthusiasts seem unsatisfied. President-elect Barack Obama argues that this level of stimulus would leave us with shattered dreams and long-lasting torpor. Our only chance is to adopt his plan of $800 billion in additional stimulus spending over the next two years. So $1.2 trillion in deficit spending leaves us in despair, but $1.6 trillion in deficit spending brings prosperity…
there is very little science behind arguments that an additional $800 billion stimulus should do the trick.
Unfortunately, the political imperative is for governments to be seen to be doing something, regardless of whether it works or not.
posted on 15 January 2009 by skirchner in Economics, Fiscal Policy
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Is Australia the Freest Country on Earth?
Australia moves up to third place in the Heritage Foundation-Wall Street Journal Index of Economic Freedom for 2009, behind only Hong Kong and Singapore. The construction of the score for Australia contains some questionable elements. For example, Australia loses five points from its monetary freedom score because ‘retail gas and electricity prices are regulated.’ Yet these regulations are a relatively minor infringement of economic liberty, while ignoring other more serious price controls (ask Andrew Norton about price controls in higher education, which limit freedom to invest in human capital). The statement on ‘investment freedom’ is self-contradictory: ‘Foreign and domestic investors receive equal treatment… Foreign investment in media, banking, airlines, airports, shipping, real estate, and telecommunications is subject to limitations. Foreign investors may own land, subject to a number of restrictions.’
The index does not purport to measure political freedom. But since Australia’s political institutions are at least as free as any other country, and certainly more free than those in Hong Kong and Singapore, Australia could make a plausible case for being the world’s freest country if sufficient weight were given to the political as well as the economic dimensions of freedom (at least as measured by Heritage).
posted on 14 January 2009 by skirchner in
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Thrift is No Paradox
I have an op-ed in today’s AFR refuting the paradox of thrift as a rationale for short-term fiscal stimulus measures. In particular, I highlight the origins of the idea in the discredited ‘secular stagnation’ hypothesis of the1930s. Text over the fold (may differ slightly from edited AFR version).
Greg Mankiw makes related arguments in the US context.
continue reading
posted on 13 January 2009 by skirchner in Economics, Fiscal Policy
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Does ‘Peak Oil’ Cause Oil Prices or Do Oil Prices Cause ‘Peak Oil’?
‘Peak oil’ is meant to drive a secular increase in oil prices. But what if the cyclical behaviour of oil prices actually drove belief in peak oil? Matthew Kahn notes that traffic at the peak oil blog The Oil Drum is closely correlated with oil prices. The direction of causality is fairly unambiguous:
I don’t believe that the Oil Drum blog causes gas price dynamics. The causality runs from oil price dynamics causing interest or declines in interest in the Oil Drum blog.
posted on 10 January 2009 by skirchner in Economics, Oil
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