The US Current Account, Private Saving and Future Income Growth

An RBA Discussion Paper by Charles Engel, which looks at the sustainability of the US current account deficit in the context of future income growth, with some implications for USD bears:

In this paper we explore the role of one other factor that also has been mentioned prominently: private saving in the US is low because income growth is expected to be strong.

Our research ultimately is motivated by the question of whether the US current account is ‘sustainable’. The way we approach the question is to see whether the high level of US spending currently is compatible with an optimal path of borrowing. In particular, what assumptions about expected future growth of the US’s share of world output could justify its current account deficit? We show that if the deficit can be explained by higher future income shares, then the size of the real depreciation, that may otherwise be required to reduce the deficit, may be quite small.

posted on 15 November 2005 by skirchner in Economics

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What Do Money and Credit Aggregates Really Tell Us?

Barry Ritholtz is on the case in relation to the Fed’s decision to discontinue publication of the M3 aggregate.  As Barry notes, this is the sort of thing that excites the tin foil hat brigade and fever-swamp Austrians, but I would suggest that there is a rather innocent explanation.  Growth rates in broad money and credit aggregates tend to be dominated by trends in financial intermediation and thus have only a very tenuous relationship with monetary policy and even a somewhat loose relationship with economic activity.  There is in fact no necessary connection between a central bank’s targeting of an official interest rate and changes in the money supply, although there is often a link in practice under current central bank operating procedures.  Even under a system of free banking in which the money supply was market-determined, a central bank could still independently target an official interest rate (see Michael Woodford’s Interest and Prices for a more formal argument in this regard).

I’m much more sympathetic than most economists to the idea that money matters.  Base money arguably has a neglected role in monetary policy transmission that is independent of the official interest rate and some of that role may also be reflected in broad money aggregates.  However, it is mistake to interpret broad money and credit aggregates as being predominantly a function of exogenous monetary policy decisions.  They have a much stronger relationship with individual portfolio choices and innovations in financial technology, in other words, capitalist acts between consenting adults.  When the fever-swamp Austrians point to growth in these aggregates as being symptomatic of the supposed monetary depredations of the Fed, they are inadvertently condemning what are largely market-determined outcomes in relation to financial intermediation.

posted on 14 November 2005 by skirchner in Economics

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The Dismissal: Get Over It

Today is the 30th anniversary of the dismissal of the Whitlam Labor government by the Queen’s representative in Australia.  Lindsay Tanner has the best advice on this subject: get over it.  Dramatic though it was, it is all too easy to exaggerate the significance of this event.  The counter-factual history is one in which the Whitlam government would have been repudiated at the next election anyway.  The removal of Whitlam in November 1975 did little to arrest the secular expansion in the size of government over the last 30 years.  The current government has built extensively on Whitlam’s legacy in its further centralisation of power in the hands of the Commonwealth.  The scope for fiscal and regulatory competition within Australia’s federal system of government has never been smaller.

November 1975 does leave an important legacy for Australian republicanism.  The 1999 republican referendum arguably failed because republicans did not adequately address the issue of the reserve powers of the head of state.  The republican movement in Australia has always been motivated by anti-establishment nationalism rather than a genuine republican constitutionalism, so it has never taken constitutional issues seriously.  Republicans will be hard pressed to offer an improvement on constitutional monarchy while it retains this narrow nationalist mindset.  As far as heads of state go, one who lives thousands of miles away and minds her own business is about as good as it gets.

posted on 11 November 2005 by skirchner in Politics

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How Many Unemployed Kiwis Would It Take to Fill Telstra Stadium?

New Zealand’s unemployment rate has fallen to its lowest on record at 3.4% and also the lowest among 27 OECD countries that report standardised unemployment rates.  Labour force participation is also at record levels.  The number of unemployed in New Zealand is now so low, they would leave more than 10,000 empty seats at Telstra Stadium for a Wallabies-All Blacks game.

By contrast, Australia’s unemployment rate in October was 5.2%.  While still close to 27 year lows, the differential with NZ highlights Australia’s failure to tackle labour market reform.  The Australian government’s proposed IR reforms are decidedly inferior to the NZ model.  While they may still assist in lowering Australia’s unemployment rate, the differential with NZ shows the extent to which unemployment in Australia is a deliberate policy choice, wilfully ignoring a superior reform model across the Tasman.

posted on 10 November 2005 by skirchner in Economics

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Seasonal Influences on US House Prices

Before getting too excited about the reported moderation in US house prices, it is worth considering what Action Economics chief economist Mike Englund has to say about seasonal influences on US house prices:

U.S. housing industry reports of moderating prices imply little about annual trends. Prices decline sharply in nearly every Q4 in this highly seasonal industry, and declines are particularly big in years with large Q2 and Q3 gains…

the declines thus far are small compared to the out-sized advances reported in the first three quarters of the year, and seem to be paralleling the powerful and widening seasonal swings that are typical for the industry. It is hardly clear that recent reported price drops are significant in the context of seasonal patterns. The jury will remain out for this sector until we enter the next big “price discovery” session for this sector—in Q2 of 2006.

posted on 09 November 2005 by skirchner in Economics

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The Doomsday Cult Capitulation Trade

‘Buffett’s Berkshire Yanks Billions In Forex Bets:’

Buffett’s Berkshire said on Friday that it had reduced its foreign currency holdings to $16.5 billion, from $21.5 billion three months earlier.

posted on 08 November 2005 by skirchner in Economics

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Schadenfreude, Sex and House Prices

David Smith has been doing for the UK what this blog has been doing in the Australian context, drawing attention to the perverse demand for predictions of housing-related economic ruin.  Predictions of this kind have been about as successful in the UK context as they have been in Australia.  As Smith notes, they have also become something of an industry in themselves:

Many parts of the media have been itching for the crash to happen. From a crowded field, my nomination for most ridiculous housing headline this year goes to the Daily Express. “House prices slump”, its banner front-page headline screamed on September 30. The story was that the Nationwide building society had reported a 0.2% drop in house prices for the month. Some slump.

A whole industry has built up around the crash story, with websites, weblogs (blogs) and newsletters. I can only think this is driven by schadenfreude - pleasure in the (potential) misfortune of others.

Rather than simple schadenfreude, there is probably a more complex story of cognitive bias at work here.  The main problem is the willingness of people to adhere to an asymmetric view of the future distribution of economic shocks, a bias which is then exploited by publicity-seeking forecasting firms and the media.  As Smith notes, predictions of stagnation are not nearly as sexy as forecasts of a crash. 

The perverse element in all this is when forecasters go looking for possible adverse shocks to rationalise their house price forecast.  Nouriel Roubini did the same thing at the Cato monetary policy conference in relation to the USD (see previous post), rattling off every conceivable thing that could go wrong for the USD to justify his essentially pre-determined view that it must fall.

posted on 07 November 2005 by skirchner in Economics

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Industrial Relations Reform

The real problem with the government’s IR reforms:

The Government’s laws, introduced into parliament this week, are much more complicated than the Fightback! industrial relations package that Mr Howard, then a Coalition frontbencher, launched in 1992 with former Liberal leader John Hewson.

Despite disputed figures on productivity, New Zealand now boasts an unemployment rate of 3.5 per cent while Australia’s official rate hovers at about 5per cent - still the lowest here for more than two decades.

posted on 04 November 2005 by skirchner in Economics

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Institutional Economics Now Available via Newstex

Institutional Economics is no longer being aggregated at Nouriel Roubini’s $600 a year doomsday cult site (can’t think why!)  However, it is now available via Newstex, where you can choose your own content from among numerous financial and other blogs:

Newstex offers Content On Demand, including tailored, real-time news and commentary from thousands of branded newswires, newspapers, magazines, financial and business sources, official government feeds and weblogs. Newstex collects full-text digital news and commentary feeds, standardizes the content format, adds stock ticker symbols, people tickers and categories, and instantly delivers the result as easy-to-integrate XML or RSS newsfeeds.

posted on 02 November 2005 by skirchner in Economics

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Inflation Targeting Works

Kevin Hassett makes part of the case for the Fed to adopt inflation targeting:

Would a target matter? One recent study found some significant differences between countries that practice inflation targeting, and those that don’t.

For example, private-sector inflation forecasts tend to show more agreement with one another in inflation-targeting countries than in the U.S. Such disagreement about future inflation is a good measure of the extra risk added to the economy because the Fed isn’t transparent
enough.

For three years now, I have been conducting an experiment in which I ask my students what they think Australia’s inflation rate will be in five years time.  I have yet to have a class in which students did not volunteer something like “2-3%” or “2.5%,” the RBA’s inflation target range.  Students quickly get the point that to forecast a number outside the target range is to implicitly forecast either a future monetary policy mistake or an inflation shock.  Had I asked students this question 10 years ago, I would have got either blank stares or random numbers.

Of course, economics students are more likely to get this right than others, but these students are also likely to be the ones who will be making future decisions where inflation expectations will be particularly important.  I would suggest any US readers who are doubtful about the merits of inflation targeting try this exercise with others and see what results they get.

posted on 01 November 2005 by skirchner in Economics

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Dear Ms. Burrow

The IMF replies to ACTU President, Sharan Burrow:

Overall, the benefits of economic reforms in Australia, including improvements in the functioning of the labor market, have been substantial, and this gives a sound basis for expecting positive results from further labor market reforms. Hence, I can not accept the statement in your letter that the staff report’s support for labor market reforms reflects poorly on the professionalism of the IMF review team.

posted on 31 October 2005 by skirchner in

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More Housing ‘Bubble’ Myth Busting

IMF research points to the role of mortgage securitisation in reducing deviations in house prices from fundamentals:

With funding conditions now determined in a national market, trends in real activity and prices have become less cyclical and converged across all regions of the United States. As a result, a model of housing prices based on economic fundamentals finds that pricing errors—the deviations of actual prices from those estimated in the model—have fallen by half. Moreover, a change in homebuilders’ behavior—in particular, a move away from speculative starts and a reduction of levels of inventories of new homes—has reduced the risk of a sharp decline in housing prices, although some indicators suggest speculative pressures in a number of metropolitan areas. This stabilization of housing activity may have made an important contribution to the reduction of the volatility of GDP growth over the same period.

posted on 31 October 2005 by skirchner in Economics

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True Confessions of Bill Gross

PIMCO boss Bill Gross tells it like it is:

I am no expert…all I know is what I read in the newspapers.

posted on 31 October 2005 by skirchner in Economics

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Inflation Targeting and Fed Governance

Greg Mankiw echoes some of this blog’s arguments for reform of Fed governance:

Some recent news reports have suggested that inflation targeting would mean a big change in policy from the Greenspan era. That is not right. Starting where we are today, a switch to inflation targeting is not so much a change in monetary policy as it is a change in the way the Fed communicates about monetary policy. To a large extent, Mr. Greenspan’s policy can be described as “covert inflation targeting.” He has never announced a target inflation rate, but there is little doubt about his goals. As former Fed governor Laurence Meyer pointed out, anyone who doesn’t know that Mr. Greenspan is aiming for a measured inflation rate of about 1% to 2% is just not paying attention…

Alan Greenspan is a rock star, at least by the standards of the American Economic Association… The most negative assessment I have ever heard about Ben Bernanke, from one of my colleagues, is that he is “a bit boring.” For an economist, boring is an occupational hazard. For a central banker, however, it is just the ticket. The central bank’s job is to create stability, not excitement. Ben Bernanke would do well to increase public confidence in the institution of the Federal Reserve: The institution matters more than the individual who happens to be leading it at the moment. It would be ideal if, after a long, successful tenure, Mr. Bernanke’s retirement as Fed chairman were a less momentous event than his arrival.

UPDATE:  Free version here.

posted on 28 October 2005 by skirchner in Economics

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RBNZ Governor Bollard Has Lost the Plot

Former RBNZ Governor (now National Party leader) Don Brash got a lot of bad press for his conduct of monetary policy, most of it undeserved.  But his successor as Governor, Alan Bollard, deserves criticism following today’s decision to raise the official cash rate to a record 7%.  The problem is not the rate increase as such.  A case can be made for further tightening, even if this partly reflects Bollard’s mistake in lowering the cash rate in 2003.  Rather, the problem is Bollard’s rationalisation for the latest tightening, which is contradictory to say the least.  According to Bollard:

The most serious risk to medium term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending.  Significant dis-saving by the household sector is showing through in a worsening current account deficit, now 8 per cent of GDP. Borrowers and lenders alike need to recognise that the current rate of debt accumulation is unsustainable. The correction of these imbalances and associated inflation pressures will require a slowdown in housing, credit growth and domestic spending. We also expect a significantly lower exchange rate. The longer these adjustments in behaviour and asset prices are deferred, the more disruptive they are likely to be.

This is not only a mischaracterisation of the risks to inflation, it is also contradictory.  Raising the official cash rate will only attract further capital inflow, already very strong, putting further upward pressure on the exchange rate and making the current account deficit even worse.  This is exactly the policy mistake the RBA made in the late 1980s, when it sought to target the current account deficit with tighter monetary policy, resulting in a recession in the early 1990s.  Both Governor Bollard and the Finance Minister have been trying to talk the NZD lower, yet monetary policy has been driving it higher.  This can only cause credibility problems for the Bank.  If anything, Bollard should be talking up the exchange rate. 

The credibility problem is made worse by the fact that the RBNZ recently sought an increase in its capitalisation to facilitate intervention in foreign exchange markets, yet it seems unwilling to back its exchange rate overvaluation rhetoric with actual intervention.  This is just as well, because we would then have a situation in which interest rate and exchange rate policy were at cross purposes, but it highlights the contradiction between what the RBNZ and the government say about the exchange rate and what the RBNZ is actually doing with monetary policy.

Before the current government watered down the RBNZ’s inflation targeting regime, the current rate of inflation might have already seen the RBNZ Board meet to decide whether to recommend dismissal of the Governor to the Minister, although the contribution to inflation from higher oil prices would fall under the caveats to the Policy Targets Agreement.  This is now much harder to do, because the inflation target has been re-defined in such a way as to accommodate a much wider range of outcomes.  By the Bank’s own admission, there is little scope for inflation to return to the target range before 2007.

posted on 27 October 2005 by skirchner in Economics

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