There have been a string of ‘BoJ sources’ stories, most notably this week in the FT, suggesting that Japan’s massive yen-selling interventions in foreign exchange markets might be coming to an end. It is no secret that the extent of Japan’s intervention in the market bothers the BoJ, but also irrelevant, since the BoJ is not the responsible decision-maker. The MoF was quick to deny any change to intervention policy, although market developments do seem to suggest a change in the level of the exchange rate the MoF is willing to tolerate. It is quite possible that the MoF is now looking to ‘smooth’ rather than effectively fix the yen, having already given exporters plenty of opportunity to lock-in lower exchange rates (although there is a moral hazard problem with this strategy).

What is perhaps more surprising is the relatively uncritical response Japan’s intervention operations have received in the financial press, particularly outside Japan (for its part, the Nikkei has been refreshingly critical). This partly reflects the dubious link the Japanese authorities have drawn between their quantitative easing policies and intervention operations. This link does not exist in practice, even if the interventions were left unsterilised, but since any pseudo-easing measure draws a favourable reflex response outside Japan, the Japanese authorities are comfortable in promoting this fiction. As we have pointed out previously, The Economist has bought heavily into this view, this week paraphrasing Andrew Smithers:

In an ideal world, he says, the ministry would go on selling until the currency was thoroughly debauched and the economy decisively reflated.

In the real world, once the positive impetus to inflation from the currency depreciation was lost, there would be an immediate disinflation/deflation, which would have a high output cost. Japan’s intervention strategy serves only to introduce distortions into relative price signals between the traded and non-traded goods sectors and delay adjustment to global macroeconomic imbalances.

posted on 1/4/2004

Somebody call the DoJ, Marginal Revolution are seeking to dominate the market for economics blogs! As Alex Tabarrok’s interview suggests, there are significant first-mover advantages for those who have the entrepreneurial insight to recognise that economics is still underrepresented in the blogosphere. It is just as well Marginal Revolution are only intellectual entrepreneurs. Commercial entrepreneurs would be setting themselves up for anti-trust action were they to put in writing their intention to dominate a market.

posted on 31/3/2004

For those of you entertaining retirement fantasies, check out Fred Bastiat’s 17th century French manor house, which is on the market for under half a million euros. People pay as much to live in gentrified 19th century working-class cottages in Sydney!

posted on 29/3/2004

Samuel Brittan reviews Clive Hamilton’s Growth Fetish:

Hamilton's Achilles heel is his belief that neo-liberals, with whom he identifies nearly all academic economists, are at the root of all the evils he discusses. It so happens that I bought his book on the fourth floor of a large and serious bookshop. There was just one small section devoted to academic economics, with just as many texts attacking or qualifying free market economics as endorsing it. Most of the surrounding space was taken up with business books and the like, while a few yards away there were stacks of volumes of a New Age kind. The best and most attractively laid out section was on popular science.

The author's claim to unmask neoliberal economists falters when he shows very little awareness of who they are or their distinctive doctrines. Friedman and Hayek always turn up as identical twins without any discussion of their differences or any mention of other neoliberals. Hayek's main concern was the advance of civilization and he avoided discussing GDP numbers or even happiness. Friedman's main concern is with individual freedom. But he regards that as a personal value judgment. Professionally he is concerned to show that a free market economy can also deliver rising living standards. Both writers formed their outlook, to some extent defensively, at a time when many people, including CIA analysts, feared that Soviet communism would eventually produce far greater wealth than the capitalist West.

Brittan amusingly notes that the ‘Genuine Progress Indicator,’ which Hamilton advocates as a measure of welfare at the expense of GDP, shows a happiness peak for the UK - in 1976!

posted on 26/3/2004

Outsourcing pays! Read this article by Dan Drezner on outsourcing and you could win $5,000.

posted on 26/3/2004

Robert Levy gives the background to the latest outrageous attack on Microsoft in the name of the competition policy:

the entire process has been instigated by US-based competitors that have failed repeatedly within the American legal system to accomplish what they have been inept at accomplishing within the global marketplace…Far from promoting consumer interests, the latest EU order transforms antitrust regulation into a corporate welfare programme for market losers. The implications will not be confined to the Microsoft case. Without some semblance of regulatory consistency, companies competing globally will not be able to satisfy the dictates of divergent legal regimes. That means special interests pursuing their favourite antitrust forum in an effort to exercise the most political clout. The real costs: fewer jobs, less innovation, inferior products and higher prices.

The rent-seeking antics of its competitors is reason enough to embrace Microsoft products.

posted on 26/3/2004

The Economist tries to suggest that Australia’s economy ‘now looks not like Mexico’s, but like that of its bigger neighbour, the United States - just before its bubble burst in 2000…Australia has become another hotbed of irrational exuberance.’ The Economist’s evidence for this is at best superficial. First, there is the obligatory reference to Australia’s current account deficit, which The Economist notes is ‘even bigger than America’s.’ All this tells us is that the Australian economy is outperforming the rest of the world and that investment demand exceeds domestic saving. As The Economist notes, ‘the country has run a deficit continuously for 30 years.’ This in itself should tell them something: contrary to popular belief, you can run a current account deficit continuously if the rates of return on domestic investment are high enough. The day Australia starts running current account surpluses will be when we really have to worry.

The Economist also cites Australia’s household saving ratio turning negative, increased household borrowing, the investment property boom and house price inflation. The Economist is quick to blame the latter on the ‘government’s tax policies,’ but this claim does not stand up to scrutiny. These developments are common to all the Anglo-American economies. A global price shock to a particular asset class can hardly be explained in country-specific terms. This is not to say that fiscal policy has not played a role in the massive volatility of dwelling investment spending in Australia since 2000. But this has nothing to do with irrational exuberance: it is simply an illustration of the hazards of activist fiscal policy. The prospect of another sharp downturn in dwelling investment is well within the terms of Australia’s recent business cycle experience. Indeed, Australia came within a whisker of a technical recession at the end of 2000 partly due to a fiscal policy-induced downswing in dwelling construction.

The negative wealth effects from a sharp fall in house prices might be more problematic. But it is certainly not necessary to invoke ‘irrational exuberance’ to explain either the recent run-up in house prices or any subsequent correction. Doing so adds nothing to our understanding of these developments, although probably does serve as a useful cloak for The Economist’s lack of depth in its discussion of the Australian economy.

UPDATE: Should it come as a surprise that The Economist's analysis appeals to the op-ed contributors over at the Spencer Street Soviet?

posted on 24/3/2004

Mercantilist thinking thrives in Japan, if we are to take either of these two items seriously. National Institute for Research Advancement has released an index which purports to measure ‘comprehensive national might,’ in which Japan ranks third after the US and Germany. The index includes a measure of ‘economic power,’ and takes into account such things as ‘military and government administrative ability.’ Surprisingly, there is no mention of national gold hoards, or its modern equivalent, foreign exchange reserves.

At the same time, METI has lost none of its faith in its ability to centrally plan the Japanese economy:

Economy, Trade and Industry Minister Shoichi Nakagawa on Tuesday proposed strengthening Japan's industrial competitiveness by designating priority sectors and making them driving forces for the national economy in the future...

The government designated seven priority areas it believes are likely to support domestic demand-led growth in Japan, the official said, adding that small as well as large companies are to be fostered under the proposal.

The seven areas are fuel cells, robots, information appliances, software contents, health and welfare equipment-related services, environmental equipment-related services and business support services.

METI will forge a complete strategy to implement the proposal in early May, including promoting research and development by the public and private sectors and taking necessary deregulatory measures, the official said.

Unfortunately, the ‘necessary deregulatory measures’ do not include getting rid of METI.

posted on 24/3/2004

Ross Gittins on the Australian Labor Party’s proposed changes to superannuation contributions tax:

On my rough figuring, his cut would have a full-year cost of up to $700 million. That's money that won't be spent on universities or government schools or public hospitals.

The naïve assumption that more government spending on the public provision of health and education is necessarily a good thing goes a long way to explaining why Ross never met a tax cut proposal he liked.

posted on 23/3/2004

Institutional Economics receives an honourable mention in an AFR Perspective story on blogging. Author Trevor Cook credits John Quiggin, Peter Gallagher and myself with having ‘provided a stream of excellent analysis of the recent free trade agreement negotiations.’ He cites this as an illustration that ‘bloggers can provide additional depth to the daily coverage of issues in their area of expertise.’

Cook notes that ‘blogging is still fairly limited in Australia.’ There are probably still significant first-mover advantages to be had for prospective Australian bloggers, especially those with a distinctive perspective reflecting specialised knowledge or experience.

One gap I would like to see filled is that for serious Australian political commentary. There is an enormous potential opportunity here, especially in an election year. I think an ad hoc group blog devoted to the election could have a big impact, especially given that elections bring out the worst in the federal parliamentary press gallery. Andrew Norton notes that serious political and cultural magazines have a poor track record in Australia. But with the blogging medium eliminating many of the costs associated with print publications, an on-line effort might stand a better chance of commercial success.

posted on 22/3/2004

The Reserve Bank of New Zealand has released a discussion paper giving the background to its request to the Minister for an expanded capacity to intervene in foreign exchange markets. In particular, the RBNZ is seeking a capital injection and an augmentation of its foreign exchange reserves in order to mount intervention operations. As discussed in a previous post (see below), the RBNZ is arguing that it should abandon its previous non-interventionist stance to ‘dampen the exchange rate cycle,’ selling the NZD when it is ‘exceptionally and quite clearly unjustifiably high,’ and buying the currency when it is ‘exceptionally and clearly unjustifiably low.’

The RBNZ apparently now evinces little faith in market-determined exchange rates. In particular, the RBNZ is now saying that it has ‘clear’ knowledge of when the exchange rate is out of line with fundamentals. This would seem unlikely. Indeed, the RBNZ’s faith in its ability to make this determination is belied by its own discussion of how this policy might have operated during the large exchange rate fluctuations of the 1990s:

We have not performed an exercise of re-running history to see whether intervention as proposed might have been used in the past. Such an exercise is, by its very nature, difficult as there are no rules that can be easily applied to tell us when we would have intervened and when we wouldn’t have.

If this is a difficult exercise to conduct historically, then it is an exercise that is even more fraught with difficulty when conducted in real-time.

The RBNZ is cautious in not overstating the benefits of the proposed intervention policy and even concedes that ‘our general assessment is that foreign exchange interventions as proposed can be effective, but that their impact is usually small and possibly temporary.' The rationale for the proposed intervention is that exchange rate volatility imposes costs on the economy. Yet no account has been taken of the increased volatility that is likely to result from the market having to second-guess the RBNZ’s intervention operations. The change in policy at the RBNZ is a disturbing sign that those who think that asset prices should be the target of public policy are gaining the upper-hand. Governor Bollard’s theme song must be I think I’m turning Japanese!

UPDATE: I should have also mentioned Ed Nelson and Nicoletta Batini's paper, 'When the Bubble Bursts: Monetary Policy Rules and Foreign Exchange Market Behavior.' It shows, using UK data, that there are welfare losses if monetary policy reacts to exchange rate 'bubbles,' and volatility is not even necessarily reduced.

posted on 18/3/2004

The Economist invokes folk wisdom:

Some readers might believe that we are obsessed with bubbles. Yet even normal folk cannot ignore the vast amounts of froth around at the moment.

Unfortunately, most of the froth is in The Economist’s writing about monetary policy and asset prices.

posted on 18/3/2004

Ross Gittins claims that the middle-class aversion to public schools and hospitals is driven by status-seeking and accuses the government of pursuing policies that encourage the consumption of basic services as ‘positional goods.’ Gittins' claim that these services are being consumed as positional goods is true in one sense: avoiding the NSW public hospital system might just help keep you in a vertical position, rather than consigning you to a horizontal position on a permanent basis. As the litany of horror stories from the public hospital system strongly argues, middle-class flight from the public provision of private goods is driven by the knowledge that governments are simply not competent to provide these services.

Far from being an exercise in status-seeking, the enormous financial sacrifices many families make to pay for services that are made available from the government for free is a damning indictment of public provision. When you can’t even give the stuff away, you know there is a serious problem. Public provision turns these services into inferior goods: consumption falls as income rises. Gittins' belief in lavishing more funds on public provision of these services at the expense of subsidising private alternatives is a massive triumph of hope over experience.

posted on 17/3/2004

Bank of Japan Superhero!  A Japanese comic strip appearing in a humour magazine features a Bank of Japan executive as one of its characters. The executive tries to do a secret deal with the US due to his concerns about the Bank’s excessive yen selling interventions in foreign exchange markets. According to the Nikkei, the comic strip is very popular with BoJ officials, who are clearly uncomfortable with the extent of their intervention in the market at the direction of the MoF. There is a concern in the BoJ that a reversal in the direction of the yen could induce massive capital losses on Japan’s USD 777 bn in foreign exchange reserves. Indeed, Peter Morgan puts the yen value of these reserves at acquisition prices at around 18% of nominal GDP. However, I agree with Morgan that there is unlikely to be a change in foreign exchange intervention policy by the end of month, as the Nikkei report would have us believe, because the MoF is unlikely to be moved by the BoJ’s concerns over prospective capital losses.

posted on 16/3/2004

The Spanish election outcome. The guys at Hispalibertas were among the first to link to Institutional Economics and now is an opportune time for me to return the favour in light of developments in the last week. Be sure to also check out Iberian Notes. Andrew Norton makes a chilling observation in terms of the implications for Australia’s own upcoming federal election, although my guess is that any such terrorist action would greatly strengthen rather than weaken the position of the incumbent conservative government. At the same time, Mark Steyn makes a welcome appearance in the local press on the same subject.

posted on 15/3/2004

Paul Krugman’s interview with the Australian Broadcasting Corporation’s Lateline program can be found in transcript here. Unfortunately, the transcript does not fully capture the stammering and squirming that took place when Don Luskin’s name was mentioned by interviewer Tony Jones. I have never seen an interviewee look so uncomfortable, if only momentarily.

posted on 12/3/2004

The Reserve Bank of New Zealand has taken a backward step, seeking wider authority to intervene in foreign exchange markets to influence the value of the exchange rate. Up until now, the RBNZ has taken a non-interventionist stance with respect to foreign exchange markets. Indeed, the Bank at one stage seriously questioned the need to maintain foreign exchange reserves at all. But there appears to have been a significant change in the intellectual climate at the Bank under Governor Bollard. It is not coincidental that Bollard has also recently expressed sympathy for the idea that central banks should target asset prices. According to the Governor:

We have recommended that when the New Zealand dollar is exceptionally and unjustifiably high, the Reserve Bank would be able to use New Zealand dollars to buy foreign exchange, which would put downward pressure on the exchange rate. And, when the exchange rate is exceptionally and unjustifiably low, we would be able to sell foreign exchange to buy New Zealand dollars, putting upwards pressure on the exchange rate. By unjustifiable, we mean when the exchange rate has moved to a level in excess of that readily explained by the relevant economic fundamentals, which occurs only infrequently. This process is similar to that used for some years by the Reserve Bank of Australia.

The RBA would I think reject the idea that it was seeking to influence the level of the exchange rate, although it does in fact intervene frequently in the market. In recent years, the RBA’s interventions have taken on something of the character of a proprietary trading operation, buying the currency when cheap and selling it again when high, even when market volatility is quite low and there is no obvious need for ‘smoothing.’ There is something of a disconnect between the RBA’s official ‘smoothing’ rationale for intervention and the increasingly routine character of its intervention operations. For the RBNZ to be using the RBA as a model in this regard is disturbing.

Together with recent changes to its Policy Targets Agreement, the RBNZ has lost much of what made it distinctive in recent years. Perhaps that is the price New Zealand has to pay for giving former Governor Brash a shot at the Prime Ministership. Contrary to the predictions of some, Brash is turning out to be quite a popular opposition leader.

posted on 11/3/2004

Ian Vasquez on the changing of the guard at the IMF:

Anne Krueger's assumption as acting head of the International Monetary Fund will not change the fact that the IMF is primarily a political institution, not an economic one. Last fall, the IMF approved a new loan to Argentina in the absence of policy progress and after the country had defaulted on IMF debt. That occurred because of pressure from the U.S. Treasury Department despite objections from IMF staff and management. Dr. Krueger can be expected to be a tougher negotiator, but we can also expect the G-7, and the United States in particular, to still make the big decisions affecting IMF lending.

The crisis in Argentina highlights the backwardness of international lending to emerging markets. By making debt repayments to the IMF and other official lending institutions senior to repayments to private sector creditors, a perverse set of incentives is created. Official creditors, who "always get paid back" and whose lending is based on political considerations, face little or no accountability in the market, thereby reducing their discipline and that of their clients. On the other hand, private creditors, who have an incentive to lend only if credible reforms are actually forthcoming, are in effect forced to subsidize official sector irresponsibility.

An Argentinean default on the IMF might do some good to the international financial system, though it would do little to help Argentina. It would be far better if Argentina began dealing seriously with its private creditors and told the IMF that its loans were no longer a priority -- a prospect that is unlikely to happen given the perverse incentives the IMF has set up.

posted on 10/3/2004

James Dorn points to new evidence confirming that ‘Lord Bauer was right:’

It is widely assumed that to be effective foreign aid should be linked to a needy country's adopting sound institutions and policies. That belief lies behind the Bush administration's decision to set up the New Millennium Challenge Account, intended to increase aid by 50 percent over the next several years. However, in a new study in the Cato Journal, Harold Brumm, an economist with the federal government, finds that "foreign aid has a negative growth effect even where economic policy is sound."

Brumm examines data for 53 underdeveloped countries and finds a statistically significant but negative relationship between aid to countries with good policies and growth of real gross domestic product per capita. His results cast doubt on a much-cited study by World Bank economists Craig Burnside and David Dollar, who concluded in "Aid, Policies, and Growth" (American Economic Review, 2000): "We find that aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies, but has little effect in the presence of poor policies."...

It is tempting to think that aid can be targeted to countries with good policies and have a positive impact. However, once we recognize that all aid is political, since it is government-to-government assistance, we should not be surprised that it has either no effect on development or a negative effect. Moreover, the World Bank continues to give substantial aid to countries with poor policies...

Free private capital markets, not the World Bank or the International Monetary Fund, can judge whether policies are good or bad. Those countries that walk the walk of the free market will find the capital they need for development. Private lenders, in the absence of bailouts by the IMF, will have an incentive to direct capital to where it has the highest risk-adjusted return, and that will be to countries following good policies. Hong Kong's development path of free trade is far superior to the dead end of aid.

posted on 9/3/2004

Alan Reynolds  on US Presidential elections and the interest rate cycle:

In short, incumbent presidents usually do better when the Fed is pushing rates up than when it is pushing rates down, unless high inflation is involved (1980). This is not as paradoxical as it may sound. Falling interest rates are usually a sign of economic distress, while a reasonable rise in interest rates is a routine side effect of a vigorous economic rebound.

It makes neither economic nor political sense to sell stocks cheap out of fear that the lowest interest rates in modern history are sure to move a bit higher, sooner or later. When the herd sells good stocks for bad reasons, I buy.

posted on 8/3/2004

A number of my former colleagues have formed Action Economics, a new wholesale financial markets consultancy. Having previously worked with most of their analytical team, I can highly recommend their service to anyone with an interest in financial markets. Here is the spiel from their website:

Action Economics, LLC provides a new breed of commentary to support trading-room decision-making in the global fixed income and currency markets. The partners of Action Economics spearheaded the early innovations of real-time market commentary with the development of MMS International, the industry leader of its time. After managing its award-winning content for over two decades, this team of seasoned economists and analysts now plans to take analysis to a new level. Our goal is to produce Highly Actionable commentary that raises standards for the real-time information industry.

posted on 6/3/2004

Australia has rocketed into the top 20 of A T Kearney’s Globalisation Index at 13th from 21st in the previous survey. Yet their discussion of the reasons for Australia’s elevation can only make one suspicious of the survey’s overall methodology. The report credits Australia’s strong FDI inflows, yet Australia runs the fifth most restrictive FDI regime in the OECD, suggesting that no account is being taken of the opportunity cost of Australia’s institutionalised capital xenophobia. The report also says that:

Automobile companies such as Ford and Mitsubishi Motors selected Australia for their regional operations and research and developments centres, reflecting the country’s attractive combination of high productivity and low operating costs.

Not to mention tariff protection and generous government subsidies, measures designed specifically to act as an offset to globalisation, not promote it! Are these guys running a globalisation or a mercantilism index?

posted on 5/3/2004

Robert Feldman is one of the best economists writing about Japan today and one of the few to understand the political economy of Japanese monetary policy. In the course of fisking his colleague Stephen Roach, he more or less summarises my own view about the role of monetary policy in Japan’s recent experience of the business cycle:

I would agree that the failure to raise interest rates in 1988 was a blunder. However, the failure to cut rates quickly after the collapse of the equity bubble in 1990-91 was not necessarily a mistake. From pure macro considerations, inflation was still on its way up in 1990-91, as aftereffects of the 1980s bubble kept product and factor markets tight. Land prices were still rising. In addition, financial institutions continued to miscalculate their levels of non-performing assets, and to throw good money after bad to more and more questionable borrowers. The financial regulatory authorities (at the Ministry of Finance) were light-years behind the curve, and the BoJ had no legal powers in this area. Finally, even if one believes that macro-policy action was needed in the aftermath of the drop of equity prices (which were acknowledged by virtually everyone at the time to be too high anyway), the BoJ acted earlier and more aggressively than did fiscal policy. Indeed, PM Miyazawa waited until August 1992 before triggering any major fiscal response; BoJ rate cuts began in July 1991. In short, both the fiscal authorities and the regulatory authorities had their heads in the sand in 1990-92, and the BoJ is getting the blame.

posted on 5/3/2004

John Makin of the American Enterprise Institute is critical of Japan’s massive intervention in foreign exchange markets, but for all the wrong reasons. Makin argues that:

If the Bank of Japan would stop sterilizing its currency intervention (i.e., withdrawing from domestic money markets the yen it uses to buy dollars), Japan's money supply would rise rapidly and help to end deflation. As it is, the sterilization helps to perpetuate chronic yen appreciation.

It is true that the increase in current account deposits at the Bank of Japan has not reflected the size of its interventions in foreign exchange markets on behalf of the MoF, implying almost complete sterilization, although there have been some episodes of unsterilised intervention in recent times. But in a zero interest rate environment, there is no real difference between sterilized and unsterilised intervention. To illustrate, base money in Japan grew 16.2% in the year to February, 16.4% in 2003 and 25.7% in 2002. In 2001, base money growth exceeded 30% and its highest ratio to nominal GDP in a century, yet this did little for nominal GDP growth or broader money and credit aggregates. Unsterilised intervention would make almost no difference in this context. Those who advocate naïve monetarist policy prescriptions for Japan need to take a look at the data on velocity and the money multipliers, which have collapsed to record lows.

Makin’s characterization of Japan as suffering ‘intensifying deflation’ is also wide of the mark. His claim of a ‘4 percent-plus deflation rate at the end of last year’ could only be justified by annualising the quarterly data. The year on year rate for the GDP deflator was -2.6% in Q4 and -2.1% in Q3. The CPI, which is the more relevant measure for monetary policy, is showing an annual growth rate that is close to flat, having seen a distinct moderation in the rate of deflation in recent months. This looks more like price stability than ‘intensifying deflation.’

By drawing the link between foreign exchange market intervention and monetary policy, Makin is falling into the intellectual trap that Japanese officials have set to help make their attempt at running a de facto fixed exchange rate regime look more respectable.

posted on 4/3/2004

Speeches from Alan Greenspan have been thick on the ground in recent weeks. I would, however, strongly commend his speech to the NY Economic Club on the current account and exchange rates. Greenspan does an excellent job putting recent developments in perspective, providing a useful corrective to some of the lazy commentary on the subject that characterises publications like The Economist. The widely held view that foreign exchange market intervention by Asian central banks is underpinning the euro and US Treasuries gets the critical scrutiny it deserves:

But a more likely possibility is that Asian currency intervention has had little effect on other currencies and that the trade-weighted average of the dollar is, thus, somewhat elevated relative to the rate that would have prevailed absent intervention. When Asian authorities intervene to ease their currencies against the dollar, they purchase dollar-denominated assets from private sector portfolios. With fewer dollar assets in private hands, the natural inclination to rebalance portfolios will tend to buoy the dollar even against currencies that are not used in intervention operations, including the euro. These transactions raise the dollar against, for example, the yen, lower the yen against the euro, and lower the euro against the dollar. The strength of the euro against the dollar thus appears to be the consequence of forces unrelated to Asian intervention. As I will explain later, this does not mean that when Asian intervention ceases the dollar will automatically fall because other influences on the dollar cannot be foreseen.

Some have argued that purchases of U.S. Treasuries by Asian officials are holding down interest rates on these instruments, and therefore U.S. interest rates are likely to rise as intervention by Asian monetary authorities slows, ceases, or even turns to net sales. While there are obvious reasons to be concerned about such an outcome, the effect of a reduction in the scale of intervention, or even net sales, on U.S. financial markets would likely be small. The reason is that central bank reserves are heavily concentrated in short-term maturities; moreover, the overall market in short-term dollar assets, combining both public and private instruments, is huge relative to the size of asset holdings of Asian monetary authorities. And because these issues are short-term and hence capable of only limited price change, realized capital losses, if any, would be small. Accordingly, any incentive for monetary authorities to sell dollars, in order to preserve market value, would be muted.

I would, however, take issue with one aspect of Greenspan’s analysis, when he says:

Granted the level of intervention pursued by the Japanese monetary authorities has influenced the market value of the yen, but the size of the impact is difficult to judge. In any event, it must be presumed that the rate of accumulation of dollar assets by the Japanese government will have to slow at some point and eventually cease. For now, partially unsterilized intervention is perceived as a means of expanding the monetary base of Japan, a basic element of monetary policy. (The same effect, of course, is available through the purchase of domestic assets.) In time, however, as the present deflationary situation abates, the monetary consequences of continued intervention could become problematic. The current performance of the Japanese economy suggests that we are getting closer to the point where continued intervention at the present scale will no longer meet the monetary policy needs of Japan.

There may well be limits on the accumulation of dollar assets, but there are few limits on the ability of a country to weaken its own currency, in contrast to the limits that foreign exchange reserves place on the ability of the authorities to strengthen their own currency. I also disagree that Japan’s foreign exchange market intervention, even when unsterilised, has anything to do with monetary policy. Japan’s intervention in foreign exchange markets is at the direction of the MoF, not the BoJ, and has a barely disguised mercantilist rationale. To the extent that the Japanese authorities make the link to monetary policy, it is only to make their policy of running a de facto fixed exchange rate regime look more respectable. The Ministry of Finance have never been overly committed to market-determined exchange rates.

posted on 3/3/2004

Everywhere a bubble.  My definition of a ‘bubble’ is any asset price inflation that the person using the term cannot otherwise explain. Increasingly, however, the term bubble is being applied to almost any asset price movement that disagrees with our prejudices or preconceived ideas. Here is an overblown example of such thinking from Stephen Roach, in an open letter to Alan Greenspan (as if Greenspan needs lessons from Roach):

There are already signs of such excesses. Property markets are frothy and so are government bonds, credit instruments, high-yield debt, and tech stocks (again). Here we are, only four years after the bursting of the first bubble, and the risks of new bubbles abound.

Peter Garber’s Famous First Bubbles: The Fundamentals of Early Manias, is a very useful corrective to this sort of intellectual laziness.

posted on 1/3/2004

Capitalist acts between consenting adults. This story nicely illustrates how consumption taxes bureaucratise virtually every transaction in an economy:

The GST as applied to stripteases and lap dances is so confusing that the Australian Taxation Office has had to withdraw a previous "interpretive decision" and replace it with three new ones to try to explain just who pays what when somebody goes the full monty.

The new decisions, titled "GST and adult entertainment services", cover the situation that arises when a dancer, engaged by a club, performs a lap dance or striptease for one or more of the club's customers.

At issue is whether the club, the dancer or somebody else is responsible for filling in a business activity statement and remitting the GST back to the Tax Office.

"When a customer requests a lap dance or striptease, they approach the [club]," the decisions say.

"It needs to be determined whether the entire amount paid by the customer is consideration for the [club's] service, or if any of the consideration is paid to the [club] acting as an agent on behalf of the dancer who is making a separate supply of their services."

The three rulings cover a range of possible circumstances: where the dancer is directly engaged by the club; where the dancer collects her (or his) own money and simply pays the club a portion for the use of the premises; and where the club contracts the dancer from another promoter, to whom the dancer is contracted.

posted on 1/3/2004

Brian Toohey argues for the abolition of company tax in terms that would do any ‘economic rationalist’ proud:

Amid all the screams that a concessional tax rate of 8 per cent on superannuation income is "too high", the government is overlooking an obvious case for reform highlighted by the latest setback for the National Australia Bank. The bank is challenging an Australian Taxation Office ruling that interest is not deductible on some hybrid securities issued seven years ago.

NAB would have put a lot of time and effort into ensuring it met legal advice on what was deductible. The ATO would have done the same in coming to the opposite view of the law. Now more time, energy and money will be spent by each side trying to convince the courts about who has made the right interpretation of a painfully complex law.

The simplest way to avoid this type of non-productive wrangle is to scrap company tax altogether. Then there could be no argument over deductions because there would be none.

A key advantage of scrapping company tax is that it can be done in a way that has little, or no, cost to revenue. Productivity should be enhanced by eliminating "dead weight" compliance costs and by encouraging new investment. With large chunks of the 9000-page Tax Act sent to the mulchers, businesses could apply their energies to generating (taxable) income for shareholders.

If it is possible to convince and old leftie like Toohey of the merits of abolishing company tax, then perhaps there is some cause for optimism on this score. Of course, one could make a similar case in relation to abolishing capital gains tax, but I doubt Toohey would buy into that one. I highly recommend a study by Alan Reynolds commissioned by the Australian Stock Exchange on capital gains taxes. The first chapter on defining capital gains challenges a lot of conventional wisdom on this issue.

posted on 28/2/2004

The IMF and Japan.  IMF MD Horst Koehler has been visiting Japan. Rather than throwing the book at Japan over its attempt at running a de facto fixed exchange rate regime through massive intervention in foreign exchange markets, Koehler has endorsed Japan’s actions:

"I do think it was an appropriate policy stance," IMF Managing Director Horst Koehler told a press conference after wrapping up two days of talks with Japanese officials….Koehler said his talks with Prime Minister Junichiro Koizumi and other officials had convinced him that intervention has been aimed primarily at slowing the pace of domestic price falls and bolstering Japan's weak financial system.

"I do not think ... that the objective of these interventions has been to boost exports," he said.

"It was an option taken because of the limited number of other options to avoid spiraling deflation and secure the integrity of the financial system here - and it worked."

With Japanese interest rates already at virtually zero and fiscal policy constrained by ballooning deficits, battling price falls through foreign exchange policy was "a practical step," he said.

His comments are likely to embolden Japan's Finance Ministry to continue to cap the yen's rise, despite complaints from Europe and elsewhere that the policy has forced the euro and other currencies higher, as they absorb a larger share of the dollar's broad-based decline.

Koehler said he supported the Bank of Japan's "increasingly proactive approach" to monetary policy under Fukui, who was appointed to head the central bank last year.

As discussed in previous posts, there is no reason to expect unsterilised foreign exchange market intervention to translate into a substantively easier monetary policy stance in the current environment and there has been almost no substantive change in Japanese monetary policy since March 2001. The fact that the IMF MD has bought into these views suggests not only a very limited understanding of the political economy of Japanese monetary and exchange rate policy, but a lack of commitment to the IMF’s own foundational principles.

Meanwhile, James Dorn argues that liberalisation of cross-border capital flows is important for human rights in China.

posted on 26/2/2004

Andrew Stoler, executive director of the Institute for International Business, Economics and Law at the University of Adelaide and former deputy director-general of the World Trade Organisation, on the Australia-US FTA:

Having just concluded FTAs with Singapore and Thailand, and embarked on the study of an FTA with China, is there really any reason to think that Australia would be punished because it negotiated the AUSFTA?

Just recently, an Indonesian minister, hearing of the FTA results, suggested that his country might be next in line for an agreement with Australia. China appears to be serious about an FTA with Australia. Many speculate that Beijing sees it as a testbed for other bilateral deals, including one with the US.

The idea that the AUSFTA has distracted Australia from the Doha round, and that this is why the round is in trouble, is almost too silly an argument to consider.

I have spent most of my adult life in Geneva, and I can confidently say that anyone trying to use what happened in the AUSFTA on sugar as an indication that Australia and the US are willing to settle for no meaningful results on agriculture at the World Trade Organisation is someone who purposefully, or through ignorance, projects a misunderstanding of Australia's position in Geneva…

Far from being left out of the deal, most Australian agricultural sectors should do quite well under the AUSFTA. Far too many people are quick to forget that in this modern Australian economy, nearly three-quarters of people work in the services sector where the AUSFTA clearly promises more competition and cost savings in Australia, and enhanced access for services exporters to the US.

posted on 25/2/2004

Leaked policy research on behalf of the Australian Labor Party shows that it wants to cut income taxes by $10bn, funded by...oh, wait, raising other taxes.

posted on 25/2/2004

Changing foreign aid practices. According to Marginal Revolution, the US is overhauling its foreign aid spending, including disintermediating international financial institutions and linking aid to measures of the rule of law and trade policy liberalisation. A similar trend is evident in Australia’s foreign aid programs. There has been a stronger emphasis on linking aid to improvements in governance, particularly in the South Pacific, where foreign aid largely underwrites poor governance practices. There is a growing realisation that foreign aid suffers from many of the same problems as domestic welfare programs. It is also interesting that among the opposition Australian Labor Party’s policy initiatives is withdrawal from the European Bank for Reconstruction and Development, perhaps the most notorious of the multilateral development banks. There is a fairly transparent political motivation to this that Australian readers will understand, but it is still good policy. One of the few advantages flowing from the politically inviolate status of the Australian federal budget surplus is that it is forcing the ALP to think more carefully about spending priorities while still in opposition.

Lynne Kiesling also reports on a recent talk by Hernando de Soto.

posted on 24/2/2004

Japan’s Recovery. This blog has often been critical of The Economist’s coverage of Japanese monetary policy. Its latest leader on the subject argues that ‘the best case for optimism that this time the recovery will last is that the Bank of Japan’s monetary policy has now become steadily and credibly expansionary.’ This is nonsense. The Economist confuses a change in style, associated with the change in the Governorship of the BoJ a year ago, with a change in substance. The Economist credits Governor Fukui with having ‘printed a lot more money,’ failing to sterilise the proceeds from foreign exchange market intervention and with rhetoric more strongly geared to promoting positive inflation expectations. In fact, all of these initiatives were well established features of monetary policy under former Governor Hayami, whom The Economist calls ‘quite possibly the world’s worst central banker.’

It is certainly true that Governor Fukui has made greater use of some of these policy tools, but almost no one apart from The Economist believes that these amount to a substantive change in policy. As even orthodox monetarists like Robert Hetzel and base money growth-rule advocates like Bennett McCallum would argue, there is no reason to expect increased monetary expansion to translate into stronger growth in nominal income or broader money and credit aggregates given the current monetary policy framework and zero interest rate environment in Japan. The BoJ’s switch to a quantitative approach to monetary policy in March 2001 under Governor Hayami was undertaken precisely so that the BoJ could appear to be taking policy action, knowing full well that these measures did not amount to much in substance.

The fact that Japan is now enjoying another cyclical upswing, with no substantive change in monetary policy since March 2001, is itself a strong argument against the view that monetary policy has been a decisive factor in holding back Japan. Japan has likely seen a permanent reduction in its trend growth rate associated with real factors. Monetary policy is largely irrelevant to this process. Most of the domestic pressure on the BoJ to adopt a more aggressive approach to monetary easing over the years has come from old-line LDP politicians and bureaucrats, the so-called ‘techno-rivalists,’ who see macroeconomic stimulus as a way of avoiding the demands of structural reform. They have a firm friend in The Economist.

posted on 20/2/2004

Nicholas Eberstadt reviews demographic trends in Asia, part of a wider project in which he looks at the implications of ‘unfolding demographic forces on the balance of international power.’ The data reviewed by Eberstadt is certainly interesting, but I am note sure that it really tells us very much about the future balance of international power. Indeed, Eberstadt is very careful not to read too much into the data he examines or to speculate about its broader implications. This is just as well, because from an economic point of view, it is not clear that demographic trends by themselves tell us very much. A great deal depends on how these trends translate into labour force utilisation and on labour productivity. The exogenous growth literature is full of ‘growth miracles’ and ‘growth disasters’ that are really only explicable in terms of institutional differences between countries. Eberstadt suggests that demography in general, and immigration in particular, has been important to US strategic pre-eminence. I suspect that this is really just a sub-set of its general openness and its adoption of political institutions conducive to that openness. The good news is that prospective demographic trends ‘contribute to the calculus of US strategic pre-eminence.’

US pre-eminence is largely a function of the classical liberal ideas that are the foundation of its institutions. People are attracted to institutional arrangements that work, while competing institutional forms have proven notoriously lethal to their often captive populations. There is a selection bias at work here.

Eberstadt is overly sanguine on Japan, pointing to what is probably a best case scenario:

Today’s writing on the negative effects of population aging in Japan focuses (sometimes to near exclusion of all other factors) on public finances and quite rightly points out the actuarially unviable state of the country’s national pension system and the looming liabilities for its public health care sector. There is no concrete commandment, though, that a country must leave parlous budgetary imbalances uncorrected. Painful though such exertions would surely be, it is entirely within the purview of the Japanese policymakers and voters to set the country’s pension and health systems on a financially secure course. (Sure enough, OECD calculations suggest that a number of relatively obvious changes could significantly improve the financial health of the national Japanese pension system.)

Eberstadt essentially glosses over the political economy of reform in Japan. Buried in the IMF’s work on public sector debt stabilisation in Japan are convenient analytical devices, such as an increase in consumption taxes to 25%. My own modeling of the Japanese economy suggests that the short-run output cost of the 1997 consumption and income tax increase was similar to that of the Great Hanshin Earthquake. Fiscal consolidation is much easier said than done.

posted on 19/2/2004

The Centre for Independent Studies is running its Liberty & Society Seminars again this year. Having attended both the IHS version in the US and the CIS version in Australia, I can say that both are a rewarding experience for students. Here is what the CIS has to say about the seminars:

Liberty and Society is for young people who may be questioning the standard answers they are getting regarding social, political and economic issues. You may not see yourself as a fitting into the 'left' or 'right' mould. This is an opportunity to consider the classical liberal perspective. Classical liberalism promotes individual freedom, private property, limited government and free trade. Join us for an intellectual experience that may change the way you think about the world.

posted on 19/2/2004

RBA Deputy Governor Glenn Stevens invokes Wicksell’s idea of the natural rate of interest in explaining the RBA’s approach to inflation targeting. There has been renewed interest in the idea of a natural rate and its role in monetary policy in recent years. This reflects the fact that monetary policy rules frequently assume or imply some neutral interest rate, usually taken to be some long-term average or fitted constant. The implications of these assumptions about a neutral rate are receiving increased attention, leading to a re-examination of Wicksell, among others. Michael Woodford has produced a new work in monetary theory that is being widely hailed as the successor to Don Patinkin’s classic work and which sets out what he calls a neo-Wicksellian approach to monetary theory. For those interested in Swedish and Austrian School approaches to monetary theory, I would highly recommend Steven Horwitz’s Microfoundations and Macroeconomics: An Austrian Perspective.

posted on 18/2/2004

Peter Ruehl subjects a certain issue to the soccer mum scratch test:

It's also interesting to hear what does or doesn't come up when you're not around politicians, other journalists or booze.
And the one thing that didn't come up the other day was John Howard's backflip on politicians' pensions.

I heard about Sydney's trains, which, in the interests of efficiency, are now about to switch over to a mule-drawn system.

And I heard about housing prices, interest rates, school discipline and the weather. The general gist was that something was wrong about everything.

Then I got home, opened up the usual collection of Saturday papers and got hit by this barfstorm of how Mark Latham had transformed the political landscape, with at least one suggestion that Howard couldn't possibly win the next election.

Look, I'm all in favour of Latham making a contest out of this, and at this point it doesn't jerk my chain whether he becomes prime minister or not, but this seemed like the biggest rush to judgment since eight-track cassettes.

I think this goes to the broader point that what is seen as important by the parliamentary press gallery is often of almost no importance to anyone else. It is interesting how first hand experience is often wildly at odds with media-constructed conventional wisdom. It is easy to dismiss such experience as anecdotal. Yet few journalists rise above the anecdotal themselves and often draw on a very narrow range of direct experience. The disintermediating role of the blogosphere in relation to traditional media has a lot to do with its ability to access this distributed knowledge and experience.

posted on 17/2/2004

Fiscal fine-tuning is making an intellectual come back in the UK in response to the demands of euro convergence, according to Samuel Brittan. Brittan argues that this is an argument against euro membership. Although I share his opposition to UK euro membership, I am less troubled by the suggestion that fiscal policy should be required to adhere to a counter-cyclical policy rule. Such a rule implies a reduction in the discretion of the fiscal authority and is thus somewhat different from the activist fiscal policies of the past that Brittan rightly argues we should avoid. I suspect Sam would argue that the operation of any such rule would suffer from severe Hayekian ‘knowledge problems,’ such as the difficulty of estimating latent variables like the output gap, making the application of the rule inherently discretionary. These problems would, of course, argue against almost any discretionary counter-cyclical response from macro economic policy. But a fiscal policy rule might still be useful in making macroeconomic policy more predictable and less destabilising, a very different proposition from the discredited fiscal policy activism of previous decades.

It is encouraging that the Australian Labor Party’s long period in opposition at a federal level has promoted a renewed interest in fiscal policy rules and central bank reform. My expectation is that if there is a change of government in Australia later this year, we are likely to see a substantial overhaul of the institutional framework for macroeconomic policy in Australia. That would be a change for the better.

posted on 16/2/2004

Daniel Gross has a reasonable layman’s discussion of the limits to US exchange rate policy in Slate. Gross is rather too generous to former Treasury Secretary Rubin, recycling the conventional wisdom that his Wall Street background made him a more skilled Treasury Secretary. Unfortunately, it also made the Treasury an easy target for regulatory capture by Wall Street, particularly institutional bond holders. The Bush Administration’s practice of appointing old-line industrialists to the position has been positive in this regard, although we have seen fewer serious financial crises that would really test whether the Administration would hold the line on these issues better than its predecessor. Interestingly enough, those who predicted that O’Neill would take a mercantilist approach to exchange rate policy because of his industrial background were dead wrong. Both O’Neill and Snow have favoured a non-interventionist policy stance.

See this article for an excellent discussion of the ‘myth of a strong dollar policy.’

posted on 14/2/2004

World Bank President Jim Wolfensohn is beginning to compete with George Soros in terms of loopiness. Wolfensohn has been visiting his native Australia, where he has been making much of the fact that world spending on defence greatly exceeds that on ‘development.’ It is easy to raise a cheer on this score, but it is a view that assumes that all spending on ‘development’ comes from the official sector. The main driver of economic growth in the developing world is private capital markets and not official development assistance. Indeed, as the late Lord Bauer argued so persuasively, much official sector development assistance hinders rather than assists growth. The World Bank’s lending is notoriously ineffective, even by its own standards. This is characteristic of the lending of other official sector international financial institutions. See Graham Hancock’s The Lords of Poverty: The Power, Prestige, and Corruption of the International Aid Business for a what remains a very relevant critique of the IFIs.

Few of the world’s developed democracies spend money on defence cheerfully. But even if we could downscale military spending, reallocating those funds to official development assistance would be a bad idea. This is something best left to private capital markets. Wolfensohn’s simplistic homilies are not doing anyone any favours.

posted on 13/2/2004

William Shawcross is not an author I would normally identify with, but this review of his book on the Iraq war suggests that he shares my own perspective:

The issue of weapons of mass destruction was not, as he explains, a simple one of whether they existed or whether they were primed for immediate attack on western countries. The real issue was whether it would have been right to take the risk that Saddam had them, might use them, or might resume development of them as soon as the coast was clear. All the evidence collected by UN weapons inspectors in 1991-98, when they were allowed in Iraq, pointed to the conclusion that Saddam could not be trusted. The inspectors themselves believed at that time that large caches of weapons materials remained to be found.

Meanwhile the containment operation, a combination of no-fly-zones, bombings and UN sanctions, was producing misery and grievances without making Saddam feel any more trustworthy. He and his regime remained a source of strategic instability in the whole Middle East, a mortal danger to his own people and a plausible sponsor of terrorism. There were no good options available, but leaving things as they were looked the worst of all.

Along with Christopher Hitchens, Shawcross is one of the few members of what I would call the realist left. After the Krugman cover episode, I was not entirely surprised that the jacket cover of Hitchens’ short book on the war gives almost no hint that he actually supported it. Evidently, the publishers thought this might be bad for sales, yet I would have thought that his distinctive point of view was the main selling point.

At the same time, The Economist reviews George Soros’ latest book in two words: ‘get real.’

posted on 12/2/2004

Some of my former colleagues have a new web site, G7Forex, devoted to technical analysis of foreign exchange markets. Having worked alongside the principals, I can vouch for their skills as market technicians and I was often impressed with their insights. If you have an interest in foreign exchange markets, I recommend you take a look at their site.

You might wonder why an advocate of the efficient market hypothesis would endorse a site devoted to technical analysis. Technical analysis is frequently misunderstood. In at least one important respect, it makes the same assumption as the EMH: price discounts everything. Technical analysis differs, however, in arguing that prices nonetheless contain exploitable information about the balance of supply and demand. There have been quite a few studies showing that simple technical trading rules can generate excess returns over a buy and hold strategy. Usually, these studies are taken to be indicative of some unknown informational inefficiency. This is not unique to technical analysis. Some fundamental indicators have also been shown to generate excess returns (the Australian dollar TWI against the terms of trade, for example).

Foreign exchange markets get a particularly bad press for their supposed failure to adhere to fundamentals. The fact that these markets are notoriously difficult to model and forecast econometrically probably reflects the fact that market participants draw on a much larger information set than is available to the econometrician. Moreover, there are some well established economic models that explain phenomena such as exchange rate ‘overshooting.’ Those who dismiss foreign exchange markets as being irrational usually do so because the market has failed to conform with their own prejudices about fundamentals. As behavioural finance research suggests, people are typically very reluctant to accept they have been wrong. The idea that everyone else is irrational is subjectively much more appealing.

Another of my former colleagues has a book out on Currency Strategy.

posted on 11/2/2004

A US perspective on the exclusion of sugar from the Australia-US FTA, from the Cato Institute.

posted on 11/2/2004

Ross Garnaut decries the Australia-US FTA in predictable and unconvincing terms. Garnaut argues correctly that:

The majority of the gains in the study for DFAT come from Australia's own reduction of barriers to American exports. We could have these gains, and much more, without the costs [?] of an FTA, by liberalising imports from all countries, in a continuation of the unilateral liberalisation that was a feature of Australian trade policy from the mid-1980s to 2000.

But this is not an argument against the FTA. Unfortunately, as Garnaut should appreciate, unilateral trade liberalisation is not going anywhere. Domestic protectionist interests have brought this process to a near halt in Australia as well as in the US. By negotiating an FTA, both Australia and the US gain leverage over these domestic interests. Governments have resorted to bilateral agreements precisely because unilateral and multilateral trade liberalisation processes have stalled. It is a way of making progress that would not otherwise be possible.

Alan Mitchell, who at least appreciates the classical case for free trade, is running the shop-worn line that ‘by embracing a discriminatory trade deal with the US, we seemed to vindicate those Asian politicians who have worked for our exclusion.’ Given Australia’s recent successes in concluding FTAs within the region, this argument is looking increasingly shaky. By all accounts, China’s interest in pursuing a FTA with Australia is a direct outcome of the US-Australia negotiations.

posted on 10/2/2004

The Australia-US Free Trade Agreement looks like a done deal. Unfortunately, analysis of the agreement will be conducted in the usual zero-sum framework, with critics bemoaning Australia’s failure to gain better access to US markets for certain agricultural products. John Quiggin calls the agreement ‘unbalanced,’ an ‘election-loser’ and cites a ‘list of wins’ that fails to mention improved US access to Australian markets, which is how Australia really stands to benefit from the agreement. Even if the agreement had been completely ‘one-sided,’ with Australia making all the concessions, we would still be better-off.

UPDATE: Peter Gallagher and Sarah Strasser have preliminary takes on the detail of the agreement.

My own concerns relate to the failure to more fully liberalise cross-border direct investment in Australia and the preservation of local content rules for media. It is good to see Australia's arts community can compete with US farmers in terms of self-interested parochialism!

posted on 9/2/2004

‘International political economy’ is a sub-discipline of international relations, in which I took some interest as an undergraduate, since I was completing an honours degree in political science, as well as majoring in economics. At the time, I was struck by how ignorant many of the scholars in the IPE field were of economics. For the most part, they were only interested in superficial caricatures of economic ideas. Reading Dick Bryan’s review of Robert Gilpin’s Global Political Economy in the most recent Economic Record, I see that little has changed. Gilpin is a leading scholar in IPE, yet as Bryan notes, he ‘too often finishes up ignoring the subtle issues that cause deep debates within disciplines…Readers may well see theories whose detail and precision they value rather trivialised and caricatured in this treatment…I find this book frustrating for the way it breezes through issues I believe need far more subtle interpretation.’ This is a great shame, because economics has the potential to greatly augment the IR discipline, which is notoriously reliant on ad hoc theorising.

This is probably an opportune time to mention Aurelia George Mulgan’s Japan’s Failed Revolution. Mulgan is a political scientist who draws on the work of economists writing about economic crises to explain contemporary Japan. Although she does not say as much, I read her book as an implicit admission that the political science discipline could not explain contemporary Japan. Indeed, I have noticed a number of Japan scholars fighting fierce rearguard actions against the encroachment of rational choice theory on their discipline.

posted on 6/2/2004

Media reporting of foreign exchange market intervention by the Bank of Japan is often inaccurate, according to an article comparing media reports to actual intervention data for the period 1995 to 1999 (Frenkel et al (2004) Journal of International Financial Markets, Institutions and Money, 14:25-36). The authors find that the probability of an intervention report being accurate is only 60%. The probability of an intervention report appearing in the press given that intervention actually occurred is only 45%. The majority of the interventions conducted by the BoJ were not reported in the press, while the press frequently report intervention that never takes place. I think this partly reflects on the nature of financial market journalism. Journalists are required to report on markets on a daily basis, regardless of whether there is an interesting story to tell. They are also called upon to account for market moves for which there may be no obvious explanation. Reporting market intervention rumours is an obvious way to fill the page and explain market moves that cannot be rationalised otherwise.

posted on 5/2/2004

The Alice Springs to Darwin railway has seen its first passenger journey, to much fanfare and overblown rhetoric. This was a project conceived in the 19th century and the 19th century is probably where it should have remained. As Australia’s leading transport entrepreneur, Chris Corrigan, has so delicately put it, the returns on the project (heavily subsidised by state and Federal governments) are probably ‘smaller than a flea’s testicles.’ Perhaps the most disturbing aspect of the project is its demonstration of the extent to which politicians and the public remain wedded to 19th century technology and thinking. Trains are all very romantic, but the romance comes from the fact that these are essentially relics of the early industrial age. What would have been an impressive achievement in the late 19th century is far from being remarkable in the 21st. The rhetoric of ‘nation-building’ that frequently accompanies such projects would probably not wash in any other developed country and even in Australia is often just a cynical cloak for a boondoggle. Australia’s public imagination needs an overhaul.

posted on 4/2/2004

Richard Clarida argues against further rhetorical innovation in relation to exchange rates on the part of the G7 at its upcoming meeting in Boca. As Clarida notes, official rhetoric on foreign exchange rates is often destabilising in itself and he argues for the G7 to stick to the formulation in the Dubai communiqué for the sake of stability. G3 macro policy coordination and joint foreign exchange market intervention has a sorry history. Perhaps the best thing the G7 could do for the sake of global macro stability would be to forswear future attempts at macro policy coordination and joint foreign exchange market intervention. A joint commitment to a non-interventionist policy stance from the G7 would remove an important source of uncertainty from financial markets and help insulate monetary and exchange rate policy from political pressures associated with current account imbalances.

posted on 3/2/2004

Samuel Brittan makes the case for benign neglect of the US dollar and points to research from Smithers and Co suggesting that the US current account deficit should arguably be wider:

According to conventional wisdom the weakness of the dollar reflects an excessive US current account deficit of 5½ per cent of GDP. This conventional wisdom reflects an outdated preoccupation with the current account which ignores offsetting capital movements.

The financial firm, Smithers, suggests however that the deficit is too low rather than too high because of the greater likely return on capital in the US than Europe or Japan. On modest assumptions about differential economic growth, it argues, the proportion of US assets owned by foreigners would only be 15 per cent five years from now and never rise above one third, even if such a deficit had to be financed indefinitely.

The 'consenting adults' view of current account deficits is now widely accepted by policymakers in Australia and has been associated with a significant improvement in macro policy outcomes compared to previous decades, when the current account balance was a preoccupation of policy. As Brittan argues, when the current account and exchange rates become a focus for policy, the consequences are usually far more destabilising than anything that would be produced by market-determined exchange rates:

Nothing will prevent jerky readjustments in the real world; but inevitable fluctuations are made a great deal worse by the efforts of governments to orchestrate the pace of change.

posted on 30/1/2004

What I am reading. Alex Kerr's Dogs and Demons: The Fall of Modern Japan in many ways picks up where Karel van Wolferen's The Enigma of Japanese Power left off and Kerr acknowledges his debt to van Wolferen, who was notable for highlighting the dysfunctional nature of the Japanese state at the height of the late 1980s boom. What makes Kerr's book distinctive is his particular concern with the state-sponsored vandalism of Japan's natural environment and its architectural and cultural heritage. Kerr is not an economist but clearly recognises the role of institutionalised rent-seeking and peverse economic incentives in the ruin of modern Japan. There is a particularly pleasing chapter on Japan's disastrous neglect of service industries such as tourism in favour of manufacturing. State-mandated privileging of manufacturing over service industries is hardly unique to Japan. These ideas remain a hardy perennial outside Japan and have been a solid staple of management and business education, not least in Australia. Yet in Japan we can see many of these ideas taken to their logical and disastrous extremes. Those who advocate high levels of state-sponsored national saving, government support for preferred technologies and manufacturing industries and heavy public investment in infrastructure often accuse their critics of being overly wedded to neo-classical theory, yet it is the practice that is more damning than the theory. Kerr's focus on the implications of these policies for the grim realities of everyday Japanese life is what makes this book so compelling.

Kerr is sometimes overly quick to make unfavourable comparisons with the rest of East Asia, even though the whole region shares many of the problems he identifies in Japan. For example, he argues that 'the drive from Changi airport into downtown Sinagpore is one of the pleasures of the modern world.' High praise indeed for what in reality is a thinly disguised runway built to military specifications!

posted on 26/1/2004

Institutional Economics Turns One. Institutional Economics was launched a year ago today, coinciding with my departure from financial markets to return to academia. It has been a rewarding experience, with the site collecting a number of gongs and traffic peaking at over 9,000 page views per week. This is modest compared to many other blogs, but still exceeded my expectations given the somewhat specialised nature of the content.

Most of my readers come from outside Australia, despite the inevitable Australian focus in my blogging. The globalisation of intellectual life via the internet in general, and blogs in particular, is something I find extremely interesting and it has been great playing a modest role in that process. My not so modest role in blowing the whistle on Paul Krugman’s UK publishers over their use of the imagery of the anti-globalisation left to market his latest book is a good example. Bloggers have a potentially important role in promoting accountability across a wide range of institutions and I would encourage people with specialised knowledge in any field to make a contribution in this way.

The rewards from blogging are largely non-pecuniary, but it is also pleasing to note that many of you have put aside the obvious free-rider issues and made donations to this site, either directly or through the associate links (a way of donating that costs you nothing). A big ‘thank you’ to those who contributed. I am still thinking of ways to provide exclusive benefits to donors. One option is a donor-only newsletter along the lines of Andrew Sullivan’s Inside Dish, but I need more expressions of interest to make this a worthwhile venture. If this is something that would interest you, and you have not previously expressed your interest, hit the tip jar.

I will be taking a break over the next couple of weeks, during which blogging will be light at best. But you can find plenty of reading at some of my favourite blogs: Marginal Revolution, Dan Drezner, Knowledge Problem and Catallaxy Files.

posted on 17/1/2004

Japanese exports to mainland China, Hong Kong and Taiwan in 2003 are estimated to have exceeded those to the U.S. for the first time:

According to Ministry of Finance trade figures, the balance of exports to China, Hong Kong and Taiwan for the first 11 months of 2003 totaled 12.34 trillion yen, up 19.5% over the same period the previous year, while exports to the U.S. were 12.29 trillion yen. Goods shipped to those three regions outpaced exports to the U.S. for the first time in March, and they have collectively held the top position in the export market for the six months since June.

posted on 17/1/2004

The threshold for Foreign Investment Review Board scrutiny may be raised as part of the Australia-US FTA currently being negotiated. This is not exactly news, but the Minister has been addressing the issue in public comments:

Australia's 30-year-old foreign investment regime faces a major overhaul in last-minute negotiations over a US free-trade deal that are due to resume next week.

Australian companies have already backed a big increase in the threshold for foreign investment regulation, and Trade Minister Mark Vaile yesterday gave a strong indication that changes would be made.

"The Americans are looking for better access to Australia as an investment destination ... and I think that, to the situation we are in now as an economy, we want foreign investment in Australia," Mr Vaile said.

Under the foreign investment regulation regime adopted in the 1970s, the Australian government has the power to reject investments as not in the national interest above a threshold that now ranges between $10 million and $50 million, depending on the type of investment.

US negotiators want Australia to change the national interest veto to the narrower US-style approach that provides for a national security veto instead.

Corporate Australia has also backed changes to the rules, saying the current threshold - which limits the amount foreign companies can invest before they have to seek Treasury approval - should be raised as much as tenfold to $500 million.

Mr Vaile said: "We're having a look at all aspects of it, and it's an area where the critical element of FIRB scrutiny is being able to look after the national interest, both in terms of a broader security sense and an economic security sense."

But he indicated that even if the threshold was changed, Australia wanted to retain some right to look at investments it deemed harmful.

Australia runs the fifth most restrictive foreign investment regime in the OECD and cross-border direct investment is subject to arbitrary ministerial veto on nebulous ‘national interest’ grounds, often at the behest of sectional interests. It remains to be seen whether the FTA can produce a more rule-bound regime for foreign direct investment in Australia. The US is the largest foreign investor in Australia, but less well known is the fact that Australia is one of the largest investors in the US (Australia has become a net exporter of direct investment capital in recent years). There would be justifiable outrage if Australia’s investment abroad were subject to the sort of arbitrary regulatory framework Australia currently imposes on prospective foreign investors.

posted on 16/1/2004

Free Trade Watch. Ryan Lizza’s new campaign blog notes that free trade has become a dirty word among Democrats. At the same time, Australia’s Federal opposition leader, Mark Latham, is backing away from his earlier support for free trade. Yet Andrew Norton notes a suprising amount of popular support for an Australia-US Free Trade Agreement.

posted on 15/1/2004

Marginal Revolution links to this survey of the labour market for new PhD hires in economics. The good news (for me at least) is that macro/monetary economists are in demand.

posted on 13/1/2004

Henry Ergas of NECG argues that the biggest threat to the Australian Competition and Consumer Commission’s informal merger review process is the ACCC’s failure to adhere to its own guidelines:

However, for an informal process to work the ACCC needs to stick to its side of the bargain. In the AGL case it didn't.

No one needs to tell the ACCC how to make the informal process work - given the commission's years of experience, it well knows how. Indeed, the commission's merger guidelines are exemplary in setting out an analytical framework and methodology for the assessment of proposed mergers.

Of course, there is room for improvements, for example, in terms of disclosing more fully the reasons for decisions. But those improvements could be made without undermining the basic features of the merger control mechanism as it has operated to date.

Whether this occurs is now up to the ACCC. Blaming the victim will do little good. Rather, if the new team at the ACCC wants to preserve the informal process, it needs to renew its commitment to a process that, though informal, is predictable and timely, and implemented in a manner strictly consistent with the commission's own merger guidelines. If it fails to do so, then it can hardly be surprised if ever-stronger pressures develop for a more formal alternative.

Unfortunately, the main reason the ACCC prefers an informal process is precisely so that it can bend the rules. The ACCC’s opposition to a more formal process is about preserving its bureaucratic discretion.

posted on 12/1/2004

That Krugman cover again. The ever-expanding genre of anti-Bush diatribes is the subject of a review in The Economist:

Yet Bush hatred arguably now exceeds even Clinton hatred in its scope. It has become a genre with endless sub-genres…More important, Bush hatred is multinational. Clintophobia largely stopped at America's borders. But Bush loathing has picked up a strong anti-American tailwind, one that the loathers are not unafraid to exploit. The cover for the American edition of Paul Krugman's collection of anti-Bush essays, “The Great Unravelling”, is fairly restrained; the British cover is a grotesque lobotomised image of the president and vice-president which would horrify readers of Mr Krugman's column in the New York Times.

As a commercial phenomenon, Bush hatred is rather interesting. But sooner or later, you have to look at the content—and this is depressing, particularly if you read more than one book. Most of the anti-Bush books are fairly lazy affairs, endlessly repeating the same old stories.

Although Krugman's latest is not actually a subject of the review, it is interesting that the book's cover has landed him a mention in a review of Michael Moore, Al Franken et al. The reviewer also notes with some sadness that he is compelled to include Kevin Phillips in this genre. Good people fallen in bad company care of Bush Derangement Syndrome.

posted on 11/1/2004

The Australian Financial Review  headlines ‘IMF lashes Bush over soaring budget deficit.’ Here is Charles Collyns, Deputy Director of the IMF's Western Hemisphere Department, introducing the report:

Summing up, the recent expansionary stance of the U.S. fiscal policy has certainly been beneficial, supporting the global economy at a difficult juncture. However, it will be important to develop a credible and robust framework to assure that the U.S. fiscal position is a strong one over the long run. This will require determined action to reduce the federal deficit over the next 5 to 10 years and to tackle the difficult long-term problems of Social Security and Medicare.

Always pays to read beyond the headline spin.

posted on 9/1/2004

Jagdish Bhagwati’s credentials as a free trader have long been compromised by his hostility to the free movement of capital. He is not alone in this. Many of the most passionate advocates of free trade in goods and services adopt a completely contrary stance when it comes to capital and labour. This is especially unfortunate in the case of Bhagwati, because he is still one of the most prominent advocates of globalization, most notably with his recent book, In Defence of Globalisation. Richard Cooper’s review highlights some of the weaknesses in Bhagwati’s arguments on these issues:

Bhagwati is less keen on the free movement of capital across national borders. He attributes the financial meltdowns of the 1990s to a "Wall Street-Treasury Complex" that pressured developing countries to liberalise capital flows. His discussion of financial crises, however, is uncharacteristically sloppy and naive. Although Washington did fight for capital liberalisation (and misguidedly continues to do so in bilateral trade negotiations), other countries can resist if it goes against their interests (as both Singapore and Chile did successfully). There was also tremendous variation among the countries that suffered crises, which Bhagwati's simplistic account overlooks. Indonesia had accepted the free movement of capital more than 20 years prior to its financial meltdown. Thailand and South Korea accepted only limited capital liberalisation in the early 1990s and carried it out in ways that clearly invited trouble. Brazil and Russia maintained some capital controls throughout (although not on foreign purchases of government securities), but such measures offered little protection. And Malaysia's much-touted restrictions on foreign capital flight were not introduced until a year after the crisis broke and thus do not explain that country's shallower recession, as critics of capital liberalisation often claim.

A look at history reveals that financial crises are not unique to the 1990s. In the 19th century, long before the US Treasury and the International Monetary Fund became influential on the international stage, rapidly growing countries - the UK, France, and the US, the developing nations of the day - experienced financial crises at least once a decade. Successful industrialists and financiers, caught up in the euphoria of growth and unimpeded by regulation, drove a dramatic boom-and-bust cycle. That pattern has repeated again and again and seems to be an inherent part of development. If there is any lesson here, it is that governments should learn more from the unpleasant experiences of other countries in other times.

Spouting facile criticism of globalisation is easy, especially when unconstrained by fact, and so is refuting it. Bhagwati's defence of globalisation is persuasive. He is less successful, however, in his attempt to offer feasible policy alternatives that are likely to improve on existing arrangements. He suggests that the World Bank finance adjustment assistance with respect to trade liberalisation in developing countries, showing no awareness that the World Bank must borrow most of its funds in capital markets at market interest rates (and hence must be repaid by its borrowers) or that adjustment assistance has worked poorly in the US. He suggests a retroactive tax on carbon dioxide emissions over the past century, the proceeds of which would go to help developing countries reduce their own greenhouse gas emissions. He recommends that multinational corporations operating in developing countries follow the same labour and environmental standards as they do at home, without acknowledging that such advice may contradict local law and could discourage some multinationals from expanding to developing countries, thus denying them the many benefits, well expounded by Bhagwati, that foreign companies can bring.

posted on 9/1/2004

A Tale of Two Current Account Deficits. This blog has been dismissive of much of the alarmist writing about the US current account deficit and the USD over the last year. My attitude to this is heavily conditioned by the fact that I live in a country where large cyclical swings in the current account balance and currency are the norm and which, not coincidentally, has had one of the strongest growth rates in the OECD in the 1990s. Tony Makin, one of my favourite economists, also compares the US and Australia in an op-ed:

So why is the local dollar so strong when Australia's current account deficit is actually bigger than that of the US?

In fact, Australia has a current account deficit of 5.8 per cent of its gross domestic product, significantly above the US deficit and still one of the largest in the world. Canberra, we have a conundrum.

What deepens the mystery is the fact that Australia's foreign debt, the consequence of past external deficits, is also much higher than that of the US as a proportion of GDP.

Not only that, but a large part of Australia's foreign debt is in foreign currency, whereas US foreign debt is in its own currency. This means US borrowers bear next to no foreign exchange risk on foreign loans, unlike many of their Australian counterparts.

Australia's current account deficit is of course the same one that was a prime focus of macroeconomic policy attention over most of the 20 years since the float of the Australian dollar. Indeed, at times, it was the only focus.

In the past, external deficits of the present size were used to justify many policy sins, most notably the major monetary policy-induced recession we supposedly had to have in the early 1990s.

This recession was essentially caused by a misunderstanding of what the current account deficit signified.

Makin blames the US budget deficit for USD weakness and suggests the following policy prescription for Australia:

Meanwhile, to alleviate the present squeeze on the tradeable goods sector of the Australian economy, the federal Government could well follow the US fiscal example. Cut income taxes, run a budget deficit and watch our dollar fall.

Of course, the politics of fiscal policy in Australia would rule out any such policy. But it is welcome to see someone thinking about fiscal policy outside the narrow confines of the budget surplus.

posted on 7/1/2004

Alan Greenspan reassuringly rejects the idea that central banks should target asset price inflation:

It is far from obvious that bubbles, even if identified early, can be preempted at lower cost than a substantial economic contraction and possible financial destabilization--the very outcomes we would be seeking to avoid...The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble while preserving economic stability is almost surely an illusion.

However, Greenspan continues to defend what he calls the ‘risk management’ approach to monetary policy, a euphemism for the almost unbounded discretion of the Fed. But as Greenspan himself notes:

rules that relate the setting of the federal funds rate to the deviations of output and inflation from their respective targets, in some configurations, do seem to capture the broad contours of what we did over the past decade and a half.

Since such rules usually incorporate an assumed inflation target, it would make sense for the Fed to formalise this implicit target in its policymaking. At the same time, FRB Governor Bernanke has been talking on the subject of ‘Fedspeak.’ The Fed’s communication with the public was widely criticised last year. One of the advantages of adopting a more rule-bound approach to the conduct of monetary policy would be to greatly simplify the Fed’s communication with the public. Under a regime of unbounded discretion, the public can be forgiven for over or misinterpreting the statements of Fed officials, since these statements are the only real guide to the Fed’s intentions apart from the actual policy decisions themselves.

posted on 5/1/2004

Richard Rahn joins the ranks of US dollar alarmists:

A continued drop in the dollar's value could destabilize the international economy, leading to a worldwide recession.

Rahn’s column evinces little faith in market-determined exchange rates. His claim that the US is discouraging foreign investors may well be true, but we do not need to speculate about the exchange rate implications of this to make an argument for freeing up foreign investment. Rahn argues that the US should reaffirm ‘belief in a strong dollar.’ But if this is not to be an empty rhetorical position, then Rahn is effectively arguing for either foreign exchange market intervention or some combination of monetary tightening and fiscal easing designed to support the dollar. These discretionary macro policy interventions have the potential to be far more destabilising than movements in market-determined exchange rates.

There has always been some tension in classical liberal circles between those who argue for market-determined foreign exchange rates and those who still view foreign exchange rates through the prism of various hard-money doctrines. Rahn claims that ‘to grow, the world economy needs reasonable currency stability.’ But it is remarkable how resilient the real economy is to exchange rate volatility. Flexible exchange rates have a valuable role to play in clearing world markets for goods, services and capital and insulating economies against external shocks. This is true not just for small open economies likely Australia, but also large, relatively closed economies such as the US.

posted on 3/1/2004

Carlton vs Glebe. Andrew Norton has a new take on Sydney-Melbourne rivalry, suggesting a book sales methodology for determining which city is the ‘chattering class’ capital of Australia. On this methodology, Sydney is a clear winner. Andrew is perplexed by the differences in the bestseller lists between the two cities. These results could be influenced by the display practices of the bookstores in question. But the results are sill surprising, given that Sydney’s intellectual and cultural life is rather impoverished relative to Melbourne. Yet perhaps this explains the difference. If there is anything to the stereotype of the superficial Sydneysider, perhaps we should expect this to be reflected in their reading habits. Sydneysiders are simply more prone to becoming intellectual fashion victims. The ‘chattering class’ books in question might play a stronger role as positional goods in Sydney than they do in Melbourne.

posted on 31/12/2003

Institutional Economics collects another gong, featuring in the ‘Best of Australia’ year-end issue of The Reader (like Arts & Letters Daily, except that it is weekly, in hard-copy and not free). Here is how they describe themselves:

We find the most interesting media content from everywhere and send it to our subscribers (and sometimes offer our views about the issues we cover). As well, we try to explain why the existing media acts the way it does. The bias of the Canberra media pack, the various proprietors, how PR infects media coverage: these are the kinds of subjects we hope will give readers some corrective lenses for the spin in the media.

The Reader seems to be part of a trend toward independent media filters that define themselves in opposition to mainstream media.

posted on 30/12/2003

Australian Competition and Consumer Commission chairman Graeme Samuel is continuing his campaign of opposition to the Dawson review recommendations in relation to a more formalised merger review process, according to the AFR. There is very little that is new in the story, except that the AFR has obtained some comment from Samuel confirming that he is talking to the Treasurer on this issue. Samuel continues to appeal to administrative convenience, but the ACCC’s main interest is protecting its bureaucratic discretion and lack of accountability in these matters (see the post from 13 November below). The ACCC has only recently undertaken to provide reasons for its merger decisions, which was probably an attempt to fend off the introduction of a more formalised review process.

posted on 30/12/2003

Universities' Lost Golden Age and Geezer Talk. The SMH op-ed page today features not one, but two, laments from essentially the same genre: one on the demise of the mythical golden age when students were free of financial pressures by conservative writer Paul Sheehan; the other on the supposed demise of the university bar by Dominic Knight. In Sheehan’s case, this is what Robert Fulford calls ‘geezer talk, the dreamy fantasies of the old and nearly old who want desperately to convince themselves that they once did everything better than young folks do it now.’ But Dominic Knight seems to be suffering from premature geezerism, harking all the way back to the 1990s: ‘students used to love Manning Bar [at Sydney University] back in 1990s.’ This is what Knight thinks today’s students are missing out on:

while the bar was a firetrap that stank of stale beer, and every step on the faded carpet squelched, the place undeniably had atmosphere.

Yep, that undeniably sums up the atmosphere. My recollections of the ANU Union Bar in the 1980s are much the same. It will take more than 20 years to turn the grim reality of that place into anything approaching nostalgia. Knight goes on to make the telling observation that the privately-run Clare Hotel opposite the University of Technology, Sydney ‘has become wildly popular with its students.’ Maybe it’s the atmosphere.

posted on 29/12/2003

Ross Gittins accuses the Productivity Commission of producing a report that is ‘intellectually dishonest and cowardly’ because of its failure to conform to his own prejudices on the role of capital gains tax relief in promoting house price inflation. Some of Gittins’ observations on the politics behind the report are fair enough. In particular, he correctly identifies the reasons for the RBA fingering negative gearing in its submission on the issue: to deflect attention from monetary policy should the house price boom end badly. A certain amount of institutional shirking and bureaucratic arse-covering is to be expected in this context.

But Gittins’ view that capital gains tax relief and negative gearing are largely to blame for the recent house price boom in Australia will not hold water. House price inflation has been a widespread development throughout the industrialised world in recent years, suggesting a common price shock to this asset class that cannot be explained in country-specific terms. For all the inevitable politics behind the report, the Commission had the correct focus. Ross was down on capital gains tax relief well before the current house price inflation came along and is just as guilty of using the housing affordability issue to press his pet causes as the other players in the debate.

Gittins also quotes some economists from the investment banking/funds management community on this issue. It should go without saying that these are not exactly disinterested players in the debate, given that they are in the business of promoting investments in asset classes that compete with residential property among retail investors and that also happen to benefit from capital gains tax relief. Ross and friends are throwing stones in the glasshouse.

UPDATE: For those interested in the issue of capital gains tax, I would highly recommend this report by Alan Reynolds commissioned by the Australian Stock Exchange. It changed the way I think about some of these issues.

posted on 22/12/2003

Remember how an Australia-US Free Trade Agreement was meant to compromise Australia’s economic engagement with Asia? According to Rowan Callick, the Australia-US negotiations have been critical in China’s decision to pursue an FTA with Australia:

[China] has selected Australia as its first partner for major bilateral FTA talks. Why? Partly, Canberra believes, because of Australia's reputation for clean, high-quality FTAs - with New Zealand, Singapore and Thailand, and most importantly with the US, which strongly reinforced the seriousness with which Australia is taken by China as an economic player…Canberra views the start of talks in January as a defining moment in Australia's history, one that must be seized. (emphasis added)

posted on 22/12/2003

Samuel Brittan on the politics of the Nobel prize in economics.

posted on 20/12/2003

Some interesting poll results out of the UK, from The Economist’s ‘Bagehot:'

By a large majority, people think they are paying too much tax and there is little faith that increased spending is improving public services. In two polls, around 80% reckoned that a large part of the money was being wasted. A Populus poll for the Times and an ICM poll for Reform, a think-tank, found, respectively, that 59% and 76% thought the government's tax-and-spend policies were damaging the economy's competitiveness.

The government must hope that this is nothing more than a snapshot of opinion before the extra spending bears fruit. And it is true that, according to both ICM and a YouGov poll in the Daily Telegraph, almost half the respondents (50% and 44% respectively) still think that taxes should go up to fund better services. Unfortunately for the government, the long-run data offer no such comfort. Hostility to overtly redistributive policies has been growing precisely since the time when the spending gusher was opened. The figure of 44% compares with 68% at the time of the last election in 2001 and 74% when Labour was returned to power in 1997. It is the lowest number in favour of extra spending since 1979, when Margaret Thatcher took office.

The Social Attitudes survey underlines the trend. A study by two academics, John Curtice and Stephen Fisher, demonstrates that while Mrs Thatcher never succeeded in converting public opinion to her way of thinking, Tony Blair seems to have done the job for her. People who identify with the Labour Party are now much less likely to hold left-of-centre views than they were during Thatcherism's heyday (58% in 2001 compared with 84% in 1987). At the same time, there has been a general drift rightwards in terms of declining support for policies intended to help the poor, especially among the young and the hard-pressed lower middle classes.

I tend to discount polls like these, because the results are notoriously sensitive to the way in which the question or choices are framed. But what is interesting is that growing dissatisfaction with the provision of public services is translating into less support for higher taxes in the UK. The Australian data are arguably more mixed. But there are good reasons for thinking that ‘health and education’ are not ‘positives’ for the federal opposition in Australia, as is commonly assumed. If people come to associate new government spending initiatives in these areas with higher taxes and further reductions in consumer sovereignty (ie, limiting their ability to opt out of public provision through reductions in their after-tax income), then such promises could turn out to be political negatives. One would hope that the horror stories coming out of the public hospital system in the state of New South Wales are more likely to lead to people wanting to opt out of the public system altogether than to support increased public spending on health. But in NSW, few people are making the obvious point that these problems are inherent in the public provision of private goods.

posted on 19/12/2003

Mark Steyn on the horror of the Bike-Path Left:

David Brooks, visiting Burlington in 1997 in search of what eventually became his thesis Bobos in Paradise, concluded that the quintessential latté burg was "relatively apolitical." He's a smart guy but he was wrong. All the stuff he took as evidence of the lack of politics--pedestrianization, independent bookstores--is the politics. Because all the big ideas failed, culminating in 1989 in Eastern Europe with the comprehensive failure of the biggest idea of all, the left retreated to all the small ideas: in a phrase, bike paths. That's what Bill Clinton meant when he said the era of big government was over; instead, he'd be ushering in the era of lots and lots of itsy bits of small government that, when you tote 'em up, works out even more expensive than the era of big government. That's what Howard Dean represents--the passion of the Bike-Path Left.

posted on 19/12/2003

Surveys of consumer and business sentiment attract a lot of media attention and are sometimes credited with moving markets. As with labour market reports, this is partly because people feel more confident in their ability to interpret what these surveys mean for the economy. This in turn reflects the persistence of the Keynesian notion that sentiment or ‘animal spirits’ are important drivers of activity.

There is considerable evidence arguing that these surveys in fact contain little information that is not already available in contemporaneous and lagged activity data. In other words, it is activity that drives sentiment, not the other way around. Sentiment surveys may still be useful in providing more timely and cost effective information about current and future activity, since they are quick and relatively cheap to implement. But their usefulness is otherwise very limited. Here are abstracts for two papers by economists from the Richmond Fed and the RBA respectively on the subject of sentiment surveys:

Consumer sentiment may predict future household spending, either because sentiment is an independent causal force or because it foreshadows current economic conditions. The empirical evidence we present favors the second interpretation. The evidence in previous research that favors the first interpretation is not robust because the analysis failed to control for the possible influences of expected changes in income and interest rates on consumer spending. Consumer sentiment foreshadows current expectations about the economy as well as about interest rates, suggesting that it is useful as a barometer of the near-term outlook for spending.

***

Indices of business and consumer sentiment receive widespread media coverage and are closely watched by market economists despite their limited success as leading indicators. In this paper we ask what explains ‘sentiment’ and find that lagged economic indicators (such as changes in GDP, job vacancies and the cash rate) can explain a substantial proportion of the variation in a number of backward and forward-looking sentiment indices. This does not rule out the possibility that they may be useful for forecasting. We find, however, that when currently available economic information is appropriately ‘filtered’ from the sentiment indices, in most cases they fail even rudimentary Granger-causality tests of predictive ability. On a more positive note, we find that the Roy Morgan consumer confidence rating, NAB actual business conditions, NAB expected employment outlook over the next three months and the second question in the Roy Morgan and Westpac/MI consumer surveys all provide some, albeit small, contribution to forecasting employment growth. The second question of both consumer confidence surveys (which asks about anticipated personal financial conditions over the coming year) also appears to have some ability to predict recessions. Outside of these results there is little evidence that the surveys tell us anything we didn’t already know. Thus, there is reason to suspect that surveyed respondents’ forecasts offer little more information about the future path of the economy than a weighted average of lagged economic variables.

posted on 17/12/2003

Fresh from debunking the great deflation scare of 2003 Alan Reynolds turns his sights on inflation angst:

As with the deflation scare earlier this year, the inflation stories in the popular press don't hold up too well on close examination. The Wall Street Journal's version mainly relies on veiled theories about inflation. A table of statistics includes only the lowest measure of inflation, the core Consumer Price Index. And any figure about past inflation tells us little about the future. Inflation is always lower before it moves higher. Other numbers in the table would be informative only if some theory could link them to inflation.

One theory relies on a syllogism: "If the Federal Reserve shares that view [about a strong economy being inflationary], it will push up the federal funds rate, which... could slow or stop the recent economic rebound." The first premise is that strong economic growth boosts interest rates. The secondary premise is that higher interest rates weaken economic growth. Accept both premises, and your conclusion must be that strong economic growth causes weak economic growth.

To avoid that paradox, scrap the second premise. Real interest rates always move higher when real gross domestic product speeds up, and rates decline in recessions. Real interest rates are what is left after subtracting inflation, so it is wrong to treat every interest rate rise as evidence of inflation.

posted on 15/12/2003

Robert Heinlein’s unpublished first novel For Us, The Living: A Comedy of Customs is reviewed at CBC News. According to the review:

In the new novel, his first draft of future history includes a take-over of the United States by what he calls "Neo-Puritans" led by the televangelist Nehemiah Scudder, a character who is also prominent in his 1941 novella If This Goes On. The novella is the story of the second American revolution, when libertarians finally overthrow a dictatorship of the religious right.

For Us, the Living also includes one chilling incident, a surprise attack on the island of Manhattan by two giant helicopters that flood the island with poison gas, killing 80 per cent of the population. The helicopters are based on aircraft carriers and the attack comes when the United States is at war with Argentina, Brazil and Chile in December 2003.

Having read the rest of Heinlein’s work at an earlier age, I will have to read this one too for the sake of completeness. According to CBC story, a Heinlein biography is also in the works.

posted on 13/12/2003

A useful resource. EconPhD.net is a useful resource for current and prospective PhD students in economics.

posted on 13/12/2003

The Australian Competition and Consumer Commission has lost another 'market power' case in the High Court:

In this latest decision the High Court argued that Rural Press's retaliatory threat was not an abuse of its monopoly power but a use of its "material and organisational assets", which would no doubt intensify small business's plea for help.

"What they're saying is that what Rural Press was trying to do was nothing more than trying to preserve the market it had for itself," said Ray Steinwall, visiting fellow at the University of NSW law faculty and general counsel at the NSW Independent Pricing Tribunal.

posted on 12/12/2003

Alan Mitchell is one of the few commentators to have consistently invoked the classical case for free trade in the debate over an Australia-US FTA. As Mitchell has long argued, the best approach to the negotiations would be to give the Americans everything they want. Unfortunately, it is not likely to play out that way:

A few weeks ago an economics professor rang to say excitedly that he'd heard that the Americans were suddenly demanding free access to the Australian university market.

Could this be true? Could an old economic rationalist's Christmases all be coming at once?

Alas, even if the Americans were interested in such a reform, it would be so good for Australian students that our negotiators would be bound to resist it to their last breath. But, as it happens, America's politicians are as determined as the Australian government to maintain the status quo.

Australian universities can relax. The government's subsidies for tertiary students will continue to discriminate in favour of the established, publicly owned universities, and against new private and foreign universities.

There will be no economic rationalist nonsense such as fully transferable vouchers that university students could use to help finance the cost of tuition in any university of their choosing, in Australia or elsewhere.

Any uppity students with ideas of studying at the feet of a US Nobel Prize winner can think again. Any Australian university that feared it might have to lift its game to compete with American universities can relax. And any enterprising university that thought it might attract adventurous US students to do their degrees in Australia can just put their enterprising ideas away.

Mitchell is unduly pessimistic about the prospects for increased competition from US universities. One of the consequences of the greatly expanded student exchange programs between Australia and the US is that Australian students are getting to see what a well-funded, consumer-driven university system looks like.

posted on 10/12/2003

The Federal Government’s Mid-Year Economic & Fiscal Outlook has seen yet another upward revision to estimates for the budget surplus, giving further encouragement to those labouring under the mistaken assumption that fiscal policy initiatives must be framed entirely within the confines of the surplus. This effectively rules out a significant reduction in the overall tax burden, since tax cuts are seen as something that can only come out of the surplus. A meaningful reduction in the tax burden can only be realised through a reduction in the Federal government’s own-purpose discretionary spending. But fiscal policy has now been reduced to a false choice between new spending or tax cuts out of the surplus, rather than meaningful reform of both revenues and outlays.

One argument that is being used against further tax cuts is that they would be stimulatory at a time when monetary policy is aiming to be contractionary, implying that tax cuts would put upward pressure on interest rates. This would not be a serious concern if the tax cuts were also accompanied by reductions in expenditure. But this argument is being used in support of an entirely different agenda, neatly summarised by Laura Tingle:

But if ever there was a year to spend a surplus on infrastructure and less immediately stimulatory projects, rather than a tax cut that will boost consumer spending, surely it must be the one now approaching.

A simplistic Keynesian multiplier analysis would suggest that infrastructure spending would be considerably more stimulatory than tax cuts, although the small numbers involved suggest that neither would be a serious concern for monetary policy. But note the disregard for economic efficiency in this argument. Infrastructure spending can, of course, promote productivity, but one has to be doubtful whether this is the case with those projects favoured by the infrastructure lobby in Australia and the pet schemes of politicians. There is little consideration given to the distortionary implications of high marginal tax rates as a competing concern.

posted on 9/12/2003

RBA Governor Macfarlane’s testimony to the House Economics Committee once again makes explicit that the RBA is not in the business of targeting house price inflation:

It is clear that, despite our best endeavours to explain ourselves, a number of people think that the Bank tightened to cool down the property market. In fact, I have more than once received unsolicited advice that it would be better for us to explain our action in this way because people could more easily identify with it. The overheated property market is something that people can see around them; it is much more concrete than such concepts as inflation-targeting or returning interest rates to normal.

However, such an approach would not be consistent with the truth. For a start, signs of overheating in the housing market were clearly evident through the second half of 2002 and all through 2003, yet the Bank did not change monetary policy. It was only when it became clear that good economic growth had returned both globally and domestically that rates were raised. I have often stressed that monetary policy has to be set taking into account the average of all the parts of the economy, not to what is happening in one sector. Of course, if a sector is overheated, it may push up the average for the economy, and in that way exert a disproportionate influence. It is also true that, historically, borrowing for housing purposes has been one of the more interest-sensitive sectors, and so it may have been more affected than other sectors by the previous low level of interest rates and it may respond more than other sectors to the recent increases. But that does not mean we singled it out.

Unfortunately, Macfarlane’s testimony also suggests that the RBA has lost none of its enthusiasm for its role as a regulator of the payments system, with BPay now in the RBA’s sights over interchange fees:

We're talking to the banks about BPay and we'll do a thorough study of the economics to see whether the interchange fee is reasonable or if indeed there should be an interchange fee at all.

Macfarlane also indicated he would like to discourage credit card use with transaction fees. Unfortunately, the RBA’s ‘economics’ in all this has been seriously flawed. The RBA is a frustrated regulator, having lost its battle to retain its regulatory role in relation to the financial system, and so all its paternalistic instincts are now being focussed on the payments system.

posted on 9/12/2003

What I am reading. Steven Pinker’s The Blank Slate: The Modern Denial of Human Nature came to me highly recommended and is one of the few books I have read recently that has changed my mind on some important issues. Following Bryan Caplan’s article on the role of economic education in the political economy of Bastiat and Mises, I was struck by this passage in Pinker:

The obvious cure for the tragic shortcomings of human intuition in a high-tech world is education. And this offers priorities for educational policy: to provide students with the cognitive tools that are most important for grasping the modern world and that are most unlike the cognitive tools they are born with. The perilous fallacies we have seen in this chapter, for example, would give high priority to economics, evolutionary biology, and probability and statistics in any high school or college curriculum. Unfortunately, most curricula have barely changed since medieval times, and are barely changeable, because no wants to be the philistine who seems to be saying that it is unimportant to learn a foreign language, or English literature, or trigonometry, or the classics. But no matter how valuable a subject may be, there are only twenty-four hours in a day, and a decision to teach one subject is also a decision not to teach another one. The question is not whether trigonometry is important, but whether it is more important than statistics; not whether an educated person should know the classics, but whether it is more important for an educated person to know the classics than to know elementary economics. In a world whose complexities are constantly challenging our intuitions, these tradeoffs cannot be responsibly avoided.

posted on 8/12/2003

That Krugman cover yet again. Symptomatic of Bush Derangement Syndrome (BDS), according to Charles Krauthammer:

It is true that BDS has struck some pretty smart guys -- Bill Moyers ranting about a "right-wing wrecking crew" engaged in "a deliberate, intentional destruction of the United States way of governing" and New York Times columnist Paul Krugman, whose recent book attacks the president so virulently that Krugman's British publisher saw fit to adorn the cover with images of Vice President Cheney in a Hitler-like mustache and Bush stitched up like Frankenstein. Nonetheless, some observers took that to be satire; others wrote off Moyers and Krugman as simple aberrations, the victims of too many years of neurologically hazardous punditry.

Not to be confused with the more localised outbreaks of Howard Derangement Syndrome (HDS).

posted on 6/12/2003

The European Union’s Growth and Stability Pact is now widely regarded as a dead-letter following the failure of European Finance Ministers to throw the book at Germany and France over their continued failure to bring their budget deficits below 3% of GDP. As usual, the demise of the Pact is being viewed as a problem with the fiscal rules rather than the euro project itself. For example, The Economist observes that:

An optimistic interpretation would be that the stability pact will now evolve from a rigid rules-based system that is both unrealistic and undesirable into a more flexible instrument that relies more on moral pressure and political understandings.

At the outset of the euro project, I wagered that at least one country would be forced out of the euro within five years because of an inability to meet the requirements of the Growth and Stability Pact. I did not allow for the possibility that the fiscal rules themselves would be dumped and that the principal offender would be Germany. The fiscal rules of the Growth and Stability Pact are indeed ‘unrealistic and undesirable,’ but this is an argument against the euro project that necessitates them. The demise of the Pact has removed one of the major underpinnings of monetary stability in the eurozone.

posted on 5/12/2003

The Reserve Bank of Australia’s latest increase in official interest rates seems to have drawn out more than the usual special interest criticism, principally, that higher interest rates are putting upward pressure on the Australian dollar. While the motivation behind these criticisms is obvious, the equally obvious response is to ask whether or not these people have heard of hedging. With both interest rates and the exchange rate having touched multi-decade lows only two years ago, there is little excuse for not having taken advantage of these opportunities to hedge the relevant exposures.

The critics of the RBA were on more solid ground in questioning the emphasis that the most recent Statement on Monetary Policy put on growth in household debt as a ‘separate, but no less important issue’ than the inflation target. Despite Governor Macfarlane’s subsequent explicit disavowal that the RBA is targeting house price inflation, the emphasis the RBA has given to credit growth is bound to create the impression that it is straying from its inflation targeting mandate. This is unfortunate, because the RBA could easily rationalise the current tightening episode with reference to the strength of the recovery in the world economy. The RBA’s own research points to the existence of a cointegrating relationship between Australian and US GDP, for example.

The latest criticisms of the RBA point to the dangers of an everything-but-the-kitchen-sink or check-list approach to rationalising monetary policy actions. The emphasis the RBA has placed on credit growth raises suspicions that the RBA is more interested in paternalistic interference with capitalist acts between consenting adults than inflation. Governor Macfarlane has indeed performed a valuable community service in sounding the alarm on these issues in recent years. But Macfarlane’s community service announcements on these issues should be kept distinct from the rationalisation for monetary policy actions. The great danger now is that any correction in house prices will be blamed on overly aggressive monetary policy, undermining support for the inflation targeting framework.

posted on 4/12/2003

Bryan Caplan has completed his two-part essay on political economy in Bastiat and Mises. Caplan argues that Bastiat and Mises have a very different view to the one suggested by conventional public choice theory. Basitiat and Mises suggest that the problem is not that people vote their own interest. The electorate is simply labouring under bad economic ideas:

The Bastiat-Mises view of democracy is often accused of being "pessimistic." This is not only irrelevant; it is false. If special interests are in the driver's seat of democracy, then economic education is in vain. Even if every voter understood economics perfectly, inefficient policy would endure. The Bastiat-Mises view, in contrast, makes economic education the key to a better world.

posted on 2/12/2003

Richard Rahn asks whether the US budget deficit is too small:

What we do need to be concerned about is not the deficit, but the very rapid growth in real, nondefense, discretionary federal government spending, which is up an average of 7.2 percent yearly for the last three years. A continuation of this trend could indeed cause real economic damage.

Finally, the analysis of the historical data clearly indicates that if we had properly structured tax cuts (like the first Reagan and the most recent Bush tax cuts) in 1969, 1973, 1979, 1989 and 2000 we may have avoided the recessions, with all their human misery and unemployment, that occurred the year following each of the above dates. Unfortunately, policymakers in all of those years were more preoccupied with reducing the deficits rather than keeping the economy growing.

The lesson is clear, economic prosperity can continue, even if the federal government never balances its budget, provided it keeps government spending from growing as a percentage of GDP, and has an ongoing program of removing tax and regulatory impediments to growth.

posted on 2/12/2003

Yet more on that Krugman cover. Don Luskin points to possibly the most bizarre ‘correction’ ever run in the NYT. As Luskin notes, as a ‘correction,’ it simply makes no sense. Corrections are for errors of fact, not interpretation. Luskin suggests it is just more defensive spin on Krugman’s behalf, but even on that score, it’s a failure. The criticism that has been made of the cover doesn't depend on some misinterpretation of one of its constituent images. Krugman himself has effectively conceded that the cover art is inappropriate and made the most damning ironic connection in relation to its actual context. Attempting to spin it otherwise just digs the hole deeper.

posted on 30/11/2003

The end of deflation in Japan. Japan’s core CPI turned marginally positive in October, with a 0.1% change over the previous year. As always, it is possible to point to one off factors influencing this result, in particular, the unseasonably cold weather that has put upward pressure on the price of rice and tax changes. But the annual rate of change in the CPI has been on an upward trend for sometime now. Measured by the GDP deflator, deflation remains more pronounced, reflecting declining capital goods prices that are included in the non-residential investment deflator, but not the CPI. Given the massive overcapitalisation of the Japanese economy, it is appropriate for capital goods prices to fall. The extent of this fall is in any event overstated by the current methodology for calculating the GDP deflators. When Japan moves to a chain-weighted methodology sometime in 2005, Japan’s measured deflationary experience will probably look less severe. In the meantime, it is remarkable that the return to a positive rate of inflation in Japan as measured by the CPI has not attracted more attention.

posted on 29/11/2003

Get Shorty. James Surowiecki discusses the SEC’s proposed trial to remove restrictions on short selling large cap stocks in the US:

The result should be a better functioning market, which is in the interest of investors as a whole. Let corporations denounce short sellers all they want. The case against these bears is a lot of bull.

Milton Friedman’s (1969) ‘In Defense of Destabilizing Speculation’ in The Optimum Quantity of Money, Chicago: Aldine is, as is so often the case with Friedman, the classic reference on this issue.

posted on 28/11/2003

The Economist’s 'Lexington' column on how Bush hatred is helping the President, including this observation:

Bush-hating is a fast-growing business, with Michael Moore and Al Franken as its robber barons and every leftish author in the land trying to break into the market.

No doubt this is the market the British publishers of Krugman’s book had in mind when they decided to adorn it with imagery supplied by the anti-globalisation left, to Krugman’s subsequent embarrassment.

Lexington’s broader argument about Bush hatred helping the President has remarkable parallels to the pathological attitudes to Prime Minister John Howard among the commentariat in Australia. Much of the commentary directed against him only serves to reinforce his electoral position, since it demonstrates that Howard is closer to the electorate on key issues than those who criticise him. Indeed, the parliamentary press gallery almost single-handedly re-elected him at the last general election by giving saturation coverage in the final days of the campaign to an issue they thought was a negative for the government that was in fact a positive in the minds of the broader electorate.

posted on 27/11/2003

Amid the positive signs of reform in Japan, METI remains as confident as ever that it can centrally plan the future of the Japanese economy:

The Ministry of Economy, Trade and Industry will designate six fields as key industries in which Japan can take a leading role and help drive the nation's economy, the Nihon Keizai Shimbun learned Monday.

METI will apply the designation to biotechnology, fuel cells, Internet-enabled home appliances, content such as computer software, environmental equipment and services, and robotics. Industries that supply these areas would also be considered key to economic growth.

METI hopes to have top corporate leaders and academics participate, and spur restructuring within the industries as well as have the government come up with support measures. The ministry plans to have a report ready by May, which will include market projections for these industries.

This is the same bureaucracy that famously told Sony not to bother with consumer electronics and suggested that Honda avoid light passenger vehicles. One of the classic studies of industry policy in Japan is "Market access and competition: A simulation study of 16K random access memories," in Empirical Methods in International Trade, Cambridge, MA: MIT Press, 1988, which showed how strategic industry policy could impose net costs on an economy. The co-author was one Paul Krugman.

posted on 26/11/2003

More on that Krugman cover. The NYT has taken up the story and has some reaction from Krugman. Krugman essentially concedes that the cover on the Commonwealth edition is inappropriate, saying:

"I should have taken a look at that and said, `What are you doing marketing me as if I am Michael Moore? This is silly.' "

Krugman deserves some credit for conceding this, except that he also tries to suggest that the cover was ‘intended to be ironic.’ The story notes that he was in fact a participant at the New York meeting of the World Economic Forum in 2002. It was the protestors outside the same meeting who then unwittingly provided the images for the cover art. This is indeed ironic, but Krugman’s claim that the irony was intentional beggars belief.

In any event, it is pleasing to me that the publishers are being held to account for this and that Krugman appears suitably embarrassed. Not so much because I have a major axe to grind against Krugman. I actually have quite a bit of respect for his scholarly output and even some of his earlier popular writing. My main concern in all this has been the way British publishers take for granted the political views of their prospective readers. The use of anti-American political iconography to market Krugman’s book tells us more about the publishing industry than it does about the author.

This episode has also served as a nice illustration of the way in which the blogosphere can promote accountability. It only takes one blog-equipped graduate student browsing in a Sydney bookstore to hold a major newspaper and publishing house to account.

UPDATE: Mickey Kaus thinks Krugman should not get off so lightly:

Why is this a legitimate story? For the same reason it's often legitimate to hold reporters responsible for the headlines on their pieces even though they don't write the headlines. The headline writer is typically a copy editor who reads the piece quickly and tries to distill its essence--thus replicating what a average reader will do. If the headline gives a tendentious or slanted impression, often that's because the piece itself gives a tendentious or slanted impression to the average reader. Similarly, a presumably intelligent British publisher has read Krugman's book and distilled its essence as something like 'More Typical Militant Left-Wing Bush Hatred.' Maybe the publisher did that because Krugman doesn't write much these days that typical militant left-wing Bush haters would be bothered by--even when that requires concealing his actual, more nuanced views. ... Someone judged his book by the cover, and it's a judgment that should embarrass him.

posted on 24/11/2003

Samuel Brittan calls for an end to immigration controls for an ‘experimental period’ with a view to showing that this would yield net benefits. Unfortunately, with apparently so few convinced of the merits of freedom of movement in relation to goods, services and capital, Brittan’s proposal is probably a non-starter and not just in the UK. By way of illustration, Australia’s arts community is currently engaged in a brazenly self-interested lobbying effort in the context of negotiations for an Australia-US free trade agreement to continue sheltering its mediocre product behind government subsidies and local content rules. Guy Rundle is effectively calling for the nationalisation of the film industry, saying ‘what we really need is a sort of government film studio,’ something we might more reasonably expect to find in North Korea.

Jean-Francois Revel has written eloquently on the consequences of cultural protectionism:

The idea that a culture can preserve its originality by barricading itself against foreign influences is an old illusion that has always produced the opposite of the desired result. Isolation breeds sterility. It is the free circulation of cultural products and talents that allows each society to perpetuate and renew itself.

posted on 22/11/2003

More on the Krugman cover Josh Gerstein of the New York Sun has got some official reaction from the publishers and makes some very goods points about the irony of Krugman’s book being marketed through images of the anti-globalisation left:

W.W. Norton & Co., the American publisher of Mr. Krugman’s book, indicated that it was made aware of the British company’s marketing plan.

“They would absolutely keep us informed,” Norton’s president and chairman, Drake McFeely, told The New York Sun. Asked if it was fair to say that his company and Penguin had taken dramatically different tacks in hawking the book, Mr. McFeely laughed heartily and replied, “I agree about that.” He said that his firm had deliberately shied away from the dramatic imagery being used to promote the British edition. “We did not need to make this kind of splash,” he said.

Mr. McFeely called Mr. Krugman a “household name” in America, but said he does not enjoy that status overseas. “They have a much trickier publishing proposition in the U.K.,” the publishing executive said.

Mr. McFeely acknowledged that the British jacket would not have been appropriate for an American audience, but he said that he doubted that he or Mr. Krugman had any legal right to reject the cover art used in other countries.

“Would I have used that jacket? No,” Mr. McFeely said.“Am I going to censor what a very good publisher over in the U.K. might think is a good way to handle this book? I’m not going to do that either.”…

Perennial World Trade Organization protesters,like those depicted on the cover, might not care for Mr. Krugman’s use of the word bogus to describe their arguments against the global trade body.

“Every successful example of economic development this past century” is attributable to globalization, he writes in one piece. In another column, he faults America’s labor movement for “working against the interests of most of the world’s poor.”

While a writer for the online magazine Slate Mr. Krugman once filed a column entitled “In Praise of Cheap Labor.”He has even argued that free trade is a net plus for the global environment.

posted on 21/11/2003

Australian Business Economists are holding their annual forecasting conference today, including keynote speaker SF Fed President Robert Parry. I am assuming ABE will put the papers up shortly. Keep an eye out for Ross Gittins' paper on the local monetary policy and political outlook. Previous presentations by Gittins at this forum have been quite insightful. Once again, it is telling that some of the most insightful commentary on Australian federal politics comes from someone who is not a member of the federal parliamentary press gallery. I would go so far as to say that Gittins has missed his true calling, except that had he been a member of the gallery, he would probably have also succumbed to its incredibly insular perspective.

posted on 21/11/2003

My previous post on the cover art for Krugman’s book has generated something of a stir in the blogosphere. I should point out that it is quite common for books to have different covers in the US compared to the same titles published in the UK and other Commonwealth countries and is partly just a reflection of the territorial division of copyright. In Australia, we generally get the UK not the US editions of any given title. When I first saw the book in a Sydney bookstore, I was surprised that no one had previously commented on the cover. It then occurred to me that the US cover might be different and a quick check on the UK and US Amazon sites confirmed this.

I am surprised that the publishers thought that such an overtly partisan cover would help sales. In their defence, it could be said that the Commonwealth version at least gives the potential buyer a clear indication that the contents is probably not going to be overly impartial or dispassionate about the Bush Administration!

UPDATE: There has been much speculation about the origin, source and meaning of the cover design. Here is the cover art credit from the back of the paperback edition:

Cover: protestors with puppet placards demonstrate against the World Economic Forum, NY, 2002, copyright Alex Webb / Magnum Photos and copyright Susan Meiselas / Magnum Photos. Cover design: BonzoJones.

So now you know!

posted on 20/11/2003

The Economist’s ‘Face Value’ column profiles Paul Krugman and pretty well sums up my own view of him:

But, increasingly, people are asking whether Mr Krugman's success as a journalist is now coming at the expense of, rather than as the result of, his economics…perhaps the most striking thing about his writing these days is not its economic rigour but its political partisanship.

I saw a copy of Krugman’s latest book in one of the local bookstores yesterday and was struck by its cover art. The cover art for the non-US or Commonwealth version of the book is very different from the unremarkable text that adorns the US version. Click here to see the version that retails at Amazon in the UK and compare it to the cover from Amazon’s US site.

The cover art work for the non-US edition is more characteristic of the shopfront trashing anti-globalisation left than what we might expect from a mainstream commentator and publishing house. If I’m right about there being two sets of cover art for the US and non-US version, then the publishers seem to be engaging in a little more than just the usual territorial price discrimination. They seem to be discriminating across markets in relation to the cover art as well. I doubt they would get away with a cover like the Commonwealth version in the US. It says a lot that they think this sort of thing will work in other markets.

posted on 18/11/2003

Opposition Treasury Spokesman Mark Latham has told the AFR that a future Labor government would legislate to make the RBA independent and remove the Treasury Secretary from the RBA Board. He also wants to see the composition of the RBA Board changed to reflect a greater focus on monetary policy expertise. These are very welcome policy proposals that tie in well with the ALP’s new-found interest in fiscal policy rules (see my post from 3 November). The current government failed to properly address the issue of central bank reform when it came to office in 1996, leaving Australia with a framework for monetary policy governance that significantly lags world’s best practice.

At least part of the motivation behind Latham’s proposal is mistaken, however. Like all oppositions, he is concerned about political pressure being placed on the central bank. But government questioning or even criticism of monetary policy decisions is perfectly legitimate in my view, so long as the RBA has the institutional capacity to resist political pressures on its decision-making. Indeed, such open signalling of policy disagreements can be taken as a welcome sign that politicians do not have access to effective back channels of influence. Robust debate over monetary policy is essential to good policy outcomes. Reinforcing the legislative basis for the RBA’s independence should make for more such debate, not less.

posted on 18/11/2003

Cato on US Fiscal Policy: 'money-sucking vampires that just won't die.' Meanwhile, in Australia, Ross Gittins is down on Treasurer Costello for contemplating tax cuts that risk being pro-cyclical. But isn’t Ross all in favour of extra spending on health, education and infrastructure? A simplistic Keynesian multiplier analysis would suggest that such spending would be even more pro-cyclical, assuming that’s what Ross is really worried about.

posted on 17/11/2003

RBA Governor Macfarlane’s address to the Melbourne Institute conference is worth reading, in particular, his concluding comments:

The potential for intergenerational conflict exists in all countries, and their future economic success depends in some sense on how they handle it. The countries that will do worst are those where the population is aging the fastest, and those where their governments have given the most generous promises. Again, we are looking mainly at Europe to find this combination of problems. But even in Australia, the conflict could become a problem and lead to all sorts of behavioural changes. At the very least, we should question the assumption that age and poverty are positively related and that concessions to alleviate the latter should be directed at the former.

In fact, I think we will have to go further and be pre-emptive in conditioning the public, particularly the grey-headed part, to accept that policy must be forward looking and directed to ensuring a vigorous Australian economy and society 20 years hence. This will mean giving priority to tomorrow's working-age population, rather than satisfying the demands of yesterday's.

What Macfarlane is saying is actually quite provocative, but said with his characteristic understatement. Macfarlane goes on to say that he was surprised at the ‘favourable public reaction’ to his comments on higher education made previously at the same forum. But then he ducks for cover behind the following motherhood statement:

I can think of no better way of ending this speech than again stating my view that an improvement in the quality of tertiary education is probably the best investment we can make in our future.

Macfarlane deserves a lot of credit for kick-starting the debate on higher education, but is obviously unwilling to push the issue, no doubt because we are in the middle of a politically sensitive debate on the subject. But having done so much to initiate the debate, surely he is obliged to say more and not hide behind a ‘lack of expertise.’ More generally, there is a good case for the RBA to become more outspoken on structural issues that have implications for productivity growth and inflation performance. FRB Chair Greenspan and former RBNZ Governor Brash have been quite outspoken on broader structural issues. Macfarlane should try being a little more adventurous, especially now that he is not seeking another term as Governor.

posted on 14/11/2003

Big Spending Conservatives. Federal discretionary spending in the US is out of control, while Australia’s highest taxing government in history is now pondering how to deploy its budget surpluses to maximise its re-election prospects. There is a big difference in the politics of fiscal policy in the two countries, with deficit spending seen as electorally damaging in Australia, but apparently not in the US. This has seen unfunded tax cuts in the US, while in Australia, tax cuts and new spending initiatives are seen as something that can only come out of the budget surplus. What both countries have in common is a complete inability to reduce discretionary spending. The really interesting question is whether this is despite or because of the notionally conservative politics of the two governments.

posted on 13/11/2003

The Australian Competition and Consumer Commission has agreed to publish the reasons for its merger decisions, in line with the recommendations of the Dawson Review. This is a welcome improvement to a process that had been serious lacking in transparency. However, reading the Commissioner’s speech to the National Press Club announcing the decision gives little confidence that the ACCC has turned over a new leaf under the new Commissioner. Much of the speech is devoted to defending the ACCC’s informal approach to the merger approval process that was the subject of reform recommendations by the Dawson Review. In particular, the new Commissioner argues:

For these reasons I am concerned that the introduction of more formalised merger assessment processes will lead to more mergers being rejected than is currently the case. In recent years the Commission has, on average, only had problems with about five percent of the mergers it considers and about half of these are able to proceed after discussion and, in some cases, the offering of appropriate enforceable undertakings. Without wishing to put a figure on it I can see that this rejection rate is likely to increase with the introduction of more formalised merger assessment processes.

The ACCC’s preference for a more informal process has more to do with enhancing its bureaucratic discretion and inhibiting accountability. The Commissioner’s explicit threat in relation to the rejection rate gives the game away. He is effectively saying that business would be better off if they kept the law out of it. Yeah, right! The ACCC has a lousy track record in the courts and has been the subject of scathing criticism from the judiciary in relation to issues such as respect for due process. The business community is partly to blame for acquiescing in this process, hence the Commissioner’s appeal to administrative convenience rather than the law.

The Commissioner also makes this rather telling observation:

There is an overwhelming focus on the Chairman. This is significantly the result of a practice, on the part of many sections of the media to personalise institutions by reference to the Chairman or Chief Executive. I began to understand this process almost 35 years ago when Robert Gottliebsen confided in me his journalistic style to refer to the head of an organisation instead of the organisation itself – a journalistic style that has been liberally adopted by his colleagues in the business media...I will continue to reinforce to anyone who is prepared to listen that while the Chairman is seen as the face of the Commission, all decisions are made by all of the Commissioners acting collectively.

The preoccupation with personalities at the expense of processes is not just the fault of the media. When the rule of law is replaced by bureaucratic discretion, there is an understandable focus on the bureaucrats exercising that discretion. The former Commissioner, Alan Fels, managed to get himself into the top ten of the AFR’s ‘power list’ and his biographer subtitled his book ‘A Portrait of Power.’ Not bad for a bureaucrat who is meant to be administering the Trade Practices Act. But as the current Commissioner rather ominously puts it:

There is virtually no transaction entered into between business and business, or between business and consumers, that is not in some way impacted by the Act and as a consequence potentially subject to scrutiny by the Commission.

posted on 13/11/2003

The Melbourne Institute is holding a conference on Pursuing Opportunity and Prosperity. Paul Kelly gives an overview of the proceedings and main issues, including the following observation:

the Howard Government's record is equivocal. Howard is a cautious reformer alert to interest group pacification. He has never been the economic neo-liberal so bizarrely depicted by many of his critics. The reform momentum has been undermined by a complex set of forces that include complacency, breakdown of political agreement, the Senate as guardian of special interests, the demise of institutional support for a common "change" agenda, alarm about the fate of losers and the de-legitimising idea that economic reform spells the death of Australian egalitarianism.

posted on 12/11/2003

From philanthropy to misanthropy. George Soros has really lost the plot. And Andrew Sullivan questions whether he is now appeasing anti-Semitic sentiment. Soros’ philanthropy did much good in Eastern Europe in the 1990s, so it is a shame to see him now wasting his funds on narrowly partisan causes.

posted on 12/11/2003

The Japanese Ministry of Finance continues its almost daily interventions in the foreign exchange market to prevent yen appreciation against the USD. Horst Kohler, call your office! The money market also has its problems. Years of zero interest rates have hollowed out the money market’s human capital, raising concerns at the BoJ about whether the market infrastructure exists to implement a termination in the Bank’s current quantitative easing policy, according to the Nikkei. These concerns are probably exaggerated. Financial institutions would not waste time reconstituting their money market desks if market conditions changed.

posted on 12/11/2003

The Reserve Bank of Australia’s Statement on Monetary Policy does little to elaborate on the rationale for last week’s tightening in monetary policy. Immediately following the Bank’s discussion of the inflation outlook, the statement contains this paragraph:

A separate, but no less important issue, flagged repeatedly in previous Statements, is the rapid run-up in household debt. While this has been associated with a boost to domestic spending which was welcome in a weak international environment, such trends carry increasing risk if they persist over long periods. Those risks, discussed at length on other occasions and so not repeated here, appear to be growing. Monetary policy should, as far as possible, avoid adding to them.

While it is true that the RBA has discussed these issues previously, it has certainly not given a clear explanation of the relationship between these risks and its inflation target. The statement that these risks ‘appear to be growing’ is far from being self-evidently true. These are complex issues, so it is not surprising the RBA should fudge them, but it does raise questions about the RBA’s overly broad mandate and weak accountability framework. Despite the increased prominence given to inflation targeting since 1993, and more formally since 1996, the RBA still gives the impression of running a check-list approach to policy, with a wide range of discretionary policy objectives potentially entering into its conduct of policy.

It is interesting to compare the RBA’s commentary with the statement accompanying the BoE’s most recent tightening in policy:

Underlying inflationary pressures are therefore likely to build gradually as demand strengthens and sterling's depreciation earlier this year feeds through. Against that background, the Committee judged that a modest increase of 0.25 percentage points in official interest rates was required to keep prospective RPIX inflation in line with the target of 2.5%.

The BoE’s statement is more narrowly focused and makes explicit that long-run inflation outcomes are not exogenous variables under an inflation targeting regime.

posted on 10/11/2003

The Japanese Cabinet Office is planning on moving to a chain-weighted approach to calculating its GDP deflators, but not until the end of 2005, according to the Nikkei. This should result in a better measure of economy-wide price movements and is likely to show that deflation is not as pronounced as the existing methodology implies. The deflators currently use a 1995 base year. Japan has been slow in adopting IMF data dissemination standards and its official statistical data suffers from being compiled by multiple agencies, rather than a single statistical authority. It falls upon the Cabinet Office to pull all the data together to constitute the national accounts.

posted on 10/11/2003

Krugman You Can Profit From. Mickey Kaus is running a Krugman Gotcha Contest: ‘The prize is for a statement that now looks highly embarrassing in light of recent economic news.’ My entry for this would have to be Krugman’s June 20, 2003 effort, ‘Still Blowing Bubbles’ (Late Edition - Final , Section A , Page 23 , Column 1). To see what makes this column embarrassing, look at a chart of the S&P; 500 around 20 June and since. Krugman was expressing his doubts about the sustainability of recent gains in equity markets. Of course, subsequent gains do not necessarily make Krugman wrong. He would probably still run similar arguments. But your portfolio would certainly be underperforming if you used the NYT’s columnist as anything other than a contrarian indicator.

UPDATE: The results are in at Kausfiles. Our entry was runner-up.

posted on 8/11/2003

USD-Bloc Labour Market Developments Australia’s unemployment rate makes new 14 year lows at 5.6%, validating the RBA’s decision to raise interest rates earlier this week. Unfortunately, this will probably only encourage further complacency among Australian policymakers, something Alex Robson is warning against. The fact that it took a decade long expansion in Australia and a major contraction in the US to bring Australia’s unemployment rate below that in the US remains a damning indictment of Australia’s labour market institutions. NZ’s unemployment rate is still nearly a full percentage point below that in Australia.

There are also signs of life in the US labour market. Ben Bernanke has been addressing the relative merits of the household and non-farm payrolls surveys as measures of the US labour market and not surprisingly comes out in favour of the payrolls survey. Allan Meltzer’s somewhat different view is now the subject of a more lengthy treatment from the AEI.

posted on 7/11/2003

A MoF-BoJ Accord to leave foreign exchange intervention operations unsterilised? The Nikkei thinks so:

Suspicion is growing in financial circles that the Bank of Japan probably reached some kind of a policy accord over foreign exchange market interventions with the Ministry of Finance in spring this year, when Toshihiko Fukui succeeded Masaru Hayami as new BOJ governor…

Fueling the suspicion is the target amount of commercial banks' current-account deposits at BOJ, which the central bank has apparently raised in accordance with increased amounts of yen-selling market interventions since Fukui took the helm in spring. The amount of market interventions ballooned to an annual record 14 trillion yen in the April-October period, and the target amount of the current-account deposits has been jacked up by 12 trillion yen since March this year. The two figures appear to have increased almost in tandem…

The MOF's enthusiasm about market interventions does not appear set to abate in the months to come, given the possibility of further yen appreciation. However, whether the BOJ will be able to continue raising the target amount of current-account deposits in accordance with a further expansion of market interventions remains to be seen. It will be interesting to see how the BOJ moves relative to the interventions.

posted on 7/11/2003

A T Kearney’s Global Business Policy Council has finally released its FDI Confidence Index for 2003 in full. As mentioned in a previous post, Australia’s rank as a desirable destination for FDI has fallen from 10th to 19th this year. Australia has ranked between 7th and 10th in previous years. Obviously, these rankings are relative to other countries, so this does not necessarily tell us much about Australia. However, Australia also ranks in the top five on the OECD’s measure of FDI restrictiveness. Not surprisingly, the A T Kearney survey has 72% of respondents citing ‘government regulation’ as among ‘the most critical risks to corporations,’ while 34% cite the ‘absence of the rule of law.’

posted on 6/11/2003

The Reserve Bank of Australia has raised its official cash rate 25 bps to 5.0%. The USD-bloc peripheral central banks often lead the global interest rate cycle. Indeed, the RBA commenced a tightening cycle in May last year, but has left rates unchanged since June 2002, largely due to what had been a struggling US economy. The statement accompanying the tightening in policy presents the usual everything-but-the-kitchen-sink check-list of factors behind the RBA’s decision. But it is significant that the RBA is hard pressed to talk-up inflation risks. The best it can come up with is this:

In the short term, these developments are unlikely to make for significant problems on CPI inflation. Indeed, it will most likely decline for a time, as the effects of the appreciation of the exchange rate show up in retail prices. Over a longer horizon, inflation is currently expected to be consistent with the target, but the risks to that forecast are beginning to tilt upwards.

'Over a longer horizon,’ of course, inflation outcomes should be endogenous, since to forecast inflation outside the target range would be to imply a failure in the conduct of monetary policy. It has long been a mystery to me why an inflation targeting central bank such as the RBA should talk about long-run inflation outcomes as though they were an exogenous variable. This can only be confusing to the public.

In any event, the household sector is now much more highly leveraged than in the past and monetary policy in Australia benefits from the widespread use of variable rate consumer debt instruments. In the absence of more serious upside inflation risks, the renewal of the tightening cycle commenced in the middle of last year can probably avoid testing previous cyclical highs in the official cash rate. But we are still 25-50 bps below a neutral setting.

UPDATE: John Edwards is also less than happy with the RBA's rationalisation of its actions:

the increase does not require the prior rationalisation we had expected in next Monday's Statement on Monetary Policy, though no doubt the motives will be more fully described there.

Some fuller rationalisation is certainly required because, as the RBA readily concedes, the retail-price inflation target, which is the basis of its declaratory policy, is not in jeopardy, and the risks of higher retail-price inflation are surely so distant they do not justify a tightening today.

The RBA is moving because of house prices and credit growth, and needs not only to say so, but to say why, and how it will judge progress towards its objective. The monetary policy rules have changed, but the new rules have not yet been described.

posted on 5/11/2003

Academic Economists You Should Be Reading Bryan Caplan is a GMU economist who is doing very interesting work applying classical liberal ideas to questions in political economy. Some of his publications can be found here. Lynne Kiesling’s blog, The Knowledge Problem, has moved to a new location. If you are not already reading her blog, you should be.

posted on 4/11/2003

The Chifley Research Centre, the Australian Labor Party’s think-tank, has produced a report on Fiscal Policy Rules in Australia. Ross Gittins discusses the report, but does not do justice to its scope and intentions.

Some might find it surprising that the Labor Party should have an interest in promoting fiscal policy rules. But it is characteristic for opposition parties to argue for fiscal and monetary rules, since they usually end-up on the wrong end of discretionary macro policy initiatives. The current government was a strong advocate of fiscal and monetary rules when in opposition. But in government, its Charter of Budget Honesty has been honoured more in the breach, while its joint Statement on the Conduct of Monetary Policy falls well short of world’s best practice in monetary policy governance. It remains to be seen whether a future Labor government would be willing to tie its hands and forgo the short-run benefits of discretionary fiscal policy in favour of a more rule-bound fiscal policy regime.

posted on 3/11/2003

Samuel Brittan invokes neo-classical growth theory to argue:

The controversial proposition I want to start from is that most of this growth takes place automatically without special policies, ministerial exhortation and all the other phenomena about which commentators and journalists become so excited.

One of the dangers of neo-classical growth theory is that it encourages us to view growth as exogenous and to downplay the role of institutions and policies in contributing to growth outcomes. Brittan is right in suggesting that much public policy is probably irrelevant to broad growth outcomes. But we also know that there are very significant cross-country differences in growth outcomes that are only approximately explained by exogenous growth theory. Although the institutional determinants of growth are notoriously difficult to pin down empirically, we should not neglect them as Brittan seems to be suggesting.

posted on 3/11/2003

Alan Reynolds reviews the sorry history of US attempts to define a dollar policy. Reynolds suggests a more sensible approach:

the dollar's current level is no more problematic today than it was in March 2000. Nor would it matter much if the dollar went up or down a bit, so long as it wasn't being driven by the wind from Washington. Two lessons of postwar history are that (1) most of us should rarely worry much about the dollar and that (2) treasury secretaries and presidents should never talk too much about the dollar.

Meanwhile, the Japanese Ministry of Finance remains determined to run a de facto fixed exchange rate regime, in defiance of the most recent G7 communique and the IMF’s Articles of Association.

posted on 1/11/2003

40 Million Aussies? Max Corden makes the case for (while considering the arguments against) in his inaugural Richard Snape Memorial Lecture.

posted on 1/11/2003