Research Economist at the Bank of England
In case anyone is interested, here are graphs of Australia’s and America’s base (cash) target rates and the spread between them.
Source: RBA, Federal Reserve
With respect to fiscal policy, I suspect that the stimulus package will help, but believe – like every other political cynic – that the package is being undertaken principally so that candidates in this year’s congressional, senate and presidential elections can be seen to be acting. I am not at all surprised that debate over the precise structure of the package never really rose above the blogosphere, since although that is of enormous significance in how effective it will be, it is of near utter insignificance from the point of view of being seen to act. I find myself agreeing both with Paul Krugman, who points out that only a third of the money will go to people likely to be liquidity-constrained and with Megan McArdle, who (here, here, here, here and here) argues that if you’re going to give aid to the poor of America, doing it via food stamps is, to say the least, less than ideal.
On the topic of monetary policy, I will prefix my thoughts with the following four points:
As I see it, there are three different concerns: whether (and if so, how) monetary policy can help in this scenario; whether the Fed’s actions come with added risks; and whether the timing of the Fed’s actions were appropriate.
First up, we have concerns over whether monetary policy will have any positive effect at all. Paul Krugman (U. Princeton) worries:
Here’s what normally happens in a recession: the Fed cuts rates, housing demand picks up, and the economy recovers. But this time the source of the economy’s problems is a bursting housing bubble. Home prices are still way out of line with fundamentals … how much can the Fed really do to help the economy?
By way of arguing for a a fiscal package, Robert Reich (U.C. Berkley) has a related concern:
[A] Fed rate cut won’t stimulate the economy. That’s because lending institutions, fearing their portfolios are far riskier than they assumed several months ago, won’t lend lots more just because the Fed lowers interest rates. Average consumers are already so deep in debt — record levels of mortgage debt, bank debt, and credit-card debt — they can’t borrow much more, anyway.
Menzie Chinn (U. Wisconsin) looks at these and other worries by going back to the textbook channels through which monetary policy works, concluding:
In answer to the question of which sector can fulfill the role previously filled by housing, I would say the only candidate is net exports. The decline in the Fed Funds rate has led to a depreciation of the dollar. In the future, net exports will be higher than they otherwise would be. However, the behavior of net exports, unlike other components of aggregate demand, depends substantially on what happens in other economies. If policy rates decline in the UK, the euro area, and elsewhere, additional declines of the dollar might not occur. (And as I’ve pointed out before, if rest-of-world GDP growth declines (as seems likely [2]), then net exports might decline even with a weakened dollar).
I think the main point is that the decreases in interest rates, working through the traditional channels, will have a positive impact on components of aggregate demand. With respect to the credit view channels, the impact on lending is going to be quite muted, I think, given the supply of credit is likely to be limited. In fact, I suspect monetary policy will only be mitigating the negative effects of slowing growth and a reduction of perceived asset values working their way through the system.
James Hamilton (U.C. San Diego) is more sanguine, arguing that:
[I]t is hard to imagine that the latest actions by the Fed would fail to have a stimulatory effect.
[A]lthough interest rates respond immediately to the anticipation of any change from the Fed, it takes a considerable amount of time for this to show up in something like new home sales, due to the substantial time lags involved for most people’s home-purchasing decisions … According to the historical correlations, we would expect the biggest effects of the January interest rate cuts to show up in home sales this April.
[The scale of any effect is unknown, though.] Tightening lending standards rather than the interest rate have in my opinion been the biggest explanation for why home sales continued to deteriorate after January 2007 … The effect of rising unemployment and expectations of falling house prices on housing demand is another big and potentially very important unknown.
Going further, Martin Wolf at the FT worries that the Fed may be doing too much, that they the recent cuts in interest rates may serve only to renew or exacerbate the problems that caused the current crisis in the first place.
[P]essimists argue that the combination of declining asset prices (particularly house prices) with household overindebtedness and a fragile banking system means that monetary policy is, in the celebrated words of John Maynard Keynes, like “pushing on a string”. It may not be quite that bad. But, on its own, monetary policy will not act swiftly unless employed on a dramatic scale. The case for fiscal action looks strong.
Yet, in current US circumstances, monetary loosening should have some expansionary effects: it will encourage refinancing of home mortgages; it will weaken the exchange rate, thereby improving net exports; it will, above all, strengthen the health of banking institutions, by giving them cheap government loans.
This brings us to the biggest question: what are the risks? Unfortunately, they are large. One is indefinite continuation of an excessively low rate of US national saving. Others are a loss of confidence in the US currency and much higher inflation.Yet another is a further round of the very asset bubbles and credit expansion that created the present crisis. After all, the financial fragility used to justify current Fed actions is, in large part, the direct result of past Fed efforts at the risk management Mr Mishkin extols.
Moreover, the risks are not just domestic. If the US authorities succeed in reigniting domestic demand, this is likely to reverse the decline in the current account deficit. It will surely reduce the pressure on other countries to change the exchange rate, fiscal, monetary and structural policies that have forced the US to absorb most of the rest of the world’s huge surplus savings.
…
I find it impossible to look at what the US is now trying to do without feeling severely torn. If it succeeds it will renew and, at worst, exacerbate the fragility, both domestic and international, that triggered the turmoil. If it fails, the US and, perhaps, much of the rest of the world could well suffer a prolonged period of economic weakness. This is hardly a pleasant choice. But that it is indeed the choice shows how weakened the world economy and particularly the financial system has become.
In reaction at the FT’s hosted blog, Christopher Carroll (Johns Hopkins U.) argues:
This situation provides a more than sufficient rationale for the Fed’s dramatic actions: Deflation combined with a debt crisis make a toxic combination, because as prices fall, real debt rises. This point was amply illustrated in Japan, where deflation amplified both the number of zombies and the degree of zombification (among the initial stock of the undead). It was also the basis of Irving Fisher’s theory of what made the Great Depression great, and has clear echoes in the macroeconomic literature on the “financial accelerator” pioneered by none other than Ben Bernanke (along with a few other authors who have pursued more respectable careers).
In this context, the risk of an extra year or two of an extra point or two of inflation (if the deflation jitters prove unwarranted and the subprime crisis proves transitory) seems a gamble well worth taking.
Martin Wolf then replied:
[W]hat the Bernanke Fed seems to be trying to halt (with enthusiastic assistance from Congress and the president) is a natural and necessary adjustment, as Ricardo Hausmann argued in the FT on January 31st. I agree that this adjustment must not be too brutal. I agree, too, that both a steep recession and deflation should be avoided. I agree, finally, that market adjustments must not be frozen, as happened in Japan. But I disagree that the US confronts a huge threat of deflation from which the Fed must rescue the economy at all costs. What I fear it is doing, instead, is bailing out the banking system and so trying to reignite the credit cycle, with the consequent dangers of a flight from the dollar, considerably higher inflation and much more bad lending ahead.
Which leaves us with the third concern, over the timing of the rate cuts. The first of them, of 75 basis points, was the largest single cut in a quarter century. The fact that it came from an out-of-schedule meeting makes it almost unprecedented. When we add the fact that the world was in the middle of a broad share sell-off – exacerbated, it turns out, by the winding out of US$75 billion of bets by Societe General – it definitely has the appearance of a panicked decision. Adding the 50bp cut eight days later made for an enormous 1.25 percentage point drop in rates in a fraction over a week.
So what’s my take? Well …
1) The Fed is not as independent as central banks in other countries are. Greg Mankiw may not like it, but the fact is that both Congress and the Whitehouse actively seek to influence monetary policy in the United States. This photograph of Ben Bernanke (chairman of the US Federal Reserve), Christopher Dodd (chairman of the US senate’s banking committee) and Hank Paulson (US Treasury secretary) from mid-August 2007 is typical:
As Martin Wolf noted at the time:
This showed Mr Bernanke as a performer in a political circus. Mr Dodd even announced Mr Bernanke’s policies: the latter had, said Mr Dodd, told him he would use “all the tools ” at his disposal to contain market turmoil and prevent it from damaging the economy. The Fed has its orders: save Main Street and rescue Wall Street. Such panic-driven politicisation is almost certain to lead to both overreaction and the creation of bad precedents.
2) The Fed is mandated to keep both inflation and unemployment low. By comparison, the other major central banks are only required to focus on inflation. When they do look at unemployment, it plays lexicographic second fiddle to keeping inflation in check. At the Fed, they are compelled to take unemployment into account at the same time as looking at inflation.
3) The banking and finance system is central to the real economy. Without a ready supply of credit to worthy and profitable ventures, economic growth would slow dramatically, if not cease altogether. Although it creates a clear moral hazard when bankers’ pay is not aligned with real economic outcomes, this – combined with the first two points – implies that the so-called “Bernanke put” is probably, to some extent, real.
4) The latest GDP numbers and IMF forecasts were released in between the two rate cuts. I have nothing to back this up, but I wouldn’t be the least bit surprised to discover that the Fed gets (or got) a preview of those numbers. Seeing that markets were already tanking, knowing that the reports would send them tumbling further, perhaps believing that they might already be in a recession, almost certainly fearing that the negative news, if released before the Fed had acted, might send risk premia skywards again and recognising that what they needed was a massive cut of at least 100bp, perhaps the Fed concluded that the best policy was to split the cut over two meeting, making a smaller but still unusually large cut before the reports were released to ensure that they didn’t trigger more credit-crunchiness and a second one after in notional “response.”
My point is this: Which would seem more like a panicked response? The way that things did pan out, or a global stock market melt-down that took several more days to settle, followed by the markets being hit with surprisingly negative reports from the IMF on the global economy and the BEA on the US economy, and then a 125 b.p. drop in a single sitting by the Fed?
As I previously mentioned, I got an iPhone for christmas. In the UK, like the USA, Apple arranged an exclusive deal with one mobile provider, in this case O2. The cheapest plan that O2 offered was for £35/month, which included the remarkably low 200 minutes and 200 texts per month, but did also allow for unlimited internet usage when using the O2 network rather than a local 802.11 network.
Perhaps because of the increasing availability of iPhone substitutes, perhaps because of the increasing numbers of jail-broken iPhones that can be used on other networks or perhaps because they know that the new v1.1.3. of the iPhone firmware has already been jailbroken and that when combined with the upcoming release of the iPhone SDK, it’ll stay jailbroken, O2 has recently realised that their time of being a true monopolist has ended. How do I know this? Because this week I received the following text message from O2:
We’re really pleased to tell you that we are upgrading your £35 iPhone tariff in Feb so you will benefit by mid March at the latest.
The new tariff will take your minutes from 200 to 600 and your texts from 200 to 500. Plus you’ll continue to receive the same unlimited UK data allowing you to surf the internet on your iPhone.
Better still, you don’t have to do a thing to get them. We’ll text you to let you know when your new tariff is live.
Simply tap the link to find out more, including details on all our new iPhone tariffs and to see the new tariff terms & conditions.
Which, as a tariff, is much closer to their competitors without the iPhone. For example, Vodafone’s £35/month plan charges £1 for the first 15MB of internet each day and £2 for each additional MB and includes your choice of:
They’ve only dropped down to the usual category of monopolistic competition (they still have pricing power, which they use to implement second-degree price discrimination), but O2’s time of being a complete monopolist has come to an end.
The NY Times looks at economists and the ‘yuck’ factor here.
You can kill a horse to make pet food in California, but not to feed a person. You can hoist a woman over your shoulder while running a 253-meter obstacle course in the Wife-Carrying World Championship in Finland, but you can’t hold a dwarf-tossing contest in France. You can donate a kidney to prevent a death and be hailed as a hero, but if you take any money for your life-saving offer in the United States, you’ll be jailed.
…
Paul Bloom, a professor of psychology at Yale … conducted a two-year study to try to get at why people consider athletes who take steroids to be cheating, but not those who take vitamins or use personal trainers … The only change that caused the interviewed subjects to alter their objections to steroids was when they were told that everyone else thought it was all right. “People have moral intuitions,” Mr. Bloom said. When it comes to accepting or changing the status quo in these situations, he said, they tended to “defer to experts or the community.”
Often introducing money into the exchange – putting it into the marketplace – is what people find repugnant. Mr. Bloom asserted that money is a relatively new invention in human existence and therefore “unnatural.”
Economists are asking the wrong question, Mr. Bloom said[.] They assume that “everything is subject to market pricing unless proven otherwise.”
“The problem is not that economists are unreasonable people, it’s that they’re evil people,” he said. “They work in a different moral universe. The burden of proof is on someone who wants to include” a transaction in the marketplace.
I disagree. Economists are not immoral (violating moral principals), they simply seek to be amoral (not involving questions of right or wrong; without moral quality; neither moral nor immoral).
There is, or ideally is, a permanent distinction in economics between positive statements (statements of fact, shorn of moral interpretation; a statement of what is) and normative statements (moral judgements; a statement of what ought to be). The distinction didn’t originate in economics. We’ve borrowed it from the philosophy department (that economics, like all branches of study, first grew out of). David Hume was using the idea back in 1739, for example.
It’s an enormously powerful technique. It allows us, for example, to observe that there are trade-offs to be balanced in creating optimal tax policy, or that there is a statistically significant correlation between increased rates of abortion and decreased crime rates 20 years later, or that the decision to be a prostitute may be a marginal one instead of a discreet one. These are statements of what is; they are positive statements and can be debated as such. But once a positive statement is agreed upon, it then informs the normative debate.
This is an awkward thing for many non-economists to grasp, because for most of us, our beliefs about facts and beliefs about morals are closely intertwined and even interdependent. None of which is to say that we always can separate the positive from the normative, especially in studying the economics of (government) policy. But even in these cases, attempting to make the separation and acknowledging where any given statement contains an element of the other makes for better, more informed debate.
This puzzle-game is brilliant. Spare an hour for it.
Canadians celebrated when the Canadian dollar (“the loonie”) hit parity with the U.S. dollar in September last year. At the time, there was some speculation about whether the Australian dollar might follow suit. You’re going to see some more speculation over the next few days. Fundamentals aside, there are two main things that are serving to push the Australian dollar up: the resource boom in Australia and the spread in the interest rates between the two countries, and the latter of those is about to jump.
The US Federal Reserve cut interest rates by 75 basis points a week ago in a surprise, out-of-cycle move. Today they are expected to announce a further cut. Apparently the markets are predicting that there’s an 80% likelihood that it will be a further 50 basis point drop. Next week on the 5th of February, on the back of some truly disastrous inflation figures, the Reserve Bank of Australia will probably raise their rate by 25 basis points. That would be an enormous, 150-point increase in the spread in the space of just two weeks. On that basis, it’s not at all surprising that the markets are already pushing up the AUD.
This article from the FT is pretty typical at the moment: “Clinton seeks profit from a Florida win”
[F]ollowing her heavy defeat to Barack Obama in South Carolina last weekend, Mrs Clinton hopes to derive favourable publicity from her expected victory in Florida’s straw poll on Tuesday.
Almost 400,000 Floridians have already cast postal votes in the Democratic race, even though all of the candidates stuck to their pledge not to campaign there or run local advertising [after Florida had all of its Democratic delegates stripped for bringing the date of its primary forward].
Mr Obama’s camp has accused Mrs Clinton of cynicism for signalling she will ask the party to restore Florida’s delegates to the convention. Florida would have more delegates than Iowa, New Hampshire, Nevada and South Carolina combined.
Why does everyone play this as Hillary the cynical and faintly desperate candidate backing down on her pledge? I understand why Obama’s staff are playing it that way, but why are the commentators agreeing with that view?
If she wins the nomination – and the best bet right now is that she will – then it will prove enormously valuable that she went to Florida, no matter whether their delegates get to vote for that nomination or not. If she hadn’t gone but still won the nomination, then come November the Republican candidate would be speaking endlessly about her absence in such a key state while waxing lyrical about the democratic right of people to have their say.
Whoever the Democratic front-runner was at this stage was always going to be forced to go to Florida because of the attention that the Republicans are giving to it. Hillary is simply making the most of it. Barack Obama, who is behind in both the primary polls and the betting markets in most of the super-Tuesday states, cannot afford to think of November yet; if he’s looking at anything past the 5th of February, I’d be stunned.
I graduated from my engineering degree in November of 1998. I already had a job lined up, which I was due to start on the 18th of January, 1999. I had a couple of months to kill and I decided to go on the dole. What I wanted to do was work in a book store, and I applied to some, but not before first applying for unemployment benefits.
The Work for the Dole scheme was up and running by that point, but since it only applied to people who had been receiving payments for over six months, it was never going to be a concern for me. If I remember correctly, I had to fill out a form every two weeks detailing which businesses I had contacted in my quest for work. I definitely remember realising that all I needed to do was open the Yellow Pages at a random page, call whomever my finger fell on and have a conversation like this:
Them: Good afternoon [I was an unemployed recently-ex-student, after all. You can’t expect me to get out of bed in the morning, can you?]. This is company XYZ. How may I help?
Me: Hi. Do you have any jobs going?
Them: Uhh, no.
Me: Okay. Thanks.
I could then list that company on my fortnightly form, safe in the knowledge that even if Centrelink did bother to check – and I seriously doubt that they ever did; I could have written that I applied to “Savage Henry’s discount rabbit stranglers” and they would have just filed it away – then I was covered.
That felt a bit too much like taking the piss though, so I made sure that my targets were legitimate. As I mentioned above, I mostly applied to book and map retailers. I never lied to Centrelink or to any of the places I applied to. I always admitted to everyone that I had a job lined up and only needed to fill in the two-month gap, but if the truth be told, I didn’t put much effort in either, except for a couple of early applications to places where I genuinely would have enjoyed working. It’s not that I was disheartened; just that I didn’t particularly care. I wasn’t desperate for the cash (although it was certainly handy) or a job (since I’d have to quit in a few weeks anyway). I was really only doing the dole thing to see what it was like and the answer was: boring, but easy.
I’ve never felt any guilt or shame at doing it and I don’t think that any of my friends at the time were judging me negatively for it. It was a little unorthodox, but just accepted. I’ve certainly paid a lot more in taxes since than I received on the dole or for my university education. Fast-forward to 2008 and I am thinking about the social acceptability of receiving welfare payments, both in Australia and abroad.
It may just be the stereotype, but I get the feeling that in continental Europe, both in 1998 and today, what I did would barely raise an eyebrow; that it would be completely accepted. In the U.S.A., on the other hand, I think that it would be regarded by many as a shameful thing to do and an abuse of federal money. In Australia and the UK, I’m not so sure. I suspect that the more “aspirant middle class” you are and the older you are, the more shameful it will seem. I have no idea if the age thing is because it’s a process that everybody goes through as they get older or if there’s been a genuine generational shift in attitudes.
Any thoughts?