Club Troppo

I am usually uninterested in the month to month guessing/commentary game around RBA board meetings. It’s the financial market version of political race calling. However the decision on Tuesday to hold the current target rate highlighted some issues around the purposes and goals of inflation targeting. Those bewildered and using market gossip and entrail gazing to divine the inner thoughts of the board might well look at this 2003 speech by then Deputy Governor Glenn Stevens that I was required to read in my second year Macro class. It is entitled Inflation Targeting: A Decade of Australian Experience, and ends with a discussion on what challenges lay ahead. Put together they help explain the caution with which the RBA approaches decisions, and I think it is also a sensible way of doing things. The whole of the relevant section will be under the fold.

Three challenges are described.

The first is a reminder that there is a lower bound on the inflation target, and that inflation targeters must conduct policy with this in mind. Deflation/disinflation is also dangerous because it increases the real burden of debt or merely because it prevents downward sticky prices adjusting.  To anchor expectations of low but positive inflation helps prevent this. I’ll mention here that this makes me think there is very little conflict between the inflation and employment mandates of monetary policy if one is assuming a “natural rate” definition of full employment – one has to be as cautious of supra NAIRU unemployment as sub NAIRU unemployment.

The second is a recognition of the difficulties inflation targeting faces with regard to supply shocks. Supply shocks increase inflation, but monetary policy only impacts demand through investment and consumption decisions. In the event of a supply shock a central bank should be careful to bring inflation back to the target gradually as the supply shock passes or the real economy adjusts to a structural change. Temporary above target inflation is acceptable so long as long term expectations do not adjust to it.

The third issue is interesting, and involves asset prices and long term stability.  Stevens describes a hypothetical situation where a central bank recognises a boom in asset prices. They then have a choice. They can keep near term inflation at the target and running the risk that the boom is in fact a bubble that, upon bursting, will result in far below target inflation or deflation. Alternatively they can tighten policy and have lower than target inflation in the short and medium term, but reigning in asset prices and maintaining a steady trajectory. In the weasily speech required of central bankers Stevens says “There would be a fair proportion of people who might select the second alternative, given the choice.”. [fn1]

How do these relate to the current situation. Number two is easy. Inflation hawks themselves describe Australian inflation as imported, making it a cost-push , supply led problem in the context of the  Australian currency zone. Added to this are the lingering effects of the Queensland floods. Monetary policy has limited capacity to address inflation from this source, especially when credit growth is already very low by historical standards. It pays to be cautious.

The implications of the thinking behind challenges 1 and 3 need combining. If I was a central bank in the current environment I would be very cautious about overshooting. With great uncertainty in the Northern Atlantic I would be wary of the risk of falling in a recession and deflationary environment (as per challenge 1) over the longer term. Subsequently I would be more prepared than usual to accept shorter term above target inflation as a trade off against the risk of longer term disin/deflation. This follows the same kind of reasoning in challenge three. Perhaps (I make no attempt to judge) the decision to hold in the face of last weeks inflation figures are vindicated in light of stock market events over the past 24 hours.

If this is the kind of reasoning the RBA is working under, I think it’s very sensible . I won’t guess whether any given monthly decision is right, but this is a fairly sensible way of going about making the decision. The implications of an inflation targeting mandate are broader than each CPI release or whether the market believes what you are going to do are what you say you are going to do. They need to be taken into consideration.

[fn1] I read this in 2005, and we were discussing it in terms of what my (American) lecturer was baldly stating was the US housing bubble. This is partially why the surprise of many in 2007 left me incredulous.  (Continued)

Progressive politics without unions? "If you want progressive policies, the comparative historical evidence suggests it’s very helpful to have a strong labor movement" writes Lane Kenworthy. But in the US unions are weak and getting weaker. Is there an alternative strategy?

No such thing as bad publicity? "I’ve received the ultimate accolade from News Corporation", writes economist John Quiggin. As Paul Krugman notes in the New York Times, Quiggin "has received a full sliming from the Murdoch empire." More here, here, here and here.

What’s the biggest benefit of a liberal arts education? For many America’s undergraduates, it’s learning how to intellectualize your "own life choices in a way that belittles others and enforces class barriers." Or at least, that’s the conclusion Ed at Ginandtacos draws from a recent story in the Huffington Post.

Electric wheelchair etiquette: "I never collide with anyone," writes Carl, "at least not when I’m sober." At Working at Perfect Carl explores the unwritten rules of driving an electric wheelchair on roads and footpaths.

Are there no limits to Kevin’s power? At Catallaxy Files Sinclair Davidson posts a graph showing how Labor’s abolition of Work Choices caused the global financial crisis … or something like that.

UPDATE: Sinclair Davidson responds "Don Arthur over at Club Troppo interprets this graph as showing that Kevin Rudd caused the GFC. Don is one of the more smarter social democrats, so it’s unsurprising they can’t handle money or manage an economy."

Virtual horses at risk of starvation: Virtual horses in the online game Second Life may starve if the real life company that sells their virtual feed loses a real life court battle. Legal Eagle explains at Skepticlawyer.

One of the heroes of ferreting out the routine criminality at the News of the World is the former Grandiosely titled Minister for Transformational Government, Tom Watson who’s been on this case longer than just about anyone and a genuine champion of open government with whom I had some dealings doing my Govt 2.0 work. Here’s his latest effort.

Me in today’s Crikey

It’s a dirty business but someone has to do it. Selling home loans that is. Now after a lifetime of howling protest about the commissions mortgage brokers make, the Australian Consumer Association – AKA Choice – is helping itself to some of those commissions.

Over eleven years ago I founded Peach Home Loans to rebate a large slice of the commission banks and other lenders pay brokers for selling their loans.

Did I say ‘selling’? Well yes, I did. Mortgage brokers are remunerated as salespeople – and for years it’s suited them to pose as independent advisors choosing the right loan for you. Among the things they don’t tell you is that they don’t cover the field, that there are loans available that don’t pay them commission and so they don’t write them.

That makes them like computer salespeople in a department store – people who often know a lot more about the product they’re selling than their clients and able to sell from a range of brands. The good ones try very hard to inform their clients and indeed to get them the best loan possible, both because they like helping people with their skill and because in a competitive marketplace, doing the best they can do for their clients is a pretty good recipe for their own self interest (See Adam Smith, 1776 for further details).

Since I founded Peach, the government has got in on the act, imposing heavy regulation on the industry including licensing.  It hasn’t mandated that brokers inform their clients that they only sell a sub-set of the loans on offer. But it has licenced them so that today loan salespeople can advertise themselves as government licenced, which legitimates their posing as objective fiduciaries when they are remunerated as agents of the lenders.

Now Choice has teamed up with an organisation of calling itself One Big Switch the main players of which appear to be luminaries with links to progressive campaigning organisation GetUp.Lachlan Harris – Kevin Rudd’s press secretary when he was PM is a co-founder.

One Big Switch claims to be able to wring better deals out of the banking oligarchs using the power of bulk purchasing. It will “help ordinary Australian households get the discounts, terms and conditions that big companies and high net worth individuals get every day.”

Having seen a fair bit over the last eleven years, I’m sceptical.  These kinds of claims are routinely made in this industry – see for instance www.ratealert.com.au and www.bidmyloan.com.au.  There may be substance to it, or it may be mostly marketing.  But there’s nothing wrong with a new commercial venture putting a commercial deal to the market and trying its luck.  I wish One Big Switch all the best.

But it amazes me, utterly flabbers my ghast that Choice is coming along for the ride, and, as it confirms on its website, will pocket referral fees “to help cover the costs of creating and delivering the Choice Big Bank Switch campaign. . . . If the fees received by Choice . . . are more than the cost of the campaign, they will be directed entirely to future campaigns that will benefit consumers.”

The One Big Switch site seems less forthcoming about its revenue model than most mortgage broking websites. I can’t find a single reference in the main pages of its website to the commissions they or Choice will make, though the Finance Broking Contract on their site does disclose that they will be paid a commission – which will be disclosed to borrowers.

Do women behave more reciprocally than men? Gender differences in real effort dictator games
Heinz, Matthias, Rau, Holger A., and Juranek, Steffen

Abstract:

We analyze dictator allocation decisions in an experiment where the recipients have to earn the pot to be divided with a real-effort task. As the recipients move before the dictators, their effort decisions resemble the first move in a trust game. Depending on the recipients’ performance, the size of the pot is either high or low. We compare this real-effort treatment to a baseline treatment where the pot is a windfall gain and where a lottery determines the pot size. In the baseline treatment, reciprocity cannot play a role. We find that female dictators show reciprocity and decrease their taking-rates significantly in the real-effort treatment. This treatment effect is larger when female dictators make a decision on recipients who successfully generated a large pot compared to the case where the recipients performed poorly. By contrast, there is no treatment effect with male dictators, who generally exhibit more sefish behaviour.

Yes, folks it’s Benford’s Law – from Kaggle’s website.

One fun aspect of working with real data is that you get to observe real-life phenomenon. For example, Benford’s Law (also known as the “first-digit law”) states:

“in lists of numbers from many (but not all) real-life sources of data, the leading digit is distributed in a specific, non-uniform way. According to this law, the first digit is 1 about 30% of the time, and larger digits occur as the leading digit with lower and lower frequency, to the point where 9 as a first digit occurs less than 5% of the time.”

A simple SQL query on the training dataset gives us the raw data with which we can compare the data:

digit	count	actual_probability	benford_expected_probability	abs diff
1	3368866	27.9%	30.1%	2.3%
2	1912850	15.8%	17.6%	1.8%
3	1483366	12.3%	12.5%	0.2%
4	1258157	10.4%	9.7%	0.7%
5	1109766	9.2%	7.9%	1.3%
6	933048	7.7%	6.7%	1.0%
7	787636	6.5%	5.8%	0.7%
8	668351	5.5%	5.1%	0.4%
9	573359	4.7%	4.6%	0.1%

Sure enough, the data from millions of shopping visits demonstrates the validity of this law.

I just thought this was an interesting application of something you hear about all the time in statistics discussions.

As thousands of Norwegians poured into Oslo’s streets singing, hugging and waving flowers, Queensland academic Merv Bendle sat at his computer fixated on how leftists and Islamists would try to exploit this latest act of mass murder. Maybe the attacks in Oslo an on the island of Utoeya were part of "a covert, ‘false-flag’ operation," he wondered. Maybe the attack was "carried out to give just this impression that it was conducted by anti-Muslim, right-wing extremists, but actually conceived and directed by other forces".

Nothing is ever as it seems, says Bendle. In an opinion piece for the Drum he wrote that Anders Behring Breivik "may be a very effective pawn in a much bigger and far more sinister game, in which there are still many more moves to be made." Not surprisingly, more than a few commenters accused him of peddling unsupported conspiracy theories (and some were less than polite).

For Bendle, this criticism is yet more evidence of a vast left wing conspiracy. In Quadrant he wrote:

(Continued)

(see here for part one and two and here for even earlier posts)

Where we economists are most useful in climate change discussions is the question of how to change the behaviour of humans and how to organise the production of public goods. Because the climate is a world public good, individual behaviour that affects it involves an externality and our training as economists leads us to particular answers as to what can be done about this externality. One of the main things that economists brought to the climate change debate early on is that in an ideal world, you would want to price the externality via taxes or trading schemes, rather than mandate behaviour directly.

There are three more things that economists know about public good provision that are absent from current climate change debates. The first is that when there are many players who have strong incentives to free-ride, then you will need punishment to induce cooperative behaviour. Voluntary sustained cooperation in the case that there is a clear gain of defecting is simply not going to happen. The second thing we economists know is that monitoring and taxation activities within countries and between them will be gamed, particularly by big business. What cannot be well-measured and taxed will be very hard to affect. The final thing we economists know is that public goods are more likely to be produced by agents with something to gain from it, which in the case of climate change means big countries negatively affected by climate change. Let us take each of these three in turn and show how the basic economics of public goods makes you look very differently at the issue of climate change from the way the debate rages in the mainstream.

(Continued)

The survey of opinion amongst Australian Economists made for some interesting reading for me. I found that I where a clear majority of respondents agreed or disagreed with a statement I did as well, and where they were divided, I also had reservations. I guess this means I ‘m safe from the vapid contrarianism and I should start worrying about groupthink instead [fn1].

I disagreed with the majority in two circumstances, but neither were on pure economics. One was quotas for female membership on corporate boards. I do think that quotas is a very crappy way of selecting board members, it’s just that I think existing board selection methods are equally as crappy, perhaps worse, so a quota is unlikely to be detrimental. The second was the opinion that income tax thresholds should be indexed to inflation.

The principle of stable and predictable real tax thresholds is sound, but in political practice it can come up against the desire for a cyclically balanced budget – a principle that also has overwhelming support. Forced to choose, I’d go for the latter.

The main reason is that politicians find nominal tax cuts far more attractive electorally than nominal tax increases, and cuts are very difficult. The travails in the US are a great reminder of this. A phenomenally large proportion of the deficit there are ostensibly “temporary” tax cuts from the Bush era, but simply doing nothing, and allowing a return to normal rates is apparently politically impossible. If revenue is ratcheted down, and spending is ratcheted up, the long term stability of the budget is unsafe. Bracket creep at least addresses the former. It allows taxes to be raised automatically, without the opportunity for grandstanding, and to offset the unoptimal choices grandstanding favours.

This came up recently in the comments of Peter Whitefords’s latest post about the tax compensation for the carbon pricing scheme.  The concern raised was that should the elasticity of demand of carbon be higher than expected, the scheme would be too successful. The less than expected revenue from permit sales would not make up for the foregone taxation revenue and the long run balance of the budget would be imperiled. This however would also imply that the price level would not be changed and the tax cuts would no longer be necessary as compensation. Peter was satisfied that bracket creep could be used claw back any proportion of the tax cut that proved unwarranted. I’d add that any compensation that was warranted would come back in the form of ritualised nominal tax cuts – one of the great benefits of incumbency. (Continued)