A Green Fiscal Stimulus

Joshua Gans, in his latest blog refers to a recently released article which advocates Fiscal Stimulus focusing on Green initiatives. This is an interesting article. I particularly liked table 1 on pages 14 and 15 which specifies 24 different options and evaluates their impacts across 7 dimensions.

Whilst I do not totally agree with the economic rationale of this article, I strongly believe that if the Government is going to borrow and spend billions of dollars, this is an option hard to beat.

Calls for public ownership make a comeback in Australia

Mark Crosby in his post Whose job really matters criticises the Australian Government's decision to block a bid by China Minmetals Corp for Oz Minerals.

The defence minister is accused of being too close to Chinese officials. Wayne Swan knocks back Minmetals proposed takeover of Ozminerals so as to not look too close to the Chinese. Seems to me like trying to save the Defence Minister’s job at the potential expense of several hundred mineworkers jobs. There can be surely be no sensible explanation for this bizarre decision. If you wanted to spy on the Instrumental range at Woomera the pub in Glendambo, or my Grandfather’s pub in Kingoonya, are much closer - or just try google earth.

China Minmetals is backed by the Chinese government. Unlike the case of foreign governments holding domestic government bonds, foreign investors have a say in how the corporations they own are run. Would Mark Crosby be just as supportive of government ownership to preserve jobs in the mining industry if it was the Australian government that was planning to nationalise Oz Minerals?

Correlation versus causation

via Andrew Leigh

Voluntary payment transactions - the case of live organ donations

Hong Kong papers today reported that the Hospital Authority has decided to waive the medical fees of live-organ donors. At the same time, they have stressed that they were not following US, UK and recent Singaporean legislation under which recipients can financially compensate donors.

There are two separate issues here: who compensates the donor, and what 'costs' does the compensation cover. In the Hong Kong case, taxpayers are subsidising the donor by covering only the transplant-related medical and surgical expenses. This is analogous to the treatment of blood donors in most countries. Of course, economic costs of blood donation are largely limited to medical costs. In the case of live organ donation, relevant economic costs would also include forgone income. In the case of Singapore, the recipient can financially compensate the donor, and this compensation is not necessarily limited to medical and surgical expenses.

Concerns about 'organ trading', commodification, financial inducements etc are vastly overstated given the regulatory environment, and distract from the more interesting aspects of the Singapore experiment. One needs to remember that in the case of Singapore, compensation is voluntary (the amendments to the legislation were required so that such payments were not longer illegal), whereas all donors in Hong Kong will have their medical expenses waived.

What I am interested in are the social norms that are likely to develop in Singapore in relation to the 'appropriate price' paid by recipients to donors, and how (if at all) this will interact with the motivations of organ donors. Voluntary compensation in market transactions is not, of course, limited to live organ donation. Tipping at restaurants is an obvious example. Closer to home, a local restaurant, Lentil as Anything, allows customers to determine the price of their meal. While repeated play considerations may come into these examples (which would be largely irrelevant in the case of organ donation), one may find an analogy in the case of donations to software developers who make their software available at a zero price.

A Future of Promise?

Earlier this week, Wayne Swan made a speech titled "A Future of Promise".

Having read through this speech, I find myself at odds with many of the assertions made. Some of which I have articulated:

Assertion 1: “There was a clear commitment from the world's 20 largest economies to substantial fiscal stimulus, because Finance Ministers from across the political divide understand the importance of boosting demand to avoid a damaging loss in output and much higher unemployment.”

No doubt, this is in reference to the 3^rd point of the G-20 communiqué dated 14^th of March. Interestingly, this point ends with the following statement

“We will ensure the restoration of growth and long-run fiscal sustainability.”

If fiscal sustainability is important, we must ask ourselves, whether or not cash bonuses are the most effective means of stimulating the economy. Many economists (for example, consider Tony Mankin's recent article) question the effectiveness of this policy.

It appears many economists throughout Europe and America also do not believe that fiscal approach is not the best way forward. The chorus of criticism and concern seems only to be getting louder.

Assertion 2: “Consider that we were among the first to announce a major stimulus package. Likewise, our moves on bank guarantees and special purpose vehicles have been in place ahead of the crisis point arriving.”

I am not sure if being first, is something to be proud of, especially in this instance. At the time, the package was criticised as being rushed, ad hoc and lacking a thorough analysis of its impacts.

Interestingly, one of the two initiatives cited, bank guarantees, proved to be less than successful. Recall the many pension funds that were frozen days after the ‘bank guarantee’. Recall the many people who could not access their money.

What made this policy initiative particularly bad was that it was totally unwarranted. Essentially, the Rudd Labour government enacted a policy that is practically meaningless. Furthermore, I believe it also had a negative impact on our confidence as it needlessly raised hysteria regarding our banks and economy.

Assertion 3: “... This is the model – act early; minimise the depth of the problem; be in a position to recover faster. In short, stay on the offence.”

Recall the countless examples in history when acting early, staying on the offence etc, has proved to be disastrous. Perhaps, one of the most well known is "rumble in the jungle". The world heavy weight championship was won by a man, who stood firm, took a few hits and then defeated his opponent by landing well-aimed blows.

Assertion 4: “The results of our first stimulus package, mostly delivered in December, speak for themselves. Despite the full horror of the global recession, consumption in Australia still held up in the December quarter.

Retail trade figures in Australia increased by 3.8 per cent in December – the biggest monthly increase since August 2000 – a standout result in a world where consumption has slumped elsewhere.”
Retail sales exceeded expectations marginally for one month. Surely there is more to show given the amount of money handed out.

Also,

What about the dramatic increase in the savings ratio that we also witnessed?

What about the recent factory closures linked to this so called retail success?

Assertion 5: “And while there's no telling how many people kept their jobs as a result of this stimulus, we do know this is a turnaround of more than 30,000 jobs on the previous three months.”

The effectiveness of economic policy cannot be judged on something that cannot be accurately measured, or as in this case measured at all!

Assertion 6: “That's why, when the global economy took a turn for the worse early in the new year, the Government did not hesitate to act again.”

“Unfortunately some fall back on ideology. Some think we should let events run their course. Some opportunistically deny our economy is being buffeted by global forces. Unfortunately, no matter what the changing circumstances, their answer is always the same: don't intervene; let it rip; let the cards fall as they may.”

“This isn't sound economic policy; it's a failure of policy courage. Or worse, the false prescriptions by people actually willing Australia to fail.”

Let me be frank, I am not against fiscal stimuluses per se. I do however object to economic mismanagement. It must be remembered, that for every dollar spent now, it means a dollar plus interest must be paid back in the future. Therefore, every dollar borrowed now must be done intelligently with careful consideration. Budget Deficits (Fiscal Policy in our current climate) = Borrowing from the future.

Dishwasher Duties

According to a report released by the ABS yesterday, it appears that I, along with the rest of the male population, are not pulling our weight when it comes to household duties.

Of particular interest is the last column which presents the ratio (female/male) of time spent performing certain tasks. It clearly indicates that the fairer sex is carrying out most of the home duties.

Payroll tax reductions and employment generation?

Another contribution to the payroll tax debate, this time by Wayne Kayler-Thomson in today's The Age, Why tax the jobs we're trying to create?

IN THE flurry of a crisis, the blindingly obvious is often overlooked, and the current economic crisis is no exception. Everyone - employer groups, unions and governments - agrees that the mantra should be "jobs, jobs, jobs", but why do we tax the jobs we are seeking to create?Australia is a country with a $14 billion tax on jobs that impacts especially on labour-intensive industries.

For many years, payroll tax as rated as the No. 1 nuisance tax among members of the Victorian Employers'Chamber of Commerce and Industry (VECCI). It cuts in at a headcount of about 10-15 employees in Victoria. Even smaller employers regard it with dread, seeing it as a brake on future growth and a disincentive to hire. Some companies actually stop hiring so as not to incur payroll tax.....

A more competitive payroll tax rate is a headline indicator that states can point to when seeking local or overseas investment, and Victoria's relatively competitive payroll tax rate has been in no small part a factor in our superior investment and jobs performance against NSW over the past decade.

The funding of the reduction and eventual abolition of payroll tax should be a major priority for the Federal Government in light of the current economic crisis and should be the focus of any future stimulus measures, as well as the Henry review into taxation. One possible long-term solution is a lower payroll tax/higher GST scenario, with some economists estimating that a 12 per cent GST would enable this.....

The central problem with this analysis is that the author ignores something discussed in Economics 101, the distinction between the legal and economic incidence of taxation. In this article, the author makes no distinction between the legal and economic incidence of the payroll taxation, and his policy conclusions are therefore undermined.

Consider a world of flexible wages, where the demand for labour is downward sloping with respect to the real wage and the supply of labour is upward sloping. In such a world, employers do not bear the entire burden of payroll tax. So just as the current payroll tax is passed on in the form of higher prices, lower wages and lower returns to shareholders, any reduction in the payroll tax will result in lower prices, higher wages and higher returns. Higher wages and lower prices, coupled with the existing levels of excess capacity, will limit the employment generating impact of a payroll tax reduction. Of course, in order for a decrease in the payroll tax to have any significant effect on employment the decrease would have to be permanent, otherwise firms will not be willing to hire workers on a long-term basis. How much bang for the buck would such a payroll tax reduction generate?

A narrow focus on the legal incidence, as opposed to the economic incidence, of taxation leads to a further error in the discussion of a revenue-neutral tax mix change (reduction in payroll taxes accompanied by an increase in the consumption tax). A basic principle of the economic incidence of taxation is that any tax taxes the jobs we are trying to create! A GST-induced jump in the CPI will produce a corresponding jump in wage demands, which will have an adverse effect on employment.

While I don't have time to comment in detail on the tax-competition part of the article, it is clear that no consideration was given to economy wide implications for tax revenue, efficiency of resource allocation etc. Beggar-thy-neighbours policies are not what is needed to address the challenges faced by the Victorian economy.

Studying economics in 2009

Stephen Matchett writes in today's The Australian on studying economics in the wake of the financial crisis. The whole piece is worth reading, I have included a few highlights.

Dismal science of economics faces dilemma.... THE ability of economists worries Craig Emerson. The Small Business Minister, whose PhD in trade policy is "very orthodox economics", says the profession should have seen the global financial crisis coming.
"After the Berlin Wall came down there was no alternative ideology to the free market and deregulation became a 'monology'," he says.......

But while he is concerned by the quality of economists' expertise, other people are worrying whether we will have enough of them. It certainly seems Australia is short of economists.

Treasury is recruiting graduates in other disciplines and has hired Monash University to teach them high-level economics. Productivity Commission chief Gary Banks says there are not enough people "skilled in quantitative methods" in the public sector.

As Joshua Gans, a professor from the citadel of academic economics, the Melbourne Business School, puts it, "everybody wants policy-based research, but nobody does the work". This is all bad news for the public service's capacity to provide government with the hard data and analysis the policy process depends on, according to Banks.

And it's also bad for business. According to HSBC chief economist John Edwards: "Economics honours graduates are very employable but not enough of them are being turned out."

Critics say the shortage of economists demonstrates difficulties in a discipline where the intellectual orthodoxy has long ignored new ideas and, ironically, what the market wants. The big issues in economics now are not explorations of the way economies work in perfect worlds, where consumers are rational and markets never fail, but exploration of the impact of neuroscience and human behaviour. And above all there is eco-economics, which argues humanity's impact on the environment makes traditional economics irrelevant......

"The real advantage of neo-classicism is that it is mathematically tight and teaches skills. But when you need to teach real-world economics it's a lot harder," UNE's McNeill argues. "Students don't like the hard-core maths of the neo-classical approach," says Sandra Hopkins, who wrote her PhD on exchange rates and is now a professor in health economics at Perth's Curtin University. She says that in a two-year appointment to the Organisation for Economic Co-operation and Development in Paris, she met many policy specialists who didn't model everything, which showed her "you don't need maths to advise government".

Two popular trends based on these ideas have opened the discipline to enormous audiences. Economists such as Steven Levitt, co-author of probably the bestseller on economics, Freakonomics, and Tim Harford, who claims to "uncover the new economics of everything", popularise the discipline's principles by applying economic laws to real life. Behavioural economics takes this one step further, testing how our brain chemistry, rather than our supposed constantly calculating conscience, shapes our economic behaviour.

But Gans says the discipline has seen it all before and rejects the idea economics is imprisoned by the false paradigm of the omniscient market. "Everything that has happened in the global financial crisis is in economics 101. The idea that economists are obsessed with markets is wrong, very few people believe markets are always rational," he says. And although he rejects the idea that an emphasis on the environment is either new or outside the scope of conventional economics, he argues it is not his role to decide what people should do with their lives. "People want bigger houses, cars with more features. Is my job as an economist to say 'No, you can't have that'? Or is my job to work out how to efficiently provide resources? In my role as an economist I don't want to be a parent. I am reluctant to tell people what they can't
have.".......

Meanwhile, after 20 years behavioural economics appears to be an established research interest for mainstream economics, with the Productivity Commission sponsoring a conference on the discipline 18 months ago.

In fact, Gans says, we need more research on core aspects of economics on essential issues, such as what the Government's stimulus packages will do. "We don't do nearly enough work on measuring things. For example, we don't know what government spending multipliers are. What studies there are were done in good times in Australia or in the US." And Australia needs more intellectual ammunition, such as the cost benefit analyses produced by the Council of Economic Advisers in the US, "the boring stuff that doesn't generate press releases".......

Quiggin on the Reallocation (Not Reduction) of Emissions Under the CPRS

The uselessness of additional action under the CPRS, by John Quiggin, March 23, 2009 ... There was a bit of dispute a month ago over the claim, made here and elsewhere, that the design of the CPRS made both voluntary action to reduce CO2 emissions, and government initiatives such as the Rudd government’s home insulation scheme, have no effect except to reduce the price of permits.

The issue seems to have been settled by this Victorian government brief, leaked to the Age, which states:

The Victorian government’s policies to cut carbon emissions will make no difference in achieving national greenhouse targets …The leaked brief, obtained by The Age newspaper, says the government must rethink policies including subsidising solar farms and buying hybrid cars for its fleet because they will not assist in meeting targets in the proposed federal Carbon Pollution Reduction Scheme (CPRS).

The Rudd government can and should fix this.

Happy Birthday Catterpillar!

Al Roth posts on the 40th birthday of the "The Very Hungry Catterpillar". This book, about a caterpilliar who eats his way through the book leaving a trail of holes behind, was a favourite in our house.

Market for childrens' books ... Bestsellers in any category are what make publishing profitable. But childrens' books must be very special, because a bestseller can have high sales for a long time, as new generations of the target audience are born. I've always thought that this must be especially true for those books made of thick cardboard, suitable for chewing on as well as reading, since each new reader needs a new copy (chewing cuts down on the used book/hand me down market). But I hadn't guessed just how big the revenue stream is. .... 'The Very Hungry Caterpillar,' ..... has sold 29 million copies and has licensing deals, Newsweek reports, of $50 million annually......

Allocation mechanisms in Scrabble

Earlier this semester Applied Microeconomics students compared the efficiency implications of allocating goods and services through a competitive price mechanism, a random mechanism and a queuing mechansism. Allocations generated by a random mechanism are considered to be generally Pareto-inferior to competitive price based allocations. While not discussed in class, it is important to recognise that random allocations are used widely in games of chance (or those that have a significant element of chance).

Professor Jeff Ely at Northwestern University provides an innovative suggestion with regards to allocation mechanisms in Scrabble! Some background - "Za" and "qi" have recently been added to the game's official word list for its original English-language edition. Given that the traditional high scoring leters are more versatile, should they be revalued?

Let’s kill two birds with one stone. Eliminate the role of chance in scrabble by having players buy their letters rather than draw them at random. Whenever a player needs to replenish his tiles, a tile is turned over and put up for auction. Players bid for the tile with points. A player who already has seven tiles who wins the auction selects one of his tiles to replace and puts that tile up for auction. This continues until all players have seven tiles.

This removes chance from the game and also eliminates the need to revalue the tiles because that will be taken care of endogenously by competitive bidding.

Public transport overcrowding 2

One strategy to reduce overcrowding on trains was discussed in today's Applied Microeconomics honours class - limit the use of 60 plus concession fares to non-peak times. While unrestricted fares may improve social welfare when trains are underutilized (the basic idea being that price discrimination improves social welfare if total consumption increases), they clearly do not where trains are full. In this case, commuters with higher willingnesses to pay than those on concession fares may be displaced. In a Kaldor-Hicks sense, introducing time restricted concession fares may result in an increase in efficiency.

Public transport overcrowding

Yesterday, The Age reported significant overcrowing on Melbourne's trains.

Melbourne's big squeeze, by Clay Lucas .. As passengers crush on to the city's overcrowded trains in record numbers, figures reveal the extent of the daily squeeze Melbourne's rail commuters endure.

Head counts carried out for the State Government over the past five years, obtained under freedom of information, show a dramatic surge in passengers during peak hours.

Melbourne's suburban six-carriage trains are considered overcrowded when they have more than 798 passengers, or 133 per carriage. Yet trains regularly carry 1200 passengers, the head counts show, and one in six of the city's suburban trains is considered overcrowded....

The squeeze has led to an increase in passengers fainting and collapsing, and Connex has told passengers they must take responsibility for their own safety, advising them to drink more water to avoid dehydration. In the past six months, ambulances have been called to stations at least 12 times because passengers have collapsed because of overcrowding. In one instance this week, a Dandenong train was cleared at South Yarra and an ambulance called after a passenger fainted.

During peak times, where train passenger numbers are close to, or at, capacity, short run marginal costs of the servicing additional passengers on the system increase dramatically. This is both in terms of 'private marginal costs' to the operator and 'external marginal costs' (the costs imposed on existing commuters, such as lost productivity, adverse health outcomes, discomfort etc).

One obvious solution is time-differentiated fares, with peak surcharges and/or off-peak rebates to encourage passangers to change their trip timing. At the moment, there are two time differentiated train fares for weekday 'Zone 1' travel.

1. Off-Peak Daily (Zone 1+2) Metcards (Reduced price). Valid on all trains, trams and buses in Zones 1 and 2 after 9am on weekdays.
2. Early Bird Metcard (Zero price). It may be used for journeys between any two stations on electrified train services operated by Connex. It can be used on weekdays for journeys that reach their destination prior to 7am.

Such time differentiated fares (particularly off-peak rebates) are also used widely overseas. The problem with this arrangement is that one would expect peak passengers to have a relatively low price elasticity of demand, given fixed work and school start times. While in the longer-run, increased capacity may address some of the most acute peak overcrowding problems, this may in fact encourage people to substitute away from private vehicles and towards train travel. A peak travelling period will still remain, as will the need for effective time-differentiated fare arrangements. Creative ideas, anyone?

Arnold Kling on fundamental attribution errors

Two of my favourite economic bloggers, Mark Thoma and Arnold Kling, have referred to my earlier post on Andrew Leigh and Mark McLeish's paper on fundamental attribution errors in economic performance. Arnold Kling provides a pointer to a related piece he wrote in 2003. While the entire piece is well worth reading, the following section had a certain resonance

The economic attribution error means that people assign too much credit or blame for economic performance to the President and other officials. But shouldn't the President be held accountable, just as a corporate CEO is held accountable for corporate performance?

... I believe that we commit attribution errors in our evaluation of corporate CEO's.

... If CEO's really make enough of a difference to merit their centerfold spreads in business magazines, then they are badly underpaid. On the other hand, if context plays the dominant role in determining corporate profitability, then CEO pay is biased upward by the attribution error. I suspect the latter.

Losing and winning

When Losing Leads to Winning, By Justin Wolfers, Freakonomics Here’s my favorite new fact about N.C.A.A. basketball: teams that are behind by one point at halftime are actually more likely to win than teams that are one point ahead. This striking finding comes courtesy of a terrific new paper by my Wharton colleagues, Jonah Berger and Devin Pope....

Berger and Pope are two of the brightest young behavioral economists around, and they posit a behavioral explanation. Losing can lead to winning because of the strong motivating effects of being close to your goal. You can link some of this to Prospect Theory — loss aversion suggests that you may be willing to work harder to avoid a negative outcome (a loss); the leading teams, by contrast, aren’t focused on the losing domain. And in fact, most of this “catch-up” occurs in the first 10 minutes after halftime.

But how can we tell whether this is the losing team working harder, or the halftime leader easing up?

Here, they move from field evidence to the Wharton behavioral lab, setting up a very simple experiment in which their subjects were challenged to a trivial task — how many times they could type “a” then “b” in half a minute. The subjects were told that if they beat their opponent, they would get a bigger payout.

After the first round of competition, some were given feedback, and others weren’t. And here’s the key to the experiment: they randomly told some folks that they were a long way behind their opponent, others were told they were a little bit behind, or exactly tied, a little ahead, or even a long way ahead. Those who were randomly told they were a little bit behind improved their performance dramatically, while the other groups improved by about the same amount as the control condition (that is, the same improvement as those given no feedback at all).

It’s an intriguing finding: being behind by a little yields the greatest possible effort. And while these researchers measure these effects on the basketball court, or on pounding keyboards, their implications for the rest of our lives are even more intriguing. Want your workers to work harder? Tell them that they are running a close second in the race for promotion.

One cheer for the Productivity Commission?

The Productivity Commission yesterday released its draft report Restrictions on the Parallel Importation of Books. As part of its proposed package of changes, the Commission proposed that the restrictions on parallel imports should apply for only 12 months from the date of first publication of a book in Australia, as opposed to the current arragements whereby restrictions can potentially apply for the full term of copyright. One cheer for this recommendation.

A brief overview of the welfare costs of parallel import restrictions to start with. Parallel import restrictions allow authors and publishers to price discriminate. Restricting supply in the domestic market will result in prices for books being higher than elsewhere. While part of the loss of surplus to consumers is transferred to producers (including foreign producers), part of it is not, and can be considered a deadweight loss. The deadweight loss also includes the extra costs to society of publishing books domestically that could have been imported more cheaply. In the absence of parallel import restrictions, while the prices for copyrighted books in Australia will not fall sufficiently to reflect long run marginal costs of production, we can expect that they would fall from their current levels, thereby removing the current deadweight losses.

Given these deadweight losses, what is the justification for parallel import restrictions (PIRs)? The report states that the main justification is the existence of 'cultural externalities':

While much of the total cultural value of a book will ... be reflected in its market value, there is also likely to be a component that is not. In particular, whereone person’s purchase and consumption of a book generates benefits for others (asidefrom the author, publisher etc, who of course receive payment for their work),unpriced benefits, or ‘externalities’ in economic parlance, can be said to arise. It is these external benefits (and costs) of activities that provide the strongest rationalefor governments to support (or, in the case of external costs, discourage) activities (p 6.9).

The existence of cultural externalities is also used to justify local content rules for television. Professor Sinclair Davidson and I have written on this previously. Local content rules and PIRs are equivalent in the blunt way that they are used to create and disseminate domestic 'culture'.

What is important to note in this case, however, is that the elimination or relaxation of PIRs on books would primarily affect an author's decision to supply the overseas market (where cultural externalities are not generated), rather than the domestic market where the external benefits of 'cultural valuable literature' are policy relevant! This is because it is the importation of remainders that displace existing domestic sales that will reduce total author income in the absence of PIRs.

Given that there is no necessary correlation between the size of cultural externalities for particular books and the expected size of the overseas market for these books , it is surprising that the Comission supports the retention of a policy that tends to disproportionately benefit those authors who expect large overseas sales, at the expense of domestic consumers.

While this is a crucial point, it seems to be overlooked in parts of the draft report. Consider the proposal to remove PIR protection for educational books, a proposal that is rejected in the report.

The report states that

This option would evidently increase the scope for price competition across the entire educational books market. To the extent that the cultural externalities in significant segments of this market appear to be limited, and the opportunities for low cost sourcing from overseas substantial ... there would be the prospect of a net gain for the community.

However, the boundary between educational and other books is often far from easy to delineate, with many books both read for pleasure and used in an educational context.Books prescribed for literature studies are an obvious example. Also, a significant number of educational texts embody a strong cultural component, with learning assisted by the presentation of ideas and arguments in Australian settings (italics mine).

This issue is irrelevant to the discussion of PIRs for books. Educators and students will be willing to pay a premium for textbooks that appropriately contextualise theory (Australian students of introductory macroeconomics would prefer to purchase a text discussing the RBA rather than the US Fed if they are to be examined on the implementation of monetary policy within the Australian context). These texts will not be affected in any way by the existence or non-existence of PIRs, as these texts are unlikely to have a large expected overseas market.

Let's hope that the Comission gives consideration to these issues in the final report.

Fiscal Policy?

Yesterday, the IMF released a statement, part of which is quoted below:

"Moreover, fiscal policy must play a central role in supporting demand while remaining consistent with medium-term sustainability. The report provides a careful assessment of the fiscal stimulus that is being provided by G-20 countries that suggests that while substantial stimulus is being provided in 2009, additional initiatives will be needed to sustain fiscal support for the global economy in 2010 by countries with fiscal space."

Interestingly, last night an interview on Lateline Business was conducted with Desmond Lachman (ex-deputy director of the IMF's Policy and Review Department). The closing comments of this interview were:

"But right now, it doesn't look good, you know, in the sense that there's no money forthcoming for the banks, and it looks like the fiscal stimulus package, really, was not as front loaded and as well designed as it should have been. The Obama Administration seems to have got sidetracked with a long-term agenda when the short term problems aren't being properly addressed."

Can the same be said about the Rudd's Government $42 Billion Nation Building Package? I think it can, two of my reasons are

1. Bonus payments didn't work properly last time. Arguably, because of the deterioration in economic conditions they are even less likely to work properly now.
2. Most of the initatives listed are described as "Long Term Nation Building Investments".

Negative real interest rates

Let's say that in the current macroeconomic environment a negative real interest rate is required to ensure full employment (ie where desired savings equals desired investment), given that all countries cannot export their way out of recession. One way to generate a negative interest rate is to have the central bank credibly commit to inflation. Greg Mankiw provides another strategy.

Reloading the Weapons of Monetary Policy Some people are concerned that in the the fight against recession, the weapons of monetary policy are nearly out of ammunition. That is certainly the case for the standard monetary weapon--cuts in short-term interest rates. Afterall, short-term interest rates are already about zero, and the Fed cannot cut interest rates below zero.

Or can it? In a discussion at a Harvard seminar recently, a clever grad student proposed a solution to the zero-lower-bound problem.

Let's begin with the basics: Why can't the Fed cut interest rates to below zero?

Why can't the Fed announce, for example, an interest rate of negative 2 percent? You borrow $100 today and repay $98 a year from now. A negative interest rate would certainly encourage people to borrow and spend, thereby expanding aggregate demand. And if negative 2 percent wasn't enough to get the economy going, we could try negative 3 percent. And so on.

The problem, you might reply, is that no one would lend money on those terms. Rather than lending at a negative interest rate, you could hold onto cash by, for example, stuffing it in your mattress. In other words, the interest rate on loanable funds cannot fall below zero because holding cash guarantees a rate of return of zero. If the Fed tried to cut interest rates below zero, money would dominate debt instruments as a portfolio investment.

With this background, I can now state the proposed solution: Reduce the return to holding money below zero. Imagine that the Fed were to announce that, one year from today, it would pick a digit from 0 to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 2 percent. Losing 2 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money by, for example, buying new car. But since expanding aggregate demand is precisely the goal of the interest rate cut, that incentive is not a bug but a feature!

Okay, I understand that this plan is not entirely practical. But you have to give the student credit for thinking out of the box. And his plan does address a fundamental problem facing the economy right now: Given the fall in wealth, increases in risk premiums, and problems in the banking system, the interest rate consistent with full employment might well be negative.

Kill Bill

The alcopops tax has been defeated in the Senate, and as a result premixed spirit drinks will no longer be taxed on the same basis as spirits.

What was the Opposition and Senator Fielding's justification for re-instating this loophole? Was it that:

1. The current rate of taxation on externality generating activities is generally too high (perhaps because of (i) the welfare argument that in an economy already distorted by a high initial level of taxation, it may be efficient to tax these activities at a lower rate than in a distortion free world or (ii) taxes crowd out the intrinsic motivation to internalise externality generating behaviour)?
2. The current rate of taxation on spirits is too high compared to the rate of taxation on other kinds of alcohol (ie volumetric pricing based on the volume of ethyl alcohol across all classes of beverages is wise policy, and the tax rate on spirits should be reduced to match the much lower rate on beer)?
3. There are grounds to treat premixed spirit drinks on a different basis from spirits (eg a lower proportion of externality generating consumers in the case of premixed drinks)?

I haven't seen any discussion of these issues.

Golden handshakes

The Federal Government has announced planned legislation that would require shareholder approval for executive payouts of more than 1-yr base pay.

The ministerial comments reported below, do not make clear what the justification for the legislation is. Is it related to the amount of the termination payment, the relationship (or lack of) between compensation and performance, or both? While the amount of the payment independent of performance is a broader distributional/social norm issue ("community standards"), the Pacific Brands case appears to be more of a traditional corporate governance/separation of ownership and control issue ("good governance").

Swan to curb 'obscene' salaries, The Age, 18 March 2009 . ... "It is very important that we ensure executive pay is in step with good governance ... and meets decent community standards,'' he told reporters.

Mr Swan said in some instances the size of golden handshakes was "obscene''.

"The government will curb golden handshakes in the form of excessive termination payments,'' he said.

Superannuation Minister Nick Sherry cited the example of former Pacific Brands chief executive Paul Moore, who received a bonus $3.5 million retirement payment when he stood down halfwaythrough 2008 financial year despite the company floundering.

Fundamental attribution error

Andrew Leigh has a fascinating post at Core Economics, discussing Lee Ross's 'fundamental attribution error' in the context of the relationship between economic performance and election outcomes

... In a paper that we released last year, Mark McLeish and I showed that Australian state governments were more likely to lose office when the national economy turned sour. To check that our results weren’t being driven merely by the modest contribution that state leaders make to economic performance, we were able to show that our results held up even if we only used a purely unrelated source of growth – the US economy.

Why do Australian voters turf out their state governments when the US economy tanks? The answer seems to lie in something psychologists call ‘the fundamental attribution error’, which is the fact that humans aren’t very good at separating situational factors from ability when making assessments. So for example managers tend to be bad at taking task difficulty into account when assessing their workers, sports fans don’t appropriately adjust for field conditions when judging ability, and shareholders tend to overpay CEOs when the market booms. Consequently, it isn’t all that surprising that voters aren’t very good at separating out the component of economic growth that lies within the control of state politicians from factors outside their control.

CBA homeloan repayment deferrals

The Australian reports that the Commonwealth Bank of Australia has announced deferrals of up to 12 months on repayments for homeowners who lose their jobs. This may cushion the economy from short-term increases in unemployment by preventing customers from falling into arrears on payments and being forced to sell their homes (I have posted on this previously). If, however, house prices fall regardless, eligible homeowners who experience an extended (ie beyond 1 year) period of unemployment may find themselves worse off, as they will be forced to sell in a depressed market, with the interest capitalized on the loan.

Automatic stabilisers

Brace Bradbury is concerned about Australia's relatively weak automatic stabilisers

Is Australian social protection ready for the great recession? by Bruce Bradbury, Club Troppo .. Australia doesn’t really do social insurance. For many years income protection policy has focussed on poverty alleviation rather than protection against negative income shocks. The forthcoming recession might be a time when we begin to regret this model. As the graph below shows, Australian average income workers losing their jobs face a larger drop in income than in most other OECD countries.

... At the macroeconomic level, this suggests that the ‘automatic stabilisers’ will be weaker in Australia than in most other rich countries. At the household level, it will mean greater short-term income shocks than experienced elsewhere. This will play out in terms of mortgage arrears, increased debt and household stress, and perhaps most importantly, political discontent.

What can be done? We cannot build an unemployment social insurance model overnight – and maybe we shouldn’t. But we cannot expect that an income support system based on poverty alleviation will be a suitable response to an economic shock of the size of the one we are about to experience. In the absence of automatic stabilisers manual action is required. Small actions could include further relaxation of liquid assets tests (beyond those won by the Greens) and reductions in Newstart waiting periods. Temporary increases in the payments to Newstart recipients – who have been conspicuous in their absence from government handouts to date - are the most obvious response.

The RBA got it right!

Tomorrow the RBA will release the minutes to the board meeting held two weeks ago. It was at this meeting the RBA decided to hold the official cash rate at 3.25%.

The decision to hold, breaks the pattern of recent months. Since September 2008 the decision at each board meeting has been to cut the official cash rate. In fact the cuts of recent months appear unprecedented in terms of steepness and depth (see graph).

I believe the RBA got it right!

I believe this for a number of reasons. One of the main reasons can be summarised in one word: timing. It is an aspect of monetary policy that is often forgotten.

The influence of the official cash rate on the economy is best described by a phrase coined by Milton Freidman “Long and variable lags”. Specifically, it takes time for inflation (and the economy in general) to respond to changes to the official cash rate. Research indicates that a whole year may elapse before the full effect of a change in the official cash rate may be felt.

This means, the recent cuts, all of which have occurred since September 2008, have yet to exert their full influence over the Australian economy. In fact, only six months has passed since the first cut was made.

Politicians and the convenience of round numbers

What is it about politicians and round numbers? Queensland Premier Anna Bligh committed to creating 100,000 new jobs over three years at Labor's official campaign launch today.

In the last few months, this 100,000 job creation figure has been used elsewhere.

In the UK:

Gordon Brown: I'll create extra 100,000 jobs, by Alastair Jamieson, Telegraph, 22 December 2008. Government spending programmes brought forward to soften the effects of the economic crisis will provide at least 100,000 jobs, Gordon Brown said.

And the US:

Salazar Says Interior Stimulus to Create 100,000 Jobs, by Daniel Whitten, Bloomberg, 20 February 2008. U.S. Interior Secretary Ken Salazar said a department “stimulus czar” and task force will help direct the spending of about $3 billion in economic-recovery funds, which may create 100,000 jobs.

China's holdings of U.S. debt

Chinese Premier Wen Jiabao has expressed concerns that the U.S. government's attempts to stimulate economic activity may result in a reduction in the value of U.S. Treasury bonds, as the U.S. dollar weakens and U.S. interest rates rise. The Wall Street Journal reports on the U.S. government's response.

U.S. Insists China Fears Over Debt Unfounded By ANDREW BATSON, ANDREW BROWNE and MICHAEL M. PHILLIPS, Wall Street Journal, March 13, 2009. The Obama administration rejected China's concerns that its vast holdings of U.S. assets might be unsafe, in an unusual diplomatic exchange that underscored the global importance and the potential fragility of the Sino-U.S. economic relationship.In a coordinated response to blunt comments from ChinesePremier Wen Jiabao, White House officials said Friday that Mr. Obama intends to return the country to fiscal prudence once the crisis passes.

"There's no safer investment in the world than in the United States," said presidential spokesman Robert Gibbs.

That view was reiterated by the president's chief economic adviser, Lawrence Summers, who defended record U.S. deficit spending as a salve to the nation's economic woes. "If you don't prime the pump and you allow the processes of decay and decline and de-leveraging to continue, it's much more costly to do it later," he said.

The U.S. offensive came after Mr. Wen said earlier Friday in Beijing that China is worried about its huge stock of U.S. Treasury securities, an ominous warning given U.S. reliance on Chinese borrowing.

"We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets," Mr. Wen said in response to a question at his annual news conference.

"Frankly speaking, I do have some worries."....

Mr. Wen's public airing of his concerns -- and the U.S. government's fast response -- highlight China's extraordinary role in the U.S. economy as the largest holder of U.S. Treasury debt. For years, the U.S. has tried to strong-arm China into allowing the yuan to rise and liberalizing its financial system. But in the last year, Beijing has become increasingly vocal about what it sees as U.S. economic mismanagement making U.S. investments riskier....

The premier's comments were unusually pointed and raised the possibility that Beijing's appetite for U.S. debt could wane. In the worst-case scenario, a significant new aversion to U.S. investments could drive down the dollar and drive up interest rates, worsening the U.S. recession. Mr. Wen indicated China wouldn't be rash in making changes to its $1.946 trillion stockpile of foreign reserves. While China is looking out for its own interests, it will "at the same time also take international financial stability into consideration, because the two are inter-related," he said......

In September, China surpassed Japan as the largest foreign holder of U.S. Treasury debt. As of December, it owned $727.4 billion in such securities, according to the latest Treasury Department data. That marked a 52% increase from a year earlier, according to the Treasury, whose figures are thought to understate China's stock of U.S. government securities.

China also has limited options for its investments-outside the U.S., there aren't many other assets that can soak up the amount of capital it needs to invest.....

Greenhouse gas emissions and policy instruments

Ross Gittins writes in today's The Age on the relative merits of taxes versus permits.

To cut emissions start by capping windy economists, by Ross Gittins, The Age ... According to a growing band of economists, we'd be better off using a carbon tax to reduce greenhouse gas emissions, not the emissions trading scheme the Rudd Government introduced to Parliament this week......

(I)f there's a reason for economists preferring one system, I think it's which objective they give higher priority: minimising economic cost or maximising environmental certainty.

If your concern is emissions reduction you control emissions quantity; if your concern is minimising economic loss then you control emissions price.

These last two sentences provide a potentially misleading picture of how economists think about greenhouse gas emissions and policy instruments to reduce these emissions.

1. When economists consider the "economic" costs of pollution or pollution control, they not only include the costs of pollution abatement. They also include the costs of environmental damages such as health impacts, lost output from climate change, lost producer and consumer surplus from degradation of environmental resources and amenities etc. As is often the case, if economists are interested in minimising the (unweighted) sum of these costs (formally, this occurs at the level of emissions reduction where the marginal costs of abatement equal the marginal benefits from abatement), policy prescriptions do not depend on economists' vision of a good society, or "which objective they give higher priority".

2. While permits do minimise uncertainty with regards to the level of emissions reduction (with taxes, the level of emissions reduction depends on polluters own cost-benefit calcuations), they do not "maximise environmental certainty". Uncertainty with regards to how rapidly atmospheric greenhouse gas concentrations will grow given the expected level of future greenhouse gas emissions with and without emissions reduction, and how higher greenhouse gas concentrations will affect global temperatures, is a given regardless of which policy prescription is adopted.

3. Taxes and pollution permits are equivalent policy instruments if there is no uncertainty with regards to pollution control costs. If the optimal number of permits are issued, the price will be bid up to the level of the appropriate (Pigouvian) tax. The choice of policy instrument will only yield different outcomes if uncertainty exists. In this case, following Martin Weitzman's classic 1974 paper in the Review of Economic Studies:
- Permits will be preferable if the marginal benefits from emissions reduction are highly sensitive to the actual quantity of emissions (such as the case of tipping points in the case of hazardous waste, when small changes in emissions have a large effect on environmental damages); and
- A tax will be preferable when the marginal abatement or pollution control cost increases sharply with emissions reduction (in this case incorrect costs estimates and subsequent excessive or inadequate supply of permits will have a large effect on total costs); therefore
- If the absolute slope of the marginal cost of abatement curve is greater than that of the marginal benefit from emissions reduction curve, taxes will lead to higher social welfare than will permits.

Of course, many of these issues are empirical in nature, and policy makers often lack the required information. I share Mr Gittins concern that, given the possible existence of tipping points in relation to greenhouse gas emissions and their impact on the environment, an emissions tax would lead to too little emissions reduction if the costs of abatement are higher than policy makers expect.

Cost? What cost?

Mark Thoma spots an absolute howler on Fox News.

Republicans Propose 'No Cost' Stimulus, Fox News: SEAN HANNITY, HOST: And in "Your America" tonight, another economic plan is also emerging tonight. The Republicans have proposed an alternative to the president's $787 billion stimulus package, and it costs a little bit less. Zero dollars. And it also promises to create two million new jobs without any of your money.

Hmmm, a 'no cost' stimulus?

JOHN SHADEGG (R), ARIZONA CONGRESSMAN .... With unemployment rates going up how can we produce American jobs? And the answer is we have had a non-energy policy in this country for a very long time. The reality is we are giving jobs to oil fieldworkers and natural gas fieldworkers in Russia and Saudi Arabia and Venezuela, when we should be putting those people to work here in the United States.

It doesn't matter how you define costs: explicit production costs, implicit opportunity costs of the resources involved in production, environmental costs. etc, there is no such thing as a 'no cost' stimulus to economic activity. On the opportunity cost story, while there are idle resources in the US economy, opening the Arctic National Wildlife Refuge to oil exploration will require specialised resources that will be diverted from other activities, reducing the net number of jobs created.

Encouraging home ownership during a recession?

The proportion of dwelling purchases financed by first-home buyers has increased to the highest level since records started in 1991. Undoubtably, the State Government's First Home Owner Grant scheme and the Australian Government's First Home Owner Boost Scheme have contributed to this result. From a policy perspective, is this a positive outcome during difficult economic times, with the expectation of worse to come? There is reason to suggest that the Federal Government should not extend the boost beyond June 30.

The positive impact that the induced increase in building activity has had on economic activity needs to be balanced by concern for first home buyers who find themselves taking on more debt than they otherwise would. Consider the following graph on housing affordability from the RBA.




There are three factors that drive changes in the measure of housing affordability: home prices; household incomes and interest rates. The decline in housing affordability from the mid-1990s until the mid-2000s largely came about through an increase in house prices. The recent improvement in housing affordability in Australia has come primarily from lower interest rates.

While in the past real incomes were increasing so that households were able to devote a greater share of income to housing, the situation today is dramatically different. If the level of unemployment increases and average household disposable income falls in the months ahead, measured household affordability will decline and, unlike in the mid-1990s to the mid-2000s, this can be expected to have real implications for levels of mortgage stress and arrears. (In the past, the latter was not an issue, primarily because of relatively low levels of unemployment and growth in real incomes.) This in turn may have implications for house prices in areas dominated by first home owners.

Will a temporary downturn in economic activity have any significant impact on relatively young households' ability to pay off a home loan over the life of the loan? Possibly. Studies (see here and here) suggest that temporary macroeconomic shocks can have persistent effects. The timing a of person's entry into the labour market appears to have an impact on his or her lifetime earnings. If this year's first home buyers are also new entrants into the labour market, the Federal government is encouraging households to take on debt precisely when their capacity to repay debt is diminished.

Lies, Statistics and Employment Data

Earlier today the Australian Bureau of Statistics published employment data relating to the month of February. Recent budget cut-backs however makes the data unreliable.

Last month in an interview conducted on ABC's PM program the February release of employment data was critically analysed. The critical analysis was a direct result of figures indicating the (full-time) employment and participation rate had actually increased. These results startled many economists as it contradicted all the information published leading up to the release. Specifically, it showed the number of employed had increased by 1200.

How can this be possible?

The explanation of this result can be attributed to statistics. More specifically, the lack of (federal Government) appreciation for robust statistical analysis. Closer examination revealed that employment may have decreased by as much as 60 000, or possibly gained nearly 62 000. The reason for this imprecision is sampling error. The reason for the sampling error was a cut to the budget of 24% which meant the ABS slashed the size of the labour survey. The coverage is now nearly half of what it was the same time last year (down to 0.24 from 0.45)

Does it matter?

Yes, for three reasons:

1. Employment data is one of the most featured variables in gauging economic well being.
2. Without reliable employment data it is much harder to critically assess Government policy. That is transparency and accountability suffers.
   
3. The information is disseminated all over the globe so that governments and businesses can use this information in decision making.
   

Therefore, it is absolutely imperative that when employment data is published it is reliable. The current arrangements mean it is not. I believe this damages the reputation of the Australian economy and possibly even raises questions about its integrity.

Appropriate fiscal stimulus, and Ricardian equivalence

My colleague, Professor Sinclair Davidson, is now posting at catallaxyfiles. He draws attention to a summary of a new paper by Matthew Shapiro and Joel Slemrod in the latest NBER digest.

In Did the 2008 Tax Rebates Stimulate Spending? (NBER Working Paper 14753), Matthew Shapiro and Joel Slemrod analyze evidence from a rider on the University of Michigan Survey Research Center’s Monthly Survey, also known as the Survey of Consumers, which was included each month from February through June 2008. The rider asked: “Thinking about your (family’s) financial situation this year, will the tax rebate lead you mostly to increase spending, mostly to increase saving, or mostly to pay off debt?” Only one-fifth of the survey respondents said that the 2008 tax rebates would lead them to mostly increase spending. Most respondents said they would either mostly save the rebate or mostly use it to pay off debt. The most common plan for the rebate was debt repayment.

These responses imply that the aggregate marginal propensity to spend from the rebate was about one third and that there would not be substantially more spending as a lagged effect of the rebate. Because of the low spending propensity, the rebates in 2008 provided low “bang for the buck” as economic stimulus, Shapiro and Slemrod conclude. Low- income individuals were particularly likely to use the rebate to pay off debt. Shapiro and Slemrod speculate that adverse shocks to housing and other wealth may have focused consumers on rebuilding their balance sheets. The authors note that, given the further decline of wealth since the 2008 rebates were implemented, the impetus to save a windfall might have become even stronger since their survey was conducted.

The overall results, that the rebate provided a very limited stimulus to aggregate demand, are similar to those found in Shapiro and Slemrod's study of the 2001 US federal income tax rebates. This earlier study is interesting for a number of reasons.

1. They found, somewhat counterintuatively, that individuals who were most likely to be liquiditiy constrained (i.e. lower income) were more likely to mostly save, rather than mostly spend, the rebate.
2. They found that the propensity to spend the tax cut was not associated with expectations of lower government spending. As a result, Barro/Ricardian equivalence, whereby a temporary reduction in taxation will not lead to an increase in aggregate demand (as Ricardian consumers will save more now to compensate for the higher taxes or lower government spending they expect to face in the future), was not supported.

In the Australian context, these two points reinforce the importance of direct government spending in stimulatating economic activity. Of course, even if Barro/Ricardian equivalence holds with regards to an increase in government spending, such an increase in spending can still be expected to generate an immediate increase in aggregate demand. This is because if there is a given increase in government spending of $X this year, consumers will not need to internalise the entire present value of the future tax liability this year. As a result the immediate offsetting reduction in consumption will be less than $X, ensuring an immediate, positive impact on aggregate demand from the increased government spending.

The Great Multiplier Debate

Menzie Chinn at Econbrowser comments on a post by Greg Mankiw, who cites a study by Cogan, Cwik, Taylor, and Wieland that suggests that fiscal multipliers are small, especially when considering New Keynesian models. According to the authors:

We first show that the assumptions made by Romer and Bernstein about monetary policy -- essentially an interest rate peg for the Federal Reserve -- are highly questionable according to new Keynesian models. We therefore modify that assumption and look at the impacts of a permanent increase in government purchases of goods and services in the alternative model. According to the alternative model the impacts are much smaller than those reported by Romer and Bernstein.

Cogan et al. use a New Keynesian dynamic stochastic general equilibrium (DSGE) model. Chinn then contrasts these results to result obtained from the IMF's New Keynesian DSGE (The Case for Global Fiscal Stimulus).

...the effect on U.S. GDP of investment expenditures is 3.9 when there is global fiscal expansion and only 2.4 when the United States acts alone. Similarly, the effect on Japanese GDP of targeted transfers is 1.5 when there is global fiscal expansion and only 1.0 when Japan acts alone. Differences in multipliers across regions relate to the size of leakages in the different areas, including leakages into saving and imports.

Chin then asks "The obvious question -- why the disjuncture? They're both New Keynesian DSGEs?" , and provides an explanation:

I think New Keynesian DSGEs -- like any other large models incorporating many equations -- can yield differing results depending on the assumptions made, some of which might seem inconsequential or conventional; what I have in mind include those assumptions regarding the nature of asset markets..... (j)ust because a model has microfoundations, intertemporal optimization, model consistent expectations, and so forth, doesn't mean it necessarily provides more plausible estimates. It matters what assumptions are made (is "complete asset markets" a good assumption, for instance? And if they were three years ago, are they still now? And I'll bet the proportion of "rule of thumb consumers" or "liquidity constrained consumers" is probably higher now than three years ago...).

What do "complete assets markets" have to do with fiscal policy effectiveness? If asset markets are imperfect, in that some households would like to borrow but cannot find credit, then these households will adjust consumption to temporary changes in lump sum payments. As I suggested in a previous post, as borrowing constraints will have the largest impact on those closest to the constraint, it is no suprise that lump sum payments targeted to relatively poor households tend to exhibit relatively larger multipliers. It is precisely these households that tend to exhibit rule-of-thumb consumption behaviour, as opposed to consumption consistent with the permanent income hypothesis.

Are we in a recession? Probably!

The definition of a recession is arbitrary. The common definition of two consecutive quarters of negative growth in real GDP is but a ‘rule of thumb’. Interestingly, as recent as 2001 the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) declared a recession despite not observing two consecutive quarters of negative growth (www.nber.org/cycles/recessions_faq.html).

So an interesting question is, from where did this definition originate?

It appears that the definition dates back to 1974. Julius Shiskin¹, in an article published in the New York Times suggested there are three characteristics of a recession, duration, depth and diffusion. Two quarters of consecutive negative growth is but one of two criteria relating to duration. Arguably, many of the features suggested by Shiskin are not relevant to the modern era. (It is important to note that at the time of this article the world economy looked remarkably different from what it does today.)

Therefore, how do we know whether we are in a recession?

More recently, Lakshman Achuthan and Aniran Banerji of the Economic Cycle Research Institute argued that GDP should not be the sole means of identification. They argue that a recession is characterised by a pronounced, pervasive and persistent downturn in a broad set of measures. These measures include jobs, income and spending.

Is Australia in a recession?

It is undeniable that recent economic data show a pronounced and pervasive downturn in the broad measures of the economy. Arguably this downturn has been persistent also, given the first signs of a downturn began in September of last year. Therefore, I suggest, we are in a recession.

However, I strongly believe, a debate about whether we are in a recession is futile. The fact is that the economy is in trouble (GDP down 0.5% according to figures released last week). Also, the future looks bleak given the plight of our economic partners. Therefore, it is absolutely necessary that government policy (proposed or otherwise) be critically assessed.

It is my opinion that the policies and ideas suggested by the federal Government are less than inspiring. Furthermore, I believe the Opposition has not been as effective as they need to be in presenting a sound alternative. The end result being, we are likely to experience a downturn more pronounced, pervasive and persistent than should otherwise be.

The demise of fractional reserve banking in the United States

The Demise of Fractional Reserve Banking, via Mark Thoma

We don't have fractional reserve banking anymore.

In statistics-speak, since last November, the monetary base has exceeded M1, which means, more or less, that bank reserves (plus surplus vault cash) exceed liquid deposits

What about the Australian experience? There has been a significant decline in the money multiplier in Australia since last October. Utilising RBA data on the money base and M1, the money mutiplier (M1/money base) from January 2000 - September 2008 averaged 4.5, with a minimum of 4 in December 2002. The multiplier fell from 4.7 to 3.8 from September 2008 to October, then to 3.5 in November and 3.2 in December.