Wednesday, June 17, 2009

Hockey jettisons his credibility

"To convey the impression that this minor rate rise is just the first of many, Hockey was willing to bamboozle the public with a patently false economic argument. His argument about the effect of government borrowing on interest rates is simply wrong." - Gittins.

Gittins' full column is here.


John Humphreys said...

Gittens is of course correct that we are now in an open economy, so the adjustment to the fiscal policy will be primarily through the exchange rate (and lower net exports) instead of the interest rates (and lower investments). However, for this to be fully true, the supply of loanable funds must be perfectly elastic.

I think this is an important open question that Gittens (and Martin, and other Keynesians) should answer: do they think the supply of loanable funds to Australia is perfectly elastic?

Gittens is of course correct that Australian borrowing is a small percentage of global borrowing. However, different country debts are not perfect substitutes. It is possible that there is a limit to how much foreigners want to lend to Australia at any fixed interest rate. This creates a sub-question for the Keynesians -- do they really think all debt is perfectly substitutable?

While such assumptions (perfect elasticity, perfect substitutes) are useful for creating basic models and explaining economic concepts, we must keep in mind that the world is generally more complex than a model.

Anonymous said...

Kettle meet Kevin Rudd.

Wil said...

Hockey 'jettisons' credibility. Oh yeah, you are inferring he had some?

Peter Martin said...


John Humphreys said...

Peter -- I was wondering if you could share your views on the elasticity of supply of loanable funds from the international money markets to Australia. Do you think it's perfectly elastic?

Peter Martin said...

Are you asking me if I think that markets are perfectly efficient?

Not always. But they can often be pretty efficient.

I haven't thought about the particular question.

Anonymous said...

No. The quesion is about the elasticity of loanable funds - not whether the market is efficient. Market efficiency makes no assumption about that elasticity.

Peter Martin said...

No, but the price elasticity of supply depends on the efficiency of the market (at least at the extreme case that you are talking about).

If the market was inefficient the supply would not be perfectly elastic.

Anonymous said...

You don't really know what you're tlking about do you? Just come ut and say, 'my bad'.

Andos said...

If you want to abuse the author of this blog, at least use a handle of some kind instead of being a cowardly 'anonymous'.

Do you have a problem with Peter because he isn't supporting your neo-liberal ideologies, or just because you're bored?

Anonymous said...

All we want is for Peter to be honest - is that too much to ask? How does that constitute 'abuse'? Please explain pseudonomous person 'Andos'. Peter might want to contribute in his own defence.

badm0f0 said...

"We" want the truth that reflects the world "we" believe exists. "We" are very insecure in our beliefs so "we" don't tolerate anything that diverges from the truth as "we" know it.

John Humphreys said...

Peter, thanks for the response. I certainly agree with you that markets aren't perfectly efficient. However, my question was just about whether the supply of loanable funds is perfectly elastic.

That isn't related to the efficiency of the market. It is possible for a perfectly efficient market to have a high or low elasticity... and it is possible for an inefficient market to have a high or low elasticity.

I'm surprised you say you hadn't thought much about the supply elasticity of loanable funds. This is the key issue in determining whether the government borrowing will come at the expense of private borrowing, or whether the money will come from overseas.

My reading of your answer is that you don't think the supply of loanable funds is perfectly elastic, and if so then I agree with you. (Though I do accept that it is highly elastic.)

That leads to the conclusion that the government borrowing is (to some degree) putting upward pressure on interest rates.

I'm not sure if this has been reflected in your previous writing on the issue.

The big question now is whether banks will respond by increasing their credit multiplier (ie decreasing their capital-asset ratio). Given the nature of the current crisis, I doubt it. And, of course, unless they do increase their lending (relative to what they otherwise would have done), then the entire stimulus package will have no effect on the size of the economy.

Peter Martin said...

Thinking about it John, for all either of us know the supply of funds could be super elastic (the price elasticity could be greater than 1). Most likely it'll be either somewhat greater or somewhat lower than 1 - not perfectly elastic but something else.

The point I was getting at was the pracical one raised by Hockey.

Did decisions about Australian government debt "directly" cause the Commonwealth Bank to push up each of its mortgage rates by 10 basis points.

You say that the that Australian government borrowing "is (to some degree) putting upward pressure on interest rates."

The question is - the degree.

Spitting into an ocean will (to some degree) raise its level, but not to a significant degree, and certainly not to the oceanic equivilant of 10 basis points.

John Humphreys said...

G'day Peter, and thanks again for taking the time to respond. I think there may be some misunderstanding about elasticities. Perfectly elastic does not mean an elasticity of 1.

I think the elasticity is almost certainly significantly greater than 1. If the elasticity was 1 then the government borrowing would almost certainly lead to higher interest rates.

The open question is whether the elasticity is infinite (ie perfectly elastic) or simply high.

I agree with you that Hockey was over-stating his case. Though I think the "spitting in an ocean" analogy is under-stating the issue.

Peter Martin said...

How much of the Commonwealth Bank's 10 points rate hike do you think was caused by the Australian government's announcement of its borrowing program?

Pete (not Peter Martin) said...

(You say that the that Australian government borrowing "is (to some degree) putting upward pressure on interest rates.")

Oh and it is. Ross Gittins is a fool.

Does he think the supply of capital is inexaustible? Does he think that lenders will lend to Australia indefinitely?

The more our Gov borrows, the more risk there is that it will have difficulties paying it back. That means RISK.

Higher risk of lending = higher rates.

Every dollar that the Gov borrows is a dollar that COULD have been used for investment elsewhere - eg, being lent to banks.

The exact 'degree' of effect is virtually impossible to measure. You can use a 'spitting into the ocean' measure, but I don't think that it reflects reality. The 'ocean' of credit could dry up exponentially as risk increases, yet the 'spit' will remain constant (without inflation).

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