The New Economy and the Dollar Puzzle: the Case of Australia

The revolutionary changes in information technology (IT), globalisation and financial innovation have overturned the Solow productivity paradox and spawned a New Economy (NE) in Australia in the late 1990s. Both growth accounting estimates and the use of the information superhighway ranks Australia next to the USA as a NE. Australia is an avid user but not a producer of IT that propels the NE. The debate on the need for a new paradigm for the new economy on the grounds that key mechanisms of the old paradigm have become obsolete is reviewed. The breakdown of the short-run Phillips curve tradeoff and the redundancy of the long-run speed limits to growth are examined and dismissed as poppycock both on theoretical and empirical grounds. The IT technology because it is subject to severe diminishing returns and problems of information overload fails to rank with the great inventions of the past and will not be a harbinger of the Third Industrial Revolution. Nonetheless, on the basis of the 'delay hypothesis' the dismissal of the case for a new paradigm for the NE may be premature at this stage. The paper also examines the puzzling nose-dive of the dollar during the first half of the year 2001. This occurred despite the strong macroeconomic fundamentals and the emergent NE. The paper concludes commenting on the policy reaction function for a small open NE committed to inflation targeting.

The Polemics and Empirics of the Sustainability of Australia’s Current Account Deficit - Revisited

In this paper the polemics and empirics on the sustainability of Australia’s high current account deficits and foreign debt that prevailed during the period 1959q3-2007q1 is revisited. The paper contends that the forces of globalization brought about a policy regime shift culminating in the floating of the Australian dollar in 1983q4. However, the policymakers failed to abandon the static old paradigm, the Keynesian-Mundell-Fleming model, which had been rendered obsolete by the policy regime shift. The policymakers continued to distill their activist policies to reduce the high current account deficits from an outmoded paradigm. The proponents of the rival new paradigm argued that the current account imbalances were the residual outcome of rational optimizing decisions of private sector agents and therefore the use of activist policies to target the reduction of the current account deficits as proposed by the adherents of the old paradigm were misconceived. The ensuing clash between the proponents of rival paradigms fuelled the policy polemics during almost a decade after the paradigm shift that occurred at the same time as the floating of the exchange rate. The activist policies failed to halt the rise in the current account deficits and foreign debt and the predicted dire economic consequences from the failure to rein in the current account deficit never materialized. Today, the current deficits and the foreign debt are at record high levels by historical standards, but they do not seem to grab the attention of the policymakers or make media headlines as in the past. The empirical results offer qualified support for prevalence of consumption smoothing during both the pre and post-float periods. The finding in favour of consumption-smoothing during the pre-float era is at odds with the findings of other studies. There appears to be evidence supporting the hypothesis that a regime-shift due to globalization and it occurred at the same time as the float and was reflected in an increase in consumption-tilting. Post-float and during the entire study period Australia, appears to have satisfied the intertemporal budget constraint and remained solvent. Furthermore, both over the whole sample period and post float period Australia appears to have engaged in effective consumption-smoothing notwithstanding the polemics and some empirics to the contrary. The solvency and consumption smoothing dynamics observed for Australia during the study period supports the new paradigm’s non-activist policy stance towards high current account deficits. However, it should be noted that this passive policy stance that is intertemporally optimal for achieving current account sustainability in Australia may not be applicable in other countries with high current account deficits because they may idiosyncratic features that differ widely from those prevalent in Australia.

Maverick Firms: An Exploratory Analysis of Mortgage Providers in Australia

Globalisation can be described as a dynamic process that links the economy of a nation with the world economy through economic and non-economic forces. In this paper I shall confine myself to the economic forces of globalisation and in particular to cross-border capital flows. The process of globalisation has its origins in antiquity but recent innovations in information and communications technology has speeded up the process and also heated up the controversies surrounding the costs and benefits of globalisation. In this paper I propose to use some well tested simple economic models to examine in a cool manner some of the hot topics of economic globalisation. Economists have a remarkable propensity to disagree among themselves and this came to the attention of the literary icon Bernard Shaw and irked a US president demanded advice from the non-existent one-handed economist. Well economists disagree because there are many good ways to skin a cat. Economists use models to analyse complex problems and give answers that may be technically correct. But just like the answer given to the hot-air balloonists who got lost and asked directions, the answers may be technically correct but not operational ( a famous joke about economists). To make the answers operational it is necessary to interpret the answers in the light of country specifics.

Microeconomic Reform and Technical Efficiency in Australian Manufacturing

The technical efficiency dividend reaped by Australian manufacturing industries following the implementation of microeconomic reforms over the past three decades is analysed empirically in this paper. The technical efficiency scores have been estimated for manufacturing industries using a combined stochastic production-frontier inefficiency model that is free of simultaneity bias. The model parameters have been estimated using maximum likelihood techniques using a panel data set covering a cross-section of 8 industries spanning a time-series of 26 years (1969-1995). The empirical results shed light on how technical inefficiency in manufacturing has been whittled down by the microeconomic reform induced trade liberalisation and technology diffusion processes. Generalised likelihood ratio tests reject the null hypotheses that trade liberalisation and technology transfer had no significant impact on the reduction of technical inefficiency. The reduction of effective rate of assistance and technical efficiency and technology proxies such as intra-industry trade and capital deepening are negatively correlated during the study period. These findings give credence to the predictions of endogenous growth theories that openness of the economy provides a conduit for accessing new technology that promotes innovation and technical efficiency. The increase in technical efficiency of manufacturing industries is the unsung hero behind the emergence of the 'new economy' or the spectacular pick-up of productivity growth observed for Australia during the 1990s. The error-correction modelling reported at the outset confirms that this productivity pick-up is not an artefact of a cyclical upturn. It is attributable to the microeconomic reforms and the technology transfer that has followed it. The paper concludes on the need for further research , first, to shed light on the constituents of total factor productivity such as technical change and technical progress and second, to design policy to address the challenging issues of equity-efficiency trade-off lest it degenerates into a back-lash that could nullify the whole reform agenda.

Microeconomic Shocks, Depreciation and Inflation: an Australian Perspective

The general equilibrium approach demonstrates that macroeconomic shocks link the exchange rate and the inflation rate through diverse transmission channels. Therefore, the one-track focus of the partial equilibrium 'pass-through' approach that predicts that exchange rate depreciation causes inflation is flawed does not explain the exchange rate inflation dynamics of post-float australia. In this paper based on a mundell-fleming stochastic rational expectations model the theoretical priors that link exogenous shocks and macro-variables such variables real exchange rate, relative prices and relative output have been identified. Thereafter, the structural var (svar) methodology has been deployed to the identify the exogenous shocks by appealing to the long-run classical neutrality postulates. The dynamic interactions between shocks and macro-variables have been empirically reviewed using innovation accounting.

Inflation Targeting Macroeconomic Distortions and the Policy Reaction Function

The paper examines the evolution of monetary policy design in Australia over the past quarter of a century culminating recently in the adoption of an inflation targeting approach through the institutional mechanism of CBI (Central Bank Independence). Cross-country empirics have repeatedly confirmed the stylized fact that high CBI delivers low inflation. This study covers new ground by using time-series techniques to test the nexus between CBI and inflation using Australian quarterly time-series data for the sample period 1973Q3-1998Q4. The theoretical analysis based on a quadratic social loss function subject to a Lucas supply curve demonstrates that the exclusive focus on the institutional mechanism of CBI to reduce inflation bias may be flawed because it ignores the spillover effects of macroeconomic distortions on inflation. Time-series composite indices were constructed to proxy CBI and macroeconomic distortions in the labour market, the tax system and in the arena of international competition. The general-to-specific methodology was applied to sequentially derive a parsimonious VECM (Vector Error Correction Model) linking CBI and macroeconomic distortions to inflation during the study period. Granger causality tests indicated that both CBI and macroeconomic distortions Granger caused inflation. The VECM empirics revealed that CBI and neocorporatism contributed in a significant manner to reduction of inflation during the study period. The fact that neocorporatism curbed inflation during the study period raises the issue that the industrial relations reforms agenda aimed at eroding neocorporatism are politically motivated and lack an economic rationale. However, when the link between inflation and neocorporatism was reanalyzed taking feedback effects into account using the VAR methodology a different picture emerged. The impulse response functions revealed that an increase in neocorporatism exacerbated inflation in the short run. Thus the VAR empirics therefore provided a rationale for the labour market reforms aimed at rectifying labour market distortion attributed to neocorporatism. Both the VECM and VAR empirics make a strong case for tax reform in order to reduce welfare payments without compromising on safety net and equity issues. It also makes a case for reducing the volatility or the real exchange rate to sharpen Australia's competitive edge. The significance of macroeconomic distortions in causing output to deviate from potential underscore that the policy reaction function is influenced by distortions. Non-nested tests revealed that the Taylor rule taking account of deviations of output from potential due to macro distortions was superior to an inflation rate only rule. Therefore the study results recommend that policymaker (Reserve Bank of Australia) should pursue a Taylor rule rather than inflation rate only rule in smoothing the overnight cash rate to achieve the pre-announced inflation target.

Rival Macroeconomic Models And Australian Stylised Facts

This paper reports the stylised facts resulting from the tests of rival macroeconomic models in explaining the Australian business cycle during the sample period 1966(3)-1995(3). The dominant rival paradigms such as the New Classical, Keynesian the Real Business Cycle theories have been tested using both Granger causality and non-nested testing techniques. The time-series data used for modelling the rival paradigms were processed using unit root and cointegration econometrics to guard against possible spurious regression inferences due to nonstationarity in the data. Parsimonious data congruent models for testing the rival paradigms were derived by the application of the general-to-specific methodology. The problem of non-spherical errors created by the use of generated regressors in the specification of business cycle models was tackled by replacing ordinary least squares by generalised least squares estimates. The empirical results supported the conclusion that hybrid macroeconomic paradigms encompassing both demand and supply side shocks provide more plausible explanations of the Australian business cycle than tests narrowly focussed only on demand side shocks. The study results challenges the narrow view that rival macroeconomic theories would have failed to provide meaningful guidelines to Australian policymakers to implement counter-cyclical policies during the study period.

Regime-Shifts & Post-Float Inflation Dynamics In Australia

Australia’s inflation rate and inflation uncertainty during the post-float era 1983Q3-2006Q4 have acted as important barometers of Australia’s macroeconomic performance. The conceptualisation and measurement of the nexus between inflation and inflation uncertainty is subject to complex dynamics. We use Markov regime switching heteroscedasticity (MRSH) model to capture long-run stochastic trend and short-run noisy components. This allows us to conclude that in post-float Australia the results deviate significantly from the mainstream Friedman paradigm on inflation and its uncertainty. We also critically review the plausibility of rival paradigm explaining this paradoxical behaviour. The regime shifts detected in the inflation dynamics appear to be linked to the macroeconomic policies pursued to achieve external and internal balance as implied by Keynesian Mundell-Fleming model.