Matt Nolan

Is the business sector in retreat: An alternative view

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Business and consumer confidence is at concerning low levels. Furthermore, there is now a general consensus that we are in a recession.

However, something feels strange. A boost in petrol prices and a drought are the factors smashing our economy – the drought is temporary and people seem to be responding strongly to the change in fuel prices.

In fact, the value of fuel sales only rose 0.1% over the three months to May, while the price of petrol rose 7.3% and diesel rose 16.2% (thank you MED and Stats). The more that people can substitute away from the use of fuel, the less impact it has on their spending power.

But our focus here isn’t households, its businesses. The rising fuel, energy, labour, and other input costs must be tightening their margins. With consumer spending languishing, there must be blood on the wall – right? I currently feel that it is looking this way, but I’m going to put down a more positive alternative point of view anyway 🙂

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Matt Nolan

Diminishing marginal utility of income and “big ticket” items

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One of the main justifications for redistribution policies is “diminishing marginal utility”. We have already discussed that this doesn’t really make sense as we can’t compare peoples “utility”. For example, people that receive higher utility from consumption will work more and thereby will earn a higher income – from here we cannot tell whether the change in welfare from taking a dollar off them and giving it to someone who earns less will be positive or negative.

Furthermore we have the fact that two people with the same lifetime income level the person with a more variable annual income will be taxed more than people who do not have a variable income – implying that DMU does not work as a defense here!

However, there is a further complication to the DMU story. Even if everyone has the same “utility function” we cannot necessarily assume that marginal utility will be diminishing in income.

Why? Well because of the cost of “big ticket” items and the increased use of services like Clever Shop List to pay for them. Read more

Matt Nolan

Money supply, leading indicators, and recessions

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Not PC has a very interesting post on identifying recessions. Using a special measure of the money supply as a leading indicator he shows that a large fall in this measure usually implies a recession (*).

This makes sense as a recession is a time when money demand falls rapidly. As the stock of money is determined by an exogenously set price and a money demand curve we would expect “money supply” in this stock sense to fall rapidly.

I disagree with his articles conclusion in the current monetary policy context (“the expansion and contraction of the money supply is the single greatest factor in causing booms and busts“) – but I do think that the method he points out is extremely clever. It is also a welcome reminder that monetary aggregates still give us some information – even if the information is all mixed up by definitional errors and technological change 🙂

Matt Nolan

NZ inflation hits 4% – Ouch

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Other people have more to say about today’s inflation result than I do (Interest blog) (the Standard) (Tumeke). Really, today’s result was pretty much what everyone was expecting – except for a stronger than expected increase in food prices (thanks to a mix of meat and fruit and veges). However, this slight uptick does make my 5% pick for September less extreme 😉

Also for all those people saying that it is only a tradable story – non-tradable inflation was 3.4%. This included some subsidies in education and health last September (so a price level shift), implying that the true rate of non-tradable inflation (growth in price level) was closer to 3.7-3.9%. Yuck.

If you have any questions about today’s inflation result, shoot – however, I won’t be checking my emails for about 27 hours from 5pm today so you better make it quick. (At least one pre-written post will magically appear tomorrow though, thanks to the magic of wordpress 🙂 )

BTW:  If you are interested in inflation, don’t forget about the inflation debate series – we are nearly up to inflation targeting, yippee.

Matt Nolan

The individual rationality of buying small cokes/chippies

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One of the most vexing questions in economics has to be why the price of a 330ml coke is often only slightly less than the price of a 1.5l coke. This issue generalises to other products such as chippies.

Now there are a number of good responses, namely:

  1. Strongly diminishing marginal utility for fresh coke and a very low value on saved coke (or a relatively high cost of storage),
  2. A 330ml bottle is easier to consume than a 1.5l bottle – as a result the value of the 330ml bottle may be higher for people on the move, and so they are priced to service different markets.
  3. The cost of producing a 330ml coke is far more than a 33/150th of the cost of producing a 1.5l coke

These answers seem to satisfy me when I think of coke. However, when I think of chippies I find this explanation sadly lacking.

Downstairs I can buy a little bag of chippies for $1.50 or a far bigger bag of chippies (x3) for $3.00. I always buy the little bag.

Now I will do this each day, and don’t get any less value from 3 day old chippies than I do fresh chippies. Furthermore, I am eating them at work – implying that there is no storage cost and no convenience benefit.

No-one steals my chippies if I get a big packet so its not that. Am I passing up a free lunch here (and thereby not being a utility maximiser as my shirt says) – or is there a reason I buy the small bag instead of the big bag.

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Matt Nolan

The inflation fighting trade-off

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Note: Other posts in this discussion are available under the tag “inflation debate“.

So, after calling on you guys to give me some indication of your views on monetary policy we discussed what inflation is, and then we moved on to discussing the costs that stem from inflation. We are now ready to discuss the big topic – the trade-off between inflation and other things.

I’m glad that we managed to talk about this topic this year, as it is the 50th anniversery of the paper “the Relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom 1861-1957” written by our own Dr Phillips. In this paper Dr Phillips found that, over this period, there was a negative relationship between money wage changes and unemployment.

This was eventually broadened to a negative relationship between inflation and unemployement, which gave rise to the Phillips curve. Initially this led economists to believe that there is a trade-off between inflation and unemployment. However, the instability of the Phillips curve when policy analysts tried to take advantage of this relationship (when analysts tried to use the relationship it disappeared), and the popularity of the natural rate hypothesis (stating that there is a “natural rate” that unemployment settles at), led to a movement away from this, and the statement that there is no long-run trade-off between inflation and unemployment! (now viewed as the NAIRU)

Taking this as given, what other trade-offs are there? Read more