BERL report on changing the PTA
I tend to avoid criticising other economists, especially inside New Zealand. However, the BERL-NZ First report into inflation targeting has crossed a threshold where I feel saying nothing would be more inappropriate than voicing my disagreement.
I have discussed the issue on my work website here. In that article I solely discuss the idea of hot money – and how they don’t properly articulate the idea that someone in NZ has to borrow the money, and that this is a key factor to try and understand to figure out where any “failure” is. However, there are several more issues I have with the piece:
- The alternate rule isn’t actually defined in the article – this makes it hard to analyse.
- Having inflation expectations anchored doesn’t mean ditching inflation targeting is costless – changing monetary regime will unanchor inflation expectations!
- The credit figures quoted aren’t inflation, or asset price, or GDP, adjusted – they are all just in current prices, and so exagerate everything.
- The rule the RBNZ sets for setting the official cash rate is endogenous with the economy – as a result, you can’t really say “the interest rates are too high”, instead you need to ask what core economic drivers are making it so.
- Monetary policy is cyclical – when any fair reading of the evidence suggests that, if there is a problem, it is a structural one that is independent of this (I expect this point, and the one before, to be a bit more contensious – even though they are relatively mainstream).
- The costs and benefits listed are relatively partial and don’t seem well considered – they should also be compared through models and evidence rather than ad hocly thrown around.
- Insulting “mainstream economists” is douchey … seriously, they are CGE modelers, they often use mainstream economic methods.
Feel free to rant about how I’m part of a “mainstream conspiracy” or that I’m only doing this because they are “competition”. But no matter what, my core belief here is that structural issues in the New Zealand economy need to be researched, and sensible changes to fiscal, financial, and competition policy should be made where appropriate. Ill informed changes to monetary policy and the PTA are not a silver bullet, and are very likely to be inappropriate.
Update: Paul and Eric also discuss. So does the ODT.
Bah: Article link is being a punk. Here it is in any case:
Not a time to muddy the water: a rebuttal to the BERL/NZ First report on the PTA
The recent BERL/NZ First report on changing the policy targets agreement (PTA) suggested that the importance of inflation targeting was gone – but this conclusion is simply wrong, and rests on a misunderstanding of what has been going on with the New Zealand economy in recent years. As a result, they confuse the facts about the New Zealand economy and come up with a fallacious recommendation to scrap inflation targeting to target a range of other factors.
Sifting through the report, BERL and NZ First’s recommendation to scrap inflation targeting is based on a fear of “hot money”. As they say, between 2002 and 2007, New Zealand saw a significant lift in private borrowing, much of which was sourced from overseas. They state that the lift in foreign lending was due to the higher interest rates in New Zealand.
However, this is only part of the story – a loan only appears when there is both a lender and a borrower. To understand the sharp increase in private debt levels, we need to ask what was driving up private sector demand for credit during this period. When we approach the issue in this way, we can recognise that the demand for credit was not the fault of interest rates being “too high”.
As the Reserve Bank and, more recently, the NZIER have stated, the key issue in New Zealand over the past 40 years has been the high real exchange rate (the exchange rate adjusting for changes in prices between countries). Our persistent current account deficits and high level of net liabilities indicate that there is a significant issue in the New Zealand economy that needs to be addressed – but this is not a consequence of the PTA, inflation targeting, or interest rate setting.
The purpose of inflation targeting is to help wage and price setters set expectations of what will happen to the price of goods and services over time. The Reserve Bank controls inflation by announcing its target and adjusting the official cash rate in a way that is consistent with changes in saving and investment behaviour within the economy. The reason interest rates have had to be higher in New Zealand is due to the economic fundamentals that have driven up debt – blaming the Reserve Bank involves getting the explanation the wrong way around!
So what are some of these fundamentals? A lack of competition in the domestic economy due to our small size, the large size of government relative to GDP, tax policy, and the nature of our housing and residential building industries are all significant factors. The solution to these issues involves the government recognising the full macroeconomic costs of policies it puts in place – not arbitrary changes to the Reserve Bank Act. The Bank may also play a role, through the introduction of macroprudential policy, but these policies do not override the Bank’s monetary policy role of inflation targeting.
There is also the argument that a number of developing economies are intervening in to knock down their exchange rates – and as a result so should we. However, this nexus does not lead to “excessive borrowing” in New Zealand, but instead merely means we are receiving goods and services from overseas for a discounted price.
Making our Reserve Bank less transparent while ignoring the real economic issues that plague New Zealand will not make everyone better off – it will make most New Zealanders significantly worse off.
I was expecting to have to wade through some huge report but here’s my tuppence ha’penny:
1. Yes, would have liked to have seen what the proposed amendment actually was.
2. I don’t believe inflation has been “tamed”. Headline CPI has fallen due to globalizations pressures (accessing lower labour costs, technological improvements) but asset price inflation has gone through the roof (excuse the housing metaphor). Inflation still is, in the main, a monetary phenomenon, unless of course, you don’t measure it!).
3. I agree our interest rates have been higher than they needed to be. This has cost us big time.
4. It’s a bit light on the mechanisms around debt origination (coming from the current account deficit and recycled into domestic debt/housing).
5. Insulting “mainstream economists” is outrageous 🙂
I still don’t believe we are all sitting on the same page here and so there is a lot of miscommunication in discussions around monetary policy. Therefore, it’s easy to see debate descend into talking across each other (much like Parliament!). Hopefully, there will be a way for more measured investigation to take place.
My belief is that all the differences in view stem from prior assumptions about shifts in investment demand and expectations formation – and so I was hoping that the evidence would be focused on those issues.
Instead, the demand side was ignored, which I felt was inappropriate – and I believe even though your views and mine differ that is something you probably also felt.
I can imagine having a very reasonable discussion around inflation targeting vs NGDP targeting. But that isn’t quite what’s been proposed.
In my limited understanding, the flexible inflation targeting vs NGDP target argument is a repeat of the “level” vs “growth” target from back in the day – definitely a worthwhile one to have, and I feel happy with policy either way.
I am not sure what the report attached to this post was aiming to do, but the way it misframes what has happened in NZ to merely criticise the “mainstream” is inappropriate and misinformation IMO.
There are different variants on NGDP targeting: some want to target NGDP levels, others NGDP growth rates. If we took an NGDP growth rate target, say 5%, then whenever expected real growth were low, they’d have to ramp up money supply to goose NGDP; if inflation plus real GDP growth exceeded 5%, they’d have to pull back.
We’d hashed some of that out earlier this year.
http://offsettingbehaviour.blogspot.co.nz/2011/04/rbnz-vs-sumner.html
I’m not convinced NGDP targeting is a great idea for NZ but it’s a defensible argument for a potential change to the PTA. What BERL’s proposing is nuts though.
NGDP growth targeting is extremely close to flexible inflation targeting – I would argue that the main difference is “communication” of the target, which IMO gives the inflation target the edge (due to data revisions, and the priors I believe individuals actually make choices off).
The difference between growth and level targeting is how you perceive “failures” – that is the entire difference. Hence why the discussion between all these things in economics is actually over a surprisingly narrow range. In truth, the debate regarding policy is a lot smaller than many non-economists realise IMO.
I agree that the report is short on specifics and this makes it difficult to interpret. But I can’t find anywhere that it actually calls for inflation targeting to be scrapped. Yes they say the Act is redundant but then they refer to amending it, not abolishing it. My impression is a more flexible approach (2 or 3 targets?) is consistent with what they are suggesting What that means is wide open – most weight could still be applied to price stability. But I’m no expert on these things … just my two cents.
I agree with your conception here – being open to arguments is the way to be.
There are four reasons I feel they are attacking inflation targeting directly though:
1) Previous writing that they have done regarding monetary policy has suggested that increasing interest rates to meet an inflation target increases debt and inflationary pressures – they have pointed at the same logic here, and it is that logic I’ve argued against
2) The NZ First policy they have made mention too does suggest moving towards targets on exchange rates at the cost of inflation targeting
3) They directly mentioned targeting inflation as now being irrelevant
4) They directly insult “mainstream” views – which are of course akin to some form of inflation targeting, straw man or not.
In terms of monetary policy, at present people seem to believe it can deliver things it can’t (increases in aggregate supply through a permanent lower dollar and magic) or they feel a slightly different “flexible” approach is appropriate. The second view is worth discussing, but hardly involves sides being strictly “wrong” or “right” – while the first view is merely due to misinformation about what monetary policy can do.
My fear is that these sorts of reports, and the weird descriptions politicians give to them, give the impression that we are facing the first sort of issue and a free lunch, rather than the marginal issue of monetary policy that is actually being discussed.
Much more important are issues of both financial stability (which I continue to hold should be viewed separately on communication, and non-cyclical, grounds) and the impact of fiscal and competition policy on the wider economy – it is almost as if the views of economists on allocative efficiency and relative prices have been ignored for so long that people don’t think these issues exist :/
I have mixed thoughts here. On the one hand, it is clear that NZ has a systematic balance of payments problem. And the graph that shows the amount of “net interest and dividends per household” that supposedly go overseas was interesting.
Against that I’d have to weigh:
– if interest rates are too high, that’s hardly encouraging NZers to borrow money. But we borrow anyway. How would lowering interest rates help with that?
– I’m very dubious about the graph being genuinely net. Firstly because the whole report is so unacademic that I don’t trust it, secondly because my recollection is that the world runs a balance of payments deficit with itself – i.e. even the real statisticians get it wrong
I think any discussion of these issues needs to be a bit broader ranging. We need to start off by defining our problem more accurately – here we seem to be starting with the solution and retrofitting a problem.
I think the problems we have (in this context) are:
– Property prices higher than most would like, and higher than other countries (e.g. USA)
– Interest rates higher than many would like, and higher than key trading partners (again, e.g. USA)
– Low national savings, and therefore low availability of local capital
– High exchange rate (in a PPP sense), and therefore imports cheaper and exports more expensive than we would prefer
I can see how some of these reinforce each other and therefore could be part of a cycle, but others seem to oppose each other, so using one as a cure for the other seems unusual.
1. Property prices. The contention seems to be that availability of money makes property prices high. Against that I say:
– high interest rates should make people less willing to borrow. Lower interest rates (a la Greece) seem to create asset price bubbles. The prescription seems to be likely to make the problem worse
– property prices seem to be largely driven by land scarcity and increases in the cost of construction. Microeconomic reform seems the answer to me, not financial reform
– scarcity of credit (if foreign borrowings weren’t available) could arguably reduce prices (supply and demand). Not sure many NZers would vote for the price of their biggest asset to reduce. Assuming they would, you could get the same effect by restricting the %deposit or other regulatory measures (although as a free marketer, I’d be against that, and I reckon it’d be easy to get around)
2. Interest rates higher. My thoughts
– interest rates are the price of money. Lower interest rates, less foreign money. Makes sense
– Less money available means less investment as well as less asset price bubbles. We need investment to continue to improve productivity – less investment is not really a good idea when NZs productivity is already dropping
– So, the real problem here is the choices NZers make with the money they borrow, not whether or not they’re borrowing
– Do we have systemic incentive issues (e.g. lack of capital gains tax), or do we have a psychological problem (NZers too risk averse)?
3. Low national savings.
– Is this really true, or is it more true that NZ is a small market, and few NZers invest locally (you’d be crazy on most investment theory to do so)
– Do we actually know NZers net overseas investment, or only the portion they declare to the taxman?
– Do wealthy NZers move overseas, taking their money with them? Is that still “foreign investment”?
– If so, is there a market for wealthy foreigners to move to NZ? Is that now local investment?
– Having asked those questions, does it suggest that concern about local v’s foreign investment is pretty silly? The key is that we have investment at all, drawing boundaries around it is a bit arbitrary
4. High exchange rate
– Logically this does mean more imports, less exports. And that is a problem
– But in a market sense, there must be an equilibrium. Is it really possible to just push down exchange rate in isolation?
– Pushing down exchange rates is basically a way of giving every NZer a pay cut and every holder of NZ assets a capital loss. Do people really understand that?
Overall, my gut feel is that intervening in this stuff is not a good idea. It’s full of unintended consequences, and in general keeping an open economy is a better idea. However, there does seem some room to play with incentives around the edges – or to reduce the govts current distortion through incentives. I think that could be a worthy area of investigation.
The savings working group discussed the underlying “framework” for looking at what has gone on in NZ. For example It seems a lot of the economists that went into that decided that a movement towards a capital gains tax made sense – especially in terms of treating all “investment” the same domestically.
And any fundamental “imbalance” that exists (which would be argued from the magnitude of the CA deficits – in of itself, persistent CA deficits are sustainable as long as they run below nominal income growth) is to do with these structural factors – not monetary policy.
The RBNZ doesn’t “set” interest rates per see – they are, on average, going to be determined by the underlying demand for investment and willingness to save within an economy, and outside it. The persistently higher real interest rates and CA deficits is not the result of monetary policy – it is to do with structural issues in the economy.
The savings working group knew this, the best reports on the issue knew this, and this BERL report decided to ignore that – throw away any sensible view of domestic “investment demand”, and attack the RBNZ for being mainstream. That might be fine amongst hipster economists, but I don’t think hipster advice is what I want guiding the policy debate in NZ.