Matt Nolan

A great explanation of the issues in Europe

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Crooked Timber has a great “pick your own adventure” style post on solving the European debt crisis (ht Eric Crampton).  Give it a go.

Eric and my work colleague here both hit option 52, while I hit option 54.  To see what 54 is I’ll repeat it below:

Maynard is staring at his legal pad. “This looks like a mess to me. Greece has defaulted, left the euro, and had a tax commissioner appointed – how many more humiliations can you heap on them? Economically it has a certain internal logic but politically it is all over the place and I think that kills the chance of the transfer payments which you need if you’re going to achieve primary balance after the default without massively contractionary domestic fiscal policy. We can type it up and submit it, but I think it’s only going to be looked at as an example of the kind of idea that an economist might come up with”.

The kind of an idea an economist might come up with – I’m taking that as a compliment even though I suspect it isn’t meant to be …

Matt Nolan

Papers to read

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Via Marginal Revolution

On a banking glut.  On excessive financing.  Both arguing against the “excessive savings” view of the crisis – which is currently my prior.

Will be reading these (rereading in the case of the second one) in order to avoid listening to more crap about the NZ election … seriously, I didn’t realise how much politicians lie during an election till I became an economist, and I’m still uncomfortable with it.

FYI:  I agree with the description of macroprudential policy, but I remain nervous about the “time series” policies – which are really just non-interest rate cyclical tools.  We need a significant burden of proof before these instruments can be used – although I suspect at present monetary authorities are aware of this.

Matt Nolan

Irish and Greek crises: Why is NZ different?

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This post from Marginal Revolution has moved me from thinking to writing.

On the surface there appears to be a lot in common with the Irish, Greek, and NZ economies.  All three have high net foreign liability positions, liabilities are highly concentrated through banks who are borrowing overseas, all three have experienced some form of housing boom and lift in consumption, and finally all three appeared to have a relatively strong fiscal position before the GFC before moving into fiscal deficits after the shock.  And yet (so far) while the Irish and Greek economies and banking systems have collapsed, New Zealand’s has been fine.

There are two major differences that have helped reduce the implied risk on our debt, making New Zealand much less likely to experience a bank run:

  1. Our banking system is primarily foreign owned (Eric Crampton expands on why this is a good thing),
  2. We have a freely floating exchange rate – combined with having much of our debt denominated in NZ$ this is useful.

These are important points to recognise.  While many commentators are saying we should “peg” our dollar and set up more domestic ownership of banks GIVEN the risks associated with the GFC, I tend to reach the opposite conclusion – namely, the reason why we haven’t suffered as much as these countries has been largely the result of our free floating exchange rate and the fact that a larger economy has a large stake in our banking system.

The terms of trade boost and our proximity and exposure to Asia has also helped, but I would say that the Greek and Irish crises give us a reason to hold onto the status quo – not to chuck it out!

Matt Nolan

Race to the bottom actually race to the top

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Note:  The title should be premised with in the current extreme environment – I am not supporting the idea that we can have permanent income gains beyond potential from printing money, that would simply be inflationary.

A bunch of poppycock from Reuters on “currency wars” here.  I’ll let Scott Sumner discuss the fallacy here.

I have no idea where these guys are coming from.  A currency war causes everyone to lose?  Why is that Mr. Reich?  Because it leads to high inflation?  And what causes the high inflation?  Rising AD?  And what is the point of the fiscal stimulus you favor?  Higher AD?

Seriously, when people talk about “currency wars” do they recognise what the mechanism is that is used to lower the value of currency – well it is printing dollars.  If we truly do have “insufficient aggregate demand” this is what we want monetary authorities to be doing.  Far from being a “war” it is really co-operation …

Note:  The “imbalance view” stems from the relative exchange rates changing and prices being sticky – so that countries can sneakingly change their real exchange rate to favour exports or some such.  This structural issue is interesting – but criticising what seems to be a bunch of central banks loosening policy on these grounds misses the point.

Furthermore, lets not forget the impossible trinity here (*,*,*) – if we try to control the exchange rate we either lose control of the inflation rate, or we have to arbitrarily restrict capital flows (which is also costly – as by restricting capital flows the cost of capital will rise).  If we want to forget about the crisis and argue for a medium term strategic (arbitrary) fixed exchange rate target this is a separate issue to any near term “currency wars”.

Update:  Paul Krugman paints out the structural issue here.  Now note that the US and Europe could devalue, and they force China to devalue – so they all print more money and stimulate aggregate demand.  Ergo, we have a recovery.

The issue here is that the recovery is “unbalanced” because of the artificial shift in the relative prices faced by exporters/importers.  This issue existed before the economic crisis – and this is a trade issue.  However, the threats regarding this are as high as they have always been – I can’t remember a time that the US wasn’t trying to get China to shift its currency.

I would also note that if China is willing to lend its export income for a tiny (maybe even negative) rate of return to the countries buying its exports then it isn’t clear that they aren’t just f’ing themselves over to be honest …

Matt Nolan

Three open economies walk into a bar …

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There has been an interesting discussion comparing the recession in three open economies, Australia, Canada, and New Zealand.  It started with the Canadians, but a couple of New Zealanders then became involved.

The facts are that:

  1. Headline inflation in all three countries is currently close to target (implying that we all made our inflation targets),
  2. New Zealand experienced the largest declines in GDP – Australia the lowest,
  3. The relative price of NZ housing declined, it was stable in Canada, it rose in Australia (all three countries were seen as “over-valued”)
  4. Canada hit the “zero bound” on monetary policy, and it didn’t seem to matter.  New Zealand had room to move, but we stopped and got beaten around the head.

This list of facts suggests one of two things to me:

  1. Demand management in NZ was poorer then in other countries
  2. NZ faced a larger supply shock.

Now, I’m willing to rule out the first one – as we did keep inflation near the target band, and to be honest inflation expectations have held up a little too well …

So this implies that NZ had a larger supply shock.  Here are some reasons I think was the case:

  1. New Zealand’s recession started with a drought, and the required restocking of agricultural breeding stock following the drought.  This was a pain.
  2. New Zealand’s national net debt position is worse than the other two countries (Note:  In NZ when I say national debt I mean private debt + public debt).  With a lot of our debt on a relatively short maturity this was problematic for a few quarters there.
  3. On that note NZ’s financial sector was more strongly hit than the other regions.  It started back in 2005/06 with the “finance company collapse” and got heavy just before our drought induced, striking in late-2007 (here and here).
  4. Terms of trade:  New Zealand’s terms of trade fell to its lowest level since 2004, Australia’s fell to its 2007 levels.  I do not know about Canada – however, the decline in our terms of trade can be seen as a massive supply side shock.
  5. Trade exposure:  Here I am conjecturing, as I am tight for time, but it is possible that NZ could be more trade exposed then the other countries.  If NZ is, it would only be a minor matter anyway I suspect.

Now while these factors explain why NZ declined more sharply than other countries, I don’t think they explain why we are still lagging behind.  Our TOT is recovering fast – it will be back at its peaks mid year.  The drought is over and restocking has been completed.  And our debt position is less of a hazard than it was 12 months ago.  Interesting.

If NZ doesn’t recover to trend (which is very much the consensus forecast out here), it is because New Zealand faced a permanent supply side shock BEFORE the global crisis – we were struggling before things hit the fan overseas, with only a strong lift in the TOT saying us.  When that flooded out at the closing stages of 2008 New Zealand dropped like a stone.

So for Australians and Canadians looking for a point of comparison with New Zealand, just remember that NZ faced a few other issues 😉

Matt Nolan

Against the Paradox of toil

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In a recent post Paul Krugman raises the “paradox of toil” to explain why tax cuts are silly and government spending is good during a recession:

So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.

However, this is completely misleading.  Cutting a tax doesn’t really “shift the supply curve” (which is what expanding the labour supply means) in this way.  Lets have a little think about wages and what cutting the tax probably does.

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