Matt Nolan

More on currency misalignment

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Given the rising pressure for the Reserve Bank to target the currency as well as other things in New Zealand it is important to have a look at reasons why people may think our currency is misaligned.  I have said before that IF the currency is overvalued I think it is a structural issue and is really unrelated to monetary policy – however, there are of course many other arguments.

We have mentioned the begger thy neighbour type externalities from domestic focused monetary policy – something that a small country like NZ cannot cause, and so we can’t blame our domestic monetary environment for.

And a new discussion paper by the Dallas Fed discusses why the exchange rate may be an important issue to look at intervening into (ht Econobrowser).  Specifically the paper states:

If the nominal exchange rate regime matters for the determination of relative prices such as the real exchange rate or the terms of trade, it must matter because there is some kind of nominal price stickiness. For example, if the U.S. dollar/euro exchange rate is to affect any real prices, it must be because there are some nominal prices that are sticky in dollar terms and others that are sticky in euros. From the standpoint of modern macroeconomics, the question should be posed: What policy best deals with the distortions from sticky prices and other sources? Is it a fully flexible exchange rate, or some sort of exchange rate targeting?

However, coming back to New Zealand I still feel fully flexible exchange rates are appropriate.  Why?  Apart from the fact that I view such a “relative price shock” as an insufficient condition for intervention, the idea of price stickiness only matters when export prices are SET by exporters.  New Zealand is a small open economy that sells on foreign markets and receives (and pays) the world price – therefore our trade prices are flexible.

The inefficiency occurs when prices are denominated in domestic dollars, and do not change in the face of some “shock” which changes the value of the exchange rate.

Finally there is an asset price bubble argument for intervention (as the currency is a forward looking asset price).  Whether we can really identify and then improve welfare by intervening against “currency bubbles” is highly debatable – and it is an area the Bank has already been involved in (by becoming a currency trader 😉 )

Matt Nolan

Supply shocks, demand shocks, and corridors

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In a recent post by Arnold Kling I see him hinting at the similarities between his recalculation view of the current recession and the corridor theory of Axel Leijonhufvud.  Now I agree with both these theories, and feel they add an important flavour to current debate – but I think the theories actually tell us about very separate elements of any large scale recession.

In order to get my head around my feelings I’ll have a brief talk about shocks, and the kind of shocks I think are being represented by the different theories.  Feel free to tell me where I am blatantly wrong.

Now, for the non-economist readers I guess this post is a little wonkish in nature – although there will be no maths sitting around this time.

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The Hand

Health Legislation: a carbon emitter?

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As speculated by some over the weekend, and confirmed today by the Economist, Copenhagen currently appears to be nothing more than a venue for which policy makers will agree to consider a future agreement on Carbon Emissions.

Undoubtedly there exist links between the U.S.’ relaxed approach to the summit and the Obama administrations efforts to pass universal healthcare; for the latter to pass the support of those contributing to the former is required. This is nothing new. What is interesting to note, however, is that such an attitude to favor health over emissions has been indirectly present within the U.S. for some time.

Earlier this year Boston became the second city (following San Francisco) to pass legislation banning the sale of cigarettes in ‘drug’ stores.  Within this legislation there exists a further directive restricting the sale of cigarettes on college campuses. This is where things become interesting. Consider a representative smoker. The impact upon this agent from said legislation results in further effort (i.e.; distance traveled) to obtain cigarettes. As such, the ‘carbon footprint’ of each cigarette has increased within the city of Boston; not too mention the shadow price of the cigarettes themselves.

The question is now posed; are carbon emissions an indirect consequence of health legislation?

Matt Nolan

Peak oil, the market will save us (at a price)

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From the Institutional Economist blog we’ve just seen an article on peak oil.  I agree with the author that markets will facilitate any movement from using oil to using a substitute.  As yes, the market will help to develop further exploration for oil fields – which will provide more oil.  But I feel two points are underplayed:

  1. The market facilitates this change by increasing the relative price of oil to other things.  This is costly to society.
  2. A natural resource like oil is like “capital stock”.  As it is non-renewable it is limited.  By consuming oil we are consuming this capital stock – I wonder if the author would be as happy to see firms cut back their capital stock in order to increase production.

Ultimately, I think there is some oil in the ground and the best way to allocate when are where this oil is consumed is with markets.  However, we should definitely not ignore the fact that, one day, the oil could run out and that would have a negative consequence on society – negative consequences that we can’t do anything about.

Peak oil theorists aren’t “economically illiterate” persee, they are just concerned about the fact that we could have this negative outcome.

Matt Nolan

One instrument, one target

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Am I the only person left that believes in this rule of thumb?  From a Herald article on the IMF:

Policy makers will need to employ judgment to look at what is driving asset price movements and discretion to avoid costly policy mistakes

Now to be fair, they also suggest that maybe central banks should have some other tools than just the interest rate.  But the fact is that, for now, they don’t.  Banks should not be targeting asset prices with interest rates at the same time as they are targeting inflation – its a recipe for policy failure.

Sure, use prudential regulation and try to deal with information issues in financial markets and the such to try and ensure that people face more of the risk regarding their own actions.  But don’t use the interest rates to attack asset prices.

There is no discretion here.  The central bank is trying to hold inflation at a target level given their interest rate tool.  Just do that.  It is mechanical, yes.  It is boring, yes.  It will not prevent crises, yes.  It is best policy, yes.

Matt Nolan

Space mirrors, carbon permits, and global warming

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Could it be.  Could technology save us from global warming through “space mirrors” and ” carbon absorbing rocks” (source).

Maybe.

In that case, should we not worry about pricing carbon.

No.

Why?  Well, if it turns out that countries can cheaply get below the appropriate carbon producing targets with these technologies, then the price of carbon permits will collapse.  The price will adjust to capture this technological change.

As a result, we should keep running with a scheme to limit the quantity of carbon emissions (in order to avoid or limit the damage of a global warming event) and we should realise that technological progress will get captured in any price adjustment – in fact the very existence of such prices will increase the incentive for people to develop these technologies.