Matt Nolan

What to watch for during the sovereign debt crisis

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Note:  Europe is where the real crisis is now – hence why this is the focus of the post, not the US.

While Europe tries to figure out how it can use the ECB as a lender of last resort, the current credit issues are likely to have some impact on the New Zealand economy.  In order to understand how, and what to look out for, we can use the same framework we did following the failure of Lehman Brothers.

This crisis is not on that level in its current incarnation – but the fact that it is borne of issues in the financial market does give us an idea of what we should look at, namely:

  1. What’s happening to our commodity prices?
  2. What’s going on with bank funding costs and access to credit?
  3. In what ways will uncertainty about the outlook lead to a delay in investment/durable good spending.

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Matt Nolan

Financial stability, the crisis, and counterfactuals

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In an interesting post on macro-blog, two things are mentioned towards the end:

Specifically, the pre-2008 consensus argued that monetary policy should follow a ‘rule’ based only on output gaps and inflation, but a few dissenters thought that credit aggregates deserved to be watched carefully and incorporated into monetary policy. The influence of the credit view has certainly advanced after the 2008–09 crash, just as respect has waned for the glib assertion that central banks could ignore potential financial bubbles and easily clean up after they burst.

…

The macroeconomic performance of individual countries varied markedly during the 2007–09 global financial crisis.… Better-performing economies featured a better-capitalised banking sector, a current account surplus, high foreign exchange reserves and low private sector credit-to-GDP. In other words, sound policy decisions and institutions reduced their vulnerability to the financial crisis. But these economies also featured a low level of financial openness and less exposure to US creditors, suggesting that good luck played a part.

In a sense, the better performance of countries with lower debt during the credit crisis is being used as evidence of the fact that central banks should limit credit growth in the economy (that was the assertion I took from reading this section of the post).

Note:  Now, a quick point I want to make before discussing this central point – when inflation targeting is mentioned above it is a separate issue.  The role of monetary policy is to target inflation, but the concept of watching out for financial stability is a separate issue.  At the moment both are taken on by central banks, but I feel that the above description implies that there is a trade-off between “price stability” and “financial stability” – which is false.

So note that, the entire discussion on financial stability says nothing about whether inflation targeting is sensible – and I really wish people would stop pushing the issues together (this comes from the fact that inflation targeting is about managing expectations).

So, to the key point.

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Matt Nolan

Quote of the day: An excellent conclusion on trade

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This is a point we all need to remember.

Even when the benefits outweigh the costs, the tabulation of gains and losses by groups highlights the facts that international trade has distributional consequences. That realization should not induce policymakers to hinder trade via protectionist measures. Rather it reminds us that transfers from gainers to losers is a prerequisite for trade to be Pareto improving.

You always see economists arguing.  But you would be hard pressed to find an economist who objected to this concept – they may argue about magnitudes, but there is a broad agreement with regards to this idea.

Matt Nolan

Looking at the wrong place on inequality

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Via Bernard Hickey’s Twitter feed I saw the following from the IMF:

But this globalisation had a dark side — a large and growing chasm between rich and poor. While trade globalisation is associated with lower inequality, financial globalisation — the big story of recent years — increased it.

Even ignoring other important policy elements, does it make sense to say we should be restricting elements of globalisation in order to “reduce inequality”.  So here, I’m ignoring the efficiency costs, I’m ignoring the fact that any arbitrary restrictions will have an arbitrary welfare cost on individuals – but I’m still not convinced.

Why?  The problem is too little globalisation, not too much.  We need to open the borders – after all nations are just large labour unions, they benefit their members to the detriment to the REAL poor people in the world – those that live in the third world.

But instead of focusing on opening up borders, and helping those that are genuinely poor, the IMF is more interested in complaining about the fact that financial deregulation has made it easier for those who are willing to save to save – and for those who are impatient to get themselves into debt.

Putting on my normative hat, I have close to no sympathy for those who couldn’t find a way to save in the first world relative to the sympathy I feel for those who are born into abject poverty.

Matt Nolan

Central Banks: Second best policy and operational separation

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Following a major crisis, such as the one we’ve just experienced, it is easy to get into a situation where the goal of policy is to “avoid another crisis”.  However, this is not a trap that our fine readers fall into – so we don’t need to worry about it here 😉 .

This isn’t to say that we shouldn’t take things from a crisis – far from it.  A crisis gives us information about the behaviour of the macroeconomy, about the feed-back loops that may exist that we may not previously pay attention to, and about the process people use for forming beliefs.  But we still need to say why these things occur – and hopefully make our given hypothesis testable – before we can decide to do anything.

So well prior to the crisis there was a string of micro-prudential policies introduced.  In truth, the retail banks have been grappling with the introduction of many of these policies during the crisis – and the Reserve Bank has stated that part of the reason the OCR is so low is because these policies have, in of themselves, tightened credit conditions.

Now all this is fine, when it comes to cyclical policy the impact of both micro and macro-prudential regulation has been widely discussed.  However, what bugs me is the lack of heavy discussion and analysis is the lack of significant discussion around the structural impact of said policy.

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Matt Nolan

Understand before you tinker

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I would be lying if I said this didn’t depress me.  Economists, great economists, economists I idolize stating that there are “imbalances” we must solve – and then telling us how to solve them without actually describing what the imbalance is and why it exists.

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