Matt Nolan

SMBC desribes macroeconomic forecasting

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Saturday Morning Breakfast Cereal is so so good.  And this cartoon is golden.

Reminds me clearly on the description of economics given here – and why the determination to “make predictions” is a bit dodge.  I see Barry Ritholz is also chatting on these things, I will be posting about that at some point!

And via the above post, I see that I compared economic forecasting to Tarot Card reading in 2009.  I have now moved on to comparing devices of economic communication to tarot card reading.  Obviously, I need to find more occult devices to improve my forecasting methods!

Note:  This is neither a criticism of broad economics, or of the specific area of economic forecasting (seen as a way of synthesizing and communicating information).  See how I view method in economics here.

Infometrics

Series on tax: Part six – where progressivity fits in

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I am continuing the series on tax over on Rates Blog with a piece on progressivity called “progressivity, how does that work?“.

The short answer … magnets:

The long answer?  You’ll have to go read the post.  However, I will give you this here:

In today’s article we discussed progressivity, and the complicated interrelationships between ideas of equity and efficiency.

Given these difficulties, it is important for policy makers and researchers to clearly communicate the trade-off that exist – so that an informed public can come to some conclusion about what they think is fair.

While the principles of tax we recently mentioned helped us to understand some of the interrelationships, the importance of elasticity in determining who actually pays a tax was made apparent here – just saying “I want that person to pay” doesn’t work when they can pass the buck on or shift away from paying tax altogether.

Furthermore, even if higher tax rates are able to redistribute income (in terms of the goods and services available to different income groups) the impact on people’s willingness to supply labour and the wedge between the private and social benefits of someone’s decision to work does imply there are efficiency costs from doing so.

In many ways it is an extension of this article – given that the reader is now assumed to have some idea about horizontal and vertical equity, poll taxes, factor taxes, and output taxes (which were the intervening articles).

 

Matt Nolan

Lucas critique and DSGE models

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I’ve seen the view that DSGE models fail the Lucas Critique come up a bunch in recent years, and nodded my head in agreement.  But I’ve never popped a post down saying it – so this speech by Plosser gives me that opportunity (ht Stephen Williamson).  I find it hard to disagree with this statement:

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Matt Nolan

Deleveraging: The question that never gets answered

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Britmouse over at uneconomical has this golden quote:

Those who assert that households “need” to deleverage (which is really an argument about expected future income) must address the question of the desired level of leverage.  Is 144% too high or too low; how should we decide where to draw the line?  Should we let central plannersbankers decide by plucking numbers out of the air?

And because debt is just (ah ha) money we owe to ourselves… let’s not forget household assets, which continue to dwarf liabilities; household net worth was up from £6tn in 2008 to £7tn in 2011 in the last Blue Book estimate, mind-boggling numbers.

“Deleveraging is good” is one of the group of poorly hidden value judgments that come from the broad “rebalancing view” that gets thrown around.

If we, as a society, see high leverage levels in the economy we need to ask “why the hell do I care”?  If the individuals borrowing, and the individuals lending to them, are doing so without coercion, and the risks they face only impact upon them, then who cares.

But we may get concerned about the stability of the banking system, we may believe that the taxpayer is implicitly subsidising risk, or as a society have a special concern around Veblen goods (think of it in terms of “keeping up with the Johnes”), we might come up with reasons why leverage can be excessive.  Armed with a cause we can design policy.

The problem is that we see something like high leverage, decide we want to do something about it, and then post hoc justifying policy on the basis of whatever economic explanation we can tie together.  As we noted in from this Friedman quote, there are an infinite number of hypotheses that “fit” the data – and as a result, this is easy.  We need to limit the number of hypotheses by actually asking “what are the trade-offs involved”, and the best way to do this is not to assume our policy conclusion as a starting point 😉

Matt Nolan

Interpreting a (monetary) quantity – we need a cause

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Over at Not PC I noticed that Peter is putting some of the “blame for the housing bubble” at the feet of the RBNZ.  His view shares similarities to the discussion I’ve been having – and will continue to have – with Lowell Manning (here, here, here).

Essentially, the view is that the Bank is allowing M3 to grow too quickly and this is showing up in excessive house prices.  By having “too much” fiat currency the central bank is devaluing the currency, and that is coming through the price of land/housing.  Now don’t get me wrong, look at monetary aggregates – they provide useful information.  Furthermore, I believe these guys deserve a response, and next month I’ll try to craft something a bit better than this.  But let me note down some points as an accidental “Reserve Bank apologist”.

This story provided does have a compelling narrative, it has a start, and end, a villian, a potential heroine, all the good elements of a believable story.  But for me, there are a few key things missing:

  1. The central bank doesn’t set the “quantity of money”, it sets the “price”.  In reality it doesn’t even do that – the interest rate is set by forces in the economy.  Instead, the central bank targets the rate of growth in the “general price level” – and it has stuck to that.   They are going to devalue fiat currency at a predictable and steady rate – and that is just what has happened.
  2. Where is individual choice in this model?  M3 growth is too high, and as a result people blindly borrow the floating $$$ to buy houses … knowing that the future real value will fall and burn them?  This sounds funny.  Instead, with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!
  3. Say that the RBNZ has been soft, why is it the relative price of housing … not general inflation … that is rising.   We may say “land is durable, and the price is high because of expected future inflation” – but then the question would be why we don’t see this across all asset classes in NZ, and more importantly why survey measures do not show these “inflation expectations”.
  4. Furthermore, if this has been a long last bubble (due to the persistent high growth in M3) why have the “relative prices” of other goods never caught up – if this has been one big long bubble due to “monetary policy” at some point we need to be getting that high inflation.  Monetary policy doesn’t keep relative prices out of whack forever.

This is the thing for me – it is a relative price of housing issue.  The money supply is “endogenous” and so, since “demand for housing” has risen, so has borrowing and M3 growth.  With no generalised inflation going on, the RBNZ isn’t printing money to cause a housing bubble – it is allowing the money supply to rise given the housing bubble, in order to not excessively constrain the rest of the economy.

Note the Bank will be concerned about a “housing bubble” if it is leading to “excessive consumption and/or investment” which creates inflationary pressures – in that case they will act with monetary policy.  They will be worried about issues of “financial stability” due to high gross debt levels, highly leveraged groups, or a concentration of debts in an asset class – in that case they will act with macroprudential policy.

Outside of this, this issue has nothing to do with the Bank.  In fact, outside of this this issue of a “bubble due to irrational expectations” is virtually IRRELEVANT for society as a whole – if people are determined to pay over the odds for something to other people, then that is just a straight transfer of goods and services.  If we really have an “irrational bubble” why are we so keen to punish the rest of the economy in a weak (and likely to fail) attempt to stop people making their own dumb mistakes – as we will be inappropriately lifting interest rates and making other forms of investment more expensive to “deal with” the fact that some people have strange ideas about the potential for house price appreciation in the future 😉 [And let’s not start talking about foreigners – as this is just a transfer FROM overseas TO NZ].

As an Austrian economist I am sure that Peter is also concerned about a misallocation of capital.  However, in this context this would require “overbuilding” … if there is a “housing bubble” we will “overinvest in building houses” (remember trading houses between each other isn’t “investment” in this sense, it is a transfer).  Is this what we are seeing?  And if it was, are the welfare costs really that large … especially relative to the practical status-quo, since no-one truly knows how to pop bubbles outside of kidnapping people or taking their savings off them!

Matt Nolan

In defence of Mankiw

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When it comes to looking at policy, I started life fairly heavily left wing.  When I started university at the age of 18, my first textbook was by Greg Mankiw.  He was a Republican, while most of my economics reading at the time had been Marxist or a frustrated attempt at reading the General Theory by Keynes.  I was immediately certain that I would hate the textbook, and that it had no value – at that point I was even more immature than I am now 😉

I was utterly and totally wrong – a situation I have become accustomed to.  Mankiw’s first year textbook is clear, to the point, and is honest about what the economic method is and what it achieves.  He “wears his assumptions on his sleeve” which I have learnt is the distinction of the best type of economist.  His textbook, and his papers on macroeconomics and tax, have been insightful for me as a way of not just understanding economic ideas, but of understanding the economic method.

So I see he wrote a paper called “defending the one percent“.  Undeniably it was titled that way to irritate people.  And undeniably it succeeded. (Update:  I’d note Cochrane states it is mistitled – and I believe to an economics auidence it is.  I touch on why I think he gave it that title for his target audience below)
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