I see that Bernard Hickey is suggesting we have the RBNZ pop the “housing bubble”. And to do it the Bank should either ignore inflation targeting and hike rates, or do some magic with macroprudential tools!
The ideal RBNZ governor?
Assume a bubble, so lets start with one! I have a list of problems with this type of article even given that 😉 :
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A quote via Scott Sumner:
But debt doesn’t make workers want to work less, it makes them want to consume less. There is a difference. We need economists to look through these framing effects, and see that the standard model that demand shocks cause high unemployment worked fine; it’s our policymakers who failed us.
There is a huge difference. Economists say GDP = C + I + G + X – M – but in macro you can’t just take these individual factors and talk about their impact on GDP, they are all massively endogenous. In other words, this decomposition can be misleading – and gets filled with “fallacy of composition” issues when people try to use it for policy!
“GDP” is produced by factors of production, it is output using labour and other factors. People are worried about high unemployment, and underutilised resources, this is exactly what Sumner is talking about when discussing active monetary policy of “demand management”.
The obsession with including “finance” into the cycle has to be viewed carefully. In so far as it improves forecasts, and thereby improves the ability to “target a path” for demand, and improves our understanding of “what could or will happen” it is very very useful. But it doesn’t actually change the fundamental relationship that monetary authorities should be focused on when setting monetary conditions!
Now this is where I get concerned with Borio’s stuff. There is a lot of very good work in there (I agree with a lot of the discussion of the financial industry – and using financial indicators to “add information” about the output gap), but he is obsessed with selling his work “output gap that is adjusted for finance” or a “finance neutral output gap”. This framing doesn’t make any sense to me – and in my reading of his papers he has never provided a full methodological reason why the output gap measure should be sold in this way. He attempts it post-hoc justifications of why finance impacts on deviations from potential bullet two of this Vox Eu article – but this is still an uncompelling base. When it comes to monetary policy the actual counterfactual we are interested in is in terms of unemployment and inflation – other factors matter (in terms of monetary policy) only INSOFAR as they influence these!
Macroprudential policy yadda yadda yadda are structural policies about “real economy” issues – monetary policy is set GIVEN these. But having monetary authorities focus on this instead of actual monetary conditions is missing the wood for the trees. Financial market information is useful to help inform us of where we are, and where we are going, BUT can we actually focus on the first order issue of the purpose of “active monetary policy” which are medium-long term inflation outcomes and short term unemployment variation (read the short-term as the outlook for 18-24 months out, I realise this term can be vague otherwise!). If the financial market information helps the central bank set policy to deliver this (which it will) use the hell out of it – but don’t then lose sight of your actual purpose and start trying to value companies and assets for the market at large. If you want to do that monetary institutions, give up your contract with government and get a job as a financial adviser 😉
When I read this sort of stuff all I see is monetary theorists saying “ahhh, NGDP growth was weaker than authorities were committed to delivering, here are some excuses”. But as soon as they give up the role they were given by government (deal with inflation and short term fluctuations in the UR) they leave themselves increasingly open to arbitrary demands and politicisation.
After ignoring prudential standards and arbitrarily trying to deal with it with monetary policy, we stumbled into the Great Depression. Pressure post Great Depression and war, in time led to the hyperinflation and stagflation through the 1970/80s, which led to a recognition that policy needed to narrow. Which led to completely ignoring macroprudential rules (which is not good either) which then led to the 2008/09 crisis. Which led to …
Over on the Herald I saw Bernard Hickey discussing how we have been performing relatively well due to China in recent years (Note, this was also on Rates Blog) – and we have to realise that if something went wrong over there it would hurt us. Fair point, and one that people should be conscious of given the lack of good information we currently have about China!
I then journeyed down into the comments, where everyone was being civil and discussing the issue. Very nice. I noticed a comment by Digby Green:
Well said.
I have noticed that our exports to many other countries have fallen in the last few years.
So “we” need to make sure we do not forget them.
And it reminded me of a neat little thing about being a small open economy with relationships with many many other economies. We are a “residual claimant” for a “homogenous good” in most of the markets we trade in, and as a result if one country is buying less of our produce we can usually ship somewhere else instead for only a slightly lower price. What this means is that we produce very little of the world output in many of the things we sell, and the things we sell are pretty “similar” to what is sold overseas. As a result, we just follow around the world price!
Now this isn’t the case for everything. NZ wine, and chilled NZ meat, gain significant premiums in some markets – and when demand in those countries cools off, NZ producers have to take quite a price cut to sell them.
However, whenever we jump onto the Statistics New Zealand site and look at the Overseas Merchandise Trade figures, this suggest that we will see the “composition” of our trade (in terms of the countries we sell to) change massively over small periods in time – the best example in the past year was Venezuela, where dairy exports have all but disappeared due to changes in South American production and purchases … but of course, we just sold those dairy products to other countries. During the drought, farmers destocked by killing livestock – and as a result, meat exports to China have gone up … but this will only be temporary.
In this way, the “amount” we sell overseas isn’t really determined by overseas demand – we are such a small fish we can make as much as we want and sell it! However, the amount NZ farmers and other exporters for homogenous goods want to produce is determined by the return they get from it! And this price is determined by demand overseas. This is very different than large economies like China and the United States, and as a result they discuss their trade figures in very different ways than we do over here.
So the lesson is we can sell as much as we make, but whether it is worth making depends on how “scarce” (and as a result how high the price is) overseas.
Note: Indeed there are exceptions, and the more we specialise into “niche” markets the more this is the case. But for the majority of New Zealand trade, and given the openness of NZ with the rest of the world, this simple little principle is very powerful.
I’m always glad to see people discussing the New Zealand economy with data and discussion. So good on Lowell Manning for doing that here.
Of course, this doesn’t mean I have to agree – but I will try to disagree with some substance 😉
There are a number of the specifics I fundamentally disagree with, I will discuss that more later in the post. But I wanted to touch a methodological line to start with. The “economy” is the aggregate of individual actions, we cannot reach a conclusion on policy by placing value on outcomes without discussing what individual choices are involved. Four things come out of this:
This piece ignores this, where are the prices of non-housing goods, where are the determinants of foreigners willingness to loan to us, and our willingness to borrow? The links related to these things are weak to non-existent, and it makes the other concerns I have even more stark. Let us move on with those:
There has been a lot of ink spilled out there about whether it is production or consumption that matter. Without production we have nothing to consume! Without the urge to consume we wouldn’t produce anything!
People will talk about “Says Law” (supply creates its own demand), or jump around talking about Keynes or Malthus (effective demand can be too low, demand creating its own supply, underconsumption!).
This all sounds grand, and makes great soundbites as it lets us say one drives the other. But I’m always struck by the question “who cares”. Production, consumption, output, in our models none of this has any inherent value unless we “assume” value. And in the world we want to make conclusions about, the inherent subjective value is something that exists that we can’t necessarily observe.
When looking at an economy as a whole, we are not a “large firm” trying to maximise output, or maximise consumption. We are a series of individuals making choices for some reason. Understanding the choices, how they relate to value, is the starting point of any thought.
This is the kicker. When we turn around an apply models (either explicit or implict in our description and conclusion) we are apply our own value judgments. If we haven’t separated them out, we will sneakingly include value judgments solely based on our own experience “because they seem natural”. However, other individuals are inherently different beasts, rules we follow aren’t necessarily the same as the ones other follow, and the rules we have to understand the actions of a social group don’t necessarily have much relation to the true nature of those groups!
In this context, both production and consumption should be seen as a means to an end. And we should analyse them in this context – in what ways does this impact on our view of “social value” or welfare. This is a question we have to answer before concluding – and the assumptions involved can only be validated through the acceptance of a community, not by strict scientific measurement of value.
Overall, this is why economics is the study of trade-offs involved in scarcity, not the study of how we should allocate scarce resources. Economists merely ask that lessons involved from our series of descriptions are taken into account when society gets together to try to discuss what they believe is “fair” and “just”. And non-economists are merely asking economists to recognise that their framework allows description, but doesn’t give them a monopoly on understanding moral questions of value!
Via the Wonkmonk twitter, this paper from the Fed.
The effect of reserve balances in simple macroeconomic models often comes through the money multiplier, affecting the money supply and the amount of bank lending in the economy. Most models currently used for macroeconomic policy analysis, however, either exclude money or model money demand as entirely endogenous, thus precluding any causal role for reserves and money.
This makes more sense if you are willing to think of economic models not as “general models” by as models of individual tendencies – identifying specific causal mechanisms. In this way, policy making requires “multiple models”, and trying to say something like “you entirely rely on money multipliers” really doesn’t make sense.