Matt Nolan

The Fed and policy: Temporary but not permanent

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Via Arnold Kling at Econlog we see this paper regarding the impact on Fed policy.  It is an interesting paper in an economic history sense, I would suggest reading it.  However, the passage I want to focus on is the same one Arnold mentioned:

First, spending and pricing decisions are assumed to be based on long-term assessments of real income and real rates of return. Second, changes in monetary policy can only change real interest rates temporarily. Ultimately, the forces of productivity and thrift determine them, not changes in nominal magnitudes on the central bank balance sheet. Combining the two propositions implies that the Federal Reserve’s interest rate policy, as long as it stays within the narrow range of experience, would not be expected to have a significant or long-lasting imprint on markets or activity.

This is a great result.  It suggests that the central banks ability to change the “structure” of the economy, or make any long lasting changes to economic conditions, is negligible.  Without any “long-run costs” of Fed policy this suggests that monetary policy CAN be used to stabilise activity in the very short run – so it reforces the view that a central bank should look at “smoothing the economic cycle” by keeping underlying inflationary pressures near a certain target.

This is consistent with the orthodox way of viewing monetary policy.  However, interestingly Arnold Kling states that this paper is something he agrees with, but it “puts (him) at odds with Scott Sumner and John Taylor, among many others.” – people who are also part of the orthodoxy.

I believe that the issue here is that people are talking past each other a little – in terms of strict monetary policy, the views that Scott Sumner and (originally) John Taylor focused on were short-run, and as a result they were interested in the stabilisation role of monetary policy.  Kling appears to have ignored the idea of the short-run to focus on the relevant view of the long-run – something we can’t do in the face of price/wage stickiness.

Now I agree with Arnold that many people give the idea that central banks can create miracles FAR too much weight.  I think that central banks should not be involved with structural policy, or if they are it NEEDS to be separated from their stabilisation role for the sake of transparency – but this issue is separate from the focus on thinkers like Sumner.

 

Matt Nolan

“Savings” problem doesn’t mean “investment” problem per see

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One issue I have with the constant discussion on savings, current account deficits, and consumption in NZ is how people look at it – they keep thinking that we are “consuming” to much and have needed to “borrow”.  That is how we’ve been told to look at it – especially with all the talk of “spending too much on big screen TV’s”.

So all this leads to statements like this from John Key:

“We are rebalancing the economy away from debt-fuelled consumption and government spending and towards savings, investment and exports” (ht Rates Blog).  Sounds good, but I think it misrepresents the issue.

Lets think about real GDP shares, when thinking about shares of expenditure GDP we are saying that “this much of the nations production is in this category”.  Saying we need to rebalance is like saying that we need to adjust these shares – the consumption one down, the investment and export ones up.

However, what does the data on real GDP says (note the period of “rampant borrowing” was around 2002-2008 … also note that Stats provides this beautiful data for free, much appreciated):

Read more

Matt Nolan

Asset sales

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There has been a lot of commentary on asset sales around the place, so much so that I didn’t feel like I need to write anything.

Dim Post mentioned a lot of the people against asset sales and also Geoff Simmons recently wrote against them.  Furthermore, both Anti-Dismal (*, *, *, *, *) and Roger Kerr (*, *, *) wrote a series of insightful posts regarding the issue.

On the left there seems to be an inherent bias against any selling at all – selling is bad.  On the right there is an inherent bias against government ownership – government ownership is bad.

So, where do I fall on the issue?  I have to admit that I am relatively in the middle – I see it as a case by case issue.  There is nothing inherently wrong with privatisation, at all.  Furthermore, I agree that generally privately run firms will “meet the market” more efficiently – implying that they either/both provide the same outputs more cheaply, provide more outputs for the same cost, and/or provide higher value outputs.

At the same time there is no doubt that some assets have social values/external benefits that are not captured by private agents.  If the cost of indirect regulation (taxes and competition policy) is too high, it may be preferable for the government to run said agencies directly – I view it as direct regulation.

In New Zealand at the moment there is definite scope for opening up SOE’s to private sector investment – that is where we are sitting now.  However, even given this I cannot go as far as Roger Douglas and say that the price does not matter – in fact, price is THE issue that the government should use when deciding whether to sell assets.

Why do I say this?  I have already said that I believe that, in the absence of external benefits, the private sector is more than likely to run the organisation more efficiently.  However, just because the evidence says this happens on average, and just because I have a value judgment that individuals are more responsive to incentives than government, isn’t sufficient to justify policy when we have prices available!

Effectively, a private purchaser will be willing to pay up to their reservation price for an asset.  This reservation price will be based on the dividend yield they expect to get from the asset, and the relevant opportunity cost of investment.

At the same time the government know that, if it keeps hold of the asset, it expects to make some dividend yield from said asset through time.  As a result, the government can price the asset – they can say they would not accept a bid below the discounted expected return from holding the asset.

If the government sticks to its guns, and a private sector agent is willing to pay MORE than this then we know that – ex ante – the private agent will be able to run the business more efficiently/add more value.  This implies that the government SHOULD NOT sell for less than their discounted expected return (not the should, so I’m being all prescriptive 😉 ).

In essence, pricing the assets (including relevant external benefits) and then seeing what price people are willing to pay gives us information regarding what can be run more efficiently in house – and more efficiently in the private sector.

Looking backwards and saying “this business is paying dividends overseas, wahhh” or “this business ended up making more than what we sold it for, wahhh” is a rubbish argument against privatisation  – but so is saying “the private sector is better, so give it the assets for free, wahh” is a poor way of justifying privatisation.

At the moment, the type of debate we are hearing in public sounds like the above quotes – and as a result the two sides appear to be talking past each other, making the debate feel more like ideology than reasoned analysis.

If we sat down and just explained the dividend example to people in society, I do not think they would be averse to a government stock take.  The tough questions will then be “how do we value external benefits” and “what is the expected dividend yield” rather than is selling blanket good or bad.

Update:  Anti-Dismal points out that there are other factors that need to be taken into consideration beyond the starting point of comparing dividend streams – that is why this is very much a case-by-case issue.

Update 2:  I somehow missed this piece by Eric Crampton (even though I did check the site while writing the post).

Matt Nolan

Saving and consumers: A note

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There has been a lot of talk about savings and rebalancing.  I’m not going to touch this stuff in much detail until the Savings Working Group releases their final report.  But in any case, I do need to say a little something now.

I didn’t like the interim report from the savings group (but remain hopefully the final report will provide a more reasonable break down of events when describing any policy conclusions.  And as a result was worried to hear that the government said it would be changing policy on the basis of the interim report.  However, most of the changes they are discussing are more than reasonable – so that is good.

One descriptive factor I have to take issue with though is this:

People borrowed heavily to buy houses and farms, property prices soared and New Zealanders felt wealthier as a result. They spent a lot on consumer goods, which led to a bubble of economic activity.

Really?  I mean, GDP tells us how much stuff we can make – apart from any loss resulting from wasted investment, and changes in relative prices, when we have a certain level of “GDP” we should be able to return to it.  It is production.

And what is this “spent a lot on consumer goods” business.  Let us look at a graph:

Did our spending relative to the amount we could produce seem excessive relative to the last 20 years?

Now, I recognise that the concern could be more long term – we could have been seen to be borrowing too much to consume for 20, 30, 40 years.  But without an actual strong reason why this is the case, and why our creditors have allowed it to persist for so long, I find this difficult.  A country CAN run persist current account deficits, a country CAN hold a large stock of debt as long as it can meet interest repayments.  We can’t say that this is a problem unless we can describe specific institutional factors.

And I haven’t seen anyone do that.  The interim report most definitely didn’t, although I am looking forward to the final report because I am sure it will go into more detail explaining “why” – which is something I would like to know about before commenting on any policy recommendations.

Matt Nolan

Keeping financial stability and monetary policy together

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I have long stated that targets of “financial stability” and “price stability” (monetary policy) were important – but should be performed in separate, yet independent, operational terms (here and here).  Namely, keep the central bank focused on monetary policy while another organisation/operational entity solely focuses on the more long term goal of financial stability.

In my view separation is important for communication – by separating the two people can tell when actions are framed towards certain goals.  By having one organisation/entity trying to attempt both, you risk muddying the waters – which in turn will lead to worse outcomes.

However, this piece at VoxEU makes the opposite case:

Interestingly, empirics tells us that bank risk not only responds to a rate cut, but that it also matters how long rates are kept low (Maddaloni and Peydro forthcoming, Altunbas et al. 2010). This relates to the argument that in the years leading up to the crisis rates were kept low for too long. Our model can provide some reasoning for why this can be damaging. We make the model dynamic and add a crucial feature, maturity mismatch.

In contrast to their short-term liabilities, banks’ assets are long-term. Because of this, banks will only adjust their portfolios if they foresee that a change to their environment is of long duration. A short-rate cut will not push them to take more risk. But a long lasting cut will. A monetary authority that considers financial imbalances therefore has a different timing of policy than an authority that cares only about inflation and output gap stabilisation.

This argument is compelling, and if you have a central bank with only one tool (the cash rate) I think I would be convinced.

However, if central banks are also willing to put in place measures to try and reduce maturity mismatch, and adjust the cyclical nature of banks reserves – then I believe we have multiple instruments.  In this case, the use of each individual instrument should still be directed at a specific target – to make communication clear.

Yes, these instruments are related, and the choice of a financial stability institution will influence the choice of a monetary institution.  But this is already the case with fiscal and monetary policy – and yet we believe we can keep monetary policy independent.

The fact is that the balancing of expectations, and the ability to communicate policy to manage these expectations, is the key part of monetary – and even financial stability – policy.  As this is the case, I continue to find it important to keep these two policy targets operationally separate.

This is an issue I find fascinating, and I’m looking forward to seeing how things develop over the next decade – and why.

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!