Matt Nolan

Export prices, import prices, terms of trade, and inflation

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As a small little open economy, international variables are incredibly important to us.  The international rate of return, world prices for tradable goods, and the availability of external people, goods, and services, all have a disproportionate impact on us.

When discussing external prices, people constantly hear economists talk about the terms of trade (note, the wiki article is crap).  During 2007 the Bank was (appropriately) lifting the official cash rate on the back of New Zealand’s climbing terms of trade.  However, what all this meant, and what was going on didn’t really seem clear to everyone at the time.

The terms of trade tells us about the price of what we sell overseas relative to what we buy in.  This is all very nice, but when people see this they might wonder why the Bank would want to react.  To understand what was (and is) going on with our terms of trade we do need to differentiate between both sides of the ratio – export prices and import prices.

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Matt Nolan

Good points on QEII

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Following QEII I noticed a bunch of snark, sarcasm, and general analysis focusing on what we know (how an increase in the money stock, or inflation expectations, impacts upon the general economy) – this was troubling, as I wanted to find some analysis of exactly how QEII is supposed to function 😀

That is why it was good to see a post from Marginal Revolution, and a post from Econbrowser, discussing a few of the issues to keep an eye on.

I would still agree overall with Scott Sumner’s point that we should judge the policy based on where market expectations for future inflation move – however, the idea that there could be a sharp step change in inflation expectations at some point in the future, that the transition path of QEII is uncertain, that there are costs from a potential “asset bubble” in exchange rate markets, and that countries with weak financial institutions may struggle are important risks.

IMO though, these are risks – they do not suddenly indicate that QEII is bad policy.  And in fact, I would say ex-ante, with inflation expectations below the Fed’s implicit target and unemployment above the natural rate QEII made some sense.  An explicit inflation target, or even direct transfers to households, may have mad more sense – but were obviously not practical in a political sense.

Matt Nolan

What is this …

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This article on Bloomberg is something I largely disagree with – however, there is statement that needs more discussion.

Quantitative easing is “terrorizing” the world economy and will lead to depreciation of the U.S. dollar, pushing down prices in Europe and exacerbating the continent’s sovereign debt crisis, Mundell said.

The European Central Bank’s mandate to control inflation would likely hamper it from stemming the euro’s rise, while the currency’s gains would “likely lead to deflation,” said Mundell, who received the prize in 1999 and is known as the intellectual father of the euro. Falling prices would increase “the real value of indebtedness.”

Mundell is a genius, and one of the intellectual fathers of open economy macro, but what is this.

He is saying the the ECB won’t loosen policy because it fears inflation, but a rising euro will lead to deflation.  By the same logic, shouldn’t the ECB loosen policy to prevent deflation.  The same logic.  What the …

On the Chinese side, I disagree with the majority of what they are saying.  But:

The U.S. “has not fully taken into consideration the shock of excessive capital flows to the financial stability of emerging markets.”

Is a fair point.  Places where credit institutions are weak could be at risk in the case where global monetary policy is softened.  IMO, this implies that there should be more pressure on these places to make risks transparent and to work on institutional setting – not that countries facing deflationary pressures should just ignore them.

If the institutional setting is appropriate, then loosening global monetary policy in the face of higher than “natural unemployment” rates is a good thing both in terms of:

  1. Meeting inflation targets and ensuring that the deviations from the “natural rate” are as small as is efficient.
  2. Pushing countries who have an inflation mandate but have been fiddling the currency to either revalue OR force them to take on greater capital controls – which will also lead to larger asset losses for them.

I’m unsurprised China is not impressed – if the US is devaluing they face a loss on the capital value of their reserves.  This does not mean that it isn’t good policy – and if they are going to fiddle exchange rates this is a risk they had to face!

Matt Nolan

Chocolate and prices

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An article in the Herald says some interesting things:

The world could run out of affordable chocolate within 20 years as farmers abandon their crops in the global cocoa basket of West Africa, industry experts claim.

…

“In 20 years chocolate will be like caviar. It will become so rare and so expensive that the average Joe just won’t be able to afford it.”

Now, as the article says, the price of cocoa is rising because alternative uses of the same land is also rising – this is not surprising, and is really what should occur.  We have scarce resources, and the price adjusts to signal this scarcity and allocate resources to the highest bidder.

But the first claim, running out of cocoa?  Surely if prices rise, this will get some people back into the market.  We don’t just magically run out of the thing – the price of cocoa relative to say washing machines should rise, but this is because the opportunity cost of growing cocoa is now higher.  Also note that these poorer farmers in Africa are getting higher incomes now – as the price of what they produce compared to, say washing machines, is higher … so they can buy more washing machines.  Why is this article begrudging them that?

And the second claim – that chocolate will be like caviar.  WTF.  I am pretty sure we would see a massive amount of entry into the market if cocoa prices went up that far – entry that will drive the price down.  When “John Mason, executive director and founder of the Ghana-based Nature Conservation Research Council” makes that claim about people not being able to afford chocolate I think he is forgetting that part of the equation.

I find these articles weird.  In a much smaller space they could have said:

With the price of agricultural crops rising, some farmers are switching crops, driving up the price of cocoa relative to non-agricultural goods and services.  This will see the price of chocolate rise – time to finally find out is white chocolate really chocolate.  This will also increase the incomes of farmers in these regions.

Matt Nolan

More on macro controls

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From Eric Crampton:

Because he personally has lost faith in modern portfolio theory, he wants to force all of us to invest locally. Yeah, things have been rough for the last few years. But the proposal here seems pretty worrying.

It is a great post – adding to the things I said here, so definitely give the whole thing a read.

When the environment changes, for some reason people want “control” – they want to feel like they can change what is going on for the better.  Although this is a noble goal, without trying to understand the underlying rationale and trade-offs associated with any choices, we are more than likely going to hurt people.

Fundamentally, I am willing to go out on the limb and say that, in this case, Bernard has no implicit model of the economy to base his policy prescriptions on – and so such prescriptions are both internally inconsistent and dangerous.  If he provides us with a model, and an actual description of why, I would gladly discuss it – but from the last few weeks of reading through his writing on the issue (I decided to pay more attention following the initial article – especially given that I was receiving a lot of pressure from others to respond) I have not yet ascertained what it is.

Markets fail, institutions fail, governments fail – let’s try to understand why before we arbitrarily play with them.  This is why economists struggle to understand why people fly off the rail like this, we see the point of our discipline as one of understanding and description – predictions are just an outcome from this process not the main goal (see lots of discussion on this issue).

Update:  Surprisingly related posts on Economist’s View and Marginal Revolution (*, and response).

On Economist’s View, the claim is made that “protectionism is instinct, as we struggle with non zero sum games”.  I have heard this before – and this explains why economics, and the actual functioning of the macroeconomy often seems “counter-intuitive”.  Introversion is essential for doing economics – but we have to be willing to question our intuition if it just doesn’t hold!

This is relevant, as I get the impression that many calls for macro-controls are on the basis of this instinct.

On Marginal Revolution there is a link to an article on the adjustment in the yuan.  Brad Delong’s reply also offers relevant points.  Overall, this illustrates that the true “concern” regarding currencies has existed for a while – and stems from currencies being fixed NOT from the fact that many monetary authorities are simultaneously devaluing now.  These issues need to be separated.

Matt Nolan

A step too far: The case against pursuing direct capital/trade/currency controls

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To start off with I have to admit I like Bernard Hickey.  I like the fact he has got out there, written about New Zealand economic issues, and pushed to add an open debate type platform to the discussion regarding the New Zealand economy.  As a result, I may have not been critical enough when I read his posts in the past – as I did not see this coming.  In truth, the calls for exchange rate, trade, and capital controls is a massive step too far in what could well be the wrong direction.  Let me talk about the points Hickey has raised:

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