Matt Nolan

A note of caution for NZ

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Things are generally looking better for New Zealand.  Consumer, business, and forecaster expectations of growth have improved, our trading partners are stabilising, and financial markets are functioning.  Yay.

But one piece of data that leaves me a little cautious is the money stock data.  The broadest measure of the money stock (M3)  declined 2% on a year earlier in November.  This was the largest decline on record (going back to 1960).

Furthermore, following this release the New Zealand dollar has climbed sharply.

If the declines in the money stock are sustained, and the higher dollar is also sustained, there is one clear interpretation – market expectations of demand driven deflation.

Of course, this data is volatile and rising commodity price expectations and the such can be used to explain the change in the dollar, but …

Matt Nolan

Uncertainty and asymmetric risks

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Justin Wolfers says Charles Plosser is being a bit silly on the Freakonomics blog.

Specifically he says that:

  1. Plosser says we should tighten more quickly than estimates of “slack” suggest, as the level of slack is uncertain,
  2. However, since slack is uncertain it could be higher or lower – so this doesn’t make sense unless you weigh the outcome with lower slack more highly than the outcome with higher slack, which seems wrong!

Now I think he is being a bit sneaky here.  Yes there is uncertainty, but the perceived ex-ante risks around this uncertain variable are asymmetric.

What the hell am I trying to say here?  Well, we know that potential economic activity seems to be “trend stationary” over time (so it tends to rise at an average rate), however we aren’t quiet sure of the trend.  When we measure “slack” in a “recession” we are normally coming off a high point – which biases up our trend estimate.  Macroeconomists do heaps of stuff to try and correct it – but we often end up with a higher estimate than seems fair.

As a result, even though slack is uncertain there is a greater likelihood that slack will turn out to be smaller than it is currently thought to be rather than larger.

Of course, on an unrelated note I would say that economists should look at the unemployment rate as a measure of slack a lot of the time – as we have a measure of it, and it does give us an indication of the relative “hole” in the economy.  With unemployment over 10% the US should still be looking at substantial stimulus – so Plosser seems a little gun ho.

Matt Nolan

Wages and recovery: A note

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There seems to be some hatred for the idea that if nominal wages were more flexible unemployment would not rise as high (here, here, and here).

However, I am a fan of the flexibility argument – and not just because my mind struggles to get outside of partial equilibrium 😉

When I view wage flexibility I think about it in THREE ways that would lead to an improvement in outcomes – in so far as they would reduce the “market failure” that leads to a “surplus of labour”.  These are both RELATIVE PRICE arguments:

  1. Wages relative to substitute inputs:  Wages need to be able to adjust more quickly than other inputs.  If this is the case then employers would cut back on other inputs ahead of labour.  Given that there is both substitutability and complementarity in inputs this is a difficult issue – but nonetheless.
  2. Wages relative to goods:  Wages need to be able to adjust more quickly than goods prices.  That way real wages will decline, making labour relatively cheaper.
  3. Relative wages:  This is the big one for me.  Often during a recession there may need to be a reallocation of labour resources, or there may be uneven shifts in demand for types of labour.  If relative wages can adjust then we ensure that the cost (in terms of climbing unemployment and general economic inefficiency) can be minimised.
Matt Nolan

Against the Paradox of toil

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In a recent post Paul Krugman raises the “paradox of toil” to explain why tax cuts are silly and government spending is good during a recession:

So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.

However, this is completely misleading.  Cutting a tax doesn’t really “shift the supply curve” (which is what expanding the labour supply means) in this way.  Lets have a little think about wages and what cutting the tax probably does.

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Matt Nolan

Land tax and benefits, a point to think on

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Land tax.  It is a popular idea among economists.

However, I have heard some people pushing it based on getting land “in use” (this was mentioned at Kiwiblog for example).  I am not sure if I agree on this point.

Saying that we should tax land so people use it is similar to saying we should cut benefits to get labour “in use”.  Both these arguments involve increasing individual costs to get “activity” going.  This isn’t necessarily welfare optimal.  Remember the goal of policy is not to increase productivity or to get our GDP number as big as possible, it is to ensure that we have a society where net happiness is as high as possible.

Focusing on getting things “in use” by pushing a cost on private individuals does not ensure that net happiness will be higher, and is definitely a violation of the principal for policy we suggested here that:

Any regulation should be based on the idea of avoiding coercion either from the private or the public sector

Arbitrarily adding costs to get people to arbitrarily do other things is coercion, and I don’t know if I can support the actions of any private or public agents that are based solely on coercion.

I like a land tax as a replacement for other taxes given that the elasticities of supply and demand are low – implying that the “deadweight loss” from taxation will be relatively low.  Furthermore, the tax on land is a “fixed cost” of production, implying that the impact on downstream costs should be minimal (depending on how this changes relative land use in the long-run of course).

These reasons are not related to some arbitrary goal of maximising statistics, but instead on the idea that we should be trying to raise any target level of revenue at the lowest possible social cost.

Matt Nolan

Supply shocks, demand shocks, and corridors

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In a recent post by Arnold Kling I see him hinting at the similarities between his recalculation view of the current recession and the corridor theory of Axel Leijonhufvud.  Now I agree with both these theories, and feel they add an important flavour to current debate – but I think the theories actually tell us about very separate elements of any large scale recession.

In order to get my head around my feelings I’ll have a brief talk about shocks, and the kind of shocks I think are being represented by the different theories.  Feel free to tell me where I am blatantly wrong.

Now, for the non-economist readers I guess this post is a little wonkish in nature – although there will be no maths sitting around this time.

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