Matt Nolan

NZ/Aussie Optimum currency area

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There is a little bit of talk about a ANZAC currency I see.  Lets be honest here, this effectively implies that New Zealand would be adopting the Aussie dollar. I remember arguing about this with my brother a while back, he was pro I was against.  Nowadays, I’m not sure – I’d like to see a few studies on it first.

Now there are costs and benefits from such a currency union.  Pages 633-634 in “Foundations of international macroeconomics” by Obstfeld and Rogoff covers these off as follows:

Benefits

  1. Lower transaction costs.  As Aussie is our main trading partner this is a biggie.
  2. Removes exchange rate risk for trade between nations, both in terms of relative prices and account reporting.
  3. Prevents damage from exchange rate verring from fundamental level.
  4. Makes trade protectionism more difficult.
  5. Added I would also add that, in this case, having the Aussie dollar will reduce the risk premium we have to pay for credit

Costs

  1. Can’t use monetary policy to compensate for region specific shocks – dairy price crashes and we can’t use a lower interest rate to help buffer the fall.  This is the primary concern.
  2. Can’t use inflation to lower public debt – our monetary policy is now determined by Aussie.  However, we don’t do this so it doesn’t matter.
  3. As fiscal policy is independent it can cause issues with splitting “seigniorage revenue“.  With a low inflation target this is not a biggie at all.
  4. Speculative attacks prior to the union.
Matt Nolan

Tax and recovery: Two ways Bill English is correct

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Whale Oil is unhappy with Bill English mentioning a capital gains tax.  Specifically he says:

In times of recession it isn’t that the government should be looking for more taxes.

But there are two reasons why I think Bill English is correct at the moment.

  1. Bill English appears to be saying that he wants income to be taxed more broadly to remove the “incentive” to shift income into housing.  As a result, he is saying that he wants to broaden the tax base, which implies that they can improve incentives and REDUCE other taxes.
  2. During a recession we could “stimulate activity” by saying we will increase taxes IN THE FUTURE.  This isn’t what he is saying, and I’m not saying it is a good idea, but it is another potential way of viewing things.

Ultimately, there are incentive problems with the tax system and when Bill English says he is interested in a CGT it is because he realises that these problems exist and that they are causing structural imbalances.  Good on him for being brave and admiting he is willing to do look at these difficult issues.

Matt Nolan

High dollar is a symptom, not a cause

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BERL’s (cheif) economist Ganesh Nana has been telling people that the Reserve Bank needs to act to get the exchange rate down. I disagree in the most part and agree in another arbitrary part.

The fact is that the “high” NZ dollar is the result of a bunch of factors: peoples willingness to lend to us, the willingness to take on risk, our own willingness to accept their credit, a high terms of trade, our higher real interest rates, and a belief that the asset value of our dollar is higher than it was in the 90’s. There is no issue with the dollar doing what it does here.

I do agree that we have an issue of “production” vs “consumption”, namely we are taking on a great amount of debt and as a country this makes us vulnerable. But in this case the questions should be “why are we taking on all this debt?’ and “is there a problem with this debt accumulation?” (like we asked here) – not “is the dollar too high?”.

The Reserve Bank should not move to crack the $NZ down, instead we should all ask why New Zealand as a whole has taken more debt on and figure out if their are any structural issues in the economy that a change in government policy can improve.

Note: Another thing I would note is that the RBNZ can lower the dollar by trying to temporarily lower real interest rates (by printing money and dropping the nominal interest rate). This again promotes consumption above investment, and surely wouldn’t help correct any “imbalance” that we are focusing on here! Let us not forget the impossible trinity here (we discussed this here).

Focusing on the dollar is like focusing on easing a patients symptoms while leaving the underlying disease untouched!!

Update:  Scott Sumner does a small discussion on prices.  The exchange rate is a price, as he notes the important thing is “why the price has changed” not what the price is per see.  The price is not the underlying issue but the factors driving the price.

Matt Nolan

Born short

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No in the title to this post I am not complaining about my lack of height.  I am simply discussing the housing market 😉

The Worthwhile Canadian Initiative gives an interesting point on housing:  We are all born with a short position on housing.

This has an interesting implication.  Since short positions involve risk and since long positions involve risk (as rental costs/incomes are volatile), the low risk position is to own one house.

As a result, we would expect the rate of return on housing to be LOWER than other asset classes.  An interesting point to keep in mind!

Matt Nolan

Baumol’s cost disease: An issue of government productivity

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Often I have heard people bring up “Baumol’s cost disease” as a reason for why labour productivity and wages can be unrelated.

Effectively, the argument is that if labour productivity rises in one sector it increases the demand for labour which in turn drives up wages in other sectors, even though productivity in other sectors is unchanged.

Now this is all well and good, but I’m not sure that this takes away the relationship between productivity and wages. Let us assume that there are an infinite number of sectors, but conveniently there are only two sectors competing for the same labour pool. Furthermore, one of these sectors experiences an exogenous increase in labour productivity and the “other sector” doesn’t.

Effectively, the increase in the cost of labour for the “other sector” will reduce the supply of that good driving up the relative price of the other good. There will be a reduction in the quantity produced and an increase in the relative price, which should imply that there will be an increase in marginal (and probably average) productivity of labour in the other sector.

What this concept DOES tell us is that maybe we shouldn’t be so tough on government for its poor productivity performance (as lamented here and here). Why? Labour productivity in the government sector hasn’t experienced any technological change, the services they provide haven’t become relatively easier to produce.

As a result, with the rest of the economy experiencing an increase in labour productivity wages have been driven up, forcing the government to also drive up wages.

Of course, this also implies that the relative size of the government should have shrunk (which it hasn’t) and that the increase in the price of government labour should have been smaller (which it wasn’t). But it does explain part of the public sector wage inflation that we have seen in recent years.

Matt Nolan

We doth blame the household too much

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I was raised as a microeconomist so I guess I have a bias, but all this discussion about our poor debt position being the fault of households makes me nervous.

It is easy to blame households, hell the RBNZ did that just today. As they point out, household savings is extremely low, and real consumption (the volume of consumption in 1995/96 prices) as a share of GDP has risen sharply in recent years. On Sunday Rod Oram did the same – blaming our debt position on households spending far too much.

However, I find that when economists start to agree we are usually wrong. Given that this argument doesn’t feel right to me in the first place I am being forced to disagree.

I have two “pieces of evidence” to suggest that households aren’t at fault here, and instead it is weird investment incentives and poor government policy that is likely to be at fault. These are:

  1. My good friend Ricardian equivalence,
  2. Nominal GDP shares.

This discussion is a slight expansion on my recent Dom Post article (secondary link), and I am hoping everyone here will be willing to attack me as much as possible 😉

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