Matt Nolan

The paradox of thrift and demand deficiency

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The paradox of thrift is one of the key lessons taught to macroeconomics students during their first undergraduate year.

Fundamentally it states that if everyone in society decides to save more right now, then it reduces consumption, with reduces economic activity and thereby incomes – and as a result it may actually decrease aggregate savings, and it will definitely reduce economic activity.

It is still widely applied, with recent Nobel prize winner Paul Krugman appealing to it in order to explain why the US needs to jump on in and get consumers spending again.

Of course this does not mean the theory is necessarily right. The paradox of thrift does not have a supply side – as long as prices and quantities can adjust to an economic shock this paradox, and the suggestion of government intervention in the face of it, does not hold water. For government intervention to be a possible solution we need a MARKET FAILURE, a market failure that causes a special macro-economic situation called “demand deficiency”. (Note: This is effectively the difference between Say and Keynes).

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Matt Nolan

Random statement of the day

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This from the Minneapolis Fed:

Thus, roughly 80 percent of such business borrowing is done outside of the banking system. The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable

There are two ways I can read this quote, one that I agree with and one that I dispute. The first way is that “this isn’t the end of the world” – I agree with this, and I still think that people too closely linked to the financial markets are expecting worse outcomes for the global economy than will actually occur.

However, I think the Minneapolis Fed’s paper overplays it a little and suggests that there is no credit rationing element – only a risk-price element.
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Matt Nolan

Arnold Kling rips into economists

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Over at Econlog Arnold Kling takes to task virtually all mainstream Macroeconomists for there “description” of the current economic crisis. This combined with my reading last night on reductionism in economics (I think it was Robert Frank Kevin Hoover – although I have now forgotten as it was an essay in a larger book) currently has me on the back foot – even though I’m a strong methodological (and even an ontological) individualist there are obviously issues with the current application of reductionism in economics.

However, let met put down some of the key bits from the Kling.

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Matt Nolan

How one could blame government for inflation

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To put my personal value judgments out initially, I generally DO NOT think that government (through fiscal policy) can be blamed for inflation. However, among many people, and even many economists there is a feeling that government is to blame in some way. Personally, I completely blame monetary policy for the failure to control inflation – and although I think they are behaving in an appropriate way in the current crisis – I think that policy was too weak in the past, which has made things more difficult now.

However, the view that it is “the government fault” is not completely without merit. Iprent at the Standard asked me to link to a discussion of how this COULD happen, and as a result I will write a post and link to it here 🙂

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goonix

Optimal tax theory and ACT’s taxation policy

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Yesterday, the ACT party released their tax policy (further discussion also over at Kiwiblog)

Some key points from ACT’s taxation policy include:

  1. restricting future increases in Government expenditure to inflation and population growth
  2. eventual personal tax rates of 12.5% up to $20,000 and 15% above $20,000
  3. eventual company tax rate of 15%
  4. eventual GST rate of 10%

Tax distorts behaviour. The concept of the ‘excess burden of taxation’ is the economic loss that society suffers as the result of a tax, over and above the revenue it collects. Distortions occur because people or firms change their behaviour in order to reduce the amount of tax they must pay, which results in deadweight loss from taxation.

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Matt Nolan

Price asymmetry and my bus ticket

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A large debate in economics stems from the idea that there is a price asymmetry in the economy. What this implies is that prices are more flexible in one direction (up or down) then they are in the other direction.

The commonly provided example is petrol prices. People feel that when crude oil rises in price it is passed on immediately, but when it falls in price it takes time for the firm to react and lower petrol prices. This implies that prices are “stickier” downwards, and so the adjustment to two shocks opposite shocks is asymmetric.

Another example is housing. People find it psychologically difficult to accept that the nominal value of their house has fallen, so it tends to be harder for the nominal price to fall than for it to rise.

Now there are a large number of economists that don’t believe these asymmetries exist (I’m in the camp that I think the downward asymmetries are exaggerated). Overall studies have been inconclusive.

Now I think sticky prices exist, but I think we’ve also got an inherent bias to look at cases where they appear to be sticky downwards compared to stick upwards. I was reminded of this when I brought my Gold Pass for the bus in September.

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