Matt Nolan

Collusion, multiple equilibrium, and petrol prices

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Conjecture is rife regarding why petrol prices have risen so strongly. There are a number of common explanations:

  1. Rising demand for oil,
  2. The weak US dollar, increasing the US$ price,
  3. Peak Oil (Infometrics article requires a subscription),
  4. Negative real interest rates in the US (as not mining the oil is the same as investing in inventories),
  5. and speculation.

All these factors are playing a part in the saga of ever rising oil prices. However, Calculated Risk has suggested another, highly interesting way that fuel prices could have risen – a backward bending supply curve and multiple equilibrium.

This idea is pretty cool – so I thought I would spend a little bit of time explaining how it could work.

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Matt Nolan

What is this savings problem?

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So far we have discussed Kiwisaver and national savings in fairly loose terms. We know that (part of) the purpose of Kiwisaver was to increase national savings and that our interest in national savings stems from the fact that we want New Zealand to have more productive capital.

So before we can discuss the myriad of burning questions surrounding these issues – and more broadly surrounding New Zealand’s productivity (such as if Kiwisaver achieves the greater capital goal even if it theoretically doesn’t increase savings) we need to ask, what is the savings problem?

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Matt Nolan

Why do we care about national savings?

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In another of our warm up posts for discussing productivity we are going to discuss why national savings are important.

As Fred states in this comment, savings are effectively deferred consumption. The incentive to defer consumption is based on individuals wish to “smooth consumption” over time (which relies on their time discount rate and expectations of future income) and the return available on these savings. Now the reason that it is possible to make money off your savings is because these savings are used by other agents in the economy who have the ability to pay you back later on – fundamentally these savings are used to invest.

Going back to our good friend supply and demand we know that the supply of funds for capital investment is a function of the interest rate and peoples willingness to smooth consumption while the demand for capital investment is a function of the interest rate and the expected return from the investment. As savings increase in the interest rate (for those who care, assume that the substitution effect dominates the income effect of a higher interest rate) and investment decreases with the interest rate (or at least the expectation of the equilibrium interest rate) we know that there will be an interest rate that makes supply and demand equal.

Fundamentally, the government may want to increase national savings if they believe that current national capital accumulation is sub-optimal for some reason – as in some sense savings=investment. Again I’m going to ask a question which I would love for everyone to have a go at answering – why may the government believe that the current rate of capital accumulation is sub-optimal?

Matt Nolan

Kiwisaver and aggregate savings: A question for our readers

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Over at the NBR comment page Trinh Le from NZIER discusses the research by John Gibson and herself into Kiwisaver and aggregate savings (here and research).

The idea that Kiwisaver can actually reduce national savings is an important one – and something that one of us will post on soon, either before or during our upcoming discussion on productivity.

For now it would be useful for you guys to have a look at this article and tell us what you think. Do you think Kiwisaver will actually increase national savings – if so (or not) why?

Matt Nolan

Tax cuts and interest rates

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Given my belief that these tax cuts, without corresponding cuts in (unproductive types of) government spending, will lead to greater inflationary outcomes I’ve decided it is important to argue the complete opposite case – namely that tax cuts will not impact on inflationary pressures and interest rates.

The common view I work off when stating that tax cuts increase inflationary pressure is that tax cuts increase “aggregate demand“, which in turn will lead upward pressure on prices, and therefore an upward shift in interest rates.

However, there is another popular view that has been raised by Stephen Kirchner of Institutional Economics. Specifically this view states that tax cuts have supply side effects on the economy (which increases the supply of goods in the economy and so reduce inflationary pressures) and some degree of Ricardian equivalence holds – such that any increase in budget surpluses will lead to borrowing from the private sector, as they expect tax cuts later. He makes these arguments here and here (I made a similar argument here).

Furthermore, tax cuts may reduce wage pressures – thereby leading to lower inflation. How? Say that the nominal wage is fixed and there are tax cuts – it this case the whole tax cut immediately goes to the employee. However, unless the employee has significant market power, the employer will be able to extract some of the surplus gained from tax cuts over time, by offering smaller wage increases.

Given these supply side arguments why am I still concerned about inflation?

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Matt Nolan

Jawboning productivity?

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Dr Cullen has told businesses to increase productivity. Although this sounds utterly ridiculous, given that businesses will make all profitable investment they can in order to make their output at a lower cost (unless you believe there is a conspiracy to keep wages low 🙂 ) there could possibly be some method to his madness.

Treasury has been working hard on the productivity issue this year, but it is a difficult issue. If we could costlessly increase our productivity then we would have no trade-offs, as output could become un-limited. As a result, the trade-off they have been interested in is the trade-off between current investment in productivity and the future benefits. To make matters even more difficult, the factors lying behind productivity remain somewhat of a black box – a subject where an individuals industry expertise trumps the musings of a whole team of economists.

Given that information regarding productivity is implicitly tied up in businesses and given that the choice of investment in infrastructure and R&D are often subject to positive spillovers, Dr Cullen’s strategy of Jawboning may be ingenious.

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