Matt Nolan

A little bit of risk is a dangerous thing

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So, our dollar has fallen 5% against the US, and 8% against the yen in the last few days. While some people may think that the prospect of no more interest-rate hikes is the driver, the truth is that market participants have become a bit more risk-averse.

A little bit of wobblying in the US stock markets, and suddenly a bunch of people have decided to unwind carry trades, and as we are the number one carry trade country, our exchange rate eased. That is why we are only down by 2% against the Aus$ since Thursday, they were a carry trade currency as well.

I expect us to stay around in the mid-70’s, we might even climb up a bit against the US. After all, this new found risk is based on subprime lending worries in the US, and the fundamentals of the strong NZ$ (high interest rates, strong commodity prices) are still in place. However, if asset prices (especially housing) start to ease too quickly, our exchange rate might be in for a bumpy ride.

Matt Nolan

GST as a neutral tax?

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I was reading a quick little post on Econlog. In it they say that you should not tax income, you should tax consumption. Ergo we should remove income taxes and replace them with a higher rate of GST.

The main criticism I often hear about this is that GST is regressive. Now I used to spout that line as well, after all poor people have a lower marginal propensity to save then wealthy people, as a result they spend more of their income, and so more is taxed.

However, then I was told to think about it a different way. Over our lifecycle we should spend all our money, so that we are on the boundary of our budget constraint. As everyone spends all their income over their lifetime, GST must be a flat tax.

Now you could make GST a progressive tax by having a higher rate of tax on luxury items (although that distorts the market by changing the relative price of goods). As a result, changing from income taxes to GST seems to make sense, if you think it is more efficient.

In the above article they said that income=consumption+savings+charity. They said that savings and charity should not be taxed, and that is why we need a GST tax. Now, as we have said that savings become consumption over time, that doesn’t hold, and you can get tax rebates on charity. As a result, the only reason I can see to switch to an only GST tax will be if it is easier and cheaper to administer, and I seriously doubt that setting up a progressive GST schedule will be easy or cheap to administer.

Note: The labour market distortion still exists with a GST tax, since even though your disposable income is higher, the cost of everything is also high, so the real return for an hour worked is the same.

Matt Nolan

Spending on government employees

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An interesting new blog on stuff tells us why interest rates had to rise. Now I agree that people in the public service are being paid too much (as I don’t work there 😉 ). However, I’m not sure that public sector core wages are the main reason for inflationary pressure (although they do play some part in the wage bargain in the private sector as well). I think that it is a broader issue, with wasteful government spending in health and education the major drivers of our inflationary mess, along with low rates of productivity growth (in both the private and public sectors).

Ultimately, much of the current inflation problem comes from government failure. There is a role for government in society, but I’m not sure that the Labour government recognises the appropriate boundaries associated with that role.

stevedoogue

You don’t mess with the Guv’nor

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Bollard has shown who wears the pants. In raising the OCR today, he has shown his disregard for Dr Cullen’s mischievous feints at invoking his powers to override the price stability objective. He has also shown the market that he’s willing to back up his tough talk on the housing market – now on its “third wind”- even if this means ratcheting up interest rates even further as the Kiwi dollar reaches record highs.

Ultimately these actions will help bring the currency down. The Kiwi is underpinned by interest rate expectations, and only by raising rates today could he claim – credibly – that inflation is coming under control, meaning further hikes were unnecessary. So far the market appears to have believed him.

Perhaps this was unnecessarily hard on the housing market. The higher rates will bite hard as fixed rate mortgages continue to roll off over coming months. But then again, why not? A few months ago, a sharp correction in the housing market would have spelt disaster for the economy, with only government spending staving off risk of recession. But now a dairy commodity boom is underway, providing a massive boost to the incomes of farmers and wider economy. This means Bollard can afford to be more aggressive with domestic demand, coming down harder on the housing market. Showing that he is, indeed, still the Guv’nor.

Will Taylor

A Strict Application of “Kiwi Made” Actually Hurts Our Exporters

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While I am all for supporting the domestic economy, I think that a strict interpretation of the requirements for a good to be labelled “Made in New Zealand” actually harms our exporters. People get upset when they find out that something that is “Made in New Zealand” is manufactured using inputs purchased from another country. Any attempt to put pressure on exporting firms to use entirely NZ inputs is detrimental given that we are a small open economy with a very volatile exchange rate. The argument I’m making has absolutely nothing to do with price or quality but instead centres on a corporate finance concept known as “Natural Hedging”. Put simply if you have a company that sells its output in a foreign currency, purchasing your inputs in that currency naturally hedges movements in the exchange rate.  A good example of this is Navman who appear to be doing fine because they purchase a lot of their inputs in US$

While I accept that a good should still in essence be New Zealand made, I  believe that when the firm is an exporter, they should outsource as much of their inputs as possible.

Matt Nolan

One hike too far

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So the RBNZ lifted rates. However, they said this is the end, no more hikes this year.

I’m can understand why Bollard wanted to lift now, Cullen threatened his manhood and Bollard had to show he had some balls. I still think this lift is unnecessary, house sales are easing and firm profit margins have recovered, easing inflationary pressure over the next few months. Furthermore, even in the June quarter when retail sales were red hot, core inflation showed signs of easing.

Bollard has said no more rate rises will happen, however I think he’s taken one more than he needed to. Remember, the OCR hits inflation with a lag, it takes 12 months for effective mortgage rates to peak, and some say the full effect of tightening can take 18 months to come into effect. 2008 looks like it will be a difficult year.