jamesz

Best article on the Treasury website?

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Fortuitously stumbled across this while looking for something else. Arthur Grimes investigates the Arbee:

In his “Life Among the Econ” Axel Leijonhufvud took an ethnographic approach to describing the Econ tribe and, especially, two of its components: the Macro and the Micro. My purpose is to delve further into the life of the Macro, specifically examining the Arbee sub-tribe. The task of our research is to examine the nature of the Arbee reaction to claims by other tribes and sub-tribes that the Arbee rituals have caused The Imbalance in The Economy. Specifically, their highly formalised OC Ritual (OCR) has been blamed for creating The Imbalance … It is the rituals of the Arbee that many claim to be the cause of The Imbalance in The Economy. If only the Arbee were to conduct their ritual in a different manner, the prices, expenditure and living standards would all right themselves.
…
The OC Ritual is a highly stylised dance. The first move involves no actions by the priests, just observation of other dancers. The priests observe the effect on all prices that result from the bigfella man’s resource directives. The high priest has a contract with the bigfella man that price rises must be kept to within a certain sacred range.

Hilarious, yet serious, it’s worthwhile reading the whole thing. See Leijonhufvud for the background.

Matt Nolan

A summary of credit creation

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This post on VoxEU gives a neat summary of the credit creation process, and the ways that collateral chains have had an impact on the process.

I’m not going to reiterate the post – as it is concise, and if you are interested it would be a good idea to go and read it.  However, what I will say is that this is akin to the standard view of credit markets – essentially at a given point in time assets and liabilities match across the market, but the more convoluted the chain, the more vulnerable financial markets are to an uncompensated change in asset prices.

Matt Nolan

Some thoughts on housing

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I see that the latest Barfoot figures are out, and they are pointing to fairly strong sales figures in the Auckland region.  That’s nice. There are also suggestions that this is indicative of a bubble or boom coming into the housing market.  However, it is important to look at a broader view of what is going on, not just house sales for one agency in Auckland, in order to get an understanding of the what is really going on.

When looking at the housing market, there are a number of little points we need to keep an eye on.

  • The regional split: We have commonly been told that Auckland and Canterbury have a shortage of property – all else equal this pushes up house prices in these regions.  This is something we have seen happen.
  • Borrowing to invest?: In 2003, households borrowed heavily and developers started building heavily.  Now we have the opposite.  Yes, in the year to April households borrowed 30% more (in gross terms) to buy housing.  Yes, this was $45.4bn.  However, the stock of mortgage debt rose by a more modest $2.4bn more – or by 1.4%, below the rate of inflation.  Even as house sales and prices have climbed, households have taken the funds from sales to pay back mortgages – not to spend or build more houses.  SO, while we could use the rising prices and investment in the mid-2000’s to point towards a bubble, this time we have limited investment and an underlying shortage of property driving up prices – this is not a bubble, this points to a failure somewhere in the building or credit markets.
  • Credit conditions:  Mortgage conditions have eased, and competition between banks (along with low wholesale funding rates) has driven down the cost for households.  This sounds similar to what was going on during the boom time.  But even so – we have pointed out that increases in NET borrowing have been low (or negative in real terms).  On top of this, for various reasons credit conditions are tight when it comes to building houses – increasing the value of existing housing.
  • Quality, income, and constraints:  As the productivity commission noted, there are significant issues currently impeding activity in the building industry – and thereby pushing up prices.

When this combination of factors is taken together, it feels like we have a situation which is “supply” driven, with a shortage or property driving up values.  This compares to any perceived “bubble” which would be “demand” driven, with expectations of capital gains leading to excessive investment and excessively high prices.

This distinction is important when it comes to the actions of the Reserve Bank.  There are three questions they need to ask when looking where housing appears within the context of their goals of inflation targeting and financial stability:

  1. Are current interest rates consistent with the level of general demand in the economy? If the lift in housing market activity is supply driven, this suggests that interest rates should be lower relative to a situation where it is demand driven, with the increasing borrowing that entails.
  2. Is the current stock of debt, and banks attitude to risk in general, taking into account the full social risk associated with these elements?  The RBNZ has introduced a range of policies to help ensure this is the case.
  3. Is the regulatory regime that the RBNZ implemented possibility having a greater impact on domestic demand, or the housing/construction market than was previously expected?
Matt Nolan

A cut to the OCR, why?

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Note:  This post is like a personal summary of information from the recent past – given that I have been too slack to write about international events here.  Sorry if it reads like a list 😛

I see that my workplace came out and said that they expect the official cash rate to be cut in June – by 25 basis points to 2.25%.  Unsurprisingly, I agree with the assessment of my colleagues.  However, a large number of other economists – whose views I also have a lot of respect for – believe that a cut is not on the cards, at least not yet.

So why is there a difference, why would a rate cut be justified (or not), and are there red flags to look out for?  Well James Weir answered all these questions in the Dominion Post so I don’t have to 😉

In my mind and in the Dom article, the combination of a persistently high currency (which holds down output and thereby inflationary pressure), low measured inflation, falling commodity prices, a weak labour market, and signs that the recovery in the housing market is not infallible all suggest that the appropriate level of the official cash rate is now lower.

Add to this the RBA’s willingness to cut their cash rate by 50 basis points due to bank funding pressures, the RBNZ’s warning on the OCR, and the fact that monetary conditions have been eased overseas (a primary driver of the relatively higher dollar – the Bank of Japan has been the latest, but lets not forget about the Fed’s willingness to hold rates at low levels until late-14) and I believe (and it seems my workplace does as well) that the “appropriate track” for the official cash rate is now lower, and so the Reserve Bank will be willing to cut to place us on a track that meets its inflation mandate and minimises volatility in the New Zealand economy 😉

It is perfectly reasonable to not agree with this view – and to say that the stimulatory impact of the rebuild in Christchurch and a broader recovery in  the housing and construction markets will see spare capacity get used up, and as a result there is not need to reduce the track for the cash rate.  It is this view that many of the banks are sticking to at present.

Now recent data has seen the market price in an 81% chance of an OCR cut in June, this combined with uncertainty in Europe following the Greek and French elections has seen the dollar fall sharply (the TWI has dropped since the start of last week).  If the currency experiences another sharp downward leg, it reduces the chance of a rate cut – think of it this way a lower currency will stimulate output in New Zealand given current prices, reducing unemployment and the output gap, meaning that the RBNZ needs to do less work to meet their mandate.

Update:  Eric Crampton offers comments here.

Matt Nolan

Bleg: What is the issue endogenous money people are after?

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I have a question where I would love some help 🙂

Via Marginal Revolution I noticed that there seems to be quite a war between economists regarding the financial sector.

However, I actually don’t see where there is an issue in the argument that is going on.  The way I see it Nick Rowe has it right with his comments here and here, and in turn this illustrates that even though a central bank doesn’t explicitly constrain the “stock” or the “supply” of money, their cash rate (and its relation to the natural rate) and inflation target (given an output gap view of the evolution of inflation) provide an implicit constraint.

The way I see it, mainstream theory and “endogenous money” theory people can both assume that the quantity and/or supply of money is endogenous, and that investment=savings-current account.  So where is the difference, what does it tell us, and how is it testable?

Matt Nolan

The bad side of independence?

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For me, the independence of central banks is one of the greatest institutional changes that has taken place in the past 30 years when it comes to “economic management”.  This independence has allowed central banks to clearly articulate goals and ensure that the arbitrary monetary distortions that previously occurred no longer take place – governments can not use storage, and central banks are generally less likely to accidentally tighten or loosen conditions inappropriately.

But this independence, and this view that a central bank provides some central “management” role has led an increasing number of writers to believe that the central bank truly controls the economy.  Not just in a broad sense, but there is a belief that a central bank can meet many disparity micro goals, changing the structure of the economy, controlling firms pay structures, changing inequality.

There was a time not so long ago when it was clearly recognised that STRUCTURAL issues were the responsibility of Treasury – if there was a clear defined market/institutional/government failure to deal with.

But now an increasing number of these broad structural issues are being blamed on central banks, there is an increasing belief that by changing an interest rate the Bank can separately determine a myriad of clear “good and bad” potential outcomes – and people appear to get frustrated because they feel that central banks are purposefully making things worse.

But this is not true, monetary policy is inherently cyclical, financial stability issues are just that … issues of financial stability.  If there are failures in the more general economy it is due to either the imperfection of the world we live in or the inappropriateness of government policy settings (in either direction) – it is not due to the central bank setting the wrong interest rate, or making the wrong comment in their latest statement.

I just hope this fundamental lesson will be remembered before people decide to start diluting the independence of, or stretching the role of, our central banks.

Update:  This issue is discussed more sensibly on the Money Illusion.  Choice quote:

Monetary policy should be boring, as it is in Australia; not exciting, as it is in the US and Japan.  Most of my readers think I am advocating use of monetary policy as a tool.  Most think I want it to be exciting.  Nothing could be further from the truth.