The Money Illusion has popularised the idea of market monetarism, leading to strong claims overseas that there needs to be more monetary easing. This is all well and good, and in fact I long agreed with many of the policy recommendations that have been stated (although I am not a complete proponent). But if we were to look at the nominal GDP numbers for New Zealand (NGDP) what would it tell us?
Or are you just flirting with me Bank of Japan?
In truth the BOJ has tried to hold back from an explicit 1% inflation target, and is just discussing it as a “near term goal”. While this isn’t as positive as the Fed move to an explicit inflation target, and Australia and New Zealand’s long-term policy of having an explicit inflation target and printed rate track, it is an improvement.
With Fed and BOJ policy improving, credit markets in Europe consistently settling since mid-December, implied volatility on markets way down (the VIX), and the cost of credit down significantly in the past 6 weeks we could be seeing a real improvement on financial markets.
What does that mean in little old New Zealand? Well our higher exchange rate is tempering part of any stimulus coming from offshore, while its up to the RBNZ to keep an eye on the rate track. If financial conditions look like they are going to improve in the near future the Bank may suggest that they will be lifting rates in larger chunks when they do get around to it. It will be interesting to see what happens when we get to the March meeting.
Sorry for my lack of posting recently, my high level of disorganisation is taking its toll at what is quite a busy time for some reason.
As a result, I will post today with a comment I wrote somewhere else – hopefully, one day I can do a real post on this issue 😉
Over at Money Illusion Marcus Nunes links to an interesting post comparing monetary policy outcomes during the GFC between Aussie and NZ. One conclusion is that, during the GFC both central banks did some good work – but Aussie was better (from the market monetarist standpoint).
I stab down a reply stating that I think this is unfair on the RBNZ. I list some reasons why and discuss. Key points are:
The one argument I can see pulled out against the RBNZ is the same one being pulled out about the BOE – that they changed the structural framework in banking without compensating for any current drop in money supply indirectly linked to this change. However, even this is a bit rough – given the high level of uncertainty about the impact of those structural changes … in essence “ex-ante” they will have been taking this into account (they were saying it), the impact may have just been larger than they reasonably expected.
Via the Money Illusion I see that there is a suggestion to make consumption taxes an automatic stabiliser for a given economy.
Russ Abbott, who is a computer science professor at Cal State LA, sent me an ingenious plan for having the Fed use fiscal policy to stabilize the economy. It involves sales tax rebates when times are bad and tax surcharges when times are good. It would be easiest to implement in an economy that already had a VAT, and/or state sales taxes. I see it as analogous to my proposal to makes cyclical adjustments to the employer-side payroll tax rate. These plans tend to work best when the central bank is targeting inflation. Of course an even better policy is to directly target NGDP expectations.
The entire paper is only 2 pages, a model of clarity and concision.
I can not access the article, so just have to discuss it in terms of a concept. It also remember that the RBNZ has discussed the issue before, but I said this on the blog before I got into the habit of hyperlinking everything … I will find a link at some point.
The way I see it, expectations regarding the relative price of consumption now to future consumption are incredibly important – which is why we need to think about these very issues in terms of expectations. This raises four things to keep in mind when thinking about a proposal like this:
So, in answer to point 1 we would determine that we are on the upswing of a cycle when we are a certain % above some trend per capita – it may not be perfect, but it works in an operational sense. Very good.
In answer to point 2, we would know whether we were above this point with a lag of about a quarter (three months) in New Zealand. A similar lag would likely exist overseas, as they wait to have sufficient data finalised.
So, when it comes to forming expectations, people in the economy will already know if we are near a point where the consumption tax is going to be hiked (due to this being a some cycle), and they will have partial data from other economic indicators for the three months after the end of this quarter – as a result, if it seem sufficiently likely that taxes are going to be hiked, consumers will foresee it and lift their consumption now. Similarly, on the downside if people start to expect that a cut in VAT/GST will happen at a near time in the future (due to expectations of a downswing) people will cut consumption now.
In other words, by making the level of VAT/GST depend on the perceived point in the cycle we are at, we make any expectations of a downturn or upturn self reinforcing.
However, this is not the full impact. When activity is below trend, then consumption taxes will fall, when activity is above trend they will rise. Although the timing does cause some cyclical elements, the existence of the tax would likely smooth out the magnitude of any underlying cycle that happens to exist in economic activity (if the cycle is sufficiently larger than the deviations from trend that are targeted with the change in VAT) – in many ways it can be justified in the same way as an interest rate target for smoothing economic activity, as both involve changing the relative price of consumption based on where we are in the economic cycle.
Do we need this
Well no. With inflation targeting, we have a natural built mechanism for dealing with cyclical changes in economic activity. Furthermore, without having to rely on some arbitrary trend estimate we don’t have to worry about a supply shock knocking the fiscal position into a perpetual deficit/surplus.
Today’s Fed statement about monetary policy followed the same pattern that we have seen from other central banks, such as the RBA and RBNZ.
Essentially, fundamental conditions remain a bit weak, and so there is a reason to keep policy stimulatory – however, this view is strongly conditional on the ECB/Europe not being bat sh*t crazy.
Should the ECB/Europe be bat sh*t crazy, these central banks will be ready to support their respective domestic economies.
It makes sense – you can’t have an organisation being BSC as a central forecast. However, the risk has to be taken into account – which is why so many other organisations are releasing “downside scenarios” alongside their primary forecasts (the RBNZ and Treasury have both done this in NZ).
Again, I stick to the following line. The current banking crisis needs to be sorted by the ECB – fiscal authorities need more discipline, and that is a structural issue, but that isn’t the marginal factor pushing things into trouble now.
The ECB is doing things – but they need to communicate them better. Improve that communication and markets can have more faith in the policies the ECB is already frikken implementing, increasing their effectiveness. By communicating so poorly they are taking on all the costs of their policies, and not receiving a large portion of the benefit. It is on the verge of nonsensical …
I’m increasingly hearing people call for an NGDP target. I’m not really convinced it is superior to inflation/price level targeting to be honest. Let me discuss below.