Matt Nolan

EU preparing to protect currency, fight off “wolfpack”

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The EU has decided it arbitrarily needs to protect the value of the euro.  Specifically:

We now see herd behavior in the markets that are really pack behavior, wolfpack behavior

Relevant picture:

Shirt source.

My question as a New Zealander who has experience the vicious swings in currency myself – why protect the value of the euro?  The euro is falling to help buffer the painful adjustment Europe is about to go through given their banking crisis, and they want to waste money trying to prevent this?  I don’t understand. Note: Krugman seems to feel a similar way.

Matt Nolan

Prior moral hazard and the credit crisis

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Were inextricably linked.  A quote that illustrates this to me strongly came from a Bloomberg article today.  The ECB decided to tell the countries that have high soverign debts to go to hell, and now that they aren’t going to take on the risk themselves private investors aren’t willing to and are selling.

This makes sense, previously people purchased the junk on the basis that someone else would pay for it – high return low risk!  Now that they have to face the real risk profile they are like “f**k that”.  However, Bloomberg (or at least David Kovacs) stated:

The reason the market is horrified now is Trichet said it’s not even being discussed. Smart investors are basically selling risk(y) assets

No s**t.  An asset appeared low risk, and now it is high risk, and the expected return is (at most) unchanged – so the risk adjusted return is lower.  No wonder they want to sell.

Now we are in a crisis, and if there is a run on good quality debt because of concerns we have to do strange things – sure.  But we need to come up with a system that rips this moral hazard out of the system.  It is the moral hazard that helps to drive crisis after crisis ultimately.

Matt Nolan

Fixed and floating mortgage rates, and the OCR

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Note:  Apologises for the lack of action here.  If I was any busy I would become a singularity.  Regular posting will eventually restart.  Now for a post …

Bernard Hickey recommended sticking to floating mortgages for the long haul on Rates blog recently.  This is in stark contrast to Tony Alexander’s suggestion that, in a few months, fixing will be the way to go.

Now fundamentally, I think it is important to know What is the difference between a Financial Planner & Wealth Management advisory? These two authors AGREE on the track for the official cash rate going forward.  The difference stems from the expectations for floating and fixed rates.  Personally I agree with Tony.  Why?

Bernards argument, in my opinion, hits a certain flaw right here:

If, for example, the Reserve Bank starts increasing the Official Cash Rate from its 2.5% to around 5% by the end of next year, then variable rates are expected to rise to around 8-8.5%. Given fixed rates are also expected to rise by a similar amount to around 9-9.5% the choice is clear for those simply looking for the cheapest rate.

This isn’t how floating and fixed rates work per see.  The current official cash rate influences interest rates now by providing some opportunity cost in sourcing funds.  The future official cash rate influences fixed interest rates now, by changing the opportunity cost of sourcing funds in the future.  As a result, the fixed rate depends upon expectations of the OCR in the future, while the floating rate only depends on the OCR now.

Given that everyone expects the OCR to lift appreciably in the coming quarters, it makes sense that the current floating rate is below the fixed rates.  However, as the OCR increases floating mortgage rates will lift by a greater amount than fixed rates.

Bernard Hickey is absolutely correct when he says that the world is different, and the make up and structure of interest rates will be different than we have experienced in the past.  However, as we move through the upward swing of the economic cycle I would expect fixed rates to become “relatively cheaper” than floating rates in a static sense.

Matt Nolan

Seperation of monetary and financial stability issues

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Economist’s View links to a post on the Vox EU site by Hans Gersbach.  At the start of the post Mark Thoma states:

I have argued many times that the Fed should have two roles. It should conduct monetary policy, and it should be the primary regulator of the financial system. However, not everyone agrees. When I was at the What’s Wrong with Modern Macro Conference in Munich recently, I met Hans Gersbach — we were on a panel together — and he passes along his argument that monetary policy and banking regulation should be conducted by separate bodies

So the disagreement here is not about the two instruments for central banks – in fact in the monetary policy community there is a strong degree of agreement regarding these two roles.  The disagreement stems from who should be in charge of the instruments – should we have one authority controlling both, or separate authorities.

This is a fascinating issue, and I have previously said I am on the side of SEPARATING.

My reasoning is that separating “monetary” and “financial stability” issues is essential in order to create transperancy in the public regarding policy movements.  If we can make sure that changes in the Bank’s cash rate are related to “monetary” policy and changes in prudential regulation/settings are related to “financial stability”.  By doing this, the actions/intentions of the individual institutions are more obvious and are more likely to anchor expectations – which is the point.

Of course monetary and financial stability policies, and these instruments (interest rates and prudential policy) are heavily related.  But of course, we know that monetary policy and fiscal policy is as well.  The fact is that in order to signal policy and control expectations we NEED individual instruments to be targeted at individual variables – and having separate institutions helps to clarify this fact.

Matt Nolan

Strategy spaces and monetary policy

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Over at Worthwhile Canadian Initiative, Nick Rowe suggests that central banks should find something else to discuss instead of interest rates.  The analogy provided is that of oligopoly competition: namely how the Cournot-Nash and Bertrand games have exceedingly different outcomes, even though the only superficial difference is that one game involves choosing output and the other game involves choosing price.

However, in the same way I don’t believe the difference in these games is just the product of “framing”, I am not sure if the call to arms against using interest rates as a focal point is necessarily that compelling.

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The Hand

Minimum wage vs inflation: A TVHE discussion

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We are sadly too busy to really post anything at the moment.

As a result, to fill in time we will put up a recent discussion between TVHE writers.  The one thing this conversation shows:  we all agree that arbitrary policies that are introduced to indirectly target a problem (eg changing the minimum wage to target inflation) tend to do more harm than good.

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