Matt Nolan

A note of caution for NZ

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Things are generally looking better for New Zealand.  Consumer, business, and forecaster expectations of growth have improved, our trading partners are stabilising, and financial markets are functioning.  Yay.

But one piece of data that leaves me a little cautious is the money stock data.  The broadest measure of the money stock (M3)  declined 2% on a year earlier in November.  This was the largest decline on record (going back to 1960).

Furthermore, following this release the New Zealand dollar has climbed sharply.

If the declines in the money stock are sustained, and the higher dollar is also sustained, there is one clear interpretation – market expectations of demand driven deflation.

Of course, this data is volatile and rising commodity price expectations and the such can be used to explain the change in the dollar, but …

Matt Nolan

Uncertainty and asymmetric risks

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Justin Wolfers says Charles Plosser is being a bit silly on the Freakonomics blog.

Specifically he says that:

  1. Plosser says we should tighten more quickly than estimates of “slack” suggest, as the level of slack is uncertain,
  2. However, since slack is uncertain it could be higher or lower – so this doesn’t make sense unless you weigh the outcome with lower slack more highly than the outcome with higher slack, which seems wrong!

Now I think he is being a bit sneaky here.  Yes there is uncertainty, but the perceived ex-ante risks around this uncertain variable are asymmetric.

What the hell am I trying to say here?  Well, we know that potential economic activity seems to be “trend stationary” over time (so it tends to rise at an average rate), however we aren’t quiet sure of the trend.  When we measure “slack” in a “recession” we are normally coming off a high point – which biases up our trend estimate.  Macroeconomists do heaps of stuff to try and correct it – but we often end up with a higher estimate than seems fair.

As a result, even though slack is uncertain there is a greater likelihood that slack will turn out to be smaller than it is currently thought to be rather than larger.

Of course, on an unrelated note I would say that economists should look at the unemployment rate as a measure of slack a lot of the time – as we have a measure of it, and it does give us an indication of the relative “hole” in the economy.  With unemployment over 10% the US should still be looking at substantial stimulus – so Plosser seems a little gun ho.

Matt Nolan

Are excess reserves driving a “currency misalignment”

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One of my favourite excuses for the “high” NZ dollar is currency reserves being built up overseas (in order to “keep their currency low” they need to buy up foreign dosh, building up currency reserves you see).  It is an argument the US likes to make without actually doing any analysis as well.

However, work has been done … a while back.

The linked to paper found that reserves were not excessive anywhere, expect China.  A good point to keep in mind no doubt.

Matt Nolan

Monetary policy discussion in the US

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Sounds like what we’ve been saying here.  From over there:

  1. The Fed should have a single nominal target.
  2. The Fed needs to be transparent and have specific and well-defined monetary policy goals.
  3. The Fed should focus only on monetary policy, and regulation of the large banks.

From over here:

  • At its heart, the consensus between the two main parties was to do with the target of monetary policy – monetary policy must be implemented by an independent Reserve Bank to ensure that inflation remains within a low and narrow band.
  • Giving the Bank multiple instruments to simultaneously achieve multiple targets would be a recipe for confusion, and would ultimately damage its ability to achieve any of its targets
  • Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy
Matt Nolan

Against the Paradox of toil

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In a recent post Paul Krugman raises the “paradox of toil” to explain why tax cuts are silly and government spending is good during a recession:

So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.

However, this is completely misleading.  Cutting a tax doesn’t really “shift the supply curve” (which is what expanding the labour supply means) in this way.  Lets have a little think about wages and what cutting the tax probably does.

Read more

Matt Nolan

More on currency misalignment

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Given the rising pressure for the Reserve Bank to target the currency as well as other things in New Zealand it is important to have a look at reasons why people may think our currency is misaligned.  I have said before that IF the currency is overvalued I think it is a structural issue and is really unrelated to monetary policy – however, there are of course many other arguments.

We have mentioned the begger thy neighbour type externalities from domestic focused monetary policy – something that a small country like NZ cannot cause, and so we can’t blame our domestic monetary environment for.

And a new discussion paper by the Dallas Fed discusses why the exchange rate may be an important issue to look at intervening into (ht Econobrowser).  Specifically the paper states:

If the nominal exchange rate regime matters for the determination of relative prices such as the real exchange rate or the terms of trade, it must matter because there is some kind of nominal price stickiness. For example, if the U.S. dollar/euro exchange rate is to affect any real prices, it must be because there are some nominal prices that are sticky in dollar terms and others that are sticky in euros. From the standpoint of modern macroeconomics, the question should be posed: What policy best deals with the distortions from sticky prices and other sources? Is it a fully flexible exchange rate, or some sort of exchange rate targeting?

However, coming back to New Zealand I still feel fully flexible exchange rates are appropriate.  Why?  Apart from the fact that I view such a “relative price shock” as an insufficient condition for intervention, the idea of price stickiness only matters when export prices are SET by exporters.  New Zealand is a small open economy that sells on foreign markets and receives (and pays) the world price – therefore our trade prices are flexible.

The inefficiency occurs when prices are denominated in domestic dollars, and do not change in the face of some “shock” which changes the value of the exchange rate.

Finally there is an asset price bubble argument for intervention (as the currency is a forward looking asset price).  Whether we can really identify and then improve welfare by intervening against “currency bubbles” is highly debatable – and it is an area the Bank has already been involved in (by becoming a currency trader 😉 )