Matt Nolan

When did NZ’s right become communist?

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I am very confused at the moment. I keep hearing the NZ right talk about “catching up to Australia” and increasing New Zealand’s labour productivity (eg here and here).

But doesn’t this presume that the government has the ability to do these things? This confuses me as I thought that the basis of the NZ right was that the government doesn’t have the ability to significantly improve economic outcomes.

For example, Don Brash, the ACT party, and Roger Kerr, believe that the government can increase real GDP growth in New Zealand sufficiently for us to catch Aussie. According to them this involves growing adding 31% more output in this period (15 years) as well as any growth that Aussie achieves. Is it me or is this insane.

I also hear people say “China has been growing in excess of 10%pa” why can’t we. Well this is because they are starting at a low base, and are catching up in technology to developed economies – we don’t have this “low hanging fruit” to pick up on.

Long-term growth is based on technology, resource allocation, and to some degree the structure of institutions in the economy. I severely doubt that the government can turn around and improve any of these things to the degree required to “catch Australia”. Hell, Australia is closer to its markets, has a larger set of currently important natural resources, and gets “economies of scale” due to its higher population. No government policies can magically fill this gap.

Update:  Paul Walker shares similar sentiments, and a bit more discussion, here.

Matt Nolan

Quote 22: Stumbling and Mumbling on Macroeconomics

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From here:

Macroeconomics failed in this crisis because it has for ages under-rated the importance of the stuff we (might) learn in industrial organization classes

Industrial economics is effectively applied microeconomics in the field of the economy (as compared to some of the more social fields that some microeconomists have moved into). I have always believed that current macroeconomics is simply an application of applied micro from 20 years earlier. Given the amount of progress made in industrial economics over the past 20-30 years I agree with this quote, and can see why an ignorance of these lessons has lead us to some observable errors.

Furthermore, I agree with this quote as it paints the future of macro in “methodological individualistic” terms – specifically we want to understand the behaviour of the individuals in a system in order to understand, and then predict, how the system will work.

I fear that macro will move back to the Friedmanesque interpretation of economic models – where all that matters is current predictive power, not the underlying “truth” of the assumptions driving the model. Why do I fear this? Well, when something goes wrong and the model stops forecasting well (which it will), if we don’t understand the assumptions we don’t know where to look for the failure.

However, I have to admit that trying to apply these lessons to an aggregate framework (which we need for macro) is a lot harder than it sounds. A factor that may make my dreams more of a pie in the sky fantasy than an actual realistic prescription for the direction of the discipline.

Update: Anti-Dismal has a related post on criticisms of macroeconomics and DSGE models. I agree with him on this point “much of the criticism aimed at DSGE models seems to result from a failure to understand the use of the DSGE model”. However, when looking at macro we have to ask – did macroeconomists maybe exaggerate the scope of their own models to get attention? If so I think maybe we deserve a little criticism to put us back in line. However, don’t throw the baby (DSGE modeling) out with the bathwater.

I also discussed criticisms of macro here in March.

Matt Nolan

RBNZ inconsistency

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Eric Crampton points out that the RBNZ seems quite inconsistent at the moment. Now I have a high level of respect for our central bank, but Crampton is completely right.

How are they inconsistent? They complained that retail banks aren’t cutting interest rates far enough, then they stated that they think household’s need to save more (something that surely requires higher interest rates). As the Bank controls interest rates, the fact that they are saying they should be both higher and lower is very weird.

This inconsistency stems from the fact that the RBNZ is talking about different periods of time. The first concern is based on the short-term. They are worried about unemployment rising sharply, which is a wasted resource, and will thereby reduce national income – paradox of thrift style. The second concern is based on the medium term, they believe that the consumption share of GDP is too high (and export activity is too low) to be sustainable.

What the Bank wants is a shift in the economy from consumption to exports without any unemployment. Effectively, they think debt levels are “too high” and they are blaming this on consumption. I don’t agree and I think if there is any failure it is more likely to be the result of policy failure than “silly households”.

One last note, when the hell did the Reserve Bank become a central planner? Their mandate is to control medium term inflation, not to decide how national income should be divided.  They should mention risks, but saying that households are incapable of looking after themselves (which is what this sounded like to me) is going too far.

Matt Nolan

We doth blame the household too much

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I was raised as a microeconomist so I guess I have a bias, but all this discussion about our poor debt position being the fault of households makes me nervous.

It is easy to blame households, hell the RBNZ did that just today. As they point out, household savings is extremely low, and real consumption (the volume of consumption in 1995/96 prices) as a share of GDP has risen sharply in recent years. On Sunday Rod Oram did the same – blaming our debt position on households spending far too much.

However, I find that when economists start to agree we are usually wrong. Given that this argument doesn’t feel right to me in the first place I am being forced to disagree.

I have two “pieces of evidence” to suggest that households aren’t at fault here, and instead it is weird investment incentives and poor government policy that is likely to be at fault. These are:

  1. My good friend Ricardian equivalence,
  2. Nominal GDP shares.

This discussion is a slight expansion on my recent Dom Post article (secondary link), and I am hoping everyone here will be willing to attack me as much as possible 😉

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Matt Nolan

On penalty cash rates

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Scott Fullwiler from New Economic Perspectives (ht Economists View) describes some issues he has with the “negative interest rate” idea being put forward by Willem Buiter , Greg Mankiw , and Scott Sumner

Now I have previously put my foot forward and said I agree with this idea (here and here) and I still feel the same, let me describe why with reference to Dr Fullwiler’s post.

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Matt Nolan

Where is the externality here?

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There have been wild debates surrounding the BERL report into the social costs of alcohol.  I haven’t read the report, I haven’t read the replies, I have to admit I have been busy.

However, in one of Eric Crampton’s many posts on the issue I see that generally an externality from lost output, excessive unemployment, and forgone wages has been assumed in the discussions.  I’m sorry but what?

The labour market is a market, how can we have an externality when there is a market with a market price (wages).  Yes, alcoholics produce less, less of them are employed, and they tend to have lower wages – but this isn’t an externality it is part of the market process.  They are paid less because their marginal product is lower, and they are willing to be paid less because the benefit they receive from consuming alcohol is sufficient compensation – this is a completely internalised decision for the drinker isn’t it, so where is the social cost.

And don’t say it is too the firm – the firm can set a lower wage because of the fact that the marginal product of this worker type is lower.

And if we are going to look at it in terms of society as a whole (which involves moving away from externality logic), sure having a lot of alcoholics lowers our “capacity to produce”, but given that this is the result of a maximising choice by individuals we can say that the benefit of drinking exceeds the cost of this lost production – the fact that people are doing all this drinking illustrates that the drinking is more highly prized among society as a whole than the output they could have produced.

As the ultimate goal of “production” is to lead to create outcomes that satisfy peoples preferences through consumption we can ultimately say that the forgone production is being consumed in an optimal way everytime an alcoholic has a drink – excellent, go alcoholics!

The only market failure I can think of stems from asymmetric information.  A firm hires someone without knowing they are an alcoholic and agrees to pay a wage, through selection we could end up with an adverse selection problem.  But I don’t really buy it, given that these attributes are partially observable, and future wage increases do help us push towards the market clearing price for alcoholic labour.

So convince me that there is an externality here …