Matt Nolan

Interpreting a (monetary) quantity – we need a cause

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Over at Not PC I noticed that Peter is putting some of the “blame for the housing bubble” at the feet of the RBNZ.  His view shares similarities to the discussion I’ve been having – and will continue to have – with Lowell Manning (here, here, here).

Essentially, the view is that the Bank is allowing M3 to grow too quickly and this is showing up in excessive house prices.  By having “too much” fiat currency the central bank is devaluing the currency, and that is coming through the price of land/housing.  Now don’t get me wrong, look at monetary aggregates – they provide useful information.  Furthermore, I believe these guys deserve a response, and next month I’ll try to craft something a bit better than this.  But let me note down some points as an accidental “Reserve Bank apologist”.

This story provided does have a compelling narrative, it has a start, and end, a villian, a potential heroine, all the good elements of a believable story.  But for me, there are a few key things missing:

  1. The central bank doesn’t set the “quantity of money”, it sets the “price”.  In reality it doesn’t even do that – the interest rate is set by forces in the economy.  Instead, the central bank targets the rate of growth in the “general price level” – and it has stuck to that.   They are going to devalue fiat currency at a predictable and steady rate – and that is just what has happened.
  2. Where is individual choice in this model?  M3 growth is too high, and as a result people blindly borrow the floating $$$ to buy houses … knowing that the future real value will fall and burn them?  This sounds funny.  Instead, with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!
  3. Say that the RBNZ has been soft, why is it the relative price of housing … not general inflation … that is rising.   We may say “land is durable, and the price is high because of expected future inflation” – but then the question would be why we don’t see this across all asset classes in NZ, and more importantly why survey measures do not show these “inflation expectations”.
  4. Furthermore, if this has been a long last bubble (due to the persistent high growth in M3) why have the “relative prices” of other goods never caught up – if this has been one big long bubble due to “monetary policy” at some point we need to be getting that high inflation.  Monetary policy doesn’t keep relative prices out of whack forever.

This is the thing for me – it is a relative price of housing issue.  The money supply is “endogenous” and so, since “demand for housing” has risen, so has borrowing and M3 growth.  With no generalised inflation going on, the RBNZ isn’t printing money to cause a housing bubble – it is allowing the money supply to rise given the housing bubble, in order to not excessively constrain the rest of the economy.

Note the Bank will be concerned about a “housing bubble” if it is leading to “excessive consumption and/or investment” which creates inflationary pressures – in that case they will act with monetary policy.  They will be worried about issues of “financial stability” due to high gross debt levels, highly leveraged groups, or a concentration of debts in an asset class – in that case they will act with macroprudential policy.

Outside of this, this issue has nothing to do with the Bank.  In fact, outside of this this issue of a “bubble due to irrational expectations” is virtually IRRELEVANT for society as a whole – if people are determined to pay over the odds for something to other people, then that is just a straight transfer of goods and services.  If we really have an “irrational bubble” why are we so keen to punish the rest of the economy in a weak (and likely to fail) attempt to stop people making their own dumb mistakes – as we will be inappropriately lifting interest rates and making other forms of investment more expensive to “deal with” the fact that some people have strange ideas about the potential for house price appreciation in the future 😉 [And let’s not start talking about foreigners – as this is just a transfer FROM overseas TO NZ].

As an Austrian economist I am sure that Peter is also concerned about a misallocation of capital.  However, in this context this would require “overbuilding” … if there is a “housing bubble” we will “overinvest in building houses” (remember trading houses between each other isn’t “investment” in this sense, it is a transfer).  Is this what we are seeing?  And if it was, are the welfare costs really that large … especially relative to the practical status-quo, since no-one truly knows how to pop bubbles outside of kidnapping people or taking their savings off them!

Matt Nolan

Gareth Morgan, housing, and blaming the RBNZ

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Lately I’ve been saying “don’t blame the RBNZ’ for things a lot (here, here).

However, Gareth Morgan’s concern about Bank policy and the housing market IS actually a legitimate area to raise concerns about Bank policy.  His view boils down to this statement:

The problem with demand for property in New Zealand is one that has arisen as a legacy from a long history now of Reserve Bank prudential policy combining with selective tax policy to provide a toxic little no brainer for property investors.

Simply put, he feels that prudential policy overtly favours housing, thereby creating the equivalent of a “tax wedge”.

So it is NOT a criticism of monetary policy and the PTA per se – but of the institutional financial framework set up by the RBNZ, which in turn has led to some type of “inefficiency” or “misallocation of resources”.

I’m not convinced, but I’m leaving my mind open. I have had similar thoughts in the past, but have in the end ruled them out – it would just take some firm evidence to lead me to re-evaluate my priors 😉 .

Update:  As if by magic, the RBNZ has a speech up defending their framework here.  Given this speech has been booked in for some time, it isn’t a direct response.  However, I would note that they point out that risk-weighting in housing is higher here than in a number of other countries (so the capital requirement for a pool of loans on housing is higher in NZ 😉 ).

Risk-weighting are set for the capital adequacy ratio for a reason, and as a result we need to articulate why these are wrong or inappropriate.  Furthermore, it isn’t clear to me that prudential policy has had a “long history” of being pro-housing – instead it has always seemed that retail banks have been pro-housing due to the fact that they see these loans as relatively lower risk, which shows up in relative interest rates and the availability of credit.  As a result, for the argument to be made needs more analysis – the burden of proof is on the analysts making the claim that prudential policy is a “causing too much investment in housing”.  A little bit more analysis in terms of numbers and counterfactual models is in order – and if these show the result and the argument could persuade more people – including the RBNZ 🙂

Note:  His movement from excessive demand for investment in housing as an “investment vehicle” to a complaint about affordability is also tenuous at best – excessive investment demand lead to a larger stock of property (that is how we get the “misallocation of investment”) and lower rents.  The yield on property falls, and ownership becomes more expensive … but the cost of buying “housing services” actually falls.  So does this imply that Bank is making housing services more affordable?  We need to be a bit more careful not to mix up issues here!

 

Matt Nolan

Inquiry suggests lower wages and taxpayers taking on firm risk

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I have read over the opposition report into manufacturing, and there is so much geniunely wrong in it that it deserves a significant post – one I will hopefully have the chance to (at least partially) do this week.  Note, I don’t disagree with absolutely everything in it, and I do congratulate them for the idea of getting together an inquiry and sorting policy – I think that is neat.  But there are trade-offs, and this report acts like there are none.

As a result, I thought I should probably translate what their report actually suggests in title of this post though.  This is not a blueprint for higher wages and “better jobs”.  This is a blue print for:

  1. Cutting the real purchasing power of households,
  2. Getting the government (therefore the taxpayer) to take on risk for businesses
  3. Therefore, subsidising an industry that the rest of the world is subsidising because of mystical “spillovers” we think may occur – ignoring the fact that having firms currently focus on their comparative advantage is making NZ into a very wealthy country …

This is our “left wing” parties talking – essentially about NZ Inc.  What happened to actually thinking about poverty and equity, issues that I know I might actually vote for them about if they ever bothered to be actual left wing parties, instead of an accidental vested interest group for firms.

Update:  Brennan McDonald discusses here.  I like the focus on specific biases between economists and (what I would term) folk economists.  IMO, economists need to be clear on their communication around these issues when discussing policy debates – as they are the principles that tend to “defy common-sense” for folk economists the burden of proof falls on us 😉 .  Also Groping to Bethleham discusses this here and here.

Will Taylor

Raising Rivals Costs: Bar Edition

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Just read a great post By Dom over at the liquor ladder. Sounds like the Hospitality Association wants to restrict liquor licensing to certain parts of Wellington (Courtney Place and Cuba St).

But the Council, who seem to think the scenes in Courtenay Place late on Fridays and Saturdays represent “vibrancy”, and the Hospitality Association, led by individuals who, I believe, own businesses in Courtenay Place, are planning a regime that will penalise anyone trying to establish a business anywhere else – businesses that might give discerning consumers an alternative to the chaos on Courtenay Place. It may not be what the Council intended, but it’s what’s called an unintended consequence. It’s what happens when you draw lines on a map and create differences between the two sides.
Of course not all the results will penalise businesses outside the strip. If you’re a Courtenay Place property owner learning that your tenants have privileges with respect to liquor licensing, you’re going to put their rent up. I look forward to hearing the Hospitality Association complaining about sky-rocketing rents in the street in about a year’s time.

Now they may be doing this for good reasons. But to put an economics slant on what Dom says, this sounds a lot like what economists call “Raising Rivals Costs” (RRC). i.e., people who already have bars in Courtney/Cuba want to limit the ability of people to operate bars in other ares, thus hindering competition from other ares of the city.

While it may raise the rent of existing tenants, from memory (I live in Auckland now….) the bars on Courtney place at least are all quite big so may be able absorb the higher fixed costs. So in a way this could be seen as shutting out competition by smaller fringe operators (i.e. most craft beer bars) who won’t have the scale to pay high rents. I for one will not be happy to see a reduction in pub innovation!

Matt Nolan

Bubbles: Remember to ask about the mechanism

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I see that Bernard Hickey is suggesting we have the RBNZ pop the “housing bubble”.  And to do it the Bank should either ignore inflation targeting and hike rates, or do some magic with macroprudential tools!

The ideal RBNZ governor?

Assume a bubble, so lets start with one!  I have a list of problems with this type of article even given that 😉 :
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The Hand

Lowell Manning responds on M3 and housing

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Hola all.   Lowell Manning was nice enough to write up a response, to Matt’s response, to his piece on M3 and the housing market on Rates Blog.  I am publishing it here.

Matt hasn’t read it yet – that would be cheating.  He’ll read it when it is on the internet.

I have no doubt Matt will respond to this saying why he fundamentally disagrees or agrees with points – from the bits he has spotted he already wants to respond.  But he will have to wait until July as he has too many urgent deadlines and planned posts between now and then 🙂

Feel free to discuss in the comments.

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