Matt Nolan

Bubbles no, resilence sure, market failure yes

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Hmmm, it looks like no-one wants to dissuade people from viewing the new RBNZ tools as ways to “stop bubbles”.  I think this is a dangerous mistake.

The focus on financial stability, and system risk in the banking system, is due to concerns that a sudden shift in asset prices could lead to a breakdown in the financial system – due to concentration, bank-runs, or some concern about fragility.

This is all well and good.  I think we need to be careful with these arguments.  I think we also need to identify why and what the failures are.  But, overall this is a way forward.

And it does nothing to truly “prevent bubbles”.  If someone wants to “overpay” for something, they can, and will – and as a society we shouldn’t give two hoots about someone pissing their own money against the wall.  True story.

If we tell people the RBNZ is “stopping bubbles” they will just assume that whatever is happening isn’t a bubble.  Does this actually seem like it will help anyone?  The RBNZ can’t really control asset prices, and it definitely can’t control them in the face of “irrational exuberance” (protip, the RBNZ doesn’t control people’s expectations of future house price appreciation).  The goal is to prevent the popping of a bubble having enormous spillover effects onto the broader economy.  If the RBNZ is doing its job right we will STILL HAVE BUBBLES – and people who took on the risk will still HURT THEMSELVES.

As a result, I hate the current description.  I hate the focus on asset prices themselves, rather than the direct stability of the banking system.  And I hate that we aren’t more focused on trying to identify where the risks and failures and and how to quantify them.

Matt Nolan

All I want for budget day

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  • Is a clear plan regarding the medium term budget.
  • A clear plan around how we will fund long-term expenditure.
  • A movement towards treating asset classes the same way through the tax system.
  • The reintroduction of interest on student loans

I’m not being greedy, these four things will pretty much do me 😉

I’ve noticed that they are talking about building costs, and housing supply.  Fair enough.  I also noticed something about milk/food in schools, fair enough as well (wonder how it will compare with the Labour scheme, which I was favourable about – and note nice post over at Offsetting).  Will be good to see these points comes out.

What are you hoping will be in your Budget day stocking?

Update:  I see alternative budgets from Don Brash and Roger Douglas.  While I agree about the long-term budget concerns (due to things like healthcare spending and superannuation), and I can understand the worries about housing investment I broadly disagree with everything else in these pieces – it isn’t that I think they are being inaccurate (they are not), I’m just not persuaded that the arguments they are making reflect the full equity-efficiency trade-off society is willing to undertake.

Matt Nolan

Series on tax: Part 2 – distortions and burden

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Over at Rates Blog I have put up part 2 or a 6 part series on tax (it was going to be 5 but I’ve extended it.  In part 1 we asked “why do we tax“.  In part 2 we are digging deeper into the costs of taxation.

We focus on two specific issues, the way taxes distort behaviour, and the idea of where the burden of tax falls.  As we explained in the first article these issues are really really difficult to actually work out – and the purpose of the second argument is just to give a “flavour” to the argument.  In honesty, if you wanted to figure out the true burden and distortions you’ll have to get yourselve a series of these CGE modeling economists armed with other economists who focus on normative judgments.

Last time I promised to discuss tax systmes that seem idea, that we don’t use.  And why we don’t.  Well, that is now the next article.

Also, thanks to Agnitio who helped me clear up this article.  It is a fairly wonkish one, and he came in at the last minute and helped me clarify what the hang I was doing 😉

Matt Nolan

“Rebalancing” and other morality plays

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On my list of future things to post on I had this post – which was intended to be a “bitch about rebalancing and targeting house prices for financial stability”.

Ever since the crisis erupted I have, especially privately, called the “rebalancing” argument one of the most pathetic quasi-economic arguments imaginable.  I found it difficult when a large section of the New Zealand economics community started using it (even papers from the RBNZ got in on the act), because apart from being a close to meaningless metaphor it also has the disadvantage of misleading people – confusing macroeconomic policy ideas with “compositional” issues, leading to the typical “fallacy of composition arguments” which lead to bad bad policy.

It is with this in mind that a good friend of mine sent me this BERL report on rebalancing the macroeconomy.  And it is with the recognition that it is not just BERL – but a large section of New Zealand’s economists – who make this argument that I aim to discuss why the focus on discussing rebalancing is bad economics.

Rebalancing is a term used to hide value judgments and sell a moral argument about the “right structure of the economy” – it is not an objective way of facing the trade-offs of policy choices, and as a result is it a bastardisation of what economists should be describing for the public.

Read more

Matt Nolan

Careful where we lay the blame

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Brian Fallow writing in his normal clear and intelligent manner has come out discussing the government budget.  As he says, a slump is not the time for “austerity” in terms of cutting back the size of government, and we should allow temporary deficits to help ease the blow – the point of automatic stabilisers is that they help out those that are struggling the most during a protracted slowdown.  Furthermore, I agree that the low level of long-term government bond rates does imply that government should be shifting investment forward now – something they seemed willing to do in 2009 but have moved away from since.

But, I have to slightly take issue with this:

Especially so since the Reserve Bank yesterday voiced concern at signs that the improvement in household saving rates may be stalling and that household debt is rising from a level already high relative to incomes.

The Government also argues that by running a tight fiscal policy it allows the bank to keep monetary policy looser than it otherwise could – lowering pressure on interest rates and the dollar.

However, as the bank reminded us yesterday, that silver lining comes with an increasingly ominous cloud in the form of rampant house price inflation, most notably in Auckland.

With the dollar as high as it is, the bank is reluctant to raise interest rates.

With the supply side of the housing market, especially in Auckland, unlikely to relieve the pressure on prices for years, and with gruesome examples in the Northern Hemisphere of what happens to an economy when a housing bubble bursts, at some point the bank is going to have to crush the demand side by raising interest rates.

If that coincides with fiscal contraction from a debt-obsessed Government, the effects could be unpleasant.

I don’t like where this logic is starting to go.  The RBNZ is responsible for “aggregate demand” in the economy.  If this is too low, then the RBNZ has set monetary conditions too tight, it is their fault.  Sure they may say it is not, some may say I am being unfair saying this … but if there is anything history has shown us, whenever we try to say “this time is different” with regards to a demand shortfall we usually end up coming back to blaming the central bank.

Relatively high debt levels and high house prices are not a monetary policy or demand issue.  They are an issue of financial stability, an issue of economic structure.  Yes, they create risks and can have negative welfare consequences.  Yes, competition, fiscal, and financial stability policy needs to account for them.  But monetary policy needs to take fiscal, competition, and financial stability policy AS GIVEN and then focus on “demand” from there.

Not dealing with demand because of concerns about these issues isn’t prudent, it is policy failure.  Blatant policy failure.  If you don’t believe me, ask someone who is both smarter and more articulate than me such as Nick Rowe.

Now, if the government remains on course and the RBNZ tightens monetary conditions to “fight the housing market” while it expects inflation to be low and unemployment high, they are explicitly violating their mandate and best practice of a central bank.  It is as simple as that.  I’m happy saying this out loud because they would not do that, they know these things, and will continue attempting to set monetary policy at the right level to deal with demand issues (as represented by their forecasts for inflation and unemployment over the next two years).  But given that the RBNZ does this appropriately, the government deficit does not matter outside of its impact on the composition of the economy.

If we want to criticise government policy during the recession, do it in terms of investment (it would have been a good time to move a bit more investment forward), and social policy related things.

Note:  If we believe that the response to interest rate changes will be very small, that in some sense investment demand is very “inelastic” then we can make a claim for government investment – we just need to be very clear on that AND we need to ask why in that case we still have a positive cash rate.  Remember, government investment here also works by driving up the “natural” interest rate … so through the same logic it will lead to a higher real exchange rate and higher government borrowing … unless the “cumulative impact” of rising demand pushing activity towards potential outweighs that.  And if we are using that “cumulative impact” argument for government spending then it also holds for a cut in domestic interest rates, just with a lower real exchange rate and compositionally more private sector activity.  So protip:  we can’t complain the exchange rate is too high and that government spending is too low at the same time!

Update:  Also after today’s unemployment and employment numbers I think people should be willing to rethink whether they think there is a “demand” issue in NZ going forward … 😉

Matt Nolan

Which side is arrogant? (Thoughts on framing and debate)

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Via Bernard Hickey on Rates Blog I see the following:

All you need to do is deregulate, privatise and target stable inflation and everything will work.

Broadly, they still believe that. I listen every day to this group think in Wellington. Treasury, the Reserve Bank and the cabinet have not changed that mindset.

The Global Financial Crisis has exposed that as both arrogant and wrong. New Zealand can kid itself that our relative economic stability and apparent prosperity (relative to everyone else) is the exception that proved rule.

Let’s put to the side that this is not what policy makers in New Zealand have done – we have had active competition policy, and we do have significant income transfers to support parts of society.

I have a more fundamental qualm with this – the idea that it is arrogant to presuppose that the knowledge of policy makers is limited and that intervention should be based on a clear idea of “what is wrong” … rather than presupposing that non-policy makers are idiots.

To me, I find the other way of looking at it arrogant – and yes, this does imply that I think that Stiglitz’s views on the ability to micromanage the economy are in themselves a touch arrogant.

Let us think about this a bit more.  What is more “arrogant” – forcing people who want to trade with each other not to because we are concerned about it, or not doing so?  What is more arrogant, accepting that our knowledge is limited and trying to work with society to ensure that as a society we can protect ourselves from unexpected things (the mainstream way of viewing things), or assuming that our knowledge of what is going on in a broad economy is great and trying to micomanage industries, credit markets, and the transactions people are allowed to choose.

In all honesty, I am sick to death of the mystical presumption that “free markets” have done horrible things to us and we need to do something about it.  Government as a share of national expenditure is larger than it used to be.  Transfers through the tax and benefit system are larger than they were 20 years ago.  Competition law and regulation is a lot clearer and much more active than it used to be.

Rant over – now to make an actual point!

Now do not get me wrong – in reality I actually don’t think Stiglitz, or Hickey (who wrote the above comment), are being arrogant.  I was trying to illustrate a point, I mean no offence 🙂

My point here was that how we frame this question makes the different sides look incredibly different!  I don’t think it is fair to call any side arrogant, in truth we just have different beliefs regarding the ability and knowledge of technocrats to guide the economy.  Stiglitz and Hickey both place more faith in the hands of policy makers to make choices for individuals that are better than the choices that individuals would make – either because of direct mistakes by individuals, or factors that stem from the interrelationship of individuals.

The economic model allows us to clearly paint the picture of these issues – and debate our value judgments.  Just like Rodrik says in this awesome piece.

So how about we stop treating the “other side” as ideological idiots, and actually ask “why” our views are different and whether the assumptions involved are appropriate or inappropriate.  I am afriad that I often see Bernard Hickey giving the Treasury and RBNZ people too little credit for their views in these pieces – the solutions are not as simple as a single newspaper article, or academic paper, will suggest!  Furthermore, there are always trade-offs – unlike politicians someone with integrity (such as an economist) will look at costs of choices as well as benefits.  And yes, that final statement was an example of stunning arrogance by me – but I’m not going back on it 😉