Matt Nolan

Treading the thin red line

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I see that, due to concerns about systemic risk for the financial stemming from the housing market, the Reserve Bank of New Zealand has decided to increase capital requirements for high loan-value mortgages.  Fine, I think this can be fit inside our concept about why you want to deal with these types of issues, as we’ve noted here.

But it is a balancing act, and there are some comments I’m inherently uncomfortable with.  Namely the context of these two statements:

credit is now increasing faster than the rate of income growth (figure 2.1), after declining as a ratio to income over the past four years. …
While credit is growing more slowly than in most of the decade before the financial crisis, that growth is stretching household debt-to-income ratios, which are already elevated (figure 2.2). Rising house prices, combined with a greater willingness on the part of banks to lend against low deposits, suggests that many new borrowers will be acquiring homes with higher debt levels relative to both income and assets. Low  mortgage rates are helping to keep household debt burdens manageable in the short term, but the increase in underlying indebtedness leaves households vulnerable to a reduction in incomes or a rise in interest rates.
Factually true, indeed.  But how do we unpack this?
It doesn’t matter that people are highly indebted … unless this stems from a process that involves the increasing level of debt, and the distribution of the debt burden, in such a way that it creates an externality.  Where this risk is in turn thrust onto other people.  The very idea of systemic risk.
This is well and good, I have no doubt the RBNZ took policy actions with this in mind.  But I would another two points when we think about credit growth:
  1. We should compare credit growth to average expected income growth – not current income growth.  You borrow in the basis of future income, so the comparison they laid down was a bit dodge.  4% credit growth is lower than this.
  2. New Zealand is rebuilding its (arguably) second biggest city.  It will have to accumulate a higher level of debt (especially relative to current income) to do this.  We are going to have higher current account deficits etc as a result – the idea is that this investment in a new city will create a rate of return that covers it.  If we believe the rebuild leaves some areas streched this is still not a concern – it is just when those sectors in turn threaten to undermine the financial system.  Given this, the increase in investment, activity, employment, and debt are all pretty slow – this type of counterfactual is an important element to keep in mind.

We DON’T care about financial stability because we are worried about asset prices, or bubbles.  If people want to piss their money against the wall gambling on a bubble, no policy maker should try to help them.  It is if their actions have an impact on the broader economy – if we think that financial markets are underpricing risk due to systemic risk issues for example – that we care.  Bubbles and debt don’t magically stop people working and producing in of themselves, and we have to be careful that we interpret the data with the perceived externality in mind, rather than solely being focused a moral distaste for bubbles and debt … which is policy irrelevant.

Matt Nolan

Something must be done

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This piece on the dangers of K2 has clearly indicated to me, as a concerned citizen, that something must be done.

I think it is pretty obvious to everyone what has to be done here … we need to legalise other drugs.

From what I can tell, K2 is inferior to other drugs for the person consuming them, and causes higher externalities than other drugs.  The only reason people are choosing it is because other drugs have been made prohibitively expensive – by being made illegal.

You may say “no no, we should just ban it”.  But isn’t the point that we really have a mental health issue here – people feel that they need to consume something to deal with the inane nature of life.  If we keep banning the things we are consuming, we are just pushing many of these people towards other more harmful forms of consumption/addiction.

I’m not saying don’t help people who are facing these sorts of issues, and become addicted to substances as a way of dealing with things going on in their lives.  What I am saying is that instead of criminalizing it, and making them criminals, we should perhaps look at it as a mental health issue and try to help them.  Pretending we care, then choosing policy actions (criminalization) that actually hurt the individuals involved can’t even be called good intentions – it’s just sort of silly and harmful.

Legalise, tax, use the tax money to pay for treatment and to help fund general mental health work.  At some level we all have mental health issues, just like we all have physical health issues.  Lets destigmatize and actually accept these issues, allow actions that people take when they are trying to cope to be legal, but make sure that as part of our social security net we help people who are really struggling – in the same way we do when someone finds themselves out of work, or injures themselves physically in a work place accident. If you agree with me, you can fill out an online application that takes only 2 minutes to complete, asking our government to step up and help people battling mental illness.

Matt Nolan

More points on long-term unemployment

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A while ago I touched on the issue of long-term unemployment, and youth unemployment, from the persistent recession in NZ.

This isn’t an issue we can yell at the RBNZ to fix, so what exactly could we do if we think this situation is leading to specific costs?  Costs that we fear the market will not deal with, given firms unwillingness to look at long-term unemployed, and concerns about skill-mismatch.

Well Via Noah Smith we spotted this by Kevin Hassett, with five policy suggestions at the end.

  1. Government hiring of long-term unemployed (Note:  A “working for the dole” scheme would fit into this – it is also unclear how much of the “signalling this gets rid of”)
  2. Policies to deal with geographical mismatch (Note:  It isn’t clear whether this is really the case for long-term unemployment in NZ – but separating the Auckland (bad), Canterbury (tight) and rest of the nation (meh) labour markets is useful).
  3. Privatised training (Note:  This is interesting in the NZ context, as we already have wide scope for people to “choose training”.  The key question is whether people have good information on the returns to skills)
  4. Work subsidies
  5. Work share programs

This isn’t to agree with any of these – just to point out that we need to ask where issues in the labour market have appeared that are due to the persistence of the slowdown, and how government policy actions can improve outcomes given this.  The long-term unemployed are the people in society that have experienced significant bad luck due to this unfortunate event, there is a rationale to help people out given this – or even better, to help form institutions (such as WINZ) who are set up to automatically provide assistance given the perceived drivers of long-term unemployment.

Note:  Paul Walker has also discussed these points here and here.

Matt Nolan

A frank (non-technical) discussion on current NZ macropolicy

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Note:  I think of macropolicy as policy that is focused on inflation, interest rates, unemployment, and GDP.  Of course, the causes of shifts in these often have micro-consequences … something I sort of suggest as we go through 😉

As we’ve come into 2013 with the unemployment rate elevated and the dollar rising strongly I have seen two things occur:

  1. An increasing, almost dogmatic, preaching from those talking about the high dollar destroying the economy.
  2. A rising disparity between economists and business expectations for economic activity (which have rebounded) and the news.

The last time I saw the second point occur was early 2010 – just before April 2010 when events in Greece took a turn for the worse.  In this way, I can understand the reluctance of news agencies to accept the large number of improving signs about the New Zealand economy – if something goes wrong overseas it will all be unwound.

I can understand the first point as well – manufacturers are finding their profitability low, and they are trying to blame “something”.  A price seems like a good thing to yell at.  Furthermore, it fits into the view that something should have been done, which would lower unemployment – looser monetary policy would have given us higher inflation (which is below the band), likely lowered unemployment, and would have “made the dollar weaker”.  An argument can be made that over the last eighteen months, monetary authorities accidentally left the OCR at slightly too high a level.

But, this is my most generous view of this side.  I find myself concerned that policy issues are being “mixed” by exchange rate zealots who want to make it a free lunch.  For example, if the central bank had lowered the OCR to get the exchange rate down, house prices would now be higher.  If they had done this and the UNCERTAINTY in Europe hadn’t led to more expensive credit (if we hadn’t seen bank funding costs look ugly for parts of last year), then they would have overstimulated the economy – they would have been forecasting failure given what the information they had … it is hardly their fault that things turned on them.

And if the RBNZ had cut the OCR, would the issue of the persistently overvalued dollar (current-account deficit that is higher than we think is justifiable) go away – no, it would actually make no difference to this as in the medium term interest rates and the real exchange rate would go back to where it would have been.  If this is the “exchange rate issue” you care about, stop talking a bunch of bullshiz about the OCR and interest rates, and try to figure out what the real causes are.

You see, it turns out that we are being hit by a lot of large external shocks (both positive and negative), and this creates a bunch of uncertainty about what to do.  In that environment, we have unfortunately ended up in a situation where unemployment is higher than it would be if the economy was “functioning nicely” – so we need to ask why this is the case and what policy solutions may help.  I think I read something about the principles of that.

A blunt tool, but blunt for a reason

The “interest rate” is a blunt tool.  Hell I struggle with the idea that the “tool” is even the OCR – in truth the RBNZ’s monetary policy measure is its flexible inflation target, and all that implies.

But what is inflation, or an interest rate.  It is an incredibly aggregated piece of information that discusses a general tendency over the economy as a whole.  A firm cares more about the interest rate THEY face on their credit, and the price of their costs and their product – not some bull like this.  In truth, we aren’t a centrally planned economy and we live in a world in flux that is filled with uncertainty – in that environment lightly changing the OCR is no way to deal with specific market or government failures we may think exist.

Exchange rate zealots need to stop being lazy with their analysis, ask what the failure is, and figure out what the cause is.  For example, house prices are “too high” – lets ask what is going on in the housing market and building industry.

The unemployment rate is too high, while vacancy numbers have climbed – interesting do we have an issue of “skill-matching” … seems we do!  Given that, the policy solutions involve trying to lower the cost of matching, and more work with unemployed people and investment in skills … not a 25bp cut in the official cash rate.

A sidenote on the exchange rate – remember it captures relative growth

Have people noticed how much growth has been outperforming since about October last year, or how much bank funding costs have dropped, or how much easier it is to access credit.

When these factors were the other way around, they really slowed economic activity in NZ – isn’t it likely that we may see strong growth off this now?  The growth outlook for much of the world is not as flash, and tbh I’m working under the impression that Australia is now hitting its wall, and as a result I don’t think this is “it”.  But the exchange rate is indeed a “price”, and it appears to have given us an indication that we are finally experiencing a (likely rebuild led) recovery.

Treating the issue as “low exchange rate good, high exchange rate bad” involves not thinking about what the exchange rate is.  Originally I thought this was because people hadn’t had the chance to look at the issues, but with the RBNZ/Treasury running a conference on this, and with my little article on “what is an exchange rate” available, I find this attitude perplexing.

QE and exchange rates though!!!!

Yes, QE is driving up the dollar, as every economist in the universe has said since the start.  There are two ways to think about this:

  1. Implied relative interest rate channel
  2. Specific currency purchases

The first channel is cool, that is relative monetary policy.  As long as everyone involved is setting an “inflation target” and sticking to it then this is just a product of all the countries “closing their output gap” – and it is a good thing for all.  Not a currency war.

If countries start trying to mess around with relative prices, by directly buying up currency or bonds in NZ, then the issue is more difficult.  We receive a “capital gain” but the exchange rate gets knocked around as a symptom of relative prices for asset classes and the such being out of whack.  This is generally a pain in the ass – and is an argument for greater co-ordination in monetary policy.  Furthermore, it isn’t actually clear whether it is a net positive or negative for NZ – we are making a capital gain out of our assets after all – what is clear is that it involves a transfer, and we might not think that is fair to some in society (although one of the beneficiaries are consumers so …).

The QE question is one that needs investigation, but on the balance of probabilities having these countries do this is better for NZ then having them experience a full scale depression

Also one note I think gets missed – if they hadn’t done QE, inflation would have been lower, and so the world price of the goods and services we export would have been lower.  For something that is vulnerable to “overcapacity” like manufacturing this would have been very acute – and as a result without QE it isn’t even clear manufacturers would see their return be that much higher!

Matt Nolan

Energy policy as a new policy issue!

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So we’ve had Labour and the Greens make the cost of energy the first big pillar of their upcoming election campaign.  The energy industry is important in a large number of ways, is something people care about, and is definitely policy relevant – so it is a good pick.  I’d note I don’t talk on “political levels” (my own failure to be sure), but it is a good area to discuss in terms of the policy society desires.

Now I’ll be honest that given this I was heavily disappointed with the analysis done by the Greens and Labour. There have been two good posts discussing the issues – Lance Wiggs and Seamus Hogan.  This isn’t going to be one of those posts.  Instead I’m going to complain about something.

I’ve seen lots of people on twitter bang on about “ideology“, “starting a debate”, etc etc … but the fundamental number they provided of an average household saving $230-$330pa is what MOST of the public cares about.  I respect the dudes and dudettes that have been saying “hey let’s just discuss energy policy”.  But I’ve just spent the last few days listening to a large number of my non-economist friends going on about how they like the idea that Labour is going to give them this money …

And that figure is a load of complete crud.

Ignore the BERL report here.  I have no real criticism of them – they were VERY transparent with their assumptions so I knew from the start that:

  1. They had assumed the energy boost was a given – they were told it by Labour and were just running a scenario,
  2. They had excluded government dividends,
  3. They had assumed persistently deficient demand.

Yes all these assumptions will in turn increase the size of the result – but none of them are actually too relevant to the claim that Labour and Greens are selling the most, that is will improve the money in your pocket.

Instead I get the feeling that Labour seems willing to ignore capital costs (I’d note the Greens do talk about the LRMC).  When looking at the electricity industry, we want to think about long-run marginal costs rather than short-run marginal costs – given that we are talking about an industry with massive fixed costs (huge costs of investment).  Kiwiblog suggests that this important point may have been put by the wayside, the use of the Wolak report gives further fuel to this fire, and finally via the Labour site:

Hydroelectric power makes up almost two-thirds of our electricity, and it costs next to nothing to generate because it uses free water and dams that were paid off years ago.

This is what the site says now – when it first came out it said “free water and dams”.  The change doesn’t matter though – as you still need to invest in new capacity as demand rises and you need to maintain the current capital stock!

Now, there are things that I would like to see work on (given I’m not an industrial economist, I don’t have the research and evidence in my head that other true industrial economists do).

  • Why has the relative price of residential power risen so quickly (relative to commercial and residential),
  • Why has investment in the industry seemed patchy at best?

Given that the electricity industry is probably the second most regulated and researched industry in New Zealand (I’m putting it behind telecommunications – although I may well have them the wrong way around!) the answers are probably out there, and ways to improve current regulation probably exist.  As a result of all this, the Labour-Greens decision to pick only a single report, misuse the figures, ignore the criticisms of those figures, and then publish a policy impact that is effectively a LIE is all the more disgusting – frikken ask some of the myriad of experts out there for some help making policy, hell some of them are Labour supporters and will likely to work at a cut price.

Sidenote:  National doesn’t get off for free here – socialism, communism, really?  In of itself a monopsony buyer is not something you can just rule out due to “ideology”.

Update:  This will teach me for commenting on blogs on a Saturday morning.  I didn’t mean to use the c word (not the really bad one), I’m trying to cut back on my swearing.  I do essentially think that the promised boost to income to people is a lie though – and I mean to use that as a loaded term – so I’ll live.

Matt Nolan

Let’s be careful judging savers

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Although my article might not give that impression at first glance – that is actually where I am in agreement with Bob Jones here.  However, I’m also saying that the RBNZ governor isn’t wrong about bringing up the “savings issue”, and it is fair for us to discuss where marketand government failures are … including in the way housing is treated by the tax system:

The point is that the complaints of economists are not the product of us assuming stupidity, or telling people they are immoral. They are the concerns of a group who believes that there may be some policy relevant issues – for example the peculiar ways that the New Zealand tax system treats housing as an asset – which are hurting New Zealanders.

Far from showing the Reserve Bank governor is out of touch, as Jones suggests, his willingness to discuss this issue illustrates that he realises how important it is for future generations of New Zealanders.

I also get concerned, as does Bob Jones, that the push towards “save more” is really a moral push to tell people what to do with their income.  However, when economists are talking about savings issuse they are saying that our persistent large current account deficits, with a range of other factors that seem unusual in New Zealand, provides a situation that we should analyse.  Analysing it has led economists to note a number of issues where there is a trade-off – a trade-off policy makers and the public feel the wrong choice has been made about.

Given this, people want to change policy settings.  I’m not jumping into this debate in of itself – but I would note that there is nothing wrong with asking the question, and merely saying “I’ve done pretty sweet on property in the past” doesn’t invalidate that.