Matt Nolan

The currency “war” myth that won’t die

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Over on Rate’s Blog I’ve seen an approving link to an article discussing the “currency wars” that are going on around the world.

As Lars Christensen says here, and as we’ve said on many occassions ourselves given that monetary policy is pegged to an implicit inflation target this isn’t “beggar thy neighbour” policy at all – this is just standard monetary easing.

Now in New Zealand the big complaint is about the exchange rate – many people feel that the New Zealand dollar is “too high”.  However, there are two issues here:

  1. Monetary policy – has NZ monetary policy just been too tight?
  2. Structural policy – are there structural reasons why our exchange rate has been (potentially) persistently over-valued.

We have discussed this before here.

This isn’t a currency war, let me requote something we’ve said before:

Central banks are not breaking the rules, this isn’t a prisoner’s dilemma – competitive devaluations HELP when demand is suppressed … just look at the Great Depression, and the choice of countries to go off the gold standard!

Yes, there likely are structural issues in the New Zealand economy.  But policy makers should be focused on those specifically (why is there insufficient residential building activity, why is the real exchange rate so high) – they cannot be solved by monetary policy or the Reserve Bank.   Even when we think a policy issue is clear we need to be careful, as Noah Smith points out:

It’s important to belabor this last point. Economists know some things, maybe a lot of things, but this is absolutely dwarfed by the size of the things we don’t know and don’t understand. If this blog has had one “unifying theme,” it would be the depth of our ignorance. So when economists urge caution in using policy to change large sectors of the economy, this doesn’t necessarily mean “We know that the free market is always perfect and good and that policy can’t help.”

Instead, caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.”

Matt Nolan

Again with the middle class …

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Good article in the Sunday Star Times on the middle class in NZ – the author seemed to share some of the sentiments I’ve had in the past (*, *, *, *,*), where he feels that concerns should be for the worst off in NZ not the “doing alright”.

I love this quote:

Of course, this is about statistics – the average. This isn’t you, living from pay cheque to pay cheque, scraping together the school donation, the football subs, the car repayment, the Sky bill, the rent for the bach this Christmas.

Although as a nerd I’d point out we are discussing the median not the average 😉 .  I wonder how many people just nodded and completely missed the sarcasm here …

I found this strange

She argues we have a tax system “very generous” to the rich, with a low maximum tax rate. And she points to Working for Families cutbacks, our unusual lack of an initial tax-free chunk of income, and an increased amount of compulsory student loan repayments – now at 12 per cent – being taken from wage packets, which particularly disadvantages women returning to work.

I realise Susan St John is a good economist, and I’ve heard many good things about here.  But the top tax rate is just over 43% (33% on income, then 15% of 67% for GST), and we definitely have a progressive tax system – I mean, does 43% of each additional dollar sound low to people?  It may be lower than we believe is optimal, but I wouldn’t put it in the low camp.

Also, we don’t have an initial tax free rate because it is not a good idea. I’d point out that non-targeted cuts of this sort will lead to higher effective marginal tax rates for the same level of final revenue – reducing efficiency for no gain.  Essentially a tax free band forces us to increase EMTR’s for the same average tax rate … this is very undesirable.

And I could then say that instead we should target benefits and not get rid of tax on the first $X of everyones income.  In layman’s terms getting rid of tax on the first $X of income means that tax rates have to be higher on other income levels to achieve the same level of spending, it would be better to directly give the very poorest money but keep tax on the very low level of income – this would achieve the same equity outcomes at a lower cost.

When it comes to tax we should also think of tax incidence here – if the very poorest only get paid the minimum wage and would otherwise have no bargaining power, then the minimum wage ensures that the entire cut in taxes goes into their pocket!  Without a minimum wage, and with no bargaining power, it would go into the employers pocket.  This is ok, however it both ignores the impact on hours worked and employment, and insofar as those stay the same the same welfare gain could be provided by simply giving low income people a flat stack of income … targeting the benefit rather than creating another tax band.

And finally, student loan repayments and the payment on investment – people have a choice to invest in higher education.  This is only an equity issue if access to education is being restricted due to it, which is not the point being made here.

Final note, I enjoyed saying this:

“It seems strange,” concludes Nolan, “to demand transfers [of wealth] to the middle-class at the same time we’re demonising those unemployed during a recession and making it harder for them to get benefits.”

😀 [Note:  My intention when I said this was to convey the idea that people were saying we should be harder on beneficiaries – the actual change in policy has been more mild, with at most an increase in work testing requirements.  While I think the push to get people to take the “first job available” is unfortunate, and bad policy, what I said to the author here in literal terms exaggerates the actual policy changes that have taken place IMO.  This is of course my fault – so I thought I should clarify here]

Matt Nolan

Why cyclical Kiwisaver would be an awful tool

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Via Rates blog I see that, at the conference on government finances over the past couple of days Michael Cullen suggested making compulsory Kiwisaver contributions pro-cyclical (combined with the scheme becoming universal) as a monetary policy tool.  I appreciate he wanted the auidence of academics there to think outside the box, but this is actually a pretty poor idea.  I am sure these matters were discussed at the conference, but I will lay them down here in any case:

There is little evidence Kiwisaver increases national savings – and when it does, it is because of the “credit constrained”

Remember, just because we have to contribute to one savings vehicle doesn’t mean that households won’t borrow or dissave from other vehicles to compensate.  Work by the Savings Working group and Treasury suggested that Kiwisaver had very little impact on savings, and in the long-term it may actually reduce savings due to it being a relatively blunt way to promote savings (inefficient).

Compulsory Kiwisaver would lift savings, in so far as it does, by making some people unable to borrow or dissave in order to meet the level of consumption/investment they desire – as a result, this policy only works to promote savings in so far as it makes people worse off …

It isn’t savings that is the monetary policy issue – it is investment/consumption demand

For kicks, lets pretend that Kiwisaver does push up savings depending on the contribution.

Also targeting domestic savings misses the point on what we are trying to do here.  Remember, we use interest rates for monetary policy because they determine the intertemporal “price” that determines when people consume or invest out of current income.  A low interest rate now makes it relatively more attractive to consume/invest now – and if resources in the economy are underutilised at current interest rates, we would like this “price” to be lower.  The combination of a clear inflation target, and central bank policy that chases down this price, helps us to smooth the ebbs and flows in the economy.

If we were a large closed economy, then we know that pushing up savings would force consumption and investment to fall for a given level of income (as disposable income is lower) – under some conditions this may well do the trick.  This is like some sort of paradox of thrift style view, with Kiwisaver actually determining savings (so it needs to bind on the upside AND the downside).

Although this is a stretch, matters are even worse than that!  We are a small open economy, households and firms can borrow from overseas if their disposable income temporarily falls.

We use interest rates because we are changing the incentive for NZer’s to invest and consume, using Kiwisaver has nothing to do with actually monetary policy in this sense.

It is not politically independent

This is an obvious one.

It is even blunter than interest rates

I’m adding this, but the first two points were really all I was interested in writing 😉

Tl;dr

Kiwisaver doesn’t necessarily change savings levels, and it is underlying consumption/investment demand that really matter.  Given this, “compulsory Kiwisaver with cyclically varying contributions” is too clever by half – and shouldn’t be considered as a stabilisation tool … especially not as part of “monetary policy”.

Matt Nolan

New Zealand’s middle class

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Here I go, banging on about how the issue of “middle class squeeze” isn’t the same in NZ as it may well be in the US.

I’ve talked on this before of course, what can I say I’m a man of limited imagination 😉

Matt Nolan

Another example of why we need a full story

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I was sitting around working the other day, and at that point in time it involved downloading and playing with PPP (purchasing power parity) data in order to compare a bunch of GDP and consumption figures for work.  All very exciting.

At that moment I looked around the internet a bit, and noticed people complaining that we needed to be more like Australia as they were richer, and that our exchange rate was too high.  Having these points put together illustrated to me how policy prescriptions can often be based on reactive thinking, without truely asking “why” this is the case.

Why did I think this?  Well, Australia’s exchange rate has been “over-valued” relative to the New Zealand exchange rate in PPP terms for a long, long, time (the last time it was close was about 1995).  In fact, if we were to go solely off PPP terms for the NZ/Aus exchange rate the New Zealand dollar should be worth more than the Australian dollar – true story.  And yet, Australia is one of the wealthiest countries in the world (on a per capita basis).

This is why, when discussing what is going on in New Zealand I prefer to focus on a clear narrative that is based on a mixture of what we see in data (the persistent current account deficit, low savings) and a consistent theory that bases these stylized facts.  Just saying that our manufacturers are uncompetitive and trying to mess around with the nominal exchange rate misses a lot of the macro story here – it misses the idea that the returns to manufacturing may be falling (due to easing scarcity), it misses that we may not have the scale for such things, it misses that we may have a comparative advantage in other place (see the trend of our rising terms of trade), it misses the fact that returns to manufacturing have been hit by a global recession, and it refuses to acknowledge possible policy settings in the country that have created the underlying and persistent low level of savings relative to investment.

There is no silver bullet, instead if we are going to implement policy we should first ask “given trade-offs that exist, where does current policy differ from policy that may be seen as socially desirable”.  To ask this, we need a clear conception of what society values and what the trade-offs are.  Chasing silver bullet policy that will “save the NZ economy” is simply a way for the loadest interest groups in society to steal resources from everyone else.

People may complain about economists here, why haven’t they been saying anything!  Well, they have – well before I was wearing my economics diapers New Zealand economists were complaining about the persistent current account deficit, the lack of savings, and NZ’s uncomfortable investment balance.  These issues are worth more discussion – and I’ll consider doing that once my sore throat has cleared up and Christmas is over 😉

Matt Nolan

Working towards a “why” of changes in manufacturing

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There has been a long-running debate in New Zealand and around the world about the “hollowing out” of manufacturing – ultimately this is a subset of the wider concern about tradable vs non-tradable economic activity in NZ.  Also as we have said, it may be possible that what we are seeing is scarcity easing in manufacturing – a situation where we would expect productivity rise, and potentially employment fall.

With this in mind the RBNZ undertook research to figure out in what ways manufacturing output has changed post-crisis.  This can be found here.

By the way, I love the title “building a picture of New Zealand manufacturing”.  It captures the descriptive essence of economics 😀

Now, what comes out of this research?

  1. Employment fell during the GFC, and hasn’t recovered.
  2. Productivity has risen
  3. Exporting sectors have done well, due to their exposure to Australia.  The low NZ$ to Aussie and a strong Aussie market for plant and machinery (think fridges as much as capital equipment 😉 ) have helped out even as global demand has been weak.
  4. Import competiting sectors have been hit – as imported capital equipment, and imported consumer goods, have been cheap.  This is a story of the high dollar, and potentially “overcapacity” overseas.
  5. Construction, and the related drop in domestic demand for manufactured goods (think furniture and hardware as well – a retail area that has been gutted), has had a major impact. Get a remodeling done at affordable kitchen remodeling from Gamma Cabinetry
  6. Although manufacturing is currently close to where we would expect given construction – during the deepest parts of the crisis it was worse.

These trends are important to note.  It is construction exposed industries that have struggled the most – not firms looking to export (although this is definitely not to suggest that there have been difficulties for exporters – after all, this is a massive global slowdown).  Painting it this way shows that the “solution” to any perceived “problem” is unlikely to be as clear as some people writing articles are keen to suggest 😉