Matt Nolan

The exchange rate and the RBNZ

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I see that we are back to discussing this sort of stuff, fair enough.  There is a Herald article with Cunliffe expressly mentioning that the RBNZ should reduce volatility in the exchange rate, and Brian Fallow discussing currency intervention following the Fed.

There are a few key points I would like us to keep in mind here:

  1. RBNZ policy depends on inflationary pressures.  A higher dollar (all other things equal) lowers tradable prices, which may have a downward impact on inflation expectations, which in turn will lead the Bank to lower the interest rate.  As a result, if people overseas start stimulating policy – then unless this leads to a significant pick up in external demand and commodity prices the Bank could well cut rates on its current mandate.
  2. For all the talk of volatility it is important to note that the NZ$ has actually been less volatile than the Australian dollar over the crisis years – surprising fact.
  3. Is it volatility in the exchange rate we care about, or volatility in the prices people actually face – remember that the “world price” of the things we sell overseas have been moving around violently, and the floating dollar has actually helped to reduce variability in the prices many exporters faced.
  4. Exporters and importers can hedge … combined with the fact that movements are smoothing external prices, this makes me feel that the volatility argument is often overplayed.
  5. Given that the exchange rate is seen as a random walk – and we have no idea what (short run) fair value really is a lot of the time – isn’t it just as likely intervention will increase volatility!
  6. If we are worried about the “relative price” argument (our dollar is too high because we are running a CA deficit that is “too large”) we should try to figure out what internal/external imbalances are causing that and deal with them directly.  This is not a volatility argument – and it should be well thought through and communicated before anything happens.
  7. If we believe the “exchange rate is too high for manufacturers” we need to ask why – is it the relative price impact above (which we have discussed), or is it “Dutch disease” – something that I don’t really believe is a disease, but merely the diagnosis of a side-effect stemming from a POSITIVE shock.

We all know I’m a sucker for the status quo, but I have no problem discussing these issues.  We should recognise that there are two perceived issues:  (1) volatility, (2) the relative price.  And then we should investigate why these things are happening, if there are associated welfare costs that we can reduce at a lower cost, and if so then clearly communicate why and what is going on.

Given my lack of faith in central government to achieve these things, as they enjoy using monetary policy as a political football, I am a strong proponent of the status quo.

Matt Nolan

November 10 Fed meeting

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The November 10 Fed meeting is more important for New Zealand then I think we currently recognise.  The decisions they make over the next two days are going to have a profound impact on the general monetary policy environment around the world – and New Zealand will not be immune.

Once they finally announce what they are doing I’ll be sure to stab down some thoughts.

Matt Nolan

Rate cuts: Not out of the realm of possibility

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I see that there is an article saying that another rate hike is unlikely in the near future – this is true.  If anything, uncertainty – both about the probability of a movement AND the direction of a movement is elevated.  I would not be putting a zero, or even a particularly small probability on a rate cut within the next two meetings.  Note:  I don’t expect one, I expect a lift by around March – and I think the Bank will probably have to move pretty quickly when they do.  But this point is still useful.

Why do I say a cut is possible?  Well it has less to do with the domestic economic situation, and more to do with this stemming from this.  If the Fed does start price level targeting, they will essentially be aiming for a pretty high near term value for inflation – which in turn will see their dollar tank.  If we take this as a broader part of a “currency war” our Reserve Bank would be acting well within their mandate, and likely in an optimal sense, by lowering the cash rate.  A higher dollar tightens monetary conditions (other things equal) and they will want to counter that.

Until we have some idea regarding what the hell the Fed is going to do there will be a huge amount of uncertainty regarding changes in the OCR.  And it isn’t the RBNZ’s fault, they will just be doing what they can given the situation thrust upon them from overseas.

Matt Nolan

Absolutes

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From Policy Progress:

The giveaway words are ‘believe’ and ‘completely’. Very absolute words, those. Generally to be avoided unless you have solid evidence.

Very true, it reminds me of an old quote:

Only a Sith deals in absolutes

Of course, this quote makes sense, given my view that economists share similarities with the Jedi in terms of:

  • our inconsistency,
  • our inability to agree,
  • our unwillingness to commit to a firm opinion,
  • (and yet) our absolutism when we are forced to make an opinion,
  • our deep sense of thinking we are saving the world by describing trade-offs,
  • our (debatable) sense of moral/general superiority over other social sciences,
  • and our cool lightsabers.

Now this is not to say that anyone is the Sith [as I’ve said before I like Bernard Hickey, I can’t imagine him getting red eyes and running round with a lightsaber hunting down economists] – as after all, if there is anything Star Wars teaches us it is that no matter the moral standpoint, a desire to provide absolute answers and view things in black and white terms is what drives people to evil.  Not the tag they live under.

So if this post had to have a conclusion [it was obviously just a reason for me to compare economists to Jedis again], it would be to not get annoyed at the “two-handed” economist – as their response is more honest, and fundamentally probably more useful in the long-term, then the response of someone who is willing to be “one-handed”.  The world is uncertain, and the economic method is just trying to shine a light on this uncertainty – not make your choices for you.

Matt Nolan

More on macro controls

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From Eric Crampton:

Because he personally has lost faith in modern portfolio theory, he wants to force all of us to invest locally. Yeah, things have been rough for the last few years. But the proposal here seems pretty worrying.

It is a great post – adding to the things I said here, so definitely give the whole thing a read.

When the environment changes, for some reason people want “control” – they want to feel like they can change what is going on for the better.  Although this is a noble goal, without trying to understand the underlying rationale and trade-offs associated with any choices, we are more than likely going to hurt people.

Fundamentally, I am willing to go out on the limb and say that, in this case, Bernard has no implicit model of the economy to base his policy prescriptions on – and so such prescriptions are both internally inconsistent and dangerous.  If he provides us with a model, and an actual description of why, I would gladly discuss it – but from the last few weeks of reading through his writing on the issue (I decided to pay more attention following the initial article – especially given that I was receiving a lot of pressure from others to respond) I have not yet ascertained what it is.

Markets fail, institutions fail, governments fail – let’s try to understand why before we arbitrarily play with them.  This is why economists struggle to understand why people fly off the rail like this, we see the point of our discipline as one of understanding and description – predictions are just an outcome from this process not the main goal (see lots of discussion on this issue).

Update:  Surprisingly related posts on Economist’s View and Marginal Revolution (*, and response).

On Economist’s View, the claim is made that “protectionism is instinct, as we struggle with non zero sum games”.  I have heard this before – and this explains why economics, and the actual functioning of the macroeconomy often seems “counter-intuitive”.  Introversion is essential for doing economics – but we have to be willing to question our intuition if it just doesn’t hold!

This is relevant, as I get the impression that many calls for macro-controls are on the basis of this instinct.

On Marginal Revolution there is a link to an article on the adjustment in the yuan.  Brad Delong’s reply also offers relevant points.  Overall, this illustrates that the true “concern” regarding currencies has existed for a while – and stems from currencies being fixed NOT from the fact that many monetary authorities are simultaneously devaluing now.  These issues need to be separated.

Matt Nolan

A step too far: The case against pursuing direct capital/trade/currency controls

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To start off with I have to admit I like Bernard Hickey.  I like the fact he has got out there, written about New Zealand economic issues, and pushed to add an open debate type platform to the discussion regarding the New Zealand economy.  As a result, I may have not been critical enough when I read his posts in the past – as I did not see this coming.  In truth, the calls for exchange rate, trade, and capital controls is a massive step too far in what could well be the wrong direction.  Let me talk about the points Hickey has raised:

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