Matt Nolan

Are excess reserves driving a “currency misalignment”

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One of my favourite excuses for the “high” NZ dollar is currency reserves being built up overseas (in order to “keep their currency low” they need to buy up foreign dosh, building up currency reserves you see).  It is an argument the US likes to make without actually doing any analysis as well.

However, work has been done … a while back.

The linked to paper found that reserves were not excessive anywhere, expect China.  A good point to keep in mind no doubt.

Matt Nolan

Monetary policy discussion in the US

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Sounds like what we’ve been saying here.  From over there:

  1. The Fed should have a single nominal target.
  2. The Fed needs to be transparent and have specific and well-defined monetary policy goals.
  3. The Fed should focus only on monetary policy, and regulation of the large banks.

From over here:

  • At its heart, the consensus between the two main parties was to do with the target of monetary policy – monetary policy must be implemented by an independent Reserve Bank to ensure that inflation remains within a low and narrow band.
  • Giving the Bank multiple instruments to simultaneously achieve multiple targets would be a recipe for confusion, and would ultimately damage its ability to achieve any of its targets
  • Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy
Matt Nolan

More good news for NZ!!

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Guess what.  The EU subsidies on dairy products, introduced at the start of this year, are GONE.

Now US, step up to the plate and dump yours.  Or are we going to move into a situation where the United States is more protectionism than Europe …

goonix

California knows how to ban stuff

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The California Energy Commission, in all their wisdom, have decided that the best way to encourage energy conservation is through imposing compulsory energy efficiency standards on TVs – in other words they are banning what they deem to be ‘energy inefficient’ TVs. They are the first state in the US to implement such a measure.

The aim of the intervention is to reduce electricity demand and hence avoid the need to build new power plants to meet this demand. In this sense, the Commission perceive the building of power plants to be a negative externality, presumably as the cost of building is reflected in the per-unit price of electricity for all users.

I take issue with this ‘externality’. For example, if a lot of consumers suddenly started demanding ‘Thierry Henry is God’ t-shirts, such that the price increased, should I feel aggrieved that the action of others is affecting the price I must pay for such a worthy product? No, that is how the market works.

Putting aside my scepticism, let’s assumes that the externality is a genuine one. What might be a superior way of discouraging consumption?

Bans are a blunt tool. From an economic efficiency perspective, you should first try and use prices to incentivise behaviour. High demand for electricity is only ever a problem over relatively short periods. For example, in New Zealand the peaks occur on weekdays in the morning as people wake up and in the evenings as people go home. In hotter climates, the peak typically occurs at the hottest part of the day as air-con works its magic. Hence one might try to charge higher prices at times of high demand to discourage consumption (and hence avoid the need to invest in new power plants). There are electricity meters that are capable of facilitating such differentiated pricing and indeed they are being rolled out in California as we blog.

Under the differentiated pricing scenario, consumers are paying the ‘true’ cost of electricity, so even if they continue to consume at high levels, one should be indifferent to building a new power station as the externality has been internalised.

The obvious perverse incentive that arises from the ban is that consumers will simply purchase their televisions out of state, knowing that they can get a better range of TVs to better suit their individual needs at more cost-effective prices.

It is far more preferable to keep consumer choice open and simply make consumers fully pay for their choice through efficient pricing (assuming that an externality exists in the first instance).

Matt Nolan

Bailouts, moral hazard, and the money supply

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Over at Anti-Dismal Paul Walker says:

The bailouts were not a good idea, just think of the moral hazard problem this has created, while there may have been more justification for the Fed acting to prevent the money supply from falling.

These are all important issues.  If the “bailout” (I use the term loosely, as buying profitable equity shares and making loans that get paid back are not what we normally view as a bailout) created a moral hazard problem we are just delaying an inevitable contraction – and supporting inefficient firms.  Furthermore, if there is another way for the Fed to control the money supply without a bailout it is likely that would be a preferable action.

However, the fact is that a bank run (which is what we were trying to prevent with the “bailout”) reduces the money supply – even if the Fed leaves the money stock unchanged.  As a result, we can’t really treat the two issues separately.  Remember, the Fed doesn’t control the money supply directly, the money supply is formed through the financial system.  As a result, I don’t think that the Fed could “maintain the money supply” in the face of a massive bank run.

In regards to the 1930’s this point is illustrated by Bruce Bartlett (ht Marginal Revolution):

There’s no way the Fed could have expanded the money supply in the early 1930s without bailing out the banks. How do you think the money supply declined in the first place? It’s because banks failed and their deposits disappeared. To keep those deposits from disappearing in an era before deposit insurance would have required keeping bankrupt banks afloat.

If we had experienced a bank run, we would have suffered a similar decline in the money supply – even with the Fed pumping money out into the money stock.  Now if prices cleared perfectly this wouldn’t matter, the drop in “velocity” would be met by a drop in the price level.  But prices don’t move immediately, implying that the drop in the money supply as a result of the bank run would have had an impact on real output (*).

Now, I completely admit that Moral Hazard is a relevant issue.  But is a the cost of letting large financial institutions know that, in a 1 in 100 year collapse in the global economy, they will be prevented from going bankrupt immediately greater than the benefit of avoiding a sharp and self-propogating decline in economic activity?  For the bailouts to be a good idea we merely need to say:

  1. the costs exceeded the benefits,
  2. this was the best scheme that was able to be approved at the time.

I think both these factors hold – although I completely understand when people feel differently, given that there is a trade-off.

The Hand

Bank runs and TARP

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This is a Hand post, but it is actually just the normal authors of the blog.  We all had the same idea at the same time 😀

Over at Anti-Dismal, Paul Walker reaches the conclusion that

The moral of the story, markets can deal with asymmetric information

In the case of bad and good banks.  He states that banks are able to signal whether they are strong or not, and so government intervention is unnecessary.

However, this doesn’t seem to weigh up properly with the vast amount of literature that points out that bank runs are a concern resulting from asymmetric information (and multiple equilibrium – for economists this is because withdrawal decisions are strategic complements) and that a small amount of government intervention can help prevent said negative outcomes (here and here are seminal pieces).

Now there is a way that we can put both points of view together. Lets look at how the market is overcoming the asymmetric information problem:

At least one major US bank is advertising the fact that it refused TARP funds.

So the market was only able deal with asymmetric information in this case because the government created a mechanism that allowed banks to credibly signal (the TARP program).  It is ONLY because the government created this mechanism that the individual banks could signal their “strength” credibly, thereby preventing an inefficient bank run equilibrium.

So I would change the moral of the story slightly to

markets can deal with asymmetric information, when the institutions are in place that allow them to credibly signal quality – an issue government can sometimes help with