Matt Nolan

On economics as method

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Via Mark Thoma’s twitter feed came this gem on “neo-classical economics”.  It strongly supports my view on what economics is so let’s have a peak at the conclusion:

I sometimes argue that the main version of economics,  at its best, is that  it is a disciplined way of thinking and arguing that makes clear where people disagree. If two economists disagree, they can unpack each other’s arguments. Do they disagree in their underlying assumptions? In their model of how those assumptions fit together? In their arguments over cause and effect? In their beliefs about what data to use? In the statistical methods they use? Even when economist end up disagreeing, they should be able to pinpoint the sources of their disagreement–and thus to agree on what issues need to be further researched and resolved. From this process, provisional truths (and is there really any other kind?) do emerge.

This is completely true, and the way a vast vast majority of economists see economics and developing economic knowledge.

However, the sentence prior to this description also raises an interesting point for me:

For noneconomists, I guess the obvious question is: “If economics doesn’t give a correct and clear answer most of of the time, what good is it?”

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Matt Nolan

Gareth Morgan, housing, and blaming the RBNZ

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Lately I’ve been saying “don’t blame the RBNZ’ for things a lot (here, here).

However, Gareth Morgan’s concern about Bank policy and the housing market IS actually a legitimate area to raise concerns about Bank policy.  His view boils down to this statement:

The problem with demand for property in New Zealand is one that has arisen as a legacy from a long history now of Reserve Bank prudential policy combining with selective tax policy to provide a toxic little no brainer for property investors.

Simply put, he feels that prudential policy overtly favours housing, thereby creating the equivalent of a “tax wedge”.

So it is NOT a criticism of monetary policy and the PTA per se – but of the institutional financial framework set up by the RBNZ, which in turn has led to some type of “inefficiency” or “misallocation of resources”.

I’m not convinced, but I’m leaving my mind open. I have had similar thoughts in the past, but have in the end ruled them out – it would just take some firm evidence to lead me to re-evaluate my priors 😉 .

Update:  As if by magic, the RBNZ has a speech up defending their framework here.  Given this speech has been booked in for some time, it isn’t a direct response.  However, I would note that they point out that risk-weighting in housing is higher here than in a number of other countries (so the capital requirement for a pool of loans on housing is higher in NZ 😉 ).

Risk-weighting are set for the capital adequacy ratio for a reason, and as a result we need to articulate why these are wrong or inappropriate.  Furthermore, it isn’t clear to me that prudential policy has had a “long history” of being pro-housing – instead it has always seemed that retail banks have been pro-housing due to the fact that they see these loans as relatively lower risk, which shows up in relative interest rates and the availability of credit.  As a result, for the argument to be made needs more analysis – the burden of proof is on the analysts making the claim that prudential policy is a “causing too much investment in housing”.  A little bit more analysis in terms of numbers and counterfactual models is in order – and if these show the result and the argument could persuade more people – including the RBNZ 🙂

Note:  His movement from excessive demand for investment in housing as an “investment vehicle” to a complaint about affordability is also tenuous at best – excessive investment demand lead to a larger stock of property (that is how we get the “misallocation of investment”) and lower rents.  The yield on property falls, and ownership becomes more expensive … but the cost of buying “housing services” actually falls.  So does this imply that Bank is making housing services more affordable?  We need to be a bit more careful not to mix up issues here!

 

Matt Nolan

In defence of Mankiw

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When it comes to looking at policy, I started life fairly heavily left wing.  When I started university at the age of 18, my first textbook was by Greg Mankiw.  He was a Republican, while most of my economics reading at the time had been Marxist or a frustrated attempt at reading the General Theory by Keynes.  I was immediately certain that I would hate the textbook, and that it had no value – at that point I was even more immature than I am now 😉

I was utterly and totally wrong – a situation I have become accustomed to.  Mankiw’s first year textbook is clear, to the point, and is honest about what the economic method is and what it achieves.  He “wears his assumptions on his sleeve” which I have learnt is the distinction of the best type of economist.  His textbook, and his papers on macroeconomics and tax, have been insightful for me as a way of not just understanding economic ideas, but of understanding the economic method.

So I see he wrote a paper called “defending the one percent“.  Undeniably it was titled that way to irritate people.  And undeniably it succeeded. (Update:  I’d note Cochrane states it is mistitled – and I believe to an economics auidence it is.  I touch on why I think he gave it that title for his target audience below)
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Matt Nolan

Quote of the day: Friedman on hypotheses

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This quote is golden, and since I’ve removed it from my paper at NZAE I have to put it somewhere … lest I lose it from my memory!

Observed facts are necessarily finite in number; possible hypotheses, infinite. If there is one hypothesis that is consistent with the available evidence, there are always an infinite number that are.
It is from “The Methodology of Positive Economics” by Milton Friedman.

The lesson that we use ceteris paribus assumptions to narrow down potential hypotheses, as well as to simplify and clarify links, was an important lesson to learn as a student.  And made “what economists do” with each paper they contribute (testing the CP assumptions, attempting to change the set of CP assumptions) make a lot more sense to me.
Matt Nolan

Inquiry suggests lower wages and taxpayers taking on firm risk

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I have read over the opposition report into manufacturing, and there is so much geniunely wrong in it that it deserves a significant post – one I will hopefully have the chance to (at least partially) do this week.  Note, I don’t disagree with absolutely everything in it, and I do congratulate them for the idea of getting together an inquiry and sorting policy – I think that is neat.  But there are trade-offs, and this report acts like there are none.

As a result, I thought I should probably translate what their report actually suggests in title of this post though.  This is not a blueprint for higher wages and “better jobs”.  This is a blue print for:

  1. Cutting the real purchasing power of households,
  2. Getting the government (therefore the taxpayer) to take on risk for businesses
  3. Therefore, subsidising an industry that the rest of the world is subsidising because of mystical “spillovers” we think may occur – ignoring the fact that having firms currently focus on their comparative advantage is making NZ into a very wealthy country …

This is our “left wing” parties talking – essentially about NZ Inc.  What happened to actually thinking about poverty and equity, issues that I know I might actually vote for them about if they ever bothered to be actual left wing parties, instead of an accidental vested interest group for firms.

Update:  Brennan McDonald discusses here.  I like the focus on specific biases between economists and (what I would term) folk economists.  IMO, economists need to be clear on their communication around these issues when discussing policy debates – as they are the principles that tend to “defy common-sense” for folk economists the burden of proof falls on us 😉 .  Also Groping to Bethleham discusses this here and here.

Matt Nolan

Perspective is great – income

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Via Tim Harford on Twitter, I see the “global rich list” site has been updated.  Take a look!

It is this sort of recognition that makes economists get so wound up about global income inequality rather than income inequality within a country.  This is why it came up in the second part of my “careful with occupy” plea in NZ back in 2011 – because I guess that is the sort of way we’ve been trained to view these equity issues.  When economists talk about equality of opportunity (which is a value judgment – so we are wandering out of our strict specialty here) we are viewing all people as equal, irrespective of the country – and this is why development economics is such a massively popular field, and I can fully understand and appreciate that.

Let us take someone working every week of the year, 40 hours a week, on the current minimum wage ($13.75 per hour).  Assume they have no kids and the such, so we are just talking about an individual.  That gives us gross income of $28,600pa.  Now go here, and we get tax of $3,710pa.  Take off the ACC levies, that is $486.20.  Add on the independent earner tax credit, so $520pa.  Ignore any other payments.  This gives us net income of $24,923.80pa.

This result would put you in the top 6.53% of the income distribution over the world.  You would be among the 6.53% of worlds richest people, if you work in NZ on the minimum wage full time.

This in term does ignore two things:

  1. The fact that goods prices tend to be higher in wealthier countries – so this factor will be exaggerating how wealthy the NZer is (as we actually care about goods and services)!
  2. It also ignores that the tax that is paid is used to fund health care, education, etc etc.  These are “goods and services” that are provided which people is much poorer countries do not have access to.  As a result, this factor will be making you look less relatively wealthy than you actually are!

Perspective, it’s interesting.