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

The attacks on Keynes and how to be a bad analyst

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Brad Delong, combined with an imbedded quote by Krugman, covers off the bone-headed remarks of Niall Ferguson on Keynes in this post.

[Note:  You might wondering why I’m posting when he has apologised – isn’t that a bit uncharitable of me.  Well, he’s said these things in the past so I believe that some element of them remains core to his analysis, and even for off the cuff remarks they indicate a rot that exists among analysts when it comes to looking at models that I want to rant about.]

Now I am not calling Niall Ferguson an idiot for no reason – I accept he is a man of high regard who has, and will, achieve more than I ever will.  Furthermore, as a historian, even as a good analyst, the ideas and philosophies imbedded in someones actions are fair game!  The fact Keynes is gay, was in the Bloomsbury group, and didn’t have kids are all relevant factors for trying to understand Keynes and the subjective assumptions he made when doing analysis!

I have simply lost all respect for Ferguson’s analysis because he has simply played the man and not the ball when doing this.  Any analyst, and especially any real historian, would given this real context in terms of where it actually matters.  Here let me explain.

Truly, the lessons we learnt from Keynes and can apply to our understanding of the economy and the management of currency (which are many) exist independent of our subjective belief about what the “right” rate of time preference is.  The debate about the correct rate of time preference hasn’t been set by any “ancient Keynesian tomb” and should be discussed directly – rather than abusing the notion of a man that can’t defend himself.

If Keynes had said “the discount factor is X” then someone may say “his subjective preferences due to his lifestyle had an impact on that, and I don’t think that is a fair interpretations of how we see things now – and the trade-offs we are willing to make”.

Instead, we see people come out feeling that the government is borrowing too much – and they decide to throw ad hominem attacks on a dead man.  Keynes as a man wasn’t even a supporter of large sustained deficits – he was simply a man trying to work out what the hell was going on during the Great Depression.  Something many modern analysts avoid by directly excluding that time period and just assuming it will never happen again.

Think about it for a second.  Economics involves many models trying to explain and add light to tendencies in the world.  During the largest slump in history and following on from a Great War and the collapse of democracy, would you expect the thinkers of the day to be focused on building and trying to understand models of 100 years in the future – or of trying to understand the extreme business cycle and institutional fluctuations of the day!  The term “the General Theory” may have been inappropriate and grandiose – but his work on business cycles was undeniably useful, especially when combined with the increasing formalisation of the discipline in the following decades.

If bagging someones entire process of thought because they were gay (in truth bisexual) is a legitimate expression of academia nowadays, it’s frankly embarrassing – and suggests that people should perhaps spend a little more time refining their understanding of philosophy before they open their mouth.  If we want to think of the type of standard that people discussing economic concepts should set (and the unfairly high standard I apply to economists I’m listening to), then we should go back to a quote by none other than Keynes, the first quote I popped up on this blog:

… the master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher–in some degree.  He must understand symbols and speak in words.  He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought.  He must study the present in the light of the past for the purposes of the future.  No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.

It was this quote that turned me to economics when I was 14, and it was attending classes with lecturers who felt this way about the subject that convinced me to give up on any other career or hobby and study economics.  So I guess I’m undoubtedly a little biased – perhaps that is colouring my defence, and I should be ignored for the man who is implicitly assuming that gay people, and people without children, effectively hate the rest of society ….

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

Series on tax: Part 1 – why?

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Huzzah, I am writing about tax on Rates Blog.  In Part 1 I ask “why do we tax“.

I get onto other issues later – in fact, this will be a five article series.  Here all I do is combine the idea of “government spending” and “paying for government spending”, and give a little wink to ideas such as equity and tax incidence.  They will play a more central role in the next article, when I discuss tax systems that seem ideal … but that we don’t use for often good reasons.

jamesz

Blanchard on expectations

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Matt loves to talk about multiple equilibria and how changing expectations can shift us between Pareto-ranked equilibria. It turns out he’s not the only one who thinks it’s an important matter in the current environment. Here is Olivier Blanchard discussing recent developments in the implementation of monetary policy.

In a world of multiple equilibria, announcements can matter a lot. Take for example the case of the Outright Monetary Transaction program announced by the European Central Bank.  …The announcement has succeeded, without the program actually having to be used.

From this viewpoint, the recent announcement by the Bank of Japan that it intends to double the monetary base is even more interesting. What effect it will have on inflation depends very much on how Japanese households and firms change their inflation expectations. If they revise them up, this will affect their wage and price decisions, and lead to higher inflation—which is the desired outcome in the Japanese deflation context.  But if they do not revise them, there is no reason to think that inflation will increase much.

This very much reinforces the message of people like Woodford and Sumner that the expectations channel is by far the most important one for monetary policy.

jamesz

Making policy is hard, but really important

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We’ve talked a bit about the costs of unemployment recently and that discussion lead me to re-read Ken Rogoff’s letter to Joe Stiglitz from 2002. It’s clear in the letter than Rogoff is enraged with Stiglitz criticism of the IMF, but also with his arrogance and the potential consequences for vulnerable people. He’s right to be: the conduct of public policy has huge consequences for millions of people and we take on a heavy burden upon ourselves when we make policy recommendations. It should never be done lightly.

This confidence brims over in your new 282 page book. Indeed, I failed to detect a single instance where you, Joe Stiglitz, admit to having been even slightly wrong about a major real world problem.

…

You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn’t this a little like observing that where there are epidemics, one tends to find more doctors?