Matt Nolan

Let’s be careful judging savers

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Although my article might not give that impression at first glance – that is actually where I am in agreement with Bob Jones here.  However, I’m also saying that the RBNZ governor isn’t wrong about bringing up the “savings issue”, and it is fair for us to discuss where marketand government failures are … including in the way housing is treated by the tax system:

The point is that the complaints of economists are not the product of us assuming stupidity, or telling people they are immoral. They are the concerns of a group who believes that there may be some policy relevant issues – for example the peculiar ways that the New Zealand tax system treats housing as an asset – which are hurting New Zealanders.

Far from showing the Reserve Bank governor is out of touch, as Jones suggests, his willingness to discuss this issue illustrates that he realises how important it is for future generations of New Zealanders.

I also get concerned, as does Bob Jones, that the push towards “save more” is really a moral push to tell people what to do with their income.  However, when economists are talking about savings issuse they are saying that our persistent large current account deficits, with a range of other factors that seem unusual in New Zealand, provides a situation that we should analyse.  Analysing it has led economists to note a number of issues where there is a trade-off – a trade-off policy makers and the public feel the wrong choice has been made about.

Given this, people want to change policy settings.  I’m not jumping into this debate in of itself – but I would note that there is nothing wrong with asking the question, and merely saying “I’ve done pretty sweet on property in the past” doesn’t invalidate that.

Matt Nolan

Be careful saying that housing is “taking away” from businesses

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There is an interesting narrative running around at the moment.  Liam Dann articulates it in the Herald:

But wait, there is more; this property investment tradition is deeply damaging to the long-term growth of the New Zealand economy.

As well as accelerating property prices it is taking investment capital away from the productive, job creating sector.

What this country needs is more jobs and higher wages, as most people would want to learn how to setup SMSF and make regular payments. That’s means more wealth-creating companies and more growth for the companies we have. Our companies need local capital.

We need a thriving stockmarket that small businesses aren’t afraid to list on. We need great pools of savings to invest in smart Kiwi companies.

Sounds fair enough right – since we are all (well not me, but other people) buying up houses off each other, we are borrowing dollars for this.  These dollars could instead go to innovate firms!  Another way of viewing it is that our demand for buying other peoples houses is  pushing up the interest rate, and that this is increasing the cost of lending to innovate firms.

Ok ok, let’s just stop right there for a second.  House prices are appreciating due to the large shortage of property (in Auckland this is especially the case), and recent improvement in credit availability.  Now the improvement in credit availability is actually reducing interest rates for “innovative firms” – but let’s put that to the side as well.

Let’s instead pretend that there is just a fixed pool of capital.  It isn’t true, but it is what this argument is based on.  And let us also ignore the fact there is a housing shortage and a terribly low build rate – instead we will assume that no houses are being built, and that there is no population growth, and no aging, and nothing that will change the composition or quality of houses required.

In this case, when people “borrow to buy houses off each other” (the primary concern of bubble proponents) we aren’t removing capital from the stock available for businesses.  Remember, the person who borrows to buy a house then gives someone else a bunch of wealth – which they can in turn invest or save (which will then go back to become credit available for our “innovative businesses”).  In the case where there is no actual INVESTMENT in housing, we aren’t (on the face of it) restricting business investment by buying property!!!

All the factors I ruled out above are reason we SHOULD invest – they are drivers that indicate we need to invest, or they were actual investment.  A bubble is supposed to “crowd out” investment to other areas by leading to TOO MUCH investment – we should be experiencing TOO MUCH building … but this isn’t what is happening. [Note:  Even if you do not believe there is a shortage of property in of itself, build rates remain low.  As a result, part of any concern about a housing bubble needs to be premised with “and I expect a sharp increase in spending on residential investment”]

We could argue that it is due to risk – the more mortgages that are written up, and the larger gross debt is, the more risk banks are taking on and as a result the less they are willing to lend to other business types!  This is true – but to think about this we have to ask about how banks view relative risk (Note:  A bubble should make mortgages relatively riskier, which in turn should (depending on regulation) make them PREFER our innovative businesses – it is on the willingness to borrow side whether things are out of whack).

We can argue about what is going on with this, and what regulation should be – but arguing that the rising house prices and a low level of building activity is crowding out local investment is fallacious.

Sidenote

This “productive vs non-productive” distinction is investment isn’t economics – it is a value-judgement.  It sounds like economics, it even smells a bit like economics.  But an economist recognises that a house provides a set of “rental services” and that an individual is willing to invest in something that provides a “low rate of return” if they trust it.  We need to ask about relative risk, relative insurance, relative returns for different investment classes (including housing) rather than giving housing a demeaning name and then expecting people to change their behaviour.

Matt Nolan

Minimum wage and tax on low income earners

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What would you say if I told you I was currently in control of a hypothetical little country in my head – other than accusing me of of having some form of psychosis.

In this little country there is a group of low income earners, who have a reservation wage (the hourly satisfaction from growing vegetables in their own garden) of $6hr.  There are also a bunch of high income earners that do what they do, and who the low income earners can’t replicate.  The kicker is that, the work these low income earners are able to do is only available from a cheeky monopsony employer!  This employer is able to extract $15 per hour of value from each of these workers, and since it has all the market power it only pays them $6 an hour.

Ok, now I’m a benevolent government in my mind – and I’ve decided this isn’t fair.  I’m trying to decide whether I should turn up an demand a $10 minimum wage, or whether I should put a 40% tax on just low income earners and then throw the money back at them.

Now you might think that what I just wrote was a typo.  Surely I meant “cut” taxes on low income employees – after all, higher taxes mean less income!

Some keen eyed may have noted that I said “throw the money back at them”.  They may say “what’s the point, you are taking money off them, having to pay for ‘churn’, and then giving them less back”!  Now for kicks, assume there is no churn in my tax system – it is in my head after all.

The majority of people at this point think that the tax scheme is just me being weird, and that it makes no difference.  However, the minimum wage would increase the wage, so lets do that.

But, what would you think if I told you that, given all these assumption, they actually have the same result!

What

Many people would say that the tax is 0.4x$6=$2.40 per hour and the transfer back is $2.40 per hour so it cancels out.  But this involves not considering the incidence of tax.  Our low income employees have NO bargaining power, they are paid the least possible by this monopsony employer.  However, they will not work for less that $6 an hour that is their reservation level.  They still need to be paid this NET of tax in order to supply their labour.

As a result, the firm needs to offer to pay a GROSS wage of $10 an hour – $4 is paid in tax, which is then given to the low income employee regardless of whether they work!  So by taxing the employee and then giving them the tax money back irrespective of work, there effective wage goes up to $10 per hour!

But this isn’t realistic!

Indeed, it isn’t in the slightest.  However, here we are using the assumptions that are common regarding why a higher “minimum wage” is good and showing that those same assumptions also suggest that we could tax low income earners more and transfer the money back to them – and they end up with higher after tax income!

Now the devil is in the details.

  1. If the tax money is only returned if the employee is working, then we don’t get this result.
  2. It is unlikely (in either case) that there would be “no employment effect” – the firm will still not hire, or employee hours, of someone they would have otherwise.  Note that if we refuse this assumption in the case of increasing taxes only on low income earners we are ALSO refusing it for the case of minimum wages!
  3. We don’t really have monopsony employers anymore … but again this is a common assumption for the minimum wage argument.
  4. Fundamentally, both the quantities of supply and demand will “respond” somewhat to changes in price (the wage), and as a result the incidence of the tax itself is not so one sided.  However, if the transfer is without churn (and churn is pretty small nowadays) we are just taking that tax chunk that is ripped out of surplus and giving it to employees … just like we stated!  We just have the additional people who lose out from not being employed and the associated dead-weight loss.
  5. If we transfer the income to the low income group who are still employed and those who are not employed (so assuming lower employment occurs), then the difference between the tax case and the minimum wage case is that those people who get left out of work are better off in the tax case, to the cost of those who manage to get work (who are still better off in the no policy case in this example).
  6. The real dynamics, and what we can really observe and respond to, are entirely different to this – this is a thought experiment that isolates tendencies stemming from these policies.
  7. If the industry is a large part of the economy, this business gets even more complicated ….

What I would note though is that, the less market power we assume our employees have, and the lower we expect the employment effects to be, the closer we get to this situation – the more of the incidence of taxation ON these people actually falls on their employer!

A lesson

There is something pretty thought provoking to come out of this example though.  We have discussed a case where taxing someone, and then giving them back the money made them better off in a redistributional sense – because prices changed.  Even though we “taxed the employee”, the incidence of tax fell on the employer, and so we transferred income from one to the other.

Many people will look at a situation and say “I want to help those people, let’s cut tax” – but we need to actually ask about the incidence of tax, and the response of government spending to the lower revenue, before we can articulate who wins and who loses.  There is FAR to much arbitrary moralising by people regarding tax rates, without any clear indication that they have thought about tax incidence when coming to their conclusion.  And if you don’t think about the incidence of tax, you are stating an opinion on tax based on no thought … I have to be blunt.

As a secondary result, hopefully by “reframing” the minimum wage argument using different words, people can look at the issue with more critical eyes – yes it should provide a transfer, but who the transfer is between isn’t always clear!  The reason some people prefer direct tax credits and direct income transfers isn’t because we are being pedantic – it is because the actual distributional consequences are clearer and more proven … it is because we want to ensure society’s wish to help people (if it has this desire) does just that, rather than using poorly designed policies that merely “show the intention” of helping.

Matt Nolan

Two undervalued points in thinking about monetary stimulus

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Tyler Cowen does his normal thing of making a lot of very good points other people aren’t.  For me these two are key:

  1. The rate of unemployment in Japan, last I checked, was 4.1%.  Yes, they calculate it differently than we do, and yes in their heyday they had an even lower rate of unemployment.  But still, ask yourself: just how labor market slack is there going to be?
  2. An alternative is that money will boost real economic activity through a Lucas supply curve combined with a fair degree of money illusion, which is what you would expect from a longstanding deflationary environment.  Businesses will confuse nominal changes with real changes, raise output, and eventually figure out the confusion and restrict output again.  The economy does get to keep a one-time gain (probably there are positive social externalities to higher output in this setting), but it doesn’t drive an enduring recovery.

The unemployment rate issue is one I have had in the back of my mind.  My presumption has been that Japan has, in recent quarters, been facing a sharp drop in demand – and as a result they are responding to a recent shock.  The stimulus isn’t about their long-run failure to me, it is a monetary policy response to a recent shock.  I am also happy that they appear to be setting up a framework that will deal with similar shocks in the future.

There seems to be this accidental view appearing when may of us, including myself, write about monetary policy – a view where we start to undermine the medium-long term neutrality of money.

Either we need to explicitly state how there is a “multiple equilibrium argument for how the neutrality of money breaks down in this circumstance” (this would certainly take us down the rabbit hole …), or we need to assume that there has been a number of shocks that have built up upon each other.

If we assume the first we are on pretty intense and shaky ground, and need to make sure our arguments are crisp and transparent.  If we assume the second (which is the camp I am closer to when looking at NZ) then we can’t say that the central bank ex-ante failed UNLESS they could have foreseen the shocks.  If the shocks are things such as policy incompetence in Europe, and sudden large shifts in commodity prices and the exchange rate, then they are indeed unforeseeable!

Matt Nolan

The new Bank of Japan

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Look at that, the Bank of Japan has joined other central banks in announcing an explicit inflation target, and doing all they can to show their credibility for achieving it.

Good.

Some will call this a currency war, or “monetization” – but again, this is the Bank targeting a specific inflation target in a forward looking manner.  This is what they should have been doing all along – and given it is a rule, it helps set expectations and acts as a “no-monetization” condition.

Some will say this destroys central bank independence.  I would note that the purpose of independence is to sovle “time inconsistency” in central banks – rule based policy does this fine.  It would only be a problem if the Japanese government tried to force them to violate the rule.

New Zealander’s will complain about the dollar.  Remember here that the BOJ has commited to inflation of 2%pa (where previously it was expected to, on average, be lower).  The return on holding a Yen has become more negative per year … and so the asset price of the Yen much fall.  This is what has happened, however the price inflation will ensure that the real exchange rate trends back to its true level.  Remember, the exchange rate is a price, and we need to think about the primitive causes of any issue in order to figure out if there is one.  The BOJ actually doing normal monetary policy isn’t negative for NZ – although it will sting the bottom line of people trying to sell to Japan in the near term (hola Rio Tinto).

Posts:  Money Illusion, Market Monetarist. (Where is the rest of the blogsphere, a credible commitment by the BOJ is actually a massive event … I haven’t seen much in the way of posts yet though.

Matt Nolan

Equilibrium

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Good Noah Smith post on economic equilibrium.

Equilibrium is a term that is often thrown around as an insult (I used to hear people talk dismissively about it at university), but in truth our concern with a model isn’t that it involves some sort of equilibrium but that we believe some of the core assumptions are inappropriate.  Articulating this claim, and why we think certain assumptions are inappropriate, is where value comes from specific criticism.

I find it quite cool that the main criticisms I hear nowadays are about equilibrium and the endogeneity of the money supply – as I’ve always felt those were issues where communication feel down.  Essentially, when discussing economic phenomenon I have always used the process of equilibrium as a way to describe tendencies – rather than pin down outcomes.  Interestingly, for a concept I’m saying is important I can only find four instances where I mentioned economists looking at tendencies (here, here, here, and here) … and one time when when I misspelt tendencies and compared Economists to Jedi 😛 .

Obviously, I need to actually write some blog posts on Mill.