Matt Nolan

NZ NDGP graphs – add your own comments!

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As a starting point – thank you Statistics New Zealand for all your tasty data.

First a graph of the deviation of per capita NGDP from its 1994-2011 trend (took out the 1991-1993 period due to the structural changes taking place) – comparing the last ANZSIC 1996 data (Dec 2011) to the September ANZSIC 2006 data:

datarevision

Then a graph of deviations in NGDP from trend and the UR (unemployment rate):

NGDPUR

The same things will case NGDP to shift and the UR to shift, in opposite directions.  In that way this is unsuprising.  Make of it what you will in the NZ context, given your implicit model of the economy – in fact, feel free to mention it in the comments.  I will be sitting out of this one at present.

jamesz

Carney on NGDPLT

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Mark Carney appeared at the Treasury Select Committee today for interrogation before being confirmed as the next Governor of the Bank of England. The big question everybody wanted answered is whether he favoured a move from inflation targeting to NGDP level targeting. The answer is ‘no’, but the reasons are interesting.

Carney is a known proponent of central bank commitment and the use of forward guidance. In recent speeches he has also spoken favourably of NGDPLT and that has prompted a storm of commentary in the UK; little of it was favourable towards the idea. Consequently, all eyes were on Carney’s evidence today. Reading the comments on Twitter suggests that he dismissed NGDPLT and retreated from his previous statements. I don’t think that is true at all.

In both his oral and written evidence he called flexible inflation targeting  “the most effective monetary policy framework implemented thus far.” However, he was at pains to point out that there are problems with it at the ZLB and there are other potential regimes, such as NGDPLT, that might help in those circumstances. In his oral evidence he spoke at length about the benefits of commitment and history dependence when encountering the ZLB. Despite that, he was not in favour of an immediate move away from inflation targeting, as you might expect given the outcome of the Bank of Canada’s review. Some of the reasons he gave are well-known: the problem of revisions and data quality, for instance. Notably, he did not think that NGDPLT would unhook inflation expectations and commented on the additional credibility a central bank could gain by implementing an inflexible rule.

The most interesting argument he made against level targeting was the one he dwelt on in his oral evidence: it relies upon people having rule-consistent expectations. That is to say, the success of a central bank relies on people expecting that it will implement its stated plans, and behaving as if they will come to fruition. Of course, he did not make the naive argument that people’s expectations are irrational. Rather, he pointed out that expectations among the populace have inertia and take time to change. If a large portion of the population have persistently incorrect expectations following a change in target then it would be costly in terms of welfare. He alluded to agent-based modelling done by the Bank of Canada to claim that these transitional costs as expectations gradually adjust could outweigh the gains to the switch.

In summary, he thinks NGDPLT is a great idea but hard to put into practice (data issues) and costly to implement (transitional costs of changing expectations.) Relative to the commentary in the UK press that is a ringing endorsement: one of the top central bankers in world says that the only real barrier is the details of implementation.

Matt Nolan

Pulling out the comparative advantage card

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Since everyone is talking about the drop in manufacturing output and employment and trying to figure out “how to fix it” I thought I’d pull out the old comparative advantage card to show why it may not be a problem.   In case you are wondering what it is, Wikipedia is always rock and roll.

New Zealand is a sparsely populated country that is far away from most large international markets. With fuel prices going up, increasing vertical integration (when different aspects of the production process are joined together in the same firm) and the rise of just-in-time inventory management, more and more manufacturers are positioning themselves “close” to market.

This trend, combined with the benefits of agglomeration in production and the improving use of technology overseas, has made manufacturing in countries like New Zealand less and less competitive.

This is tough for people who have invested time and skills in specific forms of manufacturing, but in so far as these changes are the result of changes in technology and the habits of global consumers, we cannot stand in the way of them.

…

And this is the flipside – although New Zealand is comparatively bad at manufacturing things that require large scale (such as say cars) it is comparatively good at other things (producing milk).

Other countries having become more productive in the export manufacturing space it actually a good thing for New Zealand as a whole – as it has driven down the price of what we buy from overseas relative to the price of what we sell.

This can be seen in our terms of trade (the ratio of export prices to import prices), which has risen 10% since manufacturing activity peaked.

No doubt my article may overstate the case – I would prefer not to make a policy based conclusion until there is some data heavy analysis of the issue.  However, given that changing technology and production patterns around the world will be a major driver of what is going on I felt that the argument actually needed to get some air.  I have noticed that it is popular to focus on esoteric issues when looking at what is going on – among both economists and non-economists.  However, doing so often leads us to lose sight of some of the most important issues!

As people who have done training in economics we have covered this issue a number of times on the blog (eg *,*,*,*,*) – the key point is that we need to understand “why” something is going on before we can truly define whether it is good or bad, change in itself is not bad.  Some people may not like the “descriptive” vs “prescriptive” split economics pushes, but it is the most transparent and honest, and dare I say it scientific, way of doing things.

Matt Nolan

Profits as evidence of bank competition or collusion?

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In New Zealand there are often complaints that bank profits are exorbitant – especially given that profitability rose during a massive financial crisis.  While there is an argument that banks are backed by a lender of last resort, and that they should pay for this (such as through a tax) this doesn’t tell us too much about profitability … remember a tax on bank transactions, or margins, will in part be passed on to borrowers and lenders through an increase in gross margins!  Furthermore, the increase in profitability can be seen as banks taking into account the fact that lending was now more risky (after all, the LOLR only functions when the bank collapses – making a bad loan and losing some money is still a cost that is fully faced by trading banks!).

Still, I’m not actually going to discuss any of this.  I’m hear to say that the increase in banks margins during the crisis and the corresponding drop as financial conditions have improved can be analysed in the same we economists analyse any sector.  And it may well point to a special type of “tacit collusion” in the banking sector.

We have talked about tacit collusion on the blog before, it is a fascinating issue – note that it is’t explicit collusion, it is just an illustrate of how the individual choices of banks regarding their strategy is setting price may in some situation mimic collusive outcomes.  The key example I’ve provided was the price of Nurofen but there are many examples.  If we have the type of competition modeled by Rotemberg and Saloner, then firms will tacit collude during periods of “low demand” and this collusion will break down during periods of high demand – when the size of the “pie up for grabs” is larger.  Given that banks compete on price, have a very clear idea of when a shift in demand is for their firm or for the market as a whole, and don’t face significant capacity constraints, this type of argument is actually pretty relevant!

So what does this tell us about bank lending behaviour?  Well in a situation where we do have multiple banks, lending behaviour during booms may act as if the industry is competitive, but during slow downs it will act as if it is more of a monopoly – as a result, the quantity of credit provided will fall more sharply during a slowdown and the price of credit will be higher compared to the case when the industry is just magically always competitive.   Interesting stuff!

Matt Nolan

Discussion on policy in NZ for the week

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This is a list post – so make of it what you will.

Bill Kaye-Blake has been discussing the macroeconomy in New Zealand (*,*,*), and hunting for a way to make the narrative clearer – I’ve been chatting about it with him in commetns, and Eric Crampton listed up some points here.  Reframing the narrative is important to me, and has led me to experimenting with ways of communicating ideas about the macroeconomy.  Brian Fallow shows the importance not just of clarity, but of indicating that there is no “silver bullet” in his great op-ed.

Grant Spencer has also made a point of communicating about “other tools” that the RBNZ might use, and why they would do such a thing.  The Bank knows that outside their role as protectors of monetary policy, they have to take into account the general stability of the financial system – and they want measures that they use for this to be as transparent as possible.

On the not of communication and narrative, Norman Gemmell has started a series of articles on the NZ Herald discussing issues of the day.  He is an awesome economist, and I’m greatly looking forward to these posts.  The first post tries to lay out the idea of asset sales on more objective grounds!

This brings me to Treasury.  They have noted the mixture of calls about austerity, the economic cycle, structural problems, and decided to spark things off with a piece that looks at the impact of “fiscal policy” in a macroeconomic sense.  This is a piece I intend to go through and write about in time 🙂

All in all, a good week for discourse.  Nice.

Matt Nolan

Inflation stickiness, demand, and judging the success of monetary policy

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I am still a fan of flexible inflation targeting.  I agree with Nick Rowe that explicit inflation targeting has made inflation outcomes “stickier” – and that knowing inflation is in a range of the inflation target is therefore insufficient for telling if the central bank is truly achieving “socially optimal policy”.

For all the time I’ve spent reading monetary economics books and sitting in classes where macroeconomics has been discussed, I still remember a clear (albeit very partial) description of why we do inflation targeting that came in 100 level economics.

I distinctly remember my tutor saying that the point of inflation targeting in the form we use it in New Zealand was to pin down “inflation” (price growth that is shared between all goods and services that is independent of the “relative” value of these goods and services).  With people setting prices based on this view of inflation, central banks with a clear very of the economies “ability to produce” can move around “aggregate demand” in order to prevent recessions that are due to short-falls in demand.  The flipside was often that inflation stickiness was “asymmetric”, with excess demand translating into rising prices, while insufficient demand translated into falling output – this is our good friend the upward sloping, U-shaped, short run AS curve.

This story is massively oversimplified, especially in its treatment of expectations.  But an overarching goal of anchoring inflation expectations was always part of what central banks were aiming to do.  Given this, then in so far an central banks had an idea about economic capacity (which is a very debatable point in itself) they could help to manage “demand” in a macroeconomic sense.  When I was tutoring, this was very much how active monetary policy is taught to first years, and I doubt terribly much has changed.

And this is the point – economists have always know that, if their announcement of a 2% inflation target was the sole determinant of inflation, this does not mean “success” … it just means that they can focus solely more heavily on how the actions of monetary policy have a short-run impact on output.  Deviations of inflation from their target provide information that is useful information about the state of “demand”, but as the NGDP targeting proponents point out it does not capture the whole story.  Variables such as NGDP, and unemployment, provide significant information … something central bankers already recognise and incorporate, contrary to the “narrative” of them being closed minded (Nick isn’t saying this – I’m talking about the more general stories from the media).

This is consistent with flexible inflation targeting – and it does come with one massive hole.  Judging the “success of monetary policy”.  As of course, flexible inflation targeting can only be judged on a forecast, forecasts that are determined by the central banks themselves – and filled with unobservables such as “future economic capacity”.

NGDP targeting differs from this in only three ways:

  1. It changes a partially discretionary rule based process with a fully rule based process.
  2. It targets levels instead of growth rates – making policy “history dependent”.
  3. It gives guidance, and will make “stickier” growth in nominal income – compared to flexible inflation targeting which does this for price growth.

On that final point, at the moment inflation targeting lets a firm say “with competition and the such, I was able to increase my prices 2% this year – this is the same as inflation, and so in reality my “price” is the same”.  With NGDP targeting the firm will say “I increased revenues by 5% this year – this is the same as the growth in nominal spending/value add, as a result my real “revenue” is performing as well as the average firm”.  The right “guidance” will depend strongly on what we think is the most important factor for firms and households to have certainty about (to extract appropriate “market signals”).

To put all this another way – inflation stickiness isn’t an unintended consequence, it is a feature of central banks trying to improve the “sacrifice ratio” associated with active monetary policy!