Matt Nolan

Five W’s, an H, and an E: The method of economics based on primary school techniques

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I remember when I was a 7 year old sitting around at Kio Kio school and the teacher pulled out the five w’s and an h:  Who, what, where, when, why, and how.  They were repeated constantly, and we were told that these were questions we should repeat all the time.

Now at 7, we were a bit young to understand the gravity of these questions – and no doubt it merely led to annoying situations for our parents.  However, as Wikipedia informs me this is a method of teaching to primary school students – and as I inform me, this is a great way for understanding economics.  So let’s use them.

There are two ways we could use the wh method to understand economics – we could ask these questions about economics, or we could ask how economics deals with these questions.  I’m going to do the second.

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Matt Nolan

Price discrimination based on gender: Sexist or fair?

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I see via Stuff that women have to pay more for haircuts.  This is true – in fact there are a number of service related areas where the woman’s version of that service costs more than the man’s version.  Undeniably, we are seeing price discrimination at work.

Now I’m not terribly against price discrimination – if the price discrimination is taking place based on a freely obsevable factor such as sex, then the outcome is efficient … and to be honest, price discrimination is going to become a larger part of our lives over time.  Now this doesn’t mean its fair, or unfair … in order to understand that we have to apply a series of “value judgments” about fairness.

Let’s look at the example of haircuts.  It is true women are charged more than men.  This happens due to women, on average, valuing the service more than men and generally being “less responsive” to the price.  Furthermore, even for the same haircut for a man and a woman, the service offered is not the same – not just because the women values the haircut subjectively “more” but because the physical service that is offered is usually different.

The hairdressing industry is an interesting one as well, it is hardly a place where “competition” issues exist – there are hairdressers everywhere.  As a result, a hairdressers ability to charge a premium above cost is severally limited – although it is the case that women value a haircut more than men, the very competitive nature of the hairdressing industry and the existence of a price gap seems to indicate that the “haircuts” a woman gets costs more than the haircuts a man gets.

If this is the case, I struggle to see how we could view this as unfair.  If we were to “ban” such price discrimination based on sex male haircuts would have to cross-subsidise womens cuts – to me this sounds like much more sexist pricing.

There is also the issue of choice.  Say that, somehow, all the 100 million hairstylists in Wellington were able to inforce an OPEC type relationship – and thereby collude on the price of haircuts to women.  I don’t understand what is to prevent:

  1. Entry of another hairdresser – the fixed costs seem reasonably low.
  2. Women going to a mens barber – a lot of mens barbers in Wellington wouldn’t care … if you were getting the same cut as a guy

I think this specific example shows how careful we have to be about criticising “price discrimination”.  Such discrimination is often a good thing – even given its negative sounding name.

 

Matt Nolan

QE3: Forward guidance, debt purchases, unemployment target

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As expected, the US Federal Reserve announced QE3 early this morning NZ time.

In the statement, they commit the the purchase of mortgage debt people expected (carrying on for an undefined period of time), they state they will keep the cash rate exceptionally low until at least mid-2015 (which was anticipated) – but they also say they will do more unless they get traction on the labour market.

This is reasonably significant.  They are fully testing their view that there is no structural problem in the labour market (which is empirically supported) and are banking on the idea that easier monetary conditions, combined with a credible commitment on the labour market will lead to households and firms finally bringing forward consumption and investment.

This makes more sense than prior policy.  The constant forecasting of “failure” in monetary policy in the US led to policy that can be seen as insufficient – the Fed was treating the risks of inflation (and thereby the outlook for the domestic economy) asymmetrically – obviously Woodford’s speech had an impact (although the projections still have a pretty slow improvement in the unemployment rate – would need to see employment rate forecast to really get a feeling for what they mean).

It may also be seen as reinforcing the view of market monetarists (eg Sumner) that the Fed’s expectations have a significant impact on expectations of real economic and labour market activity within the cycle (at least in response to large shocks – possibility of multiple equilibrium.  Note:  They wouldn’t see it the same way.).  This is a view I would like to see in more detail (eg what sort of expectations does this rely on, and what sort of conception of the real rate – are they are artifact of current monetary policy settings).

Although this is encouraging – when looking over here in NZ it is the European debt crisis that is impeding growth.  Yes, a stronger US economy will support growth in Asia and NZ helping remove large scale risks – but the European debt crisis continues to have a separate impact on NZ that is binding.

Update:  Having a read around on the piles of good sites discussing the issue, I ran into this post via Money Illusion.  Now, doesn’t this scream multiple equilibrium to you?  To criticise the Fed for rates being low and indicating a weak recovery, we need to blame the Fed for the drop in the natural interest rate – this has to imply that the Fed either created uncertainty, or is so far away from their mandate we’ve fallen into a “suboptimal” eqm.  You cannot blame the Fed for exogenous shocks (which you’d normally pin this on), so there MUST be an implicit multiple eqm argument behind NGDP level targeting – I find it conceivable, although potentially hard to test empirically … can someone send it to me please 🙂

Update II:  Good point from Scott Sumner:

In addition, they did move closer to level targeting, something I didn’t think was politically possible:

(Fed statement) To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

What’s changed since June?  That’s pretty easy to answer; Woodford’s paper was obviously very influential, and that changed the politics on level targeting.

This is still consistent with flexible inflation targeting at the ZLB.  Of course, NGDP level targeting and inflation targeting share a lot of similarities – and to be fair, NGDP level targeting would be more transparent when faced with the ZLB problem.  In net terms I’m still a flexible inflation targeter – as the benefits of a predictable price level ex-ante from a point in time seem significant, and best served by doing that directly (through inflation targeting).  Of course, if the facts at my disposal change I’m happy to move around 🙂

Matt Nolan

BERL report on changing the PTA

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I tend to avoid criticising other economists, especially inside New Zealand.  However, the BERL-NZ First report into inflation targeting has crossed a threshold where I feel saying nothing would be more inappropriate than voicing my disagreement.

I have discussed the issue on my work website here.  In that article I solely discuss the idea of hot money – and how they don’t properly articulate the idea that someone in NZ has to borrow the money, and that this is a key factor to try and understand to figure out where any “failure” is.  However, there are several more issues I have with the piece:

  1. The alternate rule isn’t actually defined in the article – this makes it hard to analyse.
  2. Having inflation expectations anchored doesn’t mean ditching inflation targeting is costless – changing monetary regime will unanchor inflation expectations!
  3. The credit figures quoted aren’t inflation, or asset price, or GDP, adjusted – they are all just in current prices, and so exagerate everything.
  4. The rule the RBNZ sets for setting the official cash rate is endogenous with the economy – as a result, you can’t really say “the interest rates are too high”, instead you need to ask what core economic drivers are making it so.
  5. Monetary policy is cyclical – when any fair reading of the evidence suggests that, if there is a problem, it is a structural one that is independent of this (I expect this point, and the one before, to be a bit more contensious – even though they are relatively mainstream).
  6. The costs and benefits listed are relatively partial and don’t seem well considered – they should also be compared through models and evidence rather than ad hocly thrown around.
  7. Insulting “mainstream economists” is douchey … seriously, they are CGE modelers, they often use mainstream economic methods.

Feel free to rant about how I’m part of a “mainstream conspiracy” or that I’m only doing this because they are “competition”.  But no matter what, my core belief here is that structural issues in the New Zealand economy need to be researched, and sensible changes to fiscal, financial, and competition policy should be made where appropriate.  Ill informed changes to monetary policy and the PTA are not a silver bullet, and are very likely to be inappropriate.

Update:  Paul and Eric also discuss.  So does the ODT.

Bah:  Article link is being a punk.  Here it is in any case:

 

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Matt Nolan

Farewell Dr Bollard

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Alan Bollard has now pretty much finished his role as governor of the RBNZ following today’s MPS.  He, and the RBNZ, did a great job of helping to steady the NZ economy during the global financial crisis – I think there are few other people in the world who would have felt that sort of pressure before, so it really is quite incredible.  As a result, I’d definitely like to thank him for a job well done during a time that was viciously confusing and extremely important!

Bernard Hickey (*) does the same:

I hope he celebrates his last Monetary Policy Statement news conference and parliamentary select committee appearance. He deserves at least a strong cup of coffee from his favourite café, Daniel’s, next door to the bank at the bottom of the Terrace. That’s because Reserve Bank Governor Alan Bollard can retire on September 25 with his head held high.

He presided over monetary policy and New Zealand’s financial system during the most turbulent period in our economic history since late 1984, when a run on our currency forced a shock devaluation and nearly bankrupted the nation.

Alan Bollard has managed the blunt instrument of the Official Cash Rate (OCR) and the much less simple instruments of banking regulation through New Zealand’s strongest period of economic growth in 50 years and then its deepest and longest recession in 20 years.

Very good.

Matt Nolan

Debunking Keen on Bernanke: The issue of debt deflation

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From Twitter, and email adverts, I’ve heard the Steve Keen is or was in town discussing economics.  That’s good, everyone should be discussing economics.

As you may have noted earlier both Anti-Dismal and myself have had issues with Keen’s analysis in the past – his criticism of microeconomics is just patently wrong.  However, I intend to give him a fair go in his main field of macroeconomics – and will find media of him discussing his work in New Zealand to discuss.

Before I do this though, I have another area where I have to disagree with him strongly – his unfair slandering of Ben Bernanke in these two “essential posts” on his website.

I ran into these posts when I randomly ran into the article on debt deflation on Wikipedia (an article that also unfairly attacks Bernanke – compared to this one).  I was there because I had heard people going on about how we are experiencing debt deflation – something I found strange given that we aren’t experiencing deflation, or the scale of real declines in asset prices, which really are the key feature of a debt deflation episode.

Keen twice quotes the following passage from page 17 of The Macroeconomics of the Great Depression:  A comparative approach (REPEC).

Fisher’ s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.

This makes it sound that Bernanke, and the economics discipline as a whole, doesn’t see wholesale declines in asset prices as any sort of significant issue.  Anyone following what central banks have been implementing over the past decade will know this is patently false, but it is worse than that.  He is also quoting Bernanke viciously out of context.

The article actually makes the case for how important this issue is – and then estimates the impact of this type of episode during the Great Depression and finds that it is very very important.  If we go down the page we find:

However, as the HMRC debt management has explained, the debt-deflation idea has recently experienced a revival, which has drawn its inspiration from the burgeoning literature on imperfect information and agency costs in capital markets …

From the agency perspective, a debt-deflation that unexpectedly redistributes wealth away from borrowers is not a macroeconomically neutral event: To the extent that potential borrowers have unique or lower-cost access to particular investment projects or spending opportunities, the loss of borrower net worth effectively cuts off these opportunities from the economy. Thus, for example, a financially distressed
firm may not be able to obtain working capital necessary to expand production, or to fund a project that would be viable under better financial conditions. Similarly, a household whose current nominal income has fallen relative to its debts may be barred from purchasing a new home, even though purchase is justified in a permanent-income sense. By inducing financial distress in borrower firms and households, debt-deflation can have real effects on the economy.

He also then goes on to discuss how it can hit financial stability by knocking out banks.  In the paper he discusses how debt deflation is a major issue, estimates a significant impact, and as an issue it is used to justify the lender of last resort function of a central bank – the very function that the ECB has refused to properly implement, helping to drive the current crisis.

Bernanke also places a link in a footnote to a paper he wrote, describing this very issue (NBR working paper here – and look at the major macroeconomists who helped edit it).

The only reason I can think of why Keen would so blatently misrepresent Bernanke is so that he comes off as smarter and more original than he actually is – that is a very harsh statement I nearly didn’t write, but I find what he’s done here verging on unforgivable … and as readers know, when someone does something like this I tend to get crabby.  If he is going to misquote and insult people, then I’m going to call it like it is. Update:  I’ve changed my mind – that comment by me was unnecessary, and inflamatory.  I should be saying why the misquoting is inappropriate instead of saying such things – my apologises.

Hell, the only reason I picked up on it so quickly was because I’ve recently reread these Bernanke essays when I purchased Essays on the Great Depression for my Kindle – if it wasn’t for that, I probably wouldn’t have even noticed.

But what about debt causing deflation!

This is the true claim to difference – mainstream economists do not say that debt causes deflation, however Keen believes this is the case and quotes Fisher as evidence.

Fisher wasn’t wrong – but he was discussing an economy under the gold standard … so it was an entirely different monetary regime that meant that in the face of this large non-monetary shock, the system created deflation.  Sure enough, we don’t have that sort of system now – and we haven’t seen the mass deflation that we did during the Great Depression.  The monetary regime now is a lot better, and outside of the ECB the lender of last resort function is widely accepted

Perhaps if he gave the writing of monetary policy experts like Bernanke a fairer reading, he may recognise this.