Matt Nolan

Why macroprudential regulation?

/1 Comment/in , /by

With the RBNZ asking for comments on the upcoming countercyclical capital adequacy  regulation, and the RBA/APRA releasing a report on macroprudential policy now is a good time to ask – why?

I have seen many people justify these types of policies based on “debt being high” – but this doesn’t answer “why”.  I’ve heard a large number of people say it is because government savings made the private sector borrow, leading to financial instability – this not only doesn’t answer why, but it doesn’t involve any sort of sensible role for private agents and so is incoherent.

However, economists aren’t keen to let this issue slide – thank goodness!  The key concern, as previously mentioned, is trying to figure out what the market failure involved is.  What factors drive the systemic risk in the financial sector?  One interesting approach to microfound the incentives through the cycle that lead to this market failure is found here – one I found interesting at least, as there are many more 🙂

Now, it is useful to ask why for a couple of reasons:

  1. We can explain why these policies are actually a good idea – remember, just because something is volatile doesn’t make it bad instead we have to explain why to understand it in this sense.
  2. We can understand the impact of the policies – remember that it is likely that some financial regulation will involve a trade-off between output and stability.  When that is the case, we want to actually decide whether this trade-off is worthwhile.

If we can answer these, we can put in place good policy, policy we can explain, with impacts we can describe, and outcomes we can understand (and hopefully anticipate).

Matt Nolan

Seperating shocks on financial intermediation

/2 Comments/in , , /by

Goldman Sachs has raised an interesting issue regarding the future of financial intermediation following the crisis:

New bank regulations and capital requirements are “structural” changes to the industry that are more to blame for declining profits than the U.S. economic slump, Goldman Sachs Group Inc. (GS) analysts said.

Remember, we have had the failure of Lehman Brothers (the Global Financial Crisis), the sovereign debt issues in Europe (the European debt crisis), and in the NZ context the failure of the non-bank financial sector post-05.  These crises can be expected to have a relatively persistent impact on economic activity – but not permanent.  Once all is said and done, and financial stability is returned, economic activity should in turn recover.

However, if the “wedge” (inefficiency) in financial markets persists indefinitely this suggest that something else is the cause.  Let’s also remember that at the same time that all this was going on financial regulation by central banks around the world has also changed!  While these changes will increase the stability of the financial system – they come with a permanent cost in terms of economic efficiency … there could potentially be a persistent wedge between the return to lenders and the cost to borrowers due to these policies.

Given both happened at the same time we can’t “identify” what did what – which makes the outlook even more unclear than it usually is.  However, it is important to keep all these disparate causes in mind when trying to understand what is going on.

Matt Nolan

Free food in schools: Equality of opportunity?

/20 Comments/in , /by

Recently the Labour party has suggested we have free food in low decile New Zealand schools.  At the same time, Kiwiblog suggested that this was nonsensical.

So how do we should we view this policy?

Generally, having the government buy something and give then give it out is relatively inefficient – we get no clear signal of the “value” associated with it, and the lack of clear discipline often leads to the government over spending on the service.

However, we could provide this same argument for the provision on “education”, or the provision of healthcare, or the provision of roads.  In each case, we are willing to move away from strict market provision for a reason.

We need to think about primary and secondary school education more clearly to get a good idea about the policy of free lunches.  Why do we provide this sort of education, and what does public provision achieve?  We provide this type of education to ensure there is equality of opportunity for individuals in society.  On that note, having shared lunches at school ensures the same thing – we know that appropriate nutrition at a young age is essential for the physical and mental development of an individual.  We know that, especially in low decile schools, there is a definite “underinvestment” in this attribute for kids.

Now we may feel that it is due to families having insufficient income, and we may say that instead of free lunches a more appropriate solution would be to increase benefits and transfer payments.  But is this the whole explanation?  Potentially the real limiting factor is time, parents do not have the time, or information, to provide their kids with lunches in this case.  If this was the case, then ensuring that the school provides lunch would save these parents the time, ensure that food is provided, and would benefit from “scale” in the provision of lunches. For families that needed help getting food we taught them how to apply for food stamps in louisiana. To be honest, as an individual I have always thought the provision of lunch at school makes sense from an equality of opportunity standpoint – you ship kids off to an institution for most of the day, we may as well make sure that the institution provides the services required.

Personal responsibility is a very important thing, but when it comes to children and education there is only so far such an attitude can take us.  I agree with this Labour party policy for the most part, although I wouldn’t just have it in low decile schools – I would probably make it an option for all schools to spend part of their budget on.

 

Matt Nolan

PTA’s, currency, and monetary policy

/2 Comments/in , /by

Recently I was sitting at my computer looking at Twitter, when the following popped up in my feed:

NZIER calls for changes to the RBNZ’s Policy Targets Agreement to combat the overvalued NZ dollar – http://bit.ly/Q6aOWX

I found this surprising, as earlier in the day I had read a piece on the NZIER site that I felt was saying something very different to this.  It turned out it was the same article, however it was interpreted in different ways.

Let me state how I took the NZIER piece after several readings.

They stated that, due to the current PTA including several goals, the Bank had not reacted strongly enough to credit growth during the “boom” – essentially, concerns about the exchange rate had prevented them from appropriately responding to what was going on.

As a result of this, if we leave the PTA unchanged, the Bank requires other instruments in order to achieve the “multiple goals” it faces in the current PTA.  Anti-Dismal recently had a post where Don Brash made the same point.

But what about the jazz about the exchange rate at the start

Yes, the article discusses in detail how the NZ currency appears to have been persistently overvalued – and that there has been a chronic imbalance between savings and borrowing.  However, it never lays this down as the Bank’s fault – it merely says that the Bank is facing undue pressure about the exchange rate as a result of this.

As we have discussed a myriad of times, a PERSISTENT IMBALANCE is not the fault of monetary policy – it indicates that the real exchange rate is out of whack in NZ for real economy reasons.  This could be fiscal policy, this could be an issue an issue of competition, this could be an issue of “impatience” by New Zealanders.

Macroprudential regulation can be used to help against these issues in a “financial stability” sense – and the article makes the claim that they can help monetary policy BY reducing policial and social pressure regarding factors monetary policy is uninvolved with.

The article DOES NOT say that we should change the PTA to deal with the currency directly – and if that was actually NZIER’s intention I would be more than happy to have a open, and long, discussion with them regarding why this is the case.

Matt Nolan

On “currency wars”

/6 Comments/in , , /by

We keep hearing concerns about “currency wars” around the wold, with the blame being put on Quantitative Easing.  In fact our Reserve Bank even came out to complain about QE.

But to be honest, this argument is nonsensical unless you are explicitly forecasting “monetary policy failure” overseas.

Lets go back to Essays on the Great Depression by Ben Bernanke – when talking about countries depreciating by rolling off the gold standard:

Depreciation, in this context, should not necessarily be thought of as a “beggar thy neighbor” policy; because depreciations reduced constraints on the growth of world money supplies, they may have conferred benefits abroad as well as at home.

With interest rates stuck at the zero lower bound, and a sharp contraction in lending across the world, the fact that QE lead to devaluation in the US currency should not be seen as a bad thing.

QE is, in essence, aiming to lower interest rates within the US economy in order to bring forward spending and investment – to stimulate “aggregate demand”.  Why did we not get similar arguments from people whenever the US cut interest rates prior to the crisis … as it is essentially the same thing.

Instead of getting annoyed at the high currency, lets ask what it is telling us about monetary and economic conditions here – instead of assuming that the value of the dollar is “wrong”, and asking for arbitrary organisations to “do something” lets use it like any other price, and try to understand what it is telling us.

Matt Nolan

Interpretation and the model

/in , , /by

Following the Jackson Hole speeches there was this post over at Uneasy Money.  The money section for me is:

The reductions in long-term interest rates reflect not the success of QE, but its failure. Why was QE a failure? Because the only way in which QE could have provided an economic stimulus was by increasing total spending (nominal GDP) which would have meant rising prices that would have called forth an increase in output. The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down. The success of QE would have been measured by the extent to which it would have produced rising, not falling, interest rates.

Now this is an interesting quotation for me.  There is one thing I think I know – and that is that market interest rates are very hard to interpret, given the number of different things they are representing!

This quote argues with the simplified standard economic model that is put out there.  In that model, when there is an output gap central banks aim to get the realise real interest rate below its “natural level”, taking from this paper we have:

Thus, the mechanism through which monetary policy influences aggregate demand can be thought of as working as follows: Given the sluggish adjustment of prices, by varying the short-term nominal interest rate, the central bank is able to influence the short-term real interest rate and, hence, the corresponding real interest rate gap. Through its current and expected future policy settings, the central bank is able to affect the corresponding path of [the short term real interest rate gap] and, in turn, influence the long-term real rate gap … and the gap in Tobin’s q.

In this setting, monetary policy works by pushing down real interest rates (which happens by boosting inflation expectations and lowering the nominal interest rate) and by boosting aggregate asset prices.

But it is also true that if monetary policy “succeeds”, long term interest rates should be representative of the “natural” rate of real growth and inflation (as well as including factors for risk and time preference) … essentially the long term real interest rate is a constant.

From what I can tell, the afformentioned quote by Uneasy money relies on two things outside the basic model:

  1. A central bank sets expectations of nominal income growth, not inflation
  2. There are multiple equilibrium in the macroeconomy, making unemployment of the current sort the result of a failure in a co-ordination game.

However, if anyone has any more insight that can tie these view together, I would appreciate hearing it in the comments.