Matt Nolan

Interpreting information, markups, and the economic cycle

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Over at Worthwhile Canadian Initiative, Nick Rowe bemoans the fact that economists keep ignoring the “very short run”, and the transition from that to the short-run.  In the very short-run, we may view a shock (an increase in demand) and interpret as noise – it is only when the shock persists that we may respond.

This reminded me of tacit collusion.  Why … well why not!  In a paper by Green and Porter, discusses collusion and competition between firms with market power in a way that I’ve always found compelling.  Essentially a firm sits around doing what it does, and then it observes a drop in demand for its product.  The question it then has to answer is, “is this due to the other firm undercutting me, or has consumer demand for my product fallen?”.  Given that the firm does not know, under some conditions it will respond as if the drop in demand was due to a cut in prices by the competing firm – leading to a break down in any “tacit collusion” that existed before.  Weak demand therefore leads to price wars!

Now this isn’t the only explanation of price wars – in fact Rotemberg and Saloner showed the opposite.  In their model, there was a greater “prize from deviating”  when demand is high, and so times of high demand see collusion break down!

What does this mean for markups over the business cycle?  Well in the Green and Porter case, where this issue of interpreting information is a key driver of behaviour, markups are procyclical – in the Rotemberg Saloner model, markups are countercyclical.  Furthermore, there are many other models that aim to explain changes in the markup over the business cycle – it isn’t all about models of tacit collusion.

At an industry level, things differ – and so in different cases, the different models are supported empirically when looking at this as an industrial economics issue.  But what about over the economy as a whole, which one holds?  Generally it seems markups have been shown to be procyclical and to be countercyclical… while a fair amount of economic modeling often assumes countercyclical markups (in response to demand shocks).  This is an interesting area, very interesting.

Matt Nolan

The Dismal Science … on Sciblogs

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Eric Crampton over at Offsetting has managed to wrangle the NZ econblogger community some space over at Sciblogs.

I’m very impressed that Sciblogs has allowed this, and it shows that they recognise that their desire to add to the policy debate in NZ can be helped by having an economist feed loitering around.

Although I read all these NZ economics blogs already, it will be nice to have a summary of the more indepth stuff sitting around – go and have a look 😉

Matt Nolan

Defending inflation targeting

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After seeing David Parker claim that inflation targeting was dead, I felt obliged to chip in with my two cents – which Rates Blog kindly allowed me to do.

In the article I looks at the critique of RBNZ policy based on “imported price spikes” and “credit flows” and point out how the RBNZ framework for this does makes sense – and does not need a change.

My conclusion shifts the blame for any perceived imbalances:

The determination to change what the Reserve Bank does is surprising to me. Our central bank helped to guide New Zealand through one of the largest global shocks imaginable, helped to keep our core banking system together, and by all but the strictest measures they have achieved their monetary policy mandate.

A clear target for monetary policy, a respect for their role in financial stability, and their credibility with the public were the things that helped them achieve this. It makes no sense to turn around and change what the Reserve Bank is doing after such a success.

Instead, those in government should be looking at themselves.

Policies to favour investment in residential property (through tax status and other regulatory focuses) helped to drive the “imbalances” New Zealand faces.

A failure to take into account population aging is making the government fiscal situation look increasingly unsustainable.

Transfers to the middle classes, which we may feel are fair, still come with a cost – bidding up house prices, and reducing capital investment.

If we want to explain the “imbalances” in the country, and what should be done, we need to look at government policy, and the interventionist policies taking place overseas – the monetary policy of the RBNZ is an unrelated scapegoat.

Governments aren’t honest about the costs of their policies.  The decision to introduce working for familes, and generally increase targeted spending, reduces inequality – but it reduces economic activity and “competitiveness”.  We may believe these transfers are fair, that is fine, but no amount of blaming the RBNZ will change the trade-off we face.

Politicians are either lying or are naive about the trade-offs – either way, their bleating is giving you the wrong information, and it threatening to disestablish the institutions that have helped New Zealand do relatively well in the last 20 years.

Matt Nolan

Bleg: The scope of abductive reasoning in economics

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Time to ask another question.  I was wondering, how much does the form of explanation in economics appear to take the form of abductive reasoning?

Often in economics, we will observe a stylised fact.  We then have a method that can explain that fact in a myriad of ways.  We will then build a model that shows how a given cause will lead to that stylized fact, and pat ourselves on the back.  But if this is really just a form of abductive logic, and there are a myriad of ways to “explain” said stylized fact, how can we have any confidence in our description – how can we really say that we have explained anything?

jamesz

Trespassing sexual offenders

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The Whanganui council’s reaction to Stuart Wilson’s release has been striking:

Whanganui’s public “shunning” of Wilson will be coordinated by councillors Jack Bullock and Ray Stevens.
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Mayor Annette Main said the decisions made by the council [to ban Wilson from public areas] would help keep the community safe from sex offenders such as Wilson.

Back in March we blogged about a paper on recidivism among sexual offenders. It found that community notification and reaction to released offenders actually increased the likelihood of re-offending. By making release to unpalatable to the offender it decreases the cost to them of going back to jail. Thus it may be that the Whanganui council’s actions, which reduce the deterrent of jail, may actually be placing the community at greater risk.

Matt Nolan

Are real Austrian economists neoclassical?

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According to this lovely post, the answer is yes (ht Economist’s View).  Choice quote:

Does Davidson know what a neoclassical policy is? Does Boettke? Does anyone? I don’t think so, because neoclassical economics, as such, has no policy agenda. But whatever a neoclassical policy might be, Davidson assures us that Hayek is totally against it.

Now, although the term “neoclassical policy” is a pure nonsense term, I can guess how Davidson, after talking to a bunch of Austrians — I hope not Boetkke or Bruce Caldwell, who is also quoted in Davidson’s piece — picked up on the propensity of modern self-styled Austrians — generally followers of the fanatical Murray Rothbard, as distinguished from the authentic Austrians of Hayek’s generation — to deploy “neoclassical” as a term of abuse, providing sufficient justification for these modern Austrians to dismiss any economic doctrine or policy they don’t like by strategically applying the epithet “neoclassical” to it.

So let me assert flatly that F. A. Hayek was a neoclassical economist through and through. He was also an authentic Austrian economist, schooled in both branches of Austrian theory by way of his association with his primary teacher at the University of Vienna, Friedrich von Weiser, one of the two principal successors of Carl Menger, the founder of the Austrian School, and through his subsequent collaboration with Ludwig von Mises, a leading student of Eugen von Bohm-Bawerk, the other principal successor of Menger.

As well as placing Hayek in the economic mainstream (which most mainstream economists agree with), I love the fact that this post points out that neo-classical economics has no policy agenda.  Pure neo-classical economics provides an objective framework that helps us to describe issues – given this framework we could then apply a varying set of value judgements, which can then in turn justify almost ANY policy agenda.  The advantage of using the neo-classical framework is that we are forced to make our value judgements transparent – so that the trade-offs, and our assumed values, are plain to see!

The confusion about what neo-classical economics is pervades all discussion of economics, so it is nice to see this issue pointed out here 😉

Update:  Krugman has a nice post on the issue here.