Matt Nolan

Targeting non-tradable inflation: Some points

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Bernard Hickey has stated that the RBNZ needs to target non-tradable inflation.  Fair enough, I’ve heard the argument for that before.

However, he says we should do it because of the “structural flaw” in our economy and to “help exporters”.  Ok, but remember that the RBNZ controls monetary policy – not all the structural policies in the economy.  So what happens when they target “non-tradable inflation”

  • The RBNZ lowers non-tradable inflation by increasing interest rates further … likely leading to an even higher currency.

In this context, the stated aim of targeting non-tradable inflation doesn’t met the goal.

Now Bernard Hickey likely believes that there are structural reasons why non-tradable prices are growing more quickly than relative-tradable prices.  And he would right.  The reasons are:

  • The Baumol effect, where services become relatively more expensive as we become more wealthy
  • A related issue that tradable goods experience larger increases in productivity than non-tradable goods (as they tend to be more capital intensive, and face more competition)
  • Competition issues due to our scale
  • Issues of the size of government
  • The combined impact of our rising terms of trade and productivity improvements in developing economies (which has held down imported cost pressures – ex fuel).

In this context the only two “policy relevant” issues that have changed the “structure” of our economy are competition issues and the size of government – both things that fiscal authorities and competition authorities should look at … not the RBNZ.  All the other changes were responses to fundamental changes in our economy.

Protip:  Our manufacturing sector is shrinking because it is relatively less efficient than the rest of the world – we are “relatively better” at making other things (comparative advantage).  NZ has done amazingly well from this – with our real incomes holding up, and our employment ratios still elevated, even WHILE the world has experienced the largest economic shock since the Great Depression.

tl;dr  Targeting non-tradable inflation won’t give the “structural changes” that are desired here – and “structural” issues are due to competition and fiscal policy, not inflation targeting.  Changing around the inflation target will actually lead to the opposite outcome than the one that is being targeted.

Matt Nolan

NZ fact of the day

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So, US real median incomes in 2010 were down 6.4% from their 2007 level, and down 7.1% from their 2001 level.  That is a pretty danged poor result, the situation over there has been pretty messy over the last decade.  The median income figures are biased by the fact that the cost of goods purchased by low income households have in many cases fallen (think cheap washing machines, and the $2 shop) while higher end products haven’t experienced the same sort of price declines.  Yet even with this excuse, it does appear that middle-class America has seen a tough time.

Now this is from census data – and NZ hasn’t done a census for a while so I can’t really tell how we’ve done in the same accurate way.

But what I can do is go to the HES (Household Economic Survey) provided by the good people at Stats NZ.  By taking the median households pre-tax income figure, and adjusting it for NZ’s CPI (excluding the recent change in GST – as that was met by a corresponding change in income tax) I get the following regarding the year to June 2010 [note, I’m a moron and used the June 2011 CPI, hence the adjustment – this is fixed below]:

  1. Household real income is up 2.3% 4.4% from the June 2007 year.
  2. Household real income is up 19.1% 21.6% from the June 2001 year.

Also note that the median figure for the  US is $49,455 (in 2010 US dollars).  In the June 2010 year the US/NZ dollar exchange rate averaged 0.70c … and as a result our median income was $44,429.  This is significantly closer than I would have expected, given underlying production in the US.

If we expect the dollar to be at $0.80 during the June 2012 year (not a huge assumption given where the dollar has been), and we assume that real median incomes stay unchanged during this two year period the median NZ household income level would actually be higher than the median US household income level – that is complete madness.

Matt Nolan

Watch the curve: Thoughts for the RBNZ September MPS

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Tomorrow its more than likely the RBNZ will leave the official cash rate unchanged.  Following that a lot of people are going to say one of the following:

  1. Bah, the world is in crisis they should slash rates
  2. Bah, inflation expectations are elevated and CPI growth is high, they should be increasing rates

Or who knows, some people will probably say both.

Anyway, even if they leave the official cash rate unchanged this does not mean they would have done nothing – in truth even when they leave the OCR unchanged they may loosen monetary policy due to the seizing up in global financial markets.  They do this by changing their forecast for where the official cash rate will go:

Source (RBNZ)

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Matt Nolan

Papers on the old new financial crisis

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Brad Delong links to a number of interesting papers regarding the US/global financial crisis of 2007-2009.  I recommend the optional ones.

I’m not sure I completely agree that the bailing out of Bear Stearns made matters worse – but it was an interesting perspective.

In any case, its a good idea to try and understand what happened then – in order to figure out whether the debt crisis in Europe will lead to similar global pain.

IMO when Greece does default, who holds the associated liabilities is widely know – as a result, my hope would be that nothing will really happen.  With nothing happening, the rest of the world will just move on.  The risk is that Greek default actually knocks out a big bank (it looks less likely now that it will knock out a sovereign government – although that remains the big fear in Europe).  Fluffing around in Europe has kept credit conditions tight for at least 18 months longer then they would have been, in the absense of European debt issues – it is starting to feel like some people will have to accept some loses before this crisis can end, and some semblance of global confidence can return.

Matt Nolan

Terms of trade: An Australian perspective

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Institutional Economics has some good points on the boost to Australia’s terms of trade – points we can keep in mind over here.

Relative to what we pay for our imports, Australia now gets higher prices for its exports than at any time since at least 1870. This was illustrated by Reserve Bank Governor Glenn Stevens’ observation that ‘five years ago, a ship load of iron ore was worth about the same as about 2,200 flat screen television sets. Today it is worth about 22,000 flat-screen TV sets.’

This increased international purchasing power is attributable not only to rising commodity prices, but also lower prices for imports, not least manufactured goods. The flip side of Australia’s terms of trade boom is the collapse in the terms of trade for countries like Japan.

So a higher terms of trade allows us to buy more imports for the same quantity of exports – something that is important to keep in mind when we bang on about “rebalancing” the economy.  Furthermore:

Our best response to the terms of trade boom is to become even more open to inflows of foreign labour and capital and to reduce the government’s command over resources so that the mining industry can expand with less pressure on other sectors. While the non-mining sectors will contract relative to mining, they can still expand in absolute terms if we continue to remove government-imposed resource constraints to overall economic growth.

The industries that aren’t experiencing higher returns should be expected to fail – proping them up is a policy that will just lead to worst outcomes from everyone.

So much of what has happened to New Zealand has been due to massive changes in the terms of trade – both in the 1970’s and in the 2000’s.  Asking for the “balance” of the economy to return to some past point doesn’t make sense – when the “prices/values” that dictate this point have changed … a change in economic structure is what NEEDED to happen.

It is possible some things may have gone a bit far – but it is better for us to try and understand why, where, and how before introducing policy, rather than aiming to meet some magical level of tradable to non-tradable GDP (or real consumption as a share of GDP).  If you want more details on the why, where, and how – look around the blog (pro-tip search imbalance), or contact me directly.

Matt Nolan

Sometimes TVHE does raise points

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Over at Money Illusion Scott Sumner states:

The recent Swiss devaluation has led to some interesting reactions in the blogosphere.  But one angle that I haven’t seen discussed is the relationship of the Swiss action and bubble theory.

Within an hour or two of the announcement we had said (in additional to the straight avoiding deflation argument):

Furthermore, it seems apparent that the Swiss National Bank views the current level of the currency as a bubble – people running to saftey see the Swiss Franc as attractive, and people who want to invest expect this to continue, leading to a self-fulfilling expectation driving up the value of the Franc.

Then when discussing the cap the next day we said:

I can understand why they did it, they felt there was an asset price bubble in their exchange rate – and they wanted to provide a lower focal point that traders could shift too (since expectations were driving the currency … note the increase in risk associated with intervention is also important).

TVHE is little, and doesn’t say much – but at least we picked up that angle immediately.  And so we’re going to claim it … do we get a high five