Matt Nolan

Uncertainty, policy, and recessions

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Via Anti Dismal, there is a post discussing regime uncertainty and recessions – and criticising some of the world’s Keynesian bloggers for ignoring the role of uncertainty.

Now I think the real options argument that uncertainty reduces activity is undeniable, but I also don’t think that any economist – Keynesian or not – disagrees with it.

Ultimately, we know uncertainty is a major driver of the business cycle – that is part of the reason why investment is the first thing to pull back, and one of the first things to recover when a “recovery in the economy” begins.

The difference lies in what CAUSES the uncertainty – specifically, when we think about the role of government in this context we need to ask “will this government action increase or decrease uncertainty for decision makers”.

We don’t live in a world where, without government, there is no uncertainty – in fact uncertainty appears “endogenously” during the economic cycle, it is something that is both always there and worsens when things change.  The real question isn’t whether uncertainty has a cost (it does) it is whether policy (which is what we control) makes things better or worse.

Matt Nolan

If I was to have a platform

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I am constantly criticised for not putting out conclusions for policy.  So I thought with an election coming up, I’d put down my personal election platform … this should make obvious why no-one would vote for me, not even my mother 😉

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Matt Nolan

Will the Swiss event start a series of competitive devaluations?

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In so far as we believe monetary policy in most countries is “too tight” there could be a significant upside to the Swiss decision to set a minimum value on their Euro change rate – if currency intervention is copied by most other countries it will lead to a loosening in monetary conditions.

Scott Sumner hints at this, and its an issue we’ve discussed here before.  Although it is true that “not all countries can depreciate their currencies at once” they can devalue their currency relative to goods – they can create inflation.  If there are risks of deflation, or inflation expectations are below the central banks target, such intervention could be justified.

Now, when writing about the Swiss event I wasn’t quite as confident.  This was due to the fact that the Swiss actually went out and set a value on the currency – rather than just loosening policy.

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).  But if everyone sets “targets” there is the risk that we get an exchange rate regime where this rate doesn’t respond to changing economic fundamentals – and given that economic fundamentals change constantly, this is a concern.

Matt Nolan

Self interested story of the day?

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So an investment bank comes to the conclusion in a report that too few New Zealand firms are listed, especially on New Zealand’s stock exchange.

Aha.

Why do people take all this capital deepening rubbish seriously – we are a small open economy, with open access to financial markets.  As long as price signals are in place, and property rights are protected, people will invest in things given the incentives they face.  Trying to get people to invest, and invest in specific place, just for the sake of it is bad policy.

When the goal is to make sure that “NZ Inc” has the highest reading on the “GDP meter” as possible this might make some sense (I stress might) – but if we are actually interested in achieving the best outcome for society, I haven’t seen a good argument for capital deepening.  Yes, I’ve read papers on it – but I’ve always found that they didn’t cover the underlying concept of allocation and welfare in the context they should be covered.

Matt Nolan

Swiss national bank “pegs” the currency: What’s it mean?

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With people running away from European banks, and global investors nervous, they have been moving swiftly towards “safe” assets – such as the Yen and the Swiss Franc.

There has been sustained intervention in these currencies since late-July, but now the Swiss National Bank has gone a step further – they have set a minimum exchange rate. [Marginal Revolution also discusses here]

So they’ve pegged their currency to the Euro!

Not quite – they’ve set a cap regarding how high strong currency can be against the Euro.  They’ve said in their statement that:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

This is still, in a large part, consistent with an inflation targeting mandate – they have just said the following:  “be aware that we are going to print money and buy up foriegn currency until our currency is back at a level that is consistent with our inflation mandate” – they have just identified a level of the exchange rate that wouldn’t carry the strong risks of deflation they are currently experiencing.

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.

Now I’m not the biggest fan of messing around with relative prices in this way – as it could just be that Europe is so far in the toilet that the weak Euro is telling us something … as a result, my preference would be for the Swiss to just print a whole lot of money and buy currency without setting an explicit “target” in the way they have (outside of stabilising inflation rates).

My CONCERN is that this will lead to further exchange rate management around the world – although not as dangerous as protectionism, I can still see nasty side effects from this.

The real problems are in Europe – and they need to sort them out.  However, given they won’t other countries are stuck introducing “second best” policies (with the potential for unintended consequences) which is sad.

In terms of NZ this means nothing – they are worried about an asset price bubble in currency markets due to people running to “low risk” currencies … we are the polar opposite 😉 .  Also they are worried about deflation, we aren’t.

Matt Nolan

If Europe’s bank don’t trust themselves, why would anyone else?

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Quite. (ht Marginal Revolution)

The issues in Europe remain the most concerning thing for me at the moment – the US has a large drought and a weak patch, but at least we don’t have to ask if their central bank has the ability to always act as a lender of last resort.

The fact that there is no central fiscal authority in Europe, and the fact that people are unsure whether they can trust the ECB in a worst case scenario, makes matters difficult over there.

My concern for NZ comes from the same place they always do during these financial crises: will it lift the cost of funding (which is happening in part – albeit at a time when additional credit remains cheap) and lower export commodity prices (which hasn’t happened).  With a stagnant Europe NZ can do fine, but if they lose the plot we will not be left unharmed.

Update:  For future reference (as I often use these types of posts when I’m going back to look at history – it is amazing how useful blogging has been in this context), growing issues regarding German’s willingness to bail out the region (following election defeats for the incumbent) are a major driver of increasing uncertainty at this point in time.  Also note that the decision to start suing US banks now, in the middle of a crisis, isn’t particularly helpful.