Matt Nolan

Question on the power price spikes

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So some businesses are complaining that the spot price of electricity occasionally spikes when there is a shortage (and that these spikes are inconsistent).  They want government intervention.

My question is, if these spikes are such a concern – why don’t the businesses set up fixed price contracts with electricity retailers in the same way household do.  Also, the retailers are complaining about the wholesale price spike – but couldn’t they also set up contracts on a fixed rate?  Ultimately, knowing that the price can spike heavily in the face of a shortage of power, these businesses are CHOOSING to buy at the spot price (I guess it must be cheaper) – if that is what they choose to do then they should really face the risk of it.

Now if there was something anti-competitive about the setting of wholesale energy prices sure, go ahead and complain.  But if they spike because there is a significant shortage – and this price is just representing the underlying opportunity cost associated with providing that power – then having the spike occur is a GOOD thing.

This is because the price is saying “hey, at the current time there is a severe shortage of power, and unless you can create oodles of value from it you should think about stopping power usage for a short period of time”.  When it is placed in that context the spike seems reasonable, and all the complaining about it seems weird – so what is going on?

FYI:  Good comments from Rauparaha.

Matt Nolan

Central Banks: Second best policy and operational separation

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Following a major crisis, such as the one we’ve just experienced, it is easy to get into a situation where the goal of policy is to “avoid another crisis”.  However, this is not a trap that our fine readers fall into – so we don’t need to worry about it here 😉 .

This isn’t to say that we shouldn’t take things from a crisis – far from it.  A crisis gives us information about the behaviour of the macroeconomy, about the feed-back loops that may exist that we may not previously pay attention to, and about the process people use for forming beliefs.  But we still need to say why these things occur – and hopefully make our given hypothesis testable – before we can decide to do anything.

So well prior to the crisis there was a string of micro-prudential policies introduced.  In truth, the retail banks have been grappling with the introduction of many of these policies during the crisis – and the Reserve Bank has stated that part of the reason the OCR is so low is because these policies have, in of themselves, tightened credit conditions.

Now all this is fine, when it comes to cyclical policy the impact of both micro and macro-prudential regulation has been widely discussed.  However, what bugs me is the lack of heavy discussion and analysis is the lack of significant discussion around the structural impact of said policy.

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Matt Nolan

Why I’m not holistic

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A lot of New Zealand policy discussion and debate is holisitc – we say we want a set of outcomes, these outcomes are desirable, these are the outcomes we need to achieve.  In essence, they are saying there are a set of states “we” could be in as a society and we should strive to be in the “one” they are talking about.

Note:  There are elements of holism that are ESSENTIAL, but I see them as part of reductionist philosophy as well.  For example, the idea that the state of the world influences payoffs beyond the actions of individuals is fair.  Also the idea that we can’t compute everything is acceptable.  My argument is against the idea that we start with a “target” (top down) rather than starting with “guiding principles” (bottom up) when designing policy.

What is an example, lets say “sustainability”.  The idea of being sustainable, of having sustainability, sounds nice – it is an overaching state that some people want us to have.  If they are forced to define sustainability they will say it has a whole bunch of characteristics – however, why these characteristics are good is never touched – just the fact that it takes us to this “state” of the world that they normatively believe is desirable.

However, I’ve never, not even as a child, found such descriptions convincing.  One of these states must be reducable to the sum of its parts, there must be a set of causes that lead to that state – either that or it is an impossible pipe dream.

This is part of the reason I found economics so attractive when I was young – just think of the production possibility frontier.

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Matt Nolan

A couple more points on milk

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We wrote about the milk price investigation here, all very exciting.

However, a new article on the stuff site started with this:

Dairy market heavyweight Fonterra is artificially inflating the price of milk in New Zealand in a deliberate campaign to lessen competition

What?  This is beyond my understanding – I need someone to get in here and explain to me how increasing the wholesale price of milk will lead to a reduction in competitive pressures.

My first thought was that there was some Green and Porter esque competition issues (eg – such that the loss of competition is the result of tacit collusion) – then I realised that we are saying Fonterra is a monopoly, so I can’t see too much in the way of strategic interaction …

[Update:  Glad to see that Anti-Dismal also finds the claim strange (here and here), especially since he is actually an industrial economist – which implies he has more idea about these things then I do.]

Anyway, on the note of Fonterra setting prices there is this interesting point from Fonterra:

New Zealand manufacturers have to pay the same price Fonterra pays its farmers for export returns.

Given that the export prices are set on world markets where Fonterra’s market power is severely crimped (due to competition, or effective competition, in many markets) and given that this is the price it is sold at in NZ – we can say that Fonterra is effectively competitive right.

So if we are going to moan about milk prices we have to blame supermarkets, which I’m still not convinced on to be honest.

Matt Nolan

Thoughts on milk

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There is talk about the Commerce Commission investigating milk prices in New Zealand.

An interesting passage from this piece states:

At the moment, we basically have a monopoly supplier of milk and two supermarkets selling it,” she said. “I think an inquiry could be a really good thing for consumers.

I think this is a bit over the top, and plays on how poorly the idea of a monopoly is understood in general parlance.  There is a general impression that the existence of a “monopoly” along some attribute indicates that we need government intervention – when the case is actually a lot more complicated then that. We need to ask why the market has a monopoly, what the characteristics of the market mean, and whether there a policies that can then genuinely improve outcomes – in many cases there are not.

Now note that I don’t necessarily disagree there might be issues – but we can’t just scream monopoly to ask for intervention.  So lets do a primary run down ourselves shall we 😉

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Matt Nolan

An illustration that using data for a conclusion is not objective

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There is an interesting post over at John Taylor’s blog (ht Greg Mankiw). In it he shows that government spending as a % of GDP has a strong positive correlation with unemployment, and that investment as a % of GDP has a strong negative correlation.  His conclusion is to focus on cutting taxes to increase investment instead of spending.

Update:  Here is the point I’m trying to make written up more clearly and completely.

Now, this way of viewing the data is consistent with the model he has in his head – but it is only by stating that model that we can look at the value judgments involved to figure out what we agree with or disagree with.

Looking at the data alone, we cannot make this conclusion – we can just say there are correlations.

For example, I would note that investment responds disproportionately to the economic cycle – this is a well known “stylized fact”.  The excuse economists often use is that businesses and households cut back on durable good expenditures most heavily when we enter a downturn – as the durable products they already own act as effective substitutes for new durables.

As a result, assume that government spending is a constant (so the government is doing nothing to smooth the economic cycle).  When GDP falls, investment falls more steeply.  When GDP falls, unemployment rises.  In this case, even with no government smoothing, the existence of an economic cycle will lead to BOTH of the observed correlations above (note that GDP is a denominator) – there is no way we can reach any policy conclusion from them.

We need a model, with a counterfactual – then we can use the data, and value judgments, to reach policy conclusions.  His model says that these correlations are causal.  My model would probably say that all these correlations suffer from too much endogeniety, and I would state that appropriate monetary policy is the best way to move forward – as it would reduce the observed variability in investment, unemployment, and GDP.  Both conclusions use the same data, the underlying models are just a bit different.

He is of course world famous and ridiculously intelligent, while I’m an arbitrary blogger – but I still prefer my conclusion, that’s what value judgments are for right 😉