Matt Nolan

Fiscal spending: Cycles and structures

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No, I’m not talking about the cycleway – although if Bill English does want to cut “nice to haves” surely this is a place to start 😉

I’m talking about this comment from Ganesh Nana, where I both agree with him and disagree with him simultaneously.

The plans (to cut spending) were criticised by BERL chief economist Ganesh Nana, who said cutting more state sector jobs and squeezing spending further at this point in the cycle risked keeping the economy down for longer.

It is true that when we have a cyclical downturn, cutting spending without a coordinated cut in interest rates from the central bank is likely to exacerbate the cycle.

And it is true we are in a cyclical downturn – output in the economy is below its potential level.

However, there are three factors that could well justify SOME cuts to government spending – as long as they don’t try to close the deficit immediately.

  1. The Reserve Bank still has the ability to respond by loosening monetary policy (although the effectiveness of cutting at current lows is a matter of debate),
  2. The cuts are focused on extremely low productivity elements of spending, as a result the contractionary impact will be smaller than in the case of indiscriminate cuts.
  3. Most importantly, the focus of the cuts are to remove the “structural” deficit.

The third point needs more explanation.  Fundamentally, the “potential size” of the New Zealand economy is now believed to be smaller than it previously was.  As a result, in order to have government taking up the same share (a share that is determined by the tax take, which is hopefully set according to the share society desires) the level of government spending does need to be lower – or else we run a structural deficit.

Structural deficits are not cool, it implies that the government won’t balance the books over the economic cycle and will cause unnecessary disruption to economic activity when it does try to – and as a result, it is often seen as a good idea to minimise them.

Now, for an economist I am actually relatively comfortable with short-term structural deficits.  I believe that estimating “potential” is tough, and as long as spending is transparent small structural deficits and surpluses are hard to separate from cyclical ones.  However, while the government should buffer the economy over the “cycle” it is true that in its structural sense it does need to balance its books like a household.

As long as any tightening is based on the three points listed above, I don’t think Dr Nana needs to be too concerned regarding the impact on the broader economy.  However, if they do go further just for the kicks, then his concerns are very relevant.

Matt Nolan

Why we always need a “why”

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I found this write up strange.  We are being told that student that are overseas should pay back their student loan more quickly to “help Canterbury”.  We are told that it is a “win-win” because it gets money into the economy, it lowers the budget deficit, and it means the students don’t need to pay back the interest as quickly.

Typifying this is the quote “It’s in your own interest, but an opportunity to be seen as a hero.”

This is where doing things without a full model/conception in mind is problematic – there is no such thing as a free lunch.

The student isn’t paying back the interest, because they are making sacrifices now to pay back the debt.  The government gets the cash now instead of later, so the cash balance improves but the set of non-cash assets declines – given that the interest exceeds inflation the real value of their asset position is likely to be lower.

What we SHOULD ask is:  Why aren’t the students paying it back now?  Is the policy that was introduced sensible?

Students overseas aren’t paying it all back now because the cost of doing so exceeds the benefit.  If we were to start pushing them to pay it back, we would likely be causing harm on New Zealander’s who have moved overseas – is that something we want to do?

If we don’t think that it is “fair” that students are paying back their debt at the rate they are, and we think the rate of interest is favourable (it definitely is on students who have stayed in the country) then isn’t the solution to increase the interest rate – not to start dancing around and talking about the deficit and Christchurch to guilt people into it.

Now just talking at people doesn’t cost much – there isn’t a policy failure from doing that.  But it doesn’t make it a “win-win” that we are missing out on – if students aren’t paying off their loans, they will have a reason.  Trust me.

Matt Nolan

Understand before you tinker

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I would be lying if I said this didn’t depress me.  Economists, great economists, economists I idolize stating that there are “imbalances” we must solve – and then telling us how to solve them without actually describing what the imbalance is and why it exists.

Read more

Matt Nolan

A wager: Price growth of 15% between Dec 10 and Dec 15

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In the comments of this post, Andrew Coleman and myself decided to place down a little wager on price level growth during the next five years.  The bet goes as follows:

If the CPI grows by more than 15% between its December 2010 level and its December 2015 level (excluding any changes to the GST rate), Matt pays Andrew $100 (in Dec 2010 prices)

If CPI grows by less than 15% during this period, Andrew pays Matt $100 (in Dec 2010 prices).

We put down this bet just to show that we believe our own positions enough to stake money on them.  He believes there is some probability that the Reserve Bank will allow prices to grow at more than 2.8%pa during the next five years, and that this probability is sufficiently high for him to be willing to make this bet.  On the other hand, I do not think this will happen.

Update: Eric Crampton has also joined the bet, sitting on Andrew’s side.  So it is my $200 against $100 from each of them.  Confirmation here – combined with an explanation why.  I use the same explanation if I ever bet against the All Blacks in the work pool.

Matt Nolan

Bubbles, stability, Stiglitz

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As soon as you guys have read the title and saw the article I’m discussing, you are probably expected me to go off about Stiglitz – given that, although he’s a genius, his views tend to be a touch unorthodox and I’m a slave to orthodox economic theory.  But this isn’t the case.  There are a couple of things I disagree with in the article, but I actually felt what he wrote was pretty good – in fact most of it is more orthodox than many may realise.

Now, I disagree with his assertion that:

They failed to predict the crisis; standard models even said bubbles couldn’t exist — markets were efficient.

Of course, the EMH suggests that we can’t predict crisis – and doesn’t say their can’t be bubbles.  Hell, the macro text book I’ve got next to me has a great deal on where bubbles pop up in models.  Personally, I’d go as far as saying that the “popping bubble” was not the main issue at stake during the GFC – it was the break down in trust and reputational capital in the finance sector combined with a slow policy response.  But I digress.

He also states:

The ultimate objective of a central bank is to stabilize the real economy, and financial and price stability both need to be seen as instruments toward this and other ultimate objectives.

This is a little loose.  The objective the central bank is to run a fiat money system without incurring undue variability in the real economy – we want the certainty and efficiency associated with fiat money and price stability, but we want to avoid ADDING to variability in real output.  My only real disagreement here is that I still believe ensuring price stability is the best way to achieve any cyclical goals from monetary policy – when he does not believe this.

But ignore this, he has some great insight, namely:

Perhaps the major failing of some of the earlier models was that, while the attempt to incorporate micro-foundations was laudable, it was important that they be the right micro-foundations.

The discipline needs to build and develop – and recognising that helps us understand that the discipline isn’t in some magical “final state” where it can provide all knowledge.  This isn’t a critique of the discipline – it is an admission that the discipline needs to keep learning and growing.  Furthemore, it shows he still believes in reductionism – which I’m glad to hear.

Nice.

Matt Nolan

Cartoon: Economists socially

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Via the always excellent SMBC.

I would say this is a close approximation to how I operate in town – I just usually forget the notepad 😉

On a more serious note, it is true that people who do economics do tend to be very analytical about social situations – that is the field we work in, that is what we do, and we are a self-selected group that does that.  It reminds me of that facetious paper that did an anthropological analysis of economists – does anyone know where that is so I can link it here?  Update:  Here, thanks Eric Crampton.