Saving and consumers: A note
There has been a lot of talk about savings and rebalancing. I’m not going to touch this stuff in much detail until the Savings Working Group releases their final report. But in any case, I do need to say a little something now.
I didn’t like the interim report from the savings group (but remain hopefully the final report will provide a more reasonable break down of events when describing any policy conclusions. And as a result was worried to hear that the government said it would be changing policy on the basis of the interim report. However, most of the changes they are discussing are more than reasonable – so that is good.
One descriptive factor I have to take issue with though is this:
People borrowed heavily to buy houses and farms, property prices soared and New Zealanders felt wealthier as a result. They spent a lot on consumer goods, which led to a bubble of economic activity.
Really? I mean, GDP tells us how much stuff we can make – apart from any loss resulting from wasted investment, and changes in relative prices, when we have a certain level of “GDP” we should be able to return to it. It is production.
And what is this “spent a lot on consumer goods” business. Let us look at a graph:
Did our spending relative to the amount we could produce seem excessive relative to the last 20 years?
Now, I recognise that the concern could be more long term – we could have been seen to be borrowing too much to consume for 20, 30, 40 years. But without an actual strong reason why this is the case, and why our creditors have allowed it to persist for so long, I find this difficult. A country CAN run persist current account deficits, a country CAN hold a large stock of debt as long as it can meet interest repayments. We can’t say that this is a problem unless we can describe specific institutional factors.
And I haven’t seen anyone do that. The interim report most definitely didn’t, although I am looking forward to the final report because I am sure it will go into more detail explaining “why” – which is something I would like to know about before commenting on any policy recommendations.
Keeping financial stability and monetary policy together
I have long stated that targets of “financial stability” and “price stability” (monetary policy) were important – but should be performed in separate, yet independent, operational terms (here and here). Namely, keep the central bank focused on monetary policy while another organisation/operational entity solely focuses on the more long term goal of financial stability.
In my view separation is important for communication – by separating the two people can tell when actions are framed towards certain goals. By having one organisation/entity trying to attempt both, you risk muddying the waters – which in turn will lead to worse outcomes.
However, this piece at VoxEU makes the opposite case:
Interestingly, empirics tells us that bank risk not only responds to a rate cut, but that it also matters how long rates are kept low (Maddaloni and Peydro forthcoming, Altunbas et al. 2010). This relates to the argument that in the years leading up to the crisis rates were kept low for too long. Our model can provide some reasoning for why this can be damaging. We make the model dynamic and add a crucial feature, maturity mismatch.
In contrast to their short-term liabilities, banks’ assets are long-term. Because of this, banks will only adjust their portfolios if they foresee that a change to their environment is of long duration. A short-rate cut will not push them to take more risk. But a long lasting cut will. A monetary authority that considers financial imbalances therefore has a different timing of policy than an authority that cares only about inflation and output gap stabilisation.
This argument is compelling, and if you have a central bank with only one tool (the cash rate) I think I would be convinced.
However, if central banks are also willing to put in place measures to try and reduce maturity mismatch, and adjust the cyclical nature of banks reserves – then I believe we have multiple instruments. In this case, the use of each individual instrument should still be directed at a specific target – to make communication clear.
Yes, these instruments are related, and the choice of a financial stability institution will influence the choice of a monetary institution. But this is already the case with fiscal and monetary policy – and yet we believe we can keep monetary policy independent.
The fact is that the balancing of expectations, and the ability to communicate policy to manage these expectations, is the key part of monetary – and even financial stability – policy. As this is the case, I continue to find it important to keep these two policy targets operationally separate.
This is an issue I find fascinating, and I’m looking forward to seeing how things develop over the next decade – and why.
Beware the tax-free threshold
Judging by the fact that the “tax-free threshold” has reappeared as a policy prescription, I can tell it is election year.
I am against tax-free thresholds. This has been discussed various times before, but the most detailed exposition of my feelings came out three years ago – during the previous election year.
If I had to summarise I would say:
- A tax-free threshold implies that, for the same level of government spending, effective marginal tax rates must be higher for anyone earning more than the threshold amount (assuming pro-rata increases) – which implies that there is likely to be a greater efficiency cost for the same level of government spending. [Think of it in this simplified way: if we don’t tax the first $5,000 of someones income, but need them to pay the same amount of tax on their income, then we need to charge a higher average amount on all their income about $5,000 – if this tax was flat, this would also imply a higher marginal rate]
- A tax-free threshold is an indirect form of redistribution – so for that level of “spending” the gains in terms of equity are more than likely to be lower than targeted spending.
- The benefit of the tax-free threshold is that it avoids “churn” in the tax system (if the tax-free threshold replaces some benefit spending). BUT, there is a countervailing cost from the greater level of progressivity – namely greater compliance costs and tax avoidance associated with another tax bracket.
In net terms, an increase in the progressivity of the tax system (an efficiency cost) combined with the fact that any redistribution will be poorly targeted (a relative equity cost for the same level of efficiency) appears (to me) to be far more important than the benefit of “reducing churn”.
A clear and transparent flat tax system that raises revenue, combined with benefit spending that targets social goals, is (in my view) the best way to ensure that our society achieves its preferred equity-efficiency trade-off at the lowest cost. A zero tax threshold moves us away from this – and so just doesn’t feel right to me.
Update: Kiwiblog (David Farrar) is also in favour of a tax-free threshold, because of the “reduction in churn”.
Again, remember that the tax-free threshold isn’t just for those who “receive benefits” – it is for all income earners. As a result, effective marginal tax rates HAVE to rise to keep revenue constant, reducing labour supply. This implies that there is a direct efficiency cost – which all parties seem keen to ignore.
Update 2: More points here. And NZIER also agrees. Clean sweep of economists are against, yet both people on the left and the right are for it – fascinating … I am going to have to post more on the issue I suspect.
“Irrationality” is not a sufficient condition for intervention
One thing that irritates the hell out of me is the fact that many people believe the slightest sign of cognitive limitations implies that we should have government intervention.
Hell I’m centrist, I see myself as left-leaning in somethings and right-leaning in others. But this attitude leads to ridiculous, poorly thought out, interventions.
Several things we need to think about before intervening are.
- What is the problem? Compared to what other practical outcome?
- We have to say “why the problem is occurring” this occurs before we can figure out policy,
- We have to figure out if government can practically implement a scheme, given their own cognitive and institutional constraints,
- We need to ask if the implied problems are observable,
- We need to figure out what the consequences of such a policy are – how do people respond over time.
The most common area where this occurs is in the realm of saving. More people than I care to count have told me that people are irrational, so save too little, so some form of compulsion in savings makes sense. Some of the most intelligent, articulate, and thoughtful people I know have been known to occasionally move into this school of though. However, lets see what needs to be ticked off for this to make any sense:
- We need to figure out why people are saving too little relative to how much they do save.
- We need to make a moral judgment regarding the impact on themselves (if they save too little and end up poor it is really their own problem – why do we need to intervene?)
- If we don’t have that, we need to figure out how it impacts on “other people” – and likely make a value judgment for why this is suboptimal.
- We need to figure out how well government can observe this issue.
- We need to make a policy based on this observability, how well we can target “problem savers”, and the cost of implementation.
- We need to look at the long-run implication of the choice – for example, if we make people “save” they could likely borrow on the basis of this asset … leading to no change in net savings rates.
- We need to look at the distributional and efficiency impact of this policy, and the error bands around it – given uncertainty there would need to be a significant net positive impact for intervention.
I genuinely believe that people understate the intelligence of other people in society – there is no other explanation for how often I am told “people are stupid we need to make them save”. It may surprise many people to find out that other people in society do think, and do make choices. Attacking a “straw man” version of people and mentioning “irrationality” does not justify regulation.
Often I will say “it doesn’t matter if people are irrational, how is that a justification for compulsory savings” – too which people tell me I don’t understand. I guess the failure to actually provide a logical argument does make it hard for me to understand 😉
Reactions to economists and the protestant work ethic
Economists like to discuss issues with trade-offs. Specifically, if there is a goal in mind economists LOVE to discuss how to reach that goal at the lowest cost.
For some reason, I find many non-economists out there don’t share this enthusiasm, at least implicitly. Just look at what happened when SuperFreakonomics discussed the idea of geoengineering as a solution for global warming. There were two sets of criticisms:
- They misinterpreted facts, which lead to a misleading trade-off.
- They were willing to accept the fact that we’ve made too much carbon and we need to make sacrifices to deal with it!
The first such view is fair, the second just doesn’t make sense to me.
People criticism economics for “ignoring morality”, but to be fair the idea that we should try to achieve outcomes at the lowest cost (which is a value laden, and thereby moral, judgment) is significantly better than the abject moralising that works off the basis that we need to pay proportionally for past benefits.
In a similar vein, with the recent economic crisis there was a push to say “we are now paying for previous extravagance”. This didn’t make sense to me, as we weren’t discussing a transfer between those who spent too little and those who spent to much – we were discussing a situation where the economy was producing far less then it could potentially produce.
Now why do I compare this to the protestant work ethic? Well the protestant work ethic implies that predetermination. Bad things happening are a signal of us “paying for past sins” and so should just be accepted. Instead of trying to understand trade-offs, and make the best choices, this type of attitude leads to fatalistic acceptance of poor outcomes.
Ultimately, I do believe it is valid to state that economists miss a moral dimension when they turn around and make policy conclusions – however, many of those that criticise economists are making even steeper, and in many ways logically incoherent, moral judgments when they talk about us “paying for past exuberance”.