Matt Nolan

Dom Post article: Defending the Bank

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Did an article on why we should leave the Reserve Bank Act alone in the Dom this week.  Given I’m too lazy to put up new material this morning I will just link to it (on Rates Blog, on the Infometrics site).

Money quote:

Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy.  Although pretending to solve an issue may be beneficial for politicians, it is not the best way to run New Zealand economic policy.

Update:  A bit of pointless filler – again because I’m not up to writing anything fresh today 😉

Matt Nolan

Points on optimal taxation

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There has been a lot of talk about tax (eg here).

When thinking about tax systems it is useful to run the following train of thought for optimal design:

  1. Start with a target level of government spending.  Goal is to raise this revenue at the lowest cost to society.
  2. First start with taxes which improve the allocation of resources by correcting a market failure (externality taxes).
  3. Then design a nice flat tax (either on all income or consumption) which treats everything equally.
  4. Then shift relative taxes in broad areas based on the long-run elasticity of supply and demand, and constrained by the potential for tax avoidance (Ramsey principle).

Once this initial tax system has been designed, and government spending has been sorted we face a clear “equality-efficiency” trade-off.

In a final step we then adjust the progressivity of the tax system, or the type of government welfare spending, in order to achieve the type of trade-off between these factors that society desires.

Now this doesn’t tell us what the scheme should be, but it allows us to directly look at the trade-offs we are making and make a clear decision.  If the goal is to make fiscal policy that represent the preferences of society at the lowest cost this is the way we need to think about it – instead of saying “more growth”, “more redistribution”, “more tax on land/capital/houses/consumption” etc etc without thinking about it in general terms.

Furthermore, even when we come up with a scheme based on this train of thought we only get told what would be optimal “in the long run”.  The required transition path for the tax system from now until then is still far from clear.

Matt Nolan

What happened to the term monetarism?

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Given the sudden rapid attack on New Zealand monetary policy from various segments I’ve begun to notice a few more things crawling around in political language that confuse me.

For example, the term monetarist.  In a discussion with my sister and on this post from the DimPost the term “monetarist” was used to describe a relatively right wing outlook about political issues and policy in general.  However, this confuses me.  My impression was that monetarists at their most narrow are people that believe money supply growth = inflation completely.  While more generally a monetarist is someone that believes money supply growth is in some way related to higher long run inflation.

In this sense, even some of the most left-wing economists have a touch of monetarist in them.  Monetarism is a set of beliefs about how changes in the money supply influence inflation – not a set of beliefs regarding the appropriateness of “economic freedom” or “government intervention”.

When replying to my sister I said:

Monetarism is simply people saying, if we print a whole bunch of money it will end up increasing prices. Evidence and logic add some credence to this view, and so even very left wing economists are in some sense monetarists.

However, an early monetarist was Friedman. He also wrote heaps on “economic freedom”, which is viewed as quite right wing a lot of the time. As a result, people have said Friedman=monetarist and have associated that word with political views that have nothing to do with it.

I think what they mean is “capitalism based on the idea that individual freedom almost always leads to the best outcomes for society” instead of “capitalism based on monetarist theory” – as the second statement doesn’t actually make any sense to me.

Update:  Paul Walker blogs Milton Friedman’s own views on what monetarism is.

Matt Nolan

Tax links, Rates Blog and Offsetting Behaviour

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The Rates Blog is doing this cool thing where they have written segments on different tax policies.  They have:

They are good pieces for sure, go have a look.  We promise to write something on tax in the next week or two, although I can’t vouch to live up to the high standards these guys have set.

Also have a look at Eric Crampton’s post on spending and tax.  The tax discussion is about trying to figure out how to set up the tax system to get revenue at the lowest economic cost.  There is also a separate, but important, discussion that we need to have on the optimal level of government spending – as these taxes we use to spend on government projects do have very real costs, both in terms of taking money out of peoples pockets AND the loss of efficiency associated with this taxation (deadweight loss).

Matt Nolan

On the fixed exchange rate

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It appears that the idea of a fixed exchange rate has been risen, again.

Now the suggestion in here does take into account the impossible trinity – so it is theoretically possible.  We have:

  1. Monetary policy can impact on output and inflation,
  2. The exchange rate is fixed,
  3. Capital flows ARE LIMITED

That third one is the kicker.  Two issues I have here are:

  1. Limited capital flows implies that interest rates will rise (as for the previous interest rate there is a shortage of capital relative to demand).  This implies that our functioning monetary policy that controls inflation must have higher interest rates and lower output.
  2. Limiting capital flows is pretty difficult for a small open economy like New Zealand.

On the balance of evidence and theory I would say that I strongly disagree with this proposal.

Update:  BK Drinkwater comments here.  He rightly points out that a less volatile currency isn’t obviously a good thing – it is the movement in export prices and whether they represent actual changes in relative prices that matters.

Matt Nolan

Guaranteed minimum income. Where did it come from

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So I see Gareth Morgan is suggesting a set minimum income level and a flat tax rate.  Very nice, I can see merits in some of the set up for sure given my personal value judgments.

Some on the left will think this is right wing (where is the progressivity!),

Some on the right will think its left wing (we are giving benefits to everyone!),

Others will like it (it lowers effective marginal tax rates and ensures that everyone can live),

Others will hate it (churn in the tax system, don’t need to work to live, its tax, it involves government, the rich will pay less)

So where did this come from?

Hint *.  Guess who else suggested it in the 80s.

Tell me, does this change the way you view these two people as well?  Or does knowing that these people came up with the idea change how you view the idea.  If that is the case, why?

Update:  The Standard supports, DimPost does not.