Matt Nolan

More on exchange rate targeting

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Now in the short term a look at the exchange rate is important for a monetary authority – as it is part of the “inflation targeting” framework.  This is because a stronger dollar implies a lower prices level, which may in turn influence expectations of inflation or the credibility of the central bank to maintain a level of price growth.

However, in a wider context the RBNZ has implied, and BERL has stated, that there is some role for exchange rate management.  Although I do not agree, some recent academic work has come down on their side (ht Econbrowser).

In the paper they say that an increase in home interest rates (in certain circumstances eg a future increase in productivity) can lead to “excessive consumption” at home relative to what we should experience.  Driving this is:

  1. Incomplete markets (required) and sticky export prices (not required but welfare relevant),
  2. Leading to a negative “wealth effect” on our trading partners,
  3. Leading to a suboptimal adjustment in rates (interest rates, and thereby exchange rates) overseas,
  4. Leading to the “wrong” allocation of consumption goods between countries

Although this is the case, I am not sure how relevant it is in the NZ situation.  We are a small portion of trade with our own trading partners, and so an increase in our consumption doesn’t really influence the level or price of consumption in other countries – we are a residual claimant.  As a result, the welfare loss for the “rest of the world” is virtually non-existant – there is no “negative spillover” (read negative externality from our monetary policy). Find out more on trading at https://forextrdr.com/forex-signals-uk.

In this case we are left with the fact that we are a small open economy, and we face a world interest rate.  If there are medium term allocation issues it will be the result of foreign monetary policy, not our own.  And sadly we can’t do anything about that.

Matt Nolan

Forecast of rising house prices: So what

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An Infometrics report for QBE has stated that house prices are expected to be 24% higher in three years time.  As the Rates Blog says this implies that “inflation-adjusted house prices were currently 15% above their long-term trend-line but could get toward 30% above the trend by June 2012”.

The people commenting on the blog seem incensed, but, given the balance of probabilities Infometrics found that 8%pa growth in house prices over the next three years seemed like the most sensible forecast.

There are reasons for this as I mentioned in a comment.  But I’m not going into them in detail.  Why?  These are private forecasts that a client decided to release parts of.  This discussion and knowledge is what Infometrics sells, so you would hardly expect them to completely give away their IP?  I know that Infometrics is more than willing to spend as much time as possible discussing these forecasts and risks with clients – as that is how the service works.

However, given the admission that the price level seemed high historically I think this may bear some relationship to the “imbalances” that they discussed publicly.

Obvious disclaimer:  I work at Infometrics, as I say.

Update:  Not PC makes some good points.  I agree that the indication of this sort of house price increase signals other issues – it shouldn’t be taken as “good news”.

Matt Nolan

Internalities, mechanisms, and booze

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NZIER has released an “Insight” on internalities – specifically stating that this is one way we could justify some of the costs in the BERL alcohol report as being policy relevant.  Eric Crampton discussed the release here.

What are internalities?  Internalities is the name for the cost associated with not being able to “commit” to the best set of actions over time (time inconsistency).  For example, on a Friday morning you might think about your weekend and decide it would be best if you only drank 2 beers that night.  However, once you started drinking you suddenly decided to have more – something you undoubtably regret the next day.  In this case, the inability to commit to the “optimal plan” has costs – costs that are not external but ARE policy relevant (contrary to my slogan here).

Now, both the people from BERL and NZIER that raised the internality issue are correct, and both sets of economists have far more experience and knowledge in the area of time inconsistency (I am only a macroeconomist after all).  However, there is one important point for me here – internalities matter because of commitment, and so mechanisms to aid commitment can be solutions.

Why is this so important?  Well when we look at the impact of a persons action on themselves it is often easier to develop mechanisms to solve this than in the case of “externalities” (where someones action influences an unrelated party).

In the case of alcohol there are a number of “pre-commitment mechanisms” avaliable to improve outcomes.  If we can figure out what the private cost of establishing these mechanisms is, and we see people not use these mechanisms, then we have an upper bound on the relevant “internality” associated with commitment issue!!!

So lets ask ourselves – how costly is it to commit to not drinking too much?  Some mechanisms are:

  • The instash wallet guide suggests leaving your wallet at home and only bringing in a limited amount of cash (when going to town).
  • Buying smaller portions of alcohol (when staying home).
  • Dressing badly (when going into town).
  • Committing to do something the next day which sufficiently increases the cost of drinking during the “temptation” period.

I have seen all these mechanisms in action.  They are costly, but not that costly.  As a result, my impression is that the policy relevant loss associated with the “internality” will be quite small.

Matt Nolan

More commentators on the NZ dollar

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As mentioned here earlier, the high NZ dollar is a symptom of domestic imbalances not a cause – so instead of looking at intervening in the dollar we should be trying to understand exactly what is driving structural issues in the economy.

A couple of articles that follow on in this view are:

  1. Brian Gaynor in the Herald, discussing the incentives towards property investment.
  2. Westpac on the indirectness of any link between the OCR and our structural issues.

With the Westpac piece everyone jumped on the idea that “a lower OCR doesn’t necessarily imply a lower currency”, which is true.  However, I felt the main point was more to do with the inability of monetary policy to solve structural problems in the economy – a point I agree with completely.

Matt Nolan

Fixed and floating, monetary policy, and structural imbalances

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Over at the Rates Blog Andrew Coleman has written a piece on fixed mortgage rates and the monetary policy transition mechanism.

His initial point is that the ability of the Reserve Bank to smooth economic activity has been constrained by the fact that so many New Zealander’s hand fixed rate mortgages, compared to Australia where the majority of mortgage holders were on floating rates.

While his point holds weight, given that New Zealand is a net debtor country and higher average interest rates imply that the “increase in income” associated with a fall in the OCR was smaller.

However, there are three comments I would need clarification on before deriding the effectiveness of NZ monetary easing.

Read more

Matt Nolan

Cartoon: Night classes

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An excellent cartoon from Mike Moreu:

The main thing for me is the question of “what is the social benefit”.  In part education increases the human capital of the individual, which is something that the individual should pay for, in another part education can be consumption (which the individual should pay for) and in a final part some types of education also benefit other people – which is where government subsidies come in.

I think there are many night courses we can identify as not having this social benefit – and so the government shouldn’t pay for them.  I don’t know if this is the test the government is applying, but it is the one they should be applying.

Hence, I think Mike’s comic here is spot on – when a course only has private consumption and investment value it should be the individuals choice to do it and responsibility to pay for it.