Matt Nolan

NZIER comes out in favour of wage subsidies

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Well sort of. They didn’t call them that, but reducing “payroll taxes” is equivalent to subsidising wages.

We have discussed this concept before, and decided that in a specific situation it could make some sense as a temporary measure.

Note that this relies on stick wages: Otherwise the result of a payroll tax cut and a personal tax cut would be the same. As a result, they must have slid sticky wages in there, while keeping goods prices flexible. Would definitely be interested in more details.

I would also note that the report assumes that the tax cut is a straight transfer. However, by lowering marginal tax rates (especially on high productivity stuff) it should help boost the supply side of the economy.  Furthermore, they assume that taxes will increase in the future – not that real spending will fall.

They are right that there is no free lunch from a stimulus program.  But the size of the trade-off depends strongly on the assumptions.  The assumption that the tax cut is a flat transfer and is only temporary isn’t exactly going to give a very favourable view of this trade-off 😉

Matt Nolan

Consistency in tax talk

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When reading a post on public address I came across this gem from NZI.

the next two tranches of the proposed income tax cuts should be cancelled on the grounds that they would contribute to the structural deficit, are unlikely to do much for growth, and do not support the most vulnerable households

Ok, so they are saying that the tax cuts will both significantly increase the deficit, not lead to growth, and won’t help poor households.  Now:

Very few of the benefits of these proposed tax cuts flow to the most vulnerable families during the recession: most of the benefits accrue to upper-income households

Right, so that covers off the third point.  And:

Nor are these tax cuts especially well-designed for growth creation, with the top marginal income tax rates left virtually unchanged

And that covers off the second point.

Now, when I look at this, it doesn’t make sense to me and I can’t see all three things to hold with the tax package.

The future take cuts are only for high income earners so don’t have a direct benefit for the poor (debatable given that out credit markets are still functioning and labour types are complements, but I’ll give them that for fun).

The future tax cuts DO involve cutting the top marginal tax rate, so if they do believe marginal tax rates are important for growth this is a bit funky.  This sounds like they are presuming that the cut is TOO SMALL.

They then say that the cost is substantial – but if the cost is too much the cut in the top MTR must be TOO BIG.

When the tax package involves cutting tax rates, it is pretty much impossible to say it fails in all three ways.  It is like the impossible trinity.

Either the package is too expensive for the return or the structure is wrong (either on equality or efficiency grounds).  A tax cut CAN’T fail (in the same direction) on all three grounds.

Matt Nolan

Taylor rule quote of the day

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We have all heard a lot about how the Taylor rule suggests the US needs a -5% cash rate, which is why this quote in a Bloomberg article was not surprising:

The rule might suggest the need by the end of 2009 of a funds rate of minus 7.5 percent, Laurence Meyer, vice chairman of Macroeconomic Advisers, said in a note to clients in March.

Another quote in the article, from John Taylor himself, was far more interesting:

He said his rule suggests a fed funds rate of 0.5 percent, while the central bank has cut rates to between zero percent and 0.25 percent.

What the hell?  So the guy that invented the rule is estimating a completely different appropriate target rate.  Now John Taylor is a clued on guy, so this definitely has led me to revise down my view of how much monetary stimulus the US will need.

My suspicion is that his view of potential output is well below the view of some other economists.  It is a possibility that we have also raised.

Will Taylor

Portugal: Lessons on Drugs and Statisitics

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The Liberal Conspiracy has interesting article on the drug decriminalisation in Portugal. Two highlights for me.

The opening paragraph:

The right predicted Bad Things: Drug use would explode, tourists would travel from far and wide to get high on the streets of Lisbon, law and order would collapse, and people would start riding around in modified cars and fighting in Thunderdomes

This just made me laugh:)

Now what made me cringe was the stats from a Cato paper looking at Portugal:

Prevalence rates for the 15–24 age group have increased only very slightly, whereas the rates for the critical 15–19 age group—critical because such a substantial number of young citizens begin drug usage during these years—have actually decreased in absolute terms since decriminalization along with increase in the establishment of residential drug rehab in CA so that the drug users can be treated before they get addicted too much.

Perhaps most strikingly, while prevalence rates for the period from 1999 to 2005, for the 16–18 age group, increased somewhat for cannabis (9.4 to 15.1 percent) and for drugs generally (12.3 to 17.7 percent), the prevalence rate decreased during that same period for heroin (2.5 to 1.8 percent), the substance that Portuguese drug officials believed was far and away the most socially destructive.

If you feel confused after reading that paragraph don’t worry. The Liberal Conspiracy’s description of this passage hit the  spot for me:

What the above basically demonstrates is that if you cherry-pick the right start years and end years for an age-group, you can get almost any result you want

Lies, damned lies and statistics….

Matt Nolan

Why we have to be careful equating CPI growth to inflation

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We have previously mentioned how important it is to interpret CPI growth carefully. Inflation is the trend rate of growth in the “general price level”, and as a result there are other factors that get caught up in our attempts to measure inflation.

James Hamilton at Econbrowser pointed to a paper by Reis and Watson which points out just how essential this difference is in a “low inflation environment”. The money quote from the abstract for me:

We find that pure inflation accounts for 15-20% of the variability in inflation while our aggregate relative-price index accounts most of the rest.

The pure inflation mentioned above is the fundamental increase in the general price level we often complain about as economists. “Inflation” in this paper is growth in the private consumption expenditure deflator (which is similar to the CPI – except that the bundle of goods is not fixed).

Now we don’t want to try and prevent relative price shifts – as that is the whole purpose of the price signal. So understanding this distinction is important. Very interesting.

Update: I don’t think I was clear enough on where I think the value is here. The paper seems to indicate to me that movements in the CPI and PCE deflator are relatively poor indicators of the magnitude of any change in inflation. This is a very good point, and I love it that this paper was able to mince the data up and show this.

Update 2:  Paul Walker blogs on a pre-release of the paper here.  Paul concludes:

They found that once they controlled for relative price changes, the correlation between (pure) inflation and real activity is essentially zero

That is true.  But let us be clear here, this implies that there is no money illusion (which economists currently assume), and so all quantity issues stem from nominal rigidities in prices (which we have discussed).   As a result, even pure inflation is still costly, as nominal rigidities exist causing a mis-allocation of resources (since relative prices get messed up).

Another interesting conclusion in the paper is that the rigidities in the labour market aren’t as strong as we would expect.  If this is shown to be the case over time it would change my implicit view of the economy.  Man I wish I could do a study like this for the NZ economy 🙂

Matt Nolan

Inverted commas don’t look good on economists …

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I don’t like to do this, but I’m getting a bit sick of bank commentary following the HLFS release.  This is specifically from ANZ’s weekly report this morning:

While employment tumbled 1.1 percent in Q1, the unemployment rate “only” rose to 5.0
percent as a number of workers leaving the labour force limited its rise

Three things:

  1. The participation rate fell after SPIKING LAST QUARTER.  It is still up on a year earlier.  The employment and PR series are notoriously volatile while unemployment is a fairly stable and reliable indicator – hence it is bull to say that this data is telling us that unemployment only didn’t rise further because people are leaving the labour market.  If it was fine for you guys to dismiss the lift in the PR in December (when anyone could have said unemployment only went up because participation rose) you should dismiss the fall now – you can’t cut it both ways.
  2. Stop using inverted comma’s when the data doesn’t suit your story.  The fact is that this unemployment rate was a hell of a lot better than any of us economists were expecting.  We should accept that, and try to understand it – instead of belting it with a stick until it fits our specific stories.
  3. Also, 5% is an only – there is no need for inverted commas.  5% is about New Zealand’s neutral rate – the level of unemployment we expect over the medium term.  After 15 months of recession I would expect unemployment to be higher than that – as a result this is a significant positive for the country.