Matt Nolan

The currency market – small menu costs matter

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Immediately following the release of the overseas merchandise trade data today the dollar slumped by about 20 basis points, however it didn’t stay down for long, more than recovering from this low point:

Source NBNZ

You might wonder why this fall and rise is even interesting – but the reasons behind it imply that issues such as “menu costs” can be important.  Why?  Well the headline number of today’s result provided a bad headline (monthly trade deficit biggest in 26 years!), but for a small time investment (reading the Statistics New Zealand news release) it would become obvious that the headline number was deceiving and in fact today’s result was relatively positive (as a significant proportion of the additional import activity was the result of one-off capital imports for further oil production).

The menu cost mattered in this case as the opportunity cost associated with time it would require to read the release was high – if a bad headline comes out it is in the dealers interest to react before everyone else!  As a result, a situation like this truly does have a substantial menu cost (which results from the first-mover advantage implicit in the situation) even though, on the face of it, it would initially seem difficult to view spending a minute reading a free release as a significant cost!

Why does all this matter.  Well menu costs can be the basis of price rigidity (although I doubt this in the case of currency trading) and also can be the basis of what we may view as “irrational” behaviour in the marketplace.  If small information asymmetries can have such a large impact on the behaviour of agents, and the equilibrium price, it dilutes the power of the price as an efficient signal to allocate resources.  This does not mean we should give up on prices – it merely shows us the importance of the provision of information in the economy.

Matt Nolan

Kiwisaver and aggregate savings: A question for our readers

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Over at the NBR comment page Trinh Le from NZIER discusses the research by John Gibson and herself into Kiwisaver and aggregate savings (here and research).

The idea that Kiwisaver can actually reduce national savings is an important one – and something that one of us will post on soon, either before or during our upcoming discussion on productivity.

For now it would be useful for you guys to have a look at this article and tell us what you think. Do you think Kiwisaver will actually increase national savings – if so (or not) why?

Matt Nolan

New Zealand Budget 2008: Tax cut calculator 2

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In a previous post we mentioned the Infometrics and Labour tax cut calculator.

Now NZIER have updated their tax cut calculator that compares Australia and New Zealand – the excel model can be found on their front page (or here in the future):

http://www.nzier.co.nz/

I also talked to Dr Nolan about the set of tax calculators that have been released and he asked me to remind everyone that the October 2008 cuts will only give you half of the total shown in the calculators – as they are in per annum terms but October-April is only six months long. So someone on 60,000 will get a $430 tax cut this financial year, and then a $860 cut over the 2009/10 financial year.

Furthermore, the level of wage growth assumed by the Labour and NZIER calculators both assume wage growth of about 3%pa – marginally slower than the current rate.

Update: David Farrar at Kiwiblog also mentions a Deloitte Tax Cut Calculator that was sent to him. I don’t know if excel has ever been this popular 🙂

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Matt Nolan

Tax cuts and interest rates

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Given my belief that these tax cuts, without corresponding cuts in (unproductive types of) government spending, will lead to greater inflationary outcomes I’ve decided it is important to argue the complete opposite case – namely that tax cuts will not impact on inflationary pressures and interest rates.

The common view I work off when stating that tax cuts increase inflationary pressure is that tax cuts increase “aggregate demand“, which in turn will lead upward pressure on prices, and therefore an upward shift in interest rates.

However, there is another popular view that has been raised by Stephen Kirchner of Institutional Economics. Specifically this view states that tax cuts have supply side effects on the economy (which increases the supply of goods in the economy and so reduce inflationary pressures) and some degree of Ricardian equivalence holds – such that any increase in budget surpluses will lead to borrowing from the private sector, as they expect tax cuts later. He makes these arguments here and here (I made a similar argument here).

Furthermore, tax cuts may reduce wage pressures – thereby leading to lower inflation. How? Say that the nominal wage is fixed and there are tax cuts – it this case the whole tax cut immediately goes to the employee. However, unless the employee has significant market power, the employer will be able to extract some of the surplus gained from tax cuts over time, by offering smaller wage increases.

Given these supply side arguments why am I still concerned about inflation?

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Matt Nolan

New Zealand Budget 2008: Tax cut calculator

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Chris Worthington at Infometrics Ltd just created a tax cut calculator, it can be found here:

http://www.infometrics.co.nz/taxcutcalculator.asp

Enter your personal income and see what the Budget will do to it in October 2008, April 2010, and April 2011 (as there is no tax cut in April 2009 – likely a result of inflation concerns). This calculator does not include any of the working for families business.

Update: A new tax calculator including working for families was released by Labour, it can be found here: (h.t. the Standard)

http://www.labour.org.nz/calculator/index.htm

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Matt Nolan

Should the government reward effort?

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Recent posts by two of the most prominent New Zealand left wing blogs (the Standard and New Z Blog) lament the fact that the wage people are paid does not necessarily relate to the effort they put into their work. As a policy solution to this inequitable result of the free market both blogs suggest that the government provides tax cuts that give the poor more.

However, no matter how sympathetic I am to the idea that effort and reward aren’t correlated in a way that most people would view as “fair”, I don’t think that adding further progressivity to the tax scale is the appropriate mechanism with which to achieve this social goal.  Furthermore, I don’t think the trade-off between production in society and the achievement of our “equity” goals is appropriately mentioned in these posts.
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