Hi,

My apologises, I did not mean to sound disparaging. I am happy to continue discussing it hear – but it might be best if we start over with a specific question.

To start with you could add to the discussion on monetary policy change at this post:

http://tvhe.wordpress.com/2008/07/03/re-thinking-interest-rate-policy-asking-for-submissions/

Then once you have stated your ideas on monetary policy we can discuss a specific component here. This post was initially only about why inflation expectations were a better measure than the Economist magazine was suggesting – it wasn’t on the specifics of why or if we should target inflation.

I’m at a disadvantage here, not being a trained economist, because an argument that appears to be on topic to me, is not to you.

Would you be willing to take it further in email form, because I’m not arguing merely to be a contrarian or to annoy you, but my economic “philosophy” is rather unorthox and I would like the oppurtunity to have my arguments tested so as I can perhaps reevaluate and develop it further in response to constructive criticism.

It doesn’t quite fit within not a Marxism, Austrian School, neoclassicalism, monetarism, heterodox nor classical economics.

I guess the main distinction between mine and those “schools” is our different political economy, rather than mere economic theory. The claim that economics is completely neutral and valuefree is at best self-deceiving and at worst duplictious.

No, there economy is not slowing because of there current account deficit.

“Sorry you’re incorrect. They do control the price of money and its private banks who are primarily responsible for its growth, but they also determine what banks can use as capital and what their capital reserve requirements are.”

To influence the growth in the stock of money we have to look at what instruments they change – they don’t change the capital reserve requirements as a monetary tool, so they aren’t using it to control the money supply.

The thing to remember is that money demand acts as a constraint on the Bank’s choice – it can’t violate money demand a set random levels of the quantity of money and the price of money – it has to set a price and quantity that satisfies money demand.

“Of course it is. Productivity is determined by whether or not firms want to invest in capital and monetary policy does have a bearing on that, because if borrowing costs are high, firms have to take into account whether it may affect the diminishing returns on the investment in capital.”

Long run monetary conditions matter for that insofar as firms have certainty surrounding their investment, and that the cost of capital is not too high. That is why the key to monetary policy is price stability – so that firms have confidence to invest as they know that price signals will help to promote the efficient allocation of resources. Blaming the RBNZ or inflation targeting for the high cost of capital is dis-ingenious, the Bank doesn’t set long-term interest rates (which will effect investment intentions), they are determined by the underlying preferences in the economy.

“I’m not just talking about merely appliances. EVERYTHING is going to become more expensive, because with the shift in focus China will be able to sustain higher prices for resources than we could, because of their massie trade surplus and foreign currency reserves that they’ve accumulated in the past 15 years or so.”

So you are saying that China will start spending its savings – which will in turn increase the price of goods that we all purchase. This isn’t an inflationary problem in the way I’d view it – this is a structural shift to the economy, we can’t do anything about that.

Also if China is willing to spend more of its endowment of resources, couldn’t that be beneficial for a country like NZ. After all, they will be buying our products with that money and China is a closer export destination than the US or Europe – which would reduce transportation costs.

“Well thats not true. Ideally it would merely be unit of account, but in the current system it is also a store of value, which is a big problem.”

Money is a store of value insofar as it buys products in the future – thats it. That is not a problem, at all.

“Its not just the price that makes resources being allocated ineffciently, a greater cause is inaccurate perception of returns.”

I also dislike asymmetric information which leads to sub-optimal trading. However, wouldn’t the best response to this be to promote education and information revelation? All this means is that there are other market imperfections that need to be fixed – it doesn’t reduce the relevance of the inflation problem.

Ok, we just seem to be arguing relatively weakly related points, I’m not quite sure what we are trying to achieve 🙂 . As a result, I would suggest that instead you make a comment on what you think should be done to monetary policy on the following post:

http://tvhe.wordpress.com/2008/07/03/re-thinking-interest-rate-policy-asking-for-submissions/

🙂

“From the perspective of the purchaser’s point of view, thats true, but aren’t you saying that the Reserve Bank should control wage demands?”

“We do have a debt with the world at the moment and as a result I do think that future consumption growth will be lower than income growth. But I don’t see that leading to a collapse in our economy.”

Isn’t that exactly whats happening in the United States? The main difference appears to be that our government until recently had a fiscal surplus, rather than the massive deficit that theirs does and their currency has the unique position as the world’s reserve currency, so it doesn’t face the dramatic declines in value that other countries would face, should their economic fundamentals be as bad as the current state of the U.S. economy. Well apart from the fact that they haven’t gutted their industrial productive capacity quite to the extent that we have.

“That is why I said labour shortages and not skill shortages – we have a shortage of unskilled, multipurpose type labour at the moment.”

Really? Thats news to mean. What industries?

“Ok, why does everyone use the word “monetary expansion” all the time when they don’t understand monetary policy.”

But I do.

The Reserve Bank controls only the price of money – the growth in the money stock depends on demand and supply factors and so is not as clear an instrument.”

Sorry you’re incorrect. They do control the price of money and its private banks who are primarily responsible for its growth, but they also determine what banks can use as capital and what their capital reserve requirements are.

“In 1988, G10 countries reached a consensus on minimum capital standards for internationally active banks. The Accord can be summarised in a couple of pages. In essence, it states that for every $100 of loans, a bank should have at least $8 of capital, of which at least $4 must be permanent equity. Because loans secured over residential property were seen to be less risky than other loans, they only had to have 50% as much capital. Loans to banks from OECD countries were seen to be less risky still, so they only had to have 20% as much capital, and loans to governments denominated in their local currency 0%. There were several other categories and treatment for off-balance-sheet exposures.”

“Furthermore, workers standard of living depends on the real wage they can get, which depends on productivity not flipping monetary policy. Bad monetary policy can hurt workers a bit now, but eventually they will just lift there wage demands to match it.”

Of course it is. Productivity is determined by whether or not firms want to invest in capital and monetary policy does have a bearing on that, because if borrowing costs are high, firms have to take into account whether it may affect the diminishing returns on the investment in capital.

It may be just cheaper to maintain the lower productivity of workers and workers may compromise on their wage demands in the interest of employment security.

“I understand that higher appliance prices will lead to lower real incomes for New Zealanders – but there is nothing the Reserve Bank can actually do about that. Its called a negative terms of trade shock, and simply implies that in relative terms we are poorer than we were before.”

I’m not just talking about merely appliances. EVERYTHING is going to become more expensive, because with the shift in focus China will be able to sustain higher prices for resources than we could, because of their massie trade surplus and foreign currency reserves that they’ve accumulated in the past 15 years or so.

“Money is the oil that helps transactions work – it has no value in of itself.”
Well thats not true. Ideally it would merely be unit of account, but in the current system it is also a store of value, which is a big problem.

“I did talk about “fixed prices” – prices that are costly to change. An inflationary environment either forces people to find ways to constantly change and evaluate their prices or leads to a mess up in the allocation of resources.”

Its not just the price that makes resources being allocated ineffciently, a greater cause is inaccurate perception of returns. Take the real estate market or investmet in finance companies here for example. To compound the problem that credit was to cheap and too easily available, people had an inflated perception of potential returns. Prices have little influence if the perception of returns is higher than the costs.

Why I believe that we’re so doomed is, because the instruments that are at the disposal of regulatory authorities are inadequate and people’s decision making abilities are so distorted.

Or that they are smoothing consumption over time, given that income is not constant.

We do have a debt with the world at the moment and as a result I do think that future consumption growth will be lower than income growth. But I don’t see that leading to a collapse in our economy.

“Well thats hard to predict, because some firms will realise that they’ve overallocated productive capacity and will have to trim workers.
Those firms which have staff shortages may not necessarily be able to absorb the unemployed, because they may not have the necessary skills or expertise that are required.”

That is why I said labour shortages and not skill shortages – we have a shortage of unskilled, multipurpose type labour at the moment.

Also note, I am not saying that unemployment will not rise, I’m just saying that it is inconceivable that we will shift from intense “labour” shortages, to an extreme excess of labour.

“Oh dear if thats orthodox economic theory we are sooo doomed. If all prices continue their upward trend as I’m expecting and the Reserve Bank won’t allow monetary expansion, then where does that leave workers? Their standard of living being further eroded? … It seems its ok for the Reserve Bank to allow monetary expansion when property and asset speculators derive benefit from it”

Ok, why does everyone use the word “monetary expansion” all the time when they don’t understand monetary policy. The Reserve Bank controls only the price of money – the growth in the money stock depends on demand and supply factors and so is not as clear an instrument.

They did lift the interest rate in the face of higher house price etc, this is sort of equivalent to a “monetary contraction” (would be the same if money demand didn’t grow) – so don’t pull that rubbish about the Bank serving capitalists and not workers.

Furthermore, workers standard of living depends on the real wage they can get, which depends on productivity not flipping monetary policy. Bad monetary policy can hurt workers a bit now, but eventually they will just lift there wage demands to match it.

Money is the oil that helps transactions work – it has no value in of itself.

I understand that higher appliance prices will lead to lower real incomes for New Zealanders – but there is nothing the Reserve Bank can actually do about that. Its called a negative terms of trade shock, and simply implies that in relative terms we are poorer than we were before.

“Oh you say that otherwise people on fixed incomes will be hurt by inflation, but why can’t pensions etc, be indexed to inflation?”

I didn’t say anything about fixed incomes – pensioners are indexed to inflation.

I did talk about “fixed prices” – prices that are costly to change. An inflationary environment either forces people to find ways to constantly change and evaluate their prices or leads to a mess up in the allocation of resources.

The purpose of a price is to give the value of a product relative to other products – if we have lots of inflation these price signals get minced up, and resources are not allocated efficiently. This is the cost that screws society from inflation – but since we can’t directly touch it or see it we don’t even realise how much of a pain it is. That is why economists hate inflation so much – and thats why we think its important to deal with it.

I wasn’t saying that consumption was at record levels, but I questioned whether people were sustaining the consumption level through relatively cheap credit, its still cheaper than it was in the 1980s and 1990s, during the last recessions.

“As a result, if people are borrowing now, they must expect to have savings in the future-seems fair enough when we are in the midst of a huge increase in export prices and asset prices are so high.”

I think thats a questionable assumption, because the people who use credit cards are indicating that they value consumption more today than in the future. Whether they have savings on not isn’t necessarily relevant for a lot of people. So the likely outcome for many is that in order to pay for their consumption today, they’ll have to cut discretionary spending tomorrow.

“Well we will get some unemployment, but when its hard to believe that we can move from a state of persistent labour shortages to a state of excess labour so quickly – if firms were genuinely short of labour they won’t go throwing it out the window.”

Well thats hard to predict, because some firms will realise that they’ve overallocated productive capacity and will have to trim workers.
Those firms which have staff shortages may not necessarily be able to absorb the unemployed, because they may not have the necessary skills or expertise that are required.

“As a result, if China starts to send over more expensive appliances that is a relative price shift. It only leads to inflation insofar as it increases the claims of other people in the economy towards money (money demand) which drives the general price level up.”

Oh dear if thats orthodox economic theory we are sooo doomed. If all prices continue their upward trend as I’m expecting and the Reserve Bank won’t allow monetary expansion, then where does that leave workers? Their standard of living being further eroded?

It seems its ok for the Reserve Bank to allow monetary expansion when property and asset speculators derive benefit from it, but if workers want to maintain their standard of living, its not? Their discretionary spending and therefore consumption cut.

Oh you say that otherwise people on fixed incomes will be hurt by inflation, but why can’t pensions etc, be indexed to inflation?

No – I’m just stating that the relevance of appliances is taken into account of in the weighting already, so any impact it has had on the CPI is the amount that it would have affected the “average worker”.

“Do you think access easy credit (credit cards) is keeping consumption and therefore business going despite energy inputs being at record levels, and whilst we’re suffering deflation in the housing markets?”

Firstly, consumption isn’t at record levels (in terms of growth per capita) – in fact total consumption fell 0.4% in March and is likely to fall again in June.

Also It takes two to tango – if there is going to be any consumption there also needs to be demand for it. All easy credit means is that credit is cheap, and agents that are liquidity constrained can get hold of it (mainly the second one in NZ at the moment, as credit is still quite expensive).

As a result, if people are borrowing now, they must expect to have savings in the future – seems fair enough when we are in the midst of a huge increase in export prices and asset prices are so high. However, the question is if asset prices fall sharply people will cut back spending we should get unemployment right?

Well we will get some unemployment, but when its hard to believe that we can move from a state of persistent labour shortages to a state of excess labour so quickly – if firms were genuinely short of labour they won’t go throwing it out the window.

“I can’t make sense of what you’re saying.”

Sorry about that. When we talk about inflation we are talking about an increase in the general price level. When a specific product becomes more expensive this is a “relative price movement” – which tells us that this product is now worth more than it was before (relative to other products). Relative prices are supposed to move around, that is why we have prices – so when petrol or appliance prices change this is not a change to inflation, immediately.

However, if people mis-read these relative price movements as inflation, and increase other prices as a response, then we end up with actual inflation – it is this second round effect that we care about.

As a result, if China starts to send over more expensive appliances that is a relative price shift. It only leads to inflation insofar as it increases the claims of other people in the economy towards money (money demand) which drives the general price level up. If the economy is weak this can’t happen, and as a result this “tradable result” is an illusion and the RBNZ will look past it.

“Do you think we’ll suffer the same fate?”

Yes, to a degree. Unless it turns out that China still has a bunch of productivity improvements up it’s sleeve – which is possible. However, I would say that it is more likely China will be contributing to inflationary pressures over the next decade than detracting from them – we will see.

Do you not question StatsNZ weighting then?

“as I realise that goods that are traded more often probably have more of an impact on inflation expectations than inflation, which is why I was more concerned by them.”

Sorry, didn’t read that and I guess my comment was a bit of a knee jerk reaction against the general assumptions of economics orthodoxy, rather than the considered response to your actual post, as it should have been.

“If this is the case then we probably don’t have the true “inflation threat” that we are worried about. However, I’m not sure this is true – even in a recessionary environment firms are complaining about a shortage of labour! Has job security really gone out the window?”

Do you think access easy credit (credit cards) is keeping consumption and therefore business going despite energy inputs being at record levels, and whilst we’re suffering deflation in the housing markets? I guess thats probably the main distinction between the modern economy. Perhaps easy credit plays a similar role that government stimulus and investment played in the 1970s and early 1980s?

Two things. First, if this is the case then that is sad for the world – but it only translates into true inflationary pressures insofar as it increases the general price level, not the relative price of appliances.

I can’t make sense of what you’re saying. I’m not a trained economist so I don’t understand the distinction. Could you clarify?

“Secondly, if the industries are so inefficient but technology is avaliable, could it not be the case that these cost pressures lead to a greater integration of technology and lower prices – especially given that investment accounts for 12% of their GDP! I would be more concerned if Chinese firms were efficient and then suffered from the same sized costs shocks.”

Yes, China are undergoing an investment boom, but their experience is not much better than ours, though the focus is on the stock markt rather than real estate, which is the case here. People even borrow on credit cards to “invest” in the sharemarket there.

Not to mention the fact that they’re undergoing a massive restructuring process where the government has changed its focus. They focusing on fostering internal consumption over exports now, which combined with a increasing resource and labour costs and an appreciating currency isn’t good for the West.

“Beijing now wants cleaner industries that produce higher-quality items for the local market, from cars and planes to biotech products and software.”
http://www.businessweek.com/magazine/content/08_14/b4078078846220.htm

I’ve heard that US companies have taken advantage of this shift to increase their domestic prices, because they no longer face such savage competition from foreign enterprises.

Do you think we’ll suffer the same fate?

As relevant as its weighting in the CPI I’m sure.

Furthermore, I did say that “I would be more concerned about how me measure inflation than in how consumers mis-interpret it” – as I realise that goods that are traded more often probably have more of an impact on inflation expectations than inflation, which is why I was more concerned by them.

“Its unlikely that wage demands in New Zealand will have much effect on inflation, because by now most workers now realise just how insecure their jobs are at a time like this.”

If this is the case then we probably don’t have the true “inflation threat” that we are worried about. However, I’m not sure this is true – even in a recessionary environment firms are complaining about a shortage of labour! Has job security really gone out the window?

“By all accounts thats not likely to last, because China is feeling the effects of high material prices as we have, if not more so since they spend 4 times the world average on energy relative to GDP, because their industry is so inefficient”

Two things. First, if this is the case then that is sad for the world – but it only translates into true inflationary pressures insofar as it increases the general price level, not the relative price of appliances.

Secondly, if the industries are so inefficient but technology is avaliable, could it not be the case that these cost pressures lead to a greater integration of technology and lower prices – especially given that investment accounts for 12% of their GDP! I would be more concerned if Chinese firms were efficient and then suffered from the same sized costs shocks.