Matt Nolan

Why monetary policy to target asset prices wouldn’t work

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Monetary policy is ultimately all about expectations. As Nick Rowe from Worthwhile Canadian Initiative points out, this feature of monetary policy makes the idea of “targeting asset prices” difficult – and ensures that any attempt to pop bubbles will be difficult, even if the bubbles are observable (which most of the time they are not):

Let’s imagine a conversation that might take place in the future, under a different monetary policy regime, where central banks try to target house prices.

“Should we buy that house? The price does seem rather high, compared to everything else. You don’t think it might be a bubble, like in the 2000’s?”

“No, it can’t be a bubble, because the central bank assured us its new monetary policy would prevent house price bubbles. And in any case, (the relative price of) everything else … seems to be falling … so the only safe investment seems to be in houses. If we don’t get into the housing market now, our savings will keep on depreciating, and we never will be able to afford to buy a house.”

Effectively, by saying that they will control asset prices (and being credible) they convince people that current house prices are at a fundamentally sound level. This does not prevent the existence of multiple equilibrium for house prices, and if anything it may help to drive house prices to other equilibrium by increasing the confidence that “this is not a bubble”.

Matt Nolan

We doth blame the household too much

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I was raised as a microeconomist so I guess I have a bias, but all this discussion about our poor debt position being the fault of households makes me nervous.

It is easy to blame households, hell the RBNZ did that just today. As they point out, household savings is extremely low, and real consumption (the volume of consumption in 1995/96 prices) as a share of GDP has risen sharply in recent years. On Sunday Rod Oram did the same – blaming our debt position on households spending far too much.

However, I find that when economists start to agree we are usually wrong. Given that this argument doesn’t feel right to me in the first place I am being forced to disagree.

I have two “pieces of evidence” to suggest that households aren’t at fault here, and instead it is weird investment incentives and poor government policy that is likely to be at fault. These are:

  1. My good friend Ricardian equivalence,
  2. Nominal GDP shares.

This discussion is a slight expansion on my recent Dom Post article (secondary link), and I am hoping everyone here will be willing to attack me as much as possible 😉

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Matt Nolan

On penalty cash rates

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Scott Fullwiler from New Economic Perspectives (ht Economists View) describes some issues he has with the “negative interest rate” idea being put forward by Willem Buiter , Greg Mankiw , and Scott Sumner

Now I have previously put my foot forward and said I agree with this idea (here and here) and I still feel the same, let me describe why with reference to Dr Fullwiler’s post.

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Matt Nolan

Careful with the paradox of thrift

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Paul Krugman has just mentioned that the “paradox of thrift” has shown up in the data. Now my opinion has moved over time, and I do think that the US is now experiencing a paradox of thrift – but his evidence appears to have nothing to do with this.

I believe that we are hitting a “paradox of thrift” as unemployment in the US is at 9.5% and rising – that is a hell of a lot of wasted labour input, and implies to me that there is a large failure in the labour market reducing national output. As a result, if lower individual private savings could bring some of these guys back into producing it is possible that total private savings could rise (although it is not a given).

However, Krugman puts in the following graph and says this shows the paradox of thrift:

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Matt Nolan

Where is the externality here?

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There have been wild debates surrounding the BERL report into the social costs of alcohol.  I haven’t read the report, I haven’t read the replies, I have to admit I have been busy.

However, in one of Eric Crampton’s many posts on the issue I see that generally an externality from lost output, excessive unemployment, and forgone wages has been assumed in the discussions.  I’m sorry but what?

The labour market is a market, how can we have an externality when there is a market with a market price (wages).  Yes, alcoholics produce less, less of them are employed, and they tend to have lower wages – but this isn’t an externality it is part of the market process.  They are paid less because their marginal product is lower, and they are willing to be paid less because the benefit they receive from consuming alcohol is sufficient compensation – this is a completely internalised decision for the drinker isn’t it, so where is the social cost.

And don’t say it is too the firm – the firm can set a lower wage because of the fact that the marginal product of this worker type is lower.

And if we are going to look at it in terms of society as a whole (which involves moving away from externality logic), sure having a lot of alcoholics lowers our “capacity to produce”, but given that this is the result of a maximising choice by individuals we can say that the benefit of drinking exceeds the cost of this lost production – the fact that people are doing all this drinking illustrates that the drinking is more highly prized among society as a whole than the output they could have produced.

As the ultimate goal of “production” is to lead to create outcomes that satisfy peoples preferences through consumption we can ultimately say that the forgone production is being consumed in an optimal way everytime an alcoholic has a drink – excellent, go alcoholics!

The only market failure I can think of stems from asymmetric information.  A firm hires someone without knowing they are an alcoholic and agrees to pay a wage, through selection we could end up with an adverse selection problem.  But I don’t really buy it, given that these attributes are partially observable, and future wage increases do help us push towards the market clearing price for alcoholic labour.

So convince me that there is an externality here …

Matt Nolan

Not hurting enough?

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It appears that economists at Infometrics believe New Zealand is not hurting enough from the global recession – that we aren’t noticing the true underlying risk of our debt position.

Well at least that is what the title says.  Reading the article indicates to me that the commentary is not on the current crisis at all – but about how we grow when we come out of it.  Infometrics seems to be of the opinion that once the crisis is over, fundamental imbalances in the domestic and global economies will drive us back to high current account deficits and a worse net debt position.

Once this happens, a global economy that has recently been stung by risk loving behaviour will punish us – forcing us to take on an adjustment that we didn’t complete during the current crisis.

Now I buy that reasoning.  But my only question (which isn’t covered in the newspaper article) is, what are the structural factors in the New Zealand/global economy causing this imbalance.  Is it our artificially high exchange rate (against fixed Asian currencies), is it artificially low interest rates, is it no capital gains tax, is it poor financial education, is it an inherent bias towards housing as an investment vehicle, is it poor investment decisions by firms, is it uncertainty surrounding policy?

Without an answer to this question, how are we supposed to know what New Zealand is supposed “to learn” 😛 .