Matt Nolan

The carry trade and mortgage rates: Shifts and movements

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Anyone who has done first year economics will know about shifts and movements.  When I tutored the course I would make funny hand gestures trying to illustrate it, hand gestures that were mildly less weird then when I talk about price floors and ceilings.

Still, there has been a lot of banging on about the carry trade and mortgage rates, and I think some of it stems from a little confusion regarding shifts and movements.  As an example I’ll work with this post from the Standard (ht BK Drinkwater).

Note: This is being added to the inflation debate, as a discussion of interest rate determination in a small open economy.  Starting from the bottom, the combination of posts under that tag gives a fuller idea of what we are talking about with inflation targeting and our (narrow) view of monetary policy.

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Matt Nolan

A couple of good articles on monetary policy reform

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Here are a couple of good articles on the monetary policy debate.  First from Australia (and this fine blog with more discussion here and here):

Meanwhile, the central bank’s primary focus on inflation recognizes that monetary policy needs to be based on a single instrument and policy objective. Pursuing multiple objectives with multiple instruments, as Labour now suggests, is a recipe for incoherent policy and poor economic performance such as New Zealand experienced before its path-breaking reforms of the 1980s.

And then there is BK Drinkwater, who has gone full hog discussing monetary policy issues with the Standard here and here.

I didn’t take Marty G’s post—or Cunliffe’s—seriously, because for all the storm and stress about “hot money” coming from overseas, there’s a certain obliviousness to the fact that for debt to happen, for mortgages to happen, for credit to happen, someone has to borrow in addition to there being someone willing to lend. Why ignore half of supply & demand?

This is THE point that is CONSTANTLY being ignored.  Never have I seen so many smart people ignore a demand curve for so long. 

Update:  I should point out that Westpac is also making the point on demand, good on you guys 😉 .  I don’t actually receive weekly updates from any of the other banks, if any of them are saying it as well could someone tell me in the comments and I’ll link.

Good work everyone.  Hopefully someone is listening …

Matt Nolan

One thing to keep in mind …

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I have noticed a lot of talk about how we need to change the monetary policy paradigm (like here, here, here, here, and here).  Comments here, and here, have been especially vocal.  There has been a lot of talk of monetary policy being “20 years old” so we should “fix it”.

However, what is monetary policy.  At heart it is policy regarding money.  As we discussed, in the long-run this doesn’t matter – as all prices adjust.  In the short-run, we have a trade-off between output and inflation because some prices in the economy are inflexible (read wages).

Monetary policy at heart isn’t about “unemployment” or “output” or “the exchange rate” (which is a relative price).  Monetary policy is about money, it is about the supply of money, it is about the price level and inflation.  The “interest rate” is merely an instrument central banks use to control the money supply and keep “inflation stable”.  By keeping inflation stable we increase certainty and we help make sure that money remains a good indicator of the relative value of REAL goods and services.

The idea that we should mess around with this to tinker with other things misses the point – if our exchange rate is funny, unemployment is high, or output is below potential we have to ask “what issues in REAL economy are causing this”.  Monetary policy in itself is irrelevant – monetary policy IS about money, it IS about inflation, it IS about expectations regarding these nominal variables, it IS NOT about real economic variables.

I am not saying that monetary policy hasn’t moved real variables – but in a world where monetary policy IS solely focused on inflation and consistent expectations is a world where monetary policies impact on the real economy is at its best.

Saying we need to change the monetary policy is equivalent to saying “we don’t know what the real issues are in the economy, and we are going to use the money supply as a political instrument to hide this lack of knowledge”.

When the Reserve Bank Act was made they recognised these facts.  They realised that the focus of monetary policy was money (funnily enough) and they kept it there.  Other policies (fiscal and prudential) can be used to deal with other issues in the economy, but monetary policy IS the policy of growth in the money supply – that is all.  It seems that this knowledge has been lost along the way – lets not let this gap in our memories lead us to dumping the Reserve Bank Act and forgetting the real issues that exist in the NZ economy.

Matt Nolan

Good on you Brazilian central banker

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Here is some sense talking from a central banker and trade representative from Brazil:

Senior Brazilian trade representative Mario Marconini from the Federation of Industries of Sao Paulo, says there’s a growing realisation from Brazilian businesses that trying to control the exchange rate is fruitless.

The long-term answer can only come from concerted international action to apply pressure on China to allow more flexibility in its exchange rate, Pundek says.

By removing China’s artificially low exchange rate, the massive trade imbalances created by that rate can be corrected.

This is point number one on our list of issues causing an imbalance (list at the bottom of this post).  I am loath to blame China for the whole imbalance – after all they are artificially selling their own stuff cheaply by devaluing their dollar.  However, currency pegging has to be seen as part of the PROBLEM in the current economic environment – not the solution!!

And on the idea of capital controls being fruitless, this becomes obviously when we look at one very simple fact – there has to be DEMAND for the capital for it to flow in.  The fact people want to lend is only half the story, people inside the country have to be willing to borrow at the given interest rate.  This is a little fact that seems to be continuously ignored pretty much everywhere …

goonix

California knows how to ban stuff

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The California Energy Commission, in all their wisdom, have decided that the best way to encourage energy conservation is through imposing compulsory energy efficiency standards on TVs – in other words they are banning what they deem to be ‘energy inefficient’ TVs. They are the first state in the US to implement such a measure.

The aim of the intervention is to reduce electricity demand and hence avoid the need to build new power plants to meet this demand. In this sense, the Commission perceive the building of power plants to be a negative externality, presumably as the cost of building is reflected in the per-unit price of electricity for all users.

I take issue with this ‘externality’. For example, if a lot of consumers suddenly started demanding ‘Thierry Henry is God’ t-shirts, such that the price increased, should I feel aggrieved that the action of others is affecting the price I must pay for such a worthy product? No, that is how the market works.

Putting aside my scepticism, let’s assumes that the externality is a genuine one. What might be a superior way of discouraging consumption?

Bans are a blunt tool. From an economic efficiency perspective, you should first try and use prices to incentivise behaviour. High demand for electricity is only ever a problem over relatively short periods. For example, in New Zealand the peaks occur on weekdays in the morning as people wake up and in the evenings as people go home. In hotter climates, the peak typically occurs at the hottest part of the day as air-con works its magic. Hence one might try to charge higher prices at times of high demand to discourage consumption (and hence avoid the need to invest in new power plants). There are electricity meters that are capable of facilitating such differentiated pricing and indeed they are being rolled out in California as we blog.

Under the differentiated pricing scenario, consumers are paying the ‘true’ cost of electricity, so even if they continue to consume at high levels, one should be indifferent to building a new power station as the externality has been internalised.

The obvious perverse incentive that arises from the ban is that consumers will simply purchase their televisions out of state, knowing that they can get a better range of TVs to better suit their individual needs at more cost-effective prices.

It is far more preferable to keep consumer choice open and simply make consumers fully pay for their choice through efficient pricing (assuming that an externality exists in the first instance).