Matt Nolan

Drink heavily tonight

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Because it makes you smarter:

(Source Marginal Revolution)

Note: I am joking, this is not causality.  For one we don’t have a quantity measure of drinking, and the impact of drinking on intelligence is no doubt non-linear.  In fact, you could make the argument that “smarter” people know how control their own alcohol consumption, and so do not face the severe negative impacts of drinking – in a way smart people are more likely to find ways to control, or are not subject to, time inconsistency problems in liqour.

However, I think we should also use this as a reminder that it the link between the consumption of a drug and the drugs impact can be very poorly estimated if we aren’t very careful to control for these sorts of issues – hence why I do not trust a lot of studies out there, especially the ones made by interest groups where all they do is draw lines (95% of studies according to my casual observation).

Update:  CPW sent me the link to the full set of graphs with alcohol involved – it is beautiful.

Matt Nolan

Marginal rates, interest rates, and NZ monetary policy

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One of the things that I find fascinating at the current time is the enormous gap (see page 9 of link) that has developed between marginal bank funding costs and the official cash rate.

By setting the OCR the RBNZ commits to borrowing an infinite amount off banks for 25bps less, or loaning an infinite amount too banks for 25bp more than the OCR.  Of course, this is now constrained by prudential regulation – but at the margin, the RBNZ sets the opportunity cost of bank borrowing and lending, and so can move around interest rates (which also depend on borrowers risk profile etc).

The increase in the “margin” on top of this has been assumed by many people to be permanent.  The main calls are:

  1. It is the result of higher risk, which is not going to abate soon
  2. It is the result of new prudential regulation

In part these are true.  However, is the assumption that this increased margin will remain forever really the best assumption when looking at how the OCR translates into interest rates?  Furthermore, as the OCR rises, is it fair to expect that the margin will remain unchanged, and marginal costs will keep rising by 25bps?

I’m not so sure – as I’m not convinced the Bank completely controls the marginal cost of funding right now.  Here are a few reasons off the top of my head:

  1. The Bank also focuses on financial regulation – as a result, borrowing from and lending too the Reserve Bank provides a signal of an individual banks quality.  Even though the RBNZ is willing to borrow and lend an infinite amount does not mean that individual banks will work on this basis – and marginal funding may infact come from other sources for new loans.
  2. Individual banks are constrained in setting lending rates on what they have set for deposit rates.  As deposit rates have been pushed up due to prudential regulation this has set a “floor” on lending rates – even when the marginal rate is lower, implying that the reaction to a rising OCR will be muted.
  3. International interest rates, even for moderately long maturities, are low.  This will, in turn, have an impact both on demand for funds from banks and the cost of funding from banks.  Note that, even with the new prudential regulation longer-term foreign lending can still often be used – and so could help to determine the marginal price for longer term lending.
  4. The new prudential regulations (will) mean that a bank has to fund 75% of a loan (currently 65%) from outside the RBNZ right.  So if they loan a new $1, the marginal cost of that dollar will be 3/4 set by the underlying market and 1/4 set by the OCR – at least this is my impression of how banks have to respond.

Ultimately, any factor that ensures that the “marginal $ borrowed or lent” is not coming from the RBNZ could also provide an explanation for why this “margin” has grown.  If this factor is the result of the OCR being historically low, then we can expect the OCR to have LESS punch as it rises.

This is fascinating – and I’m surprised that we haven’t seen more work come out about it.  By the end of next year, it will be very interesting to see how rates have responded to a rising OCR.  I am currently not convinced that the working assumption a perfect feed through is Bayesian rational 😉

Matt Nolan

Why all the hating on DSGEs?

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Over at Greg Mankiw’s blog he links to a comment on DSGE models by the legendary Robert Solow.  Surprisingly, the comment is relatively negative.

If I am honest, I found Solow’s attack on DSGE a little strange, and fairly inconsistent.  Here is why:

Update: (Before saying why I think this, I should say) This initially came from an Arnold Kling post, and the lingo regarding biology has moved into some of Brad’s negative writing about economists he disagrees with (ht Economist View).  My own view is that these authors are attacking a straw man when they attack DSGE’s (the straw man I’m talking about is the 1980’s RBC model, as I discuss later) – instead of attacking the inappropriate assumptions of some of the practitioners they have decided to attack the method.  This disappoints me.

Yes – all models have weaknesses.  But it is about seeing what to use and where.  And contrary to Brad’s language he is being far from objective in his attack on this type of modeling.

Now, back to the post as it was a few days ago 😉

Read more

Matt Nolan

If we think there is an implicit social dividend from land …

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… why don’t we just have a land tax, instead of trying to restrict voluntary trade of land between individuals.

My impression has always been that one of the fundamental reasons for tax was to proxy for a social return on a nations capital – such as land.  By doing this we get the advantage of actual property rights on land, even though in essence we hold a belief that society as a whole owns that land.

Now my impression of this debate is that NZ society DOES believe it implicitly owns the land.  If we had a land tax that proxied the “rental income” for society, it wouldn’t matter who owned the property right to use the land and this whole debate about foreign ownership could be chucked out the window.

Another point in favour of land tax is it?

Update:  Danylmc at Dim Post discusses the same article.  I’m not sure I would interpret history the same way as him – was there really much of a cost from the running down of our grossly inefficient railway system?  However, lets not argue about this point here – as it is peripheral to both posts.  There are two primary points that need to be raised beyond my land tax call above.

Firstly, if the problem is that the government sold the asset too cheaply, then we should raise that as the issue.

Secondly the arbitrary idea of a “strategic asset” might crop up – if we want to think along these lines, lets actually do some thinking.  We should ask “is it a public good”, “are there competition issues” and/or “are there externalities from the assets use”.  If these things hold, then we can ask what is the best way to define ownership.

Yes there are cases where the government should own assets – but they should be determined by analysis instead of arbitrary catch phrases like “strategic asset”.  Obviously there are too many management consultants floating around government at the moment given the amount that term is floating about.

Matt Nolan

Don’t stop limiting our competitors ability to compete say rivals

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That is what the title to this article is suggesting right?

My impression is that Telecoms rivals want two things to continue happening:

  1. Telecom to be ineligible for broadband subsidies that they are getting from government,
  2. Telecom to be regulated in a way that:  Reduces Telecom’s ability to increase downstream costs.  Likely increases Telecom’s marginal costs in retail markets.

As a result, is this really surprising?  By increasing the relative marginal costs of a competitor, you can improve your own profitability in the end.  I wouldn’t really trust Telecom’s competitors as an objective analyst of how telecommunication policy should take place in NZ 😉

Matt Nolan

Testing my economic knowledge

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Not PC has a quiz up on economics stuff – I thought it would be fun to do.  So here goes.

1)  Gross Domestic Product (GDP) measures a country’s total economic activity.

Answer:  False.  As it excludes activities where the market isn’t explicit.

2)  Consumer spending represents around two-thirds of the economy.

Answer:  Depends how you define “economy”.  It is around 2/3 of the expenditure measure of GDP sure, but that doesn’t really tell us much.  When we say “economy” my guess is we are thinking along the lines of all activity, and in a production sense, so I’d probably guess the answer would be false.

3)  If prices are stable, that means there is no inflation.

Answer:  Depends how we define inflation, and depends how we define prices.  If the price of a quality adjusted unit of all good or services were unchanged, then inflation as defined by an economist would be zero.  Given that we can observe no change in a price index and still have inflation (depending on changes in quality, or shifts in relative prices) I would say the answer here is false.

4)  Money is a creation of government.

Answer:  Currently money is created by the sovereign state – but this doesn’t mean that money would only exist if we had a centrally organised authority guiding it.  As a result this could be true or false.

Given that the question says “is” I am assuming it is talking about money that is currently in circulation – and yes that money is created by the state, and individuals use it when trading with each other in order to lower the search cost associated with trade (relative to a barter economy).  So I would say true.

5) A period of gently falling prices is a bad thing.

False:  We just need a single counterfactual here.  So if prices are gradually declining, and economic agents expect them to, then there is no problem.  Furthermore, if this drop is the result of productivity improvements that is a nice thing.

6)  Before the Reserve Bank/Fed/Bank of England was created, the world was wracked with inflations, booms and busts.

True:  Back in the day there was indeed lots of volatility in prices and in output.  Sure the price level was on “average” stable – but hell did it move around!!!  Now we have booms and busts nowadays, and there are likely issues with the way monetary policy is put in place – sure.  But I take the fact that prices have risen gently over time during the last 30 years as an indication that central bank policy has increased certainty for economic agents – which is a good thing.

7)  Economics is a “value-free” science

False:  No science is “value-free” in the most extreme definition of the word.  However, economics does attempt to make its premises and the link to conclusions obvious such that any debatable value judgments are clear.

When economists describe a situation they are relatively close to value-free, when they make a conclusion they are far from it.  However, I think that the economic method is very good – I appreciate the transparency associated with it.  But I realise that a truly “value-free” science is a myth.

8)  Saving takes money out of the economy

False:  This doesn’t need explanation does it. In fact, to be honest I’d need a good definition of “money” and “economy” before I could answer this clearly.

9)  Interest rates are set by the Central Bank.

Yes and no.

Central banks set the “opportunity cost” of lending/borrowing for banks.  As a result, they tend to control marginal funding and therefore price.  They can “control” long-rates through peoples expectations of their future actions as well.

However, interest rates depend on a whole range of other factors – such as risk, and interest rates globally.  That is why we see interest rates move around a lot even when the central authority isn’t doing anything.

If all the other factors are constant then, yes it is TRUE central banks do set the opportunity cost of lending and borrowing and thereby control the interest rate.

10)  A good war is good for the economy

False:  Unless people value war I guess …

11)  Government spending pumps up an economy in depression

Depends how we define a depression.

If we define a depression as a sharp drop in economic activity, where the relative price of labour isn’t able to decline, and where monetary authorities are unwilling to print money to help this adjust, then there is a potential role for government.

Given the behaviour of economic agents, and given the very real labour market issues in the face of a rare “depression” then yes, it is TRUE government spending can increase activity by getting otherwise unemployed labour doing something.

Note:  A depression is an effective supply side failure – we have a market failure in the labour market that implies there is “money on the ground”.  This is a very rare situation.

12)  Banks are inherently bankrupt.

False:  I am not sure what this question means.  Literally they aren’t bankrupt as they have money (and a claim on loans).  Figuratively they aren’t morally bankrupt as they are just providing a service to help lenders and borrowers meet – and to pool risk.