Matt Nolan

Export prices, import prices, terms of trade, and inflation

/1 Comment/in , , /by

As a small little open economy, international variables are incredibly important to us.  The international rate of return, world prices for tradable goods, and the availability of external people, goods, and services, all have a disproportionate impact on us.

When discussing external prices, people constantly hear economists talk about the terms of trade (note, the wiki article is crap).  During 2007 the Bank was (appropriately) lifting the official cash rate on the back of New Zealand’s climbing terms of trade.  However, what all this meant, and what was going on didn’t really seem clear to everyone at the time.

The terms of trade tells us about the price of what we sell overseas relative to what we buy in.  This is all very nice, but when people see this they might wonder why the Bank would want to react.  To understand what was (and is) going on with our terms of trade we do need to differentiate between both sides of the ratio – export prices and import prices.

Read more

Matt Nolan

Good points on QEII

/11 Comments/in , , /by

Following QEII I noticed a bunch of snark, sarcasm, and general analysis focusing on what we know (how an increase in the money stock, or inflation expectations, impacts upon the general economy) – this was troubling, as I wanted to find some analysis of exactly how QEII is supposed to function 😀

That is why it was good to see a post from Marginal Revolution, and a post from Econbrowser, discussing a few of the issues to keep an eye on.

I would still agree overall with Scott Sumner’s point that we should judge the policy based on where market expectations for future inflation move – however, the idea that there could be a sharp step change in inflation expectations at some point in the future, that the transition path of QEII is uncertain, that there are costs from a potential “asset bubble” in exchange rate markets, and that countries with weak financial institutions may struggle are important risks.

IMO though, these are risks – they do not suddenly indicate that QEII is bad policy.  And in fact, I would say ex-ante, with inflation expectations below the Fed’s implicit target and unemployment above the natural rate QEII made some sense.  An explicit inflation target, or even direct transfers to households, may have mad more sense – but were obviously not practical in a political sense.

Matt Nolan

New Zealand’s right continues to remain statist

/7 Comments/in /by

The combination of this article from Fran O’Sullivan, where she treats the NZ economy like a business, and the frankly poor Taskforce 2025 report has flustered me. [We have seen these actions before mind you]

I aim to do a full post discussing the Taskforce 2025 report another time, when I have a moment, but the two main issues were:

  1. It abused the data to make ideological claims rather than honestly looking at it (it is like they didn’t actually talk to anyone who analysed NZ historic data),
  2. It ignored the fundamental trade-off between efficiency and equity – this can be forgiven as long as it is mentioned as a policy relevant factor to be looked at before setting policy itself.

In a similar vein, O’Sullivan seems to think that government needs to pick winners (how they can judge business conditions better than the people actually trading I do not know) and subsidise exports – because for some reason giving other people our produce is a good thing because it makes the GDP stat look bigger.

She bemoans “purists” – a camp I guess I am in – because we care about the efficient allocation of resources, and the welfare of society, rather than using a bunch of business jargon and pretending we can centrally run an economy.

I believe that in both cases, the Taskforce report and O’Sullivan’s article, the authors believe they are suggesting what is best for everyone – what is best for society.  But this just tells me that they are confusing what a firm is and what a country is when making recommendations – it is not governments role to centrally determine society, and anyone that thinks government can pick winners, or that cutting the fiscal deficit right now will make magical things happen, is mistaken.

Matt Nolan

The exchange rate and the RBNZ

/2 Comments/in , /by

I see that we are back to discussing this sort of stuff, fair enough.  There is a Herald article with Cunliffe expressly mentioning that the RBNZ should reduce volatility in the exchange rate, and Brian Fallow discussing currency intervention following the Fed.

There are a few key points I would like us to keep in mind here:

  1. RBNZ policy depends on inflationary pressures.  A higher dollar (all other things equal) lowers tradable prices, which may have a downward impact on inflation expectations, which in turn will lead the Bank to lower the interest rate.  As a result, if people overseas start stimulating policy – then unless this leads to a significant pick up in external demand and commodity prices the Bank could well cut rates on its current mandate.
  2. For all the talk of volatility it is important to note that the NZ$ has actually been less volatile than the Australian dollar over the crisis years – surprising fact.
  3. Is it volatility in the exchange rate we care about, or volatility in the prices people actually face – remember that the “world price” of the things we sell overseas have been moving around violently, and the floating dollar has actually helped to reduce variability in the prices many exporters faced.
  4. Exporters and importers can hedge … combined with the fact that movements are smoothing external prices, this makes me feel that the volatility argument is often overplayed.
  5. Given that the exchange rate is seen as a random walk – and we have no idea what (short run) fair value really is a lot of the time – isn’t it just as likely intervention will increase volatility!
  6. If we are worried about the “relative price” argument (our dollar is too high because we are running a CA deficit that is “too large”) we should try to figure out what internal/external imbalances are causing that and deal with them directly.  This is not a volatility argument – and it should be well thought through and communicated before anything happens.
  7. If we believe the “exchange rate is too high for manufacturers” we need to ask why – is it the relative price impact above (which we have discussed), or is it “Dutch disease” – something that I don’t really believe is a disease, but merely the diagnosis of a side-effect stemming from a POSITIVE shock.

We all know I’m a sucker for the status quo, but I have no problem discussing these issues.  We should recognise that there are two perceived issues:  (1) volatility, (2) the relative price.  And then we should investigate why these things are happening, if there are associated welfare costs that we can reduce at a lower cost, and if so then clearly communicate why and what is going on.

Given my lack of faith in central government to achieve these things, as they enjoy using monetary policy as a political football, I am a strong proponent of the status quo.

Matt Nolan

What is this …

/in , , /by

This article on Bloomberg is something I largely disagree with – however, there is statement that needs more discussion.

Quantitative easing is “terrorizing” the world economy and will lead to depreciation of the U.S. dollar, pushing down prices in Europe and exacerbating the continent’s sovereign debt crisis, Mundell said.

The European Central Bank’s mandate to control inflation would likely hamper it from stemming the euro’s rise, while the currency’s gains would “likely lead to deflation,” said Mundell, who received the prize in 1999 and is known as the intellectual father of the euro. Falling prices would increase “the real value of indebtedness.”

Mundell is a genius, and one of the intellectual fathers of open economy macro, but what is this.

He is saying the the ECB won’t loosen policy because it fears inflation, but a rising euro will lead to deflation.  By the same logic, shouldn’t the ECB loosen policy to prevent deflation.  The same logic.  What the …

On the Chinese side, I disagree with the majority of what they are saying.  But:

The U.S. “has not fully taken into consideration the shock of excessive capital flows to the financial stability of emerging markets.”

Is a fair point.  Places where credit institutions are weak could be at risk in the case where global monetary policy is softened.  IMO, this implies that there should be more pressure on these places to make risks transparent and to work on institutional setting – not that countries facing deflationary pressures should just ignore them.

If the institutional setting is appropriate, then loosening global monetary policy in the face of higher than “natural unemployment” rates is a good thing both in terms of:

  1. Meeting inflation targets and ensuring that the deviations from the “natural rate” are as small as is efficient.
  2. Pushing countries who have an inflation mandate but have been fiddling the currency to either revalue OR force them to take on greater capital controls – which will also lead to larger asset losses for them.

I’m unsurprised China is not impressed – if the US is devaluing they face a loss on the capital value of their reserves.  This does not mean that it isn’t good policy – and if they are going to fiddle exchange rates this is a risk they had to face!

Matt Nolan

Chocolate and prices

/2 Comments/in , /by

An article in the Herald says some interesting things:

The world could run out of affordable chocolate within 20 years as farmers abandon their crops in the global cocoa basket of West Africa, industry experts claim.

…

“In 20 years chocolate will be like caviar. It will become so rare and so expensive that the average Joe just won’t be able to afford it.”

Now, as the article says, the price of cocoa is rising because alternative uses of the same land is also rising – this is not surprising, and is really what should occur.  We have scarce resources, and the price adjusts to signal this scarcity and allocate resources to the highest bidder.

But the first claim, running out of cocoa?  Surely if prices rise, this will get some people back into the market.  We don’t just magically run out of the thing – the price of cocoa relative to say washing machines should rise, but this is because the opportunity cost of growing cocoa is now higher.  Also note that these poorer farmers in Africa are getting higher incomes now – as the price of what they produce compared to, say washing machines, is higher … so they can buy more washing machines.  Why is this article begrudging them that?

And the second claim – that chocolate will be like caviar.  WTF.  I am pretty sure we would see a massive amount of entry into the market if cocoa prices went up that far – entry that will drive the price down.  When “John Mason, executive director and founder of the Ghana-based Nature Conservation Research Council” makes that claim about people not being able to afford chocolate I think he is forgetting that part of the equation.

I find these articles weird.  In a much smaller space they could have said:

With the price of agricultural crops rising, some farmers are switching crops, driving up the price of cocoa relative to non-agricultural goods and services.  This will see the price of chocolate rise – time to finally find out is white chocolate really chocolate.  This will also increase the incomes of farmers in these regions.