Matt Nolan

Brief thoughts on NZ’s debt position

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On Saturday I had an article in the Dominion Post on New Zealand’s debt levels, and why I think we need to spend a bit of time thinking about “why” this level of debt arose before yelling out for things like compulsory superannuation.  My conclusion was:

This issue deserves a much more in-depth analysis then the quick look over the statistics I have provided here.  It requires time looking over the data and trying to understand where there is a distortion in the market, either resulting from market or government policy failure.  Then any savings policies that are introduced should be based on our analysis of these distortions – not on the eagerness of fund managers to receive funds from compulsory savings schemes.

The article is here.  If anyone wants to quote from it or any such, please attribute it to the Dominion Post.

If you merely want to discuss it with me, do so in the comments.  Note, I am very tied down at the moment, so it will be a while till I respond to comments – however, in time I will 😛

Matt Nolan

Sigh, more like SCF?

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So this isn’t what I wanted to hear:

Mr Key also warned that other finance companies may go under and the government would continue to look after investors by keeping the guarantee on investments in place.

I think he meant:

Mr Key also warned that other finance companies may go under and the tax payer would continue to take on all the risk for investors by keeping the guarantee on investments in place.

Look.  I had no problem with the idea that we needed to do something in wholesale markets during the credit crisis to prevent an effective “bank run”.

But the two problems with keeping this going now is that:

  1. This problem is gone now,
  2. Given the fact that funds flooded into risky assets after the guarantee there is a definite case that we should have done less.

Contrary to what Kiwiblog said that “It is easy in hindsight to say that one should not have had the guarantee scheme, but in late 2008 the wordl financial system was on the brink of possible collapse, and pretty much every OECD country did much the same as a stability measure” I think it is perfectly fine to critique the scheme.

Why?  Well we KNEW there were issues with our finance firms, and we stuck them into a scheme rapidly without doing due diligence on a whole lot of the stuff.  And we made this f’ing critique AT THE TIME – so we are allowed to make it now 😉

Lets just think here for a second.  Effectively government was taking on all the risk, so why weren’t the insurance premiums insuring that all the return also went to government?

If it is hard to observe the price, couldn’t we have just said that people who entered the scheme couldn’t increase lending – this would have allowed the scheme to protect deposits without leading to the “increased risk taking” that has taken place.

Bah.

Matt Nolan

Policy success measured by decline in consumer surplus

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Via the Herald (ht Education Directions):

The Illicit Drug Monitoring System report found the price – commonly regarded as the best measure of police success against the drug – had increased each year.

Interesting.  So they use ever rising prices as a measure of ever rising success.  This is weird on two grounds:

  1. We are using regulation, not the market – yet using prices as an indicator seems to point out that we could use a market mechanism here.
  2. If we accept the market mechanism, then even in the face of externalities there is an appropriate “price” – if we go past that I wouldn’t call that a “success”

Also, they seem to have trouble attributing appropriate causation:

Dr Wilkins said dealers around the world had reacted (to restrictions) by filling the (Ectasy) pills with other substances, including methamphetamine, which could create a highly dangerous cocktail of drugs.

…

A revival in LSD use, possibly as Ecstasy users look for a stronger drug.

So they attribute the rise in LSD use to “addicts” wanting a stronger fix – even though they have already admitted that the consumers value of Ecstasy has been lowered by tightening restrictions overseas, which have reduced quality and increase the potential health impact.  If anything I would say that the “obvious” reason for the substitution from Ecstasy to LSD would be the result of these tighter restrictions …

Matt Nolan

Thoughts on South Canterbury Finance saga

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The receivers are in, and the government is throwing in $1.7bn in order to buy assets they expect to get a return of $700m from.  Sounds like a typical New Zealand investment to me 😉

There are a few points to come out of this.  In some sort of order these are:

  1. The government had to pay the money when the receivers came in – they had no real choice, after all SCF was guaranteed by government.
  2. However, it does show you the type of cost that can be associated with such a scheme – and raises the question of whether putting finance companies in the scheme was a good idea (both Agnitio and myself were skeptical).
  3. It is apparent that the scheme may have led to some dodgy lending in that sector.  I am genuinely concerned about what other moral hazard issues will appear over the coming year – is this just the tip of the iceberg from a poorly designed scheme, or is it just one unfortunate failure.
  4. Questions have to be raised regarding the price placed on risk by the guarantee – was it really high enough?
  5. Why is anyone defending Alan Hubbard when he used other peoples money to make risky bets that made people like him – just to fail and have the rest of New Zealand paying for it?  Running a company under a government guarantee and not following best practice is immoral – no matter who you are.
  6. This can’t be compared to TARP, and the lack of insurance would not have made this like Lehman Brothers.  The scope for contagion from a finance company failure like this is small – which implies absent the scheme the government should have just let this company fail.
  7. Another nail in the credit rating coffin?  What credit rating did SCF have at the start of the deposit guarantee scheme?

Another point is that this statement:

Furthermore, being in control of the receivership process takes the pressure off the receiver to quickly sell any assets

Is actually a good one, if they feel the assets would be shot off at fire sale prices.  This is one of the main lessons from TARP.  However, the sad thing is that the government is stuck buying them at an inflated price instead 🙁

Surely this tells us that it is at least near the time to get rid of this deposit guarantee scheme – and why not do it retroactively so they all don’t “fail” just before the scheme runs out.  Investors that get burned because they saw a high return and decided to face a high risks should have to deal with the consequences of it.

Update:  Bunch of details listed down on Rates Blog.

Matt Nolan

A fishy conclusion from a Fisher relation

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Interesting.  Both a Fed economist and Stephen Williamson (the author of one of my undergrad macro books) have been saying that persistently low interest rates “cause” deflation in the long run (ht Economist’s view) [Lots of others, WCI *, Money blog, Angry Bear, Paul Krugman, Money Illusion].  This seems a little counter-intuitive, but this doesn’t mean anything is wrong – I’m going to write down a few of my thoughts to see if I can figure out what is going on.

I mean, I agree that the Fisher equation must hold, and I agree that the long-run real interest rate will be exogenous.  But this ain’t enough to tell me that having the Fed keep rates at 0.25% forever “causes” deflation.

Why?  The average Fed rate and inflation expectations are both endogenously determined – they seem to be treating the Fed’s choice as exogenous, when they follow a decision rule. Yes it is true that the cash rate at a point in time is a choice variable – but the average cash rate in the long-run should effectively be determined by the real interest rate and long-run inflation target. [Update Think of it this way, I’m really assuming the central bank follows a Taylor rule and that determines the nominal rate given the inflation target.  The big kicker for any argument like this will be the way inflation expectations are formed].

As a result, we could just as easily interpret rates staying at 0.25% forever as an indicator that inflation expectations are -1.75% -> in other words we observe a low nominal interest rate BECAUSE there is deflation.  Fundamentally, this tells us nothing – as the Fisher relationship is an equilibrium statement, not a casual relationship.

In fact, if there is indeed a forecast of rates staying at 0.25% forever there is a STRONG argument for making policy more stimulatory now – is that what the guy is trying to say?

If we want to discuss a causal relationship we need a causal model of our endogenous variables right – the Fisher equation is not this.

Update: I see where they are coming from now.  However, I believe the key issue is with regards to current policy – fundamentally the mentioning of deflation was taken in context of the CURRENT disinflation going on in the USA, and it seemed like a statement that was pushing for an increase in rates to avoid deflation.

I’m also nervous about the use of the word “cause” when any observed relationship in the data will not necessarily be clear – but I’m always nervous about causation so oww well.  Namely, if I see an average cash rate of 0.25% and average -1.75% inflation I wouldn’t say “aha, having the cash rate at that level caused that” – I would want more information on how inflation expectations got there in the first place …

Matt Nolan

The difference between compulsions: Tax and forced savings

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Just having a look at the speech from Labour on savings.  One bit that has caught my eye so far is:

The Government collected tax, which is compulsory, and saved it for the future.

Now this is true, tax is compulsory.  And one way of looking at “compulsory savings” is as an increase in the tax rate.  But I think there is a more fundamental difference that makes compulsory savings a bit more ridiculous.

We pay tax as part of redistributive policy – tax is used to reallocate resources effectively.  We justify this morally by saying a couple of things:

  1. Land and other forms of endowed capital are fundamentally communally owned – but we need private ownership to ensure an efficient allocation of resources.  As a result, tax acts as a form of social rent – as part of the social contract.
  2. If we looked at society objectively – without knowing whether we would be born into poverty or wealth – we would say that some level of redistribution is desirable (Rawlsian justification).

So we have compulsory redistribution, which is justified by the “social contract” and the belief that the democratic process enforces this implicit contract.

Compulsory savings doesn’t have this justification.  We are taking someones wealth away from them, and then giving it back to them later – like when a kid in the playground takes another kids ball and plays with it, giving it back to them at the end of the lunch break.

The only “social contract” argument you could make here is that individual in society WANT to save, but lack discipline (time inconsistency).  But forced regulation is not the best solution if this is the case – providing institutions and incentives that help to solve the time inconsistency issue, while still allowing choice, is the way to go.

As a result, justifying compulsory savings on the basis that “tax is compulsory” is a slippery slope.

I will get back to reading the speech tonight I guess – I’ve sort of paused there 😀