Matt Nolan

Papers on the old new financial crisis

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Brad Delong links to a number of interesting papers regarding the US/global financial crisis of 2007-2009.  I recommend the optional ones.

I’m not sure I completely agree that the bailing out of Bear Stearns made matters worse – but it was an interesting perspective.

In any case, its a good idea to try and understand what happened then – in order to figure out whether the debt crisis in Europe will lead to similar global pain.

IMO when Greece does default, who holds the associated liabilities is widely know – as a result, my hope would be that nothing will really happen.  With nothing happening, the rest of the world will just move on.  The risk is that Greek default actually knocks out a big bank (it looks less likely now that it will knock out a sovereign government – although that remains the big fear in Europe).  Fluffing around in Europe has kept credit conditions tight for at least 18 months longer then they would have been, in the absense of European debt issues – it is starting to feel like some people will have to accept some loses before this crisis can end, and some semblance of global confidence can return.

Matt Nolan

Terms of trade: An Australian perspective

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Institutional Economics has some good points on the boost to Australia’s terms of trade – points we can keep in mind over here.

Relative to what we pay for our imports, Australia now gets higher prices for its exports than at any time since at least 1870. This was illustrated by Reserve Bank Governor Glenn Stevens’ observation that ‘five years ago, a ship load of iron ore was worth about the same as about 2,200 flat screen television sets. Today it is worth about 22,000 flat-screen TV sets.’

This increased international purchasing power is attributable not only to rising commodity prices, but also lower prices for imports, not least manufactured goods. The flip side of Australia’s terms of trade boom is the collapse in the terms of trade for countries like Japan.

So a higher terms of trade allows us to buy more imports for the same quantity of exports – something that is important to keep in mind when we bang on about “rebalancing” the economy.  Furthermore:

Our best response to the terms of trade boom is to become even more open to inflows of foreign labour and capital and to reduce the government’s command over resources so that the mining industry can expand with less pressure on other sectors. While the non-mining sectors will contract relative to mining, they can still expand in absolute terms if we continue to remove government-imposed resource constraints to overall economic growth.

The industries that aren’t experiencing higher returns should be expected to fail – proping them up is a policy that will just lead to worst outcomes from everyone.

So much of what has happened to New Zealand has been due to massive changes in the terms of trade – both in the 1970’s and in the 2000’s.  Asking for the “balance” of the economy to return to some past point doesn’t make sense – when the “prices/values” that dictate this point have changed … a change in economic structure is what NEEDED to happen.

It is possible some things may have gone a bit far – but it is better for us to try and understand why, where, and how before introducing policy, rather than aiming to meet some magical level of tradable to non-tradable GDP (or real consumption as a share of GDP).  If you want more details on the why, where, and how – look around the blog (pro-tip search imbalance), or contact me directly.

Matt Nolan

Sometimes TVHE does raise points

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Over at Money Illusion Scott Sumner states:

The recent Swiss devaluation has led to some interesting reactions in the blogosphere.  But one angle that I haven’t seen discussed is the relationship of the Swiss action and bubble theory.

Within an hour or two of the announcement we had said (in additional to the straight avoiding deflation argument):

Furthermore, it seems apparent that the Swiss National Bank views the current level of the currency as a bubble – people running to saftey see the Swiss Franc as attractive, and people who want to invest expect this to continue, leading to a self-fulfilling expectation driving up the value of the Franc.

Then when discussing the cap the next day we said:

I can understand why they did it, they felt there was an asset price bubble in their exchange rate – and they wanted to provide a lower focal point that traders could shift too (since expectations were driving the currency … note the increase in risk associated with intervention is also important).

TVHE is little, and doesn’t say much – but at least we picked up that angle immediately.  And so we’re going to claim it … do we get a high five

Matt Nolan

Uncertainty, policy, and recessions

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Via Anti Dismal, there is a post discussing regime uncertainty and recessions – and criticising some of the world’s Keynesian bloggers for ignoring the role of uncertainty.

Now I think the real options argument that uncertainty reduces activity is undeniable, but I also don’t think that any economist – Keynesian or not – disagrees with it.

Ultimately, we know uncertainty is a major driver of the business cycle – that is part of the reason why investment is the first thing to pull back, and one of the first things to recover when a “recovery in the economy” begins.

The difference lies in what CAUSES the uncertainty – specifically, when we think about the role of government in this context we need to ask “will this government action increase or decrease uncertainty for decision makers”.

We don’t live in a world where, without government, there is no uncertainty – in fact uncertainty appears “endogenously” during the economic cycle, it is something that is both always there and worsens when things change.  The real question isn’t whether uncertainty has a cost (it does) it is whether policy (which is what we control) makes things better or worse.

Matt Nolan

If I was to have a platform

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I am constantly criticised for not putting out conclusions for policy.  So I thought with an election coming up, I’d put down my personal election platform … this should make obvious why no-one would vote for me, not even my mother 😉

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Matt Nolan

Will the Swiss event start a series of competitive devaluations?

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In so far as we believe monetary policy in most countries is “too tight” there could be a significant upside to the Swiss decision to set a minimum value on their Euro change rate – if currency intervention is copied by most other countries it will lead to a loosening in monetary conditions.

Scott Sumner hints at this, and its an issue we’ve discussed here before.  Although it is true that “not all countries can depreciate their currencies at once” they can devalue their currency relative to goods – they can create inflation.  If there are risks of deflation, or inflation expectations are below the central banks target, such intervention could be justified.

Now, when writing about the Swiss event I wasn’t quite as confident.  This was due to the fact that the Swiss actually went out and set a value on the currency – rather than just loosening policy.

I can understand why they did it, they felt there was an asset price bubble in their exchange rate – and they wanted to provide a lower focal point that traders could shift too (since expectations were driving the currency … note the increase in risk associated with intervention is also important).  But if everyone sets “targets” there is the risk that we get an exchange rate regime where this rate doesn’t respond to changing economic fundamentals – and given that economic fundamentals change constantly, this is a concern.