Matt Nolan

What does market monetarism say about NZ during the crisis?

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The Money Illusion has popularised the idea of market monetarism, leading to strong claims overseas that there needs to be more monetary easing.  This is all well and good, and in fact I long agreed with many of the policy recommendations that have been stated (although I am not a complete proponent).  But if we were to look at the nominal GDP numbers for New Zealand (NGDP) what would it tell us?

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Matt Nolan

Is that an inflation target …

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Or are you just flirting with me Bank of Japan?

In truth the BOJ has tried to hold back from an explicit 1% inflation target, and is just discussing it as a “near term goal”.  While this isn’t as positive as the Fed move to an explicit inflation target, and Australia and New Zealand’s long-term policy of having an explicit inflation target and printed rate track, it is an improvement.

With Fed and BOJ policy improving, credit markets in Europe consistently settling since mid-December, implied volatility on markets way down (the VIX), and the cost of credit down significantly in the past 6 weeks we could be seeing a real improvement on financial markets.

What does that mean in little old New Zealand?  Well our higher exchange rate is tempering part of any stimulus coming from offshore, while its up to the RBNZ to keep an eye on the rate track.  If financial conditions look like they are going to improve in the near future the Bank may suggest that they will be lifting rates in larger chunks when they do get around to it.  It will be interesting to see what happens when we get to the March meeting.

Matt Nolan

The economics of valentine’s day

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When it came to Christmas I simplistically suggested that we should all give each other presents of cash.  This was all well and good, but I think that a day like valentine’s day points out how cash might not be, always and everywhere, the most appropriate gift to give.

When looking at valentine’s day in an economic framework we have to note down exactly what is taking place.  It is a day where you give a gift to your “better half”.

Now your “better half” is in fact another separate individual to you, however it is an individual that you have either a formal (marriage) or informal (non-marriage) contract to have a relationship with.  Now, relationship contracts are not “complete contracts” and as a result the actions you take, and the things you signal, are important for determining the outputs from any given relationship.

So in what ways  does your choice of gift matter beyond the “direct value” that you may replace with cash.

  1. It may signal knowledge of the other persons wants and desires,
  2. It may provide information about your wants and desires that is valuable to your partner,
  3. Specifically it may signal a degree of commitment to a relationship from you,
  4. Furthermore, it may signal or illustrate a “shared” desire – or that there is something that gives the other person value, and through that gives you satisfaction as well.

In this sense the gift means more than just the sheer value of the present itself – it also provides information and signalling value that is used to shape the relationship for at least the next year.  The significant increase in breakups post-valentine’s day may in fact be a signal that sometimes individuals are not able/willing to do this to a sufficient degree.

So just remember as you pass over your gift today, that it will be seen as a signal of the relative value you place on matters inside your relationship that are not explicitly contracted – and if you get in trouble, I’m sure a good excuse would be to explain how they are misinterpreting this signal …

Update:  XKCD points out one of the issues that this causes.

Matt Nolan

Thinking about the US output gap

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Via Marginal Revolution I noticed the argument that a drop in lifetime wealth may have reduced potential output, thereby implying that there is a smaller output gap (permanent loss in productive capacity).

Now, I share Scott Sumners concern about this view. It is true that a negative permanent wealth shock will in turn lead to lower consumption – but in of itself this does not imply that it leads to lower output, which is what GDP and potential GDP are measures of.

Tyler Cowen put up the best defence of it when he stated “Simplest response to Sumner and Yglesias is that we may have had a biased estimate of the previous trend, for bubble and TGS-related reasons.” [note, he improved the defence further in response to Krugman here], but I think we need to go a step further and ask “how could we have been past some long term potential output before”?  In truth we need an explanation that works for why potential rose and why it fell that uses the idea of wealth.

In order to understand why potential may have risen then fallen we need to ask what factors were influencing the expectations of individuals so that they supplied too much labour/invested in too much capital.  We can’t just say “they consumed more” because without the ability to produce we consume more by borrowing and importing – which leads to the increase in consumption and imports canceling out in GDP.  We need a reason why production, output, GDP, was higher.

For this we need to rely on expectations.  Start with the drop.  Suddenly wealth is lower – wealth is the stream of returns on an asset, in the aggregate sense it is the discounted sum of expected income/output that is expected in the economy.  A drop in wealth here suggests that peoples expectations of future potential output have fallen – for better or worse.  As a result, your expected return on investing is lower – whether that be in skills for work, or whether it be capital in your job.

On the other side, suddenly wealth expectations are higher.  Income now has a greater expected rate of return in the future, you are more willing to invest now.

There is a case to be made that, if the rate of return is higher now, you will be willing to invest in order to reap the benefit.  Furthermore, you would be willing to supply more labour in order to achieve the capital gain (a return) associated with those “higher house prices” in the future.

If your wealth expectations suddenly fall, you are not willing to invest as much in the future, as the expected real rate of return is lower.  You are not willing to work as much given that the return on savings will be lower.  As a result, “potential output” would have declined.

Note:  You could in turn read these the other way around, it depends on the magnitude of “income” and “substitution” effects from the change in the expected real rate of return in the economy.

Note 2:  This is an entirely supply based argument, as it is about potential output.  Potential output is the “supply” notion of the economy, while many of the other cyclical issues we discuss are “demand” based.

Sidenote

These shocks exist for any view of “potential output”.  And this doesn’t mean potential isn’t a useless concept – it just means that maybe there is a more solid variable we can use to tell us the same thing without the confusion.

Conveniently we measure the UNEMPLOYMENT RATE, and we have a relatively clear and fixed idea of what the natural rate of unemployment is.  As a result, the gap between these two is a lot more useful to look at when trying to ascertain whether we are below or above potential IMHO.

Update:  Scott Sumner discusses why this doesn’t make sense for the US.  However, I think it is a partially workable argument for NZ given the inflationary pressures we were experiencing, the high participation rate, and the amazingly low unemployment rate all prior to the crisis.

Matt Nolan

Australia and New Zealand in monetary policy

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Sorry for my lack of posting recently, my high level of disorganisation is taking its toll at what is quite a busy time for some reason.

As a result, I will post today with a comment I wrote somewhere else – hopefully, one day I can do a real post on this issue 😉

Over at Money Illusion Marcus Nunes links to an interesting post comparing monetary policy outcomes during the GFC between Aussie and NZ.  One conclusion is that, during the GFC both central banks did some good work – but Aussie was better (from the market monetarist standpoint).

I stab down a reply stating that I think this is unfair on the RBNZ.  I list some reasons why and discuss.  Key points are:

  • I think that the potential output gap suggested are wrongish,
  • In per capita terms the divergence is much weaker,
  • Australia had more of a TOT boost – which needs to be taken into account in this framework,
  • New Zealand suffered a myriad of other “supply side shocks”, which even in the market monetarist framework are expected to lead to an ex-post deviation from trend even with an optimal central bank,
  • If we stretch things out for the latest data, and look in per capita terms, the RBNZ appears to have got us back to this “trend” once we were finally free of the effects of drought, earthquakes, and regulatory changes.

The one argument I can see pulled out against the RBNZ is the same one being pulled out about the BOE – that they changed the structural framework in banking without compensating for any current drop in money supply indirectly linked to this change.  However, even this is a bit rough – given the high level of uncertainty about the impact of those structural changes … in essence “ex-ante” they will have been taking this into account (they were saying it), the impact may have just been larger than they reasonably expected.

Matt Nolan

A society of Entrepreneurs?

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Is that the future of the labour market, a myriad of “self-employed” entrepreneurs offering services in order to gain income – income that creates a claim on resources that are largely created by capital/machines.

This is what the “three laws of future employment” at new geography suggests to me. (ht Marginal Revolution) .

The laws are:

  1. Law #1: People will get jobs doing things that computers can’t do.
  2. Law #2: A global market place will result in lower pay and fewer opportunities for many careers. (But also in cheaper and better products and a higher standard of living for American consumers.)
  3. Law #3: Professional people will more likely be freelancers and less likely to have a steady job.

Where does this come from?  Say that a lot of the fundamental things we consume, both in terms of manufacturing and primary goods, can be mechanized extremely cheaply – with virtually no labour input.  In that case, investment in the machines and their maintenance is extremely valuable – and owners will as a result be willing to pay a significant sum (in terms of resources) to those who in turn look after the machines.

If only a very small number of people are required to look after and build the machines, then the rest of society has to move into roles where they do one of two things:

  1. Serve a secondary market of people without access to capital – say making food for their own small group of people, or making clothing.
  2. Offer a service to the owners of capital and the group of people who are looking after it.

In that case, there is likely to be a very very large service sector with a small base of labour manufacturing and primary production that is very productive/capital intensive.

Now why would we expect entrepreneurs, why wouldn’t we see massive scale in the service industry like we have in the other sectors?  Well, generally, services don’t fit the “scale” model – economies of scale do not exist in service industries, and as given the value of heterogeniety in the service industry the flexibility of small firms/entrepreneurs would be vital.  Lets not forget the internet either, which has reduced the cost of entry into service industries and increased competition.

In a situation where capital is very heavily concentrated (both in terms of physical and human capital – given that a small number of people in the service industry will also have significant talent and be able to extract far more rent than others), I see a role for significant redistribution and a minimum income in this type of environment.  As the constraint of scarcity is loosened, the idea of having a government to help ensure a minimum standard of living really becomes more important.  The question is, how far along that road are we now?