The always awesome Saturday Morning Breakfast Cereal (SMBC) popped this comic up.
The thing is, when I saw the first panel the first question that popped into my mind was “nominal or real dollars” – the amount I ask that, all day long, is ridiculous. These things are always best when they are relatively true …
Oilprice.com has a good interview with James Hamilton from Econbrowser up on their site. I’d suggest taking a look 😉
As will one day become clear, one of the big drivers of the slowdown in the developed world has been the sharp increase in commodity prices – specifically oil. While the global financial crisis was a major driver, it is also possible to make the case that part of the reason for the run up in debt was an assumption by households and individuals that the lift in oil prices would be temporary – when in fact it looks like it is a relatively persistent shift up.
As stated here:
James Stafford: Whenever oil prices spike politicians are quick to blame speculators and oil companies for manipulating the markets. Are you in agreement with this – are speculators and oil companies to blame? Or are there other factors that are overlooked deliberately or otherwise by the mainstream media?
James Hamilton: The story is pretty simple, and even though politicians may try to distort it, you’d hope that the media would do a better job of reporting the truth than they have. World oil production was basically stagnant between 2005 and 2008, even though world GDP was up 17%. With economic growth like that you’d normally expect increased demand, particularly from the rapidly growing emerging economies, and in fact China did increase its consumption by a million barrels a day over these 3 years. But with no more oil being produced, that meant that the rest of us– the U.S., Europe, Japan– had to reduce our consumption. It took a pretty big price run-up before that happened. To those claiming the price is too high, I would ask, how high do you think the price had to go to persuade Americans to reduce oil consumption by a million barrels a day?
We have seen demand rising (on the back of increasing productive capacity in the developing world) while supply has stagnated. Many times people have told me “there is heap of oil lying around” – and this is true – but the question is, “what is the cost of extracting this oil”. Even some of the most optimistic people say that we shouldn’t expect oil prices to fall below $70US a barrel in current dollar terms.
The big saviour will hopefully be technology – higher prices drives the incentive to find substitutes. However, that doesn’t stop the intervening period being painful.
For anyone that has been looking at posts over here, or carefully listening to Reserve Bank speeches, the topic of the real exchange rate is an important one for understanding the New Zealand economy. Many of the “concerns” or “issues” being raised at present are really just a function of some view of the real exchange rate.
Via the RBNZ we have a graph of the real exchange rate (RER) here:
Now this drives the question, what has caused the change in the real exchange rate – what shocks have we experienced that have pushed it up, and what proportion of the increase was due to these shocks. Chris McDonald at the Reserve Bank decided to have a go at answering that question. With so many factors driving the dollar, “causation” is hard to appropriately appropriate between causes – and so his primary focus is on the correlations and their magnitude, albeit within a framework that will help to show what the more important drivers are. So what is his conclusion:
- International factors relevant to New Zealand explain more (60 percent) of the exchange rate variance over our sample than idiosyncratic and domestic factors.
- The most important international factor is likely to be export commodity prices, though our empirical analysis is not conclusive. For instance, high commodity prices can explain why the exchange rate is at current high levels. But, high commodity prices may be partly a result of current low foreign interest rates.
- The best domestic indicator for the exchange rate is house price inflation. While this indicator also reflects international factors, its movements over and above the impact of these appears to capture some key domestic information for the exchange rate.
Now this doesn’t tell us anything about the key issue of the New Zealand dollar being “persistently overvalued” or not. But it does indicate the commodity prices have been a major driver of the increases we have seen. On top of that another interesting point was raised:
The RER response to the other domestic shocks suggests some of them may not be well identified. Notably, an unexplained fall in the 90-day interest rate and an unexplained fall in the output gap both have little impact on the RER. Practically, we expect these shocks to cause quite large movements in the RER. However, once we allow for the correlation of these variables with the international and New Zealand real house price inflation variables, these shocks (despite being not so well identified) have a relatively small impact on the results.
So within this decomposition, the impact of a monetary policy shock (change in 90day bill rate) or exogenous change in AD (fall in output gap) are poorly identified – and seem to have little impact on the RER. The author believes thsi result doesn’t pass the smell test, which is fair enough – after all the author has the best knowledge of what their empirical model is saying (especially since no empirical results are included). However, if we were to take it at face value it would suggest that the RBNZ’s ability to actually change the RER with monetary, even in the relatively short term, is limited.
It appears that much of the media (some parts excluded) wants to make the discussion of monetary policy a titianic battle between opposing forces – rather than informing the public of the trade-offs that exist, and the issues that are currently being looked into.
There are two issues currently being debated – only the first one has been influenced by to the financial crisis (although it was an issue that was being looked into well prior to the GFC):
The “orthodoxy” in New Zealand has been discussing these issues and trying to improve policy the entire time, in fact there was nothing wrong with the instituional settings we had in place through the Reserve Bank (hence why the PTA was little changed) – many of the problems that have occurred are to do with other things … and many of the “issues” that are being raised are in fact fallacies that show a fundamental confusion about the issue in the New Zealand context (such as the constant confusion about the nominal and real exchange rates, or the view that QE creates a “prisoner’s dilemma” between central banks).
If we had more articles like Brian Fallow’s, that aim to discuss the issues and ideas involved, instead of the type ideological drivel that often appears, we might be able to have an adult discussion on how to genuinely improve outcomes for New Zealanders.
The new policy targets argreement is out today. What have we got?
For the purpose of this agreement, the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint.
Oww I like this – actually stating the the implicit target IS 2%, not somewhere between 1-3%. Improvement for sure.
In pursuing the objective of a stable general level of prices, the Bank shall monitor prices, including asset prices, as measured by a range of price indices. The price stability target will be defined in terms of the All Groups Consumers Price Index (CPI), as published by Statistics New Zealand.
I can understand including asset prices/credit growth in the PTA – its inclusion here seems a bit strange though. Note that it is still only saying “look at how asset prices/other price indicies can forecast future growth in CPI”. This change is on the face of it small, but maybe they see that the inclusion of asset prices itself could give them more scope to discuss it in statements.
In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate.
Explicitly mentioning the Banks implicit role as the lender of last resort and as responsible for the stability of the financial sector. I always felt that we should have “two PTA’s”, and “two institutions” to split these roles – but having it explicitly mentioned is an improvement. Now, in this context it is still seperate from monetary policy – so the financial stability reports and monetary policy statements will continue to focus on seperate things.
In the news release with the statement:
Mr Wheeler also emphasised that the macro-prudential policy tools currently being developed by the Bank should be separate from, but complementary to monetary policy. “The primary purpose of such tools will remain to promote stability of the financial system.”
Excellent – as it helps to improve the clarity of communication, which helps to guide expectations.
“In addition, the PTA’s stronger focus on financial stability makes it clearer that it may be appropriate to use monetary policy to lean against the build-up of financial imbalances, if the Reserve Bank believes this could prevent a sharper economic cycle in the future.”
I don’t really like this comment much – and I would say there is no consensus about whether such a comment is appropriate at present … namely the linkage between monetary policy in of itself (apart from other regulatory tools) and financial stability is highly debatable.
However, I gave my view of it to Alex from Rates Blog:
It is a sticky comment – but I would interpret it along with the fact that macro-prudential and monetary policy tools are complements. As a result, the full impact of both monetary policy decisions and choices on macroprudential policies will be taken into account when ensuring that the financial system is sufficiently “stable”.
It is the comment I’m least happy about, as it is the issue that is likely to cause the most confusion, and where we have the least understanding – however, their determination to keep “communication” of the issues separate solves most of the problem I have with it. After all, monetary, fiscal, and financial stability policies are all “complementary” in some sense – they all require co-ordination – and they should all focus on clear goals.
It’s one of those things where we won’t actually know whether there is any effective change until we see him in action – the December MPS will be interesting. In of itself, this PTA is more “hawkish” than the previous one – both changes (2% target, focus on financial stability) imply tighter financial conditions over time IMO.
Update: Bernard Hickey comments.
Update: Given all the links in this post, I’m adding it to the rarely used “inflation debate” tab. An area where I rant incoherently about monetary policy in a way that is aiming to help this debate – rather than just be critical.
From what I can tell, the current debate about monetary policy taking place in the public makes little sense. While I am sure we all mean well with our opinion pieces, the issues, the problems, the causes, and the tools aren’t really being discussed in a way that someone with an open mind can sit down and look at. Sadly, I lack the time – and probably the ability – to give this a fair go. As a result, instead I will just list down some things we need to keep in mind here.
David Parker has recently said two things which he used to justify the RBNZ scrapping inflation targeting, and moving to targeting a bunch of stuff:
I discussed a similar post of his earlier. But right now, I want to state that neither of these things is really true – I can 100% understand how someone could come to believe this given what we see going on around us. However, they aren’t facts – they are fallacies.
Note: He does mention “protecting financial stability to help exporters” – this statement doesn’t make sense. The RBNZ does focus on financial stabilty in a seperate role, and with seperate tools – a role that is related to, but seperate from monetary policy (just like fiscal policy). In none of this is, or should, the RBNZ look at a certain sector in NZ and say “we’re giving you stuff” – that is just wrong.
Sidenote: If you say “but helping exporters with monetary transfers helps all of us” I will laugh – if NZ goes down that path, I look forward to having my views vindicated in 20 years time 😉