Matt Nolan

The cost determines the rule: Monetary policy

/1 Comment/in /by

This is a good post on optimal monetary policy by Scott Sumner.  He says the following:

I’ve often argued that the supposed “welfare costs of inflation” are better thought of as the welfare costs of volatile or excessive NGDP growth.

It is good to see this assumption shown transparently – if this is indeed the case having NGDP targeting as optimal policy makes sense.

I don’t believe output is trend stationary, I don’t believe optimal output grows at a stable rate.  As a result, I support flexible inflation targeting.  However, if I’m shown otherwise I’d be happy to switch camps – this is very much the old “level” vs “growth” debate.

Obviously if you think the CPI is a good proxy for the welfare costs of inflation, then inflation is likely to play a role in your optimal policy rule.  And if you think (as George and I do) that NGDP is a better proxy for the welfare costs of inflation then NGDP may play a role in your policy rule.  That’s just common sense.

Indeed.

We aren’t yet at the stage where mathematical models can show which policy is best.  We simply don’t know enough about the welfare costs of inflation

This is true – we still can’t derive the true structure of the economy and work out optimal policy.  This is something that is unlikely to happen, and part of the reason why economists use a lot of partial rules to try to understand what is going on.

Soctt goes on to criticise mathmatical modeling.  This is the bit I disagree with.  We do need to be more transparent about where the “costs of inflation” come from, but I would say this is the reason to make sure we build more, transparent, models so that we can clearly articulate different assumptions.  Yes we should be able to describe these in words, but maths gives us a concise way to frame and compare these issues.

Matt Nolan

The upcoming PTA

/in , /by

With Graeme Wheeler set to take over as RBNZ govenor on the 26th of this month, it is clear that a new PTA will be signed.  Westpac did an excellent piece discussing this.  I’d suggest reading it.

Some key points I took out (and agreed with, so was easy for me to pick them up 🙂 ):

  1. If anything changes it is likely to be along the lines of “credit growth” – increasing discussion of credit growth by the Bank, as well as outside it, makes this plausible.
  2. Large scale adjustments to the PTA, or functioning of the Bank, from what they are currently looking at are unlikely.
  3. The Act doesn’t set the tools – just the mandate.  Related point – the Bank has been researching macoprudential tools for a long time now, and will understand how to use them in context.
  4. Using multiple tools in a “cyclical” manner will make policy more difficult to understand and more complex.

For me, the last point is pretty essential and there is a lot of debate around it.  I’m still not a fan of the concept of discretionary countercylical macroprudential tools – when we start going down that round we are assuming we have a lot more knowledge about the macroeconomy than I believe we actually do as economists.  However, we will see – and research will keep being done that will help to improve policy and the communication of policy (which is an incredibly important thing) over time.

If only we had the same transparency with fiscal policy.

Matt Nolan

Five W’s, an H, and an E: The method of economics based on primary school techniques

/in /by

I remember when I was a 7 year old sitting around at Kio Kio school and the teacher pulled out the five w’s and an h:  Who, what, where, when, why, and how.  They were repeated constantly, and we were told that these were questions we should repeat all the time.

Now at 7, we were a bit young to understand the gravity of these questions – and no doubt it merely led to annoying situations for our parents.  However, as Wikipedia informs me this is a method of teaching to primary school students – and as I inform me, this is a great way for understanding economics.  So let’s use them.

There are two ways we could use the wh method to understand economics – we could ask these questions about economics, or we could ask how economics deals with these questions.  I’m going to do the second.

Read more

Matt Nolan

Price discrimination based on gender: Sexist or fair?

/6 Comments/in , /by

I see via Stuff that women have to pay more for haircuts.  This is true – in fact there are a number of service related areas where the woman’s version of that service costs more than the man’s version.  Undeniably, we are seeing price discrimination at work.

Now I’m not terribly against price discrimination – if the price discrimination is taking place based on a freely obsevable factor such as sex, then the outcome is efficient … and to be honest, price discrimination is going to become a larger part of our lives over time.  Now this doesn’t mean its fair, or unfair … in order to understand that we have to apply a series of “value judgments” about fairness.

Let’s look at the example of haircuts.  It is true women are charged more than men.  This happens due to women, on average, valuing the service more than men and generally being “less responsive” to the price.  Furthermore, even for the same haircut for a man and a woman, the service offered is not the same – not just because the women values the haircut subjectively “more” but because the physical service that is offered is usually different.

The hairdressing industry is an interesting one as well, it is hardly a place where “competition” issues exist – there are hairdressers everywhere.  As a result, a hairdressers ability to charge a premium above cost is severally limited – although it is the case that women value a haircut more than men, the very competitive nature of the hairdressing industry and the existence of a price gap seems to indicate that the “haircuts” a woman gets costs more than the haircuts a man gets.

If this is the case, I struggle to see how we could view this as unfair.  If we were to “ban” such price discrimination based on sex male haircuts would have to cross-subsidise womens cuts – to me this sounds like much more sexist pricing.

There is also the issue of choice.  Say that, somehow, all the 100 million hairstylists in Wellington were able to inforce an OPEC type relationship – and thereby collude on the price of haircuts to women.  I don’t understand what is to prevent:

  1. Entry of another hairdresser – the fixed costs seem reasonably low.
  2. Women going to a mens barber – a lot of mens barbers in Wellington wouldn’t care … if you were getting the same cut as a guy

I think this specific example shows how careful we have to be about criticising “price discrimination”.  Such discrimination is often a good thing – even given its negative sounding name.

 

Matt Nolan

QE3: Forward guidance, debt purchases, unemployment target

/1 Comment/in , , /by

As expected, the US Federal Reserve announced QE3 early this morning NZ time.

In the statement, they commit the the purchase of mortgage debt people expected (carrying on for an undefined period of time), they state they will keep the cash rate exceptionally low until at least mid-2015 (which was anticipated) – but they also say they will do more unless they get traction on the labour market.

This is reasonably significant.  They are fully testing their view that there is no structural problem in the labour market (which is empirically supported) and are banking on the idea that easier monetary conditions, combined with a credible commitment on the labour market will lead to households and firms finally bringing forward consumption and investment.

This makes more sense than prior policy.  The constant forecasting of “failure” in monetary policy in the US led to policy that can be seen as insufficient – the Fed was treating the risks of inflation (and thereby the outlook for the domestic economy) asymmetrically – obviously Woodford’s speech had an impact (although the projections still have a pretty slow improvement in the unemployment rate – would need to see employment rate forecast to really get a feeling for what they mean).

It may also be seen as reinforcing the view of market monetarists (eg Sumner) that the Fed’s expectations have a significant impact on expectations of real economic and labour market activity within the cycle (at least in response to large shocks – possibility of multiple equilibrium.  Note:  They wouldn’t see it the same way.).  This is a view I would like to see in more detail (eg what sort of expectations does this rely on, and what sort of conception of the real rate – are they are artifact of current monetary policy settings).

Although this is encouraging – when looking over here in NZ it is the European debt crisis that is impeding growth.  Yes, a stronger US economy will support growth in Asia and NZ helping remove large scale risks – but the European debt crisis continues to have a separate impact on NZ that is binding.

Update:  Having a read around on the piles of good sites discussing the issue, I ran into this post via Money Illusion.  Now, doesn’t this scream multiple equilibrium to you?  To criticise the Fed for rates being low and indicating a weak recovery, we need to blame the Fed for the drop in the natural interest rate – this has to imply that the Fed either created uncertainty, or is so far away from their mandate we’ve fallen into a “suboptimal” eqm.  You cannot blame the Fed for exogenous shocks (which you’d normally pin this on), so there MUST be an implicit multiple eqm argument behind NGDP level targeting – I find it conceivable, although potentially hard to test empirically … can someone send it to me please 🙂

Update II:  Good point from Scott Sumner:

In addition, they did move closer to level targeting, something I didn’t think was politically possible:

(Fed statement) To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

What’s changed since June?  That’s pretty easy to answer; Woodford’s paper was obviously very influential, and that changed the politics on level targeting.

This is still consistent with flexible inflation targeting at the ZLB.  Of course, NGDP level targeting and inflation targeting share a lot of similarities – and to be fair, NGDP level targeting would be more transparent when faced with the ZLB problem.  In net terms I’m still a flexible inflation targeter – as the benefits of a predictable price level ex-ante from a point in time seem significant, and best served by doing that directly (through inflation targeting).  Of course, if the facts at my disposal change I’m happy to move around 🙂

Matt Nolan

BERL report on changing the PTA

/12 Comments/in /by

I tend to avoid criticising other economists, especially inside New Zealand.  However, the BERL-NZ First report into inflation targeting has crossed a threshold where I feel saying nothing would be more inappropriate than voicing my disagreement.

I have discussed the issue on my work website here.  In that article I solely discuss the idea of hot money – and how they don’t properly articulate the idea that someone in NZ has to borrow the money, and that this is a key factor to try and understand to figure out where any “failure” is.  However, there are several more issues I have with the piece:

  1. The alternate rule isn’t actually defined in the article – this makes it hard to analyse.
  2. Having inflation expectations anchored doesn’t mean ditching inflation targeting is costless – changing monetary regime will unanchor inflation expectations!
  3. The credit figures quoted aren’t inflation, or asset price, or GDP, adjusted – they are all just in current prices, and so exagerate everything.
  4. The rule the RBNZ sets for setting the official cash rate is endogenous with the economy – as a result, you can’t really say “the interest rates are too high”, instead you need to ask what core economic drivers are making it so.
  5. Monetary policy is cyclical – when any fair reading of the evidence suggests that, if there is a problem, it is a structural one that is independent of this (I expect this point, and the one before, to be a bit more contensious – even though they are relatively mainstream).
  6. The costs and benefits listed are relatively partial and don’t seem well considered – they should also be compared through models and evidence rather than ad hocly thrown around.
  7. Insulting “mainstream economists” is douchey … seriously, they are CGE modelers, they often use mainstream economic methods.

Feel free to rant about how I’m part of a “mainstream conspiracy” or that I’m only doing this because they are “competition”.  But no matter what, my core belief here is that structural issues in the New Zealand economy need to be researched, and sensible changes to fiscal, financial, and competition policy should be made where appropriate.  Ill informed changes to monetary policy and the PTA are not a silver bullet, and are very likely to be inappropriate.

Update:  Paul and Eric also discuss.  So does the ODT.

Bah:  Article link is being a punk.  Here it is in any case:

 

Read more