Matt Nolan

An excellent primer on NGDP targeting

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Via Scott Sumner comes the following primer on NGDP targeting.

Its a cool little explanation of the benefits, and the functioning of monetary policy – specifically through expectations.  I also appreciated that Hayek was mentioned – Hayek was a fan of the nominal income rule, a fact many people don’t realise given belief that NGDP targeting is “left wing” and Hayek is “right wing”.  Economists are never as simple as we like them to be 😀

As I’ve said before I don’t agree with NGDP targeting for NZ at the moment.  I see NGDP targeting vs flexible inflation targeting as akin to the level vs growth targeting – and I’m still on the side of rate of change targeting.  However, it is an area where I could easily be turned around … and if NZ was to introduce NGDP targeting I wouldn’t suddenly get all wound up and talking about it being the end of the world, I would assume that we were following the policy rule because our view of what target best represents “good policy” has changed.

For those wondering, if you target a “level” then previous “policy failure” counts – in a NGDP targeting framework, changes in the terms of trade (for example) will be picked up as policy failure in a way that would elicit a response when they “shouldn’t”.  This is why I prefer inflation targeting based on a clear version of inflation like the dynamic factor model the RBNZ has.  However, even in this case we may decide that nominal income growth is a better target than price growth – that is an issue I’d like to spend more time thinking about.

A big thing for me is that we stick to a time consistent rule, instead of falling into the trap of thinking we can hide taxation through central bank actions 😉

 

jamesz

Invalid opinions

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IF you follow the econ blogs in New Zealand you’ll have seen Matt and others getting pretty grumpy about the uninformed comments sometimes made in the media. That has only been exacerbated by the recent misunderstanding of quantitative easing. A philosopher writing in the Herald sums up how I think economists feel:

If “everyone’s entitled to their opinion” just means no one has the right to stop people thinking and saying whatever they want, then the statement is true, but fairly trivial. …But if “entitled to an opinion” means “entitled to have your views treated as serious candidates for the truth” then it’s pretty clearly false… [because it] implies an equal right to be heard on a matter in which only one of the two parties has the relevant expertise.

Economists are technical experts but work in a field that affects everybody’s daily lives. So, much like doctors, they have to cope with everybody thinking they’re an expert without a shred of real knowledge. And, just like in public health debates, credence is given to groups who have an opinion but no expertise. Understandably, economists get frustrated!

However, we need to be careful where we draw the line between those with expertise and those without it. Read more

Matt Nolan

Data is data is data

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I was impressed to see Geoff Bascand, the head of Statistics New Zealand, come out in defence of the labour market data – specifically the way unemployment and underemployment are calculated.

It is true that the labour market data jumps around, and that what it defines might not be exactly what everyone trying to use it “wants” – but Statistics New Zealand is transparent about what they are recording and the shortcomings, and then a lot of this data is available free for us to help us make informed decisions.  How is that not awesome?

Lets be honest, we can’t accurately measure the exact thing we want in the social sciences – we are always working with incomplete data measuring something that is only related to the variable we are positing theories about.  Instead of complaining about it we just need to recognise that we need to use clear and consistent theory and logic to help us accurately use the data that is available.

Instead of complaining about the data – as many people who write on blog and in comment sections do – lets try to understand what is being measured, how that relates to what we are trying to discuss, and then use that to have a useful and open discussion about it.  Just because the data doesn’t fit your preconceptions doesn’t make the data wrong – either your interpretation of the data is wrong, or your theory has issues 😉

Matt Nolan

No QE “free lunch” for NZ

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As a general rule of thumb, whenever someone offers you something for nothing they aren’t telling you the full story – and that is exactly what we have with the Greens stating the Reserve Bank should start rebuilding Christchurch themselves by printing money.

Now, in order to come to this conclusion a bunch of points are being mashed together.  So in order to understand what this entails, and why does it in this way isn’t the best way forward, we need to have a think about what such a policy really means by splitting it into “monetary” and “fiscal” policy.

Monetary policy, fiscal policy

Having the RBNZ buy up a bunch of government debt which has been taken on to rebuild Christchurch works through two channels we need to think about distinctly:

  1. Monetary policy – by “increasing the money stock” in this example, they are loosening monetary conditions.
  2. Fiscal policy – by getting the RBNZ to go and fund the rebuild by printing money, we are in essence transferring resources for the rebuild.  They don’t appear from nowhere.

Now here Ganesh Nana states that he thinks RBNZ monetary policy is distinctly wrong – and that we will face deflation.  If that is the case, they should cut interest rates first.  However, he may believe that there is even more risk than that, and that cutting rates towards zero AND putting in place QE is required.  Viewing QE as a form of monetary policy this could make sense.

But, this is far from the consensus view, it is a long way away from households and firms expectations of what we will experience (which determine much of what usually happens with inflation) – and it is far from the way the Greens described it.  In truth, the RBNZ has policy about where it should be – and if it should be looser then it probably shouldn’t be by much.  As a result, we cannot use the monetary policy argument … and QE will increase inflationary pressures.  So from here, I’ll assume that the RBNZ is currently meeting its inflation mandate – a view that is held up by the evidence.

Russel Norman is completely misrepresenting QE by saying that the recent crisis is “evidence it isn’t inflationary”.  QE was put in place to fight the fact that policy was too tight overseas, and they were trying to fight deflation – in essence the fact that inflation stayed near the “target band” in these countries is evidence that QE is indeed inflationary as you would expect … just in the way they were intending.

Fiscal policy

Furthermore, choosing to do QE that is premised on an extension of government borrowing funded by the RBNZ is different to what is being done overseas!  Overseas, much of QE has been the Fed buying existing long-dated Treasury bonds from the private sector.  They haven’t been “financing deficits” persee per se, they have been trying to increase the amount of high powered money in the general economy.

The form of policy being suggested by the Greens is effectively full scale fiscal policy being fully accommodated by the RBNZ, or monetizing debt – it is saying that the government will borrow and the RBNZ will then print money to pay for it, thereby increasing inflation as a tax to pay for it.  Resources do not appear from the ether – no matter how many people inside and outside New Zealand want to pretend this is the case – this is a straight transfer of resources towards rebuilding in Christchurch and away from other places.  [Note:  This view comes from the presumption that the Greens are saying the RBNZ should buy the bonds and then write them off – if the RBNZ is just holding the bonds and expecting repayment, then you are still running a “deficit” it is just being hidden on the RBNZ’s balance sheet instead … in this case we are again easing monetary policy, we have a larger deficit which will need to be paid for with future taxes, and given monetary policy is currently sufficient this will lead to excess inflation].

Now you may believe we should fund the rebuild with a one-off tax – that’s fine, in that case get the government to put a tax in place directly (or to directly cut spending from other place).  However, taxation by stealth of this sort is likely to be worse in multiple ways:

  1. We have betrayed RBNZ independence for virtually no reason … understandably a sneak tax by the RBNZ would make people less likely to believe them in the future about holding to their inflation mandate.  As a result, we run into the time-consistency issue in monetary policy again, and it will become more painful for economy when the RBNZ tries to commit to its inflation mandate again.
  2. We have a relatively rough redistribution of resources due to this.  By putting in our sneak tax through QE, we transfer resources to those with assets, those doing the rebuild, and those who can easily adjust prices/wages – while hurting those on fixed income, and those who have saved.  It is an inflation tax – pure and simple – and as a result, it will initially transfer resources from those who can’t protect themselves (generally the poor) to those who can (generally the rich).  If we introduce the tax through fiscal policy instead we can sort out these distributional issues a little better.
  3. A country that is willing to introduce QE as a clear fiscal transfer – when there is no monetary policy reason – will destroy its credibility with international lenders.  People will scoff at this, but such a policy will increase the level of “inflation insurance” lenders ask for – increasing the cost of credit in New Zealand.

These are obvious and true costs, that have been seen from similar policies around the world for hundreds of years.  QE really isn’t anything new, and if we want a fiscal transfer of this sort just say it (as the Greens previously have to be fair), and do it through fiscal policy – it has nothing to do with the RBNZ.

But the exchange rate, it will get that down!

The constant banging on about the exchange rate and the RBNZ shows a fundamental misunderstanding of the “issues” NZ faces.

The Greens, and Ganesh Nana, are wrong in stating that the RBNZ has failed.  Distinctly and totally wrong.  Things like this:

”No system of monetary policy is perfect and New Zealand cannot remain the last devotee to a failed monetary theory while the rest of the world moves on,” Norman said.

Paint a complete and utter misrepresentation about the lessons from the Global Financial Crisis.  Our flexible inflation targeting framework saved us from a massive crisis at home – while the rest of the world fell apart.  We have learnt that there are issues of financial stability we should have looked at – issues we have discussed for a while – but this is definitely not a reason to start “fine tuning” the economy through the RBNZ.  That is exactly what Labour, the Greens, and NZ First are trying to do … and its something that has been shown time and again as folly!

We can easily make the case for the exchange rate having been persistently too high – the key word there is persistently – and the key point that comes out is that, as a result, our real exchange rate is too high.

The high real exchange rate is not due to monetary policy – which is cyclical in nature – it is due to persistent structural factors.  Things related to government policy and competition policy.

The confusion stems from the fact that the combination of the current nominal exchange rate, inflation rate, and nominal interest rate are the indicators that move around with monetary policy.  They do, and they tell us things about the stance of monetary policy – but the RBNZ only makes up one part of the determinant of these factors.  The RBNZ works to achieve its inflation mandate while other institutions in the economy run around and do what they do.

So what happens to the real exchange rate when we print money to do some building in Christchurch?  Well if this activity persists it will likely go up as we are funding more government activity through an “inflation tax”.  If it is indeed a one-off tax, then the outcome is more uncertain.

Lets stop dwelling on the exchange rate like it is some shackle holding us back, and that we have a silver bullet to shoot it down.  The macroeconomy is not, and never will be that simple.  Instead lets us “why” NZ keeps running current account deficits and why our discount rates are so high – is it because we treat investments differently, is it because we have higher growth expectations, is it because government spending is too distortionary, is it because we have issues with competitiveness in the non-tradable sector, is it because we are naturally impatient people?  The one thing we know, is that it is not because of monetary policy – that does not follow.

Conclusion

To summarise I’m saying:

  1. We don’t need QE in NZ, as we have enough monetary stimulus (and if not we can cut interest rates further).
  2. What is being suggested isn’t even QE – its the monetization of government debt, effectively a inflation tax to pay for the rebuild in Canterbury.
  3. It is unlikely that such a tax is the “best” way of raising the revenue to rebuild Christchurch – which should be the primary question.

This is the main gist of what is going on here.

Matt Nolan

Outsourcing competence

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So it seems that Stuff has decided that now it’s outsourcing its journalism to the public, it might as well try to do it with other people’s discipines as well – that combined with not knowing what economics is has led to the question “how do we fix the economy” 😉

The first solution has been released, and in true communist/NZ Inc style thought the solutions boil down to saying people shouldn’t be allowed the things they actually want and picking winners.

Now to be honest I do not blame the author of the piece – he was doing exactly what was asked of him, to frame the economy in the way he wanted it to be.  To “fix” the ways that the economy wasn’t doing what he values.

But that isn’t the way social groups should work.  We aren’t a dictatorship, we shouldn’t have a body of “enlightened individuals” telling us how and what to consume.  The fact is if households are willing to sacrifice other opportunities and income to live the “kiwi dream” they should be allowed to.

Goals such as “catching Australia”, being “more productive”, battling perceived “inequalities” of somethings – these are arbitrary goals that do not express the trade-offs we face as a set of people.  The real goal should be to create an environment where the individuals in society can make the best use of the scarce set of resources we have at our disposal, in order to satisfy their preferences.

New Zealand is not a machine, its a community of individuals – an economy isn’t something to be “fixed” it is a combination of institutions, relationships, and people … and any “issue” has to do with concerns about these relationships, not overarching goals to pick winners or tell people what to consume because, in our arrogance, we think we are smarter than they are.

Sidenote:  If Stuff does believe the economy can be “fixed” like a machine are they going to ask similar questions about physical disciplines – is the next assignment going to be “how would you cure cancer”, followed by “how would you build a perpetual motion machine” and “how would you derive the theory of everything“.

Update:  So after having a computer scientist say we should give up the kiwi dream and focus on IT in the first article, now we have someone involved in commercial and residential property saying we should cut interest rates and accept house price inflation to fix the economy.  Even as an economist, I find the level of blatent self interest surprising – and relatively humorus 🙂 .  Maybe I should write one in saying we need more economic research into the economy by economic consultants, so we can make more informed decisions and transfer resources to me … I mean and make the right decisions.

Update 2:  Wow, so we should ban people from below median income from borrowing.  Simultaneously violating the rights of those who are poor, and making it impossible for people to realistically smooth consumption over their lifecycle – and that is “assuming the best” and ignoring that it will lead to expensive black market credit for the poor, which will just make them worse off than they are now.

As well as illustrating how widely spread economic illiteracy, this exercise has shown me just how much people from every part of the political spectrum want to run other peoples lives.   And I don’t just mean economic illiteracy in the sense of not understanding the subtles of the literature – I mean economic illiteracy in terms of not understanding the basics of how other people in society are different and face different trade-offs.

Guess what, some people on below median incomes borrow because … they are fairly certain they will earn more in the future.  In fact if you look at the data that is where a large amount of the housing borrowing takes place, as you would expect if you had spent some time trying to understand the issue.  Such as by studying 100 level economics.

In fact the only reason I’m willing to publicly be so rude about this recommendation is that I find the treatment of consumers and the poor of this piece to be morally abhorent.  I don’t care who you are, if you attack the poor for being poor I have no time or patience to discuss your confusion with kid gloves.

Matt Nolan

An important warning regarding the monetary policy fine-tuning

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A recent opinion piece in the Herald, pitting Don Brash and Brendan Doyle in to debate the issue of monetary policy was good.  They seemed to agree that, ultimately, any issue is one of the real exchange rate – which is due to real economy factors.  A point I’ve heard a number of times before 😉

However, all this debate reminds me of a speech by Bernanke back in the day.  The choice quote:

Although a strict rules-based framework for monetary policy has evident drawbacks, notably its inflexibility in the face of unanticipated developments, supporters of rules in their turn have pointed out–with considerable justification–that the record of monetary policy under unfettered discretion is nothing to crow about. In the United States, the heyday of discretionary monetary policy can be dated as beginning in the early 1960s, a period of what now appears to have been substantial over-optimism about the ability of policymakers to “fine-tune” the economy. Contrary to the expectation of that era’s economists and policymakers, however, the subsequent two decades were characterized not by an efficiently managed, smoothly running economic machine but by high and variable inflation and an unstable real economy, culminating in the deep 1981-82 recession. Although a number of factors contributed to the poor economic performance of this period, I think most economists would agree that the deficiencies of a purely discretionary approach to monetary policy–including over-optimism about the ability of policy to fine-tune the economy, low credibility, vulnerability to political pressures, short policy horizons, and insufficient appreciation of the costs of high inflation–played a central role.

Is there then no middle ground for policymakers between the inflexibility of ironclad rules and the instability of unfettered discretion? My thesis today is that there is such a middle ground–an approach that I will refer to as constrained discretion–and that it is fast becoming the standard approach to monetary policy around the world, including in the United States

“Constrained discretion” is (arguably) very much the flexible inflation targeting framework we use now – the determination to “fine tune” is one that is coming out increasingly, and is based on an illusion of understanding and control regarding the macroeconomy (that and a few fallacious ideas of how things have panned out 😉 ).

No-one is arguing against having a further look at financial regulation, and trying to understand what has happened there.  However, this provides no case for messing around with the way the RBNZ performs monetary policy and the existence of a floating exchange rate – and in their determination to “do something” there are a set of politicians, journalists, and other analysts/economists trying to take us down a dark path.