Matt Nolan

New RBNZ PTA

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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.

Matt Nolan

Reframing the monetary policy debate: Some notes

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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:

  1. The RBNZ needs to help exporters – as other countries are helping exporters
  2. The RBNZ is to blame for our “persistently high exchange rate”

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 😉

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Matt Nolan

The cost determines the rule: Monetary policy

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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

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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

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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.

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Matt Nolan

Price discrimination based on gender: Sexist or fair?

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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.