Matt Nolan

RBNZ gives its frame for the debate on manufacturing and the exchange rate!

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Excellent.  The RBNZ has come out and discussed what is going on with manufacturing, what monetary policy can achieve, and the fundamental point that any “failure” stems from distortions in the domestic economy – not from flexible inflation targeting.

Globalisation, outsourcing, and international supply chains, along with competition from low cost producers and rising global demand for services, mean that the relative importance of manufacturing has been declining in all but the poorest countries for the past 40 years. New Zealand is no exception. Although the exchange rate is an important headwind for some manufacturers, the overall relative decline in our manufacturing sector is much more than a simple exchange rate story. Looking ahead, total manufacturing output is expected to increase significantly as a result of the NZD$30 billion Canterbury reconstruction.

There are no simple solutions available to the Reserve Bank on the exchange rate challenges we face. The causes of the over-valuation partly lie in the spillover effects of policies in countries most severely hit by the global financial crisis. The Bank will intervene when circumstances are right. We will use the OCR as circumstances require and we’re exploring the scope to use macro-prudential instruments that address increasing challenges to financial stability associated with ongoing increases in house prices, and that can also support monetary policy. But further efforts to improve the level and productivity of capital that labour works with, to reinforce ongoing fiscal adjustment, to re-examine the factors that diminish and distort the incentives to save and invest, and to reduce dependence on the savings of others, have to be a major part of the solution.

Unsurprisingly I agree with this heavily, and I’m really glad to hear these guys come out saying these things 🙂

I’ve been wanting the RBNZ to reframe the debate on monetary policy for some time.  And I’m also in agreement with the fact that manufacturing is shrinking (in a way akin to the agricultural revolution) and that this is likely to continue!

The Bank has written on, and heavily researched, all these things in the past – research that has helped me build a view that is no doubt similar to its view.  It is nice to see them come out and say it all directly … it also means that I feel more comfortable that I haven’t misinterpreted them in the past 😉

The one note of difference is that I am uncertain whether I believe in the slight tacit suggestion of a currency war here, something I’m not sure I agree with.  However, they may well be using a very specific view that there is currently a “bubble” in the NZ dollar.  If there has ever been a “bubble in the New Zealand currency” I suspect that the best case can be made around now – and they will have a much better handle on that than I ever will.

Matt Nolan

Neat example of the J-curve

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Japan is offering a neat example of the J-curve (short term violation of the Marshal-Lerner condition), showing that the trade balance may deteroriate following a sudden depreciation in the currency – due largely to the fact the volume of exports and imports takes time to respond to price signals (they are sufficiently price inelastic in the short term).

Japan’s trade deficit swelled to a record 1.63 trillion yen ($17.4 billion) on energy imports and a weaker yen, highlighting one cost of Prime Minister Shinzo Abe’s policies that are driving down the currency.

The increase in fuel imports due to the movement away from nuclear energy following the Tsunami – and the drop in Chinese exports due to the Senkaku Island dispute, and implicit embargo – are factors that have helped to drive a deficit overall.  But these recent movements, following a sharp depreciation in the currency after changes in expected monetary policy (the new expectation Japan may actually allow inflation above 0%), provide a new example of the J-curve in action.  A nice teachable moment for people that way inclined!

Matt Nolan

RIP Armen Alchian

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It was very sad to hear the Armen Alchian passed away today.

His views on the theory of the firm had a big impact on the profession, and on me as an individual.  I remember finding Production, Information Costs, and Economic Organization (pdf, summary) extremely useful as a student – it was probably the first paper to make me explicitly recognise not only that the firm was as a series of inter-related contracts, but that this process could be captured in a production function using typical marginalist analysis.  His work and clear writing has helped me and countless others to understand “what” a firm is and “why” it exists, which is a pretty awesome contribution to the world in my opinion!

Other regards:  Alex Tabarrok.  David Henderson.  Paul Walker.

Matt Nolan

On MMT: An ideology wrapped in a strawman

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Note:  PP on twitter asked for a post on MMT, and asked me to try to avoid making it technical.  I attempted to do that at much as I could – however, I was forced to use words like endogenous, as it was the cleanest way of trying to get across the point that by using supply and demand savings and investment are jointly determined … and the interest rate is set as the price.  The very idea that economists only think the causal chain goes only one way or the other is patently ridiculous – and does not represent economists, no matter how much people keep saying it does.  So try to keep that point in the back of your head until at least the end of the post if you read it 😉

I have nothing inherently against modern monetary theory, its proponents, or the value judgments involved.  But my impression is that MMT theorist view central bank independence and the framing of government policy as an ideological device to “shrink government” and so have decided to create a “strawman” mainstream economics to attack, rather than directly admitting they want a larger state (and the trade-offs involved in that).  For me this simply lacks transparency!

So how does MMT differ from mainstream economics.  Well in the words of Bill Mitchell (who I choose because he is clear, both here and on his blog – which is a good thing!) it comes from economists accepting three false premises:

  1. A government has to borrow to spend
  2. There is a fixed supply of savings at a point in time
  3. Governments crowd out investment for that fixed supply of savings, pushing up interest rates

Supposedly all three of these are in the core of economics, and they are all wrong.  Huzzah.

Ok, so if that is MMT then I’m not sure who in the world they are actually arguing with.  The government can print money, and this is in any graduate macro book, so that doesn’t hold as a premise.  Savings and investment are determined by supply and demand, they aren’t a “fixed thing”, so that isn’t a premise in mainstream economics (Sidenote:  Why do people keep saying “savings determines investment” or “investment determines savings” – I’ve never heard economists talk like this … remember the money multiplier is a ceteris paribus example, not a description of the causal device).   Crowding out is actually a premise – but it comes from government demand pushing up demand for underlying goods and services … because government demand for things is just like the demand of any institution.

Let me restate these premises in terms of what the mainstream actually has:

  1. A government can finance spending through taxation, selling bonds, or issuing money.  In the end, prices and expectations adjust such that someone pays for government consumption and investment.  More specifically the government has to match spending to taxes over time for a certain inflation target!
  2. Savings and investment are determined endogenously by demand and supply factors in the economy, where the “price” is the REAL interest rate (perhaps I should use the world natural/fundamental here) – as savings and investment are factors that are involved with transferring consumption (the thing we really want) over time due to technology, the rate of return on investment, our time preference, etc etc
  3. Additional government demand for goods and services will push up the price of those goods and services and push up the REAL interest rate in the economy … remember the real interest rate is a price, when the government is trying to push up investment of consumption this increases the demand for these given an underlying PRODUCTION FUNCTION, crowding out private investment and consumption … the real interest rate rises as investment/consumption demand has been pushed up and the lift in relative prices has to occur in a way that makes private agents defer consumption/investment in terms of the quantity of goods and services.  No amount of hammering the S=I identity in the face of fiat currency changes this 😉

These premises actually sound pretty good to me!

I remember my dad used to say “it isn’t money that matters when we think about people, it is the actual good and services that are made and consumed”.  He didn’t take the same point out of it I did, but I think on this statement he was right – we need to actually think about goods and services, capital, and labour here.

Now there are MMT people who claim they do (back to Bill again) – that they have a production function (which seemed to be a bit missing earlier) and they have a Phillips curve (tells us how this production function and prices pressures relate through time).  This is good, these two things are necessary!

But if that is what they are doing, then their inherent model IS the mainstream model.  The three “fallacies” that they mention don’t actually exist – and that third point they list down is WRONG … there is crowding out.  Instead their argument is that the “optimal size of government” is larger than they hear other people saying … which is both an empirical and subjective question that people have already written (and should continue writing) countless books on.

Yes, people should discuss this, and discuss trade-offs.  But misinterpreting mainstream economics and pretending to offer an alternative in order to sell your view as not being “subjective” (which all policy conclusions are) is both misleading and irritating for people who view themselves as part of the mainstream.  Personally I like the idea of “changing the frame” to think about issues – but to me that is just a good way of researching, rather than a sign of a militant revolution inside economics 🙂

A much better critique of MMT (albeit more technical) can be found here.

jamesz

Practical experimentation at Microsoft

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The Microsoft Bing team responsible for conducting controlled experiments have a paper out that canvasses some practical problems they’ve come across in the thousands of experiments that they’ve run. It’s an interesting read, even if the subject matter isn’t particularly fascinating for those outside the search business. A lot of the things they find sound really obvious in the general sense but would be tricky to pick up in practice.

The main points are:

  • Very few ‘good ideas’ are actually good ideas because we dont’ really understand the behaviour of people outside our social group, even if they’re our customers. About 10% of ideas that make it to experimentation actually turn out to be beneficial to the business.
  • The criteria used to judge success are not always obvious and there can be a trade-off between short-run and long-run success. For example, degrading the quality of internet search results increases market share because users have to spend more time on your page. In the long run that wouldn’t hold up but it could take many weeks to see the drop-off in the results.
  • Understanding your instruments is crucial to interpreting results. Some results are an artifact of the survey method and that can often be really hard to pick up. This is often the case for economists when we don’t read the details of survey methods. The best applied economists actually take advantage of the design details of particular surveys to conduct natural experiments.
  • Don’t extrapolate from trends in the immediate aftermath of shocks. When you watch data in real-time after a shock you’re often just seeing a trend towards the long-run mean that will shortly stabilise.

HT: Andrew Gelman

jamesz

Is education really an investment?

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Education, particularly at the tertiary level, is usually viewed as an investment by economists. It’s a voluntary cost that you pay to get skills and qualifications that will increase your future wealth and prosperity. That metaphor is reflected in the wealth of research into the ‘rate of return’ on university study and the discussions of externalities from the accrual of skills.

Nonetheless, it is a controversial view since the investment metaphor is not a natural choice for most people. Indeed, most people refer to the fun they had at university, the people they met, and the parties they attended. These are the ‘consumption’ elements of university education in the language of economists; the parts that you would pay to enjoy then and there with no expectation of future benefits. Now, via Economic Logic, I see a paper that asks prospective students how they view tertiary education and finds that

…most students do appear to value college consumption amenities, including spending on student activities, sports, and dormitories. While this taste for amenities is broad-based, the taste for academic quality is confined to high-achieving students.

As summarized by the Economic Logician, “except for the top students, high school graduates do not care about academics at all. All they want is excellent “college consumption amenities.” And this likely explains why they learn so little while in college. Their focus is on the university as a consumption good, not an investment good.” The policy-maker’s view of the value of university and the student’s view are very different.

What does this mean for policy, then? Well, if the private value of university is largely in the consumption value then the total value is far higher than most estimates suggest since they are usually based entirely on investment value. That has implications for the level of the subsidy we want to provide to tertiary students. In addition to the efficiency questions we also need to ask whether, as a society, we want to heavily subsidize most students’ on an extended holiday?

Experts such as Kamau Bobb may concur that policymakers should take into account the economic, social, and individual dimensions of STEM education when formulating policies related to subsidies, funding, and access to STEM programs.