A frank (non-technical) discussion on current NZ macropolicy

Note:  I think of macropolicy as policy that is focused on inflation, interest rates, unemployment, and GDP.  Of course, the causes of shifts in these often have micro-consequences … something I sort of suggest as we go through 😉

As we’ve come into 2013 with the unemployment rate elevated and the dollar rising strongly I have seen two things occur:

  1. An increasing, almost dogmatic, preaching from those talking about the high dollar destroying the economy.
  2. A rising disparity between economists and business expectations for economic activity (which have rebounded) and the news.

The last time I saw the second point occur was early 2010 – just before April 2010 when events in Greece took a turn for the worse.  In this way, I can understand the reluctance of news agencies to accept the large number of improving signs about the New Zealand economy – if something goes wrong overseas it will all be unwound.

I can understand the first point as well – manufacturers are finding their profitability low, and they are trying to blame “something”.  A price seems like a good thing to yell at.  Furthermore, it fits into the view that something should have been done, which would lower unemployment – looser monetary policy would have given us higher inflation (which is below the band), likely lowered unemployment, and would have “made the dollar weaker”.  An argument can be made that over the last eighteen months, monetary authorities accidentally left the OCR at slightly too high a level.

But, this is my most generous view of this side.  I find myself concerned that policy issues are being “mixed” by exchange rate zealots who want to make it a free lunch.  For example, if the central bank had lowered the OCR to get the exchange rate down, house prices would now be higher.  If they had done this and the UNCERTAINTY in Europe hadn’t led to more expensive credit (if we hadn’t seen bank funding costs look ugly for parts of last year), then they would have overstimulated the economy – they would have been forecasting failure given what the information they had … it is hardly their fault that things turned on them.

And if the RBNZ had cut the OCR, would the issue of the persistently overvalued dollar (current-account deficit that is higher than we think is justifiable) go away – no, it would actually make no difference to this as in the medium term interest rates and the real exchange rate would go back to where it would have been.  If this is the “exchange rate issue” you care about, stop talking a bunch of bullshiz about the OCR and interest rates, and try to figure out what the real causes are.

You see, it turns out that we are being hit by a lot of large external shocks (both positive and negative), and this creates a bunch of uncertainty about what to do.  In that environment, we have unfortunately ended up in a situation where unemployment is higher than it would be if the economy was “functioning nicely” – so we need to ask why this is the case and what policy solutions may help.  I think I read something about the principles of that.

A blunt tool, but blunt for a reason

The “interest rate” is a blunt tool.  Hell I struggle with the idea that the “tool” is even the OCR – in truth the RBNZ’s monetary policy measure is its flexible inflation target, and all that implies.

But what is inflation, or an interest rate.  It is an incredibly aggregated piece of information that discusses a general tendency over the economy as a whole.  A firm cares more about the interest rate THEY face on their credit, and the price of their costs and their product – not some bull like this.  In truth, we aren’t a centrally planned economy and we live in a world in flux that is filled with uncertainty – in that environment lightly changing the OCR is no way to deal with specific market or government failures we may think exist.

Exchange rate zealots need to stop being lazy with their analysis, ask what the failure is, and figure out what the cause is.  For example, house prices are “too high” – lets ask what is going on in the housing market and building industry.

The unemployment rate is too high, while vacancy numbers have climbed – interesting do we have an issue of “skill-matching” … seems we do!  Given that, the policy solutions involve trying to lower the cost of matching, and more work with unemployed people and investment in skills … not a 25bp cut in the official cash rate.

A sidenote on the exchange rate – remember it captures relative growth

Have people noticed how much growth has been outperforming since about October last year, or how much bank funding costs have dropped, or how much easier it is to access credit.

When these factors were the other way around, they really slowed economic activity in NZ – isn’t it likely that we may see strong growth off this now?  The growth outlook for much of the world is not as flash, and tbh I’m working under the impression that Australia is now hitting its wall, and as a result I don’t think this is “it”.  But the exchange rate is indeed a “price”, and it appears to have given us an indication that we are finally experiencing a (likely rebuild led) recovery.

Treating the issue as “low exchange rate good, high exchange rate bad” involves not thinking about what the exchange rate is.  Originally I thought this was because people hadn’t had the chance to look at the issues, but with the RBNZ/Treasury running a conference on this, and with my little article on “what is an exchange rate” available, I find this attitude perplexing.

QE and exchange rates though!!!!

Yes, QE is driving up the dollar, as every economist in the universe has said since the start.  There are two ways to think about this:

  1. Implied relative interest rate channel
  2. Specific currency purchases

The first channel is cool, that is relative monetary policy.  As long as everyone involved is setting an “inflation target” and sticking to it then this is just a product of all the countries “closing their output gap” – and it is a good thing for all.  Not a currency war.

If countries start trying to mess around with relative prices, by directly buying up currency or bonds in NZ, then the issue is more difficult.  We receive a “capital gain” but the exchange rate gets knocked around as a symptom of relative prices for asset classes and the such being out of whack.  This is generally a pain in the ass – and is an argument for greater co-ordination in monetary policy.  Furthermore, it isn’t actually clear whether it is a net positive or negative for NZ – we are making a capital gain out of our assets after all – what is clear is that it involves a transfer, and we might not think that is fair to some in society (although one of the beneficiaries are consumers so …).

The QE question is one that needs investigation, but on the balance of probabilities having these countries do this is better for NZ then having them experience a full scale depression

Also one note I think gets missed – if they hadn’t done QE, inflation would have been lower, and so the world price of the goods and services we export would have been lower.  For something that is vulnerable to “overcapacity” like manufacturing this would have been very acute – and as a result without QE it isn’t even clear manufacturers would see their return be that much higher!

  • OT Re your statement we are not a centrally planned economy, what do you think of von Mises statement there is no such thing as a mixed economy midway between socialism and capitalism as both represent a different organisation of society. Putting aside taxation and regulation, especially freedom of speech denying securities regulation, if Labour/Greens win next year, they’re going to nationalise the power industry.

    That bears little resenblance to a free market that I can see?

    • I think it is important to be clear on definitions – a centrally planned economy is an extreme where price and quantity are set by a single institution, rather than the institutional relationships of various groups. I think this gives us clear scope for defining different amounts of “central organisation” in some sense – with related trade-offs.

      The ideal is a hard thing to define, as it relies on a strong amount of subjectivity. My goal is usually to try to recognise what the trade-offs are – which is why I get so annoyed when politicians ignore them.

      When I think about how individuals organise into groups and institutions to trade, I always come back to Rousseau – “men are born free, but everywhere he is in chains”. These chains, these bonds, are not a negative in of themselves. They are a bond that suggests a value from some institutional relationship. Ultimately, as long as the society allows people scope to remove themselves from these relationships in some sense we move ourselves away from a centrally planned economy. And at present society does offer us a lot of this.

      • Under Rousseau’s social contract (which has today been transformed to the contract for the slave), he also said, importantly, that individual’s could contract out of the social contract: there is no ability to do that anymore – not for a very long time. Furthermore, his social contract was a bottom about protecting an individual’s property right, and that most certainly from the state. I think he would be appalled with the nature of society today, and what his thought has been interpreted into.

        • The social contract also works through the bond between individuals – some of these chains we discuss are in fact family bonds etc. Government is one form of a social institutions, with the same flaws and benefits as any other form of institutional relationship – and it should be viewed as such.

          My final two sentences were discussing similar things to your discussion in this comment – that people have some ability to “opt-out” in the social contract, or sections of it. And the society we have now gives individuals the ability to “opt-out” in many ways.

          We will never be able to completely “opt-out of society” and as social animals it stretches credibility to assume that people would want to opt-out 100%. In truth, we need to be conscious of the full set of choices, costs, and benefits associated with any institutional arrangement we have that influences us as individuals.

          • Mmm. Re your last para, yes, I realise I live in the village, however, the ruling ethic is now that the village owns me – that’s a planned society.

            Given the rationale that our centrally planned lives via the surveillance state has it’s foundation in tax policy and administration, I disagree with you on the ability to opt out, where it matters.

            • Hmmm, I find this distinction just far too absolute – if you use it for government now, the same argument would hold all the way until we have no institutions that influence individual actions left. To me, that shows that there is something missing from the story.

              We want individuals to have choice and opportunity, undeniably. But irrespective of the way society is made up these are constrained by the way we interact with individuals. Even if these were the only factors we cared about, I don’t find any conclusions about the way we need to change the state (including in terms of tax) self-evident.

              • Mmm. I think a civilised society is a movement toward privacy, and where a very small state (minarchy), funded voluntarily, is my servant, providing the rule of law, rather than the current state of the surveillance state being my master. A voluntary, free society.

                A beer I think. It’s hot here in the Sounds.

                • There are always issues in kind – and it isn’t the intent of the law, but the outcome that matters. I think we agree on those things. However, when it comes back to this post, my issue is that people aren’t looking at the trade-offs in the first place … and that is frustrating.

                  I want beer.

  • Blair

    Some very interesting papers on that conference website. I like the premise of Anne-Marie Brook’s paper – if we were to remove the underlying S-I mismatch, what would that involve? However her answers were still a bit vague for my liking. Also, reading the papers you would think the distortions were all internal in nature. I agree with your comment that direct manipulation of the currency price by foreign central banks can be a pain in the arse. In my view it’s lose-lose. Mark Reddell’s paper was also interesting and appeared to be quite original.

    For me, the elephant in the room is that one regime has been conspicuously successful in the OECD and that is Singapore’s. Of course we can “never” adopt it because our interest rates make the cost of carrying reserves too high. And yet … it seems that in the collective brain of the RBNZ/Treasury they actually know roughly what it would take to bring interest rates in line with US levels. It’s possible, it’s just that nobody will come out and say it. Maybe they think they’ll be tarred as mean ole economic rationalists.

    • I think the principle is a bit different. The goal isn’t to close the S-I imbalance, or to make the cost of capital the same as the US – it is to articulate why these things happen, and what trade-offs they represent.

      If our real exchange rate is higher because we have more income transfers and a faster growing population than a number of other developed countries, then the loss of competitiveness is a specific choice we’ve made as a society because we value those things. We can only “fix it” by undoing other policies we support – and we
      should be honest about that. It isn’t a problem with a win-win solution, it is a trade-off.

      “I agree with your comment that direct manipulation of the currency price by foreign central banks can be a pain in the arse. In my view it’s lose-lose.”

      I keep hearing people say that, but I can’t see a single argument about why. And we all agree “demand is too low” … making foreign stimulus a weird “win-win” in that regard. Wondering why do you think it is a lose-lose?

      • Blair

        Certainly those conference papers will help to make the trade-off clearer, although it’s a shame we don’t have a better print media to get the discussion out into a broader domain. I’d like to take up your challenge and try to make an argument that it would be win-win (or damn near) to restructure the economy, but I have to go and eat a goat tagine my wife has cooked 🙂

        Why Chinese mercantilism is lose-lose: in short, I think the mercantilist country gets a development boost for a while but eventually your trading partners run out of ability to buy more stuff and you find you have made a lot of malinvestment. That’s the best I can do in one sentence sorry!

        • Blair

          Slightly better attempt at explaining my view:
          1. Portfolio flows on the capital account drive the current account these days. Let’s say Country A manipulates its capital account to get a current account surplus through a complex of regulations we will call financial repression. This drives down the price of A’s currency. A also sterilises the effect of its surplus on domestic money growth.
          2. In Country A, the return on capital on a range of possible investments will be pushed down due to lower RER. The supply of investment capital will be pushed out due to financial repression (lack of other uses of capital). Country A will experience investment-led growth, at the cost of consumers (lower share of income, forced saving into low income investments). If the country is smart/lucky enough, productivity will grow fast enough consumers feel better off anyway.
          3. In A’s trading partner Country B, production will be pushed down in order to satisfy the accounting identity. In order to avoid mass unemployment, B will be be forced to run looser monetary policy than it would have liked, pushing up debt and asset prices. However, consumers feel rich, take lots of holidays, and life is good. The non-tradeable, capital-lite sector develops. Some economists in Country B suggesting locking in the low interest rates to build some farsighted nation-building projects, but this never happens due to focus group polling telling the government that they would get more electoral traction spending the money on swinging voters.
          4. After a while levels of total debt (whether public or private or both) in Country B have got a a level commonly associated with a financial crisis. Country B either has a financial crisis, defaults, or puts up trade barriers.
          5. Country A is left sitting on an accumulated capital base much of which was only viable due to subsided rates of return (RER), inflated assumptions of economic growth (infrastructure), subsidies or repressed interest rates.
          6. The net outcome is worse for both sides than if Country A had simply allowed its currency to appreciate in the first place.

        • “Why Chinese mercantilism is lose-lose”

          Ok, I don’t disagree with that having the potential for a lose-lose of course – sorry I misinterpreted what you said as discussing QE, as I made the comment with regards to QE.

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