Interpreting a (monetary) quantity – we need a cause

Over at Not PC I noticed that Peter is putting some of the “blame for the housing bubble” at the feet of the RBNZ.  His view shares similarities to the discussion I’ve been having – and will continue to have – with Lowell Manning (here, here, here).

Essentially, the view is that the Bank is allowing M3 to grow too quickly and this is showing up in excessive house prices.  By having “too much” fiat currency the central bank is devaluing the currency, and that is coming through the price of land/housing.  Now don’t get me wrong, look at monetary aggregates – they provide useful information.  Furthermore, I believe these guys deserve a response, and next month I’ll try to craft something a bit better than this.  But let me note down some points as an accidental “Reserve Bank apologist”.

This story provided does have a compelling narrative, it has a start, and end, a villian, a potential heroine, all the good elements of a believable story.  But for me, there are a few key things missing:

  1. The central bank doesn’t set the “quantity of money”, it sets the “price”.  In reality it doesn’t even do that – the interest rate is set by forces in the economy.  Instead, the central bank targets the rate of growth in the “general price level” – and it has stuck to that.   They are going to devalue fiat currency at a predictable and steady rate – and that is just what has happened.
  2. Where is individual choice in this model?  M3 growth is too high, and as a result people blindly borrow the floating $$$ to buy houses … knowing that the future real value will fall and burn them?  This sounds funny.  Instead, with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!
  3. Say that the RBNZ has been soft, why is it the relative price of housing … not general inflation … that is rising.   We may say “land is durable, and the price is high because of expected future inflation” – but then the question would be why we don’t see this across all asset classes in NZ, and more importantly why survey measures do not show these “inflation expectations”.
  4. Furthermore, if this has been a long last bubble (due to the persistent high growth in M3) why have the “relative prices” of other goods never caught up – if this has been one big long bubble due to “monetary policy” at some point we need to be getting that high inflation.  Monetary policy doesn’t keep relative prices out of whack forever.

This is the thing for me – it is a relative price of housing issue.  The money supply is “endogenous” and so, since “demand for housing” has risen, so has borrowing and M3 growth.  With no generalised inflation going on, the RBNZ isn’t printing money to cause a housing bubble – it is allowing the money supply to rise given the housing bubble, in order to not excessively constrain the rest of the economy.

Note the Bank will be concerned about a “housing bubble” if it is leading to “excessive consumption and/or investment” which creates inflationary pressures – in that case they will act with monetary policy.  They will be worried about issues of “financial stability” due to high gross debt levels, highly leveraged groups, or a concentration of debts in an asset class – in that case they will act with macroprudential policy.

Outside of this, this issue has nothing to do with the Bank.  In fact, outside of this this issue of a “bubble due to irrational expectations” is virtually IRRELEVANT for society as a whole – if people are determined to pay over the odds for something to other people, then that is just a straight transfer of goods and services.  If we really have an “irrational bubble” why are we so keen to punish the rest of the economy in a weak (and likely to fail) attempt to stop people making their own dumb mistakes – as we will be inappropriately lifting interest rates and making other forms of investment more expensive to “deal with” the fact that some people have strange ideas about the potential for house price appreciation in the future ;) [And let’s not start talking about foreigners – as this is just a transfer FROM overseas TO NZ].

As an Austrian economist I am sure that Peter is also concerned about a misallocation of capital.  However, in this context this would require “overbuilding” … if there is a “housing bubble” we will “overinvest in building houses” (remember trading houses between each other isn’t “investment” in this sense, it is a transfer).  Is this what we are seeing?  And if it was, are the welfare costs really that large … especially relative to the practical status-quo, since no-one truly knows how to pop bubbles outside of kidnapping people or taking their savings off them!

  • http://offsettingbehaviour.blogspot.com/ Eric Crampton

    Good stuff.

    The Cowen critique looms: sure, the government can artificially reduce the price of bananas. But only YOU can decide to put so many of them on your roof that your house falls over. Yeah, you wouldn’t have done it if they weren’t paying you to take bananas. But who made you stick ‘em on the roof? Huh?

    • http://tvhe.co.nz/ Matt Nolan

      Nice I hadn’t heard that. What is with the bannanas though – does it have something to do with Hirschman (I’ve just started his biography).

    • Luc Hansen

      Melisandre?

  • Peter Cresswell

    The point I was trying to make in that post is that virtually everyone who’s laughing at Russel Norman’s ridiculous policy to print new money is at the same time apologists for a system in which new money is instead just borrowed into existence, with all the problems of malinvestment and counterfeit capital that produces.

    Here’s my short responses to your four points, since like you I’m pushed for time now. (Yes, “short” means links and quotes I’m afraid.)

    1) The central bank’s phony focus on “price stability” gives a dangerously overwhelming sense that as long as prices as measured by the CPI are relatively stable, then all will be well. As you note yourself, the poolicy amounts at a minimum to to steady devaluation, but it’s worse than that. This policy of price stability always leads to more instability.

    This is especially the case when falls in prices of some goods, such as cheaper imports from China, help to mask what’s happening with other prices. As M.A. Abrams argued many years ago,

    In an economically progressive community (that is, one where the real costs

    of production per unit are falling and output per head is increasing), any

    additions to the supply of money in order to prevent falling prices will be

    hidden inflation; and in a retrogressive community, (that is, one where output

    per head is diminishing and real costs of production are rising), any

    contraction of the supply of money in order to prevent rising prices will be

    hidden deflation. Inflation and deflation can occur just as well behind a stable

    price level as when the price level is rising and falling…

    Thus, in the case where [economic progress] due to increased saving is

    corrected by additional money for consumers, the result is to prevent any

    [increase in the efficiency] of production; and where a fall in prices due to

    improved knowledge is corrected by additional money, the result is to force a

    transition to less [efficient] methods. In both cases the fruits of

    progress are rejected because of a determination to keep prices stable.

    Moreover, in both cases the correction of the attempted advances has involved

    the abandonment of some of the higher stages of production where certainly some

    of the factors used are highly specialized and these will therefore become

    unemployed as a result of the transition.

    2) “…with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!” Yes, it is one symptom. Exactly.

    3) Q: Why is it the relative price of housing … not general inflation … that is rising? A: That’s the nature of bubbles–they generally begin in an area that has some reason for rising prices (that truth goes right back to the Tulipmania of the seventeenth century), then once risen those rising prices begin to take on a life of their own own once all that counterfeit capital gets involved.

    4) See above for one reason.ie., land and building prices would be **relatively** high in any case, and since none of those reasons have gone away, they continue to be. But the real critique here is not just one of inflation. It’s really about continuing malinvestment, of which these things are but symptoms.

    Let me leave you with a quote from Hayek about the illusions of central-bank created “price stability,” made at a somewhat similar time in the cycle of the Great Depression to where we are now:

    “…[price] stabilisers … believed that nothing was wrong with the boom and that it might last indefinitely because prices did not rise… [F]or the last six or eight years, monetary policy all over the world has followed the advice of the stabilisers. It is high time that their influence, which has already done harm enough, should be overthrown.” (Hayek, Monetary Theory and the Trade Cycle, 1933)

    • http://tvhe.co.nz/ Matt Nolan

      “The point I was trying to make in that post is that virtually everyone
      who’s laughing at Russel Norman’s ridiculous policy to print new money
      is at the same time apologists for a system in which new money is
      instead just borrowed into existence, with all the problems of malinvestment and counterfeit capital that produces.”

      Indeed, I think you are consistent – and I think many of the people who were most virulent towards Norman may have not had a fully consistent view. Here why I had tried to flesh it out a bit more when I discussed QE on the blog.

      I appreciate you replying to my comments when you’re in a rush as well – I will have a read over it when I get a chance :)

      • raf

        Why is general inflation falling? Globalisation is driving prices lower and will continue to do so. We have wasted that “bonus” by leveraging up and allocating that surplus into housing. The central banks have been watching their CPI and RPI whilst the credit aggregates have gone boom! It’s a bit like watching the 5.40 from Ellerslie whilst the Melbourne Cup is on.

        You can apologise for the RB and their fellow travelers and say they have done their job as mandated but really they have failed badly in their financial stability role.

        As for QE, don’t get me started but some of the stuff in the media this week has been well off the mark!! The problem there is that Russel didn’t really understand it either, otherwise he would have been able to defend his “proposal” more robustly.

        • http://tvhe.co.nz/ Matt Nolan

          “Why is general inflation falling? Globalisation is driving prices lower
          and will continue to do so. We have wasted that “bonus” by leveraging up
          and allocating that surplus into housing.”

          That doesn’t make any sense to me. “General inflation” should be set by expectations of inflation, while globalisation should and any overinvestment in housing will separately change the relative prices of goods and services and housing – they are separate issues. Any chance you could explain the link to me – as I see no direct link, any movement must be due to some third factor.

          General inflation has been falling in recent years because central banks haven’t been doing enough to try and meet their inflation mandate.

          “You can apologise for the RB and their fellow travelers and say they have done their job as mandated but really they have failed badly in their financial stability role. ”

          Huh? We didn’t have a large bank fail, and were forced to introduce deposit insurance for finance companies only because wholesale markets froze globally. The collapse of finance companies wasn’t a “systemic” episode – it happened before our recession, not after. I can understand critiquing the Fed, but attacking the RBNZ on financial stability doesn’t hold much water.

          “As for QE, don’t get me started but some of the stuff in the media this week has been well off the mark!! The problem there is that Russel didn’t really understand it either, otherwise he would have been able to defend his “proposal” more robustly.”

          I’m not sure he had thought through what his proposal was – it was a solution in need of a problem ;)