Matt Nolan

A point on crowding out

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The idea of crowding out mentioned here appears to have made some uncomfortable.  On the face of it, people may feel that this sort of conclusion would mean that I agree with this sort of statement from Neil Ferguson (I don’t):

You can’t be a monetarist and a Keynesian simultaneously—at least I can’t see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.

And it might give the inference that I disagree with Sumner here (I don’t):

I hope other bloggers will adopt DeLong’s enlightened approach.  Then we might finally be able to have a sensible debate over fiscal policy, instead of a inane shouting match between intellectually bankrupt “paradox of thrift” arguments and empirically unfounded “crowding out” arguments.

When I mentioned crowding out in that context, I was merely saying “hey, increased government demand is increased demand” … I was arguing against the idea that is publically being taken from MMT (although I am sure the authors are being a bit more careful) that for some reason a higher deficit would lower interest rates, and the fact that in trying to make themselves seem different from the mainstream MMT authors appeared to be willing to let this mistaken view become accepted.

[Note:  The argument they seem to have is that, if you increase the deficit AND then expand the money supply to accommodate it, you can lower interest rates … this is a different issue again, and requires a bit more of a description regarding the impact on inflation, which mainstream economics does through the central bank reaction function and inflation/NGDP target]

I emailed James about the Neil Ferguson piece saying the following:

Look at this.  Yar, an increase in G-T increases the term structure of real interest rate relative to where it would be, which in turn suggest that the central bank will indicate policy that involves a higher nominal interest rate to meet its inflation target.  But in terms of “stimulus” it doesn’t mean they are fighting – just that eqm interest rates are higher.  The Fed isn’t trying to “make interest rates lower” it is trying to meet its inflation target in the face of a negative demand shock.

This is consistent with the idea that, outside of the ZLB on interest rates central banks do fully offset the “demand” implications of fiscal policy (making it an issue of efficiency vs equity when choosing the size, scope, and actions of government).  When at the ZLB, and faced with the central bank that refuses to do anything, the fact that the government pushes up the “inflationary non-accelerating interest rate” by increasing its deficit is the very mechanism by which the stimulus is seen as “effective”.

As Sumner says in the aforementioned post, the “multiplier” associated with the deficit can be seen as an estimate of central bank incompetence – although I prefer to use the term central bank “conservativism” in the face of uncertainty.

Matt Nolan

Trade-offs run both ways

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I see that discussions with financial market officials has seen the government come out and say that it is going to look at doing something about the interest rate premium in NZ.

Immediately you would expect me to nod and agree.  I’ve been talking about (*,*,*) a “high” real exchange rate, “high” interest rates, and low “competitiveness” stemming from these same and similar issues (although the margin and the level of rates are indicative of different issues … let’s leave that to the side) – and this is true.  But I’m not going to nod in agreement – at first brush this looks like another intermediate target, rather than a clear articulation of they “why” regarding interest rate margins and interest rate levels more generally.

Trade-offs run BOTH ways, we may have instituted policies on the basis that the cost of lower competitiveness etal is worth it for the benefit of greater “equity” in outcomes.  In the same way that I’m begging people who yell at the exchange rate to think of the issues – I beg the people listening to financial analysts who are talking about ways to “lower the cost of capital” to think of it in terms of the full implications for social outcomes.  A while back you would have heard me talking this way on productivity (*,*,*), and my severe mistrust of capital deepening (something that puts me on the fringe of many economists here tbh – and just to make sure that is clear).

Government is the body that society uses to help determine, and implement, the trade-offs that exist due to the inherent trade-off between some perception of equity and strict efficiency.  Let us keep these fundamentals in mind instead of targeting a price, or productivity, or some other “inbetween” function that obfuscates the trade-offs inherent in a decision!  Figure out the trade-offs that exist and getting society to express its desires (both hard tasks) is the way to go, and this sort of sidetracking through “targeting intermediate outputs” in an economy gets in the way of this.

My clearest post on this idea was when I discussed the recent writings by Mai Chen – full respect to her for putting out thoughtful articles on the issue, which is what allowed me to better articulate my problem with ALL those sorts of “aspirational” policy justifications (such as the ones I’ve previously criticised from the Greens – look, I’ve pretty much attacked every point on the political spectrum here 🙂 ).

Note:  This is a point where people will say “this is obvious” and roll their eyes and me – and then wink and say its just Matt ranting again (which is true).  But as well as being obvious it is fundamental – and given it is so fundamental to policy analysis I have to ask why reporting and suggestions of policy continually forgotten about it!

Hmm:  I wrote about remember equity and efficiency issues – in terms of economists recognising the importance of value judgments in 2008.  James was also talking about those issues then.  It is nice to see young “you” agreeing with old “you” on things!

Matt Nolan

The exchange rate as a price

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Over on Rates Blog I’ve knocked up an entry on exchange rates.  In it, I spend a bunch of time just talking about “what an exchange rate is” – all with the aim of turning around and saying that given it is a price, we need to understand what it is telling us and why before we can go off and demand changes.

Effectively, the exchange rate is a symptom of things going on in the real economy – and policy needs to be focused on where these fundamentals may be hit by market and goverment failures, instead of a blanket criticism of the price.  I’d also note that there is a “barrier” to intervention in all this – we do need to actually have a fundamental understand of the issues before we put policy in place.  The persistently high real exchange rate is an issue that has caused some concern (*,*,*) – but “solving” any perceived problem here does not lead us to the conclusion of arbitrarily loosening monetary policy!

Note:  I suspect the comment section over there will look a bit like this – and so will hold off from reading till the weekend.

Update:  Scott Sumner covers similar ground by railing against “imbalances” as a concept – stop concentrating on the price, and start thinking about why the price has shifted.  Lars Christensen reiterates this before both of us.  In some sense, the Lucas Critique stemmed from this very idea.  I genuinely don’t understand why simply saying “let us think of why the price changed, and what the trade-offs are from this fundamental shift (and any policy to change it)” makes people so incredibly angry – but it does!  I have no social skills, and have a passion for discussing trade-offs, so I will never stop making this point – no matter how many nights in bars I have to put up with people yelling at me while I’m drinking my beer 😉

Matt Nolan

Two links that reinforce my priors

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On bubbles (My point:  I keep hearing bubbles matter because “financial stability influences monetary policy” like it is a big idea … but really, no sh*t.  Government spending “influences” monetary policy.  So does competition policy.  They all change the time profile of the natural interest rate.  The fact is that we have monetary policy to manage monetary outcomes given these things – have other sets of government policy for other areas of government concern, and just try to base them in sound economics.)

On the minimum wage and long-run effects (My point:  Good to see actual work on given so many empirical estimates are for short-run effects – and even those show pain to the young and unskilled even if the aggregate figure isn’t statistically significant – reminds me of McCloskey).

In a time and a place where I have both time and a place to do so – I will post on these.  Hopefully.

Matt Nolan

New Zealand’s sexiest economist for 2013 is …

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As we all know there are few things sexier than economics.  And it seems this applies to New Zealand economists as well with a massive 407 votes cast in the “New Zealand’s sexiest economist poll”.  This was especially impressive as voting was via IP address, meaning that many large organisation could only cast one vote.  This turnout heavily exceeded my initial estimate of 6 votes – implying that not only did my vote model fail to pick the Global Financial Crisis, or the value of the New Zealand, it also failed to actually estimate the number of votes the poll would receive.

After frantic voting the champion was … Darren Gibbs with 97 votes (24%)

Darren Gibbs – Deutsche Bank

Darren Gibbs – Deutsche Bank

This was an impressive performance, and no doubt shows the depth of appreciation for both Darren’s looks and his application of economic ideas and concepts.

In second place was Donna Purdue with 91 votes (21%).  She receive wide ranging support from the economist and non-economist community, and was constantly threatening for first place.

Eric Crampton (3rd place) and Gareth Kiernan (5th place) made an early run during the first day of voting, however both fell off the pace as the voting went on.  Shamubeel Eaqub lived up to his reputation as a dark horse, pulling in a number of votes on the final day to take out 4th spot!

Shamubeel and Jean-Pierre de Raad may feel aggrieved, as by putting down two members of NZIER I was splitting the NZIER vote (BNZ has a similar claim) – however, I would note that the combined NZIER vote still would have had them significantly off the pace set by Darren and Donna.

All in all, congrats to Darren, it was good to see that everyone received some votes, and economics was the winner on the day.

 

Matt Nolan

Ex-ante concerns about moral hazard

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Fascinating post by Stephen Williams, who is a great monetary economist.  In it, he goes through speeches at the Federal Reserve from September 2007 – a few months into the burgeoning credit crisis.  In it he shows that there was a debate between the views of “inherent instability” and “induced fragility” for what was going on – this sort of trade-off was captured in the Sargent paper (at least in part) that we’ve mentioned before.

Now when I’ve described the crisis to people I’ve stuck to the inherent instability line, the trilogy of articles (*,*,*) I did on Rates Blog was supposed to give that impression to people – with the third article pointing out that moral hazard exists as a more long-term point.  According to this, the Fed and then the ECB didn’t do enough to stop a bank run due to “too much” weight on moral hazard – and this drove a deep crisis.

However, the induced fragility hypothesis is also compelling (note they could both have happened – but where you put the weight determines what policy lessons you learn).  According to this, it wasn’t until the policy actions of late 2007 and then the bail out of Bear Sterns then the moral hazard became compelling.  However, once financial institutions saw they would be bailed out, they immediately took on lots of risk – making the system a lot more fragile when the Fed finally decided not to bail out Lehman Brothers.

There is evidence for this, Lehman Brothers took on a lot of debt – highly risky debt – following the collapse of Bear Sterns.  I remember reading the paper that had this, a paper that actually said it was the bailout of Bear Sterns that made the crisis worse, but I have forgotten where it is … I’ll link when I find it.

If the spectre of moral hazard fed into the fragility of the finanical system that quickly, the justification for bailouts becomes a lot weaker – if we accept significant inherent instability in the financial sector, then regulation with a lender of last resort becomes more acceptable.  Evidence helping to determine what weights to put on these explanations will be very useful for designing regulation (or the lack of) in the post-GFC world.

Induced fragility as a medium term concept is a central part of how most economists see this crisis.  However, it is an open question about whether the bailout of Bear Sterns (and the earlier TAF) created “induced fragility” that made the collapse much worse.  More research on this issue will be pretty interesting, and will help to inform what sort of trade-off we are facing with policy.