Author Archives: Matt Nolan

Hot cross buns … a lesson on pricing

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Over on his blog, Bill Bennett has been discussing hot cross bun inflation over the last couple of hundred years – saying that it has averaged about 1.1%pa.

With the consumption of hot cross buns about to spike, I thought I would copy and paste my comments on hot cross bun pricing over here:

One thing I’d note though is that the increase in the price level more generally only really got kicking off during the last 50 or so years. As a result, if hot cross buns had just been generally following inflation overall, the 1.1%pa figure could be a bit misleading.

Another point when looking at hot cross buns – we need to ask what the price of these buns has done relative to all other goods and services. Over the past 200 and a bit years we have seen the relative price of inputs fall for hot cross buns, but we have also seen incomes rise – and given that hot cross buns are a “normal good” it is ambiguous whether hot cross bun inflation has exceeded inflation in goods and in prices.

A final point, a hot cross bun in 1798 would have tasted and felt different than a current hot cross bun – any changes in the quality of said bun should be taken into account.

These are all points to keep in mind when looking at changes in the price of any good or service.

On GST and regressivity

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James did an excellent post discussing tax issues recently.  After this, he obtained a copy of the book, and dug out the three ways that Rob Salmond had noted GST was regressive.  It is good to see Rob put some thought into it and found measurable reasons why regressivity exists – but I also need to point out where I disagree.

In essence, of the three reasons for regressivity I believe that only one is regressive (and by less than we may expect), that one is neutral, and that one of the reasons actually makes GST a progressive tax.

The reasons Rob outlines are:

  • Some savings are spent on acquiring multiple properties, which do not attract GST
  • Some savings are spent outside of New Zealand, which also do not attract GST
  • Some people do not spend all their savings before they die. That is, they are lifetime net savers.

Importantly, all of these forms of GST-exempt dispersal of savings are more likely among wealthy people than among poor people.

My response (with a bunch of arbitrary notes thrown in) was:

  1. The construction of a house attracts GST, so it is just the rental and “owner occupied rental” that doesn’t.  As rich households tend to spend a lower proportion of their income on rent this is progressive.  Remember in turn that this “rental” price is also related to the replacement cost of the house … part of the reason for not including rent in GST is the impression that we would be double taxing it!
  • [Note on this first point - I wrote it with regards solely to the ownership of a house, not multiple properties - as that is how I read the initial question.  Even so, it isn't clear that implied rental expenditure as a % of income rises by decline - I will have to investigate. [Huzzah, investigation done, the share of expenditure on housing of total expenditure falls as the income decile rises.]]
  1. Having GST rather than income tax leads to a one off increase in the price level, which lowers the value of the New Zealand dollar.  This pushes up the cost of goods and services overseas in the near term – given convergence towards the PPP level.  Overall, I still think this will be a regressive element though.
  • [Note:  Looking at the HES data, spending overseas as a % of total spending is surprisingly constant among income declines ... making it seem like a pretty neutral impact at present.]
  1. Although more wealthy people will leave proportionally larger bequests, bequests only have value in so far as the next generation buys goods and services – as a result, they will be taxed, and this is neutral.

I would also note that, even if all of these elements were “regressive” we would need to look at representative baskets by income groups to get an idea of how much of an impact that would make – and given that GST exists, this will be exaggerated by the fact that people are choosing volumes to consumer based on the “lower relative price” of anything where the GST burden does not fall.

Comments and discussion welcome – tax is a huge issue, with fascinating equity and efficiency considerations running through it.

Bleg: What is the issue endogenous money people are after?

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I have a question where I would love some help :)

Via Marginal Revolution I noticed that there seems to be quite a war between economists regarding the financial sector.

However, I actually don’t see where there is an issue in the argument that is going on.  The way I see it Nick Rowe has it right with his comments here and here, and in turn this illustrates that even though a central bank doesn’t explicitly constrain the “stock” or the “supply” of money, their cash rate (and its relation to the natural rate) and inflation target (given an output gap view of the evolution of inflation) provide an implicit constraint.

The way I see it, mainstream theory and “endogenous money” theory people can both assume that the quantity and/or supply of money is endogenous, and that investment=savings-current account.  So where is the difference, what does it tell us, and how is it testable?

Prices, rents, and costs

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The NBR has pointed to an article to the Economist that shows house price to income and house price to rent ratios – pointing out that the very high house price to rent ratio can be used as an indicator that the return on housing is very low/house prices are heavily overvalued.

Now one criticism that people may raise is that the “quality” of the housing stock and the rental stock has changed – and so the relative prices/spending from income could indeed change.  However, the Economist uses figures from Quotable Value New Zealand (as well as Stats NZ) – and so the quality of housing is in fact taken into account in these indices! [Note:  It is not necessarily clear the categories are comparable - so this argument could still be used]

As a result, we could say that this is true – the return for an investor in the housing market seems pretty low.

But what else can we tell from all this?  Relative to historic averages, the price to rent ratio is 68% higher, and the price to income ratio is 20% higher.  So this implies that price/rent is 168% of its average, and price/income is 120% of its average … which tells us that rent/income is 71% of its long-run average.  If we believe these figures, the rental cost … the cost of actually consuming a housing service relative to income … is very low! [Update:   So this is consistent with rising living standards, and having to spend less on housing services - a nice foil to all the suggestions that housing costs have been eating into incomes!]

I’m not sure how much I trust these figures overall, price to rent ratios in this index has been rising constantly over the last 40 years implying that there may be a “quality adjustment” issue in the data to me.

However, if we do use these figures to say that house prices are too high – they also tell us that rents are too low.  Any explanation we have needs to explain both of these parts of the data.  [Update:  This is not clear from the data - and is actually a misleading statement, so just ignore it.  In truth, we need to ask how much of the adjustment will occur through rents and how much through prices]

The cost of transition

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In an article on the Herald Brian Fallow, with the aid of Andrew Coleman, takes on the unaffordable nature of superannuation at present.

Essentially the argument boils down to two points:

  1. The implied transfer from future generations to current generations is equitable given fair assumptions of technological and population growth.
  2. A save as you go system would be a more efficient way of ensuring that the elderly save the required amount.

If they are saying these things I’ll believe them – especially given the underlying truth that changing population demographics will place a lot of strain on the country given the way institutions are currently structured.

However, there was one thing I felt was underplayed in the article – the transitional costs of changing from a pay-as-you-go system to a save as you go one.

The reason I bring this up is that Gen X and Gen Y have been paying for the generation above them – and in this way they will then have to start paying for themselves without any support from the generation below them.  That implies that a “sudden shift” is equivalent to stating that we think it is fair for a very specific generation to bear the cost of retirement for a much larger group.

No matter what we do with superannuation, someone will have to bear the burden of the shift.  Framing it in those terms, and deciding what we think is equitable as a society, will be an important step when figuring out how to move forward.

Bigger than meets the eye

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Bryan Caplan has another great post up on Econlog.  In it he mentions his rule of thumb that “Human heterogeneity is bigger than you think“.

I completely agree, and often when we look at other people, or when economists analyse decision making, we rely on the fact that other people share certain attributes with us – an assumption that can be folly.

Furthermore, I found his description about the debates around imagination in the 19th century to be eye opening.

However, I also believe a second rule of thumb “Human homogeneity is bigger than you think“.

On the face of it this seems to be contradictory – I appear to be saying that people are more different than we give them credit for AND more similar than we are willing to admit.  However, I would state that this is not contradictory at all, and that by accepting both of these rules we reach a fuller understanding of what we do when we go to analyse choice and other individuals.

Fundamentally, we view others as “less” in terms of their thought processes than we view ourselves.

Think about your own thought process.  Think about all the issues, expectations, rules of thumb, social construction, and concerns that drive your decision making on a daily basis – think of the depth of all your experience.

Then consider that the people around you have the same depth of experience and thought – no matter how hard you think about it, it is impossible to really view someone with the same level of detail that you do yourself.  You do not have the information, and you do not have the interest.

In this context, merely focusing on the fact that humans do not understand the heterogeneity of experience between individuals would give you a biased picture of any underlying cognitive biases – in truth, the lesson is that humans (and economists) create a caricature of individuals in order to help them make decisions.  That caricature doesn’t just strip out heterogeneity, it also strips out elements where individuals are similar, and helps to reinforce the importance of issues like signalling for the outcome of individual decision making.