Matt Nolan

Mark Carney points out the currency war myth

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In this piece on Bloomberg, Mark Carney (the govenor of the Bank of Canada, and soon to be governor of the Bank of England) points out that the criticism of the BOJ for the drop in the Yen isn’t fair:

Speaking on the same Davos panel, Bank of Canada Governor Mark Carney commended Japan’s focus on beating deflation. Carney, who will move to the Bank of England in July, said Amari had been “very clear and the Bank of Japan (8301) is clear in terms of the policy focused on a domestic inflation target.”

As long what is going on is consistent with an underlying inflation/NGDP target this is just normal monetary easing, not “beggar they neighbour intervention”.  I noticed that a lot of people keep throwing out this currency war myth, even in NZ, but as we have discussed in a number of posts listed here it is simply a myth.

Truly, if people are concerned about the “plunging Yen” they need to ask why – is it because they have left monetary conditions too tight in their own countries?  If so, that is really just their own fault.  If domestic monetary conditions aren’t too tight we actually have to ask what the issue is – and if there is an issue it will be to do with direct market failure or government policy, it will have nothing to do with rule/expectations based monetary targeting.

Sidenote for New Zealand:  If you are really worried about our “competitiveness” instead of going on about the currency – ask why New Zealanders are so willing, and able, to borrow from overseas.  It is the fundamental drivers of that phenomenon that are inherently related to any lack of competitiveness – the nominal currency is a symptom, a by-product, of the fact that New Zealand consistently invests more than it saves … and tends to not make a sufficient social rate of return on that investment.  To “solve” any perceived problem, we need to actually ask why in this context, rather than arbitrarily attacking things.

Matt Nolan

The currency “war” myth that won’t die

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Over on Rate’s Blog I’ve seen an approving link to an article discussing the “currency wars” that are going on around the world.

As Lars Christensen says here, and as we’ve said on many occassions ourselves given that monetary policy is pegged to an implicit inflation target this isn’t “beggar thy neighbour” policy at all – this is just standard monetary easing.

Now in New Zealand the big complaint is about the exchange rate – many people feel that the New Zealand dollar is “too high”.  However, there are two issues here:

  1. Monetary policy – has NZ monetary policy just been too tight?
  2. Structural policy – are there structural reasons why our exchange rate has been (potentially) persistently over-valued.

We have discussed this before here.

This isn’t a currency war, let me requote something we’ve said before:

Central banks are not breaking the rules, this isn’t a prisoner’s dilemma – competitive devaluations HELP when demand is suppressed … just look at the Great Depression, and the choice of countries to go off the gold standard!

Yes, there likely are structural issues in the New Zealand economy.  But policy makers should be focused on those specifically (why is there insufficient residential building activity, why is the real exchange rate so high) – they cannot be solved by monetary policy or the Reserve Bank.   Even when we think a policy issue is clear we need to be careful, as Noah Smith points out:

It’s important to belabor this last point. Economists know some things, maybe a lot of things, but this is absolutely dwarfed by the size of the things we don’t know and don’t understand. If this blog has had one “unifying theme,” it would be the depth of our ignorance. So when economists urge caution in using policy to change large sectors of the economy, this doesn’t necessarily mean “We know that the free market is always perfect and good and that policy can’t help.”

Instead, caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.”

Matt Nolan

Financial regulation: Efficiency vs stability trade-off

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Over at Rates Blog the trilogy of articles I’ve put up about the GFC has been completed with this one.  The first two artices are here and here, and the blog post I did on them are here and here.  Infometrics will be popping up some more articles on Tuesday’s, but they won’t be on the GFC anymore 😉

So in the first two I mentioned uncertainty about the lender of last resort function as a catalyst for the crisis, and a reason why it persisted.  However, this isn’t a costless function – it is true that introducing financial regulation to induce “stability” will impact on the efficiency of the financial markets.

We like to pretend this is not the case.  We like to pretend that the government has the knowledge and ability to figure out what the “externality” is and what “credit ratios” are appropriate – and so faced with a crisis we tend to focus solely on stability.

However, this is not the case.  In fact, the crisis occurred in part due to our determination to make the banking sector around the world more competitive – leading to the development of the shadow banking sector to avoid regulation.  In such a case, we can only get “appropriate” regulation when we in turn accept lower competitiveness in the banking sector.  And given the “supernormal profits” banks get in this case, they are ripe for second best style regulation through the central bank.

In truth, we either throw out the central bank and have competition over the medium of account through banks directly (allowing them to work together in the face of bank runs), or we have a central bank who directly regulates the whole businesses – it was our attempt to get the best of both worlds that helped us wander into the situation we found ourselves in.

Now none of this is news for central banks – they have been trying to length maturities for bank liabilities and clarify and improve regulation in the banking sector for some time.  The crisis was a reminder of the unintended consequences of regulation – firms (in this case banks) can innovate to avoid regulation as well, and that can be costly.  This must be taken into account, and the full cost involved should be accepted, when it comes to setting up policy – rather than throwing around piecemeal rushed ideas and concepts.

Matt Nolan

Scarcity easing in manufacturing?

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For all the talk both within New Zealand and abroad not enough time is given to the hypothesis that it is in fact improvements in technology that are “hollowing out” the manufacturing sector … and that what we really need to help the unemployed is availability to skills training, rather than trying to prop up inefficient domestic jobs in current manufacturing industries.

And yet, there is an increasing amount of evidence that this is the case (via Matt Yglesias).

Increasing output with fewer inputs is a good thing – but when labour is one of the inputs involved we know there may be losers.  If this is really what is happening, then as a nation I would suggest that we try to integrate education and benefit policy more fully, stop demonising those who are out of work arbitrarily, and also stop talking about intervening to “create jobs” in industries that are likely to be long term losers … give people opportunities in this ever changing, and technologically improving, world.

This is, after all, the same sort of thing that happened with the primary industries – with less and less labour needed to dig up coal and produce food.  Work is a cost, it is the income people get from working with a capital owner that is missed when something like this happens.  And it is this fact that we need to keep in mind.

And yet in New Zealand we have one political party talking about subsidising manufacturing and the other political party talking about how lazy the unemployed are.   It makes me a sad panda.

Matt Nolan

Cliff notes on the financial crisis

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At work we are writing occasional articles for the fine people over at Rates Blog at the moment.  I’ve decided to focus on an issue that will get people irritated – an explanation of the GFC where I largely defend economists (although admiting that the mainstream missed the development of the shadow banking sector).

I’ve stuck with the view I’ve articulated in the past (as can be seen here with and with the links), but I’ve attempted to articulate it in a clearer fashion.  I’m aiming to have a related article out at some point trying to discuss why the crisis has persisted – after all in the article I’ve linked to above, if my explanation was true, the actions of the Fed and US Treasury should have led to the crisis being over by now.   My view is that policy failure in Europe put us on this darker and more persistent path.  The three other primary views are:

  1. Fed and US Treasury policies did nothing, and this is still in essence the same crisis.
  2. Financial crises, but default, are long and ardueous.
  3. This is irrelevant and monetary policy has just been too tight due to central bankers being more conservative.

I would note here that these views (including the one I posited) are not mutually exclusive, and each has a significant grain of truth to it.

Our explanation for the crisis matters right now because it determines what sort of policy response we think is right – which is the main reason why many analysts out there are purposefully “over-arguing” how confident they are about their explanation.  In truth, things are never as simple as they seem.

Note:  And before anyone starts saying that by defending economists on some level (even though I do appropriate blame on them as well) and therefore I’m being purely self serving regarding my own failure to publically warn about the crisis, I’d also note that I only started my job in 2007 – I was just starting to get used to data sources and writing about economics on a regular basis (including starting the blog) once the crisis had begun.

It would be in my interest to attack the establishment that was already in place and pretend to be a “fresh voice” – but unlike some economists around the world who seem quick to attack the rest of the discipine, and misrepresent the views of other economists to sell their own image, I’d prefer to take a bit more of a balanced view 😉 [this comment isn’t aimed at New Zealander commentators, just to make that clear].

Matt Nolan

QE3: Forward guidance, debt purchases, unemployment target

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As expected, the US Federal Reserve announced QE3 early this morning NZ time.

In the statement, they commit the the purchase of mortgage debt people expected (carrying on for an undefined period of time), they state they will keep the cash rate exceptionally low until at least mid-2015 (which was anticipated) – but they also say they will do more unless they get traction on the labour market.

This is reasonably significant.  They are fully testing their view that there is no structural problem in the labour market (which is empirically supported) and are banking on the idea that easier monetary conditions, combined with a credible commitment on the labour market will lead to households and firms finally bringing forward consumption and investment.

This makes more sense than prior policy.  The constant forecasting of “failure” in monetary policy in the US led to policy that can be seen as insufficient – the Fed was treating the risks of inflation (and thereby the outlook for the domestic economy) asymmetrically – obviously Woodford’s speech had an impact (although the projections still have a pretty slow improvement in the unemployment rate – would need to see employment rate forecast to really get a feeling for what they mean).

It may also be seen as reinforcing the view of market monetarists (eg Sumner) that the Fed’s expectations have a significant impact on expectations of real economic and labour market activity within the cycle (at least in response to large shocks – possibility of multiple equilibrium.  Note:  They wouldn’t see it the same way.).  This is a view I would like to see in more detail (eg what sort of expectations does this rely on, and what sort of conception of the real rate – are they are artifact of current monetary policy settings).

Although this is encouraging – when looking over here in NZ it is the European debt crisis that is impeding growth.  Yes, a stronger US economy will support growth in Asia and NZ helping remove large scale risks – but the European debt crisis continues to have a separate impact on NZ that is binding.

Update:  Having a read around on the piles of good sites discussing the issue, I ran into this post via Money Illusion.  Now, doesn’t this scream multiple equilibrium to you?  To criticise the Fed for rates being low and indicating a weak recovery, we need to blame the Fed for the drop in the natural interest rate – this has to imply that the Fed either created uncertainty, or is so far away from their mandate we’ve fallen into a “suboptimal” eqm.  You cannot blame the Fed for exogenous shocks (which you’d normally pin this on), so there MUST be an implicit multiple eqm argument behind NGDP level targeting – I find it conceivable, although potentially hard to test empirically … can someone send it to me please 🙂

Update II:  Good point from Scott Sumner:

In addition, they did move closer to level targeting, something I didn’t think was politically possible:

(Fed statement) To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

What’s changed since June?  That’s pretty easy to answer; Woodford’s paper was obviously very influential, and that changed the politics on level targeting.

This is still consistent with flexible inflation targeting at the ZLB.  Of course, NGDP level targeting and inflation targeting share a lot of similarities – and to be fair, NGDP level targeting would be more transparent when faced with the ZLB problem.  In net terms I’m still a flexible inflation targeter – as the benefits of a predictable price level ex-ante from a point in time seem significant, and best served by doing that directly (through inflation targeting).  Of course, if the facts at my disposal change I’m happy to move around 🙂