Communication and monetary policy

I was sitting around eating a date scone the other day when I ran into this article by Shamubeel Eaqub.  The topic was central bank communication and whether the RBNZ (New Zealand’s central bank) was doing things well.  Within a number of hours I’d been sent the link numerous times and had received a pile of feedback – with people on all sides fairly angry.  This is an important issue though, so I thought I would note down my own thoughts while they are in my head.

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Re-opening the NGDP targeting argument

Did you follow the NGDP targeting debate with interest but bemoan the lack of theoretical arguments? Then you’ll love the latest iteration of the debate, in which ex-Bank of England macroeconomist, Tony Yates, takes on Oxford’s Simon Wren-Lewis.

Tony’s initial swings at NGDP targeting focus on the sub-optimality of weighting inflation and output equally:

I don’t see that following a levels target of any variety, NGDP or otherwise, is an alternative to raising the long run average inflation rate, however implemented.  There’s no choice but to bite the bullet and figure out a different trade-off, between the costs of long run higher inflation, and the costs of higher volatility imposed by missing stimulus at the zero bound.

Simon is more positive about NGDP targets and garners another reply from Tony. The whole exchange is well worth reading for anyone with an interest in monetary policy.

QOTD: “”I have a dream. It involves a Star Trek chair and a bank of monitors.”

Bank of England Chief Economist Andy Haldane:

“I have a dream. It involves a Star Trek chair and a bank of monitors. It would involve tracking the global flow of funds in close to real time, in much the same way as happens with global weather systems.”

Is the binding constraint on better macroprudential policy a lack of timely information? If they had that information, could a world regulator really have averted the crisis in 2007?

Full speech here.

New Zealand politicians want everyone elses wages cut

Our Prime minister, John Key, has decided to say the following:

Prime Minister John Key has indicated he thought the New Zealand dollar’s fair falue was around 65 USc and that it would be logical for the Reserve Bank to intervene to push the New Zealand dollar lower, given it was currently well above where it was fundamentally fairly valued.

Key restated his view that currency intervention was not effective in the long term to try to shift the underlying value of the currency, but agreed it was “fairly logical” for the Reserve Bank to intervene when the currency was so far away from its fundamental value.

Lots of people may think this, most of them without any thought or interest about asking “why” the dollar is where it is, but lots of people do think it.  But a sudden drop in the New Zealand dollar is akin to a cut in wages – all those imports suddenly become more expensive.

Given their standing and thereby ability to seemingly signal intervention in markets, the prime minister and finance minister really need to keep quiet about policy where there is an independent body involved – as it both creates volatility and indicates that such things are a more political issue.  I was pissed off when Cullen did this, pissed off when Key has done it in the past, and I’m pissed off hearing it now.  I don’t care if someone asked the frikken question, part of central bank independence is having fiscal authorities show a bit of discipline with their comments.

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On participation and wages

Last week the Reserve Bank released their official cash rate review.  As always, it was a good review laying out the important trends that are influencing their thinking when it comes to setting the official cash rate.

However, there is no fun in leaving it there.  There is one part of the statement I want to be pedantic about:

Wage inflation is subdued, reflecting recent low inflation outcomes, increased labour force participation, and strong net immigration.

There are two parts I want to discuss here:

  1. Increased labour force participation:  The Bank is essentially saying that wage inflation is subdued, relative to what we would expect given the increase in employment, due to the fact that labour force participation rose.  They are right, totally and completely – labour demand shifted right, and the supply curve was such that most of the change came in quantity not price, neat!  However, this can give a misleading impression of the future if we don’t read it carefully – let us not forget that labour force participation rates are at a record high at the moment.  As a result, the “capacity” in the economy is more limited – and future lifts in labour demand are likely to lead to nominal wage pressures (note this isn’t the same as higher real wages per se – but more like an increase in inflation expectations) than lifts in employment.  This is indeed what the Bank was hinting at with the statement prior “Inflation remains moderate, but strong growth in output has been absorbing spare capacity. This is expected to add to non-tradables inflation.”
  2. Strong net migration:  Hold on a second.  We keep being told that strong net migration is pushing up inflationary pressures.  Now we are being told that net migration reduced inflationary pressures (note that “wage inflation”, again not real wage growth, is a lot closer to real inflation, and real inflation expectations, than a point in times annual increase in the CPI).  Higher population growth does indeed increase “demand” and “supply” so the relevance to monetary policy itself is indeterminate.

Potential output in monetary policy

When it comes to “potential output” there is often a view that the economies potential to produce is determined by the labour, land, and forms of capital that are available to create this output from – and this is right!  Furthermore, each of these factors tends to produce a diminishing amount of additional output as you use more of it.  Although the factors of production are often complementary this often implies a situation where – in the long-run – the potential for output (and growth in said output) in a nation is fundamentally about technological change and the quality of institutions.

However, in a recent speech by John McDermott of the RBNZ he points out that, when it come to considering monetary conditions, the type of “potential output” we are interested in is a bit different.

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