Category Archives: Monetary economics

Monetary policy discussion in the US

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Sounds like what we’ve been saying here.  From over there:

  1. The Fed should have a single nominal target.
  2. The Fed needs to be transparent and have specific and well-defined monetary policy goals.
  3. The Fed should focus only on monetary policy, and regulation of the large banks.

From over here:

  • At its heart, the consensus between the two main parties was to do with the target of monetary policy – monetary policy must be implemented by an independent Reserve Bank to ensure that inflation remains within a low and narrow band.
  • Giving the Bank multiple instruments to simultaneously achieve multiple targets would be a recipe for confusion, and would ultimately damage its ability to achieve any of its targets
  • Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy

Against the Paradox of toil

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In a recent post Paul Krugman raises the “paradox of toil” to explain why tax cuts are silly and government spending is good during a recession:

So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.

However, this is completely misleading.  Cutting a tax doesn’t really “shift the supply curve” (which is what expanding the labour supply means) in this way.  Lets have a little think about wages and what cutting the tax probably does.

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More on currency misalignment

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Given the rising pressure for the Reserve Bank to target the currency as well as other things in New Zealand it is important to have a look at reasons why people may think our currency is misaligned.  I have said before that IF the currency is overvalued I think it is a structural issue and is really unrelated to monetary policy – however, there are of course many other arguments.

We have mentioned the begger thy neighbour type externalities from domestic focused monetary policy – something that a small country like NZ cannot cause, and so we can’t blame our domestic monetary environment for.

And a new discussion paper by the Dallas Fed discusses why the exchange rate may be an important issue to look at intervening into (ht Econobrowser).  Specifically the paper states:

If the nominal exchange rate regime matters for the determination of relative prices such as the real exchange rate or the terms of trade, it must matter because there is some kind of nominal price stickiness. For example, if the U.S. dollar/euro exchange rate is to affect any real prices, it must be because there are some nominal prices that are sticky in dollar terms and others that are sticky in euros. From the standpoint of modern macroeconomics, the question should be posed: What policy best deals with the distortions from sticky prices and other sources? Is it a fully flexible exchange rate, or some sort of exchange rate targeting?

However, coming back to New Zealand I still feel fully flexible exchange rates are appropriate.  Why?  Apart from the fact that I view such a “relative price shock” as an insufficient condition for intervention, the idea of price stickiness only matters when export prices are SET by exporters.  New Zealand is a small open economy that sells on foreign markets and receives (and pays) the world price – therefore our trade prices are flexible.

The inefficiency occurs when prices are denominated in domestic dollars, and do not change in the face of some “shock” which changes the value of the exchange rate.

Finally there is an asset price bubble argument for intervention (as the currency is a forward looking asset price).  Whether we can really identify and then improve welfare by intervening against “currency bubbles” is highly debatable – and it is an area the Bank has already been involved in (by becoming a currency trader ;) )

Dom Post article: Defending the Bank

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Did an article on why we should leave the Reserve Bank Act alone in the Dom this week.  Given I’m too lazy to put up new material this morning I will just link to it (on Rates Blog, on the Infometrics site).

Money quote:

Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy.  Although pretending to solve an issue may be beneficial for politicians, it is not the best way to run New Zealand economic policy.

Update:  A bit of pointless filler – again because I’m not up to writing anything fresh today ;)

On the fixed exchange rate

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It appears that the idea of a fixed exchange rate has been risen, again.

Now the suggestion in here does take into account the impossible trinity – so it is theoretically possible.  We have:

  1. Monetary policy can impact on output and inflation,
  2. The exchange rate is fixed,
  3. Capital flows ARE LIMITED

That third one is the kicker.  Two issues I have here are:

  1. Limited capital flows implies that interest rates will rise (as for the previous interest rate there is a shortage of capital relative to demand).  This implies that our functioning monetary policy that controls inflation must have higher interest rates and lower output.
  2. Limiting capital flows is pretty difficult for a small open economy like New Zealand.

On the balance of evidence and theory I would say that I strongly disagree with this proposal.

Update:  BK Drinkwater comments here.  He rightly points out that a less volatile currency isn’t obviously a good thing – it is the movement in export prices and whether they represent actual changes in relative prices that matters.