Matt Nolan

Petrol taxes and inflation

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At Kiwiblog there is mention of Don Brash stating that we should think about allowing the Reserve Bank to increase and reduce the petrol tax. This is something that the Reserve Bank has actually suggested itself (at the same time they suggested a floating GST rate).

As far as I can tell they want to do it as during a boom asset prices drive consumption, so if you tax petrol you introduce a negative income effect which lowers consumption – opposite for a recession. This works because demand for petrol is inelastic (as there are few substitutes for driving your car), and as a result the amount a person spends on fuel will increase with the price – leaving them less to spend on other stuff. This will reduce demand-pull inflation, and allows the RBNZ to keep a fund of money that they can inject into the economy when a recession is threatening. A benefit is the fact that the administration costs of the tax are low, as the institutions are already in place.

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Matt Nolan

Discretion vs Rule: The eatery edition

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What do the Reserve Bank and eateries have in common? Both implement rule based policies instead of discretionary policies and both suffer criticism from their clientèle for doing so even though it is in the clients ultimate interest.

I noticed this today when I went to get some food for lunch. A man in front of me was trying to get cash out, when there is a sign that says “no cash out” at the counter. The man was irritated by this rule, he wanted cash and there was cash in the till. The service person tried to explain to him that if they let people get cash out, then they ran out of change in the counter, which causes delays later in the day – furthermore, if they give him cash they run the chance that other people may begin expecting that they can get cash out, and employees would feel more obliged to. As there was a cash machine just outside, the cost of getting the cash somewhere else was very low for the man, however the delays later in the day would have been costly for both the firm and the consumers involved. In this case, the rule improved the social outcome – any deviation from this rule may change peoples beliefs and lead to a case where most people are worse off.

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Matt Nolan

Moral hazard and central banks

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Central banks have felt obliged to intervene in the recent credit crunch, introducing a bunch of liquidity into European and US financial markets. This has led market participants to say that “It helps with the confidence and the feeling that the Fed is going to help out the financial system“, but is this what the central bank should be doing?

Now some might say that putting a bit of liquidity in the system and risking a bit of inflation might be a small price to pay to prevent the ‘collapse’ of the financial sector. However, this is not the only costs associated with Central Bank intervention, we also have the problem of moral hazard.
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Matt Nolan

Will a fiscal stimulus in the US not be inflationary?

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According to Martin Feldstein (hat tip Greg Mankiw):

“Even if the Fed decides that it should not cut rates further at the present time, it would not raise rates to offset the stimulus effect of the fiscal change. From the Fed’s point of view, the tax cuts can provide a desirable short-run stimulus without the inflationary impact that would result from a lower interest rate and an increase in the stock of money.”

Just because Martin Feldstein is a far, far, better economist then I will ever be does not mean that I have to agree with him, and here’s why.

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Matt Nolan

Higher interest rates – stronger currency?

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In the comments Kimble had a great point “long term estimates of the level of the dollar can be heavily influenced by the current level”. Although this may seem like economists being myopic, it has more to do with our extremely limited understanding of how the exchange rate works.

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Matt Nolan

Oil shocks

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Time is tight so I can’t do a real blog post just now. However, I thought I could mention oil shocks and the difference between their impact in the 1970’s and now.

Oil prices have gone through the roof in recent times as a result of high world prices. In 2006, New Zealand was also suffering from its own oil shock, with world prices high and our dollar falling. However, we haven’t really seen much of an impact on the domestic economy, other than a slight fall off in domestic consumption. Compare this to the 1970’s, when oil shocks caused periods of massive inflation, forcing economists to see that the Phillips curve idea didn’t hold up in a dynamic setting.

Greg Mankiw goes on to discuss three reasons why oil shocks haven’t lead to massive inflation (note that the current oil shock will be severe in the USA, as their dollar has fallen strongly and world prices have risen):

  1. The economy is more energy-efficient
  2. Labour markets are more flexible, monetary policy has been designed better
  3. The inflationary impact of an oil price shock is different when it is the result of greater demand for oil (as it is currently) compared to the 1970’s when their was a cut in the supply of oil.

If I find time, I might try to talk about these issues, and how I think oil price shocks influence the NZ economy, but don’t count on it 🙂 . So, does anyone have anything to say about oil price shocks (preferably not about peak oil, but if you really have to 🙂 )

Update: There was a fourth reason in the Mankiw article. 4) The increase in oil prices was not as sudden, giving economic variables the chance to adjust (this concept comes from his New Keynesian belief in sticky wages and prices).

Update 2: Even NZPA has something to say about Oil prices and inflation, it might be a hot topic.

Update 3: Looks like the topic of Oil prices is making its rounds on the blogsphere. With US economic growth at 3.9% (this is an annualised rate, it is equivalent to have just under 1.0% quarterly growth in terms of how we measure GDP in NZ) with these high oil prices, it looks like this will be an important and interesting issue.