New Zealand Currency in Free Fall

So the NZ currency is currently at $0.705US, implying that it has fallen $0.105US in two weeks. What the hell is going on?

As far as I can tell, investors in the US are nervous about some perceived economic contagion from the troubles in the sub-prime mortgage market. As a result of this economic uncertainty in the US, everyone has become significantly more risk averse in their investment behaviour, and in currency markets a ‘flight to quality’ has begun. The quality in this case is US dollars and the Yen.

So the economic situation in the US looks weak, and their dollar has appreciated against ours, messed up aye. Still, for that very reason I don’t think that this is sustainable. The fundamentals that drove our currency to $0.81US still remain in place, robust economic growth, strong world growth, awesome soft commodity prices, and comparatively high interest rates. I’m certain we will hit $0.76US again in the near future, and I wouldn’t be surprised if we hit $0.78US before September. $0.81US was a bit ridiculous, but I think we have fallen a bit past fair value.

Update: Now we are slipping under $0.69US, this reminds me of a famous Keynes quote “The market can stay irrational longer than you can stay solvent”. Damn those animal spirits.

Government intervention and the Right

The following article by Roger Kerr discusses New Zealand economic growth relative to the OECD. He complains that our economy is growing too slowly, and as a result we are actually falling further behind other developed countries.

As he is from the Business Round Table, he has to criticise government for this lack of economic growth. There are two ways he could do this that would imply government failure. He could:

  1. attack government spending and say that it is crowding out productive investment
  2. attack where government spending is going

In a sense, he chooses to attack where government spending is going in his article, but not directly. What I find interesting is that he complains that productivity growth is too low, and then blames the government for abandoning its goal of economic growth. So he is blaming government for a lack of action, rather than saying that some active government policy was a failure. This implies that he thinks government policy can increase productivity growth.

We also happen to believe that appropriate government policy can improve productivity and economic growth, it is nice to see that people on the right-hand side of the spectrum agree with us.

Housing equity schemes

Another stunning article from someone I work with (I swear I’m not biased 😉 ), this one is about housing equity schemes.  Now it seems the government is keen to introduce a housing equity scheme, having put money in the Budget for it.

Now, the article covers most of the problems with a shared equity scheme, so all you have to do is read it and tell me if you agree 😉 .

One thing I am going to say is that I think most of government/bank money put into the scheme, when the housing market is this tight, will go to the person selling the house.

In the case when the loan is avaliable to all but not income tested, everyone would be able to take out the loan to buy the house, but as their reservation value of the house hasn’t changed (and thats what they are willing to pay + the loan) the price will just go up.  This is because the effective price is no different, and as agents are rational and know that the price of property will remain elevated, the rate of return on property won’t change the investment incentive either.

In the case when it is income tested, people on low incomes will be able to drive up the price of lower quality housing, much to the dismay of people on the margin who are unable to get the loans. Most people apply for a no credit check loan, and are able to get the loan that way. Here the full surplus may not go to the seller (as they face competition with other property types, and the whole demand curve is not getting subsidised), but some negative distributional effects will eventuate.  In this case we are likely to find that those on low-moderate incomes (not low) are forced out of the housing market, does the government think that these people are worth less than the very poor?

The week in numbers

  • According to the HLFS, unemployment was down to 3.6%, even with the participation rate at 68.8%.
  • Wage growth remained elevated at4.6% for the June year.
  • House sale fell a seasonally adjusted 10% in the July quarter.  This was the lowest seasonally adjusted number of sales since December 2001.

Sorry that this was so late, the Wellington Phoenix was playing and I had to go 😉

Should we be pleased to have a tight labour market?

Over at no right turn, they seem to believe that economists sour reaction to the low unemployment figure is ridiculous. After all, a low unemployment rate implies that people have jobs, and a secure income, which is of course valuable to society.

They seem to believe that if we accept a little more inflation we can keep this low level of unemployment, and society will be better off. However, in this doesn’t hold. As an economist would say, in the long-run there is no trade-off between inflation and unemployment. If we accept higher inflation now, then in the future unemployment will rise to its natural rate, and we will be stuck with a higher rate of inflation.  The unemployment level is a problem now because it is lower than the NAIRU implying that the upward pressure on wages is too strong, and as a result the price level will increase.

Now government policy should be focused on decreasing the natural rate of unemployment. If the government can help improve the function of the market, they can make sure that in the long-run, unemployment will be lower. One of the things the government can do to make sure the market functions better, is keep price growth low, so that firms and buyers are more certain of the price level, and savers (whose money gets invested into firms) have more incentive to say (and so there is more investment). So who knows, maybe there is a long-run relationship between inflation and unemployment, lower inflation leading to less unemployment!

Floating GST rates?

So supposedly, the RBNZ has suggested a floating GST rate as a way of controlling inflation. Now this seems silly too me for two reasons:

1) GST is a tax, as a result this would either have to be implemented through fiscal policy (and so would not work, as governments cannot commit to just focusing on inflation), or you would have to give the Bank the right to tax (as the Bank is not elected by the people this is uncomfortable)

2) The level of GST affects the price level, so if the economy is running strongly and you prop it up, you push up the price level.

Now the first criticism is self-evident, however it is a normative problem with the scheme, implying that there might be some theoretical merit. The second criticism is positive. Now, I am not saying that changing the GST tax will cause inflation, as inflation is the rate of change in the price level. Changing the GST tax will change the price level, but not change the rate at which the price level grows, in fact increasing GST will take money out of the economy, slowing growth in the price level and thereby slowing inflation.

So a floating GST tax would slow inflation, however lets think about why we want to slow inflation. We want to reduce volatility in the price level, to give people certainty. Volatility in the price level is bad as the majority of people cannot properly hedge against it. Now by having the GST tax increase and fall we are adding volatility to the price level, causing one of the problems that monetary policy is supposed to solve. It just seems a bit silly.