The issue of debt and government

There has been a bunch of web ink spilt on a recent article by John Cochrane (both pro and anti, we do discuss a little here) – I plan to spill a little bit more, but on a slightly different issue.

In the article he suggests that current people won’t loan to individuals but they will loan to the government – he suggests that the government could loan the money out to individual firms and household in order to get the economy rolling again.

This reminded me of Ricardian equivalence.  In Ricardian equivalence households expect any cut in taxes, without a cut in spending, to lead to higher future taxes – so they increase savings.  In this case, if government started putting money into risky projects, wouldn’t it increase the rate of return that the investors would need in order to invest in Treasuries?  If this is the case, then the existence of the type of “roundabout” lending that Cochrane discussed does not really exist – although I’m not sure how comfortable I am about spreading risk around like that :P

Then I remembered that, if the government loses money on loans it will just increase taxes on everyone – so if people think that buying Treasuries leads to risk being “spread around” from risky ventures they will be more willing to.  I wouldn’t say this is a good thing – but if this is why money is flooding into Treasuries at the moment it does give government “scope” to lend some of it out …

Keeping things in perspective

Colin Espiner is back from his Christmas break and he is surprised to see how panic stricken New Zealander’s are. It was the same for me when I came back from the US in mid-November – sheer panic had seemingly overtaken people view of what a recession was.

Lets keep in mind that people currently expect unemployment to peak at just over 7% in 2010, following a 2% decline in activity in 2009 (or about 3% per person). Scary numbers aren’t they – well no.

See, most people won’t notice the recession apart from a little bit of nervousness and cheaper prices (has anyone seen the deals on appliances!). For a massive majority of people there is no need to worry about a recession.

However, the impact of the recession is not the same across people – incomes don’t fall by 3% for everyone, some people lose their jobs and truly struggle. Even so, we have a tax and welfare system that redistributes from those who are working to those that have lost their jobs – the pain of being unemployed will not be as severe as it has been in the past. Furthermore, education and training are available all over the show nowadays – giving people the opportunity to take advantage of changes in the labour market.

Colin is right – if this is the end of the world then it is a bit of a let down ;)

Links agreeing with Colin in some way: Homepaddock, Kiwiblog, Rates Blog, The Reserve Bank.

Update:  I wonder if Colin convinced Blanchard to come out with this (it is part of a roundtable discussion by economists, ht Economist’s View).  Either Colin is inspirational – or his comment was impeccably well timed :)

An issue with the idea that our debt stems from housing finance

Yes we have borrowed a lot to buy houses – but if people in New Zealand have been borrowing to buy houses off each other, why does that increase our net international debt position? Someone must have been paid a good sum for their properties – what has happened to them?

This fact makes me nervous about claims that our current account deficit stems from “borrowing to buy houses off each other”. I have heard this claim a lot – and I don’t think it makes much sense.

In the US they borrowed to build “too many” houses – but we didn’t even do that here in New Zealand. So what have we done with our borrowing:

  1. Invested in a lot of plant and machinery goods which increases our productive capacity,
  2. Purchased consumption imports which are tasty.

Ok, we can have opinions about those things and whether we believe they are good (I do, outside of the possibility that households mistook recent house price gains for wealth – which was unfortunate but impossible to prevent in an appropriate way). And the housing bubble could have contributed to higher consumption imports by making home owners feel wealthier, sure. But I don’t see how borrowing to pay other New Zealander’s for their existing houses increases our national debt level …

Do those who pay with cash subsidise credit card users?

At the Freakonomics blog Steve Levitt mentions how high credit card fees are for retailers.

Now as consumers when we make our purchases we only make a decision on whether to use a credit card or cash/eftpos based on the relative cost to us and the whether the option of different types of payment are avaliable. In fact, since I get charged to use an eftpos card I prefer to use my credit card when I’m in a shop.

For some reason firms do not charge a different price based on payment method – and as a result when setting prices they will treat credit card fees as part of the cost of production.

In order to figure out if this translates into higher prices than in the case of price discrimination (and ignoring entry and exit) we need to ask – are the credit card fees seen as a fixed cost, or a variable cost. Assuming for fun that firms believe that some proportion of total sales will involve credit cards, the credit card fee becomes a variable cost – and as a result the price charged will be higher.

This makes me wonder – why do firms not charge me extra for using a credit card? If it is a framing issue why don’t they provide a cash/eftpos discount?

Update A reader says it is because credit cards are a two-sided market. So credit card companies effectively “subsidise” consumers so that they can charge retailers more. When this is combined with Grant’s statement that it is a contractual obligation that firms cannot price discriminate based on payment method this all makes sense.