The week in numbers

  1. Tourist arrivals were strong, up 3.6% on July last year.
  2. Net migration for the year to July was weak at 8,966.
  3. The merchandise trade balance continued to deteriorate, with a deficit of $6.3bn for the year to July.

Holy Cow

Have you seen the latest estimate for Fonterra milk payouts, $6.40! I know that Holy Cow was a terrible pun to make, but that’s a huge payout.

Supposedly Fonterra was able to hedge sales at $US0.71 during the time when our dollar was at $US0.80. When that good bit of management is combined with the continuing rise in world dairy prices you need up with a payout like this. To put it in perspective, last season farmers received $4.50/kg, so it is up by nearly 50%.

Hopefully we can convince farmers to invest some of this money into productive infrastructure, to increase our capital base. However, I think it is more likely that they will buy investment properties and some new quad bikes, as quad bikes are awesome 😉

Update:  They didn’t say anywhere that they hedged at $US0.71, I was just tripping.  Anyway, $6.40/kg is still heaps.  I wonder if these prices are sustainable?

RBNZ introduces some liquidity

The RBNZ has made it easier for banks to borrow money off them, in order to stave off a squeeze in credit in the banking sector. This sounds fine to me, and the measures they put in place seem reasonable, there was one thing I did not understand though. It says that the bank is selling more short-term bonds, wouldn’t this contract the money supply and reduce liquidity?

Maybe the reporter put it down wrong, but making it easier for banks to borrow money, and then providing them riskless assets to buy with it doesn’t sound like a way of increasing liquidity in the New Zealand credit market. Hopefully the RBNZ does a release soon, and explains to me how I’m an idiot, or if you’re quick maybe you can beat them to it 😉

Outgrowing the inflation problem

In this article, Rod Oram discusses the two options he sees for battling inflation:

  1. Raise interest rates to slow growth, thereby reducing the pressure on our limited resources.
  2. Increase the resource base

Both of these ‘strategies’ would reduce inflationary pressure. One would reduce aggregate demand; the other would increase aggregate supply.

The first strategy is what NZ is doing (and most countries try to do when inflation comes out of the bag). The second ‘strategy’ would be preferable, as it would increase the number of goods we can buy as a nation. However, Rod didn’t tell us how we are supposed to increase our resource base. According to him we can ‘grow it’, so as the economy is growing the resource base will magically grow as well.

I don’t agree with this idea, but I’m going to try and rationalize what he is saying, and then say why I think it won’t work. Many people have been saying that if we had lower interest rates, investment would be greater, which is an increase in our resource base. As a result, this may be his solution, lower interest rates increase investment, which increases aggregate supply. The problem is, if we kept interest rates at a lower level, we are implicitly allowing a greater level of money supply growth into the economy, which will in turn cause upward pressure on inflation. Which effect dominates depends on the productivity of new capital investment, as if new capital is very productive then the increase in resources requires an increase in the money supply for prices to remain constant.

New Zealand currently has relatively low capital productivity (capital productivity has only risen 1.2% in the last 10 years), and at the margin, this level of productivity will be even lower. This implies that any increase in the supply of resources from a lower interest rate will be very small, and as a result inflationary pressures will be strong.

Furthermore, when a firm makes a long-run investment decision what matters is the long run (risk adjusted) cost and benefit of that investment. In this case the short-term interest rate is not of importance, it is the long-run rate of interest that matters (as interest rate changes can be insured against). Uncertainty for the firms investment decision comes from issues of price, if the level of inflation is high there will be significant volatility between the price of goods (as prices would change at different discrete time periods) making the return on the investment more volatile than in a low inflation environment. As firms are risk averse, higher inflation will lead to lower long run investment – implying that trying to grow our way out of inflation will not work.

Democracy and growth

One of my favourite development economists, Daron Acemoglu, has a new paper out. Acemoglu is generally of the view that a country’s level of wealth can be traced back to the country’s institutional development. In a fascinating earlier paper he argued that the institutions set up by European colonists are a major predictor of the current wealth of colonised nations. His new paper proposes that the wealth of a nation is not correlated with the level of democracy in that country, nor is it correlated with regime change towards democracy in the country.

It seems that a trend among Western democracies is to promote democracy as the way forward for developing nations. This has particularly been the case with the US’s recent foreign policy under the Bush/Cheney regime. Does this paper suggest that efforts to ‘nation build’ and push countries towards democracy does little for their economic well-being? Hopefully, it will force nation-builders to be more rigorous about the way that they justify intervention in favour of democracy in developing countries. Suggesting that it’s the one, true path to economic growth will no longer be enough.

Econometricians will rule the world eventually

It sometimes seems that more interesting economic research is done by econometricians than theoreticians, these days. The way to make your name now is to have a knack for finding inventive experimental designs. Here is an interesting paper about the effect of cellphone use on car-crash rates. It uses the discontinuity in cellphone usage rates across peak/off-peak times to evaluate the effect that cellphone usage has on crash rates. In contrast to the prevailing literature, and quite counter-intuitively, they find no significant effect. Another reason for governments to be hesitant about hasty regulation?