The visible hand in economics

Archive for June 2008

Well, we don’t run a requests service, but never let it be said that we don’t try to give our readers what they want (or what we want them to want, anyway). The Standard asks us to have a chat about this piece in The Economist which discusses endowment effects, so here goes.

The first question to answer is probably, “Endowment effects?! Wot’s that then?” Read the rest of this entry »

The Economist has an excellent piece on inflation expectations (*) (ht Anti-dismal and the Economist blog). In it they mention some of the difficulties of using the inflation expectation measures as a gauge of inflation, namely:

  1. The problem with survey measures: Consumer often mis-interpret inflation, and take increases in the price of certain goods (eg fuel and food) as inflation – ignoring the reduction in the price of other things (appliances).
  2. The problem with market measures: Perceived risk also drives the same measures – implying that there can be biases.

Now I agree in large parts with what they have said, however I think they “over-sold” the first case. Read the rest of this entry »

So the economy shrank 0.3% over the March quarter (or 0.6% if you buy the expenditure measure instead) – the appropriate tables are here (*).

This was bang on expectations. The stock boost we talked about was there, but everything else was sufficiently bad that it landed on expectations anyway :)

What concerned me was the GDP deflator (the fourth table) – 5.8% annual growth, highest since June 2001, when our dollar had tanked and inflation was sitting happily outside the target band. The aggregate supply story that I’ve shown my affection for is still running wild (*) (*) – temporary reversals in growth over the coming quarters and rising inflation.

Consumer confidence is in the toilet (*) (*) but this is because of significant price increases in food and fuel – cutting interest rates now will simply lead to bigger increases by reducing the value of the New Zealand dollar. Once lower interest rates do feed into consumer demand (once effective mortgage rates start to fall and exporters are able to change their fixed rate contracts), the drought will be well over, and economic activity will “attempt” to shoot upwards, capacity pressures will reappear, and inflation will be out of the bag. Ohhh well.

Update:  Other New Zealand blogs talk about the figure: The Standard, The Hive.

In an interesting move, Federated Farmers president Charlie Pedersen stated that we should “thank god for the (food) producers” (*) in New Zealand, for providing us with food and/or wealth.  Now I have to admit, I find this attitude a bit ridiculous.

Don’t get me wrong, agricultural products do create a lot of wealth, hell meat and dairy alone accounted for 29% of our exports over the year to April (Source).  However, doesn’t the farmer and the other people involved in the production process extract the surplus from this trade?

They produce these goods out of their own interest – this is the beauty of free exchange.  However, I don’t start praising to the high heavens about people I buy things off.

The idea that farmers are creating wealth for us stems from the “multiplier“, whereby a small increase in a countries wealth turns into a greater return over time, helping everyone.

However, the multiplier idea is borne from the concept that demand creates its own supply – hardly a realistic assertion in economics, which is supposed to be the study of scarce resources.

Also remember that if the land and resources were not used for farming, they could be used for something else – as a result of this opportunity cost from farm production, the reduction in wealth will not be as severe as some may suggest if the farmers decided to stop producing in the face of our “lack of appreciation”.

Ultimately I feel like Mr Pedersen is saying, “farmers own a large number of the resources, and so we should thank god that they use them well” – when I frame it this way the claim seems ridiculous!

Greg Mankiw has an interesting post on what would make a good inflation target (ht CPW). According to work by Ricardo Reis and himself, aiming at the nominal wage is a good way of ensuring the highest degree of price stability – according to models calibrated to recent US data (paper here *).

Using this conclusion he shows a graph of private hourly compensation growth and states that inflationary pressures in the US are not as much of a threat as some analysts are positing.

If the same implication held in New Zealand (which there is no assurance of), how would we be looking:

Source, QES wage data Statistics New Zealand (*)

Not so good it seems :P

Over at The Standard they are discussing ‘triangular employment situations’ and a bill that is coming in to play that will give employees greater rights in these situations. Now that’s cool, I don’t have any issues with that. If I had to critique the bill I would run with the employee choice argument – if the employee chooses that he wants to work in a scheme where he doesn’t get sick leave etc (as he gets compensated for this) then these schemes provides this opportunity, so removing this opportunity will reduce the welfare of the workers in the scheme.

Still this isn’t my point. I was interested in the fact that Steve Pierson mentioned the surplus value of labour. The wikipedia definition for this is:

Surplus value is a concept created by Karl Marx in his critique of political economy, where its ultimate source is unpaid surplus labor performed by the worker for the capitalist, serving as a basis for capital accumulation.

Now I always found this idea a bit unusual. Fundamentally it states that labour unit creates more value than it is paid by the capitalist, and that excess value is taken by the capitalist and either used to create more capital or for their own consumption. Fundamentally, as capital is in some sense equivalent to savings, which is deferred consumption, the capitalist is taking this surplus away from the labour that created it.

Many contemporary proponents of the theory would not be this extreme – however, they would still fundamentally say that the surplus that the capitalist extracts comes from the exploitation of the worker. As a relatively middle of the road economist this isn’t how I feel:

Read the rest of this entry »

The New Zealand governments biofuel regulation has just come back from select committee. The Hive makes the excellent point that some of the changes to the bill may breach WTO rules. However, my focus here will be on the biofuel regulations impact on prices.

There has been a lot of talk about how mandatory biofuel sales will impact on prices, ranging from a 6c/lt increase to a 4c/lt decrease in prices (*).

Now the first thing to ask when looking at the biofuel regulation and prices is, how will it impact on the fuel companies “marginal cost”. The fuel company will set the price such that it makes the highest profit it can – as a result they will want to set marginal cost (the cost of selling one more unit) equal to the marginal revenue they receive (the return from selling one more). As marginal revenue is falling as we decrease the price there will be some point where they are equal – so the question remains, how could this impact on marginal cost?

I think the answer is that it doesn’t, the marginal cost of selling a litre of petrol will still be the same. Sure having to install a bunch of new infrastructure may be expensive, but this is an increase in fixed costs – the firm will have no incentive to pass this on to consumers, as it should be setting prices at a level that maximises profit.

However, this answer ignores a bunch of extremely important points. Read the rest of this entry »

March quarter GDP numbers are out on Friday. Westpac has a good preview of the upcoming GDP numbers here. They, the Bank, and the market are picking a 0.3% fall in quarterly GDP over the March quarter.

Remember, GDP=C+I+G+X-M (consumption + investment + government spending + exports – imports). We “know” that growth(X-M)<0 and growth(C)<0. With benefit spending falling and limited policy initiatives over the March quarter growth(G)=small if not negative. Also with residential and non-residential wpip coming in negative it appears that growth(I)<0. This is enough to give us a pretty negative result.

However, Investment may surprise if stock levels have risen significantly. For example, the Tui oilfields produced a bunch of oil of March, but the timing of Easter made it difficult for them to ship the stuff out – knocking down exports (X) but potentially leading to growth in stocks.

Update:  For some reason I forgot to mention the downside.  Given how weak partial indicators have been, a fall of 0.6% could be on the cards – however, a bigger fall than that would concern markets.  Note that we had a 1% lift in December, so a 1% fall would put us back to where we were in September (in seasonally adjusted terms).

What do you guys think – will we see a negative quarter, will we see another one over June?

On his blog, Dr Mankiw titled a post “so much for Ricardian equivalence” after noticing that US retail recovered following the government rebates. This off the cuff statement comes from the fact that the government rebate also had no reduction in the long-term level of spending, and so “in theory” consumers will have saved all the tax rebate, realising that they will have to pay this tax later anyway.

The excellent division of labour blog then takes this claim to task stating that the income tax rebate mainly went to low-middle class families, causing a common pool problem with the income tax – as the rebate is temporary, but it is not clear what form the future funding of government spending would take (although I’m not sure if this is actually a common pool problem, it just seems to be to do with giving a progressive rebate and then placing the future spending burden evenly across society, effectively increasing the net tax income of the poor who are liquidity constrained – as long as the amount the poor spends does not impact on the future need for tax income).

However, I don’t see why either side has to be wrong. Read the rest of this entry »

As promised, I will now discuss Queen Bee’s fear that the Emissions trading scheme will limit our ability to take advantage of the wealth gains New Zealand will get from high food prices.

First we should accept that there is a liability we have to pay. If anyone wants to comment saying we should just not pay our Kyoto Liability, do it somewhere else (If it makes you feel better, we will assume that the world will punish us by more than the cost of the scheme if we drop out). So given that we are looking at the situation where New Zealand has to pay for it, why is there concern around the ETS.

One concern that Queen Bee has, which is of course correct, is that rushing into an emissions trading scheme without thinking about the issues surrounding it is a mistake, but is that what we are doing. Compared to other polices the ETS has had a ton of work done around it, general equilibrium models, real options analysis of forestry stocks, all sorts of stuff. Some of the technical issues surrounding the measurement of liabilities need to be cleaned up, but in the economic sense I’m pretty happy with where we are sitting.

The feeling that we haven’t properly costed the ETS stems from the NZIER GE model on an ETS (something we discuss here). Read the rest of this entry »

According to Statistics New Zealand our terms of trade is now at its highest point in almost three and a half decades. To some degree this lift appears to be structural, with growing demand for protein goods from Asia and the increasing prevalence of biofuels two of the main factors driving up prices permanently.

However, Berl and the Hive have identified what they believe to be the main policy factors that could mess up our chance to take advantage of this national increase in income (h.t. the Hive). These factors were Inflation targeting (Berl) and the Emissions trading scheme (the Hive).

Here I aim to discuss the Berl argument – the warning is that it might sound a bit technical (more down to my inability to explain myself clearly than anything else :) ). After that I will do another post on the argument that the Hive raised, and maybe even state what I think is a major policy risk :)

Read the rest of this entry »

Since the March quarter retail numbers have been released it has been apparent that New Zealand was heading down the road of a technical recession (two quarters of negative economic growth – seasonally adjusted). This has led the countries finance minister to once again admit that a technical recession is likely – (something he admittedly said earlier in the year, much to my irritation at the time ;) ).

By Tom Scott 20/06/08 (link)

The fact that we are so close to a recession that it has gotten the attention of foreign economists – in a sense we could be viewed as world leaders, in so far as we are the first developed country heading towards a technical recession ;)

For some reason or another the idea of a recession scares us. For example Queen Bee at the Hive is stating that it is imperative that the Bank now cuts interest rates. However, in order to understand whether cutting rates is appropriate, we have to ask ourselves – why are we suffering from a recession.

Read the rest of this entry »

After reading this excellent post on the liquor store regulation idea on Kiwiblog (which aggregates the thinking of a number of other blog authors posts on the issue are found *,*,*,*), I’ve decided to do a little thinking out loud about the issue.

Now, to analyse what it going on we have to ask why we want to have tighter controls on liquor outlets in the first place. From what I can tell, liquor outlets aren’t the direct cause of harm – the consumption of alcohol is. As a result, these measures are based on the causal link: More liquor outlets -> more liquor consumption -> more crime.

For fun, lets take as given that more liquor consumption leads to more crime. We still need the prevalence of more liquor outlets to cause more liquor consumption for this story to float. How does this work?

Read the rest of this entry »

Over at Anti-dismal Paul Walker points at a paper on Pigovian taxes by John VC Nye from George Mason university. In this paper Dr Nye makes the following point:

A claim about the optimal Pigou tax is a joint claim about the size of the externality and about the optimality of observed outcomes, not just the externality. Measuring the size of the observed Pigovian externality – even if done perfectly — is not a reliable guide to the proper level of the Pigovian tax because in a world of efficient transfers we will still observe some externalities

Now this is very true – if we sit in the world of partial equilibrium analysis (which a lot of Pigovian analysis is based on) for too long we can forgot the fact that markets do not act independently, and this is bound to colour our view on the correct level of the Pigovian tax.  At some level this is a critque of Dr Mankiw’s Pigou Club.

Read the rest of this entry »

One of the major questions I face when discussing economics is:

Why do we feel that prices are the appropriate measure for illustrating the value someone receives from a product?

Now I only have a limited understanding of welfare economics, but I am going to attempt to discuss the issue anyway ;) . If anyone more knowledgeable would like to correct me I would be happy to hear from them.

In a micro sense this idea could be criticised insofar as one person may have a lower “willingness to pay” for a product which may stem from having a higher opportunity cost (as they have a lower wealth level then other people) rather than truly receiving less value from the consumption of the good/service. If this is the case we may feel that we should re-distribute the resource from the wealth to the poor in order to increase the level of aggregate welfare.

Now accepting this relative ranking of preferences and the given endowment in the market this could be a suboptimal situation in terms of welfare. After all, we know that the poor person values both of these goods more than the wealthy person (assuming no linkages between them) so “total satisfaction” in society will be maximized by this implicit “redistribution” resources. However, this does not make the price mechanism pointless, let me attempt to explain.

Read the rest of this entry »


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