The visible hand in economics

Archive for September 2008

Tax cuts are coming tomorrow, there is excitement in the air. First tax cut after a decade of effective tax rate increases (through fiscal drag). And what an interesting time for it, as we go through the largest financial crisis since the Great Depression.

Still don’t forget that there are tax cut calculators available here and here namely:

  • Infometrics: Simply type in your income and get your tax cut
  • Labour: Has disappeared – is now here (ht Agnitio)
  • NZIER: here, calculates the PPP adjusted income difference between Aus and NZ, and allows you to take into account WFF
  • Deloitte Tax Cut Calculator: Compares NZ and Aus tax cuts

Update: The Standard asks a good question “what are you going to do with your tax cut”. Me, I’m not aiming to change my level of consumption and so it will flow into my savings.

How does this fit in with Ricardian equivalence?

Warning, boring description of my optimal consumption allocation follows below the tab

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Matt McCarten was someone I enjoyed listening to when I was a young Alliance supporter many years ago – however, even in the heyday of teenage communist sympathies I would not have agreed with his conclusion that the recent credit crisis is undeniable evidence that voluntary trade does not work.

Now Kiwiblog and Anti-dismal have already gone to task explaining why they don’t believe this is a fair criticism of free trade, and good on them I think they are on the money (David Farrar focuses on why the criticism doesn’t sit well while Paul Walker paints the case for regulation being the cause of the problem – more here). The Hive also mentions dis-satisfaction with his choice of historical comparison. However, even after reading these posts you may still harbour some confusion surrounding the fact that I said voluntary trade instead of free markets.

Ultimately, his criticism of the “invisible hand” draws out something incredibly naive about the point of view that the free market is bad. Supporters of the free market are not so much saying that corporations should be allowed to manipulate information and “defraud” the public as they are saying that voluntary trade among groups is a good thing.

If two people choose to trade, it must be in their benefit and therefore giving people the freedom to trade is an important part of a society – this is what free trade represents.

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Obviously the biggest concern from this scandal should be the loss of life associated with it. However, the next biggest issue from a New Zealand standpoint is the potential loss of income associated with the damage to the “New Zealand brand”.

Now if Fonterra was taking into account the risk and return associated with their investment in Sanlu I would have little sympathy for the business in this case.  However, according to Rod Oram poor governance in Fonterra ensured that the business owners (the farmers) were put into a situation where risk and return were not taken into account appropriately, and as a result the loss of domestic income was the result of poor processes that were entirely avoidable (ht The Hive).

Furthermore there is a negative externality here.

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Congratulations to the Phoenix for their first win of the regular season (ht Yellow Fever). I should have been there, but I am currently far too swamped with work.

For those that are complaining about the lackluster crowds I have to say – why the hell are the games on Sunday night? Even if the goal is to “attract families” I don’t think Sunday 5pm is a particularly good time. Give us some Friday and Saturday games and you will see a much larger crowd.

P.S. I will reply to all the comments that appeared over the weekend at some point (hopefully tonight) – I’m just a bit too tied up at the moment to answer things cleanly.

P.P.S. Also congratulation to Liverpool for beating Everton, and to Hull City for beating Arsenal ;)

A popular explanation of the booming in house prices according to, well, everyone is that there was lots of “credit washing around” which convinced people that they should go and bid up house prices. An example of this logic is shown in this statement at the very good Big Picture blog:

The bubble in home prices, fueled by the ready availability of credit, resulted in an underestimate of the risks of residential real estate

Personally, I think this type of thinking has the causality all mixed up – if there was any error it was because people “underestimated the risks” associated with the price of residential real estate, and therefore given the “price” of credit the housing market appeared to be a better bet than it actually was. As a result, the entire blame for the bubble and associated crisis should lie with the fact that risk wasn’t being appropriately identified – not with some mystical belief that credit was springing up all over the place. If the risk problem was unsolvable, then we can blame central banks for leaving the price of credit (not its “availability) to low – however, this is a secondary issue to risk.

The whole concept of the “availability of credit” is somewhat of a misnomer.

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Econbrowser has a great post which takes this post by Brad Delong and adds some historical background.

The post mentions that policy action will aim to prevent the mistakes of 1929, the 1970’s, and Japan in the early 1990s – behind the slight humor this is actually a very important comparison.

One thing I would like to add is that the 1970’s crisis involved a huge negative terms of trade shock for a lot of the developed world (oil prices!) which we have already experienced this time around (I believe there was a smaller TOT shock in the early 90’s) – as a result, policy need to take into account this difference.

It isn’t just that policy was too tight in 1929 and the early 1990’s and too loose in the 1970’s – there are fundamental differences in the shocks being faced. Furthermore the structure of the economy is entirely different (unions are weaker, communications and information dissemination is a lot more rapid, prices appear to be more fluid in a lot of cases). As a result, a historical comparison can only take us so far – although we must not discount histories ability to provide an intensely useful benchmark.

Congratulations New Zealand – once again, leading the world in terms of an economic downturn. The 0.2% fall in production GDP in June puts us in a technical recession!

Given how trade exposed we are I would assume that we would lag the rest of the world – but mother nature came in, provided us with a drought, and dragged us into recession.

More details on GDP to come, maybe :)

According to a recent post on Frog Blog it would appear so.

As well as randomly comparing the current crisis to the methodologically flawed “shock doctrine”, frog states that NZ MUST:

invest in rebuilding our local communities so that they are economically independent and self sustainable

This would surely only be the best thing to do if you have an extremely pessimistic outlook for the world and world trade.

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Capital inflows are the reverse side of the current account deficits that we like to discuss on this blog (most recently here). For some reason a capital account surplus is often seen as a good thing by journalists while a current account deficit is seen as a bad thing (ht Bluematter). This does not make sense to us as economists, as we know they are the same thing.

However, I suspect the difference in attitude stems from some dose of reality – fundamentally there are good and bad elements in a current account deficit/capital account surplus, and when the two attitudes shown by journalists are put together we get a fairly good breakdown of what is really going on :)

On that note, Dani Rodrik discusses a paper on capital inflows. As Dr Rodrik states:

They find that capital inflow bonanzas have become more frequent as restrictions on international capital flows have been removed, that these episodes can last for quite some time (lulling policy makers into thinking that they are permanent), that they end with an abrupt reversal “more often than not,” that they are are associated with greater incidence of banking, currency, and inflation crises (except for in the high income countries), and that economic growth tends to be higher in the run-up to a bonanza and then systematically lower

Now New Zealand is a country that has had some capital inflows – so lets discuss what this view of capital inflows means for us:

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It appears that many people fear a contraction in the economy – and are determined to bring to justice any factors that could lead to such a situation.

As of late, one such factor was the “credit crisis”, which has lead to a sudden freeze in lending and potentially to a contraction in economic growth in many of the worlds largest economies.

Given that it was a seemingly inevitable freezing in the credit market that has caused this reduction in economic activity many people state that it we should have regulated the credit market more – to prevent this sort of contraction from happening.

However, even if we do take the current slump in the credit market as inevitable – I am not convinced that this type of regulation would have improved the situation.

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I don’t like thinks that sound like conspiracy theories – and the title of this post does! However, I am starting to get the impression that this is one situation where it may actually be the case. Overall it stinks like socialism for the rich (good cartoon here, good article here)

Two articles from Bloomberg this morning have pushed me into this view:

Bernanke Signals U.S. Should Pay More for Bad Debt

Bernanke Says Normal Markets Needed or Growth to Halt

As Felix Salmon states here, Bernanke’s interest in paying the hold to maturity price for assets just doesn’t make sense when a good proportion of the assets aren’t going to mature – and even if they wish to take into account risk, the US Treasury does not have time to sufficiently evaluate the risks.

Surely the aim of the bailout should be to do as little as possible to ensure that credit markets start functioning again – in this sense, over paying for assets seems excessive.

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Over at No Right Turn I/S states that we can’t simply view “free trade” as beneficial, we have to be mindful of the costs. Now this is true, as with any policy we have to look at the costs associated with change as well as the benefits before we decide what to do.

However, I am not convinced that the issue is exactly the way I/S has framed it – fundamentally, I fear the I/S views farmers (or potentially exporters more generally) as the only people who benefit from a free trade deal – while stating that the rest of society bears some “cost”. It is the benefit side of the equation I wish to discuss here:

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Over at Kiwiblog, David Farrar comments on outward migration from New Zealand. He concludes by stating:

Inwards migration of new New Zealanders (which is a great thing) helps keep the overall population stable, but that does not mean there isn’t a serious problem with the numbers leaving.

A similar theme was mentioned a few weeks ago in an extremely interesting newspaper article by David Grimmond, which concluded:

Ultimately outward migration flows are a barometer of perceptions of government management. The steady growth in departures suggests a growing disillusion with the current government. It potentially also suggests a lack of confidence that the alternative will make much difference.

However, I don’t feel that this view of outward migration gives us the full picture of what is good and bad – lets discuss (Note: The Standard discusses the issue here):

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I was interested to see the Standard and No Right Turn link to a PSA advert from the latest Listener. The advert seems like a whole lot of mis-information piled right into a single page.

The criticism of the ad is quite simple – they come up with a sum and then they take away jobs people actually do care about in order to get to that sum, rather than actually describing the jobs that will be cut for any tax cut. Now I think people should know that a tax cut will lead to a cut in government spending – but telling them it will lead to less nurses is just wrong.

Furthermore, by illustrating the individual benefit but focusing on the full cost to society from the change, they exaggerate the size of the cost to the individual. If we have one less policy analyst what will that cost the individual compared to the 10c gain?

Ultimately, I agree that we as a society need to discuss the trade-off between the level of government spending and the size of tax cuts. However, the type of argument provided by the PSA ad (along with their constant stream of news releases) implies that spending by government is “virtuous” while the same spending by the individual is “waste” – I am not comfortable with this line of reasoning.

Anyway, given current policies and polling I suspect the trade-off will look more like this:

In an earlier post we mentioned that the US currency appears to appreciate in the face of bad news – a bad sign for economic stabilisation. After saying this, I noticed two articles up on bloomberg:

Dollar Falls on Speculation U.S. Bailout Plan to Increase Debt

Treasuries Prove Irresistible as Deflation Bet Trumps Paulson

Very interesting.

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