The visible hand in economics

Archive for the ‘International economics’ Category

So we all know that Iceland is bankrupt – what is the situation like for New Zealand?

A few of the stories I saw when Iceland first went into massive trouble were here, here, and here.  At the time the comparison was so popular that there was a Dom Post article on the risks of New Zealand’s current account.

However, I think by now it is obvious that I am not going to agree :P  Our stock of debt is equal to one years income – I don’t see how this is unsustainable!

So tell me – are we heading towards bankruptcy, are we heading towards a bumpy ride, or are we heading towards more “golden weather” :)

A recent survey stated that New Zealand exports were “resiliant” in the face of a massive global recession.

Now this is something that, at first, might seem unusual. New Zealand relies on exports so much, and if the global economy is collapsing surely we will have no-one left to sell too.

However, it is important to remember the difference between “prices” and “quantities”.

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This is from an email exchange between Agnitio and myself on why dairy prices rose, following his post on Fonterra’s auctions:

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Excellent article by Tyler Cowen in the New York Times. (ht Economists View, Marginal Revolution).

Paul Walker at Anti-Dismal has also covered this issue heavily (here, here, here, here, here, and here).

Fundamentally, for New Zealand, there appears to be no reason for any change to fiscal policy to help deal with the slowdown – something we have discussed here.

Show me the actual “market failure” – then we can figure out how the government can improve outcomes. If there is no market failure, then government action to “stabilise” the economy will simply make matters worse.

Note: This is different to government actions to try and help cushion the impact of a sharp change in fundamental economic conditions. Although a change in the economic situation may change the optimal allocation of resources, a labour market that allows people to upskill and gives them firm institutions to rely on in the bad times will help to reduce the welfare cost associated with the change. This is subtly, but importantly, different from a simple “fiscal expansion”.

It appears that the UK wants to spend their way out of a recession. The US has a plan too, as does New Zealand, Europe, and Australia. Governments all across the world want to spend their way out of a recession – however, there is only three ways they can get the money together.

  1. Increase taxes – knocking out any stimulus anyways,
  2. Borrow,
  3. Print money.

Assume that monetary policy will act to constrain any excessive “money printing” that will be going on this leaves us with borrowing.

If all the governments in the world want to increase their borrowing, this will increase demand for global credit, which will push up interest rates – won’t it? This will lead to an increase in private savings, and will just move around the allocation of resources rather than creating wealth.

There is no free lunch when it comes to “getting out of a recession” – give me the “market failure” we are facing, then we can talk about improving outcomes!

Over at the Standard they discuss one of Lord Keynes’s “real ideas” – namely an international organisation that tries to push savers to spend, by buying the things borrowers save.  When I put it this way the idea sounds ridiculous – which it is.

This unusual view comes from a belief that a trade deficit or surplus is a “imbalance” that needs to be “solved” by a benevolent organisation.  This is of course rubbish, nations, like individuals, should be able to run trade balances or surpluses based on the preferences of the individuals involved.

Now I haven’t heard this idea before, and if Keynes did come up with it I think it has more to do with the elitist world view of the Cambridge school combined with some foggy mercantilist sentiment than with the practical relevance of such a policy.

“Imbalances” that are caused by market failures are the ones we should solve – not arbitrary imbalances that we have assumed exist because we want to regulate.

Ultimately, there has been a disjoint between risk and return in some areas of society, a problem that has been able to occur because of large information asymmetries across the financial market.  Transparency of information and wider education surround risk are the best ways to improve outcomes in the financial market – not arbitrary regulation based on a view that “all countries should run a trade balance”.

Over at Kiwiblog they cover John Key’s speech at the APEC summit. The following passage is quoted, and then David Farrar suggests that economics blogs should discuss it – it seems simple enough so lets give it a go together :)

The question is: faced with this situation again would we do something different to address it? To my mind, this question should lead economies to consider whether monetary policy, fiscal policy, and prudential policy should be more counter-cyclical, and lean against credit growth in an upswing

Now, this by itself tells me very little. Simply put, John Key appears to be saying that “credit market policy” should be counter-cyclical. Now, just 18 months ago people were complaining about interest rates being too high – that is counter-cyclical monetary policy guys, and it helps to tighten domestic credit markets. Our institutions have been relatively prudent (as lenders and households actually do face the risk associated with there decisions, unlike the US :P ).

Of course, there is more to this statement than just that – there are good inferences and a bad inferences to make from the flavour of the speech. Let me sketch them out – then we can discuss them, or whether these inferences are fair :)

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Over at Frog Blog, Frog discusses the current economic crisis and the magnificent fall in the Baltic Dry index. The sentence that summarised this feeling for me was:

Another part of me says that any indicator that drops 93% in less than six months is reflecting a serious ailment in the global economy

Now Frog is right to be concerned – he is right that this movement indicates a slowdown in global trade, and that any slowdown in global trade will impact on New Zealand by knocking down commodity prices. However, I would like to put the movement in perspective – as a figure such as a “93% drop” may give people the impression that we are in a more dire situation than we actually are.

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The paradox of thrift is one of the key lessons taught to macroeconomics students during their first undergraduate year.

Fundamentally it states that if everyone in society decides to save more right now, then it reduces consumption, with reduces economic activity and thereby incomes – and as a result it may actually decrease aggregate savings, and it will definitely reduce economic activity.

It is still widely applied, with recent Nobel prize winner Paul Krugman appealing to it in order to explain why the US needs to jump on in and get consumers spending again.

Of course this does not mean the theory is necessarily right. The paradox of thrift does not have a supply side – as long as prices and quantities can adjust to an economic shock this paradox, and the suggestion of government intervention in the face of it, does not hold water. For government intervention to be a possible solution we need a MARKET FAILURE, a market failure that causes a special macro-economic situation called “demand deficiency”. (Note: This is effectively the difference between Say and Keynes).

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As a footnote to todays post on the Depression I feel it is important to add this from Dr Doom, Nouriel Roubini (ht Greg Mankiw).  He puts down four reasons why deflation is now the concern:

  1. (1) a slack in goods markets,
  2. (2) a re-coupling of the rest of the world with the U.S. recession,
  3. (3) a slack in labor markets, and
  4. (4) a sharp fall in commodity prices following such U.S. and global contraction, which would reduce inflationary forces and lead to deflationary forces in the global economy

I think that the only key one is the third one – the goods market is too flexible, the second is merely a means for the other reasons, and the change in commodity prices is a relative price movement again.

Ultimately, if the price in the labour market it too inflexible (wages) we will see a knock down in employment sure – but deflation?  Deflation stems from a reduction in the quantity of money – central banks are going to keep printing all they can to keep price levels up, a factor that will reduce real wages and then in turn reduce the scope for increases in unemployment.

I don’t see deflation occurring when fiscal and monetary policy is determined to stop it.

The Law and Economics Association of New Zealand (LEANZ) is hosting an interesting seminar in Wellingotn next Monday on the free trade deal with China. It is being presented by some people in MFAT who were involved the behind the scenes economic and legal analysis of the deal. I (Agnitio) went to this seminar in Auckland and enjoyed it.

Seminar and RSPV details below

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This from the Minneapolis Fed:

Thus, roughly 80 percent of such business borrowing is done outside of the banking system. The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable

There are two ways I can read this quote, one that I agree with and one that I dispute. The first way is that “this isn’t the end of the world” – I agree with this, and I still think that people too closely linked to the financial markets are expecting worse outcomes for the global economy than will actually occur.

However, I think the Minneapolis Fed’s paper overplays it a little and suggests that there is no credit rationing element – only a risk-price element.
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Often in New Zealand we bemoan the fact that so much of our “skilled labour” is heading overseas.

This concern is fine – however, looking at this factor by itself does not tell us anything about the change in our skill base domestically.

In a paper by Satish Chand and Michael Clemens it is claimed that skilled migration out of Fiji has been caused by the same factor behind the increase in the stock of skilled labour in Fiji (ht Market Movers) – namely an increase in the return on skills overseas.

This makes sense, an increase in demand for skilled labour overseas increases the return for skilled labour overseas – with an open labour market skilled labour will then bugger off. This in turn will reduce the supply of skilled labour, increasing the wage and increasing the incentive for people to train in these specific skills – increasing the long-run supply of this labour type.

I find the perceived result that the skilled capital stock INCREASES (which is what they find) a touch implausible, as if domestic demand for those skills does not change and a higher return on labour exists overseas (holding the wage rate up) surely the equilibrium level of employment for that skill is lower. Still I do not know what mechanism they use to explain this – as I have not gone through most of the paper. Once I have I’ll correct myself in the comments :P

Still it is a valid point that we have to look at why people are leaving before making judgments – instead of merely stating that people leaving is a bad thing.

So the Green’s want a Tobin tax do they (ht Frog Blog and Stephen). Ok, so I’m hoping they aren’t justifying it on externality grounds – this leaves us with the conclusion that they must believe that it is the most efficient means available to make a certain level of government income.

They do seem to follow this point of view when they quote from a Guardian article:

Set at a lower level it would raise considerable sums of money. If a levy of just one basis point (one hundreth of 1%) was placed on all currency deals, governments would find themselves with an additional $70bn a year. At a time when they are chucking vast amounts of taxpayers’ money at the banks, that would be a nice little earner, and might help assuage the concerns that the public are going to pay for the folly of financiers.

I find it interesting that they see the money appearing out of thin air – if $70bn of tax is raised, it must come from some value somewhere. This is the same issue I have with people who like the financial transactions tax (furthermore, the assumption that capital/trade flows would not change when you tax them – even a little bit, is silly, as a result this over-estimates the associated revenue).

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Over at Market Movers, Felix Salmon discusses “Lehman’s Lies“.

In the wake of the collapse, it was clear that if Lehman couldn’t be trusted, then it would be silly to trust any other troubled financial institution, either — AIG, WaMu, Wachovia, Fortis, Hypo Real Estate, you name it.

This breakdown in “trust” destroyed the delicate equilibrium we were in, and has sent us spinning towards a worse set of outcomes.

Fundamentally, this has happened because “trust” (the fact that we would be playing a “infinitely” repeated game, which then rewards people for collusive behaviour) had allowed us to bypass the asymmetric information problem inherent in the market. With that trust gone, no-one will lend or purchases assets, as they think that only the worst deals are available on the market.

In this light, the behaviour of Lehman appears to be a major factor behind the crisis we now find ourselves in – damned investment banks :P


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