The visible hand in economics

Archive for the ‘Monetary economics’ Category

In what appears to be becoming a “stand up for the Bank” day, I was surprised to see Steve Pierson at the Standard state that he believes the Reserve Bank cut interest rates too late!

Now, if the Reserve Bank had known exactly what was going to happen in the world and decided to hike rates for the hell of it I would agree – but ex-ante they (like the majority of other people) had no idea what was going to happen.

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A lot of people appear to be discussing the RBNZ’s call that the New Zealand recession is over (here, here, and here).

Now I have to admit that I do not find his call ridiculous for a few reasons:

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With the official cash rate set to fall even further later this week, shares become relatively appealing when compared with other financial instruments, such as bonds and term deposits.

The old adage of ‘buy low, sell high’ seems fitting, given the battering shares the world over have taken in the past while. The NZX and Dow Jones industrial averages, for example, are both down around a quarter from their respective values six months ago.

But just when is the market ‘low’?

I don’t know! If I did, I’m sure I’d be a lot wealthier than I am. However, I thought it would be useful to write a blog entry to stimulate discussion and debate on what TVHE readers are picking for the sharemarket:

  1. Is now a good time to buy?
  2. What industries/companies would you consider investing it?
  3. What factors are influencing your decisions to invest, or not?

I look forward to hearing our readers’ views on the current state of the sharemarket.

Copyright ©

Over at Paul Krugman’s blog he discusses the idea that monetary authorities could have prevented the Great Depression and how that relates to now (ht Economist’s View). Specifically he states that recent events imply that “the thesis of the Monetary History (Friedman’s book) has just taken a hit”.

I am not sure I agree with Krugman’s argument here. He states that the Fed controls the money stock. Given that the money stock grew through the late part of the Depression, and given the money stock has increased meteorically now he states that we can’t “blame” the Fed for either slowdown.

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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!

Complaining about inflation now may seem to be similar to the captain of a boat complaining about pushing the engine too hard when the ship is sinking – but I’m going to do it anyway ;)

Bank in September Fred Mishkin wrote an article for the Wall Street Journal (ht Economists View and Greg Mankiw).  In it he mentions that the concern should not lie with headline annual growth in the consumer price index, but a more generalised and persistent increase in the price level.  Looking at core inflation, nominal wage growth, and the such in the US indicates that they are not truly suffering from an inflation problem.

Heading into the recent crisis this still seemed to be the case.  The October NBNZ Business confidence survey (which I will discuss tomorrow) still had elevated inflationary pressure, and I suspect the labour market data we have seen today and back on Monday (note that I haven’t seen this data when I wrote this) would indicate a strong inflationary undercurrent.

The truth is, even with a drastic slowdown in domestic economic activity, there is the risk that some form of underlying inflation mark-up is occurring during the wage negotations of the firm and the price setting behaviour of other firms.  I think this is evident in changing marketing strategies – with a “fixed price contract” now seen as an amazingly special deal by electricity retailers.  Purging this from the economic environment is difficult and costly – and is the ultimate cost of loose policy over the past six years.  If our recession is deeper than that experienced by the rest of the world, we can probably put it down to a historical failure by our central authorities.

The US may be able to relax about inflation – but we still can’t :(

To put my personal value judgments out initially, I generally DO NOT think that government (through fiscal policy) can be blamed for inflation. However, among many people, and even many economists there is a feeling that government is to blame in some way. Personally, I completely blame monetary policy for the failure to control inflation – and although I think they are behaving in an appropriate way in the current crisis – I think that policy was too weak in the past, which has made things more difficult now.

However, the view that it is “the government fault” is not completely without merit. Iprent at the Standard asked me to link to a discussion of how this COULD happen, and as a result I will write a post and link to it here :)

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That is the view put forward on the Rates Blog by Neville Bennett. It is also a view that Berl has enjoyed some airtime with. It is also, in part nonsense from a bunch of very smart people. Lets flesh it out a bit.

The quote that captures the essence of the argument (and the one that I least disagree with):

Its high Interest rates, like NZ’s, encouraged the borrowing of foreign currency.

In part this is could be true – if the Reserve Bank can only control the domestic interest rate then the relative “price” of domestic credit is higher, so banks will substitute to foreign credit. Very good. However, although this initially sounds bad or maybe scary, this factor by itself ignores ALOT about how inflation targeting impacts on the economy. It only tells us that banks MAY source a greater proportion of credit overseas – not more credit.

Furthermore, it gives the impression (which appears to have at least been implied here, and has been fully stated by Berl) that higher interest rates lead to more domestic borrowing. This my friends is complete nonsense. Let me wave my economics wand and show you why ;)

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I’ve said Michael Cullen should be quiet about interest rates before – now it is John Key that needs to be quiet about interest rates.

The Reserve Bank is independent – if you are a politician you don’t say what you think they should do, as any opinion can be construed as pressure on the Governor. No politician should do it – especially not a potential prime minister in waiting!

Ultimately, the Reserve Bank is a machine that turns interest rates into inflation outcomes – but it can only perform this process (effectively) as long as people believe it is “credible”. If the government leaves the machine alone it can function, and it can keep inflation low without damaging growth. If politicians start stuffing with the machine by questioning it, its credibility stops working and we end up with worse outcomes.

It is a magical machine – politicians should not mess with it. So please, John Key, do not say what you think should happen with interest rates. If you become prime minister you can mess with aggregate demand through fiscal policy – there is no need to try to jump into monetary policy as well.

Winston Peters can say things about monetary policy as no-one listens to him, but both John Key and Micheal Cullen are individuals that people do listen to – as a result, please pick your words around monetary policy carefully, this is not the United States after all.

Update: On that note, here is Winston Peters talking rubbish.  Truly, this sort of rubbish makes me certain that he cares more about getting into parliament than he does about the people he is supposed to serve.

100 basis points slashed by the Reserve Bank of Australia. There cash rate is now 6%. A 50 basis point cut was expected, 75 seemed possible, 100 is epic.

At the start of the recent freeze in credit markets a 75 basis point cut by the RBNZ seemed highly unlikely – but possible. Now a 75 basis point cut is looking increasingly likely – and 100 basis points also seems possible. To put this in perspective – the Bank may have felt that a 50 point cut in October was on the cards following the September cut. Financing costs have now moved up so much that it is (sort of) like the previous cut never happened – implying we need a 100 basis points of cuts just to get where the Bank was aiming, maybe :P

Does this indicate that the economic situation for Australiasia has deteriorated rapidly – yes and no.

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ISCR have just launched New Zealand’s first prediction market.

From iPredict:

Who’s going to be the next Prime Minister – Helen or John? Will the price of petrol be $3 a litre by Christmas? Will Winston be sacked before election day?

These are some of the questions Kiwis may find themselves backing their opinions on with iPredict – – New Zealand’s first real money online prediction market, which launches tomorrow (9 September).

The online marketplace enables users to trade on their predictions on a broad range of future political and business events that pay real money if their prediction comes true.

Established as a research tool by Victoria University of Wellington and think tank ISCR, iPredict harnesses the wisdom of crowds via the Internet to predict future outcomes and has a strong focus on helping companies, government agencies and academics with research. …

Mr Burgess says that iPredict is like a simple stock exchange, trading real money.

“How it works is that contracts pay $1 if an event comes true – nothing otherwise – and the price these contracts trade for is the prediction. For example, you could have a contract that pays $1 if Helen Clark is the next Prime Minister, and pays nothing otherwise. If that contract trades for 60 cents, then the market’s prediction is a 60% probability that Helen Clark will stay on as Prime Minister.”

Mr Burgess says that prediction markets are the gold standard for forecasting.

“Traders on prediction markets combine information from polls, expert commentary and any other source to produce a prediction that is more accurate than any available alternative,” Mr Burgess says.

“Prediction markets work because they ask traders to put their money where their mouths are, so it pays to be honest, objective, and even do a little homework.” …

Anybody can browse iPredict and see the predictions for free by going to but traders have to be 18 years and older to set up an account. Accounts are free to set up and people can start trading with as little as $5.

Get some money on your account and get predicting.


On Thursday the Reserve Bank is going to take another look at interest rates – and they will also be releasing a new set of forecasts. Like last time, lets try to describe the Reserve Bank’s decision and state what they are likely to do (rather than stating what we think they should do).

Essentially, in a preview to the Thursday meeting we want to ask two overarching questions:

  1. How has economic data panned out compared to the June forecast – and how will this influence the RBNZ’s interest rate decisions,
  2. How has economic data panned out since July (when they cut rates – between forecasts) – and what does this tell us about the potential for interest rate cuts.

Once we have explored this is more detail – we can talk about the likelihood of of the Reserve Bank cutting rates given the net impact of the change in data.

For people that don’t want to read a long boring post, it appears the data from June-July was substantially softer, while data from July-September was stronger. In my opinion, the net impact of data over the past 3 months has made rate cuts more likely – but maybe not to the degree that the market has priced in.

If you want to read my reasoning – have a look below the tab ;)

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I’m feeling sick today, so I won’t be able to write much.  As a result, I’m going to link to a good article over at the Rate’s Blog by Bernard Hickey.

I agree with his conclusion that the NZ banking system is in good hands – however, it is important to remember that it was trouble in the banking system that lead to the great depression.  As a result, the outlook for our banks will be incredibly important over the coming year – a factor that the RBNZ is definitely keeping an eye on.

Who knows, the real reason why the RBNZ is cutting rates and the RBA is on the verge of cutting may be issues in the banking sector (definitely something they would know and we wouldn’t).

Poverty is not an issue that we have touched on terribly much on this blog – however it is a fundamentally important issue when it comes to discussing what outcomes we want as a society.

Now the general impression is that poverty is bad, at least that is how I feel when I hear the word. However, a general feeling is not enough to base policy on – we have to define “poverty” and then define what we think is an appropriate way of increasing social welfare with respect to poverty.

There are two different ways of defining poverty in a population of people: Relative and absolute.

Absolute poverty measures tell us that if a person/household cannot afford a certain bundle of goods, they are experiencing poverty. Relative poverty tells us that if a person/household is in a certain income decile, or earns only a certain proportion of the average wage then they are poor.

A good casual defense of the absolute poverty measure is provided by Tim Harford (*) while a strong case for discussing relative poverty is given by Terence at LAANTA (*)

Now both poverty measures are extremely useful, but neither neatly fits into the strict “feeling” of poverty that society as a whole wants to deal with. In order to understand how to use these measures, we have to ask “why does society care about poverty”?

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As I said, I will discuss the RBNZ speech from yesterday.

Personally, I thought the speech was spot on – Dr Bollard understands the issues associated with inflation targeting, but he also more than understands the benefits.

Look at this statement surrounding oil prices shocks:

Instead, the key policy requirement in this situation is to allow the initial externally driven relative price changes to occur, but keep monetary policy sufficiently firm to ensure that generalised second-round inflation effects do not take hold – in other words, to keep inflation expectations anchored.

This is all I wanted the Bank to say in their latest statement – that they would react to the second round of price increases stemming from an increase in oil prices if it occurs. Tell the market that, although the CPI figure looks bad, once we’ve cleared the recent shocks inflation will again be the primary concern.

Furthermore, the Bank damned alternatives to inflation targeting – specifically:

Another alternative that could appear superficially attractive is to require monetary policy to target multiple objectives such as growth, employment, export and the balance of payments. This was the approach taken in New Zealand and many other countries in the post-war period up to the early 1980s. It inevitably had a short-term focus, and resulted in stop-go policies and high inflation. We now know that one instrument cannot succeed in achieving multiple objectives over the cycle. The move to inflation targeting, with its single, clear objective, resulted from the lessons learned in that period. We do not want to re-learn those lessons.

Very good :)
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