A frank (non-technical) discussion on current NZ macropolicy

By Matt Nolan 24/04/2013


Note:  I think of macropolicy as policy that is focused on inflation, interest rates, unemployment, and GDP.  Of course, the causes of shifts in these often have micro-consequences … something I sort of suggest as we go through ;)

As we’ve come into 2013 with the unemployment rate elevated and the dollar rising strongly I have seen two things occur:

  1. An increasing, almost dogmatic, preaching from those talking about the high dollar destroying the economy.
  2. A rising disparity between economists and business expectations for economic activity (which have rebounded) and the news.

The last time I saw the second point occur was early 2010 – just before April 2010 when events in Greece took a turn for the worse.  In this way, I can understand the reluctance of news agencies to accept the large number of improving signs about the New Zealand economy – if something goes wrong overseas it will all be unwound.

I can understand the first point as well – manufacturers are finding their profitability low, and they are trying to blame “something”.  A price seems like a good thing to yell at.  Furthermore, it fits into the view that something should have been done, which would lower unemployment – looser monetary policy would have given us higher inflation (which is below the band), likely lowered unemployment, and would have “made the dollar weaker”.  An argument can be made that over the last eighteen months, monetary authorities accidentally left the OCR at slightly too high a level.

But, this is my most generous view of this side.  I find myself concerned that policy issues are being “mixed” by exchange rate zealots who want to make it a free lunch.  For example, if the central bank had lowered the OCR to get the exchange rate down, house prices would now be higher.  If they had done this and the UNCERTAINTY in Europe hadn’t led to more expensive credit (if we hadn’t seen bank funding costs look ugly for parts of last year), then they would have overstimulated the economy – they would have been forecasting failure given what the information they had … it is hardly their fault that things turned on them.

And if the RBNZ had cut the OCR, would the issue of the persistently overvalued dollar (current-account deficit that is higher than we think is justifiable) go away – no, it would actually make no difference to this as in the medium term interest rates and the real exchange rate would go back to where it would have been.  If this is the “exchange rate issue” you care about, stop talking a bunch of bullshiz about the OCR and interest rates, and try to figure out what the real causes are.

You see, it turns out that we are being hit by a lot of large external shocks (both positive and negative), and this creates a bunch of uncertainty about what to do.  In that environment, we have unfortunately ended up in a situation where unemployment is higher than it would be if the economy was “functioning nicely” – so we need to ask why this is the case and what policy solutions may help.  I think I read something about the principles of that.

A blunt tool, but blunt for a reason

The “interest rate” is a blunt tool.  Hell I struggle with the idea that the “tool” is even the OCR – in truth the RBNZ’s monetary policy measure is its flexible inflation target, and all that implies.

But what is inflation, or an interest rate.  It is an incredibly aggregated piece of information that discusses a general tendency over the economy as a whole.  A firm cares more about the interest rate THEY face on their credit, and the price of their costs and their product – not some bull like this.  In truth, we aren’t a centrally planned economy and we live in a world in flux that is filled with uncertainty – in that environment lightly changing the OCR is no way to deal with specific market or government failures we may think exist.

Exchange rate zealots need to stop being lazy with their analysis, ask what the failure is, and figure out what the cause is.  For example, house prices are “too high” – lets ask what is going on in the housing market and building industry.

The unemployment rate is too high, while vacancy numbers have climbed – interesting do we have an issue of “skill-matching” … seems we do!  Given that, the policy solutions involve trying to lower the cost of matching, and more work with unemployed people and investment in skills … not a 25bp cut in the official cash rate.

A sidenote on the exchange rate – remember it captures relative growth

Have people noticed how much growth has been outperforming since about October last year, or how much bank funding costs have dropped, or how much easier it is to access credit.

When these factors were the other way around, they really slowed economic activity in NZ – isn’t it likely that we may see strong growth off this now?  The growth outlook for much of the world is not as flash, and tbh I’m working under the impression that Australia is now hitting its wall, and as a result I don’t think this is “it”.  But the exchange rate is indeed a “price”, and it appears to have given us an indication that we are finally experiencing a (likely rebuild led) recovery.

Treating the issue as “low exchange rate good, high exchange rate bad” involves not thinking about what the exchange rate is.  Originally I thought this was because people hadn’t had the chance to look at the issues, but with the RBNZ/Treasury running a conference on this, and with my little article on “what is an exchange rate” available, I find this attitude perplexing.

QE and exchange rates though!!!!

Yes, QE is driving up the dollar, as every economist in the universe has said since the start.  There are two ways to think about this:

  1. Implied relative interest rate channel
  2. Specific currency purchases

The first channel is cool, that is relative monetary policy.  As long as everyone involved is setting an “inflation target” and sticking to it then this is just a product of all the countries “closing their output gap” – and it is a good thing for all.  Not a currency war.

If countries start trying to mess around with relative prices, by directly buying up currency or bonds in NZ, then the issue is more difficult.  We receive a “capital gain” but the exchange rate gets knocked around as a symptom of relative prices for asset classes and the such being out of whack.  This is generally a pain in the ass – and is an argument for greater co-ordination in monetary policy.  Furthermore, it isn’t actually clear whether it is a net positive or negative for NZ – we are making a capital gain out of our assets after all – what is clear is that it involves a transfer, and we might not think that is fair to some in society (although one of the beneficiaries are consumers so …).

The QE question is one that needs investigation, but on the balance of probabilities having these countries do this is better for NZ then having them experience a full scale depression

Also one note I think gets missed – if they hadn’t done QE, inflation would have been lower, and so the world price of the goods and services we export would have been lower.  For something that is vulnerable to “overcapacity” like manufacturing this would have been very acute – and as a result without QE it isn’t even clear manufacturers would see their return be that much higher!