Tuesday, 23 June 2015

A tale of two GDPs

Last week's lower than expected GDP growth in the March quarter - 0.2% compared with the forecasters' 0.6% pick - understandably got a lot of attention. But a couple of things have been niggling away at the back of my mind about it, especially as it doesn't seem to reconcile well with what the likes of the ANZ business survey or the BusinessNZ/BNZ performance indices were saying about business conditions at the time.

First thing is, what's the confidence interval around the actual 0.2%? If for example Stats says the number is 0.2%, but plus or minus 0.5%, then there's much less reason for angst over a number that's within the range. I couldn't find any info about a possible confidence interval in the detailed announcement so I got in touch with Stats, who tell me there isn't one (at least not in any formal statistical-theory sense). As a second-best approach, I thought I'd take a look at the historical volatility of the quarterly GDP changes, and here it is.

The upshot is that the quarterly change is quite a volatile beast. Yes, there tend to be strings of positive numbers during a business cycle expansion, but successive quarters are still rather erratic. More formally, the average quarterly change over the whole period is +0.6%, but the standard deviation is 0.8%: if the distribution were anything like normal you'd expect that two thirds of the time the quarterly change would be in a rather wide range between -0.2% and +1.4%. So my quick take is that we ought to keep some sense of calmer perspective about the March outcome.

The other thing that seemed strange to me was the -2.8% fall in business fixed investment in the March quarter. The latest ANZ survey, for example, showed that (ex investment in livestock) investment intentions have been running strong by historical standards, as shown below.

But when you unpick the investment numbers, again you get to the same conclusion: there's less to an apparently weak number than meets the eye. There was a surge in investment in plant and machinery and in transport equipment in the September and December quarters of last year: in March the numbers dropped almost exactly back to where they were in June '14 ($9.88 billion compared to last June's $9.84 billion). Look at the numbers in a less volatile way - on a running four-quarters-total basis, for example - and the 'drop' in investment disappears completely.

All up, I'm prepared to believe we're past the peak of the current business cycle - the ANZ survey shows it pretty clearly- but I'm also prepared to believe that the headline March number made things look a good deal worse than they really are.

On the other hand I've also been looking at what's been happening to Australia's GDP: the graph below comes from the Reserve Bank of Australia's excellent Chart Pack, which is a very handy guide to the Aussie macroeconomy.

This looks very much like a gradual long-term deceleration in Australia's growth rate, and at first I thought it might have been due to the winding down of the resource project boom. But the timing is all wrong for that as an explanation: in fact, the mining investment boom did not get properly underway until around 2000, and did not peak until 2012-13. In fact the slowdown in overall GDP growth happened despite the substantial boost to activity from the mining sector.

There's been quite a bit of debate about whether developed countries are looking down the barrel of slower economic or productivity growth in the future: it's been a particularly big issue in the US and UK, where recent productivity growth performance has been very weak. Until I looked at these graphs, I hadn't really expected the Lucky Country to be in the frame as well.

Sunday, 14 June 2015

The dollar's down, interest rates are lower. It's all good. Or is it?

Every now and then I like to go to the fridge and get out the semi-frozen jar at the back that contains what's left of the old Monetary Conditions Index, the MCI. For those of you of tender years, this used to be how our Reserve Bank measured the overall tightness of monetary policy by combining the level of interest rates and the level of the Kiwi dollar into one single number.

It's fallen out of intellectual favour these days, but it still seems to me to say something valuable: it's indisputable that the overall effect of monetary policy reflects the combined impact of both interest rates and exchange rates, and something like the MCI that attempts, however roughly, to measure both at the same time gives you a better overall perspective than following moves in the OCR alone, or moves in the NZ$ alone.

Last time I did it, one result leaped out: the MCI was saying, correctly, that overall policy was way too tight. In that light it's not so surprising that last week we saw the RBNZ start its retreat from Moscow. So what's the MCI saying now?

Well, monetary conditions are still on the tighter side of neutral, if you take neutral to be the average level of the MCI since January 1991, when our Reserve Bank got going in its modern form. At the latest readings for 90 day bills (3.3%) and the TWI (73.2), the MCI comes out at the red star on the graph (876) - still somewhat north of neutral, which would be around the 600-650 mark*. So despite the interest rate cut and the drop in the dollar, businesses still face some modest level of monetary conditions headwind against them.

And, as I did last time, you can do a rough calculation of where 90 day bills or the TWI would need to be to make life merely neutral for businesses. To get to neutral, banks bills would need to drop to around 1% if the TWI stays where it is, or the TWI would need to drop by around 5% if bank bills stay where they are. If you were looking for some plausible combination of the two, bills at 2.75% and the currency 4% lower would do the trick. For things to work out well, we likely need the Reserve Bank to ease a little more than it indicated last week, and the forex markets to play ball: if we don't get that combo, then either inflation will remain below the Bank's target (not good), or the economy's growth rate will take a hit (not good) or both (double plus ungood).

* Since I last posted about the MCI, I've upgraded my calculations to use the new broader 17-currency TWI instead of the old narrower 5-currency one. The trend in the updated MCI  is exactly the same as the old MCI but the absolute numbers are a bit different.

Friday, 12 June 2015

What's happening in the telco sector

Earlier this week the Commerce Commission came out with its latest Annual Telecommunications Monitoring Report (pdf), and very interesting reading it was, too (as was last year's, as I commented here). In passing, it's daft that the Commission is obliged to report on the state of competition in the telco markets, while it is not allowed to publish proactive reports on the state of competition in the rest of the economy. If you're interested in the whole 'who can report on the state of competition' and 'market studies' issue, I'll be talking about it at this year's New Zealand Association of Economists annual conference - full programme here.

Back to the report. Lot of things to like by way of positive developments in the sector, though there is still quite a flavour of the deadweight legacy cost of the copper network, and the Commission's likely reduction of the copper price next month will be a positive move. In particular among the positives, consumers are mostly getting better value for mobile services: as the two graphs below show, mobile bundles are competitive by international standards, and prices have been falling.

But there are some oddities even on the mobile side. When you see the table and graph below you have to ask, why the very expensive prices by international standards for slugs of mobile data, and why aren't they falling, too?

I don't have any good rationale for this and neither does the Commission: on static prices, it comments (p33) that "This suggests there is a lack of demand for and/or competition to supply mobile broadband data when it is not part a bundle of mobile phone services, particularly when it is a relatively large amount of data". Don't know about lack of demand - you'd think there are plenty of people running around these days with lots of uses for their tablet-style devices - and you'd think mobile companies would compete harder for this upmarket business. Odd.

Apart from the prices, usage, revenue and investment sort of stuff, the report has heaps of other interesting stuff. For example, did you know this (below) about the percentage of our students who are taking computer science courses?

There was one pair of graphs which I had some difficulty with. I'd like to believe this one, which shows we're right at the head of the international pack for the proportion of businesses selling over the internet...

...but I can't square it with this one...

...which says that only 11% of small businesses make sales over the net. If (conservatively) you say 80% of all businesses are small businesses, you can't get to the national 47-48% figure of the first graph.

Never mind: this is still an excellent resource. As well as all the obvious stuff, it's also got a very useful chronology of events in the sector over the period January 2014 to March 2015: if, like me, you have to go away and look up things like the sequence of draft copper loop pricing decisions, it's all there in one convenient spot. 

Thursday, 11 June 2015

Where are we? Where are we?

We got a somewhat unexpected interest rate cut from the Reserve Bank this morning - though having been wrong on enough occasions about the macroeconomic cycle, I think I'm allowed to say that I personally wasn't too surprised - and inevitably the question arose for the folks at No 2 The Terrace: you raised interest rates back in 2014, and now you've had to change direction. Did you take a misstep last year?

The Bank came prepared for the criticism with Box A in the Monetary Policy Statement. Here are two of the graphs from that Box.

The first one (below) compares the Bank's expected track for 90 day interest rates at the time of the December '13 Monetary Policy Statement with the expected track in today's. Back then, the prospect was for a series of increases (with 100 basis points of increase actually delivered by the Bank in the first half of 2014); now, the prospect is for lower rates, with one 0.25% cut already in the bag and another likely. So there's no getting past the fact that what the Bank thought it had to do has gone through a complete turnaround, and the rises in 2014 now look rather odd. What happened?

That brings us to the graph below, which shows the Bank's perceptions of the output gap in December '13 (red line), its take on the state of the output gap as of today (blue line), and the difference between the two (the grey bars). The output gap is a measure of how close the economy is to full capacity, and positive output gaps (i.e. the economy going especially strongly) tend to bring inflationary pressures in their wake.

And as you can see, back at the end of 2013 the Bank thought that the economy was already bursting at the seams, and would become increasingly more strained again. Hence the need for interest rises to cut off the inflationary pressure that would be likely to follow. On more recent estimates of the state of the economy, however, we weren't actually at full capacity in late 2013 (mostly because labour supply was expanding faster than thought, thanks to sharply higher immigration and a higher participation rate), and it's only around now that we've got there.

So, not a mistake, just the best decision you can make on the best, albeit fragile, evidence in front of you at the time. And as I've said before, I have considerable sympathy for policymakers making these important decisions in what is essentially an economic fog. What's more, you can't rule out that there may be similar changes of direction in the future: self-evidently, these output gap measurements are fickle beasts, and you can't be sure they're telling you the right thing today, or won't tell you something different tomorrow.

Here's another chart (from p21 of the Statement): it shows the Bank's estimated range of uncertainty around the location of the output gap. Right now, their best guess is that we're roughly around full capacity, but for all we really know we could be somewhat below it (1% of GDP below) or quite a bit above it (by some 1.75% of GDP).

So while it's tempting to take pot shots at Reserve Bank governors backtracking - or Finance Ministers not quite getting to surplus, for that matter - hold your fire. Bag them if they make decisions at odds with the info at the time, sure. But they're not: this is what making sensible decisions under uncertainty looks like, and, unless there's a miraculous leap forward in the art of output gap assessment, probably always will.

Tuesday, 2 June 2015

Pssst! Do you want another US$4 billion?

Deregulation of the airline industry is one of the success stories of economics from a number of perspectives (as I wrote earlier here). It's not often that the politicians take the economists' advice, and rarer still when you have well dug-in interests with a previously protected patch to defend, but deregulation of the airline business not only got adopted in the US, and subsequently internationally to a greater or lesser degree, but has worked out exactly as the economists predicted: competition increased, prices fell, choice expanded, more people could afford to fly, and consumers benefitted hugely.

Oddly enough, until very recently nobody had put a figure on the size of the consumer benefits. Step forward Clifford Winston of the Brookings Institution and Jia Yan of Washington State University, who've done precisely that. Here's the Brookings announcement about their results, and if you want the whole nine yards the announcement has links to a longer media summary and to their academic journal article in the American Economic Journal: Economic Policy.

They principally looked at the impact of the "open skies agreements" that the US negotiated with other countries over 2005-09. Their model enabled them to identify the (substantial) declines in price and increase in choice that followed deregulation: it also let them  do the counterfactual "what if" exercise of running the model as if the deregulation had never happened. In that case (I'm quoting from p396 of the journal article)
eliminating the open skies agreements on US international routes that have been signed between 2005 and 2009 would initially raise fares in all segments, with the greatest effect, 50 percent, on business and first-class fares [it was 21% on full price economy and 13% on discount economy]; reduce passenger demand in all segments and market demand [by 13% overall]; reduce the number of flights; and increase the number of carriers per route. Travelers would lose $3 billion annually, nearly $2 billion from higher fares and $1 billion from fewer flights, indicating that they gained substantially from the open skies agreements that had been negotiated during that period. As noted, we are understating the total gains because we cannot measure the additional long-run effects that would increase the initial gains.
On top of the US$3 billion of gains from the 2005-09 agreements, they also found that consumers benefitted by close to a billion dollars more from agreements negotiated before 2000. And they also extended their model to the routes where the US has yet to negotiate open skies agreements, and found that deregulation and competition would yield a further US$4 billion of consumer benefit. And there are still further gains (actual and potential) left uncounted, including the benefits from domestic deregulation in the US and elsewhere, and the benefits of open skies agreements on routes not involving the US.

The numbers show the shabbiness of airline protectionism: pre deregulation, and to this day in some countries, governments had been giving a tiny group of 'flag carriers' - sometimes just a single operator in a country - free licence to rip off their own citizens. It's both stupid and perverse (as I've previously said, here or here).

You'd  think that by now the rort would be too anachronistic to survive:  the process for all the world is as if a medieval monarch were giving his gracious consent to the trade in beaver pelts. These days, it's who is allowed to fly into or out of Shanghai or Manila, but in essence it's no different to Charles I (as I've just read in Peter Ackroyd's Civil War) deciding who should be allowed to make pens, playing cards or spectacles.

Unfortunately governments still seem unwilling to leave the airline market alone, with the latest bunfight being US airlines' allegation that some Middle Eastern airlines are being given unfair competition-distorting subsidies and the US carriers' attempt to have open skies access for Qatar and the UAE rolled back (here's the Economist's article about the issues). The multi-billion dollar consumer benefits of further liberalisation are still going a-begging.