New Zealand labour market – unemployment gap around zero.

The unemployment rate gap is the unemployment rate minus the estimate of the natural rate of unemployment. The natural rate of unemployment is the difference between those who would like a job at the current wage rate – and those who are willing and able to take a job. In the above diagram, it is the level (Q2-Q1).

The natural rate of unemployment will therefore include:

Frictional unemployment – those people in-between jobs. Structural unemployment – those people that don’t have the skills that fit the jobs that are available.

It is also referred to as the Non-Accelerating Inflation Rate of Unemployment (NAIRU) – the job market neither pushes up inflation nor holds it back.

The size of the gap gives us an idea about the amount of capacity in the labour market, and hence pressure (or otherwise) on wages and inflation. ASB estimate that the NAIRU is currently hovering just above 4%, the bottom of the RBNZ’s recently estimated range (4.0-5.5%). With the current HLFS unemployment rate at 4.2%, a NAIRU of 4% suggests the unemployment gap is currently around zero. In other words, the labour market is neither particular tight nor loose. This is of course quite a change from a few decades ago when a 4% unemployment rate would indicate a super tight labour market and strong pressure on wages to rise. Broadly, what we have seen is a fundamental change in the capacity and inflation trade-off, not just in the labour market but economy-wide.It could be that increased globalisation and technological change are facilitating a shift in these trade-offs, which likely explains why inflation both here and abroad has been so low despite historically-low rates of unemployment and elevated measures of resource utilisation. Source: ASB Bank Economic Note

The inverted yield curve – what does it mean?

There has been a lot in the news about the ‘inverted yield curve’ which occurs when interest rates on short-term ends are higher that the interest rates paid on long-term bonds – see video below from WSJ. Here we are talking about 2 year bonds in relation to 10 year bonds. The thinking is that people are so worried about near-term future that they are putting money into safer long-term investments.

When an economy is growing at steady rate bondholders want a higher yield (return) on longer-term bonds than for short-term bonds. The rationale behind this is that if your money is tied up for a longer period of time (10 year bond) you want to be rewarded for that risk. In contrast bonds that require shorter time commitments don’t require as much sacrifice and usually pay less.

However this week the yield on 10 year bonds fell below the yield on 2 year bonds for the first time since 2007 – remember this was followed by the GFC. The chart below shows the difference in the yield between 2 year and 10 year bonds – as stated bonds of longer duration should have a higher yield. What is significant is that the inverted yield curve has occurred before every US recession since 1955 and is viewed as a strong predictor of a recession / downturn. If people are willing to take such little money for their long-term bonds it would indicate that inflation is not a concern.

50 basis points cut by RBNZ – are they going negative?

The 50 basis points of the OCR (Official Cash Rate) by the RBNZ took everyone by surprise. Cuts of this magnitude generally only occur when significant events happen – 9/11, the GFC, the Christchurch earthquake etc. However the US China trade dispute have significant implications for global trade and ultimately the NZ economy. The idea behind such a cut is to be proactive and get ahead of the curve – why wait and be reactionary.

The Bank has forecast the OCR to trough at 0.9 percent, indicating a possible further interest rate cut in the near future. The RBNZ believe that lower interest rates will drive economic growth by encouraging more investment but you would have thought that such low rates wold have been stimulatory by now. I don’t recall the corporate sector complaining too much about interest rates and according to the NZIER (New Zealand Institute of Economic Research) latest survey of business opinion only 4% of firms cited finance as the factor most limiting their ability to increase turnover. The problem seems to be an increase in input costs for firms which is hard to pass on to consumers.

Lower interest rates have a downside in the reduction in spending by savers and this could also impact on consumer confidence. Any hint of further easing seems to encourage financial risk-taking more than real investment. Central bankers have thus become prisoners of the atmosphere they helped to create. There is still a belief amongst politicians that central bankers have the power by to solve these issues in an economy and politicians keep asking why those powers aren’t being used.

Are negative Interest rates an option?

The idea behind this is that if trading banks are charged interest for holding money at the central bank they are more likely to make additional loans to people. Although this sounds good negative interest rates on those that hold deposits at the bank could lead to customers storing their money elsewhere.

The European Central Bank sees that negative interest rates have an expansionary effect which outweighs the contractionary effect. An example of this is Jyske Bank, Denmark’s third-largest bank, offered a 10-year fixed-rate mortgage with an interest rate of -0.5%. for a ten-year mortgage – in other words the bank pay you to take out a mortgage.

However negative interest rates is seen as a short-run fix for the economy. Getting people to pay interest for deposit holdings may mean that banks have less deposits to lend out in the long-run and this may choke off lending and ultimately growth in the EU.

China: currency manipulator or market forces?

A good summary from the FT – see video below. The Renminbi is permitted to trade 2 per cent on either side of a daily midpoint set by the People’s Bank of China (PBOC). This suggests that the PBOC still has significant control of the renminbi. Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$. It is then permitted to trade 2 per cent on either side of the midpoint rate. The midpoint set by the PBOC on Monday of Rmb 6.9225 was the lowest since December, when trade tensions were last at fever pitch. The PBOC blamed the tariffs and trade protectionist measures on Chinese goods as the reason why the exchange rate has depreciated.

But is China a currency manipulator? According to the US Treasury a country is a currency manipulator when it does the following 3 things

  • A significant bilateral trade surplus with the US.(Check! China’s got that.)
  • A material current account surplus of more than 3% of GDP.(China does not have that.)
  • Persistent one-sided intervention in its currency market.(China’s move on Monday doesn’t fit this bill, so no.)

But isn’t downward pressure on the Renminbi just part of the what happens to a currency when its economy starts to slow and it’s selling fewer exports.

Winners with a cheaper yuan
1. Chinese exporters are more competitive abroad.
2. Foreign consumers of Chinese products – imported products are more affordable.
3. China’s case for becoming a reserve currency could be bolstered by letting markets determine the exchange rate.

Losers
1. Chinese companies that have debt denominated in dollars, or buy things in dollars
like Chinese airlines, or other businesses that rely on imported oil.
2. Companies that compete with Chinese firms – including those in neighboring countries.
3. Companies that depend on exports to China – like the makers of luxury goods and mining companies.
4. Anyone worried about weak inflation in the U.S. or Europe

Sources: FT and Business Insider

Using M&M’s to teach MC=MR

Today I held the annual M&M’s competition with my A2 class. I use them to teach MC=MR also Minimum (loss) and Maximum (profit).

Profit is maximised at the rate of output where the positive difference between total revenues and total costs is the greatest – see graph above. Using marginal analysis, the perfectly competitive firm will produce at a rate of output where marginal revenue equals marginal cost. Marginal revenue, however, is equal to price. Therefore, the perfectly competitive firm produces at an output rate where marginal cost equals the price of output. Remember that the firm will make profits as long as the extra revenue brought in from selling the last unit of output(MR) is greater than the extra cost which is incurred in producing it (MC). Below are some Perfect Competition and Monopolistic Competition graphs created by my A2 class using M&M’s

Market structures and Netflix

Covering this topic with my A2 class and fortuitously came across a very relevant blog post from Michael Cameron’s blog Sex Drugs and Economics. He talks about Netflix increasing its subscription price by 19% (now $21.99) for the premium plan and how Kiwi subscribers are going to social media to announce their departure from the streaming service.

However although people are voting with their feet it is highly likely that Netflix are not too perturbed by this. With the law of demand a higher price will reduce the demand for the service – simple Law of Demand.

The diagram below from the Cameron Blog shows a horizontal MC=AC curve which means that the cost of producing one more unit of output is the same. Some would suggest that it could be close to zero as the additional cost of providing one more subscriber with the service doesn’t involve significant costs.

Let’s assume that Netflix originally charged a price of P0 and sold a quantity of Q0 before the increase. Note here that they still make a supernormal profit rectangle – P0 C H F.

However they are not producing at the profit maximisation which is where MC=MR. Therefore although Netflix is increasing their price it is unlikely that they are charging a price at profit maximisation output as Netflix has too many subscribers to maximise profits. If they did produce at profit maximisation output Q1 and charge price P1 they would make profits of P1 B E F. So at a price of P1 – they gain profit of P1 B G P0 but lose the area G C H E. However the former area is bigger than the latter.

So with the market power that Netflix has it is not surprising that they are increasing their subscription price. With the video stores like Blockbuster, Video Ezy, United now struggling to survive and in some cases out of the market, they are less alternatives out there for the consumer.

UK pound under pressure

From the FT – a weaker pound makes imports more expensive raising prices in the shops and eroding the real value of their earnings and savings. If the pound falls against other currencies, it makes those of us whose earnings or savings or investment income is in pounds poorer. However with a weaker exchange rate it should makes UK exports cheaper – but this doesn’t seem to be the case as although the pound depreciated significantly after the GFC it had little or no effect on the trade balance. Companies that rely on imports haven’t been able to reduce their price as the overall production cost has increased.

Liberalism v GDP per capita

Martin Wolf in the FT wrote an interesting piece entitled ‘Liberalism will endure but must be renewed’. He states that liberalism is not a precise philosophy, it is an attitude. Liberals share a belief and trust in the capacity of human beings to decide things for themselves and express opinions and participate in public life.

Liberals share a belief that agency depends on possession of economic and political rights. As Martin Wolf stated ‘institutions are needed to protect those rights’ but liberalism also depends on markets to co-ordinate independent economic actors, free media to allow the spread of opinions, and political parties to organise politics. The graph below shows that economic growth and political freedom tend to go together as both depend on the rule of law. Liberal societies tend to be rich and rich societies tend to be liberal. Note that :

  • New Zealand is one of the most liberal economies – approx 98 on the index – with its GDP per head being just over US$40,000.
  • Singapore has a GDP per head over US$100,000 in relation to a Liberal Freedom index of approximately 72.
  • Eritrea ranks as the lowest

Behavioural Economics – do people return found wallets?

In Science magazine last month Alain Cohn of the University of Michigan and his colleagues published some interesting research into how honest people are. He surveyed 17,000 people people in 355 cities within 40 countries. Cohn’s research assistants entered public buildings – banks, theatres, hotels, police stations, post offices and courts – and handed into an employee at the reception area a dummy wallet. They stated that they found the wallet on the street outside. Each wallet was the same:

  • see through plastic card case
  • 3 identical business cards – with a unique email address and fictitious native man’s name
  • a shopping list – in the local language
  • some had a key
  • some had cash – $94.15 in local currency – only done in 3 countries
  • some had cash – $13.45 in local currency
  • some had no cash

Once handed in the researchers waited for the email about returning the wallet. Results were as follows:

  • In 38 of the 40 countries were more likely to return wallets which had money in them. The two outlier countries were Peru and Mexico – wallets with no money were more likely to be returned than those with.
  • When they increased the amount of money in the wallets by seven times in three countries, they found the average return rate climbed by 18%
  • For wallets with money, the highest rate of reporting was in Denmark (82%) and the lowest in Peru (13%).
  • Switzerland (73%) and China (7%) had the highest and lowest rates of reporting of wallets without money.
  • New Zealand – wallets returned – 60% with no money but 80% with money

People displayed more honesty when there was more money in the wallet – with greater temptation comes greater honesty. However economists are aware of previous research that shows whilst people do care about others they care more about themselves. Researchers concluded that participants main motivation was an aversion to viewing oneself as a thief so the psychological forces cane stronger than the financial ones. People stated that:

  • Not reporting a wallet without money – not stealing
  • Not reporting a wallet with money – stealing

What about the key?
Altrusim played a secondary role in the study. The key in the wallet is of no value to the finder but wallets with keys were more likely to be returned. Switzerland was the best place to lose a wallet containing a key but with no money.

The satisfaction from doing the right thing (returning the wallet) is a powerful motivator and goes against rational economic thinking. This study shows that altruism is evident and widespread.

Source: The Economist – June 22nd 2019, The Guardian