His central argument is that preferences are not stationary and can be influenced by publicly expressed attitudes. So, if the government subsidises green technologies as part of its climate change policy, then people’s preferences shift towards green products. Because the subsidy increases the production of green products, which are now preferred, total welfare might increase. Obviously the final welfare outcome depends on the coefficients on each effect, but Yakita shows that an increase in welfare is possible.

While that’s all well and good in theory it’d be nice to have some evidence of the effect. After all, it could get awfully close to saying that anything the government does is good because people will grow to love it. Yakita’s evidence for the effect comes from two industries. First, he points to the explosion of interest in hybrid cars, where sales growth has been huge despite the 50% price premium they command. Sales of hybrids in Japan have grown by 19%pa from ‘98 to ‘06, while the overall growth in car sales is ~1%pa.

Secondly he points to sales of organic food. While there may be dispute over whether organic foods are actually environmentally friendly, there is no doubt about how they are generally perceived. He reports that the organic food market has grown 15%pa over the last decade as the environmental movement has taken hold.

Those two pieces of evidence together do suggest that preference shifts have taken place. However, it’s a bit of a jump from there to suggesting that government action can instigate a preference shift. I’m willing to believe that preference shifts could make it worthwhile for the government to promote green activities to boost welfare, but I’d suggest the causation has to run from preference shift to government action rather than the other way around. Nonetheless it’s a novel way to look at the benefits of unilateral action on climate change.

To draw an analogy to university staff pay, the quality of university staff depends in part upon the difference between their university salary and their outside options. As Daniel Hamermesh puts it:

If a university went ahead and paid equally, lowering economists’ pay and raising French professors’ pay, it would have a great French staff and a dreadful bunch of economists.

Of course, Hamermesh is talking from the perspective of a US academic. In the US they pay different salaries for different disciplines. In NZ we do pay all university staff equally and the research bears out the truth of Hamermesh’s conjecture. So paying people with different market values equally is essentially a subsidy on those with low market value.

To come back to the issue of students’ fees, subsidising all students equally is a subsidy on students whose degrees have only private value. Surely, in order to be fair to all departments and all students, the subsidy on education should pay for only the social benefit. The entire private benefit to the student should be paid for by the student. At the very least the subsidy should be proportionate to the social benefit and differ across disciplines.

So who would be the winners and who would be the losers? Speculate away!

…two World Bank environmental advisers claim that instead of 18 per cent of global emissions being caused by meat, the true figure is 51 per cent.

So am I thinking about becoming vegetarian since meat is known to be more costly than I previously thought? Of course not. As tempting as it is to see these things in black and white, it’s very unlikely that the cost of meat will ever get high enough that we cease to eat it. Rather people will substitute away from eating as much meat as the price rises.

At present we don’t have to pay the social cost of meat so we overconsume it. From a moral perspective I may then choose to eat less meat than I otherwise would. It’s even possible that, because I don’t know the true cost but presume it to be extremely high, that I’d employ the heuristic of becoming vegetarian. However, I wouldn’t feel bad about eating a steak at Christmas if I did turn (mostly) vegetarian.

Studies like this really reinforce what we talk about constantly on the blog here: it’s very difficult to accurately guess what the morally right thing to do is. Without price mechanisms to guide us we fall back on rules of thumb that probably do a pretty poor job in many situations.

NB: I see Eric Crampton goes on about much the same thing in a few posts. If there’s one thing economists all agree on it’s the importance of prices!

plans … to crack down on illegal downloaders by threatening to cut their internet connections … could harm the music industry by punishing its core customers.

Now that seems like a stretch. The key here is to figure out a plausible counterfactual to the present situation. The Herald seems to be suggesting that, if these people didn’t have access to an internet connection then they’d lose all interest in music. Which is pretty unlikely! Let’s think about what might be a more plausible counterfactual.

Suppose there are two kinds of music: paid for and illegal. If illegal becomes more expensive all of a sudden – because of the risk of your internet being cut off – then two things happen. First, you’ll probably consume less music overall, because it’s more expensive now. Secondly, you’ll switch out some of your illegally obtained music for free music because the two are substitutes. So a first look suggests that the music industry would probably be better off if the cost of illegal downloads went up, even if everyone who buys also downloads.

Of course, there could be other effects which confound the initial analysis. It is possible that a reduction in goodwill towards the music companies would shift people towards preferring illegally downloaded music. That might offset the price effects.

It may also be that, over time, demand for artists illegal and legally distributed tracks is complementary. For example, I doubt that Britney Spears needs any exposure via free downloads to boost her record sales. However, an emerging artist may gain sales as people hear of them through costless online downloads. Of course, there’s nothing to stop that artist from distributing some tracks for free in order to gain recognition. Many musicians already do that through their own websites and MP3 blogs. Indeed, the existence of illegal downloads just prevents artists like Britney from maximising their profits without offering any new means of distribution to emerging artists.

It’s hard to say which of these effects will prevail without some empirical evidence, but it’ll definitely be interesting to look at the figures once the UK has started to crack down hard.

Now the legalisation of drugs is an issue we have discussed at length here (* * * * * *).  Now if society is fully informed of the costs and benefits of drug use, then I am happy for policy to be instituted along these lines.

This does raise an interesting question for me though.  Why do countries with a closer tie to Britain (Britain, the US, NZ, Australia) seem to push an agenda of strong drug regulations when a number of other nations (the Netherlands, Portugal) tend to be more interested in allowing individual action to guide the use of these products?

What makes Anglo-Saxon countries so much more sure of their ability to centrally determine what is the best set of actions for their citizens?  What makes Anglo-Saxon governments so sure of their superiority relative to the people they are “serving”?

I have heard this suggestion from many, many, other economists as well – suggesting that this view is fairly mainstream.  Furthermore, Dr Bollard does keep mentioning the fact that “consumption” is too high and we need a switch away from consumption to exports and investment.

However, we can tell there is something fishy as soon as we listen to exporters.  They are saying they want a lower OCR, and a lower dollar, in order to stimulate exporting activity.  The fact that both a lower and a higher OCR can be justified on the basis of rebalancing tells us that there is something we are missing in this analysis.

Given my obsession with being contrarian (and the fact I actually do believe a different story this time) lets roll.

So what is going on?

When the RBNZ increases the official cash rate they increase the risk-free rate of return (in New Zealand dollars).  This attracts foreign capital, which drives up the dollar.  The dollar hits a new equilibrium because the lift in the relative value of our currency increases the “risk” associated with investing in NZ dollars.  Ok, so we have a mechanism that tells us how a higher OCR increases the dollar (although this mechanism is complicated by the fact that “foreign capital” actually needs to find people to borrow it in NZ – but this is an issue for another day).

Now inside NZ, when people decide whether to consume or not they look at the interest rate (because if they consume now they miss out on the additional consumption in the future that the interest rate provides) and the price of goods now (both relative to the future and their lifetime income).  An increase in the OCR increases domestic interest rates, but it also lowers the price of consumption goods (by increasing the exchange rate) – as a result the impact on consumption is ambiguous.

However, it is taken as a fact that a higher OCR depresses consumption – so lets accept that.  Even this is not sufficient to ensure that “consumptions share of GDP” will decline as the OCR increases.

Why?  Well other components of GDP can be more responsive to higher interest rates – such as investment.  As a result, the higher OCR may have a smaller impact on consumption relative to other bits, leading to a higher proportion of GDP being used as consumption.

Why do we care about that?  Well the “rebalancing” we keep asking for involves reduces consumptions share of GDP – moving from more consumption to more investment and exporting.  It is in no way clear whether a higher OCR helps in this sense at all.

So that’s it then

No.  This brings up an even more fundamental issue.  There does appear to be imbalances in the NZ economy.  Dr Bollard is right when he brings them up.  But he shouldn’t bring them up in an OCR review.

The idea that our economy is imbalanced suggests that fiscal policy and prudential policy may need to change.  This is definitely a financial stability issue – and so does fall within the scope of the RBNZ.

However, as discussed above this IS NOT a monetary policy issue.  Monetary policy is solely about keeping inflation expectations anchored, and because of the shape of the short-run Phillips Curve the Bank also gets to roll out a bit of economic stabilisation.  As a result, the Bank should not be throwing financial stability issues into a monetary policy release – because it makes people believe that it is a monetary policy issue and that they should do something about it!!!

This implies to me that we need to copy the Aussies and have separate institutions for monetary policy and financial stability.  Until then these relatively separate roles will keep getting mixed up, making it harder to achieve either stable inflation expectations or a stable economy.

Meat is a wasteful use of water and creates a lot of greenhouse gases. It puts enormous pressure on the world’s resources. A vegetarian diet is better.

[Stern] predicted that people’s attitudes would evolve until meat eating became unacceptable.

Matt talked recently about why subsidising agriculture is a bad idea, so I don’t want to rehash those arguments. What really baffles me is why Stern feels that changes in peoples’ attitudes are important. If we price greenhouse gasses, and other natural resources, appropriately then there is no need to worry about peoples’ attitudes. As Stern says, meat is far more environmentally costly to produce, so its price will rise. Meat will become a luxury that most can’t afford to eat on a daily basis. That’s something that will happen whether people consciously make a choice to become vegetarian or not.

Will attitudes then shift? I don’t see any reason to think that meat will become unfashionable because it is more expensive. I would imagien that the opposite will happen: meat will become the fancy food that you serve on special occasions because it is too expensive to eat regularly.

So why is attitudinal change important? Public support for pricing natural resources appropriately is essential if politicians are to pass enabling legislation. It’s hard to see many governments passing deeply unpopular legislation, at a significant cost, in order to protect the environment. The argument over meat is a storm in a teacup. The overarching question is whether we have the political motivation to price carbon, and other greenhouse gasses. If we can sort that out then nobody has to worry about taking a moral stand on vegetarianism, leather shoes or any other ‘trendy greenie’ issues.

We expect such support will be needed for some time. As a result, we continue to expect to keep the OCR at or below the current level through until the latter part of 2010.

Well this happened:

In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010.

So they have moved from implying they won’t lift rates till the last quarter of 2010 to now implying that the 3rd quarter is the most likely.  Could more positive information shift them earlier?  Maybe.  Will we see a rate increase in January (like the market was pricing in)?  Not likely.

How do I feel about this suggestion, well I agree.  Legalise it, that way we can apply standard quality controls, pump out education and information, and place externality taxes on it.

Worst case scenario:  The externality tax makes the drug so expensive that the current gang based supply of drugs (with an associated motive to avoid tax) remains the cheapest option for people – in this case the legalisation makes no real difference.  However, I would still only support bans above taxation here if it turned out that bans were arbitrarily cheaper – as other social outcomes would be the same.

There is nothing wrong with someone making a choice to take drugs when they understand the issues surrounding them.  Legalisation helps us create a situation where people can make well informed decisions regarding drug use.

Furthermore, there is nothing wrong with an individual taking the drug persee – although we may be concerned about how their actions following any use impact on other people.  In this case legalisation, education, and a bunch of taxation will do the trick – the current situation does not target these external activities very well at all.

New Zealand has moved away from looking at monetary stimulus persee and is currently thinking about the “sustainability of growth” moving forward.  Given our large foreign debt position, our seemingly persistent trade deficit, and the large share of real GDP made up of consumption goods and residential investment there are justifiable concerns about the nature of New Zealand economic growth going forward.

Given that prices denominated in local currency are slow to move, the higher the New Zealand dollar is, the relatively cheaper to import something then to buy it from someone in New Zealand.  As a result, if New Zealand runs a trade deficit in the short-term one reason may be that the dollar is too high.

The flip-side of this is that if New Zealand appears to be running persistent trade deficits, and running up a growing stock of debt, then there may be downward pressure on the exchange rate.  A lower exchange rate would then increase the cost of bringing in imports and lead NZ to making a relatively larger amount of its stuff at home.

This often leads to the conclusion that we need to lower our dollar in order to deal with what appears to be an unbalanced economy, but …

But?

The exchange rate is not some lever that we fix in order to get outcomes – it is a price, a price that is determined by the (relative) supply of and demand for New Zealand currency.  If our Reserve Bank is setting interest rates in order to keep inflation expectations anchored at its target level (approximately 2%) but we have “imbalances” then we have to ask why.

After all, if price growth is known to be 2%pa (on average) economic growth is known to be 2.5% (on average) and interest rates are set in conjunction with these expectations then the value of the exchange rate should (on average) represent the balance of prices (and expectations of other variables) between different economies.

If the dollar persistently differs from this level, and the nature of economic activity appears unbalanced, then it indicates that there are structural issues either inside the economy or externally – the exchange rate is a price, it acts as a signal not as the cause of issues.

As a result, if the exchange rate is not “adjusting” in the way it “should be” we need to ask why.  Is it because:

1. Other countries are trying to suppress the value of their currency (as suggested here, here, here, and here),
2. Households and businesses are taking on too much debt,
3. Government policy is creating a wedge between the private and social benefits of individual actions.

If we can figure out what factors are driving the imbalances in our economy then we can come up with policy changes to improve outcomes.  Arbitrarily changing monetary policy so that we reduce the level of flexibility in our exchange rate is not the way to go.