Economics & Development: Time for something new

[Marmoot]

I am bored at work, so here it goes:

Do you think that this time the government actually needs to lower the interest rate to control the public spending rather than increase the interest rate?

As you know, the government has increased interest rate quite sharply and it still has not reduced the public spending. It even lead to reduced export output and a lot of companies (mostly in export industry) are now cutting jobs as they cannot sustain themselves. Not only that, tourism, education and technology industries are also getting the slow-down because New Zealand is now simply too expensive compared to the rest of the world.

My hypothesis is: by lowering the interest rate sharply, the foreign investment will run away and our currency exchange rate will collapse. Collapsing currency exchange rate would lead to increased import prices and reduced export prices, which will result in two things:

Increased import prices = public will be reluctant to buy things = decreased public spending.

Reduced export prices = more export volume = perfect situation for a nation who depends heavily on dairy product manufacturing. It would mean less manufactured goods go wasted/expired, and at the same time pushing our national income high. This, in turn will lead to opening of more jobs, and pushing the national welfare standard higher.

Is this a logical hypothesis? Would this contradictive plan actually work for getting out of our looming economic crisis?
I know normally increasing interest rate works in steering public spending, but that was an old concept before the advancement of Internet, Globalization, online shopping, and quick overseas delivery services. Perhaps it is time for a drastic change in economic concepts?

[The_Dover]

I'm bored at work, but not that bored.

The last thing I need is the pacific peso to be devalued when I got to send money back to the motherland!

[Ixion]

Nope. Lower interest rates and people will just go straight out and get a bigger mortgage and buy another house.

If the gubbernmint really wanted to reduce spending they should increase the percentage that banks have to keep on hand (ie reduce the multiplier factor in their spending).

Of course, the REAL answer is communism, then there is no problem with public spending.

[Grahameeboy]

Well Keanes Theory is that more spending has an overall good effect of the economy.....shops, manufacturers etc sell more, GST revenue increases, shops etc expand, employ more staff etc, so more income tax is paid which the Govt happily accepts and should go back into economy.

Not sure that increasing interest to reduce house spending is a good thing.....people will just use credit cards and wait for hings to change.

NZ does need investment. Higher interest rates will discourage this I guess.

Imports, exchange rate has traditionally been GBP1 = NZ3 and is around 2.5 plus and improving right now so if it goes back to 3 I cannot see much harm.

Problem in NZ is that people buy a house as an investment..in many case it is for retirement. We pay taxes in many forms so the Govt should run the Country for us.......banks are hardly short of a penny eh....

I think it is just legalised extortion sometimes......

Trubs is that Economy's go in cycles...often called the Sigmoid Curve so like flares things come back.....

[James Deuce]

That's Keynes, as in Keynesian Economics.

http://en.wikipedia.org/wiki/Keynesian_economics

[Motu]

They said this was the election to lose,those who wanted a National Government will just have to be patient....but imagine if National had of got in,they'd never recover.If Labour gets through this downturn with the country in good shape I wonder if they'll get the credit?

[myvice]

Pack of fukin hypocrites!
"Stop spending" they cry in horror and then they give themselves a nice fat raise backdated 6 months?
How about if THEY stop spending OUR money for a change?

[Hitcher]

That's Keynes, as in Keynesian Economics.
Was his first name Milton?

[Swoop]

Was his first name Milton?
I believe that there are twins called Milton...:devil2:

[chickenfunkstar]

I am bored at work, so here it goes:

Do you think that this time the government actually needs to lower the interest rate to control the public spending rather than increase the interest rate?
.....
Is this a logical hypothesis? Would this contradictive plan actually work for getting out of our looming economic crisis?
I know normally increasing interest rate works in steering public spending, but that was an old concept before the advancement of Internet, Globalization, online shopping, and quick overseas delivery services. Perhaps it is time for a drastic change in economic concepts?

It would cause our currency to depreciate, which would be good for exports. This is a good thing for sure but wouldn't it cause people to borrow more? This certainly isn't what we need at the moment. Full employment would be exceeded leading to a bit of a disaster sometime in the future. It would be good in the short term though. Inflation would also increase, which would be difficult to get rid of. I think that doing that now would generally overcook the economy.

If we were in abit of a bad economic situation i'd agree with you though.

Cheers for the question, I need a bit of practice at International finance for next semester.

[Winston001]

Oh no no, you mean Milton Friedman. :motu:

[Winston001]

Do you think that this time the government actually needs to lower the interest rate to control the public spending rather than increase the interest rate?

My hypothesis is: by lowering the interest rate sharply, the foreign investment will run away and our currency exchange rate will collapse. Collapsing currency exchange rate would lead to increased import prices and reduced export prices, which will result in two things:

Increased import prices = public will be reluctant to buy things = decreased public spending.



Good question and at first glance what you suggest sounds sensible. Unfortunately our economy is far more complex than the media or our politicians care to believe.

Firstly lets remember that NZ has had a booming economy for the past 4 years despite also having a relatively high dollar. The currency hasn't prevented economic good times. In fact it has helped because imports such as cars, bikes, machinery etc have been cheaper than ever which means we've been able to buy the stuff instead of just wishing.

Secondly spare a kind thought for all the poor countries with over-valued currencies. You know - USA, Japan, Switzerland, Germany et al. Those guys are really suffering. :killingme

The point is that having a high value currency isn't always a problem. In fact it usually means your citizens enjoy a very high standard of living. In the best of worlds NZ should be aiming to revalue the $NZ through increasing our national wealth.

Dropping interest rates right now would probably lead to a $NZ collapse. Given that we import oil, computers, plastics, hell just about everything you can think of except butter and milk - we'd all feel very poor very suddenly.

Which is not to say that rates won't come down, they will, but in stages.

[geoffm]

One problem is that interest rates are now only loosly linked to the cost of borrowing on the supply side. All our banks are owned offshore, and they buy their money from home or elsewhere - why pay twice as much by buying the money in NZ
increased interest rates in NZ just means more profit margin for the banks.
Geoff

[Winston001]

One problem is that interest rates are now only loosley linked to the cost of borrowing on the supply side.
Geoff

Thats right. Much of the money lent in NZ is borrowed by the banks from retail (ie mum and dad) Japanese investors. These are known as Uridashi bonds.

Our interest rates are extremely attractive to Japanese and European investors because at home 2 - 3% is all they can get. What is more, they actually take on the exchange rate risk meaning they can lose money if our currency drops.

So NZ banks don't need to worry too much about the Reserve Bank rate because they can buy money from overseas cheaper than locally.

And here we have a significant example of what our small economy is up against. Even our central bank cannot control the flow of money from the rest of the world.

Robert Muldoon had a weapon called the Reserve Ratio. It required all banks to deposit a percentage of their funds with the Reserve Bank at all times. By changing the percentage Muldoon could shape the money supply that banks could lend.

A fine idea but you'll recall that mortgage interest rates under Muldoon reached 21% for a brief time. Term deposit rates were 17%. Nobody wants to go there again.

[Ixion]

Robert Muldoon had a weapon called the Reserve Ratio. It required all banks to deposit a percentage of their funds with the Reserve Bank at all times. By changing the percentage Muldoon could shape the money supply that banks could lend.

Ah, that's what I was thinking of. Don't they have it any more? Pity, damn good idea if you ask me. Come back Sir Robert, all is forgiven.

[chickenfunkstar]

Thats right. Much of the money lent in NZ is borrowed by the banks from retail (ie mum and dad) Japanese investors. These are known as Uridashi bonds.

Our interest rates are extremely attractive to Japanese and European investors because at home 2 - 3% is all they can get. What is more, they actually take on the exchange rate risk meaning they can lose money if our currency drops.

So NZ banks don't need to worry too much about the Reserve Bank rate because they can buy money from overseas cheaper than locally.

And here we have a significant example of what our small economy is up against. Even our central bank cannot control the flow of money from the rest of the world.

Robert Muldoon had a weapon called the Reserve Ratio. It required all banks to deposit a percentage of their funds with the Reserve Bank at all times. By changing the percentage Muldoon could shape the money supply that banks could lend.

A fine idea but you'll recall that mortgage interest rates under Muldoon reached 21% for a brief time. Term deposit rates were 17%. Nobody wants to go there again.


How much cheaper can banks borrow from overseas investors? Is it significantly cheaper than the tax / regulatory advantages of Euro currency?

If its quite a bit cheaper couldn't banks just undertake an arbitrage strategy by borrowing from from overseas and depositing the money at the reserve bank at 25 points below the OCR?

Or why do overseas investors not just bypass the bank and buy NZ Govt bonds?

[Marmoot]

First of all, sorry if my quotes are not in order, but I am replying to points for a bigger picture in point #3 below....


Dropping interest rates right now would probably lead to a $NZ collapse.

#1. Given that I come from tourism industry, and I know this country heavily depends on income from export and tourism, wouldn't this NZ$ collapse be exactly the thing that we need at the moment?


Secondly spare a kind thought for all the poor countries with over-valued currencies
#2. Related to point #1 above, our currency seems to be overvalued at the moment, which is leading to a slump in our core income: export and tourism. Buying from NZ (export) or coming to NZ (tourism) simply has become too expensive that the market has shrunk significantly in the last few months. In tourism areas, we have discussions on how pathetic this summer has been compared to normal times in previous years. From export areas, we have heard talks about job cuts due to companies cannot support themselves, caused by reduction in sales. If these income slump continues, would it not lead to national budget running on deficit and looming economic malaise/depression? It would be a disaster if it happens, no?


Firstly lets remember that NZ has had a booming economy for the past 4 years despite also having a relatively high dollar. The currency hasn't prevented economic good times. In fact it has helped because imports such as cars, bikes, machinery etc have been cheaper than ever which means we've been able to buy the stuff instead of just wishing.
#3. Yes, the price has got cheaper by much due to our currency exchange. Which is exactly my point that government should try to reduce our currency rate if they want to control public spending. If our currency rate falls, import prices will soar up and people will be reluctant to get a loan to buy anything. This is exactly what the government is trying (and fails) to achieve with increasing rate at the moment, no? I think it is time they start trying the opposite of increasing rate, since increasing rate has been proven to only increase currency exchange which decreases import prices and increases people spending.........which leads to economic disaster quicker.

Great thoughts here. I am really interested in testing my hypothesis and see if it makes sense. Keep it up ;)

[Winston001]

How much cheaper can banks borrow from overseas investors? Is it significantly cheaper than the tax / regulatory advantages of Euro currency?

If its quite a bit cheaper couldn't banks just undertake an arbitrage strategy by borrowing from from overseas and depositing the money at the reserve bank at 25 points below the OCR?

Or why do overseas investors not just bypass the bank and buy NZ Govt bonds?

Excellent questions and to be completely honest - I don't know.

However I assume the rate paid is 0.25 - 0.5% above Govt bonds.

As to borrowing and depositing rather then lending - the exchange rate risk would be with the bank. So if the $NZ dropped the bank would look sick. The attraction of the Uradashi and Kiwi Eurobonds is that they are denominated in $NZ, not euros or yen. Thus the lender/investor takes the currency risk.

[rogson]

Remember, the governor of the reserve bank's employment contract requires him to keep the inflation rate within a target range (if I recall correctly its something like 1 - 3%). In fact, I suspect this is the only quantitative measure he has.

Lowering interest rates will likely raise inflation. So, ultimately its got nothing to do with the economy - its about one man's job security.

[Winston001]

OK, have a look at this thread from Sharetrader http://www.sharetrader.co.nz/topic.asp?TOPIC_ID=22790 It is of some help for this topic.


As to lowering the Reserve Bank rate - the fear is that it will be inflationary and people will start spending up large again.

But it isn't a silly idea because human behaviour isn't entirely predictable. In the 1970-80s interest rates hit 21% and the conventional theory was that people would stop spending and borrowing. But they didn't. Kiwi behaviour confounded classical economics. Buyers kept buying houses and paying extraordinary interest.

It all came to a blinding halt when the new Lange govt floated the $NZ (which had been tied to the $US) and it fell like a stone.

[Marmoot]

Lowering interest rates will likely raise inflation. So, ultimately its got nothing to do with the economy - its about one man's job security.

Ah....then it all makes sense. :no:
This is the best economic revelation I've had in the past few years.

Green bling awarded!

[ManDownUnder]

I'm bored at work, but not that bored.

The last thing I need is the pacific peso to be devalued when I got to send money back to the motherland!

Yeah you do - you're just looking at the problem wrong...

Borrow NZD from an NZ bank - and send it to the motherland.

When the dollar plummets, bring it back from the motherland (at it's increased value) and pay off the trifling loan with it... pocketing the rest...

Leverage (without a bending moment)

[Lou Girardin]

But it isn't a silly idea because human behaviour isn't entirely predictable. In the 1970-80s interest rates hit 21% and the conventional theory was that people would stop spending and borrowing. But they didn't. Kiwi behaviour confounded classical economics. Buyers kept buying houses and paying extraordinary interest.

It was predictable to a degree. While interest rates were high, so was inflation. What started as an onerous mortgage for me became very affordable after a few wage rises. So you borrowed till it hurt, knowing that the hurt wouldn't be for long.

[Marmoot]

It was predictable to a degree. While interest rates were high, so was inflation. What started as an onerous mortgage for me became very affordable after a few wage rises. So you borrowed till it hurt, knowing that the hurt wouldn't be for long.

and that was where my hypothesis of 'government should push the interest rate down' came from

[Winston001]

and that was where my hypothesis of 'government should push the interest rate down' came from

While your idea is contrary to economic logic, it could work. What would be needed is for our currency to fall at the same time and consumers to stop spending. That is quite possible given all the warnings of economic gloom and the raw reality of people now being laid off.

But no central bank anywhere would risk the experiment. Pity.

Keynesian economics requires governments to spend money in recessions which is why Dr Cullen has been holding onto a budget surplus - we are going to need it.