Monday, June 1, 2020

Financing the Budget Deficit and the Wealth Effect

People are already thinking about the bill of COVID-19, and how would it be paid. Just look up the Google mail and see the flood of articles. The New Zealand Minister said that the government will borrow to finance the deficit, but it is not as simple as this. At some point in time, a government, which may not be this government would have to raise taxes. The borrowing matters whether the public holds an interest-bearing government bonds or non-interest bearing bonds. The latter type is like the US Treasury Bills. They are non-interest bearing bonds or zero-coupons, which are bought at a discount price of their face value i.e., they pay no interest, but eventually sell at the par value, therefore, they bring about a positive yield to holders.  

What's the difference between these bonds and what is the effect on the economy?

On this issue, I remember a paper that I read when I was a graduate student preparing for my PhD exams, Robert Barro (1974) wrote in the Journal of Political Economy "Are Government Bonds Net Wealth?" This issue is pertinent to the situation we and others are facing.

Barro argued that government debt, which is held by the public could increase or decrease in real terms when the price level changes. So if the price level falls for whatever reason (the situation now with a near zero interest rate means that people are indifferent between holding money or bonds), the real value of government debt increases, and economy's level of wealth increases too. However, if the government finances the budget deficit with interest-bearing bonds, and people anticipate an increase in future taxes to finance the deficit, an increase in the real value of government debt outstanding will also imply an increase in the present value of future tax liabilities. Therefore, government debt cannot be considered a net wealth increase for New Zealanders.This bond buying business may not stimulate the economy as much as the government thinks. 

The NZ government bonds are low interest bearing bonds as shown in the this statement, but not a zero-coupon. Therefore, holding these bonds cannot be net wealth.

Financing the budget deficit with a non-interest bearing bonds (zero coupon bonds), on the other hand, could be a net wealth to New Zealanders. The reason is that the increase in the real value of the debt outstanding is not associated with an expected increase in tax liabilities. 

I seems like a great idea to buy government bonds while working and cash them to finance retirement, if they were zero-coupon type of bonds. In this case government debt is net wealth to Kiwis, and the government can finance its deficit and lower income tax on people's labor income. One can see how such fiscal policy can increase labor productivity. 



Friday, May 22, 2020

What Have I Learned from COVID-19 Data So Far...

Everyone knows that there is an argument about the data of the number of confirmed cases. Many papers were written about understating the number of infections. The typical story is that, with the absence of reliable and timely tests, we may have understated the infections by a factor of 10. Because the US government pays hospitals for treating infected patients, and also pay them more if the patients need to be on ventilators, some hospitals were overstating the number of COVID-19 deaths related cases. Minnesota was one state circulating in the news. So, if the numbers of confirmed cases, which we are using from Oxford University, the Johns Hopkins, or else in our research, are understated, researchers must deal with these measurement errors. Ordinary Least Squared regressions estimates are biased and inconsistent. IV estimators should be used. Testing for COVID 19 matters for reducing the number of deaths even though millions remained untested. See my paper

The second thing I learned from COVID-19 data is that the modelling of the infection using the Gompertz (1825) function overestimates the peak infection. Usually, we try to model the data as they arrive. The data have a steep upward slope. The Gompertz function is a very suitable model for this kind of events. However, it is a statistical function, which has a couple of fixed parameters. It does not account for policy. So if we have data from time t to t+k and we fit the function up to time t+k+1 without having accounted for policy, we will overestimate the peak infection. Policy (stringent) reduces the number of infections, but the Gompertz function does not take this into account.

Figure (1) plots my estimates of the New Zealand curve, see my paper ...The data that I used in this paper were from Feb 28 to Mar 27. Figure (2) use the same graph but add the actual data up to Apr 23. As you can see in figure (1), I predicted the peak infection to be 2630 cases on April 3. Then we learned when the actual data arrived that the number of infections on April 3 was 772, see figure (2). The peak, probably did not occur until April 22...and much lower than my estimate.

Figure (1)
Figure (2)

I also learned that policy responds to the number of infections positively, and the latter responds to the former negatively. Policy response, however, is endogenous and country-specific. New Zealand and Australia responded quite differently to the infection, but the outcomes of the two countries are pretty much similar. I also learned that if country A adopts country B policy response, country A cannot achieve the same outcomes of country B. I tested whether, or not, the New Zealand policy response, which achieved zero infections, could reduce infection to zero if it is adopted by Denmark, Sweden, and the USA.I found that it is effective in reducing the infections significantly, but not to zero as it did in New Zealand. There are omitted factors that need to be taken into account in such analysis. Culture might be an important missing variable. Although the Swedes and the Danes are seemingly Scandinavians, they followed different polices and the people have been reacting differently. The outcomes are very different. See my paper.     

I am sure that we will learn more from doing more research.

Friday, May 8, 2020

Future Prices and inflation

What happens to the future prices and inflation as a result of the expansionary polices in response to the pandemic? 

As a result of the increases in the money supply and government spending in response to the pandemic, future prices of goods, services, and assets will increase for sure...not necessarily the inflation rate. 

Under a system of inflation targeting, bygones are treated as bygones. It means that the increase in prices is not a concern, but the rate of growth of prices, i.e., inflation, is kept constant. 

The plot shows that currency per unit of real output and the CPI are positively correlated, thus in the short run the increase in the money supply increases prices under inflation targeting (it increases real output sooner, in the short run).

The second plot shows that there is no correlation between the growth rate of money per unit of real output and the expected inflation rate in the long run (6 quarter moving average) under inflation targeting. 

These are New Zealand data, but it is true in all inflation targeting countries.

That said, the pandemic might be an adverse supply shock. It knocks output production and increases the price.

Sunday, April 26, 2020

New Zealand's Coronavirus Policies

The government's Coronavirus policy is driven by many factors, but R0 number (the reproduction rate) seems to be the PM (Jacinda Ardern) preferred indicator. The reproduction rate depends on total infections. There are more papers posted now arguing that total infections are understated especially when "testing" is lacking. So R0 is understated too. The official R0 is less than 0.5, maybe it is more than 1 or even higher. 

Conversely, the good news is that the death rate would be smaller than what we have, which is already relatively small. (death rate is number of deaths / infections). Should death rate be the guide for successful policy? I think so.

But what about those asymptomatic people who are infected? If indeed we have more infected people than we can tell, and we relax the lockdown to level 3 or 2, we could have a spike of infections and deaths next month.  I think that effective testing can resolve the problem. Those who test positive get quarantined and treated and those who test negative go back to work. The question is about testing every person, and quickly. Testing, however, requires money and resources.

It was reported that the government is looking into the proposal of the Chief Economist of the Kiwibank Mr. Kerr to give people cash, maybe 6 billion dollars. Cash gift is an ineffective stimulus. The theory of consumption predicts that people do not spend windfalls. A few desperate people might, but there will be no significant increase in consumption. Deposits in Kiwibank might go up a little :) A better way to spend the money, in my view, is that the PM Jacinda Ardern spends it on testing. Test every person, and do it before the end of the year. Hopefully a vaccine will be available early next year.

Tuesday, April 14, 2020

Does Testing for Coronaviris Reduce Death?

The Nobel Laureate Paul Romer explained his plan to restart the U.S. economy. He argues that conducting 30 million tests a day and allowing those who test negative to resume working would restart the economy sooner. Certainly, this is a smart idea that I have not heard anyone in this entirely infected world think about. Although they have been thinking about it for sure, so far, no government has provided any plan on how to restart the economy. Trump in fact said that he might stop testing altogether! 

Germans, on the other hand, have been testing people more efficiently. Say that there are five people in your bubble. They do a combined test for all five at once. If the result is negative then all five people are safe. If positive, they redo the test to each one in the bubble. So Germany could easily follow Romer's plan to restart the economy.

The population is very small in NZ so we have a very good chance that we can restart the economy in a week if the government follows these strategies. 

Ten days ago I began working on examining the effect of testing for Coronavirus on death. Ten days ago I found two data sets. The first one is published by the  EU (here) and the other is by Oxford University (here). The EU data set is large and reports data for deaths and infections by more than 200 countries and territories. Oxford University data set is smaller and reports data on testing for Coronavirus. The data are daily. Some countries report fewer data than other, different dates, and many have missing data. I combined both data sets to arrive at a balanced panel of 8 countries only that have continuous data from March 1 to March 31 for all three variables, tests, death, and infections.

I found that, on average, a one percent increase in daily testing for the Coronavirus reduces death by about 4 a day. When I allowed the coefficients to vary across countries, I found that the U.S. and Italy could reduce death by about 13 and 68 respectively. At a lower significance level, the Belgium and the U.K. could reduce death by about 2 and 32 respectively. Japan could reduce death by 25. So there is reasonable evidence in this small panel that testing for the virus reduces death. You can read the paper on Massey University Website in a couple of days (here). 

Sunday, March 29, 2020

The Efficacy of Loackdown in New Zealand

I thought that I write another short essay on COVID-19 to analyze the effectiveness of the lockdown - the so called social distancing.

The idea of social distancing is perfectly logical. The virus is like a fire and people are like the wood, if people separate the fire dies down with minimum losses.

To model the infection rate I use the Gompertz Curve

You can look it up. It is a Sigmoid function which has four parameters, (a), (e), (b), and (c). The parameter (a) is an asymptote, (e) is called the Euler's constant equal to 2.71828, (b) is a parameter that governs the displacement along the x-axis, and (c) is the growth rate.

I take the data of the total infection cases in NZ from the World Health Organization (daily) Situation Report from the data we started reporting, which was Feb 28 up to Mar 27 to illustrate the fit of the data to the Gompertz Curve. For (a=0.1), (b=0.2) and (c=0.5) along with (e) fixed at 2.71828, the data seem to fit remarkably well.

Then I have two scenarios. The first scenario is about an effective and enforced lockdown, i.e. an effective social distancing. Under such scenario, the infection growth rate (c) falls significantly, and sooner. The second scenario is a less effective lockdown, whereby the growth rate falls at a slower rate and takes more time. Here are the assumed growth rate scenarios.

Here is the projection of the infection rate under the effective lockdown scenario. The infection rate peaks at 2,630 cases on April 3, then takes a nosedive very similar to the Chinese case.

And here is the less effective lockdown (less effective social distancing), where the infection peaks at a staggering 78,203 cases on April 15.

This is quite a significant increase in two weeks period, a staggering 75,573 more cases. It emphasizes the importance and effectiveness of the lockdown and strict social distancing, which seems to be crucial to defeat the virus. 

See Greenstone and Nigam (2020).[1] In a rather more elaborate model, they projected that moderate social distancing would save 1.7 million lives between March 1 and October 1 in the United States. 

[1] Greenstone, M. and V. Nigam. (2020). Does Social Distancing Matter? University of Chicago - Becker Friedman Institute for Economics WP No. 2020-26


Monday, March 16, 2020

The Pandemic and Policy in New Zealand

The economic lessons of the COVID 19 pandemic are clear now. The economy is about people who produce goods and services then sell them in markets, i.e., global trade. Without labor, production declines regardless of how much capital is there.

Global growth will soon decline because of a decline in aggregate supply. Declining demand will make the situation worse. Those who claim that high growth is unnecessary or damaging will have to wake up and re-examine their claim. When economies stop growing life becomes very difficult.

The problem the world is facing now is not about throwing money at people. Money and credit have nothing to do with growth. It is about getting the production of goods and services to presume as soon as possible, trade to continue, and global markets to function. It is about labor now. The longer the pandemic lasts the more difficult the problem becomes. Although loose monetary and fiscal policies are typical response in such circumstances, health policy is most important. It is about managing the pandemic, and it is about making sure that the workforce remains healthy.

The PM realizes that the problem is about people first. Closing the border is the right decision. Responsible private institutions could suspend work, gatherings, parties, games, etc. without government instructions. Nonetheless, the economy will suffer especially if the pandemic takes longer to control and NZ winter catches up with it.      

My current research is about the effect of OCR on bank lending rate in New Zealand. The paper is work-in-progress, but here is what we found so far. My coauthor and I model a profit-maximizing representative NZ bank subject to a capital-asset ratio, and estimate the model. We make baseline projections to 2024 and examine additional projections under a number of counterfactual scenarios. The counterfactual scenarios include an OCR cut to 0.50, 0.25 (which is today’s announcement), zero, then –0.25 and –0.50. Everything else remains unchanged; the bank lending rate tumbles and eventually goes negative when the OCR is negative. Banks have to generate additional revenues, or reduce cost in order to keep profit unchanged; otherwise, profit will decline sharply and some banks may suffer substantial losses. It is important that we do not create the conditions for a banking crisis.