On item that did catch my attention was the discussion around the creation of a levy on digital music devices, much like the existing levy on blank tapes and CDs. I’m not exactly sure where the Government has picked up its talking point of an “ipod tax” but it seems to have originated with a 2007 proposal from the Copyright Board of Canada to place a $75 levy placed on music devices exceeding 30GB in capacity. Since then it seems to have become a cudgel with which the Government beats the opposition. Again, I’ll leave the political discussion for “experts.”

This levy caught my interest because of a comment made by a friend of mine on twitter commenting that this levy is “like a tax on silverware. [It] [w]on’t affect those who can’t afford it.”

That is a statement I have to take issue with as an economist, because such a levy will affect people who can currently afford an iPod and the retailers in which they might by it. That’s because for a (relatively) cheap consumer good like an iPod, there’s a not insignificant number of people at the margin that will be affected by price change caused by the levy. Rinse. Repeat.

If we assume that the price of other goods broadly stays the same and that people’s preferences across all goods stay the same both before and after the implementation, then we get a number of effects. This is like a $75 price increase of iPods, so people will adjust their consumption away from them all other goods. This will result is lower iPod sales (which could hurt the business that sells them) which could eventually reduce in lower consumption of electronic music, which could result in the levy taking in less money which could result in a higher necessary levy to achieve the projected revenues.

Of course, I’ve extended the substitution of other goods for iPods pretty dramatically above, but over time that could happen. If the levy was only put on iPods above a certain size, that could also shift demand towards smaller players and change demand for file (or song) size produced.

The basic point is that the tax/levy just wouldn’t have an impact. There’s a number of flow through effects of the levy that need to be considered, not the least of which is making people who are currently at the margin and can afford iPods worse off (ie: less happy) since a levy would prevent them from buying an iPod. While it’s hard to say the exact size of this effect because of the different preferences, different marginal propensities to consume and budget sets of Canadians, it does show that things are a lot more complex than my friend assumes.

‘Peak Coaler’ just doesn’t have the same ring, but I bet it raises the same vitriol for stupid economists

(h/t to Stephen Gordon)

While I believe that the BoC is quite right to caution about the possible consequences of a high level of household debt in Canada, I think there’s another important point that these figures convey. The traditional monetary policy transmission mechanism still works quite effectively in Canada. This is a non-trivial point considering the ZIRP (zero interest rate policies) and quantitative easing efforts in other major economies.

Before analyzing that point, let’s take a small step back and take a quick look at how monetary policy—in this case adjusting interest rates—is roughly supposed to work. Using Canada as a rough example, the central bank has a target for inflation (technically core inflation, but that’s an aside). Since 1992 this has taken the form of a band for inflation of between 1% and 3% with the midpoint target of 2% being where the bank is most comfortable with inflation being around.

If inflation edges towards or above the top part of that band, then the Bank will tighten raise (also called “tighten”) interest rates (technically the “overnight rate” but that rate influences interest rates across the economy). A higher interest rate makes it more expensive for people to borrow money, reducing the demand for people to borrow money and cooling (reducing the pressure) on the economy. This is when the bank is “taking the punchbowl away right at the height of the party” as it were, to keep the economy from becoming overheated.

Conversely, if inflation is toward the lower part of its target band, or even below, the Bank will lower (also called “loosen”) interest rates. This is an attempt to make the cost of borrowing less, which will make borrowing money more attractive to people who then will spend (or invest) that borrowed money and boost the economy towards a fuller utilization of resources.

(Aside: There are a lot of inputs that help the BoC determine when rates need to be adjusted, including the global economic situation, how the Canadian economy is compared to the BoC’s forecast of potential output, etc, etc. What I’ve discussed above is just a simple sketch of things).

It is the case at the lower bound of interest rates which is important when considering my initial point, made at the top of this post. When the global economy fell into recession (pulling Canada along with it), the Bank of Canada furiously cut its overnight rate to 0.25%, the lowest level on record. This made borrowing incredibly cheap by historical standards and, reacting rationally and as monetary policy would want, Canadians stampeded to their banks/credit cards/ what-have-you to borrow money . While this had the effect of pushing up consumer debt levels, it provided a nice boost to the economy in the midst of  the recession.

With interest rates having increased (slightly) to 1%, the growth rate of consumer debt has slowed according to the Bank of Canada. This shows that monetary policy continues to work well in Canada. However, it is here where the Bank is encountering problems which are why Governor Carney has taken to issuing warnings about consumer debt and the Department of Finance is looking at policy approaches to stymie the debt growth.

Unlike the simple world I outlined above, there are a number of factors that inform the Bank’s decision on interest rates, not the least of which is the strength of Canada’s trading partners and the global economy. With the strength of the global economic recovery (and demand from trading partners) still “unusually uncertain,” it’s hard for the Bank of Canada to tighten interest rates much further without worrying about stifling Canada’s economy.  So, “jawboning” and other policy moves might be the only approaches left to the Bank (and Government) to keep consumer debt from ballooning too much.

That’s why the news that Fed Finance is looking to work with the chartered banks to tighten lending requirements is a good move in the short-term. At least until the Bank can increase interest rates from their low (by historical) levels.

Since changing jobs, I no longer pour over this report like I once did. However, I was forced to give Canada’s current account position some thought this week when I a good friend of mine pointed out a CNBC column to me and asked me if these deficits were a big story.

But, to me the shrinking trade surplus with the US (lowest since September 1992) and the large current account deficit doesn’t strike me as a big story and really isn’t even that’s surprising. As for why, well let’s begin with a basic identity used to discuss the component parts of GDP. That is:

***This post is an edited and amended version of an email.***
***Thanks to my friend for the question, gave me some much needed inspiration for the post.***

None of this anticipation or interpretation accompanied the days where the Bank of Canada released its monetary policy stances.  Partly this was (and still is) a result of the fact that the BoC doesn’t have the global importance of the US Fed, but mostly it was because the Bank of Canada’s releases are always bound to be boring. But not in the same way that Canadian TV is boring compared to its American counterpart.

Instead, the BoC is far more boring than the Fed because everyone knows what it’s trying to do. Since 1991 when it moved to an inflation target, the BoC has managed monetary policy to keep core inflation low, stable and predictable around an annual rate of 2% (the middle of a control range of 1%-3%). So, when the BoC goes to make a decision, the markets (and economy) broadly know where the Bank is going. Since most of the economic data (including the CPI) used by the BoC to make its decisions is released publically, people generally have a reasonable idea how far things are from target and how drastic the actions of the Bank might need to be. Add to that the Bank of Canada’s move to incorporate hard numbers and forecasts in its policy releases and Monetary Policy updates (not just the feelings or sentiment the Fed largely expresses its forecasts in) and the level of uncertainty about their actions is further reduced.

So while on occasion the Bank might break form changing interest rates or move a little more aggressively, people don’t get terribly excited. It’s the equivalent of the Bank stopping for milk or taking a short cut on the drive home, everyone knows where there eventually headed so there’s no reason to panic if they take a slightly different route.  It also makes the BoC pretty boring.

Given this history and stability, it’s interesting that the BoC (according to its Governor) is open to changing its policy instrument to price level targeting.

Price level targeting is similar to the inflation targeting regime currently in place, but when it’s used  higher (or lower) than targeted growth in one year is offset by lower (higher) growth in the next to keep on the target. For example, if the BoC chose to target a price level of 2% and inflation was 3% in this year, next year the Bank would seek to keep inflation at 1% to achieve its target.  This is a very Keynesian policy because during periods of recession, when inflation tends to fall sharply, the BoC would have to undertake very expansionist monetary policies to get the price level back up to target. Conversely, during boom periods the BoC will need pretty restrictive policies to stay near its target.

This would represent an interesting policy shift for the Bank and make its actions even more transparent to the market. The mechanics of implementing the policy, the “grace period” the Bank would allow itself to make up for missing the target and the level of the target all still need to be clarified. If implemented though, it could stand to make the Bank even more predictable and boring, which isn’t a bad thing when it comes to monetary policy.

(HT to Worthwhile Canadian Initiative since I know they had a post on price level targeting a while back. It provided a deeper look at it, but their post got me thinking about the practical means of price level targeting)

While there were a few factors, the largely took the form of having to allocate my very scarce resources (time, sanity, the limited number of words I can use each day) to satisfy some nearly unlimited demands (blogging, completing my thesis, continued existence). Like a good little rational actor that exists largely only in textbooks I managed to satisfy my most pressing demands while a number fell by the wayside.

But, having completed my thesis and recently transitioned into a new job which allows me the freedom to write (and be wrong) again, I figured I’d reboot this little endeavor. So dear reader, you’ve been warned.

As I’ve written about before Ontario has decided to move to an HST on July 1 2010. Well today comes the news that British Columbia will also be moving to an HST on the same date.

This is good news, but to prevent myself from rehashing why I’ll just point you to my previous post on the issue, linked above in the Ontario case. But there’s an extra wrinkle that makes the BC move even more interesting and a better idea. BC is next to Alberta. While this is a rather obvious point, this creates two important challanges for BC on tax policy:

1) Alberta does not have a provincial sales tax. So locating a business in that province (all other factors being equal) means you face a lower effective tax rate than locating in BC because the intermediate costs levied by the PST don’t exist. For many companies this can be tens of thousands of dollars a year (or more) in revenue that simply moving one province over saves. By harmonizing sales tax, this competitive advantage of locating in Alberta is going to disappear.

2) This is likely a point a little less familiar to some, but Alberta and BC have combined to form the largest internal trade bloc in Canada. Thanks to the TILMA (Trade, Investment, Labour Mobility Agreement) signed by both provinces earlier this decade, a number of barriers (needing to be re-certified as a teacher/nurse/etc in both provinces, re-registering company in each prov, etc) have been removed making it incredibly easy to move people and businesses between the provinces. Much easier than say moving from New Brunswick to Ontario or anywhere else. By moving to an HST, the entire TILMA region now no longer faces the intermediate business taxation which makes the BC/AB region an incredibly attractive place to locate. Given that the agreement is the first of it’s kind in Canada (after much discussion reaching back to 1992 about barriers to internal trade) it will be interesting to see how the harmonization affects business creation and movement within the region. With the ease of movement and sensible set up of taxes, its hard to imagine harmonization doing anything but help.

For now I’ll  limit my comments to something a little more current and interesting to more people–the recession. However, while there is data that is all very interesting and that deflation scare the Globe and Mail tried to start last week never really took off, there is one piece of news that’s extremely interesting.

The biggest item comes from the news (http://bit.ly/6lAZa) about consumer spending today and the noticeable increase in spending in some of the bigger ticket (autos, home reno) sectors. This strikes me as enchouraging news because the trend can be connected to the outlook of consumers on the economy as a whole.

First though, it’s important to note why economists and others look closely at retail sales. This has to do with the division of the overall level of the economy or GDP  (or Y as it’s often noted). There are several distinct sectors that make up Y, including Consumption (C), Investment (I, can be broken down further but that’s not where we’re going today), Government purchases (G) and net exports (X-M). Taken all together Y=C+I+G+(X-M) with C being by far the largest single component, accounting for roughly 70% of Y.

So, that’s why the report out today is important because it provides some insight into what the value of C might be and (more importantly) some idea of the trend.

Since typically people are reticent to spend or take on large debts if they believe that they’re going to end up unemployed or face a protracted period of less work/lower wages. Buying a car (even with the steep discounting ongoing as excess volume is reduced) is a big commitment and typically the second largest purchase for most people. It’s also (pending accidents of course) a durable good that requires expensive ancillary costs (fuel, insurance) that people are aware of before purchasing a vehicle. Since these are burdens faced in the medium and long terms, it suggests that people are less skeptical about the overall economy and that consumer confidence may be increasing.

The increase in sectors that deal in home reno (lumber yards, supply stores, etc) is interesting not only because home renovations typically are expensive and again can be a sign of consumer confidence. No, the reason that the increase in these sectors is interesting is because it may represent people responding to incentives and government stimulus having an effect.

Though you may not recall it if you’re in my age bracket and aren’t a home owner, but one of the bigger items in the budget passed in February was a home renovation tax credit worth 15% of work between $1000 and $10,000. As opposed to “shovel ready” (sigh) projects this represents a targeted incentive to allow people to undertake improvements that they otherwise wouldn’t. Or, to put it slightly different, it changes the relative cost of home renovations compared to everything else. Since people are much quicker at responding to new budget/incentive structures than government, the stimulus idea behind the tax credit seemed likely to have an effect.

After some time, this is what seems to have happened because saying consumers are quicker to react than governments doesn’t mean they react instantaneously. What the May numbers in the Stats Can report show is that after thinking about the work they wanted to get done and perhaps getting time off or quotes to get the work done, homeowners have started spending. This extra incentive appears to be pushing up the retail sectors that cater to home renos.

Since I was a touch busy and the credit didn’t apply to me, not being a property owner an all,
I can’t recall exactly the reaction to this individual item in the budget. It will be interesting to be interesting to see how the year-over-year changes for the sectors that home renos buy next year (credit expires on Feb 1 2010), compared to this year. If it shows a statically significant increase, this would indicate that the credit was an effective stimulus measure and that any chuckles or jokes made about it when the budget was proposed weren’t terribly well thought out.

As with every monthly data set from Stats Can one must not get carried away. These results represent a snapshot at the Canadian economy from May and it will be interesting to see the extent to which these trends carry forward into the next quarters of the year. One thing is clear though, after a steep decline in spending in Dec-Jan, consumers appear to be more willing to open up their wallets–even if only slightly.

Governments are good at overcoming market inefficiencies, providing services that are clearly beneficial to society at large and using their stick and carrot act to induce more efficiency from the economy. However, government are pretty terrible at “picking winners and losers.” When the government’s criteria for making economic decisions becomes all about preserving current jobs, it leads to a worse economic future. That’s because resources and human capital are tied up in inefficient industries (likely at wrong levels) and by removing the profit motive from companies (and replacing it with a “keep employment up” one) industries become bloated and don’t respond to consumer demands or the changing needs of Ontario.

So, though this might be a throwaway comment, it’s rather galling that the minister supposedly entrusted with the economic development of Ontario is advocating for an extraordinarily expensive course of action that would instead lead to economic stagnation.

As inevitable happens as pricing points change or government begin to open up the spending taps on infrastructure projects, the number of news stories on light rail has ballooned since the start of 2008. In most of this recent batch of coverage looking at rail systems from Portland to Edmonton to North Carolina to Ottawa the slant has been almost overwhelmingly positive with the benefits being extolled and upfront costs barely mentioned.

But generally these stories look at surface indicators and assuming that the results are largely correlated with light rail development and not other important factors. In their paper, Baum-Snow and Kahn have availed themselves of the awesome data stores of the Federal Reserve System and developed a unique data set to develop an idea of the true results of light rail development.

Though not entirely related to what I’m looking for, the paper begins with an exposition of the benefits of transit, including reducing vehicle traffic (and therefore congestion costs, pollution) and that well developed mass transit systems especially benefit the urban poor by increasing the geographic size of labour market that they can tap into. These are fairly well established conclusions within economics literature. The expanded labour market is an extremely interesting case because it’s a facet of light rail allowing the urban poor to commute out to suburbs to work likely low skill jobs that pay better because suburban residents aren’t interested in the work. This is an exceptionally straightforward observation, but it is something that is often lost in the debates about transit and the perceived benefit that the suburban-to-urban commuter will benefit the most from light rail.

The authors focus the study on the Census Metropolitan Areas of Atlanta, Washington, Boston, Chicago and Portland during the 1980-1990 time frames. They note that they chose these cities overtly because they were the only major centers to invest in transit during the period and the cities also allow a strong mix of established vs. new systems and different population densities.

From this they begin to walk through the mathematical foundation of their model and hedonic regression, a part, which I find extremely interesting, but might scare some mathphobes off. A simple explanation/example of a hedonic regression comes from real estate (and is directly tied to this paper). Since houses can’t ever be exactly the same, hedonic regressions try to break down the valuation of the houses into component parts. So, the models use regressions and test to see how much of a difference 1 bathroom makes versus 1.5 bathrooms in the price of a house. This can be expanded from just physical attributed of the house to distance from certain stores/services/utilities.  So, using this method, Baum-Snow and Kahn can see how much distance from station effects house pricing (important because stations can increase traffic, crime, etc) a key variable they’re looking at.
So, what exactly did Baum-Snow and Kahn find?

Not surprisingly, that better access to the rail and transit lines increased the use by people. By reducing the distance a person lived away from transit from 3km to 1km, average use of that transit second increased by about 1.4 per cent. A statically significant gain in ridership to be sure but perhaps not as large as one might think and a gain that is actually less than that achieved by simply speeding up the trains. Studies have shown that simply boosting the train’s speed by 6 miles per hour from 24mph to 30mph would up use by 5.3% in the “long run.”

I’ll leave out their discussion on demographics because it’s extremely variable and over time as people migrate between the urban areas and the suburbs (and back in some cities) it can have a big effect on the demographic conclusions drawn.

The most interesting (to me) result of the paper is that the light rail developments are worked into the value of Real Estate.  Contrary to the upheaval and crime that some believe light rail brings (factors which would logically decrease Real Estate values), Baum-Snow and Kahn show that reducing distance from the light rail by 1% increased rents by 0.024 per cent and housing values by 0.034 per cent. In real terms they not that by halving the distance from rail, the average increase in home prices was of 1.5%. Again, not massive increase in valuation, but a result that runs counterintuitive to some of the arguments put forward by home owners and businesses that light rail will hurt them in the long-run.

The usual codas about economic papers apply here, but there are perhaps a few things that can be drawn out from this paper and perhaps applied to Ottawa’s move to light rail. I’ll note that these extrapolations are my own and in no way should reflect upon the authors work cited above. So if you think I’m wrong it’s all on me.

But given that Ottawa is moving from a bus-based system that is often (especially in the downtown core) subject to congestion delays to a light rail system, it is easy to believe that it will see stronger benefits than the modest ones outlined in the paper. Rail on dedicated lines that aren’t subjected to road delays will drastically speed up the system and make it more attractive to more users. A rider’s “total cost” (including direct monetary and non-monetary costs) should decline with this increased speed, allowing the system to not only capture the benefits of expanded capacity the paper draws out, but also the speed benefit they highlight as well.

Additionally, the concerns that business and homeowners have with decreased property values with the development of the system probably won’t materialize. In fact, they’re likely to see net gain overtime as the light rail system increases the mobility of people and makes a larger geographic area attractive and feasible for them to live in or operate a business out of. However, as these benefits are spread out over time and any cost (or loss of revenue) will be upfront as construction delays or reduces access to areas, this may be a hard case for people to understand or support.

In a broad sense, the paper and it’s framework make it clear to me that if you were to ignore the environmental and city density benefits of that could result from the development of urban light rail, there is still a compelling economic case for it to be built. Especially in cities like Ottawa where there is no (or almost no) light rail in existence and the benefits of reducing (or eliminating) congestion costs could be quite large in their own regard.