Debt to income limits: some questions

One of the jobs of the new Minister of Finance will be to decide whether or not to accept the Governor of the Reserve Bank’s request to add some sort of debt-to-income limit tool to the list of direct regulatory interventions that the government gives the Reserve Bank political cover to use.  It does this under the Memorandum of Understanding on (so-called) macroprudential tools.  I phrase things in that slightly awkward way because Parliament has delegated so much power to the Reserve Bank –  probably without fully realising the import of several legislative changes over the years –  that one unelected official, the Governor, does not actually need approval of the Minister of Finance, or of Parliament, to impose such intrusive direct controls.

To give some credit to the outgoing Minister of Finance, the Memorandum of Understanding framework, while legally non-binding, does more or less ensure that the current Governor would not use such a regulatory intervention without at least the political cover provided by allowing the inclusion of a debt-to-income limit on the list of approved tools.  Longer-term, reform of the governance and regulatory powers of the Bank should include making decisions on the application of such controls formally a matter for the Minister of Finance, on the recommendation of the Reserve Bank.

The Reserve Bank has been at pains to claim that their successive waves of LVR controls have improved the resilience of the banking system.  That claim is less well-founded than they would like people to believe.  For example, shifting a large group of borrowers from say 81 per cent LVR mortgages to, say, 79 per cent LVR mortgages won’t make any material difference to the expected losses a bank might face in a severe downturn, but might actually modestly reduce the ability of a bank to withstand those losses (since loans with less than an 80 per cent LVR typically have lower risk weights).   This risk is one my former colleague Ian Harrison has drawn attention to.  In addition, the Bank has never presented any sort of analysis, not even impressionistic in nature, of what banks are doing instead of making high LVR housing mortgages.  If their risk appetites haven’t changed, and the capital invested in the business hasn’t changed, the risks are likely to be developing somewhere else, perhaps somewhere rather less visible, on banks’ books.  There are also ongoing questions about the evidence base behind the regulatory discrimination against those borrowing to buy a house for residental rental purposes.  Before giving his imprimatur to the possibility of further Reserve Bank regulatory interventions, the new Minister of Finance might reasonably ask some harder questions about what has already been done.  He might also ask some questions about when the drift towards ever more direct intervention –  initially sold as quite temporary back in 2013 –  might end.

Before approving the addition of any sort of debt to income limit tool to the approved list, it would also be worth the Minister insisting that the Bank’s background papers get public scrutiny.  No doubt Treasury gets to see them and Treasury has had some serious questions in the past about proposed Bank interventions.  But since the Governor says there is no urgency about using a debt to income tool, there can be no good grounds for not putting the background material out for wider scrutiny now, before the Minister makes his decision, not sometime –  if ever –  afterwards, when (with luck) the OIA finally gets the papers out of the Bank.

In particular, it would be good to see a careful assessment of the empirical evidence the Bank is using in support of its case for a DTI limit, on both soundness and efficiency dimensions (both important in the Reserve Bank Act).  Along those lines, there was an interesting post out earlier this week on the blog of Richard Green a professor (in housing, real estater economics etc) at the University of Southern California.

In that post, he reports some interesting empirical work on a sample of 281000 fixed-rate mortgages purchased by Freddie Mac, one of the US quasi-government “agencies”, in 2004.  He runs a regression model across two-thirds of these mortgages, using a range of variables to model the probability of subsequent default, including through the largest shakeout in the US housing market in many decades.  His DTI term is not actually the ratio of debt to income, but the ratio of debt service to income, but clearly the two will be highly correlated, especially for these relatively high quality mortgages (ones that met US agency standards –  “qualifying”), looking at all the mortgages across the same period of time.

The equation results are in Green’s post.

Note that while DTI is significant, it is not particularly important as a predictor of default.  To place this in context, note that a cash-out refinance is 5.2 percentage points more likely to default than a purchase money loan, while a 10 percentage point change in DTI will produce a 1.3 percent increase the probability of default.

To be clear, increasing the total service burden from, say, 40 per cent of income to 50 per cent of income –  a huge increase – produced a 1.3 per cent increase in the (always quite low) probability of default.

One reason he notes is measurement

First, while DTI is a predictor of mortgage default, it is a fairly weak predictor.  The reason is that it tends to be measured badly, for a variety of reasons.  For instance, suppose someone applying for a loan has salary income and non-salary income.  If the salary income is sufficient to obtain a mortgage, both the borrower and the lender have incentives not to report the more difficult to document non-salary income.  The borrower’s income will thus be understated, the DTI will be overstated, and the variable’s measurement contaminated.

More generally, and in the US context

The Consumer Financial Protection Board has deemed mortgages with DTIs above 43 percent to not be “qualified.”  This means lenders making these loans do not have a safe-harbor for proving that the loans meet an ability to repay standard.  Fannie and Freddie are for now exempt from this rule, but they have generally not been willing to originate loans with DTIs in excess of 45 percent.  This basically means that no matter the loan-applicant’s score arising from a regression model predicting default, if her DTI is above 45 percent, she will not get a loan.

This is not only analytically incoherent, it means that high quality borrowers are failing to get loans, and that the mix of loans being originated is worse in quality than it otherwise would be.  That’s because a well-specified regression will do a better job sorting borrowers more likely to default than a heuristic such as a DTI limit.

He tests this by applying his model to the one third of the sample of loans held back in the initial estimation.

To make the point, I run the following comparison using my holdout sample: the default rate observed if we use the DTI cut-off rule vs a rule that ranks borrowers based on default likelihood.  If we used the DTI rule, we would have made loans to 91185 borrowers within the holdout sample, and observed a default rate of 14.0 percent.  If we use the regression based rule…… we get an observed default rate of 10.0 percent.  One could obviously loosen up on the regression rule, give more borrowers access to credit, and still have better loan performance.  

And extending the point

Let’s do one more exercise, and impose the DTI rule on top of the regression rule I used above.  The number of borrowers getting loans drops to 73133 (or about 20 percent), while the default rate drops by .7 percent relative to the model alone.  That means an awful lot of borrowers are rejected in exchange for a modest improvement in default.  If one used the model alone to reduce the number of approved loans by 20 percent, one would improve default performance by 1.4 percent relative to the 10 percent baseline.  In short, whether the goal is access to credit, or loan performance (or, ideally, both), regression based underwriting just works far better than DTI overlays.  

The current focus in the US isn’t on responding to a house price boom, but on access to finance (in a market still dominated by the government).  But the sorts of questions posed by these sorts of results are just as relevant here as they might be in a US context.  Perhaps here too, high debt to income borrowers might generally be better quality borrowers?     How confident can the Reserve Bank be that an actual debt to income limit –  as distinct from a pure hypothetical –  will actually improve the resilience of banks –  not just on the housing book, but overall?  And even if there is some improvement in resilience, at what cost –  recall the statutory efficiency mandate –  in terms of access to credit would that gain come at?

Perhaps there are good answers to all these sorts of questions.  Perhaps the Reserve Bank has access to other careful studies that produce different, and robust, results.  But these are the sorts of questions the new Minister of Finance, and the public, should be asking in response to the Governor’s request for political imprimatur for adding another tool to his kit of potential interventions.     And, more broadly, how confident can we be of any sustained gains from such interventions, as compared to the sure increases in resilience that would result from either higher risk weights on housing loans more generally, or higher overall capital requirements for banks (and non-banks regulated by the Reserve Bank)?


Two main parties with new leaders hasn’t happened often

Idly reflecting this morning on the change in the leadership of the National Party, I started trying to work out how often the two main parties have both gone into a general election with a new leader.

The National Party was formed in 1936.  Here are the names of the leaders of the National and Labour parties at each election since then.

Main party leaders
Labour National
1938 Savage Hamilton
1943 Fraser Holland
1946 Fraser Holland
1949 Fraser Holland
1951 Nash Holland
1954 Nash Holland
1957 Nash Holyoake
1960 Nash Holyoake
1963 Nordmeyer Holyoake
1966 Kirk Holyoake
1969 Kirk Holyoake
1972 Kirk Marshall
1975 Rowling Muldoon
1978 Rowling Muldoon
1981 Rowling Muldoon
1984 Lange Muldoon
1987 Lange Bolger
1990 Moore Bolger
1993 Moore Bolger
1996 Clark Bolger
1999 Clark Shipley
2002 Clark English
2005 Clark Brash
2008 Clark Key
2011 Goff Key
2014 Cunliffe Key
2017 Little English

New leaders for both main parties hasn’t happened often.  The most recent previous occasion was 1975, and the  only other time before that was 1943.  On both occasions, the incumbent Prime Minister had died during the previous electoral term, and the opposition party (in both cases National) had experienced a thumping defeat at the previous election.

Steven Joyce as Minister of Finance

Bill English is reported to have the numbers to become leader of the National Party and, thus, our next Prime Minister.  And if he does succeed in that quest he has indicated that Steven Joyce will become the Minister of Finance.

That news had me digging out a couple of posts I’d written this year on Mr Joyce’s comments and claims.  He has been Minister of Economic Development for some years –  years in which, as throughout the term of this government, there has been no progress towards closing the large productivity gaps with other advanced countries. In fact, over the last four years official statistics suggests New Zealand has had no productivity growth at all.

In a post in April I posed A Question for Steven Joyce after an interview in which as Science and Innovation minister he argued for even more migration to meet the needs of the tech sector.   He went on

“That’s one of the reasons I’m leery of calls to halt immigration – apart from the fact there’s not much reason to because of the economic gains,” he said.

I noted that

In the last fifteen years, we have had huge waves of immigration,  under both governments, and yet there is not the slightest evidence of economic gains accruing to the New Zealand population as a whole.  Tradables sector production per capita has gone nowhere in fifteen years, productivity growth has been lousy, and there is no sign of any progress at all towards meeting Mr Joyce’s own government’s (well-intentioned but flawed) exports target.

My question was (and remains)

“what evidence can the Minister point to suggesting that the very high rates of immigration to New Zealand in recent decades have done anything to lift productivity in New Zealand, or lift the average per capita incomes of New Zealanders?”.


Mr Joyce and the other MBIE ministers have huge resources, staff and budgets, at their disposal.  Surely they should be able to point to clear demonstrated economic gains for New Zealanders as a whole from such a large government intervention.  Our non-citizen immigration programme is already one of the largest (per capita) in the world.  Citizens might reasonably ask for evidence that such an outlier programme has benefited them before considering calls from Ministers for “even more immigration”.

A few months later Mr Joyce was on TVNZ’s Q&A programme defending the government’s economic record.   My post on it is here .   There was an attempt to defend the skills focus of New Zealand immigrants, all the time ignoring data from the same survey indicating that New Zealand already had some of the most skilled workers in the OECD.

TVNZ’s interviewer pushed Mr Joyce on the failure to make any progress in meeting on the centrepiece target in the government’s so-called Business Growth Agenda.

The goal, announced several years ago, was to lift exports as a share of GDP from around 30 per cent to around 40 per cent by 2025.  I thought the formal target was daft and dangerous, even while sympathizing with the intuition that motivated it – small countries get and stay successful by selling lots of stuff, competitively, in the rest of the world.


Here is chart of exports to GDP, going back to the start of the quarterly national accounts data in 1987. This time, I’ve also shown the average export share for each of the last three governments.

exports to gdp by govt

Plenty of things cause fluctuations in the series, and not many of them are under the direct control of governments.  Nonetheless, the average export share of GDP is materially lower under this government than it was under the previous government, and the latest observations are below even that average. Since the start of 2009, exports have averaged 27.7 per cent of GDP.  Under the previous National government –  one that first took office more than 25 years ago, that average was 27.5 per cent.  The government’s goal was to lift the export share by 10 full percentage points, and there is now only nine years left until the target date.  On performance to date –  and policy to date – we might be waiting several more centuries to achieve that sort of goal.

It is time Mr Joyce and his colleagues faced the fact that they are simply failing on this count.  A rather different approach is needed –  one which permits/facilitates a sustainably lower real exchange rate, orienting the economy more strongly towards investment in the tradables sector, and enabling more able firms to grow (and locate here doing so) by successfully selling to the rest of the world.  As I’ve noted before, per capita output in that vital outward-oriented part of the economy hasn’t increased at all for 15 years now.  It seems unlikely that that sort of reorientation will occur, all else equal, while we continue to bring in, as a matter of policy, so many not-overly-highly-skilled non-citizen migrants each year.

I haven’t written much about our export education industry and the huge increase in the number of student visas in the last few years –  a strategy championed by Steven Joyce as Minister of Tertiary Education.    In general, I’m keen on export education –  if New Zealand firms have good products that the rest of the world wants, good luck to them, and over time those additional sales should benefit us all.  But there has been more and more sign that most of the growth in export education in recent years hasn’t been about the quality of New Zealand’s educational institutions, but about immigration access.  We aren’t getting (many) top-notch students at all, they aren’t going to our best tertiary institutions, and in many cases they fund their stay here by competing directly in the labour market against relatively unskilled younger New Zealanders.  And there are more and more stories of rorts and exploitation –  well captured in the Herald’s series this week –  that really should leave New Zealand policymakers –  and perhaps especially the responsible minister –  ashamed of what is being done, and permitted and even encouraged, in our name.  It is all very well for officials and ministers to say they have now identified problems and are responding to them, but these sorts of rorts and outright exploitation were pretty predictable from that start.  And is there any sign that Steven Joyce cared?  Export incentives and lightly-disguised subsidies, all in pursuit of a short-term kick to economic activity, with little regard for any evidence of likely long-term gains to New Zealanders, or for the shorter-term damage to the good name of New Zealand and its institutions.

One could go on and talk about the dubious deal that MBIE and their Minister were party to, such as those around Sky City and the convention centre.

The prospect of Joyce as Minister of Finance isn’t encouraging.  Perhaps his Prime Minister will restrain his impuluses to intervene here or there, subsidise this firm or that, this industry or that.   But after eight years, isn’t it perhaps more likely that the purse strings will be loosened to pursue even more of these sorts of “smart active government” strategies that successive governments have pursued for decades, all the while watching New Zealand drift slowly further behind productivity levels in the rest of the advanced world.

At the end of one of the earlier posts, I wondered if perhaps Mr Joyce could point us to the evidence that guides his interventions (or those he favours).  Reflecting on that it reminded me of a seminar I was at some years ago.  Asked by one attendee why there was no cost-benefit analysis for some fairly expensive project, Mr Joyce responded “because I already knew the answer”.

The quality of regulatory impact statements, and associated cost-benefit analyses, emerging from Mr Joyce’s MBIE in the last few years have often been disturbingly weak.  Ministers and departments will do that if they can get away with it.  As Minister of Finance, Mr Joyce would have responsibility for Treasury’s work in trying to lift/sustain the quality of regulatory impact statements.   They have largely failed in that goal under Bill English.  It is not hard to see the quality of policymaking deteriorating again under a Treasury overseen by the activist Mr Joyce.

Mr Joyce is reputed to have troubleshooter skills –  he was, eg, the minister charged with sorting out the Novopay debacle.  But it is difficult to optimistic about the directions in which as Minister of Finance he would guide the overall approach to economic policy.

Eight (more) wasted years

Perhaps nothing became John Key more than the manner of his departure.  Tired –  “nothing left in the tank” –  and admirably unwilling to go into an election year and lie about his willingness to serve another full term, or to just struggle on, he chose to walk away instead.

It is rare for political leaders to leave voluntarily when they are well, undefeated, and not facing any serious internal challenge.  Harold Wilson (in the UK) and Calvin Coolidge are two who spring to mind.    Enoch Powell’s maxim was that

“All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs.”

John F Kennedy and Norman Kirk were examples of leaders cut off in their prime, and reputations shaped for decades by the combination of their short time in office and the unexpected early deaths.

At one level, John Key’s political career won’t have ended in failure.  He remained popular and had had a pretty good chance of leading his party to a fourth term in government next year.  But at another level, so what?  If almost all political careers end in failure, in Powell’s terms,  that includes the careers of many very great men and women.  For each of Bob Hawke, Paul Keating, and John Howard, their careers ended in failure and defeat, but it doesn’t change what they had accomplished over the course of their careers.  The same could be said for Margaret Thatcher, Winston Churchill or Charles de Gaulle.  I might even include Tony Blair and Gordon Brown in such a list.  They left having made a difference. I’m not sure that same can be said of John Key.

There were three election victories, to be sure.  But here are the centre-right (National +ACT) vote shares for those three elections.

2008 48.58 per cent
2011 48.38 per cent
2014 47.73 per cent

Only at the 2008 election did those two parties together have a clear electoral majority (they obtained a tiny majority in 2014, and lost it shortly afterwards in the Northland by-election).   Those vote shares – and those of the National Party alone –  look very impressive in an FPP context, but those weren’t the rules Key was operating under.  Throughout his term he had either small majorities or a minority-government position.  Passing any contentious legislation required cobbling together the numbers among minority parties, and partly for that reason not much contentious was actually done.

In his 1975 election campaign, the then Opposition leader Robert Muldoon stated that if his party was elected his goal was to leave the country no worse than he found it.   That wasn’t how John Key articulated his vision.  In his campaign opening address in 2008 he talked about serious change.

You are looking for a Government that will focus on the issues that matter to you – a Government with a plan for economic recovery, and a Government with fresh ideas and the energy to meet the challenges this country faces.

At this election National is offering exactly that.

I am campaigning on strengthening our economy, on rising to the challenge presented by tough global conditions, and on delivering greater prosperity to New Zealanders and their families

Of Labour’s economic performance he said

It’s a shocking record, and Helen Clark and Michael Cullen should be judged by it.

Promising something different

National’s plan faces the fact that we must lift productivity in this country.

Labour has a dreadful record on productivity and National will do better. ……Labour won’t do that. End of story.

Third, National’s plan recognises that lifting productivity also means removing the bottlenecks in the economy – the roading problems and the creaky communications networks that are holding business back. That’s why National will fix the Resource Management Act and that’s why we’ll invest more in the infrastructure the economy needs to grow.

Fourth, lifting productivity also means encouraging businesses to invest.

The guys in red like to talk about this idea. But let me tell you something. I’ve had a bit more to do with business than them and it’s actually more straightforward than they think.

The number 1 reason that private companies invest is because they are profitable and feeling positive about the future. All the R&D credits in the world won’t cut it if companies aren’t making any money. We have to get the fundamentals right first.


…we must grow our economy faster.

I know we can do it.

You want to know why? Because I’ve actually worked in the world of finance and business. Helen Clark hasn’t. I’ve actually picked up a struggling business and made it grow. Helen Clark never has. And I’ve actually got stuck into a business, trimmed its sails, and delivered some profits to its shareholders.

And that’s what I am determined to do for this country.

I was always a bit of a sceptic on John Key, but during that election campaign –  in the middle of a recession and with the international financial crises as backdrop – the aspirations  he spoke of occasionally resonated.  The National Party has now taken down the link to the economic speech Key gave just a few days before the 2008 election but –  naive as I perhaps was –  I actually found this passage quite inspiring, and had it pinned above my desk at The Treasury for the following year or two.

I came into politics because I believed New Zealand was underperforming economically as a country. I don’t think it’s good enough that so many New Zealanders feel forced to leave our country each year to seek higher wages in Australia. I don’t think it’s good enough that our average incomes lag so far behind the rest of the world. And I think it’s unforgivable that the Labour Party has done so little to address these fundamental challenges.

I believe that a very big step change is needed in our economic performance to ensure New Zealand can make the most of its considerable potential. Growing the economy of this country continues to be my driving ambition. I stand before you today ready to deliver on that ambition for New Zealand.

You have my personal commitment that if I am elected Prime Minister in eight days’ time I will work tirelessly over the next three years to deliver the stronger economic future our country deserves.

I don’t doubt that he has worked tirelessly over the last eight years, but to what end?

There has been no “very big step change” in our economic performance.  What is worse perhaps, there has been no serious attempt to bring about such a change.   The 2025 Taskforce’s prescription was dismissed –  from some Caribbean island where the Prime Minister was –  the night before its report was released.  And if he didn’t like that prescription there was no sign of any energy being put into finding a package of measures he really believed would make a difference.  Worse still has been the sheer dishonesty of the last few years in which the Prime Minister repeatedly asserts that New Zealand is doing very well by international standards, and is somehow the envy of the advanced world.  Only a few months ago we had the nonsensical claims that he was remaking New Zealand as the Switzerland of the South Pacific, or the frankly rather offensive proposition (to all those struggling in that market) that Auckland house prices were just what one expects in a successful global city –  when all the time, Auckland’s GDP per capita has been falling relative to that in the rest of the country (and when the government knows it has been making little or no progress in freeing up land use restrictions).  And for all the talk of international connections etc, there has been no nationwide productivity growth in the last few years, and exports as a share of GDP are, if anything, a bit lower now than they were in 2008.

Of course, over eight years in office almost any government is going to do some worthwhile things.  When Malcolm Turnbull last year talked to wanting to emulate the Key reform programme, I managed a brief list of worthwhile reforms.

But on the other hand, I noted this list

  • Higher effective corporate tax rates
  • The debacle of the earthquake-strengthening legislation
  • The continuing debasement of our skills-based immigration system, both in the way it is administered and in formal announced policy.
  • New overlays of financial market regulation
  • The re-establishment of direct government controls over who banks can and cannot lend to
  • The continuation of a regime of “corporate welfare”, including for example the Sky and Tiwai Point deals, and the smell that the Saudi sheep deal gives off
  • The degree of central government control of the Christchurch repair project, involving both wasteful projects (some of which may not finally go ahead), and the way central government has artificially boosted land prices and impeded the prompt redevelopment of the central city.
  • The continuing apparent decline in the rigour of public sector policy advice, and in the use of robust cost-benefit analyses in underpinning policy decisions.
  • Increased first home buyer subsidies.
  • Undermining housing affordability with mandatory insulation etc requirements for rental properties
  • Continuing increases in minimum wages, from very high levels (relative to median wages) at a time when unemployment is quite high, and policy was supposedly oriented to getting people off welfare.
  • Heavy investment in the newly state-repurchased loss-making Kiwirail

As Eric Crampton notes, the new government regulations that killed off ipredict now mean we don’t even have functioning predictions markets to follow in the wake of the Prime Minister’s resignation.

Of course, some credit is due to the government for returning the budget to balance, or even modest surplus.  It isn’t a trivial achievement, especially against the backdrop of the Canterbury earthquakes, but equally when you have benefited from (a) high terms of trade, (b) low interest rates, (c) rapid population growth which in the short-term tends to raised government revenue more than expenditure, and (d) unexpectedly slow wage inflation, and (e) some very big spending programmes from the outgoing previous government that had not yet become firmly entrenched, it was all a little easier than it might otherwise have been.  And important as maintaining fiscal balance is, it isn’t the sort of structural reform that generates the very big step changes in economic performance that John Key talked of.

The Prime Minister would also no doubt note the reduced outflow of New Zealanders to Australia.     As I’ve noted here previously, there is a lot of year-to-year volatility in those figures, but the average outflow  of New Zealanders has been lower over his term than over the nine years of the Clark-Cullen government.   That would have been encouraging if a reflected a sustained narrowing in the income/productivity gaps between New Zealand and Australia.  As it is, it seems to reflect higher unemployment rates in Australia and a recognition that the position of New Zealanders moving to Australia isn’t alwasy very secure if things don’t turn out well.  As for productivity, those gaps have only continued to widen over the Key years (and especially the last few years).


Of course, relative to other advanced countries the years since 2008 have not been especially bad in New Zealand.  There have been plenty of countries that have done worse, and plenty that have done better.  We’ve been middling at best and that is probably about the least we should have expected as –  through some mix of good management or good luck –  our incoming government in 2008 inherited neither a fiscal nor a financial crisis.

I haven’t touched much on the  debacle that is the housing market.  It didn’t feature in that 2008 campaign  launch – probably house prices were falling at that point of the recession. But in many parts of the country – including our largest city – the issues of unaffordability are so much worse now than they were then. Turning around our long-term productivity performance might seem really hard. Doing something effective to reverse the inexorable climb in real house prices just wouldn’t have been that hard – between land use law reforms, and easing back on the immigration-led population pressures until new policy frameworks left the housing market better able to cope. But, in fact, there has been almost no serious reform, and a generation of young families are increasingly shut out of home ownership. It is inexcusable. And perhaps the worst of it is that there was never any sign that the government was willing to go down fighting, to spend serious political capital – and perhaps to fail in the attempt nonetheless – to make a real difference. That isn’t leadership. At best it is followership.

I could go on.  About, for example, the suspension of property rights following the earthquakes, about the weak regard for the institutions of our democracy, or –  mundanely –  about the fiscal and moral failure that the big increase in (already high) prisoner numbers over the term of this government represents.  But I’m sure you get the drift.  It has been eight largely wasted years –  building on at least the previous nine largely wasted years –  in which none of the big structural economic challenges New Zealand  faced has been even seriously addressed.  On not one of them can the government show serious progress and on some –  house prices most noticeably –  things are now even worse than they were in November 2008 when John Key spoke of his goal of securing a very big step change in economic performance.  He has held office, and left at a time of his own choosing.  But to what end?  In that sense, surely, his political career ends in a failure much more indelible than that  of a mere electoral defeat or internal coup.

Superannuation choices

Economics is sometimes known as “the dismal science” – thanks to the 19th century writer and historian Thomas Carlyle.  I’m not sure that either word in that phrase is generally fair or accurate, but sometimes economists don’t help themselves.

A good example is around “the ageing population”, something that economists have been worrying about for at least as long as I can remember.  In fact, of course, the ageing population is one of the very greatest achievements of mankind in the last couple of hundred years.   In the UK –  at the leading edge of the Industrial Revolution –  average life expectancy at birth in 1840 was just over 40.  Now it is over 80.  In the first half of the 20th century, many of the gains were  in reductions in infant and childhood mortality.  In recent decades, the gains have been concentrated among adults.  The typical adult is living longer, and that is  –  typically –  something to celebrate.   Here is the New Zealand data on the increase in remaining life expectancy at age 65 over recent decades.


An ageing population isn’t something to try to “remedy”, whether by encouraging more births, (or more wars?) or targeting more migrants.   If there is an ageing population “problem”, it is largely an artefact of the rules we’ve set up for paying state pensions.  There are no doubt some issues around health  –  amid that debate as to whether people living longer means more health spending, or just means that the health spending (usually concentrated around the last few years of life) happens at an older age.  But my focus today is on the state pension system –  New Zealand Superannuation.

When The Treasury recently released their Long-Term Fiscal Statement, I saw criticism of them in some quarters for not making more of the “need” to change the New Zealand Superannuation settings, often with a subtext that reform was urgently needed. I’m critical of Treasury on a variety of scores, but that isn’t one of them.

Treasury included this chart in the report.


As I noted then, one could reasonably run this under a headline “no urgent need for any big fiscal changes for 20 years”.  On these projections, in 2035 the spending share of GDP would be around where it was five years ago.  Actual fiscal policy changes happen all the time, and the base on which revenue is raised changes too.  It wouldn’t take much for spending as a share of GDP in 2035 to be not much different from where it has been on average over the last decade.  One can’t reasonably generate “fiscal crisis” headlines –  or urgent official advice to ministers – out of that sort of scenario.

In saying that, I’m not expressing even the slightest sympathy with the Prime Minister’s dismissal of the Treasury projections as, to put it mildly, not worth the paper they are written on.  If he genuinely believed that there is an easy solution: amend the Public Finance Act and save us the not-inconsiderable amount of resources that goes into producing these statements every few years.   As he has done since he was first elected, the Prime Minister simply wants to make the issues around NZS someone else’s problem –  he knows the parameters should change, and will change, but just not while he is PM.  As someone who is 54, I’ve always assumed that the NZS eligibility age would have increased somewhat by the time I reached 65.  That now seems increasingly doubtful.

But these really aren’t primarily economic issues, and despite Treasury’s enthrallment with their Living Standards framework, they don’t have a mandate for using taxpayer resources to push strongly for the sort of society they –  a few hundred bureaucrats –  happen to favour.  It isn’t even their role to try to work out what choices the public would prefer – that is the stuff of politics.    I read the evidence as suggesting that lower average tax rates would tend to lift New Zealand’s productivity and GDP per capita, but the effects seem to be small and uncertain, and New Zealand’s government spending as a share of GDP isn’t extraordinarily large by modern advanced country standards.

To my mind, issues around New Zealand Superannuation are substantially moral in nature, and the debate would be better if centred on those dimensions, rather than on fiscal policy.  Our level of government debt isn’t that low, but by international standards it isn’t high either, and if anything looks likely to drop as a share of GDP over the next few years.  So the issue shouldn’t be “can we afford to pay a universal welfare benefit to an ever-increasing share of the population?” –  ever-increasing, on the assumption that adult life expectancy continues to increase.  We probably could.  But rather “should we?”, or “is it right to do so?”.   Economists quickly get uncomfortable with “is it right” type questions, sidelining them as “political choices”, but almost all the important political choices are about conceptions of what sort of society or government we want –  competing visions of what is “right”.   Of course, there are practical dimensions, and areas where experts can offer technical perspectives  –  eg the implications of particular choices for other things we care about (eg labour force participation, incentives to save etc) –  but the key choices shouldn’t really be seen as technocratic in nature.

For me, there is simply something wrong about offering a universal income to an ever-increasing share of the population.   Governments don’t exist to support us all, but on the other hand they probably do exist, in part, as a vehicle through which society can support those genuinely unable to support themselves.

I’m often struck by the contrast between the situation now and that in 1898 when the first (asset and income-tested) age pension was introduced in New Zealand.  The age of eligibility then was 65.  Life expectancy at birth then, even in a rich colony like New Zealand, was less than 65, and for the minority who made it that far, average  remaining life expectancy was perhaps another 10 years.   But the people who were turning 65 in 1898 will have typically entered the workforce very young –  even for those with a reasonable base of schooling, full-time work would have started by 12 or 14.  That meant fifty years in the workforce –  whether paid directly, or managing a household –  before the question of eligibility for a state pension even arose.  And there weren’t working-age benefits available either.

These days, by contrast, a typical young adult won’t enter the fulltime workforce until perhaps around age 20.  A few leave school and go straight into fulltime work at 16.  Many of the mass who now do university study will be 21 or older before they start fulltime work.    And around 10 per cent of the working age population is on a welfare benefit at any one time.  And when people do finally get to 65 –  as most do – their average life expectancy is now another 20 years.

So we’ve gone from a situation where most adults would support themselves (or within families etc) for their entire adult lives, and a small proportion might have perhaps a decade of state support in old age, to a situation where on average a typical adult will be receiving a state pension or benefit for perhaps a third of their adult life.  That is too much of a change, a shift towards state dependence, for me (as citizen/voter) to regard with equanimity.

This isn’t an argument for abolition of all welfare, or even for harshly treating those permanently unable to support themselves.  For the latter group –  a small minority – I worry that our system has already become unreasonably harsh and burdensome.    It is really simply a view that our conversations and debates should be around what sort of society we want, and what the appropriate role of the state vs self (and family) reliance is.    Shifting towards making NZS available at, say, 67, and then legislating to index that age of eligibility to future increases in adult life expectancy, just isn’t a terribly radical reconception of the role of the state in the face of such large (and welcome) increases in life expectancy, and in the ability of most people in, say, the 65-70 age group to maintain paid employment.

There also needs to be more public debate about the residence requirements for NZS.  When the age pension was first introduced in 1898, there was a requirement of 25 years continuous residence in New Zealand to be eligible.  A recipient had to have spent at least half their adult life in New Zealand –  whether as taxpayer or other contributor to the society/community.  Consider, by contrast, the rules today, under which one can be eligible for (a much higher rate of) NZS having lived in New Zealand for only 10 years, including five years after the age of 50.   That is extraordinary enough, but then there is the oft-overlooked provisions under which, in MSD’s words

We can also count periods of residence spent in countries that New Zealand has social security agreements with.

  • New Zealand has social security agreements with the United Kingdom, the Netherlands, Ireland, Jersey, Guernsey, Australia, Greece, Canada and Denmark
  • These agreements allow you to use residence in these countries to qualify for periods of residence (or contributions) and presence and the ordinary residence criteria.


Australia is, of course, the big issue there.  Not only have huge numbers of New Zealanders gone to Australia and spent the bulk of their adult lives there, but these provisions also apparently cover Australians who have never lived in New Zealand.

Fortunately for us, perhaps, people tend not to migrate towards colder climates in their old age, but the rules still seem quite extraordinary.  What obligation should New Zealanders have towards people who left for Australia at, say, 20, never paid any material amount of taxes in New Zealand, and then late in life decide that a universal pension in New Zealand seems an attractive fallback.  Even the fiscal risks aren’t small.

I’ve written about some of these issues before.  As I noted then

Personally, I’m happy that we should treat quite generously people who have spent most of their life in New Zealand and have reached an age that can genuinely be considered “elderly”, but I don’t feel the same sense of generosity towards those who have migrated here quite late in life, or to New Zealanders who have spent most of their working lives (and taxpaying years) abroad.

Of course, among the political questions societies need to face is the extent to which income support in (relatively) old age is universal or dependent on circumstances.  New Zealand has gravitated towards a structure where the state pension is paid to everyone, regardless of income or assets, and subject to a very undemanding residence requirement.

Is there a case for income and/or asset testing?    We tried such a model between the mid 1980s and the late 1990s, and it proved politically unsustainable.  Personally, I don’t think it is an issue worth trying to fight again.  It is easy to say “why pay NZS to people earning more than $100000 per annum”, but there aren’t many of them, and even those still earning high incomes at around age 65 will typically see labour income drop away quite quickly.  So there isn’t much money to be saved from instituting a means-test that cuts in at a high income.  There is quite a lot of money at stake if, say, an abatement regime could cut in at, say, the current NZS payment rate (any private income above that threshold would progressively reduce NZS payments).  But if we tried that sort of regime again, there would be huge resistance (on “fairness” grounds –  “I saved all my life, and that person who saved little gets the full NZS payment”), huge incentives to mask or transform the nature of income/assets, and a pretty serious disincentives effect on lower or midde income people to remain in the workforce past age 65.   Would it make much difference to private savings behaviour?  It is hard to tell: very low income people don’t have the capacity to save much anyway, and for seriously wealthy people it would make no difference.  For those in the middle, it might well deter private savings for some and raise it for others  –  the net effect just depends on whether the income or substitution effects are more dominant.  As it is, it is unlikely that the current NZS system materially adversely affects private saving – although the pension is universal, it doesn’t offer a comfortable standard of living for those from the income cohorts who had much capacity to save during their working lives.  For those people, our system discourages private savings less than, say, many of the other advanced country systems (offering an individual-income related unfunded state pension) do.

Frankly, I think any serious means or asset testing regime is largely futile, and probably unsustainable over time, unless or until society could recreate some sense of “shame” in being reliant on the state.  If NZS is seen as an entitlement, that no one should be embarrassed to take, people will do whatever it takes to maximise their claim to the entitlement.  Behavioural responses will be quite different than in a system in which people are ashamed to be dependent on the state, and will do everything possible to avoid themselves (or their parents/relatives) being dependent on the state for income support.

A few years ago, I came across an account of the New Zealand age pension system published just a few years after it was introduced.  William Pember Reeves had been a reforming minister in the Liberal government of the 1890s, and in 1902 published his two volume State Experiments in Australia and New Zealand. Included in that book is a fascinating and lengthy discussion as to how the new age pension system was working.  At the time around 4 per cent of New Zealand’s population was over 65 (compared to 14 per cent now).

I reread the relevant section this morning, and it was a reminder of a different age (different in some good ways and some not so good ones).  Applicants for the age pension had to appear in open court to present the evidence that they met the statutory tests.  Applicants were subject to good character tests, including being disqualified if they had had a recent period of imprisonment (by contrast, today on the MSD website it isn’t actually clear whether even current prisoners are disqualified).   And the income and assets tests were very demanding –  the marginal abatement rate was 100 per cent for private income above 34 pounds a year in private income.  Reeves was generally a supporter of the reforms he was writing about, but he also notes that even in those early days of the regime, there were opportunities to game the system, some legal, some not.

Our current NZS system has a number of good features. It does prevent the extremes of elderly poverty sometimes seen in other countries or in other times.  And it does nothing to directly discouraging older people from remaining in the workforce.  It is also administratively straightforward. And it probably does relatively little to deter private savings.   But –  and whatever the state of the government’s finances – with an age of eligibility that is the same now as it was 100 years ago, in the face of dramatic and continuing gains in life expectancy, it seems simply wrong – and expensive –  to keep paying a universal pension to an over-increasing share of the population.  And I can see no compelling reason for why full NZS should be available to anyone who has not spent at least 30 adult years physically resident in New Zealand –  be they immigrants, or New Zealanders who have spent much of their lives abroad.

Of course, others will have different conceptions of the role of the state.  No doubt, for those who favour a Universal Basic Income, NZS appears as a precursor to their vision for how the whole of society should be organised.  A related group –  those who worry as to whether there will be enough jobs to go round in future –  no doubt share that sort of view.  To date, a shortage of jobs just hasn’t been an issue in New Zealand and for me –  and these are ultimately moral debates –  the UBI proposals are deeply corrosive of the way in which I think society should operate.

To close, for those interested in the numbers, Treasury estimates that NZS spending will rise from around 4.8 per cent of GDP now to around 7.9 per cent by 2060.   Neither immigration nor productivity assumptions really make much difference to those numbers.  In their scenarios, raising the age of eligibility for NZS to 67 cuts that share by around one percentage point.    They don’t quote the numbers in this statement, but indexing the eligibility age to future gains in life expectancy offers materially larger savings than that, over time (eg over four decades, life expectancy could increase by perhaps another 7 years).  I don’t have a good sense of the savings a more binding residence requirement might offer, but it seems quite plausible that with these three changes, the public finances would be under no great pressure at all in continuing to offer something like the current wage-indexed level of NZS to the genuinely elderly who have spent most of their lives in New Zealand, in a minimally distortionary way.  But they are reforms that should happen –  should already happen –  regardless of what the 20 or 40 year ahead fiscal projections look like.


Two immigrants debate immigration

A month or two back, Professor George Borgas, professor of economics at the Kennedy School at Harvard and a leading researcher on the economics of immigration (and a Cuban immigrant in childhood) published a new book, We Wanted Workers: Unravelling the Immigration Narrative.  Borgas’s empirical work has led him to be somewhat sceptical of whether there are material economic gains to Americans from non-citizen immigration, and to suggest that perhaps immigration policy –  even in the US – is largely just a redistributionist policy, typically away from the more lowly-skilled Americans.  His empirical work has suggested long-term losses to these relatively low income people.

I haven’t yet read the book – much of which, I understand, is a more popular treatment of material dealt with more formally in his Immigration Economics a couple of years ago But Reason magazine –  a libertarian-oriented publication – has published a substantial and considered exchange of views, prompted by Borgas’s book, between Borgas and Shikha Dalmia, a senior analyst at a US libertarian think-tank (and an Indian immigrant).    Dalmia apparently describes herself as a “progressive libertarian and an agnostic with Buddhist longings and a Sufi soul”, so probably not your typical libertarian.

The exchange between Borgas and Dalmia is now freely available on-line here.    For anyone interested in immigration issues, it is worth reading.  The specific issues are, of course, a bit different here than they are in the United States.  A recent New Yorker review of various books on immigration, including Borgas’s, is also worth reading.

From the Reason debate perhaps two extracts struck me most forcefully.  The first from the libertarian open borders  Shikha

I agree completely that the “overreliance on economic modeling and statistical findings” on this subject is a regrettable development that fosters the notion that “purely technocratic determinations of public policy” are possible. In fact, the scientific hubris underlying such efforts prevents a full airing of the normative and ideological commitments that ultimately do—and perhaps should—guide policy.

and the second from Borgas

I ended my discussion in the first round by noting that “immigration creates winners and losers and the net gain may not be as large as some had hoped. So any discussion of immigration policy has to contrast the gains accruing to the winners with the losses suffered by the losers.” You did not address this very thorny issue in your response, so let me conclude by rephrasing it in even starker terms, as it isolates the problem at the core of our disagreement.

The evidence summarized in We Wanted Workers suggests that it is quite possible that the “efficiency gains” that receive so much emphasis in the libertarian narrative are totally offset by the costs associated with welfare expenditures or harmful productivity spillovers. As I said, it may well be that “immigration is just another government redistribution program.” My italicization of “just” was not a random click on my track pad. It was meant to drive home the point that there is a good chance that all that immigration does is redistribute wealth.

If there are no efficiency gains to be had, then espousing any specific immigration policy is nothing but a declaration that group x is preferred to group y. It is easy to avoid clarifying who you are rooting for by trying to reframe the debate in terms of amorphous philosophical ideals about mobility rights and the like. But this is where we go our separate ways.

When I read yesterday a new IMF article by Sebastian Mallaby (itself quite worth reading) asserting that “the movement of people [is] perhaps the most important of the three traditional forms of globalisation”, it brought home again how essentially ideological (meant not in a pejorative sense, but rather as “driven off a prior world view”, and we all have them) much of the support for large scale immigration often is.  Perhaps the same can be said for the sceptics.  And perhaps that is both inevitable, and not necessarily a problem, so long as we recognise the nature of the debate.

The Financial Stability Report: falling short again

The Reserve Bank yesterday released its six-monthly Financial Stability Report.   With (fortunately) no new direct controls to announce, the latest FSR didn’t get a great deal of coverage, and I won’t be writing about it at great length either.  But there were a few points that I thought it was worth making.

First, I thought it was a little surprising that the Bank did not have a bit more discussion of euro (and EU) break-up risk.  It has been a slow-burn process (materially slower than pessimists like me had expected) but none of the underlying stresses seem to be going away.  This weekend alone we have the Italian referendum, which could see the fall of the mainstream Italian government, and the rerun of the Austrian presidential election.  In the first half of next year, there are elections in France and the Netherlands, and in both countries anti-euro parties are polling very strongly.  The Reserve Bank does note problems in the banking systems of various European countries, but these are symptoms of some of the underlying problems not the source of the main risk.  As with all tail-risks, it is impossible to get the timing right, but to me these euro/EU risks remain by far the largest visible disruptive threat to the world economy and world markets over the next decade (China, by contrast, is more closed to the world, and has a strong (grossly over-strong) central government).  Perhaps the Reserve Bank feels uncomfortable writing about these euro/EU risks –  it might make for awkward conversations for the Governor the next time he goes to BIS meetings –  but these reports are for New Zealand citizens, not for the international fraternity of central bankers.  If it is too awkward to reflect on real and substantial risks, one has to ask how much value there is in FSRs more generally.  Conventional, and anodyne, references to Brexit and/or the US election don’t really cut it.

Second, it was a bit disappointing that even in a financial system piece like the FSR, the Bank still couldn’t help itself, and insists on running the line that

“New Zealand’s economy is strong relative to other advanced economies, growing 2.8 per cent in the year to 2016”.

And our population grew by 2.1 per cent in that year.  Per capita GDP growth is weak, and has been over the last few years taken together. I illustrated a while ago that relative to other advanced countries, growth in real GDP per capita since 2013 has been around the median.  And there has been no labour productivity growth here at all.

At one level when the Bank writes misleading things like this it doesn’t matter very much.  But at another level it does. Society has delegated an enormous amount of power to the Governor, including the resources to produce major reports like the FSR. We should expect them to avoid rose-tinted political perspectives.  If they don’t on small issues like this, how can we have much confidence in their willingness to accurately represent things in conditions of much greater stress or risk?

In the FSR the Bank puts quite a bit of weight on the increased use banks have been making of offshore wholesale funding.  I was a bit puzzled by this increased use, since there has been no sign of the current account deficit widening notably (and bank offshore borrowing tends to grow most notably when the current account deficit is large –  it was the main channel through which the larger deficits were financed).  I was interested in this chart, drawing on data from the Reserve Bank website.  It shows annual growth in Private Sector Credit to resident, and a broad measure of the money supply (M3, from residents), both adjusted for repo transactions.

psc and m3.png

The deposit side of the financial system balance sheet is growing at around the same rate as the credit side, hardly suggestive of any particular problems.  If anything, it looks as though banks’ increased reliance on foreign wholesale funding markets isn’t reflecting some deteriorating domestic macroeconomic imbalances, so much as the specification of the Reserve Bank’s core funding requirement (CFR) which, somewhat arbitrarily, distinguishes between some types of domestic deposits and others.  I don’t have a strong view on how the CFR is set up, and I believe some funding restrictions are necessary –  to internalise what would otherwise be a willingness of banks to simply rely on the central bank in times of stress.  But no such rule is perfect, and it would be good if the Bank were a bit more explicit about where the pressure for more (more expensive) foreign wholesale funding seems to be coming from.

One of my longstanding criticisms of FSRs over the years (including when I sat on the editorial committee reviewing them internally) is the weak treatment of the efficiency side of the Bank’s statutory responsibilities.  The Bank is required to use its statutory bank regulation powers to “promote the maintenance of a sound and efficient financial system”.  There is an almost inevitable tension between those two strands –  something I believe that Parliament recognised in phrasing things the way it did –  and the Act also requires the Bank to write FSRs in ways that allow the conduct of policy to be evaluated against the statutory criteria.

In yesterday’s FSR there is one paragraph (and one table) on the efficiency side of the Bank’s responsibility, under the somewhat ambiguous heading “Some indicators suggest New Zealand’s banking system is operating efficiently”.  Am I meant to take from that that other indicators, not reported, suggest otherwise?  I’m also a bit genuinely puzzled why the Reserve Bank considers that a low ratio of NPLs is an indicator of system efficiency.  In credit booms there are typically very few NPLs –  they come after the boom has bust.  In very risk averse systems there are typically very few NPLs.  In isolation, it simply doesn’t look like an efficiency indicator.      And the Bank simply does not address the inevitable adverse efficiency implictions of its increasing reliance on direct controls on specific classes of lending by specific types of institutions.   There has never been a proper cost-benefit analysis on the repeated waves of new controls.  Perhaps it is hard to do one formally, but the FSR should be an opportunity for some more considered analysis exploring some of these issues. As it is, it risks veering towards being a propaganda sheet for the Governor’s chosen policies.  Perhaps it is hard for it to be otherwise, especially under the current governance model –  the Governor signing off on a report on his own policy –  which simply highlights against the desirability of structural governance reform.

The FSR reports no reason to doubt the ability of the insurance sector to cope with the recent severe earthquake.  Perhaps the event was too recent to allow them to deal with the issue in any greater depth, but for the next FSR it might be worth posing the question as to what might threaten the ability of New Zealand insurers to keep getting reinsurance in large volumes for earthquake risk.    The NOAA database suggests that of the 33 earthquakes of 6.5 magnitude or greater to have hit New Zealand since 1840, 10 –  or almost a third –  have hit in the last 10 years (and the very destructive February 2011 aftershock was less than 6.5).    Is there a risk that a continuation of that sort of higher quake frequency could serously impair the ability to insure earthquake risk in New Zealand?  As we know that the Reserve Bank solvency standards for insurers were not set to cope with a repetition of the Christchurch quakes, what sort of tail risk concerns might this raise –   not just for the insurers, at least for the wider (currently) insured population?

The Reserve Bank has underway a review of the capital requirements for banks. on which they expect to consult next year.  As they note at present

The Reserve Bank will also look at international norms when considering calibration of New Zealand’s capital requirements. In raw international comparisons, the current capital ratio of New Zealand banks is relatively low. But a simple comparison is potentially misleading as the risk weights that New Zealand banks must apply to certain asset classes are set conservatively. This means New Zealand banks’ capital ratios appear lower than foreign banks’ ratios for the same underlying portfolios.

After adjusting for the conservative approach New Zealand takes, the Reserve Bank’s preliminary assessment is that New Zealand banks’ riskweighted capital ratios have been near or above international norms.

Looking ahead  (emphasis added)

As part of the review, the Reserve Bank will consider the appropriate amount and quality of capital New Zealand banks should be required to maintain. This will involve a survey of recent academic and central bank studies on optimal capital ratios. Care will be taken when interpreting these studies as they tend to be sensitive to assumptions about the effect of capital on banks’ funding costs and the scale of GDP losses that are directly attributable to banking crises.  It is also unclear how the inclusion of different types of capital affects the results of these studies.

I found those comments encouraging.  While I would hope that the Bank always interprets literature carefully, there are particular issues in this area.

Thus, those arguing for much higher bank capital ratios often suggest (for example) that all or most of the underperformance in economies since 2008 can be ascribed to the banking crises. If one assumes that, it is worth society spending almost any amount of money to avoid a repeat.  A more plausible story is that the banking crises themselves explain only a rather small amount of a structural global slowdown in productivity growth (that was already underway well before the crisis).  On other hand, those opposed to higher capital requirements often argue that having to fund a larger proportion of loans from equity would materially increase the cost of funding.  That approach tends to ignore both the potential for the Reserve Bank to cut the OCR, to offset any incipient rise in interest rates, and –  more importantly –  ignores the extent to which a higher reliance on equity reduces the riskiness of the institutions, and should reduce the required rate of return on equity.  Tax systems can complicate that story, but the New Zealand (and Australian) tax systems, with dividend imputation, tend to treat debt and equity more or less equally.

My own, provisional, view is that for banks operating in New Zealand somewhat higher capital requirements would probably be beneficial, and that there would be few or no welfare costs involved in imposing such a standard.  My focus is not on avoiding the possible wider economic costs of banking crises (which I think are typically modest –  if there are major issues, they are about the misallocation of capital in booms), but on minimising the expected fiscal cost of government bailouts.  As I’ve explained previously, I do not think the OBR tool is a credible or time-consistent policy.

Many of these have been relatively small points, at least for now.

I am more uneasy about two aspects of the report, one of which is missing completely.

There is simply no discussion at all –  and has been none in past reports –  of what the implications of drifting ever closer to the near-zero lower bound on nominal interest rates might be for financial system resilience in a further severe recession.  One of the great merits of a floating exchange rate system has been the flexibility it provides to national central banks to adjust policy interest rates, more or less without limit, as domestic conditions require. But the limits are now becoming increasingly visible.  It is remiss of the Bank – both in its MPS, its FSR, and its more corporate documents such as its Statement of Intent, or governors’ speeches – not to even begin to address these issues openly.  Simply ignoring them doesn’t make them go away, and there will no acceptable excuse if we find ourselves in the same position many other advanced countries found themselves in after 2008, having been given a decade’s sharp-focus notice of the potential problem.

And my final source of unease is around the Reserve Bank’s analysis of the housing market.  The Bank puts a great deal of importance on developments in the housing market, and the market for housing credit.  It is has imposed successive rafts of direct controls, of the sort never seen before in post-liberalisation New Zealand, all on the basis of little or no research.  And in the latest FSR, there is no fresh analysis, just the looming threat of debt to income restrictions –  if the market takes off again –  so long as the Governor can persuade the Minister of Finance to give him political cover (and of course he will, or otherwise the Opposition will attack the Minister for standing in the way of the Reserve Bank).

I’ve noted in the past that we’ve seen no analysis from the Bank on, for examples, countries that have had large increases in house prices and where there has been no subsequent financial crisis, or even collapse in house prices.  New Zealand, Australia, the United Kingdom and Canada in the 2000s are just some of the examples that spring to mind.  And although the Bank keeps talking about the problems in housing supply, they show no sign of having really thought deeply, or researched, the role of land market restrictions.  The New Zealand housing market is unlikely to be sorted out by simply building enough houses to keep the occupancy rate stable – or even a few more.  There is a much more structural issue around restrictions on land use (accentuated by the heavy regulatory costs imposed on building new houses).  I’m not aware of countries with floating exchange rates and tight land use restrictions where urban house and land prices have sustainably come down again.  Perhaps the Bank is, but if so surely the onus is on them to disseminate the research, rather than continuing to hand-wave and treat all house price increases as more or less equally risky.  When house prices are bid up on the back of congressional and executive pressure on lenders to lower lending standards, on pain of potentially losing favour with the regulators, that is a very different issue than when the combination of population pressures and land use restrictions drive prices up. But the Reserve Bank has never articulated that sort of distinction.

It is more than three years now since the Reserve Bank set off down the path of increasing direct controls (with no end in sight, let alone the prospect of removing the controls).  I went through the list of their Analytical Notes, Discussion Papers,  and  Bulletins over the last three years or so, and was struck by how little housing-market research they have published.  For an organisation with so much discretionary power, and a substantial publicly-funded research capability, it really isn’t good enough.

I could repeat a variety of points from previous commentaries –  including questions about what other risks banks are assuming if they are prevented from taking on as many high LVR housing loans as they would like –  but will leave it at that for now.