A few HYEFU thoughts

At the time the PREFU was published in August, I ran a short post illustrating that not even Treasury seemed to believe there was any prospect of increasing the export share of GDP in the next few years.  Their projections were that, on the then-government’s policies, the decline in the export share would continue unabated over the years to 2021.

The next set of Treasury forecasts were published in the HYEFU yesterday.  We have a new government  –  even a Minister for Export Growth –  so I was curious to see what the updated forecasts looked like.

This chart captures the actual export share of GDP, now through to the June 2017 year, and shows separately the PREFU and HYEFU forecasts.

exports hyefu

There is a bit of a lift between PREFU and HYEFU, but interestingly the downward trend is still in place in the last set of numbers.

What has changed?  Mostly the exchange rate.   Here are the assumptions/projections for the exchange rate in the two sets of forecasts.

TWI hyefu

Over the full forecast horizon, the exchange rate is now assumed to be around 5.5 per cent lower than was previously assumed –  more or less just treating the fall in the last few months as if it will be sustained.   Some of that fall will flow through into the domestic price level, but it is still a real exchange rate fall of around 5 per cent.    But even though that fall is assumed to be sustained for several years –  4.5 years to the end of the forecast horizon –  there is no sign of the decline in New Zealand’s export share of GDP being reversed.  Presumably it would need (policy changes that brought about) a much larger sustained decline to really begin to make a substantial difference.

I know some commentators think the exchange rate could soon fall quite a bit further –  after all if the US keeps on raising interest rates, they’ll soon have a Fed funds target rate equalling our OCR.   But Treasury doesn’t think that is likely: they still have large increases in the OCR (and 90 day rates) forecast for the next few years, far larger (and sooner) than anything in the Reserve Bank’s numbers.   Frankly that still seems unlikely, but these are the projections/advice of the government’s leading economic advisory agency.  On their numbers, the prospects for the tradables sector don’t look good.

There are other sobering aspects in the numbers.   Take this chart for example.

output gap hyefu

The solid line is the Treasury estimate –  on their numbers the output gap is still estimated to be negative, bringing to 10 years the period in which our leading economic advisers think the economy has been running below capacity.   When things like that happen –  and they shouldn’t –  it is usually an adverse reflection on macroeconomic management.  It also isn’t very clear why things should suddenly come right next year –  with a forecast of the biggest change in the output gap in the last decade, suddenly moving the economy into an excess demand situation.  We’ll see.

And there are also some heroic forecasts for productivity growth.  Recall that we’ve had no productivity growth at all for five years now.  Treasury don’t expect any this year either.  But then suddenly things come right, and over the subsequent four years growth in real GDP per hour worked is expected to exceed 1.5 per cent per annum.  On quite what basis –  other than wishful hope –  it isn’t really clear.  Apart from anything else, the optimistic assumption probably flatters the fiscal numbers.

But in some ways the biggest mystery in the entire document is the bottom line fiscal numbers themselves. As I noted before the election, I found it hard to conceive that people voting for a change of governmnet, for a left-wing government, were really voting for government spending as a share of GDP to keep on falling.  On the government’s – perhaps over-optimistic numbers, core Crown expenses in the last forecast year is expected to be smaller, as a share of GDP, than in any year of the previous National-led government.    To be sure, lower government spending will keep some pressure off the real exchange rate, but there are other ways to deliver that outcome.   And it is curious to think that the governing parties campaigned on the existence of all sorts of deficits in the provision of public services, and yet their fiscal numbers keep net debt (including the assets in the NZSF) dropping away to almost nothing.

net debt

I doubt it will happen: the economy is likely to be weaker (and it would be unprecedented if we got to 2022 without a recession) and spending pressures are likely to be greater than allowed for in these numbers, but these are plans the government is articulating and defending.  I’m not entirely sure why.

But that is something to speculate on next year.  This is the last post from me for the year.  I imagine I’ll have found interesting stuff to write about  –  and the urge to do so –  by the second week of January or even earlier, but it might depend on whether the glorious Wellington summer continues.

 

Central bank e-cash

After my post last week, prompted by the Reserve Bank’s recent statement that

Work is currently under-way to assess the future demand for New Zealand fiat currency and to consider whether it would be feasible for the Reserve Bank to replace the physical currency that currently circulates with a digital alternative.

I exchanged notes with a few readers with some in-depth thoughts on the issue, and found my way to some other relevant material including the recent first report of the Swedish central bank’s e-krona project.    And I noticed that Phil Lowe, Governor of the Reserve Bank of Australia, was giving a speech on exactly that topic – “An eAUD?” –  yesterday.  I gather that among advanced country central banks this is now treated as quite a high priority issue.    But it is also interesting that –  contrary to the Reserve Bank of New Zealand comment about their work –  both the RBA and the Riksbank are only talking about the possibility of electronic retail cash as a a complement to physical currency, rather than a replacement for it (and Sweden already has one of the very lowest currency to GDP ratios of any country anywhere).

Lowe’s speech was interesting, but also unsatisfying and unconvincing in a number of important areas.    As a New Zealand reader –  from a country with many of the same banks (and presumably banking technology options) –  I was struck by the contrast in what has been happening to currency to GDP ratios in the two countries.   Lowe illustrates that the share of transactions being effected by cash is also dropping sharply in Australia.  But here is the New Zealand currency to GDP chart I ran last week

notes and coin

And here is comparable Australian chart from Lowe’s speech.

Aus currency to GDP
45 years ago, the levels of the two series were very similar.  Since then, the trends have been very different and now there are many more physical AUDs in circulation (relative to GDP) than NZDs.   But there is nothing in Lowe’s speech about just why so much physical currency continues to be held in Australia –  far more than any plausible transactions demands (supported by evidence from payments practices data) would support.    Ken Rogoff suggested, in a US context, that the bulk must be held to facilitate illegal activities, or tax evasion in respect of otherwise legal activities.   Perhaps Lowe felt it wasn’t his place to venture far into territory around lost tax revenue, crime etc, but it was still a surprise to see no mention at all, when the RBA seems largely content with currency physical currency arrangements.

I was also rather surprised to see no serious engagement with the issues around the near-zero lower bound on nominal interest rates, which arises because of the option to convert unlimited amounts of bank deposits etc into zero-interest physical currency, an option that would be likely to be exercised on a large scale if official interest rates were dropped much below, say, -0.75 per cent.  Like New Zealand, Australia hasn’t yet approached the near-zero bound.  Neither had the US, Japan, Switzerland, Sweden, or the euro-area, until they did.   But Australia’s official interest rate is now only 1.5 per cent.  Perhaps it will be raised a bit before the next serious recession hits, but no prudent central banker could be discounting the possibility that even the RBA will hit the effective floor –  and limits of conventional monetary policy –  when that next recession comes.    Dealing effectively with that floor  –  by significantly winding back access to physical cash –  should be one important consideration when central banks are considering e-cash options.  But Lowe doesn’t even mention the issue, and while the limits of monetary policy might not have been of much interest to his immediate listeners (the Australian Payment Summit), interest in his speech –  and the issue –  goes much wider than the immediate audience.   (Strangely, in the Riksbank’s work they also talk in terms of zero-interest e-cash options –  albeit with the flexibility to change that at a later date –  and thus don’t really grapple either with the near-zero bound problem.)

To me, the heart of Lowe’s speech was his discussion of the possibility of the Reserve Bank of Australia issuing one or other of two types of eAUDs.

  • An electronic form of banknotes could coexist with the electronic payment systems operated by the banks, although the case for this new form of money is not yet established. If an electronic form of Australian dollar banknotes was to become a commonly used payment method, it would probably best be issued by the RBA and distributed by financial institutions, just as physical banknotes are today.

  • Another possibility that is sometimes suggested for encouraging the shift to electronic payments would be for the RBA to offer every Australian an exchange settlement account with easy, low-cost payments functionality. To be clear, we see no case for doing this.

I’m not sure I have a particularly good sense of what the first option involves, but here is how Lowe describes the possibility

The technologies for doing this on an economy-wide scale are still developing. It is possible that it could be achieved through a distributed ledger, although there are other possibilities as well. The issuing authority could issue electronic currency in the form of files or ‘tokens’. These tokens could be stored in digital wallets, provided by financial institutions and others. These tokens could then be used for payments in a similar way that physical banknotes are used today.

But he doesn’t seem keen, and so I’m going to focus my discussion in the rest of this post on the second of his options.   The issues and risks are pretty similar for both options, and I favour (provisionally) something like the second option.

At present, central banks offer exchange settlement accounts to facilitate the interbank settlement of transactions (the RBNZ policy is here –  something they must be reviewing, as there was an RFP for work in this area a few months ago).   These accounts facilitate payments, but they also allow entities given access to such accounts to hold electronic claims on the Reserve Bank (that are free of credit risk).  Central bank physical banknotes are also credit risk-free claims on the central bank.   But one set of claims is newer technology, regularly updated, enabling banks to both easily make payments and store value, while the other is a declining technology.

Here is how Lowe describes the option in this area

Another possible change that some have suggested would encourage the shift to electronic payments would be for the central bank to issue every person a bank account – for each Australian to have their own exchange settlement account with the RBA. In addition to serving as deposit accounts, these accounts could be used for low-cost electronic payments, in a similar way that third-party payment providers currently use accounts at the RBA to make payments between themselves. Some advocates of this model also suggest that the central bank could pay interest on these accounts or even charge interest if the policy rate was negative.

I’m not sure anyone argues for this approach to “encourage the shift to electronic payments”, but rather to reflect the world we now find ourselves in, in which electronic payments media and (records of) stores of value overwhelmingly dominate.   If favoured banks and financial institutions are allowed access to risk-free overnigh electronic balances, why shouldn’t ordinary Australians (or New Zealanders) have such access?  After all, at the absurd extreme, central banks could still insist that to the extent banks wanted to deal with them, they did so in physical banknotes.  It would be wildly inefficient to do so, but it could be done.  But if it doesn’t make sense to restrict such “big end of town” transactions to physical currency, why does it make sense to restrict ordinary citizens’ access to central bank outside money?

But the RBA is firmly opposed to change of this sort.

On this issue, we have reached a conclusion, rather than just develop a hypothesis. The conclusion is that we do not see it as in the public interest to go down this route.

Why?   Lowe raises three concerns, of which two are substantive and one is mostly rhetorical.

If we did go down this route, the RBA would find itself in direct competition with the private banking sector, both in terms of deposits and payment services. In doing so, the nature of commercial banking as we know it today would be reshaped. The RBA could find itself not just as the nation’s central bank, but as a type of large commercial bank as well.

In times of stress, it is highly likely that people might want to run from what funds they still hold in commercial bank accounts to their account at the RBA. This would make the remaining private banking system prone to runs.

On both counts, I think he is largely wrong, and that any issues are quite readily manageable.

It isn’t at all clear why (many of) the public would want to use an RBA (or RBNZ) exchange settlement account for routine transactions services.  Revealed preference suggests that people are mostly very happy to run the modest credit risk associated with using private bank deposit and payment services.  Almost all of us now use bank deposits for most of our transactions –  even when physical cash is a perfectly feasible alternative (eg there is no additional cost in time or anything else to, say, taking out $400 from an ATM once a week rather than say $200).  And in the handful of places where private banknotes still circulate (eg Scotland) there doesn’t seem to be any unease about taking them, or transacting with them.

In addition, banks can offer bundled products –  cheaper fees for example where you have your mortgage, or term deposits, with the same bank as your transaction account.  No one proposes that central banks will be offering mortgages, term deposits or any of the rest of the gamut of products the typical commercial bank makes available.

I’m not aware that anyone is suggesting central banks should set out to out-compete banks.  The argument for making central bank e-cash readily available is about a fallback –  a residual option, much as cash is now for many purposes.   Central banks almost inevitably would lag behind commercial banks in their technology anyway, which wouldn’t make a central bank transactions account product particularly attractive.   And it could easily be kept that way –  don’t offer provision for regular direct debits etc, don’t allow overdrafts at all, keep the fees just a bit higher than those on commercial bank accounts, and –  of course –  be prepared to adjust the interest rates paid (or charged) on credit balances to limit potential demand.    What would be on offer would be a basic credit-risk free product –  something similar to the fairly basic products central banks provide to banks themselves.  Frankly, I’d be a bit surprised if there was much (normal times) demand at all (and I think back to the days –  decades ago –  when the Reserve Bank offered –  in direct competition with the private banks –  cheque accounts to its own staff; perhaps some people used theirs extensively,  but I used it hardly at all).

Lowe’s other concern –  and I’ve seen this concern in other places too –  is that provision of e-cash for ordinary citizens might destabilise the banking system.    As he noted earlier in his speech “it is likely that the process of switching from commercial bank deposits to digital banknotes would be easier than switching to physical banknotes. In other words, it might be easier to run on the banking system.”

Frankly, if the only thing that prevents runs on the banking system is that it is too hard to run to cash, central banks and regulators have bigger problems that they might need to address directly.  Runs are often quite rational –  there are real issues with the “victims” funding and/or asset quality.  If it really were easier to run with electronic central bank cash, banks – and their regulators –  might need to look to the size of the capital and liquidity buffers.   As it is, Lowe seems to be suggesting banks can free-ride on technical obstacles their (retail) depositors face.

But I’m not really persuaded that simply making available a basic retail e-central bank cash option would either increase the prevalence of runs or threaten the stability of the financial system.     When there is a concern about an individual bank (or non-bank) people “run” electronically anyway –  mostly they don’t withdraw their deposits into physical cash, but into liabilities of another private institution (and we seem to have been seeing such a quiet run on UDC in recent months).   Wholesale runs –  the sort that took down Bear Stearns and Lehmans –  all happen electronically.  Banks themselves can run straight to central bank cash, when they cut lines on each other.  Is the Governor really suggesting that it is just fine that wholesale investors should find it easy to run but not retail investors?  In practice, that is what he is saying.  In a systemic run –  or a period of heightened systemic unease – it is very easy for wholesale investors to find a safe asset (whether exchange settlement account balances for banks, or government bonds/ Treasury bills for others).  It isn’t for retail investors.  And recall that in New Zealand we have no deposit insurance.

If I’m uneasy at all about the idea of making available an eNZD (or AUD) for retail users –  a basic store of value/means of payment technology with no credit risk –  it is that demand would be very limited in normal times, and that if there ever was a systemic crisis it might prove very hard to scale the product quickly to adequately demand.   There are probably ways of resolving that concern, but it does need more work.

One other concern I’ve heard expressed if this if the central bank issued retail e-cash it would create a reinvestment problem –  what would the Reserve Bank buy and hold on the other side of its balance sheet (with associated credit and quasi-fiscal risks).  This is mostly a non-problem for several reasons:

  • normal times demand is likely to be low, and can be kept fairly low through pricing,
  • retail e-cash would probably go hand in hand with steps to reduce the stock of physical cash (and central banks already reinvest the proceeds of the sale of notes),
  • in a crisis, central banks have this issue anyway –  the substantial liquidity injections typically involve material credit risk anyway, and
  • in practice, many central banks typically reinvest the proceeds of note issue (or subscribed capital) in government bonds (predominant approach in New Zealand) or foreign reserves (typically mostly the government bonds of other countries).

With an integrated approach to gradually reduce the stock of physical currency, while making available a retail e-cash product, I would expect that if anything central bank balance sheets would shrink somewhat (especially in Australia, with a higher currency to GDP ratio) rather than grow.   Steps in that direction would:

  • help deal with the zero lower bound problem,
  • reduce the tax evasion etc issues apparently associated with large holdings of physical cash, and
  • provide ordinary citizens with the same sort of basic risk mitigant/payments product open to banks.

Finally, I said that one of Phil Lowe’s counter-arguments was mostly rhetorical. That was this one

The point here is that exchange settlement accounts are for settlement of interbank obligations between institutions that operate third-party payment businesses to address systemic risk – something that is central to our mandate. A decision to offer exchange settlement accounts for day-to-day use would be a step into a completely different policy area.

Well, yes, as conceived at present exchange settlement accounts are about interbank dealings.  That is a core part of the RBA’s (and RBNZ”s) responsibilities.  But the provision of basic “outside money” –  credit risk free –  has also long been a core part of both central bank’s responsibilitiies.  Retail e-cash helps fulfil that part of those mandates in a technological age.

 

 

Why so secretive?

Five weeks ago now, on 7 November, the Minister of Finance announced a process for his review of the Reserve Bank Act.    There was to be a two-stage process: the first stage led by Treasury to come up with specific recommendations on how to implement the Labour Party promises around monetary policy (goal and decisionmaking issues), and then an amorphous second stage, to be jointly led by the Reserve Bank and Treasury, to look at other  –  as yet undefined – issues around the Reserve Bank Act.  We were told that the phase one would be completed, with a report to the Minister, in early 2018.

Presumably the work is well underway.  At the post-Cabinet press conference the other day, we were told that the new Policy Targets Agreement –  which has to be signed by the Minister and the Governor-designate before Adrian Orr can be formally appointed  – will be informed by the recommendations of the first phase of the review.    As Orr is scheduled to take office on 27 March, you’d have to suppose that the report of the review would have gone to the Minister of Finance at least a couple of weeks prior to that.    After all, Orr himself would need to consider any proposed changes to the PTA, and might wish to take his own advice from Reserve Bank staff.

But if the work is well underway it is being kept very secretive, something that seems quite out of step with how things were portrayed when the Minister announced the terms of reference and associated process five weeks ago.

For example, we were told that an Independent Expert Advisory Panel was to be appointed.  According to the Q&A sheet issued on 7 November

Who will be on the Independent Expert Advisory Panel?

The panel members will be announced once they have been confirmed, but they will be individuals with independence and stature in the field of monetary policy, including in governance roles.

But there has been no announcement.   Either members haven’t been appointed yet –  in which case, how is the work going to be well done in the remaining time? –  or the Minister has gone back on his commitment to openness.  I have Official Information Act requests in with both Treasury and the Minister seeking the names.  The expectation of openness was confirmed with this q&a

Will their views be made public?

In commissioning the review, I have asked officials for advice on the terms of engagement of the Independent Expert Advisory Panel. This will include how their views are made public, and further details will be made public once that has been confirmed.

Note the “how”, not “whether”.   But, five weeks on, still no details.

The Minister also promised more details about a timeline for the whole review.  Five weeks on, heading into Christmas, still no details.  At yet the first stage is supposed to be completed by early March.

When will it conclude/report?

I expect the Treasury to report to me on phase one of the review early in 2018.

In commissioning the review, I have also asked officials to develop a detailed timeline for the review, and more details will be provided once they have been agreed.

I had supposed that the review would be seeking submissions or public input.  I wondered if that was just my imagination, but no.  Going back to the Q&As

Will there be public consultation? When?

I have also asked officials to develop a detailed timeline for the review, including how public consultation can best be facilitated. More details will be made public once they have been agreed.

Five weeks on, heading into Christmas, still nothing.   If the underlying review by officials is well underway, it makes a mockery of any sort of public consultation if views are only to be invited very late in the piece, if at all.

I’m not sure what the Minister of Finance can possibly have to hide.  The Labour Party campaigned on making changes along these lines, and the first stage of the review is supposed to be largely about giving that effect, and associated consequential issues.  But whatever the reason, it isn’t a particulary look, and again undermines any suggestion that the government might be committed to a more open approach.   Rhetoric around the Official Information Act is fine, but this stuff should be easy –  and it was explicitly promised weeks ago, in a review that is operating to tight timeframes.

It also isn’t clear why the Minister and Treasury are still keeping secret the Rennie review and associated documents.  The Rennie review of Reserve Bank goverance was commissioned by Treasury, at the request of the previous Minister of Finance.  The report was completed in April, and yet Treasury has repeatedly refused to release it and associated material (eg comments from expert reviewers), even though it is clearly official information and should be highly relevant to discussion/debate/submissions around the new government’s own proposals and review.      I have appealed the latest denial to the Ombudsman, and had confirmation this morning that the Ombudsman has opened an investigation.      But such investigations simply shouldn’t be needed, if we had any semblance of an open government.

As noted above, a new Policy Targets Agreement has to be agreed and signed by March.    The Policy Targets Agreement is the major document guiding short-term stabilisation policy for the next five years –  it affects us all.   And yet it seems that deliberations will continue to go on in secret (as has been the custom).    Again, it would be a good opportunity for a more open approach.  I’ve pointed previously to the Canadian model of conducting the research leading up to the renewal of the inflation target early and openly discussing/reviewing/debating it in public seminars/workshops.  It would be a good practice to adopt here, but it is probably too late for this time round.  But it wouldn’t be too late for the papers the Reserve Bank and Treasury have inevitably already prepared on the topic to be made public, in a way that would enable market economists and other observers to provide input on how this major macroeconomic tool is to be specificied and managed for the next five years.    We’d never pass legislation as secretly as the PTA is done. Indeed, the Reserve Bank couldn’t even put on the latest iteration of LVR controls  –  half-life perhaps one year – without proper serious consultation.  It is time for a more open and consultative approach to shaping macroeconomic policy.   Robertson (and Orr) could lead the way.

In addition to the work Treasury and Reserve Bank staff have done, consultation could take account of the comments the Minister made recently about contemplating removing references to the target midpoint from the PTA (I have mixed feelings about that idea, but think it is probably a bad idea, reinforcing the weakness of inflation expectations).  And there were other suggestions at the post-Cabinet press conference –  Robertson talking of how the government doesn’t just want the Bank to focus on price stability, or employment, but on “the overalll wellbeing of New Zealanders” –  that dread Treasury phrase once again, as devoid of specific meaning as ever.   But in case he isn’t aware, the 4th Labour government already included its own “virtue signalling” mandate in the Reserve Bank Act

169 Bank to exhibit sense of social responsibility

It shall be an objective of the Bank to exhibit a sense of social responsibility in exercising its powers under this Act.

38 years on and still no one knows what it means, if anything. But it probably felt good to include it.  Perhaps those words could be carried up into the Policy Targets Agreement, and the Governor could cite them every so often?

 

 

 

 

 

 

Governing financial stability policy

On Monday afternoon, The Treasury hosted Professor Prasanna Gai of Auckland University, who gave a guest lecture on the topic “Resilience and reform –  towards a financial stability framework for New Zealand”.     The timing of this event, put on at quite short notice, is presumably not unrelated to the current review of the Reserve Bank Act.

Prasanna Gai is well-qualified to talk about such issues.  He was formerly a professor at ANU, and prior to that worked at both the Bank of Canada and the Bank of England.  These days –  even from the ends of the earth –  he is an adviser to the European Systemic Risk Board.  A few years ago he served as an external academic adviser to the Reserve Bank of New Zealand, and did one of the periodic visitor reviews of our forecasting and monetary policy processes, based on his observation of one Monetary Policy Statement round.

In his presentation the other day, he appeared to set out to be “politely provocative” in pushing for reform, including greater transparency and accountability.   There was a fairly large number of Reserve Bank people at the lecture, and I suspect Prasanna’s calls won’t have gone down that well with them.

He began by noting that even now, 10 years after the last international financial crisis, there is very little academic analysis of the political economy of financial stability policy/regulation.  As he noted, in monetary policy there were key defining papers that laid the groundwork for monetary policy operational independence to become the norm internationally.    There is still really nothing comparable in respect of financial stability –  and certainly nothing robust that would justify delegating a very high degree of autonomy (arounds goals, instruments, and intermediate targets) to unelected officials (especially a single such official).

As he notes, in most countries –  though not the US or the euro-area –  politicians (as representatives of societies) play the lead role in setting/approving the inflation target.   Things aren’t just mechanical from there –  there can be, and are, real debates about how aggressively to respond to deviations from target and the like –  but at least there is some benchmark to measure performance against.    There is nothing comparable for financial stability, and Prasanna Gai argues  –  and I strongly agree with him –  that politicians need to “own” financial stability policy, including taking a view (implicit or explicit) on things like the probability of a crisis that society is willing to tolerate (it is the implicit metric behind much of what systemic financial regulators do).

Gai’s focus in his talk was on what he –  and the literature –  likes to call “macroprudential policy”.     He draws a distinction between the supervision of individual banks and the supervision/regulation of the system as a whole.  I’ve never been convinced that it is a particularly robust distinction, at least in the New Zealand context, where a key defining characteristic of our banking system is four big banks, all with offshore parents from a single overseas countries, all with relatively similar credit exposures (and funding mixes).   Gai –  and others (including the Reserve Bank when it suits them) –  argue that each bank might manage its own risks relatively prudently, but has no incentive to take adequate account of the impact of its choices on other banks.  Again, in a concentrated system like our own, I’m not sure that is really true, at least in a way that has much substantive content.   Anyone lending on dairy farms (for example) will know that the market in such collateral gets extremely illiquid whenever times turn tough (as they did after 2007).  You’d be a fool, in managing your own bank’s risks, not to recognise that other people might be trying to liquidate collateral at the same time as you.   Much the same goes for housing loans –  and even if you didn’t directly take account of other banks’ exposures, if your bank has a quarter of the market, you can’t just assume your actions will have no impact on the value of the overall collateral stock (whereas, say, a 1 per cent player might be able to).   It doesn’t mean that banks don’t get carried away at times, and excessively ease credit standards, but I doubt the big 4 are ever not aware they are big fish in a small pond.  Banks were all very consious of firesale risks in managing dairy exposures in 2009/10.

And if the banks themselves forget it, I don’t think the Reserve Bank ever has.   As regular readers know, I don’t feel a need to defend the Reserve Bank on every count, but……I sat on the Financial System Oversight Committee for the best part of 20 years, and was involved in putting together Financial Stability Reports, and the sort of narrow “my bank only” focus people talk about when they try to carve out macroprudential policy as something different from micro-prudential supervision never resembled the way the Reserve Bank dealt with these issues and risks.   Perhaps it happened to some extent at the level of an individual supervisor, but not at the institution level.  The starting assumption tends to be that the risks –  credit and funding –  are pretty similar in nature for all the big banks.  In fact, we see that illustrated in the way our Reserve Bank treats stress tests –  here is the focus is systemic whereas, for example, the Bank of England provides a high degree of individual institution detail (since banks fail individually, I think the BOE approach is preferable).    What also marks out New Zealand supervision/regulation, is that the statutory mandate is explicitly systemic in focus; there is no explicit depositor protection mandate.

So although Gai’s talk was avowedly focused on macroprudential functions, in the end most of what he had to say applies (at least here) to the full gamut of the Reserve Bank’s financial regulatory functions.  I think that conclusion is reinforced by the scepticism Gai expressed about the ability of central banks/regulators to do much effective to dampen credit/housing cycles, leaning against booms.  He sees the case for regulation as primarily about building the resilience of the financial system.

In passing, I would note that I also think he grossly overstates the cost of financial crises.  He put up a series of charts for various countries showing the path of actual GDP in comparison to what it might have been if the pre-2007 trends had continued, and asserted that the difference was the effect of financial crises (perhaps as much as 70 per cent of one year’s GDP).  I’ve disputed that sort of claim previously here (including here and here) and a few months ago I ran this chart  suggesting that another meaningful way of looking at the issue might involve comparing the path of GDP for a country at the epicentre of the crisis (the US in this case), with the paths for advanced countries that didn’t experience material domestic financial crises,

US vs NZ Can etc

But if the costs of financial crises are far smaller than people like Gai (or Andy Haldane) assert, they probably aren’t trivial either, especially in the short-term (one or two year horizons).  And much the damage isn’t done in the crisis itself, but in the misallocation of credit and real resources in the build-up to the crisis.

So I’m not arguing a case against supervision/regulation –  and have been recently arguing that we should, on second best grounds, introduce a deposit insurance scheme, which would only reinforce the case –  but I am more sceptical than many, perhaps including Gai, about how much value supervisors can really achieve, whether macro or micro focused.    There has been a great deal of  regulatory activity –  sound and fury –  in the few years since the last crisis, but that was precisely the period when banking systems were least likely to run into trouble anyway (managers, shareholders, rating agencies all remembered –  and were often scarred by –  the 2008/09 crisis, and actually demand for credit was generally pretty subdued too).  The test of supervision/regulation isn’t the difference it makes in times like the last 7 or 8 years, but the difference at makes at the height of the next systemic credit boom.  It isn’t obvious –  including from past cycles –  that regulators, and their political masters, will be much different from bankers next time round either.  Some regulators might well want to be different, but typically they will be marginalised, or just never (re)appointed to key positions in the first place.

But given that we have bank regulation/supervision, how should it best be organised and governed?     There is no one model, either in the academic literature or in the institutional design adopted in other advanced countries.  One of the question is how closely tied financial stability policy should be to monetary policy.   At one end there is  –  perhaps the practical majority  – view (including from Lars Svensson) that monetary policy and financial stability are two quite separate things, and should be run separately, possibly even in separate institutions.   At the other extreme, there is an academic view that monetary and financial stability are inextricably connected and policy needs to address both together.  A middle ground is perhaps a view associated with the BIS, seeing a role for monetary policy to lean against credit asset booms, with the advantage –  relative to regulatory measures –  that “interest rates get in all the cracks”.

In New Zealand, the Reserve Bank Act has since 1989 required the Bank to have regard to the soundness and efficiency of the financial system in its conduct of monetary policy (a requirement carried over in the PTA in 2012).  But no one really knows what it means – to the drafters in 1989 it seems to have meant something about avoiding direct controls –  but it sounds good –  motherhood-ish almost.   In practice, it has never meant much: successive Governors have, at times, anguished about housing markets and possible future risks, and on the odd occasion have tempered their OCR calls by those concerns.  But my observation suggested they’d have done so anyway.

So we are in the curious position where financial stability considerations don’t matter to any great extent to monetary policy, and yet we have single decisionmaker deciding policy in both areas with –  partly as a result –  little direct accountability.    The Minister of Finance has little effective involvement in the appointment of the decisionmaker, or in the specification of the goals of financial stability policy.   The Governor decides –  based on whim, rigour, or prejudice, but with little or no legitimacy or democratic mandate. Even the legislation grew like topsy, and the governance provisions never envisaged as active prudential policy as we’ve seen in recent years.

There is a range of different models, and Gai covered some of them in his talk.  In Sweden there is little or no integration between the central bank and the financial regulatory agency.  In the UK, all the functions are (now back) in the Bank of England, but there are statutorily separate committees (albeit with overlapping membersships), most of the members are appointed by the Chancellor, and all members are individually accountable for their views/votes.  In Australia, there are multiple agencies, a Council chaired  by the Reserve Bank, but also a strong role in policysetting for the Federal Treasury, representative of the Treasurer (and the Treasurer/government directly appoint the key players, including the Governor).  There are other countries –  for example, Norway –  where decisionmaking powers on systemic prudential interventions are reserved to the Minister of Finance.

Prasanna Gai wrapped up his talk arguing that there is a strong case for rethinking the governance model around systemic financial stability in New Zealand.     Specifically, he made the case for the Minister of Finance to be more directly involved.  As he had noted earlier in his talk, the sort of regulatory interventions like LVRs are almost inevitably highly political in nature (especially as they can be highly granular –  we saw a couple of years back regulatory distinctions between Auckland and non-Auckland, and we still have distinctions between types of purchasers, even if the collateral is identical), and that the more independent a central bank is around such interventions the more politicised the institution risks becoming.  Gai argued –  and I agree with him –  that we’ve seen this in New Zealand in the last few years.  He argues that wider participation in decisionmaking could help safeguard monetary policy credibility (and perhaps the Bank’s effective operational independence there).

Gai argues for the establishment of a statutory committee to be responsible for systemic financial regulatory matters that are currently the sole preserve of the Governor.  He didn’t spell out clearly what, if any, powers he would reserve to the Minister –  perhaps that is captured in establishing a mandate (backed by statute, not the goodwill/moral pressure of the current MOU).  But he envisages a model in which the members of the committee would be appointed by the Minister of Finance, and would be individually accountable (including to Parliament) –  presumably implying a considerable degree of transparency around minutes/voting records.  He argues –  correctly in my view –  that such a committee would not only provide access to more technical expertise but that it would provide greater “legitimacy” for the choices being made.

Mostly, Gai’s talk was very diplomatic.  But there was a bit of a dig at the current Reserve Bank, noting that there didn’t seem to be much turnover (“churn”) at the senior levels of the Reserve Bank, at least when compared to the experience of places like the RBA or the Bank of England, which –  he argued –  limited the scope for challenging “house views” or established orthodoxies.    Bringing in outsiders –  individually accountable – to a statutory committee could counteract those risks.    Personally I’m less sure that turnover (generally) is the issue –  and as compared to the RBA (most notably) the Reserve Bank of New Zealand has been weak at building internally capability (as a result, 1982 is still the last time a Reserve Bank Governor was appointed from within).  The issues at the Reserve Bank seem to be more about the capability of certain key individuals –  several of whom (Spencer, McDermott, Fiennes and Hodgetts) have been in their roles for a long time –  and the sort of culture fostered from the top in the Wheeler years in particular.     In a high-performing organisation, constantly opening itself to challenge, scrutiny and new ideas (from inside and outside) that stability might be a real strength.  In our Reserve Bank it has become a considerable weakness.  But an external committee, properly constructed, could be part of a process of change, and entrenching new and better behaviours.

Gai’s summary:

  • financial stability policy should be on an equal footing with monetary policy,
  • the focus of such policy should be on resilience of the system, not trying to fine-tune the credit cycle (just too ambitious),
  • politicians need to own the standards of resilience policy is working to maintain/manage, and be engaged more overtly in decisionmaking, and
  • because it will never be possible to establish very specific, short horizon, goals comparable to those in the PTA, the process of policy formulation and governance/accountability mechanisms take on an even greater importance for financial stability than for monetary policy.

I’d largely agree with him.

I hope these are issues that the Minister of Finance is going to take seriously as part of his (currently secretive) review of the Reserve Bank Act.    With central bankers who have a strong incentive to defend their patch and their powers –  including a new Governor with a reputation for fighting his corner, come what may –  if the Minister isn’t engaged it would be all too easy to end up with no material change, and far too much power still concentrated in the hands of one, less than excellent, institution and its single decisionmaker.     This is the opportunity for serious reform – bearing in mind Mervyn King’s injunction that legitimacy (the “battle for hearts and minds”) matters greatly –  and I hope the Minister is exposed to the advice Prasanna Gai offered the other day.  A Financial Stability Committee shouldn’t be dominated by academics, but the Minister could do worse, in establishing such a committee, than to appoint Prasanna as one of the founding members.

For anyone interested in these issues, there is also a presentation here given last year by David Archer – former Assistant Governor of the Reserve Bank, and now a senior official at the BIS. I meant to write about it at the time, but never did.  His title is “A coming crisis of legitimacy?”  and this from his first slide captures his concern

Make the case that many central banks are at risk of a crisis of legitimacy, with respect to new macro financial stability mandates. The issue is an inability to write clear objectives.

He highlights some similar issues to Gai, but is more strongly committed to keeping ministers out of regular decisionmaking, and so his approach is to supplement committees with a clear statutory specification of the issues, considerations etc that should be taken into account in using/adjusting systemic financial regulatory policy.

Adrian Orr as Governor-designate

There are some good aspects in the announcement yesterday that the government intends to appoint Adrian Orr as the next Governor of the Reserve Bank.

For a start, the appointment will be a lawful one –  always a help.  Steven Joyce’s unlawful appointee as “acting Governor” will continue to mind the store until late March, and then at least we will be back to having someone lawful in office.   The unlawful interlude was unnecessary, and reflects poorly on governance and policymaking in New Zealand, but it will be soon be over.  Be thankful for small mercies.

It also seems highly unlikely that Adrian Orr will spend his first five years in office skulking in corners, avoiding any serious media scrutiny.   He is a vigorous and, mostly, effective communicator (on which more below) and in that sense is likely to be a welcome breath of fresh air in the Reserve Bank.  If he can model greater openness, across all the Bank’s function, it would be a significant step forward.

And there might be reason to hope that an Orr-led Reserve Bank might start to take transparency –  within and beyond the confines of the Official Information Act –  rather more seriously.  I’m not a huge fan of the New Zealand Superannuation Fund, but I am quite impressed by their transparency, including in dealing with Official Information Act requests.  When I asked recently for the background papers justifying the decision to cut the Fund’s carbon exposures –  they’d already pro-actively released some papers –  I got (from memory) something like 3000 pages of material.  When one asks the Reserve Bank for background papers to monetary policy decisions, one is repeatedly stonewalled (unless it is about things from 10 years ago).  I hope the contrast bodes well for the sort of leadership Adrian will bring to the Bank.

That is the positive side of the appointment.  But here is what I wrote earlier in the year, at the time when controversy was raging about his NZSF salary.

Orr simply isn’t –  and I wouldn’t have thought he’d claim otherwise –  some investment guru, blessed with extraordinary insights into markets, prospective returns etc etc.  He was a capable economist, and a good communicator (at least when he doesn’t lapse into vulgarity), who turned himself into a manager and seems to have done quite well at that.   He always seeemed skilled at managing upwards, and his management style (in my observation at the Reserve Bank) seemed to err towards the polarising (“are you with us, or against us”), attracting and retaining loyalists, but not exactly encouraging diversity of perspectives or styles.  He isn’t exactly a self-effacing character. (That is one reason I’m not convinced he is quite the right person to be the next Governor of the Reserve Bank.)

I’d stand by those comments today.

He is more of a manager –  and perhaps a salesperson – than an economist, despite some comments in the last day about him being an “exceptional economist”.  That has probably been so for at least 20 years now.  In itself, that isn’t a criticism, and there is a significant management dimension to the Reserve Bank role –  in particular, at present, a change management responsibility (both to implement whatever changes emerge from the Minister of Finance’s secretive review of the Reserve Bank Act, and to lift the internal performance, and improve the culture, of the Bank).

His management approach might be more questionable. In his first short stint at the Reserve Bank, 20 years ago, he took over a department that was severely demoralised and lacking the influence it would normally have had.  In a narrow sense, he did an effective job of turning around that underperformance.   But his style always seemed to be quite a divisive one, playing up “his team” at the expense of others, rather than seeking to lift the entire organisation  –  in fact, he boasted of it in his farewell speech when he left the Bank in 2000.  I haven’t observed him directly in the last decade, but I am struck by the number of able people I’ve known who’ve worked for him for a time, and then didn’t.    It wasn’t, as far as I could see, that they went on to bigger and better things either.  Adrian seems to build cohesive teams of loyalists.  That has its place, but it isn’t obvious that the Reserve Bank is one of those places.

What of his communications skills?  He can be hugely entertaining, and quite remarkably vulgar (an astonishingly crude analogy involving toothbrushes springs to mind).   Just the thing –  perhaps –  in an old-fashioned market economist.  Not, perhaps, the sort of thing we might hope for from a Reserve Bank Governor.   Financial markets can get rather precious about very slight changes in phrasing etc from the Reserve Bank, and it is hard to be confident just how well Orr will go down.  No doubt he will rein in his tongue most of the time –  and perhaps he has calmed down a bit with age – but it is the exceptions that are likely to prove problematic.

And what happens when some journalist or market economist riles him?    Perhaps a journalist might ask him about how he would approach an episode like the Toplis affair?  You (and I) might like to hope things would be different, but I have in mind an episode from Orr’s time as Deputy Governor.  A visiting economist was engaging in what they thought was a bit of robust dialogue with Orr in a meeting with several people at the Bank.  Shortly afterwards, Orr bailed the visitor up in the street and told him ‘never, ever, do that in front of my staff again”.

And yet, so we are told, part of the motivation for the forthcoming reforms to the Reserve Bank is to ensure that more perspectives are heard, and incorporated, in decisionmaking at the Bank.   How confident can we be that Orr will actually implement the reforms in a way that will foster debate and diversity, rather than clamp down on it and marginalise anyone he perceives as disagreeing with him?   Particularly if the person or people disagreeing with them doesn’t share his blokish style, or might simply know more about a particular issue than Orr does.

And how is Orr going to do –  repeatedly in the public eye, in a way he hasn’t been for the last decade –  with the sort of gravitas and political neutrality the role of Governor requires?  Only a few weeks ago – when he must already have known that he was likely to become Governor –  Orr gave a speech to the Institute of Directors, in which he reportedly dismissed the views of Deputy Prime Minister on the economy as “bollocks” and went on to suggest, in answer to a question about nuclear risks in North Korea, that perhaps two issues could be solved at once ‘because Winston is going to North Korea”.  Recall that at the time, Orr was not some independent market economist, but a senior public servant.     He might well have been right in his views on the economy, but is this how senior public servants should be operating?

I also have concerns about the way Orr engages with issues and evidence. My very first dealing with him involved some controversial reform proposals we were working on at the Bank, while Adrian was still in the private sector.   Adrian’s submission had played rather fast and loose with the data, something I pointed out to Don Brash, the then Governor.  Don went rather quiet and didn’t say much, which puzzled me a little, until a day or two later Adrian’s appointment as Reserve Bank chief economist was announced.  Much more recently, there was some debate earlier in the year about NZSF’s performance.   On a good day, and in official documents, Adrian will happily tell you NZSF’s performance can only really be judged over, say, 20 or 30 years horizons.  But then he will pop up in the newspaper suggesting that a few moderately good years –  amid a global asset market boom –  vindicate the existence of the Fund and the way it is run.    He keeps trying to convince us that he runs  a “sovereign wealth fund”, when it fact it is a speculative punt on world markets, using borrowed money (yours and mine).  He has simply refused to engage with the international evidence casting doubt on whether active funds management can generate positive expected returns in the long-run, and when he led the NZSF into a big (politically popular, but economically questionable) move out of carbon exposures –  an active management call if ever there was one – he took steps to ensure that taxpayers couldn’t really know whether his judgement paid off (hiding the change in the benchmark itself, rather than being constantly reported in devations from a benchmark).     I’m just not sure it is quite the degree of rigour, authority and independence of mind that we should be looking for in a Reserve Bank Governor.  What example, for a start, does it set for his own subordinates in how they marshall evidence and arguments for him?

On the same note, there was that speech Orr gave last month to the Institute of Directors (full text here).  It was given at a time when he knew he was in the final stages of the gubernatorial selection process.   It was advertised as a substantial speech

Looking Beyond Our Shores – Adrian Orr’s Address to the Institute of Directors

Adrian Orr’s address to the Institute of Directors, Wellington, 16 November 2017.
Adrian shares his thoughts on what directors need to think about to make sure New Zealand benefits from its place in the globalised economy.

So you might have expected some considerable substantive analysis.   But there wasn’t much there at all.     You won’t find anything about New Zealand’s underperformance –  productivity, exports, or whatever.   But you will find one conventional wisdom thought after another (albeit with a tantalising aside on Chinese influence), whether or not they apply to New Zealand  (eg “returns to the owners of capital versus labour –  which is stretched to extremes at present within and between nations” –  when the labour share of income has been rising in New Zealand for 15 years).  And then it devolves to “doing something” about climate change –  which might or might not be sound, but isn’t going to make us materially better off – and lots of self-praise (not all of it even accurate) for the NZSF.    A speech on how to “make sure New Zealands benefits from its place in the globalised economy” ends with these platitudes

My summary thoughts are:

  • Companies must take more long-term ownership of all their activities – it is the Board’s role; 
  • New Zealand needs to embrace a global reputation of longtermism, and sell it; and
  • We can start with climate and our culture at the company level.

No real answers, and not much depth there.   Perhaps it wasn’t characteristic –  I haven’t gone back and read his other speeches from recent years –  but this was the speech on a topic somewhat closer to his new areas of responsibility as a (singlehanded) key economic decisionmaker.

I’m sure there are those capable people who are genuinely impressed with Adrian (as presumably, the Reserve Bank Board was –  the same people who appointed Graeme Wheeler).  But don’t be fooled by the absence of any sceptical comment at all in the last day or so.     Of the people the media is likely to go to for comment, many will be needing to maintain a professional relationship with him in his new role, and others will work for organisations that do business with NZSF –  and Orr is still chief executive there for a few more months.

Only time will now tell how Orr does in the job.   For a time he will be by far the most powerful unelected person in New Zealand –  exercising singlehandedly all the monetary policy, regulatory, and intervention powers the various Acts give to the Governor –  and then and beyond responsible for leading the transition to a reformed Reserve Bank (details of which are still unknown –  including how much effective power will be left with the Governor).  As someone who is well-known to fight for his patch, his people, I’ve further revised down my estimate of the prospects for real change at the Bank –  especially around the financial stability functions where (a) the Bank is almost lawless, and (b) the Minister of Finance doesn’t care very much.  I’d like to believe he will do well –  for the New Zealand public –  but it is hard not to shake the impression that Adrian Orr is no Phil Lowe (RBA), Stephen Poloz (Bank of Canada), Philip Lane (central bank of Ireland), Stan Fischer (former central bank of Israel and recent vice-chair of the Fed).   In some ways he will be very different from Graeme Wheeler, but in many areas we could be exchanging one set of weaknesses for another.

But I suspect he will be wildly popular at the annual financial markets function the Reserve Bank hosts.   Bonhomie, backslapping, and plenty to drink tended to characterise those functions when I had to attend them.

 

 

Two BIMs and a bureaucrat

As I noted last week, government departments’ (and agencies’) briefings to incoming ministers have mostly become a bit of a joke: mostly devoid of any substance, typically specifically tailored to the preferences of the particular incoming government (ie written/finalised after the shape of the new government is clear), and mostly not much more than process pieces.  If one is interested in the actual substantive advice –  the sort of things the Lange government intended to make available when they began publishing BIMs in the mid 1980s –  citizens need to fall back on the Official Information Act, with all its limitations.

There are exceptions –  I wrote the other day about some substance in the Reserve Bank’s BIM.   And even on the little that is released, sometimes tantalising hints sneak through.  The intelligence services, for example, left unredacted a suggestion that governments might need to be concerned about the influence activities in New Zealand of foreign governments –  something neither the current Prime Minister nor her predecessor have been willing to take seriously or address openly.

Of the other economic functions, neither the Treasury nor the Immigration BIMs say much.  But sometimes there is quite a bit even in a few words.  Take immigration for example.    It was only a few years ago that MBIE was telling Ministers of Immigration (and the public) that immigration was a “critical economic enabler” –  a potential catalyst to transform New Zealand’s dismal productivity performance.   There isn’t much in this year’s Immigration portfolio BIM –  mostly process again –  but my eye lit on this paragraph

New Zealand’s immigration system enables migrants to visit, work, study, invest, and live in New Zealand. Economically, it contributes to filling skill shortages, encouraging investment, enabling and supporting innovation and growing export markets. Immigration has contributed to New Zealand’s strong overall GDP growth in recent years largely through its contribution to population growth. However, the evidence suggests that the contribution of immigration to per capita growth and productivity is likely to be relatively modest.

The theory –  dodgy bits like “filling skill shortages” and the more plausible bits –  is there in the first half of the paragraph.  But by the end of the paragraph, even MBIE has to concede that there isn’t likely to be much boost to per capita income or productivity at all –  the effects are “likely to be relatively modest”.  It is hard to avoid that sort of conclusion –  looking specifically at the New Zealand experience –  when (to take MBIE’s list from the second sentence) “skill shortages” have been a story told in New Zealand for 150 years, business investment has been weak by OECD standards for decades, firms haven’t regarded it as particularly attractive to invest heavily in innovation (again by world standards), and the export share of GDP is now at its lowest since 1976.  Still, it is good to see reality slowing dawning on MBIE.  On my telling, they are still too optimistic, but even on their telling when such a large scale policy intervention seems to produce such modest economic results it might be time for a rethink.

And what about the BIMs prepared by Treasury?   There isn’t much in the main Finance document (lots of process stuff, and plenty of talk of diversity and wellbeing and none on productivity).  There is an appendix specifically aimed to address what Treasury understand to be the new Minister’s priorities, but not much about Treasury’s own view of what needs to be done, or the pressing problems.    If anything, reading Gabs Makhlouf’s covering letter to Grant Robertson one might conclude that Treasury didn’t think there was much to worry about at all.

You are taking up your role at a time when New Zealand’s economy is in a relatively strong position.  There is solid forecast growth, complemented by fiscal surpluses and a strong debt position.  And while international markets still present a number of risks and uncertainties, overall the global economy –  as reflected in the IMF’s recent outlook –  presents opportunities for New Zealand to seize, in particular with Asia’s ongoing growth.

Presumably the Secretary didn’t think it worth emphasising five years of no productivity growth, seventy years of pretty weak productivity growth, shrinking exports as a share of GDP, sky-high house/land prices, pretty weak business investment and so on.  Or even the fact that notwithstanding “Asia’s ongoing growth” –  a story now for more than forty years –  nothing has looked like turning around New Zealand’s continuing gradual economic decline.    And perhaps when you are a temporary immigrant yourself –  as Makhlouf presumably is –  the cumulative (net) loss of a million New Zealanders isn’t something that concerns you?

In their BIM Treasury proudly asserts that “We are the Government’s lead economic and financial adviser”.  Perhaps they hold that formal office, but it is hard to be optimistic about the content of what they might be offering the government.

But Treasury also had some other BIMs for other portfolios they have responsibilities for.  The one I noticed was the Infrastructure one.    Buried in the middle of that document was this observation

Auckland’s ability to absorb growth has been reached. Environmental, housing and transport indicators all reflect a city under increasing pressure. Traditionally, Auckland has been more productive than other regions of New Zealand but, on a per capita basis, this productivity premium has been shrinking over time. Auckland is not performing as well as expected for its size and in comparison to other primary cities around the world.  There are opportunities to increase this productivity but only if supply constraints, especially transport and housing, are resolved.

That key middle sentence –  no hint of which appears in the main Treasury BIM –  could easily have been lifted from one of my various posts on similar lines.    They could have illustrated the point with a chart like this.

akld failure

 

Appearing in the standalone Infrastructure BIM, Treasury appear to want to blame these poor outcomes largely on infrastructure gaps –  a conclusion which I think is flawed –  but I’m encouraged to see a recognition of the problem in official advice to the Minister of Finance.   It is all a far cry from the rather lightweight celebratory speech Gabs Makhlouf was giving about Auckland’s economy only 18 months ago, which I summed up this way

[it] might all sound fine,  until one starts to look for the evidence.  And there simply isn’t any.  Perhaps 25 years ago it was a plausible hypothesis for how things might work out if only we adopted the sort of policies that have been pursued. But after 25 years surely the Secretary to the Treasury can’t get away with simply repeating the rhetoric, offering no evidence, confronting no contrary indicators, all simply with the caveat that in “the long run” things will be fine and prosperous.  How many more generations does Makhouf think we should wait to see his preferred policies producing this “more prosperous New Zealand in the long run”?

If the Secretary to the Treasury was going to address the economic issues around Auckland, one might have hoped there would be at least passing reference to:

  • New Zealand’s continuing relative economic decline, despite the rapid growth in our largest city,
  • Auckland’s 15 year long relative decline (in GDP per capita), relative to the rest of New Zealand,
  • The contrast between that experience, and the typical experience abroad in which big city GDP per capita has been rising relative to that in the rest of the respective countries,
  • The failure of exports to increase as a share of GDP for 25 years,
  • The fact that few or any major export industries I’m aware of our centred in Auckland (the exception is probably the subsidized export education sector) –  and by “centred” I don’t mean where the corporate head office is, but where the centre of relevant economic activity is.

There is nothing of economic substance on immigration in the main Treasury BIM this year, but perhaps over the next few years Treasury could start thinking harder about whether it really makes sense to be using policy to bring ever more people to one of the most remote corners on earth, even as personal connections and supply chains seem to be becoming ever more important, at least in industries that aren’t simply based on natural resources.

The one other thing that did catch my eye in the Treasury BIM was this paragraph

The Treasury Board. This external advisory group supports the Treasury’s Secretary and ELT to ensure that its organisational strategy, capability and performance make the best possible contribution to the achievement of its goals. Current members of the Board are the Secretary to the Treasury (Gabriel Makhlouf), the Chief Operating Officer (Fiona Ross), Sir Ralph Norris, Whaimutu Dewes, Cathy Quinn, Mark Verbiest, Harlene Hayne and John Fraser (Secretary to the Australian Treasury).

Now, to be fair, the “Treasury Board” has no statutory existence, and no statutory powers.  It isn’t even clear why it exists at all –  Boards are typically supposed to represent shareholders, and as regards Treasury, the Minister of Finance, Parliament, and the SSC are supposed to do that on our behalf.  But given that there is an advisory Board, what is a senior public servant from another country  –  the Secretary to the Australian federal Treasury –  doing on it?      New Zealand and Australia might be two of the closer countries in the world, but we don’t always have the same interests, and at times those interests –  and perspectives – clash rather sharply.    I gather John Fraser is quite highly regarded, but who does he owe allegiance to, and whose interests is he advancing in his work on the New Zealand “Treasury Board”?  I might not worry if he were a retired former Treasury Secretary from Australia, but he is a serving official of the Australian government.  It seems extraordinary, and quite inappropriate.   Did he, for example, have any involvement in the recent, superficially questionable, appointment of a former senior Queensland public servant to a top position in our Treasury?    Again, close working relationships between the two Treasurys –  each as servants of their own governments –  might be reasonably expected, and perhaps mutually beneficial.   But providing a senior official of another government with inside access to the senior-level workings of one of our premier government departments seems questionable at best.  GIven Makhlouf’s past enthusiasm for China, perhaps the appeasers at the New Zealand China Council will soon be suggesting he appoint someone from China’s Ministry of Finance could join Fraser on the “Board”?

And finally, some kudos for a bureaucrat.  As various people have noted, Graeme Wheeler went for five years as Governor –  as the most powerful unelected person in New Zealand –  without ever exposing himself to a searching interview, or making himself available for an interview on either main TV channel’s weekend current affairs shows.  His appointment might be highly legally questionable, he might be only minding the store for a few months, but yesterday Grant Spencer went one better than Wheeler and sat down for interview on Q&A with Corin Dann.    I thought he did well, but what really counted was just showing up, and being open to questions.

Since much of the interview was about Spencer’s speech last week, which I’ve already written about, there was much in it that I disagreed with.  But I’m not going over that ground again.  Perhaps the one new thing that caught my attention was when Spencer claimed that the Bank is independent for monetary policy, but not around things like LVRs.   That is simply factually untrue.  The Act makes it very clear that any decisions to impose or lift LVR restrictions are solely a matter for the Governor (also a point that the Prime Minister, the Minister of Finance and their predecessors have recognised).   Spencer went on to say that if the then government had not wanted the Bank to impose LVR restrictions they wouldn’t have done so.     That might be fine, but I hope they never apply that standard to monetary policy decisions.  And if LVR decisions really are more political and redistributive in nature, perhaps as part of the forthcoming review, the Reserve Bank Act should be changed so that the Reserve Bank offers technical professional advice, but the Minister of Finance makes the decision?.  We can, after all, toss out elected governments.

 

 

 

Westpac’s plan to lower productivity

You may have seen the story in various media a few days ago about new work commissioned by Westpac suggesting that

New Zealand’s economy has a nearly $900 million annual economic hole because of low numbers of women in management roles, new research suggests.

But if there was an even split of men and women in management there would potentially be an $881m boost to the economy and a positive impact on businesses themselves.

I didn’t pay much attention to it, beyond noting to myself that $881 million is about 0.3 per cent of GDP –  not much of a “hole” in other words, even on Westpac’s (and the consultancy company they paid to do the research) own claims.

But I wondered quite how they’d come up with these estimates so last night –  while the resident woman in management was off at her office party –  I downloaded the document.

It begins with lots of puffery around the alleged economic and financial benefits of diversity –  our banks now apparently see themselves as “social justice warriors”.   I don’t claim any expertise in that particular literature, but I’d refer you to some of Eric Crampton’s reads or, indeed, to a paper I wrote about here a while ago, that leaves me pretty sceptical that there is anything much in the sorts of claims Westpac makes.

The bank is horrified that “60 per cent of businesses do not have a gender parity policy or strategy in place” –  as if picking the best person for the job, male, female, black, white or whatever –  isn’t any sort of legitimate approach to employment these days.   And seems to think that the mere existence of gaps between median earnings of mean and median earnings of women is somehow proof that employers are breaching laws “mandating equal pay for equal work”.  Perhaps Westpac’s crusading CEO could spend some time reading Claudia Goldin, for example.    In the Westpac world, there is apparently no recognition that more mothers than fathers prefer to take time out –  or work in less demanding roles –  to be actively involved in raising children (note the word “more” –  in this household, I’m the “primary caregiver”).  There are implausible claims (without proper documentation in the report) that raising the share of female managers raises rates of return on assets –  in New Zealand’s case they argue that reaching parity could raise returns on assets by 1.5 percentage points.     Not only are these huge numbers, but what sort of metric is return on assets anyway?  Some businesses require lots of fixed assets and other require not many at all.

But what I was really curious about was this alleged $881 million per annum that Westpac reckoned was being left on the table, simply because the share of female managers was less than the share of male managers.  How on earth, I wondered, did they get these estimates?

Fortunately, there is appendix to the report on the modelling.  They’ve attempted to come up with estimates of two separate effects:

  • a “role model” effect in which a higher share of female managers encourages more women into the labour force, and
  • an effect in which the availability of more (by number) flexible employment policies increases the number of women in the labour force.

Taking the “role model” effect first, the OECD has apparently been collecting data recently on the share of employed workers who are managers, by gender, for various countries (unfortunately for this study, there is no data for New Zealand).    But there is only data for four years (2011 to 2014), which even the authors concede make the subsequent model they estimate “statistically challenging”.    They model the labour force participation rate as a function of various things, including the share of women in managerial roles, and they find a statistically significant result.  Statistically significant, but very small.  On the assumption that the gap between the share of male employees who are managers and the share of female is the same in New Zealand as in Australia, if that gap was not there then, on this model, overall labour supply in New Zealand would rise by 0.15 per cent and –  according to a separate Deloittes model –  that would raise New Zealand GDP by 0.07 per cent.   Knocking off an hour earlier/later on Christmas Eve is probably worth about the same amount.

Even then, the results don’t really hold up to much scrutiny.  There is no underlying model of what determines the share of women in management roles (whether here –  for which they have no data –  or abroad), nothing that is robust across time (remember four years of data) and no insight as to what might be involved in achieving the sort of “parity” Westpac wants to see: closing the gap is treated (or so it seems) as something one can simply wave a wand and deliver.

If those estimates are both small and shaky, what follows is worse.   They attempt to estimate an effect on a company changing the number of flexible work policies of the proportion of women in management, and then translate that into an increase in overall labour supply.   Unfortunately all their data are Australian –  include a survey result on the number of working age people not in the labour force who claim that flexible working policies are very important consideration for them, and a count on the number of flexible working policies surveyed companies have in place.   In a simple model, they find that the number of flexible working policies (there is no sense of the empirical size/significance of any of them) is explained (statistically significantly) by the number of women in management in those companies, and thus conclude that if the proportion of women in management was raised to the same as men, there would be (in Australia) a 13 per cent increase in the number of flexible working policies.

The authors then take that 13 per cent increase, the 23 per cent of people not in the workforce who said flexible working practices mattered to them to get an estimate of how many more people would join the labour force through this channel if only the proportion of women in management was raised to parity with men.    They then adjust the result for the fact that many of the new entrants would only be part-time, and estimate that the overall labour supply in New Zealand would rise by 0.55 per cent.   Using the same Deloitte model as earlier this, it is estimated, would raise GDP by 0.26 per cent.

This is all incredibly ropey.  There is no attempt, for example, to assess how robust those answers to the survey were (probably many more people will say flexible working conditions really matter than actually mean it –  it is a socially desirable response).  There is no attempt to look at what the trade-offs for more –  by number –  flexible working policies might be: is there, for example, an offset in lower wages?  And there is no attempt to look for common third factors: maybe it isn’t women in management who  (causally) lead companies to offer more (by number) flexible working policies, but (say) a particular ethos among the owner and top managers of the particular business that drives both outcomes.  And there is no attempt to look at whether the presence of those flexible policies affects more strongly which firm a person (especially a woman) joins, rather than the choice to join the labour market at all.   And there is also no evidence for whether there are threshold effects –  eg perhaps having a lot of women managers lead to more –  by number – flexible work policies,  but the effects might be much smaller if the share of female managers moves from  say 35 per cent to 50 per cent, than if the share moves from 5 per cent to 20 per cent.

I’m not suggesting there is no effect, just that the case is not even remotely compellingly made on these numbers.  It might be fine for David McLean –  Westpac’s CEO –  to lead his firm’s “social justice warrior” campaign, but he really should be rather embarrassed to rely on numbers as shaky as these in support.  I do hope he does banking itself a bit better (then again, there were all those unapproved models where he found himself falling afoul of the Reserve Bank).

But to revert to my headline, did you notice the bottom line numbers for those two effects?  Here is my summary, just replicating their own numbers:

westpac lab supply

In each case, the increase in the labour supply (a cost to the individual concerned) exceeds the estimated increase in GDP.  In other words, on their own numbers nationwide productivity falls as a result (of increasing the proportion of female managers to that of males).

Do I believe the number?  No, I don’t.  I’m sure they are just an artefact of the CGE model of the New Zealand economy they assume –  perhaps something like adding labour, but with no change in productive capital or somesuch.  But Westpac published the numbers, and Westpac claimed the headlines, even though their own numbers suggest our nationwide would fall in the magic wand could be waved and their goal of parity achieved just like that.   It is a case of ropey inputs, ropey outputs, and not much more in the end than a left-liberal feel-good crusade.  Perhaps bankers should stick to banking.