Looking to the past

It was tempting to devote the whole of this morning’s post to the two latest utterances from the Governor of the Reserve Bank (perhaps together with the column in the Herald by the Governor’s chief journalistic channeller).  Particularly egregious was Orr’s sunny upbeat piece in the Sunday Star-Times yesterday.  Perhaps I still will write such a post –  it is frightening that such powerful senior officials are capable of such pap, and yet face very little accountability – but for now perhaps  I’ll just copy the heading of the email someone sent me yesterday about the SST column.


But in this post I wanted to look at a couple of papers that came out a week or so ago trying to look at some of the economic effects of past pandemics.  One of these appeared even to have been cited or referred by the Prime Minister in her press conference yesterday.    For those comments I’m relying on the report this morning in the Politik newsletter.  On several points it appears that there was quite a lot of spin in her remarks, but I suspect that on the narrow economic point she will simply have been relying on something she’s been told, whether from The Treasury or her own department.

Of the spin, two things in particular caught my eye. The first was the continued boasting about the government’s initial economic package (size/timing), when a large chunk of that package had little or nothing to do with the coronavirus, or the economic effects thereof, and those parts instead just represented a permanent worsening in the underlying fiscal position at a time when the rapidly deteriorating economy was in any case about to cut rather severely into the revenue base.   Little of the package was really cognisant of what was just about to break over them (recall that this package was a mere three weeks ago).  For all the advertising urging us to “Unite”, when politicians continue to play politics they can’t expect to go unscrutinised or citizens simply to fall in behind them.

The other point that I wanted to comment on briefly was the Prime Minister’s use of work by Rodney Jones’s firm to justify the lockdown. I heard her on RNZ this morning say that the government had had work suggesting that we might soon be at 4000 cases and that since we had only 1039 it showed the lockdown had worked.    But that is the same sort of all-or-nothing reasoning I criticised in my post on Friday.   As I understand it, that work essentially applied estimated aggregate reproduction rates as they were up to when the numbers the PM referred to were calculated.  Such an approach would also have generated predictions of 4000 cases in New South Wales by early April (up from about 400), and yet New South Wales was only at around 2200 cases by then.  But all that was before really widespread voluntary behavioural change had cut in. And New South Wales is still not in the equivalent of the Prime Minister’s level 4, and in significant respects is not as restrictive as New Zealand.  I don’t doubt the government’s lockdown has made a difference to the path of the virus in New Zealand, but it is highly misleading to imply that the move to Level 4 has made anything like all the difference in those numbers the PM was referring to.   For now, growth in case numbers in Australia also seems to be levelling off, and the total confirmed cases in the two countries are now much the same in per capita terms (Australia previously having had consistently higher numbers). Ideally –  and it might not be possible –  in thinking about the merits of retaining the current highly restrictive approach a truly marginal analysis (of both costs and benefits) would be desirable.

But it was the economics I wanted to focus on.  According to Politik, mostly direct quotes from the PM

“A strategy that sacrifices people in favour of supposedly a better economic outcome is a false dichotomy and has been shown to produce the worst of both worlds loss of life and prolonged economic pain. “

Ardern quoted “research available” on the Spanish flu which underlined her point. That research is presumably a paper published last week by three New York Federal Reserve researchers [actually two Fed researchers and one from MIT] which showed that areas that were more severely affected by the 1918 Flu Pandemic saw a sharp and persistent decline in real economic activity.

“We find that cities that implemented early and extensive non-pharmaceutical interventions suffered no adverse economic effects over the medium term,” they said.

“On the contrary, cities that intervened earlier and more aggressively experienced a relative increase in real economic activity after the pandemic subsided.”

There is a link to the full paper here.  For geeks, it is a fascinating exercise, and must be a testimony to the resources available to US researchers, that they managed to pull together so much data –  even if often a bit fragmentary –  and make sense of it in such a short space of time.

The centrepiece, including in shorter write-ups of the paper, is this chart.

npi chart 1

For the cities for which they could data, it shows on the x axis the influenza death rate in 1918 and on the y-axis growth in manufacturing employment over the period 1914-1919,  The red dots are the cities which use non-pharmaceutical interventions (eg shutdowns on public places) more and the green dots are the cities that used such interventions relatively less.    In the chart you can see two things:

  • first, cities with a lower flu death rate had higher growth in manufacturing employment (differences statistically significant and economically material), and
  • second, cities that use NPIs more intensively and earlier had, on average, low flu death rates.

And on this chart appears to rest the communications line applied to today used by many, including by our Prime Minister.

As I said, I thought it was a pretty impressive exercise to pull all this data together and make sense of it.  The authors report a number of checks and controls they used suggesting that the relationship they report, for one country in 1918, was something real.

On the other hand, it is only fair to point out that when they look at some other economic variables –  bank assets, bank loan losses, and motor vehicles registration –  the results, attempting to relate city-level mortality to later economic outcomes are mostly not statistically significant.   And I haven’t seen this line in the paper much referred to either

Several studies explore the long-run implications of the 1918 Flu. Brainerd and Siegler (2003) find that states with higher 1918 influenza mortality experience stronger per capita income growth in the long-run, from 1919 to 1929.

So count me a little sceptical as to just how generalisable the specific result in the chart above was for 1918, let alone now.   For 1918, there was huge variability across countries in mortality rates, and although the data on death rates is not particularly robust, I’m not aware of papers suggesting that differences in mortality rates across countries were an important explanatory factor in relative economic performance over the following decade or two.  Perhaps I’ve missed something, but if the literature existed I imagine these researchers would have cited it.

But there are some more important caveats around the ability to apply this study re 1918 to the current situation and use it to justify a claim –  of the sort the PM seemed to be making –  that a pretty severe lockdown is a net positive in terms of economic outcomes.

Among those caveats:

  • note that all those cities in the chart above had really quite substantial death rates from the flu, (as distinct from, say, the current situation in New Zealand or even Australia),
  • the deaths in the 1918 pandemic were unusually heavily concentrated among men in the 20-40 age group (prime working age, and at a time when female labour force participation was lower).   In other words, a higher death rate directly reduced manufacturing labour supply (and presumably output).  By contrast, in all the countries we’ve seen much data of so far, for this virus deaths are very heavily concentrated among those out of the labour force,
  • and perhaps most importantly, none of the NPIs cited in the paper the PM referred to were anything like as stringent as what is being applied in New Zealand at present.    The paper lists many examples of the approaches adopted in different cities, but the restrictions imposed seem to have been mostly limited to things like schools, large public gathering and parades, places of entertainment, and in some cases staggering working hours to allow greater physical distancing on public transport.  In some places, shopping hours were limited.  But I could not see a single example cited – either here, or in the various other 1918 books/papers I’ve read –  of the sort of restrictions New Zealand has, which simply forcibly close almost all shops, and most workplaces (to the extent work can’t be done from home).

I am not, repeat not, here taking a view on whether the New Zealand approach is the correct one (it is similar to those in some other countries), simply noting that whereas in 1918 disruptions to production were mostly about absences due to sickness, and the restrictions were around the margins for most firms, on this occasion – including in New Zealand – the restrictions go much more consciously and deliberately to the heart of the production process.    Not only are the short-term GDP/income losses almost inevitably deeper, but given the shock to households and the additional failures of many firms, there is little or no reason to think that the specific 1918 result in this Fed/MIT paper would be of general applicability to lockdowns like those in New Zealand.    It might turn out to be so, but nothing in the paper really gives us any specific reason for confidence –  and it should not be cited to that end by our Prime Minister.  That is all particularly so because –  as the Prime Minister herself noted on RNZ this morning –  even if we manage to largely stamp out each new outbreak, the disruptions, restrictions and uncertainties are likely to be with us for some considerable time.

(In addition, it is worth noting that nothing in the paper offers any insight on, say, whether the Australian approach at present is likely to produce better/less-bad economic results, over say a 1-2 year horizon, than the New Zealand approach.  Again, I am not taking a view on the answer to that issue, but it is where (say) Treasury officials and ministers should be concentrating some of their analytical resource right now.)

The Prime Minister doesn’t appear to have been referencing the other paper I wanted to write about. It is a short piece by several of my favourite economic history/crisis authors trying to look at some of the longer-run economic consequences of pandemics, back to and including the Black Death.

Here is the key bit of the abstract

 Significant macroeconomic after-effects of the pandemics persist for about 40 years, with real rates of return substantially depressed. In contrast, we find that wars have no such effect, indeed the opposite. This is consistent with the destruction of capital that happens in wars, but not in pandemics. Using more sparse data, we find real wages somewhat elevated following pandemics.

They look at twelve “major pandemics”


It is a pretty heroic effort to make what they can of the very limited data.  But it is worth bearing in mind that dreadful as these events must have been for those directly affected, only two stand out as likely to have been large enough to have had the substantial macroeconomic effects that the fragmentary data might support: the Black Death (which killed probably a third of the population) and the Spanish flu (bad as it was still on a much much smaller scale).

And I’m not sure the experience of the Black Death is likely to be very enlightening at all.  As is, I think, fairly well understood, in an economy where land and labour were the two main factors of production, and in an early economy where most adults worked because they had to to live (no widespread concept of retirement), if you take out a third of the available labour, returns to the remaining labour (wages, for the moderate proportion of the population who were wage labourers, rather than tilling their own –  or rented – land) were likely to rise, and returns per unit of land were likely to fall.    And that that is exactly what happened in the standard reading of the evidence, which the authors of this paper share, noting a doubling of real wages and a sharp fall in rates of return on land, effects that persisted for decades.

The authors produce results suggesting that a pandemic has the effect of lowering the natural rate of interest by up to 2 percentage points, effects unfolding over to a maximum effect 20 years out.    They contrast this to the effects of major wars

plagues 2

I guess my first caveat is that none of the results are statistically significant over the first 10 years (beyond that not only do connections inevitably become more tenuous, but even the more recent events often overlap).  And while authors try to distinguish a pandemic from a war by arguing the destruction of physical capital stock in wars, my impression-   perhaps wrongly – is that that destruction is far from universal.  Take, as an example, the war in the West in World War One.   I guess there was a great deal of physical destruction in north-eastern France and parts of Belgium, but almost none in the UK, much of France, Germany, let alone Canada, Australia, New Zealand and the United States.  World War Two, of course, was different, and yet our most destructive modern war was also followed by a sustained period of pretty low real interest rates (by most standards other than the last few years).

More specifically, if we try to think about the current situation, the strategies being adopted by all or almost all advanced countries at present are based on the assumption that the total death toll can be kept very low (relative to anything like per capita death rates in 1918 for example).  If that proves to have worked, we will –  mercifully –  have lost few people (and those mostly not in the labour force) and yet taken on huge amounts of new debt, especially public but also private.  Next to none of the capital stock will have been scrapped/destroyed either, and the capital stock is not now fixed natural resources, but reproducible/scalable machines, ideas etc, and who knows what dynamic the political/economic policy process will yet loose upon us.

None of this is to criticise the paper. I’m glad the authors put it together for us to read.  But however much light is shed on some past events (and collections thereof) I’m a little sceptical that we can garner much insight on how some of those key economic variables will be affected by this coronavirus and the policies being adopted to fight it, and to counter some of the worst of the individual and firm level economic losses. In fairness, the authors’ own final words are “this time may be different” (although even then it isn’t clear whether this is economists’ irony –  it is a standard dismissive response to people trying to explain why this time will be different – or a real uncertainty: quite probably the authors aren’t quite sure either).



The OECD stylised estimates of direct GDP effects

Earlier this week the OECD put out a useful little note Evaluating the initial impact of COVID-19 containment measures on economic activity.  

It is less than five pages long, including a couple of charts, and isn’t even attempting to offer definitive answers.   And what it offers isn’t an assessment of the impact of the differing containment measures being adopted in each country, but of the likely impact of the initial economic structure of each country’s economy to a set of common assumptions about the extent of containment and associated changes in economic activity.   Thus when, as local media have reported, this chart shows that New Zealand is one of the most adversely affected economies

oecd covid 2

it isn’t telling you anything about the impact or intensity of New Zealand policies, but simply about the pre-existing structure, given the (common across countries) assumptions OECD staff make about which sectors are most hit as containment measures take hold.  We don’t have many high-tech online services firms and, on the other hand, we have a lot of construction and a lot of production accounted for by tourism. (If you are wondering about Ireland –  far left –  remember that GDP in Ireland is massively inflated by some of the corporate tax distortions, and the loss of national income will be much larger than is shown here).  I was interested in the number of central European countries close to us on the chart, which appears to reflect the importance of the motor vehicle manufacturing and supply chains in those economies (and Germany), and of course car sales –  and production – have collapsed.

It is also important to remember that these are direct effects only.  That might not much affect the cross-country comparisons but will affect the absolute magnitudes of the likely falls in activity.  On the numbers in the chart, the direct effects alone crunch GDP by about 25 per cent for the median country shown.  Indirect effects, including confidence effects, credit availability effects, uncertainty effects, income effects and so on will probably amplify these numbers greatly.  I struggle to see how a fairly extensive lockdown will not reduce GDP while it is in place by up to perhaps 60 per cent (I noticed the comments yesterday by the chair of ANZ Bank in New Zealand, John Key, who was using numbers of that sort of order of magnitude).  Measurement is going to be a huge challenge –  and it may be several years down the track until, say, SNZ can offer us fairly definitive estimates (especially in the absence of quarterly income –  profits –  data) –  but reality (even if not accurately measured) is more important than whatever the published headline numbers.     Even in most industries deemed “essential” activity levels are going to be very significantly reduced (not many new mortgages being written for example, production capacity in meat works reportedly half what it was in norma times, and so on).

The OECD’s second chart –  using the expenditure approach to GDP –  is consistent with these sorts of really large numbers.  It focuses on consumer spending (rather than total GDP), and they show estimates for only a few countries.

oecd covid 3

Read the footnotes, and if anything these look as though they could be underestimates, at least in a New Zealand context (eg pretty sure car use here has dropped by more than half, and hotel/restaurant spending by more than three quarters (since all restaurants are closed and hotels must have little more than a few residual stranded tourists).

Of course, imports will be lower, which offers some offset.  But so are exports, most notably our tourism and business travel exports.  And, in any properly measured sense, a fair bit of public consumption spending is going to be affected too – teachers might be getting fully paid, but no one supposes school online is going to be anything like the extent/quality of the normal product.

And then there is investment.   Last year, almost 24 per cent of GDP was accounted for by investment spending (gross fixed capital formation).  60 per cent of that in turn was construction (residential and other).  None of that is happening this week.  Very little of any other investment spending will be occurring either, whether because it is simply illegal for firms (or bits of government) to operate or because of the extreme uncertainty of the environment, sharp reductions in forecast demand, or whatever.

It is difficult to get anything like a fully comparable estimates of the extent of the “containment measures” various countries have taken, partly because there are so many dimensions to most countries’ restrictions (and in places like the US, restrictions are at a state or county level), and because whatever the headline how the rules are applied in practice also matters (who knew, for example, the Arobake’s luxury baked goods counted as “essential”?).   But relative to at least the other Anglo countries –  with whom we often compare ourselves –  New Zealand’s partial lockdown seems to be more extensive.  If so, the immediate economic costs here are likely to be greater, especially as –  first chart – if the OECD rough and ready analysis is right then our production structure meant that for any given set of restrictions we were more exposed than the other Anglo countries.

That isn’t a commentary (at all) on the merits of the extent of the New Zealand lockdown. It also isn’t a commentary on whether a tougher approach now will, or won’t, reduce the overall economic costs across time (there are a couple of papers around on that latter issue which I will try to write about next week).  It is simply to make the point that many of the estimates that are around for the extent of the fall in New Zealand’s GDP –  including the sorts of numbers the Ministe of Finance alluded to at the select committee on Thursday – still seem on the light side.   We don’t have monthly GDP data (they have such estimates in Canada and the UK) but if we did then for the period of the current partial lockdown I’d have thought you would have to struggle to produce estimates of a fall as small as 50 per cent.



Choices that matter are often hard.  That is one of the messages of Matthew Hooton’s lengthy column in the Herald this morning, which people really should read if you possibly can.  It isn’t that Hooton is saying anything particularly new, but he is putting it firmly in a contemporary New Zealand context.  He poses the choices around handling the coronavirus pandemic as primarily those for the Prime Minister (and Cabinet), but really we should think of them as choices for New Zealanders as a whole, for which elected leaders –  none of whom here was seriously chosen for their ability to confront the gravest crisis in many many decades – really should primarily be there to facilitate and articulate, but perhaps help shape too, our collective view; the choices we wish to make on matters that affect life and death –  perhaps for many – and the functioning of our society and our economy.

As it is, the government has already failed us.  What other conclusion can we reach when much of the country is in lockdown, officials and ministers are deciding by the hour whose businesses will and won’t survive, with no apparent exit strategy?    There appear to have been alternatives (see Taiwan and South Korea).  It isn’t as if this virus became an issue in New Zealand with no notice –  Taiwan drew it to the attention of the WHO in December, Wuhan was locked down two months before our own lockdown, and so on.  All the evidence is that the government (political and official) simply did not take the threat very seriously at all for far too long (whether reflected in complacent commments from the PM, minimising tweets from the Ministry of Health, the casual approach of the Reserve Bank (with the Treasury Secretary sitting on the key committee).  And even if they would like to claim they did take the threat seriously –  if so, perhaps they could produce the draft detailed lockdown plan from even, say, three weeks ago –  they certainly did not level with the public, did nothing (as basic as, for example) to alert supermarkets that the public might soon be wanting more and different stuff (eg basics like bags of flour to bake our daily bread).

Worse, they still aren’t levelling with the public.   We finally had the Ministry of Health release earlier this week various background modelling exercises done for them on contract by academic researchers –  including one dated 27 February (itself labelled a “revised preliminary report” so presumably the government had the guts of it earlier.  That report notes

We estimate likely deaths to be between 12,600 and 33,600 people in our “plan for” scenario

Did the public see or hear any of this from the Prime Minister, the Minister of Health, or the Director-General at the time?  There was no hint of any of it –  let alone any greatly accelerated planning –  in thePM’s press conference a few days later.   And at the time the Ministry was still playing down not only the risk of asymptomatic transmission, but of any sort of community outbreak more generally.  If they were taking it all very seriously, they chose to treat us like children and keep us in the dark.  More likely, most of them weren’t very serious, and of course that was reflected in the way they were then setting about designing their (backward looking China focused) support package (before events began to overwhelm them).    Since the government and officials never acknowledge any of this, and still refuse any semblance of pro-active transparency, it is hard to trust a word they say any longer –  no doubt, some of what they is useful, but who can tell the difference? Who knows whether they won’t lurch again –  as they’ve done several times already.

This was the government that some time ago committed itself to much greater transparency around the release of Cabinet papers.  It was a pretty good initiative at hte time.  But as far I’m aware we have not seen a single Cabinet paper or any of the key officials papers on any aspect of the unfolding crisis, whether health or economic.

And in particular we’ve seen nothing that sets out any sort of cost-benefit framework that is influencing the government’s decisions (thus the Otago health modelling is useful in its way, but in isolation it adds not much to our ability as citizens to either evaluate the choices/processes the government is using, or to reach a view on the best way forward).    We just get the latest lurch.  A few weeks ago it became apparent that the government had adopted a mitigation approach – the PM was on a stage waving around a “flattening the curve” graphic.  But we’ve seen no serious analysis of what led them to that option.  Now a senior official –  not even the PM or an elected Minister –  tells the select committee that the government is set on an elimination approach.   But we’ve seen no serious analysis of the costs and benefits, risks and potential mitigants, of that either.    And then yesterday, the Director General of Health –  again not even the PM –  appears to double down, telling us that there is no Plan B, and that suppression will simply be maintained however long it takes.  But again, no papers, no analysis, no nothing, just rhetoric.  Not even a hint of what considerations our politicial masters took into account, what weight they put on them or of any fallbacks or contigency plans.   It isn’t like a real war – the enemy isn’t listening.  And we are supposed to be citizens, not children.  It is our country, economy, society,  and lives, not those of the politicians and senior officials?

I don’t have a particularly strong view on the appropriate policy at this point, given where the government complacency and lack of planning got us to.   It is the process, the total lack of transparency, lack of engagement, and –  frankly –  lack of any evidence of a robust disciplined policy assessment (yes, even under quite some time pressure) that really bothers me right now.  No one made any of these officials and politicians take their current positions: they sought them and accepted them, and they simply do not seem to be doing even an adequate job, let alone displaying the sort of excellence one would hope for in a crisis.  It is revealing about the degradation of our political and official systems and agencies in recent years, but confirming worst fears is no consolation. People can rise sometimes rise above themselves in a crisis, but there is no visible evidence of that from any of the key political or official players so far.

From an economist’s perspective there is no sign of any attempt at a serious cost-benefit analysis of possible alternative strategies.    Did Treasury not insist on one, or did Ministers refuse to have any such work done?  Or is there such a document lurking, hidden from citizens?  Whatever the answer, the Prime Minister has offered us nothing, just flat assertions and  – presumably on her behalf –  “there is no alternative” rhetoric.    There are always alternatives and choices.  Even in wars that pose near-existential threats, surrenders eventually happen, when things go badly enough different from plan.

All we’ve been offered so far –  and even that not released for days after the Prime Minister claimed to be relying on it –  was some modelling by researchers at Otago University.  This is where the central estimate of the “worst case” of 27600 lives lost comes from.  Of itself, this number doesn’t seem terribly enlightening –  it involves a similar share of the population getting infected, and the proportion of the infected dying, – that people were talking about at least a month earlier.   Intelligent readers of the ongoing debate would have got to numbers in a similar ballpark.  But it makes good headlines, which seems to be the main use the report has been put to.

The biggest problem with the report, from a disciplined policymaking perspective, is that it offers precisely no marginal analysis.  That probably isn’t a criticism of the report, since most likely that sort of analysis wasn’t asked for by the Ministry of Health.  But it matters quite a lot in evaluating current policy choices.   Thus, we have no analysis at all –  or so it appears –  of the likely death toll if (for example) the over-70s put themselves into isolation for six months.  No analysis, that I can see, of the likely death toll if the public were seriously alarmed about the risk and chose extensive physical distancing themselves.  No analysis, I can see, for what difference the actual partial lockdown might make relative to variants on it (tighter and looser).  No analysis of what difference a very aggressive test, trace and isolate strategy might make, perhaps in the context of a less severe lockdown.   Nothing. It is almost all framed in an “all or nothing” way.

And then there is just nothing anywhere about the economic and social costs.  Again, doing so isn’t easy.  As I noted to someone who emailed me yesterday, it is easy enough to produce huge numbers for the economic cost –  GDP could easily be $75 billion lower this year than last (roughly 25 per cent), with further losses (but smaller) next year and beyond. It is really easy to get to a $100 billion figure.

Some sceptics of the government’s substantive approach will then compare $100 billion to the value of the lives saved.  Suppose we could save all 27000 people in the Otago modelling only by the approach we are adopting.  For general government cost-benefit analysis we know that the assumed value of a life saved is around $5 million dollar, but if that is – in principle –  roughly the price we’d pay to save someone of median age, we know that the very elderly are most at risk of dying from this virus.  If we halved the value of the statistical life of those most at risk –  using say $2.5 million per person (which would probably be generous) one could tot up expected savings of $67.5 billion and conclude the strategy just does not make sense.

But that would also be all or nothing thinking, not focusing on the bits of the equation the New Zealand government choices actually affect.    The case for any particular intervention by the New Zealand government can really only sensibly be evaluated looking at the marginal benefits (lives saved, mostly in this case) and the marginal costs.  To illustrate, consider the economic side.  If our government were to lift all domestic and border restrictions tomorrow (an absurd proposition, but this is for illustrative purposes only) it isn’t as if those $100 billion economic costs would just evaporate.   There would be hardly any foreign tourists (apart from anything else, most governments are strongly advising their citizens not to travel abroad, if there are even flights), and probably not many new foreign students.  And what of New Zealanders?  The risk of the disease wouldn’t go away –  in fact, it would probably be greater than it is right now – and plenty of people would choose to be extremely cautious – whether about work, schools, social occasions, air travel or whatever. Oh, and the uncertainty around future policy –  and global economic activity –  wouldn’t change one iota, and extreme uncertainty is the great enemy of most spending and investment.    We would still have a very serious recession on our hands.   Those losses simply aren’t relevant to the case for the lockdown (present or possibility of extensions, perhaps without foreseeable limit).

Quite how then one puts a number on the marginal cost of the lockdown, or variants to it, is a challenge. It is clear that if it were removed tomorrow, some firms would spring back into operation, but how many?  How many would have many customers?  I don’t know the answer, but it isn’t clear that the government –  with all its resources –  has made any effort to either.  And that is pretty inexcusable.

And, as noted, there is no analysis of the lives saved at the margins either.  And absolutely nothing on what it means for a society to be simply shutdown by order of the state –  individuals (many live alone) consigned to, in effect, solitary confinement home detention for an indeterminate horizon,  funerals/committals totally banned (for all intents and purposes), people dying alone with spouses or children simply banned from making their own choice to be at the bedside, and so on through the less dramatic implications.  If the Director General really speaks for the Prime Minister in his “no Plan B” rhetoric, are they open to Christmas –  community, society, festivity –  being scratched this year, even though it is still almost nine months away.

It is as if the government is afraid of confronting and dealing with real hard choices –  and being honest on what they value, what they don’t –  and just prefers now to deal in simplistic rhetorical absolutes, when not much is very absolute at all.  We deserve a great deal better from our Prime Minister, her Cabinet, and the phalanxes of highly-paid officials and agencies who surround them. In the end, these are our choices –  our lives, societies, economies – and the government system is supposed to be our servants not our masters.  When, with all the resources at their command, they simply don’t do the analysis, and aren’t open with us –  radically so, given the gravity of the crisis – they betray our trust.  That is something governments can ill-afford in times like these.

Measure what is measurable, and make measurable what is not so

Late last year a (long ago) former Reserve Bank economist closed down his blog just like that. I didn’t have anything quite so dramatic in mind.  But after my elderly mother died last August, I got to thinking about the next stage in my life and how I could best use what skills and talents I have.  And before Christmas I’d decided that today would be my last day of high-frequency blogging.  Why today?  Well, for all practical purposes it is the fifth anniversary of the blog; five years today since I left the Reserve Bank.  It wasn’t that I’d run out of ideas or energy, but there is always the opportunity cost to consider, and I’d begun to map out a series of archival-research-based projects (mostly in New Zealand economic history) I wanted to pursue, as well as making more space for some other interests and priorities.   I’d planned to keep writing here perhaps once a week or so.

That is still what I want to move towards at some stage.  But in the middle of the most dramatic economic developments, and wrenching dislocations of economic policy, of our lifetimes it doesn’t quite seem the time to change course just yet.  We’ll see how things go, but for now, quite probably for at least the rest of this year, normal service continues (and in the meantime thanks to all of you who’ve become readers –  numbers that, for a fairly geeky New Zealand focused blog, I never imagined – and to (almost) all who’ve commented, either on the blog itself or directly to me).

And today I’m indulging the inner geek.

One of the most frustrating (to me) aspects of the response to the massive economic dislocation by the government and the Reserve Bank is their utter complacency, bounded by some deep-seated conventional wisdom, that interest rates can’t, shouldn’t, and won’t move down from here –  the OCR having been cut, in the biggest slump in modern history, by a mere 75 basis points.    The Minister of Finance was at it again in his testimony to the epidemic select committee yesterday highlighting the “certainty provided” by the MPC’s commitment not to change the OCR for some considerable time.  I presume he had in mind the idea that the MPC wouldn’t raise the OCR – as if anyone has supposed such increases were at all likely in the foreseeable future –  but he seems totally uninterested in the idea that considerable relief could be provided, and desirable income rebalancings achieved, with much lower interest rates.

Sadly most of our media also seems more interested in channelling conventional wisdoms rather than challenging them.  So I’ve heard MPs and journalists ask the Minister of Finance about commercial rents, but never once about interest rates, even though commercial rents are based on private contracts, whereas the OCR –  which influences a wide range of variable private interest rates – is directly under official control.   If the Reserve Bank refuses to act –  as it appears they do –  the Minister has existing statutory powers to simply override them.  They aren’t powers that should be used lightly, but they were put in the Act for a purpose, and these are pretty extreme times.  If the Minister refuses to use his powers, he makes himself directly party to the choice to hold New Zealand retail interest rates well above where they should be at present.   All while facilitating/encouraging firms and households to take on more debt at these interest rates.

Still, for the time being at least, the MPC’s floor is the floor, and markets have to take that into account in pricing other securities.  This has been an issue in a variety of other markets for some considerable time, particularly since the last recession when various central banks got a point where they were simply not willing to cut further, no matter the economic conditions, or to make the changes (around physical currency) that would have made further deep cuts –  of the sort Taylor rule estimates in the US, for example, suggested economic conditions warranted –  effective.   Central banks fell back on trying to do what they could –  often not much –  with other “unconventional” instruments.

And years ago, a Reserve Bank of New Zealand researcher Leo Krippner, got interested in the question of how one might represent the effectiveness of such policies in a single number.  Whereas in normal times, the OCR itself readily expresses the stance of policy, if there is a self-imposed floor on the OCR but other things are being tried, how best to express the overall stance of policy.

Leo is an expert in yield curve modelling, and got to try to estimate how different the interest rate yield curve was –  especially in the US –  in the presence of the floor on the Fed funds rate, as a result of unconventional policies (“QE”, loosely).     He has published various technical papers in journals, but I think his first paper in the area was published in 2012 in the Reserve Bank’s Analytical Notes series.  I was the editor of that series, and one of my priorities was to ensure that as much as possible was accessible to intelligent lay readers, and my impression is it still remains a good introduction to the work Leo is continuing to do and to update.

One can think of a yield curve of government bond interest rates (from overnight out to, say thirty years) as, broadly speaking,  a series of market implied expectations about the future setting of the official overnight interest rate (the OCR in New Zealand).  All else equal, if the central bank sets a floor on the OCR –  which is regarded as binding and credible – markets pricing say a 10 year bond will rule out any chance of an OCR below that floor, and the 10 year bond rate will be higher (all else equal) than it would be in the absence of such a floor.  On the other hand, if large scale bond purchases by the central bank –  even actively targeting a bond rate (as Japan and now Australia are doing) –  may succeed in lowering to some extent where the bond yields settle, relative to the floor-constrained normal market price.    Leo’s work, calculating what he calls a Shadow Short Rate, attempts to combine the OCR and this effect into a single number.

This work wasn’t very relevant to New Zealand itself for a long time (there were internal sceptics as to whether it should even be done)….and yet now it is. (In his speech a couple of weeks ago the Governor even suggested the Bank might publish a semi-official series of such a measure.)   Leo’s work has been recognised in various places abroad –  cited in public by at least one Fed Reserve president, and honoured by the house journal of the central banking community, Central Banking magazine (for whom I do some reviewing: my light lockdown reading is here).  Leo left the Reserve Bank last year, but is continuing to update his work and earlier this week circulated a note with a Shadow Short Rate series for New Zealand, now that we operate with a formal OCR floor and in the presence of the MPC’s commitment to buy $30 billion of government bonds over the coming year. (The quote that heads this post, from Galileo, appears upfront in Leo’s note.)

Leo’s modelling estimates that the overall stance of monetary policy is “approximately equal to an OCR of -0.48 per cent”, compared to an OCR itself of 0.25 per cent.    If so, that suggests a small but somewhat useful contribution from the “unconventional monetary policy” or UMP.  Small because even a total of 150 basis points of effective easing is tiny by comparison to the scale of the economic shock.

There are a number of caveats to this modelling.  Leo articulates some of them himself

  1. The SSR is an estimated value rather than a setting like the OCR or an observed market short rate. Hence, any SSR series will (unavoidably) vary with the model specication and data used for its estimation. The choices I have made for the SSR series in this note have produced more favorable properties than alternatives for the United States,4 but the magnitudes of negative SSR estimations can easily vary by fractions of a percentage point on re-estimations, and sometimes more for UMP periods if the lower-bound setting in the model needs revisiting in light of central bank communications and/or actions. My model for New Zealand currently uses a lower-bound setting of 0.25%, consistent with the RBNZs 16 March 2020 forward guidance.
  2. Related to estimation, in the present global UMP environment compared to previous years (e.g. for the United States easing/tightening cycle) yield curves may no longer capture sufficient information to quantify the stance of monetary policy. The reason is that yield curves in New Zealand and around the world are now very at(i.e. longermaturity rates are close to shorter-maturity rates). Only time (and updated analysis) will tell on this aspect, and model refinements may be needed.
  3. The SSR is not a market rate at which borrowers and lenders can transact, particularly in UMP times when the OCR and short rates will remain close to zero while the SSR may become increasingly negative. Hence, SSR declines in UMP times will not result in the same cash flow effects from interest payments and receipts as OCR cuts in CMP times, so the SSR transmission to the economy may differ from at least that perspective.

I went back to Leo and asked about how safe it was to use a floor of 0.25 per cent for New Zealand (after all, we’ve seen more than a few policy lurches from the Reserve Bank over the last year, in fact over the last few weeks, and some other central banks have – eventually –  shown a willingness to take their policy rates lower, in the Swiss National Bank’s case as low as -0.75 per cent.  Leo noted that if one were to assume the New Zealand floor was anything like that low, the SSR for New Zealand would still be much the same as the OCR itself.

He went to say (with his permission to quote)

The longer answer is: should one use an assumption of the effective  lower bound in the model (perhaps something like your -0.7, but also  see further below), or should one use a value that central banks have  indicated they would go to? Across the different economies I’ve  modeled, I’ve noticed that the different yield curves seem to use the latter. For example, the US yield curve data has pretty much respected  the lower point of the 0-25 bp range, and the euro area data (OIS  rates) has pretty much respected the incremental settings of the ECB  policy rate. In particular, neither have had longer-maturity yields  rush to, say, the -75 bps of Switzerland.

So, based on what I’ve seen with the data, I set the lower-bound for  each economy according to the central bank’s indications. And then I  lower that if/when the policy rate gets set lower (which, again, seems  to be how the yield curves behave – perhaps not rational though, I agree).

To which my response in turn was to note that in at least some of those overseas central banks –  the Fed in particular –  the stated floor has been consistently applied for a decade, while the Reserve Bank of New Zealand has no track record in this area at all –  indeed in that same speech a few weeks ago the Governor was openly talking of negative rates as a possibility.  A rational investor in the current climate, with a Governor prone to lurches (and, actually, in the presence of override powers), might not price in a 100 per cent chance of the MPC sticking to its word.  Time will tell.

My bigger unease about this work, stretching all the way back to that 2012 paper (where I recognise a couple of sentences I insisted on being added) is the third in Leo’s own list of caveats above: the SSR is not a rate that can be transacted, and if much of borrowing and lending in an economy is either at (or swapped back to) or very close to a floating rate, the actual OCR (self-imposed constraint and all) will be a lot more important than the SSR estimate might suggest.  In the US, for example, a lot of mortgage lending takes places at very long-term fixed rates (and so what happens to very long-term bond and swap rates has a direct transmission mechanism).  That is much less so in New Zealand (or Australia or the UK).  That is consistent with some of the doubts I’ve expressed in earlier posts around quite what difference the Bank’s large scale asset purchase programme really makes where it matters (thus, on my telling, the main advantange of that programme is that it should reveal quite quickly how severe those limitations are and turn the focus back on the OCR and that self-imposed floor).

This stuff won’t be everyone’s cup of tea, but I’m really glad to see that Leo is continuing with this work –  he says he will provide updated estimates on his website http://www.ljkmfa.com each month for the time being –  and will be interested to see whether the Reserve Bank follows through on the suggestion of a quasi-official series (for what its worth, I would suggest they not do so, and use work such as Leo’s as a reference point for commentary/research when it is relevant).

Coronavirus economics and policy: April Fools’ edition

Sadly, of course, we don’t wake up this April Fools’ morning and learn that the last quarter has simply been a huge and dreadful illusion.  We really are in the midst of a pandemic.

Unfortunately, we also wake up and realise afresh just how irresponsible some of the economic policy choices the New Zealand government has made in recent weeks have been, as they lagged badly behind in recognising the severity of what was breaking over us.   The government’s key economic figures, the Minister of Finance, the Secretary to the Treasury….oh, and Phil Twyford….are apparently fronting up to the Epidemic Select Committee this morning.  I hope ministers are grilled on these points.

First, we had the decision to push ahead with a further large increase in the minimum wage (from today), in a country where the ratio of minimum wages to median wages is already among the highest in the OECD, at a time when unemployment is rocketing upwards and the earnings capacity of the country has plummeted (partly, most recently, as a result of government choices, but realistically mostly because of stuff simply outside New Zealand’s control).   Perhaps one might have been able to defend such a decision six weeks ago when it might have seemed to wishful ministers not taking the threat seriously –  as indeed the Ministry of Health evidently was not – that it was just a China thing and any adverse economic effects would be small, concentrated, and shortlived.  It makes no sense whatever today.  It is a pure act of ideological self-assertion –  from a government that at the same time runs relentless propaganda urging us all to “unite”.

Things are so bad right now that perhaps the higher minimum wage won’t lead to many additional job losses right now: if your revenue has fallen 90 or 100 per cent, a higher wage rate for staff you can’t afford anyway is more or less irrelevant.   But it is an additional cost on employers at a time when for most firms profit is non-existent, at a time (as it happens) when it is very difficult to spend much money at all anyway on anything other than food and rent.

But where the increase will start to matter a great deal more is in the months and years to come.  Again, if the government once assumed the unemployment rate would barely rise, they’ve known for weeks now that any such view was simply deeply deeply wrong.  We’ll be trying to get people back into work, starting from a peak unemployment rate that may soon surpass even the Great Depression peaks, and as I noted yesterday it is ludicrous to suppose that getting back to full employment is going to be easy or quick.  The minimum wage decision makes it that much harder, and the burden will fall most heavily on the people least equipped to do well in the labour market, whom employers just won’t need to, and typically won’t be willing to, take a punt on.  Oh, and realistically the whole economy is going to be on a lower path of income per head or labour productivity (earnings capacity) than any ministers envisaged when they first rashly promised these successive increases.

If anything, we want to get price signals positioned in a way that is most supportive of as fast a return to full employment.  There are macro policy aspects to that –  eg interest and exchange rate – but minimum wage rules are also part of the mix.  On current policy settings, the government seems determined to hamstring the private sector led rebound.

And then there were those permanent worsenings in the fiscal position implemented as part of the economic package a bare two weeks ago.   In the face of what was very obviously coming, both the bulk of the business tax changes and the permanent increases in welfare benefit rates were almost reprehensibly irresponsible.  Here is what I said at the time

But the increase in welfare benefits now is much more pernicious than that.  Life on a benefit isn’t easy (and before anyone scoffs about what do I know, that isn’t just rhetoric: I have a close family member living on a long term benefit).   But what beneficiaries at least had going for them this year was certainty of income: the government was not going to default or closedown, unlike many private sector employers (with the best will in the world on their part).  They and public servants were safe.  And yet the government chooses to lock-in a permanent boost to its spending commitments (a) to those with the least degree of income uncertainty now, and (b) when the country is in the process of becoming a lot poorer and scarce resources need to be used wisely.   Raising benefits might or might not have been a reasonable luxury in settled times.  It is simply irresponsible and evidence of fundamental unseriousness to do so now.  (And before anyone tells me about the high marginal propensity to consume that beneficiaries have, let me remind you that now is not the time for stimulus or encouraging people to spend more: instead we are entering a phase of deliberately choosing to shrink the economy to give us the best hope of fighting of the effects of the virus).  Oh, and the unemployment rate is going to rise a lot, and one of the big challenges after this is all over is going to be reconnecting people with the labour market, at a time when wage inflation will have been depressed anyway.  In that context, higher benefit replacement rates (relative to wages) is really the last thing that makes sense in getting the economy back on track.

We are poorer as a nation –  very considerably poorer so for the time being –  and yet the government splashes permanent increases on one of the only groups in the country whose real incomes this year are actually secure.

But it isn’t some April Fools’ joke, it is fiscal and economic policy as delivered to us by the Labour/NZ First (and Greens) government.

I could go on, reprising themes from recent posts.   In many ways Grant Robertson has always just been Mr Conventionality when it comes to economic policy –  happy to go along with whatever establishment thinking is for the moment.    That was true pre-crisis –  whether, for example, you liked the Budget Responsibility Rules or not, the conventional wisdom did; whether you thought something really needed to be done about our utterly dreadful productivity growth record, the conventional wisdom was content to tinker (and The Treasury was worse, content to play with its Living Standards Framework distractive toys).

But exactly the same Mr Conventionality is one display now.  He is content to sit by, not even saying a word let alone using his statutory powers, about his Monetary Policy Committee simply refusing to cut interest rates in face of the biggest slump in modern history –  because establishment thinking tells him there is nothing there, the same sort of establishment figures so wedded to the Gold Standard pegs in the early days of the Great Depression.    Sure, fiscal policy today looks very different than it did even a month ago, but not in any surprising, bold or innovative ways.  The wage subsidy scheme doesn’t run for long, is now quite ungenerous by international standards, and there is no sign at all that the Minister has grappled at all with the nature of the extreme uncertainty that all businesses are facing.   And perhaps as bad, the government seems much more interested in bail-outs for big and prominent companies than it does in something systematic and economywide.   But it is those big companies who will have the ear of ministers and senior officials, who will get the media coverage.    Small firms typically don’t (in the same way grieving families barred from any sort of funeral, no matter how small or distanced, outdoors, don’t command the attention of this government).  That big company focus –  case by case consideration of individual big firms, presumably with little transparency and no accountability –  is reflected in stories online this morning (sorry, can’t immediate re-find the link).

And if there is a strategy it appears to be infrastructure, infrastructure, infrastructure…..without much regard for the twin facts that (a) whatever infrastructure projects might have passed decent cost-benefit tests six months ago now (a subset of those actually approved), fewer will today, and (b) relatedly, whatever we thought we needed six months ago, we will need less in the next few years.   I’m not opposed to sound infrastructure projects getting accelerated go-ahead, in principle, but if the government believes high-speed rail from Auckland to Tauranga or Hamilton, or lots more Island Bay cycleways, are the answers, they will simply be on the path to making us poorer.

There has been much comment from Labour ministers evoking Michael Joseph Savage in recent weeks. I know he is some sort of Labour icon –  I’m always surprised that some friends of ours still have his photo on their wall – and no doubt there were a handful of good things done on his watch. But, as a reminder, the Savage government had almost nothing to do with New Zealand recovering from the Great Depression – it was almost wholly over in New Zealand by December 1935 –  and its reckless macroeconomic policies ran New Zealand into such a serious financial crisis in late 1938 that we ended with tight exchange controls –  government permission for your overseas magazine subscription or your holiday or your retirement investment portfolio –  for the next 45 year, and only narrowly averted a much more serious default on the government’s debt that anything that actually occurred during the Great Depression itself (and we weren’t spared that by decent New Zealand management, but by the grace and favour of the UK government, concerned not to severely dislocate New Zealand when the war was likely to be only months away).   Labour might have a sentimental attachment to the man –  who seems mostly to have been a decent sort as an individual –  but it is distinctly unnerving when one reads senior government figures, including Grant Robertson, evoking those times and policies as an example for now.  Did I mention that part of what that government kicked off was the retreat from the world –  going into the 1930s we had probably the highest per capita exports of any country.  This time we start already having the lowest share of GDP accounted for by exports of any modestly-sized advanced country.   We need an outward focus, as much as possible, to whatever extent is reasonably possible, not a guiding philosophy that thinks we can get rich mostly, as a very small country, simply by taking in each others’ washing.

The government has done very poorly so far on the economic response to the crisis.   That needs to change urgently.  It isn’t promising when media report, as the Herald did this morning that the focus is still on a Budget six weeks away.

They have also been extraordinarily non-transparent.  One might think that the best way to build and retain trust, and develop confidence in your strategy, would be to pro-actively all the advice and memos the government has received in formulating policy –  it would also be less labour intensive than responding to the avalanche of OIA requests that is becoming increasingly inevitable.   But, as far as I can see, we’ve seen nothing at all of The Treasury’s analysis and advice on the economic implications and options.




The old world won’t snap back and we shouldn’t make policy assuming it will

There was a thoughtful short piece in the BNZ’s weekly commentary yesterday on economic prospects for the next few years.  Perhaps there are others around that I missed – I only heard of this one when my son drew this report of it to my attention

BNZ’s head of research Stephen Toplis is warning that economic activity won’t return to pre-crisis levels till some time in 2023, while unemployment might not get back below 5% before 2025.

I gulped. I hadn’t quite thought about it in those specific terms.  But as I did, I realised it probably wasn’t an implausible story (as Toplis notes in his piece, and as everyone must, precise numbers/forecasts have little meaning at present; the issue is more about broad orders of magnitude and the nature of the supporting story).

Toplis’s own short-term story seemed, if anything, insufficiently bleak, although he may just have been making the point that however optimistic you are about restrictions, the virus etc, a big slump in GDP is inevitable (much has already happened, if you think of week by week GDP).  And even if one assumes, as BNZ guesstimates, that two-thirds are people are still working (at home or essential on-site), many of those will be working at much lower rates of productivity than in normal times (how many people who notionally should be able to work from home actually can’t, whether because of kids or no work laptop or…?), and in many firms/agencies demand for services will be lower even if supply could be maintained from home.

These are his two charts, first GDP

toplis 2020 1

and unemployment

toplis 2020 2

It would be staggering if the unemployment rate stays below the early 1990s peak, but the real issue –  and the focus of Toplis’s commentary –  is the rate of recovery.  On his telling, if something like 5 per cent is our NAIRU, we don’t get there even in 2025.  (And don’t forget the underemployment rate: people who have some work, but really want more hours.)

As Toplis’s chart suggests, it is easy to envisage a quick snap-back to a considerable extent in some areas.  If people haven’t bought clothes for (say) six months, there will be significant sales next spring/summer.  But that initial bit of recovery is the easy bit.  In his note, Toplis articulates lots of mostly plausible reasons why anything like a full recovery will, almost certainly, be slow, here and (no doubt) abroad.  One thing I noticed is that he hardly mentioned the role of macroeconomic policy, usually vital in helping economies back towards full employment after any serious dislocation.

One can’t cover everything in a short note, but it is possible macro policy will be hamstrung in the (eventual) recovery period.  If the Reserve Bank’s Monetary Policy Committee simply refuses to cut interest rates, and the government lets them get away with it, we will probably have rising real interest rates heading into a recovery (notice the 0.4 percentage point slump in inflation expectations in the ANZ survey released this afternoon, before the sheer scale of the economic shock had really begun to dawn).  As for fiscal policy, a great deal with be done in the slump itself, but you have to wonder just how ready voters and taxpayers will be to see new large commitments into the indefinite future, potentially at times when (as in the BNZ charts) things are much less bad than at the bottom, even if not that good at all.  This has been my worry about using fiscal policy too soon in all my writings in recent years about the risk of the next recession.  At present, of course, the fiscal taps are open wide –  and rightly so –  but the tolerance of that won’t last forever.  It never has anywhere else, any time else  (and, for what it is worth, fiscal stimulus into the recovery will –  all else equal –  push up the real exchange rate, the very last thing this economy is likely to need.)

Which is partly by way of a long prelude to a point that I think needs to be recognised not just superficially but at a much more profound level across the country, and in particular in debates around appropriate economic policy responses.   There is no possibility now of simply hibernating for a couple of months only to reawaken and pick up where we left off at the end of the summer holidays.    It was a tempting way to frame things in the early days and weeks, and to greater degree or less was probably part of the way almost all of us thought.  It was the sort of conception that seemed to have been in mind when the government began shaping its first assistance package a month or so back.

But it simply isn’t a helpful or relevant way of framing the challenges now.    And policymakers –  and those advising them (and we have seen precisely none of The Treasury’s advice) –  need to stop working on that outdated, if understandable, view.

Perhaps there is still some limited applicability of that model for the businesses that have only been savagely affected by the government’s partial lockdown.  If there were this magic world in which four weeks hence, the partial lockdown would be lifted and domestic life go back to normal, with certainty that regime would endure, then perhaps there would still be a role for assistance explicitly premised on keeping existing firms together.   (Especially as while closing, say, the Island Bay Butcher might have been good public health policy, but it was also still a straight regulatory taking, for which there could be good grounds for pure compensation.)

But everyone knows that isn’t the real world.  Even if partial lockdowns are eased, they may come back.  And no one supposes we are quickly going back even to normal domestic life, or with any degree of certainty.  As for large chunks of the outward-oriented sectors, no one knows when people will be (a) able and (b) in large numbers willing to travel. Every business owner and manager either recognises this outlook, or should be now in the process of working it out.

And, although the government knows more about its strategy (if there is one – David Skegg this morning being the latest to cast doubt on that) than we do –  although even that is mostly because they’ve not been at all transparent in releasing advice, Cabinet papers etc –  in reality they really don’t know much more than any of us.  Facts will surprise, public pressure will surprise, and even if there is a strategy now, it may well change faced with future reality (that isn’t a criticism, it is just the nature of things).

And so government policies shouldn’t be based on some particular vision or dream of what the economy should or might look like –  except perhaps being supportive of getting back to full employment just as quickly as possible.   Although there may be some practical advantages in getting short-term income support to households via current employers (it is not clear quite what those advantages are, unless MSD is truly overloaded), we shouldn’t be attempting to design packages that attempt to lock in place existing firms, existing industries.  But that is still the tendency/temptation in too many places, including in the latest Australian package yesterday.

It is also why I still think that my “ACC for the whole economy for one year” model is the best conceptual framework around which to organise support and assistance.

Recall the key dimensions from a couple of earlier posts:

  • Parliament would legislate urgently (preferably, or the guarantee powers in the Public Finance Act would be used) to guarantee that every tax-resident firm and individual in the coming year would have net income at least 80 per cent of their net taxable income in the previous year (loosely the 2019/20 and 2020/21 tax years, but of course the slump will already have been serious this month),
  • the guarantee would be restricted to a single year (Parliament and the Minister can’t bind themselves not to extend, but the framing would be a one-year commitment),
  • it is a no-fault no-favourites approach.  My taxes have to prop up Sky City just as yours will have to support people/firms you really can’t stand.  Picking favourites is a recipe for corroding trust and the willingness of the public to see the public purse used responsibly to get us through the next few years,
  • since the guarantee would be legally binding, and structured to be assignable, financial institutions should generally be willing to extend credit on the security of the guarantee (they don’t need the cash upfront, just the assurance that the Crown can’t really walk away).  This is primarily relevant to businesses, given the ‘mortgage holiday’ banks have already agreed,
  •  the guarantee need not displace actual immediate income support measures, designed to get cash in the pockets of households now (rather any such state payments would be factored in when everything was squared up at the time of next year’s tax return), but especially if you are in lockdown and any mortgage commitments are deferred, high levels of immediate cash are less an issue than usual (not much to spend cash on).
  • for firms, the guarantee would not be conditioned on any commitment to stay in business.  In you are a heavily indebted tour operator in Rotorua and you think it will be three years until “normality” returns, walking away (closing down) now may well make a lot of sense.  The 80 per cent guarantee for one year is simply a buffer, that limits the downside for the first year, and buys some time both for the business(owners) and their financiers.    For some, however, it will be enough to give them time, and access to credit, to get their firm to a scale best suited to being able to come back.  But that needs to be their judgement, and that of financiers, not a template imposed from Wellington.
  • for individuals, the income guarantee will also help to underpin public support/tolerance for whatever restrictions remain in place for an extended period.  In addition, I quite liked the idea the New Zealand Initiative put forward the other day (of allowing people to borrow –  capped amounts – directly from the Crown, akin to a student loan, with income-contingent future repayments) and also like Michael Littlewood’s proposal –  akin to what has already been done in Australia – of allowing people easy access to a capped portion of their Kiwisaver funds, it being after all their own money, and times being very tough. (KiwiSaver and COVID Littlewood)
  •  there might be merit, fiscally and from a fairness perspective, in considering supplementing the downside guarantee with a one-year special additional tax on any 2020/2021 earnings more than 120 per cent of the previous year (there wouldn’t be much revenue in it, and it plays no stabilisation role, but there might be an appealing political/social symmetry).

The key pushback against my proposal is the expense.     My view is that that particular concern is overdone, and that the likely cost would not be unsustainable (and quite a bit of it it is already being spent anyway, in measures announced so far).

GDP last year was $311 billion dollars.  Since I only propose guaranteeing 80 per cent of the previous year’s net income, it is only if aggregate GDP drops by more than 20 per cent for the full year that the numbers start getting large at all (there will be expense well before that because many people –  notably public servants, and those in some “essential industries” – will face no hit to wages or profits, while others are already experiencing huge losses.  Suppose that full-year GDP fell by even 30 per cent –  larger than any guesstimate I’ve seen, although who knows what next week will bring-  and you still looking at an overall fiscal cost that should be no more than perhaps 20 per cent of GDP.  That simply isn’t an unbearable burden for a country that had net general government financial liabilities last year (OECD measure) of 0 per cent of GDP (no, no typo there, zero).

Perhaps some readers will look at this idea and go “nice idea, but aren’t we better saving our fiscal capacity –  including political tolerance for more fiscal support –  for after the crisis is over; after all, no one knows how long that will be”.  I guess my response is that

  • monetary policy, including the exchange rate, can do most of the recovery work, if it is allowed to be used aggressively, and
  • this is the sort of pandemic national self-insurance policy we might have voted to put in place 20 years ago, if we’d thought hard about the risks (and private insurance really isn’t an option; even if the policies existed, in a severe enough crisis, there will be systemic failure of insurers).  We are each eligible to draw from the national pool, no questions asked, as a one-year buffer (another way of thinking of it is as akin to redundancy pay or income protection insurance).  In fact, one could reasonably argue it was, at least implicitly, the policy we did set up, without quite being explicit about it, in choosing to run consistently low levels of debt, always citing our vulnerability to natural disasters etc (even if pandemics weren’t front of brain most of that time).  It is about a buffer, buying time to learn more, explore options etc, without locking anyone (firms or households) into arrangements/relationship that just might not be sensible again any time soon.

If something like this isn’t done soon, a rapidly growing number of firms will simply fail/close.  The extreme uncertainty combined with the extreme revenue losses will leave too many thinking they have no realistic choice.  And the government shows all the signs of helping the bigger and more prominent firms –  perhaps even less generously than I’ve suggested here, but in ways that could deeply sour public sympathy for doing anything much, and undermine any sense that the government is treating people and firms in a way that will perceived as fair and equitable.


The government should insist the OCR be deeply negative for now

It really is quite remarkable that the government is willing to shred our civil liberties, abandon Parliament, ban funerals –  to my mind, the most egregiously inhumane, almost evil, specific of the entire Ardern partial lockdown –  and accentuate, for now, the temporary implosion of the economy, and yet the same government is unwilling to act to bring about lower interest rates.

They have a recalcitrant public agency that simply refuses to (has formally promised not to) act, in face of a huge slump in activity and employment, a period when time has no economic value.  And yet they just sit politely by, as if this was some minor difference of emphasis over 25 basis points or so.  They have all the powers they need to act, but simply refuse to do so.  Having chosen not to act, interest rates are current levels are now the direct responsibility of the Prime Minister, the Minister of Finance, and the rest of the Cabinet collectively.

Consider a thought experiment.  Suppose that for the last 18 years instead of an inflation target of 1-3 per cent, centred on 2 per cent, we’d actually had a target of 9-11 per cent, centred on 10 per cent. (Note, I do not think this would have been an appropriate or necessary policy, but just humour me for a moment).  And pretty much everything else –  good and bad – about the economy to the end of 2019 unfolded as it did.  Assume that coming out of the Great Recession a decade ago, central banks would still have struggled to (or been as reluctant to) do what it takes to keep inflation at target, but they had more or less got there by 2019.  Perhaps core inflation was about 9.7 per cent, perhaps inflation expectations (a mix of survey and market measures) were somewhere between 9 and 10 per cent.    And, consistent with that, assume the OCR had been 9 per cent at the end of last year (a full percentage point below the target midpoint just as it was in real life.)

(And, yes, I know all about the interaction between the tax system and inflation which mean these things aren’t exact by any means, but for now this is just a very simple story.)

And then the coronavirus hits, and all that followed around fighting the virus  – policy measures here and abroad, personal choices to distance etc here and abroad – happened just as in real life.

Oh, and the economy?  Well, serious people would still be talking about the unemployment rate going to perhaps 25 per cent, a really major export industry had simply closed down, investment demand (national accounts sense) was heading for zero, and so on.

Does anyone imagine, for the slightest moment, that in such an alternative world –  but a path we and other countries’ could have chosen –  that the OCR would have been cut by only 75 basis points?

Of course not.    Not only do typical New Zealand (or US) recession see around 500 basis points of cuts, but even in crisis-type events in the past (precautionary responses to 9/11 and the 2011 earthquake) the Reserve Bank has cut by a bit more than that  –  and the Christchurch earthquakes, after the very brief initial hiatus, represented one of the largest positive, unforecast, demand shocks to the New Zealand economy ever experienced.

Who knows how low the OCR would have been cut in that alternative world where the OCR had started at 9 per cent.  But we know that in the 2009/09 recession – when GDP fell by about 3 per cent –  the Bank cut by 575 basis points. In the US, where the Fed cut by about 500 points in 2008/09, versions of the Taylor rule later suggested that the Fed funds rate could more appropriately have been cut by another 500 basis points on top of that.

So why (didn’t and) don’t adjustment of this magnitude happen?    Because central bankers abroad –  but specifically here, where the MPC has set an explicit floor at 0.25 per cent –  have becom almost terrified of the possibility of seriously negative nominal interest rates, and have spent a decade doing nothing much about making such outcomes work effectively.  Far too much of the focus of central bankers this last decade was on looking to the next tightening, and the idea of “normalisation”, not preparing for the next serious downturn –  now upon us in unusual and particularly savage form.

But they would have had few qualms in lowering a nominal OCR of 9 per cent –  in the presence of a 10 per cent inflation target –  to, say, 1 per cent.    It makes no sense.  It is bad money illusion in reverse, without any good justification.

Now, of course, everyone knows and accepts that monetary policy isn’t going to stop GDP collapsing over the next month (at least) –  perhaps on a scale just without precedent ever (if we ever had the data).  But it wasn’t really that much different in the fourth quarter of 2008.  Really substantial cuts in official interest rates happened, and rightly so, but in a climate an extreme loss of confidence, fear etc, that wasn’t going to stop GDP falling right then.  At the best of times, the lags are longer than that.

But markedly lower interest rates, when massive excess capacity is opening up and the neutral interest rate is falling, still do a number of useful things:

  •  they signal to markets (and the wider public) that the central bank is thoroughly serious about doing its job, and keeping inflation expectations up very close to target  (the risks around this not happening are much greater in our real world than in the alternative, higher inflation target, world I mentioned above),
  • they get relative prices positioned as soon as possible in way that puts the economy in as less-bad position as possible for the eventual recovery (not just the bounce back to a, say, 15 per cent loss of GDP if the lockdown itself is eased/lifted),
  • and the greatly ease debt servicing burdens, reallocating income from (close to) variable rate depositors to (close to) variable rate borrowers, consistent with the new stylised facts in which time for now has no economic value.   As it is, short-term term depositors are still being taken at positive real interest rates – even as the economy is shutdown –  while variable rate borrowers, even with rock-solid collateral, are still paying substantially positive real interest rates.  All this at a time when the government appears keen to encourage firms to borrow more….

Given the significant margins between the OCR and retail interest rates (lending and borrowing) we really need, and should have, a substantially negative OCR –  deeply negative in real terms, and not that inflation expectations have been falling.

You might be wondering if (materially) negative official interest rates is just some hobbyhorse of mine.  Even if that we the case, it is still the arguments that should be examined, not the advocates.  But it isn’t the case.  Over the last decade or more, people like former Bank of England Monetary Policy Committee member Willem Buiter, or US academic Miles Kimball (who was the guest of the RB or Treasury just a few years ago) have been among those pushing the case for ensuring that official interest rates could be taken a lot lower in the next crisis.

As a refresher, the twin obstacles are that (a) central banks now have a monopoly on the issuance of physical currency, and (b) as monopolies do, did not innovate over time so still operate with much the same rules and technology as 100 years ago.  If the OCR were to be taken deeply negative, on those rules, it would at some point become attractive for wholesale investors, in particular, to switch from holding securities and bank deposits, to holding physical cash.   If so, you can cut the OCR all you like and it won’t make much useful difference to anything, except stocks of zero-interest cash.  It doesn’t happen easily: storage and insurance costs are real, AML restrictions are annoying, and it isn’t worth doing if you think the OCR will only be very low for a month or two  We don’t know quite where the limits are, but the current consensus has been that no one is really willing to try  –  on current rules – below about -0.7 per cent.

But those rules and practices can be changed.  Ideally, doing so would have been properly consulted on and socialised over a long period by governments and central banks. But in a crisis –  perhaps especially a crisis where surfaces, including bank notes, can carry the virus –  things can be done very quickly.  They should be in this case.    Suspend the issuance of net new bills in excess of $50, cap the total currency issuance (for now) at, say, 20 per cent above the current level, and if revealed demand for currency is higher than that, ration by price (run a weekly auction at which banks offer a premium over face value to buy physical currency, which they can pass through to all customers or just those taking a large amount of cash, at their discretion).

Of course, having led to believe for the last couple of years that a modestly negative OCR was an option they were open too, the Governor now tells us that the Reserve Bank simply never got round to ensuring that all banks’ systems would be able to cope with negative interest rates.  That’s a pretty stunning indictment, that he/they should be held to account for one day (perhaps the Simon Bridges-chaired select committee could summon him?)

As I’ve noted before, mostly even if what the Governor says is true, it is more likely an excuse for inaction (action they don’t want to take) rather than a real and valid justification.  As I’ve noted previously, many wholesale interest rates abroad have been modestly negative for years now.  An bank operating internationally has to have been able to cope (even in New Zealand some of our inflation indexed bond yields had gone negative).   And even setting all that aside, if the OCR were set to say -2 per cent, that would still only be consistent with term deposit rates near zero and lending rates still positive (business one quite a lot positive).    There is material relief that can be given, that really should be given urgently, without the main retail rates even getting to the point of going negative.   And, frankly, it is surely time for some naming and shaming.  If better banks have systems that can operate negative rates, it will provide a competitive advantage and put pressure on those who just didn’t get ready to fix things quickly (even if initially in an improvised way).  In the current climate, an OCR of -5 per cent might be something good to aim for.

A couple of my old colleagues have offered brief dissenting views in comments on earlier posts. I appreciate them taking the time to do so.    I dealt with the first comments, from Geof Mortlock, in a post late last week

A former colleague, from mostly a banking supervision background, left a comment yesterday disagreeing with my call for negative rates.



What to make of Geof’s specific arguments?

First, I don’t accept that it would be destabilising to the financial system at all –  if anything, at the margin it would assist financial stability by shifting the burden from borowers (increasingly indebted in most cases) to depositors (time is offering no real return right now).

I also don’t belief that there would be anything like the sort of flight to Australia Geof suggests.  After all, exchange rates –  even NZD/AUD are volatile enough and transactions costs high enough – to swamp any possible small interest gains.   Perhaps more to the point, in a floating exchange rate system, unless there is a run to physical cash – and recall that under my model cash would be more expensive to purchase/withdraw –  the total deposits in the banking system do not shrink because someone seeks to withdraw money.    For every seller of NZD there has to be a buyer.  And, frankly, the more people wanted to sell NZD at present, the better –  a materially lower exchange rate is one more helpful part of the stabilisation package.

Finally, Geof also notes that lower interest rates won’t do much to boost spending right now.  That is, of course, true and a point I’ve been making throughout.   The point of policy right now is not to boost spending (the time for “stimulus” will be later) but, in this case, to ease servicing burdens materially, and to help stabilise and reverse the falls in medium-term inflation expectations that risk materially complicating the recovery phase, by starting us off with higher real interest rates than those we went into the crisis with.

Ian Harrison, now of Tailrisk Economics, also weighed in

I think the negative interest rate is a diversion, with several problems and does nothing that can not be done more effectively in most cases by direct interventions in our wartime economy.

Thinking about the flow through to interest rates people are paying – banks have reduced the floating rate to 4.5 percent – a huge margin still. It appears that the fixed rates where the business gets done haven’t moved much at all.

My off the top of the head suggestion is to pretend that time doesn’t exist for one two or three months. Time bound contractual -rents interest wouldnt exist for that period. lots of fishhooks and inequities of course. and it would put the banks under pressure. If that got too much then the OBR could be activated for the entire banking system and owners’ interest effectively confiscated.

But I think this is itself something of a distraction, and (after all) my scheme actually involves some quite direct interventions.  I quite like, at a conceptual level,  the idea of pretending that time doesn’t exist for contractural purposes in the midst of the crisis, but no one believes that problems are going away in two or three months.  When, for example, do we suppose the tourism sector might be back to “normal”.  Not next year would be my guess: we need relative prices to signal resource-switching and draw forward demand as recovery begins to beome possible.

As for OBR, it is of course a bank failure/resolution tool, but for now at least the presenting problem is not potential bank failure  (that could become a risk in time, as the toxic brew of falling asset prices and collapsing incomes lasts long enough) but the sustainability of borrowers themselves.  And using OBR in a bank failure –  unlikely to ever happen –  does nothing to relieve borrowers or support existing companies holding together.

Ian followed up on Friday with another comment

The problem with relying on a reduction in the OCR is that the transmission to borrowers who actually need the relief is highly uncertain. Some thing as direct as a maximum interest on bank lending would have some of the desired effect. – say 6percent, accompanied by no reduction in lending limits.

To which my response is that yes the transmission is a bit uncertain in the abstract.   In concrete terms though, what Ian suggests could be achieved by making it a condition of participation in the governments’s business loan guarantee scheme that any OCR cuts are fully, or almost fully passed through.  If necessary –  it is an emergency – legislation could be used directly.   And we don’t need 6 per cent interest rates for reasonable credit business borrowers at present, but something more like zero or negative (still a significant risk margin over, say, an OCR of – 5 per cent),

And finally, Geof put in another comment

Your continued advocacy for zero or negative interest rates ignores the commercial reality that, in periods of stress, such as this, the risk premium in interest rates will rise. This as true (maybe even more so) in a period of prospective deflation. Lenders will price in the risk of lending such that, even in periods where the zero default rate might be zero or negative, bank lending rates will be positive. Equally, bank funding rates are unlikely to go to zero or negative given that depositors, especially at the wholesale level, are factoring in the increased (but still low) risk of bank default. As credit markets globally tighten further, that risk premium is likely to rise. I therefore view your stance on negative interest rates as commercially unrealistic and inconsistent with how a well functioning market could be expected to operate.

As for Ian’s suggestion of regulatory caps on interest rates, I think that would be daft. Such regulatory responses rarely produce desired outcomes. They distort risk pricing in both funding and lending rates and impede efficient credit allocation.

The smartest way to address borrower stress is to provide targeted income support for a defined period, together with debt servicing holidays. If the lockdown is effective in markedly lowering infection rates to a low level, then we should be able to progressively normalise things after 4 to 8 weeks. Border controls will need to continue for months to come, but if the quick result (15 minute) tests, which are apparently under development, can be deployed as a prerequisite for boarding a plane or ship bound for NZ, or at leadt on arrival here, then maybe the economic damage can be reduced to a significant degree.

What is needed now are the indicators (eg infection rates etc) that will be applied for a progressive easing of restrictions after this 4 week period.

On his first point, as I’ve noted since the OCR in this climate should be deeply negative, retail interest rates that would be zero or slightly negative –  not that 6 per cent advertised rates ordinary SMEs face at present –  leaves plenty of margin for risk premia.

On his second point, if depositors are so confident about alternative investment options –  whether other countries or other assets – as to reluctant to accept negative deposit rates, that is (all else equal) a good thing, monetary policy at work.  Either they are spending (ie demand rising), trying to shift abroad (lowering the exchange rate, welcome), or supporting otherwise cheap asset prices (again one way monetary policy works.

On regulatory caps, of course in general they aren’t a good thing. They might not even be needed with a deeply negative OCR, but even if they are sometimes exceptional times call for exceptional measures.  We’ve seen a few in the last few weeks….

For the rest, I’m not debating what might or might not be possible on testing etc, but no one supposes that even if the current lockdown is lifted in a month or two, that we will quickly snap back to even a recession of the relative shallowness (by these standards) of 2008/09.  We still need, and should want, deeply supportive monetary policy, including because whatever fiscal policy might be able to do as time goes on, it is almost inevitable that there will be pushback before that long about the bills being run up for the future.  Monetary policy is designed to be the principal stabilisation and countercyclical tool.      If it is allowed to work and used decisively again, it can play that role again once the worst of the virus is behind us.

I’m happy to engage with, or respond to, any other sceptics with specific points.  But on the face of it –  and thinking much more deeply and practically – we are overdue some vigorous easing in monetary conditions.  The MPC could and should do it.  But if they refuse, the government should –  in these extreme circumstances –  simply override them and compel them to act.

(In the meantime, of course, the bigger issue is that of extreme uncertainty and downside risk around business and household incomes.  The government has done quite a bit to support households, although quite time limited.  On the business side, there isn’t much other than encouraging firms to take more debt, when for most it simply won’t be worth doing so.  And there are disconcerting hints of the government helping big firms, but not the vast mass of companies that make up most of the economy. My “ACC for the whole economy”,firms and households, remains the best option to provide some insurance, some certainty, to buy time, all without attempting to lock in firms that really may now have no readily conceivable future.)