Illusions of History

That is the title of a new New Zealand Initiative report out yesterday, with the subtitle “How misunderstanding the past jeopardises our future”.

I’m no fan of this government, including its economic policies, and often lament how little New Zealand economic history is taught (none at all for example in our capital city university), so I should have been favourably predisposed towards such a report, which appears to have been prompted (specifically) by a couple of recent quotes from the Minister of Finance. This is how the report starts

And here is how it ends

You’ll get the drift.

I’m very sympathetic to the story that both Robertson and his boss are keen on a “bigger and more intrusive and directive government”, and it is clear that they have no serious ideas about (and demonstrate little interest in) reversing the decades of relative productivity decline. Most likely, their approach will see New Zealand outcomes worsen relative to those in the rest of the world. I’ve also been quite critical of this year’s Budget and the huge cyclically-adjusted deficits the government was choosing to run at a time when their forecasts suggested the economy was running at pretty much full capacity.

And yet, and yet.

There seem to be two themes or driving concerns to the report. The first is to re-present aspects of New Zealand’s economic (policy) history in ways less sympathetic to Grant Robertson’s rhetoric, and the second is alarm – I would probably call it alarmism – about the current and prospective global situation. On that latter, these paragraphs also come from the last couple of pages of the report.

I’m probably not much more keen on big debt and big deficits than the report’s author – Bryce Wilkinson – is, but this sort of broad-brush rhetoric seems set to discredit useful and important points that could be made, especially in the New Zealand context.

Are there “unresolved fiscal problems that followed the 2008 global financial crisis”? Most probably there are, in some countries anyway, although even in the United States – exemplar of chaotic fiscal policy surely – the problems were evident before 2008, were worsened again by the Trump tax package, and are now being worsened again by what the Democrats are now trying to push through. It is a sorry picture – and the US is still a consequential country – but it isn’t the New Zealand story. We ran into big deficits for a time after 2008 – some mix of a late spend-up by the previous government, poor macro forecasts, the recession itself, and the earthquakes – but we pulled ourselves out of that hole, with (in the main) bipartisan support for doing so. On the OECD’s net general government financial liabilities measure (the broadest and most internationally comparable) we were at zero net debt just prior to Covid (and almost a quarter of OECD countries had positive net general government financial assets).

As Bryce acknowledges, the New Zealand government’s own fiscal projections have debt stablising and then slowly falling as a per cent of GDP. And if the level the socialists are happy to see it stabilise at might be higher than either Bryce or I would prefer…it is hard to get very excited about that level. Whichever measure you prefer, on none of them is there any risk of New Zealand running into a public debt crisis. Of the government’s range of debt indicators, I like the net debt one that includes NZSF assets: Treasury see that being 25 per cent of GDP in 2025.

And what about “monetary excesses”? Well, I’m not fan of QE-type programmes, but mostly because they make little sustained macroeconomic difference, but provide central banks some feeling of “doing something”. And perhaps the world really is about to see a sustained break-out of inflation, but……nowhere in the advanced world, not even in the US, are financial markets (with money at stake) suggesting that is the most likely outcome. Our own central bank, having presided over 10 years of undershooting the inflation target, was actually on the brink of tightening just last month, and may yet do so next month. At the moment, markets think governments will allow central banks to (and central banks will act to) keep any sustained lift in core inflation pressures in check. Markets may be wrong – it has been known – but I’m not sure our Minister of Finance has a strong ground for thinking they are.

And what about the history, the central part of the report’s title?

There is a rather weird reverence in some circles for the first Labour government, at least the period under M J Savage in the late 1930s. Labour seem particularly prone to it, which I suppose is somewhat understandable, but it even infects the other side of politics at times (In this post I unpicked some Todd Muller rhetoric on similar lines, during his brief stint as Leader of the Opposition). It seems to be sentimental rather than rigorous, and the NZ Initiative report is a useful quick canter (albeit with a historical error or two) through material on the macroeconomic mess that Labour government ran us into by 1938/39. At a macro level, we were simply saved by the war, but then lived with the panoply of microeconomic restrictions and controls in one form or another for the next 45 years. But it is rather light on some significant differences from the present: not only was the New Zealand government very highly indebted in the late 1930s (well over 100 per cent of GDP, not primarily the fault of the Labour government), but we were also running a system of fixed exchange rates. And we did not have a monetary policy run consistent with the demands of the exchange rate system

There is more (also with some arguable interpretations/emphases) on the macroeconomic mess New Zealand was in by 1984. That mess can be overstated – partly because inflation itself overstated the severity of (notably) fiscal deficits – but the truth was messy enough. But it wasn’t primarily a fiscal crisis – there was no question of default, no question of lenders being unwilling to lend to us – but a productivity underperformance one and (in the immediate) a monetary policy crisis. We had a fixed exchange rate regime, and we did not have a monetary policy run consistent with the demands of the exchange rate system.

By contrast, at present we have a long-running woeful productivity performance – basically the enduring theme of New Zealand economic history at least since World War Two – but we know (including because we experienced it for the last 25 years) that that isn’t inconsistent with macroeconomic stability.

We have large fiscal deficits for this year and next (on the Treasury’s best interpretation of government policy as communicated to them) but public debt ratios that are low by any standards (cross country or historical) at a time when servicing costs, while not as low as in some countries, are very low by historical standards. The effective duration of the government’s debt portfolio is shorter than desirable – and the LSAP programme is responsible for that – but crisis material it isn’t (and it wouldn’t be even if we had another bad earthquake in the next few years).

And, we do have a central bank that – for all its many weaknesses (mostly the key people) – still operates, by law (and it seems in practice) at arms-length from the government, and (for all its florid rhetoric about other stuff) shows every sign of easing policy when core inflation falls away and tightening policy when core inflation looks like rising. And which has a target, set by the government, that is totally conventional internationally. And if nothing else, having a monetary policy that runs that way – consistent with our exchange rate regime and with the inflation target – makes things utterly different, in macroeconomic stability terms, than in 1938/39 or in 1984.

Having said that, I suspect the real thing that drove the report was the opportunity to litigate Grant Robertson’s take on the 4th Labour government. Personally I tend to take that sort of Robertson rhetoric with a considerable pinch of salt, since a great deal of his style seems to involve the appearance of product differentation from the 4th Labour government even when the substance barely changes (the Reserve Bank Act amendments are a classic examples). Feelings around the late 1980s are clearly still raw, especially in the Labour Party, and it seems to be good politics to pander to that.

But Bryce Wilkinson frames six “myths” about the 1984-93 reforms. He summarises them thus

Personally, I think the truth is probably somewhere in the middle. Take for example, the first one. The Robertson quote emphasises the damage to communities, and even Wilkinson in the report acknowledges the pain of the reforms for many. He might argue it was unavoidable by then, and Robertson would have been better not to have talked about “economic carnage” (especially when the basic economic model now isn’t that different).

Were the reforms “extreme”? I don’t think so, but they were unusually far-reaching, and in places went where few other countries had yet gone. For better or worse (I think mostly better) they positioned us very well in many international policy/institutional comparisons by the 1990s having started well behind. And I recall the time we spent in one OECD review of New Zealand urging them to take out language (which they intended as a compliment) suggesting that our reforms were unusually ambitious.

Were the reforms “undemocratic”? At one level, clearly note. They were undertaken by democratically-elected governments. But Wilkinson’s specific rebuttals risk inviting derision. He suggests that the snap election “gave no time” to Labour to articulate its ideas…..which more or less concedes the platform was never campaigned on. I have a bit more sympathy for the 1987 re-election argument, except…..that Labour’s manifesto that election, with talk of further significant reforms, was published after the election. And the 1990-93 Bolger government story was also a mixed bag – labour market reform was a significant part of their campaign but (for example) benefit cuts were not, let alone the amped-up superannuation surcharge. Call it democratic or undemocratic as you like, perhaps even call it unavoidable, but it wasn’t very transparent ex ante.

Call my overly literal, but “decimated” probably roughly accurately describes the welfare system effect – it was still there and, rightly or wrongly, just quite a bit less generous than it had been before.

And then there is myth 2. Bryce and I have debated this point on many occasions over the years, and I’ve written about it here before. I can’t prove that he, or Roger Kerr, have not been surprised at how poorly the New Zealand economy has performed over the last 30 years, or by the failure to even begin to close the gaps with the OECD leaders, or by the widening productivity gaps to, notably, Australia. But I’m pretty sure most people who supported the reforms don’t think outcomes have lived up to their expectations and hopes. I recall the very first time I ever appeared before a select committee it was with the Bank’s then chief economist to tell MPs our story about how as we emerged from the reforms we would expect multiple years of above-average growth, consistent with closing the gaps to the rest of the world.

But to me the single best illustration of the point was this photo, from 1989 but rerun in the Herald a decade ago

For the younger among you, that is David Caygill, then Minister of Finance and one of the foremost reformers. It is pretty clear he expected the reform programme – which was extended after his time – to pay off in closed productivity/GDP gaps. It is also clear that it didn’t.

Bryce Wilkinson thinks more should have been done, and could have been done. He was a member of the 2025 Taskforce a decade ago on closing the gaps to Australia. But even if he is right on that – and on some specifics I agree with him – I’m not sure what is gained by continuing to run the line that the economic outcomes really weren’t disappointing or unexpected at all.

To close, the New Zealand Initiative’s report ends up being a funny beast. For better or worse, most people probably won’t care about the pre-84 history, and it isn’t clear how much relevance the specifics have to today anyway. And if there is a lot wrong with this government’s economic policy (and there is) this report is too once-over-lightly (and a little florid in places, given our relative macro stability) to add much value or get much traction. Perhaps there is still a place for debates about the 1984-93 period – in fact there definitely is, even granting that to many younger people it is (my daughter’s phrase) “ancient history” – but to do so usefully probably needs more space, more nuance, and more data than is in the relevant section of this report.

Puzzling over the New Zealand macro data

I have no doubt that our labour market has been tight and that core inflation has been rising (finally above the target midpoint). It won’t make that much difference in the long-run, but it is a shame the “Level 4 lockdown” didn’t come a day or two later because if it had the Reserve Bank would, appropriately enough, have raised the OCR. I also don’t have any reason to doubt that there was a lot of GDP growth in the June quarter.

But that doesn’t mean there aren’t some puzzles.

According to the official data the New Zealand economy is quite a lot bigger than it was pre-Covid, Of the two quarterly measures of real GDP, one was 5.3 per cent higher in the June quarter than it had been in the December 2019 quarter and the other was 4.3 per cent higher. Average the two and the best guess is a lift of 4.8 per cent. That’s a lot, especially for a country that has (a) had at best mediocre productivity growth in normal times, and (b) has had the borders largely closed to new migrants (and quite difficult even for returning New Zealanders) for almost all of that period.

Ah well, perhaps it is all the cyclical stimulus, with fiscal and monetary policy “finally” (as some might put it) coming to the party and giving the economy a well-overdue boost. But……according to SNZ, the unemployment rate in the June quarter was exactly the same as it had been in the December 2019 quarter, and so was the employment rate, so there was no sign that suddenly we’d been able to get hitherto-unutilised resources producing.

So where might the reported growth have come from? Statistics New Zealand does not publish an official quarterly series for labour productivity, but we can derive one ourselves. In this chart I’ve shown growth in labour productivity, using a measure in which the two measures of real GDP and the two hours measures (HLFS and QES) are all set to equal 100 at the start of the chart, and the resulting real GDP per hours worked indicator is calculated and shown.

New Zealand’s productivity growth has been mediocre for a long time – little over 10 per cent in total in almost 15 years – and yet according to this indicator, calculated entirely with official statistics, closing the border (with all its ramifications), and for that matter diverting material resources into testing, MIQ, enforcement etc) has resulted in no deterioration in productivity growth. If anything, productivity growth over the last 18 months has been a bit higher than usual (but such is the noise, and routine potential for revisions we probably should not make too much of that lift).

How can this be? In the depths of lockdowns there was some sign of “averaging up” – low productivity workers (notably in tourism and hospitality) will have been disproportionately likely to have lost jobs/hours, and even if everyone else was only as productive as ever, the economywide average would have risen. But if, as there probably was, there was something to that story 18 months ago (and perhaps right now), it can’t really have been the story in June when – as a already noted – employment and unemployment rates were right back to pre-Covid levels.

So if less than half the reported real GDP growth came from labour productivity, and none came from a reduction in the unemployment rate or increase in the employment rate, where did it come from? The only other possibility is more labour inputs. And (unusually) the HLFS and the QES happen to agree: whether hours worked (HLFS) or hours paid (QES), hours in the June quarter were about 3 per cent higher than they’d been in December 2019 (all data seasonally adjusted). And that isn’t (mainly) individuals working longer hours, as both the HLFS (people employed) and the QES (filled jobs) suggest quite a significant increase in the number of people working.

And why is that? Because SNZ tells us that the population has been growing still quite rapidly: the “working age population” for example is estimated to have been 2.5 per cent higher in June 2021 than in December 2019. The official total population is estimated to have risen by 1.9 per cent over the same period.

How come? Well, this is the story SNZ currently tells.

The orange line represents natural increase (births less deaths), which will be measured accurately. Natural increase is quite stable, and quite modest, at just over 0.5 percentage points contribution per annum. The variability – and the huge measurement uncertainty – comes with the net migration numbers.

According to SNZ we had the three biggest quarterly net migration inflows in the 30 year history of the population series in the September and December quarters of 2019 and the March quarter of 2020 (something not showing in their contemporaneous estimates). And on their reckoning, net migration has been positive throughout the entire Covid period, dipping very slightly negative for a single quarter.

Perhaps it is all true. But here, on the other hand, is the monthly series of net arrivals and departures from New Zealand (all citizenships, all purposes) since the start of last year.

As one might have expected, there were really big net outflows over the three months to April (Covid having first become a significant issue near the peak of the tourist season), but there has also been a steady outflow ever since. In the year to June, for example, a net outflow (all purposes) of 35226 people, with only a single month seeing a net inflow. (The net outflow continued in July and August). SNZ, by contrast, estimate – and it is an estimate, not a full count unlike the air traffic numbers – net migration inflow of about 5000 over that year.

You wouldn’t expect the two series to match exactly. There will have been people (New Zealanders and foreigners) going and coming who were not away for long, but in any sort of net sense those numbers must have gotten very small as the months went on – hardly any holidaymakers for example. Whatever the precise composition we know that there were few people in New Zealand in June 2021 than there had been either in June 2020 or in December 2019, even if SNZ claims that the official resident population has kept on increasing.

If so, it is a bit of a mystery where all those extra hours/jobs are, given that the employment and unemployment rates haven’t changed. One might reasonably suggest that the GDP (and hours/jobs) numbers themselves build on estimates of the population that are more than usually uncertain.

One other way of looking at things is to see how Australia is reported to have done. It helps that the ABS reckons that by the June quarter of this year, Australia’s unemployment rate was also back to pre-Covid levels. As it happens, labour productivity is also estimated to have risen quite a bit in Australia – up by 2.1 per cent over the 18 months to June 2021. Of course, Australian productivity growth has typically outstripped New Zealand’s, but it still seems surprisingly high given that their borders were also closed.

But the ABS also reckons that real GDP in Australia in the June 2021 quarter was only 1.6 per cent higher than it had been in December 2019. And before anyone mentions Victorian lockdowns, NSW Delta, or whatever…..this was June, when things were looking good across Australia and New Zealand (remember the “bubble”).

And if GDP growth was less than productivity growth then….hours worked are estimated to have fallen. by about 0.5 per cent.

So what explains the difference?

Here is the ABS version of the population growth components chart.

Again, natural increase has been low but stable, but (a) Australia doesn’t show anything like the NZ net migration spike pre-Covid (the Australian 2019 numbers looked much as they had for the previous few years), and (b) net migration since the middle of last year has been consistently negative. These data are only to March 2020, but the population number implicit in Australia’s June GDP and GDP per capita numbers is consistent with a small quarterly net inflow in the June quarter.

I don’t have answers, only questions. But recall that (a) over the 18 months from December 2019 to June 2020 Australia had much the same experience of Covid as we did, (b) in both countries, unemployment was back to pre-Covid levels in June 2020, and (c) Australia had very stringent restrictions on its nationals leaving Australia (unlike New Zealand) so it seems a little hard to believe that Australia (the much richer country) has had material net migration outflows while we have had modest inflows. The total arrivals and departures data for Australia also show big net outflows, except in the June quarter of this year.

Perhaps it is true. Perhaps too productivity growth (in both countries) really held up rather strongly through the uncertainty and disruption of Covid. Or perhaps – perhaps especially in the New Zealand case – much will just end up getting revised away. The biggest annual revisions are due over the next three months, and often they have been big indeed. There are other challenges, such as the 3 per cent levels gap between the production and expenditure measures of GDP.

On the productivity front, it would defy almost all conventional economic models if productivity growth was really no worse than usual amid closed borders, rampant uncertainty etc etc (with no discernible cyclical effects either). Those firms in today’s media sending staff abroad uncertain when they can come home clearly don’t believe travel and face to face contact don’t matter.

And then, of course, we have all the uncertainties about SNZ measurement of the latest lockdown to look forward to. As I recall last year, their estimates for last June treated school inputs and outputs as having continued largely unchanged, a story that probably won’t have rung true to most parents, and doesn’t now seemed backed by literature on loss of learning in lockdowns.

Tightening LVR restrictions

The Reserve Bank’s faux “consultation” on tightening LVR controls closes today. If you felt so inclined the consultation document is here, but it isn’t clear why you’d bother except for the record. Poor performance by powerful government agencies shouldn’t go unremarked.

I have put in a a short submission, simply to document some of the many problems with the consultation.

submission to RB on tightening LVR restrictions Sept 2021

Much of the text simply elaborates points I noted in a post last week. But here are a few extracts

More substantively, there is no discussion at all in the consultation document of the Reserve Bank’s capital requirements or the capital positions of the banks you are putting more controls on. As you will be well aware, the risk-adjusted capital ratios of New Zealand banks are high by international standards, and will be increased further – as a regulatory requirement – over the next few years.   Capital is, and always should be, the key buffer against loans going bad, and we know that the New Zealand framework imposes relatively (by international standards) high capital requirements in respect of housing loans, including high LVR ones.   It is simply unserious – or a desire to operate ultra vires – not to engage with the capital position of the banking system.  That is especially so as your consultation document acknowledges that tighter LVR controls will impair the efficiency of the financial system.  Given that acknowledged cost, there has to be a clear gain to financial system soundness (the other limb of your statutory goals/purposes) from any new regulatory impost, but your document makes no effort to quantify such a gain (reduced probability of failure), or to demonstrate that tighter LVR controls are the least-cost way to generate such a reduction.   There is not, I think, even any attempt to engage with the “1 in 200 years” failure framework that the Bank dreamed up a few years ago to support the capital proposals it was then consulting on.

….

The Bank’s consultative document also attempts to make quite a bit of an argument that somehow LVR restrictions now can dampen the size of future “boom-and-bust cycles” in the economy, even going so far as to claim these incremental restrictions will improve the medium-term performance of the economy. But none of this argument engages with the (very healthy) capital position of the banking system and at times it seems internally contradictory.  Thus, in paragraph 47 the Bank worries about dampening effects on consumption and economic activity from “increased serviceability stress” as a result of some future increase in interest rates, but never seems to recognise that the reason the monetary policy arm of the Bank would be raising interest rates is to dampen demand and inflationary pressures.  If anything, the Bank’s argument would seem to suggest that more high-LVR lending would, if anything, and in those circumstances increase the potency of monetary policy, and reduce the extent of any required OCR increases.    More generally, the Bank continues to place a considerable reliance on claims about a significant housing wealth effect on consumption that appear inconsistent with New Zealand macroeconomic data over many decades, and which appear to over-emphasise existing homeowners while largely ignoring the loss of wealth/purchasing power for those who do not (yet) own a house.

….

In conclusion, the Bank has simply not made any sort of compelling case for further tightening of LVR restrictions. At very least, such a case would have to involved a careful and documented cost-benefit analysis, that included engagement with the bank capital regulatory regime.  There is no pressing financial stability risk, and so this proposal – in practice, these new rules – has the feel of action taken for the sake of action, perhaps to provide some cover for a government that fails to address the house price issue at source, or to fend off (misguided) critics of the Bank’s LSAP monetary policy programme.   That isn’t a good or acceptable use of the powers of the state. 

To the extent the initiative is about protecting borrowers from themselves – as your communications sometimes suggests – it may be nobly intended but is no part of the Bank’s statutory responsibility (and thus not a legitimate basis for use of regulatory powers). Perhaps as importantly it seems to assume the current crop of central bankers and regulators knows more about the risks of house prices falling substantially and sustainably than (a) borrowers and their bankers (each with money on the lines) and (b) than their central banking predecessors over 30 years did (each Governor having at some point or other anguished about the risks of falls, even as central and local government policy continued to underpin the decades-long scandalous lift in real house prices). No evidence is advanced for either proposition.

 

My former Reserve Bank colleague – now Tailrisk Economics – Ian Harrison had a similarly cynical view on the consultation process but also put in a short submission, which he has given me permission to quote from.

Ian makes a number of serious analytical points about the substantive weaknesses in the Bank’s document

Introduction

It is clear that, from the content of the consultation paper and the time given for submissions, the consideration of submissions and final decision making, that this is not a serious consultation, and that submissions will mostly be ignored.  In that vein not all of this submission is entirely serious.  Part A discusses some key elements of the Bank’s analysis.  It shows that the Bank’s concerns appear to be driven by a data error and a lack of understanding of how loan portfolios evolve over time.

The Bank has suppressed lending to housing investors following the Minister’s wish to give first time homebuyers a better chance of securing a property.  Now that this demand has emerged the Bank wants to choke it off. 

This is based on an almost irrational obsession with housing lending risk.   Even when high LVR loans are a small part of banks’ portfolios, and its own stress testing shows that housing losses will account for a relatively small part of overall losses in fairly extreme stress events (about 28 percent), it does not seem to be able to resist tinkering with quantitative interventions.

The easiest and most effective solution to the identified problems would be to increase housing interest rates, but that option is not even mentioned.

Part B of this submission provides a different professional perspective on the Bank’s behavior.

But sometimes points are made more potently – at least in responding to unserious spin masquerading as policy analysis – by satire. And this is Ian’s Part B

Part B 

Meduni Vienna, Department of Psychiatry and Psychotherapy

Währinger Gürtel 18-20
1090 Vienna, Austria 

Consultation report

 Patient : R. Bank 

Date:   7/9/2021

Diagnosis:

From our consultation with the patient R. Bank we observed the following clinical symptoms.  Our consultation conclusions are based on the patient’s writings (in particular the document loan-to valuation ratio restrictions) and our observations of behavior over the last three years.

Moderate paranoia: The patient had a tendency to blowup the risks of everyday life into impending disasters.

Hyperactivity: There was a pronounced tendency to do things when nothing needs to be done.

Megalomania: The patient exhibits the classic signs of megalomania: overestimation of one’s abilities, feelings of uniqueness, inflated self-esteem, and a drive to maintain control over others.

Misplaced empathy:  The patient exhibited some concern that others may make mistakes but uses this as a reason to exercise control over them.

Irrationality: There was a lack of capacity to identify real problems and connect them with solutions.

Unwillingness to listen to others:  The patient will pretend to listen to alternative views but this is almost always a sham.

Treatment:

  • Heavy sedation
  • Counselling

The patient should be removed from positions of authority until there is a pronounced improvement in behavior.

Albert Pystaek Phd., Dip. A.E.M, Fm.d, Head of Clinical Psychiatry

USSR, Russia, and China

I’ve been reading a couple of books in the last week or so about the decline and fall of the Soviet Union (USSR). The first is Armageddon Averted: The Soviet Collapse 1970-2000, by Stephen Kotkin a Princeton historian who has since gone on to write an (as yet unfinished) three-volume life of Stalin, and the second The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, by Chris Miller, another US academic historian.

Both are quite short, but for anyone interested in the era they are well worth reading. Kotkin’s book was first published in 2000 so really rather close to the events he was trying to make sense of (the revised edition I read dates from 2008), while Miller’s book is much more recent, published in 2016. Kotkin attempts to synthesise and offer an overall interpretation, while the Miller book draws deeply on Soviet-era archives, up to and including minutes of Politburo meetings. I found Kotkin interesting for a number of points, including the (obvious once you think about it) way in which this heavily armed behemoth, heir to hundreds of years of Russian imperial expansionism, dissolved so peacefully. He highlights the contrast, not far away and at much the same time, with the wars of the Yugoslav succession, but also with the unwinding of European empires a few decades earlier. Another point he emphasises is that the dissolution of the empire was, at least in part, a consequence of way the Soviets had set up their system. The tie that bound the individual republics (set up after the Revolution) together was not, so he argues, the central state itself (republics were not legally subservient to the central state) but rather the Communist Party, and once the Party’s monopoly on power was reduced/eliminated by Gorbachev there was little left to hold the Union together – other perhaps than brute force which by 1991 no one was willing to consistently use (not even those who staged the feeble coup of August 1991).

The Miller book was much closer to the usual concerns of this blog. It was a fascinating discussion of economic policy in the last years of the Soviet Union, with a particular emphasis on what the Soviets were learning from China. I hadn’t known how closely and carefully Soviet officials and scholars were studying the Chinese experiments with economic liberalisation after the late 1970s, or the extent to which (a) they were recognised as successful and (b) especially after 1985 were imitated. Miller also highlights how Soviet officialdom already knew what gains could be on offer from reform, from previous (abortive, short-circuited) experiments, including under Brezhnev in the 1960s. The macroeconomics was also enlightening – both the extent to which the Soviet Union had maintained macroeconomic stability and fiscal discipline up to the early 1980, but then the extent to which budget discipline was thrown to the wind in the Gorbachev years. That was partly bad luck – falling oil prices, partly the consequences of ill-thought-through initiatives (eg loss of tax revenue from the assault on heavy vodka drinking) – but much of it was in an attempt to buy off reluctance to reform from the powerful interests and patronage networks which – so Miller argues – by this time dominated the Soviet system (be it the agriculture sector, oil and gas, the military and the associated industrial complex or whatever. Miller argues that those around Gorbachev thought of this partly as a reasonable gamble – if they could materially accelerate growth, as in China, they could grow their way through the deterioriating fiscal (and hence monetary) position. It was not, of course, a gamble that worked, and the first few years after 1991 saw widespread economic chaos.

Miller argues that the strategy was never likely to have worked, and contrasts that with the experience in China. Why couldn’t it have worked? In the end, his claim reduces to the proposition that those who really favoured reform simply did not have the political clout to make it happen, even if one of those was the General Secretary himself. For decades after Stalin – under whose reign of terror many were shot, senior people were moved around frequently – the patronage networks (within which people often spent an entire career) were able to grow to become a force they simply weren’t in China (just after the further upheaval of the Cultural Revolution). Add to that things like the fact that life in the USSR was relatively comfortable in 1985, in a way that it hadn’t been in China in the late 70s. The imperative for change was much weaker, whether near the top, or at the grassroots (he contrasts the attitude to agricultural reforms of Chinese peasants and Russian farm workers). And there was the military, consuming a huge proportion of GDP in the USSR and reluctant to adjust, in contrast to the reduced military expenditure in China in the first years of economic reform.

There is one contrast between the USSR and the PRC that emphasises that in China the Communist Party kept hold on power and Russia it gave up power. For the CCP that is a clear victory (whatever it means for the Chinese people). But the other often attempts to tell a story about relative economic performance, with an emphasis on those first few severely disrupted years after 1991 in the (former Soviet Union) and, of course, the high growth rates the PRC continued to report for a long time. In this part of the world, New Zealand politicians and business people are nauseatingly prone to praising what they see as the economic success of the PRC (as if somehow this covers for the innumerable abuses of the regime).

China was, of course, richer than Russia for a long time. For not inconsiderable periods of history China was at least as rich – or richer – than anywhere on the planet. Russia never was. But here is the (rough) picture of GDP per capita comparisons for various years, drawn from the (widely-used) Maddison database.

russian and china

By 1913 – the eve of World War One – estimated GDP per capita for the “former USSR” (of which Russia is the largest chunk) was almost three times that of China. The “former USSR” in turn enjoyed real GDP per capita less than a third that of the leading bunch of countries (including New Zealand), and less than a third that of (say) France and Germany

By 1980 – several decades each of Communist Party rule – real GDP per capita was about six times that in China (as noted above, the starting points for reform were very different). China really was an utter basket case.

But where do things stand now, after decades of fairly rapid growth in China, and decades on from the chaos of the immediate post USSR period?

Here are the IMF’s estimates for real GDP per capita for the former Soviet Union countries and China.

former USSR

Even using these official numbers – and people like Michael Pettis will argue compellingly that GDP in China does not mean what it does elsewhere – China currently has real GDP per capita a bit less than Belarus, a bit more than Turkmenistan. The Baltic states are stellar performers but even authoritarian Russia, heir to all that 1990s dislocation, has real per capita incomes 55 per cent higher than those in China.

And what about labour productivity? The IMF doesn’t produce estimates for that, but the Conference Board does. Here are their latest estimates for the whole former Soviet bloc, and China.

former eastern bloc

China makes Belarus look really rather good, and on these estimates China is still lagging behind Moldova. The gap between China and Russia is huge and – as best as can be told from these estimates – Chinese productivity growth has slowed sufficiently it is no longer obvious they are even closing the gap.

Russia, of course, is hardly a stellar performer. You can see it even on these charts, and in GDP per capita terms it is still only about half the incomes earned per capita in France and Germany/

And then one last set of comparisons.

prod comparisons russia

China pales by comparison with all of these economies, even grossly-underperforming New Zealand.

There were things the USSR was able to learn from the PRC 40 years ago. But how to generate a high income country, that might match the material living standards in the West – a constant aspiration – was not then, and is not now, one of them.

Housing

I hadn’t paid much attention to the renewed wave of restrictive regulation of the housing finance market being imposed by the Governor of the Reserve Bank this year, but a journalist rang yesterday to talk about the latest proposal which prompted me to download and read the “consultative document” the Bank released last Friday.

Why the quote marks? Because quite evidently this is not about consultation at all, simply trying to do the bare minimum to jump through the legal hoops to allow the Governor to do whatever he wants. The document was released on Friday 3 September. The consultation period is a mere two weeks, which is bad enough. But then they tell people who might be inclined to submit that ‘we expect to release our final decision in late September’ – at most nine working days after submissions close – with the new rules to come into effect from 1 October. And if you were still in any doubt there is that line they love to use: “we expect banks to comply with the spirit of the new restrictions immediately”.

WIth that sort of urgency and disregard for any serious bow in the direction of consultation and reflection, you’d have to assume the Bank had a compelling case for urgent action, such that (for example) a delay of even as much as a month would pose an unendurable threat to the soundness and efficiency of the financial system (still the statutory purposes these regulatory powers are supposed to be exercised for). And since the Bank is quite open about the fact that the new restrictions will impede the efficiency of the system, you’d expect an overwhelming case for a soundness threat, complete with a careful analysis indicating that these new controls – directly affecting huge numbers of ordinary people – were the best, least inefficient, response.

But there is nothing of the sort. Instead they are actually at pains to stress that the financial system is sound at present, so the worry is about what might happen if things went on as they are. But that can’t possibly be an issue that rides on a one month, it must be something about several more years.

But even then their case amounts to very little. For example, they point that if house prices were to fall 20 per cent from current levels some $4 billion of lending would be to borrowers who would then have negative equity, But that is hardly news. The typical first-home buyer has always – at least in liberal financial systems – borrowed at least 80 per cent of the value of the home they are purchasing. It is usually sensible and rational for them to do so (indeed 90 per cent would often be sensible and prudent). So a fall of 20 per cent in house prices would always put a lot of recent borrowers into a negative equity position. Note, however, that (a) $4 billion is not much over 1 per cent of total housing lending, and (b) it is $4 billion of loans, not $4 billion of negative equity. If I borrowed 82 per cent of the value of the house, the house fell in value 20 per cent, and I lost my job and had to sell up, the loss to the bank might be not much more than 2 per cent of the loan.

More generally, in the entire document there appears to be not a single mention of the capital position of banks operating in New Zealand, or the Reserve Bank’s capital requirements. You might recall that New Zealand banks have some of the highest effective capital ratios anywhere in the advanced world, and that the Bank is putting in place a steady increase in those capital requirements. Moreover, if you read the Bank’s document – at least as a lay reader – you might miss entirely the point that the capital rules, and the internal models banks use, require more dollars of capital for higher risk loans than for lower risk loans. It is how the system is supposed to work. There are big buffers, those buffers are getting bigger (as per cent of risk-weighted assets), and the dollar amount of capital required rises automatically if banks are doing more higher-risk lending.

Of course, the Bank says a significant fall in house prices is more likely now. But we’ve heard that sort of line from every Reserve Bank Governor at one time or another over 30 years now. As it happens – and for what little it is worth – I happen to think house prices may be more likely to fall than to rise further over the next 12-18 months (even put a number consistent with that in the Roy Morgan survey when their pollster rang a few days ago), but I don’t back my hunch by using arbitrary regulatory restrictions that – on their own telling – will force many first home buyers back out of the market.

And it might all be more compelling if the Bank showed any sign of understanding the housing market. Thus, we are told (more or less correctly) that immigration is currently low (really negative) and lots of houses are being built. But, amazingly after all these years, there appears to be no substantive discussion of the land-use regulations and the land market more generally. Perhaps there will be something of a temporary “glut” in dwelling numbers – at current prices – but unless far-reaching changes are made to land-use rules that won’t change the basic regulatory underpinning for land prices. We know the government’s RMA reforms aren’t likely to help – may even worsen the situation – including because if these were credible reforms, the effect would be showing through in land prices now. And we know from the PM and Minister of Finance – and possibly the National Party too – that they don’t even want to do reforms that would materially lower house/land prices.

It all just has the feel of more action for action’s sake. Perhaps the government isn’t too keen on first-home buyers being squeezed out, but at least when they are criticised for not fixing the dysfunctional over-regulated housing/land market they can wave their hands and talk about all the things they and their agencies do, however ineffectual. As even the Bank notes, LVR restrictions don’t make much difference to prices for long. And if there is a compelling financial stability case, it isn’t made in this document – which, again, offers nothing remotely resembling a cost-benefit analysis for respondents to address. This despite bold – totally unsubstantiated – claims in the paper that their new controls would be beneficial for “medium-term economic performance”.

Then again, why would they bother with serious analysis when the whole thing is a faux-consultation anyway.

At which point in this post, I’m going to turn on a dime and come to the defence of both the Bank and the government. A couple of weeks ago the Listener magazine ran an impassioned piece by Arthur Grimes arguing that the amendment to the Reserve Bank Act in 2018 was a – perhaps even “the” – main factor in what had gone crazily wrong with house prices in the last few years. Conveniently, the article is now available on the Herald website where it sits under the heading “Government has caused housing crisis to become a catastrophe”.

Grimes was closely involved in the design of the 1989 Reserve Bank Act, and for a couple of years in the early 1990s was the Bank’s chief economist (and my boss). He left the Bank for some mix of private sector, research, and academic employment, but also spent some years on the Reserve Bank’s board – the largely toothless monitoring body that spent decades mostly providing cover for whoever was Governor. These days he is a professor of “wellbeing and public policy” at Victoria University.

However, whatever his credentials, his argument simply does not stack up, and given some of the valuable work he has done in the past, on land prices, it is remarkable that he is even making it.

There is quite a bit in the first half of the article that I totally agree with. High house prices are a public policy disaster and one which hurts most severely those at the bottom of the economic ladder, the young, the poor, the outsiders (including, disproportionately, Maori and Pacific populations). But then we get a story that house prices have been the outcome of the interaction between high net migration and housebuilding. As Arthur notes, immigration has hardly been a factor in the last 18 months (actually it has been negative, even if the SNZ 12/16 model has not yet caught up) and there has been quite a lot of housebuilding going on.

And yet in the entire article there is nothing – not a word – about the continuing pervasive land use restrictions (and only passing mention about the past). If new land on the fringes of our cities – often with very limited value in alternative uses – cannot easily be brought into development (if owners of such land are not competing with each other to be able to do so) there is no reason to suppose that even a temporary surge in building activity will make much difference to a sustainable price for house+land. Instead, any boost to demand will still just flow into higher prices.

Remarkably, in discussing the events of the last year there is also no mention of fiscal policy – the boost to demand that stems from a shift from a balanced budget just prior to Covid to one that, on Treasury’s own numbers, is a very large structural deficit this year.

Instead, on the Grimes telling the problem is a reversion to “Muldoonism” – not, note, the fiscal deficits, but the amendment to the statutory goal for the Reserve Bank’s monetary policy enacted almost three years ago now. Recall the new wording

The Bank, acting through the MPC, has the function of formulating a monetary policy directed to the economic objectives of—

(a) achieving and maintaining stability in the general level of prices over the medium term; and

(b) supporting maximum sustainable employment.

The main change being the addition of b).

Grimes has been staunchly opposed to that amendment from the start, but his assertion that it makes much difference to anything has never really stood up to close scrutiny. It has long had more of a sense about it of being aggrieved that a formulation he had been closely associated with had been changed.

He has never (at least that I’ve seen) engaged with (a) the Governor’s claim (which rings true to me) that the changed mandate had made no difference to how the Bank had set monetary policy during the Covid period, (b) the more generalised proposition (that the Governor is drawing on) that in the face of demand shocks a pure price stability mandate (and the RB’s was never pure) and an employment objective (or constraint) prompt exactly the same sort of policy response, or (c) the extent to which the New Zealand statutory goals remains (i) cleaner than those of many other advanced countries and yet (ii) substantially similar (as the respective central banks describe what they are doing) to the models in, notably, the United States and Australia. Similarly, he never engages with the straight inflation forecasts the Bank was publishing this time last year: if they believed those numbers, the purest of simple inflation targeting central banks would have been doing just what the RB did (and arguably more, given that the forecasts remained at/below the bottom of the target range for a protracted period).

Grimes seems to be running a line that the LSAP was the problem

The central culprit has been monetary policy that has flooded the economy with liquidity. This liquidity in turn has found its way into the housing market.

But there is just no credible story or data that backs up those claims. Banks simply weren’t (and aren’t) constrained by “liquidity”. The LSAP was financially risky performative display, but it made no material difference to any macro outcomes that matter, including house prices.

There is quite a lot of this sort of stuff.

Grimes ends on a better note, lamenting the refusal of governments – past and present – to contemplate substantially lower house prices, let alone take the steps that would bring them about (his final line “And no politician seems to care enough to do anything about it” is one I totally endorse). But in trying to argue a case that a change to the Reserve Bank Act – that had no impact on anything discernible as it went through Parliament or in its first year on the books – somehow explains our house price outcomes (especially in a world where many similar price rises are occurring, and where there was no change in central bank legislation), seems unsupported, and ends up largely serving the interests of the government, by distracting attention from the thing – land use deregulation – that really would make a marked difference and which the government absolutely refuses to do anything much about.

Borders

There have been a few stories in recent days about the potential implications for economic activity in the rest of the country of the temporary border between Auckland and the rest of the country. The articles seem to have focused on transition across the border, which is strange since (at least as I understand it) freight itself is largely unrestricted. The issues seem to be more about what activities (including production activities) are able to be undertaken in Auckland while it is still under the government’s Level 4 restrictions (which could be weeks yet). And, of course, the point of Level 4 is that not very much – at least that can’t be done sitting at a computer or producing/distributing food, power, water etc – is supposed to be able to be done. For good or ill (perhaps for ill last year, perhaps for good this year – given the intensified risks with Delta) New Zealand has taken a much more restrictive approach than most countries, and even than Australian states. And if a lot of New Zealand manufacturing is in Auckland that is going to have ramifications for what economic activity can be sustained in the rest of the country in Level 3 (or Level 2).

A reasonable guess – but it is a stab in the dark, since SNZ had real measurement challenges – is that the Level 4 lockdown last year coincided with a 25 per cent reduction in GDP while it lasted, and that probably remains a sensible (but perhaps lower bound) guess for the current situation. See this year’s Treasury assumptions here. For level 3, Treasury estimates that the economy as a whole would experience a reduction of GDP of 10-15 per cent for the duration of those restrictions, but there is less data to go on. Whatever the number, it is still large, perhaps $800 million per week (in GDP losses alone) if the whole country were in Level 3.

But, of course, it isn’t. And in the last year for which we have data, Auckland accounted for 38 per cent of national GDP. In a particular production process, the unavailability of even one component that happened to be manufactured in Auckland but used nationwide could quite quickly – depending on inventory levels held outside Auckland – begin to impair production in the rest of the country that could otherwise quite lawfully occur.

But it seems fairly unavoidable, at least for as long as elimination remains the goal (as no doubt it should for some months yet). The Auckland outbreak has been a serious one, has grown more quickly than those in either Victoria or New South Wales, and existing restrictions have not yet squashed it. It certainly can’t be time for freeing up more activities in Auckland, no matter the possible GDP gains there or elsewhere in the country.

But the other thing that has struck me in the last day or two is the stories about people moving across the border. Of course, freight means people (whether train drivers, truck drivers, pilots), but there are other people too. There have been those extraordinary stories of students flying out of Auckland and encountering no checks either when they purchased the ticket or when they boarded. Essential workers in Auckland who live outside the border have permission to come and go for work. (A few) politicians have been moving. And even hospital patients have been being transferred to other cities to relieve pressure on Auckland hospitals. Reports suggest some of the (few) planes out of Auckland are quite full.

And it appears that not one of those people is subject to frequent testing or any isolation restrictions. I heard on Morning Report that Ashley Bloomfield had mused aloud yesterday that some testing might be a good idea – prompting spluttering from the Managing Director of Mainfreight – to which one could only think “well, indeed, and if only there were senior officials and ministers able to bring it about, and not actively blocking it”. Eric Crampton had a nice piece on his blog yesterday highlighting the extraordinary delays of rolling out government saliva testing, and the prohibitions on the import and use (by firms, by anyone) of the rapid self-tests, which produce results in 15 minutes and could be used before each shift and/or border crossing.

Rapid antigen tests give results in about fifteen minutes. They are not likely to catch cases with low viral loads but are decent at high viral loads – the people who would wind up being infectious. Having workers run a self-test before starting shifts would add an additional layer of protection. But no rapid antigen test has been authorised for use in New Zealand. It is unclear whether MedSafe has even considered any – I have a request in with them for more information. 

This sort of thing is being done in much of the rest of the world, but not here. That is entirely on the government and their officials.

It all seems a part of the sort of issue I highlighted last week of not taking the risks sufficiently seriously (seemingly a bit indifferent to the significant economic losses, and draconian incursions of normal life/freedom, that lockdowns bring).

A matter of weeks ago we had no community Covid in New Zealand but they had community outbreaks in Australia (and Fiji and other places). The focus here was, supposedly, on keeping it out. Arrivals from some places were largely barred altogether, quarantine-free travel from Australia was suspended (so that any future arrivals had to go through MIQ), there was even the charade of a pre-departure testing requirement (a charade because (a) it didn’t apply to NSW, (b) it still allowed up to three days between testing and departure for someone to become infected, and (c) for quite a while the government wasn’t even checking that most arrivals had had tests. And fairly tight protocols were in place around crew on cargo ships docking at our ports.

Now we have a significant community outbreak in Auckland (in per capita terms still worse than that in Victoria), and none of those sorts of protections on the internal borders. The government has restricted the number of people who can cross – essential to the regime of course – but does nothing systematic or rigorous to reduce to an absolute minimum the risks associated with those who do come out of Auckland (in some cases, coming and going every day). It seems unserious and not commensurate with the magnitude of the risks (remember the costs of renewed Level 4 lockdowns). Sure there are Level 4 restrictions in place in Auckland, governing everyone while there, but….there is still community transmission occurring. And once people are out of Auckland the restrictions are much less onerous, especially if much of the rest of the country was to shift to Level 2.

My suspicion is that this is another of those things/risks that just wasn’t properly planned for – despite the government having had months of notice. If it were otherwise, how could they possibly be so cavalier about the risks of cross- (internal) border transmission?

There don’t seem to be public figures on how many people are crossing the border each day*, or how far they are ranging, but it seems certain that the numbers are more than those crossing the external border each day (averaging just over 300 a day even over the last week), and we know that MIQ isn’t foolproof (how Delta got here in the first place), and is potentially becoming less secure than it was, with the vaccination/Delta combination. As yesterday’s events showed, isolation/quarantine hotels aren’t either. And there are no testing/isolation requirements on any of these people moving each day into Covid-free rest of New Zealand.

[*UPDATE: A Stuff story says 2000 trucks a day across the southern border, plus however many – presumably a much smaller number – across the northern border from today.

FURTHER UPDATE: A Herald story states that “of the first 3059 vehicles Police stopped at five checkpoints [on the southern border] just 114 were turned away]

It seems extraordinarily negligent, and inconsistent with the stated goal of elimination for the time being, at least while keeping to an absolute minimum the risk of new draconian lockdowns in the rest of the country. We have managed the risks around goods flow through the ports over the last 18 months, but barely even seem to be trying with internal movement now – when the threat (from Delta) is much greater. It all has the feel of a race between squashing the outbreak in Auckland and the likelihood that on current policies and practices it will get through again to the rest of the country. I’m sure we all cheer for and hope for the former, but it seems quite reckless of the government simply to gamble rather than act.

Which brings me back to Eric Crampton, this time from his Newsroom column quoted in the post

The government could, today, order a couple million rapid antigen tests. They are broadly available. It could distribute those test kits to every essential workplace in Auckland and require that every essential worker be tested every day before starting work.

It could be a condition of a Level 4 modified to suit Delta.

Within about fifteen minutes, each worker’s result would be available. Infectious workers could be sent to government testing stations for confirmation. And workplace transmission would be sharply reduced.

But not just essential workers in Auckland, but everyone crossing the internal border out of Auckland. If they won’t do something like that it is hard to take their words seriously. They are again exposing us to new lockdowns, and recall that the best estimate of a Level 4 lockdown is that lost GDP alone (never recovered) is $1600 million a week, and all that disruption to the rituals of life, including in its toughest and darkest times.

Reading Michael Cullen

There aren’t many New Zealand political memoirs/autobiographies – and even fewer diaries (although I was recently reading John A Lee’s for 1936-40) – and most of them aren’t that good. Voracious book buyer that I am, I usually don’t buy them until they turn up very cheap in a charity shop or community book sale. After all, sometimes there are interesting snippets and you never know when some angle on some event might prove at least somewhat enlightening.

But I thought I’d make an exception for Michael Cullen. He had, after all, been an academic historian in an earlier life, and was unquestionably smart and funny, and had been Labour’s finance/economics spokesman for 17 years and Minister of Finance for nine years (terms really only rivalled in modern New Zealand by Walter Nash and Rob Muldoon). I’d probably have been better off waiting for the charity shop copies to turn up.

There were interesting bits and pieces. Early chapters of autobiographies are often complained about but I almost always like them. There was, for example, the ancestor who was the last person burned at the stake in England for heresy (twice actually). Or the snippet of Cullen and his first wife buying their first house in Dunedin in 1971 for $10500 – “only twice my annual gross salary” as a new lecturer (lecturers at Otago now seem to start at about $82000). Or the prize he won at about the same time for the best University of Edinburgh PhD history thesis that year – enough to pay off in full the 30 per cent deposit they’d borrowed from his wife’s parents. Or the picture of the Dunedin Labour Party in the 70s – including the raffle organiser (“Labour used to be a raffle-funded party”) who “made a Ponzi scheme look positively generous” by offering a first prize in one raffle a full book of tickets in the next raffle.

And there were the national politics snippets, including the observation/claim that David Lange had persuaded Roger Douglas to stay in politics in 1981 by promising that if/when Lange became leader Douglas would be his Minister of Finance. As Cullen notes, some things might have been quite different…..although it is interesting to wonder just how much. Cullen’s perspectives – as senior whip and then junior Cabinet minister (often written in counterpoint to Michael Bassett’s book on the period) – on the Lange/Douglas tensions over 1978/88 were worth having, including his suggestion that (given the tensions, that only built further) perhaps Lange should have sacked Douglas in April 1987.

But it tended to go downhill from there, dramatically so for his treatment of the nine years of the 5th Labour government, which takes up almost half the book. Much of it has about it the character of a family Christmas letter from proud parents who just don’t know when to stop. If you want a canter through the things the government did during those nine years, trivial and not, I guess this is the book for you. Almost everyone did everything ably. But to anyone who was around New Zealand at the time, you simply aren’t going to learn very much (although I was surprised to read that Jim Anderton had been – so Cullen claims – one of the ministers most keen on lower company taxes late in the government’s term).

Two things in particular struck me. The first was that while Cullen was a Labour Party MP and minister, clearly he was not a Labour Party person (consistent with this in the early days his then wife had been more active than he was), and there is very little on the internal ructions that convulsed the party a few decades ago. More generally, there is little insight anywhere in the book on the many really significant political figures Cullen worked with over the years, none at all on Helen Clark (or Heather Simpson for that matter). There was almost no insight on some of the key public servants, or anything on the tensions. interactions etc. And this 12 years after he left office. Cullen seems to have reasonably kind words for most people – exceptions I think being Richard Prebble, Don Brash and (mixed with some admiration/envy at his success) John Key – but no insights. And if he ever worked with Grant Robertson, Jacinda Ardern or Chris Hipkins when he was Deputy Prime Minister and they were in Clark’s office, you wouldn’t know it from the book.

Presumably Cullen kept no diaries, and he notes somewhere in the book that he hadn’t been very good at answering questions from researchers over the years about past events because his mental approach was to compartmentalise and then move on (and of course he carried a formidably huge load during those Clark years). And writing the book can’t have been helped by the knowledge that his time might be very short (as it turned out to be) and that between illness and Covid he was only able to make a single trip to Dunedin to consult his papers in the Hocken Library. In a bigger country, he’d almost certainly have had a research assistant he could have drawn on. As it was, he tells us he drew heavily on what happened to be available on the web.

But there is also a sense of someone who – despite the training as an historian (which he often reminds us of) – just wasn’t that reflective. 50 years on from that house purchase he told readers about, house prices are appallingly high – and these developments were going on on his watch too – but there is nothing on how, technocratically and politically, his generation bequeathed that disaster. He was Labour’s finance spokesman for 17 years, beginning as the reforms (which he mostly supported) were supposed to be starting to pay off in reductions in the productivity gaps between us and the rest of the advanced world. Under his watch there were various bows in the direction of aspiring to make a difference. And yet here we are, with the gaps wider than ever. There is no sign anywhere in the book of any reflection, self-questioning, or even curiosity about the failure. Perhaps the only note of regret about policy I recall is a regret that the government had not been more active in determining the strategy of Fonterra, the behemoth they enabled but which also failed to deliver.

Perhaps it would have been different if he’d had more time. Even on the text he did write it is not hard to see where a good editor could have insisted on cutting out at least 50 pages (of a 400 page book) – perhaps including the line that knighthoods were a good thing because they gave a lot of pleasure to the recipients.

Of course, part of my interest in the book was in its treatment of Reserve Bank issues, he having been the Minister responsible for the Bank through nine sometimes difficult years, and Opposition spokesman beginning little more than a year after the 1989 Reserve Bank Act had come into effect. The Reserve Bank monetary policy framework has not, shall we say, been without its controversies over those 30 years – including the often very antagonistic approach taken by Jim Anderton whose party at times rivalled Labour on the left in the 1990s.

But again, it was curiously bloodless. You’d not have known, for example, that in his early days (perhaps as late as the 1996 election, as I recall us debating it at the Bank at one election and I was working overseas in 1993)), he (as Labour’s spokesman) championed a change to the inflation target (then 0-2 per cent annual inflation, with caveats). But Labour’s proposal – they needed product differentiation from National, the Alliance, and New Zealand First – was to adopt a target range of -1 to 3 per cent inflation. As I recall it, part of the aim was to capture more of the headline inflation shocks (oil prices, tax changes etc etc), but it could have led to the curious world in which the Bank was supposed to be more or less indifferent to inflation going negative, which didn’t seem as though it would prove very robust at first confrontation with experience.

Perhaps charitably, Cullen does not mention the (frankly fairly incompetent) way we ran monetary policy over 1997 and 1998 (the infamous monetary conditions index) but nor does he mention his oft-expressed (and somewhat valid) concerns about the volatility of both the exchange rate and interest rates, or his calls for changes to the Policy Targets Agreement and/or for an independent inquiry into the conduct of monetary policy. As it happened, the PTA was changed when Cullen took office, to add a new form of words that was supposed to appear substantive but which, to this day, no one really knew what the words actually meant for policy (I’ve long argued “precisely nothing”). At the Bank we were sufficiently uneasy that in the first few weeks of the new government I was sent on a whistle-stop 10 day tour of the RBA, the Monetary Authority of Singapore, the Bank of Japan, the Bank of England, the Bank of Canada, the Federal Reserve and the US Treasury to brush up our knowledge of, and perspectives on, operationalising foreign exchange intervention.

Out of office Cullen had called for an independent inquiry – which went over well with the left of his own party, and with the Alliance, with which Labour was mending fences. In office, he commissioned an inquiry, but consciously and deliberately chose as his reviewer someone who could be counted on not to make trouble – a leading academic author on inflation targeting, Lars Svensson (he could quite readily have chosen as reviewer any number of other quite reputable people – just one example being Bernie Fraser the former Governor of the RBA (and known as somewhat left-leaning). As it was, Svensson predictably made no difficulties and at times we (I was one of the small secretariat) had to talk him into revising down his effusive praise of Don Brash. He did propose adopting an MPC – but made up solely of executive staff of the Bank – a proposal that Cullen rejected, and what came out of the review were very minor changes indeed (the Governor to no longer chair the Bank’s Board, the Board to write an Annual Report). But he’d been seen to have had a review.

If there were ongoing government niggles re the Bank’s monetary policy they must have been quite limited for a while. In 2001 we’d been quite pro-active in easing monetary policy (somewhat burned by 1997/98) both in response to the global tech slowdown and after 9/11 (decisions I still think were warranted, but which some more hawkish people differ on). But Don Brash was still a bit of an issue. He’d made a high profile controversial speech to the government’s Knowledge Wave conference in 2001, stepping well outside areas he had any policy responsibility for (and, not surprisingly, championing policy approaches that weren’t really to Labour’s liking). Powers that be in the Beehive were understood to be not best pleased.

Nothing of all this in in the book.

Don Brash resigned as Governor on 26 April 2002 to seek selection as a National Party candidate at the forthcoming election (having been pro-actively recruited and given to understand he’d get a high list place, and perhaps a reasonable chance of being Minister of Finance – in the unlikely event National was to win). Cullen writes about this resignation, but comments only that he was “flabbergasted”, proceeding to write some generalised negative comments about Brash and his self-belief. As Don records in his own autobiography of his conversation with Cullen “I don’t think he was pleased but he was polite”, but he goes on to note “much more polite than Helen Clark was later in the day”. As I understood it, the PM had been (understandably in my view) outraged, felt it was something of a betrayal (to step straight out of high public office onto the campaign trail) and was specifically very aggrieved at the Bank’s Board (and specifically the then chair of the non-executive directors) – responsible to Cullen – for having written an employment contract that did not enforce a decent stand-down period. All of which might have been useful points for Cullen to have included, rather than just glib remarks (true or not) about Brash’s “extraordinary sense of self-belief”.

Appointing a new permanent Governor was a challenge. Under the law, the Governor had to be someone the Board nominated, but the Minister could reject a nomination and ask (endlessly, in principle) for another. Brash’s deputy, Rod Carr, filled in as (statutory) acting Governor including through the election campaign period, and assiduously sought to get the permanent role. Cullen records – and this I did not know – that the Board had formally recommended that Carr be made Governor.

I had nothing personal against Rod, but he was so dry that he made even Brash look slightly moist. I was not in the least convinced that he could adopt the somewhat more flexible approach I was looking for. I rejected the recommendation….Finding a replacement posed a problem, especially if my action was interpreted to mean a lack of commitment to the basic principles of the Reserve Bank Act. I was saved by Alan Bollard. He offered to put his name forward.

Of course, it would not have been hard to have found someone else, except that the understanding was that the word had gone out that no one associated with the Brash Reserve Bank was to be appointed. Thus, Murray Sherwin – until recently Deputy Governor, then Director General of Agriculture – would have made a good Governor, but he’d been of the Brash era. Less plausibly – though probably with politics more akin to Labour’s – another former Brash Deputy Governor Peter Nicholl (then Governor of the central bank of Bosnia) might have been keen (although I know the Bank’s Board wasn’t).

Again, what Cullen doesn’t record was the fascination with the RBA in the Beehive (including the 9th floor at the time). In some ways it was understandable – the RBA was run by a succession of competent people, the Australian economy was generally doing better than New Zealand’s, real interest rates were generally a bit lower (visiting RBA people would even encourage us to be more like them and we might get our interest rates down to “world” levels) and had been less volatile. My diary records a conversation with someone who had been to visit Peter Harris – now an MPC member, then Cullen’s main economic advisor – during this period, and Harris had apparently even toyed (perhaps not fully seriously) with the idea that they could get Glenn Stevens (then Deputy Governor of the RBA) as Reserve Bank Governor. The Prime Minister was known to want a policy target mirroring the Australian one (centred on 2.5 per cent inflation), something that Alan Bollard successfully resisted).

(Cullen goes on to record that he also knocked back SSC’s recommendation of Mark Prebble to be Secretary to the Treasury, primarily on ideological grounds. That was interesting but he never tells his readers that at the time – when Cullen was deputy PM – Prebble was chief executive of DPMC, that Clark had attacked that appointment in 1998 (again on ideological grounds) but had acquiesced in Prebble’s reappointment in 2000). It might have been interesting to have read some reflection on what changed.)

The period from late 2003 to the end of Labour’s term was a difficult one for monetary policy. Cullen does a little bit of sniping in the book – mainly at the idea that the Bank was engaged in targeting inflation forecasts (he words it a little differently but it is the implication of his repeated comments about an output gap focus) – but he displays almost no awareness of what was going on (including the sustained and significant rise in actual core inflation, the demand effects of rapid growth in population, the demand effects of the housing market (prices and volumes), the strong growth in the terms of trade, or the implications of fiscal policy. And I don’t think he once mentions the exchange rate, which became an increasing bugbear through this period, both for him and for his handpicked Governor. The best evidence for the proposition that throughout those years we did not tighten aggressively enough early enough is that core inflation moved to and beyond the top of the inflation target range (as benchmark, in the subsequent decade core inflation undershot, but never quite fell outside the bottom of the band).

There was an increasing search for some sort of circuit-breaker, with a particular focus then on things that might help dampen housing market pressures without necessitating further OCR increases and further rises in the real exchange rate. This culminated first in the Supplementary Stabilisation Instruments project, which Cullen claims to have known almost nothing of. This is the relevant extract from his book.

Both the Reserve Bank and the Treasury realised that in that situation [economic imbalances] the use of the official cash rate as almost the only means of dealing with such imbalances was far from satisfactory. It was rather like many anti-cancer drugs in causing significant collateral damage, so they had decided to work on what they called a Supplementary Stabilisation Instruments Project. This was their initiative, not mine, but it got John Key excited and he managed to invent all kinds of malign intentions the government had. I have no idea where the project went since it did not seem to produce any results.

Which simply wasn’t true. House prices became such a political problem there was a special unit set up in DPMC to look at what might be done, and John Whitehead and Alan Bollard agreed with Cullen to commission the SSI work. In a release at the time, Cullen claims that

He expressed concern at the impact of the high dollar on the export sector but said the Supplementary Stabilisation Instrument Project, the terms of which were drawn up by the Treasury and the Reserve Bank and released without reference to the government, would explore options to reduce pressure on the exchange rate by reducing monetary policy reliance on the OCR.

I can’t remember if the precise Terms of Reference were cleared by his office, but it was made very clear (from the Beehive) that difficult political options (capital gains taxes, public sector savings programmes, anything around the welfare system) were out of scope. These specific exclusions are mentioned in the published Terms of Reference (page 39 here). Cullen’s hands were all over this commission (my diary records a week or two prior an observation that Cullen, Bollard, and Whitehead had all apparently been keen on some particular tweaky tool I’d devised – I can’t recall what it was but am embarrassed that it seems to have been an LVR-based control).

The Minister goes on to claim that “I have no idea where the project went since it did not seem to produce any results”. Except that, readily available on the web, is our report to him on the analysis and possible tools, from March 2006.

And did it go no further then? Well hardly. Instead there was some considerable interest in the idea of a Mortgage Interest Levy – a scheme under which we might raise the cost of mortgages without raising the OCR – and I and a Treasury counterpart spent (what seems like) months devising something that might be workable, exploring fishhooks etc etc. That paper is here, as is the report to Dr Cullen.

And was this simply a bureaucratic conceit, or no interest to a busy Minister of Finance? Well, no. Actually, Cullen tried to persuade the National Party to go along. I knew this was so, but looking through some old papers found a press release from Michael Cullen, as Minister of Finance (9 February 2007), saying so and attacking Bill English (new National finance spokesperson) for not being willing to go along.

National leader John Key and finance spokesman Bill English are clearly at odds over the concept of a mortgage levy, which could potentially ease pressure on exporters, Finance Minister Michael Cullen said today.

…I can now reveal that Mr Key and Mr English were invited to a meeting in my office before Christmas to discuss alternatives to existing monetary policy instruments to tackle inflation.

…At that meeting Mr Key took a balanced and serious approach. Mr English though largely remained silent and his body language spoke volumes about his willingness to embrace new measures that may have a chance to help the New Zealand economy 

And so on.

And at that Cullen requested that further work be discontinued.

Cullen was a busy man, but it wasn’t as if this was an isolated project. The Minister continued to express concerns – quite serious ones. Not six years after his Svensson review had reported, Labour initiated a full-scale Finance and Expenditure Committee review of monetary policy (quite possibly intended more for shown than substance). More than once Cullen opened mused about the powers open to him under the Reserve Bank Act (but never used) to direct the Bank to pursue a different target (I wrote the internal paper musing on how we should respond, what options the Minister had, what constraints there were on him) and he also became increasingly critical of our public line that fiscal policy was adding to demand and inflation pressures, all else equal putting the real exchange rate and the OCR higher than they otherwise would be. Labour was on its late-term fiscal splurge (helped by Treasury advice that concluded the boom-time revenues were mostly permanent) and although the budget was still in surplus, running down that surplus actively added to the imbalances in the rest of the economy. For Cullen no doubt it was politically awkward – Labour was well behind and the polls, and the money was there. We were reduced to (among other things) writing boxes in the Monetary Policy Statement to explain our (entirely conventional view).

My point here is not that Cullen would necessarily have remembered all of this – busy man etc – but there is not even a hint of any of it. The book would have been much better with at least some of it, rather than the Christmas letter type of account.

Out of curiosity, I also looked for Cullen’s account of the genesis of deposit guarantee scheme. It is a somewhat self-serving account, including his attempt to blame the entire South Canterbury Finance situation on the National government that took office the following month. I wrote my own account of those few days here (I was very closely involved), and included this paragraph.

The main, and important, area in which Dr Cullen departed from official advice was around the matter of fees.   We’d recommended that the risk-based fees would apply from the first dollar of covered deposits (as in any other sort of insurance).     The Minister’s approach was transparently political –  he was happy to charge fees to big Australian banks (who represented the lowest risks) but not to New Zealand institutions (including Kiwibank).  And so an arbitrary line was drawn that fees would be charged only on deposits in excess of $5 billion.   Apart from any other considerations, that gave up a lot of the potential revenue that would have partly offset expected losses.  The initial decision was insane, and a few days later we got him to agree to a regime where really lowly-rated (or unrated) institutions would have to pay a (too low) fee on any material increases in their deposits. A few days later again an attenuated pricing schedule was applied to deposit-growth in all covered entities.   But the seeds of the subsequent problems were sown in that initial set of decisions.

They were his calls to make, and it was an election campaign, but perhaps a political memoir would be more helpful in revealing some of the tradeoffs, tensions, risks etc (or even the fact that – especially with Parliament dissolved – a Minister of Finance could issue such blanket guarantees with few/no checks and balances.

These were just the areas that I know something about in depth. So I’m left wondering what weight I should put on any of the rest, other than as chronology (which I too could get from the web).

On the front cover of the book, Helen Clark describes Cullen as “one of our greatest finance ministers”. There aren’t that many (relatively long-serving ones) to choose from but I’d hesitate to endorse the accolade. Running down the public debt was an achievement but (a) demographics, (b) a prolonged, but productivity-lite, boom, and (c) the terms of trade ran strongly in his favour, and the dam burst in the final three years of his term. I guess he has monuments to his name – Kiwisaver and the NZSF (“Cullen fund”) – but then so does Bill Birch from his time as Minister of Energy, and the best evidence to date is that Kiwisaver has not changed national savings rates, and it isn’t clear what useful function the big taxpayer-owned hedge fund has accomplished. Meanwhile Cullen – and Clark herself of course – bequeathed to the next government (who in turn bequeathed it to this one), the twin economic failures: house prices and productivity (the latter shorthand for all the opportunities foregone, especially for those nearer the bottom of the income distribution).

In that sense, what marks him out from a generation or two of New Zealand politicians, who have spent careers in office, and presided over the continuing decline?

Costs, benefits, etc

Any sort of serious cost-benefit analysis undertaken by officials to advise ministers and inform the public has been notably absent over the 19 months now since Covid has been an issue for New Zealand. You may hazily recall last year that neither Treasury nor the Ministry of Health ever attempted any such disciplined analysis – presumably in the spirit of the senior minister in the previous government who responded to a question I once asked about some expensive initiative he was implementing observing that a cost-benefit analysis wasn’t needed because he already knew the correct answer. There were, of course, a few outsiders who made the effort – from the sceptical side consultant and former academic Martin Lally, and also an analyst at the Productivity Commission (whose efforts seemed to rile up those who already knew the right answer). Earlier in the year when the government extended its regulatory Covid reach, I OIA’ed the Ministry of Health for any cost-benefit analysis undertaken in conjunction with this new restriction. I was quite surprised to get a very prompt response, making it clear that none had been undertaken. Only later did it become clear that the Ministry of Health itself had opposed the initiative.

Of course, for any remotely-complex issue the best cost-benefit analysis in the world won’t produce a single definitive answer that everyone agrees on. But it forces proponents of a course of action (or inaction) to identify and write down their assumptions, think in a disciplined way about how people are likely to behave, think about a wide range of costs, and so on. It should sharpen the thinking of decisionmakers and those advising them, and aid the public scrutiny of ministers and officials,

The thinking that results in this post was initially sparked by seeing a comment in an interview earlier in the week by the Reserve Bank’s deputy chief executive responsible for economics and monetary policy where he claimed that

“Lockdowns have been about delaying the timing of spending rather than taking away spending in total”

and then yesterday I noticed the government’s adviser, and eminent epidemiologist, David Skegg suggest that we might as well push on with the elimination strategy as (words to the effect of) there was no real cost to doing so.

I don’t suppose the Reserve Bank has any real input into Covid policy – and his comment was mostly in the context of output gaps and inflation outlooks perhaps a year out – but Hawkesby is a smart guy, and it was a weird comment, tending to minimise the costs of restrictions.

This chart is an illustration of what I have in mind.

covid GDP losses

Quite clearly what happened was that spending/production returned to more or less normal levels relatively quickly, but “the hole” was never filled in. Real GDP per capita was about 12 per cent lower than otherwise in the June quarter of last year, and 2 per cent lower than normal in March quarter. GDP just prior to Covid had been about $80 billion a quarter, so almost $12 billion of GDP (value-added) we would normally have expected to have occurred in the first half of last year never happened. And there is no sign it was ever made up for later (not surprisingly, since few of the people who couldn’t work at all in April would have gone on to work twice the hours in June). These are really big losses – rather swamping the most recent derided example of planned government waste, the proposed walking/cycling bridge across Waitemata harbour. And those GDP outcomes were held up – to an extent not yet clear – by really huge fiscal outlays, which represents a future burden on New Zealand taxpayers.

Note that I am not citing these numbers to get into a debate about last year’s lockdown, and in thinking about the regulatory restrictions in that period it is vital to recall that many of those losses would have happened anyway (at least given the rest of policy up to mid-March), as individuals were already beginning to take their own precautions. But that was then when – if one wanted to be charitable – one could note that the government and officials were to some extent flying blind.

My concern is more about this year. Ministers and officials now had a good basis for knowing that lockdowns (of the draconian New Zealand sort) did not come cheap. There are all sorts of costs other than the ones captured in GDP – read the heartrending example in Matthew Hooton’s column this morning – but the GDP ones are real enough. I’ve seen mentions that The Treasury is working on an assumption of 25 per cent of GDP lost under “Level 4”, so we’ll use that assumption. Applied to last quarter’s GDP that represents a loss – unlikely ever to be recovered (see above) – of $1.6 billion dollars a week. After 10 days of nationwide level 4 that is already about $2.3 billion – and on a best-case scenario there is probably the best part of another couple of billion to come. $4bn might do as a rough estimate (five cycling bridges) in economic costs alone (and preservation of basic freedoms should itself be valued highly).

Again, I cite these numbers not to question the current lockdown (callously and deliberately cruel and inhumane as parts of it are), but to highlight that officials and ministers have known the cost of this sort of scenario all year. So you’d have supposed they’d have done absolutely everything possible, including spending lots of money if necessary, to make sure it didn’t happen. After all, Parliament had appropriated lots of money in the Covid fund.

Now people might push back and say that it was only in the last few months that the enhanced threat of the Delta variant became apparent, and no doubt that is true. But our politicians and officials are entrusted – paid – with the responsibility to prepare against a wide range of contingencies (just as, say, in a defence and foreign policy context). Similarly, we heard for months public health people bemoaning the alleged “complacency” of the public, but the public aren’t charged with preparing against all such contingencies and the government (politicians and officials) is. And the idea that a more troublesome variant might arise was hardly a new one no one had ever contemplated before Delta.

The only reasonable conclusion is that this draconian lockdown – and the extreme intrusions/restrictions should be priced quite highly – was preventable and the government objectively chose not to prevent it. I don’t suppose they wished it, but – having decided firmly on elimination (and quite probably sensibly so) – with all the resources of the public sector – and the wider base of expertise beyond it – they chose not to do the things that would have made it unnecessary (whether by preventing Delta arriving in the first place, or having the population and systems in a position where much less onerous and costly restrictions might have been appropriate). And I don’t suppose anyone anywhere in the public sector stopped and did some serious cost-benefit type of thinking. Frittering away the Covid fund on wider Labour political preferences must have been so much easier and more fun for the politicians. And as for the officials, who can say, but presumably the quiet and comfortable life suited them. It wasn’t as if they did nothing ever, but that is hardly the test when faced with such a threat.

What might the government have done (and been reasonably expected to have done, not just with the benefit of hindsight)?

There is a pretty standard list by now of things that could have been put in place over months, some of which would have made a difference with certainty, some just probabilistically (but this is a game of probabilities):

  • the astonishing lack of urgency the government displayed in securing vaccines (whether that is about when orders were placed, whether anything could have accelerated Pfizer deliveries, or the choice  – pure choice – to put themselves in the hands of a single supplier),
  •  the neglect of saliva-test options (now widely used abroad, and cheap –  to individuals and governments),
  • the now-apparent failure to put in place systems to prioritise testing (and processing of test of) close contacts),
  • the clear failure to have stress-tested and war-gamed the contact tracing system to ensure that it could really cope with what was being promised.

There were, of course, small things even last week.   Knowing by then, with utter confidence, of how threatening Delta was, when a community case was discovered in Auckland first the Prime Minister and her Covid minister hightailed it out of Auckland (how could they then know whether or not they had been contacts?) but more generally people were allowed to leave Auckland –  with no isolation requirements at all –  for almost 2.5 days after the first Auckland community case was known about.  Now, sure, there would have been contacts outside Auckland anyway, but the government’s choice knowingly added to the problem (some of the Wellington cases were people who left after the initial case was known) –  the numbers, the testing, the processing, the risks (that lockdowns are now designed to contain).

And then there is the border.  They knew the border was not totally secure –  after all, there had been several breaches here over the months.   And it probably could not be made 100 per cent secure –  for every person arriving (by air, or as crew on ships) there was some chance, however individually small, of a breach.  If it wasn’t obvious to them, the Skegg report was telling them a breach was inevitable at some point.   

And yet the government did nothing to reduce to an absolute minimum the number of people arriving.  If anything, it seemed to be constantly giving in to pressures to allow more in (not even compassionate cases, but discretionary sports, business and entertainment priorities of the government).  Just a few days before this lockdown there was the extraordinary proposal to allow home isolation for some (big end of town) vaccinated people, even as the government quite openly told us that any Delta breach would be likely to have an immediate Level 4 lockdown (with attendant cost).  Perhaps there was a case at the time for allowing quarantine-free travel from Australia, but even there they were astonishingly slow –  given what they knew of the cost of lockdowns –  to close down that travel when community cases arose in one or other of the Australian states (they seemed to rely on advice from Australian officials rather than taking the pro-active precautionary approach), and then kept allowing New Zealanders to leave Australia for a time even when the QFT was finally suspended altogether (sure, there was pre-departure testing, but that was more theatre than anything, given that the test could be taken up to three days prior to departure –  and many of them weren’t checked anyway).

(Of course, in any cost-benefit analysis you would want to include the costs to the individuals left unable to travel by a tighter approach at the border at the margin. It is likely to be a small number, relative to the costs imposed on five million of us.)

Given the commitment to elimination (which I am not questioning), it is simply inexcusable that ministers and officials were not doing this sort of cost-benefit calculation/analysis, and routinely updating it in the light of new information (including about Delta). One might not a year ago have put a 100 per cent chance of a new Level 4 lockdown a year ago, but perhaps it would have been prudent even then to have planned for a 30 per cent chance, with that probability clearly rise (to near inevitable in the Skegg report) as the year went on, and planned and prepared accordingly. Perhaps by mid this year it really was too late to do anything much to fix the vaccine problem, but – knowing the likely extreme costs of a lockdown (output never recovered, really high non-economic costs too – it should have led to even more of a focused drive to do everything to stop Delta getting in, and having foolproof, tested and robust, plans to immediately contain the spread (including beyond whatever area the first case was found in), Instead, it is if the lives, fortunes and freedoms of New Zealanders are just playthings for the government and officials – “it doesn’t really matter if we didn’t do our job well, after all, we can simply keep everyone shut up for days longer”. Hundreds of millions of dollars (and equivalent) lost/wasted? Never mind, we are well practised at that. After all, look at where the Covid fund went.

None of this bears on what choices Cabinet should make today, but it has real implications for the path ahead. If the government is committed to elimination for the time being, and holds over us constantly the Damoclean sword of Level 4 lockdowns, they need to take much more seriously minimising to the utmost the risks of future breaches.

$4 billion really is a lot of money – $800 per man, woman, and child – simply gone, and that on relatively optimistic estimates (and many of the costs not dollar-valued at all).

UPDATE 28/8: This Matt Nippert piece from today’s Herald, on the dawning awareness of the Delta variant, despite drawing on authorised officials in the Prime Minister’s own office presumably keen to provide cover for the government/officialdom, really makes my point. Even though the variant (then known as the Indian variant) was first identified late last year, was ravaging India in February, there is no hint in the article that ministers or officials were planning for really bad scenarios, and taking aggressive steps to prevent them being realised, until very late in the piece. It is one thing to hope for the best, but in officials/ministers charged with crisis management – and having themselves deliberately and consciously adopted the elimination strategy – it is no basis for planning. One wonders if there is any dedicated group anywhere in the official system charged with championing alternative (bad) scenarios, with a direct line to ministers.

MPC members speaking

When I finished yesterday’s post I realised there was plenty else that could have been said.

First, of course, is the way that the Reserve Bank’s housing graphic feeds a narrative that a fall in house prices would itself be a bad thing, at an economywide level. After all, presumably their mental model is symmetrical.

As I noted yesterday, their framing totally ignores the context in which house prices change. Were a government ever to summon up the intestinal fortitude to free up land use, we would expect to see house/land prices fall, and fall a long way. This would, of course, be tough for some individuals, but their losses would be largely offset by gains to others (the young, the poor, the renters), and for many people – owner-occupiers with modest or no mortgages – it would really make no difference at all. Speaking personally, I would cheer the day nationwide policy reforms meant real house/land prices dropped back, say, to where they were when I first entered the market in 1988. It would make no difference to my consumption, but would make the prospects of my children a great deal better.

It is just possible that such a reform might even spark a whole new wave of housebuilding, and perhaps even help lift economywide productivity (since land is better able to be used for things people – not governments – value most). But, of course, none of this appears in the Reserve Bank’s spin.

Wealth effects (at an economywide level) are generally thought of as much more powerful re non-housing assets. There was a nice piece yesterday by Michael Pettis, who writes mainly about China, headed Why the Bezzle Matters for the Economy. The “bezzle” is a phrase dreamed up by J K Galbraith to capture the notion that if someone has defrauded you and you don’t yet know it, both you and he think you have the wealth, and collectively society thinks it is wealthier than it really is. Until the fraud is discovered. Pettis generalises the point to apply to grossly-overvalued equity markets, or to physical investments that might have been put in place – by firms or governments – that in the course of time will just never pay off. One could think too of housing booms in which far too many physical houses end up getting built. The waste has already happened but it can take a considerable time, sometimes a specific shock, for societies to wake up, and adjust. Anyway, it is a good read – although quite unrelated to things RB.

But what I was really planning to write about today was the round of media interviews granted to various media outlets by the Reserve Bank senior management following last week’s MPS. The round of interviews seems to have become something of a ritual. FIrst there was the Governor (in Stuff). He seemed typically loose, not very rigorous, but also not very controversial.

Then the Deputy Governor popped up in an interview at Business Desk. You’ll recall that in a post late last week I took the Governor to task for having suggested to FEC that somehow the Bank was contractually bound to keep offering the Funding for Lending scheme for the next year plus, even as the MPC was saying it wanted to tighten monetary conditions quite a bit. It looked as though Bascand had been sent out in part to tidy up after the Governor (a job that, as a safer pair of hands who’d have made a less bad Governor, he seems to do a bit of). In that interview we learned that – at least in Bascand’s view – actually it wasn’t a matter of contract at all, but of “keeping our word”. He went on to add that

“I do place quite a lot of weight on RBNZ’s words being listened to and us being true to what we say. That’s where our credibility comes from,”

The same daft argument they adopted for sticking to their odd pledge in March 2020 not to change the OCR, either way and come what may, for a year. And on the other hand, the one they obviously discounted when (sensibly if belatedly) choosing to stop LSAP purchases. If you want to be credible, stick to making few (and sensible) pledges, and only ones that respect the extreme uncertainty every monetary policy maker faces when contemplating future policy moves.

Bascand went on to try to articulate a substantive case for keeping offering the Funding for Lending scheme (although never actually engaged with the distortions that accompany it), arguing about the FfL scheme that “one doesn’t really know” what impact changes in the scheme would have. But that is hardly a satisfactory answer both because (a) it is an implied admission that they are running a crisis-intervention instrument that they don’t really understand the effects of (but is having those effects now), and (b) because on their own telling the scheme will end next year, policy now is set on forecasts, so those forecasts must already be building in some view on what impact the end of the FfL scheme will have. But even if there was anything much to the Bank’s concern about precision – and there isn’t, since exchange rate reactions to OCR changes are never that predictable – nothing would stop them phasing the scheme out over a few months, enabling any observed effects to be taken account of as the OCR itself was being set.

So, to recap. To this point, we’d had the Governor suggest a contract and the Deputy Governor disavow that notion (and word). But then the Bank’s Chief Economist – who has not been let loose to do a single speech on-the-record in the 3+ years he has been a statutory officeholder – was interviewed by interest.co.nz. And up popped the idea of a contractual obligation again

Furthermore, Yuong confirmed the RBNZ would keep its Funding for Lending Programme (FLP) in place until the end of 2022 to uphold the “contractual arrangement” it made with retail banks last year.

His words, no paraphrasing.

Ha’s interview seemed to focus on the future of the LSAP, and here he seemed back on-message with all this talk about unpredictability and lack of precision.

Hesitation over going down an untrodden path

As for the LSAP, Ha said the RBNZ’s initial thinking is that it isn’t keen to actively sell the $54 billion of New Zealand Government Bonds it has bought from banks, fund managers, etc since March 2020.

By buying these bonds it put downward pressure on interest rates. Actively selling them before they mature would tighten monetary conditions.  

Ha said, “We know a lot more about how to calibrate tightening policy through an OCR. We know less about how you would do that through selling down government bonds.”

He was also wary of the RBNZ not flooding the market with bonds at a time Treasury’s bond issuance remains elevated ($30 billion of issuance is planned for the 2021/22 year).

“The key thing to remember is, on the way down, you sort of made a big splash about the LSAP. Markets are dysfunctional, you want to keep interest rates low,” Ha said.

“On the way out, you want to be quite methodical and want to be operational in the background. We’re not intending to send massive policy signals through the withdrawal of the LSAP programme.

“We largely see it now as just managing… the holdings of those assets on our balance sheet.”

So last year they were all gung-ho on how much they were achieving by buying bonds, but now it is all too hard, and they propose to simply sit on their hands (and risk more large losses to the taxpayer). And if the bond market was a bit dysfunctional briefly last March, it wasn’t through most of the period the Bank was buying heavily and it isn’t now. It simply defies belief that they can seriously believe that a pre-announced sales programme of, say, $2billion a month would create any difficulties for the market at all. What is more likely is that, in their heart of hearts, they know that LSAP bond sales wouldn’t make any material macro difference it all. They wouldn’t tighten conditions any more than the purchases – heavily focused at long maturities of little relevance to anyone much in the New Zealand market – themselves did. But it would a bit awkward to concede that, after all the spin last year.

The fourth policymaker interview (at least of those I noticed) was by the Assistant Governor (the deputy CE responsible for monetary policy) Christian Hawkesby with Bloomberg. Bloomberg seemed more interested in getting comment on the likely stance of policy, rather than details of which instrument. I was encouraged that Hawkesby told his interviewers that the MPC that a 50 point OCR increases was “definitely on the table” last week and “actively considered”, even as I wondered why we learned this from an interview with a specific paywalled proprietary outlet and not from, say, the minutes of the MPC meeting (or even, at a pinch, the Governor’s press conference). In an update to their story, Bloomberg reports that their story – and a sense that Hawkesby was still hawkish – moved both the exchange rate and the market pricing on an October OCR increase.

I’m left with a number of concerns:

  • on the specific of communications around the FfL scheme, three top managers over three days couldn’t even keep their lines consistent (“contract” or not),
  • the poor quality of what argumentation these highly-paid supposedly expert monetary policymakers are putting up about getting out of the crisis programmes, and
  • none of this (whether crisis programme arguments or the possibility of a 50bps OCR increase) was in the MPS or the minutes of the MPC meeting, which are supposed to be at the heart of the transparency and accountability around monetary policy, including because everyone has equal access to those public documents and knows when they will be released.

It really isn’t good enough.

One could go on to note that we’ve (again) heard nothing from the three “independent” non-executive members of the MPC. Of course, in a way that isn’t surprising: one has no relevant expertise at all (and never been heard from once) and all three were clearly carefully selected to not make waves and to provide reputational cover for the Governor’s continued control, despite the formal Committee structure, and formal commitments to greater transparency.

And, to be clear, if I am criticising the different lines Orr, Bascand, and Ha are running it is simply because they are supposed to be representing a decision already made, presumably with justifications agreed at the time. I’m all in favour of much more openness and diversity of view – both what should be captured in serious minutes, and that which serious speeches and lectures can provide. There is (always) real uncertainty about how the economy is working, and we should be able to see evidence of a serious contest of ideas and evidence. That sort of openness actually helps stimulate debate (internal and external) and scrutiny ex ante, as well as ex post accountability. Thus, you can see why the MPC members, perhaps the Governor most of all, just prefer to keep things the half-baked way they are.

Rising house prices do not make New Zealanders better off

I didn’t really read the housing section of last week’s Reserve Bank MPS – housing isn’t their responsibility and their analysis of it has rarely been up to much, often lurching unpredictably from one story to another. And their new material on house prices in each MPS only stems from the Remit change Grant Robertson foisted on them early in the year, knowing it would make no substantive difference to anything, but designed to look as though the government cared.

So it was only when the Herald’s Thomas Coughlan tweeted this chart yesterday that I noticed it.

RB house prices

The chart is prefaced with this text

The MPC sets monetary policy to achieve its inflation and employment objectives in the Remit. It considers the outlook for the housing market because house prices can influence broader economic activity, employment, and consumer price inflation (figure A5).

So we are presumably supposed to take this as the best professional view of the seven members of the Monetary Policy Committee. After all, it isn’t a throwaway line from a single member in an ill-considered press conference or interview comment. There is a bunch of different channels identified (and no obvious space constraints – they could easily have added more if they thought others were important), and nothing of substance gets into a Monetary Policy Statement without a fair degree of senior management scrutiny and review.

There are so many problems with this graphic it is difficult to know where to start. But perhaps first with the clear impression a casual reader would take away from this that the seven Robertson-appointed members of the MPC think that higher house prices are “a good thing”. After all, for most of the last decade inflation undershot the Bank’s target (unemployment lingered disconcertingly high for a disconcerting period of time too). More would have been better on both counts. Perhaps a charitable reader might wonder if the MPC really only had some short-term effects in view, but there is nothing in the substance of the chart or its title to suggest that.

And then there is the problem of the left-hand box: they start from “house prices” and “housing market activity” but these things never occur in a vacuum (as, for example, they would no doubt – and rightly – point out if they were talking about any other price (say, the exchange rate). Most often, surges in house prices (at least in New Zealand) have been associated in time with surges in economic activity driven by a range of different (policy and non-policy) factors.

But perhaps the biggest problem is with the claim – almost explicit in the top box of the second column – that higher house prices leave New Zealanders as a whole (remember, this is a whole-economy macroeconomic agency) better off. They don’t.

That they don’t, in principle, is easy enough to see. Everyone in the country needs a roof over his or her head. If I need a roof over my head for the rest of my life, ownership of one house meets my housing consumption needs. What matters is the shelter services the house priovides not the notional value the house might be sold at. Whether my house is valued today as $0.5m (roughly what I paid for it years ago), $1.75m (roughly what an e-valuer site tells me it is worth today) or $3.5m makes not the slightest difference to me. I still want to consume the bundle of services (location, size, sun etc) that this particular house provides.

Now, I might feel differently if I had a large mortgage: after all, negative equity gives the bank the right to foreclose (which can be both expensive and inconvenient), and even if the bank didn’t foreclose (mostly they don’t) it might also make it impossible for me to buy a similar house elsewhere if job opportunities suggested a move.

But this is where one needs to step back and think about the population as a whole. To a first approximation, for every apparent winner from higher (national) house prices there is a loser and for most – perhaps especially middle-aged owner occupiers – it makes no difference at all. There is no more economywide purchasing power created. And real gains that accrue to some people are offset by real losses to others. Owners of rental properties really are better off when real house prices go up. After all, they don’t own houses to live in them, but mostly for the profit they expect to make and the future consumption opportunities for themselves and their families. They can realise their gains and move on, or simply borrow against them.

But on the other hand, there are a lot of people made materially worse off by higher house prices – the people who don’t own a house now who either want to buy one in future or who are, and expect to, keep on renting. Consider someone just graduating from university who, a few decades ago, might have expected to buy a house after a couple of years working. But with real house prices in New Zealand as they are now not only does the deposit requirement push back any feasible purchase date, but the total amount of the lifetime income of the young graduate will have to devote to house purchase costs is so much greater. (Of course, real interest rates are lower than they were decades ago but recall that in the Bank’s scenario we are just thinking about house prices.) Earnings that are (eventually) used for the acquisition of a house can’t be used for other things. Earnings saved now to accumulate a deposit are not spent.

The story isn’t so different for long-term renters since in the medium-term (the adjustment isn’t instantaneous) if house prices are higher one can expect rents to be higher (than otherwise). In latter day New Zealand that has taken the form of rents holding up, or rising a bit, even as real interest rates have fallen a lot, which would otherwise have been expected to lower rents. Earnings spent (and expected to be spent) on rents can’t be spent on other things.

What (mostly) happens when house prices rise is that purchasing power is redistributed – usually towards those who have (houses) and away from those who have not (houses). Of course, it is further muddled by things like the Accommodation Supplement which shifts some of the losses onto the Crown……but that only means that taxes will be higher than otherwise in future. There is no net new purchasing power for society as a whole. (Were one inclined to an inequality story one might note that wealthier people tend to have lower marginal propensities to consume than poorer people.)

Are there possible caveats to this in-principle story? The story I used to tell was that, in principle, we might be better off from higher house prices if we all sold our houses to foreigners (at over the odds prices) and rented for the rest of our lives. But it was a story to illustrate the absurdity (and marginal relevance) of the point, and that was before the current government made such foreign house-buying illegal.

I’ve told you an in-principle story. The Bank likes to claim that the data don’t back this sort of story, And it is certainly true that there will often be a correlation between increases in house prices and increases in consumer spending. But that is mostly because – as I noted earlier – in the real world something triggers house price increases, and that something is often strong lift in economic activity and employment (in turn with triggers behind those developments). When the economy is running hot – and especially when land supply is restricted – buoyant demand, buoyant employment, rising wage inflation, increased turnover of the housing stock, and surges in house inflation are often happening at the same time. And in recessions vice versa. It isn’t easy to unpick chains of causation in the data.

Since higher house prices do not add to the lifetime purchasing power of New Zealanders as a whole, the Bank’s wealth effect story has to rest largely on some sort of view that households are systematically fooled by the house price changes. It is possible I suppose, at least the first time prices surge, but it doesn’t seem very likely. It isn’t as if surges in house prices – nominal and/or real have been uncommon in modern New Zealand.

The Bank also sometimes likes to highlight a story (it is there in that graphic) that even if the population doesn’t feel any wealthier, rising house prices might also boost consumption – at least bring it forward, without boosting lifetime consumption – by easing collateral constraints. In principle, a bank would lend even more to me secured on the value of my house than they might have done a couple of years ago. But again my ability to borrow a bit more has to be set against the reduced ability to borrow of the young graduate who now has to save even more in a deposit to get on the (residential mortgage) borrowing ladder at all. Sadly, in today’s bizarrely distorted housing market, we often find parents with freehold or lightly-indebted houses gifting or lending money to children, net effect on consumption probably roughly zero. With real house prices surging to fresh highs each cycle for decades now, it doesn’t seem that likely that many people are very collateral constrained.

For years I’ve been running a commonsense test over the Bank’s claims. This chart is of New Zealand real house prices

house prices aug 21

This series ends in December last year, so as of now we can probably think of real New Zealand house prices being four times what they were in December 1990 (I chose the starting point because that quarter was just prior to the 1991 recession getting underway, but you can see that real house prices hadn’t moved much for several years).

These are huge increases in real house prices, some of the very largest (for a whole country) seen anywhere over a comparable period (notably a period in which productivity growth was underwhelming). Were there to be much to the Reserve Bank’s wealth effects story (or its collateral constraints story) at the whole economy level mightn’t one have expected to see consumption as a share of national income rising, savings as a share of national income falling?

Of course there is all sorts of other stuff going on, but this is a really big – unprecedented in New Zealand – change in real (and nominal) house prices. But here is consumption as a share of national disposable income, back to the late 80s, just before house prices began to surge. The data are for March years.

consumption and NDI

The orange line is private sector (households and non-profits) consumption, while the blue line adds in public (government) consumption spending.

Of course, there are cycles in the series. There are two peaks, during the two big recessions (1991/92 and 2008/09): consumption tends (quite rationally) to be smoother than income. There is quite a dip in the early-mid 2000s, which can readily be shown to line up with the really big surpluses the government was running at the time – the country was earning a lot of income, but the Crown was temporarily sitting on a disproportionate share of that income.

And what of the house price booms. There were three during the period in the data (so not including the last year) – the few years running up to 1996, the period from 2003 to 2007 (particularly the early part of that period), and the period from about 2013 to about 2016. There is nothing in the consumption/savings data over those periods that would surprise someone who didn’t know about the house price surges.

And across the period as a whole, at best consumption has been flat as a share of income over 30 years of unprecedented house price increases. Looked at in the right light perhaps it has even been trending down a bit (private consumption as a share of income was as low in the March 2020 year as it was 16-17 years early when not only was the Crown running huge surpluses but real house prices were much lower.

I’m not suggesting any of this is definitive but when there is (a) no reason to think that New Zealanders as a whole are any wealthier when real house prices rise, and (b) no sign over decades in the macroeconomic data of the sort of effect the Bank likes to talk up, it might be safer to conclude that the effect just isn’t there to any meaningful macroeconomically significant effect.

Of course, as noted earlier there are all sorts of short-term correlations, typically resulting from common third factors at work, but the story the Bank seemed to be trying to tell in that graphic was neither representative of the economy as a whole, nor helpful.

The line I’ve run in this post is not new. In fact, 10 years ago now the Reserve Bank itself published an article in its then Bulletin discussing many of the same issues, and suggesting very similar sorts of conclusions (with, of course, 10 years less data). I was one of the authors of the article but – as was the norm – Bulletin articles carried the imprimatur of the Bank, and were not just disclaimed as the views of the authors.