How strong a recovery?

One line sometimes heard in the current New Zealand economic discussion is a suggestion that New Zealand has. or has had, a “robust” recovery.  I reckon “robust” is generally a good word to avoid, since it has connotations of something well-founded and sustainable which, in a sense, only time will tell.  But just how strong has our recovery been?

Official quarterly GDP data go back only to 1987 [surely, surely, we need rather better funding for core official economic statistics] but Viv Hall and John McDermott have generated a series, using earlier annual estimates by SNZ and other authors, all the way back to 1947.

The chart below shows the annual percentage change in real quarterly GDP (seasonally adjusted, since that is how Hall and McDermott present their estimates).  There are some oddities around the estimates for the first few years (if I recall rightly, having to do with the level of aggregation in export prices used in generating the original annual real series) so here I’ve shown the data only from the year to December 1952 (a version showing the data all the way back to 1948 is shown at the end of the post).  It is a long time series by New Zealand standards.


On these estimates, real GDP has been quite volatile over the years.  We’ve had five episodes in which GDP has fallen by 2 per cent or more between one quarter and the same quarter the following year.  The recession in 2008/09 was almost as deep as the deepest of these five contractions.  But what is noteworthy is just how subdued the recent recovery has been.  Annual growth has inched up to around 3.5 per cent, and few, if any, forecasters seems to be picking it to go any higher.  In past cycles, growth peaks in excess of 6 per cent have not been uncommon and periods of growth in excess of 4 per cent per annum have been the norm.

Of course, there is no doubt something to be said for some stability to growth rates. But there is probably more to be said – perhaps especially for those who became unemployed  –  for a quick rebound from a serious recession.  We haven’t had that sort of rebound.  Of course, most other advanced economies have not either but many of them have policy interest rates around zero and have largely exhausted the limits of conventional monetary policy.    Sometimes inflation doesn’t provide any leeway for an inflation targeting central bank to accommodate a strong recovery, but that hasn’t been a problem here.

One could mount an argument – reasonable people would differ on the point – that faced with a location-specific demand shock such as the Christchurch repair and rebuild process, it might have been quite reasonable to have expected a particularly strong rebound in GDP for a time, and perhaps even some overshooting in headline CPI inflation (since medium-term trends are what the Bank is instructed to focus on).

But whatever your view on that particular point, given the depth of the recession, how far below pre-recession trends GDP still is, and how low core inflation has drifted, peak GDP growth of 3.5 per cent should be counted more as a failure than as a success.  An economy firing on two, faltering, cylinders might be a better description than “strong” or “robust”.

One other argument I have heard against cutting the OCR now is the risk of a repeat of what is loosely characterised by my old colleague Rodney Dickens as “Alan Bollard’s go-for-growth experiment” of 2003/04.  That there was such an “experiment” is hard to disagree with –  the government had given Alan a higher inflation target, and he (and the then government) seemed to have a sense that the old-school Reserve Bank hardliners had been holding back New Zealand’s growth potential.  I think the characterisation is a little unfair on Alan, but even he later admitted that the policy approach in 2003 had been a mistake.

I could discuss the similarities and differences between 2003 and the current situation at some length (and I don’t feel defensive about 2003, as I working overseas that year), but the stark and simple contrast is captured in this chart, which I’ve run already this week.

core cpi

In 2003 and 2004, core inflation was well above the target midpoint, had increased materally over the previous year or so, and was increasing further.  Of course, the PTA at the time made no mention of the midpoint, but no one ever thought the top part of the target range was something to actively aim for.  This particular analytical series did not exist then, but it captures trends that were apparent in other ways of slicing and dicing the CPI.   Even allowing for the uncertainties (SARS etc), to have cut the OCR then and to have been so slow to move it back up when the initial scare passed, is hard to defend.  As Alan later said, it was a mistake.

What is the situation now?  The Bank has, as much by accident as by good planning, achieved something worthwhile in the last few years in finally demonstrating that core inflation will not always be in the top half of the target range.  But this is not a price level target regime, and the PTA is clear that the focus now needs to be on keeping future inflation near the 2 per cent midpoint.  Actual measures of core inflation have been falling for years, and are now well below the target midpoint.  A material increase in the (core) inflation rate would be highly desirable, given the target the Minister and the Governor have agreed.  It has been forecast for several years, but it has simply not arrived.  Perhaps it is just a “not yet”, but the case for OCR cuts now is very very different from the case in 2003.


The first chart above for the full period since 1948.


Why not?

The Governor’s press release this morning, leaving the OCR unchanged, was no surprise.

But it continues to seem out of step with the data, and with his responsibilities under the Policy Targets Agreement. The statement has the feel of being written by someone who really really does not want to cut the OCR, but who won’t explain why.  It is if the current level of the OCR were being treated as an end in itself, or being held up in pursuit of some other goal, rather than being a tool for influencing the (rather too low) medium-term rate of inflation.

Fortunately, the statement corrects what must have been a mis-step in John McDermott’s speech last week.  Today the Governor states that:

It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target.

Last week, that criterion was expressed in terms of lower than the “target range”.

But there is no reference anywhere in the statement to the 2 per cent midpoint, even though the Governor and the Minister explicitly agreed that the midpoint should be the Bank’s focus.  And wage and price-setting outcomes are already inconsistent with the target midpoint and have been now for some years.  This statement offers no tangible basis for expecting that to change, just the limp observation that underlying inflation “is expected to pick-up gradually”.  Why?  When?  What is about to change that will now reverse a slide in core inflation that has been underway, more or less continuously, since 2007?  It has to be something more than just a belief that monetary policy is “stimulatory”.

Once again, the Governor anguishes about the exchange rate.  I agree totally with the substance of his references to New Zealand’s long-term economic fundamentals and how out of step the exchange rate is with them (it was the heart of this paper I wrote for the Treasury-Reserve Bank forum on exchange rate issues in 2013).  But……this is a press release about the nominal OCR, not about the real factors that shape New Zealand’s longer-term competitiveness.  And while the Governor observes that “the appreciation in the exchange rate, while our key export prices have been falling, has been unwelcome”, he seems unwilling to take the obvious step in response.  Exchange rates are largely influenced by expected relative risk-adjusted returns, broadly defined.  When New Zealand interest rates have been rising while those in most of the rest of the world have been falling, and we have a Governor who appears very reluctant to cut those interest rates, it is hardly surprising that we end up with a cyclically strong exchange rate.  Cutting the OCR won’t solve the long-term economic challenges:  they are about real factors, not monetary policy. But a strong sense from the Bank that the OCR was heading back towards 2.5 per cent over the coming year, or perhaps even lower, would be likely to make a useful difference.

And why not do so?  Core inflation is very low, the number of people unemployed (and underemployed) lingers uncomfortably high, inflation expectations are falling, farm incomes are falling, credit growth is pretty modest, and so on.  So why not cut?    Of course, no one can be totally certain that, with hindsight, cuts will prove to have been the right policy, but on the New Zealand and global data as they stand today –  and without a compelling case to suggest the inflation picture is about to change materially –  not doing so increasingly looks negligent.  In time, it is the sort of stance that also risks further undermining public and political support for the broad monetary policy framework, and the Governor of the Bank’s powerful position within it.

The Bank’s take on the rest of the world, as reflected in the press release, is both puzzling and disconcerting.  The Governor reiterates what appears to be one of his favourite lines, that trading partner growth is around its long-term average.  This is true, but largely irrelevant.  First, it simply reflects the fact that China is a more important trading partner than it was, and its growth rates are higher than those in our other trading partners.  But even China is slowing, probably quite sharply.  And commodity prices –  a key way the rest of the world’s economy affects New Zealand –  have fallen a lot.

In addition, in almost all of our trading partners – and in most countries that are not our trading partners –  GDP remains well below pre-crisis trend levels. Not all of that is excess capacity, but a significant proportion is likely to be.  Again, the Governor makes much of the low interest rates abroad, but seems not to put much weight on why those rates are so low.  There are all sorts of idiosyncratic factors in individual countries, but across the world interest rates are low and falling not because central banks have arbitrarily put them there (it isn’t some “monetary policy shock” in the jargon), but because markets and central banks both judge that underlying demand and inflation pressures require interest rates be at least as low as they are.  That is a very worrying perspective on the world, not a comforting one.

Finally, the Reserve Bank likes to claim that it is highly transparent, citing for example its scores in papers like this one.  But in many of the more transparent central bank we could look forward to the minutes of the meetings that led to the decision being published. In some central banks, even the range of views is extensively outlined.  The Governor has noted he now makes his OCR decision in the so-called Governing Committee, with his three senior colleagues.  But we do not have access to the minutes of these meetings, even with a lag, or to a summary of the advice provided to the Governor by his wider group of advisers, including the external advisers.  Transparency and open government are not just about announcing and explaining final decisions, but about the process whereby those decisions were reached.  Some other New Zealand government agencies are quite good at pro-active release of background material (for example, papers leading up to the Budget).  It is a model the Reserve Bank could look at emulating.  In the next few days, I am expecting a response from the Reserve Bank to my OIA request for background papers to an OCR decision from 10 years ago.  It will be interesting to see how they interpret the Act is deciding how to respond.

Tomorrow’s OCR announcement

Tomorrow morning Graeme Wheeler, the single unelected official responsible for the conduct of New Zealand’s monetary policy, will announce his latest OCR decision.  That decision will, no doubt, already have been made – lags between decision and announcement are longer in New Zealand than in most other countries, even more so at Monetary Policy Statements  – and the only discussion now will be around wording the one page press release.   Do we really need to say anything this time about future policy?  Will that slight change of words spook the markets?  Is that claim really defensible?  How appropriate is it to comment on another country’s monetary policy?  How does talk about the exchange rate and the medium-term challenges it poses fit in a statement about today’s OCR.  How will local economists read it?  How will offshore markets read it?  Where are the political fishhooks?  Don’t we need a comma there rather than a semi-colon?  And so on. But the heart of the matter is the OCR decision itself – where will the interest rate the Bank pays on (some) settlement cash balances be set for the next six weeks or so.  The key influence on that should be the inflation target: a range of 1 to 3 per cent annual CPI inflation, with a focus on keeping future inflation “near the 2 per cent target midpoint”. The Reserve Bank would no doubt argue that that is exactly what they have been doing.  The target is not about inflation today, it is about “future inflation outcomes over the medium term”.   The Reserve Bank’s published inflation forecasts always show inflation coming back towards the target midpoint a year or two ahead.  They do that by construction, but policy over the last few years has been set consistent with that view.  The judgement was that interest rates needed to be first at 2.5 per cent, and then move progressively higher, to ensure that future inflation did turn out consistent with the inflation target.   Reading through the Monetary Policy Statement from last March, when the OCR increases began, it is quite clear that the Bank expected to see more non-tradables inflation, higher inflation expectations and higher wage inflation, even with the programme of OCR increases they had in mind. But the Reserve Bank was wrong.  There is no particular shame in being wrong, so long as one learns from one’s mistakes.  It isn’t clear that the Reserve Bank has been very good at that.  Of course, what matters is not that so-called headline inflation was 0.1 per cent in the last year.  All sorts of things will throw headline inflation around in the short-term and generally it won’t make sense for monetary policy to try to offset them.  That is why people develop measures of core inflation –  simple ones like CPI ex food and energy (volatile items), trimmed means, weighted medians, and the sectoral core factor model. Core inflation has been falling core cpi So have household inflation expectations household So have business wage and inflation expectations business And dairy prices – a major influence on incomes, and incentives to invest – have been coming in much lower than the Reserve Bank expected, consistent with the pretty relentless decline in global commodity prices. Had the Reserve Bank had known last March how the New Zealand economic data would turn out, I don’t think Mr Wheeler would have seriously considered raising the OCR then.  Had they done so anyway, they would, I hope, have faced very serious questions from their Board and from the Finance and Expenditure Committee: raising the OCR while showing forecasts suggested that core inflation would keep falling even further below the target midpoint looks like something other than inflation targeting. Everyone makes mistakes, and economic forecasting is something of a mug’s game,  But it is the Reserve Bank that chooses what weight to put on its own forecasts, and how far ahead to look.  When they have been so persistently one-sided in their errors, it is surely time to down-weight the forecasts quite considerably.  The “model” –  the way of thinking about what is going on –  just isn’t helping much, if at all. Such one-sided errors aren’t new.  During the boom years, the Reserve Bank was consistently surprised by how strong inflation was.  We didn’t fully understand what was going on, but didn’t correct for that and, as a result, by the end of the boom core inflation measures were above the top of the target range.  The underlying belief that surprisingly strong inflation pressures were just about to end is quite strongly parallel to what seems to be going on now – an apparent wish to believe that whatever has kept inflation down is just about to end. With perfect foresight the OCR would not have been raised to 3.5 per cent. No one has perfect foresight, but knowing what we now know  there is a strong case for starting to lower the OCR now.     As it is, it is not just that nominal interest rates were raised by 100 basis points last year (and not just the OCR, but floating mortgage rates) but that as inflation expectations are still falling, real borrowing rates are still rising further. Perhaps it would be different if there were strong, well-substantiated, reasons to think that underlying inflation pressures were just about to recover strongly –  and I stress “strongly”; it has taken five years or more for core inflation to drift this far below the target midpoint. But there aren’t.  The construction cycle looks to be pretty close to peaking .  Recall that the gearing-up of activity in Christchurch represented the biggest single project pressure on resources in New Zealand at least since Think Big, and yet core inflation just went on falling.  There is no sign of business or consumer confidence pushing up to new heights.  Export commodity prices are weak, especially for dairy –  and the exchange rate is at a level which, if sustained, can only act as a drag on other tradables sector activity.  And while I wouldn’t suggest setting policy on a non-consensus forecast for the rest of the world, no one really sees global activity or inflation posing a material new inflationary risk in New Zealand in the next year or two.  If anything, the deflationary clouds continue to gather. John McDermott’s speech last week was slightly encouraging –  a very belated recognition of just how weak inflation has been, and how little the Reserve Bank (or anyone) really understands about what is going on.  But I noted then this disconcerting line from the speech:

We remain vigilant in watching wage bargaining and price-setting outcomes. Should these settle at levels lower than our target range for inflation, it would be appropriate to ease policy.

In 2012, the Governor and Minister explicitly, and consciously, decided to include a focus on the target midpoint in the PTA.    It is the midpoint, not the bottom of the target range which the Bank should be focusing on. I can really only see one argument against an OCR cut, a line which I’ve seen reported in various media: the housing market, and what lower interest rates might do to house prices.  There are several points worth making briefly here:

  • In its monetary policy, the Reserve Bank is explicitly not charged with managing house prices.  The only target for monetary policy –  agreed with the Minister – is for the CPI.  Neither existing house prices nor land prices are in the CPI, and the CPI’s treatment of housing is one the Reserve Bank has endorsed.
  • To the extent that rising house and land prices in some parts of the country reflect the interaction of regulatory obstacles and population pressures, they are real relative prices changes –  not something that, even in principle, monetary policy should be paying much attention to.
  • House prices in much of the country have been flat or even falling.  There is no evidence of some generalised speculative dynamic, let alone a credit boom.
  • Any possible threats to future financial stability –  the case for which the Reserve Bank has not yet convincingly made – should be dealt with through prudential regulatory tools.  Higher required capital ratios, or higher risk weights on housing loans, would be an orthodox response if a cost-benefit analysis suggested that larger buffers were required.

Finally, the Reserve Bank does not have an explicit “dual mandate”.  But any time a central bank engages in discretionary monetary policy – as opposed to, say, a long-term fixed exchange rate – it is assumes such a responsibility de facto.  Changes in the OCR affect output and employment in the short to medium term.  Perhaps I’ve completely lost perspective, but it disconcerts me how little public attention the Reserve Bank gives to the number of people unemployed (and underemployed).  At 5.7 per cent, the unemployment rate is still well above normal, and underemployment measures in the HLFS have not come down much at all.  The decision to hold the OCR is not just a decision between higher and low inflation.  If it were, there would still be a case for a cut.  But the cut/hold choice is also one between a faster reduction in the number of people unemployed and a slower reduction.  Involuntary unemployment is a blight, that scars families and individuals, and often has permanent adverse economic effects on the unemployed.    When there is so much  inflation leeway –  inflation so far below target, with few looming inflation pressures – the plight of the unemployed should get more attention from the Reserve Bank, and from those who hold it to account.

Another potential “blunder of our governments”?

I commented the other day on possible New Zealand cases of government blunders.  My former colleague, Ian Harrison, reminded me of his work on another possible candidate, the Building (Earthquake-prone Buildings) Amendment Bill, currently before a Select Committee, which is due to report by the end of July.  Ian’s trenchant assessment of MBIE’s work leading up to this bill made pretty sobering reading the first time I went through it, and it was no less disquieting the second time.  I’ve seen no sign of any sort of substantial rebuttal to the thrust of the analysis Ian presents.

I’m certainly not indifferent to earthquake risk.  I live on the side of a hill in Wellington.  And my parents’ apartment block was severely damaged (and later demolished) in the February 2011 earthquake.  But this bill just does not look like the fruit of good public policy making, cost-effectively addressing real and substantive risks.  Perhaps the work of the Select Committee might yet limit the prospective damage and costs?

Eric Crampton discussed some of Ian’s earlier work a couple of years ago.  This suggestion made a lot of sense:

There’s a good case for having liability rules or standards for buildings that the public is forced to attend by the state: courtrooms, prisons, public licensing offices and the like. We can’t use a revealed preference argument around risk acceptance for those venues. But for other buildings where entry is voluntary, what’s wrong with mandating signs advising the public that “Engineering assessment suggests this building has (very low, below average, average, above average, seriously high risk) of falling down in case of earthquake. Entry is at own risk.”

Ian’s focus is bureaucratic failures. I particularly enjoyed this, perhaps somewhat jaundiced, list of factors that lead official agencies, however well-intentioned, towards bad outcomes.



As King and Crewe’s book reflects, officials will make plenty of mistakes, but cases that rise to the level of  “blunders” hardly ever result from the efforts of officials alone.

Whither the inflation target?

I’ve just been finalising for publication some comments I presented late last year at the IJCB-RBNZ conference marking the 25th anniversary of inflation targeting, and reflecting again on the wider set of options from which authorities can choose.  Looking ahead, I’m not convinced that inflation targeting is clearly superior to the alternatives.  The slightly unconventional option that I would prefer to see explored in more depth is nominal wage targeting.   Wages are the stickiest of the nominal prices, and nominal wages are also the key element underpinning the servicing of nominal debt.

But that is a topic for another day.  Today I want to focus more narrowly on the question of “if we are going to run an inflation target, where should that target be set”.  In our system, the Minister of Finance has the lead in setting the target[1].

The approach to setting the level of the first inflation target was pretty simple. The Act specified that the primary goal of monetary policy was “stability in the general level of prices”, and in setting an inflation target range the idea was simply to have something as close as feasible to that.   I think most of those involved thought a 0 to 2 per cent annual inflation target was a pretty close approximation to “price stability”.

The more hard-line among us were a bit disappointed when Winston Peters and Don Brash later agreed to shift the target up to 0 to 3 per cent, and then Michael Cullen and Alan Bollard agreed to a further shift up to 1 to 3 per cent.   These changes seemed to arise from some mix of political product differentiation, and convergence towards the targets being used in other countries.  But I don’t think anyone at the Bank really thought these changes would make much macroeconomic difference, good or ill.  Nominal targets generally shouldn’t.  The tax system works a little less well with slightly higher inflation, but any downward nominal rigidities are also a little less pressing.

One factor that never got much attention was the near-zero lower bound on nominal interest rates.  We knew it was there –  if policy interest rates got much below zero people could simply shift to cash – but it never seemed likely to be much of an issue for New Zealand.

Craig Ebert, senior economist at the BNZ, put out an interesting note a month ago arguing that New Zealand should think seriously about lowering its inflation target.  The gist of the argument is that deflation isn’t particularly harmful and that the current global low inflation is, from a New Zealand perspective, a good thing, which should be accommodated rather than offset.

I’m not persuaded.   Deflation isn’t likely to be harmful if it results from positive productivity shocks, and occurs in economies where private debt has only a modest role.   In most of the older deflations that the recent BIS paper looked at, not only was private debt much less important than it is now, but the near-zero lower bound was not a binding constraint.  We have never had a period in (modern?) history when policy interest rates have been near-zero for so long, and when private debt (and private financial assets) have been so pervasively important.

Last year, a leading figure in global central banking over the last 20 years visited New Zealand.  I asked him whether, purely with the benefit of hindsight, he wished that inflation targets had been set nearer 5 per cent than 2 per cent.  Doing so would have provided additional leeway to reduce real policy interest rates, to more deeply negative levels, during the period since 2007.  I didn’t really expect him to agree with the proposition, but what really surprised me was how few arguments he could put up in defence of  inflation targets centred on 2 per cent.  For countries that have now spent years at the near-zero lower bound, the with-hindsight case for higher initial inflation targets seems pretty clear-cut.  In the old line from James Tobin “it takes a heap of Harberger triangles to fill an Okun’s gap”.   Yes, the tax system worked a bit better with lower inflation, but there are an awfully large number of people unemployed across the advanced world at present.  The limits of monetary policy are part of the story.

But where should inflation targets be set now?  Is there a case now for raising them to 4 or 5 per cent, as commentators as eminent as Olivier Blanchard and Ken Rogoff have suggested?  In particular, is there such a case for New Zealand?   Eric Rosengren, President of the Boston Fed recently called for a debate on whether the Fed’s inflation target should be raised.  The FT suggests he was the first serving policymaker to openly canvass the issue.

The issue is perhaps more relevant for New Zealand (and Australia) than for most other advanced countries.  Why?  Quite simply because advanced countries that are at the near-zero lower bound  at present have no way of credibly raising inflation, and inflation expectations, from something around current inflation targets to something around 4-5 per cent.

If they could then inflation expectations would rise and real interest rates would fall, drawing forward more demand, and absorbing the current excess capacity (getting people back into jobs).  But policy interest rates in these countries can’t (with current institutional constraints) be cut materially further, and no one really believes that QE can make that degree of difference.   And people might reasonably conclude that an announced higher target was simply a desperate measure for crisis times, and that the authorities would renege on it once economic recovery got underway.

Some have suggested that expansionary fiscal policy provides a way through.  In principle that sounds fine, but in most (but not all) of these countries public debt is already very high (and understated in official figures, which often don’t record public sector pension liabilities), populations are ageing and –  probably not unrelatedly –  the political appetite for materially expansionary fiscal policy is largely non-existent.  Witness, as an example, the current UK election.

New Zealand is not at the near-zero lower bound.  But neither was most of the rest of the advanced world in 2007.  Indeed, almost all those countries had policy interest rates then above New Zealand’s current 3.5 per cent.  In the last rate-cutting cycle, the OCR was cut by 575 basis points and in the previous cycle, in the 1990s, short-term interest rates were allowed to fall by a similar amount.    Future recessions will happen, and there is no obvious reason to think that they will be smaller than we’ve seen before.  But the OCR could not now be cut by 575 basis points or anything like it.  Our Minister of Finance, and his advisers, should be treating that as a pressing concern.

Nominal targets shouldn’t matter very much for medium-term economic outcomes.  And they wouldn’t without the near-zero bound, and the free option of converting to cash.   Some argue that a negative 5 per cent Fed funds rate would have been helpful in the US in the depths of the recession. But if such a rate had been implemented there would have been large scale conversions  to physical cash and effective interest rates would not have gone materially negative.  Every central bank knows this, and none has been willing to cut policy rates so far as to see those large scale conversions.  These provisions are acting as a real constraint on central banks now, and constraining the speed at which economies can rebound from recession.

New Zealand should be acting now to be better positioned when the next serious downturn comes.  We don’t know when that will be.  If things turn nasty in China, in the rest of the emerging world, or in Europe once the first country leaves the euro, it could be very soon.  But it could be years away.    Or it might never happen.  No one can forecast timings.  But contingency planning isn’t about timing, but about planning for identified vulnerabilities.

There are two broad options:

  • Serious policy work on overcoming the near-zero lower bound, or
  • Raise the inflation target

What could be done about the near-zero lower bound?

  • In the longer-term, it might involve looking to phase out physical central bank notes and coins (which now play a very small role in day-to-day transactions)
  • It might involve repealing the legislative monopoly the Reserve Bank has on issuing physical notes and coins. The scope for innovative market-led alternatives might make it easier to end physical issuance by the central bank altogether
  • The stock of notes and coins could be capped at current  levels.  To the extent that physical currency has value as a retail payments medium it would still be available, but if it became scarcer the price would rise.
  • Central banks could put impose a fixed fee for converting settlement account balances into physical currency.  A 10 per cent fee, for example, would be likely to provide material additional leeway to allow policy rates to be cut more deeply negative.

People like Miles Kimball, Willem Buiter and others have written on some of these issues in much more depth.  I’m not sure which of these options, or others that have been touted, would be best.  But they are issues that central banks and finance ministries should be exploring in more depth now.  In New Zealand’s case, a joint working party with Australian officials might be an efficient way to address the issues.

Dealing with the near-zero lower bound –  mostly a government intervention which has become troublesome – should be a better option.  Something like a stable value of money seems a better outcome for society than a steady targeted debasement of the value of the currency.    If that could be done, a lower medium-term inflation target, centred on (true) zero might be desirable.

But if –  for whatever reason –  the authorities are not willing to do anything active about removing the near-zero lower bound, then they need to be thinking much harder about raising the inflation target[2].  New Zealand can actually deliver higher inflation, and do it quite quickly.  The OCR is 3.5 per cent, and there is nothing to suggest that the transmission mechanism is so impaired that lower policy rates would not flow through into lower retail interest rates, a lower exchange rate, and to higher inflation.   In some ways it would be a shame to have to do it.  But the possibility of a prolonged period in which the scope for conventional monetary policy has been exhausted, and the number of unemployed people sits far above normal levels for years, is not a risk that a democratic government should contemplate with equanimity.

[1] Section 9 of the Reserve Bank Act requires that “The Minister shall, before appointing, or reappointing, any person as Governor, fix, in agreement with that person, policy targets for the carrying out by the Bank of its primary function during that person’s term of office, or next term of office, as Governor.”  Since the Minister has a blocking veto on any recommended person for appointment as Governor, the Minister should normally have the dominant influence on the content of the Policy Targets Agreement.

[2] And would then need to do something about indexation of the tax system.

Anthony Trollope and a blunder of our governments

Anthony Trollope, the great English novelist, was born 200 years ago last Friday.

He and his wife spent two months in New Zealand in 1872.  Trollope recorded his observations and experiences in Australia and New Zealand.  Large chunks of the New Zealand bits were republished in 1969 in With Anthony Trollope in New Zealand, edited by A H Reed.  I’ve dipped into this book over the last few days, and reproduced a few of his observations on Anglican Christchurch here.  His description of a visit to the, now long-lost, Pink and White Terraces is evocative and well worth reading

But Trollope also came to Wellington.  Recall that the early 1870s was the prime of Julius Vogel, first as Colonial Treasurer and then as Premier, leading a heavy borrowing programme to finance large scale public works, railways, and immigration.  Trollope’s time in Wellington coincided with a motion of no-confidence in Vogel moved in the House of Representatives by the former Premier Edward Stafford.

I don’t think Trollope could quite make up his mind about railways and New Zealand (not unexpectedly perhaps: he was a novelist from abroad and former public servant in the British Post Office).  He repeats, and appears to accept, the oft-heard argument that New Zealand was different from Britain, and that government must be involved in marshalling the capital for railroads.  He observes “nothing tends so quickly to enrich a country and to enable a people to use their wealth which God has placed within their reach, as a ready conveyance for themselves and their goods.  But, faced with specifics, he also observes  that a rail line to the “valley of the Hutt” appears of “questionable political economy”.

But Trollope really gets into his stride on the issue of incentives and (lack of) adequate disciplines once such works programmes are envisaged.



Logrolling, mixed motives, the self-delusions to which all office holders are prone, the lure of the immediate over the longer-term, it is all there.  This, after all, was the man who was shortly to write the excellent The Way We Live Now.

How far has the analysis of rail in New Zealand moved on?  The allure of rail seems to remain real in some quarters – and perhaps we all fall for it briefly any time we take, say, the Eurostar between Paris and London.  One very senior public servant was heard to utter, not six years ago, in a serious discussion of New Zealand’s disappointing economic performance, his view that one of New Zealand’s great failings over its history had been under-investment in rail infrastructure –  rail having been, he noted, one of the great legacies to the world of Victorian Britain.

The previous government bought back the rail company, and the current one seems to be pouring extraordinary amounts of money into the renamed Kiwirail.  There is little sign that any very rigorous cost-benefit analysis is being done to evaluate the prospective expenditure and continuing operations at poor economic returns.  Perhaps it is still too soon to tell, but I suspect that the continued heavy spending on an extensive rail network will prove a worthy candidate to add to a New Zealand list of blunders of our governments.

The Blunders of our Governments

British governments that is.

A couple of weeks ago I wrote a little about the recent American book Why Government Fails So Often?   The Blunders of our Governments is a nice British complement to it.  Anthony King and Ivor Crewe have both been professors of government, and Crewe is now Master of University College, Oxford.  Unlike Peter Schuck, the author of the American book, they don’t say anything much about themselves, but it is not hard to deduce that they are probably instinctively (and perhaps analytically) inclined to believe in the good that government can do.   Holland, Germany, and the Nordics appear to be the preferred models of government process.

The chapter “An array of successes” begins “governments often succeed, far more often than they are usually given credit for”.  If true that would be good,  given how much of society’s resources governments command.  But the case was somewhat undermined when the first great success they listed was the Town and Country Planning Act 1947, and the associated restrictions on urban housebuilding etc.  I doubt many first home buyers near London –  facing even more ruinous prices than those in Auckland –  would give it the same degree of credit.  The authors might want to check on economic historian Nicholas Crafts’ recent paper on the role that largely-unrestricted housebuilding played in Britain’s 1930s recovery.

The book focuses on eleven specific “blunders” of British governments over the last 30 years or so ( like Schick they exclude foreign affairs and defence).  This isn’t just about wrong judgement calls, or unforeseeable changes of circumstance, or about a partisan view of the merits of what a government was trying to achieve.  They define a “blunder”

as an episode in which a government adopts a specific course of action in order to achieve one or more objectives and, as a result largely or wholly of its own mistakes, either fails completely to achieve those objectives, or does achieve some or all of them but contrives at the same time to cause a significant amount of “collateral damage” in the form of unintended and undesired consequences….financial, human, political or some combination of all three.

The first part of the book is a series of 11 chapters on each of the “blunder” episodes.  Some will be familiar, and will live in history –  the poll tax debacle in particular.  Others will be less familiar, especially to New Zealand readers.  They include the British exit from the ERM, private pensions mis-selling, individual training credits, the Millennium Dome, plans for national ID cards, and the public-private partnerships around the London Underground.  They are equal opportunity critics –  examples are drawn from both the Thatcher and Major Conservative governments and the Labour governments of Blair and Brown.  The authors appear to have a special distaste for the current government, but acknowledge that it is too soon to decide whether any of the examples they point to will eventually be seen as “blunders”.

The second half of the book turns to trying to distill lessons: why do so many things go so badly wrong?    They point to a variety of factors:

  • Cultural disconnects between the worlds of ministers and officials and those of the ordinary Briton.
  • A lack of effective political accountability
  • The rise of a process-management mentality in the public service
  • Groupthink
  • Fear of the consequences –  especially for public servants (but also for junior ministers) – of asking questions or expressing doubt (the name Gordon Brown was often mentioned in this context).
  • The focus in political management on spin and symbolism at the expense of substance.
  • The relative weakness of Parliament (although they note that backbench rebellions  –  not often visible in New Zealand –  have become much more common in recent decades.

It is a book worth reading for those interested in good government, and policy and operational processes in New Zealand.  There are enough similarities between the United Kingdom and New Zealand –  institutionally and culturally –  that many of the issues raised are likely to ring true to some extent in New Zealand.  In some respects, the challenges here are even greater: fewer “veto players”, less external policy scrutiny, and so on.  And it is not as if a book of this sort, that might attract a fairly wide readership among informed lay people, is likely to be written in New Zealand.

But as I read the book, I was jotting down episodes that might count as New Zealand policy “blunders”, on the King-Crewe definition.  Examples that came to mind included:

  • The Think Big programme of the early 1980s
  • The Novopay teachers’ pay system
  • The Reserve Bank’s experiment with the Monetary Conditions Index in the late 1990s
  • The attempt to introduce public hospital part-charges in the early 1990s.

There are probably many others.  Some might argue that the entire policy/operations split in state sector reform in the 1980s was an example, but then others might argue that the reversal of those reforms now underway could yet prove to be the “blunder”.  What of the rushed legislative powers over Christchurch taken following the earthquakes, or the Deposit Guarantee Scheme (and the eventual heavy losses)?  It might be easier to think of local body debacles –  the Otago Stadium, the Hamilton street-race, or (for those of a certain age), Wellington’s Sesqui.

I’m not looking to generate an argument about individual items on the list (a couple of which I was involved in myself).  But it is important to recognise, and build our institutions around the recognition, that “blunders” happen here too.  Citizens should expect that ministers and officials  learn from the blunders, and the propensities that give rise to them.   There have been recent substantial legislative changes around the state sector – including the bestowal on the State Services Commissioner of the rather grandiose title, “Head of the State Sector”.   But to what extent have these changes been informed by rigorous analysis of government successes and failures, here and abroad?  There is certainly a strong sense that process-management has primacy in appointments the Commission makes, and in the development processes it has underway.  Equally, there are not-infrequently heard doubts as to just how much free and frank advice and the contest of ideas is welcomed, either within departments and agencies, or from departments to ministers.

I don’t know the answer to the specific question in the previous paragraph, but I was mildly disconcerted that when I searched the State Services Commission’s website the last reference to “government failure” was from September 2003.  Perhaps reflecting my own biases, I also checked “analytical rigour”.  That wasn’t much more reassuring – the last reference was November 2003, almost 12 years ago.  Perhaps the absence is beginning to show?

Gillian Tett on the euro

Gillian Tett’s Friday FT columns are always worth reading.  This week she worries, and reports official US government worries, that European ministers and officials are understating the severity of the risks if Greece were to leave the euro.  Earlier in the week, I argued that Greek exit may well set off a chain of events that, in time, leads to the complete dissolution of the euro, and threaten the EU itself.

Tett’s perspective on the markets risk is plausible.  The honest assessment has to be “who knows”, and she herself makes that point.    Against the list of points she highlights, many of which would have been compelling in 2010, one could highlight that, unlike the Lehmans failure, the risk of Grexit has now been a long time coming.  About the only upside of the protracted Argentine journey to failure and default 15 years ago, for example, was that it was so long coming that in the end contagion was pretty limited.

But even if she is right about market risks, or I am about the political risks, not everything that is costly and potentially destructive can always be avoided.  This isn’t a cyclone or a tsunami, but perhaps it is the macroeconomic equivalent.  What is the credible effective politically-achievable way through the current storm that both avoids Grexit and puts Greece on a strong sustainable path to recovery and towards full employment?     Perhaps a divine choreographer could do it but, as I noted to a commenter the other day, God doesn’t usually seem to do macroeconomic management.  The interests are so diverse, the narratives are so diverse, and there is no choreographer.  That is democracy –  messy but better than the alternatives.  Probably such diverse democracies should never have signed up for the common currency.  But they did.  And now it seems hard to escape a conclusion that they can only drive on through the storm, hoping to limit the damage, to a new and very different future.  Perhaps no one will be better off.  Perhaps it won’t happen this quarter.   But –  other than just buying a little more time, when patience increasingly seems exhausted and the status quo doesn’t seem particularly satisfying –  what is the realistic alternative?

24 April 1915

(NB: There is almost no economics in this post.  It is for the history-minded)

Papers Past is one of New Zealand’s little-heralded resources.  The National Library has made available electronically copies of dozens of New Zealand newspaper titles dating from, in one case, as early as 1841 and often up to 1945.  It is a shame they haven’t yet attempted, or perhaps been able, to do more recent decades.

I was curious to see what Wellingtonians might have been reading on Saturday afternoon, 24 April 1915, so I downloaded the Evening Post for that day.

Older newspapers typically had their classified advertisements first.  But the first news page that day had the shipping news and the market data.  New Zealand government bonds maturing in 1929 and quoted in London were yielding about 4.15 per cent –  rather higher than today’s 3.37 per cent 10 year yield.

War news features heavily of course:

  • A fascinating story that, in the middle of a war, the Hungarian Parliament (Hungary then being part of the dual monarchy Austria-Hungary) had failed to pass the war credits sought by the government.
  • Much talk (perhaps deliberately encouraged?), of a forthcoming major naval confrontation in the North Sea.
  • Zeppelins observed over Newcastle
  • A report of the efforts of members of the Socialist Party of Germany to promote an early peace.
  • An account of two British efforts in 1807 to force the Dardanelles – they succeeded, but failed to take Constantinople.
  • Uncertainty about the adequacy of the supply of wheat in New Zealand, European agriculture having been disrupted by the war.

But it isn’t all, probably not even mostly, about the war.

  • “Owing to exceptional pressures on space, the usual sporting, football, and hockey notes have been held over”,  but space for a listing of which Wellington grounds had been allocated by the Council to various different sports codes.
  • Campaigning for local body elections was in full swing, with various accounts of the views of candidates and meetings they addressed.
  • An account of William Jennings Bryan (“cross of gold”), the US Secretary of State witnessing in his office the impact of alcohol poured over plants  (“What seemed to please Mr. Bryan most was that- when the plant was given alcohol it passed through a- brief period of obvious exhiliration, followed by a decided drooping, indicating that even plants must pay the price of “the morning after.”)
  • The progress of new consumer-oriented technology, in Germany.
  • The weekly book reviews

And a remarkably long discussion on the latest northern hemisphere spring fashions.

It is a fascinating snapshot, of the quotidian affairs amid the most awful, and escalating, war. Of course, there is no hint of the next morning’s Gallipoli landings, or of the systematic Turkish efforts to slaughter Armenian Christians just getting underway in Constantinople that very Saturday.

Boat, bach and BMW? Really….

The Dominion-Post reported yesterday on the results of the latest Westpac (in association with the Productivity Commission) Grow New Zealand survey of “nearly 1200 small and medium businesses” with turnover ranging from $250000 to $5 million.  The results were interesting –  data almost always are –  including the comparisons with the earlier 2011 report, taken when the economy was only just beginning to emerge from the recession.  But the interpretations placed on the results were what caught my eye.

In the 2015 survey many fewer respondents saw the “current state of the market” and “lack of funds” as the main obstacle to growth in their own business.     As those obstacles had been removed, more cited a desire to “maintain my work/life balance” and “want to retire/leave the business” soon.  These results shouldn’t surprise us.  After all, in 2011 the recession had only just ended –  times were tougher, on average, for businesses.  In 2015, many business owners reasonably enough feel that they have more choices.

There has been a popular line running round the New Zealand debate for some years that what ails New Zealand is lifestyle – the people who run New Zealand small and medium businesses don’t have the hunger they perhaps “should” or could have, and are instead content to get to a certain scale and then settle for a very comfortable lifestyle, characterised as “bach, boat, and BMW”.    The Dom-Post journalist uses the Westpac survey results to give this line another run.    The chair of the Productivity Commission is reporting as suggesting that “in the more competitive United States market, the concept of taking it easy for the purposes of leisure time was unheard of.”

But how seriously should we take the “bach, boat and BMW” syndrome as an obstacle to growth?  New Zealanders work longer hours per capita than their peers in most Western advanced economies, and it isn’t obvious why we should assume that our business owners are particularly different.  And are US small and medium business owners really so different?   The US is a very big and diverse country, and perhaps there is a risk of forgetting that for every Microsoft or Oracle there are thousands of small businesses in small towns and medium-sized cities, often protected by occupational licensing and entry restrictions that make New Zealand look intensely competitive.  Many owners will be keen on a round of golf on Wednesday afternoon, or just the flexibility that comes with being one’s own boss.     The range of factors that motivate people to set up a business is likely to be as diverse there as here.

In preparing its first report in 2009, the 2025 Taskforce – charged with understanding why New Zealand GDP per capita lagged so far behind Australia’s (and other advanced countries) –  went through some of the common arguments.   Here is what they said (and if the prose style feels familiar, I drafted it for the Taskforce):

Sometimes it is also claimed that successful New Zealand business people are too willing to cash up too soon, and enjoy the fruits of success (the boat, bach, and BMW) rather than continuing to build their businesses up. We have not encountered any systematic evidence to support this claim. Everywhere in the world, some people build businesses, and then cash up to enjoy the fruits – from successful merchants or industrialists retiring from Manchester to build elegant country houses in the 19th century, to businessmen selling up to go into politics. Some will be talented creators, but not natural managers of large enterprises. Some will have owed their success as much to good fortune as to innate skill: for them, selling up and crystallizing the gains is likely to be a very prudent step. Others will simply put a higher value on other things in life than making more money. In any society – especially one New Zealand’s size – there are likely to be only a relatively few highly successful highly-driven entrepreneurs.

Tastes and preferences vary, but I reckon that in a country that was once among the very richest in the world, peopled with those whose ancestors made the costly effort to come to uttermost parts of the earth to build a better life, we would be better off looking for the pitfalls in government policy for the answers than in suggesting that our business owners are somehow letting us down by through their own lifestyle preferences

Incidentally, in the same article I noticed Murray Sherwin quoted as suggesting that the survey results “reflect that New Zealand has had a very good global financial crisis compared to most”.  I was a bit puzzled, and emailed Murray, who tells me that what he had in mind was GDP per hour worked.    Growth in GDP per hour worked has slowed a lot since 2007 when compared with the previous decade, but the slowing has certainly been less marked here than in many advanced countries.

But our overall economic performance since 2007 –  just before the global crisis hit –  has been mediocre at best.  We’ve had lots of advantages – high terms of trade, no domestic financial crisis, and no major external constraints on using macro policy (not in the euro, avoided the near-zero lower bound) –  and yet in GDP per capita terms we’ve tracked very similarly to the United States, the country at the epicentre of the initial crisis.  Even that picture flatters us: US productivity has been better than New Zealand’s, but we’ve made up for it with more people working.  It could have been worse – and in most euro-area countries it has been – but the years since 2007 haven’t been good ones for New Zealand.

nz vs us