The Reserve Bank’s Financial Stability Report is due out later this morning. As I have a few other things to do, and I want to read the whole thing (well, I might make an exception for the payments system discussion) I don’t expect to comment on it today.
Instead, I wanted to prompt some thought about how in New Zealand we ensure that there is adequate scrutiny and contest of ideas around powerful government agencies operating in the economic and financial area.
Late last year, Ross Levine, a professor at Berkeley, visited Victoria University and the Reserve Bank. It was a very stimulating visit. One of Levine’s books, written with a couple of co-authors, is Guardians of Finance, in which he argues that US financial regulators are too close to those they are regulating, and that something needs to be done to counterbalance that bias. To be clear, Levine is not alleging any personal financial corruption on the part of anyone involved, but rather highlighting the role played by the large financial resources of the sector, the complexity of the issues, and the revolving door which sees people moving between regulatory and regulated institutions. The authors also highlight what they call “home-field advantage” – drawing from evidence from sports, they suggest that regulators will naturally become attuned to, responsive to, and share to some extent the perspectives of those whom they regulate (moving within a common professional, and sometimes personal, milieu).
Levine argues that these weaknesses were a significant part in explaining the 2008/09 crises, and that institutional change is needed as some form of counterbalance. I found the connection to the crisis unconvincing for a variety of reasons, including but not limited to the fact that senior regulators who had tried to stand up against the risks building up in the system would almost certainly not have been reappointed. But I was most interested in his proposal for a new US agency – the Sentinel.
The one power this small institution would have would be the right to obtain any information it wanted/needed from financial regulatory agencies. It would be insulated from short-term political pressure to some extent, by being funded by a prior claim on seignorage. It would be shielded from too much financial sector or financial regulator influence by restrictions on the ability of staff to move from the Sentinel into financial sector or financial regulatory positions. Any useful impact it had would come from the quality of its research and analytical material. It is proposed that the agency would pay well, and offer a prestigious and influential opportunity for top-notch people from across a range of disciplines.
In reading Levine et al’s book, and in discussion with Levine during his visit, I had been thinking about the relevance of his insights to New Zealand. The result was this discussion note
which I jotted down on the Saturday before Christmas, when my wife and kids had already left town. (At the time, it was mainly for my then colleagues at the Reserve Bank, but since I expected to be leaving the Reserve Bank shortly I deliberately wrote it out of Bank time and off Bank premises.)
In it, I explore the idea of introducing greater challenge and contest in respect of a range of economic policy and advice functions in New Zealand (not just, and not even primarily, financial regulatory ones). The issues are different in New Zealand to those in the US in a wide variety of ways, but the lack of scrutiny and challenge is a much more serious problem here than there – not through ill-will or malevolence on anyone’s part, but mostly because of being a small country.
I highlight the way that review agencies have been set up in many areas of New Zealand government in the last 30-40 years, and suggest that the scrutiny and review of the economic policy and advice functions now lag behind. My concrete proposal was the establishment of a small Macroeconomic Council, to independently scrutinise and challenge thinking and policy (advice) emerging from agencies such as the Treasury, the Reserve Bank, the FMA, and MBIE. Such an agency would deliberately operate outside government – a contrast, say, with the Productivity Commission (which has done some very good work, but operates – by statute – inside government, largely on topics assigned by ministers).
There are weaknesses with the proposal, and if I were writing the note today I would make some of the case differently. But I think there is a real weakness in our system, and the confidence that the public can have in the quality of regulatory and advisory processes suffers because too few resources are devoted to scrutiny and challenge. In some ways, I’m uncomfortable suggesting spending more public resources, but as even the 2025 Taskforce pointed out, the things that governments really needs to do need to be done excellently.
In the meantime, I hope that the Financial Stability Report has complied with Parliament’s requirements and will
contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.
Remember, it is for us – citizens, Parliament – to make our own assessment. The Bank’s own assessment is likely to be interesting, but we need the information and perspectives to evaluate their case, and their activities, to ensure (in the words of Levine’s sub-title) that regulators really are working for us.