Monetary policy transparency – and the lack of it

The Reserve Bank makes much of its transparency around monetary policy.  A good example was this speech by central banking newcomer, Deputy Governor Geoff Bascand, which invoked a recent academic study by Dincer and Eichengreen, in which the Reserve Bank of New Zealand scored second on transparency, behind only Sweden’s Riksbank.

There is a range of different dimensions of transparency.   Central banks and monetary policy are generally materially more transparent, and open to scrutiny, than they were in the early post-liberalisation years.   But things aren’t necessarily so much more transparent than they were in earlier decades.  A fixed exchange rate, such as New Zealand had for many decades, was very transparent – probably easier to understand, and benchmark performance against, than the inflation target (with all its caveats and exclusions).  Reserve requirements on banks, and regulated interest rates were also very visible and open.  Price freezes were also transparent and, like them or not, LVR restrictions are rather more transparent than adjustments to minimum risk weights in bank regulatory capital frameworks.  More transparent policies are not always better policies than less transparent ones, but in respect of any particular type of policy more transparency will generally be better than less.  That is more about democracy, open government, and substantive accountability than it is about the ability of transparent policy to influence behaviour towards government ends.  On that latter score, the benefits of transparency are typically oversold.

Perhaps a useful distinction for thinking about the transparency of New Zealand monetary policy is between transparency about stuff one knows little about, and transparency about stuff one knows a lot about.  The Reserve Bank is very good about the former, and quite poor on the latter.

Let me explain.  Since the 1980s (and initially under the influence of the new Official Information Act) the Reserve Bank has been publishing economic forecasts.  No other central bank did so at the time.  For a long time the forecasts didn’t mean a great deal – I once sat in a meeting with Roger Douglas in which the then Deputy Governor memorably disowned the forecasts as “just those of the Economics Department”.  But by the mid- 1990s, as inflation targeting bedded down, economic and inflation forecasts became the centrepiece of how the Reserve Bank formulated, and talked about, monetary policy.  From 1997, and almost by accident, the Bank started publishing forecasts of its own actions.  A new model had a policy rule embedded in it, in which the interest rate adjusted to keep inflation, over the medium-term, near the midpoint of the target range.  The Reserve Bank of New Zealand was the first central bank to publish such endogenous interest rate projections.  It is still in a minority in doing so.  If one is going to publish forecasts, there are pros and cons to publishing an endogenous interest rate track (rather than, say, publishing economic projection based on current interest rates, or using market implied future rates).  My bias has always been not to have done so, but reasonable people can differ on that.

Economic forecasts take a lot of effort to put together, and a lot of effort to burnish and refine for publication.  They remain at the heart of the Reserve Bank’s Monetary Policy Statements, and interest rate announcements, more so than in many other countries.  And yet they contain almost no useful information.    The Reserve Bank publishes projections two to three years ahead, which in the case of the interest rate projections involves looked four to five years ahead (since interest rates work with a lag and are, in principle, set in response to the outlook for inflation pressures).  But no one knows anything very much about what will happen to the New Zealand economy, or that of the wider world.  Perhaps there might be a little bit of information in economic projections three to six months ahead, but beyond that the Reserve Bank has no useful information, and so can convey no useful information to the public or to markets.    The Governor might have a policy reaction function in mind (ie how he might react if things turn out the way the projections suggest) but that reaction function has never been disclosed and has probably changed over time (perhaps from quarter to quarter).

Suggesting that central banks don’t know much about the future should never have been a controversial proposition, but the last decade makes the point very starkly.  The Reserve Bank (like everyone else) was totally wrong-footed by the recession of 2008/09, and then has been consistently wrong about the outlook for inflation and interest rates since then.  I’m not particularly critical of them for that (after all, markets have mostly been more wrong, and other central banks almost as wrong).  It is the way the world is.  My point simply is that there is not much more information in a central bank’s medium-term economic forecast than in a horoscope.  And the horoscope takes a lot fewer expensive (and scarce) real resources to generate.

For all the rhetoric about forecast-based policies, the success of the Taylor rule in describing how central banks operated, across many countries and several decades, also illustrates that central banks mostly adjust policy by “looking out the window”.  Even contemporaneous data are ridddled with uncertainty and scope for revision, but looking at what is going on today and responding to that is about as good as it gets.  It might not be “optimal” in some models, but such models typically won’t capture the degree of uncertainty in the real world.

So our Reserve Bank –  like many of its peers –  is quite transparent about the stuff it knows almost nothing about, but it is really not very transparent about the stuff it knows a lot about.  Open government and accountability are more about those latter things.

Let me illustrate:

  • The Reserve Bank’s main forecasting model is still not public.  I gather the intention is to publish it (they keep referring to it as “forthcoming”) but it has now been in use for a couple of years, was put together at significant public expense (replacing a predecessor compiled at even greater expense), but is not public, and certainly not in a useable form.  Why not?  Similar concerns have been raised in the UK about the non-disclosure of the Bank of England’s model.  The point here is not that the model itself will offer any great insights to future policy, but that it documents the understanding of the Bank’s economic staff as to how the economy works, and what the key relationships are.  Those are insights we should have direct access to –  apart from anything else, we paid for them.  Similarly, it would be useful for observers to know what policy reaction function the Bank uses as the baseline in its model.   It is one benchmark which observers could use to pose questions about the Governor’s actual interest rate decisions.  And it would be useful to know whether, eg, changes in the PTA changed the reaction function staff used to describe policy.
  • The Bank does not publish any minutes of any of its monetary policy meetings (or those in other areas of policy, but that is a topic for another day).  The standard argument has been that the MPS itself is the New Zealand equivalent – it lays out the conclusions of the single decision-maker.  But that argument won’t wash.  Successive Governors have stressed that they operate collegial processes, seeking advice from a range of internal and external advisers. The current Governor says he makes major decisions in the forum of a Governing Committee.  Especially in an area as riddled with uncertainty as monetary policy, citizens should be entitled to understand the range of competing considerations and arguments that went in to shaping particular policy decisions.  Submissions to Select Committees on draft legislation are public, and private citizens’ submissions on public sector consultative documents are typically published, so why shouldn’t we, after the event, be able to see the range of perspectives that went into setting a particular interest rate?  Reasonable people can disagree on how full such minutes should be, and how quickly they should be released, but the Reserve Bank of New Zealand has refused to release such material at all.  Are substantive minutes being made at all of meetings of the Governing Committee?
  • The Reserve Bank does not release, even with a considerable lag, the key background papers considered by the Governor in preparing each quarter’s forecasts and MPS.  As regulars readers will know, when I recently requested these documents from a forecast round ten years ago (about which there can be no market sensitivity, and no difficulty around free exchange of views), I was fobbed off with the claim that they could not process the request in the standard 20 working days.  I’m still awaiting the final response.  I hope the Bank is thinking seriously about a new standard release policy for all these background papers –  perhaps releasing all them with a lag of no more than one OCR review after the decision to which they related.  Pro-active release of background documents is a growing practice in other areas of government (and has been around Budget papers)  but it has not yet come to the Reserve Bank.  This is hard information, generated at public expense, and yet there is no openness or transparency in making the material available.
  • There is little or no openness around the process for negotiating Policy Targets Agreements.  In Canada, several of the five yearly inflation control agreements (and these are not legally binding documents, just statements of shared understanding) have been proceeded by an extensive programme of research and debate on possible areas of change.  There has been nothing similar here, ever.  In New Zealand’s case, the possibility of ex ante transparency is not helped by weaknesses in the legislation: a PTA must be signed by the Minister and Governor before a new Governor is formally appointed.  If, by contrast, a Policy Targets Agreement were reached with the Bank – not an individual – at a time not tied to the appointment of the Governor, it would be much easier to run an open process.  Perhaps a year out from the expiry of a PTA, the Minister of Finance or Treasury could invite submissions. A workshop could be held to explore alternative proposals, even if the final result was simply to reaffirm the status quo.     But even now, there is no good grounds for an ex post lack of transparency.  What stops the Reserve Bank, the Treasury, and the Minister of Finance publishing all significant documents generated in the course of negotiating a new PTA once it has been published?  I recently asked for copies of the background documents to the 2012 PTA (something signed almost three years ago).  I didn’t want them to find out stuff I didn’t know –  I had some involvement in the process, and so had a fair idea of the issues that were discussed etc  –  but to serve the interests of public transparency, and to enable people to see how, if at all, risks like the zero lower bound were taken into account.  I was presented with a large bill that would have to be paid if I wanted to pursue the matter.  The Bank is probably within its legal rights to do so, but what does it say about the transparency of the institution and monetary policy that it does so?
  • The Reserve Bank’s Board exists to hold the Governor to account.  And yet papers that go to the Board, and the conclusions of the Board on monetary policy, are not published.  The Green Party was, for a while, routinely requesting Board papers, as much as anything to make a point about lack of transparency.   It is certainly true the the Board now publishes an Annual Report, but it is an anodyne document offering no real insight into the processes or debates the Board might have had, in assessing the Bank’s conduct of monetary policy.  Again, no doubt release would need to be with a lag.    For some other work I have underway, I recently obtained Board minutes from 20 years ago, unexpurgated.  But I wonder how someone would get on asking for material the Board considered on monetary policy perhaps one to two years ago?
  • Another aspect of monetary policy where the Bank is not very transparent is foreign exchange intervention.  Best practice internationally is to disclose such intervention within a few days. In the Reserve Bank of New Zealand’s case, there is no disclosure until the end of the following month (ie the lag can be as long as two months) and even then we are only left to deduce the size of the intervention from tables that have not changed since the intervention policy was introduced.  Again, best practice would make available, with a modest lag, daily data on the Bank’s intervention positions.  Doing so would enable people to better assess any impact of the intervention, and to better hold the Bank to account for the profits and losses on intervention (its large wager at our risk/expense).
  • The Bank also isn’t very good about transparent self-critical analysis of its own performance.  The provisions of the Act around Monetary Policy Statements are awkwardly worded, and need updating, but they actually require the Bank to provide a regular “review and assessment” of its own past policy.  That is difficult to do well, and there are inevitably lags involved, but it just isn’t done very much at all.  “Assess” means more than “describe and defend”.    Perhaps, for example, they could take the opportunity every two years or so to do a special chapter in an MPS self-critically reviewing their own performance.  The idea isn’t about a public whipping – monetary policy is one of those areas where everyone faces huge uncertainty.  We have live with the mistakes and misjudgements central banks make, but there needs to be a strong commitment to learn from those inevitable mistakes and account for them to citizens.
  • And finally, the Reserve Bank does not typically release its MPS OCR decisions until almost two weeks after they are made.  This is less an issue of transparency than of risk, but is out of step with practices anywhere else in the advanced world.

In each case, no doubt arguments can be made that particular items on my list should not be disclosed, or should only be disclosed to researchers years later.  My point is simply that the Reserve Bank is not very transparent, or committed to open government, on things it actually knows about –  its own operations, its own analysis, its own deliberations.  It is pretty transparent about what it thinks might happen in the future –  but that isn’t much use to anyone since the Reserve Bank knows no more than anyone else about the future, and “anyone else” knows almost nothing.

And the benchmark here is not just about what other central banks do.  It should be about a strong commitment to open government and substantive accountability.  To, for example, the principle in the Official Information Act –  one of the surprising legacies of the Muldoon government –  that

The question whether any official information is to be made available, where that question arises under this Act, shall be determined, except where this Act otherwise expressly requires, in accordance with the purposes of this Act and the principle that the information shall be made available unless there is good reason for withholding it.

A much more pro-active approach from the Reserve Bank would, over time enhance its own reputation, for good quality policymaking and for a commitment to recognising the obligations powerful government agencies should have in an open democracy.