Time to reform Reserve Bank governance – domestic public sector perspectives

Yesterday, in discussing my proposition that it is now Time to reform the governance of the Reserve Bank I outlined the contrast between the international perspectives available in the late 1980s when Parliament set up the governance model for the Bank and those available now.  Very few countries then  central banks (or financial regulatory agencies) that had statutory and effective operational policy independence. There was no international standard that could have been followed.  But of the many countries who have reformed their institutions since 1989 not one has followed the New Zealand model.  It is very rare for a single unelected individual to have sole legal responsibility for monetary policy decisions, and unknown for one such person to have decision-making authority on both monetary policy and major policy aspects of financial institution regulation and supervision.

Today, I went to look briefly at how New Zealand public sector governance, and conception around it, have changed since 1989.   The Reserve Bank is just one among many New Zealand public sector agencies, and it is inevitable, and highly appropriate, that thinking around how to design, manage, and govern other New Zealand public sector agencies should influence how we structure our central bank and financial institution regulatory agency.  Huge change took place in the New Zealand public sector in the late 1980s, and the Reserve Bank was somewhat uneasily fitted in to the model.

Back then, the Governor of the Reserve Bank was seen as somewhat akin to a core government CEO. In the reforms of the day, those CEOs were to have performance agreements with ministers, and would be able to be dismissed if they did not achieve the “output” targets specified in those agreements.  Departmental CEOs were envisaged as having considerable operational autonomy to achieve these measureable goals.

The state sector has changed considerably since then.  For a variety of reasons, departmental chief executives have much less autonomy, and there is much greater emphasis on departments working together, and a recognition that most key decisions rest with ministers.  The public service CEO model is not a good guide to how to organise the Reserve Bank, which does have considerable autonomy in policy.

By contrast, the Crown entity model has been developed and systematised subsequently.  The numerous Crown entities each perform statutory roles, across a range of types of activities (some more policy-oriented, and others largely just service delivery).  But I am not aware of any of these entities in which a chief executive has principal policymaking powers.  Rather, key framework decisions are typically made by the board of the respective entity –  and members, and the chair, are directly appointed by a minister.  The Reserve Bank is not a Crown entity (in the formal central government organisation chart) but as a model for governing agencies that exercise independent authority on behalf of the Crown the approaches used in Crown entities (perhaps especially the “Crown agents” class) seem to be a much more suitable starting point for thinking about governing the Reserve Bank.

In the rest of our system of government, single individuals simply do not exercise the degree of power –  without meaningful prospect of appeal or review – that Governor of the Reserve Bank has.

Some extracts from my paper:

As things stood in the late 1980s:

The Reserve Bank was just one of many New Zealand public sector agencies to face far-reaching reforms in the late 1980s.

The governance of government-owned commercial operations had been reformed first (the   SOE model came into effect in 1987).  For entities operating under the SOE model, the governance was to be very similar to that in a conventional corporate: the Minister appointed Board members, who in turn appointed a CEO to conduct affairs under authority granted to him/her by the Board.    For a time, the Treasury had been very interested in the possibility of applying the SOE model to the Bank[1].

The State Sector Act 1988 (and the Public Finance Act 1989) dealt with the non-commercial departments.  The insights that shaped that legislation were more practically relevant to later discussions around the Reserve Bank.

Under the previous state sector legislation, heads of government departments had permanent appointments – a model which had both significant advantages (as regards free and frank policy advice) and significant disadvantages (all but impossible to get rid of weak performers).  The new legislation put chief executives of government departments on fixed term contracts and provided for the establishment of performance agreements between chief executives and the respective ministers.  It provided stronger operational autonomy (from Ministers and from the State Services Commission) for chief executives and agencies, and the focus was on being able to hold individuals to account.

A key part of this, at least conceptually, was the attempt at a clear delineation between, on the one hand, the “outputs” of government agencies (things agencies could directly control – e.g. volume and quality of policy advice; hours devoted to traffic patrols etc) and, on the other hand, “outcomes”.  Outcomes (e.g. a lower crime rate) were things that politicians and the public probably most cared about.  Outcomes were typically affected by the actions of government agencies, but there was no direct and unambiguous mapping between specific actions of agencies and desired “outcomes”.  The conception was that CEOs could be held directly accountable for the achievement of output targets that were set by Ministers in performance agreements.

And as things stand now

Some aspects of 1980s public sector reform have proved resilient.  The domestic SOE model proved relatively successful for commercial operations owned by government, and relatively enduring, in form as well as in substance.  It is becoming less important, particular since the recent wave of partial privatisations, but the proposition that government business activities should be managed commercially, using fairly standard business governance models, has stood up well.

By contrast, in core government departments, the usefulness of the outputs vs outcomes approach as a guiding principle for assignment of responsibilities, and accountability, has probably not lived up to the hopes of the designers.   And, not unrelatedly, the degree of effective operational autonomy for (single decision-maker) department chief executives is far less than was probably envisaged by the early advocates of the model.  More recently, as a matter of active policy, departmental autonomy now appears to be consciously discouraged, with an emphasis on “whole of government” or “joined-up government” approaches –  whether with a view to cost-savings, better policy outcomes, or both.

Much about the way policy is implemented is politically sensitive (i.e. voters expect politicians to be accountable for choices about both “whats” and “hows”).   A government concerned to lift educational standards (an outcome) cannot conceivably simply leave to the Secretary of Education the question of whether to adopt, say, a National Standards regime as an “output” in support of the government’s desired “outcome”

As a result, the clean delineation between outcomes and outputs has rarely worked overly well.  Government departments still have single (unelected) decision-makers (i.e. their chief executives) but those individuals have little effective independence over outward-facing “how” decisions[2] (or, increasingly, over key aspects of the internal management of their own agencies).

There have always been many government entities beyond departments and SOEs.  Numerous Crown entities exist to carry out a wide variety of public functions[3].   A consistent framework for these institutions did not exist in the 1980s but in 2004 the Crown Entities Act was passed.  It was designed, in Treasury’s words, to “reform the law relating to Crown entities and provide a consistent framework for the establishment, governance and operation of Crown entities. It also clarifies accountability relationships between Crown entities, their board members, their responsible Ministers and the House of Representatives”.

The Reserve Bank is not, formally, a Crown entity, standing in a category of its own in the government organisation chart.  There is no obvious reason for that to continue, since there is little obviously unique about the role or functions of the Bank.  But the point I wish to make here is simply that, across the wide range of Crown entities (and various sub-categories within that grouping), I am not aware of any case where a chief executive has principal or exclusive decision-making powers  Crown entities typically exist to give effect to:

  • implement some aspect of government policy (e.g. EQC, ACC, FMA, NZQA),
  • provide advice and/or participate in public debate (e.g. Productivity Commission, Retirement Commission, Law Commission), or
  • carry out some function government has determined to fund and provide (e.g. NZSO, Te Papa).

In some areas, of course, aspects of the application of policy will shade into policy itself, but matters with pervasive external effects are not simply decided by a CEO.  Each of the significant entities I am aware of have a board which has ultimate responsibility for the conduct, and key framework decisions, of the organisation[4].  Board members, and typically the chair, are directly appointed by Ministers, and each chief executive exercises their delegated power under the direct authority of the respective board.

The practice of collective decision-making (and/or formal review or appeal rights) goes still broader, and is deeply entrenched in our system. Indeed, in New Zealand public life, it is difficult to think of any other position in which the holder wields as much individual power, without practical possibility of appeal[5], as the Governor of the Reserve Bank does.  Judges, of course, have the power to imprison – but all lower court decisions are subject to appeal, and higher courts sit as a bench, so that no one person’s view alone decides the case.  Resource management consent decisions, which hugely and directly affect property rights and values, are subject to appeal.  Individual Ministers exercise significant authority, although often requiring the involvement of Cabinet.  In New Zealand, all ministers are elected MPs, and any individual minister serves only at the pleasure of the Prime Minister.  The Prime Minister, of course, has huge power, but cabinet government is a key feature of our system, and (more hard-headedly) the Prime Minister holds power only while he commands the confidence of his own (elected) caucus.  As Kevin Rudd found, that confidence can be withdrawn very quickly.

Typically, public policy decisions that have far-reaching ramifications or that are not customarily made within clear and prescriptive guidelines, are either made collectively, or are subject to appeal, or both.       There is nothing comparable in respect of the Reserve Bank.

[1] The ideas are discussed, not entirely impartially, in chapter 5 of the Singleton et al history of the Reserve Bank.  Note that at the time there was no formal framework for Crown entities.

[2] Of course “who” decisions (eg on prosecutions, or tax audits, or licenses etc) rightly remain far-removed from Ministers.

[3] http://www.ssc.govt.nz/state_sector_organisations sets out all current state sector organisations.

[4] I have not attempted to work through the entire list of Crown entities to check their respective pieces of legislation, so if there are exceptions I would be happy to be advised of them.

[5] The override powers in Section 12 of the Reserve Bank Act do, of course, provide some scope for acting to deal with a Governor doing rogue things – but are not a routine part of governance (and have never been used).  The Reserve Bank can induce, or materially worsen, a recession without significant threat of those powers being used.  Perhaps, for example, it did in 1998, during the MCI fiasco.

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