Time to reform Reserve Bank goverance – the Bank does different things

Reader numbers tell me that anything on housing is more popular than things I write on Reserve Bank governance.  And, in fairness, the housing issues are probably more important.   But a good quality central bank, subject to best-practice governance models, matters too, and the governance issues are actually much easier to deal with. Any minister willing to pick them up would be pushing at an open door.  There would (and should) be debate around details, but no one would fight for the status quo.

This is last in my series of posts on the basic case for changing the Reserve Bank governance model adopted in 1989.  I haven’t set out to re-litigate the choices made in 1989.  At this point, doing so would only be of historical interest, and in any case I’ve tried to illustrate the quite rational and reasonable basis on which the 1989 choices were made.  But things are different now, and the governance model needs to be overhauled to reflect the way things are today.

As I noted on Tuesday, no other country does things the way we do (gives a single unelected official formal decision-making powers over both monetary policy and financial regulatory policy), even though many countries have reformed their systems since 1989.

As I noted on Wednesday, in no other area of policy in New Zealand are decisions made the way we allow Reserve Bank policy to be made.  Policy decisions (as distinct from the application of policy in individuals’ cases) are typically made by elected politicians, or by boards, not by single officials.

As I noted yesterday, back in the late 1980s monetary policy was seen by some as likely to be pretty straightforward and uncontroversial, involving little exercise of discretion. As one of my former colleagues put it, exaggerating to make the point, “with the right PTA, any bozo could be Governor”.  In fact, experience here and abroad suggests that considerable discretion is needed, and the choices have material implications for the short-term performance of the economy.  So it isn’t the sort of policy for which one might appropriately rely just on the talents and preferences of a single unelected individual, no matter how able.

And, if the conception of monetary policy has changed, so has the conception of the Bank itself.  The sort of organisation the Bank was seen as becoming materially influenced the governance model chosen.

In 1989, the Reserve Bank was seen as being en route to becoming a rather simple institution.  It would be primarily a monetary policy institution, with next to no financial risks on its quite small balance sheet.  Banking registration and supervision powers were put in the Act, but no one envisaged the Bank as being engaged in much active discretionary prudential supervision (and key failure management powers were, in any case, reserved to the Minister).

I’ve already talked about the changed conception of monetary policy, which meant that a PTA did not provide any simple or easy way to hold the single unelected decision-maker to account.  But the changes to the rest of the Bank, and their implications for governance and accountability, are probably even greater, and more important.  The Bank has been assigned by Parliament a much wider range of regulatory responsibilities (non-bank deposit-takers, insurance companies, AML, and the payment system (where it is bidding for still more powers)).  That alone represents a hugely greater weight on regulatory matters.  But in addition the Bank has chosen to use its existing statutory powers over banks in ways that involve much greater degrees of discretion.  The most obvious examples are the recent and proposed LVR restrictions, but there is also a lot of (not very transparent)  discretion involved in the approval processes for the capital models used by the big banks in calculating regulatory capital requirements.  Where considerable discretion is involved, the personal preferences of the decision-maker become important.    And that discretion can’t easily be constrained by something like a PTA  –  it is pretty much common ground that nothing like a PTA, that would materially constrain discretion, could be put in place for the financial stability policy responsibilities the Bank has.   The state of knowledge is just too limited[1].

Note that, for these purposes, I’m not questioning whether or not the Bank should have such powers, or should interpret them as it does.  I’m simply making the point that when so much discretion is involved it is inappropriate –  and not seen anywhere else –  to have a single unelected official making the decisions.  It is simply too risky.  It isn’t the way the New Zealand generally allows policy to be made.

New Zealand has pretty good quality institutions and systems of government and public sector governance.  The Reserve Bank governance model has become out of step with practice globally,  with that in the rest of the New Zealand public sector, and with what the Reserve Bank now actually does.  It really is Time to Reform the Governance of the Reserve Bank.

As things appeared in 1989

At the time Reserve Bank was thought of as being (in the process of becoming) a relatively simple institution.  Exchange control had gone in 1984, direct controls had been removed by early 1985, and government banking, tendering and registry functions were gradually being removed from the Bank.  No one in officialdom had much interest in foreign exchange intervention and the foreign reserves the Bank was allowed to hold were well-hedged.

The 1989 Act gave the Reserve Bank powers in a variety of areas, but the Bank was overwhelmingly seen as a monetary policy institution[2]  Many of the clauses of the Act were devoted to the registration of new banks, and the management of bank failures, but there was little or no sense that the Bank was likely to become a particularly active regulatory agency. People close to the work on the 1989 Act report that in detailed discussions around the drafting of the 1989 legislation, little or no attention was given to governance issues as they affected the regulatory responsibilities of the Bank.  Thus, although the governance arrangements (single decision-maker, complemented by the monitoring role of the Board) covered all the Bank’s responsibilities, it is clear that they were designed primarily with (the rather simple conception of) monetary policy in mind.

And, by contrast, how they are today:

The third aspect that has turned out materially differently than the designers of the 1989 legislation expected is the wider role of the Reserve Bank.

In the late 1980s, the Reserve Bank was envisaged primarily as a monetary policy institution, with a very limited – and well-hedged – balance sheet. Since then the Bank’s roles have expanded considerably, but there has been no material change in its (single unelected official) governance.   What are the changes in role?

The Bank has taken on substantial foreign exchange risk, including a more active foreign exchange intervention role. In crisis periods it has assumed substantial credit risk.  And whereas in 1989 the registry business was in steep decline, the Bank is now the owner and operator of New Zealand’s major securities clearing and settlement system.

But perhaps the most substantial changes have been in the supervisory and regulatory functions, which now take a much larger, and a more active, place.  Considerable amounts of regulator discretion are now being exercised, as to policy and the implementation of policy.  The change has accelerated in the last half-dozen years with:

  • The move to Basle II and then Basle III capital models (involving approval of risk models, and the exercise of detailed discretion and judgement on risk weights etc)
  • The introduction of the so-called macro-prudential (time-varying) approach to regulation of banks, including the 2013 residential mortgage LVR “speed limit” and the recent proposal for a ban on high LVR property investor lending in Auckland.  Regional differentiation in the way prudential policy is applied is yet another new step in regulator discretion.
  • The Reserve Bank becoming responsible for the regulation of non-bank deposit-taking institutions
  • The Reserve Bank becoming responsible for insurance supervision.
  • The Reserve Bank becoming responsible for implementing anti-money laundering etc legislation in respect of the financial institutions it regulates, and
  • The Reserve Bank’s bid (not yet successful) for more payment system powers.

It is common ground that there no framework in the Act for defining output-based performance standards for these functions and that for most of them it is simply not possible to do so.  That is not a criticism of the Reserve Bank, or of the roles Parliament has assigned, but simply a description of the difficulty all countries face in these areas.

So the Reserve Bank is now an organisation that, with the acquiescence of ministers and sometimes with the specific mandate of Parliament, has a wide range of functions and powers, but typically has rather ill-defined, and hard to measure, goals[3].   But that means it is very difficult to defend a conception of the Bank in which having a single (unelected) decision-maker provides for clear and decisive point of accountability across these multiple different functions and responsibilities.

[1] Although it has been pointed out that the UK Banking Act makes an effort in this regard.

[2] Section 8 of the Reserve Bank Act still states that monetary policy is the “primary function of the Bank”.

[3] In one or two areas there are memoranda of understanding with the Minister of Finance, but these documents have no legal status, and bind neither subsequent ministers nor subsequent governors.

7 thoughts on “Time to reform Reserve Bank goverance – the Bank does different things

  1. Michael,

    I am interested in the RB issues that you discuss. Just to make sure I understand what you are saying, please confirm that you are not calling for having an elected politician to be a governor? You use the word “elected” liberally in your blog and that is a central matter in economic literature. If you are not calling for an elected governor, then many would agree with you that a reform of the governance framework is a sensible thing to do, but still not sufficient for having optimal monetary policy. I won’t mention “discretion” because it is another central issue in this literature that you mention but you do not discuss. Note that the US is moving closer to institutionalize “rules” rather “discretion” in the making of MP decisions. See John Taylor’s bolg http://economicsone.com/ a bill has already been passed and debate in the Senate would probably make make that a law.


  2. Weshah

    No. I’m certainly not suggesting an elected Governor. I’m simply suggesting that no one unelected person should have so much power, and that the powers should be exercised by a Board/committee (or 2 of them). of course, single elected ministers make major decisions all the time, but ministers have to face Parliament each week, can be dismissed by PM with no notice, and have to face the voters every three years. There is nothing similar for a Reserve Bank Governor.

    Re the Taylor law, I’ll be astonished if it is ever enacted, but technically it does not impose a rule, just a need to account for actual decisions relative to the rule.



    • Thanks. This is clear now. Although the optimality of the RB contract is well established by Carl Walsh in a well known article in the early 1990s. Everyone knows that the government could dismiss the governor when fails to achieve the target and explain it. Did not happen, but it is there. The target is established by the government, which is elected. I agree though that they the RB may need to reform its decision making processes, have a committee, etc. But you need to explain to us what benefits the average Kiwi would have from doing that?

      Monetary policy cannot affect potential output or the natural rate of unemployment or productivity, or the natural rate of interest. However, MP could cause a lot of havoc in the short-run (over the business cycle) and that is why you want to make sure that the decisions adhere to first principles. One hopes that a committee could help accounting for that – reduce policy errors. All what monetary policy in NZ can do is maintaining low and stable inflation, and hopefully the stability of the financial system, albeit not guaranteed.


      • Weshah

        Thanks for the comments. I think you are materially understating the degree of discretion the Reserve Bank has. I think what we have learned over the last 25 years is that we cannot write a contract effectively expressing how we want a central bank Governor to respond (if we could “any bozo could be Governor” and we could easily fire him or her). Money base rules would have been easy, but there is no sign that they would have been sensible. As I note in the paper, the experience of just the last decade illustrates just how much practical discretion governors have had – Bollard to go well above target for sustained periods, with no repercussions, and now Wheeler in the opposite direction. Discretion is inevitable, and will probably be misused to some extent, but it is better – more democratically legitimate – not to put the decisions about discretion, and which preferences to prioritise, in the hands of a singe official.

        The situation is even more stark in respect of financial regulatory matters, where there is nothing akin to the PTA, and probably could not be. In those areas, the Governor has much greater effective discretion, around tools and goals. A particular Governor may make good calls, or bad calls, but in democracies we don’t usually think it appropriate to give a single official such power, no matter how good a particular individual holding the roles might be. I would probably make the case that policy in this area should be decided by politicians (with independent officials to apply it to individual instiutions) but if the powers are going to be with the RB they should be with a committee/Board, advised by the Governor and his staff.



  3. In Canada monetary policy decisions are the responsibility of the Governor and only the Governor. Although there are committee discussions, the minutes of these meetings are not kept so that they cannot be released in the future, and the announced decision is that of the Governor. Please get your facts straight before making such sweeping statements.

    Your obsession with your former employer is nauseating. The RBNZ is not one of the worst central banks in the world by any measure, and is certainly not the largest problem with New Zealand, as you would seem to think.


    • Michael

      I’m not sure which facts you are questioning. I have been very clear that the Bank of Canda had (legally) a single decision-maker, but also that the Bank of Canada is not responsible for the financial supervision/regulation, thus the single decisionmaker has much less power than the RBNZ Governor has.

      And I entirely agree that there are much bigger issues for NZ than anything to do with mon pol or financial supervision. Indeed, I was clear in my paper on governance that in making the case for change, I am arguing on grounds of good governance and democratic legitimacy, not on an expectation that policy-outcomes would on average be much different.


  4. Michael R.

    Thanks for your reply. Leave discretion for now. We cannot resolve our differences on this via these exchanges. My question was about the benefits we would have if we have a committee or a board at the RB?

    As far as monetary policy is concerned, I guess we would have none, unless the committee or the board is made of a number of high caliber economists, specialized in monetary and macroeconomics, i.e., technocrats. There is no guarantee that would be the case. I know your old views (don’t know if you changed your mind). But the time inconsistency argument, the inflation bias, and CB independence are interconnected issues of the same literature, and they are vital for the price stability objective of the RB. The conclusion of this literature is that we cannot have a politician running MP. Politicians will soon inflate the economy and the housing market to win elections. We cannot possibly be concerned citizens and allow the country to go back to pre 1984. I also think that there is nothing particularly inconsistent with democracy in the RB Act.

    For 20 years as a civil servant in Wellington, I saw little accountability. Bureaucrats, including people at the RB, made costly mistakes and policy errors, but no one paid them. Take for example the Asian crisis and the MCI blunder. Did anyone pay? I think that, generally speaking, the same applies to the government departments in Wellington. Was anyone held accountable for the computer failure of the teachers.pay..for the death of the 29 young people in the mine explosion down south, for the investment bank’s fraud, millions spent on restructuring departments with absolutely no material gains, and the list goes on. Someone makes a policy decision is someone who must be accountable in democracy. The RB Act should be preserved, albeit minor reforms about having a board or a committee won’t hurt, but won’t make a difference to the main issues neither. We will live to see another crisis, which we could not forecast.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s