The Reserve Bank published its annual Statement of Intent on Friday. I hesitated to write about the document, because to write about it I have to read it. I always avoided doing so when I worked at the Bank.
The requirement to publish an SOI was added to the Act about 10 years ago. And dry as they typically are, the SOIs were presumably intended by Parliament to help us understand what the Governor plans that the Bank will be doing over the next few years, and to help us – and the Board and Parliament – hold the Governor to account. It should give us a sense of where he sees the bigger looming issues.
Here is what the Act says:
There is a reasonable amount of material in the document, and tempting as it is to comment on “the Bank’s aspirational goal of being the Best Small Central Bank” (the first time I’ve noticed this in a public document) I’ll save that for another day. Instead, I want to look at what the Governor does, and apparently does not, see as the priorities for the Bank in the next few years, in the three broad areas of the Bank’s main statutory responsibilities:
- Monetary policy
- Banking supervision
Two of the Bank’s 10 strategic priorities relate to physical currency
- Delivering New Zealand’s new banknotes
The release of Series 7 banknotes (Brighter Money) is scheduled for
the end of 2015 and in 2016. A successful release will require continued
extensive interaction with the Canadian Banknote Company, and
increased engagement with the public, the financial services industry,
and other key stakeholders.
- Developing a plan for future custody and
distribution arrangements for currency
The Bank will review its currency operating model and supporting
infrastructure to ensure that the currency needs of New Zealanders will
be met in the future. The review will assess the current operating model,
and identify options for the custody and distribution of currency. The
Bank will consult and collaborate with key stakeholders during 2015-
16 to ensure that the review’s recommendations are understood and
Those look fine as far as they go, even if the first now seems more operational than strategic. But neither in this list, nor in the “functional initiatives” section, is there any sense of the significance of the zero lower bound, and the role that central bank physical currency monopolies play in exacerbating periods of economic weakness when policy interest rates get to (just below) zero. New Zealand has been fortunate not yet to have the zero lower bound (ZLB) issue, but with a policy rate at 3.25 per cent and which is widely expected to fall quite a bit further it is not that far away. We went into the last downturn with policy rates of 8.25 per cent.
Issues around the central bank physical currency monopoly, and whether (for example) retail electronic outside money might help alleviate the ZLB problems cannot be dealt with or resolved overnight. But that is why it is so disappointing that nowhere in this medium-term document is there any sense that the Bank is taking the issue, and associated risks, seriously. It looks as though they will be quite content to just run the risk that one day we get to an OCR of zero, unbothered that nothing was done to get ready for (and mitigate the risk of) that day. For countries that got to zero in 2008/09 it was a pardonable surprise perhaps, but the rest of the advanced world has now put us on notice. This was a chance to be pro-active, and mitigate future risks, but the Governor does not seem interested in even commissioning work to look in more depth at the issues and options. There aren’t straightforward “right or wrong” solutions, but the issues and options need serious analytical work now.
Not one of the Reserve Bank’s strategic priorities for the next few years relates to monetary policy, which remains (by statute) the Bank’s primary function. This is so despite:
- several years in which inflation has consistently undershot the targets agreed between Ministers of Finance and successive Governors
- the salience of the zero lower bound issues to the ability of monetary policy to adequately deal with possible future serious shocks. In view of the Governor’s worries about the potential threats to financial stability, it is all the more surprising that nothing major appears to be on the work programme to deal with these issues.
- A new Policy Targets Agreement is due in just over two years (so inside the period covered by this SOI.
I have some sympathy with the argument that normal year-to-year issues in monetary policy don’t easily fit a “strategic priorities” framework, so perhaps the persistent forecast errors (and associated monetary policy mistakes) might not be expected to appear, even though they are now quite persistent, and have come at quite some cost to the unemployed.
But the ZLB issues certainly aren’t just routine issues. They have represented a major constraint on the ability of central banks in other countries to do the sort of macroeconomic stabilisation expected of them. Should we be doing something about removing the technical ZLB constraint? If not, should we thinking harder about raising the inflation target midpoint? What are the costs and benefits of the various options, and what might the implications be for other areas of policy (eg the tax system).
But the “functional initiatives” list offers nothing either. Here is what it says:
The Bank’s Economics Department has four key work streams for 2015.
- Macroprudential and monetary policy interface: undertake analysis and develop frameworks to better understand the interaction between macroprudential and monetary policy.
- Support the formulation of monetary policy: understand how events such as a construction and housing boom, fiscal consolidation, and international developments will shape the next business cycle.
- Monetary policy research: undertake analysis to improve the Bank’s understanding of the New Zealand economy and key monetary policy issues.
- Exchange rate analysis: reviewing the Bank’s frameworks for assessing the long-term sustainable level of the exchange rate and analysis of the cyclical impact of the exchange rate on New Zealand economic activity and inflation.
Nothing particularly objectionable there, perhaps, but nothing that seriously engages with the sorts of issues I listed above either.
The Bank has three strategic priorities related to banking supervision:
- Exploring macro-prudential policy options to manage the financial stability implications of housing cycles
The Bank will explore macro-prudential policy options for managing the financial stability implications of housing market cycles. It will continue to investigate the interactions between monetary policy, prudential policy and the objectives of price and financial stability. The Macro-Financial department will lead work through the Macro-Financial Committee and
Governing Committee, with support from the Economics and Prudential Supervision departments.
- Updating the prudential policy and supervision frameworks.
The Bank will implement changes arising from the regulatory stocktake and will review other key policy settings. These will include outsourcing requirements on banks, and capital and liquidity settings in light of the revised Basel standards.
- Developing a comprehensive stress-testing framework for the New Zealand banking system
The Macro-Financial and Prudential Supervision departments are developing a comprehensive stress-testing framework to gauge the resilience of the banking system to adverse shocks. The Reserve Bank will work with the banks to identify and implement improvements to the banks’ technical stress-testing frameworks and processes. In addition,
the Bank will ensure that stress tests become a centerpiece of banks’ internal risk management, and are regularly scrutinised by senior management and boards.
One might question just how “strategic” 5 and 6 are – presumably here the Governor just means “we will put a lot of time into”? I noticed that the Governor says he will “ensure that stress tests become a centrepiece of banks’ internal risk management”. But banks might reasonably ask the same of the Reserve Bank. The Bank is currently trying to further restrict banks’ business operations, even though the latest stress test results suggest there is no threat to the health of individual banks, or to that of the financial system as a whole.
There is also a long list of “Initiatives and strategies” in this area:
Initiatives and strategies
To address these issues, the Bank will:
- explore additional macro-prudential policy options for managing the financial stability implications of housing market cycles;
- work with the banks to ensure that stress-testing models and processes are robust and a core centrepiece of the banks’ internal risk management
continue to assess the linkages between monetary and macroprudential policy to ensure that complementary or opposing effects between the two policy areas are properly taken into account;
- continue to enhance the reporting of financial system stability and efficiency, and policy assessments, contained in the FSR and other reports;
- publish a stress-testing guide with a view to improving the stresstesting practices of New Zealand banks, and continue to develop a comprehensive stress-testing framework for New Zealand banks, a joint initiative with the Macro-Financial department;
- complete the regulatory stocktake by consulting on and implementing initial enhancements to improve the efficiency, clarity and targeting of prudential standards for banks and NBDTs, and identifying separate areas for further work;
- maintain supervisory engagement with executives and directors of regulated banks;
- complete a review of, and consult on, the outsourcing arrangements that currently apply to ‘large banks’;
- work closely with banks to ensure timely compliance with new outsourcing requirements;
- review the Bank’s existing liquidity policy against finalised international liquidity standards;
- review the Bank’s broad suite of capital requirements;
- consult on a range of amendments to the statutory management powers in the Reserve Bank of New Zealand Act 1989 to clarify aspects of the legislative framework for the Open Bank Resolution policy;
- promote legislative changes recommended by the review of the prudential regime for NBDTs that was completed in 2013;
- finalise policy to strengthen the Bank’s oversight of financial market infrastructures; and
- implement the business-as-usual supervisory framework for licensed insurers.
Again, what is there is not objectionable, but I think some questions should be asked about what is not there. For example:
- There is no sign of any proposed rigorous (let alone independent) ex-post evaluation of the Bank’s LVR regulations, even though they have been a major innovation in New Zealand policy.
- There is no sign of any particular work on the efficiency of the financial system, even though any (arguable) soundness benefits from measures like the actual and proposed LVR controls come with undoubted efficiency costs.
- There is no sign of any initiatives to lift either the quantity of quality of the Bank’s research and policy analysis in prudential regulatory and financial stability areas. For example, there is no sign of any work programme on how to best interpret the lessons of other countries which have, and have not, experienced financial crises in the last decade or so.
More generally, there is no sign of an organisation that recognises the importance of, and wants to foster, the robust contest of ideas, internally and externally.
In a sense, none of this should be very surprising. As I have been highlighting, too many of the Reserve Bank’s powers (ie all of them) rest with the Governor alone. But the draft of this SOI will have been seen by the Minister, and it might be interesting to ask the Bank or the Minister for a copy of any comments the Minister provided. Probably a draft went to the Reserve Bank’s own Board – but the Board exists to review the Governor’s performance after the event, not to set strategic priorities, approve functional initiatives, or even set Budgets. The SOI is a reflection of the single decision-maker’s preferences and priorities – a model which has both strengths, and some significant weaknesses and risks
There is no suggestion of any further work on possible improvements in, or changes to, the statutory governance of the Bank. I have just lodged an OIA request with the Bank asking for copies of any work done in this area over the last couple of years. Of course, decisions on governance and statutory changes are a matter ultimately for the Minister and Parliament, but in his early months the Governor did appear to recognise some weaknesses in the current model, prompting him to establish the Governing Committtee (him, and the three deputy/assistant governors), as a forum in which the Governor would make major decisions, to help mitigate some of the internal risks in the current statutory system.
The Reserve Bank’s Statement of Intent stands referred to Parliament. It might be interesting for the Finance and Expenditure Committee to ask the Governor about the some of the issues raised here. Other departments have an estimates hearing before their funding is appropriated. There is nothing similar for the Bank’s five year funding, but the SOI does provide a basis for some scrutiny and challenge.