Criticism of the RB is “bizarre”

Reading the Herald over lunch, I found a column by Matthew Goodson, the head of a funds management company.   Authors don’t get to write the headlines, but I think the gist of Goodson’s piece is summed up here in his own words:

“Thank goodness that Graeme Wheeler and the RBNZ are beginning to pay attention to the issue.  It is simply bizarre that they are being criticised for being the one official institution to show some leadership and tentatively use their limited tools to lean against Auckland house prices.”

I assume that I’m one of those whose views are being described as “bizarre”.

But let’s step through Goodson’s argument:

First, he seems to suggest that critics of the Bank think house prices will never come down.  Perhaps there are some who believe that, but I’m quite happy to work with an assumption that some event, at some point, could lower Auckland house prices by 50 per cent.  Indeed, that is what the Reserve Bank assumed when they did their stress tests.  And the banks came through unscathed.  Goodson does not mention this work, which has been published by the Bank, and Graeme Wheeler has not engaged with it.  Perhaps it is wrong or seriously misleading –  I’m open to the possibility –  but let’s see the evidence and argumentation.

Second, Goodson rightly stresses the bad economic consequences that have at times followed from credit-fuelled asset price booms.  As he says, the post-1987 New Zealand equity and commercial property crash springs to mind.  But the operative word is “credit-fuelled”.    Credit is growing at around 5 per cent per annum, just a little faster than nominal GDP, right now.  But over the years since 2007 the ratio of credit to GDP has fallen, not risen.  Big increases in the ratio of debt to GDP over quite short periods of time have been one of the better indicators of future problems (but there have been plenty of “false positives” too).  We had those sorts of increases from 2002 to 2007.  We’ve had nothing similar since.

Third, Goodson invokes Spain and Ireland, and fails to mention that these were economies that had German interest rates during the boom when they needed something more like New Zealand ones, and when the construction boom burst –  and construction booms do much more damage than pure asset prices booms – they were still stuck with German interest rates, not something lower, and couldn’t adjust their nominal exchange rates either.  There are plenty of lessons from Spain and Ireland if New Zealand is ever thinking of adopting a common currency.  But otherwise not.

Fourth, Goodson does not mention that all his points could have been made, more compellingly, about New Zealand in 2007.  We’d had rapid rises in the prices of all types of assets, rapid growth in credit across all components of bank lending books, signs of material deterioration in credit quality around dairy loans, and probably commercial construction, and big corporate-finance loans as well.  And yet, the banking system came through unscathed.  If controls had been put on back then, would they still be on today, at what costs to individuals and to the efficiency of the financial system?

Fifth, Goodson does not engage with the provisions of the Reserve Bank Act.  Perhaps what Graeme Wheeler is doing is in some sense good for the country –  I doubt it, but let’s grant the possibility.  But Graeme is not the elected Minister of Finance, proposing legislation to a Parliament of elected members.  He is an unelected official, supposed to operate within the confines of a specific Act.  That Act requires him to use his banking regulatory powers to promote the soundness and efficiency of the financial system.  But his own stress tests tell him that the soundness of the banking system is not impaired –  and even if it were to be, the capital buffers in the system are much bigger than they were in, say, 2007.  And what of the adverse impact on the efficiency of the system?  Equally creditworthy borrowers in Auckland will not, by the coercive power of the state, be permitted to take a loan from a bank that they would be able to if they were in Wellington or Christchurch. And non-banks can make such loans in Auckland, but banks can’t. Where is the evidence that banks and borrowers are behaving so recklessly that they cannot safely be permitted to have a single cent of debt secured on investment property if the loan is above a 70 per cent LVR?  Goodson doesn’t present it, and neither has the Bank.  Build bigger capital buffers if you must –  they have much smaller efficiency costs, and  don’t directly come between willing borrowers and willing lenders.

Finally, Goodson observes that “the RBNZ’s tools need to be sharpened rather than tempered, with other countries providing plenty of evidence for the success or failure of tools such as stamp duty, removing the tax advantages of so-called investors, overseas investment restrictions, loan restrictions et al”. To which I would make two responses.  The first is to say “Really?”   I think the evidence of the impact these differences make to house prices is much less clear.  Tax regimes differ enormously around the world, and if ours offer unjustifiable advantages to anyone it is to unleveraged owner-occupiers, rather than those operating residential rental services businesses (“so-called investors”).

But perhaps more importantly, I hope he isn’t suggesting that such tools should be wielded by the Reserve Bank.  We live in a democracy, where key economic policy decisions should be taken by those whom we elect, and whom we can vote out.  Goodson alludes to Sir Robert Muldooon.   Some of Muldoon’s interventions were pretty damaging and unwise, but we voted him into office, and we could (and did) vote him out again.

As I’ve said previously, the sense that “something needs to be done” seems to be  leading to sense that “anything is something, so let’s welcome anything”, with no proper problem definition, no sense of what should properly be done by whom, and no sense of the risks and costs if the authorities have it wrong.    The Reserve Bank has an important role to play. It should be doing two things.  It should be continuing to refine its stress-testing exercises, and the risk-weighting models used by banks in their internal capital models, to ensure that the banks really can cope with a very nasty shock.  And beyond that should be using part of the significant research and analysis capability the taxpayer funds to produce rigorous and well-grounded papers identifying the real issues in the local housing (and housing finance) markets, reviewing the lesssons from countries that have, and have not, had banking crises related to their house prices booms, reviewing lessons from past interventions (successful and otherwise).  They might even develop (or commission) expertise in things like capital income taxation or urban planning regulations, to better be able to provide advice on the costs and benefits of action, or inaction.  Considered analysis of this sort, complementing that from core government departments, can provide a good foundation for political decision-makers to act, or not act.  But these are the sorts of instruments that, in a free society, only elected people should be deciding on.

Serious liberalisation of planning laws, and/or a reduction in the non-citizen target immigration level would be good places to start.  Both would, very belatedly, lower house and land prices, probably rather a lot.  But they would not threaten the soundness of our financial system..

Productivity growth worse than in Greece

In the interview with Richard Harman I noted that one of my main interests and (rather more importantly) one of the bigger challenges for New Zealand was its disappointing economic performance over the last 25 years.    The liberalisation of the economy in the 1980s and early 1990s was generally expected to have reversed the earlier decades of relative decline.  Not everyone shared that optimism, but among the advocates of reform within government and the public service, and among most international observers (for example, the IMF and OECD, and financial markets), that sort of re-convergence was generally expected.

But it didn’t happen.  For a while there was a “the cheque is in the mail” hypothesis doing the rounds –  it hadn’t happened yet, but it surely wasn’t far away.   But 25 years is a long time, and it just has not happened.  Around 1990, the former eastern-bloc countries started serious liberalisation.  Their economies had been much more heavily distorted than New Zealand’s (notwithstanding the Bob Jones crack in 1984 about the New Zealand economy resembling a Polish shipyard), but they have subsequently seen considerable convergence.

Here is my favourite summary chart of our underperformance over that period.  Using the Conference Board data, it is total growth in real GDP per hour worked for 42 advanced countries (OECD, EU, and Singapore and Taiwan) since 1990.  Only five countries had had slower growth over that period than New Zealand –  and two of them (Switzerland and the Netherlands) had had among the highest levels of labour productivity in any of these countries in 1990 (so one might have expected unspectacular growth subsequently).  No cross-country comparative measure is perfect, but I don’t this one is particularly unrepresentative of New Zealand’s relative performance  On this measure, Greece and Portugal have done less badly than us  (but recall that this is GDP per hour worked, and in the current Greek Depression total hours worked have dropped away precipitously).

GDPphw since 1990

I’ve been running a story about the role of immigration policy in explaining that failure to converge –  total GDP has grown a lot, even if GDP per hour worked hasn’t.  In this wider sample of countries, New Zealand has had among the faster rates of population growth, despite the huge outflow of New Zealanders (around 525,000)  over that period.   Singapore (86%) and Israel (77%) have had much faster rates of population growth than New Zealand (30%) over this period.

My argument has been that in a country with a low savings rate, rapid population growth has put considerable sustained upward pressure on real interest rates and the real exchange rate, squeezing the share of GDP devoted to business investment and preventing the emergence of new tradables sector firms/products at the rate that (a) convergence would have required, and (b) the rest of NZ’s microeconomic policy framework might have suggested/warranted.  A few weeks ago, I showed how our real exchange rate against Australia had failed to decline despite the deterioration in our relative economic performance over decades.

Here is another way of looking at the same point.  The two countries with the fastest growth in the chart above were Taiwan and Korea.  Singapore has also done impressively well.  In 1990, Taiwan and Korea were well behind New Zealand, and Singapore had about the same level of real GDP per hour worked as New Zealand  (precise comparisons depend on which set of relative prices are used, but on any measure all three countries have had growth outstripping that of New Zealand).

And here is the picture over 50 years, again using the Conference Board data
gdpphw asia
All three Asian countries have had some of the more dramatic catch-ups in productivity levels seen anywhere.  New Zealand, by contrast, in 1965 was among the advanced countries with the highest levels of labour productivity, and has been in relative decline since.

But what has happened to the countries’ real exchange rates since?  As ever, there is no unambiguous way to measure that, but the BIS have real exchange rate indexes for each of the four countries going back to the 1960s.  Of course, real exchange rates can move around a lot from year to year, so in this chart I’ve shown the percentage change in the real exchange rate from the average for 1966-70[1] to the average for the 10 years to May 2015.

bis rer asia

The countries that have had such dramatic productivity improvements have all recorded modest falls in their real exchange rates, and by contrast New Zealand has had an increase in its real exchange rate.  That is opposite of what one might initially have expected.  One might have expected a strong real appreciation in the Asian currencies (as has happened in Japan), as much higher incomes supported more and cheaper consumption in these countries.  Fewer resources now needed to be devoted to the tradables sectors in those countries.   And in New Zealand one might have expected the deteriorating productivity performance, and hence declining (relative) future consumption opportunities, to have been met by a declining real exchange rate. That would have increased the returns to productive investment in New Zealand –  helping to reverse the decline – and raised the relative price of consumption.

How does my story explain what went on?

In last 25 years, Korea and Taiwan have had materially slower population growth rates than New Zealand has, and much higher savings rates.  That meant both less pressure on resources simply to maintain the capital stock per person, and more domestic resources available to meet investment demand.  The net result: little upward pressure on real interest rates and the real exchange rate, despite the continuing productivity gains.

Singapore is at the extreme.  The national savings rate has averaged 46 per cent in Singapore over the last 25 years, roughly double the rate for advanced countries as a whole.  With so many resources available (earned but not consumed) even the investment needs of an average population growth rate of 2.5 per cent puts no pressure on domestic resources, or hence on real interest rates and the real exchange rate, despite the continuing productivity gains.

And that is my story in a nutshell: with very high saving rates your country might need lots more people to make the most of the savings.  But in a country with only a rather modest savings rate (for whatever reason) then having lots more people –  and especially bringing them in as a matter of policy – simply looks wrongheaded.  It undermines what policy is setting out to achieve.

It isn’t that migrants somehow “take away jobs”, but rather that rapid population growth (whether migrants or high birth rates) tends to divert resources (jobs) away from growing the bits of the economy that sell to the rest of world (a huge and diverse market, and probably where our future prosperity is to be found) to ensuring that the physical infrastructure (houses, roads, shops, factories, schools) keeps pace with the needs of the growing population. It makes it very hard to catch up with the richer countries.   Israel has found something much the same.

No comparison of any pairs of countries, in any particular period, is ever going to be conclusive.  I use the examples in this post simply to illustrate the story.

[1] Starting the comparison from the start of the BIS series in 1964 would result in an even larger fall for Korea