A severe commentary

Plenty of commentaries have remarked on the very low inflation numbers out this morning.

None (that I have seen) has highlighted what a severe commentary these numbers are on the Reserve Bank’s conduct of monetary policy over the last few years.

Reciting the history in numbers gets a little repetitive, but:
• December 2009 was the last time the sectoral factor model measure of core inflation was at or above the target midpoint (2 per cent)
• Annual non-tradables inflation has been lower than at present only briefly, in 2001, when the inflation target itself was 0.5 percentage points lower than it is now.
• Non-tradables inflation is only as high as it is because of the large contribution being made by tobacco tax increases (which aren’t “inflation” in any meaningful sense).
• Even with the rebound in petrol prices, CPI inflation ex tobacco was -0.1 over the last year – this at the peak of a building boom.
• CPI ex petrol inflation has never been lower (than the current 0.7 per cent) in the 15 years for which SNZ report the data.
• Both trimmed mean and weighted median measures of inflation have reached new lows, and appear to be as low as they’ve ever been.

This wasn’t the way the Bank told us it was going to be. And more importantly, it wasn’t the basis on which they held interest rates up through 2012 and 2013, and then raised them last year. As late as December last year, they were still talking of raising the OCR further. Real interest rates never needed to rise, and as a result of the misjudgement they rose even further than the Bank intended (inflation expectations fell away).

It has been a sequence of cumulatively severe misjudgements. The word “mistake” keeps springing to mind, although of course the Governor rejected that characterisation at the time of last month’s MPS. Perhaps he is rethinking now? As I’ve pointed out previously, inflation outcomes so far weren’t mostly the result of unforeseeable external economic shocks. And if core inflation measures are this weak now, we have to start worrying what will happen to them as economic growth slows further, construction pressures ease, and the deepening loss of income from the declining terms of trade bites. Wage inflation has been very low, and more recently wage inflation expectations have been falling.

The Reserve Bank has belatedly recognised the need to modestly change direction. The Governor cut the OCR by 25 basis points last month, and foreshadowed that at least one more cut was likely. But the problem is that they are still well behind the game. The data are weakening faster than they are cutting, and the OCR was already too high right through last year. Difficult as it might be to make a large move at an intra-quarter review next week, the substantive case for a 50 point move is certainly strong. If not next week, then at the latest it should happen at the September MPS. There also needs to be a recognition that there is nothing wrong or inappropriate even if the OCR goes to new lows. The OCR simply needs to be set consistent with a realistic appraisal of the inflation outlook (not the upwardly biased one that has guided too many central banks in recent years). An apology, and a heartfelt mea culpa, from the (single decision-maker) Governor would also be appropriate.

As inflation expectations measures are likely to keep falling, this mistake is also increasing the risk that the zero lower bound will end up being binding in New Zealand. But, if we take the Reserve Bank’s Statement of Intent seriously, this is not something they worry about. They should.

But questions also need to be asked about the role of the Bank’s Board as agent for the public and the Minister of Finance. Inflation outcomes now are reflecting policy choices made last year. But here is all the Reserve Bank Board has to say about monetary policy in their latest Annual Report, published only nine months or so ago. In introducing the document, they note that:

Our formal review of the Bank’s performance is included in the Bank’s Annual Report.

And when they get to monetary policy

In the last year, we have considered the Bank’s decisions to hold the OCR at a record low of 2.5 percent for an unprecedented three-year period, and to increase the OCR four times from March to July 2014.

The level of disclosure in monetary policy was very high. We considered that the Bank’s policy decisions were appropriate, initially taking into account the need to provide support for the economic recovery after the disruptions of recession and earthquakes, and lately the need to ensure that the recovery is sustainable, by restraining emerging inflationary pressure.

This was a “formal review”? I still find it astounding that, less than a year ago, the Bank’s Board – the independent agency responsible for scrutinising the Bank – made no mention at all of the continued undershooting of the inflation target. I’m not suggesting they should have read the data better than the Governor – they are paid as ex-post monitors, not as monetary policy decision makers – but there is little sign of any serious scrutiny at all. It reinforces my view that the governance model is inappropriate in a wide variety of dimensions, and that the Board in particular plays little useful or effective role as agent for either the Minister or the public. By construction, it is simply too close to the Bank, and thus is more prone to act as defensive cover for the Governor, than as a source of serious scrutiny and challenge in the public interest. At very least, we should expect something much more substantive from the Board in its next Annual Report.

The Minister of Finance has commented a couple of times recently about the Bank undershooting the inflation target midpoint (which was added explicitly to the PTA by him in 2012). Such “shots across the bow” seem both understandable, and quite appropriate. The Minister initiates the inflation target, but has no say in individual OCR decisions. But he is responsible to the public (and Parliament) for having the target met by the Governor. Whether with hindsight or foresight, monetary policy has been too tight for probably five years. Partly as a result, New Zealand’s economic recovery has been anaemic – much more muted than in a usual recovery, despite the huge boost to demand provided by the Canterbury repair and rebuild process. The unemployed pay a particularly severe price for that, but they aren’t the only ones.

The real question is whether the Minister is willing to do more than talk. My impression is that his instincts are often in the right direction, but there is often a reluctance to follow through (one could think of housing supply issues as a prime example).

I’ve touched previously on some of the options the Minister has to show that he takes these issues seriously. In May I noted:

The Minister could seek a report from The Treasury on their view of how well the Governor was doing consistent with the Policy Targets Agreement, could let it be known such work was underway, and could arrange for such a report to be published. The New Zealand Treasury offers independent professional advice to the Minister of Finance and would have to take seriously such an exercise. It might be expected to consult externally (but confidentially) to canvass opinion. At present, for example, most financial market economists – not the only relevant observers but not unimportant either – in New Zealand seem quite comfortable with the Governor’s handling of monetary policy.
The Minister could also seek formal advice from the Bank’s Board, and let it be known that he was doing so. This would be a totally orthodox approach – the Board exists as a monitoring agent for the Minister – and it was, for example, the approach taken in the mid-1990s when inflation first went outside the target range. The Board has a number of able people on it, but as an effective agent for accountability risks being too close to management. The Governor sits on the Board, the Board meets on Bank premises, it has no independent resources, and it has been chaired exclusively by former senior managers of the Reserve Bank. It was striking that last year’s Board Annual Report (which is just embedded in the Bank’s Annual Report document) had nothing substantive on the deviation of inflation from the policy target.

Those are both still serious options. I suspect that it might be timely to exercise both of them.

Longer-term, it is now only just over two years until the Governor’s term expires. There must be real questions as to whether Graeme Wheeler could credibly be reappointed (recommended by the Board or accepted by the Minister) after his succession of overconfident monetary policy misjudgements, and in light of the poor quality analysis he has used to support his over-reaching policy initiatives in the regulatory areas. Perhaps Graeme will make it easy and conclude that, at his age, one term is enough?

The mistakes of the last few years don’t result primarily from the governance model, but the governance model – with too few checks on the Governor, as decision-maker and chief executive responsible for all the supporting analysis – is likely to have contributed. The mistakes –  an exaggerated version of those made in various other countries – highlight the material weaknesses in our most unusual system. The start of a new gubernatorial term is a good opportunity for the Minister to take the lead in reforming the Reserve Bank Act to bring governance of this powerful agency more into line with international practice and with governance standards in the rest of the New Zealand public sector. Treasury recommended doing something in 2012, and the Minister refused. He should take the lead this time. If he did, I suspect he would find pretty widespread support – from other political parties and from market economists. Perhaps even from the Reserve Bank itself.

PS.  Following on from earlier commentary, SNZ has altered how it is doing seasonal adjustment of the non-tradables inflation series.  The cost of doing so, is quite a short series, but for what it is worth, seasonally adjusted quarterly non-tradables inflation last quarter (0.3 per cent) was about half what it had been each quarter for the last 2-3 years.

Considering the veracity of Chinese GDP – Christopher Balding

One of my favourite sites for making sense of what is, and isn’t, going on in China is Balding’s World, written by Christopher Balding, a professor of economics of Peking University.

He has had a succession of useful posts over the last few weeks, and here is the link to his piece on yesterday’s somewhat implausible GDP data.  The summary of Balding’s take is captured in his title.  As he notes, the problems with Chinese data have been deep-seated, extensive, and long-running.  In conclusion he tellingly observes:

Only last month, an initiative was announced to improve labor market data as the official unemployment rate has been nearly unchanged for more than a decade.  If Chinese leaders are telling the world how poor the statistical agencies in China are, imagine the reality.

Wouldn’t it be preferable if these issues were getting serious treatment in the media rather than the hyper-ventilation about the gyrations of the Chinese stock markets? When stock prices rise 100% in less than a year, in an economy that appears to have been slowing sharply, sharp falls are hardly a surprise. And they mean no more for economic performance than falls in stock prices in the US in 1929 did – while media continue to run a cheap, incorrect, line that a collapse in share prices somehow caused the great depression. Stock prices move for a reason, and it is much more useful to try and get behind what is going on in the underlying economies than to focus too much on share prices themselves. That was true in New Zealand around 1987, and is probably true of China today.

The Productivity Commission looks into immigration

The Australian Productivity Commission that is.

The Australian Productivity Commission has underway an interesting inquiry, initiated by the Federal Treasurer, into immigration to Australia. Here is the scope of the inquiry, taken from the Treasurer’s Terms of Reference.

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It is interesting that the Australian government has chosen to initiate another Productivity Commission inquiry only 9 years after the previous large report into the economic impact of immigration. That bulky report concluded that in Australia, the gains from immigration mostly accrued to the immigrants, with little evidence of any material gains to native Australians. Despite the size of that earlier report, there was some aspects of the economic issues (possible benefits, as well as possible costs) that were not covered at all, and the modelling work that was done looked at the medium-term rather than the long term.

The new inquiry has two areas of focus. The first is helping to answer the questions about the costs and benefits of immigration, both to Australian citizens more generally and to the fiscal position of Australian governments more specifically. The second is around the intriguing idea of charging for entry. The idea of rationing entry by price turns up in immigration debates from time to time. “Intriguing” here is my code word for something like “this idea appeals to the economist in me, but yet there is something about it – which I can’t quite put my finger on – that is distasteful, and it seems unlikely to fly”. I can’t see it happening, and yet I’m not entirely sure why it shouldn’t. If we set aside the refugee quota, countries like New Zealand and Australia allow and promote immigration largely for economic reasons, and a price should tell something useful about who could get most value out of permission to live in our country. Perhaps willingness to pay is not overly well aligned to ability to help generate domestic productivity benefits?   But is there good reason not to use price to ration demand for places among those who meet certain basic criteria (age, English language, lack of criminal history etc)? It will be interesting to see what the Commission comes up with in this area.

To their credit, the team working on this immigration inquiry sent a couple of senior people to Wellington this week. New Zealand has quite similar immigration policies to Australia, and for Australia in particular, the largely-free trans-Tasman immigration area also complicates things (as it does for us, in the possibility of people returning home late in life to claim New Zealand welfare benefits). I was among the various groups of public and private sector people they met while they were here, and we had a good wide-ranging discussion.

I noted that I had increasingly come to think that good immigration policy – in countries like ours, with no treaty obligations to allow open access, and (unlike Israel) no national identity/security reasons to promote immigration – is best thought of as an optional complement to economic success. The alternative, which seems to be at the heart of the arguments of immigration advocates in New Zealand, is to see immigration policy as an engine (perhaps large, perhaps small) helping generate economic success.  I can’t think of a country – going back centuries – where immigration has materially improved the economic fortunes of the recipient country. In the last great age of immigration – the decades prior to World War One – migrants flowed to countries that were already economically successful (be it New Zealand, Australia, Canada, Argentina, the United States or even within Europe itself). Economic success allows a country, if it chooses, to support more people at high incomes. And emigration eases the pressures in the source country, lifting living standards among those who remain.

There is, of course, an exception to my story. Immigration has transformed the economic prospects of some physical territories, but only by totally taking over and largely replacing the indigenous population, and the economic institutions of that culture.   New Zealand – like each of the colonies of settlement – is an example of that. And it is an uncomfortable example. My assessment (backed, for example, by the work of people like Easterly, looking at long-term global economic performance) is that Maori average incomes are higher now than they would have been without extensive European settlement, but was the trade worthwhile – across all its dimensions – for the indigenous population? There are huge discontinuities between 21st century New Zealand and 18th century “New Zealand” that don’t exist for, say, the United Kingdom or France.

By advanced economy standards, New Zealand is a classic example of an underperforming country that people should be leaving. And, of course, for decades New Zealanders have been doing so, mostly to more successful Australia.   Of course, we can always attract plenty of people from other (even poorer) countries if we want to. But why would we?     There is no obvious area of the world where the culture and economic institutions are so obviously superior to our own Northern European-sourced ones that we can get the sort of transformative gains (at whatever costs) that Maori may have achieved by allowing extensive European settlement in the 19th century. There is no sign in the data that slightly larger countries grow faster (per capita) than slightly smaller ones.  And there is no reason to think we can somehow attract the very best of possible migrants to a small, remote, underperforming, but pleasant, country.   And if current migration patterns were repeated at scale, or for long enough, we would face the risk of factor price equalisation occurring, but not in the way we want – the typical migrant to New Zealand comes from countries, and economic cultures, that generate materially lower living standards and levels of productivity than New Zealand (or Australia) does.

The draft report of the Australian inquiry is due out in mid-November. I’ll be keeping an eye out for it. Perhaps it might be time for a similar inquiry in New Zealand. I think I’ve mentioned that when I first started raising my arguments about the possible link between immigration policy and New Zealand economic underperformance, there was a lot of discomfort at Treasury. Senior people then talked of the new Productivity Commission as a good place for such issues to be explored. That remains true today, and Treasury has a key role in advising ministers which inquiries to request from our Productivity Commission.

I have had Official Information Act requests in for some time with Treasury and MBIE for copies of advice to ministers on the economic impacts of immigration, and on the target level of permanent residence approvals. As is customary with government agencies, the responses to the requests have both been extended/delayed.   These aren’t particularly time-sensitive requests, but I will be interested to see what the departments have had to say. MBIE is well-known to be strongly pro-immigration, and I have heard reported that current Secretary to the Treasury (himself a temporary migrant) recently reiterated in private a view that “immigration is good; it is as simple as that” (repeating the tenor of comments in a speech earlier this year). Perhaps, but let’s see the argumentation, in the specific context of New Zealand, and in the light of cross-country economic history and experience.