Bagehot on reforming the Reserve Bank Act

In a comment the other day on my post outlining a possible alternative governance model for the Reserve Bank, Andrew Coleman at the University of Otago included some quotes from Walter Bagehot’s 1873 classic work Lombard Street: A Description of the Money Market (available free here).

The quote that particularly took my fancy was some concluding remarks Bagehot made about the need for changes to the structure and governance of the Bank of England.

“There should be no delicacy as to altering the constitution of the Bank of England. The existing constitution was framed in times that have passed away, and was intended to be used for purposes very different from the present. The founders may have considered that it would lend money to the Government, that it would keep the money of the Government, that it would issue notes payable to bearer, but that it would keep the ‘Banking reserve’ of a great nation no one in the seventeenth century imagined. And when the use to which we are putting an old thing is a new use, in common sense we should think whether the old thing is quite fit for the use to which we are setting it. ‘Putting new wine into old bottles’ is safe only when you watch the condition of the bottle, and adapt its structure most carefully.”

He could have been writing about New Zealand’s situation now.

As I’ve pointed out, our Reserve Bank Act, and particularly the governance features of it, were designed in 1989.  Back then, there weren’t many modern international models to build on.  The provisions of the Act were designed to align with a vision of how core government departments would be run that has now been largely abandoned, they were designed for a conception of what the central bank would be doing that envisaged very little effective discretion, and they were designed before the Crown entities framework was developed for the many other non-departmental government agencies in New Zealand.

Those times have, in Bagehot’s words,  “passed away” and we now need a review and extensive revision of governance, transparency and accountability provisions of the Reserve Bank Act.  Discussion of the issue often focuses on monetary policy, but the governance of the Bank’s extensive powers in banking, non-bank, and insurance regulation is at least as important (and more challenging because the goals are less well-defined).  And as I have been highlighting in the last few weeks, we need to ensure much more openness from the Bank across all its functions, and some more effective structures for holding the Bank and its decision-makers to account.  Bagehot uses a biblical image, but we can go a little further: putting new wine [new expectations of what the Bank should do and how] into old wineskins [the 26 year old Act]  leaves the New Zealand system out of step, and is a recipe for some rather poor and unsatisfactory outcomes.

And with that, I’ll stop for now.  I’ll be back around 13 October,

A partial backdown from the Reserve Bank

Last week I ran a post about the Reserve Bank’s refusal to release the submissions on the new investor finance restrictions, and in particular the reliance the Bank appeared to be putting on the confidentiality provisions in section 105 of the Reserve Bank Act. Those provisions appear to prohibit the Bank releasing any information  it received from anyone “ relating to the exercise, or possible exercise, of the powers conferred by this Part” of the Act.

As I noted then

This seems like a travesty of democracy. Submissions –  on major new public policy initiatives – can be disclosed to foreign central banks or supervisors, but not to the New Zealand public. Any views banks or members of the public might submit to the Reserve Bank on monetary policy would typically be discoverable under the OIA, but those on prudential matters are apparently not. And this is so, even though for for monetary policy there is a relatively specific objective for which the Governor can be held to account, while there is nothing remotely specific about how the statutory objectives for prudential policy should be measured.


A system in which the Governor can tell us as much, or as little, and then with his own slant, on the submissions he receives should be seen as simply unacceptable.  In this case, quite a simple amendment to the Reserve Bank Act would rectify the situation, making explicit that submissions on proposed changes to conditions of registration, or any other restrictions that affect all institutions, are not covered by the section 105 exemption, and should routinely be published on the Reserve Bank’s website.

And noted that.

Of course, if anyone else wants to request copies of the submissions, the Bank should presumably respond immediately declining their request and explaining why.  Unless they want to reconsider and change their interpretation of section 105, any delay would itself be a breach of the Official Information Act.

I knew then that another request had been made and had not been responded to immediately.

Today, the Reserve Bank has responded to that request, and there has been a major change of heart .

Having told me that it would be too much work to release the papers, that the summary of submissions met the statutory requirements (both laughable arguments), and that in any case much of the each of the submissions would have to be withheld, they have had a (welcome) re-think.  The Reserve Bank has now released in full, on its website, the submissions made by all people and entities who are not banks regulated by the Reserve Bank.

This is a significant step forward. It is probably the first time the Reserve Bank has released any submissions on proposed regulatory changes.  I hope that this now sets a precedent, and to check that I have requested copies of the submissions on the regulatory stocktake.

However, the Reserve Bank is still refusing to release submissions made by banks.  It asserts that these are protected by the confidentiality provisions in section 105 of the Reserve Bank Act.  I describe it as an “assertion” because there is no supporting argument or evidence in the letter to Jenny Ruth as to how section 105 protects bank submissions but not those made by other submitters.  Here is what the Act says:

  • This section applies to—

under, or for the purposes of, or in connection with the exercise of powers conferred by, this Part:

    • (b) information and data derived from or based upon information, data, and forecasts referred to in paragraph (a):
    • (c) information relating to the exercise, or possible exercise, of the powers conferred by this Part.

There is no hint I can see of any legal differentiation between material supplied by banks, and material supplied on the same issue by other parties.

If the Bank has a strong legal case, they should let us see it.  I’m certainly not suggesting that they should break the law and release bank submissions if they are legally prohibited from doing so, although I suspect  that they may be doing so by releasing any submissions at all

Whatever the law currently says, is there a case for withholding bank submissions?  I think the answer is no, and if anything it is much more important that bank submissions are discoverable than that those of other submitters are.  After all, banks are regulated entities and the idea that regulated entities should be able to lobby the regulator in secret, and we (citizens) have no ability to see what arguments they have made goes strongly against the principles of open government.   Those concerns about regulators and the regulated getting too close were what motivated Ross Levine to write an entire book, The Guardians of Finance (which I wrote about here).  If anything, there is probably a case for more material on banks to be made public, as I noted in yesterday’s post, but certainly their submissions on policy proposals should not have legislative protection.

In conclusion, I wanted to make two other observations.

First, the Bank has asserted that the “summary of submissions we’ve published accurately and fully summarises the responses received from banks”.  If that is so, it would certainly be welcome, but as their summary certainly didn’t accurately or fully summarise my submission, we have no reason to be confident as to how they have reported bank submissions.

And second, I received a letter from the Reserve Bank this afternoon attempting to rationalise their refusal to release anything to me when I sought the same material.  Here is what they had to say:

Subsequent to publication of our summary of submissions and response to submissions for our consultation on adjustments to restrictions on high-LVR residential mortgage lending, the Bank received another Official Information request seeking copies of all submissions. The timing of these two equivalent requests is a differentiating factor in the Bank’s responses to these requests.

  • Your request was made prior to us doing the necessary work to collate, assess, and consider our response to the submissions and then publish our summary and response. 
  • The subsequent request, from a newspaper, was made on 24 August, after we had completed our assessments and published the summary and our responses.  

The difference in timing is significant because one of the primary reasons for declining to provide information to you was, as envisaged by section 16(2)(a) of the Official Information Act, that doing so would impair efficient administration due to the need to repeat the work assessing submissions for their primary purpose while also assessing them to respond to your request. With the primary assessment work completed, we do not need to repeat it for the Official Information request made on 24 August. Accordingly, our response to the request we received on 24 August is that we are releasing submissions made to us by individual and by non-bank organisations that we do not regulate,

Again, this simply not persuasive, and appears to be a rather desperate ex post rationalisation for what is clearly a change of view.   For any OIA request, the Bank has 20 working days to respond, and can (and has previously, and regularly, done so) extend that time by another 20 working days if necessary.  There was no need for any repetition, or any disruption to their deliberations (especially as they had openly signalled that they intended to turn the submissions around, and announce the Governor’s decision, quite quickly).

I don’t hold it against people when, having reflected more fully on the issue, they change their minds.  I’ve welcomed the partial step forward reflected in the release of the material today.  But it would best not to pretend that the two requests were so different that they had good legal grounds to refuse my request altogether, but were also legally required to release today’s material .  One decision was a mistake –  hopefully not a wilful one.

As I noted last week about section 105

Like so much about the Reserve Bank Act, it is past time to reform these provisions.  Good access to official information is vital if we are to ensure that such a powerful institution is to be robustly accountable.  At present, there is far too little effective accountability and scrutiny.  A system in which the Governor can tell us as much, or as little, and then with his own slant, on the submissions he receives should be seen as simply unacceptable.  In this case, quite a simple amendment to the Reserve Bank Act would rectify the situation, making explicit that submissions on proposed changes to conditions of registration, or any other restrictions that affect all institutions, are not covered by the section 105 exemption, and should routinely be published on the Reserve Bank’s website.

The Reserve Bank’s “regulatory stocktake”

The Reserve Bank has had out for consultation a document described as a “regulatory stocktake of the prudential requirements applying to registered banks”.  In fact, it covers only a limited range of issues, as most of the more important issues were ruled out in the terms of reference.   Submissions close tomorrow.

I hadn’t really planned to make a submission, but some discussions got me thinking a bit more about disclosure requirements and the way in which this document seemed to risk leading to less information being available to depositors and creditors, while more information was provided confidentially to the Reserve Bank itself.  That seems wrongheaded, when the focus of the regulatory regime has long been intended to be to support a framework in which creditors carry the risks if things go wrong, not the government or the Reserve Bank.

So I have written a brief submission, which is available here.

Submission to RBNZ regulatory stocktake Sept 2015

I focused on only two aspects.  The first is around the “fit and proper” tests the Reserve Bank imposes for directors and senior managers.  There is no evidence that this process is adding any value in promoting the soundness of the New Zealand financial system.  I raised some questions, and proposed a much less discretionary, disclosure-focused, alternative approach to the issue:

No doubt there will be people (and perhaps there already have been) who were employed by failed finance companies coming up for Reserve Bank approval in the next few years.  In some cases, those people will have had no responsibility for the failure, and in others there may have been some culpability.  But business failures happen, and they aren’t always a bad thing (indeed, unlike some systems, our banking regulatory system is explicitly designed not to avoid all failures).  Why is the Reserve Bank better placed than the registered bank concerned to reach a judgement on whether any previous involvement with a failed finance company should disqualify someone from a future senior position in a bank (or other regulated financial institution)?

In a similar vein, I wonder if the Reserve Bank has done any sort of retrospective exercise and asked itself how likely it is that, with the information available at the time, it would have rejected any (or any reasonable number) of those responsible for the 1980s failures of the DFC and the BNZ.  Done in a suitably sceptical way, it would be an interesting exercise

I’m not suggesting there be no rules at all.  My two specific proposals would be as follows:

  • conviction for an offence involving dishonesty in the previous 10 years should be an automatic basis for disqualification from such senior positions.   It wouldn’t be a perfect test, but it is certain and predictable, and probably better than a “we don’t like the cut of your jib” sort of discretionary judgement exercised by regulatory officials.  And it doesn’t hold the false promise of regulators being able to sift out in advance people who might, in the wrong circumstances, later be partly responsible for a bank failure.
  • a requirement that a summary CV for each director and key officer be shown on the registered bank’s website.  Those summary CVs might be required to list all previous employers or directorships, and any previous criminal convictions and formal regulatory actions against the individual.

By contrast, the current fit and proper tests seem to be an additional compliance cost, for no obvious (or demonstrated) public policy benefit in safeguarding or promoting the soundness of the New Zealand financial system.

And the second area I commented on was around financial disclosure requirements.  I noted that if the disclosure statements were not providing the information the Reserve Bank needed (as they state), they clearly couldn’t be providing the information that a prudent creditor/depositor would find useful in evaluating his or her bank.  Accordingly, I proposed changes that would materially reduce compliance costs and materially increase the availability of rather more timely data to creditors/depositors –  those, that is, whose money is at risk.

In the consultative document, the Reserve Bank canvasses the possibility of further reducing the amount of information made public, while potentially further increasing the amount of private information the Reserve Bank itself obtains from banks.  That seems a wrong-headed approach, and quite inconsistent with the desire to promote  (a) market discipline and (b) an expectation that government bailouts are not the option of first resort if a bank runs into difficulty.  If the Reserve Bank has revealing private information not available to depositors, and the Bank subsequently  fails, why would a reasonable small depositor not argue with some force that the responsibility for her loss of money rested, proximately, with the Reserve Bank?  Such arguments, correct or not in some narrow economic sense, will strengthen the (already high) likelihood of government bailouts.

My alternative proposal is to reshape disclosure requirements so that depositors and creditors are given the same information that the Reserve Bank considers necessary for it to be able to monitor the health, and emerging risks, in individual banks.

In other words, scrap the existing disclosure requirements completely (which would, no doubt, materially reduce compliance costs), and require instead that all regulatory returns that banks provide to the Reserve Bank be published on the relevant bank’s website within, say, an hour of the information being sent to the Reserve Bank.  If the private information is valuable to the Reserve Bank it would also be valuable (at least in principle) to depositors/creditors and those in the private sector monitoring banks on their behalf.  It is, after all , the money of the depositors and creditors that is at stake,  not that of the government or the Reserve Bank.    And private readers have rather more incentive to use the information well than officials at the Reserve Bank do (however able or well-intentioned the latter may be).

Moving in the direction discussed just above would, of course, represent a substantial change in approach.  Timely statistical returns of the sort banks supply to the Reserve Bank can’t first go through a full audit sign-off and director attestation, but the Reserve Bank itself –  by its own revealed preferences –  clearly thinks that in terms of knowing what is going on on a timely basis, those protections are less important than getting timely information.  If things are very timely there will almost inevitably be the occasional error, but that is not an argument against the idea.  After all, even Statistics New Zealand (perhaps even the Reserve Bank) occasionally finds mistakes in its data.  The concern shouldn’t be errors –  people are human and will err –  but about the risk of being deceived.  But adequate protections against deliberate attempts to deceive either the Reserve Bank or creditors (by deliberately supplying erroneous or misleading information) surely either already exist in statute or common law, or could be legislated separately.  And the fact that the Reserve Bank’s own analysts would be reliant on the same data that were going public would provide an additional layer of comfort –  since the Bank is readily able to ask, and require answers to, probing follow-up questions.


I am also not suggesting an absolutist approach to this issue.  I have no problem with the answers to ad hoc inquiries by the Reserve Bank of an individual bank not being published.  And in times when an individual institution may be approaching crisis, there probably needs to be greater confidentiality around the handling of the detailed information involved in crisis management (although such material should probably still be discoverable after the event).  Indeed, protecting that sort of information was a part of the justification for the (now abused) section 105 secrecy provisions in the Reserve Bank Act.  There is no foolproof dividing line, but I would suggest as a starting point that any statistical returns which are (a) regular, and (b) required of all (or a significant subset of) banks should be subject to my immediate disclosure rule.  And perhaps the Reserve Bank Board could offer an attestation in its Annual Report that it has satisfied itself that staff and management are operating the system in a way that ensures all regular supervisory information is being made available to depositors and other creditors.

It was a short list. I couldn’t think of any.

As a conservative, monarchist and Christian, I had been encouraged by the political success of Tony Abbott, and quite seriously underwhelmed at the idea of Malcolm Turnbull becoming Prime Minister of our closest ally, major trade and investment partner, and more generally the most similar country in the world to New Zealand.

On its own the latest round in the Italian-style revolving Prime Ministership in Australia wouldn’t have prompted a post on a blog that is mostly about economics and public policy issues.  But reading stories this morning in which the incoming Australian Prime Minister is quoted as praising John Key’s economic management was just too much.  Turnbull is quoted as saying

“John Key has been able to achieve very significant economic reforms in New Zealand by doing just that, by taking on and explaining complex issues and then making the case for them. And I, that is certainly something that I believe we should do and Julie and I are very keen to do that again.”

I grabbed a piece of paper from my bedside table and starting trying to jot down on the back of the envelope the “very significant economic reforms” in New Zealand over the last seven years.

It was a short list.  I couldn’t think of any.

Perhaps Turnbull had in mind the tax package of 2010?  Some of it might have been useful, but (a) it was pretty small in the scheme of things and (b), as the Treasury pointed out at the time, the net effect of that package was to raise the average tax rate on business income, not lower it.

From almost seven years of a Key-led government, I managed a few other small useful items for the list of reforms:

No doubt there are others, but if anyone can point me to a “very significant economic reform” undertaken in New Zealand since November 2008 I’d be grateful.  I don’t count closing the fiscal deficit.  It is welcome of course, but we’ve had persistent deficits despite record high terms of trade, and simply closing a deficit is not itself an economic reform.   Weak wage pressures across the economy have made fiscal management a lot easier than might have been expected.

And the problem with even the list above is the list of measures that could appear on a  “steps backward” list:

  • Higher effective corporate tax rates
  • The debacle of the earthquake-strengthening legislation
  • The continuing debasement of our skills-based immigration system, both in the way it is administered and in formal announced policy.
  • New overlays of financial market regulation
  • The re-establishment of direct government controls over who banks can and cannot lend to
  • The continuation of a regime of “corporate welfare”, including for example the Sky and Tiwai Point deals, and the smell that the Saudi sheep deal gives off
  • The degree of central government control of the Christchurch repair project, involving both wasteful projects (some of which may not finally go ahead), and the way central government has artificially boosted land prices and impeded the prompt redevelopment of the central city.
  • The continuing apparent decline in the rigour of public sector policy advice, and in the use of robust cost-benefit analyses in underpinning policy decisions.
  • Increased first home buyer subsidies.
  • Undermining housing affordability with mandatory insulation etc requirements for rental properties
  • Continuing increases in minimum wages, from very high levels (relative to median wages) at a time when unemployment is quite high, and policy was supposedly oriented to getting people off welfare.
  • Heavy investment in the newly state-repurchased loss-making Kiwirail

But, mostly, the story is just about the failure to do anything much.   I’ve previously quoted some quite-inspiring Key lines from a speech just before the 2008 election.

I came into politics because I believed New Zealand was underperforming economically as a country. I don’t think it’s good enough that so many New Zealanders feel forced to leave our country each year to seek higher wages in Australia. I don’t think it’s good enough that our average incomes lag so far behind the rest of the world. And I think it’s unforgivable that the Labour Party has done so little to address these fundamental challenges.

I believe that a very big step change is needed in our economic performance to ensure New Zealand can make the most of its considerable potential. Growing the economy of this country continues to be my driving ambition. I stand before you today ready to deliver on that ambition for New Zealand.

You have my personal commitment that if I am elected Prime Minister in eight days’ time I will work tirelessly over the next three years to deliver the stronger economic future our country deserves.

That commitment was made just before the Prime Minister was elected.  A year later, in its first report in late 2009, the 2025 Taskforce, established (and then abolished) by the current government included on one of its front pages another aspirational quote from John Key, now well-established as Prime Minister..  The quote the 2025 Taskforce used (from the SST of 8 Nov 2009) was “Our vision is to close the gap with Australia by 2025”

Fine words, but there has been almost no action.

Fine words, but with no tangible results.  New Zealand has made no progress in closing gaps with Australia over the seven years John  Key has been Prime Minister –  not on GDP per capita, not on national income per capita, and not on productivity either.  If anything, we’ve drifted further backwards.  I put lots of charts in this post last week, but here are just a few reminders:

Real GDP per capita for the two countries, where we’ve done a little worse than Australia.

national real GDP pc

And here is real GDP per hour worked.

national real GDP phw

Of course, our Prime Minister has won three successive elections, the last two rather narrowly, and that must sound quite appealing to the backbenchers in marginal seats in the Liberal Party’s caucus.  But if Malcolm Turnbull is serious about economic reform –  which frankly seems unlikely –  he shouldn’t be looking across the Tasman for inspiration and example.

Housing, the Reserve Bank, and an advisory

In the wake of Thursday’s Monetary Policy Statement there has been a round of further comment on house prices and the risks around the housing market.  In fairness to the Reserve Bank, it wasn’t a focus of their document, and comments from the Governor and Deputy Governor seem to have been made in response to questions, at the press conference and at the Finance and Expenditure Committee.

I had been a little sceptical of the strength of the nationwide housing market, and pressures are clearly still concentrated in Auckland and, to a lesser extent, nearby cities.  But, equally, the overall level of activity appears to have picked up.  Here is my favourite timely chart, of per capita mortgage approvals.

mortgage approvals

Earlier in the year. mortgage approvals were running no faster than they were last year.  In the last couple of months the pace has clearly picked up.  That shouldn’t be surprising, as the interest rate increases last year have gradually been reversed, but it is worth bearing in mind not only that the rate of approvals is still below the decade average, but it is barely two-thirds the rate in the peak years of this series, 2005 and 2006.  And the mortgage approvals series does not go back far enough to capture 2003, the year when national house prices rose 23 per cent.  There is no nationwide house price boom.

Housing market activity has clearly picked up.  As it should have.  I don’t think I’ve seen any commentator make the (perhaps too obvious) point that cuts to official interest rates work by a combination of lowering the exchange rate, and encouraging more interest-sensitive expenditure.  In part, that is about bringing forward some spending from tomorrow to today.  But it is also about boosting the prices of long-lived fixed assets, which (in part) encourages people to build instead of buy.  If house prices hadn’t risen to some extent  – relative to some unobserved counterfactual –  in response to lower interest rates. there would probably be reason for concern. Real long-term interest rates have fallen by around 50 basis point since this time last year (15 year inflation indexed bond).

But, of course, this brings us back to the question of what is a fixed asset.  Houses are long-lived assets, but –  in principle –  a new house can be built quite quickly.  And lower interest rates actually reduce the cost of new building a bit (finance costs are non-trivial).  Land is in fixed supply, but unregulated land isn’t particularly valuable or expensive.   Good dairy land goes at perhaps $50000 per hectare.  Lower expected long-term interest rates should raise the unregulated market price of land – at these low interest rates, a 50 basis point change in long-term real interest rates might make quite a large difference, all else equal.  The unregulated price of land is a small component in the cost of a suburban house+land.  But the unregulated price isn’t what we observe.  Instead, what has driven land (and thus house+land) prices sky high is the interaction of two policies – high levels of inward immigration, mostly under direct government controls, in conjunction with tight land use restrictions.  The combination has been disastrous in Auckland.   Non-resident purchases probably haven’t helped either.  With much looser land use restrictions, house+land prices would be much less sensitive to demand pressures (whether from population or interest rates) than they are now.

The Reserve Bank talks of the Auckland market being in “dangerous” territory, but mostly that seems to be slightly inflammatory rhetoric more than the fruit of hard analysis.  Yes, house price to income ratios are higher than in most cities around the world.  And yes, that is a social and political scandal.  But it is largely the outcome of real forces –  not underlying economic ones, but mostly government policy-controlled ones.  They also aren’t, by contrast, the result of some speculative frenzied lending binge (unlike many of the boom-bust markets in the US last decade).  Of course, many property purchases need credit, but credit growth remains pretty subdued, and housing market activity (per capita) remains well below previous peaks. And the Reserve Bank has pointed to no evidence of a material deterioration in credit standards.  If that sort of deterioration is going on, it is surely incumbent on the Reserve Bank to illustrate the evidence (as, say, Waynes Byres recently surveyed the Australian evidence).   Moreover, banks operate on a nationwide basis, and as the Governor observed the other day, the “problem” is largely an Auckland one.  That suggests looking at Auckland-specific causes –  and the interaction of immigration policy and land use restriction policy is the most obvious one.

The Deputy Governor was quoted the other day as telling MPs that “it’s always very difficult to pick the top of any asset price cycle”.  Indeed, and nor is it the job of officials to do so.  But it is also very difficult to know what the equilibrium price of an asset is, especially when the market for that asset is so heavily distorted by policy interventions, in this case policy-driven population growth running head on into land use restrictions.  Auckland prices are very high, scandalously so, but there is nothing that guarantees –  or even offers a high degree of certainty – that real house prices will settle any lower over the longer-term.  I hope they do, and I’m sure most of those currently shut out of the Auckland market do, but this is not just (or even primarily) a market process.  The same goes for Sydney, or London, or Vancouver, or San Francisco.  All the Reserve Bank should be doing is monitoring lending standards, and  –  most importantly  – ensuring that banks have ample capital to cope with things going badly wrong.  They’ve done the second part of that job, and on their own numbers they (and the banks themselves) have done it well.  Beyond that, if they can add in-depth and considered research that sheds light on the housing issues that might be welcome –  although the research resources might be better spent on getting monetary policy right – but beyond that the housing market just isn’t their job.

Just briefly, I noticed a soft interview with the Governor in today’s Herald. It is a platform for the Governor to advance his (remarkably upbeat) case, rather than an occasion when the journalist posed any searching questions. Some of it is just misleading, or straight out wrong.  New Zealand’s economic performance in the last few years has been mediocre at best –  better, certainly, than many of the euro area countries, but generally underwhelming  – poor by historical standards, and no better than, say, the United States which was at the epicentre of the financial crisis.  There has been no per capita real income growth at all in the last 18 months, and real per capita GDP is not much higher than it was in 2007.  That isn’t (mostly) the Bank’s doing, but it isn’t a good performance either.  Oh, and the unemployment rate –  had I mentioned that before –  has hardly come down since the severe recession of 2008/09.

The Governor attempts to rebut some (currently straw man) critics.

Wheeler is keen to make the point that the bank is anything but robotic with its primary focus on inflation.

Critics, particularly on the political left, have called for the bank to broaden its outlook.

“Some people say … we don’t care about growth. But I think every central bank thinks quite deeply about how the economy is going, what’s happening to demand, to investment, to unemployment.”

Perhaps, but right at the moment –  and for the last five years –  a rather more “robotic” focus on actual inflation might have produced better outcomes than we’ve seen.  The Governor seems totally unbothered about his persistent inflation errors, or about the increase in the already high unemployment rate.  As I noted the other day, at present there are no nasty trade-offs between real activity and inflation.  Easier monetary policy would be likely to lower the exchange rate –  something the Governor calls for at every opportunity –  to boost economic activity, lower unemployment, and –  not incidentally –  get inflation averaging somewhat closer to the 2 per cent target midpoint that he agreed three years ago to deliver.

And finally an advisory.  There won’t be many posts here in the next few days, and none for several weeks from next Thursday.  We are taking the kids off to see museums and art galleries (and a few other things) in the United States, and to reintroduce two of them to the land of their birth.  Despite a suggestion from one reader, I won’t be blogging about the lead up to the presidential primaries, fascinating as those races always are, or anything at all.  I’ve been quite taken aback by the level of interest in this blog, and have really appreciated the many typically thoughtful comments and questions. I’ve also written much more than I had ever expected, or intended to (and especially more than I intended to about the Reserve Bank), but it has been fun.  As for the future, I have quite a large pile of topics I haven’t yet got to write about –  in some cases ones that were on the pile on 2 April when I left the Reserve Bank –  so I expect I’ll be back writing here once the rest of the family is back to school and work on 13 October.

The Labour Party spokesman and the Reserve Bank

I wrote this morning that I didn’t really understand why the current government was not willing to do something about reforming the governance of the Reserve Bank.  But it isn’t my only area of puzzlement around how politicians deal with Reserve Bank issues.

For the last day or so, I’ve been pondering the post-MPS statement put out by the (relatively) new Labour Party Finance spokesperson, Grant Robertson.  It continues a line he has run for some time, in which he lauds Graeme Wheeler for doing what must be done on monetary policy, and speaking the truth to power around the state of the economy and the housing market.  Wheeler as the active hero and Bill English as the neglectful spectator is the thrust of his story.

I understand that the point of Opposition is to become the government, and one does that by casting the current lot in a bad light.  But Grant Robertson’s approach doesn’t seem to be a particularly well-chosen way to do that.  Indeed, one could have some sympathy for the Minister of Finance.  He appointed Graeme Wheeler, and signed him up to a more specific inflation target than previously, with an explicit focus on the 2 per cent midpoint.  Three years on there is no sign of core inflation –  or headline –  being anywhere near 2 per cent.  There might be good reasons for that, but the Governor has failed to do well his primary function.  Believe the Governor and we’ll be back at 2 per cent next year, but then he said that last year, and the year before.  And it was the Governor who raised interest rates by a whole 100 basis points last year, when there was never a clear and compelling need for any rate increases, and now it is the Governor who is only grudgingly bringing them down again.  World dairy prices aren’t something the Governor can control, but the economy now would not be as weak as it seems to be,   and – not incidentally –  inflation would be nearer target if (a) interest rates had not been raised so much, and (b) if having been raised, they had been lowered more quickly.  As I noted yesterday, we are probably the only OECD country that has real interest rates higher than they were at the start of last year, and that is Graeme Wheeler’s doing (and that of his staff).  It certainly isn’t Bill English’s fault.  Does anyone actually think it is?

But there is still room to criticise the Minister of Finance.  The Bank’s Board is appointed by the Minister of Finance, and paid, to hold the Governor to account.  The Minister has made the odd frustrated noise in public, and is probably more frustrated in private.  But what is he doing about it?  Has he sought advice from Treasury, and let it be known that he was seeking such advice?  Has he sought advice from the Board, and let it be known that he was seeking such advice? Bill Birch did back in the 1990s when inflation was temporarily outside the top of the target range.  But there is no sign of either action this time.  And in his annual letter of expectation to the Governor earlier this year there was also no sign of any discontent or serious concern from the Minister, despite years of core inflation falling increasingly below target.    The Governor has a lot of power, but it is the Minister’s job (directly and through his agents) to hold the Governor to account.  To the extent that he fails to do so, he makes himself complicit in the Governor’s mistakes.    Perhaps it would be too geeky and “inside the Beltway” for the Opposition to make these points, but they would be more telling charges than praising the Governor as a way to make the government look bad.

Robertson also seems to laud Graeme Wheeler’s contribution to the housing debate, while curiously suggesting that a “housing market that threatens banking stability [it doesn’t]” is “beyond the remit of the Reserve Bank”.  If anything, the Reserve Bank’s contribution to the housing market debate is pretty disappointingly weak.  Wheeler has rushed in with a series of relatively ineffective, but quite distortionary and nastily redistributive, interventions, for which he has no real mandate, all founded on very poor quality analysis and non-existent research.  And all the while keeping secret any submissions that have been made on those proposals.  In terms of wider housing policy preferences, he and the Bank simply seem to fall in line with the preferences of the current government –  he likes things that were done in the Budget, and thinks there should be “more supply”, but offers no serious analysis of the role of policy-driven demand pressures, whether around tax or around immigration policy.  And having done stress tests which suggest a  pretty robust banking system, even in the face of very large adverse shocks, the Governor has been quite unable (certainly unwilling) to make a case for why his own interventions are appropriate, in terms of the statutory goals Parliament has given the Bank.  The Reserve Bank’s job is to keep the financial system sound.  It appears, on its own numbers, to have done that.  Beyond that, if it is going to make a useful contribution to a debate around housing, as a public agency, it needs to do so on the basis of much richer and more robust research than we’ve seen to date.  The Minister of Finance is responsible, on our behalf, for ensuring that they do rather better.  Again, the Labour Party could point this out.

We have a poor system for governing our, now extremely powerful, Reserve Bank.  The Labour Party could usefully make the case for change. They’ve toyed with it in the past, but seem uninterested now when the problems are more than just theoretical ones. Inflation is well away from target, and may drift further away, and all while the unemployment rate is rising. That is largely the Reserve Bank’s fault, but even in this area Robertson seems only interested in highlighting contrasts between the Reserve Bank’s latest projections and past government ones.   Labour might point out that it is the government’s job to hold the institution, and the incumbent Governor, to account, and to fix the systemic/institutional problems.  At present, it seems to be doing neither.

A possible alternative governance approach

In my previous post, I noted that I had previously outlined a possible alternative governance model for the Reserve Bank.  That model was buried many pages into a linked paper, so here are the key elements of a better alternative model.  It has significant similarities with the approach adopted by the British government when they recently reformed the Bank of England and the organisation/governance of a very similar range of functions to those undertaken by our Reserve Bank.  In this model, a Governor plays an important central role, but is not –  except perhaps by the strength of his arguments – a dominant figure.  A significant part of the Governor’s role is to facilitate the work of the various committees, in which he is (formally) no more than primus inter pares.

My main point in writing this note is to make the case for moving away from the current single decision-maker model. That model now suffers from an increasingly severe deficit of democratic legitimacy and lacks robustness.

However, in the interests of contributing to the debate, and providing an alternative model against which to look at the current system, I have outlined below the key features of an alternative model that seems to me best suited to the current responsibilities of the Bank, the size of our country, and practice in other areas of government.

Key elements of such a model would be:

  • The Reserve Bank Board would be reformed to become more like a corporate (or Crown entity) Board, with responsibility for all aspects of the Reserve Bank other than those explicitly assigned to others (NZClear, foreign reserves management, currency, and the overall resourcing and performance of the institution).
  •  Two policy committees would be established: a Monetary Policy Committee and a Prudential Policy Committee each responsible for those policy decisions in these two areas that are currently the (final) responsibility of the Governor.  Thus, the Monetary Policy Committee would be responsible for OCR decisions, for Monetary Policy Statements, for negotiating a PTA with the Minister, and for the foreign exchange intervention framework.  The Prudential Policy Committee would be responsible for all prudential matters, including so-called macro-prudential policy, affecting banks, non-bank deposit takers and insurance companies.  The PPC would also be responsible for Financial Stability Reports.
  •  Committees should be kept to a moderate size, and should comprise the Governor, a Deputy Governor, and between three and five others (non staff) all of whom would be appointed by the Minister of Finance and subject to scrutiny hearings before Parliament’s Finance and Expenditure Committee.  There should be no presumption in the amended legislation that these outside appointees would be “expert”, although it might be reasonable to expect that at least one person with strong subject expertise would be appointed to each committee.
  •  The Secretary to the Treasury, or his/her nominee, would be a non-voting member of each committee.

A common argument against this sort of model is the small size of the population in New Zealand.  I think this is a materially overstated concern:

  • As noted earlier, ministers manage to fill countless boards and committees, covering a wide range of functions – some more important than others, some more technical than others.  
  • If it is difficult to find enough good people to serve as a voting committee, it is at least equally likely to be hard to consistently find a top-notch person to serve as Governor. 
  • No other small advanced economy has either a single decision maker, or a committee of internal management experts only. 
  • While I don’t generally favour using foreign appointees on policymaking bodies, it is likely to be more feasible and acceptable to use foreign appointees in a system in which the foreign member is one vote of five or seven, than in the current system (which is all or nothing). Bank of England policy committees have had foreign members appointed by the Chancellor on several occasions. 
  • In respect of monetary policy, the Bank has managed for 10 years or more to fill two external monetary policy adviser positions.

In the same paper, I explained why I did not the thing the model proposed by Lars Svensson in 2001, apparently similar to what Graeme Wheeler probably favours, would be the right solution.

In 2001, Lars Svensson’s report to the Minister of Finance proposed legislating for a small committee of internal experts (senior managers of the Reserve Bank[1]26, working in executive roles in the monetary policy area, whether initially appointed from outside or within) to make monetary policy decisions.

Simply legislating for a committee of fulltime executives would have some modest advantages over the current situation.  Whatever decision-making benefits might arise from committees, per se, would presumably be captured.  However, without much more substantial structural change, it would represent a material further dilution of ministerial responsibility for monetary policy.  The Minister appoints (and, in principle, can dismiss) the Governor, but has no involvement in appointing those in the Bank’s management hierarchy.

The Svensson solution was designed for monetary policy.  In principle, there is no reason why there should not be a similar internal committee for prudential matters, probably with somewhat overlapping membership[2].

But it is not clear why a model of this sort it would appeal to political decision makers (Minister of Finance, and MPs).  The model was rejected by Michael Cullen in 2001, and has not since been revived by any politicians.

In such a model, the Governor would clearly be the dominant figure. He or she would be the chief executive to whom the other members work. The chief executive would presumably set their salaries, and determine resourcing for their individual departments. In practice, it is not a model which would provide much additional resilience in the face of a bad Governor, and it would remain well out of step with decision-making models elsewhere in the public sector.

As a decision making model, it would also seem to confuse the important role of technical expertise as an input to the decision-making process, and the policy decision itself.  To illustrate the point, consider the role ministers play in decision-making in our system of government.  Ministers (individually or in Cabinet) make policy decisions in a wide range of areas, in which typically only by chance are they technical experts.   They can draw on a wide range of advice, technical and otherwise, whether from the public service or from outside.

Parliament has chosen not to have ministers making decisions on many of the Reserve Bank’s areas of responsibility, but that is mostly about the incentives that politicians are perceived to face (electoral cycles).  It has never been about a need to have all decisions made by executive technical experts[3].

It is important, and valuable, to keep a clear distinction between expert advice, and a decision-making process.  Doing so helps ensure that a range of options is examined in a careful and balanced way. When the Governor and his/her own executive deputies are those making the monetary policy decisions, and are directly responsible for those generating the underlying analysis, there is a heightened risk that they will receive staff analysis tending to support their own known biases and predilections (staff respond to incentives). Similar risks arise around regulatory policy decisions.  A very good Governor might be able to manage this risk, but it is not one that we generally take in public sector organisational design.  In respect of fiscal policy, for example, there are two clearly separate roles – adviser and implementer (Secretary to the Treasury) and decision maker (Minister).  The Secretary is responsible for the quality of the advice and analysis going to the Minister, but the Minister is responsible for the policy.  There is no comparable separation of responsibilities in respect of the Reserve Bank’s activities.

In short, simply legislating a series of internal semi-expert committees would still not represent particularly good governance.  It would remain well out of step with conventional practice in the New Zealand public sector.  Expert committees can, and do, play a valuable advisory role in policy development, and can play a decision-making role in technical implementation decisions, but – outside the Reserve Bank – I am not aware of any area of New Zealand policy governance in which material policy decisions (as distinct from the application of policy to particular entities) are delegated to an expert panel.

[1] Governor, Deputy Governor, Head of Economics, Head of Financial Markets

[2] In the current management structure, perhaps a Monetary Policy Committee made up of the Governor, Deputy Chief Executive, Head of Economics and Head of Financial Markets, and a Prudential Policy Committee made up of the Governor, Deputy Chief Executive, Head of Prudential Supervision, and Head of the Macro-financial Department

[3] Otherwise, for example, there would presumably be much more stringent qualifications for a Governor laid down in the Act.  Each of the three people who have held office under the current model have had a background in economics, but I don’t think any of them would have described themselves as technical experts in monetary policy or banking regulation.

Towards a better-governed Reserve Bank

Yesterday saw comments on Reserve Bank governance from a couple of senior politicians.

The Green Party’s new finance spokesperson, Julie Anne Genter, put out a press release yesterday arguing that

The Reserve Bank made the right decision today to cut the OCR – effectively reversing the mistaken OCR increases in 2014 – but concentrating this power in just one person isn’t the right way to make good decisions,” Green Party finance spokesperson Julie Anne Genter said.

“We’d like to see the Reserve Bank’s decision-making power broadened to more than just one person – decision making by a panel of experts from across the economy would be in line with what happens in other OECD countries.

“Over-forecast inflation has kept interest rates higher than they should have been in recent years, which has cost the economy jobs

I happen to think she is right.  We don’t change the governance model to produce a different OCR decision on any particular day, but as one part of securing a better, more transparent, more resilient central bank.  There are no guarantees, but such a central bank is less likely to make mistakes like last year’s monetary policy –  recall that this is the only central bank in the world that has twice started tightening and then had to reverse itself.  Other countries don’t run things the New Zealand way, and we don’t run other areas of government this way either.  The case for change is pretty clear, and multi-dimensional.

I was interested in one aspect of her statement.  The Greens have previously favoured making the Reserve Bank’s Board the decision-making body for the Bank (which would parallel the approach in Australia), and have at times talked of ensuring that there are representatives of industry, employees etc on the Board.

But in this statement she calls for a “a panel of experts from across the economy”, which appears to suggest something rather more technocratic  (and, hence, perhaps more aligned with a majority of OECD countries, which often have decision-making committees with a majority of at least semi-expert members).  I’m not sure if they intended to convey a change of approach –  perhaps she just want to sound more internationally conventional –  but the change of tone is interesting.

Genter followed up her press release with an oral question in the House yesterday afternoon (number 9), asking the Minister of Finance if he still had confidence in the Reserve Bank following yesterday’s decision, using it as a hook to ask a series of supplementaries about governance (in one of which she repeated the point about a “panel of experts from across the economy”).  The questioning didn’t go overly well for her.  That was partly because the Minister of Finance was away, and Steven Joyce answered for him.  But it was also because she allowed some serious questions about governance to be tied too closely to a specific OCR decision, which allowed Joyce to bat her away with comments along the lines that he didn’t agree there had been a mistake, and we didn’t want politicians second-guessing individual OCR decisions.

Nonetheless, the responses that she received were still interesting.

First, there was a slightly backhanded compliment

Hon STEVEN JOYCE : The suggestion that the member makes, of having a panel of people making the decision, is, I have to say, not the silliest suggestion in monetary policy we have heard from the Greens over the years, and many countries—


Julie Anne Genter : Does he agree with Treasury’s advice to him that “The current single decision-maker approach poses risks”, and that “on balance, we think there would be benefits to moving towards a monetary policy committee in the future.”; if not, why not?

Hon STEVEN JOYCE : I am, of course, aware of that policy advice. But it is important to note that the New Zealand system has served us very well, I think, over the last 26-odd years. Yes, you could have a change at some point, but, again, I think that if you wanted to do it, and it is not a proposal that we are at all considering at this point, but if it was something that you wanted to do, you would have to do it for the right reasons and not because you disagreed.


Julie Anne Genter : Is the Minister aware that no other OECD country with a central bank gives so much legal power to a single official?

Hon STEVEN JOYCE : As I said previously, I am aware of that. Actually, as I said to the member in one of my earlier answers—this is on behalf of the Minister of Finance—actually, there is a range of ways in which that is done internationally. But the basis on which you would change that is not on the basis that a number of members of Parliament think that the Reserve Bank Governor had made the wrong or unnecessary decision in a previous year, which the member asserted in one of her previous questions.

Julie Anne Genter : Given that the only independent review of New Zealand’s monetary policy framework since the 1989 Act was put in place recommended changing the law in regard to bank governance, and that no other OECD country with a central bank gives so much power to a single individual, will his Government consider updating the law?

Hon STEVEN JOYCE : I thought I had answered that previously, but the answer is no, we have no plans to do so at this stage.

Not once did the Minister defend the basic elements of the current governance structure.  He defended operational independence for the Bank (which Genter didn’t seem to be questioning), he claimed that the system had served us well for 26 years, but there was no principled defence of allowing so much legal power to a single individual.  And he didn’t even rule out change, just noting at the end of the questions that the current government “have no plans to do so at this stage”.

I’ve been a bit puzzled as to why the current government has been resistant to change.  The independent review undertake for the previous government recommended legislative change (and the range of things the Governor is personally deciding has widened materially since then), the Treasury favoured change[1], they found that many market economists favoured change.  And most of the Opposition parties appear to have favoured change –  Labour seems to have come and gone on the issue, but is hardly likely to be a robust supporter of giving so much power to one official.  And, of course, we have good reason to believe – although he is now highly secretive about it –  that Graeme Wheeler favours change.

Among those favouring change, there will be a variety of different motivations and a variety of different alternative models in view.  I sketched out my preferred model here, but I know able people with different perspectives on the details of a new model.

I suspect that the Minister of Finance has little time for the Governor’s preferred model, of legislating to entrench a system in which Reserve Bank senior staff alone get to make the decisions.  Michael Cullen certainly didn’t like that specific option when Lars Svensson recommended it.  And this isn’t just an issue of monetary policy, and there are likely to be quite some differences  –  including with Treasury  – around the Bank’s prudential powers.  But the reluctance to open up the issue is still a bit of a puzzle.  Graeme Wheeler’s poor stewardship of the office of Governor is strengthening the case for change, but these are decisions that really should be made independent of the personalities, and of the foibles of the individuals involved.  That was why the Treasury advice in 2012 was appropriate –  ie flagging the issue with the Minister before it was apparent who would be nominated as the next Governor.

Perhaps the Minister of Finance worries that opening up the issue now would:

  • Be seen as political interference in current monetary policy
  • Be seen as a vote of no-confidence in the current Governor
  • Be seen as a win for Opposition parties, and particularly the Greens.

I hope none of those is the explanation for inaction, but I don’t really understand what is.  It seems most unlikely to be a strong in-principle preference for a model that gives unprecedented amounts of power to a single unelected official (or else presumably Steven Joyce would have run those lines)

Good legislation takes time. Graeme Wheeler will soon start the last two years of his term.  Now is the time for the Minister to open up the issue.  Perhaps he could ask Treasury to prepare a consultative document on the issues and options and put it out for several months of submissions and discussions.  That could allow legislation to be drafted next year, and to be in place so that the new Governor, taking office in late September 2017, would take office knowing that it was on the basis of the new model, while allowing Graeme Wheeler to see out his term on the arrangements that he was appointed on.  There is nothing sacrosanct about those arrangements –  Parliament makes the rules and can change them –  but the timing would now work quite well.  Moreover, since revitalising the Reserve Bank, and making it more rigorous, open, and resilient, will probably require a quite different sort of person, the change of Governor would be a good time for a new law to take effect.

There probably aren’t many votes in Reserve Bank reform, but good governance reforms, bringing our Reserve Bank more into line with international practice and the way other government agencies in New Zealand are run, would be one part of a good legacy for a long-serving Minister of Finance.

[1] I don’t know where Treasury now stands on the issue but have lodged an OIA for copies of any work they have been doing on the issue.

Some thoughts on the Monetary Policy Statement

What to write about the Monetary Policy Statement?

The Governor continues to deny that any mistakes were made last year. I’m not sure why. As I’ve said before, perhaps the first OCR increases were defensible (certainly lots of onshore economists thought so), but to keep on hiking and then take a year to start cutting, quite grudgingly, even as core inflation stayed very low, was just indefensible. The Governor and his staff are human, so they will make mistakes. They should acknowledge this one and then move on. Unfortunately the continuing reluctance to admit any mistake, perhaps even to themselves, is colouring how they are running policy now. The OCR is still higher than it was at the start of last year – the only OECD country of which that is true – even as inflation expectations have fallen further. What is it about a situation of rising unemployment, near-zero per capita GDP growth, and well-below-target inflation makes them think we’ve needed higher real interest rates?

I was disappointed, if not overly surprised, by the questioning of the Governor at the press conference this morning. Here are a couple of questions I think we should expect the Governor to provide straight answers to:

  • Governor, the Reserve Bank – like its peers abroad – has been telling us for years that core inflation is just about to pick up, and it hasn’t. If anything, it has kept drifting down, and with the unemployment rate still rising it is likely to fall further. In the very first paragraph of your Annual Report last year you once again told us that inflation was heading back to the midpoint. Again it hasn’t done so. . How have you corrected for this persistent bias, and why should we (or the public) have any more confidence in your inflation outlook now?
  • Governor, given the Bank’s persistent forecasting bias – shared, of course, by local market economists – why not adopt a strategy that aims to get core inflation to something nearer 3 per cent. Given the (unintentional) biases you’ve shown to date, that might give us a good chance of actually getting core inflation up to 2 per cent.  If inflation really looked to be rising strongly – to something well above 2 per cent – surely you have plenty of time to correct when you actually see the material increases in inflation?.

There was, as far as I could see, no particular basis in the document for a belief that core inflation is about to head back towards 2 per cent. Indeed, there is almost an attempt to sweep those awkward measures under the carpet, and to focus instead on headline inflation. Yes, headline inflation will probably pick up to some extent, and perhaps it will even creep over 1 per cent early next year. The evidence for that proposition isn’t great, and the Bank’s own past published research has cast doubt on it. Some tradables prices will no doubt rise – some already have – but exchange rates fall for a reason and are often accompanied by falling non-tradables inflation.  It is those core or domestic components of inflation that really matter, and there was nothing in the Governor’s July speech or in this document to think the downside surprises have come to an end. Indeed, the Bank acknowledges that non-tradables inflation is likely to fall further (partly for one-off reasons), and as they are projecting the unemployment rate to carry on rising it would be surprising if their favoured core inflation measure did not fall further.

I’ve gone on quite a bit over the last few months about the apparent indifference to the unemployed. No one thinks that a 5.9 per cent unemployment rate is New Zealand’s NAIRU, the rate has been rising for several quarters already, and the Reserve Bank is now forecasting that the unemployment rate will rise even more. There is, conveniently, no chart of the unemployment rate in this MPS, but the tables at the back show them forecasting an unemployment rate up to 6.1 per cent next March, and only back down to 5.9 per cent a year later in March 2017. The unemployment rate was only 6.2 per cent in March 2010, just after the 2008/09 recession ended.  Seven years on they expect no material inroads will have been made on the unemployment rate.

That March 2017 unemployment rate of 6.1 per cent is well within the sort of window that monetary policy can do something about. But the Governor is doing next to nothing more about it (these unemployment forecasts are after taking account of today’s cut and one more OCR cut). Lest I upset some economists, I should be clear that I’m not suggesting that monetary policy has very much impact on the longer-term average unemployment rate, but it has a considerable influence on fluctuations around the normal or natural level (itself determined by some mix of regulation, demographics, and so on). If core inflation was already 2 per cent and clearly rising, higher short-term unemployment might be an unavoidable price of keeping inflation in check. But core inflation is now 1.3 per cent, and probably falling. There is really no excuse for the OCR still to be so high. This is one of those times when there is no nasty trade-off: looser monetary policy would raise inflation (which we need, to get back to target) and lower the unemployment rate. Targeting house price inflation in Auckland isn’t part of the Reserve Bank’s mandate.

I don’t really understand why this high unemployment rate doesn’t seem to bother more people. I don’t hear market economists talking about it, or business journalists. I don’t hear business lobby groups doing so. The libertarian economist Bryan Caplan wrote a nice piece a couple of years ago about the grave evil of unemployment, and the way that people on the right tended not to take the problem seriously. But curiously, I also don’t hear the political Opposition talking much, or with much intensity, about unemployment.

And, as I’ve noted before, I really wonder what the Governor says to the unemployed people when he runs into them? How does he justify the Bank having run monetary policy in ways that delivered years of above-trend unemployment, scarring permanently the prospects for some of the people concerned. Mistakes happen, but the minimally decent thing to do is to acknowledge them and apologise. And how does he justify not adopting a more aggressive policy now, a stance that might get more of the unemployed back to work sooner?  The Chief Economist gave us a little lecture about the neutral interest rate having fallen 3 basis points a quarter for the last decade, but whatever neutral is –  and no one knows –  there is no sign that keeping medium-term trend inflation near 2 per cent requires an OCR as high as it is now.

I was encouraged by one aspect of the Governor’s press conference. He seems to be becoming slowly more uneasy about the situation in China. In answer to one question he uttered the dreaded d word – deflation, observing that if there was a substantial depreciation of the yuan that would export deflation around the world. He actually sounded worried. Given that almost every emerging market currency has depreciated markedly against the USD in the last 12 months or so, and that the Chinese are rapidly running through their foreign reserves, he probably should be worried. But if he is worried, he should be doing some preparation, focusing on keeping inflation expectations up, and on removing the obstacle that the near-zero lower bound poses for monetary policy. We still have some way to go to get to zero, but that space is steadily diminishing, and if the Bank’s Statement of Intent is any guide, he is doing nothing pre-emptive about managing the risk.

I wonder how the Bank’s Board and the Minister of Finance feel about this Monetary Policy Statement. Is the Minister yet asking for advice from the Board and/or Treasury on just what is going on?

The Governor on goverance

I will have some thoughts on the Monetary Policy Statement itself later, but I wanted to comment briefly on the answer Graeme Wheeler gave to a question at the press conference.

Jenny Ruth from NBR asked him whether he thought the governance model for the Reserve Bank should be changed.  He simply never answered the question.

Instead, he gave a fairly long description of the current system, although only as it applies to quarterly Monetary Policy Statement decisions.  He suggested that people were misunderstanding the current system, but as he described it, it is all very well known.   The process starts with several days of meetings with lots of staff in attendance.  Then a Monetary Policy Committee, apparently now with 12 members including the two external participants, offers advice on the appropriate OCR decision.  The Governor now makes his final decision on the OCR in a meeting of the Governing Committee (himself, his two deputy governors and the assistant governor).  He added that for the last decade there has not been an occasion when the Governor made an OCR decision that went against the advice of the majority of his advisers.    That is no doubt true (I was on the relevant committee for most of the time), although there were several episodes in earlier years when the Governor went against the majority of his advisers (and on at least one of those occasions was right to do so).

But Graeme Wheeler deliberately avoids addressing the issues that those calling for change have made:

  • There is no other advanced country central bank or financial regulatory agency that gives so much legal power to a single official.
  • There is no other autonomous public agency in New Zealand which gives so much legal power to a single individual.
  • The only independent review of New Zealand’s monetary policy framework since the 1989 Act was put in place recommended changing the law (as it happens, to something like the Governor’s de facto model).
  • The issues are really about risk –  not about, say, the current stance of monetary (or prudential policy).  We need regimes that cope with mediocre governors, not just good ones.
  • All the advisers owe their appointments, and in most cases their pay and promotion prospects to the Governor.  That alters their incentives to disagree with the Governor, at least in respect of Governors –  like the current one –  who do not welcome debate or dissenting opinions).

The issue has never been one around whether, in normal circumstances, a Governor would take decisions his staff disagreed with, but about institutionalising a regime that encouraged challenge, debate, and openness to a range of perspectives, not just those of the Reserve Bank’s staff.

In his reply to Jenny Ruth, the Governor mentioned the speech on governance he gave in 2013.  I mentioned that a couple of weeks ago.

In 2013 he gave a speech in which he informed the public that he had decided to make decisions in the forum of a Governing Committee –  himself and his three deputy/assistant governors.  He retained the legal powers and responsibilities, but he envisaged working formally in that committee model.   In his speech, he spoke quite favourably of central banks where decisions are the responsibility of executive committees.  And there was no first principles defence of a single decision-maker model.

So it is pretty clear that the Governor favoured legislative change, and along the lines of an internal executive body (which also happen to be much the same lines as Lars Svensson recommended in that review 15 years ago).  He has also made some rather rash comments to staff about his views on the rather different governance ideas of some particular political parties.

Why is he not willing to come out and say that he favours legislative change, even if only to cement the de facto position? It could be argued that such law changes are matters for politicians not central bankers themselves, but the Governor hasn’t been shy of, eg, offering his support for tax changes and other matters rather further from his patch.

As it happens, it isn’t clear that anyone is now strongly defending the current law, which still vests all the legal powers in a hands of a single individual.   But for the Governor to openly favour change would open up debate to a wider range of governance options, and more searching scrutiny of the Governor’s powers outside monetary policy.  And he isn’t keen on debate.

We know that the Reserve Bank has been doing work on the matter. Only recently they refused to release any of it to me, including on the implausible, surely spurious, ground of potential damage to the “substantial economic interests of New Zealand”.  This is, sadly, par for the course when it comes to our highly non-transparent central bank.  It doesn’t publish its economic model, it doesn’t publish submissions on its regulatory changes, it won’t publish work it has been doing on governance reform,  it doesn’t publish minutes of the Governing Committee meetings on policy issues, and it won’t publish the background papers to its Monetary Policy Statements. 

It is past time for change.