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.

Net economic benefits from refugees?

I noticed an odd story in the Dominion-Post this morning.  In the hard copy it is headed “Economic benefits to compassion”, while on Stuff it goes under the title “Refugees are good for NZ’s economy, say economists”.  The first heading seems like a category error, while the second is almost certainly wrong.

Let’s take the category error.  Surely we exercise compassion for its own sake, not looking out for what is in it for us?     We might, reasonably, count the costs and consider the risks.  In some sense, no doubt, the Good Samaritan did.   But if an act –  personally or nationally –  is about compassion, it is somewhat sullied by attempting to tot up what is in it for us.  Perhaps some see a refugee programme as an “economic lever” too, but I doubt there are many.

An economist then suggests that we should think of the money spent on resettling refugees as an investment.  But he lost me when he started talking about the economic benefits of other areas of government spending such as sport.  Does anyone really think that governments (central and local) spending money on the Rugby World Cup had a net economic benefit?  Or the America’s Cup?   The absence of economic benefits isn’t necessarily a reason not to spend the money:  there is nothing wrong with a party from time to time, so long as we recognise that it is a party, not an investment opportunity.

Perhaps even more egregious, a refugee advocate compares the cost of new refugees with the new flag proposal, noting that people have talked of billions of dollars of possible benefits from a new flag and that we should, similarly, be thinking about the opportunities the refugees create.  In fact, only the Prime Minister has mentioned such benefits, and no one else seems to agree with him.  But again, to change the flag, or not, shouldn’t be primarily a matter of economic costs and benefits.

But if we do want to do the economic calculations, how likely is it that new Syrian refugees will prove to be of net economic benefit to New Zealand (ie improving economic outcomes for New Zealanders)?  Professor Paul Spoonley is confident, but it is not clear what he bases his confidence on.    He notes that the average migrant to New Zealand is estimated to have made a positive fiscal contribution, but:

  • That is an average across all migrants, and everyone recognises that there are far higher upfront costs for refugees than for most migrants
  • The one careful study on fiscal contributions was a snapshot done a decade ago, and not looking at the lifetime fiscal costs and benefits.
  • That study was also done when the government was running very large surpluses (ie taxes on everyone were higher than they needed to be)
  • Fiscal costs/benefits are not the same as economic costs/benefits.

Spoonley recognises that refugees start at a disadvantage, but still believes they are “likely to make a net positive contribution”, albeit over a longer timeframe.

But reading the article reminded me of a table I had seen in the immigration papers MBIE released to me.  For those granted residence approvals between April 2001 and March 2009 it showed the proportion (of those 18 and over) who were on welfare benefits, and the proportion earnings wages and salaries as at 31 March 2011.  These new residents had, on average, been in New Zealand  for six years by this time.

For those who came under the skilled/business streams (about half the total), only 1.5 per cent were on welfare benefits and 71.8 per cent were earnings wages and salaries.  Even that latter number seemed surprisingly low, but let’s treat it as some sort of benchmark for now.

The table does not show the figures separately for refugees.  But it does report the numbers for those under the combined “International/humanitarian” stream, which includes 750 refugees per annum, and around 1500 people under the Samoan quota and Pacific Access category.  These latter are people who do not meet our skilled migration requirements, but who all come from countries where English is widely used (Samoa, Kiribati, Tonga).  It is a lot easier for them to adjust than for refugees from most countries.

And yet for the combined “international/humanitarian” stream, after six years in New Zealand  only 50.9 per cent (of those 18 and over) were earnings wages and salaries and 25 per cent were receiving welfare benefits.   I think it is reasonable to presume that figures will have been worse (perhaps materially worse) for the refugee quota alone.   Why would the Syrian refugees be different?.

Between coming from a non-English speaking environment, from a country whose economic institutions have been moribund for decades, and which had managed no convergence with the advanced world over the 50 years before the conflict, the chances are simply not good that these refugees, as a group, will end up making a net economic contribution to New Zealand.  And it is most unlikely that they will even make a positive fiscal cost.

None of which is an argument for not taking refugees.  Doing so is mainly a humanitarian choice, not something we do because we benefit from doing so.  I don’t have a strong view on how many refugees New Zealand should take [1], but I don’t think possible economic benefits to us should be a factor one way or the other.

UPDATE: A commenter correctly notes that we might reasonably consider the most effective way in which to provide assistance, and “most effective” would include a whole variety of possible costs.  In principle, benefits to us may reduce the net costs of some forms of assistance.  But my wider point holds, that the decision to assist shouldn’t be driven materially by any expected benefits to us.

[1]  Subsequent to writing this post, I have written a post on refugees and migrants on my Christian blog.