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.