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.

5 thoughts on “A possible alternative governance approach

  1. Is it a matter of giving the existing members of the RBNZ Board real jobs? I see there are seven external directors and, going by one of your earlier posts on their Annual Report, they don’t seem to do much.

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    • Here was what I said on that option in my paper. A lot turns of whether one thinks the two prime functions should be governed by the same people, to essentially the same objective, or not. Reasonable people can differ on that.

      Perhaps the most straightforward route would be to convert the existing Board of the Reserve Bank from an ex post review role to a decision-making role. The Board would then become a more conventional corporate (or, more particularly, Crown entity) board, responsible for all facets of the organisation, and delegating to the Governor as chief executive (and probably managing director) various management responsibilities. This is, essentially, the model in place at the Reserve Bank of Australia for many years29
      29 The Payment Systems Board now slightly complicates the RBA picture.
      15
      Such a structure would, arguably, be a much superior use of the skills and talents of the members of Board. Past and present Boards have typically been comprised of people with a range of expertise, most of whom have had extensive corporate or Crown entity directorship experience. They are used to making decisions, and yet under the current Reserve Bank structure they have very few to make. The Board has typically had at least one member with a reasonably strong economics background (often an academic), to help scrutinise and review the technical input from management and staff.
      If the Reserve Bank was responsible for only one main area of policy, I think this could be an appealing option. Nothing in monetary policy, or financial regulation, is more technically complex or difficult than issues that ministers and other Crown entity boards regularly deal with. However, it does not get around the issue of confused lines of accountability. Monetary policy and financial regulation are two quite different types of policy issues, required to respond to different statutory imperatives. It would be very difficult to hold the Board to account for decisions in such a wide range of areas – each member can only be dismissed once.
      It would be a better model than we have now, but not as good as we could do

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  2. Hi Michael
    I haven’t followed your website for some time – a couple of day jobs has sucked up all the time – but I am curious on your thoughts about Bagehot’s discussion on Governance in Chapter 8 of Lombard Street, still (in my view) the best book on central banking available even though it is 142 years old. As you know, at the time the Bank of England had a large Board of Directors from which the Governor and Deputy Governor were selected; and the Governor was replaced frequently (every two years) by the Deputy Governor. The Board of directors had people of a wide range of age and experience, including a number of ex-Governors who formed an inner committee that was expected to advise and argue with the current Governor. By this method the Governors were always experienced in the ways of the Bank. Bagehot comments on the weakness of the approach, but also strongly cautions against the problems that could arise from having long term appointments, for the power and the prestige of the job would create difficulties. He pulls no punches about the difficulties of appointing a Governor…..

    ” I do not believe that we should always get the best man for the post; often I fear that we should not even get a tolerable man. There are many cases in which the offer of too high a pay would prevent our obtaining the man we wish for, and this is one of them. A very high pay of prestige is almost always very dangerous. It causes the post to be desired by vain men, by lazy men, by men of rank; and when that post is one of real and technical business, and when, therefore, it requires much previous training, much continuous labour, and much patient and quick judgment, all such men are dangerous. But they are sure to covet all posts of splendid dignity, and can only be kept out of them with the greatest difficulty. Probably, in every Cabinet there are still some members (in the days of the old close boroughs there were many) whose posts have come to them not from personal ability or inherent merit, but from their rank, their wealth, or even their imposing exterior. The highest political offices are, indeed, kept clear of such people, for in them serious and important duties must constantly be performed in the face of the world. A Prime Minister, or a Chancellor of the Exchequer, or a Secretary of State must explain his policy and defend his actions in Parliament, and the discriminating tact of a critical assembly—abounding in experience, and guided by tradition—will soon discover what he is. But the Governor of the Bank would only perform quiet functions, which look like routine, though they are not, in which there is no immediate risk of success or failure; which years hence may indeed issue in a crop of bad debts, but which any grave persons may make at the time to look fair and plausible. A large Bank is exactly the place where a vain and shallow person in authority, if he be a man of gravity and method, as such men often are, may do infinite evil in no long time, and before he is detected. If he is lucky enough to begin at a time of expansion in trade, he is nearly sure not to be found out till the time of contraction has arrived, and then very large figures will be required to reckon the evil he has done.”

    I am not advocating the adoption of a 150 year old system: times have changed. But the problems that the Bank of England grappled with are very similar to the problems current central banks grapple with. A feature of their system was the insistence that the central Bank Governor have lengthy experience in the industry, and had been a member of the Board of Directors for some time. This to my mind is one of the more notable features of the New Zealand system – there seems to be an aversion to appointing people who have work experience in the industry. None of the Governors worked at the Reserve Bank of New Zealand until they were appointed to the job; nor did they have a lot of experience working in banks or experience with monetary policy issues. (Don Brash had some experience in finance; Dr Wheeler worked at the World Bank, although that scarcely counts as a real life banking institution.) In essence, NZ has seen fit to appoint talented people with no experience, provide them with sole decision making powers, and see what happens.

    The contrast with the last three Governors of the Reserve Bank of Australia is notable,

    Glenn Stevens, the current Governor of the Reserve Bank of Australia was appointed in 2006. He had been Assistant Governor from 1996 – 2001, Deputy Governor from 2001-2006, and had worked in the Bank since the 1980s.

    The previous Governor, Ian McFarlane (1996- 2006) had been assistant or deputy governor for 6 years, and had worked at the Bank for the previous 12 years.

    Bernie Fraser (1989-2006) is the exception; he had little financial market experience, and was the Secretary to the Treasury for 6 years before his appointment.

    Giving sole authority to people with little relevant experience is risky, no matter how talented they are (and I have no reason to question the innate talent of our three previous appointees). Personally, I like to go to doctors who not only were trained for the job but provide evidence that the like the job by actually doing it.

    To Finsh with Bagehot
    “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.”

    Andrew

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  3. Thanks Andrew

    That final quote is brilliant – I’m tempted to give it its own post.

    I think I have mixed feelings. I’ve often done that RBA vs RBNZ contrast myself, and it should be sobering that it is now 33 years since an internal candidate was last appointed as Governor. That suggests something is wrong with the institution internally – strong institutions typically promote from within, whether in the public or private sector. On each occasion an appointment has been made there has been a reason for going outside – Muldoon definitively was never going to appoint Rod Deane, Roger Douglas wanted reform, Helen Clark was antagonistic to anyone associated with Don Brash (not helped by the manner of Don’s departure), and…..well I’m not sure there was a good reason in 2012 – but over time it is quite a pattern. It is also quite a contrast to the historical pattern (I guess less so in the last 20 years) at the NZ Treasury.

    Then again, I look at the Federal Reserve which has no worse a track record – perhaps a little better – than the RB and in recent decades I’d really only call Volcker an experienced central banker. But then their system is not a single decision-maker model, even if at times it looks to have come close by default. Perhaps in a large institution, and diffuse system, the person who is Chairman matters a little less?

    As I put it in the original paper I wrote, the old wine skin probably aligned ok with some visions in 1989 of how little the Reserve Bank should, or was expected to, do. With the range of powers the RB has – which might be too large, but that is another debate – we can’t rely on the constant promotion/appointment of people who will prove to have the qualities and temperament needed to be a good single decision-maker. I think we need a different governance model, and mine was one which allows a mix of technical expertise, judicious senior lay people, and perhaps a Governor who might focus more on strengthening the organisation and ensuring it provides strong and balanced input to the decision-makers, rather than having the whole weight on his own shoulders.

    Bagehot’s line about ministers having to defend themselves in Parliament is a reminder of a point Bernard Hickey made recently: not only does the Governor not have to face question time each day, but he has not in three years given a single interview to one of the major news or current affairs programmes.

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  4. You do not need a brilliant RB Governor. What you need is a Chairman of a Board of Directors approach. A person that leaves it to the government to do what is necessary and will only intervene in a crises. The RB governor is seen too much like a superstar with everyone hanging out waiting on every word. This is absolute nonsense. Intervention right or wrong creates uncertainty and unintended consequences.

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