Some interesting comments from Bill English on inflation and the Policy Targets Agreement appeared in the media over the weekend.
The lead comment was
Finance Minister Bill English says he’s willing to wait for next year’s review of the Reserve Bank’s policy targets agreement (PTA) to consider whether it is still appropriate in a global economy where inflationary pressures have dissipated.
That seems appropriate. We have a statutory structure which provides normally for five-year PTAs. That provides reliable guidance to the Reserve Bank and some predictability for the rest of us. We don’t have to worry that whenever people get a little uncomfortable about the inflation numbers, the target will be revised up, or down, on the fly. The Reserve Bank should just get on and meet the target, whatever it is at the time.
And, as it happens, it is only 18 months now until the Governor’s term expires. (Of course, one of the downsides of the current structure is that the Governor will soon be making monetary policy decisions, the full effects of which on inflation will not be apparent until after his term has expired.)
The Minister also noted
English said he was reluctant to prejudge the outcome of the review, which would include advice from the Treasury, but noted he hadn’t seen any compelling argument that the agreement itself could change or any particularly coherent alternative.
I don’t myself favour material change to the PTA, although I think that coherent arguments can be made for a variety of possible alternative approaches. I doubt that a different way of specifying the target would have made much difference either during the boom years when the Reserve Bank had monetary policy too loose, or over the last few years when policy has been too tight. The mistakes and misjudgements over the years have been either forecasting ones, or ones reflecting the private preferences of the successive Reserve Bank Governors – probably mostly some combination of the two.
The Minister goes on to note that
“I think they’re in some challenging territory. We’ve got an agreement in place and we’re happy that they’re acting consistent with the agreement. We are not trying to second guess the decisions the governor should make.
Again, if we are going to have an operationally independent central bank in respect of monetary policy, ministers generally shouldn’t be trying to “second guess” or put pressure on the Governor. Except, that is, to fulfil the PTA – or “do his job”.
The New Zealand system is relatively unusual in providing such a prominent structured role for the Minister of Finance not just in setting a target for the Reserve Bank, and having responsibility for ensuring that the Bank meets the target. The Bank isn’t meeting the target, and has not done so for some years.
The Minister claims that the Bank is “acting consistent with” the PTA. It is shame that the journalists behind the story didn’t ask the Minister more specifically what he meant. I suspect the Governor really would like to see inflation a bit higher than it is, and core inflation (reflected in a range of measures) might still be just inside the target zone. Of course, the forecasts always show inflation heading back towards 2 per cent, sometimes rather slowly. It is just that actual inflation – even stripping out oil prices, tobacco taxes, ACC levies and so on – just hasn’t done so. A proper assessment of the Governor’s performance would surely require not just a judgement about the Bank’s intentions, but about their competence and their actions. If we delegate a major function of public policy to an unelected technocrat and his staff advisers, we should expect a very high level of technical capability to be on display. Year after year of missing the target doesn’t suggest they have been meeting that standard. They neither seem to adequately understand what is going on, nor to have been willing or able to adjust for their (widely shared) difficulties in how they run monetary policy. When you market yourselves as the technical experts, backed by a high level of public resources, the performance standard has to be higher than if, say, a mere elected politician had been making the interest rate decisions.
In fact, I think what the whole experience is highlighting again is the unrealism around the Reserve Bank governance model. The idea was to make a single individual responsible for a clear and specific target, and to dismiss that individual if he or she missed the target. It was never a realistic approach, at least if one wanted a reasonably sensible monetary policy. That had already become apparent under Don Brash’s term, but the point has been reinforced in the last decade.
Under Alan Bollard the Reserve Bank consistently ran with monetary policy that was too loose to be consistent with the PTA – through a combination of technocratic forecasting errors, and gubernatorial preferences (a great deal of angst about the tradables sector). There was no serious pressure on the Governor to operate in a way more consistent with the target, and if anything the political pressure – at the height of one of the bigger booms in our modern history – was for easier policy not tighter. And yet the Minister of Finance was the one responsible for the Governor’s performance relative to the PTA.
And in recent years the Reserve Bank has undershot its target – a failure made more obvious by the explicit addition of the midpoint reference to the PTA in 2012. It has been some combination of technocratic forecasting errors and gubernatorial preferences (a great deal of angst about the Auckland housing market – or on a bad day, about specific suburbs in Hamilton or Tauranga). There has been no serious pressure on the Governor to operate in a way more consistent with the target – not even, we are led to believe, from the Bank’s Board – even though the unemployment rate has lingered uncomfortably high and the growth performance of the economy, in per capita terms, has been poor at best. The Minister of Finance is the one responsible for ensuring the Governor’s performance relative to the PTA, and yet (at least while the polls run strongly) the Minister has no obvious incentive to suggest there is anything wrong or disappointing about New Zealand’s economic performance.
My point here is not mainly to criticize the Minister. I don’t think he – or his Board – is really operating as the Act envisaged, but mostly that is a reflection of the unrealism of the statutory provisions. Our Act gives a huge amount of power to a single unelected individual on the assumption that a high level of effective accountability is possible. History suggests it is not possible. There is too much imprecision, and any concerns too quickly become personalized. We would be better off with an alternative governance model – a more internationally conventional one – in which less emphasis was placed on the ability to dismiss an individual, or more emphasis was placed on spreading and sharing the power that is delegated to an unelected body. It would be less ambitious than what we have now, but more realistic – offering more ongoing effective scrutiny, with less high stakes emphasis on a single person (strengths, preferences, failures and so on). In my model, we’d have a Monetary Policy Committee, appointed by the Minister of Finance, with members subject to hearings before the Finance and Expenditure Committee before taking up their position, serviced by technical experts from the staff of the Reserve Bank, with stronger effective statutory transparency provisions, and with the Secretary to the Treasury as an ex officio (perhaps non-voting) member, would be a much better way forward. It would complement a Financial Policy Committee responsible for the regulatory and financial stability functions.
A model of this sort would not give us perfect monetary policy – perfection is a useless standard in almost any area of public life – but it would better reflect what we now understand about monetary policy, and effective accountability, than the current 1989 provisions do.
Finally, I noticed that the Minister talked about how the review of the PTA next year would ‘include advice from Treasury”. That is all very well and good. But the Policy Targets Agreement is the major instrument articulating how short-term macroeconomic management should be conducted in New Zealand over the following five years. These reviews have typically been conducted with a totally unnecessary and inappropriate degree of secrecy, both before and after the event (recall the Reserve Bank’s refusal to release material relating to the 2012 PTA). As I noted earlier, I don’t favour material changes in the PTA, but the Minister might be more likely to be exposed to arguments or evidence for a different approach if he opened up the process to wider input beyond just the Reserve Bank and the Treasury. Governments and government agencies engage in public consultative processes on all manner of regulatory and related issues, most of which are no more important that the monetary policy regime. If the Canadians can run a fairly open process, producing and scrutinizing relevant research, it isn’t obvious why we can’t. As the current Policy Targets Agreement expires just more than three years since the last election – and the political consensus around monetary policy is no longer strong – the sooner such a process was got underway the more likely it is that it would produce something offering persuasive insights, rather than the merely partisan.