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.
croaking cassandra 
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.
Humph.
Well if you keep on doing what you have always done WHY would we expect a different result?
The idea is broken and has been for quite some years. Indeed when Brash began with it inflation was already on the wain even if from a very high level and slow to reach here..
Inflation, deflation et al are a consequence of policy aimed at the wrong target.
What Kiwi’s want/need is a wealthy nimble economy that allows us to live well, educate ourselves, maintain our health and have some cash to spare for the bad times. We need constant change and growth to achieve that and remove the largess that a social economy infests upon us.
We have had absolutely lousy GDP growth forever, we are in constant debt both local and Central Govt. and in our institutions. We have wasted 30 – 40 years standing still while being taken advantage of by overseas companies.
We need to change our thinking rapidly and invest money in our futures rather than chasing interest rates and exchange rates almost daily because money is so volatile.
Instead of losing 30 -40 thousand people a year to other countries with better wages and prospects we need to up our game with technology, education and get everyone busy, keep them here after spending a fortune educating them and put them to work.
From where I sit I see many many Kiwi’s working harder and for longer than ever we did and while we have lots of “assets” we are also in hock with those assets. We export more than we ever have and are constantly exhorted to do better at export but guess what, yep, just when you start to win that game the stupidity of inflation fitting ramps up the interest rate and hence the exchange rate and we all lose. Happens repeatedly.
We import more money to grow those exports and buy all the nice stuff in life than we earn to pay for them all.
the model is broken and we need fresh thinking, not more of the same.
Something like Trump is doing to the GOP.
To much vested interest in control and not enough disruption thinking.
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I agree with most of the gist of what you are saying. Where we part is on the idea that changing monetary policy would materially change those longer term real outcomes. It won’t (which might be excessively stark, but it just isn’t where the heart of the answer lies)
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Would I be right to summarise your views on changing the way that the PTA is enacted as being – a decision by a committee would hopefully be closer to the appropriate choice than the decision of single person, which as we have seen have been consistently biased one way or another by the last two(?) Governors.
I had liked the idea of having a single person responsible. But I can see the hope/belief that a committee may be less likely to all have the same bias, and thus arrive at a better result.
I recall that there is a “shadow” committee. I wonder how they have performed as a proxy for what a real committee may have done? Do you recall if they have varied in their choices from what the RBNZ has decided? I suspect they haven’t? Or perhaps not by much. I’m thinking it might be worth having a committee, but I’m not holding my breath that the results would necessarily be any/much different.
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In principle, I believe the story (and experimental evidence in various studies) that a committee will have fewer biases and be less prone to freak/weird decisions etc, but in practice I’m rather less sure. The Governor’s favoured sort of committee – just him and his senior deputies – would make almost no difference; after all, it has been rare for the Governor to take an OCR decision that has gone against the majority view of his internal advisers.
I’ve blogged about the Shadow MPC previously – on almost all occasions they have been essentially replicating the decision the RB made.
So I mostly favour reforming the governance model to better align with how we run other govt agencies/bodies – ie very rarely are key decisions made by single individuals. The current model was designed for a high accountability (severe consequences) model, which proved untenable, but leaves all the power with one person. A committee on which staff were a minority (and real outsiders a majority), subject to confirmation hearings, and in which proper minutes had to be published, and background papers were released with a few weeks lag, would allow better scrutiny of the RB choices, including the contest of ideas among those who are decisionmakers (including thru speeches and media interviews). There is a great deal of uncertainty around the best monetary policy, and we want structures that reflect that.
As you suggest, the bottom line OCR outcomes might not be much different – after all, in the pre 2007 boom most market economists were more dovish than we at the Bank were, not more hawkish – but we would have stronger and more open processes, befitting choices that have such a material and pervasive influence on the economy over a 1-2 year horizon.
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The Reserve Bank surprised markets and economists today by cutting the Official Cash Rate by 25 basis points to 2.25% and forecasting another cut by the middle of the year.
The New Zealand dollar immediately sank by 1 cent in value against the American currency. A short time ago it was at US66.80c, from US67.78 just before the announcement.
http://www.interest.co.nz/news/80516/rbnz-surprises-25-bps-cut-225-forecasts-one-more-cut-concerned-about-falling-inflation
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Michael
I like your “proposal” that the RBNZ board garner greater power over Governor decisions.
Im interested in your views on a couple of details
1. Bernanke’s book shows that the Fed operates with the directors having an unusual (by corporate standards) degree of independence. For instance they give speeches and have their individual views on board decisions recorded. Do you see a RB board with greater power operating in this way, or would you see directors acting in a more standard NZ corporate board way where dissent tends to be only internal or private (similar to Cabinet where ministers can disagree internally but not externally)?
2. If you look at almost all NZ regulatory agencies (Commerce Commission being the main exception) they have a board which is often made up of experienced people who represent a diverse range of stakeholders. FMA is an excellent example, with investors, brokers, accountants, lawyers, etc all represented around the board table. I think this is a good model, but its miles away from the Fed which seems to only have highly trained academics and industry insiders. Would you see the RN board made up of stakeholder representatives or experts?
Tim
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Tim
On your first question, I like the way the Fed has evolved (greater freedom than when Greenspan was there). The Bank of England model has become somewhat similar. I think these monetary policy decisions are less like a corporate board decision (yea or nay on a major project say, where it is the shareholders’ money at stake, not the public’s), and something a bit more like a crowdsourcing exercise. That sounds rather new-agey, which isn’t really my intent, but simply a way of saying that there is so much uncertainty, and genuine differences of perspective, that the more debate, and the more open the debate – as a way of drawing in outside perpsectives as well as inside ones – the better. That said, I’m not wedded to an extremely open ex ante model, so long as there is a huge amount of effective transparency ex post (good minutes, access to background documents etc) – the way the system would work probably depends more on the qualities of the people appointed than on the details of whether they operate with their own debates occurring primarily internally.
On your second point, I think there is probably a big difference between say a Monetary Policy Committee, and a Financial Policy or Regulatory Implementation Committee. In general, I don’t really favour either a preponderance of “experts” or “stakeholders” – Cabinet, after all, is neither. On a Monetary Policy Committee of say 5 or 7 people, I’d have the Governor and a Deputy Governor on (on might be an expert, one might be more generalist, a good academic economist might usefully take one seat, and for the rest I’d look for good judgement and the right instincts more than expertise. You need real expertise at the staff level, less so at a governance level.
For a Financial Policy Committee, my instincts are probably similar – look for expertise mostly at the staff level, but you need more practically-oriented people on the committee than pointy-heads. Conflicts of interest and regulatory capture are a real issue though (i’m not sure how the FMA practically deals with them – but recall that FMA implements policy, not sets it). I think a having a retired senior banker on the ctte would make some sense, but the ultimate stakeholders are public (we regulate banks in the public interest, not to promote banking) so again it drives me back towards informed practical people of good judgement.
One of the challenges in reforming the RB is that if it keeps both the mon pol and regulatory functions is that the type of person who might be a good CE might be quite different for those two functions. It is perhaps easier to square the circle if the Governor is just one member of each committee- responsible for the staff who support the decisionmakers – rather than being the key decisionmaker himself.
Michael
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Michael
Thanks for the full response. It’s a very interesting and tricky point.
Ive just read Dear Mr Chairman a book about shareholder activism in the US over the last 100 years. It notes that alignment of shareholders, directors and managers is critical to long term success. What is true for commercial companies is almost certainly true for regulatory agencies and all too often my experience with government regulatory agencies indicates poor alignment.
If RBNZ does get around to facilitating a public discussion of its own governance (and why wouldn’t they?) I hope they get in someone like Timothy Geithner to provide some insights. The American system seems to be much more muscular than ours, and the shift you are advocating to greater transparency and personal discretion/responsibility would push our way of doing things in their direction.
NB. I note that the RBNZ today is generally regarded as doing a satisfactory job and change in regulatory systems tend to be very expensive (as everyone learns new signals etc). Hence if any real momentum for change arises it will be highly desirable to debate and review the proposals carefully and with more than “the usual suspects” participating.
Tim
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Tim
At the moment, unfortunately, the Reserve Bank is flatly refusing to release the considerable amount of work they did a year or two back on possible ways of reforming the governance system.
I guess my only caution on what you are saying is that I think there is a big difference between, say, a board governing the RB itself (NZ Clear, budgets, etc) and a Monetary Policy Committee. In the latter context in particular, the public need to be thought of as the primary ‘shareholders’.
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