Ambivalence about expectations of the Board

(For those interested in the ongoing lock-up issues, my thanks to an offshore reader for drawing my attention to newly-released Audit Report by the Federal Reserve’s Office of Inspector General on the Fed’s lock-up procedures and processes.  The Fed procedures appear to have left open significant risks of leaks and breaches of embargoes –  and there was one actual breach last year.  In effect, again the system relied largely on trust.  The report contains a variety of recommendations to tighten security. A Reuters article on the OIG is here.)

Since reading yesterday morning (eg here ) about the OIA release by the Minister of Finance of a near-final draft of a new (November 2015) “letter of expectation” to Rod Carr, chair of the Reserve Bank’s Board, I’ve been trying to work out what to make of it. (The letter itself is near the back of the document released here.)   On the whole, I think it is probably a step forward, at least in the specific current circumstances.  But it has some dangers too, and risks undermining some of the good features of the statutory governance model for the Reserve Bank.

I’ve written previously about the Minister of Finance’s letter of expectation to the Governor , and in due course will be interested in this year’s letter.  Last year’s was surprisingly light on (ie there was no reference at all to) any concerns about the persistent deviation of inflation from the target.  The Minister and the Governor have a clear and direct legal relationship across a variety of strands: the Minister appoints (and can dismiss) the Governor, the Minister and the Governor sign a PTA that governs  the Bank’s conduct of monetary policy, and the Minister has a wide range of powers in a variety of matters (mostly regulatory, but including also fx intervention) dealt with in the various pieces of legislation the Reserve Bank is responsible for.

The relationship between the Minister and Board members is designed to be much weaker than that.   Board members are appointed by the Minister, and can be dismissed by the Minister (for cause),  but (unusually) the Minister does not even get to decide which of the Board members will be the Chair.  That is decided by Board members themselves.    The Board has quite a limited ongoing legal relationship with the Minister of Finance.  They are responsible for making a recommendation to the Minister as to who to appoint as Governor, and they are required to provide advice to the Minister on the Bank’s annual dividend.   But that is about it.  The Board must prepare a (published) Annual Report, which must be physically delivered to the Minister, but is not specifically described in the Act as a report to the Minister.

It is when things go seriously wrong that the Board is supposed to start talking to the Minister.   Section 53(3) of the Act provides that

If the Board is satisfied—

(a) that the Bank is not adequately carrying out its functions; or
(b) that the Governor has not adequately discharged the responsibilities of that office; or
(c) that the performance of the Governor in ensuring that the Bank achieves the policy targets fixed under section 9 or section 12(7)(b) has been inadequate; or
(d) that a policy statement made pursuant to section 15 is inconsistent in a material respect with the Bank’s primary function or any policy target fixed under section 9 or section 12(7)(b); or
(e) that the resources of the Bank have not been properly or effectively managed; or
(f) that the Governor, except as provided in his or her conditions of employment has, while holding office as Governor,—
  • (i) held any other office of profit; or
  • (ii) engaged in any other occupation for reward; or
  • (iv) had an interest in a bank carrying on business outside New Zealand; or
(g) that the Governor is unable to carry out the responsibilities of office, or has been guilty of serious neglect of duty, or has been guilty of misconduct,—

the Board shall advise the Minister in writing and may recommend to the Minister that the Governor be removed from office.

That is (rightly) quite a high threshold to cross before the Board must make such reports to the Minister.  The Act never envisaged a close or regular reporting relationship between the Board and the Minister.

I have sometimes written of the Board as being essentially the Minister’s monitoring agent (and I see the new letter uses the same language).  But if it was a pardonable shorthand, on further reflection I don’t think it is a fully accurate description either.  What the Act seems to envisage is a model in which the Board is charged with reporting publicly on how well, or otherwise, the Governor has been doing his job, but is supposed to stay at quite an arms-length from the Minister: paid to keep an eye on the Governor certainly, but expected to stay quite clear of the Minister unless things are so bad that the possibility of dismissal is coming into focus.

And I think that is the way it should be, at least if we want to maintain an operationally autonomous central bank.   Why?  Because the whole logic of making the central bank operationally independent, especially on monetary policy, is based on the (not totally uncontentious) view that we will typically get worse outcomes if elected politicians are too close to the decision-making process.  Instead, we set up an open and transparent medium-term PTA, in which the Minister takes the lead in setting the target, and the Governor is responsible for implementing policy consistent with that agreement .  PTAs are deliberately written for terms of five years, and the Governor is left to get on with the job (with all the reporting requirements, public and market scrutiny etc).

And so I am a little uneasy about this new letter of expectation, even if it supposedly flowed from a conversation initiated by the Board (I take that with a pinch of salt, as the Board may well have been responding to the Minister’s public expression of unease with the Bank last year).

The letter seems to have three broad areas of substance.  The first is a list of Minister’s specific interests for the Board in its monitoring role.

  • Monitoring the performance of monetary policy with respect to the Policy Targets Agreement (PTA).  I expect the Board to provide me with a clear sense of its judgements and the basis for them in assessing performance in meeting the PTA, recognising that the policy targets have evolved to be flexible and forward looking.

  • Assessing the performance of the Bank in promoting the maintenance of a sound and efficient financial system.  I expect the Board to articulate how it judges performance with respect to this statutory objective. I am particularly interested in how the objectives of soundness and efficiency are promoted and balanced.

  • Monitoring the Bank’s regulatory policy processes. The Bank has important regulatory responsibilities.  I expect the Board to take a close interest in the robustness of regulatory policy development and to articulate how it judges performance with respect to this function.   In particular, the Board should:

    • – Keep under review how the Bank’s regulatory policy is developed in light of the Government’s response to the Productivity Commission’s report on regulatory institutions and practices, and how these changes improve regulatory practice.
    • – Test the Bank’s thinking on regulatory policy developments and be satisfied that the Bank has reasonably addressed any alternative perspectives from other relevant parties (eg, the Government, the Treasury, the Council of Financial Regulators, Australian stakeholders, the financial sector and the wider public through consultation).
  • Monitoring the Bank’s relationships.  The Bank has a number of important stakeholder relationships – with me, with the Treasury, with regulated entities and with other agencies.  I would expect the Board to keep under review how these relationships are operating in practice.

  • Monitoring of operational functions.  The Bank has a range of operational functions, including those related to payment systems and currency.  I expect the Board to monitor the Bank’s operational performance and risk, particularly with regard to the use of the Crown’s resources and wider economic efficiency.  •

  • Organisational strategy and financial management.  The Bank is a complex organisation with a large balance sheet. I expect the Board to take a strong interest in the Bank’s strategy and financial management.  The Board should closely monitor the Bank’s performance against the Statement of Intent (SOI)

It is an interesting list, and in some cases quite pointed.  For example, the explicit recognition of the possible tensions between regulatory measures to promote system soundness, and the statutory provisions around the efficiency of the financial system.  Or “the Board should test the Bank’s thinking on regulatory policy developments and be satisfied that the Bank has reasonably addressed any alternative perspectives…. [including from] the wider public through consultation”.  That would certainly be welcome.

The letter of expectation also deals with the Annual Report

The annual Board report, as required under the Act, is the formal document that sets out the Board’s assessment of performance.  I expect this to provide enough detail to enable me and the wider public to understand how the Board has undertaken its review role.

I have written previously about the severe shortcomings in past Board annual reports.  Last year’s said almost nothing of any substance, and tended to reflect the prevailing practice in which the Board has seen itself as “having the Governor’s back”, and being part of the Bank’s efforts to spread its messages.

If this provision in the letter of expectation is a shot across the bows, suggesting that better and fuller Annual Reports should be produced, it is most welcome.  The Minister outlined a variety of specific areas he is interested in (above), and we should hope that there would be substantive material on each in the next Annual Report –  not just about the processes the Board used, but about its substantive assessments and residual uncertainties. I remain somewhat skeptical, but time will tell.

Towards the end of the letter, the Minister includes these paragraphs

The duties of the Board include keeping under review the performance of the Governor.  I would expect to discuss your assessment of the Governor’s performance from time to time.  I would not expect you to limit your communications on the performance of the Governor or the Bank to the narrow criteria set out in section 53(3), as I hope those circumstances would apply rarely if ever.

Greater visibility of the Board’s activities throughout the year would also be welcome and I would be interested in any suggestions you have to facilitate that.  In addition, I will ask my office to establish six-monthly meetings with me.  In advance of those meetings, I invite you to share any other documents regarding the Bank’s performance which would support the discussion.

Here I am just not sure.  It is no secret that I don’t think the current Governor has done a particularly good job, so in one sense the more questions asked about his performance the better.  But the institutions are not designed around any particular individual, and probably nor should the practical implementation arrangements be.  Non-transparent regular discussions between the Board and the Minister about the Governor’s performance create risks of inappropriate pressures being placed on the Governor (not just on monetary policy, perhaps more especially in regulatory matters).  Since the Minister has deliberately been given the power to dismiss the Governor only in fairly extreme circumstances, it isn’t clear what is gained by the Minister and the Board holding such conversations, unless those potential-dismissal thresholds are coming into view (and, as the Minister notes, he hopes that is “rarely if ever”).  Indeed, is there even a legitimate ministerial interest, given the choices Parliament has made about the structure of the Bank and the role of the Governor?  I think there are material flaws in the allocation of responsibilities under the Reserve Bank Act.  One of those is that the Governor has too much control of financial regulatory policy (as distinct from the application of that policy).  The Minister might share some of those concerns, but the right way to deal with the issue is to amend the Act, not use the Board as back-channel leverage.

When I first read that final paragraph in the letter, I wondered if “greater visibility” meant public visibility.  If it did, that would be quite inappropriate –  a good published Annual Report is the appropriate model and at other times the Board should have a low profile, not detracting from that of the Governor.  In fact, I think the Minister is only talking about the Board being ‘visible’ to him.  But, as discussed above, I remain uneasy about the idea of regular formal meetings with the Minister –  as distinct perhaps from the odd informal discussion over lunch –  especially if it involves additional “documents” being provided to the Minister.  It runs the risk of the Minister and Board second-guessing individual decisions by the Governor, and that simply isn’t the statutory model.

But there is another risk.  I’ve noted previously that the Reserve Bank Board has tended to act as if its role is to provide cover for the Governor.  In principle, they should be able to have free and frank exchanges with the Governor in private –  including on the issues the Minister touched on in his letter.  But if the Board is getting into a regular/routine reporting relationship with the Minister, I fear that the “have the Governor’s back” tendency will just be reinforced.  The Minister might appoint Board members, but they meet at the Bank, the Governor is a Board member, the Board has no resources of its own (only what the Bank provides), and a senior Bank manager is Secretary of the Board.  So far, they have only chosen former staff (Arthur Grimes and now Rod Carr) as chair.  They have become quasi-insiders.   None of this is intended as criticism of any of the individuals concerned; the incentives simply work together to make it a model that is never likely to generate regular hard-nosed rigorous scrutiny of the Governor’s performance.  It is a model that few, if any, other countries have adopted.

And so I’m left ambivalent about the letter of expectation to the Board.  On the one hand, it seems likely that this initiative has flowed, at least in part, from the tensions around the current Governor’s performance –  and so in that short-term sense, I’m pleased to see more questions being asked, and challenges posed.  And anything that produces better quality Board Annual Reports would be welcome.

But the model of governance Parliament established for the Reserve Bank 27 years ago does not envisage routine close ties between the Board and the Minister.   Indeed, I’m aware of no advanced country with an operationally independent central bank where there are such close ties.  If we want a central bank with operational independence, the Minister of Finance should be at a considerable arms-length.  In one sense, the Board is the Minister’s monitoring agent, but only with qualifications –  the role the Act envisages for the Board, as it related to the Minister, is for quite extreme circumstances.  The Board are not, say, the Minister’s employees who just happen to be representing him on some committee or other.

Of course, my overarching view is that the Bank’s governance model is flawed, and if there as ever a sound argument for it, it is no longer well-suited to range of functions the Bank undertakes, and is out of step both with international practice and with how New Zealand governs other public sector agencies. The model should be changed, and it remains something of a mystery why the Minister is so resistant to change.  My alternative, which uses the able people on the Board more actively in a decisionmaking role, was outlined here.



8 thoughts on “Ambivalence about expectations of the Board

  1. I recall Don Brash, Allan Bollard and also Wheeler wading into the Capital Gains Tax arena. These areas are totally outside of any of their individual expertise as economists. I recall thinking that Allan Bollard sounded rather daft when he put forward restriction of tax losses on the LAQC(Loss Attributing Qualifying Company) regime in one of his speeches but continued to allow tax losses to individuals and partnerships on investment properties. All that did was create work for Accountants and lawyers to charge to advise clients to change ownership structures. The final result was the LTC(Look Through Company) with tax losses still fully available. A lot of advisory fees went to accountants and lawyers though.

    The LTC is also one of the 2 favoured NZ tax foreign ownership structures offered by Mossack Fonseca.


    • 17/03/2007 A report to the Reserve Bank Governor, Alan Bollard, in February last year explored the idea of having Inland Revenue more strictly enforce thelaw on investment property gains.

      Bollard referred to it in his monetary policy statement.

      “The [central] bank has identified several policy options that it believes could usefully play a part in dampening the housing cycle and thereby promote financial stability over the longer term,” he said.

      Potential measures included “greater emphasis on the enforcement of existing tax laws regarding capital gains made on investment properties, and changes to the tax rules around investor housing”.


    • 13/05/2013 The Reserve Bank has once again thrown the gauntlet down to the Government over taxing housing speculators.But Mr Wheeler agreed with Mr Norman that  it would be fair to characterise the Bank’s position as wanting to see fresh consideration of some tax policy measures.

      “Then you get into issues like interest deductibility, the treatment of capital gains, whether there are issues around stamp duty that might be appropriate in respect of foreign buyers.”


  2. “The [central] bank has identified several policy options that it believes could usefully play a part in dampening the housing cycle and thereby promote financial stability over the longer term,” he said.

    Potential measures included “greater emphasis on the enforcement of existing tax laws regarding capital gains made on investment properties, and changes to the tax rules around investor housing”.


  3. Perhaps the letter of expectations is just a small step in trying to improve the overall process.

    As you say the the board should start to talk to the minister when things go seriously wrong, but to me that is too late. I compare it with an employee having annual performance reviews. I wouldn’t want to be told at the end of the year that my performance was not up to scratch and that I was in danger of losing my job unless I had been told that during the year.

    it may or may not be a perfect letter of expectations, time will tell, but better to try than to not try at all. Hopefully it will help, and maybe in another year another letter of expectations will be sent with some changes where they have learnt improvements can be made.


  4. Yes, I hope it acts to improve things. In terms of the employee/employer feedback analogy tho, I think that should be covered in the conversations between the Board and the Governor, not requiring any involvement of the Minister (unless those really extreme circumstances where dismissal might be an option are looming – and actually, I agree with the minister’s public words, that that will almost never happen. Apart from anything else, when there is a fixed term appointment, it is often easier to avoid really hard conversations (did you notice English today noting that it wasn’t yet resolived whether Wheeler would seek a second term).


    • I think that Wheeler has overall done a good job other than a completely dumbo period in 2014 when he aggressively moved interest rates up 4 times to try and dampen a non existent inflation. This in effect slowed down building activity in Christchurch and Auckland which is contrary to basic economics 101. How does reducing building activity crimping supply by decimating the building sector through increasing interest rates translate to lower house prices?

      And a silly tax related jab at the government with Wheeler forcing the government to tax speculators. The bright line test brought in to satisfy the RBNZ will just reduce supply to the market because it forces speculators to now live in the properties for 2 years before selling.


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