Month: June 2016

Some snippets on New Zealand’s continuing economic underperformance

Michael Reddell Uncategorized

I’m tied up with some other stuff for much of this week, so if there is a post each day it is likely to be a fairly short one.

Today, I wanted to show just a few charts –  mostly updates of ones I’ve shown before.

In yesterday’s Sunday Star Times, I read Rod Oram’s column.  It was headed Australia’s Delusions Run Deep, on some of the economic challenges Australia undoubtedly faces.  It was fine, as far as it went, but it did bring to mind the words

“Why do you look at the speck of sawdust in your brother’s eye and pay no attention to the plank in your own eye?

Whatever Australia’s challenges, it remains far richer than New Zealand.  We rather take that as given these days, but through most of our modern history there was no such gap.  And there is nothing suggesting that yawning gap is about to begin to sustainably close.

Even over the shorter-term the comparisons don’t flatter us.  Here is real GDP per hour worked (ie labour productivity) for the two countries since the end of 2007 (ie just prior to the recession).

real gdp phw nz and aus

The big differences aren’t about the recession period (our recession was worse than the Australian (income) recession) but are actually apparent in the last few years.  In short, on the official numbers –  and always subject to revisions –  there has been no productivity growth at all in New Zealand for the last four years.  And yet those were the years when, for some reason, people –  even Australians –  started talking about “rockstar” economies on this side of the Tasman, and our Prime Minister (and his acolytes) having been telling us how well New Zealand has been doing, with any stresses “quality problems” and “signs of success”.

At present New Zealand’s unemployment rate is exactly the same as Australia’s –  both at 5.7 per cent.  But in the decade leading up to the 08/09 recession, Australia’s unemployment rate had averaged 5.9 per cent, while ours averaged 5.2 per cent.    Australia’s unemployment rate is actually a little less bad than average, while ours is worse.

The HLFS has been running for 30 years now.  Over that time, Australia’s unemployment rate has usually been above New Zealand’s –  and they have a more heavily regulated labour market so that is what one should expect –  but not now.

U rates Aus less NZ

But turning back to the New Zealand national accounts, the media coverage did note that per capita real GDP growth has been very slow.    But no one seemed unduly bothered.  Of course there is some quarter to quarter variability in the series, and the data are revised over time, but the simple fact is that, on the official data we currently have, and averaging the production and expenditure measures of GDP, there was no real per capita growth at all last quarter.  And yet this is supposed to be some sort of success story?  Even in the last full year, real per capita GDP growth has been only around 0.6 per cent in total. It remains something of a mystery to me why the Reserve Bank and Treasury expect growth to pick-up from here.

And here is the (rough and ready) breakdown of per capita GDP into its tradable and non-tradable sector components.

pc gdp components

Tradables here includes primary production, manufacturing and exports of services.  Non-tradables is the rest.  So the tradables sector, as captured here, includes the booming (subsidized) export education sector and the booming tourism sector.    And yet there has been no overall growth in tradables sector real GDP per capita for more than 15 years.

Successful economies, building on a sustainable footing, do so by selling more and different stuff in competition with the best the rest of the world has to offer.   That doesn’t describe New Zealand at all –  under this government or its predecessor.

We have

  • no productivity growth
  • a continuing high unemployment rate
  • ruinous house prices, and
  • a tradables sector that has achieved no per capita growth for 15 years.

And yet, so our ministers and officials tell us, our immigration policy is a “critical economic enabler”.    Frankly, it seems bizarre that, as a matter of policy, we bring more and more people –  many of them just not that skilled anyway –  to such an underperforming place.  It is as if theory trumps experience.  New Zealanders pay the price for these political and bureaucratic preconceptions, and for an unwillingness to look out the window and recognize that all is far from well with New Zealand’s economy. Even Australia, for all its challenges, just keeps doing better.

UPDATE:  After finishing that post, I noticed this chart in the Westpac consumer confidence report.  Respondents aren’t always correct in their expectations, but at present they (potential voters all) don’t seem remotely optimistic about the medium-term outlook for New Zealand.

consumer confidence

Business leaders and the case for large scale immigration

Michael Reddell Immigration

New Zealand has one of the very largest planned and managed active legal non-citizen immigration programmes of any country anywhere.  Individual EU countries sometimes have larger legal inflows –  but mostly they can’t control intra-EU flows –  and in recent times the illegal inflows (some mix of refugees and economic migrants) to some countries have been very large. Immigration is a big issue in the UK Brexit debate, but immigration to the UK is on a much smaller scale than that to New Zealand.

Cross-border flows in conflict zones are often high –  and an unwelcome, if second best, outcome all round.  Most of the Syrians who have flooded into Lebanon, Turkey or Jordan would prefer to be back home in a secure Syria.  The Lebanese, Turks, and Jordanians would no doubt prefer that too.

As I’ve noted recently, the United States issues green cards at a rate about a third the (per capita) rate New Zealand grants residence approvals.  Canada –  a much richer country than New Zealand – has just increased its target migrant intake, but in per capita terms it is still less than New Zealand’s.   The only advanced country I’m aware of that sets out to (and succeeds in) attracting more migrants, per capita, than New Zealand is Israel,  and their circumstances are quite different for two key reasons.    The first is geopolitical, in that population could well prove critical to the future existence of the state of Israel.  And the second is about the founding conception of the state of Israel as a Jewish homeland –  the Law of Return allows any Jew (and some descendants) to migrate to Israel, and grants immediate citizenship to those who do.

We are an outlier.  We have total control of our borders,  no geopolitical threats to our existence, and no sense of New Zealand as the historic homeland for some ethnic or religious group scattered across the earth.  And yet we bring in huge numbers of non-citizen migrants each year.  The anomalous nature of our approach is heightened when it is remembered that people who know New Zealand, and its opportunities, best –  ie New Zealanders – have been leaving in large numbers for decades.  Oh, and ours is an economics-based programme, and yet our long-term economic performance just keeps on being pretty disconcertingly poor.

I know most of the theoretical arguments for immigration (and emigration).  But this isn’t a theoretical argument about some abstract stylized country. It is an argument about the appropriate role, and effects, of our particular immigration policy, faced with the specifics of this particular country at this particular time in its history.  Theoretical models can be helpful in thinking about the issues, but only in so far as they capture the key relevant features of the New Zealand economy.  On my reading, few do.

And so I’m always keen to see the strongest cases that people can make for our unusual immigration policy, in a New Zealand specific context.  Hand-waving accompanied by citing papers that take a global perspective doesn’t shed much light on the particulars of New Zealand’s situation.  The government’s chief economic adviser, the Secretary to the Treasury, simply asserts there are economic benefits from immigration, but has made no attempt to demonstrate how they arising in the specific context of New Zealand.  His perspectives often seem more relevant to the British debate –  recalling that is only about six or seven years since he moved here from the UK.  Neither Treasury nor MBIE’s advice –  in formal publications or in material released under the OIA –  provides much to engage with.

There is a bureaucratic/academic elite consensus around the key elements of the immigration programme.  But the other key source of support is the business community.  Mostly they’ve favoured large scale immigration for decades –  through periods of overfull employment and of uncomfortably high unemployment.  Throughout those decades, New Zealand’s relative economic performance has continued to deteriorate.  Perhaps they think – if they stopped to analyse the issue –  we should just be thankful we avoided the counterfactual –  who knows how bad our living standards might now be if, say, our population had increased by perhaps 50 per cent over the last hundred years (as in a typical Northern European country) rather than 300 per cent?

Various representatives of the business community have been out this year championing our immigration policy.  I’m not suggesting that all of them support every detail of how the current system is working, but the general message seems to be that we are on the right track –  running such an unusually large immigration programme, even though our productivity performance remains disconcertingly bad.

A few months ago, I wrote about a brief contribution to the debate from Roger Partridge, the chair of New Zealand’s premier business-funded (typically non-tradables business funded) economic think-tank.   Running under the heading Immigration Grows the Pie, it wasn’t a long piece but it was typically forthright:

And that is not the end to the good news. Countless international studies have shown that increases in immigration not only tend to increase jobs, but also to increase the prosperity of the host nation. We benefit from their productive endeavours, their ingenuity and their diversity. And the more skilled the migrants, the greater the benefits.

That there are gains from immigration has received cross-party support in New Zealand since at least the 4th Labour Government. Let us hope the anti-immigration demagoguery falls on deaf ears. Going down that path we all lose.

The challenge is not keeping out the migrants; it is keeping out the bad ideas. Luckily, that does not need a wall, just clear thinking.

But, as Partridge acknowledged in subsequent comments, none of those “countless” studies focused on the specifics of New Zealand’s situation.

And then in the last couple of weeks, as the immigration debate has received a bit more attention, the Dominion-Post has run advocacy pieces from the leaders of two business advocacy or lobby groups.

On 10 June, the chief executive of BusinessNZ, Kirk Hope, was out with a column headed –  at least in the hard copy – Don’t stem the immigrant tide (there is an identical piece on the BusinessNZ website, under the more subdued heading Improve immigration for the long-term).   Hope has form – I highlighted another one of his op-eds earlier in the year which celebrated our GDP growth rate as among the higher in the OECD, while never once mentioning that rapid population growth was such that recent per capita growth had been quite disappointing by international standards.

In his latest piece, Hope takes issue with calls to cut our residence approvals target.

Immigration is in the news again – being blamed for Auckland’s housing problems, with suggestions that immigration should be drastically cut, to around say 10,000 new permanent residents per year, to restrain Auckland house prices.

The numbers involved –with roughly 30,000 new permanent residents settling in Auckland a year alongside a current shortfall of about 30,000 houses in Auckland – would seem to support the suggestion.

But the suggestion doesn’t stand up to scrutiny.

Reducing the quota to 10,000 would not by itself solve Auckland’s housing problem, and would bring problems of its own.

I’m not sure that anyone has suggested that reform mainly to restrain house prices.  There are other things that could and should be done on that score –   but mostly aren’t.  But equally, there is little real doubt that a much lower expected future rate of population growth would materially lower real house prices.  The sustained reversal of immigration flows from the mid 1970s was a big factor in the 40 per cent fall in real house prices in New Zealand in the late 1970s.
I don’t disagree with everything Hope says. He rightly says that we shouldn’t focus too much on cyclical peaks (or troughs), especially as those cyclical fluctuations (mostly New Zealanders leaving at a faster or slower rate) aren’t something policy can directly control.  But then that is why a sensible discussion on immigration policy focuses on the fairly stable medium-term target level for residence approvals.  At present, that target is 45000 to 50000 per annum.  I argue that New Zealanders would be better off with something more (US like) along the lines of 10000 to 15000 per annum.  All that said, sometimes it is the peaks –  and troughs –  which help spark serious conversations about the medium-term policy settings.
But why is Kirk Hope so keen on a high rate of non-citizen immigration?

Restricting immigration as proposed would harm the economy.

With a birth rate just above replacement level, an ageing population and baby boomers retiring, we need immigrants to sustain the economy and pay for our superannuation, just as in decades past.

And that seems to be his main argument.  It isn’t a very persuasive one.

On the immigration side of the story, around 10 per cent of residence approvals are under the “parent” heading –  ie mostly people who are already quite elderly themselves, and won’t be making much contribution to paying for NZS.  Another 1000 or so will be refugees.  I don’t have any problem with us taking refugees, but the evidence suggest refugees struggle to match New Zealanders’ earnings and employment rate even decades after arriving here.  And unlike the systems in many countries, immigrants themselves are entitled to the full NZS themselves after only a relatively short time living in New Zealand –  ten years.

And on the NZS side of things, if there are affordability challenges with the current system, we have it in our own hands to modify the system to make it more readily affordable.  We could raise the age of eligibility –  National knows it needs to happen, even if the Prime Minister has pledged not to, and Labour campaigned for a higher age at the last election.  Other countries have made these sorts of changes.  We could also age-index NZS eligibility.  We could modify the entitlements of those who haven’t spent most of their working lives in New Zealand.  And there are other options I don’t support, but which would also ease the fiscal pressures, such as income and asset testing, or linking NZS increases to prices rather than wages.  And we can keep the way open for more older people to stay in the labour force for longer –  on the count, we already have one of the least distortionary old age pensions systems anywhere.  We are quite capable of managing the pressures ourselves.

Large scale immigration might make a small difference to NZS affordability, but it is an awfully big intervention for a really quite small difference.  As it is, New Zealand’s birth rate is around replacement, unlike many European and Asian countries, so the ageing population issues are in any case less pressing here than in most places.

In the end, the best way to support the various social spending commitments society wants to make is to foster a highly productive economy.  We’ve kept on failing to do that, and while immigration policy almost certainly isn’t the whole story, there is no evidence whatever that high rates of immigration have improved the position.

The NZS affordability argument seemed to be the sum total of the BusinessNZ case.  In his article, Hope goes on to suggest some refinements to the current system

The jobs being filled by temporary work visas right now are mostly chefs, dairy farm workers and carpenters, showing the current growth points in the economy: tourism, dairy and construction.

There’s no problem using migrants to fill these current needs – but they are not necessarily the needs of the future.

Our aspiration for the future is to grow businesses and industries in high value areas – engineering, high tech manufacturing and services, digital technologies and high value addition to primary products.

We should be welcoming new permanent residents who have skills relevant to these areas to help these sectors to grow.

If he just means that we should be putting more focus on highly-skilled migrants then –  subject to the current overall target continuing –  I’d agree with him.  But it is curious to see the leader of a business group reckon that he knows what skills and what industries will be the ones that will prosper in a future, more successful, New Zealand.  And it is puzzling to see so little faith placed in the workings of the labour market, or the skills and capabilities of New Zealand.  It is redolent of some sort of 1960s indicative planning mentality –  the sort of line of argument I have previously criticized MBIE for.

Successful economies don’t need lots of migrants.  In some cases they might welcome them anyway, but in others not.  As I’ve noted previously, the United States was at the peak of its economic and political dominance during the decades when it was taking very few immigrants at all.  I’m not suggesting a causal relationship (in which the US prospered because it cut back immigration) simply that it wasn’t obvious that high immigration was a necessary part of economic success.

Kirk Hope’s article was followed yesterday by an article from John Milford, the chief executive of the Wellington Chamber of Commerce, under the (hard copy) heading “Skilled migrants a win for us all”.

His evidence appears to be a recent MBIE National Survey of Employers. Asked their views on the impact of immigration, employers responded as follows

 

survey of employers

It isn’t an ideal piece of information.  After all, MBIE –  the people commissioning the survey –  are also the key official champions of immigration policy, and the administrators of the system.  And even setting that to one side, we don’t know how many people disagreed, and how many didn’t answer or didn’t know.

But even setting those points to one side, I’m not surprised at all that individual employers answered along the lines indicated in that chart. For an individual employer, the ability to choose a migrant for a particular vacancy increases that employer’s choices at the wage rate being offered.  Indeed, in some sectors  –  one could think of aged care nurses  –  the wage rates might be sufficiently low that most of the suitable applicants might well be immigrants from poorer countries with lower reservation wages.  But the ability to fill a particular vacancy says nothing at all about whether immigration policy is working to serve the longer-term economic interests of New Zealanders.  And nor would individual employers have any particular expertise in evaluating the arguments in that regard.   It is a lot like the idea that immigration eases skills shortages. For an individual employer, facing a specific hiring decision, the ability to recruit an immigrant may well ease that employer’s specific “skill shortage” (ie prevent the wage offered having to rise) but for the economy as a whole, large scale immigration increases resource pressures, it doesn’t ease them.  New Zealand economists knew that decades ago.

Back in the 1950s and 1960s many New Zealand employers probably also thought that manufacturing protectionism was good for New Zealand too.  It might well have been good for many of them individually, but it wasn’t good for the longer-term living standards of New Zealanders.

Business sector advocates often try to have us believe that key sectors just couldn’t survive without reliance on large scale immigration.  Set aside the inherent implausibility of the argument –  how do firms in the rest of the world manage –  and think about some specifics.  Sure, it is probably hard to get New Zealanders with alternative options to work in rest homes at present.  So, absent the immigration channel, wage rates in that sector would have to rise.  Were they to do so, I can see no reason why in time plenty of New Zealanders would not gravitate to the sector.  It was New Zealanders who staffed the old people’s home my grandparents and great aunts were in 30 years ago.

Same goes for the dairy sector, or the tourism sector.  As one former senior MBIE person put it to me a while ago, what reliance on migrant workers in dairy has done is mostly to enable dairy land prices to be bid a bit higher than otherwise.    Raise the wages and New Zealanders will, over time, gravitate to the opportunities in the sector.  That is how labour markets work.

Of course, none of this is obvious to an individual employer.  They probably can’t raise their wages to attract New Zealand workers instead, even if they wanted to.  To do so would undermine that particular firm’s competitive position.  But again, this is the difference between an individual firm’s perspective, and a whole of economy perspective –  and the latter should be what shapes national policy.  Cut back the immigration target, along the lines I’ve suggested, and we’d see materially fewer resources needing to be spent on simply building to keep up with the infrastructure needs of a rising population.   We’d see materially low real interest rates, and with them a materially lower exchange rate.  The lower exchange rate would enable New Zealand dairy farmers, and tourism operators, to pay the higher wages that might be needed to recruit New Zealanders into their industries, and probably still be more competitive than they are now.  And plenty of New Zealanders now working in sectors totally reliant on an ever-growing population would, in any case, be looking for opportunities in other sectors.

Perhaps some readers might think I’m being unfair to Partridge, Hope, and Milford.  After all, no one can cover all their arguments in a single article of a few hundred words.  As readers know, I certainly can’t.  But surely the best, and most robust, arguments would be put forward first in high profile pieces?.  And what they’ve offered us doesn’t look very robust or convincing at all.  It feels like either a high level application of general international theory, without thinking about the specifics of New Zealand, or an individual employer’s view of the world –  where the ability to hire more people, on the day, at much the same wage is always going to feel like “a good thing”, no matter what the macroeconomic implications might be.  I really hope some of the advocates of the current policy can make the effort to put together a more sustained case for how New Zealand’s current large scale immigration –  or even their preferred refinements to it –  has really been working to lift productivity and the medium-term living standards of New Zealanders.

Of course, there are people on the other side of the argument, even some fairly eminent ones with some serious business backgrounds.  Don Brash spent 18 years as a private sector CEO before turning first to public policy and then politics.  No one can accuse Don of being some of nativist, or of having even a shred of doubt about the benefits of an open economy.  Don published his memoirs a couple of years ago, and included some chapters on various policy issues.  One of those chapters was devoted to issues around immigration, including some of the earlier versions of the arguments I was raising.  Don concluded

I’ve been reluctantly forced to the conclusion that, if we want faster growth in per capita incomes and a lower balance of payments deficit, among the policy measures we need to take is a much more restrictive attitude to total inwards migration

Commenting further

…employers in the export sector who benefit from employing immigrant workers may themselves carry some of the “blame” for the high real exchange rate which makes their lives so uncomfortable

The current government has, during its term, commissioned two external panels to report on issues to do with New Zealand’s disappointing economic performance.  Don Brash chaired the 2025 Taskforce, and Kerry McDonald chaired the 2010 Savings Working Group.

McDonald started his career as an economist, spent time as director of the NZIER, and then moved into the corporate world, spending decades as chief executive of Comalco.  He continues to sit on various corporate boards.  This week he came out with a fairly trenchant piece on the failings in the New Zealand political and policy process.  I didn’t agree with it all by any means, but here is what this economics-trained senior business leader had to say about immigration.

The high rate of immigration is a national disaster. It is lowering the present and future living standards of New Zealanders by serious adverse economic, social and environmental consequences.

The critical criterion for policy is impact on the living standards of New Zealand residents. The impact on the immigrants is irrelevant. But, the political view is a simple and misleading “quantity” based one – more immigrants means population growth and more jobs, houses and infrastructure spending, so GDP increases. This suggests a strong, well-managed economy – which is a nonsense in New Zealand’s case with an export dependent economy.

In terms of national benefit the “per capita” impact is the important one. Unless immigrants increase New Zealand’s exports and foreign exchange earnings and savings per capita, or bring particularly valuable skills to the economy, they simply impose substantial additional costs on and reduce the living standards of New Zealand residents.

Having a job, even in an export industry or tourism, is not enough, and many immigrants lack the particular, high level of skill and productivity to add the necessary value. Using them to fill low skill, low productivity gaps in the labour market, eg. building houses for our excess population (other than on a temporary basis), is damaging to New Zealand’s interests, in the short and long term. So, we scramble to build more houses and ignore the fundamental policy problems.

As I say, I don’t agree with everything he says, but at very least his is a robust honest recognition that, whatever the glee club says, things aren’t going well for New Zealand, haven’t for a long time, and that current policy –  perhaps including immigration policy –  and political leaders have to take some considerable measure of responsibility for that.

 

 

 

 

 

 

How good a forecaster is the Reserve Bank?

Michael Reddell Reserve Bank

Not very good at all.

Of course, that isn’t necessarily a particular criticism of the Reserve Bank.  Forecasting is hard –  especially, as the old line goes, when it is about the future.  But economic forecasters find the past a challenge too.  Yesterday, we finally got the first estimate of GDP data for a quarter that happened, on average, four months ago (ie mid February to mid June).  Even for forecasts done not long before the official data are released the forecasts errors are often non-trivial (the Bank’s forecasters used to try to convince us that even errors of 0.5 percentage points for quarterly GDP forecasts shouldn’t be particularly bothersome).  I don’t have much confidence in economic forecasting, and I mostly try to stay clear of it in my comments on this blog.

You might wonder why, if forecasting is so challenging, central banks devote so much effort to it.  It is not as if there are no alternatives, or as if monetary policy has always been run this way.   A Taylor rule –  using just current estimates of a neutral interest rate, an output gap, and the distance between current inflation and the target –  is one quite plausible alternative as a starting point for policy deliberations.

It is easier to understand why other institutions do economic forecasts.  There is a demand for them from people (corporates, local authorities) who need numbers to populate the cells of planning spreadsheets.  Even central governments, planning expenditure over several years ahead, need such numbers –  but for them, as for other users, trends matter more than cycles.  For central banks, it is cycles that really matter.

Forecasts also get media coverage –  as horoscopes helped sell newspapers in years gone by –  and part of a bank economist’s role is media coverage, and visibility for the respective banks’ brands.  For some other forecasters, the visibility of forecasts might, at the margin, help sell other consulting services.

Whatever the reasons behind their respective operations, there are now plenty of outfits doing economic forecasts for key New Zealand variables.  And yesterday the Reserve Bank published an issue of the Bulletin devoted to a statistical analysis of how the Reserve Bank’s forecasts have done over recent years relative to a large group of these other forecasters.  They’ve done these exercises from time to time, but this one in particular seems to be part of the Reserve Bank’s defensive operation to cover for its monetary policy misjudgments in recent years.  Although there is nothing complex about the analysis, and although the Reserve Bank has a large team of numerate researchers and analysts, the analysis (and article) was contracted out to NZIER.  As it happened, the NZIER researcher –  Kirdan Lees –  had, in fact, been one of the managers in the Bank’s Economics Department, fully involved in the scrutiny of the forecasts, in the early years of the period the exercise reviews (2009 to 2015).

It is good that official agencies do these exercises.  They help shed some light on questions that those who approve agency budgets, and assess their performance, might reasonably ask.   The new Reserve Bank exercise helpfully uses the same approach adopted in a 2009 analysis of the previous few years of Bank forecasting performance, but benefits from a larger sample of forecasters.  The Treasury just last month published a new review of its own macro and tax forecasting performance.

Having said that, it is as well to take each exercise with a considerable pinch of salt.   Most of these studies look at quite short periods.  The Bank’s previous exercise looked at forecasts done over 2003 to 2008.  This one looks at forecasts done from 2009 to 2015.  For two-year ahead forecasts –  and it is the medium-term the Reserve Bank ostensibly focuses on in setting policy –  that means no more than three non-overlapping forecasts for each observation (eg a March 2009 forecast for March 2011,  a March 2011 forecast for March 2013, and a March 2013 forecast for 2015).  There just isn’t enough data to meaningfully tell the various forecasters apart in a statistical sense (as the author recognizes in explicitly choosing not report measures of the statistical significance of differences across forecasters).  Good performance  –  or bad performance – in a particular period might just be a result of luck.  The recent Treasury exercise used a longer-run of data (in some cases all the way back to 1991) and it might have been interesting for the Bank researchers to have at least(also) looked at the full period performance since 2003.

It is also important to recognize that the way the exercise is done is systematically set up to favour the Reserve Bank (the Treasury exercise has the same problem, a point which their write up explicitly notes).   The Reserve Bank collects forecasts from a variety of other official and private forecasters two to three weeks before the Bank’s own forecasts as finalized.  That collection of external forecasts is one input in the Bank’s own forecasting and scrutiny process.  We would sit around the MPC table, scrutinizing the draft projections our own forecasters had come up with, and use the external forecasters’ numbers as a basis for questions of our own.  Often enough, people (me included) were quite dismissive of the external forecasters, but we were keen to understand the logic where the forecasts of the more respected external forecasters differed materially from our own draft forecasts.    It  was one part of running a process designed to assure the Bank’s Board (for example) that we had thought about alternative possibilities and to test the robustness of our own numbers.

But what that inevitably means is that in comparing these external forecasts with the Reserve Bank ones, not only does the Reserve Bank have several weeks more data than the external forecasters have, but the Reserve Bank can condition its forecasts on any useful information in the external forecasts (individually or in aggregate).  For some variables, that two to three weeks can make quite a difference –  eg the exchange rate can move a lot, oil and dairy prices can move quite a bit, and some (typically second tier) domestic data will have emerged that the external forecasters just didn’t have.  For the June MPS forecasts, the Bank often has Budget information private external forecasters wouldn’t have had.  How large that advantage is is an empirical question (which can’t readily be answered), but the direction of the advantage is clear.  The Reserve Bank should typically do a bit better than most external forecasters –  not hugely so, as much about the future is inherently unknowable, but better.

Oh, and the Reserve Bank spends massively more on macro forecasting and analysis than any other agency monitoring/forecasting the New Zealand economy: a typical large domestic economics team is perhaps five people in total and several of the forecasters on the list are one-person operations.  The Reserve Bank used to have perhaps eight people in its forecasting team, another half dozen doing modelling (mostly oriented to forecasting concerns), more doing research, and more monitoring international economies.  And key senior managers (from the Governor on down) are heavily involved in reviewing/challenging/confirming the forecasts, along with a couple of external advisers.  These (mostly very smart) people don’t just do forecasting, but a sceptical Treasury analyst, considering the Reserve Bank’s funding agreement submissions, might reasonably ask about how large the marginal gains in forecasting accuracy and policy quality are from all the additional resource the Bank devotes to the operation.

How did the Bank do?  The usual method for looking at forecast accuracy is to calculate the Root Mean Squared Error, a measure which looks at the size of absolute errors (ie upside and downside errors don’t offset each others) and which particularly penalizes large errors.

The Bank reports the results of their comparison for four variables (GDP growth, 90 day bill rate, CPI inflation, and the TWI) and for both one and two years ahead.   They also show the results for each other forecaster –  anonymized –  and the results if on each occasion the Bank published a forecast they simply used the median forecast for each variable from the most recent grouping of external forecasts.      That means we can look at 16 RMSE comparisons.  Here is my summary table.

Reserve Bank forecasting performance
Better than the median forecaster Better than the median forecast
GDP 1 yr ahead Yes Yes
2 yrs ahead No No
90 day bill 1 yr ahead Yes Yes
2 yrs ahead No No
CPI 1 yr ahead Yes Yes
2 yrs ahead Yes Yes
TWI 1 yr ahead No No
2 yrs ahead No No

Of the sixteen observations, the Reserve Bank does better than the median eight times, and worse than the median eight times.   That is a little bit better than it sounds –  it has long been recognized that using a median forecast will typically produce a better forecast than using any individual forecast.  In the charts in the article, adopting a rule of just using the median forecast on each occasion produces results that would typically put someone running that rule in the best third of the forecasters examined here.

But recall that:

  • the Reserve Bank has information advantages over the external forecasters
  • the Reserve Bank devotes a lot more resources to forecasting
  • the Reserve Bank actually (in effect) sets the 90 day rate (in announcing an OCR as part of its forecasts)
  • the variable that the Reserve Bank has consistently beaten the median (forecast and forecaster) on is CPI inflation, a variable which has undershot the target now for four years.
  • the Bank does relatively worse on the two year ahead forecasts than the one year ahead forecasts, even though monetary policy is ostensibly set on a medium-term (18 mth to two year ahead) view.    Information advantages are likely to be materially less for two year ahead forecasts than for year ahead ones.

The Bank’s article has its own summary measure of forecast errors (aggregating across the four measures –  details are in the article).

Here is the chart for one year ahead forecasts

forecast errors 1 yr ahead

The median forecaster is between forecasters J and I, with an RMSE of .965.  The Reserve Bank’s RMSE of .94 is neither economically nor statistically significantly different from that median forecaster’s (and those of a bunch of others clustered near)

And here for two year ahead forecasts

forecast errors 2 yrsThe median forecaster is between forecasters J and D.  Again, the Reserve Bank looks no better (or worse) than the group of forecasters clustered near the median forecaster.

In doing the analysis, Kirdan Lees did the interesting exercise of looking at how using the median forecast on each case would have performed.  But another exercise one could think of doing is to compare how these forecasters (including the RB) did relative to simply using the most recent actual information, and assuming that what we see today is what will be (the best forecast f0r) the outcome one and two years ahead.  For forecasting the exchange rate, it is widely accepted that it is very difficult to beat this “random walk” approach.

I did a quick exercise to see how the random walk would have done over 2009 to 2015 for the CPI and the OCR (not the same as the 90 day rate, but very close).  For year ahead inflation forecasts, forecasters certainly did better.  At the two year horizon, the Reserve Bank did a little better than the random walk over this sample period, but most of the other forecasters didn’t.  Given the small sample, over this period, there might have no useful information in the laboriously produced medium-term inflation forecasts at all.

What about the OCR?  Looking a year ahead, the Reserve Bank’s 90 day bill forecasts had the same RMSE as simply forecasting the OCR using a random walk –  and the Reserve Bank sets the OCR, using its own reaction function.  Quite a few forecasters did worse than the random walk, but then they had less information than the Bank.   On two year ahead forecasts, only one forecaster was as good (on this measure over this time) as the random walk OCR forecast.  The Reserve Bank was among those who were far worse.

Perhaps it would also be interesting to look at some other comparisons.  For example, to see whether forecast errors at the Bank are different from one Governor to the other (probably not, but gubernatorial overlay is a well-recognized and, in principle, quite legitimate part of the RB forecasts).  One could look at (implicit) forecasts from predictions markets (rather thin, and now undermined by regulatory interference) and for 90 day bills one could compare the Reserve Bank’s forecasts with implicit market prices.  But those weren’t the point of this particular exercise.

What would I take from all this?  Not overly much.  In the Reserve Bank’s press release they were rather inclined to oversell the Bank’s performance –  noting neither the Bank’s information advantages, nor the lack of statistical (or economic) significance in most of the results.  Forecasting is a mug’s game and it shouldn’t be any surprise that no one much can do it consistently well.  It might be better to stop pretending otherwise.

I suspect that the Reserve Bank is –  on average – about as good, or bad, as the other forecasters focusing on New Zealand.  At one level, perhaps we shouldn’t expect more.  Then again, they (a) spend huge amounts of public money on generating and publishing forecasts, and (b) are charged –  and have agreed to accept – a mandate that involves their ability to adjust the OCR to deliver on an inflation target.  I haven’t looked at the bias results in this post (all the results are in the article) but there were huge biases in the inflation forecasts over this period.  The Reserve Bank’s were a bit less than most –  and that had certainly been my impression when I was still at the Bank –  but it is hardly an impressive performance.  As Bernard Hickey noted in questions at the recent MPS press conference, on their own –  not overly good –  forecasts, they are on track for six years below target.

As I noted earlier, these exercises need to be done from time to time. But I’m not sure they really shed much light on the policy judgements and misjudgements over the last few years (or indeed in the period covered by the earlier article).    There is some defensive cover in being in among the pack in (small sample) forecasting comparisons –  in that it is better than the alternative of being shown to be consistently most wrong –  but it doesn’t really justify what has gone on.  A lot of smart people, led by the Governor and his chief economist, got it consistently wrong, made overly bold calls at key junctures, then proved continually averse to scrutiny or to even acknowledging errors and misjudgements (to which all humans are prone), and continue to rely today on overly bold assumptions about things being just about to come right.

 

 

Immigration policy and values statements

Michael Reddell Immigration

Vernon Small has an interesting column in the Dominion-Post this morning (not yet online) under the heading “Terror risk muddies rational migration debate”.  He seems keen on a national debate on the economics of our immigration policy, including highlighting  The Treasury’s concerns about whether the skill level of the typical migrant is really fully consistent with the original vision of a skills-based migration programme providing economic benefits to New Zealanders.

But at the same time, with a somewhat lofty condescension, he seems uneasy about other public concerns. In particular, he isn’t taken with calls from Winston Peters and David Seymour for immigrants (including refugees) to sign some sort of national values statement.

Actually, I’m also not keen on requiring immigrants to sign values statements.  Not just because they don’t seem enforceable –   and if you really want to get to Australia, why would a commitment to “respect” (whatever that means) “a spirit of egalitarianism” (one element of the required Australian values statement”) deter one?.  Who knows what it means anyway  Perhaps turning over the Prime Minister every year or so, so that as many people as possible get a go?

My concerns are about two, perhaps opposing, risks.  The first is that any values statement becomes a lowest common denominator statement as to be totally meaningless.  The second is that the wording of any values statement –  if taken seriously –  would be hotly and continuously contested, as culture wars ebbed and flowed.  And frankly, I don’t seem to be welcome in David Seymour’s New Zealand.

Here is the Australian Values Statement, required of migrants to Australia:

I understand:

  • Australian society values respect for the freedom and dignity of the individual, freedom of religion, commitment to the rule of law, Parliamentary democracy, equality of men and women and a spirit of egalitarianism that embraces mutual respect, tolerance, fair play and compassion for those in need and pursuit of the public good
  • Australian society values equality of opportunity for individuals, regardless of their race, religion or ethnic background
  • the English language, as the national language, is an important unifying element of Australian society.

I undertake to respect these values of Australian society during my stay in Australia and to obey the laws of Australia.

I understand that, if I should seek to become an Australian citizen:

  • Australian citizenship is a shared identity, a common bond which unites all Australians while respecting their diversity
  • Australian citizenship involves reciprocal rights and responsibilities. The responsibilities of Australian Citizenship include obeying Australian laws, including those relating to voting at elections and serving on a jury.

If I meet the legal qualifications for becoming an Australian citizen and my application is approved I understand that I would have to pledge my loyalty to Australia and its people.

No doubt it isn’t aimed at people like me, and were I migrating to Australia, I could probably, at a pinch, sign it.  But I would have a few mental reservations.  If I knew what the sprit of egalitarianism was, I’d certainly accept it as part of the folk mythology of Australia,  but I’m not sure I’d really “respect” it.  And as for “equality of men and women”, well yes certainly in the most important senses –  equality before the law and before God.  But I’m a Christian, and like most Christian churches (including in Australia the Catholic church, and the Anglican church in Sydney), I don’t believe that women should serve as priests.  I don’t see that as matter of inequality, but many would.

I’m not sure when the Australian Values Statement was written, but it feels as though it might be 10 or 15 years old.   The culture wars have moved on, and David Seymour offers this, rather shorter version as a possibility for New Zealand.

Seymour said it wouldn’t be difficult to pull together a simple charter, stating for example: “We believe regardless of gender, sexuality, ethnicity or religion, you have the same legal rights as everybody else.”

If by that he means that, for example, people should be able to “marry” others of the same sex, then I don’t believe that.  Actually, for almost all of history –  including New Zealand’s history –  very few people did. Most Christian churches don’t today.  It is, for now, the law in New Zealand, but it doesn’t mean I agree with or respect that law.    And, for better or worse, in some respects New Zealand law isn’t even consistent with Seymour’s statement: after all, to name just one example, we have Maori seats in Parliament.  And where does the Treaty fit in the mix?

In fairness to Seymour, his might have been the fruit of 20 minutes scribbling on the back of an envelope. Any values statement actually put into legislation would no doubt be more carefully drafted –  and for that reason, among others, quite a lot longer, to capture all the caveats and competing emphases.

And where would it stop?  I had a quick look this morning at statements I could find in which each of the three largest political parties describe their values.  There was some overlap (and the particular Labour Party document I found had three of four pages of text, while the Greens and National Party had quite short lists), but there were quite a few substantial differences.  Which is what one might expect: a significant part of political debate is the contest of ideas and values, particularly in an era of cultural transition (eg secularization, in which culture and religion are no longer intrinsically interwoven).

I might find the references to loyalty to the sovereign, and limited government, in the National Party’s list appealing.    Many other New Zealanders wouldn’t.   “Respect the planet” might be something central to a Green view on things, but to me the concept of respecting an inanimate object just seems weird.  And even though there was serious uncertainty about the consequences of doing so, I’m glad our ancestors took decisive action to confront Hitler, rather than “take the path of caution”.

As far as I can see, none of the values statement (yet) talk of the rights of the unborn, or transgender rights to bathrooms –  to take just a couple of issues that have convulsed American debate.

Perhaps we might get agreement on process issues –  parliamentary sovereignty, a universal franchise, the rule of law etc –  but even on process it might be thin pickings.  There are probably plenty of supporters here of moving to a written constitution, and others who still hanker for a return to FPP.  In the end, is there genuine common ground on very much at all, other perhaps than that change should occur non-violently?  We can all agree that individuals do and should have rights, and probably all agree that in some circumstances the needs/interests of the “community” override those individual rights.  But where that boundary is, and how it should shift, is the intrinsic stuff of politics.  We can’t agree among ourselves, so what is there for immigrants to sign up to, other than today’s (temporary) shifting majority.  I was amused, for example, to read the Prime Minister’s rewriting of history, in answering the values question, noting that for him it included “understanding that New Zealand’s always been a tolerant society”.   Really?  To name just one low-key example, our treatment of conscientious objectors during the two World Wars meets no reasonable definition of “tolerant”.

And yet the people who call for migrants to sign values statements do capture a fair point.  When large numbers of people are allowed by our governments to come and live in New Zealand they have the potential to change our society.  People are not just bloodless economic units –  dessicated calculating machines.  They bring their own attitudes and values, and while the new arrivals are likely to be changed by living here so –  if the numbers are large enough – is our society.  One need only think of European migration to New Zealand over the last 200 years –  we their descendants may be changed by living here rather than in, say, the United Kingdom, but the similarities with modern Britain are probably greater than those with pre-1840 Maori society.  The point is not that modern New Zealand is better or worse for those migrants (and their values/attitudes/technologies), but that the fact of change is inescapable and largely irreversible.  Seeking that sort of change is itself a political act.

Which is one of a number of reasons why I’m skeptical that –  even if there were material economic benefits to residents of the recipient countries – large scale immigration programmes are normally a legitimate role of government at all.  We’ll always have some immigration.  New Zealanders travel, and some will meet and marry foreigners.  Often enough the new couple will want to settle here.  And our humanitarian impulses will, rightly, drive us to take some refugees.  But in neither case –  both on generally quite a small scale – do we grant permission to reside here with a goal of changing our society.

But once we get into large scale immigration programme, governments are in the culture change business, actively or passively, often without even realizing it. In terms of the domestic culture wars, and ongoing debates, the ability to attract more people like one side or another skews the playing field.  Instead of working out our differences, and debating change, within the existing community of New Zealanders, we tilt the playing field one way or the other. I might be comfortable with a large influx of mid-western evangelicals, while most Wellingtonians might prefer liberal Swedes.  I might be happy with strongly Anglican Ugandans or Kenyans, while many would prefer secular French.   In the specific New Zealand context, few migrants have any strong reason to feel a commitment to the Treaty of Waitangi, and for those New Zealanders for whom that is an important issue, any large scale immigration skews the game against (that representation) of Maori interests

It is far easier to resolve disputes, and find an ongoing place for each other, among communities with shared memories, experiences and commitments.  Families do it better than countries.  Countries do it better than the world.  Globalists might not like to acknowledge that, but it doesn’t change the reality.  Families don’t usually resolve their differences –  sometimes painful lasting differences –   by injecting new members into the family.

 

 

 

 

 

Cry Freedom…but count the possible cost

Michael Reddell UK

As I noted in my post on Saturday, were I British I would be voting for Brexit, and so I’m pleased to see the polls moving that way.  Should that cause succeed, there is likely to be considerable disruption, both to Britain, the other EU countries, and to the wider world economy and financial system.  Perhaps it will be the episode which illustrates the point I and others have been making for several years: when interest rates are already at or very near the effective floor, and there is little fiscal room left, any new serious adverse shock will expose countries as having few tools left to respond.  Central banks and governments that have done nothing about removing the near-zero lower bound would then have something to answer for.

In the Telegraph a day or two ago, Ambrose Evans-Pritchard had a powerful column articulating his own reasons for voting to leave the EU.  It was all the more powerful because it recognized and gave full weight to the transitional disruptions that are all but certain, and to the possibility that even in the medium term there might be some economic costs.  The cause of freedom –  the ability to set one’s own laws, appoint one’s own judges, and toss out elected leaders  –  might have a price, and he thinks it is a possible price worth paying.

In my post the other day, I noted that there were other examples of people being willing to pay such a price.  By the end of the 19th century Ireland was an integral part of the United Kingdom, with full representation at Westminister and unrestricted markets in goods, services, people, and capital.  And yet the cause of Irish independence gained strength rather than abated, and the south eventually gained independence, as the Irish Free State, in 1922.   Ireland kept on using sterling, and kept close economic ties to the UK –  as one would expect, given the proximity of the two countries and the previously highly-integrated economies.  But no one thinks Irish independence was good for Irish material living standards in the subsequent decades.

Here are the data in the Maddison database for GDP per capita.  The first observation is for 1913, before the disruptions of World War One, and the subsequent unrest leading up to independence.

ireland real gdpI’ve also shown the data for 1929 (the eve of the Great Depression) and 1939 (the eve of World War Two, which Ireland stayed out of).  There is always a lot else going on, so the whole story of Irish relative economic decline isn’t (the policy choices/constraints that followed) independence.  But much of it was.   Today, of course, Irish real GDP per capita is higher than that of the United Kingdom.

Was independence a mistake?  Well, it had a cost, but most things people count worthwhile do.

I got curious about some other post-colonial episodes, each involved economies much less integrated with the UK than Ireland’s had been.

India, for example, became independent in 1947.  In the late 1920s, full independence probably appeared to be many decades away, and probably wasn’t influencing investment choices or other economic decision-making.

india

Independence came at a cost –  wars in addition to any economic cost – but with hindsight would the Indians have chosen continued colonial rule?  Almost certainly not.

I spent a couple of years working as an economic adviser in Zambia.  At independence in 1964, Zambia had had GDP per capita as high as those of South Korea and Taiwan.  By the early 1990s it was something of a byword for basket cases (Zimbabwe’s true awfulness was still to come).  But here are the comparisons with the UK –  not, itself, a great economic success story over these years.

zambia

There were a few people who regretted independence – my colleague, the (local) chief economist lamented to me one day that the British had left when they did.  But it wasn’t a very common sentiment (or one that was politically acceptable to voice).

How about Rhodesia/Zimbabwe?  There was a two-stage process.  The white-minority government declaring unilateral independence in 1965, and then full legal independence with a universal franchise came in 1980.

rhodesia

In the first few years after the UDI there doesn’t seem to have been a material economic cost.  Those who supported UDI probably thought of it as some sort of win-win.  It didn’t last  –  the country soon descended into an insurgent war –  and of course the economic consequences after independence in 1980 are all too apparent.  I can imagine that quite a few Zimbabweans might really regret the course of the last 35 years –  though not, I imagine, too many members of ZANU-PF.

My final example is Bangladesh.  At Indian independence in 1947, what is now Bangladesh became East Pakistan.    But in 1971, after brief but awful war Bangladesh became independent.

bangladesh

Pakistan has scarcely been an Asian tiger –  model of economic transformation.  Bangladesh has done worse.

Inevitably this has been a rather limited exercise, focusing on countries in which I had an interest (NZ Baptist churches have had missionaries in what is now Bangladesh for 130 years), and where there is accessible –  if probably no better than indicative-  data.

I didn’t include New Zealand, Australia, and Canada because in all three cases there was no clear point at which the countries broke away from Britain.  It was an evolutionary process.  Perhaps in an ideal (economic) world, if Britain were going to pull back from the EU it would do so in a similarly evolutionary way.  But that option doesn’t seem to have been available.

And there may well be other examples of countries which flourished with independence –  Singapore is perhaps the striking example (although productivity growth in Singapore over say 1960 to 2000 was very similar to that in Hong Kong, which was British-ruled for almost all that period).  My point is not to argue that independence, or taking back parliamentary sovereignty, is inevitably or even generally costly.  I’m sure it isn’t.  But it can be.  And that may well be a price that citizens, even with hindsight, think is worth paying.

The relationship of Britain to the EU today isn’t that between, say, colonial Zambia and the UK, or even East Pakistan to West Pakistan.  But, equally,  Britain has strong established institutions and, if Brexit happens, every motivation, and plenty of opportunity, to secure pretty good economic outcomes.  If Brexit happens, I suspect that in 30 years time  –  perhaps 100 years time – scholars will still be debating what the long-term economic consequences of exit were (as indeed, they are still debating the economic consequences for Britain of entering the EU 43 years ago).  If so, perhaps the economic issues are not of first-order significance.

 

 

 

 

 

 

 

 

Stress tests really should reassure us…for now

Michael Reddell Financial stability, Stress tests

Last year, in the course of the Reserve Bank’s faux consultations on its proposed investor finance LVR restrictions, I devoted several posts to the results of the Reserve Bank’s stress-testing exercise.  Those tests –  2014 ones –  appeared to show that, even if faced with a very severe adverse shock to (in particular) house prices and unemployment, the New Zealand banking and financial system would come through substantially unscathed.  “Substantially unscathed” here meant some significant loan losses, not typically enough to wipe out even a full year’s profit, and a decline in capital ratios –  the latter simply because in the models as house prices fell the assigned risk weight on each still-performing loan would rise (eg a loan that might have had a 60 per cent LVR at origination becomes a 90 per cent  LVR loan if house prices fall by a third).   But there was nothing that suggested a threat to the soundness of any of the banks, or the banking system as a whole.   That result should not have been too surprising.  Bank shareholders have considerable amounts of  their own money at stake and credit allocation in New Zealand is not distorted by large scale government interventions (unlike pre-crisis US, or Ireland).  Housing loan books typically don’t see huge losses even in really severe crises –  and there hasn’t been a mad rush of highly risky corporate or property development lending in recent years.  But if the  banks came through such tough stress tests in relatively good shape, what possible basis could there be for yet more rounds of direct regulatory controls, which inevitably impair to some extent the efficiency of the financial system?

The Reserve Bank was never really satisfactorily able to respond to this point, even when some media and MPs started asking the questions.  The Governor went ahead and regulated anyway.

And now he seems to want to do so again.

This year, the Reserve Bank has been back with some more stress test results.  I wrote about their 2014 dairy stress test results here.  That scenario, and the results, didn’t look sufficiently severe, and there are already signs of worse outcomes than those indicated by the stress tests.

And then in last month’s FSR, we had the results of another set of stress tests on banks’ entire loan portfolios.

In late 2015, the four largest banks in New Zealand participated in a common scenario ICAAP test. This test was a hybrid between an internal test (conducted regularly with each institution choosing their own scenarios) and a regulator-led stress test (occurring every 2-3 years with common scenarios and assumptions). Due to the use of a common scenario across banks, the results of the test provided insights for the financial system as a whole. However, the test featured less standardisation of methodology than a full regulator-led exercise. For example, there was no ‘phase 2’ where loss rates were standardised.

Like the 2014 regulator-led stress tests, the scenario used in this exercise was severe

As with previous regulator-led tests, the stress scenario was a severe macroeconomic downturn. Over a three-year period, real GDP fell by 6 percent, unemployment rose to 13 percent, and dairy incomes remained at low levels. Residential property prices fell by 40 percent (with a more severe fall of 55 percent assumed for Auckland); and both commercial and rural property values fell by 40 percent. Finally, the 90-day interest rate fell by about 3 percentage points due to monetary policy easing,

These are very demanding scenarios.  In particular, for the unemployment rate to rise to 13 per cent, it would have to increase by more than 7 percentage points from the current quite-elevated level.  Even in the severe recession in the early 1990s, associated both with a financial crisis, disinflation and considerable fiscal consolidation, and a period of substantial structural change, New Zealand’s unemployment rate did not get above about 11 per cent.  No other floating exchange rate country has experienced an increase in its unemployment rate of that magnitude in modern times –  not even, for example, the US following 2007.

To be clear, I’m not objecting to the scenario.  Stress tests are really only useful if they use quite severe scenarios –  anyone can pass easy tests –  but this scenario looks to have quite a few buffers built in.  Similarly, a 55 per cent fall in Auckland house prices would be one of the larger falls ever seen anywhere –  again, not totally implausible, especially as New Zealand is prone to population shocks –  but about as large as the biggest falls ever experienced in an advanced country major city.   On the other hand, the last sentence of that scenario is worth noting: the ability to cut policy interest rates provides a substantial buffer (to economies and banking systems) in difficult times.  But with the OCR at 2.25 per cent, it would now be quite a stretch –  to the outer limits of conventional monetary policy –  for the 90 day bill rate to fall by three percentage points.  The Bank may need to take explicit account of that limitation in future stress tests.

In this stress test, the overall losses were quite substantial

The cumulative hit to profits averaged around 4 percent of initial assets (figure C1), which is a similar outcome to phase 2 of the full regulator-led exercise conducted in late 2014

Nonetheless, underlying operating margins were largely maintained, so that

underlying earnings during the scenario were of a similar magnitude to reported credit losses, so that return on assets averaged around zero.

In a very severe adverse scenario, banks did not make losses.  They simply did not make any profits.

But risk-weighted capital ratios still fell.

Although projected credit losses were largely absorbed with underlying profitability, capital ratios were expected to decline throughout the scenario. This reflected an increase in the average risk weight from around 50 to 70 percent, due to negative ratings migrations (rising probability of borrower defaults) and falling collateral values (rising losses given default).

In fact, although risk-weighted capital ratios fell during the scenario, simple leverage ratios, of total capital to total assets, (while not reported) are likely to have increased.  The dollar value of capital did not fall (no overall losses) while in estimating how the Reserve Bank’s severe shock would affect them and their businesses, banks generated results which implied a decline in credit exposures by 11 per cent. The Reserve Bank does not like leverage ratios, but most other regulators and analysts see a useful place for them –  the OECD, for example, used to regularly urge New Zealand to adopt them.

And here, for completeness, is that Reserve Bank’s chart of how the capital ratios behaved.

C2: Capital ratios relative to respective minimum requirements (% of risk-weighted assets)

Figure C2 Capital ratios relative to respective minimum requirements (% of riskweighted assets)

The regulatory minimum is zero on this chart, so banks were well away from that, even after this severe adverse shock –  and, of course, regulatory minima have been increased since before the 2008/09 downturn.  The grey area is the so-called “conservation buffer” and as the Reserve Bank notes

the average bank reported falling into the upper end of the capital conservation buffer in the final year of the test, which would trigger restrictions on dividend payments to shareholders (figure C2).

Since none of the big banks in New Zealand is listed, the temporary limitation on the ability to pay a dividend is unlikely to be too troubling.    Banks don’t want to be in the conservation buffer, and will seek to get out of it again.  But carry the scenario forward a year or two and on the basis of normal earnings they would probably get back there fairly quickly.  What each bank might actually do might, of course, depend on the health of its parent –  if the parents were experiencing a similar adverse scenario in Australia, the market and management pressures on the New Zealand subsidiary to quickly restore capital buffers would be materially greater.

Despite all this essentially “good news” story –  savage recession, huge unemployment, severe falls in leveraged asset prices, and yet the banking system is still in pretty good shape –  the Reserve Bank has never really been happy with the story.   That is implicit in the FSR and, from what I hear, also the story they tell people who come to visit them.

I think there is a variety of reasons for that, including innate regulator/central banker caution.  Some of that attitude is a good thing, provided it is conditioned by a good understanding of how systemic banking crises in other places/times have actually developed.  Here it doesn’t seem to be.

They also seem uneasy because their scenarios do not consciously take account of any second-round effects of the reduction in credit exposures the banks would effect as part of the response to the extreme adverse scenario.   As noted above, banks estimated that their credit exposures would fall by 11 per cent.  The Reserve Bank has long worried that such a reduction in the stock of credit would act as an additional factor amplifying the economic downturn and the fall in asset prices, such that the initial macro scenario they set out for the banks was no longer sufficiently demanding.

In principle, it is a fair point.  In practice, I think it is misplaced for two main reasons.

The first is that in developing their severe economic scenario they will have benchmarked it against other really nasty downturns in other times/places.  But any additional impact of forced bank deleveraging –  over and above the initial shock that triggered the downturn –  will already be included in the GDP/unemployment and asset price numbers we see.  The 1991 downturn in New Zealand included any additional impact from the BNZ and DFC failures, the post 2007 US recession included any deleveraging impacts from all the financial institution failure and additional lender caution, and so on.  It would be double-counting to take as extreme a scenario as the Reserve Bank is using, and then add a whole new downturn on top of that, as banks pulled in their lending horns.

The second reason is that it doesn’t look as though the Reserve Bank has given anything like adequate weight to the way in which the size of a mortgage book is driven primarily by house prices and housing turnover.    In the FSR discussion, they do note that the reduction in credit exposures “could reflect a reduction in customer demand” –  there is less investment etc in recessions for example – this seems a very weak statement of what would be likely to occur with bank mortgage books in particular.

A while ago, I ran a chart illustrating the way in which a simple initial shock to house prices goes on raising household debt to income ratios for years afterwards, even if there is no subsequent further increase in house prices.  That occurs just because the housing stock turns over relatively slowly, and so after prices move to a new high level it takes years for all purchases to have taken place at the new higher price (and associated higher need for credit).

This was that chart.  Price double in year 1, are unchanged thereafter, and borrower LVRs are the same after the initial shock as they were before.

scenario debt to income

In fact, in housing booms typically involve borrowers and lenders becoming less risk-averse and housing turnover increasing.

scenarios 2

You can see the difference higher initial LVRs and slower repayments make –  it still takes years for debt to income ratios to reach a new steady-state level, and the process will happen more or less automatically, unless banks actively stand in the way. Turnover and prices drive mortgage books.  When both increase, banks’ credit exposure will increase without them really trying.

But the same process can happen in reverse.

Recall that in the Reserve Bank’s scenario house prices fall by 40 per cent (and 55 per cent in Auckland.)  I’m assuming that the 40 per cent applies to the rest of the country, so lets say nationwide house prices fall by 45 per cent.  Each new house being purchased, even if the initial LVRs stay the same, now takes 45 per cent smaller mortgages than was required before house prices fell.

But in downturns, it isn’t only prices that fall.  In fact, turnover often falls first.  Sellers are reluctant to sell below purchase price, and many people are just genuinely uncertain. Economic downturns leave potential buyers more cautious too.  The drops in turnover can be very substantial.   Even in New Zealand, house sales per capita over 2008 to 2011 were only around half the rate seen at the peak of the boom in 2003.  Housing mortgage  approvals data only start at the end of 2003, but the same sort of fall is evident in approvals –  and this is a recession much less severe than the one in the Reserve Bank’s stress test scenario, and in which house prices fell by only around 10 to 15 per cent.

So what happens to the volume of housing credit outstanding if we assume:

  • house prices nationwide fall by 45 per cent, and stay at that low level thereafter
  • housing turnover (and new mortgages) fall by 50 per cent and stay at that low level for five years, before reverting to normal.

In the base scenario (the first chart above), we assumed prices double in year 1.    That produced a stock of debt which rose substantially in the first few years, and then kept rising slowly thereafter for many years.  Lets assume the severe adverse shock happens in year 10.  This is what happens to the stock of housing mortgage debt in the two scenarios.

scenarios 3

The differences are really large, without the banks even trying.   The housing market does it for them.  Within five years of the severe adverse shock, the stock of household mortgage debt is 10 per cent lower than it was just before the shock hit, and 20 per cent lower than it would be in the base scenario (where continuing turnover at the higher initial house prices carried household debt continually higher).  Even when turnover returns to normal, the stock of credit keeps dropping, just because new purchases are at the new much lower prices.

These scenarios are only illustrative, but they illustrate a key point: turnover and house prices drive the size of mortgage books, independently of any active choices banks make.  It seems quite plausible that bank balance sheets would shrink quite materially in the years following a shock like the stress test scenario, without the banks having to do very much active at all. Between lower turnover and low prices on both the housing and dairy books on the one hand and lower investment demand on account of the weaker economy on the other, there would be big savings in required capital simply from these customer choices.

Of course, in severe downturns, borrowers tend to be more cautious about how much they are willing to borrow –  and so it is quite plausible that borrower LVRs would shrink in the course of a shakeout like this, even without action by the banks.  That would further reduce the stock of debt.

And, of course, in a savage downturn of this sort one would have to expect banks to alter their lending standards –  pull in their horns.  This is something the Reserve Bank has never seemed comfortable with.   Way back in April 2008, just as the 2008/09 recession was beginning to become apparent, the then Governor was saying openly

Banks should avoid overreacting to the economic downturn, Reserve Bank Governor Alan Bollard told the Marlborough Chamber of Commerce today. “The New Zealand economy remains fundamentally sound and creditworthy,” he said.

“Banks, businesses and households alike need to recognise the new external environment and adopt a cautious approach – but don’t go into hibernation, the underlying economy remains robust,” he said.

In fact, the only sensible reaction of both banks and businesses, going into what proved to be a severe recession, from which in some respects the economy has still not fully recovered, was to pull in their horns.  That was especially so as the economy had quite severely overheated during the previous boom, and in some areas –  property development and dairy in particular –  credit standards had deterioriated very sharply during the boom.  The recession would prove that some of the critical assumptions –  by borrowers and lenders –  made during the boom were misplaced.  In the middle of the downturn no one knows what the correct “new normal” actually is, and considerably greater caution –  by lenders and borrowers –  was quite appropriate.  The only prudent step was to stop and reassess.

So it would be in a downturn –  a savage downturn –  of the sort in the stress test scenario.  Central bankers might win political brownie points by urging banks to keep lending.  But it isn’t obvious that it would be good business –  no Governor knows the future, any more than bankers and borrowers do.  Things no doubt do return to some sort of normal eventually, but as we’ve seen –  even in non-crisis in New Zealand –  quite when and how is a very open question.   And as I noted earlier, all those severe downturns that the Reserve Bank used to benchmark its stress test scenarios already included any pulling in of horns by banks (and borrowers).

This has become rather too long a post, so I will stop here.  Bank supervisors should never on their laurels.  Bank, and borrower, behavior can change quite quickly and the quality of loan books can deteriorate quite alarmingly quickly  –  and often does in the few years just before crises.  But on the stress tests the Reserve Bank has presented, and the supporting analysis the Bank has provided, there is little sign of anything other than a reasonably cautious prudent banking system, with robust capital buffers to cope with even seriously adverse shocks.  If the Reserve Bank wants to keep on imposing more and more controls, the onus really should be on it to show us what is wrong with its own published analysis and stress test results.

 

 

Household debt, house prices….and Sky

Michael Reddell Financial stabilty, Housing, Reserve Bank

 

Stories about household debt and house prices are everywhere at present.  For anyone interested, Radio NZ’s Sunday morning show yesterday had a 20 minute (pre-recorded) discussion with Chris Green, of First NZ Capital, and me on some of the issues. I think we agreed on more than we disagreed, both emphasizing that large falls in real house prices have happened before and will, no doubt, happen again.  And the domestic economy is currently less robust than either Treasury or the Reserve Bank would have us believe.

The Radio NZ interviewer was, it seemed, keen to run with a narrative of mass collective irresponsibility, but as I’ve noted here before there is no sign that higher house prices are leading to a huge surge in consumption (any more than has happened with previous house price booms), and good reason to think that many people are very uneasy about the size of the debts they are having to assume to get into a first house.  I could have added that house sales per capita, and mortgage approvals per capita are not particularly high by historical standards.  Scandalous as the house price situation is, if there is a mania –  contagious exuberant optimism –  it must be very localized.

Tomorrow, I want to focus again on the Reserve Bank’s stress tests and how we should think about those results.  But before getting into that, it is worth briefly repeating a few other relevant points.

First, there is the constantly repeated claim, especially from some commentators on the left, that the system of banking regulation incentivizes banks to lend on housing security, skewing their whole portfolios towards housing lending, beyond the natural levels justified by the underlying riskiness of different classes of loans.     That is simply false.    The essence of the argument is that in calculating capital requirements, loans secured on housing generally carry a lower “risk weight” than most other forms of bank credit.   They do, and that is because such loans are generally less risky.  Compare a loan secured on an existing house in an established suburb, supported by the wage or salary income of the occupants, with a loan to a property developer for a new project on the fringe of a fast-growing town and you start to get a sense of the difference in risk.   If anything, the initial risk-weighted capital regime (Basle I) probably overstated the riskiness of a typical housing loan and understated the riskiness of many corporate loans (and sovereign exposures for that matter).  In the shift to Basle II, many countries appear to allow banks to reduce risk weights for housing exposures too far.  New Zealand (the Reserve Bank) was much more cautious (even than, say, APRA in Australia).  As I’ve noted previously, the IMF has accepted that New Zealand’s housing risk weights are among the highest used anywhere –  other countries have been coming towards us.   There are reasonable arguments as to whether risk weights can ever be assigned in a fully satisfactory way –  hence the support in many circles for simple leverage ratios, as a buttress to the capital regime –  but there is no reason to think that all types of credit exposures should be treated identically.  Bankers wouldn’t –  with their own shareholders’ money at stake.

Second, there have been plenty of systemic banking crises around the world over the decades.  But as the Norwegian central bank, the Norges Bank, pointed out in a nice survey a few years back, which has been cited by our own Reserve Bank,

Normally, banking losses during crises appear to be driven by losses on commercial loans. Loans for building and construction projects and (particularly) commercial property loans have historically been vulnerable. Losses on household loans appear to be a less significant factor,

This was true, for example, in the Scandinavian crises of the early 1990s –  savage recessions in which (in Finland) house prices fell by 50 per cent and banking systems around the region got into severe difficulties –  and in Ireland in the most recent recession.  And each of those crises occurred in fixed exchange rate countries, in which the authorities had (in effect) abandoned the ability to use monetary policy to buffer severe adverse events.

Are there exceptions?  Well, the US in the most recent crisis certainly looks like one on the face of it.  Housing loans were at the epicenter of the crisis, and the US has a floating exchange rate.  But as I’ve pointed out previously, drawing on excellent book Hidden in Plain Sight, much of what went on in the United States was the direct result of the heavy direct government involvement in the US housing finance market, and the legislative and regulatory pressure placed on private and quasi-government lenders to lower their lending standards on housing exposures. Government-directed credit is often a recipe for some pretty bad outcomes.  Advanced countries where the government did not have a substantial role in the allocation of credit (especially housing credit) and where domestic monetary policy was set to domestic economic conditions –  rather than, say, pegged to German conditions –  did not have banking systems which experienced large losses on their domestic loan books, and especially not their domestic housing loan books.  I’m not aware of any exceptions in recent decades.   I looked at the post=2007 crises here.

Individuals who have taken out large amounts of debt just before housing (or other asset) markets turn can find themselves in a very difficult financial position.  If the borrower has a good income, it might just be an overhang of debt that limits mobility.  In principle, banks can foreclose on mortgages with negative equity, but they very rarely do so as long as the loan is being serviced.  And nasty housing market shakeouts often take place in the context of severe recessions –  in part because building activity is one of the most cyclical aspects of the economy and building activity tends to dry up when house prices fall sharply.  But the case just has not been convincingly made that the New Zealand economy and financial system are seriously exposed as a result of current house prices per se, or of the current level of household debt.  As a reminder (a) that level of debt (relative to disposable income or GDP) is little changed over the last eight years, after a sharp increase in the previous fifteen years, and (b) that level of debt did not cause evident problems when New Zealand last experienced a pretty serious recession in 2008/09.   And relative to the situation on the eve of the 2008/09, New Zealand households now have a much higher level of financial assets (again relative to income or GDP) than they had then.     The risks now may be more localized and concentrated in Auckland than they were in 2007, but there is little to suggest that they pose more of an independent threat to the whole economy or the financial system.  On all published metrics –  whether or capital or liquidity – the banking system is in better health today than it was in 2007 –  and the same goes for the Australian parent banks.  When you dig into the details of the Reserve Bank’s FSR, that is what the data say, but it isn’t what you hear from the Governor.

I’ve been concerned for some time that the Governor has an inappropriate focus on the US experience.  He lived in the United States for more than a decade, including during the 2008/09 crisis, and although his role at the World Bank was focused on emerging markets, he got to participate in some of the international meetings that were epiphenomena around the crisis –  ie lots of headlines, but of little actual relevance to dealing with the various national crises.  Inevitably, that sort of experience influences a person’s perspectives.   But the Governor has never given us any reason to believe that the New Zealand situation now is remotely comparable to the US situation in the run-up to the financial crisis.

Despite all the research resource at its disposal, the Reserve Bank has never published any analysis or research looking at the countries which did, and did not, have domestic financial crises (and especially ones sourced in the housing mortgage books).    What marked out the US and Ireland, for example, from New Zealand, Australia, Canada, the United Kingdom, Norway or Sweden?  Each had very high house prices going into the global recession of 2008/09, each had had very rapid credit growth, most were seriously affected by the recession itself, and yet some had serious domestic loan losses and domestic financial crises, and most didn’t.    Almost certainly, the difference was not simply that the US and Ireland were selected for crises by some celestial random number generator, which indifferently spared the other countries and their banking systems.    As he rushes from one ill-considered distortionary intervention to another, overlapping one control upon another, exempting some borrowers and some institutions but not others, and impairing the efficiency of the financial system, surely the Governor owes us at least this modicum of explanation and analysis?  And that is even before we start asking questions about why the Governor (and his staff) should be thought better able to decide on the appropriate allocation of credit than private institutions whose managers have built careers on making lending decisions, and whose shareholders have considerable amounts of their own money at stake.  Last I looked, the Reserve Bank –  and the Governor –  has nothing at stake in the matter, and they have demonstrated no track record of expertise in making credit allocation decisions. In that respect, of course, they are little different than their peers in other countries. The level of hubris on the one hand, and lack of deep thinking, research and analysis on the other, is quite breathtaking.

And yet our politicians let them get away with it.  They leave so much power vested in a single unelected individual –  selected by another pool of unelected individuals  – whose term is rapidly running out, and who won’t be around to be accountable for the consequences of his intervention.   Then again, perhaps he will.  A typically well-sourced Wellington political newsletter last week claimed that the Governor is well-regarded in the Beehive and might well be reappointed.  It seems unlikely –  and I’d be surprised if our scrutiny-averse Governor even sought another term – but the line must have come from someone, presumably someone reasonably senior.

But, on a quite different topic, now I’m going to stick up for the Reserve Bank.  Bashing government agency spending on all sorts of things makes good headlines.  Bad policies deserve lots of critical scrutiny, and bad polices typically cost taxpayers a lot of money, whether directly or indirectly.  But frankly I was unpersuaded by the Taxpayers’ Union’s latest effort, highlighted in the Sunday Star-Times yesterday, around government agencies’ spending on Sky subscriptions.  Among core government agencies, the Reserve Bank was one of the larger spenders, with a total outlay of around $12000 in the last year.  The Taxpayers’ Union specifically called attention to the Bank.

But why?   The Reserve Bank has a variety of functions, some of which (notably the financial markets crisis management functions) which might warrant a Sky subscription even for professional purposes.  But even if the rest of them are scattered around lunch and breakout rooms in the rest of the building, so what?  Any organization seeks to create a climate that encourages high levels of staff engagement, and the recruitment and retention of good staff.  Some people are just motivated by cash salary –  always the overwhelming bulk of costs for central government policy and operational agencies –  but many are motivated by a richer complex of considerations, including on-site staff facilities –  which might include the quality of the cafeteria, fruit bowls, coffee machines, the Christmas Party, Friday night drinks, medical benefit schemes, access to newspapers, or even access to Sky.  In the private corporate sector there is a range of different approaches –  some no doubt work best for some types of workers, and some for others.  Sometimes these things are actually cheap at the price –  there is more motivational benefit than there is cost to the organization, which suggests everyone is better off.   Access to Sky was never one of the things the Bank offered that particularly appealed to me –  then again, the bonds built over a morning coffee, or gathered round a TV late on a rare afternoon when New Zealand was on edge of winning a cricket test in Australia, were probably good for the Bank, and for staff attitudes to the Bank.

I’m all for serious scrutiny of government agencies.  But focus on the big picture. Look at the quality of the policy advice and research being offered up. Look at the overall costs of organisations and functions, including overall average remuneration levels –  and perhaps even focus on the details when it comes to what senior managers spend on themselves.   But leave managers some flexibility to  attract, manage, and reward good staff  –  within those overall constraints –  in ways that don’t leave them constantly fearing “will this be a Stuff headline”.    We’ll all be a little less well off –  citizens who need a good quality public sector, with a limited number of able staff –  if we don’t.

 

Brexit thoughts from the Antipodes

Michael Reddell Euro area, UK

My wife suggested a post on the contrast between British entry to the EU (or EEC as it was then) and the looming possibility of British exit.  She is young enough that British entry was a featured topic in New Zealand history when she did School Certificate history in the 1980s (for me, it was closer to being current affairs).  By contrast New Zealand media coverage of the British referendum is largely devoid of any particular New Zealand dimensions.  On a day when the British papers are highlighting a new poll suggesting that the Brexit cause could win, it seems like a good day for a few thoughts.

A lot has changed in the years since the early 1960s when New Zealand first faced the possibility of Britain entering the EEC, and the threat that posed to New Zealand’s major markets for dairy and lamb exports.  So important was the issue that, apparently, at New Zealand economists’ conferences in the 1960s a toast was often drunk to Charles de Gaulle, for his two vetoes of UK entry.

The make-up of our population has changed over that time, but in some ways less than one might think. In the 1961 Census, 9 per cent of the population had been born in the United Kingdom, and in the 2013 Census, 6 per cent had been.  And in most years, the United Kingdom is still the source country for the largest group of those given residence permits to live in New Zealand.  The UK still seems to be the favoured destination for New Zealanders looking for an OE, at least one beyond Australia.  Sporting ties, and rivalries, seem as strong as ever.   But if state high schools still sing “Jerusalem” and cathedral choirs still sing Stanford and Parry, the emotional ties are much less strong than they were.   In the early 1960s, it was less than 20 years since the end of World War Two, and less than that since the conflicts in Korea and Malaya where New Zealand and British troops had fought side by side.

But it is probably the economic ties that have changed most.  One of the after-effects of the war  –  and the huge overhang of debt the UK had taken on – was the Sterling Area, of which New Zealand was a part.  With a fixed exchange rate to sterling –  unchanged for almost 20 years – and our foreign exchange rate reserves held in sterling, overall sterling area access to US dollars affected each country in the area. Private international debt markets were much less developed than they had been in the past, or are now.  And New Zealand government offshore borrowing had been undertaken in the UK for more than 100 years –  it wasn’t until the very end of the 1950s that the first, expensive, New Zealand government loan was raised in the US.  Britain had been keen on New Zealand joining the IMF and World Bank –  we didn’t until 1961 –  partly because it would facilitate access to dollars for New Zealand’s capital needs.

And, most of all, the United Kingdom was a major export market –  as late as 1967, 44 per cent total exports went to the United Kingdom.  In the 1960s, almost all our dairy and lamb/mutton exports went to the United Kingdom.  As the New Zealand Ambassador to the US put it, in a prominent lecture he gave in New York in 1963, “the problem which we faced….was the threatened removal of the one remaining important free market for primary produce at a time when the highly industrialised countries of Europe are intensifying the trend to self-sufficiency in these products”.   There were, at the time, no credible alternative markets for some of the largest chunks of our exports.  And if Continental leaders were willing to consider UK entry to the EEC, they certainly didn’t see continuing New Zealand easy access to UK markets as part of the deal,  Indeed, one of the attractions of UK entry to them was detaching Britain from the Commonwealth and traditional suppliers of agricultural products (Australia as well).

Possible British entry was a huge issue for politicians and economic advisers in New Zealand in the 1960s and early 1970s, but it wasn’t a trivial issue in the British debate either.  Some of that was about past ties of blood, shared military sacrifice, shared family bonds and so on.  But some of it was economic too: New Zealand lamb and butter –  known as coming from New Zealand – had an established and significant place in the British retail market.  It would have been difficult –  perhaps impossible –  for Britain to have joined the EEC –  for British public opinion to have allowed it –  without “acceptable” arrangements for New Zealand and Australia.

At the time, material living standards in New Zealand were still higher than those in the United Kingdom –  ours were still among the best in the world.  The prospect of UK entry, with all that risked implying for markets for New Zealand produce, was a very dark cloud over those living standards.  (In that same lecture, our Ambassador to US, presumably citing received official opinion saw import substitution by building up local manufacturing, combined with rapid population growth –  natural increase and immigration –  as part of the solution).

The situation is nothing like symmetrical today.  The United Kingdom is still our sixth largest trading partner, but lagging a long way behind Australia, China, the United States and the euro-area.  If London remains one of the most important financial centres in the world, open capital accounts mean that the UK is not a particularly important source of financial capital at the margin –  and, of course, our government doesn’t borrow abroad, and our exchange rate floats.    There might be opportunities for New Zealand individuals and firms if the UK actually leaves the EU  –  our lamb exports to Europe (including the UK) are still restricted, and there are some hopes that revised immigration policies might treat New Zealanders the same as, say, other Europeans.  But these are probably second or third order issues for the New Zealand economy as a whole.   Some of those strongly campaigning for Brexit would favour a much more market-oriented approach to trade and regulatory policy, and anything that lifted medium-term productivity prospects would be good for the world (including us).   Whether there would be much improvement in the quality of policy is perhaps debatable –  other Anglo countries, not caught up in the web of Brussels, have not exactly been at the forefront of market-oriented liberalization in the last decade or so.

If Brexit isn’t a great economic opportunity for New Zealand, what about the risks on the other side?  The great and good of the economic establishment –  in Britain and internationally –  have been weighing into the debate to urge British voters to vote “Remain”.   Even President Obama has been recruited to the Prime Minister’s cause –  as if the views of a foreign leader should influence British voters views about the future of their own country.  Hundreds of economists have been writing to the papers urging the voters to vote to stay in the EU.  It is a curious spectacle.  One might have supposed that agencies such as the IMF and the OECD would have little credibility with anyone these days, and nor is it clear that they have (or even should have) British voters’ best interests at heart when they offer their advice.

The economic debate seems to turn on two, separate, issues.  The first is about the transition, and the second about the medium-term.  Actually, the two quickly converge.

We’ve already seen markets rattled each time polls suggest a heightened probability of Brexit.  It will, almost certainly, get much worse in the next few weeks if the latest polls are picking up something real.  And if Britain votes to leave, the days after that result is declared could be very very messy indeed.  Apart from anything else, the path ahead –  even for Britain –  is quite unclear, starting with who will be leading the British government to negotiate the exit terms.

The world economy and financial system are hardly in fine robust health.  And the policy buffers if things go wrong are few and very limited –  in monetary policy alone, almost everyone is already starting with interest rates around zero.  Britain itself just isn’t that important –  nukes, a Security Council seats, and London as a financial centre notwithstanding. Then again, it is only a year or so since the Scottish referendum was unnerving markets, and Greek crises have repeatedly wrought havoc for the last few years.  Why?  Because what starts in one place probably won’t stop there.   No one was really comfortable that the wounds to the euro could be cauterized if Greece left. What of the EU itself?

It isn’t as if euro-skepticism is a uniquely British phenomenon.  I thought this Pew Research chart from a few days ago was fairly telling

eu favourability

Public opinion in France is less favourable to the EU than that in the UK, and the UK numbers are little different than those in Spain, Germany and the Netherlands.

Which is why a lot of the economists’ contributions to the UK debate seem rather moot.  They come up with estimates –  really not much better than back of the envelope ones, despite all the apparent sophistication  –  suggesting a potential loss of income to the average Briton if the UK leaves.  But that all assumes that the rest of the EU holds together largely as it is.  And that doesn’t seem very likely at all.  In fact, as with the cause of Scottish independence, a defeat in a single referendum seems unlikely to make the exit issue go away even in the UK.  As with the euro itself: break-up fears wax and wane, but it will be a very very long-term (most likely never) until that risk disappears altogether.

So really the economic establishment –  in the UK and globally –  is urging British voters to vote “Remain” to hold the whole EU project together.  They can’t actually say that –  that would suggest a fragility they just can’t publicly acknowledge –  so they have to pretend that it is all about the British voters’ own best interests.  This week it reached ludicrous extremes with David Cameron suggested that people who voted “Exit” weren’t being patriotic and didn’t believe in their country.

But very few British voters really want any part of an “ever-closer union”.  Actually, few voters in most of the rest of Europe do either.  And yet everyone recognizes that  the euro in particular can’t credibly hold together without further progress in that direction.  Probably most voters are quite keen on free trade in goods –  and to a lesser extent in services – among European countries, but they don’t want their laws made by unelected officials in Brussels, or even by majorities of ministers from other countries.  And they don’t want their laws interpreted, and application decided, by foreign judges.  It is quite a bit about what being a nation state is.  Many aren’t too keen on a lot of immigration either –  no matter how often the elites assert that benefits flow from it.  That seems like the sort of choice citizens of each country should get to make.  And to be able to toss out the people who make laws and regulations they disagree with.

I’m not a Brit –  all my ancestors were, but they left in 1850 and shortly thereafter –  but of all the countries in the world other than New Zealand, Britain is  probably the one I care most about.  Were I a British voter, I’d vote for Exit.  Not because Britons would necessarily be better off economically –  they could be, with the right policies, but one doesn’t decide the future of one’s country based solely on narrow economic considerations.   Had it been otherwise, perhaps New Zealand in the 1960s could have done a Newfoundland, and given up our independence to become part of the UK (in case anyone is wondering, I’ve not found any who suggested doing that).

Voting to leave the EU would be, to some extent, a step into the unknown.  But big important choices often are – whether to go to war, to marry or to break-up a marriage, to split a country, or an empire.  People in Ireland were probably worse off (economically) for decades from leaving the United Kingdom, but who is to say their choice was wrong or illegitimate. One must be prepared to count the cost of those choices.   But if British voters want their country to be as independent –  but still, inevitably interdependent –  as New Zealand, or Australia, or Canada, or the United States, then Exit seems like the way to vote.  It might be a rocky ride, even for the rest of us –  perhaps it might even be the unwelcome way in which Graeme Wheeler gets the TWI down –  but it is a perfectly reasonable choice.  And one voters in other countries are likely also to make before long.   The EU as we see it today looks a lot like a project that has badly over-reached.

 

A question for The Treasury

Michael Reddell Immigration, New Zealand economic performance, Treasury

One thing I like about the Reserve Bank is that it has largely stayed clear of Twitter.  They use it –  you can find them here – but there was a deliberate decision made a few years ago to use it only to highlight new Reserve Bank releases; links to articles, research papers, press releases etc.  I’ve always been sceptical of a medium for expressing ideas in 140 characters or fewer.

The Treasury is a bit more adventurous in their use of Twitter (here), offering editorial perspectives at times, and enthusiastically retweeting things from other people and organisations  (here and abroad) who either endorse something Treasury has done or said, or that Treasury agrees with or endorses.

This Treasury retweet of something from a British academic caught my eye the other day.

             

Jun 1

Distance matters (still): Trade volume with UK vs distance of trading partner from the UK.  

It is quite a nice chart from The Economist that illustrates a now fairly well-known point.  Firms and people do much more trade, all else equal, with firms and people in countries close to them that with those in countries far away. I don’t think this particular version of the chart is wholly compelling: it uses the total value of trade between countries, but population numbers matter as well, and it might have been better to illustrate the point using per capita trade values instead.  Doing so in this chart would move both Ireland and New Zealand a long way up relative to the other –  mostly much larger –  countries that are highlighted.  But the key point holds: distance matters, a lot.  Not just in terms of who one trades with, but in terms of how much total foreign trade is done at all.  For small countries even more than for large countries, the ability to successfully sell more and better stuff to the rest of the world is a vital part of improving a country’s long-term economic fortunes.

In retweeting it, presumably official Treasury was keen to remind us that distance matters to New Zealand too.    There is no way Australia, for example, would be the largest trading partner for New Zealand firms if, for example, these islands were set in the Bay of Biscay.

Treasury has made a useful contribution over the years in reminding us of this point.  They developed the useful line 15 of so years ago that drawing a circle with a 1000 km radius around Wellington would encompass 4.5 million people and lots and lots of seagulls. while a comparable circle around Vienna or Seoul would encompass hundreds of millions of people.  Sadly, seagulls aren’t a terribly promising market.

Treasury also included this chart in their Holding On and Letting Go document, which formed part of their 2014 Post-election Briefing to the Minister of Finance

Figure 8: New Zealand’s geographic challenge
Selected countries distance from world markets and populationFigure 8: New Zealand's geographic challenge . Note: The x axis is scaled so that each marker is ten times the magnitude of the previous one.
Source:  World Bank: World Development Indicators, ITC: Trade Map, CEPII

Among OECD and major emerging economies, New Zealand is more distant from markets than any other country.  Chile and Australia are almost as distant.  Chile is a much poorer country, and Australia –  while wealthier –  is very fortunate in the scale of its usable natural resources, but when one looks at the productivity data it is no longer in the top tier of countries.

Treasury also produced an interesting piece of formal empirical research a couple of years ago  using cross-country data to look at the various barriers to foreign trade that New Zealand faces.  In the modelling they report, distance shows up as a highly statistically significant factor influencing (negatively) the volume of foreign trade a country does.

Distance  –  and trade – isn’t mostly about land, it is about people.  Our islands are really remote, but much of what counts is the people living here, who have to find ways of making and selling stuff abroad, especially if we are to have any chance of offering top tier incomes and material living standards to those people.

And so it puzzles me that Treasury never seems to consider population size –  and especially the role of immigration policy in changing population size over time – when they discuss the implications of distance.  4.5 million or so of us face the (quite substantial) penalty of distance.  What leads Treasury to think that exposing ever more people to that “tax” –  not as a result of New Zealanders’ private fertility choices, but as a direct result of government policy –  makes sense.  As I’ve pointed before, in none of Treasury’s writing on immigration policy in recent years has there been any sense of evidence that a large scale (notionally skills -focused) immigration policy has been doing anything useful to lift the overall productivity performance of New Zealand, and the income prospects of New Zealanders.  If anything, we’ve continued to lose ground relative to other advanced countries.

For some time it has surprised me that Holding On and Letting Go had scarcely any mention of immigration policy, and most of the (few) references to immigration were simply to the cyclical pressures, rather than the medium-term issues, even though (for better or worse) it is one of the larger government policy interventions in the New Zealand economy.

Treasury argues that “geography isn’t destiny”, and there is clearly an element of truth in that.  But I don’t think they have yet taken seriously enough the nature of the geographic constraint.  Yes, New Zealand did have top tier incomes for decades, but it did so by exporting natural resource based products deploying/supporting a very small population.  There are no more natural resources here than there were 100 years ago,  the overwhelming bulk of our exports are still natural resource based (not just the obvious farm products, but fish, wine, gold, oil, the electricity that produces aluminium, and tourism) and yet we now have four times as many people as we had in 1916.  Some countries make the transition from natural resources.  When Captain Cook got to New Zealand, Britain’s exports were about 95 per cent based on Britain’s own natural resources.  These days, very little of her exports are.  We have shown very little sign of being able to make that transition.

That isn’t because we don’t have smart, able, innovative people, or good institutions, it seems to be largely because places this remote don’t successfully support many non-natural resource based businesses.  There aren’t any other examples of places that successfully do –  the other even more remote islands are too insignificant to even get on Treasury’s chart.   Internationally-oriented non natural resource based businesses might start here, but mostly the business will be worth more if, in time, it comes to be based somewhere a lot nearer markets.  In some cases, proprietors will like to live here, and will sacrifice growth to keep the business here –  but it is a sacrifice, and in that sacrifice is a measure of the limitations of this place  as a (remunerative) home for too many people.  As one person who runs a small global business here recently put it to me, face to face contact still matters a lot, and if air travel is a bit cheaper than it was 50 years ago, it is no less physically draining or time-consuming.

So my question for Treasury is something along the lines of, why not take seriously (a) the lack of hard evidence that New Zealanders have had economic benefits from immigration, combined with (b) your own recognition that distance matters a lot, and (c) the fact that New Zealand remains a heavily natural resource based economy, with few signs that that is really changing, with no more natural resources being made (and increasing environmental concerns/constraints),  and then think harder about whether a government policy to drive up New Zealand’s population –  even as New Zealanders have kept on leaving –  really makes much economic sense at all.  Treasury has recently asked some good questions about the skill mix of our actual migrants, but they need to think harder about whether there are really top tier income-earning opportunities here for very many people, even if we could somewhat improve the average skills level of those who come.

Distance and location really do seem to matter, a lot.  Policymaking hasn’t really taken that seriously.

Still unconvincing

Michael Reddell Monetary policy, OCR

We expect inflation to strengthen reflecting the accommodative stance of monetary policy, increases in fuel and other commodity prices, an expected depreciation in the New Zealand dollar and some increase in capacity pressures.

So said Graeme Wheeler in his MPS press release this morning.  I thought it sounded like a familiar line, so I went back and had a look.  This seems to have been the Governor’s 30th OCR decision.  Back in his very first OCR announcement in October 2012 he said this

While annual CPI inflation has fallen to 0.8 percent, the Bank continues to expect inflation to head back towards the middle of the target range.

And in all those 29 statements since then –  with perhaps just one exception –  he has been saying much the same thing: inflation will increase.  And actual inflation –  headline, and the range of core measures – just keeps on being below target.

At the Bank’s press conference, Bernard Hickey asked if the Bank could be regarded as having done its job, given that even on its own forecasts (persistently too optimistic) there would have been six years of inflation below the target midpoint by the end of 2017, when the Bank again expects headline inflation to be back to 2 per cent (the Bank doesn’t publish forecasts of the core inflation measures, but I doubt the picture would be any different if they did –  it has also been four or five years since the various core measures were clustered around 2 per cent).  There were a range of possible plausible answers to that question, but I wasn’t prepared for the one Assistant Governor John McDermott actually gave: he said “your timeframe is very short”.  Six years……when monetary policy generally works over perhaps a two year horizon, and when the Governor’s term –  in a system built on personal accountability –  is only five years.

Yes, it wasn’t a very good day at the Reserve Bank today.    Inflation is apparently expected to increase partly because the exchange rate is expected to fall.  At 8:59am, the exchange rate was already above what the Bank was assuming in the MPS projections,  and a few minutes later it was another per cent higher, and it rose a bit more in the course of the press conference.  I’m not sure why the Governor expects the exchange rate to fall back if his rosy domestic economic story is correct.  Perhaps he expects a lot more tightening in the US.  But, again, he has been expecting that almost since he took office in 2012.

Some of the other bits in that statement as to why he expects inflation to rise were a bit puzzling too.  The Governor apparently thinks “accommodative monetary policy” will do the trick, but in real terms the OCR is probably a bit higher than it has been for much of his term (certainly than in the year or so before the unwarranted tightenings), and the TWI this afternoon is only slightly lower than the average level for the Governor’s term to date.  Set aside for now the question of whether conditions are actually “stimulatory” or “accommodative” in absolute terms, but if they are more accommodative now than over the last four years, the difference isn’t large.  Core inflation didn’t pick up over those four years, and it isn’t obvious why it is going to do so now.

The Governor also apparently expects “some increase in capacity pressures”.  One would hope so, given that on the Bank’s own estimates we have had eight consecutive years of a negative output gap.  But it isn’t clear why the Bank expects capacity pressures to increase from here.  They are forecasting quite an increase in residential building, but we’ve already had four or five years of increasing residential investment activity, through two very large shocks to demand for residential investment –  the Canterbury earthquakes, and the large unexpected surge in immigration.  All of that, on top of buoyant commodity prices earlier in the period, wasn’t enough to turn the output gap positive or get the unemployment rate back to more normal levels, or lift inflation back to target.  It isn’t obvious why things should change now –  especially as, like other forecasters, the Bank expects the net migration inflow to fall away quite sharply.

The Governor could be right.  Macroeconomic forecasting is, in many ways, a mug’s game.  But he has been wrong for several years now, as his predecessor was in his last couple of years.  It isn’t obvious that he has a compelling story to tell as to why inflation pressures are finally about to pick up. But if he has such a story it isn’t in the Monetary Policy Statement.

Meanwhile, there is a great deal of complacency. I heard the Governor talk of significant real wage increases, strong tourism, strong immigration, significant building activity, and so on.  All without any sense that per capita income growth has remained disappointingly weak.  Neither the Governor in his comments nor the text of the MPS itself even mention an unemployment rate that lingers at 5.7 per cent, years after the end of the recession.  If anything, the Bank appears to believe that excess capacity in the labour market is already exhausted (see Figure 4.8).

The Governor also made great play of non-tradables inflation.  He is quite right that, over time, non-tradables inflation (or at least the core of it, excluding government taxes and charges) is what monetary policy can really influence.  Even exchange rate effects –  which the Governor weirdly tried to play down –  over the medium-term work by influencing overall pressure on domestic resources and thus non-tradables inflation.  But non-tradables inflation typically runs quite a bit higher than tradables inflation, even in a stable exchange rate environment.  That is partly about the labour intensive nature of many of the services included in non-tradables inflation (hair cuts are the classic example, where there is limited scope for productivity gains).  With an inflation target centred on 2 per cent, the common view among economists inside the Bank used to be that one might expect non-tradables inflation to average perhaps a bit above 2.5 per cent, while tradables inflation might average a bit below 1.5 per cent per annum.  Together, they would be consistent with medium-term CPI inflation (ex taxes etc) of around 2 per cent.

But here is what non-tradables inflation looks like in recent years.  This series excludes government charges (eg the cut in ACC motor vehicles levies) and tobacco taxes (which have been increasing sharply each year).  It doesn’t take out the effect of the 2010 GST effect, but it is easy enough to visually correct for that – it accounts for about 2 percentage points of the inflation rate over 2010/11.

nt ex govt charges and tobacco

There is a bit of variability in the series, but it has been years since this measure of core non-tradables inflation got even briefly as high as 2.5 per cent, let alone fluctuating at or above that level.  And this is the series that should have borne the brunt of the Christchurch rebuild pressures –  which probably explained the increase in this measure of inflation in 2013/14.  Non-tradables inflation is what the Bank can influence. It really needs to be quite a bit higher to be consistent with the target specified in the PTA –  and on current Bank policy, there is no particular reason to think it is going to happen.

I outlined again yesterday my take on how the Governor operates: he is really bothered about the housing market, and really doesn’t want to cut the OCR.  But he can’t afford to see core inflation drift much lower –  he can get away with it holding around current levels (somewhere, in the MPS words, in a 0.9 to 1.6 per cent range) –  so will cut if data surprises really force him to, but not otherwise.  Today was a classic example of that model in action.  In the run-up to the March MPS it was, he said, the expectations survey data that really rattled him.  There has been nothing comparable since and so, mediocre economic performance and weak inflation notwithstanding, there was no OCR adjustment.

Instead, today was all about housing, and financial stability.  Perhaps we were supposed to have forgotten that the FSR was released only a few weeks ago and in his press release on that occasion the Governor began by extolling the resilience of the New Zealand financial system.  Often enough the Governor has been reluctant to comment on financial stability issues in monetary policy press conferences, and it is only three months since I praised him for his response on house prices at the March MPS press conference

And when asked about the impact of a lower OCR on house prices, he succinctly observed “well, that’s just something we’ll have to watch”.  By conscious choice, house prices are not part of the inflation target, either in New Zealand or in most (if not all) inflation targeting countries.  It is one, important, relative price, influenced heavily by a range of other policy considerations.  And if bank supervisors should pay a lot of attention to house prices, and associated credit risks, it is a different matter for monetary policymakers.

All that was long gone today.  It was, in effect, all about house prices and the possible threat to financial stability.  I don’t recall hearing, or reading, anything about stress tests (they’ve been pretty positive), or capital requirements (they seem to have been quite – rightly –  onerous by international standards), or even about the Bank’s benchmarking exercise to better understand how individual banks are modelling similar risks.  High house prices can be a source of risk if they are financed with poor quality lending, backed with inadequate capital.  But there was none of that analysis today.  Instead, there was a regulator champing at the bit to impose even more controls, touting the LVR restrictions to date as “very successful”.  Apparently more LVR controls could be only weeks away –  although of course they will have to consult on any new controls, with a mind open to considering alternative perspectives and evidence –  while loan to income restrictions seem to be a bit further down the track (they are doing analytical work on them, rather than detailed instrument design, or so it seemed from the Governor’s comments).  The Governor really seems to have it in for people buying residential properties for rental purposes, and yet can never quite tell us why.  He reminded us again today that some 40 per cent of property turnover involves such purchasers, but never ever addresses the simple point that in a badly-distorted system where the home ownership rate is dropping towards 60 per cent, the remaining homes have to be owned by someone.

The Governor and Assistant Governor were at great pains to emphasise that monetary policy is required to have regard to “financial stability”.  The relevant phrase isn’t new –  it has been in the Act since 1989 –  but it isn’t quite what the Governor said it is either.  Section 10 of the Act requires that

“In formulating and implementing monetary policy the Bank shall have regard to the efficiency and soundness of the financial system”.

Efficiency is listed first, both there and in the Policy Targets Agreement.  And yet, puzzlingly, I didn’t hear anything today –  or in the FSR press conference a few weeks ago –  about the efficiency of the financial system.  New controls, ever more detailed controls, overlapping LVR and DTI controls, all imposed on some classes of lenders and not on others, some classes of borrowers and not others, are usually considered ways of seriously undermining the efficiency of the financial system.  But the Governor seems not to care.

Perhaps more importantly, in a discussion about monetary policy, neither financial soundness nor financial system efficiency –  nor the avoidance of “unnecessary instability in output, interest rates and the exchange rate” –  are equal objectives with the inflation target.  Price stability is the Bank’s primary statutory objective, and the inflation target centred on 2 per cent in the practical expression of that.  It doesn’t mean headline CPI inflation is, or should be, bang on 2 per cent each and every quarter.  But six years –  with no assurance that even six years will be an end of it –  below target really is too much.  It was, after all, the Governor who added explicit mention of the midpoint to the PTA.

The Governor also found himself on the backfoot over communications, coming on the back of the recent BNZ analysis and yesterday’s Dominion-Post article.  In some obviously-prepared lines, the Governor went to great lengths to argue that there was simply no problem.  For a start, he and his colleagues agreed, people simply hadn’t read his February speech carefully enough  (set aside for a moment that point that if people misread your carefully prepared communication, it probably says something about that communication itself).  Oh, and we shouldn’t be surprised that there had been quite a few surprises in monetary policy lately, because the OCR was actually changing.  He seemed to ignore the fact that, as I noted yesterday, in 2014 the OCR had moved quite a lot and there were no major communications problems.  It got worse when he then argued that if one looked at 2006 to 2010 there were similar surprises –  as if he thought we’d forget that 2008/09 saw one of the biggest global financial crises ever, and huge  –  unprecedented  – OCR changes.  It simply wasn’t a very convincing performance.  The Governor’s communications haven’t been good enough recently.

A journalist asked him about the sharp reduction in the number of on-the-record speeches. I hadn’t really noticed this, but when I checked it was certainly true.  In his early years, the Governor made much of how the Bank was going to do more on-the-record speeches. In 2013 there were 17 and in 2014 there were 18.  Last year there were only eight –  a fairly normal sort of level in pre-Wheeler years – and this year so far there have been only four, only one of which was given by the Governor himself.  The Governor could offer no particular reason for this, but then fell back on a rather petulant anecdote, citing one business journalist who the Bank had asked for comment on the Governor’s speeches.  This journalist had apparently described them as “too complicated and with too many ideas”.  The Governor’s plaintive response was “I hope they get read”.  It was a slightly sad performance.  Unfortunately, it is true that neither the Governor’s speeches nor those of his colleagues really match the standards of those of their peers at the RBA, the Bank of England, the Bank of Canada, or the Fed.  We should expect better –  considered reflections, expressed clearly.  Part of accountability often involves such speeches, especially when –  as with this Governor –  he is apparently so reluctant to give interviews.  Embattled, the Governor appears to have withdrawn to his fortress.

Oddly, John McDermott offered the thought that while the number of speeches had dropped, there had been a “massive increase” in the number of other publications: “we don’t just communicate through speeches”.  I was a bit taken aback by this claim  and went to the website to check.  There does seem to have been a small increase in the number of Analytical Notes (author’s own research, including the standard disclaimer that it doesn’t speak for the Bank) and Bulletin articles (although there the increase seems to relate mostly to financial markets and the regulatory functions).  But there has been a big increase –  perhaps “massive” is not too strong a word –  in the number of Discussion Papers.  This year, so far (five months in), there have been eight published, compared to a typical annual total of six each year in recent years.  But…again, Discussion Papers are authors’ own research, complete with the standard disclaimer. In most cases, DPs are intended as the basis for submissions to academic journals by the Bank’s research staff.  Sometimes they have interesting material, but often –  abstract and introduction aside – they are fairly incomprehensible to someone who is not a specialist in the particular area.  They don’t attract much attention outside academe, and have never –  to my knowledge –  been used as part of official policy communications.   If senior policymaker speeches have a role, publications like DPs aren’t a substitute for them.

All in all, neither the MPS itself nor the press conference were the Reserve Bank anywhere near its best.  They will probably get away with it because the domestic banks seem mostly unbothered about the persistent undershoot of the inflation target.  But they really shouldn’t.  The Board, the Minister and Treasury should be asking hard questions –  both about the substance of policy and its presentation.

Finally, the Reserve Bank’s “modelling” of long-term inflation expectations got elevated as far as the press release today.  We are assured that these expectations are “well-anchored at 2 per cent” (not even “around” or “near” but “at”).  For these purposes, the Bank uses a couple of surveys of a handful of economists.  It isn’t clear what useful information the results have for current policy, since respondents will reasonably assume that some other Governor, and some other chief economist, will be setting monetary policy before too long.  But it also gives no weight at all to the market-based measure of implicit inflation expectations we do have.

iib breakevens to june 16

125 points of OCR cuts has still not been enough to convince people actually buying and selling government bonds to raise their implied 10 year expectations above 1 per cent.

People just don’t believe –  whether on this measure or in the other surveys – that inflation is going to settle back at 2 per cent any time soon.  They’ve been right to be skeptical.   That should trouble the Bank, and those paid to monitor it.    Expectations surveys aren’t an independent influence on inflation –  often they are a reflection of past actual outcomes –  but the way the Governor was talking today it sounded as though it might take another inflation expectations shock, or perhaps a GDP surprise, to bring about another cut.  The next expectations survey data won’t be available until after the next MPS.