“Ethical” investment

There has been a new upsurge recently in coverage of so-called “ethical” investment, and some mix of genuine and confected “outrage” over the investment of money in the shares of companies that may be involved in the production of various disapproved goods and services.  The main focus of attention has been on the government’s own investments – particularly those in ACC and NZSF –  and those of the government-promoted Kiwisaver funds, especially the default funds in which many people passively find some portion of their savings invested.  There even seems to be the possibility that some of these holdings may be illegal, and knowing/intentional breaches of the statutory ban on financing the production of cluster bombs carry very heavy criminal penalties.

In the Dominion-Post on Monday, Rob Stock had an article pointing out that moral concerns might not be limited to companies making cluster bombs, tobacco products, or whatever other product is particularly shunned right now.  I wasn’t entirely sure whether he was serious, or simply trying to highlight the absurdity of the whole business, but as he noted one could raise similar objections to holding the sovereign bonds of many countries based on the policies those governments run –  on his reckoning such a list could readily include Qatar, Israel, China, the US, Japan, Turkey, Russia, the Philippines.

Choices people make about what to do with their money are a moral matter.  Passively or actively, a person’s choices reveals what matters to them.  I’m a Christian, and so a believer in absolute truth.  But I doubt that would even lead to a unanimous view on what investments were appropriate, even among members of a single small local congregation.  How much greater is the difficulty in reaching a common view among much larger pools of investors, in an age when all faiths and none compete in the marketplace for ideas?

That is one reason why I remain staunchly opposed to the New Zealand Superannuation Fund.   In that fund, the government has taken money, by force, from citizens and invested it according to the moral precepts of those running the fund.  Actually, it is probably worse than that.  They’ll invest in anything (lawful), but will pull back if particular vocal lobbies succeed in creating too much perceived reputational risk for them.  It simply rewards the vocal, and the modern rent-seekers (pursuing a “cause” rather than personal profit) and forces minorities into investment holdings they may be quite uncomfortable with  (and in some cases probably keeps even majorities out of investments they might be quite comfortable with).

Some might be unhappy with investments in firms making weapons, tobacco products, involved in whale hunting, or in funding governments that apply the death penalty. Others probably have problems with coal or oil producers.  I don’t have a particular problem with any of those investments, but I do object to investing in (or having my taxes invested in), for example, firms associated with the Chinese government, or (US-listed) hospital chains providing abortions, or casino companies and so on.  My point is not to argue the merits of my particular concerns, but to highlight the near-impossibility of reconciling the range of individual concerns, individual freedom, and investments through large scale collective (particularly compulsory) entities.

In the genuinely private sector, and for schemes that are open to new money, there is a bit of a market test: funds won’t keep on investing in particular companies/products if investors are withdrawing their funds or new investors are going elsewhere.  But that doesn’t grapple with the moral point.   Personally, it leaves me uncomfortable with collective investment vehicles, unless they are very clear in advance of what sorts of companies, or governments, they’ll invest with.  You make your choices and I’ll make mine.  And all  but the most scrupulous –  or most morally indifferent –  will almost inevitably have to make trade-offs: what matters enough to adjust one’s investment (or consumer custom) in response to.

As it happens, I’m a trustee of a superannuation scheme –  the Reserve Bank Staff Superannuation and Provident Fund.   Our scheme is not a public body, isn’t subject to the Official Information Act,  and is not subject to any directions from either the Reserve Bank itself or the Minister of Finance. Neither the Crown nor the Bank gets any direct financial benefit from our investment choices.  We aim to ensure that we obey the law, and as the law requires, we seek to act in the best interests of members.  So the investments of our scheme are really only a matter for our members.  Probably the only thing the members have in common is that they work, or once worked (most are now retired) for the Reserve Bank.   Some will be smokers, some won’t.  Some will favour coal mining, others won’t.  Some will support Israel, others won’t.  And so on. Quite how the trustees of such a fund should invest, or avoid investing, is quite a challenge.  Since we have fiduciary responsibilities, it can’t just be on the basis of the personal preferences –  likes and dislikes –  of individual trustees –  let alone, some prevailing public “mood”.  In an age where one can no longer count on much common ground in values, morality etc, it is probably another reason to welcome the demise of old-fashioned workplace savings schemes.

New dwellings and population growth

I hadn’t really intended to write anything today –  tempted as I was by the topic of so-called “ethical investing” – but yesterday’s post on how best to look at new building consents relative to population (growth) sparked a surprising number of comments so I thought some brief follow-up comments and charts might be in order.

My single main point yesterday was that new building permits per capita, whether compared across time or across TLAs, is not a particularly useful indicator of anything.  There are substantial differences in population growth rates –  both across time and across TLAs – so that simple comparisons of consents for new dwellings relative to the current stock of population won’t tell observers anything useful about how supply/demand balances are unfolding in particular markets, or how responsive land use and building regulation allow markets to be in particular times and places.

For either purpose –  and perhaps particularly for the latter – one really probably needs a more formal empirical model that can capture more of the idiosyncracies of particular times and places, and some of the two-way causation that can be at work (eg population growth generates demand for housing, but a readily responsive housing supply might also make such a locality more attractive to more people).  Fortunately, in comparing across TLAs in a single country we can treat a lot of things as constant (applying similarly across all TLAs) –  eg the same tax system, the same interest rates, the same banking system, the same trends in divorce rates, or childbirth rates (the latter two have clear implications for the number of houses demanded per capita).  But there are still local idiosyncratic features that need to be taken into account at times.  The most obvious of these in recent New Zealand history is the impact of the Canterbury earthquakes, which led to the loss of a lot of existing houses, especially in Christchurch city and Waimakariri (Kaiapoi).    Even if the population of those places didn’t change much at all, one would expect a lot of new dwelling consents in the years following such destruction simply to re-establish the previously desired volume of housing.  Seeing a lot of new dwelling permits in those (and neighbouring) localities might not tell one much about the responsiveness of the regulatory systems in those council areas, but simply about the specific nature of the shock.  And –  fortunately –  we don’t know how other localities (and their regulatory systems) would have responded to a natural disaster of that sort.

Building permits per capita don’t tell us much at all.  Building permits for new dwellings per person increase in population tells us more, but it is still a far from perfect measure –  especially when, as around Christchurch, there is a sudden need to replace existing lost houses.  So in my post yesterday I used the SNZ national data on housing stocks, and compared the (estimated) change in the housing stock to the (estimated) change in population.  This was the resulting chart.

housing stock

At a national level, the net increase in the number of houses has been very weak relative to (estimated) population growth, and there is no sign of any improvement.   It isn’t a perfect indicator –  changing birth rates or divorce rates might affect the desired number of people per house – but it is less bad than anything else we have.

What about at the TLA level?  We don’t have annual housing stock estimates (that I’m aware of) and the latest annual subnational population estimates are for June 2015.  So we are pushed back to using new dwelling consents.  Comparing consents with population growth produces silly answers in places with falling populations –  where there is usually some new building just to slowly replace the existing stock –  or even places with very low population growth rates.  So in what follows I’m just going to focus on places that are

  • relatively large, and/or
  • have had reasonable population growth

but with a particular focus on Auckland, greater Wellington, greater Christchurch, Hamilton and Tauranga.  The readily accessible data go back to 1996.

Here is an easy-to-read chart comparing the experiences of Auckland and Hamilton.  Both cities have had around a 40 per cent increase in population over the period.

akld and hamilton

But in only one year of these nineteen were more new houses being built per each new resident in Auckland than in Hamilton.  There might be some underlying demographic differences  –  as I said, ideally one needs a fuller empirical model –  but on the face of things it doesn’t reflect very favourably on the land use and building restriction of the Auckland council(s).  At least up to June 2015, there was no sign of the gap closing.

Tauranga has actually had faster population growth than either Auckland or Hamilton over the 20 years.  Here is what the chart looks like when we add Tauranga.

akld hamilton tuaranga

Pretty consistently higher (apparently more responsive to changes in demand) than Auckland in particular.  But what really stands out is the final four or five years on the chart.  Auckland and Hamilton are seeing less new building (relative to population growth) than they used to, while activity in Tauranga has held up at around the average for the previous 15 years.

What about Wellington and Christchurch?  The population of greater Wellington (Wellington, Upper and Lower Hutt, Porirua, and Kapiti) has grown by only 17 per cent over this period.  I never voluntarily defend Wellington local authorities.  Perhaps –  quite probably –  in a climate of heavy land and building regulation it is easier for building to keep pace with more modest population growth.  But for the full period, here is the number of new dwelling consents per person increase in population.

Auckland 0.32
Hamilton 0.38
Tauranga 0.45
Wellington 0.49

Greater Wellington has actually seen more building, relative to population growth, than even the least bad of those northern cities.

Christchurch is a story complicated by the loss of houses as a result of the earthquakes.  One would simply expect to see a lot more permits in that region following the earthquakes even if the population changed little.  Greater Christchurch encompasses three TLAs –  Christchurch city, Waimakariri and Selwyn.  The Selwyn council has a reputation for having facilitated growth –  including the otherwise improbable meteoric post-quake growth of Rolleston.

If we split the sample and look at the years up to June 2010 (ie before the first earthquake), the number of new dwelling permits in greater Christchurch relative to the (quite strong) growth in population had been higher than in Auckland, Hamilton or Tauranga over the same period –  but still a little behind Wellington.

The loss of existing houses muddies the post-2010 data.  If we take the full period (1996 to 2015) in the table above greater Christchurch comes out at 0.66 –  far above the other large cities.  But, of course, greater Christchurch lost lots of existing houses –  so the high numbers tell one nothing about supply/demand balances, or responsiveness of councils.

But one interesting angle is to look just at Selwyn.  Queenstown apart, Selwyn has had the highest population growth rate of any TLA in New Zealand over the last 20 years (107 per cent).  And Selwyn had few houses destroyed in the quakes. This is the chart of new dwelling consents per person increase in population in Selwyn.

selwyn

It is certainly a better experience than Auckland’s, but nothing to write home about.  In fact, in the sub-period prior to the quakes, the rate of new dwelling consents per increase in population was a little lower in Selwyn than it had been in Christchurch city itself. Of course, an open question is to what extent people moved to Selwyn because of a responsive regulatory system –  in turn pushed to its limits –  and to what extent because the land itself was more stable, and the new motorway made places like Rolleston very easy to get to and from.

And what if we add fast-growing Queenstown into the mix?

New dwelling consents per person increase in population (June years 1997 to 2015)

Auckland 0.32
Hamilton 0.38
Tauranga 0.45
Wellington (greater) 0.49
Christchurch (greater) to 2010 0.50
Queenstown 0.53

Of course, much of Queenstown’s construction is likely to be holiday homes, but nonetheless the contrast –  in a town with very rapid population growth – with Auckland (and even Hamilton) is striking.

As a final caution, do note that the sub-national population numbers for the period since the 2013 census are estimates, themselves derived from national population estimates.  In a couple of years’ time, after the next census, some of the recent population data could look quite different, affecting the interpretation of some of these recent construction numbers.  But in most cases, the patterns were well in place before even the 2013 census.

 

The badly dysfunctional New Zealand housing supply market

This chart has had a bit of coverage in the last few days.  It was produced by Statistics New Zealand, and was included in a useful release last week bringing together dwelling consent and population data over the last 50 years or so.

snz picture

As SNZ noted, there is a bit in the chart for everyone.

The number of new homes consented per capita has doubled over the past five years, but is only half the level seen at the peak of the 1970s building boom, Statistics New Zealand said today.

One sees these sorts of per capita charts from time to time, but I’ve never been sure they were very enlightening.  After all, the existing population typically doesn’t need many new houses built –  it is already housed, and the modest associated flow of new building permits will result mostly from changes in tastes, changes in occupancy patterns (eg more marriage breakups will probably increase the number of dwellings required for any given total population) or perhaps even the age composition of the population.  Even quite big differences in  the number of new dwelling permits per capita don’t, in isolation, tell you much: Marlborough and Gisborne have very similar populations, but over the 21 years for which SNZ provides the data, there were almost three times as many houses built in Marlborough as in Gisborne.

Mostly (at least in countries like this one), new houses are needed for increases in the population.  Marlborough’s population was growing over that period, and Gisborne’s wasn’t.

So we might be more interested in the growth of the housing stock relative to the growth of the population.   Growth in the housing stock is typically more interesting than building permits, because if two old villas are demolished to build six townhouses, it is the net addition to the number of dwellings that is typically more interesting, than the number of new units consented.  In recent New Zealand context, if lots of houses are destroyed by an earthquake, the gross number of new consents won’t offer much insight on the supply/demand balance.

SNZ produces some housing stock estimates.  I’m not sure quite how they do them, but they suggest that each year typically about 2000 existing dwellings are destroyed, a tiny proportion of the (current) stock of around 1.8 million dwellings.  If New Zealand’s overall population was static, there would still be a small amount of replacement activity and –  if the Gisborne numbers are roughly indicative –  perhaps 11000 new dwelling consents a year for the country as a whole would be fine.   Gisborne house prices, for anyone interested, are still lower than they were a decade ago.

Here is the nationwide picture since 1991.  This shows the increase in the number of dwellings per increase in the population  (thus, 0.4 means one new dwelling added for each additional 2.5 people).

housing stock

So, far from  the situation improving in the last few years –  as the SNZ chart above might have suggested (and as SNZ themselves suggested) –  things were worse than ever in the year to June 2016.  The population is estimated to have increased by 97300, and yet the housing stock is estimated to have increased by only 23800.  Talk about dysfunction, and no wonder house prices have been rising strongly.  In 1999, 2000 and 2001, by contrast, the population increased by only around 21000 per annum.

SNZ doesn’t have (or not that I can find) annual housing stock estimates back to the 1960s, but we can still look at the new building permit numbers relative to the change in the population.   Here is the chart showing new dwelling permits per person increase in the population.

housing 60sWhat happened?   Well, in the late 1970s the large scale outflow of New Zealanders got underway, and the number of non-citizen immigrants had also been scaled right back.  In the years to June 1979 and June 1980, the population is actually estimated to have fallen slightly, and yet 18000 and 15000 new dwelling consents were granted in each of those two years.  For the three June years from 1978 to  1980 there was no population growth at all, and yet there were more than 50000 new dwellings consented.  No wonder that over the late 1970s and through to around early 1981, New Zealand experienced the largest fall in real house prices (around 40 per cent) in modern history.

Nothing in the data suggests that the New Zealand housing and land supply market is now even remotely capable of coping with population increases of 2 per cent per annum.  Of course in some sense it should, and could, be fixed.  But there is little or no sign of it happening –  are there any reports of peripheral land prices in Auckland collapsing since the Unitary Plan was adopted? – which makes the continued active pursuit of rapid population growth look even more irresponsible (than it would already be, given the absence of evidence of other real economic gains to New Zealanders from such a, now decades-old, strategy)

Still abusing the Official Information Act

I still don’t have much energy back and posting next week is also likely to be light, but I didn’t want to let pass another shameless abuse of the Official Information Act.

Several weeks ago I lodged a submission with the Reserve Bank on their (long and slow) consultation on the publication of submissions to consultations.  I made the case for a default approach of full publication –  bringing the Bank into line with a widespread practice now in the rest of the public sector.  If necessary, I argued, the Bank should promote a minor legislative change that, for the avoidance of doubt, might ensure that they were fully able to release submissions on matters relating to the exercise of the Bank’s regulatory powers.

The consultation on publication of submissions was not about the exercise of regulatory powers, so there was no question that submissions to that consultation were covered by the Official Information Act.  So I lodged a request asking for copies of the submissions.

I don’t suppose they will have received that many submissions to this consultation.  Few of the submissions are likely to have been long.  The issues covered by the consultation concern the Reserve Bank only, not any other agencies, so there shouldn’t be any need for inter-agency consultation.  And of course the Act requires official information to be released “as soon as reasonably practicable”.  So my request should, quite easily, have been able to be dealt with within, say, 10 days.

But this afternoon I received this letter

Dear Mr Reddell

On 3 August 2016 you made a request  under the provisions of the Official Information Act (OIA), seeking:

“copies of all submissions received by the Reserve Bank on this consultation up to and including the close of the consultation period on 5 August 2016,” where the consultation you are referring to is the consultation on the default option for publication of submissions.

The Reserve Bank is extending by 20 working days the time limit for a decision on your request, to Friday 23 September 2016, as permitted under section 15A(1)(b) of the Official Information Act, because consultations necessary to make a decision on the request are such that a proper response to the request cannot reasonably be made within the original time limit.

You have the right, under section 28(3) of the Official Information Act, to make a complaint to an Ombudsman about the Reserve Bank’s decisions relating to your request.

Yours sincerely

Angus Barclay

External Communications Advisor | Reserve Bank of New Zealand 2 The Terrace, Wellington 6011 | P O Box 2498, Wellington 6140   +64 4 471 3698 | M. +64 27 337 1102

It isn’t the most time-sensitive request ever, and there have been more egregious Reserve Bank obstructions, but the law is the law.

Actually, I suspect they are delaying not because any “consultations” are necessary, but simply because it doesn’t suit them to release anything until they have released their own final decision.    But that isn’t a legitimate grounds for extending a request, and nor should it be.  The Bank is, of course, free to make its decision on the substance of the policy on its own timetable, but the submissions are public information.  A public institution committed to open government, transparent policymaking etc etc, would already have released the submissions.    But not the Reserve Bank.

The Ombudsman promised a few months ago to start reporting on how agencies did in responding to OIA requests.  It will be interesting to see how the Reserve Bank –  which actually does make much of its alleged openness and transparency (about stuff it doesn’t know –  the future –  rather than stuff it does know –  official information)  – scores.

The Governor has form

If one had simply been handed the Governor’s speech this morning, with no other knowledge of the New Zealand data, or of the Governor’s stewardship of monetary policy in his four years in office, it might have seemed quite reasonable.  And a person who had a good track record in making sense of inflation pressures and adjusting the OCR to keep inflation fluctuating around the target would have built a store of reputation and credibility.  Backed by all the analytical resources at his command, one might be inclined to be influenced by such a person’s analysis and storytelling.

But Graeme Wheeler is not that sort of person. Instead, he –  and his advisers –  badly misread inflation pressures, and after champing at the bit to raise interest rates, he launched an ill-judged, unnecessary, and ill-fated tightening cycle.  He set out on his quest talking up a coming 200 basis points of OCR increases, before finally bowing to reality after 100 basis points, and has only, and mostly very grudgingly, lowered the OCR since then.  In real terms, the OCR today is no lower than it was before that tightening cycle began.    And so core inflation lingers well below the midpoint of the target –  a focus he and the Minister had explicitly added to the PTA in 2012 –  and the unemployment rate is now into an eighth year materially above anyone’s estimates of the NAIRU.

Of course, forecasting and policy mistakes are, to an extent, inevitable.  No one is granted the gift of perfect foresight –  and if anyone had, they’d be better employed somewhere other than a central bank.  But what has compounded the problem –  the reasons not to take too seriously what the Governor says –  is his continued failure to even acknowledge mistakes, let alone express any contrition.  It is hard to have any confidence that someone has learned from their mistakes if they won’t even own up to having made obvious ones.  And while no individual speech can cover everything, it is striking how totally absent any treatment of the Bank’s conduct of monetary policy over the last four years was from this one.

Since my wife will be ticking me off for overdoing it and not resting if I write too much, I wanted to pick up on just two points in the speech.

The first was the Governor’s apparent model of inflation.

low inflation in some countries is linked to demographic change, especially in countries with a declining workforce and rapidly ageing population. Low inflation is also due to technological change around information flows and energy production, and to the global over-supply of commodities and manufactured goods;

Which sounded depressingly like the excuses and alternative explanations that were touted, in reverse, in the 1960s and 1970s.  At that stage people talked about the role of union power, occasionally even about demographics, about oil prices and resource scarcity and so on.  Each of those phenomena were real –  as those in the Governor’s list are –  but to cite them as explanations for persistently high, or persistently low, inflation is some mix of cop-out and analytical failure.

Persistent inflation –  or the absence of persistent inflation – is always and everywhere a monetary phenomenon.  By that, I don’t mean printing banknotes, and I don’t mean particular levels or growth rates for things central banks call “monetary aggregates”.   I mean simply that monetary policy can, if it chooses (or is permitted to) counter the impact of the sorts of factors the Governor listed and deliver an inflation rate that averages around target.  If they no longer believe that, the Reserve Bank should hand back its remit.

Sometimes, the job of monetary policy is harder than normal, and sometimes easier.  In the 1960s and 70s, with overfull employment in many countries, lots of union power, and lots of demand pressure associated with a rapidly growing workforce, it took a lot of effort to get and keep inflation under control.  Some countries did pretty well.  Others –  and New Zealand and the UK were two prime examples –  did poorly.  In the current climate, there seem to be a variety of ill-understood factors dampening inflation pressures globally.  Some countries have done well in countering them –  Norway is an example, and on Stan Fischer’s reckoning the US might be too.  Others less so.  But last year, on IMF numbers, around 90 countries had inflation in excess of 2 per cent, and almost 70 had inflation in excess of 4 per cent

Of course, the current effective lower bound on nominal interest rates, a bit below zero, does constrain many countries’ freedom of action.  But it doesn’t change the fact that inflation is a monetary phenomenon –  it is just that regulatory and administrative practices hamstring the ability to use monetary policy to the full in those countries.  Low inflation in other countries doesn’t make the Reserve Bank of New Zealand’s job harder. although common global factors –  affecting us as much as other countries –  may do.

Before turning to the second main aspect of the speech I wanted to comment on, I would note that there was plenty in the speech that I agreed with.  My differences with the Bank have never been about how the inflation target is specified and I agree that the government should not be considering lowering the target when the next PTA is signed next year. There might be a case for considering raising the target –  to minimize the risk that the near-zero bound becomes a problem –  but that is a topic for another day.   As the Governor notes, no other governments in other countries have changed the inflation targets their central banks work to, or abandoned inflation targeting.

The second area I wanted to focus on was the section devoted to explaining why the Governor disagrees with people like me, who think that interest rates should be cut further now.  Here is what the Governor has to say.

This view advocates bringing inflation quickly back to the mid-point of the inflation band by rapidly cutting the OCR. Driving interest rates down quickly would lower the exchange rate, contributing to increased traded goods inflation and stronger traded goods sector activity. The ensuing increase in house price inflation is not seen as a consideration for monetary policy, even though there would be an increased risk of a large correction in the housing market and associated deterioration in economic growth.

There would be considerable risks in this strategy. An aggressive monetary policy that is seen as exacerbating imbalances in the economy would not be regarded as sustainable and would not generate the exchange rate relief being sought.

With the economy currently growing at around 2½ – 3 percent and with annual growth projected to increase to around 3½ percent, rapid and ongoing decreases in interest rates would likely result in an unsustainable surge in growth, capacity bottlenecks, and further inflame an already seriously overheating property market. It would use up much of the Bank’s capacity to respond to the likely boom/bust situation that would follow and would place the Reserve Bank in a situation similar to many other central banks of having limited room to respond to future economic or financial shocks.

Such consequences suggest that a strategy of rapid policy easing to extremely low rates would be counter to the provisions in the PTA that require the Bank to “seek to avoid unnecessary instability in output, interest rates and the exchange rate” and to “have regard to the soundness of the financial system”.

Do note the rather loaded language throughout this section.

Note too, as context, the chart of the real OCR

real ocr to aug 16

To this point, far from having seen “rapid” OCR cuts, the OCR in real terms hasn’t yet got back down to where it was before the ill-judged tightening cycle began.  Context matters: if the Governor were making these sorts of arguments when the real OCR was already 100 bps below previous record lows, with the labour market overheating and inflation rapidly heading back to 2 per cent, they might sound more plausible

As it is, I’m not  quite sure what to make of the comments.  On the one hand, in the first paragraph he accepts that such a strategy would work by lowering the exchange rate. But then in the next paragraph he appears to suggested that unexpectedly rapid OCR cuts would not in fact lower the exchange rate.  We all know that foreign exchange markets can be fickle things, but I’m pretty confident that if he’d come out this morning and said “you know, on reflection it does look as though interest rates will need to be quite a bit lower than we had thought.  We’ll do whatever it takes to get inflation fluctuating back around 2 per cent, and at present it looks as though that might mean the OCR has to head towards 1 per cent” that the exchange rate would be quite a lot lower.

And what of GDP growth?  Recall, that the Bank has persistently overestimated how rapidly spare capacity has been used up.  Their forecasts currently have GDP growth accelerating to 3.5 per cent. But the expectations survey they run  –  and apparently now want to gut – suggests informed observers don’t agree: latest expectations among that group were for growth of 2.5 per cent and 2.4 per cent in each of the next two years.   On that basis, those observers don’t expect the substantial excess capacity in the labour market to be absorbed any time soon.  And as a reminder to the Bank, to absorb an overhang of unemployed people the economy has to have a period of faster-than-sustainable growth.  To get core inflation back to target typically involves much the same sort of pressures.

In fact, most of this is –  as always with this Governor –  about house prices.  In his description of the “further cuts” view, the Governor notes that for those running this view

The ensuing increase in house price inflation is not seen as a consideration for monetary policy

That is because it is not, under the current Act and PTA, a relevant consideration for monetary policy.  The target is medium-term CPI inflation.  House prices don’t figure in that index and –  unless they have had a major recent change of view –  the Bank doesn’t think they should.  Monetary policy has one instrument and can really only successfully pursue one target.  The Minister of Finance and the Governor agreed that target would be medium-term CPI inflation.

But perhaps my biggest concern is that the Governor is now falling back, quite openly and formally, on the spurious argument that if he cut more now, he would only increase the chances of running into the near-zero lower bound at some future date.   His logic here is totally wrong, and his approach is only increasing the risk of lower-bound problems becoming an issue for the Reserve Bank of New Zealand.

With hindsight that is pretty clear. Remember that I’ve pointed out that we’d have been better off if the Governor had done nothing at all on monetary policy in his four years in office.  Actual inflation would be a bit higher –  since average interest rates would have been lower, and no doubt the average exchange rate –  and, on the Bank’s own reckoning (they point out that expectations appear to have become more backward looking) inflation expectations would have been higher.  Higher inflation expectation would, in turn, have supported higher nominal interest rates now (for the same real interest rates).    But the same analysis applies looking ahead.  If the OCR were cut further and faster than the Bank currently plans then, on their forecasts, inflation and inflation expectations would rise, helping to underpin higher nominal interest rates in future.  The risk of the current strategy –  especially given the Bank’s asymmetric track record –  is that actual inflation continues to undershoot, excess capacity lingers, and in response inflation expectations drift ever further downwards.  If that happens, the nominal OCR will have to be lowered just to stop real interest rates rising.

The lesson from a wide variety of advanced countries over the last decade is surely that, with hindsight, they didn’t cut their official interest rates hard enough and far enough early enough.  I stress the “with hindsight” –  there was little good basis for knowing that in 2009, but there is much less excuse for central banks, like the RBNZ and RBA, that still have conventional policy capacity.

On which point, two other observations:

  • there was still no reference in the speech to New Zealand doing anything about making the near-zero lower bound less binding.  There is simply no excuse for the New Zealand authorities to have done nothing pre-emptive to ensure that the ability to use monetary policy aggressively in the next downturn is not constrained by artificial constraints around the price of physical banknotes.
  • in his alarmist rhetoric about “further inflaming” the housing market, the Governor appears to have forgotten completely the line the Bank used when LVR restrictions were first imposed.  Asked then why not use monetary policy instead, the (correct) response was that our modelling suggesting that it would take 200 basis points of OCR increases to have the same impact on the housing market as the (quite limited) estimated impact of LVR controls.  No one –  not even me –  is suggesting that the OCR should be cut by 200 basis points now.  And if the Bank is concerned about banking system risks from high house prices, it has capital requirements that it could adjust.

Once again, this is a speech that reflects a key aspect of the Governor’s underlying “model” –  his fear that inflation might be just about to break out, all while taking little or no responsibility for the fact that it repeatedly fails to do so.  I’m caricaturing a little bit, but not a lot. Go back and read what he was saying leading into the 2014 tightening cycle, and then read those paragraphs from today’s speech that I included above –  written from a point where the real OCR is still slightly higher than it was before the tightening cycle.  That mindset clearly shapes how he thinks about policy and his asymmetric view of risks.  Past performance might not be a good predictor of future performance in investment management, but in senior managers and key decisionmakers it often is. It is hard to self-correct unrecognized biases –  perhaps especially if the decisionmaker thinks those biases are actually strengths.   The Governor has form. Unfortunately, it is has mostly been poor form.  It is not clear why that bad run is about to break.

In passing, it is just worth noting one of the Governor’s final observations

Central banks do not have special powers of market foresight or a franchise on wisdom. But they do have significant research and analytical capacity that can deliver valuable insights, and this is being applied to challenges associated with the current global economic and financial developments.

And yet, neither in the text of the speech nor in any of the 11 footnotes, is there any reference to any Reserve Bank research at all.

English demonstrates why monetary policy governance needs to change

Writing about monetary policy the other day, I observed that

we all know that ex post accountability for monetary policy judgements means little in practice (perhaps inevitably so)

Our (unusual) system for the governance of monetary policy was built around the presumption that such accountability could be made effective, but it has long been clear that wasn’t correct.  The Acting Chief Economist of Westpac, Michael Gordon, is quoted in the Herald saying:

“There needs be tighter enforcement of it [inflation targeting]. The problem at the moment is the only option the Finance Minister or the Reserve Bank board has is the nuclear option of sacking the governor, and of course they don’t want to do that, so it’s just left to drift.”

I think that is only partly right (and actually the Board can’t dismiss the Governor, only the Minister can).  The issue isn’t so much the lack of powers as the lack of will (in turn perhaps reflecting lack of incentives).  The Board and the Minister could give the Governor a very hard time –  well short of sacking him (something I doubt anyone wants) –  but don’t.

The Reserve Bank’s Board met yesterday and, if past practice is anything to go by, it will have been the meeting at which they finalized their Annual Report –  their job being, primarily, to monitor and hold to account the Governor.  It has been a pretty bad year for the Bank and the Governor.  Inflation continued to undershoot the target, communications has been patchy at best, and the analysis in support of the Governor’s housing finance market controls remains at least as poor as ever.  And then there was the OCR leak.  These things happen –  sometimes it takes a breach to highlight system vulnerabilities –  but the refusal to take any responsibility, and then to resort to smearing the person who brought the leak to their attention, showed something of the character of the Governor, his Deputy, and the Board members who –  passively or (in the case of the chair) actively – backed his approach.  In a post last month, I suggested what a good Board Annual Report might actually look like –  one that took seriously the problems, as well as seeking to build on the strengths of the institution.  We’ll see when the report is finally published, but I’m not optimistic that there will be any evidence of serious scrutiny or accountability.

The Minister’s approach to all this was nicely reflected in another useful Bernard Hickey story

English was asked if the Governor had failed to meet his PTA target with English.

“I think that’s an unfair assessment in the circumstances,” English told reporters in Parliament.

So inflation, on the Bank’s own forecasts, will be away from target for seven years and that’s okay according to the Minister of Finance.  Of course, the first year or two of that wasn’t the current Governor’s responsibility, but it seems unlikely that in the five years of inflation outcomes he is responsible for, inflation will get to 2 per cent at all.   And yet Mr English and Mr Wheeler explicitly inserted that 2 per cent focal point into the PTA.

I’m not sure that “failed” is open to an easy yes or no answer.  But it wouldn’t have been hard for the Minister to have noted that “look. pretty obviously there have been some mistakes and misjudgments, at least with the benefit of hindsight, and that’s unfortunate.  But humans make mistakes –  even politicians do –  and, as I think the Governor has pointed out, often private economists had even higher inflation forecasts than the Bank did”.

But, no.  Instead, the Governor is absolved of all blame/responsibility.

“If world inflation was 2-3% and we were wandering along at 1% and had high unemployment then I think you could say that,” he said.

As the Treasury has pointed out –  to him and to us –  the unemployment rate is still well above the NAIRU, and has been for the whole of the Governor’s term (in fact, almost the whole of the government’s term).  Oh, and there is that pesky new under-utilisation series as well –  almost 13 per cent.

And then there was the first half of that sentence.  It sounded a lot like the sort of nonsense criticism we used to get back in the late 1980s when the price stability target was being set: Winston Peters, for example, used to argue that we couldn’t possibly get inflation lower than that of our trading partners.  Perhaps it was true in the days of fixed exchange rates, but securing that monetary independence was one of the reasons the exchange rate was floated 30 years ago.  If your target inflation rate is lower than that of your trading partners, you should expect to see the exchange rate appreciate over time, and if your target inflation rate is higher, than the exchange rate should depreciate over time.

And as it happens, when I checked the IMF database, world inflation last year was 2.8 per cent last year, a little lower than the 3.2 per cent the year before.  I suppose the Minister had in mind other advanced economies or the G7 –  they each had an inflation rate last year of around 0.3 per cent.

The Minister goes on

“But the fact is we’re dealing with the threat of deflation around the world.”

Well yes.  Many countries have exhausted their conventional monetary policy capacity, and are stuck.  We aren’t, and there is simply no reason why a country with policy interest rates well clear of the effective floor can’t keep core inflation relatively near target.  As Norway has done, for example.

I suspect the Minister knows all this very well, but it is easier and less politically risky to blame deep foreign trends outside our control, than to cast any doubt on the performance of the Governor for whom he is responsible, and risk reflecting adversely on his own government’s economic performance.  He did fire the odd shot across the bows of the Governor last year –  which never came to much, even in his annual letter of expectation –  but perhaps the government itself was under less pressure then?

The Minister continues with his defence, falling back on the “quality problems” approach preferred by his leader.

English said any assessment had to take into account that the economy was growing at faster than 3% with stable interest rates and moderate wage growth.

“These are characteristics of an economy that is actually succeeding, not one that’s failing, and that’s the important context of the discussion you have about the Reserve Bank,” he said.

“Whatever the niceties of Reserve Bank monetary policy, the fact is the economy is producing jobs, it’s lifting incomes and that’s relatively unusual.”

GDP growth has been around 3 per cent in the last year –  but then population growth has been just over 2 per cent.  That’s pretty feeble per capita income growth.  Perhaps GDP growth will strengthen from here –  as the Reserve Bank forecasts –  or perhaps not.

And I’m not sure what to make of the final phrase in that block, the claim that “the economy is producing, jobs, it’s lifting incomes and that’s relatively unusual”.   I’ve been among those making much of the dismal long-term economic performance of the New Zealand economy, but per capita real income growth is the norm not the exception –  and typically at a faster rate than we’ve had in the last few years.

But perhaps the Minister has in mind international comparisons.  Since 2007 we’ve done a little better than the median advanced country in GDP per capita comparisons.  Good quarterly estimates are harder to come by, but I did find some on the OECD website.  Of the 28 member countries for which they have data, the median increase in real capita GDP in the most recent year (typically year to March 2016, as for NZ) is 0.9 per cent.  In other words, per capita growth in the typical advanced country is running about as fast (or slow) as that in New Zealand.  Few people anywhere in the advanced world think that is a mark of success.

Pushed further, the Minister reverts to his “it is all too hard” defence of the Bank (and, by implication, himself):

“But any reasonable person would think that it’s quite difficult when you’ve got a deflationary effect around the world, where deflation has become the big threat, rather than inflation. Our Reserve Bank is trying to achieve the target in a global context where inflation is zero and interest rates are negative in some places,” English said, adding it was challenging for the Reserve Bank to hit its target.”

Many “reasonable people” might think that –  it might sound initially plausible when the Minister of Finance says it –  but they would be wrong.  Many other countries have largely run out of policy capacity.  We haven’t, but we –  or rather the Governor –  have simply chosen not to use it.  Perhaps few people would want to hold against the Bank the initial failure to recognize what was going in the wake of the 2008/09 recession, but it is seven years later now.  We spend a lot of money employing capable people in the Reserve Bank to recognize trends promptly and respond sufficiently firmly to keep inflation near target.  Perhaps one day we’ll also have exhausted conventional monetary policy capacity –  sadly, more probable than it needs to be because the Minister and Governor have done no planning to remove the roadblocks that create effective lower bounds –  but we are nowhere near that situation now.

As I noted the other day, all the Governor has needed to do over his entire first four years in office was…..nothing.  If he’d just left the OCR at 2.5 per cent then, whatever, the global pressures, inflation (and inflation expectations) would be nearer the 2 per cent target today.  I’m sure the Minister knows that.  He probably knows that the 2014 tightening cycle was completely unnecessary, and that subsequent reversal was –  and remains –  grudging at best.  But the Minister won’t say any of that, even in more muted and diplomatic terms.

And I can sort of understand why not.  After all, the economy isn’t in fact doing that well.  Unemployment remains disconcertingly high, the government’s export target is totally off track, per capita income growth is subdued, and there is no sign of governments fixing the disaster they’ve made of the housing market.  But if the Minister is critical of the Governor’s performance –  even though that is the model the Act envisages –  it will probably blowback on the Minister himself.   The Governor isn’t up for election, but the Minister and his colleagues are.

And that was my starting point: the sort of ex post accountability the current legislative framework is built around is simply unrealistic in all but the most egregious (almost inconceivable) circumstances.  And that makes it all the more important to the get the right people for the job in the first place, including not putting so much power in the hands of single unelected person who most probably won’t effectively be held to account if that person does make mistakes or prove not well-suited to the job.  The current Governor only has a year to go on his term.  It is tempting to suggest, quoting Cromwell to the Rump Parliament or (more recently) Leo Amery to Neville Chamberlain

You have sat too long here for any good you have been doing. Depart, I say, and let us have done with you. In the name of God, go!

In fact, we’ll just have to wait out the end of the Governor’s term, and the Minister –  despite his defence –  may be as pleased as anyone to see that term end.  There is a real challenge in finding the right replacement –  there is no obvious Churchill figure (nor, fo course, a crisis of that magnitude)  –  but the focus should really be on reforming the institutional arrangements so that no one person carries that much power without effective responsibility.  Other countries don’t do it.  And we don’t do it in other areas of government.  It is time for a change.

(And it is also time for a break. I’ve been slowly recovering from surgery last week. I have a reasonable amount of energy for the basics, but none to spare, and next week I have some other stuff I just have to do. If there are any posts next week, they will be few in number.)

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The social democrats at the Productivity Commission

A short time ago, a press release from the Productivity Commission dropped into my in-box, announcing the release this morning of the Commission’s draft report on better urban planning.    The Government asked the Commission to take a first principles, or “blue skies” approach to the issue.

I’ve been increasingly skeptical of the work of the Productivity Commission.  They often provide some interesting background analysis and research, and yet they increasingly seem to be well described by the old line “when your only tool is a hammer, it is tempting to see every problem as a nail”.  The Productivity Commission is mostly made-up of, and run by, (able) long-term public servants.  Public servants design and help implement the instrument of state –  government attempts to remedy problems, typically with government-based tools.  There is a self-selection bias problem –  people who are inclined believe in the importance/viability of government solutions are more likely to work for government than those who don’t –  and a greater reluctance than usual to ask hard questions about one’s own capabilities, since government agencies typically face few market tests and weak accountability.  The Productivity Commission –  like the OECD –  tends towards smarter better government, not to asking hard questions about whether we couldn’t just get government out of the way in many more areas, as prone too often to being the source of problems rather than the solution.

The Productivity Commission’s report runs to over 400 pages, and since it was released at 5am this morning, I assume no one has read it all.  I was, however, struck by the fact that in a 600 word press release there is no mention of property rights and a single mention of markets (and that not positively).  There is a 10 page overview of the entire report, and a word search suggests that “rights” does not appear at all and “markets” only once.

My unease was heightened when I read this line in the press release

Planning is where individual interests bump up against their neighbours’ interests, and where community and private objectives meet. It is inherently contested and difficult trade-offs sometimes have to be made. These decisions are best made through the political process not the courts.

Again, no mention of rights.  And the prioritisation of the amorphous “community interests”.   The suggestion of increased reliance on the political process rather than the courts hardly seems like a recipe for a clear, stable, predictable (and non-corrupt) regime for managing potential conflicts between the property rights of various individuals and groups.

Perhaps this draft report will recommend some  useful steps in the right direction.  Time will tell.  But on the face of it –  the shop window, of the press release and summary – it seems to fall quite a long way short of a first principles approach in a free society.