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.)


22 thoughts on “English demonstrates why monetary policy governance needs to change

  1. Hi Michael – thanks for picking up on my comments. (Yes, I glossed over the Board’s powers for the sake of brevity.)

    I don’t really agree that “giving the Governor a hard time” is sufficient though. For one, it’s not the kind of role that attracts love and admiration no matter how well you’re doing; anyone who takes the job has to be pretty thick-skinned. I don’t think the public sniping that we’ve seen at times has done anything to improve the situation, and I can’t imagine it would be any more effective if done behind closed doors. Surely there needs to be a more tangible reward/punishment, e.g. performance pay?


    • Michael

      Thanks for the comments. I’m not sure GW is very thick-skinned, but I take your more general point. In principle, the Governor is presumably paid for performance (he has an annual salary review), but that still comes back to (a) is there a formal metric one can use (I doubt it – it isn’t exactly even an EVA calculation) and (b) is the Board willing to penalize underperformance (or are they just too close to him, too inclined to see their role as those “having the Governor’s back”)

      I guess what I meant wasn’t the low level shots across the bow, but measured/considered statements. For example, MOF has posed few/no hard questions on mon pol in his letter of expectation. The Board has never said anything critical in the Ann Report. Day to day working relationships need to be managed, so I’m not suggesting flamboyant language, but even understated language can build pressure on Governors. I know that when I was much closer to things, we (and the Governor) took quite seriously repeated serious questions from the Board – and that was before the days of letters of expectation or Board Annual Reports.

      So I don’t have a problem in principle with what you are suggesting but (a) it isn’t done anywhere else, and (b) partly therefore, I’m a bit skeptical that it can really be done very effectively here. Which is why I fall on back on governance reform – less ambitious in what it expects, but more robust when someone not entirely well-suited ends up in a position of control.


  2. Cheers for picking up on English’s comments to me and challenging them at length.
    Absolutely fair enough, particularly on the IMF measures of inflation globally.
    It surprises me there’s so few people willing to publicly stand up for non-asymmetric inflation targeting and applying accountability for the failure. Also that the exporting community in particular is so deathly quiet about the failure.

    Liked by 1 person

    • Frankly it did not work when Allan Bollard went bonkers and pushed the OCR to 9% and interest rates hit 10% plus. All it did was drive a booming NZ economy into a deep recession decimating an entire building industry, also decimating an entire finance industry funding developments with the shut down of 61 plus Finance companies. NZ recession had nothing to do with the GFC and everything to do with extremely poor OCR decisions by Allan Bollard driving the NZ recession in 2007.

      It is already clear zero bound interest rates will hurt savers. There are more savers than there are borrowers in NZ. Savings deposits are a record $156 billion. There is no way that consumption will increase that leads to higher inflation if savers get burnt with lower and lower interest rates.

      2.25% feels about normal in the current environment. 2% is already on the low end.

      Lets not get carried away with academics view of the world. None of them have worked a day in the real world sitting in their ivory towers and sipping tea and being paid huge salaries day dreaming.


      • Note that I am a borrower with a portfolio of investment properties and I am not at all comfortable with interest rates falling further.

        An micro example is the behaviour of student loans. I was listening to RNZ on a study of Student loans this morning. Students were more inclined to pay debt off when interest is being charged. But because interest is not being charged you students lose the incentive to pay debt off and instead they binge on borrowings and less debt ends up being paid.


      • I am very surprised that my supportive comments on the recognition of the NZ land wars by Bill English and the National government was censored as irrelevant. How can the birth of a nation be ever considered irrelevant in any conversation about the wellbeing of New Zealanders and the right economic policies?

        The public holiday for the recognition of the NZ land wars is a must to have equal standing with Anzac day. You might consider the day as lost productivity and irrelevant to a conversation on monetary policy but it is a important first step towards reconciliation without which you might as well not have monetary policy. The Maori party is a key coalition partner.

        With Labour and the Greens gaining traction on the housing issue. Clearly being poll driven, National is getting very supportive of Maori needs. Farmers needs for lower interest rates has fallen by the wayside. Borrowers are already happy with current interest rates, there is no need for interest rates to fall further. Savers are already feeling the pain so polls says best not to push down any further as it will translate to lost votes.

        Young voters like the high NZD that offers cheap travel and cheap 60 inch tv for gaming. Older kiwis also like the cheap travel and the high NZD.

        Farmers are not paying the full cost of production. It is not sensible to have 50 million cows shifting everywhere. It is environmentally better to have 50 million people rather than 50 million cows as we can live in cities with smaller footprints and our waste is collected and treated.

        The tourist and international student industrial is booming so the high NZD has been ignored by the travellers wanting to come to NZ. So we do not need a lower NZD. Afterall this industry is also being heavily subsidised and taking up residential housing putting pressure on local resources.


      • If I’d written a post on the subject that would be one thing. I hadn’t. (my own view on the specific issue is much more skeptical. I struggle to think of a country that has a public holiday to mark a civil war/war of conquest. Seems likely to be rather divisive – probably even more divisive than Waitangi Day too-often is.)

        Liked by 2 people

  3. Tend to think monetary policy is asymmetric: if inflation had been consistently above target, the press, the politicians and the public would’ve take on a different mentality.

    But as it stands, a cheaper & bigger telly is no bad thing when you are pondering the odd article about low consumer prices – especially having just been battered by another bout of commentary on rampant house prices.


  4. I wonder if the RBNZ board could be asked/required to provide an objective rating of the Governor. Although obviously the inflation rate is one of the main measures of success, I would think they could come up with a dozen or so metrics, rate them each out of ten, weight them, and come up with an overall rating. To those in the industry it may not add anything, but a headline in the news of “Board gives Governor 4/10” would be easily understood by the public, and might add some pressure to the Governor, the board and the minister/government.

    Perhaps you could come up with some metrics, and do retrospective assessments for past years/governors? Might even be able to get some others to do the rating too for some more publicity?


    • Interesting idea. I doubt it is a viable option under the current structure – they are just too close to the Governor (he is a Board member, controls the paper flow, and they appointed him). But under the sort of Macroeconomic Advisory Council I’ve argued for it might be a more feasible option – being done by people at more of an arms-length from the Governor (and from day to day political constraints).

      Will give some thought to the retrospective assessment idea. It would probably be hard to score lower than Don Brash would probably rate in 1997.


      • I’m sure it would be challenging for the Board given their relationship. But if the Minister made them do it, that would then become their problem.

        It might be interesting to see what might happen if a reasonably designed rating system was devised. Perhaps a few other economic commentators could be persuaded to provide an assessment. Media/opposition questions to the Minister could be interesting too – Have you or any of your staff spent a few minutes to use MR’s rating system to assess the performance of the Governor? What is your view on the “fail” rating that 5 of NZ’s economic commentator’s have given the Governor?


      • He his two(?) main areas, inflation and financial stability. Inflation has never got into the required range, so I think that would have to be a very low mark. If 5/10 is a pass, then maybe you could argue for 5/10 if he had been in/out of the range for half the time. Having never been in the range anything more 1/10 would be hard to justify. On financial stability, he is perhaps deserving of a high mark, we have been stable after all. 9/10? Although I suspect some might mark him down LVRs etc. How would you weight them? I think at present inflation must be more highly rated because it seems so hard to get right and financial stability seems so easy. I struggle to see how anything above 3/10 could be justified.


      • Lindley, sure we may not have low inflation at 2% but we do have consistent and stable prices. In the age of browser searches for the best deals around the world and fast and cost effective freight, our retailers are competing with the cheapest available product from around the world. With savings at a record $156 billion NZ does actually have more savers than borrowers which means there is a fine balance. Push interest rates too far down and savers stop spending so the effect of lower interest rate effects is muted.

        Also banks have started to push interest only loans into principle loan repayments plus interest which means borrowers are being forced into debt repayments so lower interest rates do not actually translate to consumption binges that it used to.

        Getting to 2% inflation with oil prices falling as well is actually an extremely tough target.

        Constraining the NZD is also difficult with a booming international students and tourism market demanding $14 billion in NZD each year.

        Under Allan Bollard and Don Brash our other productive industries got decimated and we saw only Dairy and milk growing but every other industry shrinking. Under Wheeler we are seeing the birth and expansion of new industries, international students, tourism, wine, space industry, IT, corporate legal taxation services all expanding. Actually Wheeler deserves a 7 out of 10.


  5. I’ll take up your challenge and think about a reasonable way to think about evaluating Governors. As you say, if required to do so, the Board would no doubt comply, but all the incentives would be to give consistently fairly high scores. After all, that is what they do, passively or actively, now in their written Annual Reports


    • I look forward to it. I agree about the incentives. But I would also look forward to them giving a question such as “maintained CPI in accordance with PTA in the last 12 months” anything more than 1 out of 10.


      • Actually even I would probably rate him more than that on that question. After all, on the range of core measures, inflation has probably been somewhere in a 1 to 1.5 per cent range, which is within the target range. A fair way from 2 per cent, the focus for forward-looking policy, but one could think of quite materially worse inflation outcome (after all, on those same core measures, core inflation was outside the top of the target range – not just in the upper part – at the end of the last boom, in 07/08.

        I think the challenge in these sorts of exercises is the distinctions between inputs, outputs, and outcomes. Outcomes are probably what we – the public – most care about, but inputs and outputs are more controllable. Thus, in ref to your earlier email, I’d give the credit for the stability of the financial system mostly to banks, partly just to it being the upswing phase of the cycle (banks lending on property collateral don’t fail when property prices are rising) and only very slightly to any central bank in any particular year. So I’d be focusing more on the measures the Bank took, the quality of their research and analysis (which shed light on how well the understand the issues/risks) etc.

        On the other things Wheeler is responsible for, the new issue of notes seems to have gone very smoothly, and (altho I don’t like them) most people even seem to like the designs. So, from what one can see from the outside probably a 9 or 10 for that one.

        Much harder to evaluate is what he has done to foster an internal climate that generates ongoing analytical and operational excellence, including fostering a willingness to ask hard or uncomfortable questions. It is hard to assess that from the outside, but from my observation of his first 2.5 years inside, it would probably be the item I would score him worst on. Perhaps even lower than his handling of the OCR leak……..

        As for effective external communications, his speeches compare poorly to those of international peers, and remarkably he refuses to make himself available for searching interviews (eg with the main current affairs shows), so probably couldn’t score better than a 4 there. But we’ll get another speech in an hour or so


  6. Part of the problem is that NZ does not have an economic growth plan, rather it has a political plan targeted at the next election.
    As long as we all feel wealthier apparently we will keep voting for the incumbent party. A failure to achieve two percent inflation target is not politically significant for voters (despite what it could achieve for the productive economy). And chances are that the RB Board will not say if the target had been achieved this is how much better the country would have been but rather play the ”good citizen” card and keep their jobs.

    Liked by 1 person

  7. Watched 4 Corners on the Murray Golburn $200 million claw back from overpaying a $6 milk price to Australian farmers. Fonterra has also jumped in with their version of a payment claw back from Australian farmers. Malcolm Turnbull will have a dressing down chat with both co-ops for dealing this painful and unethical blow to Australian farmers.

    NZ farmers just need to survive longer than Australian farmers to come out smiling. Australian farmers are sending their herd by the thousands to the abattoir to cut costs. This is the nature of commodity prices, they go up and they go down. No need to panic. The NZ economy has already diversified from dairy.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s