Year: 2016

It is quite possible to get inflation back up: Norway did

Michael Reddell inflation, Monetary policy

Six months or so ago I was getting a little frustrated by talk suggesting that low inflation was just one of those things. No one else, it was implied, was succeeding in meeting their inflation targets, and so we shouldn’t really be expecting the Reserve Bank of New Zealand to meet the target the Minister of Finance had set for them.

And so I wrote a short post about Norway.  It was a small advanced economy, which has had substantial issues around rising house prices and high household debt, and which had been hit by an even nastier terms of trade shock (falling oil prices) than New Zealand had faced.  Oh, and Norway has typically had lower policy interest rates than New Zealand (so perhaps less room for manoeuvre), and has a higher inflation target (2.5 per cent rather than 2 per cent).     Like New Zealand, they started raising policy rates again quite soon after the 2008/09 recession (and crisis conditions) ended, but they realized that wasn’t necessary and reversed themselves.  Unlike our Reserve Bank, they didn’t make same mistake twice.

Norway also saw its inflation rate fall away quite sharply in the aftermath of the recession.  Here is the suite of core inflation measures that the Norges Bank itself highlights –  recall that the target is 2.5 per cent inflation.

norway core inflation

Inflation –  even core inflation – seems to be more variable in Norway than in New Zealand.  It was very low in 2011 and 2012, but has been trending back upwards for several years now.  When I wrote about Norway last in February, these core measures averaged 2.5 per cent.  Core inflation has increased further since then, now averaging 3.5 per cent (although the Norges Bank observes that they expect it to settle back nearer 2.5 per cent).

It isn’t as if Norway’s economy has been booming.  Indeed, Norway’s unemployment rate –  while still below New Zealand’s –  has risen quite markedly in the last few years.

No doubt there are lots of other detailed differences between the two countries’ experiences, but it seems to me that the biggest of them has been the New Zealand policy mistake –  promising to raise the OCR aggressively, then doing so, and only reluctantly reversing that mistake.   Here are two countries’ policy interest rates.

policy int rates nz and norway

Here are the BIS index measures of the two countries’ exchange rates.

nz and norway exch rates

In Norway, the central bank doesn’t anguish about tradables inflation being negative for years and outside their control.  Here is the chart from a recent Norges Bank MPS that I reproduced in February.
norway inflationAnd here are two-year ahead inflation expectations in the two countries –  the Reserve Bank survey for New Zealand, and a survey measure for Norway that I’ve taken from their MPS.

infl expecs nz and norway

It looks a lot like a story in which

(a) the Reserve Bank of New Zealand badly misread (actual and prospective) inflation pressures,

(b) leading them to raise the OCR when they should have been holding or cutting it,

(c) which drove the exchange rate up (the juicy prospects of high and rising NZ yields)

(d) and drove tradables inflation more persistently negative than it should have been

(e) all while the Reserve Bank only very slowly realized its error, never explicitly acknowledged it, and only very reluctant reversed the rate hike cycle,

(f) all of which understandably dampened expectations of future inflation  quite a long way, while still suggesting to people looking at NZD assets that if there was ever yield to be found anywhere in the OECD the RB woiuld do its utmost to make sure that place was New Zealand.

As a result, the exchange rate (while quite variable) stays high, inflation stays low, and inflation expectations are at constant risk of falling further.  All because the Governor (and his advisers) got things wrong, and refuse to convincingly change tack.  As I noted yesterday –  and as several others have now pointed out –  the Governor was given an easy opportunity to affirm that he’d do whatever it takes to get inflation back to target.  For whatever reason, he simply passed up the opportunity. People, probably quite rationally, think he will in fact be very reluctant to do what is needed.

Frankly, if Norway can get inflation back to (and even beyond) target, so can we. It is mostly a matter of (a) reading inflation pressures roughly correctly, and (b) really wanting to.  The Governor –  and his advisers –  have failed on both counts.

It isn’t always true, but sadly over the last few years it wouldn’t be wildly wrong to suggest that New Zealand outcomes would have been better over the Wheeler years if the Governor and his senior team had simply taken a holiday, and done nothing at all to the OCR for four years.  We’d have avoided the badly misjudged tightening cycle, and although the OCR would still be a bit higher now –  it was 2.5 per cent when Wheeler took office –  inflation expectations would almost certainly be higher, and so real interest rates would, most likely, be no higher at all.  That would have had the incidental benefit of leaving New Zealand more headroom against the risk of hitting the near-zero lower bound at some point.

Perhaps spurred on by criticism in various quarters that the Governor doesn’t make himself available for searching interviews, he seems to have established a pattern of talking to the Herald after the release of the MPS.  The latest sets of questions and answers is here.  It is all pretty soft-soap stuff, with no follow-ups or challenges, allowing the Governor to get away without even answering the question (as here, where he –  in customary style – injects a variety of interesting but not very relevant detail, while not dealing with central issue.)

Rate cuts are supposed to bring the currency down, this didn’t. What’s happened?

Since the June statement we’ve seen the Bank of Japan ease, Bank of England ease, we’ve seen the Reserve Bank of Australia ease. If you combine that with quantitative easing that is larger than at any other time – and it was pretty large in 2009 – and with negative interest rates in countries that account for a quarter of world output, you’re just in a phenomenal situation.

There is no doubt the world is in a puzzling situation, but the Bank –  and the Governor –  are paid to do a competent job, not to end up sounding as if it is all too hard and is someone else’s fault.  I’m sure his markets staff had advised him that the probability of the exchange rate rising yesterday was quite high –  if they didn’t, they certainly weren’t doing their job.  The Governor simply made a choice –  he is a reluctant cutter, and that became clear once again yesterday.

It is a shame that the Herald, given the privileged access, didn’t ask a few more questions such as:

  • Why didn’t you cut by 50 basis points, given that your own forecasts suggests further OCR cuts will be needed, and that on those forecasts it is still another two years until inflation gets back to target?
  • Why are you so apparently indifferent to an unemployment rate that has now been above any NAIRU estimate for seven years?
  • What plans and preparations are you putting in place to cope with the possibility that New Zealand finds itself exhausting the limits of conventional monetary policy?
  • Inflation was below 2 per cent when you took office, has not been near 2 per cent since then, and on your own forecasts won’t be back to 2 per cent until a year after your term ends.  You and the Minister put the 2 per cent midpoint explicitly in the PTA.  How would you assess your performance in respect of the Bank’s primary responsibility, monetary policy?

Still reluctant to do what it takes

Michael Reddell Monetary policy, Uncategorized

I’ve been laid aside (medically) this week so won’t be writing much about today’s MPS.  But I had a few observations nonetheless

The OCR cut itself was really the least the Governor could do, especially having laid the groundwork with his interim statement a few weeks ago.  It was interesting that for the first time since the easing cycle (better described as “reversal of the ill-judged tightening cycle”) got underway, the Bank now says not just that further easing “may” or “seems likely” to be required, but “will be required”.   Of course, that is still conditional on their forecasts panning out, but it is pretty strong language for a central bank.  It does rather prompt the question of why, if they are that confident they didn’t just cut the OCR by 50 basis points now.  On their current forecasts, inflation wouldn’t have overshot the target –  perhaps they’d have got back to the target midpoint at the start of 2018, rather than the September 2018 (still two years away, and well beyond the expiry of the Governor’s term) they currently project.   Perhaps they’d even have got the exchange rate down somewhat –  instead of another OCR review in which the exchange rate rises, at least on the day.  And yet the Governor said they hadn’t had any serious discussion of the option of a 50 basis point cut.  If so, that seems somewhat remiss –  if nothing else, seriously thinking about alternative policy approaches can help clarify arguments, even if that alternative is never adopted.

As I watched the press conference, I thought the Governor was looking rather tired and beaten-down.  In one sense that shouldn’t be too surprising.  The whole story upon which he based monetary policy for the first half of his term simply turned to dust.  There was no upsurge in inflation to get on top of, and instead he has been managing a staged withdrawal for more than a year now, still reluctant ever to acknowledge a mistake.

Perhaps more importantly, there is a reluctance to take responsibility: New Zealand’s inflation rate is largely something that New Zealand’s central bank controls.  There are all sorts of influences on prices, but we –  citizens –  pay the Bank to recognize those influences and respond sufficiently vigorously to keep inflation near the target we’ve set for them. Low world inflation is, for us, just one of those things.  We don’t control it, but we can adjust domestic monetary policy to take advantage of it.  And I say “take advantage” deliberately: low world inflation would have given us the opportunity to have had lower real domestic interest rates over the last few years, and with it stronger domestic activity, lower unemployment, a lower exchange rate, and inflation closer to target.  But even now, the Governor is clearly reluctant.  He keeps emphasizing the “unprecedented” global stimulus –  even though the best evidence of “stimulus” is something being stimulated, and there is little sign of global inflation being stimulated much –  and, domestically, “accommodative” monetary policy.  But again, where is there much sign of the “accommodation”?  Inflation is consistently well below target, and the unemployment rate has been above any estimate of a NAIRU for 7 years now.  No doubt some will respond “look at house prices”, to which my response is to refer people to the structural pressures: the interaction of rapid population growth and land use restrictions.

The Bank remains optimistic that GDP growth is going to accelerate, expecting 3.5 per cent per annum over the next couple of years.  Perhaps they will be right, but I still don’t see what is likely to bring about such stronger growth. If anything, waning population pressures should lower headline growth, even if per capita growth were to strengthen a little.  Between the high exchange rate, subdued commodity prices, subdued world activity, and a waning (and then reversing) impulse from net migration, I’d have thought New Zealand will struggle to grow as fast over the next year as it has done this year.

I’ve noted previously that the Governor would be well-advised to stop making open calls that the “exchange rate needs to come down”.  This morning, the TWI was sitting just above the average level that has prevailed over his entire term.  It was higher when markets thought we’d go on tightening for some time, and lower when it looked like the rest of the world might start tightening. But over four years it hasn’t really gone anywhere.

wheeler exch rate.png

And in many ways that isn’t very surprising.  After all, real interest rates in New Zealand haven’t gone far for years either.

real ocr to aug 16.png

Even after this morning’s cut, the real OCR on this measure is still only about where it was just before the February 2011 earthquakes hit.  Back then, we were in middle of coping with the increase in the rate of GST and no one really recognized just how weak New Zealand or global inflation pressures were turning out to be.  There is no easy rule of thumb to say where the OCR should be now, but I think there is a pretty strong case –  in the context of the inflation targeting regime, which the Governor strongly (and rightly) recommitted to this morning –  that it should be lower than it is now.  Given how much we’ve been surprised over the last few years –  about things at home and abroad –  one could pretty easily make a case for a negative real OCR right now.

A few years ago, Mario Draghi the head of ECB galvanized and totally changed market sentiment about the euro-area with his off-the-cuff pledge to “do whatever it takes” to hold the euro together.  We haven’t seen that sort of commitment in respect of New Zealand monetary policy.  When asked this morning whether he’d be willing to take the OCR to zero if necessary, the Governor fended off the question.  Instead, it would have been a great opportunity to say “yes, of course.  We’ll look at the data every six weeks, but we are concerned about persistently low inflation –  and about expectations drifting down, and about unemployment lingering high.  We’ll do what it takes”.  Instead, we heard unease that if the Bank did too much it might create “more damage” to the economy.  Than what, I was prompted to wonder.  As it is, New Zealand continues to look like the last bastion offering some –  no longer much – yield to investors.  Interest rates of 2 per cent aren’t much, but they are much higher than you can get in most places. If so, no wonder the exchange rate remains relatively high.   And, relative to the Bank’s target, there is simply no need for interest rates to be that high –  not even on the Bank’s own forecasts, let alone a more realistic assessment of capacity pressures.

The Bank attempts to make quite a lot in the MPS of the idea that capacity pressures are becoming real in New Zealand, while they are largely absent in the rest of the advanced world.  They attempt to support that using various international output gap estimates, and their own estimates for New Zealand.  As they, and we, know output gap estimates are very imprecise, and prone to considerable revisions over time (especially for estimates of where the economy is right now).  For the last five years, the Bank has repeatedly tried to run the line that spare capacity has been used up in New Zealand, only to have to revise those estimates back again.  Another way to look at these things is through the lens of unemployment rates,  They aren’t a perfect measure, but are often more useful than output gap estimates, and relate back to some specific human concerns –  people who are actually out looking for work.  Here are the unemployment rates since 2005 for New Zealand, the OECD as a whole, and the G7 as a whole.

U rates to aug 16

New Zealand’s unemployment rate has been consistently below the other lines –  not surprising, as we have a more deregulated labour market than most.  But all three lines went up a long way during the 2008/09 recession, and there is no sign that New Zealand’s has fallen faster since.  If anything, it is rather the reverse.  The gap between New Zealand’s unemployment rate and those of the rest of the advanced world is smaller than at any other time in this sample.

The answers to our inflation challenges –  getting it up to and keeping it around target – really are in our own hands, or more specifically in the Governor’s hands.  We could have had lower interest rates, a lower exchange rate, more demand, lower unemployment, and higher inflation.   (And if the powers that be couldn’t fix up housing supply or immigration policy, the Governor could have required banks to hold larger capital buffers in case the domestic housing market caused future loan loss problems).

 

The Reserve Bank’s challenge tomorrow

Michael Reddell Uncategorized

I ran a couple of cartoons from my 1980s and 90s collection a couple of weeks ago.  Many of the ones in my folder were about monetary policy –  the hugely controversial disinflation process we were engaged in, trying to get inflation down to 0 to 2 per cent per annum, and then keep it there.  No one much believed we would manage it (or even be allowed to do so by the political process)  –  there were even cartoons along the lines of “pigs might fly”.  This was one from my collection.

william tell cartoon

These days the challenge is the other way round –  getting inflation back up to (a now higher) target.

This chart shows inflation over Graeme Wheeler’s term as Governor. It has never got nearer the 2 per cent target midpoint that he and the Minister explicitly inserted into the PTA in 2012.  Most of the time, the annual inflation rate has been below the 1 per cent lower bound of the target range.

wheeler inflation

And so the cartoon struck me as apposite on the eve of the next MPS.  At almost every single OCR review and MPS the Governor has assured us that inflation will soon be getting back to around 2 per cent. Each time, so far at least, he has been wrong.  Forecasts have been revised down repeatedly, and with them the OCR.

Of course, if you look carefully, that cartoon was dated March 1991. By the end of that year, inflation was finally inside the target range.  Indeed, most studies looking at New Zealand’s experience of low inflation start from around then.

Perhaps we will be surprised, and after all the surprises and failures  so far inflation really will be back to around 2 per cent before too long.    The right monetary policy judgements are a part of making that prospect real.

A submission to the Reserve Bank’s faux consultation

Michael Reddell Financial stabilty, Housing, Uncategorized

A bit under three weeks ago the Reserve Bank announced a proposal for a further, substantial, extension of its LVR controls on banks’ mortgage lending  It is formally a proposal, subject to a consultative process, but it is all done in such a mad rush that it is difficult for anyone to take the “consultation” process seriously.  Late last year, the Bank announced that it would be allowing substantial consultative periods, and on this occasion they have offered no argument or evidence for why it is so urgent that such a short time is allowed for consultation and the preparation of submissions.  Presumably it is just the impatience –  backed by very little analysis – of the Governor –  much the same impatience that means this is now the third attempt in three years to get LVR controls “right”.  What was worse was the instruction to banks to simply fall into line now.  We live in a country supposedly governed by the rule of law, not the whims of men.  And until the proper consultative process has been completed, and the Governor has had regard to all the submissions, what he is proposing (a) is not law, and (b) cannot be counted on as ever being so.  But just to write that is to explain why it is hard to take the consultative process seriously.

I have  written and lodged a submission.  It was a fairly rushed job, but I’m out of commission for the next couple of days and needed to get it in this evening.

Submission to RBNZ consultation on further extension of LVR limits Aug 2016

This is the heart of the conclusion of my submission

In substance, the proposal if adopted will further undermine the efficiency of the financial system, while doing little or nothing to reduce any threats to financial stability (risks which, on your own stress tests are already very low). Indeed, there is a risk that such direct controls could increase, albeit modestly, the risk of serious financial system stresses because it will reduce the volume of capital held against bank mortgage books.    Over time, the growing use of direct controls risks progressively undermining the willingness and ability of banks to do their credit risk assessments, and to compete with each other in doing so,  rewarding going along with the Bank’s assessment of risks, while gaming the rules at the margin wherever possible. 

Since the Bank offers us no reason to think that its own assessment of credit risks –  in the aggregate or at a more disaggregated level –  is superior to that of the market, and since our banks actually came through a much larger housing and credit boom largely unscathed, there is little basis for us to prefer the Bank’s judgement.  And it has offered nothing to suggest how much its planned intervention might affect the probability or severity of any crisis. 

Over-reliance on a very slender base of international evidence, and a failure to think hard about the distinctiveness of New Zealand (from, say, the Irish or US experience) or to make the attempt to gather and analyse New Zealand loss experiences should give citizens little reason to have any confidence in what the Bank is proposing,   Even if investor loans were to prove slightly riskier, all else equal, than owner-occupier loans, the scale of the differentiation in the rules for the two types of lending suggests the Bank is driven at least as much by tilting the playing field against investors and in favour of first-home buyers as by its statutory responsibilities to use its powers in the interests of financial system soundness and efficiency.  If so –  and I hope there is nothing to that suspicion –  it would have involved the Bank stepping well beyond its responsibilities (with little ability for citizens to hold it to account if it did so).

There isn’t much to like in the consultative document.  The empirical evidence they now rely on is two studies undertaken by a central bank (the Irish one) which had already decided to have a regulatory distinction between investor loans and owner-occupier loans.  One of those studies is claimed to examine the UK experience –  in fact, it looks as the loan books in the UK of the three (failed) Irish banks, not necessarily a representative sample of UK experience.  I’m open to the possibility that investor loans are slightly riskier than owner-occupier ones, but have simply not yet been presented with any compelling evidence.  And the Bank has still made no effort to look at the experience in New Zealand, where the post-2008 reductions in house prices in some regions were not dissimilar to the UK experience, where unemployment rates lingered high, and where in some cities nominal house prices stayed well below previous peaks for a prolonged period. Obviously, New Zealand data reflecting New Zealand banking practice, New Zealand law, and New Zealand cultural norms would be more persuasive than the experience of the Irish banks (and even those research papers have some real problems).

The proposed controls differentiate between investor loans and owner-occupier ones to a huge extent.  Implicit in these proposed new rules is the view that loans to an owner-occupier with an 80 per cent LVR are less risky – not just as risky –  as loans to investors with a 60 per cent LVR.   Nothing in the data they’ve presented warrants that sort of differentiation, and it looks like a bit of covert redistributive policy: regardless of the riskiness of the respective loans, make things harder for investors and help out the first home buyers (even though those young buyers might be getting in right near a peak).  That simply isn’t the Bank’s job.  It is charged with financial system soundness and efficiency: it pays lip service at best to the efficiency issues (and the way its controls will progressively undermine competitive credit allocation decisions) and its own stress tests say that the financial stability risks are slight.  And why should regulatory policy be prohibiting a young person in, say, Wanganui getting into the rental property market with an LVR above 60 per cent.  Direct controls lead to arbitrary boundaries, absurd outcomes, and/or ever-increasing regulatory complexity.  That was part of the reason why we deregulated markets, and relied more extensively on indirect instruments, in the 1980s. it remains a good model –  and served New Zealand well through the boom and bust of the last decade, when our banks came through largely unscathed.

A key feature missing from the consultative document is any recognition that to the extent that the controls reduce high LVR lending, they will also reduce the amount of capital banks need to hold against their mortgage books. The Bank argues that the proposals will reduce the risk of financial crisis, but they show no sign of having thought much about the implications of the reduction in required capital.  If the capital requirements for high LVR loans were too low in the first place, that might be one thing. But our risk weights on housing loans are among the highest anywhere, and the Bank went through a consultative process not that long ago to increase those risk weights on high LVR lending.  And as part of what the controls will do is push a pile of lending to just below the respective ceilings –  there will be a lot of 59.9 per cent investor loans , even though a 59.9 per cent loan is little less risky than, say, a 60.1 per cent loan.  Capital requirements are likely to fall further as a result, even if the underlying risks haven’t changed much.   It would be unfortunate if measures ostensibly designed to reduce financial system risk actually modestly increased those risks, by reducing the capital buffers banks have to hold.

I don’t suppose submissions will make any difference to the Bank, but time (not much time, if they plan to have the restrictions in effect from 1 September) will tell.

Readers will recall that a couple of weeks ago the ANZ’s local head, David Hisco, called for the controls to be much more constraining than what the Bank is proposing. As I noted, there was nothing to stop ANZ restraining its lending accordingly.  But I do hope the ANZ will now pro-actively release its submission to the consultation so that we can see if Hisco’s submission on regulatory policy aligned at all with the rhetoric in his newspaper article.

I have lodged an Official Information Act request for all the submissions the Bank receives.  If past practice prevails they will eventually release those of entities other than banks, while claiming that the Reserve Bank Act prohibits the release of the bank submissions. I discussed this curious interpretation of section 105 of the Act the other day.  It cries out for a short amendment to the Reserve Bank Act to make it clear that all submissions on new regulatory proposals of this sort are covered by the Official Information Act.  That, of course, would be just a start on the sort of extensive reforms of the governance of the Reserve Bank that are needed.

 

 

Perhaps 20 more terms in office will be enough?

Michael Reddell Exports, New Zealand economic performance

The ever-ebullient Minister of Economic Development (and a great deal else beside) Steven Joyce was interviewed on TVNZ’s Q&A programme yesterday, defending the government’s economic record.  Despite the efforts of the interviewer to pin him down –  including on the rising degree of unease even among some of those one might think of as “elites” about immigration policy –  Joyce put up a pretty forceful defence, often citing the Prime Minister’s mantra that if New Zealand has challenges they are ‘quality problems” or “side-effects of success”.  If one didn’t have access to the facts, it might even have sounded persuasive.

I was tempted to devote a lengthy post to the Minister’s claims, but I have other stuff I really have to finish today.  So apart from noting in passing New Zealand’s continuing lousy productivity performance (see the chart in this post), I wanted to focus on just two of the areas the Minister covered.

The first was around the skills of immigrants.  In June the OECD released the results of a fascinating multi-country study of the skills level of workers.  It suggested that the skill levels of New Zealand workers –  over several dimensions – were pretty high.  I wrote about it at the time, and summarized the high-level findings this way

Looking across the three measures, by my reckoning only Finland, Japan, and perhaps Sweden do better than New Zealand.    Perhaps there is something very wrong with the way the survey is done, and it is badly mis-measuring things, but those aren’t usually the OECD’s vices.  For the time being, I think we can take it as reasonably solid data.

As I also noted, the survey also looked at the skill levels of non-native born workers.  In almost every country, including New Zealand, the skill levels of immigrants were below that of natives.  Of course, in every country there will be many very able immigrants, but these are averages across the full samples of native born workers and immigrants.  As I pointed out, if your country (New Zealand) already had among the very highest skill levels in the world, and immigrants had less good skills, it didn’t lend much support to the idea that we needed lots and lots of immigration to lift the productivity of New Zealand workers, and make up for deficient skill levels at home.

But none of that stopped Steven Joyce introducing this same report in support of the government’s immigration policy.  How did he manage that?  Well, he correctly pointed out that New Zealand’s immigration policy is more skills-focused than those of most countries.  Unlike most countries, we have almost complete control over who we let in –  there isn’t a material illegal immigration problem –  and unlike, say, the United States (where legal immigration is mostly family-focused) we have an explicit economic/skills focus.  We may not do it well –  my argument –  but we are less bad, on that score, than most.

One might reasonably expect literacy skills of immigrant workers to lag behind those of natives –  after all, for many/most English isn’t their native language.  But the OECD survey also reports results for “problem solving proficiency in a technology-rich environment” (Figure 3.15 of the OECD report).  There are 28 countries/regions in the OECD study, but there is only data on the skill levels of immigrant workers for 17 of them (many of the other simply don’t have much immigration).

Here is the proportion of foreign-born workers with what the OECD calls relatively high level skills in this (problem-solving) area.

skills technology

New Zealand scores well here.  Our (really large scale) immigration programme seems to have done better in attracting people with these sorts of skills (and keeping out others) than most other countries have.

But remember that our overall workforce –  mostly native-born –  also has among the very highest level of skills of any of these countries. On this particular measure, we were top equal with Sweden.

So here is the gap between the skill level of natives and the skill levels of immigrants (again, on this problem solving proficiency measure).

skills gap

New Zealand doesn’t do too badly –  although Israel and Ireland stand out as clearly better –  but in every single one of these countries the skill levels of the average immigrant worker are less than those of the average native worker.  And this in an area –  the use of technology –  where the Minister often likes to stress the importance of immigration.  We don’t have the problems of Sweden or the Netherlands, but these OECD data –  which the Minister himself quoted in support of his policy –  just do not support the claim that our immigration programmes have been boosting overall skill levels in New Zealand.  If anything, those programmes have been a net drag.  As I’ve repeated many times, I’m not suggesting immigration never could boost skill levels –  or that there are not many highly-skilled individual immigrants (as there are many highly skilled natives) –  but our skills-focused programme, on the scale the government continues to stick to, just isn’t achieving that goal.  Perhaps with annual target of 10000 to 15000 non-citizen migrants (per capita, the same sort of rate as the US has) we might do so.

The interviewer also attempted to push the Minister onto the back foot over the government’s target for the share of exports in GDP.  The goal, announced several years ago, was to lift exports as a share of GDP from around 30 per cent to around 40 per cent by 2025.  I thought the formal target was daft and dangerous, even while sympathizing with the intuition that motivated it – small countries get and stay successful by selling lots of stuff, competitively, in the rest of the world.

As the Minister fairly noted, the base level of exports got revised in one of SNZ’s long-term national accounts revisions.  But that does not change the fact that exports as a share of GDP have been going nowhere.  It is all very well to blame low dairy prices –  as Mr Joyce sought to –  but on other occasions he’d be telling us just how well tourism and export education sectors were doing right now.

Here is chart of exports to GDP, going back to the start of the quarterly national accounts data in 1987. This time, I’ve also shown the average export share for each of the last three governments.

exports to gdp by govt

Plenty of things cause fluctuations in the series, and not many of them are under the direct control of governments.  Nonetheless, the average export share of GDP is materially lower under this government than it was under the previous government, and the latest observations are below even that average. Since the start of 2009, exports have averaged 27.7 per cent of GDP.  Under the previous National government –  one that first took office more than 25 years ago, that average was 27.5 per cent.  The government’s goal was to lift the export share by 10 full percentage points, and there is now only nine years left until the target date.  On performance to date –  and policy to date – we might be waiting several more centuries to achieve that sort of goal.

It is time Mr Joyce and his colleagues faced the fact that they are simply failing on this count.  A rather different approach is needed –  one which permits/facilitates a sustainably lower real exchange rate, orienting the economy more strongly towards investment in the tradables sector, and enabling more able firms to grow (and locate here doing so) by successfully selling to the rest of the world.  As I’ve noted before, per capita output in that vital outward-oriented part of the economy hasn’t increased at all for 15 years now.  It seems unlikely that that sort of reorientation will occur, all else equal, while we continue to bring in, as a matter of policy, so many not-overly-highly-skilled non-citizen migrants each year.

And finally, the interviewer introduced my name to the discussion as one of those skeptical of some of the government’s claims.  Mr Joyce suggested that I was among those who had predicted a large balance of payments blowout, thus apparently undermining the credibility of my arguments.  Of course, economists are pretty hopeless forecasters, so when an economist offers a prediction about the future one should (a) always take it with a considerable pinch of salt, and (b) wonder if the economist recognizes his/her own unwarranted over-confidence.  But in this particular case, I didn’t even recognize the forecast.  Since I’ve spent the last four years –  both inside and outside the Reserve Bank –  arguing against interest rate increases and for interest rate cuts, it would be surprising if I had been worrying about the current account deficit blowing out.  Demand has been consistently weaker than it should have been –  inflation has been below target, and unemployment has lingered above the NAIRU.  Whatever I’ve warned about, I’m pretty sure it hasn’t been the current account of the balance of payments.

(UPDATE: And, as a reader notes, as banks’ dairy losses mount there will be an almost one-for-one temporary reduction in (mostly foreign-owned) banks’ profits, and thus in the current account deficit.   That won’t be a sign  of economic success either.)

Government consumption

Michael Reddell Fiscal policy

Playing around in the consumption data yesterday prompted me to have a look at what had been happening with government consumption spending.  Government consumption, in the national accounts, isn’t the same as total government operating spending.  The latter includes transfers –  the huge amounts modern governments spend on direct payments to households, through the welfare and social insurance systems etc.  Government consumption parallels private consumption –  it is the stuff governments and their agencies (central and local) purchase directly (excluding capital spending, which is investment).    That includes stuff directly consumed by households but paid for by governments –  think of lots of health and education spending –  as well as stuff “consumed” collectively, or in some sense by governments themselves.  The cost of The Treasury, MFAT, the courts, or defence spending are examples of the latter.

Take total government consumption spending first.  The OECD has data for all its member countries since 1995, so I’ve focused on that period.  Here is how New Zealand and Australia have done relative to the median OECD country over that period.

gen govt C aus nz

It is sobering to observe (a) how stable the government consumption share has been in Australia, and (b) how much government consumption as a share of GDP has increased since 1995.  We were consistently a bit below Australia, and in recent years we’ve been a bit above.  Australia may have more pressing fiscal problems right now than New Zealand does, but government consumption has been better held in check there than here.  That increase in government consumption spending will have contributed to the upward pressure on the real exchange rate (tending to raise non-tradables prices relative to tradables prices).

And here is the chart for all OECD countries, showing both the 2014 numbers and the average for the full period 1995 to 2014.

gen govt C oecd

A few things struck me.  There is, of course, a huge range across quite similarly successful countries –  Switzerland and the United States at one end, and the Netherlands, Sweden and Denmark at the other.  The same pattern shows up when one looks at total government spending.  But what struck me more forcefully this time was that while there was little change in the government consumption share of GDP among the countries in the middle of the chart –  say those from Australia to Canada – most of the countries with very high government consumption spending had been increasing that share further over the last 20 year (all seven of the countries furthest to the right).  And at the same time, the countries with the lowest government consumption shares had also been increasing that share (five of the seven countries furthest to the left).   Only a handful of countries had government consumption shares of GDP lower at the end of the period than the full period average –  and there wasn’t anything very obvious in common among those countries (eg Israel, Hungary, Portugal and Latvia).

As I noted earlier, total government consumption spending includes stuff individual households consume directly but the government pays for, as well as the more traditional stuff of government (policy advice, defence, law and order etc).  The latter is known by the national accountants as “collective consumption”.  Here are the same two charts as above, but this time just for collective consumption.

The New Zealand/Australia comparisons

collective C nz and aus

Trends here look quite a lot more favourable for New Zealand (and Australia even more so).  No doubt it helps how little we spend on defence, but I think it is generally accepted that – even if there are whole agencies that could be closed with no real loss – that the New Zealand core public sector is fairly lean.

And the OECD as a whole.

collective C oecd

Note that the countries at the right of this chart are quite different from those at the right of the total government consumption chart above.  The Nordic countries are actually towards the left of the chart –  Sweden, Denmark and Norway don’t spend much more running their governments than we or Australia do.  The big differences are in the individual consumption the government pays for   – be it childcare, health or education.  The countries to the right of this chart look a lot more like those which tend to spend a lot on defence –  those that really need to (Israel, and increasingly perhaps the Baltics,  as well as Greece and Turkey with their historic rivalries and suspicions).   It is interesting then how far to the left Korea is –  perhaps offset in part by US defence spending and security pledges?

There aren’t any very obvious patterns in the changes between the 1995 to 2014 average and the current level.  Overall, the OECD median has increased a little (as the earlier chart showed), but the increases don’t seem to be concentrated in low-spending countries, or high-spending countries, or countries that are militarily exposed, or countries that had strong fiscal positions.  And I can’t see such patterns for the countries that have been shrinking collective consumption either.

Reasonable people can differ on the appropriate role for government in income support, or provision of health and education, but this is collective consumption.  I’d be keen to learn a little more about how Switzerland manages to run such a successful and well-functioning country with collective consumption of only around 5 per cent of GDP.

Perhaps there is an example after all

Michael Reddell Housing, Uncategorized

I’m pretty pessimistic about the prospects of sorting out the housing supply/land use regulatory mess that, in conjunction with population pressures, has given us –  Auckland in particular –  extremely high house prices (and price to income ratios).  There are no great technical barriers to getting the market working again, with housing as affordable as it used to be.  But I have repeatedly noted here that I’m not aware of any country/region/locality that had once got into such a mess and had found its way back again, unwinding the morass of regulation (tell me again how many pages there are in the draft Unitary Plan).  Each time I make the point, I really hope someone is going to tell me about a compelling counter-example, demonstrating that what it technically possible has also proved politically feasible.

But reading Tyler Cowen’s Marginal Revolution blog just now I found a really encouraging piece headed Laissez-faire in Toyko Land , which in turn draws on a fascinating Financial Times article Why Tokyo is the land of rising home construction but not prices .  I hadn’t paid much attention to Japanese house prices, implicitly ascribing the lack of house price inflation to (a) the aftermath of the 1980s boom, and (b) the flat and now falling population.    But here is the key chart in the FT article

tokyo

Over the last 20 years, Tokyo itself has had about the same rate of population increase as London.  A nice locality apparently relatively near the centre has had faster population growth than San Francisco.  And yet look at the differences in the rates of house price increases.   Sure, the chart flatters Japan because Japan has had general consumer price deflation, while the US and the UK have had general inflation –  but even in real terms, the differences would be large.

Anyway, I’d encourage people to read the blog piece and the underlying article itself.  It isn’t a totally laissez-faire story, but the flexibility that seems to have been introduced to the system following the 1980s boom looks impressive.  I’m not expert – no doubt there are other perspectives on the Tokyo experience –  and perhaps the changes that were put through in Japan could never be done in Anglo countries.  But they were done in Japan. That in itself is encouraging.

UPDATE: I had been continuing to mull this FT material.  It focuses on the change in prices over the last 20 years as a whole, and not at all on the levels.  This 2014 link from one of the FT blogs confirms that the bulk of the 1980s boom in Tokyo prices had been reversed by 1995.  However, it also includes a chart showing price to income ratios for new Tokyo apartments (in the greater Tokyo area) which –  while pretty stable over the last 20 years –  still seem strikingly high, especially once one takes account of the “famously diminutive” size of Tokyo apartments.

And here is an interesting post with a more extensive discussion of Japanese zoning procedures and rules.

Are we just pulling consumption forward?

Michael Reddell Monetary policy

I was having a discussion with someone the other day about interest rates, the OCR, and how we should think about what has been going on in recent years.  The person I was talking to was worried that, whatever short-term support lower interest rates might be providing to demand, activity and employment, it was at the expense of simply pulling forward consumption.  And (lifetime) income which is spent today can’t be spent again tomorrow.

My usual starting point in such discussions is to draw attention to the little-recognized fact that consumption as a share of GDP has been largely flat in New Zealand for decades.  There is some cyclical variability –  consumption is a bit more stable than income, so the ratio tends to rise in recessions, and falls back as the economy recovers –  but the trend has been almost dead flat.  Actually, GDP isn’t the best denominator, because GDP measures what is produced here, not what accrues to New Zealanders (the difference is mostly the income earned by foreigners on the relatively large negative NIIP position New Zealand has). GNI is a measure of the aggregate incomes of New Zealanders, and here I’ve shown the various components of consumption relative to GNI since 1987, when quarterly national accounts data are available from (but using four-quarter running totals)

First, private consumption (including non-profits)

pte consumption to gni

And then general government consumption

govt consumption to gni

And then total consumption

total consumption to GNI

I’ve shown full period averages for each.  The only component of consumption where the share of GNI is a bit above the long-term average is general government consumption, the bit that is least likely to be sensitive to changes in interest rates.

Of course, if interest rates had been kept arbitrarily higher then consumption as a share of GNI might well be weaker now than it actually is, but there is really isn’t any sign of a great consumption splurge –  a society desperately (over)spending now and thus increasingly likely to come a cropper later.    (And as I’ve noted previously there is also nothing in any of these charts to suggest some large average wealth effect from the sharp rise in real house prices in recent decades –  not surprisingly, since wealth is being transferred among New Zealanders, but no additional real wealth –  future purchasing power –  has been created in aggregate).

As we continued our discussion, the person I was talking to reminded me that the US picture has been somewhat different.

Here I draw on the OECD database, which has annual data for most of its members back to 1970. Here is total consumption (public + private) as a share of GDP for the United States, United Kingdom and New Zealand.

consumption us uk and nz

Even over the full 45 year period there is no upward trend in the consumption share in New Zealand.

And here, on the same scale, is the consumption share of GDP for the median OECD country.

oecd median consumption

And here are Australia and Canada

consumption aus and canada

Like New Zealand, no trend in either country, at least (see Australia) since the mid 1970s.

And here is Actual Individual Consumption (private consumption plus the stuff the government purchases but individuals consume directly eg healthcare and education) as a per cent of GDP for New Zealand, Australia and Canada.

aic consumption

I’m not quite sure what was happening to this data in New Zealand around 1985, but again for the last thirty years there has been no upward trend in consumption as a share of income.

What does all this mean?  To be honest, I’m not quite sure.  After all, if population growth rates have been slowing, less of GDP needs to be devoted to investment and that might mean more is available for consumption.  But in the UK in particular, population growth rates have been somewhat faster in the last couple of decades than they had been previously.    And things like defence spending trends can also complicate the picture –  weapons system purchases are now part of investment, and we know in the US (and the UK) defence spending as a share of GDP is much lower than it was some decades ago.

I guess all I take from it is my original point. At least in New Zealand –  and in most of the OECD –  there is no sign that lower interest rates are resulting in a large scale bringing forward of consumption, for which at some point there must be payback.  But that shouldn’t be too surprising.  After all, interest rates are as low as they are for a good –  if ill-understood by anyone –  reason: in summary, because if they weren’t this low, consumption and investment spending would be even weaker.  That, in a market economy, is really all interest rates do: they balance desired savings and investment patterns.  Central banks that are too slow to adjust to changes in desired savings or investment patterns –  at any given interest rate –  can slow the adjustment, but in that respect a good central bank shouldn’t be trying to stand in the way of the sorts of real adjustments the private sector has underway,  A century or more ago Wicksell introduced the concept of a neutral or natural interest rate.  Those rates change over time, for reasons that aren’t always easy to recognize.  Markets don’t need a fully convincing analytical reason –  they just reflect the changing balance of demand and supply.  Central banks shouldn’t let the difficulty of finding a good explanation stand in the way of allowing what would be the market processes to work

But quite why consumption shares in the US and UK have risen so much is an interesting question –  to which I don’t have any good answers right now.

 

 

Wellington Airport: a factual high level summary

Michael Reddell Wellington

This morning’s Dominion-Post features a full page advert, notionally inviting people to make submissions on the resource consent application to extend the runway at Wellington Airport.

In fact, the advert is mainly an opportunity to tout the case for the hugely-expensive proposed extension –  in what must be one of the most expensive locations in the world in which one could add 300 metres to a runway (and still not comfortably meet international safety guidelines).  The pretty graphic highlights 20 Pacific Rim cities which planes could reach from Wellington –  without ever mentioning that the most likely outcome, if the project succeeds at all, is flights once or twice a week to one or two of them.

All one really needs to know about the proposal is that the owners of the airport think the project is sufficiently unattractive that there is no way they would proceed with the extension if it involved investing their own money.

The owners –  WIAL, majority-owned by Infratil – have been quite clear that the project will only proceed, even if it gets resource consent, if there is a massive public subsidy –  huge contributions from some combination of local, regional, and central government that would not be reflected in a commensurate ownership interest in the airport.  But there is no mention, at all, of this fact.

In a little note at the bottom of the advert  it is described as a “high level factual summary of some of key effects from the extension”.   I did spot the odd fact in the advert, but mostly it was boosterish opinions, clothed in consultants’ reports – and  all summarized in the huge alleged national benefit estimates.  I’m deeply unconvinced by the economic case for this airport runway extension –  the benefits appear to be overstated, and the discount rate used to evaluate them seems too low – but would have no real objection if private shareholders were paying for it.  But they aren’t.

I wrote a few posts about this proposal late last year, here, here, and here. Ian Harrison, at Tailrisk, has a nice piece here on the same issue.

I’m not making a submission.  As a matter of principle, I don’t think the Resource Management Act should be used to block business developments, unless there are compelling environmental grounds –  and I have no expertise in environmental issues, and am interested only to the extent Lyall Bay remains a pleasant spot for the family to swim.

The real debate should be around decisions new local and regional councilors consider making about injecting public subsidies to this operation (over and above what has already been spent). The quality of public sector investment spending is typically quite poor, and around the country airport investments (see eg Rotorua) are no exception.   As the local body elections are just weeks away, the focus needs to be on the attitude towards the project that each candidate takes.  So much money is involved, and attitudes to this project seem to reveal so much about candidates’ views on the role of local and regional government, that for me it will be a defining issue.  I will be seeking out candidates who are clearly opposed to spending public money on the extension.  In the huge field of mayoral candidates there appear to be a couple of options –  but their fine print needs checking out.  I haven’t yet done my research on the council and regional council candidates.  I encourage greater Wellington readers –  because although the Wellington City Council has been driving this, they’ll be looking for money from other local authorities in the region –  to prioritise this issue.

My fear is that once the election is over, there will be a behind-closed-doors process rushed through, with no rigorous evaluation of the economics of the project.  Cheer-leading from the local business community –  always keen on the sort of public subsidies and activities that don’t face the market test that keep Wellington afloat – reinforces the risk.

Surveyed expectations

Michael Reddell expectations

The Reserve Bank’s quarterly survey of semi-expert opinion on the outlook for various macroeconomic variables was out the other day –  a bit earlier than usual, presumably because of the changes in the schedule of MPS releases.  This is a really rich survey, covering a wide range of variables, and has been running now for nearly 30 years.  But I noticed that the number of respondents is now down to only 52 (and on some questions there were fewer than 40 answers).  Once upon a time, if my memory isn’t failing me, there were nearer 200 respondents.

My impression is that the Bank’s aims have shifted over time: when the survey began in 1987 it was designed to capture the expectations of people making key transactional decisions in the economy.  There were always some economists, but quite a lot of effort went into getting business people and –  reflecting the much greater role of collective employment contracts then  – union officials to participate.   We even had large enough samples that we used to report responses separately for the different classes of respondents.  For some years, we ran a staff survey in parallel, which occasionally highlighted interesting differences between staff and external expectations for the same variables.    I’m not sure who is captured in the 52 respondents the survey now has, but I suspect economists must now make up quite a large proportion.  There isn’t necessarily anything wrong with that –  I suspect few people other than economists have explicit expectations for most macroeconomic variables (inflation might be an exception) and if they ever need such forecasts, they will typically draw on the numbers prepared by economists.  But it probably means the survey is drifting progressively ever closer to something like a consensus forecasts exercise of economists, rather than capturing how people are necessarily thinking in the wider economy.  It is broader than, say, the NZIER Consensus exercise, or than the pool of forecasters the Reserve Bank benchmarks its forecasts against (after all, it includes views of people like me who don’t prepare formal forecasts), but it is a similar class of exercise.

But what to make of the latest survey?  Only one thing really took me by surprise and that was that inflation expectations didn’t fall further.  I revised mine down, after having been stable for several quarters, and had expected the overall survey to show something similar.  After all, the June quarter CPI had surprised on the low side, the exchange rate had increased quite markedly and –  for what its worth –  the breakeven inflation rates derived from indexed and conventional government bonds had fallen further.  In fact, there was barely any change  –  if anything, a barely perceptible increase.

But it is worth remembering just how very weak these inflation expectations are.  The target midpoint –  which the Bank is required to focus on –  is 2 per cent, and last survey in 2014 was the last time two year ahead expectations were as high as 2 per cent.  And that was before the easing phase even got underway.  There have only been two quarters in the last four years when one year ahead expectations have been as high as 2 per cent.  Many of the deviations aren’t that large, but respondents really don’t believe the Bank will be delivering inflation fluctuating around 2 per cent.  That should trouble the Reserve Bank, and must trouble those paid to hold the Bank to account.  After all, actual inflation has been below 2 per cent for a long time now.

There is some short-term noise in the inflation expectations series, and there is some seasonality in the CPI.  But here is another way of looking at the data.   I’ve just averaged the last four observations for each of the four inflation expectations questions (this quarter, next quarter, year ahead, two years ahead) and annualized the two quarterly numbers. In the chart, I’ve shown them against the target midpoint, going all the way back to the end of 1991 –  which was when inflation dropped into the target range for the first time.

inflation expectations ann avg

That prompts several thoughts:

  • we’ve never previously seen all the measures below the midpoint. The last eighteen months or so really is different
  • we’ve never previously seen the two year expectations measures detach from all the other measures for so long,
  • when the shorter-term expectations often ran above the two year measure during the pre-2008 boom, it was the shorter-term measures that better aligned with (I’m hesitant to say “predicted”) what happened to the core inflation measures (the Bank’s own preferred, quite stable, measure peaked above 3 per cent).

The Reserve Bank might defend itself arguing that the fact that the two year expectations are still not too far below 2 per cent is reassuring –  “people trust us, despite the short-term variability”.   I don’t think that is a particularly safe interpretation –  especially when for the shorter-term horizons, about which respondents have much more information, expectations just keep on tracking very low.  Another common response from the Bank is to highlight exchange rate and oil price movements –  but most of the collapse in oil prices was 18 months ago now, and the current exchange rate is around the average for the Governor’s term to date.

A couple of other aspects of the survey caught my eye.  The first was the question about monetary conditions.  Here is what respondents said when asked about the conditions they expected a year from now.

mon conditions yr ahead.png

For seven surveys in a row, respondents have revised down their future expectations. This question has only been running since 1999, but that sort of run of downward revisions has no precedent –  not even during the 2008/09 recession.  Typically, the Bank raises or lowers the OCR and people seem to eventually expect policy to work and conditions to get back to normal. You can see that during 2008/09  –  by the June 2009 survey, respondents were already beginning to revise back up their future expectations.   But not –  yet –  this time.  I’d argue that isn’t surprising –  after all, the 2014 tightening cycle was a mistake, and even now with the OCR at 2.25 per cent, real policy interest rates are still higher than they were as that cycle was getting underway.  But perhaps there is another interpretation that is more favorable to the Bank?

I was also interested in the responses on expected 90 day interest rates –  a close proxy for the OCR.  Quarter ahead and year ahead expectations both fell by 10 basis points, but by next June the median respondent still thinks the 90 day rate will be 2.1 per cent.  That is probably consistent with the OCR at 1.85 per cent.  Respondents expect one more OCR cut –  most probably next week, according to the survey responses, but aren’t sure there will be anything much beyond that.  Perhaps more surprising, the lower quartile response for the year ahead was 2 per cent.  No one can tell the future with any great confidence, but I’d have thought there was rather more of a chance than that that the OCR might need to be cut to 1.5 per cent, or even below, to get inflation back nearer target.

It isn’t obvious how it is going to happen otherwise.  Respondents expect GDP growth to remain around 2.5 per cent.  And they don’t expect any material further reduction in the unemployment rate –  even though I see that Treasury has now revised its NAIRU estimate to 4 per cent –  and they expect only as very modest increase in nominal wage inflation (and of course those responses were completed before yesterday’s wages data).  It typically takes increased capacity pressure to get an acceleration in core inflation, and there is little or no sign of those sorts of pressures emerging in this survey.

So perhaps what we have is respondents reading the Governor much the way I do –  really reluctant to cut the OCR, but he will do so if events overwhelm him (his recent statement suggests next week’s MPS might be that time, if there hasn’t been another miscommunication or policy reversal).  But such a stance offers little chance of inflation getting sustainably back to around 2 per cent in the foreseeable future –  unless there is some really big unforeseen demand shock.

So those two year ahead survey expectations of inflation still look too high to me.   For many years, the ANZ’s survey of (non-expert) small and medium businesses had inflation expectations results above the Bank’s two year ahead survey.  Even those non-expert respondents now have (year ahead) expectations of only 1.49 per cent –  and that much larger survey has had an upside bias, over-predicting actual inflation, over the years.  I still feel pretty confident that the OCR will get to 1.5 per cent before too long –  but the sooner it is done, the less the risk of having to cut even further to restore practical confidence that future inflation will be averaging near the target the Bank has been set.  Sadly, with only 13 months of his term to go, it seems unlikely that Graeme Wheeler will ever preside over a 2 per cent inflation rate, let alone one that averages 2 per cent. But he can still set a better platform now for his successor.