Inflation: monetary policy works

Next week will see the first Reserve Bank OCR announcement (and Monetary Policy Statement) for the year (and for some time, given the long summer break the Bank took).   They’ll be trying to make sense of a whole range of data, including no doubt the quarterly labour market data to be released tomorrow.  And while no one expects the OCR to be changed next week, some commentators (and markets) appear to have turned their attention to the question of when the OCR might be raised –  with some talking of that possibly happening later this year.  I’m sceptical of that: apart from anything else, whenever a central bank changes direction in a year (and it was only November 2016 when the OCR was cut to the current 1.75 per cent), it usually involves correcting a past mistake.  Perhaps last year’s OCR cuts will prove to have been a mistake.  If so, I (and, almost by definition, the Reserve Bank) will be surprised.

Inflation has picked up over the last few quarters.  But then it needed to.  Annual headline CPI inflation had been below 1 per cent for two years, and although headline inflation shouldn’t be (and typically isn’t) the focus of monetary policy, it wasn’t something that could be entirely ignored either, partly for the risk that people (households and firms) would increasingly come to treat inflation well below 2 per cent as normal –  the implicit assumption they use in economic behaviour.  As a reminder, the Governor and the then Minister of Finance made the 2 per cent midpoint of the target range the explicit focus for monetary policy in the 2012 Policy Targets Agreement.

Headline inflation isn’t the focus of policy, because it is thrown around by all sorts of things (some from the market, some from governments) that monetary policy either shouldn’t or can’t sensibly do much about.  There is no single or ideal measure of “core” or “underlying” inflation – which try to abstract from those one-offs and get at the medium-term trend in inflation.

But whichever of the many different measures one uses, there is little doubt that the medium-term trend rate of inflation was also well below 2 per cent for a prolonged period.  On some of those measures there were even concerns that underlying inflation might be falling away further, and that that process could, if things went really badly, become self-reinforcing.   In essence, that weakness in inflation was the justification for the succession of OCR cuts from mid 2015 to late last year.

Here are the six core measures I’ve used previously.

Annual inflation rate
Dec-14 Dec-15 Dec-16
CPI ex petrol 1 0.5 1.4
Weighted median 1.5 1.5 2
Trimmed mean 0.7 0.4 1.6
Factor model 1.2 1.1 1.5
Sectoral factor model 1.2 1.5 1.5
CPI ex food and energy 1 0.9 1.6
Median 1.10 1.00 1.55

At the low point, the median of these six measures was around 1 per cent, although it seems unlikely that policy was being made on that basis –  the Governor often talked of core measures being still comfortably inside the target range, and on occasion explicitly emphasised the sectoral factor model measure as his preferred indicator.  That measure is certainly the least volatile of all the underlying measures (over the whole history of the series), although it has its own limitations –  including that the series is prone to historical revision as new data about the present emerge.  But for what it is worth, here is the chart of the sectoral factor model measure.

sec-factor-model-to-dec-16The fact that this measure is not very volatile tends to mean more weight should be put on deviations from the target –  they aren’t likely to be simply “noise”.  Perhaps the latest estimates will eventually be revised up a little in time, but as it happens the sectoral factor model estimate is now around the median of the whole suite of core measures.  The medium-term trend in inflation was probably around 1.5-1.6 per cent late last year.

It is interesting that we don’t see a rise in core inflation in the other advanced economies taken as a group.  Headline inflation is rising somewhat on account of petrol prices, but exclude food and energy –  the most widely available core measure –  and here is what we find in the OECD data.


It is monthly data and there is a bit of month to month volatility, but no real sign of any sustained rise in this measure of core inflation.  I’d tend to put most weight on the green line –  the median inflation rate among all OECD countries.  In most countries, inflation also appears still to be below the respective inflation targets.

When the Reserve Bank was cutting the OCR last year, opponents of further cuts were sometimes heard arguing that “the case for cuts isn’t that good, and anyway, monetary policy isn’t likely to do much good [at such low interest rates/in this global climate]).  But the data suggest quite the opposite.    Here are a few measures of New Zealand real interest rates over the last five years.


Real interest rates rose in 2014 and into early 2015 as the Governor (supported by his advisers) raised the OCR by 100 basis points.  The medium term trend rate of inflation was low when the tightening phase started and, if anything went a bit lower subsequently.  It is likely that the weakness in inflation was the result of some combination of weak global inflation, the sharp fall in oil prices (spilling over into core measures) and the Reserve Bank’s monetary policy stance, which also helped drive the exchange rate up.  It is now generally accepted that the 2014 tightenings were simply unnecessary, although perhaps reasonable people can differ on the extent to which the mistake was foreseeable at the time.  But there is little doubt that the unnecessary tightenings stood in the way of inflation getting back to around the middle of the target range.

From mid 2015 the Reserve Bank was cutting the OCR.  The cuts were initially rather grudging –  the Bank was uncomfortable with recognising that they had got things wrong previously –  but in  total ended up being quite large.  A cumulative cut in the OCR of 175 basis points was needed simply to undo the effects of the 100 basis point tightening because expectations of future inflation fell quite materially, largely in response to the persistently low actual (headline and core) inflation.   Even now, real retail interest rates are not quite as low as they were when the tightening cycle began in early 2014.   The easier stance of monetary policy helped support growth in demand and activity –  although even now per capita GDP and income growth remains unspectacular.  And of course –  subject to data updates tomorrow –  there is still excess capacity in the labour market, with the unemployment rate  having been still well above Treasury’s estimate of the NAIRU.

Who knows what the outlook is from here.  If the TWI remains at current levels, the recovery in headline inflation could be shortlived.  Perhaps the medium-term trend in the rate of inflation will rise further.  We should hope so.  I wouldn’t be advocating further OCR cuts at present, but it seems to me that the best approach at present is to assume that we have little knowledge about the future, and that if an OCR change is required in the next 12-18 months it might as easily be a further cut as an increase.  Since the 2008/09 recession the Reserve Bank was twice started tightening phases that proved to be unnecessary and had to be reversed.  And in those cycles they typically had the support of market economists and financial markets.  Given that track record, the absence of any real rise in global inflation, and the difficulties of making sense of what has been going on, a prudent approach might be to wait to see core inflation actually at 2 per cent before looking to raise the OCR.   If the unemployment rate were to drop sharply further, or if per capita growth accelerated sharply, that stance might reasonably be reassessed.

Prices differentiated by location

We drove back to Wellington from Ohope yesterday and, having been intrigued by some incredibly low petrol prices in Otaki as we had driven north, my trusty research assistant set out to jot down all the petrol prices (for 91) we saw as we drove home again.  She only fell asleep once, necessitating a momentary stop in Foxton so that I could take down the  –  rather low – price there

To the owner of the G.A.S. outlet at Lake Rotoma I can only offer the advice that if you want passing motorists to buy your petrol, it probably pays to make the price visible from the road.

This is what we saw:

Whakatane           178.7/9

Awakeri                 188.9

Rotorua                  162.7/9    (this was three stations on the road to the airport; one other a few kms away by Whakarewarewa was advertising 182.9)

Waiotapu                178.9

Taupo                       185.9 to 190.9

Te Rangiita             192.9 and 194.9

Turangi                    194.9

Waiouru                   197.9

Taihape                    195.9

Hunterville             195.9/196.9

Bulls                          191.9

Sanson                      192.9

Foxton                       179

Levin                          176.7 to 180.9

Otaki                          205.9

Waikanae                  191.9/193.9

Paraparaumu           193.9

Plimmerton              206.9 to 208.9

Central Wellington   208.9

Given that the retail price of petrol has a very large tax component, it is an extraordinary range of prices: 46.2 cents from low to high.   The AA website tells me that on each litre of petrol there is a fixed 67.284 cents per litre tax component, with the variable (in terms of cents per litre) GST on top of that.    That means the price of petrol excluding excise is around 50 per cent higher in Wellington (141.6 cents per litre) than in Rotorua (95.4 cents per litre).  Yes, there are some differences in transport costs –  but not much between Whakatane and Awakeri, or between Levin and Otaki.  The biggest difference –  and the rather obvious one –  is the state of competition in the respective markets.  Gull (and Waitomo in Foxton) seems to more or less have guaranteed low prices.  Absent that sort of competition and prospects aren’t good at all.  Sadly for Wellingtonians there is no such aggressive competition here.

I don’t have a policy point to make, but surely there must be a market opportunity here? Levin just isn’t that far from Wellington, and they seem to manage.

On another topic, what to make of the Peter Thiel citizenship story?

Had the man wished to settle here I’d have had no objection.  He seems to be of good character, unlikely to burden the New Zealand taxpayer, and there might even be some of the famed spillover benefits (the immigration advocates are always championing) to New Zealanders had he done so.

But, and while the facts seem to be emerging quite slowly, there is no sign that he had ever intended to settle here. And, one would have to ask, why would someone like him seriously think of doing so –  being fully engaged in the US political processs, and heavily involved in industries that are centred in the US?

Against that backdrop, it looks as though we (well, the government) have simply “sold” him citizenship.     The sort of thing they used to do in places like Tonga and Panama –  and still apparently do in some otherwise respectable countries.

I’m not sure what advantages there are to a New Zealand passport for someone who doesn’t want to live here.  For some, perhaps it is the number of countries people can travel to visa-free.  For others perhaps, it is a way around the overseas investment restrictions on purchases of New Zealand land.  I think most of those restrictions should be abolished, but I don’t think our government should be offering sweetheart deals to wealthy foreigners to enable them to get around laws and restrictions that our Parliament has passed.

One of the newspapers today reports the government suggesting that up to 300 grants of citizenship are made each year under the “exceptional circumstances” provisions.  If so, that is extraordinary, and is being done with little or no transparency.  I’d have no problem with a very rare grant of citizenship to, say, an international human rights campaigner declared stateless (and passportless) by their own country –  which is the sort of circumstance a superficial reading of the statutory provision seems to suggest.

But citizenship is more than just a certificate of convenience.  It is about membership in a nation.  Mostly it comes by birth or descent.  For most others, it involves moving here, settling here, and intending to stay –  to become an ongoing part of the group of people who are New Zealand.    Sure, the boundaries can be fuzzy.    There are people who were born here, who no longer live here and have never paid New Zealand taxes, who are still New Zealand citizens.  But a relationship by birth/blood is different than one by administrative grant.

Thiel, it seems, has never lived here, and probably has no intention to do so.  By contrast, a typical migrant who moves here –  0r indeed someone who has citizenship by descent (including two of my children) but wishes to be a fully naturalised New Zealand – not only has to have lived here for a sustained period (typically five years) but must intend to keep living here.  As the Department of Internal Affairs website puts it

You have to plan to keep living in NZ. If you don’t, it has to be because you’ll be:

  • working overseas for the New Zealand government
  • working for an international organisation the NZ government is a member of (like the UN), or
  • employed by a person or organisation that’s based in NZ.

There is simply no sign that Peter Thiel would have met that test.   Again, perhaps there is a case for fast-tracking a grant of citizenship on rare occasions (eg to represent the country in an international event) but even then surely only for someone where there is an intention to stay living here.

It isn’t even clear what contribution Thiel has made that might have enabled the Minister to be satisfied that there were exceptional circumstances.  There are reports of a large donation to an earthquake charity in 2011 –  which looks uncomfortably like a “fee”, but with the benefit not even going to the public purse –  and talk of investment in some New Zealand companies, which seems mostly like private benefits all round (to the investor, and to the invested in).

At very least, if we are going to grant ministers of the Crown authority to make discretionary grants of citizenship, the public needs some more protections.    Perhaps in any case where the Minister proposes to exercise this discretionary power, the name of the person should be notified in the Gazette for, say, two months prior to the grant of citizenship? Ministers could be statutorily required to have regard to any submissions made on the proposed citizenship grants.

Granting citizenship to Thiel isn’t corruption in any direct sense –  no doubt it was done quite lawfully.  But the statutory provisions, when used in this way  –  even for an otherwise blameless individual – risk corrupting what it means to be a citizen, and gives too much discretionary power to ministers and their officials who can use the power of membership of this country to serve their own interests.  Citizenship is a privilege; one that should be secured by birth or prolonged residence (I’d probably favour a period longer than five years, but that is incidental).  And it should be a matter of entitlement once specific pre-specified detailed conditions are met.  Citizenship in a serious country shouldn’t be on offer to people with no familial connection to New Zealand, no evidence of having settled here and no plans to make New Zealand their primary location, and certainly not to people –  however able – who are willing to disburse money to favoured causes.

Finally, in a week when on the one hand “alternative facts” has entered the political lexicon, and on the other when the latest Demographia housing numbers are out, one is reminded that this citizenship grant occurred under a government led by a Prime Minister willing to assert, in defiance of all the facts, that high and rising house prices were simply a mark of how well New Zealand was doing, and how desirable New Zealand was as a place to live.  As distasteful as Trump’s are, alternative facts aren’t new.


Immigration: where should the burden of proof lie?

The New Zealand Initiative, the business (and Wellington City Council) funded think-tank, is on record as strongly in favour of allowing high levels of non-citizen immigration.  Indeed, some of their senior staff seem quite strongly influenced by the “open borders” strand of libertarian literature that, in principle at least, favours allowing in almost anyone who wants to come.  But very little of what they have had to say thus far has been very New Zealand specific at all – the presumption seems to be that whatever might be true and valid in some places abroad will also apply here.

The Initiative has indicated that it will shortly (later this month?) be releasing a major report on immigration policy as it applies in New Zealand.  They ran a seminar on a draft of the report late last year and I was no doubt only one of many people who gave them fairly extensive comments on the draft.

Over the last couple of years I’ve been highlighting that there is no modern empirical analysis focused on New Zealand indicating that New Zealanders have benefited, in economic terms, from the large scale non-citizen immigration policy that has been run over the last 25 years or so (as a reminder the net inflow of non-citizens is about three times that in the United States, both in per capita terms).  Champions of large scale immigration to New Zealand –  including well-resourced public agencies like Treasury and MBIE, MBIE-funded academics, and think-tanks/lobby groups like Business NZ and the New Zealand Initiative – all rely either on overseas research about other countries (often much more central ones, like the US or various northern European countries), or relatively simple theoretical arguments about possible gains to New Zealanders.  And mostly they do not seriously engage either with the specifics of the continuing economic underperformance of New Zealand, despite the large scale non-citizen notionally-skills-focused immigration programme, or with the continuing natural resource orientation of this specific economy  My challenge has been along the lines of “show us the evidence”.  After all, if a policy has been run for a quarter of a century, on a relatively large scale, and it really has material economic benefits to New Zealanders as a whole  surely it shouldn’t be too hard to demonstrate those gains?

I had hoped that in the forthcoming report the New Zealand Initiative might take up that challenge and do some New Zealand specific research that would support their enthusiasm for high rates of inward non-citizen immigration.  If they had done so, no doubt there would still be plenty of room for debate –  no one study is ever definitive on any topic –  but at least there would then be a marker out there for sceptics to look at,be challenged by, and be forced to engage with.

But the other day a reader  – who is, I think, generally sceptical of my immigration analysis –  forwarded me a link to a tweet from the Initiative’s head of research, Eric Crampton.

In it, Eric was retweeting something from Erik Berglof, a professor at LSE, who in turn was linking to what proved to be a two year old piece by a Bulgarian sociologist who had (a) asserted that the academic evidence of the impact of immigration (to the UK) was overwhelmingly positive and (b) debunked a few of the dubious claims sometimes made about the impact of immigration in the UK (eg on social housing demand).  There was no  evidence on the wider economic impact advanced at all –  and in fairness to the Bulgarian sociologist, hers was only a two page piece.

But what really struck me was Eric Crampton’s own strong language –  aimed, I assume, at people like me.  We apparently “insist the null hypothesis is that NZ migration is terrible unless proved otherwise” and then “That shouldn’t be the null”.  A lot turns on that second sentence.

I’m quite open to the possibility that large scale immigration to New Zealand might have little or no long-term net economic impact on New Zealanders.  If so, that wouldn’t make such immigration “terrible”, but it would rather undermine the assertions of academics and officials that there are material gains for New Zealanders as a whole –  in MBIE’s terms that our immigration programme is, and has been, a “critical economic enabler” for New Zealand.  If it was all a wash –  and there were no material economic gains or losses for New Zealanders as a whole – we might still keep an immigration programme going if we wanted to offer that opportunity to the immigrants (who clearly expect to benefit or they wouldn’t move) but if New Zealand voters preferred not to do so, economists and officials would have no good reason to gainsay that preference.

My own suspicion is that our immigration programmes –  since World War Two, but particularly in the last quarter century, have been more damaging than that.  I’ve advanced a story –  which hangs together, even if it may not finally be the correct story –  which explains our continuing deterioriation in relative productivity performance in terms of the continuing rapid growth in population (mostly immigration policy driven) into a location with relatively few strong natural economic opportunities, reinforced by the pressure that rapid population growth (in an economy with a modest savings rate) has put on our real interest and exchange rates.  My story has never been that immigration is always and everywhere bad for natives, just that at times it could be, and that modern New Zealand could be one of those times places.  We see enough moribund towns, here and in other settler countries, to realise that where settlers arrive isn’t always where they can generate good returns over the longer-run.

Do I have robust formal empirical evidence for this story?  Well, no, I don’t.  And I don’t have the resources, or technical skills, of our leading government agencies to do such empirical research –  even if there were an easy or obvious way to formulate the test.  I’ve tended to rely on a “competing narratives” approach –  looking for stories that can best explain the various stylised facts of New Zealand’s disappointing long-term economic performance, and assessing how well each of those narratives do.

Eric Crampton proposes that the burden of proof be reversed from the traditional one.  In his story, we should welcome large scale immigration –  probably even larger than we have now –  unless there is clear proof that the immigration programme is harming New Zealanders.  It seems a lot like a concession that the alleged economic gains to New Zealanders can’t easily be shown –  and won’t be shown in the forthcoming Initiative report.  That point alone should be telling –  it defies the repeated rhetoric from politicians, officials, academics etc.

But how reasonable is the argument?  In some markets, and some products, I think it is a quite reasonable approach.  I don’t think we should be banning, or differentially taxing, trade in goods or services without pretty clear evidence of harm to New Zealanders as a whole.  I don’t think we should typically be regulating domestic markets in this, that or the other thing without clear evidence of harm –  and it is a test that is too little applied, at least with any rigour.  But non-citizen immigration is different.

What makes it different?  I think it is the fact that migrants are people, not goods, services (or dollars).  And the two categories are profoundly different.   People aren’t a sofa or a holiday.  People –  immigrants, not holidaymakers – take up residence , and in time become citizens and voters, and that they embody a whole set of institutions/cultural norms etc.  And people from other countries will often have a quite different culture etc from the people already here.   And even if they don’t, the natural resources in a particular location might be limited –  and if natural resources certainly aren’t everything, they aren’t nothing either, especially in remote locations such as this.

None of this is intended as a novel or particularly provocative observation. Norway (and Norwegians) are different than Portugese who are different than Argentineans or Singaporeans, and all of them are different from New Zealanders.  And of course there is plenty of diversity among New Zealanders.  The differences and similarities within and across countries aren’t easy to define, but there have to be some things that bind us together as New Zealanders –  if “New Zealand” is to be any more than some arbitrary administrative boundary such as that between the Wellington City’s southern and eastern wards.   We feel (by revealed preference of our political choices) some obligation to mutual support of fellow New Zealanders in a way that we  don’t feel –  or practice –  for people in Iceland, Ireland or Malta.  It doesn’t mean we think those people are inferior, but they simply aren’t our people.

I suspect every human society ever has maintained boundaries.  Outsiders have never been totally free to join an alternative grouping (whether a national state, or some other), no matter how attractive the alternative might appear.  No doubt there are various reasons for that, but it will include the intuited wisdom that communities with similar values and backgrounds tend to function more efficiently and effectively –  trust, for example, is a key dimension of any well-functioning society, and trust is developed and maintained most easily among those with similar backgrounds and shared experiences.  Yes, market insitutions can reduce to some extent the need to rely on trust, but only to some extent.   If anything, there is probably a “diversity tax”more often than a diversity dividend (and I wrote last year about some suggestive work in that area).

None of this means that effective societies can’t or shouldn’t cope with any newcomers.  But the capacity to absorb newcomers –  especially if from quite different cultures –  and still maintain the trust and intuitive understanding of each other –  is likely to be quite limited: human nature isn’t likely to have suddenly changed in the last few decades after millenia of operating within relatively homogeneous groupings.   If there are really big gains from welcoming lots of newcomers, those gains will offset any diversity costs.  But that brings us back to the question of starting presumptions.   The advocates of New Zealand’s large scale immigration programme simply haven’t been able to show such gains –  whether it was in the 50s and 60s, where the bulk of the immigrants were from the UK, or more recently.  There is a lot of wisdom embedded in established human institutions –  they evolved for a reason, typically a good one. The libertarian conceit is that those institutions, or presumptions, can simply be demolished and all will be fine.  Perhaps it will, but really the burden should be on them –  and their fellow travellers – to show it, including in the case of large scale movements of people.

So perhaps there was a case to be made 30 years ago that we should give large scale immigration from an indiscrimate range of countries a go.  Perhaps there really were large economic benefits to be had for New Zealanders.  And since few people had ever tried the experiment, we’d never know unless we tried.  But we did try, and have gone on doing so for at least 25 years now.  At this point, the onus really should be shifted to the advocates to show that their policy –  historically unusual, unusual in a cross-country context – is really producing benefits for New Zealanders as a whole.

I’ll look forward to the forthcoming Initiative report, and will no doubt comment further when I’ve had a chance to read it.  I was struck however by two observations I’ve seen in the last few days.  The first was the blurb for an old New Yorker article, in a newsletter that came through promoting a collection articles about Barack Obama.

Obama’s aunt told him that his father had never understood that, as she put it, “if everyone is family, no one is family.” Obama found this striking enough so that he repeated it later on in his book, in italics: If everyone is family, no one is family. Universalism is a delusion.

That sounded right, and uncontroversial (perhaps to all except libertarians).  The family analogy isn’t perfect, but it isn’t without value either.

And the second was a piece on Canterbury university lecturer Paul Walker’s blog, with the salutary reminder –  drawing on a piece from Nobel laureate Ronald Coase – about the limitations of empirical economic research, and the tendency of researchers –  and one might no doubt generalise it to analysts more broadly –  to find what they expect or want to find.  In Coase’s words

I remarked earlier on the tendency of economists to get the result their theory tells them to expect. In a talk I gave…. I said that if you torture the data enough, nature will always confess, a saying which, in a somewhat altered form, has taken its place in the statistical literature. Kuhn puts the point more elegantly and makes the process sound more like a seduction: “nature undoubtedly responds to the theoretical predispositions with which she is approached by the measuring scientist.”

It doesn’t mean the work shouldn’t be done, but it is a caution, and a reminder that societies rarely make policy choices, especially about big issues that have the potential to change the character of the society, on the basis of empirical studies.   All too often such studies offer support more than illumination.

Before stopping (for a couple of weeks):

Some readers might be interested in a 1990s piece from the late professor Ranginui Walker on immigration policy from a Maori perspective that a reader sent me the other day.    The nature of what large scale immigration did to the Maori place in New Zealand –  perhaps offering economic benefits but other losses –  still seems too little discussed in the current debate.

And Radio New Zealand on Monday broadcast a prerecorded discussion on some of New Zealand’s economic challenges between me, Ganesh Nana of BERL, and Rod Drury, CEO of Xero.    This was the discussion referred to in a pre-Christmas post on cities , in the context of the relative underperformance of Auckland.

Greenspan and pressure on independent central bankers

I’ve been reading a succession of long biographies of influential Americans.  The US election result prompted me to read biographies of the four presidents from Eisenhower to Nixon – one president with no prior experience in elected office, and three very flawed individuals –  and in the middle of all that I read (to review) Sebastian Mallaby’s big new biography of Alan Greenspan, The Man Who Knew.  There is some overlap:  Greenspan played a role in Nixon’s 1968 election campaign  – in domestic policy, and in doing polling analysis (his economic consultancy/forecasting firm had just acquired its first computer) –  and Greenspan was nominated to his first official government job, Chairman of the Council of Economic Advisers, in the last days of the Nixon administration.

I’d strongly recommend the Greenspan book.  It is well-written, deeply-researched (the author notes that one of his research assistants read the full transcripts of every FOMC meeting in the 19 year Greenspan term), and as interesting for the pre-Fed period as for Greenspan’s lengthy term as Chairman.  For some there might be a little too much on his succession of girlfriends over 40 years –  of one, we learn what she was wearing when Greenspan first encountered her in the Oval Office –  or the tennis holidays, but it is a biography of the man and his times, not the story of monetary policy.  Even in New Zealand bookshops, the price of the 750 page hardback isn’t extortionately expensive.

I’m not going to attempt a full review here.  Instead, I wanted to highlight Mallaby’s account of one interesting little episode from the early 1970s, when Greenspan was still prospering from his success as an economic adviser to major corporations (“the man who knew”).

As I noted, Greenspan had been quite involved in the 1968 Nixon campaign –  Nixon built a fairly formidable team of policy advisers, and carried many of them into the White House with him.    Greenspan had turned down the offer of a fulltime government position after the election, reckoning that the only positions that interested him were ones he was not yet senior enough to be offered (eg Secretary to the Treasury).  But he stayed involved, serving on the commission that (sucessfully) recommended the abolition of military consciption and on a presidential commission on financial reform.

By 1970, the chairman of the Federal Reserve was Arthur Burns, one of Greenspan’s former professors with whom Greenspan had stayed close.  Burns had also been quite involved in both Nixon presidential campaigns, and (somewhat against his own wishes, so his diary records) had been brought into the White House at the start of Nixon’s term as Counsellor, with Cabinet rank.

One of Nixon’s perennial concerns (he was a politician after all) was his re-election prospects.  As it happened he needn’t have worried –  his 1972 margin of victory was one of the largest ever – but he did, obsessively.  And in mid 1971 he was very concerned about what the state of the economy might be by the election time in 1972.   He had been convinced that Fed misreading of the state of the economy had contributed to his narrow defeat by Kennedy in 1960.

On 23 July 1971, Mallaby records,

Nixon invited three advisers to join him on the presidential yacht, Sequoia, for a Friday-night cruise on the Potomac.  The men kicked about ideas on how to deal with the wayward Fed chairman. Burns was behaving like a professional Eeeyore, talking down the economy with one gloomy comment after another…..Building on a suggestion from John Connally, the Treasury secretary, Nixon and his henchmaen settled on a plan.  They would make Burns shut up by planting a negative story in the press about him.

Burns had been urging the president to take a stand against inflationary wage increases. the Nixon men resolved to tell the press that Burns had simultaneously been lobbying behind the scenes for a personal pay raise [in fact, he had argued for an increase in the Chairman’s salary, but starting from the commencement of his successor’s term].  Coupling this charge of hypocrisy with crude intimidation, they would also inform reporters that Nixon was contemplating a reorganization of the Federal Reserve to curb the chairman’s authority.

Four days later the story appeared in the press, and the President’s press secretary “gave the story legs by refusing to deny it”.

With Burns now on the defensive, Nixon’s men moved in for the kill.  They would get a message to Burns demanding a positive speech on the economy. If the Fed chairman wanted to avoid all-out war he would have to cry uncle.

Charles Colson, a member of the Sequoia trio who would later serve jail time for organising Nixon’s dirty tricks, tracked down Greenspan.  He phoned him in New York and asked him to get Burns to change his tune on the economy.

Years later Greenspan insisted he refused to do Colson’s bidding.  But Colson’s handwritten notes from the conversation suggest otherwise.  After taking Colson’s phone call, Greenspan spoke at length to Burns.  Then he reported back to the White House.

Burns were seriously put out –  “very disturbed” was Greenspan’s description.  Mallaby continues for a couple of pages, with accounts of conversations between Nixon, his chief of staff Haldeman, and Connally about keeping up the pressure on Burns, including Greenspan’s role.

And then

Within twenty-four hours, the Fed chairman caved and Nixon appeared at a press conference to disavow the shameful attacks on his good character.  “Arthur Burns has taken a very unfair shot,” the President said, explaining how Burns had in fact turned down  a pay increase when the White House budget office had recommended one. A transscript of Nixon’s remarks was forwarded to Burns, who was soon on the phone to express his gratitude.

“It warmed my heart,” an elated Burns told Nixon’s speechwriter, William Safire.  “I haven’t been so deeply moved in years. I may not have shown it, but I was pretty upset.  This just proves what a decent and warm man the president is.  We have to work more closely together now.”

Burns’s diary for the years 1969 to 1974 has been published –  and is a good read for junkies.  Unfortunately, it is a little patchy and doesn’t cover July 1971.

Mallaby asserts that this episode, in which Greenspan appears to have played a not unimportant role, was a key turning point in the whole of monetary policy in the 1970s (Burns remained chair until 1977) when inflation became an increasingly serious problem, not just in the US, but around much of the advanced world.

In fact, distasteful as the episode is , reflecting no credit on anyone involved, Mallaby probably exaggerates when he writes that

The central bank had not been so clearly under the thumb of the White House since the Fed-Treasury accord of 1951. Politics had triumphed, and Greenspan had been a party its victory.

It is worth remembering the timing.  All this happened just a few weeks before the US suspended gold convertibility and the Adminstration imposed wage and price controls and temporary import levies.  They weren’t normal times, and nor  –  as the fixed exchange rate era broke down –  was it an era in which one might expect the usual distance between the White House and the Fed.

As importantly though, White House pressure on the Fed wasn’t new.  Burns’s diary on 21 March records his request for a meeting with Nixon “to have a candid talk about the war of nerves the White House gang had set in motion”.

And nor was the tension within Burns, between his anti-inflation instincts and his apparent desire for access to, and influence with, the President new.  In the same entry he records:

I informed the President as follows: (1) that his friendship was one of the three that has counted most in my life and that I wanted to keep it if I possibly could; (2) that I took the present post to repay the debt of an immigrant boy to a nation that had given him the opportunity to develop and use his brains constructively; (3) that there was never the slightest conflict between my doing what was right for the economy and my doing what served the political interests of RN; (4) that if a conflict ever arose between those objectives I would not lose a minute in informing RB and seeking a solution together; (5) that the sniping in the press that the White House staff was engaged in had not the slightest influence on Fed policy, since I will be moved only by evidence that what the Fed is doing is not serving the nation’s best interests

and so on.  He notes “RN seemed pleased by my reassurances to him, indicated that he never had  any doubts, that he would put an end promptly to the sniping about the Fed that has been going on at the White House…”

Perhaps more useful still, is Allan Meltzer’s comprehensive history of the Federal Reserve.  Meltzer was a monetarist and in the 1970s had not been particularly supportive of the rather ad hoc way in which the Fed ran monetary policy and allowed inflation to build up.   But in his careful discussion, and analysis of the documentary record, Meltzer absolves the Fed of the charge that in the run-up to the 1972 presidential election it was shaping policy according to political imperatives.  As he notes, the FOMC votes were rarely close (typically unanimous), and the FOMC itself was manned by plenty of independent-minded people who had been appointed by Presidents Kenndy and Johnson (one of the most independent had been appointed first by another Democrat president, Truman).

As he notes

Burns was able to get a majority vote of the FOMC because he could appeal to beliefs that considerable resources were idle, that inflation would be held back by price controls, and that their principal mandate was to contribute to full employment.  This was compatible with service to the president’s reelection campaign.

It is an alien world in many respects –  quite different models of how to think about inflation, the primary role of the central bank etc –  and none of the key figures emerges that well –  Nixon, Burns, Greenspan, Colson, Connally, Haldeman.  Some of that is clearer with hindsight, others should have been clear at the time.  But it wasn’t a case of the President’s placeman successfully orienting policy simply to re-election.

One of the themes of Mallaby’s book is how Greenspan, who started out very close to Ayn Rand, quickly gravitated towards the centre of affairs –  at times willing to compromise perhaps rather too much to retain that place. Mallaby praises Greenspan’s deft political management skills.  I couldn’t help feeling slightly uncomfortable.  One example was the account of the way Greenspan hosted annual 4 July parties at the Fed, at his own expense, for the movers and shakers of Washington and their families –  effectively buying influence and regard.  I came away from the book with a strong sense that 19 years was just too long for any one unelected official to hold such an influential office –  and as the book illustrates there is no evidence that Greenspan was uniquely well able to read the economy, or judge the best policy response –  but perhaps that is a topic for another post another day.

Immigration as a tool to advantage professional women

One day earlier this week the Dominion-Post was editorialising about whether some form of “Trumpism” might come to New Zealand.  As I wrote a few weeks ago, I remain a bit sceptical about quite how much Trump’s victory and the Brexit vote have in common, or about sweeping generalisations as to what electorates are doing/choosing/saying.     The editorial noted that although some have talked of Winston Peters as “New Zealand’s Trump”, in fact (as I have noted previously) Peters has done little when he has held ministerial office:

He did nothing to advance the anti-immigrant agenda when he gained power.  And this fact is a great blessing to New Zealand.

If we allow that, despite the editorialist’s enthusiasm, one of the things that seems to bothering an increasing number of voters in many Western countries has been high rates of immigration –  actual or perceived –  then a Bloomberg article on the very same page of that issue of the Dominion-Post might offer one strand in the complex picture of why.  In that article, a Cambridge University economics academic, Victoria Bateman,  argues in favour of a pretty open approach to immigration because such immigration makes the lives of professional women (and their spouses) so much easier.

Not only does immigration boost the economy, it has also helped empower professional women in the U.K. and U.S. economies over the last 50 years.   The entry of professional women into the labor market has been supported by an army of low-paid — often immigrant — domestic helpers. …. At the end of the day, where would “power couples” be without the low-paid, often female and immigrant, labor on which they depend?


Reduced immigration will leave us with a choice: Either life will be more difficult for professional women, or professional men will have to do more around the home.

Yes, I can see all the gains-from-trade arguments that Bateman, and libertarian supporters of an open approach to immigration policy, would advance.  Highly productive people can do, and produce, more if they can deploy support services to assist their participation in the labour force.  This is the counterpoint to the easy-assimilation approach used in New Zealand immigration policy –  if one brings in people much like those who are already here they might settle in easily, but there are few gains from trade.

But it is also a very stark example of the way in which immigration policy is more about redistribution than it is about the prospect of any material overall gains to the citizens of the recipient country.    In the best of cases, the evidence that high levels of immigration boost productivity and per capita GDP in recipient countries very much at all is pretty slender.  There are reasonable theoretical arguments, but even if the signs are sometimes right (ie there are real overall economic gains) the magnitudes are typically small, and can’t easily be seen even over decades.  In some places –  I argue that New Zealand is a prime example –  misguided immigration policy may be materially impairing the economic fortunes of the country as a whole.  But there isn’t much doubt that –  as with many other policy levers –  immigration policy can advantage some groups at the expense of others.  For example, combine planning restrictions with high levels of immigration and there are real windfalls gains for existing landowners –  and commensurate losses for those who would have been seeking to enter that market.

And that is just the sort of redistribution Bateman is talking about.  She welcomes immigration that keeps down the cost of low-skilled labour which means that

educated women have been able to subcontract out their traditional domestic duties, from cleaning and childcare to preparing meals and looking after the elderly.

Perhaps this wouldn’t be (as) morally offensive if there was an entirely separable class of temporary guest workers, who didn’t substitute at all for low-skilled domestic workers.   The temporary workers would gain from the trade, and so would those employing them. But that (separability) isn’t how labour markets operate.  What Bateman is in fact arguing for is a policy designed to explicitly help people like her, at the expense of poorer less highly-skilled Britons (in fact, in the roles she talks of typically poorer relatively unskilled British women).  No one person is ever an exact substitute for another, but there is a great deal of overlap.    Even though she never says it, what Bateman is arguing for is a policy designed to increase the differences in incomes between the highly-skilled and the less-skilled –  for the comfort of the highly-skilled (women and their spouses).

Many advocates of a fairly liberal approach to immigration like to downplay the possibility of any costs to low-skilled natives of the recipient country, but Bateman’s argument relies almost entirely on those costs.  Reasonable people can debate how large the actual adverse effects are, but Bateman clearly believes they are large –  that is why, in her view, immigration makes things so much easier for people like her.     And she can’t even be arguing  –  as some might –  that it is just a transitional effect, or otherwise the possibility of outsourcing domestic duties cheaply would soon go away again.  So it seems to be a vision of society that involves repeatedly importing new waves of lowly-skilled immigrants to keep the relative returns to low-skilled labour sufficiently low to make life comfortable for the professional classes.

Libertarians might not like it, but stable societies are organised around a set of common interests, and a common sense of identity.  Whatever the other arguments for and against immigration, it is hardly surprising that citizens might rebel against a proposal to bring in lots of foreigners to widen the income gaps in society –  not just those between nationals and non-citizen foreigners, but those between skilled and unskilled nationals.   Sceptics of other economic reforms will argue that some of those changes also had that effect, but even if so (which I mostly dispute) it was never the intention, or the envisaged long-term effect.  By contrast, Bateman’s argument is in effect for using immigration to maintain a permanent class of helots –  not always the same specific people, but a constantly refreshed pool of people able to earn relatively little, because of the direct competition fron unskilled new arrivals.

I remain of the view that any immigration we do actively pursue should focus on a small number of very highly-skilled people (in addition to a limited number of refugees etc).  By contrast, Bateman’s vision –  whether applied here, or in the UK or the US – would seem to undermine most people’s sense of what a well-functioning society and economy should look like.

If people are really worried about obstacles to outsourcing domestic duties, take another look at the high maximum marginal tax rates that in many countries (less so New Zealand than most) still encourage people to do it themselves, within families.

Thank goodness that so far Bateman appears to have kept to pen and paper (so to speak) to articulate this argument, rather than the alternative surfaces she used last year for her highly-publicised anti-Brexit protest.

And now it is time to hang out the washing and spend some time with the kids.

Major cities in many countries have become progressively less dense

A reader yesterday linked to the recently-published United Nations World Cities ReportSceptical as I am of most UN things, out of curiosity I dipped into a few chapters of the report.

On doing so, I stumbled on this chart


In a quite striking way it makes the same point made in an early post on this blog: as countries become richer, the cities in those countries tend to become less densely populated.  Here was the chart from the earlier post showing data for London as far back as 1680 (just over a decade after the Great Fire).


These numbers shouldn’t really be a surprise.  Space is a normal good –  people typically want more of it, all else equal, when they can afford it –  and technological advances make longer distance commutes feasible.

No doubt there will be some issues with how the data are compiled/estimated –  quite where are the boundaries around the “built up area”, and how well is that known for, say, 1855.  But the general proposition shouldn’t be surprising: it is easy enough to think of the cramped tenement dwellings of New York in the late 19th century.

Of course, these trends aren’t ones that seem to please either the United Nations or many of our own local councils.  This text is from the UN report, just after the chart above

In recent years, UN-Habitat has brought into the forefront of attention the need for orderly expansion and densification so as to achieve more compact, integrated and connected cities. UN-Habitat’s support for planned city extensions programmes as well as promotion of tools such as land readjustment aims to increase densities (both residential and economic) with compact communities in addition to guiding new redevelopment to areas better suited for urbanization. These interventions are suggested to be an integral part of the New Urban Agenda as elaborated in Chapter 10.

And the constant refrain locally is for “more density”, when there is little or no evidence that such densification is what residents would prefer for themselves.  Indeed, it would be surprising if the revealed preferences across time and across countries/cultures had suddenly reversed.

I have no particular problem if people wish to live in high-rise apartments, or in small townhouses with no garden.  And people will choose to do so if regulatory constraints limit their options –  eg if land simply becomes too expensive –  but it doesn’t look like a first-best unconstrained preferred choice for most people.  We don’t, for example, see such bunching in our own provincial cities –  where housing is less unaffordable than in, say, Auckland –  and of course by international standards even our own largest city, Auckland, is not much more than a large provincial city (just a bit smaller than, say, Nashville).

Freeing up the use of land around cities remains the key to making housing affordable again and providing the choices/options that people value.  Experience suggests more populous cities will cover more space.  That isn’t something officials and politicians should be trying to stop.

Stress tests and credit availability

It is 3 January, a public holiday, the heart of summer (notionally at least –  it is actually cool and wet in Wellington), and something of a low ebb in local news and analysis.  But bright and early this morning, I did a radio interview on the Reserve Bank’s stress tests of the major banks.

The request was apparently prompted by a Stuff article, itself prompted by a recent new Reserve Bank animated video explaining stress tests.    The article, rightly, pointed out that following a very severe recession and significant credit losses for banks it was likely that banks’ lending standards would be somewhat tighter than they would have been in the previous boom.  That might even affect some of those hoping to take advantage of lower asset prices.

The stress tests themselves aren’t new.  They were done in late 2015, and were written up in the Reserve Bank’s Financial Stability Report last May.   I wrote about those results at the time.  In that stress test the Reserve Bank, quite appropriately, looked at how banks would cope if they were faced with a very severe recession and a very sharp fall in asset prices.  Stress tests are useless unless they use very demanding shocks.   These were. In the stress test, the unemployment rate rose to around 13 per cent and stayed there for some time.  For housing loan books it is the combination of unemployment and falling house prices that creates the scope for large loan losses –  either strand alone isn’t enough.  In fact, the increase in the unemployment rate was larger than anything experienced in any advanced economy with its own monetary policy in the 70 years since the end of World War Two.  And house prices were assumed to fall by 40 per cent generally, and by 55 per cent in Auckland –  about as large as any falls anywhere.

The banks emerged from these very demanding stress tests intact.  It wasn’t even a close run thing.  Capital ratios dropped, but mostly because the risk weights applied to banks’ outstanding loans increased  (a 50 per cent initial LVR loan looks riskier after house prices fall by 40 per cent).  The actual loan losses weren’t large enough to offset bank’s other operational earnings, so that the actual dollar value of banking system capital was not reduced.  This is the Reserve Bank’s chart of losses.


Total losses, over four years, were around 4 per cent of assets.  As the Bank observed

The cumulative hit to profits averaged around 4 percent of initial assets (figure C1), which is a similar outcome to phase 2 of the full regulator-led exercise conducted in late 2014. About 30 percent of total losses were related to mortgage lending, with half of this due to the Auckland property market. SME and rural lending accounted for most of the remainder of financial system losses. Loss rates for mortgage lending were around 2 percent, significantly lower than the 5 percent loss rate observed for most other sectors.

Faced with such very demanding economic circumstances, banks could be expected to become more cautious about lending.  That is what generally happens in economic downturns.    Banks –  like others in the economy –  find that things hadn’t turned out as they expected, and aren’t sure what will happen next, or how long the downturn will last for.  Central banks don’t know either.

In this sort of climate banks are typically keen to conserve capital –  it isn’t necessarily easy to raise more capital, and shareholders are a bit uneasy.  On the other hand, banks stay in business by lending and borrowing, and being known to be reasonably willing to extend credit.    As I noted in my earlier post, lower asset prices (houses and farms) tend to result in a lower stock of credit over time just through the normal process of turnover.  What was a million dollar house might now be a half million dollar house, and a new purchaser will typically need a lot less credit to facilitate the transaction than the previous million dollar purchaser would have.  That process takes time, but it is fairly inexorable.  Combine it with the lower turnover that is typical during recessions and there is likely to be a lot less new credit going out the door, even without credit standards tightening.  Business credit demand also tends to fall away sharply during recessions –  demand for new investment projects dries up, and that is particularly marked in sectors like commercial property (where empirical evidence suggests banks are particularly prone to taking losses).

But I’m sceptical of the notion that even in the sort of recession dealt with in the Reserve Bank’s stress tests credit conditions for home buyers would tighten much.  There are really three reasons for that.  The first  –  unique to current circumstances –  is that credit conditions for home buyers are already quite (inappropriately) tight as a result of the Reserve Bank’s successive waves of LVR controls.  That is a very different climate than existed in previous booms (here or abroad).  Those controls would typically be expected to be lifted in any downturn.  The second reason is that, as the Bank’s results above show, even in a scenario of this sort loan losses on the housing loan books are not large –  not trivial by any means, by not of the sort of scale that is likely to take banks by surprise if such a shakeout ever occurs.   Servicing capacity remains a vitally important factor and any young couple with a secure income would be unlikely to find it that difficult to secure a 70 or 80 per cent LVR loan to purchase a first home.  Banks, after all, will often be keen to replace extremely highly indebted borrowers (eg investment property borrowers with negative equity) with less indebted owner occupiers with decades of home ownership in front of them.

The third reason is history.  Take, for example, the banking crisis of the late 1980s and early 1990s, which was much more damaging that the stress test results in the recent Reserve Bank exercise.  Several major banks were severely adversely affected, and the BNZ would have failed were it not for the government bailout.  And yet through that period-  late 80s and early 90s –  banks’ housing credit stock grew quite rapidly.  Even though the unemployment rate was high and rising –  not to 13 per cent –  and interest rates were still quite high, banks recognised that housing loans were generally relatively lower risk exposures.  To be sure, the stock of housing credit was much lower then than it is now –  and there was still some reintermediation (from non-banks to banks) going on, so I wouldn’t expect a repeat, but it is a reason not to be too worried about the availability of credit to house purchasers with reasonable deposits even in the aftermath of a very nasty recession and a sharp fall in house prices.  Even good projects advanced by property developers would probably struggle to get credit  –  as happened after 2007/08 –  but existing suburban houses are likely to be a very different proposition than new commercial developments, or even new fringe residential subdivisions.   (One caveat to that might be if governments were to intervene, in response to a sharp fall in house prices, and impair the value or certainty of banks’ security interests in residential mortgages –  but that isn’t an element in the Reserve Bank stress test.)

As a reminder, the stress test scenarios are very demanding.  The Reserve Bank likes to suggest that the scenarios don’t fully account for the second round effects of tighter credit conditions after the initial shakeout, but the scenario is so severe –  more so, say, than the US experience in 2008/09 – that we can largely set that concern to one side.     Based on the lending standards our banks were adopting in 2015 –  when the stress tests were done –  our banks look to be able to withstand all but the very worst imaginable economic shocks, and to be able to emerge still providing finance to reasonable projects, perhaps especially mortgages on existing residential properties.  Indeed, credit conditions for potential mortgage borrowers might be little or no worse than they are now, given the direct interference in that market through the waves of LVR restrictions.

The Stuff article appeared to be driven by the idea that those hoping to take advantage of a future fall in house prices might be out of luck, as the credit might not be available to do so.    For the potential first home buyer considering waiting for a future shakeout that seems a misplaced concern (although it might not be for someone wanting to buy say 20 properties at once).

The bigger question, of course, is what might trigger a really sharp fall in New Zealand real and nominal house prices.  I don’t think there is any evidence that what has happened here is, primarily, some sort of speculative bubble.  Mostly it is a consequence of the land use restrictions, exacerbated by the rapid immigration-policy fuelled population growth.  As we saw in 2008/09, recessions and reversals in immigration numbers can prompt a temporary fall in nominal house prices.  But without far-reaching reforms in land use regulation, perhaps supported by permanent material changes in target immigration levels, it is difficult to be optimistic that the sustained halving in house prices, that might re-establish more reasonable levels of affordability, is in prospect.