A radical alternative to macro policy?

Last Friday, an outfit called Strategy2040 New Zealand, together with Victoria University’s School of Government, hosted a lunchtime address by an Australian academic, Professor Bill Mitchell of the University of Newcastle.   He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

Mitchell attracted some interest on his trip to New Zealand.  He apparently did two substantial interviews on Radio New Zealand and attracted perhaps 150 people to the lunchtime address –  a pretty left-liberal crowd mostly, to judge from the murmurs of approval each time he inveighed against the “neo-liberals”.    In fact, the presence of former Prime Minister Jim Bolger was noted –  he who, without apparently recanting any specific reforms his government had put in place, now believes that “neo-liberalism has failed New Zealand”.     Following the open lecture, 20 or so invitees (academics, journalists and economists –  mostly of a fairly leftish persuasion) joined Mitchell for a roundtable discussion of his ideas.   Perhaps a little surprisingly, I didn’t recognise anyone from The Treasury or the Reserve Bank at either event.

Mitchell has it in for mainstream academic economics.   Quite probably there is something in what he says about that.  Between the sort of internal incentives (“groupthink”) that shape any discipline, and the inevitable simplifications that teaching and textbooks require, it seems highly likely there is room for improvement.   If textbooks are, for example, really still teaching the money multiplier as the dominant approach to money, so much the worse for them.   But as I pointed out to him, that was his problem (as an academic working among academics): I wasn’t aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously.  He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand.    And if very few people correctly diagnosed what was going on just prior to the financial crises in some countries in 2008/09, that should be a little troubling.  But it doesn’t shed much (any, I would argue) light on the best regular approach to macroeconomic management and cyclical stabilisation.  Perhaps especially so as (to us) he was talking about policy in Australia and New Zealand, and neither country had a US-style financial crisis.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were reamrkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit.    It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.




Uncle Philip comes to visit

I wasn’t really planning a post today.  I’m in the middle of preparing a speech/presentation on the Reserve Bank and the housing market (working title “Intervening without understanding”).     But the Reserve Bank yesterday released some (a) comments on their forecasting review process and some aspects of monetary policy, prepared by a former BIS economist, and (b) the Bank’s spin on those comments.  Various people got in touch to say that they were looking forward to my reaction.

When an old uncle or family friend is in town and comes for dinner, the visitor will usually compliment the cook, praise the kids’ efforts on the piano, the sportsfield, or in dinner table conversation, and pass over in silence any tensions or problems –  even burnt meals –  he or she happens to observe.    Mostly, it is the way society works.  No one takes the specific words too seriously –  they are social conventions as much as anything.  One certainly wouldn’t want to cite them as evidence of anything much else than an ongoing, mutually beneficial relationship.

Philip Turner is a British economist who has recently retired from a reasonably senior position at the Bank for International Settlements.  The BIS is a club for central banks, and a body that has been champing at the bit for much of the last decade, encouraging central banks to get on and raise interest rates again.    Turner himself spent his working life in international organisations –  before the BIS he spent years at the OECD, where he developed a relationship with Graeme Wheeler (who was The Treasury’s representative at the OECD for six years or so).  He has never actually been a central banker, or involved in national policymaking.

Back in 2014, Graeme asked Turner to review the Reserve Bank’s formal structural model of the economy (NZSIM).   I didn’t have much to do with him on his visit then, but my impression (perhaps wrongly) was of someone now more avuncular than incisive (albeit with the odd interesting angle).   Having left the BIS last year, the Governor invited him back to New Zealand earlier this year, during which he sat through, and offered some thoughts on, the three-day series of forecast review meetings the Bank undertakes in the lead-up to each Monetary Policy Statement.  

There is nothing particularly unusual about that.  Perhaps twice a year the Bank has someone in who does something similar –  often a visiting academic or foreign central banker who was going to be in Wellington anyway.  It is an interesting experience for the visitor –  I will always remember the time Glenn Stevens (subsequently the RBA Governor) participated, and came out declaring that he now realised we were much less mechanistic than we seemed –  and usually there is the warm fuzzy feeling of mutual regard.  The visitors – friends of the Reserve Bank to start with –  get closer to the monetary policy process than is typically permitted in other central banks, and they are usually suitably appreciative.   Their reports, typically passed on to the Board, typically convey the sense of how good the process is, but sometimes there are even quite useful specific suggestions.    I’m not aware that such reports have ever previously been made public –  and I suspect that had someone asked for them under the Official Information Act, the Bank would have been as obstructive as ever.   Perhaps Turner’s report was particularly generous, perhaps the Governor was feeling particularly beleagured –  eg after the Toplis censorship attempts – but for whatever reason they have both released his report, and attempted to spin it well beyond what it warrants.

Actually, for those not familiar with the Reserve Bank’s internal process, the report may be of mild interest.   The description of the three days of meetings Turner sat through rang true –  and was interesting to me because it suggested things are still much as they were when I was last involved 2.5 years ago.  It will complement some of the other material the Bank itself has released on its processes.

In its press release, the Reserve Bank claims that Turner “commended the Reserve Bank’s forecasting and monetary policy decision-making processes”.  In fact, he did nothing of the sort.   He had no involvement in observing the preparation of the draft forecasts (the background work undertaken by the staff economists), he was not apparently invited to observe the Governing Committee discussions where the Governor makes his final OCR decision, and he engaged in no attempt to assess the Bank’s track record in forecasting or policy.  That isn’t a criticism of Turner.  He wasn’t asked to do those things.  Instead, he will have been handed a binder of background papers, and sat through perhaps 8 to 10 hours of meetings where those papers are discussed and issues around them identified.

That said, there is no doubt he is effusively positive about that process.

This process, which takes advantage of the small size of the central bank, avoids a problem that affects many other institutions. This is that unpopular or unorthodox opinions can get filtered out by successive levels in the hierarchy, as it is only more senior staff who make the presentations to Governors……

The open working-level culture is a credit to the RBNZ. Junior staff are given their voice. Views or arguments expressed by colleagues are challenged in a constructive and professional way. This is essential if the policy blind spots of a few individuals are to be avoided.

In my (rather long) experience there was an element of truth to all this.  The Bank is unusual in having very junior staff presenting directly to Governors.  That is generally good for them, and sometimes works well.  Then again, the Bank is a small organisation.  But it often involves people with quite limited experience or perspectives who can be quickly at sea when taken just slightly off their own safe ground or the established “model”.   It is an operational model that has some strengths, in staff development, but strongly prioritises (by default –  it is usually what 22 year old economists can do) fluent updates on the status quo.

There was also typically plenty of opportunity for people to chip in with unthreatening questions or clarifications.

But as for unpopular or unorthodox views being welcomed and heard……..

Perhaps things have changed a lot for the better in the last 2.5 years,  but it hadn’t been my impression of the Bank’s processes for quite some considerable time.   I largely stay clear of Reserve Bank people these days  (for their sake as much as anything) but nothing I hear through others suggests that the institutional culture has improved.  And how likely is it when the Governor is so outraged by external critical comments that he enlists each of his top managers to try to shut Stephen Toplis up, and when that fails he tries heavy-handed approaches to the CEO of the BNZ, a body the Governor himself regulates?  Whatever Turner’s (no-doubt genuine impressions) of the meetings he sat through, I suspect he saw what he wanted to see.      He formed a good impression of the Bank decades ago, his friend Graeme is now the boss and invites him over for a spot of post-retirement consulting, and when everything is presented as rosy, everyone is happy.

As a reminder, the Governor is so scared of diversity of view that he refuses to release –  even years after the event –  background papers, the balance of the advice he receives on particular OCR decisions, or the minutes of Governing Committee meetings.  But apparently Uncle Philip says all is good, and that should really be enough for us.

Turner saw what he thought he saw in the meetings he sat through.  Then again, he will have little or no familiarity with the New Zealand data, issues, or context.

And on that count what was perhaps more surprising was the rather strongly-worded declarations he offered on monetary policy (substance not decisionmaking process) in New Zealand in recent years.    One might suppose that such conclusions –  not just offered in passing over a drink, but now as an officially-authorised publication of the Reserve Bank – might require engaging with the data, with the details of the Bank’s mandate, with alternative perspectives, and so on.  But there is no evidence of any of that.

What specifically bothers me?  Well, for a start there is no mention of the fact that the Reserve Bank of New Zealand is unique in having run two quickly-aborted tightening cycles since the end of the 2008/09 recessions.  Then again, as I noted earlier, the BIS has long looked rather askance at low global interest rates, and has been keen –  with no mandate whatever –  to have advanced country interest rates raised again.  So was the Governor –  who keeps talking about how extraordinarily stimulatory monetary policy is.  But as an experiment, raising interest rates didn’t work out that well here.  And, at bottom, however good the process looked, the substance of the forecasts was repeatedly wrong.

Turner also gets into selective quotation of the Policy Targets Agrement.  He argues that

Clause 4(b) adds further that “the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate”. I have italicised these words because they describe a mandate that is realistic about what monetary policy can achieve. This mandate would not have been fulfilled in recent years, given the large shocks to international prices, by trying to keep the year-on-year inflation rate in New Zealand at close to 2 percent. To have achieved this, interest rates would have had to move by more than they have in recent years, and this would have created the unnecessary instability in output and the exchange rate that the RBNZ is enjoined to avoid.

Of course, no one has ever argued that headline CPI inflation should be kept at 2 per cent each and every year, so to that extent he is addressing a straw man.   Perhaps, charitably, he means keeping core inflation near target, something the Bank has failed to do for years.    But even then Turner omits a key phrase: the Bank is asked to avoid ‘unnecessary instability”, but only “in pursuing its price stability objective”.  The inflation target is paramount, and “unnecessary” variability here is clearly intended to  be distinguished from the necessary variability required to achieve the inflation target.    It isn’t an independent goal in its own right.

In fact, the whole of Turner’s quotation is pretty extraordinary once one remembers that this was the same Bank that marched the OCR  up the hill in 2014, only to have to smartly march it back down again in 2015 and 2016.  If that wasn’t “unnecessary variability” it is hard to know what would have been.  And quite what leads Turner to think that a stronger economy, getting inflation back to target, would have led to “unnecessary variability” in output –  when per capita growth (and even total GDP growth) has been anaemic by the standards of past cycles – is beyond me.  But no doubt Graeme and his acolytes told Philip so.

In his conclusion, Turner observes

The main conclusion is that the monetary policy process at the Reserve Bank of New Zealand works well. This is hardly a surprise given the RBNZ’s distinction as a pioneer in much of modern central banking (e.g. the inflation-targeting framework, the careful attention given to an accountability regime for the central bank that actually works) and given its high standing today among its central banking peers.

As I said, he seems to have formed a favourable impression of the Reserve Bank 25 years ago, and at this late stage isn’t minded to reassess.    If the Reserve Bank of New Zealand is still highly regarded among its “central banking peers” –  which frankly I doubt –  it can only mostly be because of that historical memory, of the pioneering days when –  for better and worse –  the Reserve Bank was genuinely innovative in monetary policy institutional design and banking regulation reform.  Frankly, I doubt many overseas central bankers pay much attention to New Zealand economic data, or to the publications and speeches of our central bank.  Why would they?  And no doubt Graeme is fluent enough when he turns up at BIS meetings.      Perhaps the biggest clue to what is wrong with that paragraph is the idea that we have “an accountability regime that actually works”.  No one close to it thinks so (however good it looked on paper 25 years ago).

Turner’s final paragraph is as follows

A final remark, in conclusion. Results over the past few years speak for themselves. The RBNZ has helped steer its economy through several large external shocks. Because it has done so without becoming trapped at a zero policy rate and without multiplying the size of its balance sheet by buying domestic assets, it has retained more room to pursue, if needed, a more expansionary monetary policy than is available at present to many central banks of other advanced economies.

This is simply almost incomprehensibly bad.     Inflation has been well below target, even in a climate of no productivity growth and lingering high unemployment.  If New Zealand isn’t “trapped” by the zero bound, it is entirely because we’ve persistently had neutral interest rates so much higher than those almost anywhere else –  which is neither to the credit nor the blame of the Reserve Bank –  and so were able (belatedly) to cut interest rates more than almost anyone else.  Because neutral interest rates are still, apparently, materially higher than those elsewhere, the Reserve Bank does have a bit more policy leeway than most other central banks when the next recession hits.  But, contra Turner, it is no cause for complacency –  no advanced country has enough room now –  and no credit to the Reserve Bank.

It is a shame the Reserve Bank is reduced to publishing, and touting, a report like this in its own defence.  When good old Uncle Philip, a fan of yours for years, swings by, it must be mutally affirming to chat and exchange warm reassuring thoughts.  But as evidence for the defence his rather thin thoughts, reflecting the favourable prejudices of years gone by, and institutional biases against doing much about inflation deviating from target, isn’t exactly compelling evidence for the defence.    Sadly, getting too close to Graeme Wheeler as Governor seems to diminish anyone’s reputation.  It is a shame Turner has allowed himself to join that exclusive club.




Some productivity snippets

I’ve shown previously various iterations of this chart, real GDP per hour worked for New Zealand and Australia.

real GDP phw july 17

It isn’t exactly an encouraging picture for New Zealand.   Then again, it is also a bit surprising.  For all of New Zealand’s underperformance over the decades, we haven’t usually diverged that badly from Australia over such a short period (the last four years or so).

That chart is for the whole of each economy, and just uses a crude measure of total hours worked.  The ABS and SNZ also produce annual data –  with quite a lag – in which they look only at the more readily measureable market sector of the economy (from memory around 85 per cent of the economy) and also attempt to adjust for changing labour quality over time (eg improvements in education and thus, in principle, human capital).

Here is that chart for labour productivity, indexed to 1000 in 1997/98, the first year for which the data are available for both countries.

market sector LP

The picture is much the same –  a new large gap has opened, in Australia’s favour, in the last few years.

Presumably part of those measured productivity gains in Australia reflects the massive private sector investment boom in the minerals and energy sectors that peaked back in 2011/12.

But out of curiosity I wondered how Australia had done recently relative to other advanced economies.    Using annual data from the OECD, percentage total growth in real GDP per hour worked over the five years 2011 to 2016 had been as follows:

Australia                                  5.3%

OECD Total                              6.3%   (and OECD median country, 5.7%)

G7                                              5.5%

EU                                              4.3%

Even the euro-area as a whole (2.5 per cent) just beat out New Zealand (2.3 per cent).     In that light, Australia’s relatively strong productivity performance didn’t look so anomalous at all.

Over that five year period, these are the OECD countries that managed more than 10 per cent productivity growth:   Estonia, Hungary, Korea, Latvia, Poland, Slovakia, and Turkey.    In fact every single one of the emerging OECD countries (the former eastern bloc countries and Korea) –  all with lower initial levels of productivity than New Zealand – managed stronger productivity growth than New Zealand did.   All but Slovenia had faster productivity growth than Australia.    That is what convergence –  supposedly the goal for New Zealand –  is supposed to look like.

Of course, several of these emerging countries had had a much worse experience –  even on productivity, which often isn’t very cyclical –  than New Zealand over the crisis/recession period around 2008/09.   But even if one looks at, say, the last decade as a whole, they are mostly catching up (often quite rapidly) and we are not.  In fact, relative to Australia –  typical closest comparator, and the place where so much of the New Zealand diaspora dwells –  we are getting further behind.

I ran a chart a few weeks ago about how low investment has been in New Zealand.  As I noted of business investment it “is now smaller as a share of GDP than in every single quarter from 1992 to 2008.   And this even though our population growth rate has accelerated strongly, to the fastest rate experienced since the early 1970s.”

Of course, an important story out of Australia is how business investment has fallen back since the peak of the mining investment boom.   Here is the business investment proxy (total investment less general government investment less residential investment) for the two countries.

bus investment aus and NZ

Business investment in Australia, as a share of GDP, has fallen very dramatically over the last few years.   But it was a very big boom –  we had nothing of the sort in New Zealand.  And even at current levels, Australia’s busines investment still materially exceeds the share of GDP devoted to business investment in New Zealand.  In fact, the gap between the two lines isn’t that dissimilar to the typical gaps that prevailed before the mining investment boom got underway in the mid 2000s.

Then again, over the last 25 years Australia’s population growth has averaged a little faster than New Zealand’s.   All else equal, faster population would generally require a larger share of current GDP to be devoted to business investment just to maintain the average quantity of capital per worker.

But here is the chart of the two countries’ population growth rates

popn growth aus and nz

Australia’s current population growth rate (1.5 per cent) isn’t much above the 25 year average (1.3 per cent). In New Zealand, the average population growth rate over the last 25 years has been 1.2 per cent, but in the last 12 months the population has increased by 2.1 per cent.     We have lots (and lots) more people, but firms presumably have not been finding it profitable to increase investment (on average across the whole economy), in ways that might suggest some possibility of the sort of productivity growth that might finally allow New Zealand to join the club of fast-growing countries, catching up to the wealthier countries in the OECD.

Not that our politicians give any sense of being worried.  An ill-governed place like Turkey –  not richer or more productive than New Zealand in our entire modern history –  might shortly go past us.   Countries that labour under communist regimes thirty years ago might go past us.  But none of our leaders seems to care. None of our parties has a platform that suggests they care, let alone offering a programme that might make a real difference.

Keep an eye on the earth, not the stars

So far this year, there has been only a single on-the-record speech from the Reserve Bank Governor, and none at all [UPDATE: actually one] from his Deputy Chief Executive (and incoming –  although unlawful – acting Governor) Grant Spencer.   But there have been quite a few speeches from the next tier or two down –  in some cases probably as part of Wheeler-backed bids for the governorship.   Geoff Bascand –  currently, in effect, chief operating officer –  is probably the only really serious internal contender, and I still intend a post on the  speech he gave last week on matters  –  New Zealand’s external indebtedness – well outside the range of his day job.

But yesterday there was another speech from Assistant Governor and Head of Economics, John McDermott, delivered to an Auckland corporate/fx audience.  The speech was put out under the rather groan-inducing heading Looking at the Stars.   In formal economic models, the equilibrium values of variables are often denoted with an *.    Thus, r* –  or “r star”  –  is the equilibrium, or neutral, interest rate.  McDermott’s speech was an attempt to explain how the Bank uses some of these equilibrium variables  (“the” output gap, “the” neutral interest rate, and “the” equilibrium exchange rate) in setting monetary policy.

I had various picky concerns about the speech, but I won’t bore you with those.

The speech was pretty consistent with the sort of speeches McDermott has given over the years.   In his role, he is (among other things) the Governor’s chief adviser on the New Zealand economy and monetary policy.  He’s had the job for 10 years now, and yet there is still a pervasive tone of the textbook about his speeches.   Models –  disciplined ways of thinking through issues –  have a role to play, probably in all areas of policy.  But in his speeches McDermott never seems to have found a way of successfully conveying a nuanced understanding of the economy and policy issues, in a way that doesn’t leave too much of the formal architecture on display.    It is quite a contrast to successful senior policymakers in central banks in other countries.

At times, it is as if he doesn’t feel comfortable without the formal apparatus, even when he knows the rather severe limitations of those tools and techniques.  Here is an example of what I mean.  In the conclusion to his speech, McDermott states that

To set monetary policy we need to know [emphasis added] where the key macroeconomic factors (such as interest rates, output, and the exchange rate) are tracking relative to their equilibrium levels, denoted by our ‘stars’. These stars are unobservable and complex to estimate, so we use a range of techniques to help form our view of their values over time. Like the night sky, our stars keep moving.

Earlier in his speech he had noted that these equilibrium values “are the anchors around which we aim to stabilise the economy”.

Such in a world –  in which the Reserve Bank, and others, knew where these equilibrium levels are, and how they are changing – might well be great.    (Although even then a single instrument –  the OCR –  just can’t manage three other variables, in addition to inflation.)     But it isn’t the world we live in.

In fact, McDermott more or less acknowledges that.  Take the output gap  –  the difference between actual GDP and estimates of potential GDP –  as an example.    There have been huge revisions to the Bank’s estimates of the output gap over time (I’ve illustrated this previously, but it isn’t contentious –  everyone recognises the point), and McDermott himself states in the speech that “we have a range of uncertainty with respect to the output gap; around 2 per cent of potential output.”.    In a series which the Bank estimates has only flucuated in a range of -3 to +3 in the last 25 years or so, those margins of error are large enough that only rarely can the Bank even be confident which sign the output gap has.    If knowing potential output and the output gap is as essential to monetary policy making as McDermott claims in this speech, we might as well give up completely.  They don’t know, and neither does anyone else with any great confidence.

The conceptual framework might well be useful –  you are more likely to need to tighten if the economy is running above capacity –  but real-time empirical representations of this sort often aren’t very much use at all.  In fact, one of the more obvious gaps in the speech is there are no observations, or charts, illustrating how the Bank’s view of these equilibrium values goes on changing.   It isn’t so much that 2017’s neutral interest rate might be different from 2007’s, but that the 2017 estimates of the 2007 neutral interest rate may be very different to what the Bank thought the 2007 neutral rate was when it was making policy in 2007.    For some research purposes –  making sense of economic history etc- that doesn’t matter, in fact it is how knowledge advances.  But actual policymakers have to operate in the knowledge that they are highly likely to be wrong in their contemporaneous estimates of these equilibrium relationships.    And there is simply nothing of that in this speech.

If the errors was just randomly distributed it might matter less.  But some of them are rather more systematic.  Neutral interest rates are a good example.   Most people now accept that neutral interest rates are lower than they were, but most –  including most policymakers –  have been slow to adjust those estimates.    That is a natural human tendency, but it also means that any policymaker who puts a great deal of weight on their current estimates of neutral interest rates will think any particular level of market interest rates is further from the “true” neutral rate than will actually turn out to have been the case.  Monetary policy will then have been run too tight.    One could mount a reasonable argument that that is a material part of the story of what has gone on at our Reserve Bank.   Recall that the Governor keeps asserting that monetary conditions are extremely stimulatory –  suggesting he has in mind quite a strong view about what “the” neutral interest rate is.    Recall too McDermott’s comment that the Bank seeks to use these equilibrium relationships as “anchors around which we aim to stabilise the economy”.  There has been a strong sense over the years of the Reserve Bank constantly wanting to get the OCR back much closer to its estimate of the neutral rate.

Actual policymaking isn’t always that bad.   How could it be when on the one hand they think the economy is running at full capacity (one equilibrium concept they tell us they rely on), while the OCR is a whole 175 basis points below neutral (the other main equilibrium concept they tell us they rely on knowing).   But it hasn’t been very good either.  And the policy communications –  examples like this speech –  are pretty consistently poor.

Sometimes I even worry about basic levels of apparent competence.   McDermott includes this chart in his speech

Figure 1: Nominal Neutral OCR and Actual OCR


Source: RBNZ estimates


This is their current estimate of how the neutral OCR has tracked over the history of the series (the OCR was only introduced in 1999).    They have a suite of tools and models that produce a range of estimates –  the grey band –  and the blue line is the mean of those estimates.    In the text, McDermott says the Bank is now using 3.5 per cent as the neutral OCR in their modelling and forecasting, which is about where the blue line is at present.

There is some economic discussion around the chart

Over time, the neutral interest rate has been slowly falling; a trend that has been seen in many countries around the world. Economic theory tells us that changes in neutral real interest rates reflect changes in real economic factors such as population growth, productivity growth, preferences for savings, and world conditions. A combination of these factors appears to have been contributing to the fall in neutral, both in New Zealand and abroad.

Which all sounds fine, and sounds consistent.   But then you remember that the neutral interest rate the Reserve Bank is using is the OCR, and the OCR is an interest rate that isn’t paid by any borrower, or received  by any saver, in the wider economy.    For those one has to look at data on, say, term deposit rates or floating mortgage rates.

Start with the chart above.   The Bank says its estimate of the neutral OCR is now 3.5 per cent.  But go back a decade –  July 2007 was just before the financial crisis stresses really started to infest funding markets globally –  and the blue line looks as though it would be almost bang on 5 per cent.    If I recall rightly, at the time we thought the neutral OCR was much higher than that –  perhaps as high as 6.5 per cent –  but as things stand now the Reserve Bank is telling us it thinks the neutral OCR has fallen by 1.5 percentage points over the last decade.

That might sound like a lot.   In fact, it is nothing at all.  Here’s why.  In July 2007, the OCR was 8.25 per cent.   At the same time, the Reserve Bank’s measure of six month term deposit rates was 7.98 per cent, and the Bank’s measure of new floating first mortgage rates was 10.35 per cent.  Term deposit rates were 27 basis points below the OCR, and first mortgage rates were 210 basis points above the OCR.

Right now, the OCR is 1.75 per cent and has been all year.  Last month (latest data), the term deposit rate indicator was 3.31 per cent (156 basis points above the OCR) and the indicative new first mortgage rate was 5.84 per cent (409 basis points above the OCR).

In other words, the margins between the rates people are actually paying/receiving and the OCR have blown out enormously –  in fact by around 190 basis points.    Implicitly, the Reserve Bank has revised upwards its estimates of neutral retail interest rates.

Those spreads between the OCR and retail rates can and do move around, so I’m not suggesting you focus on the difference between the 150 point cut in the neutral OCR, and the 190 point increase in spreads between the OCR and retail rates.   The real point is that, despite the fine words in the chief economist’s speech about reasons why neutral interest rates here and abroad have probably fallen –  perhaps quite considerably –  the Reserve Bank has made practically no adjustment of substance at all.  As they’ve always said, it is retail interest rates –  not the OCR –  that affects spending and investment choices.

I can’t believe McDermott doesn’t know all this –  we used to have charts presented with each set of forecasts illustrating how the spreads had changed since before the crisis –  but if that is right, what is the explanation for how the speech is written?    And is this the sort of presentation that has the Governor still asserting that monetary policy is highly stimulatory, even as inflation continues to track “broadly sideways”?

In a way, these things shouldn’t matter.  A prudent central bank would simply treat current interest rates as a starting point, and look for actual data –  new developments –  suggesting a case for change.  But at our central bank it does seem to matter to some extent, because we have key policymakers out asserting that they “know” what the equlibrium values are, and can/should use them to make monetary policy.   What say instead the Reserve Bank had assumed a 150 basis point fall in neutral mortgage rate?  That would translate to a neutral OCR of around 2 per cent at present.  It seems at least as plausible as the Bank’s own number –  with inflation persistently below target, an output gap they think is near zero, and unemployment persistently above the NAIRU.  Then presumably we would be hearing quite different rhetoric from the Governor about just how stimulatory, or otherwise, monetary policy is.

Changing tack, the other thing that is striking about the speech is the reminder of just how little focus the Reserve Bank puts on the labour market.   Labour is by far the biggest input to the economy, and also the market in which the rigidities and slow price adjustments –  a key concern for monetary policy – are most prevalent.  And yet it hardly rates a mention in McDermott’s speech.   Many other central banks –  and forecasters –  find the concept of the NAIRU (the non-accelerating inflation rate of unemployment), and the gap between actual unemployment and the NAIRU, as a useful (even central) part of their forecasting and analysis framework.  That is partly because the unemployment itself is a directly observed and, in principle, is a direct measure of excess capacity (more so, certainly, than the output gap).   But it is also because policy is supposed to be about people, and ability of people to get a job when they want a job is one of the key markers of a successfully functioning economy.   We have active discretionary monetary policy because the judgement has been made that without it the inevitable shocks that hit the economy would leave countries too prone to prolonged periods of unnecessary unemployment (Greece is the extreme contemporaneous example).   Voters don’t greatly care about unemployed machines, but they do care about unemployed people.

Contrast the Reserve Bank of New Zealand’s approach to that of the Reserve Bank of Australia –  with a very similar inflation target.   Yesterday, the RBA Governor was out with a thoughtful nuanced speech on labour market issues, in which he observed that “the unemployment rate is still around 1/2 a percentage point above estimates of full employment in Australia”.   He referenced a clear and useful recent Bulletin article on “Estimating the NAIRU and the unemployment gap”  which opens with this clear and simple statement

Labour underutilisation is an important consideration for monetary policy. Spare capacity in the labour market affects wage growth and thus inflation (Graph 1). Reducing it is also an end in itself, given the Bank’s legislated mandate to pursue full employment. The NAIRU – or non-accelerating inflation rate of unemployment – is a benchmark for assessing the degree of spare capacity and inflationary pressures in the labour market. When the observed unemployment rate is below the NAIRU, conditions in the labour market are tight and there will be upward pressure on wage growth and inflation. When the observed unemployment rate is above the NAIRU, there is spare capacity in the labour market and downward pressure on wage growth and inflation. The difference between the unemployment rate and the NAIRU – or the ‘unemployment gap’ – is therefore an important input into the forecasts for wage growth and inflation.

You’ll see nothing of the sort from the Reserve Bank of New Zealand.      It is as if they fear that somehow talking about ordinary people, and the overall balance in the labour market, will somehow be betraying their mission.    But their mission is about people’s lives, jobs, and opportunitites.

I’m not suggesting that at present the RBA is running policy any better than the RBNZ is –  in both countries there looks to me a case for thinking about possible further rate cuts –  but the RBA certainly communicates much better, and in a way that suggests both a grounded story about what is happening in Australia and the world, and an identification with the interests of ordinary Australians.

That is part of the reason why, somewhat reluctantly, I’ve come to the view that the Labour Party is right to campaign on amending the Reserve Bank Act to add a focus on unemployment to the goals of monetary policy.   It should be implicit in the current way the Act is currently written, but in practice it seems to have become something the Bank is uncomfortable with, rather than something central to their reason for being.  Phil Lowe and Janet Yellen  –  or their respective decisionmaking boards –  aren’t some rampant wet inflationistas, and yet they manage to talk openly and sensibly about these issues, and find it a useful framework for analysis and communication, in a way that seems beyond our Reserve Bank.    We’ve got to the point where far-reaching is needed at the Bank –  in its legislation, its ethos, and in its senior people.

I’ve always been a bit hesitant about suggestions that the Reserve Bank operates primarily in the interests of one group of New Zealanders over another –  that hesitancy shouldn’t be surprise; after all, I sat round the monetary policy decisionmaking table for a couple of decades and we all want to believe that we serve the public interest.  But, with the benefit of a bit more detachment, I increasingly worry that the Bank –  unconsciously rather than deliberately – reflects more the perspectives and interests of what the Australians talk of as “the big end of town”, than of ordinary New Zealanders.

There are just a couple of illustration of what bothers me.  After each MPS the Reserve Bank runs (or at least did when I was there) a series of presentations around the country to explain its thinking.  In some ways they worked quite well –  we spread out across the country (usually the three main centres plus one provincial centre a quarter) the morning after the MPS.  I enjoyed participating.   But all these functions were hosted by the banks, and the invited attendees were the banks’ business, corporate and financial customers –  in smaller provincial areas, they were often hosted in a bank’s business customer lounge.   Never once did we do those talks to union-organised gatherings of interested employees, to church or community groups, to students, to meetings of beneficiaries or the like.  Don’t get me wrong –  the Bank does, or did, accept some invitations in the course of the year to talk to other groups, but the big events are about corporate audiences.

It struck me again yesterday when I picked up John McDermott’s speech. It was delivered to HiFX (presumably staff and invited clients), a “a UK-based foreign exchange broker and payments provider that has been owned by Euronet Worldwide since 2014”.  Out of interest, I looked back through the other on-the-record speeches McDermott has done during Graeme Wheeler’s term of office.  They were to audiences at:

  • Federated Farmers
  • FINSIA (a financial sector training group)
  • NZICA CFOs and Financial Controllers
  • Goldman Sachs Australia
  • Macroeconomic Policy Meetings, Melbourne
  • Bay of Plenty Employers and Manufacturers
  • Wellington Chamber of Commerce
  • Waikato Chamber of Commerce/Institute of Directors

Each a perfectly worthy audience in its own right no doubt.  But there is something of a pattern –  it is an employers and financial sector focus, rather than (m)any groups broadly representative of the citizenry.    When the people you talk to are mostly rather comfortable, it must to an extent influence the way in which you as an organisation end up thinking.    Few if any of those audiences would be much bothered if the unemployment rate had been above the NAIRU for, say, eight years and counting.

McDermott told us about how he was looking at “the stars”.  In fact he knows almost nothing particularly useful about them –  and if there is a criticism it isn’t that he doesn’t know the unknowable, but that he keeps asserting against all the evidence that he can.  Perhaps he and his colleagues would be better off keeping a cold hard eye on the ground, on the things we know rather better –  a (core) inflation rate still well below target, wage inflation still very subdued, and an unemployment rate still persistently high.   And talk to us in language that suggests a care about the interests of ordinary New Zealanders.



Nonsense repeated endlessly is still nonsense

For decades –  in fact going back to the 19th century –  business groups in New Zealand have claimed that we need lots of immigration (often even more immigration) to relieve pressing skill shortages.   No one ever seems to ask them how other countries –  which typically have nowhere near as much immigration as we do –  manage to survive and prosper, but set that to one side for now.

Sometimes the alleged skill shortages relate to really highly-skilled positions.  I don’t suppose anyone is going to have a problem if DHBs manage to recruit the odd paediatric oncologist from abroad.   But more commonly the calls relate to the sorts of jobs that require considerably less advanced skills.  In generations past the call was for more domestic servants –  colonial girls were apparently reluctant to take on such roles, at least at the sorts of wages that middle New Zealand wanted to offer.     These days…….well, we all know the sorts of role firms claim they simply have to have immigrants for.  Without them, the more florid suggest, the economy will topple over.

For an individual employer, those calls make a lot of sense.  Each firm has to operate with the rest of the economy as it is.    Faced with two potential employees of exactly the same quality, of course an employer will prefer the one who will work for less.  And they’ll be keen to have the competition among potential employees, to keep down any pressure for higher wages.  And if your firm couldn’t hire immigrants while your competitor could, your business might well be in some considerable strife.     Moreover, if the whole pattern of the economy has adjusted to using large amounts of modestly-skilled immigrant labour, so that some sectors rely mainly on that labour, of course it will look to employers in those sectors as if the continuation of current policy is absolutely vital.   Who, we are asked, will staff the rest homes otherwise?  Or milk the cows?

Deprive an individual employer of the ability to hire modestly-skilled migrant labour, and the argument will stack up.   But if we are thinking about immigration policy as a whole we need to take a macroeconomic, whole of economy, perspective.  And then the perspective, or experience, of an individual employer is largely irrelevant.    With a materially different immigration policy, much about the economy will be different, not just the ability of that individual firm to hire a particular immigrant.

This isn’t some striking new perspective.  New Zealand economists were saying it decades ago, responding to exactly the same sort of business sector claims.   Mostly the response consisted of pointing out two things, both of which really should be obvious but seem to repeatedly get lost in the “our business needs more migrants” rhetoric:

  • migrants aren’t just producers (sources of labour supply) but consumers, and someone else has to produce the stuff they want to consume, and
  • in a modern economy each new person generates a need for quite a lot of additional capital (a place to live, roads, schools, hospitals, shops etc) and someone else has to produce and put in place that capital.

In other words, whatever beneficial impact an individual migrant may seem to have at the level of the individual firm, there is little reason to suppose that in aggregate high rates of immigration will do anything at all to ease so-called “skill shortages” or “labour constraints”.    In fact, mostly the claim was rather the reverse: big migration inflows temporarily exacerbate those pressures across the economy as a whole.

I’ve written previously about Professor Horace Belshaw’s contribution to the immigration debate as long ago as 1952, as the post-war immigration wave was getting into full swing.   Belshaw was, at a time, one of our leading macroeconomists.  He noted

At the time when there are more vacancies than workers, it is natural to assume that immigration will relieve the labour shortage. This however, is a superficial view.  The immigrants are not only producers but also consumers. To relieve the shortage of labour it would be necessary for more to be contributed to the production of consumer goods or of export commodities used to buy imported goods than the increased numbers withdraw in consumption.  That is unlikely….[and] there will be some temporary net additional pressure on consumption.


Of much greater importance is the fact that each immigrant requires substantial additional capital investment, not in money but in real things.  Houses and additional accommodation in schools and hospitals will be needed. In order to maintain existing production and services, and even more to maximize production per head, there must be more investment in manufacturing and farming, transport, hydro-electric power, municipal amenities and so on.

To anticipate a little, immigration is not likely to ease the labour shortage while it is occurring, and is more likely to increase it because although additional consumers are brought in, more labour than they provide must be diverted to creating capital if the ratio of capital to production is to be maintained.

A few years later, the Reserve Bank published an article in its Bulletin (April 1961) on “Economic Policy for New Zealand” by a visiting British academic, who noted

It is an illusion to assume that inflationary pressure and labour shortage can be relieved by increased immigration….the main immediate effect of increased immigration is to add to the shortage of capital goods. Even single men need to be housed, and they need capital equipment with which to work in industry…..Resources have to be devoted to providing this capital that could otherwise have been devoted to increasing and modernising capital equipment per man employed.

A few years later, another leading New Zealand economist, Frank (later Sir Frank) Holmes – Belshaw’s successor as McCarthy Professor of Economics at Victoria – published a series of articles on immigration for the NZIER.  I could quote from him at length, but suffice to say he was convinced that in the short-term the demand effects (including for additional labour) from increased immigration outweighed, by some considerable margin, the supply effects.   And here “short-term” didn’t mean a month or two.  In fact, he quoted from some recent estimates by the Monetary and Economic Council –  the Productivity Commission of its time – suggesting the additional excess demand would last for up to five years.

Or, a few years on, a quote from economic historian Professor Gary Hawke

Ironically, the success with which full employment was pursued until the late 1960s led to frequent claims that labour was in short supply so that more immigrants were desirable. The output of an individual industrialist might indeed have been constrained by the unavailability of labour so that more migrants would have been beneficial to the firm, especially if the costs of migration could be shifted to taxpayers generally through government subsidies. But migrants also demanded goods and services, especially if they arrived in family groups or formed households soon after arrival and so required housing and social services such as schools and health services. The economy as a whole then remained just as “short of labour” after their arrival.”

This sort of conclusion wasn’t even very controversial among economists.   Whatever the possible longer-term merits of high immigration –  and on that point views did differ –  no serious analyst saw it as a way to relieve labour market pressures or deal with other excess demand pressures.   It simply didn’t.

For 15 years there wasn’t very much immigration to New Zealand and in the process this knowledge seemed to have been largely lost.      But the character of the economy didn’t really change, let alone the basic propositions that (a) migrants are consumers too, and (b) more people requires the accumulation of materially more physical capital.    At the Reserve Bank it took us a while to wake up to this, in the face of first big post-liberalisation surge in immigration in the mid 1990s, but thereafter it became established wisdom for us.     Consistent with this was a piece of research the Bank published just a few years ago.  In that paper Chris McDonald looked at the impact of a one per cent lift in the population from net migration on, in this chart, the output gap (the estimated difference between actual GDP and the economy’s productive potential).

output gap mcdonald

On this estimate, unexpected changes in migration increase the excess demand pressures on the New Zealand economy.    The dark blue line is the central estimate, while the lighter lines represent confidence intervals around that central estimate.   Coincidentally –  see the Monetary and Economic Council estimates from earlier decades – on this model it takes five years (60 months) for the excess demand effects to fully dissipate.   Over  that time, on this model, immigration will be exacerbating aggregate labour market pressures, not relieving them.

I don’t want to put too much weight on any particular model estimates, and the Reserve Bank itself has tried to back away from this particular one.   What causes the change in immigration matters to some extent.     But the general conclusion –  immigration does not ease resource pressures –  shouldn’t be controversial.  Indeed, only a few months ago some IMF modelling on New Zealand’s experience again produced similar results.

None of this should be a surprise (including to economically literate officials advising ministers).  As I noted earlier there are two strands through which immigrants add to demand.  The first is consumption.  The household savings rate in New Zealand is roughly zero: on average, people consume what they earn.   Perhaps the typical (or marginal) migrant is different –  some will be sending remittances back to their homelands –  but even if we assume that new immigrants have hugely different behaviour than New Zealanders, perhaps consuming equal to only 80 per cent of income, it is still a significant boost to demand.  In effect, much of what the immigrants produce will be consumed by them (not exactly the same stuff, but across the economy as a whole).  That is no criticism of them –  people do what people do –  but it is the first leg in the story about why claims that immigration eases labour shortages are typically simply false.

But the much more important part of the story is the capital requirements that new people (migrants or natives) generate.     Here Statistics New Zealand’s capital stock data can help us.     The latest estimates of the net capital stock (ie net, as in depreciated, and excluding land) are around $750 billion.   Total GDP is around $250 billion.   That ratio of net capital stock to GDP has been pretty stable around 3 for decades.

cap stock to GDP

Each dollar of additional GDP seems to require three dollars of new capital.    And this ratio understates the issue for two reasons:

  • the first is that the capital stock is a net (depreciated) figure and the GDP is gross (it includes capital spending to cover depreciation  –  around 15 per cent of GDP), and
  • the second is that our focus is here on the contribution of labour.    The ratio of the net capital stock to compensation of employees (the national accounts measure of total labour earnings) is almost 7.

These are average numbers of course, and in discussing immigration the focus should be on the margin.    It might be reasonable to point out that the typical migrant won’t need much more government capital in the short-term (eg schools and hospitals)  –  but then central government makes up only around a sixth of the total capital stock.  Perhaps the typical migrant, at least their early years, will settle for less good quality housing than the typical native?   But on the other hand, the productivity of the typical migrant is also likely to be lower than the national average, again at least in the early years (MBIE’s own labour market research highlights how long it takes many migrants to reach the earnings of similarly qualified locals).   So I’m not here to give you a definitive number for how much new capital spending is typically going to be associated with each new migrant, but it will be large.  It will be a significant multiple of the first year’s labour supply of the typical new migrant.  It will, in other words, for several years exacerbate any aggregate shortages of labour, not relieve them.

Of course, quite a bit of physical capital is imported.  All those earlier estimates already, explicitly or implicitly, take those imports into account.  SNZ’s input-output tables suggest that across capital formation as a whole the import component isn’t high –  around 21 per cent in 2013.  That shouldn’t be surprising.  Buildings make more than half the physical capital stock, and although they have some imported components, there is a great deal of domestic labour (and domestically produced timber and concrete).  Accommodating more people simply adds greatly to the demand for employment over the first few years after they arrive.

Commentators and politicians who argue that migrants don’t take jobs away from New Zealanders are largely correct  (again, past modelling exercises confirm that sort of intuition).  They don’t do so –  and they don’t succeed in lowering aggregate wages –  precisely because influxes of immigration (or unexpected reductions in the net outflow of New Zealanders) add to demand –  for goods and services, but thus for labour –  more than they add to supply.    There are probably some sector-specific adverse wage effects –  in sectors where immigrant labour has been made particularly readily available –  but much the bigger determinant of overall real wage prospects in New Zealand is productivity growth.  Sadly, our record on that score over many decades has been poor. Over the last five years it has been shocking –  no labour productivity growth at all.    That, in turn, may be in part because of the effects of rapid population growth –  all that spending associated with more people crowding out (notably through a high exchange rate) activities that might have offered more productivity growth prospects.    Despite the political rhetoric to the contrary, there is no surprise that more people create more jobs –  always have, probably always will.  But there is also no surprise that as it was decades ago, is now, and probably ever will be, increased immigration doesn’t ease overall labour market pressures.

So too much of the New Zealand debate is simply misplaced.  If we want to deal with domestic unemployment, as we should, look to monetary policy (it was a point Frank Holmes made 50 years ago). In the current context, hire a Governor who will take seriously the ambition of non-inflationary full employment.  If there are sectoral market pressures, let wages in those sectors adjust –  that is what happens to tomato prices when tomatoes are in short supply.   And if we were serious about wanting sustained productivity growth –  as we should be –  it increasingly looks as though much lower levels of non-citizen migration would be the way to go.

On our woeful productivity performance, even the Reserve Bank is starting to openly recognise the issue.  This chart (using their estimate of TFP) was in the chief economist’s speech this morning

Figure 3: Potential GDP Growth

Figure 3: Potential GDP Growth

Source: RBNZ estimates.

Little investment –  as the Deputy Governor noted in his speech last week –  and almost no productivity growth, and simply lots and lots more people.  To what end –  beneficial to the average New Zealander –  one might reasonably wonder?


Renting and buying

In his Sunday Star-Times column this week, economist Shamubeel Eaqub announced that “I’ve bought a house at last” .   He and his wife had had quite a lot of coverage for their choice to stay renting, even though they could readily have purchased a house in Auckland.    As they noted in their book Generation Rent, their decision to rent had been both a lifestyle and a financial one.

Economists have form in this area.  Most people want to own their own house sooner or later, and in the longer-term those who don’t are usually those who can’t.   When economists don’t buy it is usually a choice.

The most prominent New Zealand economist who once chose not to buy was the then new Governor of the Reserve Bank, Don Brash.    Taking up his role as Governor in 1988 involved shifting from Auckland to Wellington.  At the time, after the break-up of his first marriage, Brash was on his own.  But he was also struck by just how high interest rates in New Zealand were.   To buy a house would involve paying mortgage interest rates that implicitly assumed inflation would not come down further, even though the mission Brash had been given was to keep on reducing inflation.   Renting looked a lot cheaper than buying, at least if inflation was going to be successfully reduced.   Brash pointed this out in the media and, even if there was a certain logic to his point, cartoonists had fun.  This was Tom Scott’s contribution.

Brash cartoon housingNot that long afterwards, Don remarried and they then had a child.   Like the Eaqubs, whatever the cold financial analysis might have shown, he bought a house.

I went through a similar phase.  In those far-flung days, Reserve Bank staff could get mortgages at 4.5 per cent.  I got a secondment to Papua New Guinea in 1985, and my father urged me to buy a house before I went.  I did the numbers and calmly talked him through the analysis demonstrating that if the inflation rate was going to be cut as the government and the Reserve Bank were suggesting then it wouldn’t be worthwhile to buy, even at 4.5 per cent (according to the RB website, private borrowers at the time were paying 17.5 per cent for a new first mortgage).  More fool me.  In the following few years one of New Zealand’s biggest credit booms ever happened, and with it a whole new last wave of high inflation.

There is nothing wrong with renting.  For anyone living in a city or town only temporarily, or newly arrived and not sure where they want to be long-term, it is usually the more sensible option.  Transactions costs, and the uncertainty, associated with buying and selling houses are quite a deterrent to doing it very often at all.  And there is the added advantage that maintenance etc is someone else’s problem.   For most people just starting out in the workforce, there aren’t serious alternatives even in well-functioning markets (ie without land use restrictions, or LVR controls).

But for most people in most places renting is a phase they want to get past.  Often, just as quickly as possible.    This chart shows home ownership rates for a bunch of OECD and EU countries.

home ownership rates

The median for these countries is 72.8 per cent. New Zealand was under 65 per cent at the last census, and probably falling further.

I’m not sure that home ownership is one of those things we want governments actively encouraging –  that way lies, for example, the sorts of credit misallocations that, in the US, contributed to the financial crisis of 2008/09.    But, equally, we don’t want governments standing in the way of people fulfilling a natural human aspiration for a place of their own (as governments do now, through some toxic mix of land use restrictions, together with policy-driven rapid population growth and credit controls).     Economists sometimes fret about people having “all their eggs in one basket” –  their biggest asset in the same location as their job etc –  but revealed preference internationally suggests that economists have it wrong.  People typically weigh the advantages of home ownership as outweighing any of the risks/costs that economists sometimes focus on.

It is sometimes claimed that the tax system materially favours owner-occupation, but it doesn’t really.   The tax system (arguably) favours those with a large amount of equity in their homes, but it bears down on most people buying a first home.  To be sure, they aren’t taxed on the imputed rental value of living in their own house.  But, unlike rental property owners, these (typically highly-indebted) owner-occupiers can’t deduct interest or other home ownership expenses.   Few/no first home buyers would be paying any more tax –  many would be paying less – even if the tax treatment of housing was put on what most economists would regard as a more neutral footing.

To my mind, the main policy priority should be fixing up the land supply issues (probably supported by reduced immigration and eased credit controls).  Do that –  all quite readily technically feasible, whatever the political failures of nerve –  and for most people renting will become a short-term proposition again.   Sure, there will always be a handful of people unable to buy, or to cope with having their own house, and in many cases state housing (or state-financed housing) is likely to be the solution.  But there shouldn’t be any reason why ordinary working people couldn’t buy their own house in their 20s, as used to happen.  After all, they’ll have another 40 years plus of working life to pay off a mortgage –  and it is quite rational for low income people to spread such a bulky purchase over a long working life.

So calls for various reforms of tenancy laws to facilitate longer-term renting seem mostly like a concession of failure –  a refusal by successive governments to sort out the housing supply market itself.    Shamubeel Eaqub and others sometimes talk up Germany and, to a lesser extent, Switzerland.    I see nothing appealing about the Swiss housing market –  hugely highly-priced (and accompanied by very high levels of –  probably tax-induced –  household debt), and with outcomes badly out-of-step with most other advanced countries.  Sure, one could make rental tenure more secure, but is there any evidence that most ordinary citizens would prefer that over owning a place of their own?

I’m not that familiar with the details of tenancy law, but it isn’t clear to me that there is any legal obstacle to long-term fixed tenancies, mutually agreed between owner and renter.  Perhaps if there is an issue it relates to the ownership patterns of the New Zealand rental stock.

One good feature of the New Zealand tax system is that it has treated individuals owning rental properties very similarly to institutional investors owning rental properties (although that has been changing over the last decade or so).  That isn’t the case in lots of other countries where, for example, rental properties owned by a tax-preferred retirement savings entity will be much more favourably treated than properties owned by an individual holder.  Perhaps partly as a result, most private rental properties in New Zealand have been owned by people with quite modest portfolios of properties.   That probably works fine for renters much of the time when most renters have quite short-term horizons.  If they have a longer horizon, it can become more problematic if the owner wants to rebalance or liquidate their modest portfolio of properties.  Those problems are much less likely for an institutional owner who, in principle, might have 1000 properties, and sees themselves in the rental business for the long-term.

Even so, I have wondered why we don’t see more institutional owners of rental properties.  At times, I’ve wondered whether it had to do with the nature of our housing stock –  mostly detached houses.  Perhaps institutional ownership was easier and more natural with, say, whole apartment blocks, or some of those squares in London all owned (but rented with long leases) by a single estate.   A big portfolio of detached houses might be harder to manage, maintain etc.

And so I was interested to see a lengthy article in the Wall St Journal the other day on private companies doing exactly that in the US on a large scale.

Those four companies and others like them have become big landlords in other Nashville suburbs, and in neighborhoods outside Atlanta, Phoenix and a couple dozen other metropolitan areas. All told, big investors have spent some $40 billion buying about 200,000 houses, renovating them and building rental-management businesses, estimates real-estate research firm Green Street Advisors LLC.

It is a fascinating article (google, “Meet your new landlord: Wall Street”).  It isn’t clear whether it will prove to be a viable model in the long-term, or whether it is largely a post-crisis phenomenon that might fade away again in a few years.     But if people are serious about a better-functioning long-term rental market in New Zealand –  if people are giving up, as they shouldn’t, on fixing the housing supply market, enabling a recovery in the home ownership rate –  it is the sort of business model they should be hoping to see develop in New Zealand.

In closing, I wanted to pick up just one specific point from Shamubeel Eaqub’s article.   Talking about the rent vs own choice he notes

we don’t hate home ownership at all. We just didn’t think it was the best use of our hard-earned money to spend it meeting ownership costs (such as house maintenance) that are much higher than rents, nor to deprive us of the opportunity to invest in businesses that will hopefully give us good financial returns and create jobs and prosperity for other New Zealanders.

Sadly, now that our money is tied up in one huge asset, it gives us shelter and security, but it no longer has the opportunity to be directly invested in New Zealand businesses to get them started, or to help them grow.

At an individual level, no doubt the logic seems fine.  The Eaqubs did have shares in businesses (or units in unit trusts which had shares in businesses) and now they own a house.     But their purchase of a house last week didn’t change, even slightly, the total number of houses in New Zealand, the number of people living in houses, or the number of companies with shares on issue.  All that happened was that ownership changed: the Eaqubs purchased a house and someone else sold one. The Eaqubs sold shares and others purchased them.    Renting rather than owning doesn’t change, by one iota, the volume of real resources in the economy devoted to housing.

I’m not sure there is anything particularly virtuous in preferring a smaller simpler house over a larger better-appointed house, but it would only be if people were consistently choosing smaller simpler accommodation  –  rather than just changing who owns those houses –  and were saving rather than spending the leftover money, that additional real resources might be available to the business sector.   Since the typical concern is that we have too few houses for the number of people in New Zealand,  and some often highlight that many of our houses aren’t of great quality (cold, drafty etc), it seems curious for someone who is on record as generally favouring our immigration programme to suggest that fewer resources in New Zealand should be devoted to housing.

Vision, measurement, and (lack of) achievement

You might get the impression that I can be rather critical.  No doubt I can.  But one the thing the last couple of years has confirmed to me is that there is a still a sunny upbeat, naively optimistic, streak lurking within.    In particular, I keep being surprised by just how bad things really are at the Reserve Bank, and that despite having spent 32 (mostly quite enjoyable) years on the payroll.

A few weeks ago I wrote about the Reserve Bank’s (statutorily obligatory, but largely pointless –  given that the Governor is just about to leave, and the Governor makes all the decisions) Statement of Intent for the next three years.

Quite early in the document, in a section headed “Strategic direction”, I had come across this

The Reserve Bank’s purpose is to promote a sound and dynamic monetary and financial system. It seeks to achieve its vision – of being the best small central bank

As I noted then

It was a line one used to hear from the Governor from time to time when I worked at the Bank (somewhere I think I still have a copy of a paper that attempted to elaborate the vision), but it hasn’t been seen much outside the Bank, and if I’d given the matter any thought at all I guess I’d have assumed the goal had been quietly dropped.   Apparently not.

As an aspiration, it is one that has always puzzled me.

It is good to aim high I suppose, but isn’t it really for the owners to decide how high they want the Reserve Bank to aim? Then it is the manager’s responsibility to deliver.  I’ve not seen the Minister ask the Reserve Bank to be the “best small central bank”.    That isn’t just an idle point, because the ability to be the best will depend, at least in part, on the resources society chooses to make available to the Reserve Bank.  There are some gold-plated, extremely well-resourced, central banks around, particularly in countries that are richer than New Zealand.   I suspect New Zealand probably skimps a little on spending on quite a few core government functions including the Reserve Bank (but I’m probably somewhat biased, having spent my life as a bureaucrat), but that is a choice.    If we asked of the Reserve Bank what we ask of it now, but made available twice as many resources, we should expect better results.   As it is, there are limitations to what we should expect from 240 FTEs, covering a really wide range of responsibilities (the Swedish central bank, for example, appears to have about 40 per cent more staff, for a materially narrower range of responsibilities).

Given that the Governor has now restated the vision of having the Reserve Bank as the best small central bank, I assume he must have some benchmark comparators in mind, and assume they must have done some work to assess how they compare.  Since I assume any such documents would be readily to hand, I’ve lodged a request for them.

Specifically I asked as follows

I refer to the observation on p10 of the Bank’s new Statement of Intent, in which it is stated that the Bank’s vision is to be “the best small central bank”. I would be grateful if you could provide me with copies of any and all benchmarking exercises conducted since the vision was adopted (the start of the current Governor’s term?) indicating how the Reserve Bank is doing relative to other small central banks.

I’m not quite sure what I expected, but it wasn’t what I finally received this morning.

The Reserve Bank is declining your request under section 18(e) of the Official Information Act, because the document alleged to contain the information does not exist or cannot be found. Specifically to this ground, the Bank is declining your request as it has not conducted any benchmarking exercises since the vision was adopted indicating how the Bank is doing relative to other small central banks.

Not a thing.   No comparative tables.  Not a single paper for the Senior Management Committee or the Governing Committee.  Not a single paper for the Board, the body paid to hold the Governor to account, and to scrutinise and report on the Bank’s performance.

I’m still flabbergasted.  This is, so staff and the now the public are told, the Bank’s “vision”.  It was a distinctive emphasis introduced by the current Governor shortly after he took office, still being repeated front and centre in a key accountability document as the Governor gets ready to leave office.  And yet, he and they have apparently done nothing at all to assess where they stood at the start, and what if any progress they might have made since.   I’m sure that any junior manager at the Reserve Bank who articulated an ambitious vision for his or her own team would rightly have got pushback along the lines of “how will know you’ve achieved it?” and “who are you benchmarking yourself against”, or “what data collections processes will you put in place to enable us to assess whether you are making progress”.

Ambition is good.  Vision is good –  “where there is no vision, the people perish”.     But hand-wavy “visions” with little or nothing behind them, that apparently drive no decisions, and where there are no benchmarks, and no way of assessing progress, are worth almost nothing at all.   Within an agency, they just fuel staff cynicism.  Beyond the four walls of the institution concerned, they border on the deliberately dishonest – the sort of cheap and empty rhetoric (small beer in this case) that is corroding confidence is institutions and leaders across the Western world.     The pervasiveness of this sort of cheap rhetoric is presumably reflected in the fact that both the Minister of Finance and the Reserve Bank’s Board reviewed drafts of the Statement of Intent.  Did none of them ask: “Governor, this vision of being the ‘best small central bank’, where do you stand now, what progress have you been making, and how will we –  those charged with holding you to account – know?”?

Visions have their place.  But from independent government bureaucracies, I’d settle for consistently excellent delivery on the tasks Parliament has given them.  For too long now, we’ve not had that from the Reserve Bank, or from those charged with holding them to account on our behalf.  But when they met last week, applications for Governor’s job having closed, was the Reserve Bank Board even aware of the deficiencies?  And, even if so, did they care?