On Graeme Wheeler’s farewell speech

Checking back over my notes from the last Monetary Policy Statement press conference, I see that Graeme Wheeler told the assembled journalists that he would shortly be doing a speech that would answer many of their questions.   He was, for example, asked whether he thought his critics had been fair and whether he had ever allowed his judgement to be clouded by those criticisms. Perhaps unsurprisingly, there was nothing on any of those sorts of points  –  or any of the others he suggested he would cover –  in the speech he delivered yesterday to the Northern Club, safe from any further journalistic scrutiny.

In his term as Governor, Graeme Wheeler has given about 20 on-the-record speeches.  The first one was to a private Auckland club, and so was the last one.    And all the ones in between were given either to bureuacratic/academic audiences, or to business and finance ones.   It will have been very much the same for the off-the-record addresses the Governor gives to commercial bank business clients the morning after each MPS.    And unlike the practice of his RBA peers (who mostly put Q&A sessions up on the website), people not at these functions –  generally accessible only to invited guests –  don’t have access to his responses to questions.   When his preferred audiences skew strongly towards one set of economic interests –  so the questions and comments reflect their perspectives – that should leave us rather uncomfortable.  Perhaps union groups or community groups, for example, wouldn’t have had any interest in the Governor speaking?   But across the whole country, across five years, that seems unlikely.    It should be something for the new Governor –  whoever he or she is –  to reflect on.

But this post is mainly about some of the points of substance of yesterday’s speech.

When, three weeks out from a general election, a press release turns up extolling New Zealand’s economic performance, one might have supposed it was a party political message on behalf of the incumbent government, or at least from one of their lobby group supporters.  But this was from the outgoing –  supposedly apolitical – central bank Governor.

His press release was headed “Reserve Bank policy a key driver in economic performance” and the opening sentence read

The Reserve Bank’s monetary policy has been an important driver in the last five years behind above-trend growth in the economy and employment,

Which is quite a curious claim –  even without digging into the data –  because generally the Reserve Bank shouldn’t be having that much influence on the performance of the economy.  And the Bank’s main job is to keep inflation near target –  and on that count it has repeatedly undershot throughout Wheeler’s term.   Prima facie, that might suggest that, on average, monetary policy hasn’t done enough.

Wheeler’s claim seems to rest on the proposition that “during this time [the last five years] monetary policy has been stimulatory, with the Official Cash Rate averaging 2-3 percentage points below the neutral interest rate”.    Since the OCR has averaged 2.55 per cent over his term, he seems now to be saying that the neutral OCR was between 4.5 and 5.5 per cent on average over the course of his term.   I doubt there would now be many takers for that view, and if anything views on what a neutral interest rate might be have been being revised downwards.  They have further to go.

But, let’s suppose that Wheeler is right on that count.  If so, surely we should have expected a supercharged performance of the New Zealand economy.   After all:

  • although it is never mentioned in the speech, the terms of trade have been 10 per cent higher on average than they were during the Bollard decade,
  • we’ve had a huge boost to demand from the repair and rebuild process in Canterbury (the initial disruptions and losses of output were all in his predecessors’ term),
  • we’ve had another big population surge, and
  • there have been no serious recessions or financial crises abroad.

Throw in highly stimulatory monetary policy, and we should surely have seen something pretty impressive.  At very least we might have expected inflation to be at, or perhaps a bit above, target.

I don’t like to hold central banks to account for medium-term real economic outcomes.  Central banks just don’t have that much power.   So I don’t blame Graeme Wheeler or the Bank for, say, five years of zero productivity growth, while I do hold him responsible (solely responsible) for five years of undershooting (core) inflation.

But it is the Governor in his speech, only three weeks out from an election, who is actively trying to suggest not only that the New Zealand economy has done well in the last five years, but that he and the Bank deserve credit for that.    Neither is true.

He includes a table which I’ve reproduced part of here, showing annual average growth rates

wheeler table

Inflation targeting began in New Zealand formally in early 1990.  So Wheeler’s story is that while the world economy has done a little worse during his term that it was doing in the previous 20 years, the New Zealand economy has actually grown faster than it managed in the previous 20 or so years.   Put that way, New Zealand’s performance looks good, and Wheeler appears to want to claim a considerable portion of the credit.

But this is the same nonsense that we get from the government, boasting about headline GDP numbers, and keeping very quiet indeed about the per capita performance.    Over the Wheeler term  –  not directly influenced by him at all –  New Zealand’s population is estimated to have increased by 8.5 per cent.     Advanced countries in total have had a population increase of less than 2 per cent.   Not surprising, headline GDP numbers here look moderately respectable.

But how does per capita growth in real GDP compare?  In this chart, I’ve shown the average annual growth rate in real per capita GDP for, on the one hand, the 22 years from when inflation targeting began to the end of Alan Bollard’s term as Governor, and on the other for the Wheeler term.   Remember that in the first period there were three recessions, two quite severe ones, and in the more recent period there have been none.

real GDP  pc wheeler.png

The only other gubernatorial term in which there wasn’t a recession was Alan Bollard’s first term (to September 2007).  Over that five year period real per capita GDP growth averaged 2.3 per cent per annum.

What about productivity?  Wheeler does acknowledge that “labour productivity has been disappointing”, suggesting that this is a problem most other advanced countries have but consigning to a footnote the recognition that New Zealand has had no labour productivity growth at all in recent years (unlike, say, Australia or the United States).

Here is how New Zealand’s labour productivty growth has been over (a) the whole pre-Wheeler inflation targeting period, (b) the last gubernatorial term without a recession (which also featured a housing boom and material lift in the terms of trade) and (c) the Wheeler term.

real GDP phw wheeler

To repeat, productivity is not something the Governor has much influence on, but…..it was him that was claiming credit for the “strong” performance of the New Zealand economy.

How about the labour market?     The Governor highlights that employment growth has been faster in his term than in the earlier inflation targeting period, but doesn’t mention that working age population growth has also been much faster during that period.   Actually, the rate of job creation relative to population growth hasn’t been at all bad in recent years – surprise increases in population create big increases in labour demand  –  but it is worth remembering that the quarter Wheeler took office saw unemployment at 6.7 per cent, the highest rate in the previous 13 years.  So we’d have hoped to see employment rising strongly and unemployment falling.  As it is, the unemployment rate averaged 4.8 per cent in the Bollard decade (boom and bust) and has averaged 5.4 per cent in the Wheeler term –  and all this as reasonable estimates suggest that the non-inflationary unemployment rate (the NAIRU) has probably been falling.

Even on the labour side of things, here is hours worked per person of working age.

hours worked per wap

Yes, the series has been recovering during the Wheeler term, from recessionary troughs, but is still not to the average levels prevailing for the four or five years prior to the recession.      Perhaps those levels might have amounted to “over-full” employment, but the unemployment numbers don’t suggest we are at that sort of point now.

I’m really not quite sure what Graeme Wheeler thought he was doing in making these claims. I don’t really suppose that he intended to be party political –  although the timing is such that he should have been more circumspect  – and actually in a way his claims, if valid, would actually suggest some serious problems in the economy –  if we could only manage such feeble outcomes even with highly stimulatory monetary policy.   But I guess it was mostly an attempt at distraction, to keep the focus away from what might otherwise have been.

Wheeler couldn’t do anything about (a) the aftermath of Canterbury earthquakes or (b) the migration influx (in any case only a touch larger than his predecessor had had to deal with), both of which have skewed the economy away from the non-tradables sector, probably helping to explain the distinctively poor New Zealand productivity performance.  He can’t do much about the neutral interest rate –  whatever it really is –  or about the troubling medium-term level of the real exchange rate.   But he could have done quite a lot about inflation.  Had he taken the steps that would have had core inflation averaging around 2 per cent –  instead of 1.4 per cent –  we’d have had a lower unemployment rate sooner, faster growth in per capita GDP (not indefinitely, but over this period), and stronger growth in employment and working hours.    He’d have delivered on his primary statutory mandate, and most New Zealanders would have been better off.

Humans make mistakes, and institutional structures that put lots of power in the hands of one person are particularly prone to mistakes.    The Reserve Bank of New Zealand is a good example of that, over the terms of successive Governors.   There are some things to be said for Wheeler’s stewardship –  as I’ve noted previously, core inflation has been quite remarkably stable during his term –  but he seems determined to never acknowledge a mistake, even with the benefit of several years hindsight. Individuals and institutions that don’t even recognise mistakes struggle to learn from them.   The Governor can repeat as often as he likes that local market economists and the relevant desk officer at the IMF thought the Reserve Bank was doing the right thing in 2014 (while ignoring the alternative minority voices).  The fact remains that they weren’t doing the right thing, when judged against their own mandate.  They remain the only advanced country central bank to have had two tightening phases since the last recession, and to have had to unwind them both.    Some acknowledgement of, and regret for, those mistakes might have been a gracious way for the Governor to have left office.  But I guess it is hard for leopards to change their spots.

I don’t want to spend any material time on the Governor’s treatment of housing market issues.  There is still no sign that they really understand the issues that have driven house prices to such unaffordable levels.  And I’m not going to bore you by running through the issues around LVRs again except to note that (a) there is no attempt to evaluate the Bank’s interventions against the only criteria the matter, the statutory responsibility to promote both the soundness and the efficiency of the financial system, and (b) my jaw almost dropped when I found no reference to any adverse effects on anyone of the LVR restrictions, except the rather self-pitying observation that “we were conscious that the introduction of LVR restrictions would make life difficult for the Bank”.   Not nearly as difficult as it makes things for willing lenders and willing borrowers to put in place credit facilities……

The final point I wanted to touch on was the Governor’s disconcerting complacency about the next recession.     The Govenor notes

If growth in the global economy slows because of debt-related or other issues, our economy will be affected. However, there is scope to help buffer against such shocks. We have greater room for monetary policy manoeuvre than central banks in many advanced economies.  Our Official Cash Rate is 1.75 percent – above the zero and negative policy rates of several advanced country central banks – and the Bank has not grossed up its balance sheet by buying domestic assets.  Similarly, with budget surpluses and low net Government debt relative to GDP, the Government has flexibility on the fiscal policy side.

Frankly, the issue that should be concerning the Bank isn’t some modest “slowing” in the global economy, it is the next serious global recession, the seriousness of which is likely to be accentuated by the fact that monetary authorities in most of the advanced world have very little scope to cut interest rates much.  And there is about as little scope in most of those countries to do much with fiscal policy.    In a typical US recession, for example, policy rates have been cut by around 7 percentage points.  At present, the Fed funds target is around 1 per cent.

In a typical New Zealand recession, the OCR (or equivalent) has fallen by perhaps 5 to 6 percentage points (our exchange rate tends to fall too, unlike in the US).  But our OCR is now 1.75 per cent, and inflation is well below target (the Bank thinks things are heading back to target, but their own official stance at present is neutral).    And while it is fine to note that our fiscal accounts aren’t in bad shape, in any serious recession they will look a great worse quite quickly (in flow terms).  There is some technical room for additional discretionary fiscal stimulus in a downturn, but the practical political room for additional discretionary stimulus has never been that large anywhere –  see, for example, the battles in the US in early 2009 around the stimulus package.

So while it is better to be in our position than that of some other countries, our position isn’t very good either –  and our Reserve Bank is responsible for our position, not that of other countries.   Going into the 2008/09 recession the Bank could say with confidence that we would cut as far as was needed –  and starting from 8.25 per cent, no one doubted our capacity.  Going into the next serious recession, if starting from around the current level of the OCR, no one will believe the Bank can do, or the government will do, that much.

Throughout his term, Graeme Wheeler appears to have done precisely nothing to position the Bank to cope with the next serious downturn  – despite all the advance warning, and experiences of other countries running out of conventional capacity.  The issue has never appeared in his Statement of Intent, or in past speeches.   He hasn’t got inflation back up to target, which would have led to nominal interest rates stabilising at a higher level than they are now.  He hasn’t done anything about addressing the institutional issues that make the near-zero interest rate bound a practical problem.  And, despite all that, he objects to any suggestion of raising the inflation target

It is not clear that central banks could readily increase inflation to these levels and attempting to do so would further stimulate asset markets, at least in the short run.  Raising an inflation target when productivity growth is weak makes little economic sense.

Perhaps it is too late in some countries –  although the largest of them, the US, has been raising interest rates, suggesting that a lower track of rates would produce somewhat higher inflation –  but it clearly isn’t here.  And as for the productivity argument, he has that quite back to front.  In a climate of weak productivity growth, and weakening global population growth, the case for a higher inflation target is stronger than otherwise –  precisely because there is more chance than otherwise that the near-zero bound would prove binding.

I guess the Governor has got to the end of his term and these particular risks haven’t crystallised.  Now it will be someone else’s problem, and I don’t suppose the Governor will have to worry about being one of those caught unemployed for a prolonged period in the next recession.   Forecasting is hard, and anyone can make mistakes. But failing to actively address this sort of foreseeable risk –  timing unknown of course –  is close to derelicition of duty in someone entrusted personally with all the powers of Governor of the Reserve Bank.    Getting on with some serious work in this area should be a priority for the new Governor, and for the Treasury/Minister of Finance.

(And I suspect that the key clue to Wheeler is the “asset markets” reference in that last quote.  There and throughout the speech his concerns about asset markets are pervasive.  And yet there is little sign of analysis that offers insights into those markets, and no sign of any Reserve Bank statutory responsiblity for such markets.)

Finally, it was interesting that in his reflections the Governor chose not to touch on the governance issues.  We know that he has favoured change (making he and the deputies he appointed collectively responsible under law).  And we know that the Opposition parties favour change.  And we know that Steven Joyce is sitting on (and refusing to release) a report to The Treasury commissioned from former State Services Commissioner, Iain Rennie on possible governance reforms.  It would, nonetheless, have been interesting and timely to have heard the Governor’s reflection on the issue, in light of his five years’ experience.

I keep wondering why the Rennie report is being kept secret –  months after it was completed.  One possibility is that Rennie is recommending reasonably substantial changes, going further than the Minister of Finance might have envisaged when he asked for the work to be done.  Whether that is so or not, there doesn’t seem to be any legitimate (OIA) reasons for the report (from a consultant to a ministry) to be kept secret.

And reform is overdue –  we shouldn’t be running a system where when the outgoing Governor opines on what will happen to LVR limits everyone knows that a month from now his views will mean nothing and there will be a different single decisionmaker in place.  Well-governed institutions are typically built around greater continuity and resilience to the preferences of single individuals.


Labour share of income

The other day I ran this chart showing how the labour share of income (“compensation of employees” in national-accounts-speak) had changed in New Zealand over recent decades.    COE

It isn’t data I usually pay any attention to, and I was somewhat surprised by the trend increase since around 2002.

And then I was reading a Financial Times article about last weekend’s Jackson Hole retreat for central bankers (perhaps including Graeme Wheeler) and assorted other eminent people.   The journalist mentioned that one prominent Asian central banker had warned that a declining labour share of income around the world could make problems for central bankers (the idea being that workers  –  especially low income ones – tend to spend most of their income, and demand shortfalls are a potentially serious issue, especially when the next recession happens).    And that left me wondering just how unusual New Zealand’s experience –  a rising labour share –  had been.

So I downloaded the OECD data back to 1970.    They have data for 25 advanced countries for the entire period (the exceptions are mostly the former eastern bloc countries).  Here is the share of GDP accounted for by compensation of employees for the median of those countries.


Slightly higher at the end of the period than at the start, and not very much change overall for the last thirty years.

And here is how the labour share has changed in the individual countries since 1970.

lab share since 1970

The median change is basically zero, but what is striking is how diverse the experiences of these advanced countries have been.  There are easy explanations for some of them –  Ireland’s change, for example, will reflect the company tax structure, which has encouraged (a) a lot of foreign investment, but (b) a lot of effort by multinationals to book profits in Ireland.  For Ireland, the labour share of GNI would be more enlightenning.  But for most of these countries the GNI/GDP gap is small, and yet there are still huge differences in the experience.

New Zealand –  like all the Anglo countries –  is towards the left of that chart.  But what about the experience since 2001, when the labour share of income troughed in New Zealand?  For that period, there is data for almost all OECD countries, not just the 25 in the earlier charts.

lab share since 2001

Over this period, not only is New Zealand near the right of the chart, but our experience has been quite different from that of the other Anglo countries.

This just isn’t my field, and I’m not pushing any particular interpretation of these data.  I simply found them interesting, and a little surprising.  But if they data are broadly correct, they do suggest that whether over 45 years or over the last 15, the overall labour share of income in advanced countries hasn’t changed much.  Of course, in most countries, productivity growth has been a lot slower than it was in the glory days of the post WW2 decades, and thus real wage growth will have been slower.  But the overall labour share hasn’t changed much –  and the differences across countries are much larger than the differences across (this period of) time for the advanced world as a whole.

These data also don’t shed any light on the inequality narrative.   Labour as a whole may have held its share of overall income, and yet differences in pre-tax market labour incomes may have become more pronounced (eg increases in chief executive salaries in the US or UK relative to median wages, or the rise of an extremely highly-remunerated subset of financial markets employees).     But if there are trends there, they haven’t been mirrored in a shrinking share of the cake going to labour as a whole.  Indeed, in New Zealand the labour share of income has increased quite a bit in the last 15 years or so (concentrated in the boom years of the 2000s, but not reversed since then).

And finally, another curiosity I stumbled on.   There is quite a sense that New Zealand’s labour market functions reasonably well and  –  in conjunction with counter-cyclical macro policy – delivers us unemployment rates that have been relatively low by OECD standards.    And I think that is probably not a totally inaccurate story –  who’d trade our labour market for that of Spain or Italy?

But here is a comparison of unemployment rates of Mexico and New Zealand

mexico U

Over the 25 years for which there is data for both countries, in only one –  at the height of the Mexican financial crisis –  did Mexico have an unemployment rate even slightly higher than that of New Zealand.   And if people suspect (as I do) that our long-run sustainable unemployment rate is getting down to around 4 per cent now, experience suggests that in Mexico it has been that low for decades.

Why mention Mexico?  Mostly because, despite its advantages –  oil, proximity to the United States, coasts on two oceans –  Mexico is a  relatively poor and (absolutely) not very productive OECD country.  Data are a bit patchy, but best indications are that Mexico’s productivity performance over the last 50 years has been even worse than that of New Zealand.    And yet, whatever the reasons, they’ve managed a system with consistently less unemployment than New Zealand has had (and, actually, even their prime age male participation rate is higher than that in New Zealand –  as perhaps one might expect in a materially poorer country).

On a declared candidate for Governor

Last week, we had an unusual public confirmation from a senior figure who  disclosed that they had applied for the job of Governor of the Reserve Bank.

I’m pretty sure it has never happened before in New Zealand.  The current Reserve Bank Act, which gives the lead role in appointing a new Governor to the Bank’s Board, has been in place since 1990, and this is only the third time there has been a vacancy to fill (as distinct from an incumbent being reappointed).  I can’t recall either in 2002 or in 2012 that anyone publicly disclosed their candidacy –  although in both cases, it was generally assumed that the incumbent deputies (Rod Carr and Grant Spencer) had applied.      It doesn’t happen in other countries, where the Governor of the central bank is generally appointed directly by the Minister of Finance or the President, without an advertised application process.  Again, sometimes it is widely known that someone is keenly interested –  eg in the US case a few years ago Larry Summers, the former Treasury Secretary –  but formal public confirmation is rare or unknown.

But in an (otherwise mostly unremarkable) interview with interest.co.nz’s Alex Tarrant last week, Reserve Bank Head of Operations and Deputy Governor, Geoff Bascand, confirmed his application

He’s put his hat in the ring for the Governor’s job. It’s been rumoured that he’d be the front-runner among the insiders if he wanted to stand, and now he’s confirming that he is going for it.

“The Reserve Bank matters to New Zealand’s economic performance and ultimately therefore to people’s welfare, and I’d like to be part of continuing to make this an excellent and strong institution, and to lead it in a way that it would be really successful for the next five years,” Bascand says.

If he doesn’t get it, then fair play to whoever does. Bascand says he’d like stay on in the Financial Stability role he’s about to take over when Grant Spencer moves into the Acting Governor position for six months starting late-September.

It is an unusual move.  In some respects, it is to his credit –  after all, one reason people don’t usually answer such questions is that it can be embarrassing to miss out, particularly if you are (or will be by then) the incumbent deputy, and perhaps more so if everyone knows you had applied.     But then it is presumably just another part of the multi-year effort by Graeme Wheeler to promote Bascand as his sucessor.   After all, the bulk of the interview (authorised by Wheeler) was about monetary policy and making sense of inflation –  normally issues that would be handled by either the Governor, or the Assistant Governor/Chief Economist, not by the chief operating officer responsible for things like notes and coins, security and property, communications, the operation of the securities settlement system, HR and the like.

Bascand’s background, of course, is in economics.  He started at Treasury, spent quite a bit of time at the old Department of Labour, running for a time its well-regarded Labour Market Policy Group, before moving to Statistics New Zealand where he eventually spent some years as Government Statistician.   There seem to be a range of views as to quite how successful that tenure was.  A while ago someone sent me a link to a somewhat sycophantic profile written while Geoff was in office.  Then again, I’ve heard that SNZ ran into some pretty serious financial problems on his watch.

When Geoff was appointed as Head of Operations and Deputy Governor, I was pretty positive on the appointment.  In part, that was the contrast to his predecessor, but much of it was about Geoff’s own merits. Graeme had set out to appoint someone who could contribute to policy, not just keep the operations ticking over, and in Geoff he had found such a person.   I hadn’t had a lot to do with him over the years, but what I’d seen left a fairly good impression, of someone who was smart, thoughtful, and level-headed.

It was an interesting move for Bascand himself.  He stepped down from a chief executive position in an operational agency to take up a number 3 position at the Reserve Bank  My take on day 1 (as recorded in my diary the day his appointment was announced) has remained my view throughout

“No doubt he sees it as a stepping stone back to either Governor or Secretary to the Treasury, via replacing Grant [Spencer] when he goes”

The expectation at the time was that Spencer probably wouldn’t stick around for five years, but as it happens next month Basacand will indeed take up Spencer’s position as Head of Financial Stability and deputy chief executive.

I recall Bascand telling an internal forum a few years ago that he’d only had two more years at SNZ to run, and hadn’t been interested in either joining the international consultancy circuit, or in the sort of operations-focused government chief executive roles that the State Services Commissioner had discussed with him.   Even though he’d had relatively limited experience in macro, and none in the financial sector, taking a fairly senior well-remunerated position at the Reserve Bank for a few years was a move back towards “home” –  his interests in economic policy.   And one that might position him well in time to secure the glittering prizes.

I don’t have many thoughts on how well he has done his day job –  head of operations  –  at the Bank over the past four years.  They aren’t areas I pay a great deal of intention to, and are largely inwards-focused anyway.  But the new bank notes seemed to be introduced smoothly, and many people seem to like them.  So he seems to have been a competent safe pair of hands, presiding over a continuation of the status quo (including, for example, the Bank’s obstructive approach to the Official Information Act, for which Bascand had responsibility).

What has been more noticeable has been the relatively high public profile Bascand has been given by the Governor on economics-related issues, especially in the last couple of years.     Bascand’s predecessor as head of operations gave almost no speeches, and certainly none on economic policy and analytical issues (and it is not as if the Bank has moved to do more speeches in total).

And it isn’t as if they have been bad speeches.    There are things I’d disagree with in all of them  –  and I’ve noted his over-enthusiastic embrace last year of the Bank’s new labour market capacity indicator –   but that isn’t a criticism.   If anything, I’ve found Bascand’s speeches the best of those put out by the four Reserve Bank senior managers, and certainly better, on economic issues, than those of the Chief Economist.  Bascand’s speeches come closer to comparing with those of senior managers in other central banks, including the Reserve Bank of Australia.

So in a way it isn’t surprising, or inappropriate, that the outgoing Governor has been smoothing the way, allowing Bascand to raise his public profile on economic policy issues, and –  in effect –  promoting him as the next Governor.

A few months ago the Bank’s Board advertised the position of Governor.   In their “candidate profile” they listed the sort of qualities they were looking for.  I wasn’t convinced that was the right list, but here is how I see Bascand against that list of characteristics.   My scale is 1 to 5, with 5 the best possible.

Outstanding intellectual ability 3.5
Leader in the national and international financial community 2
Substantial and proven leadership skills in a high-performing entity 3.5
Proven ability to manage governance relationships 4
Sound understanding of public policy decision-making regimes 5
Ability to make decisions in the context of complex and sensitive environments 3.5
Personal style will be consistent with the national importance and gravitas of the role 4

The Board had one more quality they were looking for

The successful candidate will also demonstrate an appreciation of the significance of the Bank’s independence and the behaviours required for ensuring long-term sustainability of that independence.

Personally, I suspect that is, in effect, ultra vires.  Decisions on the extent, or otherwise, of independence are matters for Parliament.    But I suspect Bascand would be a competent safe pair of hands on that count.

Overall, against this set of qualities, Bascand scores well on the “public sector” types of qualities, as he should.    We don’t know much about how he’d do as a single decisionmaker in a body with such high profile and extensive functions as the Bank (nor, in truth, do we know that for any of the possible candidates).  He is a capable analyst without, I suspect, claiming to be any sort of soaring intellect.  Where he probably scores lowest on this list of qualities is that he can’t make any serious claim to being a leader in the “national and international financial community”.   No one, I imagine, thinks of a distinctive Bascand perspective on any of the relevant issues.   Relatedly, he has no background with financial markets, banking, or financial system regulation –  at least beyond what he will have picked up sitting around the relevant committees, incidental to his day job,  in the last four years.

It is pretty clear that there is no ideal candidate to be the next Governor  (indeed, I heard at secondhand that the chair of the Board has said as much).  If so, Geoff Bascand strikes me as having the inside running if the powers that be are pretty content with things as they are, and aren’t looking for anything materially different over the next five years than they’ve had in the last five.    He is, after all, the only serious potential internal applicant, and the Board members have been able to see him every month for the last four years and take his measure.   Things probably wouldn’t run badly off the rails with Geoff in charge, and in some respects I expect he’d been a little better than Wheeler.

That is in the nature of a conditional prediction: if you think things have mostly been just fine at the Bank why go past Bascand?

But if he looks more or less suitable (given the slim alternative pickings) on the face of it, I still remain somewhat uneasy about appointing Geoff Bascand as Governor, in which position he alone would have personal legal responsibility not just for monetary policy, but for a wide range of regulatory interventions.   Some of that has been because he has been a key member of the Bank’s top-tier over the last four years, when monetary policy hasn’t been done well, and hasn’t been communicated well, and when the regulatory interventions have compounded, backed up by not particularly persuasive analysis.   I wonder if he’ll be able to demonstrate to the Board or the Minister that he was trying to influence the Governor towards better approaches?    Or even that he has learned something from those unsatisfactory experiences?

But my impression is that he is more a follower and capable implementer than a leader.   I was exchanging views a few weeks ago with another former colleague and we both noted that when Geoff first joined the Bank he’d seemed good and open, but quickly seemed to pick up the (internal) political signals and fall into line.  At a point when I was a lone internal voice on monetary policy I recall his somewhat strident objection that anyone could take a different view –  without ever making the effort to come and talk it over and understand a difference of perspective (in an area riddled with uncertainty).

Then, of course, there were episodes like the Toplis affair. Graeme Wheeler had got a bee in his bonnet about Stephen’s Toplis’s criticisms, and had all his fellow governors meet individually with Toplis to try to get him to back off.  Is that the sort of behaviour Bascand regards as acceptable from a top public servant?  And, if not, why did he simply go along –  after all, his day job didn’t involve contact with commercial bank chief economists?   Did he try to persuade the Governor to let it go?

Or the OCR leak episode.  I’m reluctant to make too much of it, because I was involved.  Then again, one collects data partly through experiences with people.   There is nothing in Geoff Bascand’s involvement in that episode, as revealed by the material the Bank had to release, that suggests someone with the sort of stature, and decency under pressure, that would mark him out from Wheeler.   Bascand was the senior manager responsible for external communications, lock-ups etc, as well as the one who commissioned the leak inquiry.

One could even think about Geoff’s speeches and interviews.  As I’ve already mentioned, I think they’ve been quite good.  But there isn’t any hint of a fresh or distinctive angle to them  (with the possible slight exception of comments around immigration in the Tarrant interview, which I would welcome).  Sure, the Governor is the sole decisionmaker, and it is his line that needs to be conveyed primarily.  But in a substantive speech a thoughtful senior adviser should be able to offer fresh insights or angles, without making trouble with the boss.  There is little sign Bascand has.

But my most sustained involvement with Geoff Bascand has been as fellow trustees of the Reserve Bank superannuation scheme over the past 4+ years.  Geoff serves as alternate for the Governor, and I’m an elected members’ representative.   Until late last year, Geoff was chair of the trustees (probably an illegal appointment, but that was an issue for those who appointed him –  the Board –  not for him personally).

Trustees of superannuation schemes –  regardless of who appointed/elected them – are required to act in the best interests of the beneficiaries of the trust, in this case, the members and pensioners.   A defined benefit superannuation scheme is a complex beast, involving huge elements of trust reposed in the trustees by members stretching over many decades (from memory, our median pensioner is now aged about 85).  The regulatory regime for superannuation schemes in New Zealand is quite limited –  something I have mixed feelings about, given my generally support for less regulation –  but there have long been statutory provisions, judicial precedents, and the obligations of the specific trust deed and rules themselves.  These days, superannuation schemes are the responsibility of the Financial Markets Authority –  a fellow regulator that Geoff Bascand will no doubt be dealing with extensively in his new role as Head of Financial Stability for the Reserve Bank (while at the same time a complaint against the trustees sits in FMA’s hands).

The Reserve Bank’s regulatory approach to banks is often characterised as being quite light-handed.  Certainly, there are few/no on-site inspections of the sort often seen in other countries.   But there are quite onerous requirements imposed on directors and managers, including various strict liability offences –  ones, that is, where people are liable whether or not they ever intended to commit an offence.  Strict liability provisions are generally repugnant, but there has been no sign of the Reserve Bank walking back its support for such provisions.  It is the standard they require of those who hold our money, or make our payments, in New Zealand registered banks.   Banks quake at the thought of breaching Reserve Bank regulatory requirements (we see it in the big buffers they run around the LVR limits).

Given this stern approach to the regulation of entities they have statutory responsibility for, you might suppose that they would consistently seek to adopt a “whiter than white” approach to the management of the long-term financial entity they themselves sponsor.  It isn’t an entity that is exactly invisible to the Bank either: successive Governors have been trustees, and when they choose not to attend one of their senior managers does so for them.  The Bank’s Board –  of which the Governor is a member –  appoints two of the trustees, and has to approve any rule changes.

Sadly, the standard the Bank –  and its senior managers –  have taken to the superannuation fund falls far short of the standard they require private financial institutions to adopt.   I won’t attempt to bore readers with details.  The worst abuses were done some decades ago.  Bascand’s involvement has been as these abuses have come to light, and how he has sought to guide the response and reaction.

Three years ago a particularly persistent retired member wrote to the trustees highlighting a series of potential problems around some rule changes in 1988 and 1991.  He suggested there was reason to doubt that one significant element of the the 1991 changes had been done lawfully at all, and that key elements of the 1988 changes (which gave the Bank power to, in effect, reduce pensions) had been done without the members’ consent that appeared to have been required by the rules, and under the relevant legislation.  Geoff’s immediate response –  as chair of a group of trustees, responsible for the fund, and working in the best interests of members –  was to write a memoradum to trustees proposing that we agree there was nothing of substance in the submission, and that we do no further investigation.

Fortunately, that did not gain agreement from fellow trustees.  I say “fortunately” because with only a little bit of follow-up work it emerged that in fact there had actually been a breach of the Superannuation Schemes Act (members had never actually been told at the time of the 1991 rule change).  Fortunately for today’s trustees, the statute of limitations had passed, but the trustees felt obliged to apologise to members for that earlier breach.

With a bit more follow-up work and some legal advice, it became clear that one element of the 1988 changes could simply never lawfully have been made (I think we are all agreed in shaking our heads in wonderment at how this happened), and another change that could lawfully have been made, nonetheless never had the member consent that clearly was required.  In fact, the Bank (and the Board) had known of some of these problems for more than 20 years and had never told members  (it was no small point –  the illegal change had meant that any surplus on wind-up could go the Bank).      That in turn has opened up issues around the validity of the consent members gave in the mid 1990s to a rule change that has been worth at least $5m to the Reserve Bank –  money it, in effect, extracted from the Fund, having apparently (and wilfully or perhaps otherwise) misled members about the alternatives.

The issue here isn’t the rights and wrongs on specific points.  It is about the cast of mind displayed by someone who will shortly be responsible for the regulation of most of our financial intermediation sector, and someone who asks to be given the huge powers Parliament places in the hands of the Governor of the Reserve Bank.    Geoff has been quite seriously engaged on the issues where the Bank’s financial interests might be threatened –  a process likely to end up in the High Court next year.  But he has never shown much sign of acting with the interests of the Fund’s members and pensioners at heart.    Despite him, rather than because of him (even though he was chair), some of the issues have continued to be pursued.    This isn’t the place to traverse the rights and wrongs of the specific issues; it is about my observation of a senior manager’s inclinations and cast of mind.   I’ve noted previously his seeming inability to recognise, and respect, the differences between his responsibilities as a Bank manager, and those as a superannuation scheme trustee –  the sort of lack of regard for boundaries that would rightly trouble the Reserve Bank if, say, it was apparent in a director of a New Zealand bank appointed by a foreign parent.

I don’t think Bascand has malevolent intent.  He is a pleasant and thoughtful person as an individual.  But he doesn’t seem to recognise his responsibilities, and rarely seems to want to dig deeper if he isn’t forced to.   Leadership is partly about asking hard questions, and insisting on rocks being turned over even if it might be inconvenient.  It is about recognising implications, and looking a bit further ahead than most.   Sadly, there doesn’t seem to have been sign of that sort of standard in the Bascand’s approch.  A few years ago a prominent person noted that the standard you walk past is the standard you accept.   The sorts of standards on display in recent years aren’t those we should be tolerating in a Reserve Bank Governor.

Then again, standards in public life in New Zealand appear to be slipping.  As I say, Bascand looks like the probable preferred status quo candidate for Governor.  But the status quo shouldn’t be nearly good enough.


Participating in the labour market

Looking through the various comments posted here yesterday, I noticed there had been a bit of an exchange about this chart.

BNZ labpart

It had, apparently, been used in a presentation by BNZ economist Stephen Toplis, and was reproduced at Kiwiblog.    A commenter here pointed me and others to it, with the observation

just shows what a world class economy we are running, world record immigration and look at the participation rate..amazing. That is an economy running probably as one of the best…productivity measure is meaningless

I’d have been inclined to ignore it, but others didn’t.   So I thought I’d offer a few thoughts on what to make of the labour force participation rate data.   As a reminder, the participation rate is the sum of all the people in paid work (at least an hour a week) and those actively looking (a reasonably demanding definition) for work, as a share of the working age population.   The definitions are pretty similar across countries.

To get one thing out of the way quickly, I’ve been consistently running the line that immigration boosts demand (including demand for labour) more than it does supply, at least in the first few years.  And since the participation rate itself varies procyclically it isn’t remotely surprising that extraordinarily rapid, and unexpected, population growth has gone hand in hand with a pick-up in the labour force participation rate.   There are more jobs around, and so more people actively participate in the labour market.

But a more important point, and a trickier one, is that there is no good way of determining what a “good” participation rate is.  Unemployment rates are different: in general, the lower the better, because it is a measure of those whose wishes are frustrated (people actively looking for work and not  –  yet –  able to find it).

And enthusiasts for citing high labour force participation rates often risk sounding a bit like Soviet-era Stakhanovites, for whom the greater glory of the state is advanced by unrelenting labour.   But labour is a cost.  People do it for a whole variety of reasons –  sense of fulfilment, something to do, the company –  but for most people the main reason they engage in paid work is to earn the money to live, and to purchase the things they and their families wish to consume.   Higher earnings rates mean people can work less (and do other stuff), or work as much (or even more ) and consume more on-market goods and services.    Over history, it looks as though the income effect has dominated.  Thus:

  • labour force participation rates for 14 year olds were once very high (not many went to secondary school).  They are now pretty low, and most people probably count that as “a good thing”.
  • as recently as thirty years ago, the participation rate for 15 to 19 year old was around 65 per cent, and now it is around 45 per cent, as more young people are staying at school longer, and then doing tertiary study.
  • go back a couple of hundred years and most people worked until they physically couldn’t work any longer.   These days, we have widespread “retirement”.

All of these changes –  reduced labour force participation – have been made possible by advances in productivity and incomes.   The same goes for shorter worker hours for those in work.   All else equal –  which is never is –  then one might expect countries with lower productivity (and thus lower real wages) to have higher hours of work per capita and higher participation rates.

Social customs also change in ways that increase labour force participation.  For a long time it was customary for one parent (most often the mother) to stay out of the paid labour force for some years when children were young (or even at school age).   These days it is a more uncommon choice.    There is no easy way to assess whether that is “a good thing” or not.  Individuals and families make choices, in the light of their own opportunities and constraints –  in some families only one parent is in the paid workforce because they can afford that, and prioritise certain things for their children; in other families, they might wish to operate that way but nevertheless be more engaged in the paid workforce than they’d prefer just because of extreme housing unaffordabilty.

There is a tendency is laud the rising labour force participation among the over 65s.  To some extent, I share that enthusiasm, because I favour an increase in the eligibility age for NZS (and because, to some extent, the increasing labour force participation rate is probably a reflection of improving health over time at, say, age 65).   But choices about state pension ages are somewhat arbitrary, and someone who favoured keeping the NZS age at 65 could quite readily suggest that the rising participation rate was a reflection of financial stresses (including, eg, declining rates of home ownership).

Where we might be on safer ground is in looking at things that deter people from participating in the labour force when they might otherwise be quite happy to.   Thus, I like our NZS scheme partly because it does not penalise people from staying in the workforce after 65 if they want to.   Neither, typically, do private pension or savings arrangements, but many other state schemes do.    But even when we look at things like these provisions, almost every one is value-laden.   Do we, for example, have any basis for evaluating whether in a two-parent family, one parent doing paid work fulltime and the other being at home is better than both parents working 20 hours a week?  In the latter case, the participation rate will be higher, but total hours worked might be much the same.

So when people do these comparisons across advanced countries, they often focus on the subgroup of prime-age (25 to 54) males.  Not because prime age males are any more important than anyone else, but because there has been a strong cultural expectation that these people would be in the labour force, and there haven’t been big social changes (such as those affecting the young, the old, and woman) that have very systematically affected those expectations in recent decades.    Here is how the participation rate for that group has changed since 1986 (when our HLFS began) for the OECD countries that have data for the entire period.

prime age males.png

New Zealand’s prime age male participation rate is still a little above that of the median OECD country, but over the past 30 years the fall has been just a little more than that for the median country.    The gap comes and goes, and in the last few years the participation rate for New Zealand prime age males has been rising relative to that in other OECD countries.

prime age males time

I’m still not sure one can make very much of cross-country comparisons of participation rates.   There are both demographic and cultural features  one needs to take account of.  Perhaps one is better to be looking at the various government interventions that affect the choices people make about participating, and evaluate the costs and benefits of their own merits  (individually and collectively).  Thus, as examples,

  • a high minimum wage relative to median wage is likely to price some people out of jobs, and discourage some from searching, lowering employment and participation rates (although this is likely to be a less important issue for prime age people than for young people starting out),
  • really expensive tertiary education might at some point discourage people from studying and see them go straight into the labour force,
  • generous working-age welfare systems will discourage some from working, and from actively seeking, work,
  • tight restrictions on lay-offs may make it harder for new people to be hired, discouraging some from searching,
  • a universal NZS system may, at the margin, discourage some prime age participation (since basic retirement income doesn’t depend on participation),
  • income-splitting for tax purposes (once proposed by Peter Dunne) might not much affect total hours worked, but might lead to more specialisation within households and lower measured labour force participation.

Some of these policies/proposals seem good and sensible to me, while others seem quite damaging.  But they are probably best assessed on their own merits, and overall comparisons of participation rates probably aren’t very enlightening unless your country is quite an outlier.   The only time our prime-age male participation rate has been more than one standard deviation from the OECD median was right back at the start of the series in the mid 1980s (at a time when, by conventional reckoning, our labour market was over-regulated, and our economy still rather inefficient).

To match the initial chart, here are the unemployment rates for the three countries over the full thirty years.

U rate since 1986

Over the full thirty years, the average unemployment rates for the three countries aren’t very much different, although Australia’s has averaged a bit higher than ours, suggesting their labour market institutions are less good at facilitating people’s desire to work than either ours or those of the US have been.

I don’t have a strong conclusion to draw, except to make the point that overall participation rates (in particular) really don’t tell one much, either across time or across countries.  Those in New Zealand have been picking up in the last few years, and that is probably (broadly speaking) a good thing –  a cyclical reflection of an improving state of the labour market.  That is a useful counter to those who want to argue that immigration systematically takes away jobs from natives.   But if one is wanting to make an overall assessment of how the economy is doing, productivity growth is typically a much more important and meaningful indicator.  And for five years now, we’ve had none.  For five decades now we’ve had less than almost any other advanced economy.


Wages and profits

There was a story buried deep in the Dominion-Post this morning that caught my eye.   The heading was “Profits up as wages stand still“,  and the article was prompted by the release yesterday by Statistics New Zealand of some summary results from the Annual Enterprise Survey.

In their media release yesterday, SNZ –  true to their apparent policy of accentuating the positive – was at pains to highlight the increase in profits over the 2015/16 year.   Overall, operating profits in the business sector had risen by 8.6 per cent –  rather faster than the increase in nominal GDP.

But it was this chart in the SNZ release that caught my eye

profits AES

Profits had certainly increased quite a bit  in 2015/16, but look at that top line.  Total profits in 2015/16 were no higher ($bn) than they had been in 2011/12, and yet over that period nominal GDP had increased by just over 17 per cent.  On this measure, profits as a share of GDP would have fallen quite a bit over those four years.

In the Dom-Post article,  the journalist had juxtaposed the increase in profits over the last year with the very weak increase in wages, at least according to the Quarterly Employment survey.  Lobby group representatives were quoted in a fairly predictable way.

Council of Trade Unions economist Bill Rosenberg said the statistics were more evidence that the share of income going to wages and salaries was falling.
“That indicates wages are not keeping up with what the economy’s income could actually afford.”
The share of income going to wages in New Zealand was low internationally, he said. “To see it fall further is very disturbing. It is an indication we are a low-wage economy.”


Kirk Hope, chief executive of BusinessNZ, said the increase in company profits meant jobs were more secure.
It was also positive for “the many thousands of New Zealanders”, including Kiwisaver investors, who now owned shares and who would be receiving increased dividends, he said.
“Wage growth is not the only responsibility companies must address.
“A proportion of company profits must be reinvested to safeguard the future existence of the company; without that investment there will be no ability to maintain or grow jobs.”
Business profits can jump around significantly from year to year, but even taking a longer-term view, Statistics NZ figures show they appear to be greatly outstripping pay rises.

And when the journalist did take a long-term perspective, he looked at profit increases since 2009, and compared them to wage increases since then, even though 2009 was the worst of the severe recession, and profits are typically much more cyclically variable than wages.

But, as I noted in a post the other day, if one uses the more-stable and better-constructed Labour Cost Index measures, it looks as though real wages in recent years have been materially outstripping the (non-existent) productivity growth.    Real wage inflation hasn’t been high in absolute terms, but it has been a lot faster than any gains in productivity.

real wages and productivity growth

In the wake of that post, I’d also gone back and dug out from the national accounts the data on the wages and salaries (“compensation of employees”) share of GDP.    The data go all the way back to 1972.


Broadly speaking, the national accounts suggest that the labour share of GDP has been increasing for almost 15 years now (the latest data are the year to March 2016).    Even from the peak of the last boom (year to March 2008) to now, the labour share of GDP has increased a bit further.

And it isn’t because more people are working more hours.   Here is a chart of hours worked per capita.

hours per capita

Total hours worked per capita are still slightly below the previous cyclical peak.   To the extent that the labour share of GDP has been increasing, it looks to have been a result of relatively good (relative to productivity) increases in wages.

As for profits, they are (more or less) the inverse of the labour share of income: they’ve been falling over the last 15 years.

Overall economic performance remains dismal, redeemed only by the strength of the terms of trade.  But relative to that disappointing performance –  weak productivity growth, growth skewed to the non-tradables sector –  labour (as a whole) doesn’t seem to have been missing out.

Land prices on the developable fringe of Auckland

It is now pretty well-recognised that local authority zoning decisions can materially affect land values, creating an artificial scarcity in developable land and driving up the price of such land relative to the price land would otherwise command for alternative uses.    The best-known empirical study on this effect around Auckland (and the metropolitan urban limit in particular) was by Grimes and Aitken, summarised as follows:

We capture the impact of the MUL boundary on land prices by separately allowing for land which is: (i) well inside the MUL boundary,(ii) just within the boundary, (iii) sitting astride the boundary, (iv) sitting just outside the boundary, (v) sitting just a little further beyond the boundary, and (vi) sitting well beyond the boundary. We find a boundary land value ratio of between 7.9 and 13.2 (i.e. land just inside the MUL is worth around ten times more per hectare than land just outside it)

In a well-functioning liberal market, one might normally suppose that developable land on the periphery of an urban area would trade for around the value of that land in its best alternative use – typically agriculture.   If it went for much more than the agricultural use value, most farmers would be well-advised to sell, and they would do so until the prices in the alternative uses were more or less equalised.   The median sale price of dairy land is around $50000 per hectare.

Everyone knows that that is not remotely how things are in our highly distorted market.  But sometimes concrete examples bring home the point more starkly.

The other day a reader who knows something about property sent me a copy of a real estate agent’s newsletter on recent land sales in Dairy Flat, an –  as yet –  largely undeveloped area between Albany and Whangaparoa/Orewa, which is apparently classified as a “future urban zone”.    As my reader noted, the area does not yet have wastewater connections, so in his words “it is ages from development”.     Here were the sales in  July.

Total price ($) Parcel size (hectares)
1950000 1.557
1478000 1
2450000 2.493
2976000 3.189
1250000 0.303
1950000 0.9809

The average price of this land was $1.266m per hectare.

In our subsequent exchange, my reader noted that the value of this land for agricultural purposes might not be much more than $30000 per hectare.  He went on to point out that not that long ago 3800 hectares of forest land –  a little further inland than Dairy Flat, but similar terrain and a similar distance from central Auckland – had sold for $1700 per hectare.    In other words, the preferentially-zoned Dairy Flat land was selling as 750 times the price of the forest land.

Perhaps $1.266m per hectare doesn’t sound too bad.   But this is the unimproved value of the land –  none of any relevant earthworks have been done, no suburban streeets been formed, no development levies incorporated.  Even the holding costs for the few years until development actually occurs won’t be trivial (at, say, a low end estimate of a 10 per cent per annum cost of capital).  By the time tiny suburban sections are being sold to potential residents, they will have to be very expensive to cover the costs of someone now paying $1.266m per hectare.

And most of this “value” is simply added by politicians and bureaucrats drawing lines on a map.  It is obscene, and unnecessary.  It continues to skew the game against the young and those on relatively low incomes and/or limited access to credit, in favour of those who already have, or who can lobby councils to draw the lines in suitably limited places.

And, although I don’t have a time series of this sort of data, it doesn’t speak of any confidence among those actually buying and selling land right now that the next government –  of whatever political stripe – will make much difference in sorting out the shameful disgrace that is the New Zealand housing and urban land market.    I’ve long been sceptical, but these people are putting real money on such a call.  Perhaps they’ll be wrong and lose the lot.   But what reason is there to believe that is likely, when not one of our major political figures will even suggest that much lower house and land prices would be a desirable outcome towards which their party would be working?

Disagreeing with Don Brash on monetary policy

The Labour Party is campaigning on a couple of changes to the Reserve Bank Act.  One would make a statutory committee, rather than the Governor alone, legally responsble for monetary policy decisions, and would require the minutes of that committee to be published fairly shortly after the relevant meeting.   I don’t think that change goes far enough – and it doesn’t deal at all with the extensive (and much less constrained) decisionmaking powers the Bank has around financial institution regulation –  but if not everyone actively favours change, there aren’t now that many defenders of the (single decisionmaker, secretive) status quo.  Even Steven Joyce got The Treasury to commission some advice on possible changes, although his officials now refuse to release that report.

There is more dispute around the other limb of Labour’s proposed changes, in which they proposed to amend the statutory goal of monetary policy from “stability in the general level of prices” only “to also include a commitment to full employment”.

Earlier this week, so NBR reports, Grant Robertson and former longserving Governor Don Brash came head to head at BusinessNZ election conference.   Don thinks the proposed change is wrong and was reported as pointing to two reviews undertaken during the term of the previous Labour government, both of which saw no reason to change the statutory objective for monetary policy.

My initial reaction to the proposed Labour change was also sceptical, and I initially went as far as to describe it as “virtue signalling”.  I was discussant at an Victoria University event a few months ago where Robertson launched his policy, and this is how I summarised my view in a post written the following day.

I was (and am) much more sceptical, and nothing that was said in response to questions really clarified things much.    I get that full employment is an historical aspiration of the labour movement, and one that the Labour Party wants to make quite a lot of this year.  In many respects I applaud that.  I’m often surprised by how little outrage there is that one in 20 of our labour force, ready to start work straight away, is unemployed.  That is about two years per person over a 45 year working life.  Two years……     How many readers of this blog envisage anything like that for themselves or their kids?

But still the question is one of what the role of monetary policy is in all this, over and above what is already implied by inflation targeting (ie when core inflation is persistently  below target then even on its own current terms monetary policy hasn’t been well run, and a looser monetary policy would have brought the unemployment rate closer to the NAIRU (probably now not much above 4 per cent)).

I noted that I’m sceptical that the wording of section 8 of the RB Act is much to blame.  After all, for several years prior to the recession, our unemployment rate was not just one of the lowest in the OECD, it was also below any NAIRU estimates.  And when I checked this morning, I found that our unemployment rate this century has averaged lower than those of Australia, Canada, the US and the UK, and our legislation hasn’t changed in that times.  Robertson often cites Australia and the US.

The last few years haven’t been so good relatively speaking.  But if the legislation hasn’t changed and the (relative) outcomes have, that suggests it is the people in the institution who made a mistake –  they used the wrong mental model and were slow to recognise their error and respond to it.  Getting the right people, and a well-functioning organisation, is probably more important than tweaking section 8.

I stand by most of those individual comments.  But as I thought about things further, I’ve come to conclude that the direction Labour is wanting to go is the right one (although details matter, and there are few/no details).   If anything, one could mount an argument that defence of the current statutory formulation risks being “virtue signalling”.

Don Brash relies in part on the two enquiries undertaken in the term of the previous Labour government.  The second, conducted by Parliament’s Finance and Expenditure Committee, can largely be discounted.  It was set up in 2007 at time when there was quite a bit of caucus (and ministerial) discontent with the Reserve Bank –  the OCR had been raised again, and the exchange rate was again strong.   A lot of work went into the inquiry, and it reported in 2008, just weeks before the 2008 election.  But however much grumpiness there had been, a government-dominated committee was never going to come out a few weeks before an election their party looked like losing arguing that a key aspect of macroeconomic policy had been done badly throughout their term in office.

The earlier inquiry, conducted by Swedish economist, Lars Svensson at the request of the incoming Minister of Finance in 2000/01 would normally be a more potent argument.    Svensson was an academic expert in matters around inflation targeting and he was content to recommend retaining the statutory goal for monetary policy as it was.

So what has changed?   Robertson is quoted in the NBR article as saying that monetary policy has “enormously changed” since the international crises of 2008/09.  Here I simply disagree with him, and find myself (I think) strongly agreeing with the outgoing Governor of the Reserve Bank, who  notes that for all the talk it is remarkable how little change there has been in monetary policy anywhere.  Sure, interest rates are a lot lower, and various major central banks resorted to unconventional quantity-based measures to supplement their toolkit.  But there is no sign of any material change in any of those countries in how the goals of monetary policy have been specified (whether in statute or in more-operational documents).  As the Governor often notes, no one has abandoned inflation targeting, and no one has lowered (or raised) their inflation target.

Of course, if there was once in some circles a degree of hubris around quite how much good stuff central banks can deliver, much of that has now dissipated.  And the use of unconventional tools has raised questions about accountability, given that some of those tools can verge quite close to fiscal policy, for which legislatures are typically responsible.

But perhaps two relevant things have changed.  The first is Lars Svensson, who –  having had several years experience as a senior policymaker – now quite openly argues that flexible inflation targeting should involve a clear and explicit specification of an inflation target and  the identification of a sustainable long-run unemployment rate, with explicit weights assigned to deviations from these two variables.      I wrote at some length about Svensson’s view of these things in a post in April.   As I noted then

I don’t know specifically what Svensson would make of the current debate in New Zealand, or of what the Labour Party (at quite a high level of generality) is proposing.    What we do know is that Labour is proposing nothing nearly as specific or formal as Svensson argues for: there would be no numerical unemployment target or an official external assessment of the NAIRU (or LSRU).  My impression would be that his reaction would be along the lines of “well, of course the unemployment rate –  and short to medium term deviations from the long-run level, determined by non-monetary factors – should be a key consideration for monetary policymakers; in fact it is more or less intrinsic to what flexible inflation targeting is”.   He might suggest there are already elements of that in the PTA, but that making it a little more high profile, with an explicit reference to unemployment, might be helpful.

At the time, I suggested they might find it useful to get in touch with Svensson, who retains an interest in New Zealand.    Should they form the government after the election next month, he would be someone that they would be wise to consult, both in making their proposed legislative change, and in articulating a social-democratic vision of what should be looked for from a central bank.

The other thing that has changed over the last 15 years or so is our own central bank.   It is striking how little public attention they ever pay to unemployment, even though it is the most tangible measure of excess capacity – and one directly involving people’s lives and livelihoods.  But perhaps more striking still is the way in which they have conducted monetary policy in a way that has left the unemployment rate above any reasonable estimates of the NAIRU for eight years.    That would have seemed staggering to us when we were looking at getting inflation under control in the late 1980s –  when we knew that temporarily higher unemployment was a price of getting inflation down.  It is pretty inexcusable in today’s climate –  which doesn’t stop people making excuses.

And so I come back to the point I made in the remarks quoted above.   Getting the right person –  and people –  into the senior positions responsible for the conduct of monetary policy probably matters more than changing the statutory objective.  At the moment, an incoming Minister of Finance has no way of putting his or her preferred types of people in those roles –  all that power rests with the Board (the company directors and the like appointed by the outgoing government, with almost no accountability).  That needs to be tackled directly, and quickly.

But the way the statutory goal is expressed should affect expectations on the new Governor (and any committee that is established as part of governance reforms).    Over recent years, fear of booms seems to have driven the Governor (and his staff)  – with no statutory mandate at all –  and there has been no pressure on them to focus on delivering low and sustainable rates of unemployment.    Changing the Act  –  in the generalised way Labour seems to be talking of  – and not changing the sort of people making the decisions won’t have much impact at all.  But changing the Act in this area, can be one part of an array of changes that lead the Reserve Bank in future to put much more emphasis on unemployment, in public and in private, in the way that many other advanced country central banks do.  Policy is, after all, supposed to be about people.

What array of changes should any new government make?

  • a move to a decisionmaking committee, appointed by the Minister, and subject to parliamentary hearings before taking up the appointment,
  • making a low sustainable rate of unemployment (“full employment” if you must) a part of the statutory goal of monetary policy,
  • require the Reserve Bank to publish estimates of the NAIRU and, in the Monetary Policy Statement,  require them to explain reasons for any material deviations from those NAIRU estimates,
  • require the timely publication of minutes of the decisionmaking committee and (with a longer lag) of the background analysis papers provided to the committee, and
  • in the immediate future, change the Act to allow the Minister and Cabinet to appoint the new Governor directly (this is the normal way such appointments are made in other countries).  Getting the right person to lead these reforms is vital and there is no reason to think people like the current Board would deliver that person.

And just briefly on the substantive issue: the reason we have active discretionary monetary policy is because people have judged, over decades, that, were we not to do so, output and employment would be much more variable, and in particular recessions –  and periods of high unemployment –  would be more more savage and sustained than they need to be.   That is not a novel proposition now, and it isn’t even a particular controversial one (although some free bankers will point out that, say, the worst US recessions have been since the central bank was set up) –  it is a standard insight of modern macroeconomics.  Greeece is a particularly nasty example of the alternative approach.   That’s why I’m uneasy about those defending a single price stability goal for monetary policy: it may well be the medium-term constraint on what else monetary policy can do, it is one of desired outcomes we want to preserve (I say preserve because sustained inflation is a phenomenon of the central banking era, whereas longer-term price stability was a feature of earlier centuries), but it isn’t the main reason why we have active discretionary central banks.  We have such institutions primarily because we care about minimising the bad times –  sustained periods of excess capacity and high unemployment.  We aren’t –  or shouldn’t be – averse to booms (except to the extent they portend busts) but we should be, and mostly are, very averse to significant deviations from “full employment”.  Keeping unemployment as low as the other labour market institutions (welfare systems, minimum wages etc) allow could reasonably be seen as the primary goal of monetary policy.     Rising inflation would then be an indicator that the central bank had overdone things, and thus price stability represents a useful constraint or check on over-optimism about how low the unemployment rate can be got at any particular point in time.   At present however, defenders of the current specification of the goal can almost come across as if it is a point of virtue not to care, let alone to mention, about those who are unemployed.

Things were a little different in 1989 when Parliament was first debating the Reserve Bank legislation. Arguably it made a lot of sense then to put in a single goal of price stability –  because having lost sight of the constraint (price stability) in earlier decades, it was important to establish confidence that inflation would in future be taken very seriously.    That isn’t the main message we, the markets, or the Reserve Bank need to hear after years of below-target inflation, and even more years of above-NAIRU unemployment rates.

So although I have a great deal of respect for Don Brash, and these days count him as a friend, on this occasion I think he’s wrong and Grant Robertson is much closer to right.

Wage inflation: surprisingly high

There is plenty of talk about weak wage inflation, here and abroad.

Mostly, I have tried not to put too much weight on New Zealand wages data.  I’m not always consistent, and higher nominal wage inflation is probably one of things we should normally be expecting to see if core inflation was really heading back to 2 per cent.    But, one can’t really bang on about how there has been no labour productivity growth (reported by SNZ) for almost five years now, and expect much in the way of wage inflation.   And I’m not one of those who thinks that immigration surprises tend to dampen wages (relative to GDP per capita, or productivity, that is): they may do so in certain specific occupational areas where there is a particular large presence of migrants, but generally –  as New Zealand economists have believed for decades –  immigration surprises add more to demand (including demand for labour) than they do to supply, at least over the first few years following a migration influx.    With the unemployment rate still somewhat above most estimates of the NAIRU, one probably shouldn’t really expect much acceleration of wage inflation, but there isn’t any obvious reason why workers should be doing particularly poorly relative to the rest of the economy.   Overall, of course, the economy isn’t doing that well; weak per capita GDP growth, and no productivity growth.

But listening to Steven Joyce talking about wages on Morning Report this morning  prompted me to dig out and play with some relevant data.

My preferred measure of wage inflation is taken from the Labour Cost Index.  The LCI series that get lots of coverage purport to adjust for changes in productivity etc.  I don’t have a great deal of confidence in the adjustment (mostly because it is a bit of a black box to outsiders), and so I prefer to use the Analytical Unadjusted Index of private sector wages (ie the data before the productivity adjustments).

analy unadj wages

It is a relatively smooth series.  Wage inflation picked up a lot during the 2000s boom, slumped in the recession and after an initial recovery seems to have been tailing off somewhat since then.

But this is a measure of nominal wages.  And inflation is a lot lower than it was.  Here is the same series adjusted for the Reserve Bank’s sectoral core factor model measure of inflation.

real wages

It is a noisier series (suggesting that perhaps parties bargain in nominal terms, rather than having reals in mind), although it is pretty unmistakeable that the average rate of real wage increases has been lower in recent years than in most of the earlier period.   I could have done that chart with some smoothed moving average of CPI inflation but (a) lots of the short-term fluctuations in the CPI aren’t things that should affect wages (eg changes in ACC levies or tobacco taxes) and (b) doing so would actually only make the gap shown in the next chart larger and more striking.

Over time, one might expect real wage inflation to roughly equal the rate of growth in labour productivity.   Productivity growth is, by and large, the way living standards improve, and for most people real wages rates are an important element in their potential living standards.

One wouldn’t expect those relationships to hold in the very short-term. There are measurement problems in each of the series (wages, inflation, and productivity).  There is also a great of short-term volat5ility in the published series that are used to generate the productivity estimates.   And if labour is particularly scarce, or abundant, bargaining outcomes can easily differ for a time from what a productivity growth benchmark might suggest.  Finally, a sustained lift in the terms of trade can also lead to real wages rising faster than real productivity measures.

In this chart I’ve shown real wages (same measure as above) and smoothed growth in labour productivity (real GDP per hour worked).  I’ve taken the quarterly observations for the last two years, compared them to the quarterly observations for the previous two years (and so on) and then converted the result back into an annualised growth rate.  There are plenty of other ways of smoothing the series, but none is going to change the fact that we have had no (reported) productivity growth for a number of years now.   My particular measure provides a reasonably smooth series for productivity growth, consistent with my prior that to the extent inflation and productivity affect wage bargaining they are likely to do so in a smoothed or trend sense.   Anyway, here is the resulting chart.

real wages and productivity growth

It hasn’t been a particularly close relationship over the (relatively short) history of the data.  On average, real wage inflation (on this measure, although it is also true using a smoothed CPI measure of inflation) has grown faster than measured productivity over much of the period, perhaps consistent with the step up in the terms of trade from around 2004. (The remaining small upward biases in the CPI work in the other direction, understating real wage growth).

But the gap between the two lines at the end of the period is strikingly large and seems to have become quite persistent.  Real wage inflation –  although quite a bit slower than it was – still appears to be running much faster than productivity growth in recent years looks able to have supported.

If so, that represents a real exchange rate appreciation, representing a deterioration in the competitiveness of many of our producers.  Looking ahead, and since we can’t count on the terms of trade appreciating for ever (for all their ups and downs, over 100 years they’ve been basically flat)  we need to see some material acceleration in productivity growth or we are likely to see real wage growth falling away further still.   For all the talk of moderate wage inflation in countries such as the US, not many countries (and certainly not the US and Australia) have had no productivity growth at all in the last five years.  The puzzle in other countries may be why real wage inflation is so low, but here the focus should probably be on why it is still so high.


Capital gains tax: quite a few reasons for scepticism

Going through some old papers to refresh my memory on capital gains tax (CGT) debates, I found reference to a note I’d written back in 2011 headed “A Capital Gains Tax for New Zealand: Ten reasons to be sceptical”.  Unfortunately, I couldn’t find the note itself, so you won’t get all 10 reasons today.    But here are some of the reasons why I’m sceptical of the sort of real world CGTs that could follow from this year’s election.  Mostly, repeated calls for CGTs – whether from political parties, or from bodies like the IMF and OECD –  seem to be about some misplaced rhetorical sense of “fairness” or are cover for a failure to confront and deal directly with the real problems in the regulation of the housing and urban land markets.

Anyway, here are some of the points I make:

  • in a well-functioning efficient market, there are typically no real (ie inflation adjusted) expected capital gains.    An individual participant might expect an asset price to rise for some reason, but that participant will be balanced by others expecting it to fall.  If it were not so then, typically, the price would already have adjusted.  In well-functioning markets, there aren’t free lunches.    It also means that, on average, capital losses will be pretty common too, and thus a tax system that treated capital gains and losses symmetrically wouldn’t raise much money on average over time.   A CGT is no magic money tree.   And there is no strong efficiency argument for taxing windfalls.
  • if you thought, for some reason, that people were inefficiently reluctant to take risk, there might be some argument for a properly symmetrical CGT.  In such a system, the government would take, say, a third of your gains, but would also remit a third of your losses (the overall risks being pooled by the state).    The variance of an individual’s private after-tax returns would be reduced, and they might be more willing to take risk.   But, in fact, no CGT system I’m aware of is properly symmetrical –  there are typically tough restrictions on claiming refunds in respect of capital losses (one might only be able to do so by offsetting them against future gains).  There are some reasonable base-protection arguments for these restrictions, but they undermine the case for a CGT itself.
  • All real world CGTs are based on realised gains (and losses to an extent).   That makes it not a pure CGT, but in significant part a turnover tax –  if you never trade, you never pay (“never” isn’t literal, but tax deferred for decades discounts to a very small present value).    And that creates lock-in problems, where people are very reluctant to sell, even if their circumstances change or if a new potential owner could make much more of the asset, for fear of crystallising a CGT liability.  In other words, introducing a CGT introduces a new inefficiency to asset markets, making it less likely that over time assets will be owned by the parties best able to utilise them.
  • Basing a CGT on realised gains will also, over time, bias the ownership of assets subject to CGT to those most able to avoid realising the gains.  A long-lived pension fund, or even a very wealthy family, will typically be better able to  count on not having to sell than, say, an individual starting out with one or two rental properties, or some other small business, where changed circumstances (eg a recesssion or a divorce) might compel early liquidation.  Large funds are also typically better able to take advantage of loss-offsetting provisions.  The democratisation of finance and asset holding it certainly isn’t.
  • CGTs in many countries exclude “the family home” altogether.  In other countries, they provide “rollover relief”, enabling any tax liability to be deferred.  Most advocates of a CGT here seem to favour the exclusion of the family home, even though unleveraged owners of family homes already have the most favourable tax treatment in our system.  Again, a CGT applied to investment properties but not owner-occupied ones would simply trade one (possible) distortion for another.
  • In practice, most of the arguments made for a CGT in New Zealand have to do with the housing market.   But, on the one hand, all major (and minor?) parties claim that they have the fix for the housing market (various combinations of RMA reform, infrastructure reforms, changes to immigration, restrictions on foreign ownership, state building programmes or whatever).  If they are right, there is no reason to expect significant systematic real capital gains in houses.  If anything, real house prices should be falling –  a long way, for a long time.    Of course, prices in some localities might still rise at some point, if unexpected new opportunities appear.  But “unexpected” is the operative word.   Enthusiasm for a CGT, at least at a political level, seems to involve a concession that the parties don’t believe, or aren’t really serious about their housing reform policies.
  • Oh, and no one I’m aware of anywhere argues that a realisation-based CGT applied to (a minority of) housing has made any very material difference to the level of house prices, or indeed to cycles in house prices.
  • In general, capital gains taxes amount to double-taxation.    Think of a business or a farm.  If the owner makes a success of the business, or product selling prices improve, expected profits will increase.  If and when those profits are achieved, they would, in the normal course of affairs, be subject to income tax.  The value of the business is the discounted value of the expected future profits.  It will rise when the expected profits rise.  Tax that gain and you will be taxing twice the same increase in profits –  only with a CGT you tax it before it has even happened.   Of course, at least in principle, there is a double deduction for losses, but as noted above utilising losses (whether of income, or capital) is a lot more difficult.    If you think that New Zealand has had less business investment than might, in some sense, have been desirable,  you might want to be cautious about applauding a new tax that would fall heavily on those who took business risks and succeeded.
  • Perhaps double taxation of expected business profits doesn’t bother you.  But trying reasoning by analogy with wages.   If the market value of your particular skills has gone up, your wages would be expected to rise.  When they do you will pay taxes on those higher wages.  But by the logic of a CGT, we should capitalise the value of your expected future labour income and tax your on both that “capital gain” and on the later actual earnings.  Fortunately, we abolished slavery long ago, but in principle the two cases aren’t much different: if there is a case for a CGT on the value of a business, it isn’t obvious why one shouldn’t have one on the value of a person’s human capital.
  • (I should note here, for the purists, that there are other concepts of double-taxation often referred to in tax literature, none of which invalidate the point I’m making here.)
  • Real world CGTs also tend to complicate fiscal management?  Why?   Because CGT revenue tends to peak when asset markets and the economy are doing well, and when other government revenue sources are performing well.  CGT revenue doesn’t increase a little as the economy improves and asset markets increase, it increases multiplicatively.  And then dries up almost completely.  Think of a simple example in which real asset prices had been increasing at 1 per cent per annum, and then some shock boost asset prices by 10 per cent.  CGT revenue might easily rise by 100 per cent in that year (setting aside issues around the timing of realisations).  And then in a period of falling asset prices there will be almost no CGT revenue at all.   Strongly pro-cyclical revenue sources create serious fiscal management problems, because in the good times they create a pot of money that invites politicians to (compete to) spend it.  If asset booms run for several years, politicians start to treat the revenue gains as permanent, and increase spending accordingly. And if/when asset markets correct –  often associated with recession and downturns in other revenue sources-  the drying up of CGT revenue increases the pressure on the budget in already tough times.     It is easy to talk about ringfencing such revenue (mentally, if not legally) but such devices rarely seem to work.

None of this means that I think there is no case for changes in elements of our tax system as they affect housing.  The ability for business borrowers to deduct the full amount of nominal interest, even though a significant portion of that interest is simply compensation for inflation (rather than a real cost), is a systematic bias.  It doesn’t really benefit new buyers of investment properties (the benefit is, in principle, already priced into the market) but it is a systematic distortion for which there is no good economic justification   Inflation-indexing key elements of our tax system is highly desirable –  at least if we can’t prudently lower the medium-term inflation target –  and might be a good topic for a tax working group.  In the process, it would also ease the tax burden on people reliant on fixed interest earnings (much of which is also just inflation compensation, not a real income).

Of course, at the same time it would be desirable to look again at a couple of systematic distortions that work against owners of investment properties.  Houses are normal goods and (physically) depreciate.  And yet depreciation is no longer deductible.  Perhaps there was a half-defensible case for that when prices were rising seemingly inexorably –  but even then most of the increase was in land value, not in value of the structures on the land –  but there is no justification if land reform and (eg) new state building is going to fix the housing market.    Similarly, when the PIE system was introduced a decade or so ago, it gave systematic tax advantages to entities with 20 or more unrelated investors.  Most New Zealand rental properties historically haven’t been held in such entities.  There is no good economic justification for this distinction, which in practice both puts residential investment at a relative tax disadvantage as a saving option, and creates a bias towards institutional vehicles for holding such assets.  Institutional vehicles have their own fundamental advantages –  greater opportunities for diversification and liquidity –  but it isn’t obvious why the tax system should be skewing people towards such vehicles rather than self–managed options.  As noted above, any CGT will only reinforce that bias.  Funds managers, and associated lawyers and accountants, would welcome that. It isn’t obvious why New Zealand savers should do so.

I see that there are more than 10 bullet points in the list above.  I’m not sure it covers all the issues I raised in my paper a few years ago, but it is enough to be going on with.

And in all this in a country where we systematically over-tax capital income already.  I commend to readers a comment on yesterday’s tax post by Andrew Coleman, of Otago University (and formerly Treasury).  As Andrew noted:

Somehow, New Zealand’s policy advising community decided it would restrict most of its attention to the ways income tax could be perfected rather than question whether income taxes (which are particularly distortionary when applied to capital incomes) should be replaced by other taxes. It is almost as if we have the Stockholm Tax Syndrome – fallen in love with a system that abuses us.

A broad-based capital gains tax would just reinforce that problem.


Treasury not convinced about the economic strategy?

Or so it would seem from looking at the forecast tables accompanying today’s PREFU.

Recall that the government has long had a goal of materially increasing the share of New Zealand’s GDP accounted for by exports (with, presumably, a more or less matching increase in imports).  As I’ve highlighted on various occasions –  yesterday most recently – if anything the actual export share of GDP has been shrinking.

Here is the share of exports in GDP, showing actuals for the last decade or so, and Treasury’s projections for the next few years.

x to gdp

By the end of that forecast period, there will only be four more years until the goal of a much-increased export share of GDP was to be met.  On these numbers, exports as a share of GDP would by then be at their lowest since 1989, 32 years earlier.  So much for a more open globalising economy.

(The government actually specifies their target as the ratio of real exports to real GDP, while this chart is nominal exports to nominal GDP.    Statisticians generally advise against using the real formulation.  But on this occasion, it doesn’t make much difference either way.    Over the five forecast years, the volume of exports is forecast to rise by 10.8 per cent, and real GDP is forecast to rise by 15.6 per cent.   Whichever way you look at it, The Treasury expects the export share of the economy to carry on shrinking over the next few years.)

In many respects that isn’t very surprising.  Treasury expects no fall in the exchange rate at all over the period, and they expect rapid increases in the OCR from around the end of next year.  And they expect continued rapid population growth.

It is a non-tradables skewed economy, and while there is nothing intrinsically wrong with non-tradables, it isn’t usually a successful path for countries seeking to achieve higher productivity and sustained national prosperity.    (Although Treasury does forecast that six years of zero productivity growth will finally come to an end, and we’ll have respectable productivity growth from 2019 onwards.  What this is based on, who knows.  We can hope I suppose.)