Month: December 2017

A few HYEFU thoughts

Michael Reddell Fiscal policy, New Zealand economic performance

At the time the PREFU was published in August, I ran a short post illustrating that not even Treasury seemed to believe there was any prospect of increasing the export share of GDP in the next few years.  Their projections were that, on the then-government’s policies, the decline in the export share would continue unabated over the years to 2021.

The next set of Treasury forecasts were published in the HYEFU yesterday.  We have a new government  –  even a Minister for Export Growth –  so I was curious to see what the updated forecasts looked like.

This chart captures the actual export share of GDP, now through to the June 2017 year, and shows separately the PREFU and HYEFU forecasts.

exports hyefu

There is a bit of a lift between PREFU and HYEFU, but interestingly the downward trend is still in place in the last set of numbers.

What has changed?  Mostly the exchange rate.   Here are the assumptions/projections for the exchange rate in the two sets of forecasts.

TWI hyefu

Over the full forecast horizon, the exchange rate is now assumed to be around 5.5 per cent lower than was previously assumed –  more or less just treating the fall in the last few months as if it will be sustained.   Some of that fall will flow through into the domestic price level, but it is still a real exchange rate fall of around 5 per cent.    But even though that fall is assumed to be sustained for several years –  4.5 years to the end of the forecast horizon –  there is no sign of the decline in New Zealand’s export share of GDP being reversed.  Presumably it would need (policy changes that brought about) a much larger sustained decline to really begin to make a substantial difference.

I know some commentators think the exchange rate could soon fall quite a bit further –  after all if the US keeps on raising interest rates, they’ll soon have a Fed funds target rate equalling our OCR.   But Treasury doesn’t think that is likely: they still have large increases in the OCR (and 90 day rates) forecast for the next few years, far larger (and sooner) than anything in the Reserve Bank’s numbers.   Frankly that still seems unlikely, but these are the projections/advice of the government’s leading economic advisory agency.  On their numbers, the prospects for the tradables sector don’t look good.

There are other sobering aspects in the numbers.   Take this chart for example.

output gap hyefu

The solid line is the Treasury estimate –  on their numbers the output gap is still estimated to be negative, bringing to 10 years the period in which our leading economic advisers think the economy has been running below capacity.   When things like that happen –  and they shouldn’t –  it is usually an adverse reflection on macroeconomic management.  It also isn’t very clear why things should suddenly come right next year –  with a forecast of the biggest change in the output gap in the last decade, suddenly moving the economy into an excess demand situation.  We’ll see.

And there are also some heroic forecasts for productivity growth.  Recall that we’ve had no productivity growth at all for five years now.  Treasury don’t expect any this year either.  But then suddenly things come right, and over the subsequent four years growth in real GDP per hour worked is expected to exceed 1.5 per cent per annum.  On quite what basis –  other than wishful hope –  it isn’t really clear.  Apart from anything else, the optimistic assumption probably flatters the fiscal numbers.

But in some ways the biggest mystery in the entire document is the bottom line fiscal numbers themselves. As I noted before the election, I found it hard to conceive that people voting for a change of governmnet, for a left-wing government, were really voting for government spending as a share of GDP to keep on falling.  On the government’s – perhaps over-optimistic numbers, core Crown expenses in the last forecast year is expected to be smaller, as a share of GDP, than in any year of the previous National-led government.    To be sure, lower government spending will keep some pressure off the real exchange rate, but there are other ways to deliver that outcome.   And it is curious to think that the governing parties campaigned on the existence of all sorts of deficits in the provision of public services, and yet their fiscal numbers keep net debt (including the assets in the NZSF) dropping away to almost nothing.

net debt

I doubt it will happen: the economy is likely to be weaker (and it would be unprecedented if we got to 2022 without a recession) and spending pressures are likely to be greater than allowed for in these numbers, but these are plans the government is articulating and defending.  I’m not entirely sure why.

But that is something to speculate on next year.  This is the last post from me for the year.  I imagine I’ll have found interesting stuff to write about  –  and the urge to do so –  by the second week of January or even earlier, but it might depend on whether the glorious Wellington summer continues.

 

Central bank e-cash

Michael Reddell Australia, e-cash, zero lower bound

After my post last week, prompted by the Reserve Bank’s recent statement that

Work is currently under-way to assess the future demand for New Zealand fiat currency and to consider whether it would be feasible for the Reserve Bank to replace the physical currency that currently circulates with a digital alternative.

I exchanged notes with a few readers with some in-depth thoughts on the issue, and found my way to some other relevant material including the recent first report of the Swedish central bank’s e-krona project.    And I noticed that Phil Lowe, Governor of the Reserve Bank of Australia, was giving a speech on exactly that topic – “An eAUD?” –  yesterday.  I gather that among advanced country central banks this is now treated as quite a high priority issue.    But it is also interesting that –  contrary to the Reserve Bank of New Zealand comment about their work –  both the RBA and the Riksbank are only talking about the possibility of electronic retail cash as a a complement to physical currency, rather than a replacement for it (and Sweden already has one of the very lowest currency to GDP ratios of any country anywhere).

Lowe’s speech was interesting, but also unsatisfying and unconvincing in a number of important areas.    As a New Zealand reader –  from a country with many of the same banks (and presumably banking technology options) –  I was struck by the contrast in what has been happening to currency to GDP ratios in the two countries.   Lowe illustrates that the share of transactions being effected by cash is also dropping sharply in Australia.  But here is the New Zealand currency to GDP chart I ran last week

notes and coin

And here is comparable Australian chart from Lowe’s speech.

Aus currency to GDP
45 years ago, the levels of the two series were very similar.  Since then, the trends have been very different and now there are many more physical AUDs in circulation (relative to GDP) than NZDs.   But there is nothing in Lowe’s speech about just why so much physical currency continues to be held in Australia –  far more than any plausible transactions demands (supported by evidence from payments practices data) would support.    Ken Rogoff suggested, in a US context, that the bulk must be held to facilitate illegal activities, or tax evasion in respect of otherwise legal activities.   Perhaps Lowe felt it wasn’t his place to venture far into territory around lost tax revenue, crime etc, but it was still a surprise to see no mention at all, when the RBA seems largely content with currency physical currency arrangements.

I was also rather surprised to see no serious engagement with the issues around the near-zero lower bound on nominal interest rates, which arises because of the option to convert unlimited amounts of bank deposits etc into zero-interest physical currency, an option that would be likely to be exercised on a large scale if official interest rates were dropped much below, say, -0.75 per cent.  Like New Zealand, Australia hasn’t yet approached the near-zero bound.  Neither had the US, Japan, Switzerland, Sweden, or the euro-area, until they did.   But Australia’s official interest rate is now only 1.5 per cent.  Perhaps it will be raised a bit before the next serious recession hits, but no prudent central banker could be discounting the possibility that even the RBA will hit the effective floor –  and limits of conventional monetary policy –  when that next recession comes.    Dealing effectively with that floor  –  by significantly winding back access to physical cash –  should be one important consideration when central banks are considering e-cash options.  But Lowe doesn’t even mention the issue, and while the limits of monetary policy might not have been of much interest to his immediate listeners (the Australian Payment Summit), interest in his speech –  and the issue –  goes much wider than the immediate audience.   (Strangely, in the Riksbank’s work they also talk in terms of zero-interest e-cash options –  albeit with the flexibility to change that at a later date –  and thus don’t really grapple either with the near-zero bound problem.)

To me, the heart of Lowe’s speech was his discussion of the possibility of the Reserve Bank of Australia issuing one or other of two types of eAUDs.

  • An electronic form of banknotes could coexist with the electronic payment systems operated by the banks, although the case for this new form of money is not yet established. If an electronic form of Australian dollar banknotes was to become a commonly used payment method, it would probably best be issued by the RBA and distributed by financial institutions, just as physical banknotes are today.

  • Another possibility that is sometimes suggested for encouraging the shift to electronic payments would be for the RBA to offer every Australian an exchange settlement account with easy, low-cost payments functionality. To be clear, we see no case for doing this.

I’m not sure I have a particularly good sense of what the first option involves, but here is how Lowe describes the possibility

The technologies for doing this on an economy-wide scale are still developing. It is possible that it could be achieved through a distributed ledger, although there are other possibilities as well. The issuing authority could issue electronic currency in the form of files or ‘tokens’. These tokens could be stored in digital wallets, provided by financial institutions and others. These tokens could then be used for payments in a similar way that physical banknotes are used today.

But he doesn’t seem keen, and so I’m going to focus my discussion in the rest of this post on the second of his options.   The issues and risks are pretty similar for both options, and I favour (provisionally) something like the second option.

At present, central banks offer exchange settlement accounts to facilitate the interbank settlement of transactions (the RBNZ policy is here –  something they must be reviewing, as there was an RFP for work in this area a few months ago).   These accounts facilitate payments, but they also allow entities given access to such accounts to hold electronic claims on the Reserve Bank (that are free of credit risk).  Central bank physical banknotes are also credit risk-free claims on the central bank.   But one set of claims is newer technology, regularly updated, enabling banks to both easily make payments and store value, while the other is a declining technology.

Here is how Lowe describes the option in this area

Another possible change that some have suggested would encourage the shift to electronic payments would be for the central bank to issue every person a bank account – for each Australian to have their own exchange settlement account with the RBA. In addition to serving as deposit accounts, these accounts could be used for low-cost electronic payments, in a similar way that third-party payment providers currently use accounts at the RBA to make payments between themselves. Some advocates of this model also suggest that the central bank could pay interest on these accounts or even charge interest if the policy rate was negative.

I’m not sure anyone argues for this approach to “encourage the shift to electronic payments”, but rather to reflect the world we now find ourselves in, in which electronic payments media and (records of) stores of value overwhelmingly dominate.   If favoured banks and financial institutions are allowed access to risk-free overnigh electronic balances, why shouldn’t ordinary Australians (or New Zealanders) have such access?  After all, at the absurd extreme, central banks could still insist that to the extent banks wanted to deal with them, they did so in physical banknotes.  It would be wildly inefficient to do so, but it could be done.  But if it doesn’t make sense to restrict such “big end of town” transactions to physical currency, why does it make sense to restrict ordinary citizens’ access to central bank outside money?

But the RBA is firmly opposed to change of this sort.

On this issue, we have reached a conclusion, rather than just develop a hypothesis. The conclusion is that we do not see it as in the public interest to go down this route.

Why?   Lowe raises three concerns, of which two are substantive and one is mostly rhetorical.

If we did go down this route, the RBA would find itself in direct competition with the private banking sector, both in terms of deposits and payment services. In doing so, the nature of commercial banking as we know it today would be reshaped. The RBA could find itself not just as the nation’s central bank, but as a type of large commercial bank as well.

In times of stress, it is highly likely that people might want to run from what funds they still hold in commercial bank accounts to their account at the RBA. This would make the remaining private banking system prone to runs.

On both counts, I think he is largely wrong, and that any issues are quite readily manageable.

It isn’t at all clear why (many of) the public would want to use an RBA (or RBNZ) exchange settlement account for routine transactions services.  Revealed preference suggests that people are mostly very happy to run the modest credit risk associated with using private bank deposit and payment services.  Almost all of us now use bank deposits for most of our transactions –  even when physical cash is a perfectly feasible alternative (eg there is no additional cost in time or anything else to, say, taking out $400 from an ATM once a week rather than say $200).  And in the handful of places where private banknotes still circulate (eg Scotland) there doesn’t seem to be any unease about taking them, or transacting with them.

In addition, banks can offer bundled products –  cheaper fees for example where you have your mortgage, or term deposits, with the same bank as your transaction account.  No one proposes that central banks will be offering mortgages, term deposits or any of the rest of the gamut of products the typical commercial bank makes available.

I’m not aware that anyone is suggesting central banks should set out to out-compete banks.  The argument for making central bank e-cash readily available is about a fallback –  a residual option, much as cash is now for many purposes.   Central banks almost inevitably would lag behind commercial banks in their technology anyway, which wouldn’t make a central bank transactions account product particularly attractive.   And it could easily be kept that way –  don’t offer provision for regular direct debits etc, don’t allow overdrafts at all, keep the fees just a bit higher than those on commercial bank accounts, and –  of course –  be prepared to adjust the interest rates paid (or charged) on credit balances to limit potential demand.    What would be on offer would be a basic credit-risk free product –  something similar to the fairly basic products central banks provide to banks themselves.  Frankly, I’d be a bit surprised if there was much (normal times) demand at all (and I think back to the days –  decades ago –  when the Reserve Bank offered –  in direct competition with the private banks –  cheque accounts to its own staff; perhaps some people used theirs extensively,  but I used it hardly at all).

Lowe’s other concern –  and I’ve seen this concern in other places too –  is that provision of e-cash for ordinary citizens might destabilise the banking system.    As he noted earlier in his speech “it is likely that the process of switching from commercial bank deposits to digital banknotes would be easier than switching to physical banknotes. In other words, it might be easier to run on the banking system.”

Frankly, if the only thing that prevents runs on the banking system is that it is too hard to run to cash, central banks and regulators have bigger problems that they might need to address directly.  Runs are often quite rational –  there are real issues with the “victims” funding and/or asset quality.  If it really were easier to run with electronic central bank cash, banks – and their regulators –  might need to look to the size of the capital and liquidity buffers.   As it is, Lowe seems to be suggesting banks can free-ride on technical obstacles their (retail) depositors face.

But I’m not really persuaded that simply making available a basic retail e-central bank cash option would either increase the prevalence of runs or threaten the stability of the financial system.     When there is a concern about an individual bank (or non-bank) people “run” electronically anyway –  mostly they don’t withdraw their deposits into physical cash, but into liabilities of another private institution (and we seem to have been seeing such a quiet run on UDC in recent months).   Wholesale runs –  the sort that took down Bear Stearns and Lehmans –  all happen electronically.  Banks themselves can run straight to central bank cash, when they cut lines on each other.  Is the Governor really suggesting that it is just fine that wholesale investors should find it easy to run but not retail investors?  In practice, that is what he is saying.  In a systemic run –  or a period of heightened systemic unease – it is very easy for wholesale investors to find a safe asset (whether exchange settlement account balances for banks, or government bonds/ Treasury bills for others).  It isn’t for retail investors.  And recall that in New Zealand we have no deposit insurance.

If I’m uneasy at all about the idea of making available an eNZD (or AUD) for retail users –  a basic store of value/means of payment technology with no credit risk –  it is that demand would be very limited in normal times, and that if there ever was a systemic crisis it might prove very hard to scale the product quickly to adequately demand.   There are probably ways of resolving that concern, but it does need more work.

One other concern I’ve heard expressed if this if the central bank issued retail e-cash it would create a reinvestment problem –  what would the Reserve Bank buy and hold on the other side of its balance sheet (with associated credit and quasi-fiscal risks).  This is mostly a non-problem for several reasons:

  • normal times demand is likely to be low, and can be kept fairly low through pricing,
  • retail e-cash would probably go hand in hand with steps to reduce the stock of physical cash (and central banks already reinvest the proceeds of the sale of notes),
  • in a crisis, central banks have this issue anyway –  the substantial liquidity injections typically involve material credit risk anyway, and
  • in practice, many central banks typically reinvest the proceeds of note issue (or subscribed capital) in government bonds (predominant approach in New Zealand) or foreign reserves (typically mostly the government bonds of other countries).

With an integrated approach to gradually reduce the stock of physical currency, while making available a retail e-cash product, I would expect that if anything central bank balance sheets would shrink somewhat (especially in Australia, with a higher currency to GDP ratio) rather than grow.   Steps in that direction would:

  • help deal with the zero lower bound problem,
  • reduce the tax evasion etc issues apparently associated with large holdings of physical cash, and
  • provide ordinary citizens with the same sort of basic risk mitigant/payments product open to banks.

Finally, I said that one of Phil Lowe’s counter-arguments was mostly rhetorical. That was this one

The point here is that exchange settlement accounts are for settlement of interbank obligations between institutions that operate third-party payment businesses to address systemic risk – something that is central to our mandate. A decision to offer exchange settlement accounts for day-to-day use would be a step into a completely different policy area.

Well, yes, as conceived at present exchange settlement accounts are about interbank dealings.  That is a core part of the RBA’s (and RBNZ”s) responsibilities.  But the provision of basic “outside money” –  credit risk free –  has also long been a core part of both central bank’s responsibilitiies.  Retail e-cash helps fulfil that part of those mandates in a technological age.

 

 

Why so secretive?

Michael Reddell PTAs, Reserve Bank Act reforms, Uncategorized

Five weeks ago now, on 7 November, the Minister of Finance announced a process for his review of the Reserve Bank Act.    There was to be a two-stage process: the first stage led by Treasury to come up with specific recommendations on how to implement the Labour Party promises around monetary policy (goal and decisionmaking issues), and then an amorphous second stage, to be jointly led by the Reserve Bank and Treasury, to look at other  –  as yet undefined – issues around the Reserve Bank Act.  We were told that the phase one would be completed, with a report to the Minister, in early 2018.

Presumably the work is well underway.  At the post-Cabinet press conference the other day, we were told that the new Policy Targets Agreement –  which has to be signed by the Minister and the Governor-designate before Adrian Orr can be formally appointed  – will be informed by the recommendations of the first phase of the review.    As Orr is scheduled to take office on 27 March, you’d have to suppose that the report of the review would have gone to the Minister of Finance at least a couple of weeks prior to that.    After all, Orr himself would need to consider any proposed changes to the PTA, and might wish to take his own advice from Reserve Bank staff.

But if the work is well underway it is being kept very secretive, something that seems quite out of step with how things were portrayed when the Minister announced the terms of reference and associated process five weeks ago.

For example, we were told that an Independent Expert Advisory Panel was to be appointed.  According to the Q&A sheet issued on 7 November

Who will be on the Independent Expert Advisory Panel?

The panel members will be announced once they have been confirmed, but they will be individuals with independence and stature in the field of monetary policy, including in governance roles.

But there has been no announcement.   Either members haven’t been appointed yet –  in which case, how is the work going to be well done in the remaining time? –  or the Minister has gone back on his commitment to openness.  I have Official Information Act requests in with both Treasury and the Minister seeking the names.  The expectation of openness was confirmed with this q&a

Will their views be made public?

In commissioning the review, I have asked officials for advice on the terms of engagement of the Independent Expert Advisory Panel. This will include how their views are made public, and further details will be made public once that has been confirmed.

Note the “how”, not “whether”.   But, five weeks on, still no details.

The Minister also promised more details about a timeline for the whole review.  Five weeks on, heading into Christmas, still no details.  At yet the first stage is supposed to be completed by early March.

When will it conclude/report?

I expect the Treasury to report to me on phase one of the review early in 2018.

In commissioning the review, I have also asked officials to develop a detailed timeline for the review, and more details will be provided once they have been agreed.

I had supposed that the review would be seeking submissions or public input.  I wondered if that was just my imagination, but no.  Going back to the Q&As

Will there be public consultation? When?

I have also asked officials to develop a detailed timeline for the review, including how public consultation can best be facilitated. More details will be made public once they have been agreed.

Five weeks on, heading into Christmas, still nothing.   If the underlying review by officials is well underway, it makes a mockery of any sort of public consultation if views are only to be invited very late in the piece, if at all.

I’m not sure what the Minister of Finance can possibly have to hide.  The Labour Party campaigned on making changes along these lines, and the first stage of the review is supposed to be largely about giving that effect, and associated consequential issues.  But whatever the reason, it isn’t a particulary look, and again undermines any suggestion that the government might be committed to a more open approach.   Rhetoric around the Official Information Act is fine, but this stuff should be easy –  and it was explicitly promised weeks ago, in a review that is operating to tight timeframes.

It also isn’t clear why the Minister and Treasury are still keeping secret the Rennie review and associated documents.  The Rennie review of Reserve Bank goverance was commissioned by Treasury, at the request of the previous Minister of Finance.  The report was completed in April, and yet Treasury has repeatedly refused to release it and associated material (eg comments from expert reviewers), even though it is clearly official information and should be highly relevant to discussion/debate/submissions around the new government’s own proposals and review.      I have appealed the latest denial to the Ombudsman, and had confirmation this morning that the Ombudsman has opened an investigation.      But such investigations simply shouldn’t be needed, if we had any semblance of an open government.

As noted above, a new Policy Targets Agreement has to be agreed and signed by March.    The Policy Targets Agreement is the major document guiding short-term stabilisation policy for the next five years –  it affects us all.   And yet it seems that deliberations will continue to go on in secret (as has been the custom).    Again, it would be a good opportunity for a more open approach.  I’ve pointed previously to the Canadian model of conducting the research leading up to the renewal of the inflation target early and openly discussing/reviewing/debating it in public seminars/workshops.  It would be a good practice to adopt here, but it is probably too late for this time round.  But it wouldn’t be too late for the papers the Reserve Bank and Treasury have inevitably already prepared on the topic to be made public, in a way that would enable market economists and other observers to provide input on how this major macroeconomic tool is to be specificied and managed for the next five years.    We’d never pass legislation as secretly as the PTA is done. Indeed, the Reserve Bank couldn’t even put on the latest iteration of LVR controls  –  half-life perhaps one year – without proper serious consultation.  It is time for a more open and consultative approach to shaping macroeconomic policy.   Robertson (and Orr) could lead the way.

In addition to the work Treasury and Reserve Bank staff have done, consultation could take account of the comments the Minister made recently about contemplating removing references to the target midpoint from the PTA (I have mixed feelings about that idea, but think it is probably a bad idea, reinforcing the weakness of inflation expectations).  And there were other suggestions at the post-Cabinet press conference –  Robertson talking of how the government doesn’t just want the Bank to focus on price stability, or employment, but on “the overalll wellbeing of New Zealanders” –  that dread Treasury phrase once again, as devoid of specific meaning as ever.   But in case he isn’t aware, the 4th Labour government already included its own “virtue signalling” mandate in the Reserve Bank Act

169 Bank to exhibit sense of social responsibility

It shall be an objective of the Bank to exhibit a sense of social responsibility in exercising its powers under this Act.

38 years on and still no one knows what it means, if anything. But it probably felt good to include it.  Perhaps those words could be carried up into the Policy Targets Agreement, and the Governor could cite them every so often?

 

 

 

 

 

 

Governing financial stability policy

Michael Reddell Financial stabilty, Reserve Bank Act reforms, Uncategorized

On Monday afternoon, The Treasury hosted Professor Prasanna Gai of Auckland University, who gave a guest lecture on the topic “Resilience and reform –  towards a financial stability framework for New Zealand”.     The timing of this event, put on at quite short notice, is presumably not unrelated to the current review of the Reserve Bank Act.

Prasanna Gai is well-qualified to talk about such issues.  He was formerly a professor at ANU, and prior to that worked at both the Bank of Canada and the Bank of England.  These days –  even from the ends of the earth –  he is an adviser to the European Systemic Risk Board.  A few years ago he served as an external academic adviser to the Reserve Bank of New Zealand, and did one of the periodic visitor reviews of our forecasting and monetary policy processes, based on his observation of one Monetary Policy Statement round.

In his presentation the other day, he appeared to set out to be “politely provocative” in pushing for reform, including greater transparency and accountability.   There was a fairly large number of Reserve Bank people at the lecture, and I suspect Prasanna’s calls won’t have gone down that well with them.

He began by noting that even now, 10 years after the last international financial crisis, there is very little academic analysis of the political economy of financial stability policy/regulation.  As he noted, in monetary policy there were key defining papers that laid the groundwork for monetary policy operational independence to become the norm internationally.    There is still really nothing comparable in respect of financial stability –  and certainly nothing robust that would justify delegating a very high degree of autonomy (arounds goals, instruments, and intermediate targets) to unelected officials (especially a single such official).

As he notes, in most countries –  though not the US or the euro-area –  politicians (as representatives of societies) play the lead role in setting/approving the inflation target.   Things aren’t just mechanical from there –  there can be, and are, real debates about how aggressively to respond to deviations from target and the like –  but at least there is some benchmark to measure performance against.    There is nothing comparable for financial stability, and Prasanna Gai argues  –  and I strongly agree with him –  that politicians need to “own” financial stability policy, including taking a view (implicit or explicit) on things like the probability of a crisis that society is willing to tolerate (it is the implicit metric behind much of what systemic financial regulators do).

Gai’s focus in his talk was on what he –  and the literature –  likes to call “macroprudential policy”.     He draws a distinction between the supervision of individual banks and the supervision/regulation of the system as a whole.  I’ve never been convinced that it is a particularly robust distinction, at least in the New Zealand context, where a key defining characteristic of our banking system is four big banks, all with offshore parents from a single overseas countries, all with relatively similar credit exposures (and funding mixes).   Gai –  and others (including the Reserve Bank when it suits them) –  argue that each bank might manage its own risks relatively prudently, but has no incentive to take adequate account of the impact of its choices on other banks.  Again, in a concentrated system like our own, I’m not sure that is really true, at least in a way that has much substantive content.   Anyone lending on dairy farms (for example) will know that the market in such collateral gets extremely illiquid whenever times turn tough (as they did after 2007).  You’d be a fool, in managing your own bank’s risks, not to recognise that other people might be trying to liquidate collateral at the same time as you.   Much the same goes for housing loans –  and even if you didn’t directly take account of other banks’ exposures, if your bank has a quarter of the market, you can’t just assume your actions will have no impact on the value of the overall collateral stock (whereas, say, a 1 per cent player might be able to).   It doesn’t mean that banks don’t get carried away at times, and excessively ease credit standards, but I doubt the big 4 are ever not aware they are big fish in a small pond.  Banks were all very consious of firesale risks in managing dairy exposures in 2009/10.

And if the banks themselves forget it, I don’t think the Reserve Bank ever has.   As regular readers know, I don’t feel a need to defend the Reserve Bank on every count, but……I sat on the Financial System Oversight Committee for the best part of 20 years, and was involved in putting together Financial Stability Reports, and the sort of narrow “my bank only” focus people talk about when they try to carve out macroprudential policy as something different from micro-prudential supervision never resembled the way the Reserve Bank dealt with these issues and risks.   Perhaps it happened to some extent at the level of an individual supervisor, but not at the institution level.  The starting assumption tends to be that the risks –  credit and funding –  are pretty similar in nature for all the big banks.  In fact, we see that illustrated in the way our Reserve Bank treats stress tests –  here is the focus is systemic whereas, for example, the Bank of England provides a high degree of individual institution detail (since banks fail individually, I think the BOE approach is preferable).    What also marks out New Zealand supervision/regulation, is that the statutory mandate is explicitly systemic in focus; there is no explicit depositor protection mandate.

So although Gai’s talk was avowedly focused on macroprudential functions, in the end most of what he had to say applies (at least here) to the full gamut of the Reserve Bank’s financial regulatory functions.  I think that conclusion is reinforced by the scepticism Gai expressed about the ability of central banks/regulators to do much effective to dampen credit/housing cycles, leaning against booms.  He sees the case for regulation as primarily about building the resilience of the financial system.

In passing, I would note that I also think he grossly overstates the cost of financial crises.  He put up a series of charts for various countries showing the path of actual GDP in comparison to what it might have been if the pre-2007 trends had continued, and asserted that the difference was the effect of financial crises (perhaps as much as 70 per cent of one year’s GDP).  I’ve disputed that sort of claim previously here (including here and here) and a few months ago I ran this chart  suggesting that another meaningful way of looking at the issue might involve comparing the path of GDP for a country at the epicentre of the crisis (the US in this case), with the paths for advanced countries that didn’t experience material domestic financial crises,

US vs NZ Can etc

But if the costs of financial crises are far smaller than people like Gai (or Andy Haldane) assert, they probably aren’t trivial either, especially in the short-term (one or two year horizons).  And much the damage isn’t done in the crisis itself, but in the misallocation of credit and real resources in the build-up to the crisis.

So I’m not arguing a case against supervision/regulation –  and have been recently arguing that we should, on second best grounds, introduce a deposit insurance scheme, which would only reinforce the case –  but I am more sceptical than many, perhaps including Gai, about how much value supervisors can really achieve, whether macro or micro focused.    There has been a great deal of  regulatory activity –  sound and fury –  in the few years since the last crisis, but that was precisely the period when banking systems were least likely to run into trouble anyway (managers, shareholders, rating agencies all remembered –  and were often scarred by –  the 2008/09 crisis, and actually demand for credit was generally pretty subdued too).  The test of supervision/regulation isn’t the difference it makes in times like the last 7 or 8 years, but the difference at makes at the height of the next systemic credit boom.  It isn’t obvious –  including from past cycles –  that regulators, and their political masters, will be much different from bankers next time round either.  Some regulators might well want to be different, but typically they will be marginalised, or just never (re)appointed to key positions in the first place.

But given that we have bank regulation/supervision, how should it best be organised and governed?     There is no one model, either in the academic literature or in the institutional design adopted in other advanced countries.  One of the question is how closely tied financial stability policy should be to monetary policy.   At one end there is  –  perhaps the practical majority  – view (including from Lars Svensson) that monetary policy and financial stability are two quite separate things, and should be run separately, possibly even in separate institutions.   At the other extreme, there is an academic view that monetary and financial stability are inextricably connected and policy needs to address both together.  A middle ground is perhaps a view associated with the BIS, seeing a role for monetary policy to lean against credit asset booms, with the advantage –  relative to regulatory measures –  that “interest rates get in all the cracks”.

In New Zealand, the Reserve Bank Act has since 1989 required the Bank to have regard to the soundness and efficiency of the financial system in its conduct of monetary policy (a requirement carried over in the PTA in 2012).  But no one really knows what it means – to the drafters in 1989 it seems to have meant something about avoiding direct controls –  but it sounds good –  motherhood-ish almost.   In practice, it has never meant much: successive Governors have, at times, anguished about housing markets and possible future risks, and on the odd occasion have tempered their OCR calls by those concerns.  But my observation suggested they’d have done so anyway.

So we are in the curious position where financial stability considerations don’t matter to any great extent to monetary policy, and yet we have single decisionmaker deciding policy in both areas with –  partly as a result –  little direct accountability.    The Minister of Finance has little effective involvement in the appointment of the decisionmaker, or in the specification of the goals of financial stability policy.   The Governor decides –  based on whim, rigour, or prejudice, but with little or no legitimacy or democratic mandate. Even the legislation grew like topsy, and the governance provisions never envisaged as active prudential policy as we’ve seen in recent years.

There is a range of different models, and Gai covered some of them in his talk.  In Sweden there is little or no integration between the central bank and the financial regulatory agency.  In the UK, all the functions are (now back) in the Bank of England, but there are statutorily separate committees (albeit with overlapping membersships), most of the members are appointed by the Chancellor, and all members are individually accountable for their views/votes.  In Australia, there are multiple agencies, a Council chaired  by the Reserve Bank, but also a strong role in policysetting for the Federal Treasury, representative of the Treasurer (and the Treasurer/government directly appoint the key players, including the Governor).  There are other countries –  for example, Norway –  where decisionmaking powers on systemic prudential interventions are reserved to the Minister of Finance.

Prasanna Gai wrapped up his talk arguing that there is a strong case for rethinking the governance model around systemic financial stability in New Zealand.     Specifically, he made the case for the Minister of Finance to be more directly involved.  As he had noted earlier in his talk, the sort of regulatory interventions like LVRs are almost inevitably highly political in nature (especially as they can be highly granular –  we saw a couple of years back regulatory distinctions between Auckland and non-Auckland, and we still have distinctions between types of purchasers, even if the collateral is identical), and that the more independent a central bank is around such interventions the more politicised the institution risks becoming.  Gai argued –  and I agree with him –  that we’ve seen this in New Zealand in the last few years.  He argues that wider participation in decisionmaking could help safeguard monetary policy credibility (and perhaps the Bank’s effective operational independence there).

Gai argues for the establishment of a statutory committee to be responsible for systemic financial regulatory matters that are currently the sole preserve of the Governor.  He didn’t spell out clearly what, if any, powers he would reserve to the Minister –  perhaps that is captured in establishing a mandate (backed by statute, not the goodwill/moral pressure of the current MOU).  But he envisages a model in which the members of the committee would be appointed by the Minister of Finance, and would be individually accountable (including to Parliament) –  presumably implying a considerable degree of transparency around minutes/voting records.  He argues –  correctly in my view –  that such a committee would not only provide access to more technical expertise but that it would provide greater “legitimacy” for the choices being made.

Mostly, Gai’s talk was very diplomatic.  But there was a bit of a dig at the current Reserve Bank, noting that there didn’t seem to be much turnover (“churn”) at the senior levels of the Reserve Bank, at least when compared to the experience of places like the RBA or the Bank of England, which –  he argued –  limited the scope for challenging “house views” or established orthodoxies.    Bringing in outsiders –  individually accountable – to a statutory committee could counteract those risks.    Personally I’m less sure that turnover (generally) is the issue –  and as compared to the RBA (most notably) the Reserve Bank of New Zealand has been weak at building internally capability (as a result, 1982 is still the last time a Reserve Bank Governor was appointed from within).  The issues at the Reserve Bank seem to be more about the capability of certain key individuals –  several of whom (Spencer, McDermott, Fiennes and Hodgetts) have been in their roles for a long time –  and the sort of culture fostered from the top in the Wheeler years in particular.     In a high-performing organisation, constantly opening itself to challenge, scrutiny and new ideas (from inside and outside) that stability might be a real strength.  In our Reserve Bank it has become a considerable weakness.  But an external committee, properly constructed, could be part of a process of change, and entrenching new and better behaviours.

Gai’s summary:

  • financial stability policy should be on an equal footing with monetary policy,
  • the focus of such policy should be on resilience of the system, not trying to fine-tune the credit cycle (just too ambitious),
  • politicians need to own the standards of resilience policy is working to maintain/manage, and be engaged more overtly in decisionmaking, and
  • because it will never be possible to establish very specific, short horizon, goals comparable to those in the PTA, the process of policy formulation and governance/accountability mechanisms take on an even greater importance for financial stability than for monetary policy.

I’d largely agree with him.

I hope these are issues that the Minister of Finance is going to take seriously as part of his (currently secretive) review of the Reserve Bank Act.    With central bankers who have a strong incentive to defend their patch and their powers –  including a new Governor with a reputation for fighting his corner, come what may –  if the Minister isn’t engaged it would be all too easy to end up with no material change, and far too much power still concentrated in the hands of one, less than excellent, institution and its single decisionmaker.     This is the opportunity for serious reform – bearing in mind Mervyn King’s injunction that legitimacy (the “battle for hearts and minds”) matters greatly –  and I hope the Minister is exposed to the advice Prasanna Gai offered the other day.  A Financial Stability Committee shouldn’t be dominated by academics, but the Minister could do worse, in establishing such a committee, than to appoint Prasanna as one of the founding members.

For anyone interested in these issues, there is also a presentation here given last year by David Archer – former Assistant Governor of the Reserve Bank, and now a senior official at the BIS. I meant to write about it at the time, but never did.  His title is “A coming crisis of legitimacy?”  and this from his first slide captures his concern

Make the case that many central banks are at risk of a crisis of legitimacy, with respect to new macro financial stability mandates. The issue is an inability to write clear objectives.

He highlights some similar issues to Gai, but is more strongly committed to keeping ministers out of regular decisionmaking, and so his approach is to supplement committees with a clear statutory specification of the issues, considerations etc that should be taken into account in using/adjusting systemic financial regulatory policy.

Adrian Orr as Governor-designate

Michael Reddell Adrian Orr, Reserve Bank, Reserve Bank Act reforms

There are some good aspects in the announcement yesterday that the government intends to appoint Adrian Orr as the next Governor of the Reserve Bank.

For a start, the appointment will be a lawful one –  always a help.  Steven Joyce’s unlawful appointee as “acting Governor” will continue to mind the store until late March, and then at least we will be back to having someone lawful in office.   The unlawful interlude was unnecessary, and reflects poorly on governance and policymaking in New Zealand, but it will be soon be over.  Be thankful for small mercies.

It also seems highly unlikely that Adrian Orr will spend his first five years in office skulking in corners, avoiding any serious media scrutiny.   He is a vigorous and, mostly, effective communicator (on which more below) and in that sense is likely to be a welcome breath of fresh air in the Reserve Bank.  If he can model greater openness, across all the Bank’s function, it would be a significant step forward.

And there might be reason to hope that an Orr-led Reserve Bank might start to take transparency –  within and beyond the confines of the Official Information Act –  rather more seriously.  I’m not a huge fan of the New Zealand Superannuation Fund, but I am quite impressed by their transparency, including in dealing with Official Information Act requests.  When I asked recently for the background papers justifying the decision to cut the Fund’s carbon exposures –  they’d already pro-actively released some papers –  I got (from memory) something like 3000 pages of material.  When one asks the Reserve Bank for background papers to monetary policy decisions, one is repeatedly stonewalled (unless it is about things from 10 years ago).  I hope the contrast bodes well for the sort of leadership Adrian will bring to the Bank.

That is the positive side of the appointment.  But here is what I wrote earlier in the year, at the time when controversy was raging about his NZSF salary.

Orr simply isn’t –  and I wouldn’t have thought he’d claim otherwise –  some investment guru, blessed with extraordinary insights into markets, prospective returns etc etc.  He was a capable economist, and a good communicator (at least when he doesn’t lapse into vulgarity), who turned himself into a manager and seems to have done quite well at that.   He always seeemed skilled at managing upwards, and his management style (in my observation at the Reserve Bank) seemed to err towards the polarising (“are you with us, or against us”), attracting and retaining loyalists, but not exactly encouraging diversity of perspectives or styles.  He isn’t exactly a self-effacing character. (That is one reason I’m not convinced he is quite the right person to be the next Governor of the Reserve Bank.)

I’d stand by those comments today.

He is more of a manager –  and perhaps a salesperson – than an economist, despite some comments in the last day about him being an “exceptional economist”.  That has probably been so for at least 20 years now.  In itself, that isn’t a criticism, and there is a significant management dimension to the Reserve Bank role –  in particular, at present, a change management responsibility (both to implement whatever changes emerge from the Minister of Finance’s secretive review of the Reserve Bank Act, and to lift the internal performance, and improve the culture, of the Bank).

His management approach might be more questionable. In his first short stint at the Reserve Bank, 20 years ago, he took over a department that was severely demoralised and lacking the influence it would normally have had.  In a narrow sense, he did an effective job of turning around that underperformance.   But his style always seemed to be quite a divisive one, playing up “his team” at the expense of others, rather than seeking to lift the entire organisation  –  in fact, he boasted of it in his farewell speech when he left the Bank in 2000.  I haven’t observed him directly in the last decade, but I am struck by the number of able people I’ve known who’ve worked for him for a time, and then didn’t.    It wasn’t, as far as I could see, that they went on to bigger and better things either.  Adrian seems to build cohesive teams of loyalists.  That has its place, but it isn’t obvious that the Reserve Bank is one of those places.

What of his communications skills?  He can be hugely entertaining, and quite remarkably vulgar (an astonishingly crude analogy involving toothbrushes springs to mind).   Just the thing –  perhaps –  in an old-fashioned market economist.  Not, perhaps, the sort of thing we might hope for from a Reserve Bank Governor.   Financial markets can get rather precious about very slight changes in phrasing etc from the Reserve Bank, and it is hard to be confident just how well Orr will go down.  No doubt he will rein in his tongue most of the time –  and perhaps he has calmed down a bit with age – but it is the exceptions that are likely to prove problematic.

And what happens when some journalist or market economist riles him?    Perhaps a journalist might ask him about how he would approach an episode like the Toplis affair?  You (and I) might like to hope things would be different, but I have in mind an episode from Orr’s time as Deputy Governor.  A visiting economist was engaging in what they thought was a bit of robust dialogue with Orr in a meeting with several people at the Bank.  Shortly afterwards, Orr bailed the visitor up in the street and told him ‘never, ever, do that in front of my staff again”.

And yet, so we are told, part of the motivation for the forthcoming reforms to the Reserve Bank is to ensure that more perspectives are heard, and incorporated, in decisionmaking at the Bank.   How confident can we be that Orr will actually implement the reforms in a way that will foster debate and diversity, rather than clamp down on it and marginalise anyone he perceives as disagreeing with him?   Particularly if the person or people disagreeing with them doesn’t share his blokish style, or might simply know more about a particular issue than Orr does.

And how is Orr going to do –  repeatedly in the public eye, in a way he hasn’t been for the last decade –  with the sort of gravitas and political neutrality the role of Governor requires?  Only a few weeks ago – when he must already have known that he was likely to become Governor –  Orr gave a speech to the Institute of Directors, in which he reportedly dismissed the views of Deputy Prime Minister on the economy as “bollocks” and went on to suggest, in answer to a question about nuclear risks in North Korea, that perhaps two issues could be solved at once ‘because Winston is going to North Korea”.  Recall that at the time, Orr was not some independent market economist, but a senior public servant.     He might well have been right in his views on the economy, but is this how senior public servants should be operating?

I also have concerns about the way Orr engages with issues and evidence. My very first dealing with him involved some controversial reform proposals we were working on at the Bank, while Adrian was still in the private sector.   Adrian’s submission had played rather fast and loose with the data, something I pointed out to Don Brash, the then Governor.  Don went rather quiet and didn’t say much, which puzzled me a little, until a day or two later Adrian’s appointment as Reserve Bank chief economist was announced.  Much more recently, there was some debate earlier in the year about NZSF’s performance.   On a good day, and in official documents, Adrian will happily tell you NZSF’s performance can only really be judged over, say, 20 or 30 years horizons.  But then he will pop up in the newspaper suggesting that a few moderately good years –  amid a global asset market boom –  vindicate the existence of the Fund and the way it is run.    He keeps trying to convince us that he runs  a “sovereign wealth fund”, when it fact it is a speculative punt on world markets, using borrowed money (yours and mine).  He has simply refused to engage with the international evidence casting doubt on whether active funds management can generate positive expected returns in the long-run, and when he led the NZSF into a big (politically popular, but economically questionable) move out of carbon exposures –  an active management call if ever there was one – he took steps to ensure that taxpayers couldn’t really know whether his judgement paid off (hiding the change in the benchmark itself, rather than being constantly reported in devations from a benchmark).     I’m just not sure it is quite the degree of rigour, authority and independence of mind that we should be looking for in a Reserve Bank Governor.  What example, for a start, does it set for his own subordinates in how they marshall evidence and arguments for him?

On the same note, there was that speech Orr gave last month to the Institute of Directors (full text here).  It was given at a time when he knew he was in the final stages of the gubernatorial selection process.   It was advertised as a substantial speech

Looking Beyond Our Shores – Adrian Orr’s Address to the Institute of Directors

Adrian Orr’s address to the Institute of Directors, Wellington, 16 November 2017.
Adrian shares his thoughts on what directors need to think about to make sure New Zealand benefits from its place in the globalised economy.

So you might have expected some considerable substantive analysis.   But there wasn’t much there at all.     You won’t find anything about New Zealand’s underperformance –  productivity, exports, or whatever.   But you will find one conventional wisdom thought after another (albeit with a tantalising aside on Chinese influence), whether or not they apply to New Zealand  (eg “returns to the owners of capital versus labour –  which is stretched to extremes at present within and between nations” –  when the labour share of income has been rising in New Zealand for 15 years).  And then it devolves to “doing something” about climate change –  which might or might not be sound, but isn’t going to make us materially better off – and lots of self-praise (not all of it even accurate) for the NZSF.    A speech on how to “make sure New Zealands benefits from its place in the globalised economy” ends with these platitudes

My summary thoughts are:

  • Companies must take more long-term ownership of all their activities – it is the Board’s role; 
  • New Zealand needs to embrace a global reputation of longtermism, and sell it; and
  • We can start with climate and our culture at the company level.

No real answers, and not much depth there.   Perhaps it wasn’t characteristic –  I haven’t gone back and read his other speeches from recent years –  but this was the speech on a topic somewhat closer to his new areas of responsibility as a (singlehanded) key economic decisionmaker.

I’m sure there are those capable people who are genuinely impressed with Adrian (as presumably, the Reserve Bank Board was –  the same people who appointed Graeme Wheeler).  But don’t be fooled by the absence of any sceptical comment at all in the last day or so.     Of the people the media is likely to go to for comment, many will be needing to maintain a professional relationship with him in his new role, and others will work for organisations that do business with NZSF –  and Orr is still chief executive there for a few more months.

Only time will now tell how Orr does in the job.   For a time he will be by far the most powerful unelected person in New Zealand –  exercising singlehandedly all the monetary policy, regulatory, and intervention powers the various Acts give to the Governor –  and then and beyond responsible for leading the transition to a reformed Reserve Bank (details of which are still unknown –  including how much effective power will be left with the Governor).  As someone who is well-known to fight for his patch, his people, I’ve further revised down my estimate of the prospects for real change at the Bank –  especially around the financial stability functions where (a) the Bank is almost lawless, and (b) the Minister of Finance doesn’t care very much.  I’d like to believe he will do well –  for the New Zealand public –  but it is hard not to shake the impression that Adrian Orr is no Phil Lowe (RBA), Stephen Poloz (Bank of Canada), Philip Lane (central bank of Ireland), Stan Fischer (former central bank of Israel and recent vice-chair of the Fed).   In some ways he will be very different from Graeme Wheeler, but in many areas we could be exchanging one set of weaknesses for another.

But I suspect he will be wildly popular at the annual financial markets function the Reserve Bank hosts.   Bonhomie, backslapping, and plenty to drink tended to characterise those functions when I had to attend them.

 

 

Two BIMs and a bureaucrat

Michael Reddell Immigration, Reserve Bank, Treasury

As I noted last week, government departments’ (and agencies’) briefings to incoming ministers have mostly become a bit of a joke: mostly devoid of any substance, typically specifically tailored to the preferences of the particular incoming government (ie written/finalised after the shape of the new government is clear), and mostly not much more than process pieces.  If one is interested in the actual substantive advice –  the sort of things the Lange government intended to make available when they began publishing BIMs in the mid 1980s –  citizens need to fall back on the Official Information Act, with all its limitations.

There are exceptions –  I wrote the other day about some substance in the Reserve Bank’s BIM.   And even on the little that is released, sometimes tantalising hints sneak through.  The intelligence services, for example, left unredacted a suggestion that governments might need to be concerned about the influence activities in New Zealand of foreign governments –  something neither the current Prime Minister nor her predecessor have been willing to take seriously or address openly.

Of the other economic functions, neither the Treasury nor the Immigration BIMs say much.  But sometimes there is quite a bit even in a few words.  Take immigration for example.    It was only a few years ago that MBIE was telling Ministers of Immigration (and the public) that immigration was a “critical economic enabler” –  a potential catalyst to transform New Zealand’s dismal productivity performance.   There isn’t much in this year’s Immigration portfolio BIM –  mostly process again –  but my eye lit on this paragraph

New Zealand’s immigration system enables migrants to visit, work, study, invest, and live in New Zealand. Economically, it contributes to filling skill shortages, encouraging investment, enabling and supporting innovation and growing export markets. Immigration has contributed to New Zealand’s strong overall GDP growth in recent years largely through its contribution to population growth. However, the evidence suggests that the contribution of immigration to per capita growth and productivity is likely to be relatively modest.

The theory –  dodgy bits like “filling skill shortages” and the more plausible bits –  is there in the first half of the paragraph.  But by the end of the paragraph, even MBIE has to concede that there isn’t likely to be much boost to per capita income or productivity at all –  the effects are “likely to be relatively modest”.  It is hard to avoid that sort of conclusion –  looking specifically at the New Zealand experience –  when (to take MBIE’s list from the second sentence) “skill shortages” have been a story told in New Zealand for 150 years, business investment has been weak by OECD standards for decades, firms haven’t regarded it as particularly attractive to invest heavily in innovation (again by world standards), and the export share of GDP is now at its lowest since 1976.  Still, it is good to see reality slowing dawning on MBIE.  On my telling, they are still too optimistic, but even on their telling when such a large scale policy intervention seems to produce such modest economic results it might be time for a rethink.

And what about the BIMs prepared by Treasury?   There isn’t much in the main Finance document (lots of process stuff, and plenty of talk of diversity and wellbeing and none on productivity).  There is an appendix specifically aimed to address what Treasury understand to be the new Minister’s priorities, but not much about Treasury’s own view of what needs to be done, or the pressing problems.    If anything, reading Gabs Makhlouf’s covering letter to Grant Robertson one might conclude that Treasury didn’t think there was much to worry about at all.

You are taking up your role at a time when New Zealand’s economy is in a relatively strong position.  There is solid forecast growth, complemented by fiscal surpluses and a strong debt position.  And while international markets still present a number of risks and uncertainties, overall the global economy –  as reflected in the IMF’s recent outlook –  presents opportunities for New Zealand to seize, in particular with Asia’s ongoing growth.

Presumably the Secretary didn’t think it worth emphasising five years of no productivity growth, seventy years of pretty weak productivity growth, shrinking exports as a share of GDP, sky-high house/land prices, pretty weak business investment and so on.  Or even the fact that notwithstanding “Asia’s ongoing growth” –  a story now for more than forty years –  nothing has looked like turning around New Zealand’s continuing gradual economic decline.    And perhaps when you are a temporary immigrant yourself –  as Makhlouf presumably is –  the cumulative (net) loss of a million New Zealanders isn’t something that concerns you?

In their BIM Treasury proudly asserts that “We are the Government’s lead economic and financial adviser”.  Perhaps they hold that formal office, but it is hard to be optimistic about the content of what they might be offering the government.

But Treasury also had some other BIMs for other portfolios they have responsibilities for.  The one I noticed was the Infrastructure one.    Buried in the middle of that document was this observation

Auckland’s ability to absorb growth has been reached. Environmental, housing and transport indicators all reflect a city under increasing pressure. Traditionally, Auckland has been more productive than other regions of New Zealand but, on a per capita basis, this productivity premium has been shrinking over time. Auckland is not performing as well as expected for its size and in comparison to other primary cities around the world.  There are opportunities to increase this productivity but only if supply constraints, especially transport and housing, are resolved.

That key middle sentence –  no hint of which appears in the main Treasury BIM –  could easily have been lifted from one of my various posts on similar lines.    They could have illustrated the point with a chart like this.

akld failure

 

Appearing in the standalone Infrastructure BIM, Treasury appear to want to blame these poor outcomes largely on infrastructure gaps –  a conclusion which I think is flawed –  but I’m encouraged to see a recognition of the problem in official advice to the Minister of Finance.   It is all a far cry from the rather lightweight celebratory speech Gabs Makhlouf was giving about Auckland’s economy only 18 months ago, which I summed up this way

[it] might all sound fine,  until one starts to look for the evidence.  And there simply isn’t any.  Perhaps 25 years ago it was a plausible hypothesis for how things might work out if only we adopted the sort of policies that have been pursued. But after 25 years surely the Secretary to the Treasury can’t get away with simply repeating the rhetoric, offering no evidence, confronting no contrary indicators, all simply with the caveat that in “the long run” things will be fine and prosperous.  How many more generations does Makhouf think we should wait to see his preferred policies producing this “more prosperous New Zealand in the long run”?

If the Secretary to the Treasury was going to address the economic issues around Auckland, one might have hoped there would be at least passing reference to:

  • New Zealand’s continuing relative economic decline, despite the rapid growth in our largest city,
  • Auckland’s 15 year long relative decline (in GDP per capita), relative to the rest of New Zealand,
  • The contrast between that experience, and the typical experience abroad in which big city GDP per capita has been rising relative to that in the rest of the respective countries,
  • The failure of exports to increase as a share of GDP for 25 years,
  • The fact that few or any major export industries I’m aware of our centred in Auckland (the exception is probably the subsidized export education sector) –  and by “centred” I don’t mean where the corporate head office is, but where the centre of relevant economic activity is.

There is nothing of economic substance on immigration in the main Treasury BIM this year, but perhaps over the next few years Treasury could start thinking harder about whether it really makes sense to be using policy to bring ever more people to one of the most remote corners on earth, even as personal connections and supply chains seem to be becoming ever more important, at least in industries that aren’t simply based on natural resources.

The one other thing that did catch my eye in the Treasury BIM was this paragraph

The Treasury Board. This external advisory group supports the Treasury’s Secretary and ELT to ensure that its organisational strategy, capability and performance make the best possible contribution to the achievement of its goals. Current members of the Board are the Secretary to the Treasury (Gabriel Makhlouf), the Chief Operating Officer (Fiona Ross), Sir Ralph Norris, Whaimutu Dewes, Cathy Quinn, Mark Verbiest, Harlene Hayne and John Fraser (Secretary to the Australian Treasury).

Now, to be fair, the “Treasury Board” has no statutory existence, and no statutory powers.  It isn’t even clear why it exists at all –  Boards are typically supposed to represent shareholders, and as regards Treasury, the Minister of Finance, Parliament, and the SSC are supposed to do that on our behalf.  But given that there is an advisory Board, what is a senior public servant from another country  –  the Secretary to the Australian federal Treasury –  doing on it?      New Zealand and Australia might be two of the closer countries in the world, but we don’t always have the same interests, and at times those interests –  and perspectives – clash rather sharply.    I gather John Fraser is quite highly regarded, but who does he owe allegiance to, and whose interests is he advancing in his work on the New Zealand “Treasury Board”?  I might not worry if he were a retired former Treasury Secretary from Australia, but he is a serving official of the Australian government.  It seems extraordinary, and quite inappropriate.   Did he, for example, have any involvement in the recent, superficially questionable, appointment of a former senior Queensland public servant to a top position in our Treasury?    Again, close working relationships between the two Treasurys –  each as servants of their own governments –  might be reasonably expected, and perhaps mutually beneficial.   But providing a senior official of another government with inside access to the senior-level workings of one of our premier government departments seems questionable at best.  GIven Makhlouf’s past enthusiasm for China, perhaps the appeasers at the New Zealand China Council will soon be suggesting he appoint someone from China’s Ministry of Finance could join Fraser on the “Board”?

And finally, some kudos for a bureaucrat.  As various people have noted, Graeme Wheeler went for five years as Governor –  as the most powerful unelected person in New Zealand –  without ever exposing himself to a searching interview, or making himself available for an interview on either main TV channel’s weekend current affairs shows.  His appointment might be highly legally questionable, he might be only minding the store for a few months, but yesterday Grant Spencer went one better than Wheeler and sat down for interview on Q&A with Corin Dann.    I thought he did well, but what really counted was just showing up, and being open to questions.

Since much of the interview was about Spencer’s speech last week, which I’ve already written about, there was much in it that I disagreed with.  But I’m not going over that ground again.  Perhaps the one new thing that caught my attention was when Spencer claimed that the Bank is independent for monetary policy, but not around things like LVRs.   That is simply factually untrue.  The Act makes it very clear that any decisions to impose or lift LVR restrictions are solely a matter for the Governor (also a point that the Prime Minister, the Minister of Finance and their predecessors have recognised).   Spencer went on to say that if the then government had not wanted the Bank to impose LVR restrictions they wouldn’t have done so.     That might be fine, but I hope they never apply that standard to monetary policy decisions.  And if LVR decisions really are more political and redistributive in nature, perhaps as part of the forthcoming review, the Reserve Bank Act should be changed so that the Reserve Bank offers technical professional advice, but the Minister of Finance makes the decision?.  We can, after all, toss out elected governments.

 

 

 

Westpac’s plan to lower productivity

Michael Reddell Uncategorized

You may have seen the story in various media a few days ago about new work commissioned by Westpac suggesting that

New Zealand’s economy has a nearly $900 million annual economic hole because of low numbers of women in management roles, new research suggests.

But if there was an even split of men and women in management there would potentially be an $881m boost to the economy and a positive impact on businesses themselves.

I didn’t pay much attention to it, beyond noting to myself that $881 million is about 0.3 per cent of GDP –  not much of a “hole” in other words, even on Westpac’s (and the consultancy company they paid to do the research) own claims.

But I wondered quite how they’d come up with these estimates so last night –  while the resident woman in management was off at her office party –  I downloaded the document.

It begins with lots of puffery around the alleged economic and financial benefits of diversity –  our banks now apparently see themselves as “social justice warriors”.   I don’t claim any expertise in that particular literature, but I’d refer you to some of Eric Crampton’s reads or, indeed, to a paper I wrote about here a while ago, that leaves me pretty sceptical that there is anything much in the sorts of claims Westpac makes.

The bank is horrified that “60 per cent of businesses do not have a gender parity policy or strategy in place” –  as if picking the best person for the job, male, female, black, white or whatever –  isn’t any sort of legitimate approach to employment these days.   And seems to think that the mere existence of gaps between median earnings of mean and median earnings of women is somehow proof that employers are breaching laws “mandating equal pay for equal work”.  Perhaps Westpac’s crusading CEO could spend some time reading Claudia Goldin, for example.    In the Westpac world, there is apparently no recognition that more mothers than fathers prefer to take time out –  or work in less demanding roles –  to be actively involved in raising children (note the word “more” –  in this household, I’m the “primary caregiver”).  There are implausible claims (without proper documentation in the report) that raising the share of female managers raises rates of return on assets –  in New Zealand’s case they argue that reaching parity could raise returns on assets by 1.5 percentage points.     Not only are these huge numbers, but what sort of metric is return on assets anyway?  Some businesses require lots of fixed assets and other require not many at all.

But what I was really curious about was this alleged $881 million per annum that Westpac reckoned was being left on the table, simply because the share of female managers was less than the share of male managers.  How on earth, I wondered, did they get these estimates?

Fortunately, there is appendix to the report on the modelling.  They’ve attempted to come up with estimates of two separate effects:

  • a “role model” effect in which a higher share of female managers encourages more women into the labour force, and
  • an effect in which the availability of more (by number) flexible employment policies increases the number of women in the labour force.

Taking the “role model” effect first, the OECD has apparently been collecting data recently on the share of employed workers who are managers, by gender, for various countries (unfortunately for this study, there is no data for New Zealand).    But there is only data for four years (2011 to 2014), which even the authors concede make the subsequent model they estimate “statistically challenging”.    They model the labour force participation rate as a function of various things, including the share of women in managerial roles, and they find a statistically significant result.  Statistically significant, but very small.  On the assumption that the gap between the share of male employees who are managers and the share of female is the same in New Zealand as in Australia, if that gap was not there then, on this model, overall labour supply in New Zealand would rise by 0.15 per cent and –  according to a separate Deloittes model –  that would raise New Zealand GDP by 0.07 per cent.   Knocking off an hour earlier/later on Christmas Eve is probably worth about the same amount.

Even then, the results don’t really hold up to much scrutiny.  There is no underlying model of what determines the share of women in management roles (whether here –  for which they have no data –  or abroad), nothing that is robust across time (remember four years of data) and no insight as to what might be involved in achieving the sort of “parity” Westpac wants to see: closing the gap is treated (or so it seems) as something one can simply wave a wand and deliver.

If those estimates are both small and shaky, what follows is worse.   They attempt to estimate an effect on a company changing the number of flexible work policies of the proportion of women in management, and then translate that into an increase in overall labour supply.   Unfortunately all their data are Australian –  include a survey result on the number of working age people not in the labour force who claim that flexible working policies are very important consideration for them, and a count on the number of flexible working policies surveyed companies have in place.   In a simple model, they find that the number of flexible working policies (there is no sense of the empirical size/significance of any of them) is explained (statistically significantly) by the number of women in management in those companies, and thus conclude that if the proportion of women in management was raised to the same as men, there would be (in Australia) a 13 per cent increase in the number of flexible working policies.

The authors then take that 13 per cent increase, the 23 per cent of people not in the workforce who said flexible working practices mattered to them to get an estimate of how many more people would join the labour force through this channel if only the proportion of women in management was raised to parity with men.    They then adjust the result for the fact that many of the new entrants would only be part-time, and estimate that the overall labour supply in New Zealand would rise by 0.55 per cent.   Using the same Deloitte model as earlier this, it is estimated, would raise GDP by 0.26 per cent.

This is all incredibly ropey.  There is no attempt, for example, to assess how robust those answers to the survey were (probably many more people will say flexible working conditions really matter than actually mean it –  it is a socially desirable response).  There is no attempt to look at what the trade-offs for more –  by number –  flexible working policies might be: is there, for example, an offset in lower wages?  And there is no attempt to look for common third factors: maybe it isn’t women in management who  (causally) lead companies to offer more (by number) flexible working policies, but (say) a particular ethos among the owner and top managers of the particular business that drives both outcomes.  And there is no attempt to look at whether the presence of those flexible policies affects more strongly which firm a person (especially a woman) joins, rather than the choice to join the labour market at all.   And there is also no evidence for whether there are threshold effects –  eg perhaps having a lot of women managers lead to more –  by number – flexible work policies,  but the effects might be much smaller if the share of female managers moves from  say 35 per cent to 50 per cent, than if the share moves from 5 per cent to 20 per cent.

I’m not suggesting there is no effect, just that the case is not even remotely compellingly made on these numbers.  It might be fine for David McLean –  Westpac’s CEO –  to lead his firm’s “social justice warrior” campaign, but he really should be rather embarrassed to rely on numbers as shaky as these in support.  I do hope he does banking itself a bit better (then again, there were all those unapproved models where he found himself falling afoul of the Reserve Bank).

But to revert to my headline, did you notice the bottom line numbers for those two effects?  Here is my summary, just replicating their own numbers:

westpac lab supply

In each case, the increase in the labour supply (a cost to the individual concerned) exceeds the estimated increase in GDP.  In other words, on their own numbers nationwide productivity falls as a result (of increasing the proportion of female managers to that of males).

Do I believe the number?  No, I don’t.  I’m sure they are just an artefact of the CGE model of the New Zealand economy they assume –  perhaps something like adding labour, but with no change in productive capital or somesuch.  But Westpac published the numbers, and Westpac claimed the headlines, even though their own numbers suggest our nationwide would fall in the magic wand could be waved and their goal of parity achieved just like that.   It is a case of ropey inputs, ropey outputs, and not much more in the end than a left-liberal feel-good crusade.  Perhaps bankers should stick to banking.

 

Reserve Bank BIM: resisting reform

Michael Reddell Reserve Bank Act reforms, Uncategorized

Once upon a time, post-election briefings to an incoming minister actually contained some free and frank official advice on major policy issues.  I have sitting on my desk the 1987 Treasury briefing  –  almost 800 pages of analysis and advice (good and bad).   But as the briefings started being  routinely published, it seemed to start an inexorable trend towards documents of astonishing banality, often containing little more than lists of the official ministerial responsibilities and/or the activities of agencies (I just flicked through the BIM of one major ministry, released yesterday, and it was a startlingly content-free zone).  If there still is free and frank advice offered by the public service, you won’t often find it in these documents.  It isn’t helped by the growing practice of writing (or finalising) the BIMs only after the composition of the new government is known, rather than in advance of the election.

Reserve Bank BIMs over the years have tended to go in the same banal descriptive direction.  So I didn’t expect to find anything interesting when I opened up the document released yesterday.  But I was wrong.    The (unlawfully appointed) “acting Governor” Grant Spencer had used the opportunity to make his case for minimal change to the governance and decisionmaking provisions of the Reserve Bank Act, including an eleven page appendix on that specific issue.

At the time of last month’s Monetary Policy Statement, Spencer –  and his deputy, Geoff Bascand –  went public on their opposition to any substantial change.  But they did that just in response to press conference questions.   I summed up their position –  “just cement in the status quo, and if we really have to have externals make sure they are silenced and that there is no greater transparency” –  this way

[their] approach is that of “the priesthood of the temple” –  we will tell you, the great unwashed, only what it suits us to tell you, in the form we want to present it.  It is simply out of step with notions of open government, or with a serious recognition that monetary policy is an area of great uncertainty and understanding is most likely to be advanced by the open challenge and contest of ideas.

In the BIM, they go further and stress how keen they are that any external appointments should be made by the Governor rather than –  as is the case in most other advanced democracies –  the Minister.   They were keen to keep any review of the Act very narrow, and to control the process themselves as far as possible

we would be happy to prepare a draft terms of reference, in consultation with the Treasury

Fortunately, they lost that one and the review is being led by The Treasury, supposedly supported by an (as yet unnamed – or unannounced – Independent Expert Advisory Panel).

But it was that eleven page appendix I really wanted to write about this morning.  They describe even it as a “brief summary” and refer to a more detailed version of the paper being available. I have lodged a request for it, without any great expectation of it ever seeing the light of day (it might, for example, have been logical to have released it when the Minister of Finance announced his review –  logical, that is, if the government or Bank were interested in open government).

The Bank’s first claim is that the current system –  a single unelected decisionmaker, appointed by other unelected people –  “works well” at least for monetary policy, and that the Reserve Bank’s monetary policy “is highly regarded internationally”.    In principle, those are two separate points.  It is hard to imagine the Reserve Bank being held in “high regard” internationally for its monetary policy over the last decade –  whatever sentimental respect there still is for the Bank as pioneer of inflation targeting almost 30 years ago.    Our central bank remains the only advanced country central bank to have launched into two tightening cycles since the 2008/09 recession, only to have to fully unwind both of them.   Perhaps it is the sort of mistake anyone might have made, but our Reserve Bank did.    And the Bank has no more successful than anyone else in keeping inflation close to target –  even though, with interest rates still well above zero, it faced fewer obstacles than most.

The one recent report the Bank attempts to use in its defence is a brief one written earlier this year by an old friend of the then Governor.  I wrote about it at the time.

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

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

In a way, what strikes me most about the Bank’s appendix is the near-complete absence of (a) any critical self-scrutiny, and (b) any sense of operating in a society that expects scrutiny and accountability of powerful public agencies, and not just on terms set by those agencies.

For example, they organise their thoughts around the notion that “the objective of decision-making design is to create a system that leads to rigorous decision making”.  I’m not sure which management textbook they got that from, but it doesn’t sound a lot like the way we should organise things  for making public decisions in a democratic society (internal management decisions in a private company might be another matter).  “Rigour” in decisionmaking is certainly important, but when those decision are outward-facing and have pervasive effects across a country, with no rights of review or appeal, it is far from being the only relevant criterion.   “Legitimacy” for example –  an ongoing sense of public confidence that the agency is being well run, in the interests of the public not just of officialdom – matters a lot.  So should openness.  For many year now our statute books have contained this provision (part of the purpose clause in the Official Information Act).

to increase progressively the availability of official information to the people of New Zealand in order—
(i) to enable their more effective participation in the making and administration of laws and policies; and
(ii) to promote the accountability of Ministers of the Crown and officials,—
and thereby to enhance respect for the law and to promote the good government of New Zealand:

Around their centrepiece –  the goal of “rigorous decisionmaking” –  they circle “four key components”

  • institutional design,
  • high quality inputs,
  • genuine deliberation, and
  • accountable for decisions

There is nothing of interest under their heading of “institutional design”.  As they note, the Governor is legally responsible for all Reserve Bank decisions, and although all Governors since 1989 have operated with advisory committees (the form and names have changed over time), in a single decisionmaker model there is only one Reserve Bank view.   However, it is worth noting that the Reserve Bank remains intensely secretive about the range of internal views or advice ever becoming known, in ways that do nothing to support good decisionmaking, let alone robust scrutiny, challenge, and accountability.

On ‘high quality inputs’, the Bank claims that its decisionmaking “is supported by a broad range of high quality inputs”.  Perhaps, but (a) despite the inputs they’ve still made some bad policy mistakes, which should at least raise questions about the inputs (recognising that in a field like monetary policy, riddled with uncertainty, some mistakes are inevitable), and (b) we don’t know, because they hold all the inputs very closely, and refuse to release any, even years later.   Just yesterday, we had the refusal to release their background analysis on the aspects of the new government’s policy they’ve incorporated in their latest projections.  I once wrote a paper with Grant Spencer to the then Minister of Finance in which we referred rather scathingly to one particular proposal as involving “trust us, we know what we are doing”.  These days, unfortunately, Grant seems to treat it as a practical guide to running a central bank (whether on most regulatory matters or monetary policy).

They claim, only briefly, that their current system produces “genuine deliberation”.  Again, how would we know?   They refuse to release the minutes of the Monetary Policy Committee, or of the Governing Committee, they refuse to release a summary of the individual recommendations on the OCR, and they refuse to release the background papers.  Not just in the weeks after a decision, but even years later. I know, I’ve asked.   How robust, for example, were the deliberations around the ill-judged tightening cycle than began in 2014?  In my observation –  I was still involved at the time –  not very.

Then there is “accountability”, which sounds good, but isn’t really.  Of course, they cite the role of the Reserve Bank Board, and its reports to the public and to the Minister. But this is the same Board that will have appointed the Governor and which, in history, has never openly said a remotely critical word about any Reserve Bank decision.   Perhaps in private they do a really good job  –  in my experience, at times some of them (usually the more awkward ones) asked some useful questions –  but that isn’t serious public accountability.  The Board seems to see their role primarily as having the back of the Governor –  how else, for example, did they stay silent in the face of Graeme Wheeler’s deployment of his entire senior management to try to silence Stephen Toplis?   The Bank goes on to claim (correctly) that the Board is given the materials used to lead up to OCR decisions, but then (outrageously) claims that “a subset of this information is made available to the general public”.  In fact, none is at all.    All we get is what the Governor chooses to allow us to see scrubbed up and sanitised in his Monetary Policy Statement, even though all the background material is public information, produced with public money.    They have a very strange definition of accountability at the Reserve Bank.

(As they do every few months, they roll out an academic paper from a few years ago suggesting that on that particular measure, the Reserve Bank is one of the most transparent central banks in the world.  As I’ve noted previously, there is a big difference between telling us a lot about what they know (almost) nothing about –  eg where the OCR might be in 2020 –  and telling us stuff they do know about (their own advice, analysis, range of views etc). They do the former well, and the latter is almost non-existent.)

The Bank then turns to potential modifications to the Act.   The (unlawfully appointed)
“acting Governor’s” preference is simply to codify the current committee (the Governing Committee, consisting at present of the “acting Governor”, the Deputy Governor and the chief economist).

In earlier incarnations of this idea, the proposal was that the members of such a statutory committee would all have formal voting rights.  But even that –  weak advance –  has now gone out the window and the Bank is now arguing to protect the single decisionmaker model, while putting into statute simply a requirement that the Governor have an advisory committee.  Under their proposal the Governor “would be responsible for the manner in which the Governing Committee conducts itself”.

Frankly, this is a worse than useless suggestion.  The Bank claims it would increase transparency around the decisionmaking process. In fact, the effect would be quite the reverse.  For a good Governor it might make no effective difference.  For a bad Governor, it would allow him or her the fig-leaf of being able to claim that decisions were made in (statutory) committee even though (a) the other members had no formal vote, and (b) all members would be appointed by, remunerated by, and accountable to, the Governor.  The Bank simply shows no sign of recognising the institutions need to built to be robust to bad appointees (because, in every human institution, they will happen from time to time).

Interestingly, they are open to the idea of separate committees for monetary and financial policy.  I’ve strongly favoured that, but recall that the sort of committees they propose are advisory only.  In fact, there is nothing to have stopped them putting such committees in place already.  Arguably, it was actually the way things worked before the Governing Committee was established: the Governor made OCR decisions in the OCR Advisory Group, and financial regulatory decisions in the Financial System Oversight Committee.  Those specialist committees still exist (OCRAG renamed as the – formal –  MPC).

We get to the real concerns –  they know they’ve lost the fight over keeping the single decisionmaker model –  when they come to the question of external members, the decisionmaking approach, and the communications.

On externals, they argue

The extent to which policy committees benefit from external members depends on the nature and objectives of the committee and the conditions associated with the external members’ appointment. Policy committees which have to interpret political objectives or indeed establish goals to be achieved should benefit from having external members. In New Zealand, the objectives of monetary policy are clear in the Act, and through the PTA. For prudential policy, the objectives of soundness and efficiency are clear, but their interpretation requires complex judgement.

To which my reaction is “yeah right”.  No one thinks the prudential policy objectives are clear –  in the sense of easily operationalisable.  There are big choices to be made about goals and instruments (eg around use of LVR restrictions). But actually it isn’t much different with monetary policy.  No one seriously regards the PTA as a document that avoids trade-offs, or involves no judgements –  indeed, wasn’t the “acting Governor” only the other day arguing for more flexibility in interpreting the goals?   More generally, they offer no support –  none –  for their claim that there is a special case for external members where goals are relatively more fuzzy.  External members can matter for a range of reasons, including minimising the risk of external groupthink, and helping ensure that a full range of models/perspectives are brought to the table.

They go on.

Policy making in monetary and financial policy often involves complex considerations based on multiple indicators, analytic models and competing economic theories. Full-time members with experience and expertise are likely to be better suited to this task than part-time external participants.

So you say.  But there are two separate issues here.  The first is about expertise (do we need subject experts only, or a range of perspectives) and the second is about whether the job is fulltime or part-time.   In Sweden, for example, most of the monetary policy committees members are outsiders (often academics or former market economists), but they are appointed to non-executive fulltime roles while they are on the committee (weirdly, this leads the Reserve Bank to claim they are insiders).  As for expertise, the Bank still seems to have made no effort to show that the issues it deals with an inherently more complex, or in more need of specialist expertise at the decisionmaking phase (as distinct from technical advice and supporting analysis) than many other agencies of the New Zealand government (which are typically run by part-time boards, appointed by ministers, with a range of backgrounds).  Even among executives, I don’t imagine the chief economist actually spends much time on financial regulatory matters on which he helps the Governor make decisions in the Governing Committee (at best, he is a part-timer non-expert in that area).

I’ve covered previously the Bank’s preference to avoid voting in committees, and (especially) to avoid any public revelation of differences of perspective.  They claim that

Research into decision-making practices finds that consensus is the preferred decision approach as it allows for more in-depth discussions, the frank exchange of views, more accurate judgement on average, and higher committee morale.

But they neither provide any references, nor engage with the practical experiences of various other advanced central banks that seem to have found a voting plus openness model works well –  I’ve noted previously the cases of the UK, the US, and Sweden.    And, as I’ve noted previously, you have to wonder how local councils, Parliaments, and higher courts manage?  The Supreme Court –  rather more important on the whole than the Reserve Bank –  seems to manage with both voting and disclosure of individual views.  The public –  a priority, if not for the Bank –  seems to be better for it.

Perhaps most extraordinary is the Reserve Bank’s assertion around the appointment process.

In New Zealand, the Governing Committee is a “technical” committee created to carry out the purpose and objectives set out in the Act, the PTA and the MoU. The Reserve Bank is the government’s agent in carrying out its monetary, prudential and macro-prudential policy objectives, and we consider it critical that policy committee appointments be made by the Reserve Bank for their policy competence and not through a political body.

I could understand if they thought that “on balance, we think it would be better” to have appointments made by the Bank itself.  But “critical”……….really?

You have to wonder what makes New Zealand so different from most other advanced countries.    In Australia, the Governor and the Deputy Governor are both appointed by the Treasurer.  In the UK, the Governor and the (various) Deputy Governors are appointed by the Chancellor.  In the UK, the members of Fed Board of Governors are all appointed by the President (confirmed by the Senate). In Sweden, the key appointments are made by the parliamentary committee that oversees the Riksbank.

It is a good practice that major policy decisions should be made only by elected people –  and the Reserve Bank can’t surely pretend their decisions aren’t “major”, including having significant redistributive consequences –  and that where any such powers are delegated they should be made by people appointed directly by elected officials.  Typically, such decisions –  like those of the Cabinet –  will actually be made (legally) collectively.  But for some reason –  that they refuse to state –  the Reserve Bank thinks it should be different.  It shouldn’t.   There are plenty of different models of how Reserve Bank goverance should be done, but a system that keeps single decisionmaking, or which has all decisionmakers appointed by the Reserve Bank itself, should simply be ruled out from the start.

As a final point, the Bank includes a table which they use to support a claim that “about two thirds of the monetary policy committees of inflation targeting central banks have external members”.  It is a pretty shonky table.  For example, they class Sweden as having no external members, when (as noted earlier) most members are non-executive (but fulltime) externals.  They seem to make the same mistake for the Czech Republic, which appears to have several fulltime non-executives.  Weirdly, they claim that the ECB has a majority of outsiders –  but they appear just to mean the Governors of the constituent central banks, who are insiders if ever there were.  But perhaps as importantly, I’m not sure that Armenia, Peru, Hungary, South Africa, Thailand, Guatemala –  none beacons of good governance –  are the sorts of places I’d be looking to for guidance in structuring a robust and accountable decisionmaking system for the central bank.    Not all of the more advanced countries do have externals on their monetary policy decisionmaking committees, but Australia, Norway, Sweden, the US, the UK, Israel, Iceland, Japan, and Korea do.  And of all those advanced countries, only New Zealand and Canada have the sort of single decisionmaker system that the Reserve Bank wants to maintain.

South Africa –  an embattled central bank, facing the increasing prospect of political interference –  doesn’t have externals, but I did find this nice quote on their website

In monetary policy decision-making processes, committees are preferred above individuals. Not one central bank has replaced a committee with a single decision-maker, a fact that has both theoretical and empirical support; the ability to draw diverse viewpoints from constituent members in committees ensures that there is likely to be some moderation of extreme positions and policies and more even policymaking.

Indeed.  We shouldn’t let the Reserve Bank keep such a flawed system, even gussied up with a statutory advisory committee appointed by the Governor himself.   Other countries don’t do it that way –  and our Reserve Bank has far more power than most central banks because of its regulatory functions –  and hardly any other government functions in New Zealand are run that way.

It was good that the Bank included this material in its BIM, rather than just quietly slipping it to the Minister of Finance in a document we didn’t know existed.  It would be better still if they now released the full version of the document making their case. At present, that case is looking pretty threadbare, not informed by either good comparisons or a strong recognition of what open government should look like, and –  if anything –  designed to serve the interests of career bureaucrats rather than of the public.  That’s not too surprising: bureaucrats typically do what they can to protect their bureau.  But it doesn’t make it a good basis for public policy.

As for the Minister of Finance, perhaps he could take a stronger lead by (a) encouraging the Bank to release the fuller paper, (b) ensuring that Treasury releases the Rennie report on similar issues (and associated supporting documents) and (c) actually named the Independent Expert Advisory Panel supposedly playing a key role in the current Treasury-led review of the relevant provisions of the Reserve Bank Act.

As non-transparent, and obstructive, as ever

Michael Reddell Monetary policy, OIA, Uncategorized

Just when you think there are the occasional promising signs that the Reserve Bank might, perhaps, be becoming a little more open…….they come along and confirm that they are just as secretive as ever.

At the last Monetary Policy Statement, the Reserve Bank indicated that it had made allowance for four (and only four) specific pieces of the new government’s policy programme.   They provided no details, beyond the barest descriptions, even though these assumptions fed directly into their projections and to the “acting Governor’s” OCR decision.  In one specific example, they indicated that they had assumed that half the planned Kiwibuild houses would displace private sector housebuilding activity that would otherwise have taken place.   That assumption directly feeds into their forecasts of resource pressures, but is also quite politically sensitive.  You might suppose that in an open democracy, a public agency that came up with such estimates would publish their workings, at least when a formal request was made.

You’d be quite wrong.  I lodged a request a few weeks ago, asking for “copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions”.  I wasn’t asking for emails back and forth between staff, and I wasn’t even asking for the minutes of meetings where these papers were discussed.  I certainly wasn’t asking for copies any other government department or minister might have supplied them.  Just the analysis and related background papers the Bank’s own staff had done.

In response –  having taken several weeks of delay –  they didn’t redact particularly sensitive items, they simply withheld everything (down to an including the names of the papers concerned).   This is, it is claimed, to “protect the substantial economic interests of New Zealand”, a claim which is simply laughable.  Protecting senior officials of the Reserve Bank from scrutiny is not, even approximately, the same thing as protecting the “substantial economic interests of New Zealand”.  It might even be less intolerable conduct if they had laid out the gist of their reasoning in the MPS itself.  But they didn’t.

Of course, it is par for the course from the Reserve Bank.  They consistently refuse to release any background papers related to the MPS, no matter how technical they might be, or how high the degree of legitimate public interest (I did once get them to release such papers from 10 years ago).  They simply have no conception of the sort of open government the Official Information Act envisages.

Reform –  including opening up the institution –  is long overdue.  I do hope that the Minister’s review of the Act is going to address these issues seriously.

And in the meantime you and I –  citizens, taxpayers, who paid for this analysis –  are left none the wiser as to why, say, the Bank thinks a 50 per cent offset is the right assumption for Kiwibuild.  Perhaps it is, perhaps it isn’t, but the debate –  including around monetary policy –  would be better for having the workings in the public domain.

I was tempted to reuse my “shameless and shameful” description from yesterday, but that might a) overstate slightly the true importance of this particular issue, and (b) is a description better kept today for the Prime Minister and her willed blindness to the issues around China’s interference in the domestic affairs of New Zealand.  Anything for an FTA extension, nothing for protecting the democratic institutions and values of New Zealanders.

Full letter from the Bank below.

Dear Mr Reddell

On 16 November you made an Official Information request seeking:

copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions about the impact of four specific policies of the new government (minimum wages, fiscal policy, immigration, and Kiwibuild), as published in last week’s Monetary Policy Statement.

The Reserve Bank is withholding the information for the following reasons, and under the following provisions, of the Official Information Act (the OIA):

  • section 9(2)(d) – to avoid prejudice to the substantial economic interests of New Zealand;
  • section 9(2)(g)(i) – to maintain the effective conduct of public affairs through the free and frank expression of opinions by or between officers and employees of the Reserve Bank in the course of their duty; and
  • section 9(2)(f)(iv) –  to maintain the constitutional convention for the time being which protects the confidentiality of advice provided by officials.

You have the right to seek a review of the Bank’s decision under section 28 of the OIA.

Yours sincerely

Roger Marwick

External Communications Adviser | Reserve Bank of New Zealand | Te Pūtea Matua

2 The Terrace, Wellington 6011 | P O Box 2498, Wellington 6140

  1. + 64 4 471 3694

Email: roger.marwick@rbnz.govt.nz  | www.rbnz.govt.nz

 

More excuses for a job not well done

Michael Reddell Monetary policy, Uncategorized

It is another glorious day in Wellington –  I always reckoned a 2 degrees warmer Wellington would be a good thing – and there is Christmas shopping to do, but I couldn’t let the latest speech from the Reserve Bank go by without comment.

It is presented as a speech by “Reserve Bank Governor Grant Spencer”.   Fortunately, most of the media haven’t fallen for that line –  which they’ve tried on in a number of recent documents.   If Spencer is anything, he is “acting Governor”, and no more.

How do I know?  Because Parliament was quite clear that

The Governor shall be appointed for a term of 5 years

And when he appointed Spencer, Steven Joyce was quite clear that the appointment was for six months only.   He only ever claimed to be appointing an “acting Governor”  –  who can, under certain conditions, be appointed for only up to six months.

As it happens, even that appointment is almost certainly unlawful.  The Act is also pretty clear that an acting Governor can only be appointed when a Governor leaves office before his or her term has expired.   That wasn’t the case here.  In other circumstances, the Minister and the Board are simply expected to get on and make a permanent appointment, so that a new permanent appointee can take office when the previous appointee’s term expires (a date known, in this case, for the previous five years).  It might not be ideal phrasing, but it is the law, and if there was a problem –  as there was in the case, around the election –  either the law needs to be worked within, or to be changed by Parliament.

But we now have the strange situation where the Minister who appointed him thought Spencer was acting Governor, while Spencer himself now seems to purport to be –  not just have the powers of  – Governor.  As I’ve been doing for the last couple of months, I will continue to describe him only as “acting Governor”, or “the economist purporting to be acting Governor”.

Whatever his label, there is a bit of sense of relief that Graeme Wheeler is gone and that Spencer –  someone well-liked and generally more open –  is minding the store.   But his speech earlier this week, on monetary policy and the challenges of low inflation, still left a great deal to be desired.  I suspect it wasn’t intended this way, but in practice it amounts to not much more than excuses for not keeping inflation near target for the last five years, partly by attempting to obscure a New Zealand debate with the (somewhat different) issues some other advanced countries face.  And, of course, whatever the merits of Spencer’s views, he’ll be gone in little over three months and as yet we have no idea who the new single decisionmaker will be (let alone who will eventually serve on the new statutory monetary policy committee to be put in place next year).

There is some interesting stuff in the speech though.  Most notable perhaps was the number of references to unemployment.  Often enough Reserve Bank monetary policy documents mention it barely at all –  the Bank even tried to displace it with a new (but sadly ill-fated) labour market capacity indicator of its own devising.  For decades, the capacity variable in the Bank’s inflation models was (its estimate of) the output gap, and there were typically lots of references to it in speeches or Monetary Policy Statements.  

But in Spencer’s speech –  his first as “acting Governor”, and the first under the new government – there is but one reference to the output gap (and then only in abstract terms) and 17 references to “unemployment”.    And to think that some people reckon it doesn’t make much difference who is appointed Governor.

But the odd thing is that much of the speech is devoted to making the case that the unemployment rate (itself) hasn’t been much help in explaining inflation in recent years.  Which might be true, to some extent, but so what (at least when considering events of the last decade)?  After all, for years the Bank told us they didn’t put much weight on the unemployment rate, didn’t think they could fix on a NAIRU etc etc, and that we really should be focusing –  as they did –  on the output gap and a broader suite of high-tech capacity indicators.    It might even –  if valid –  be an argument for not putting too much specific focus on a specific or precise unemployment rate in the new monetary policy regime the government envisages –  but that isn’t the case Spencer makes, and weirdly he suggests that the Bank is already (since when?) putting more weight than previously on employment indicators.  It isn’t very coherent, in a New Zealand context.

This chart ran in the recent Monetary Policy Statement (when I didn’t get round to commenting on it) and it appears again in Spencer’s speech.

GS speech 1

It is the sort of chart the word “chutzpah” might have been invented for.  They use it to try to suggest that much of the advanced world is “stuck” in a situation in which the unemployment rate is below the sustainable rate (a NAIRU) and yet inflation is also below target.

There are a number of odd things about the chart.  For example, they include three separate observations for Germany, the Netherlands, and France, even though all three are in a common currency (and thus common monetary policy) area.  And surely it would have been more enlightening to include the other advanced countries with independent monetary policies (eg Norway, South Korea, Israel, Iceland?  There is also no place at all for inflation expectations in the story the Bank is trying to tell in the chart.

But the biggest, most obvious, omission is New Zealand.  And where would New Zealand fit on the chart?  Well, core inflation is about half a per cent below target and on most estimates –  even on the most recently quarterly unemployment observation (4.6 per cent) –  the unemployment rate is still above an estimate of the NAIRU.    If these relationships hold at all, there are lags, and the average unemployment rate for the last four quarters was 4.9 per cent.  By contrast, before the major revision downwards to the HLFS unemployment rate last year, the Reserve Bank had a NAIRU estimate of 4.5 per cent in its models (a part of that model that had no implications for the inflation forecasts), and after those revisions, Treasury published estimates suggesting they thought the NAIRU was now nearer 4 per cent.   In other words, for now at least, New Zealand still belongs in the bottom right quadrant of the Reserve Bank chart, the one in which there isn’t much of a mystery or puzzle at all: with inflation below target and unemployment above a NAIRU, a typical response  –  in an inflation-targeting framework –  would be to cut the OCR.    Switzerland and France can’t do that –  Swiss interest rates are already negative, and France can’t control interest rates  –  but New Zealand could.  It is just that the Reserve Bank chose not to.

In the chart the Bank uses OECD estimates of the NAIRU.  That is understandable –  they are the only consistent cross-country estimates I’m aware of –  but not one without its problems.  For example, somewhat unusually, the OECD thinks the New Zealand NAIRU this year is still in excess of 5 per cent.   Then again, if you believe the OECD’s estimates, unemployment in New Zealand has been below the NAIRU for almost the entire 21st century so far (rising just very slightly above only in 2009, 2010, and 2012).  It simply doesn’t ring true.

nairu less U

The Reserve Bank’s next chart in this area is this one

GS speech 2

The suggestion is that there was a relationship between unemployment and inflation in the 2000s (when they also didn’t use the relationship), but that it has disappeared (for now at least) in the last few years.

Given that the relationship (even in the previous decade) wasn’t tight by any means, and many of the higher inflation numbers related to things –  eg oil shocks and short-term exchange rate movements –  that didn’t have much to do with New Zealand unemployment rates, I didn’t find the chart overly persuasive.   Moreover, since everyone recognises that the NAIRU changes over time –  with things like demographics, labour market regulation, some hysteresis etc –  even the theoretical relationship shouldn’t be with the unemployment rate itself, but with the gap between the NAIRU and unemployment rate.    I suspect the Bank is currently feverishly working on a suite of time-varying NAIRU estimates –  to reflect the new government’s interest –  but there is no hint of those in this speech.

Ideally, one might want to look at something more like an unemployment gap estimate against deviations of core inflation  from target (what the Bank was trying to do, in a snapshot) for other countries in the first chart).  As I’ve already said, I don’t have any confidence in the OECD’s levels estimates of the New Zealand NAIRU, although the changes in the associated gap from year to year might not be too bad.    For now, it is all I have.

So in this chart, using annual data (all we have for the unemployment gap) I’ve shown the deviations  of sectoral core factor model inflation from the midpoint of the inflation target and the OECD estimate of the unemployment gap from 1993 (when the core inflation data start) to 2016 (each dot is one year’s data).

GS speech 3

Even including the most recent years (the furthest left observations) there is still a relationship there, albeit not a very tight one.    Then again, it wasn’t very tight –  although a bit more upward sloping –  when I deleted those most recent years.  No doubt the Bank could –  and perhaps is doing so privately –  do this sort of analysis in a more sophisticated way.

I’m not suggesting there are no puzzles about New Zealand’s inflation performance in the last few years.    But simply plotting the raw unemployment rate (and not even looking at, say, the underutilisation rate or the gap) against headline inflation isn’t going to tell you much –  we aren’t in 1958 now (when Phillips wrote)  and, apart from anything else, inflation expectations matter.

For the last couple of years, the Bank has consistently tried to tell a story of how inflation expectations are firmly anchored at the 2 per cent midpoint of the inflation target.   That has always been a questionable proposition, especially as regards the sorts of expectations that might affect wage and price setting behaviour.     Their favoured two-year ahead measure of inflation expectations is now around 2 per cent, but a decade ago it was averaging almost 3 per cent.  Household inflation expectations are also lower than they were.  Again, that isn’t very surprising because a decade ago the Reserve Bank wasn’t seriously aiming to deliver inflation at 2 per cent (the target midpoint): we might have been happy enough to take it if inflation had got there of its own accord, but our projections (the Governor’s choice) rarely showed inflation dropping below 2.5 per cent any time soon.  Actual core inflation was up around 3 per cent.

And these days?  Well, core inflation hasn’t been anywhere near 2 per cent for years now –  persistently below.  And although the Bank consistently talks of getting inflation back to 2 per cent, it hasn’t done so, and for several years consistently erred on the hawkish side, with constant talk of wanting to “normalise” interest rates, and actually following through on an unnecessary and ill-judged tightening cycle.   Even now, “normalisation” got a lot of attention in last week’s FSR (although mercifully absent from the speech), and the Bank constantly talks about not wanting to act aggressively to get inflation back to target.  Any rational observer would not only assume inflation will be materially lower than it was, but that the Bank is quite relaxed about that (it more or less says so).  The practical target isn’t really 2 per cent –  any more than it was, on the other side, 10 years ago – but something a bit lower.

The Bank must hate data from the inflation-indexed bond market (because it never engages with it in any of its publications), but the gap between indexed and conventional bonds is not inconsistent with my story.     Interpreting that data in fine detail isn’t easy. For a long time, we had only a single indexed bond (matured in Feb 2016), and by late in its life headline inflation (eg the GST change in 2010) mattered much more than the medium to long-term outlook).  These days there are several indexed bonds, but they have fixed maturity dates while the Reserve Bank’s published “10 year bond rate” has, in effect, a maturity date that moves through time.

But consider this chart, showing the gap between yields on successive indexed bonds and the conventional 10 year bond rate.

IIB expecs to dec 17

In the years prior to 2008 (when the indexed bond still had 10 years to run), the implied inflation expectation was around 2.5 per cent.   As noted earlier, that wasn’t too far from how we were running things in practice.   What of now?  It is late 2017, so 10 years from now is roughly half way between 2025 and 2030, the two indexed bond maturity dates either side of 2027.   In November, the average gap between orange and grey lines was 1.3 per cent, and for the year to date the average gap has been 1.2 per cent.

No doubt, there are all sorts of idiosnycratic things going on, so these breakeven inflation rates may not be “true” inflation expectations (as, for example, they weren’t in the midst of the crisis in 2008).  There are, for example, a lot of inflation bonds on the market, and it is possible that Treasury has somewhat glutted the market.    My point simply is that if one wants to make sense of relationships between unemployment (or other capacity measures) and core inflation over the Wheeler years, it is wilfully blind to simply ignore a story about changing inflation norms.

The next chart is just a rough and ready thought experiment.  What if, when Graeme Wheeler took office in September 2012, inflation expectations were genuinely about 2 per cent, and people really thought that was what the Reserve Bank was serious about.  The indexed bond yields –  rough and ready as they are –  suggest that isn’t wildly implausible.  And, say, now people really think the target (for sectoral core inflation) is more like 1.3 per cent –  the most recent actuals are 1.4 per cent.  Then the chart just shows the relationship (using quarterly data) between the unemployment rate and the gap between actual core inflation and an implied target taken by interpolating from 2 per cent in 2012 to 1.3 per cent now.

GS speech 4

I”m not suggesting that is the “true” relationship, but it looks like an idea worth taking more seriously than the Bank has thus far been willing to do in public. After all, expectations adjust gradually in most circumstances.  It seems negligent, or deliberately obtuse, not even to engage with the possibility.

After all, the “acting Governor” –  I almost slipped there and initially typed it as Governor – ends his speech with the suggestion that

To the extent that the leverage of monetary policy over domestic inflation may have reduced, this suggests a cautious approach when responding to inflation deviations from target and careful attention to our assessment of economic slack. It may be appropriate for monetary policy to put relatively more weight on output, employment and financial stability relative to inflation.

Why wouldn’t a reasonable observer conclude that the Bank isn’t really targeting 2 per cent (although it might be happy enough to get there by accident) and continue to adjust their expectations and behaviour accordingly.

With a new government planning to revise the Bank’s mandate to increase the Bank’s focus on employment/unemployment, Spencer’s line would almost be some sort of sick joke if it weren’t so serious.    When the unemployment rate has been above New Zealand estimates of a NAIRU for nine years, and when the economic recovery (average growth in real per capita GDP) has been so muted, you might reasonably suppose that the government would have been expecting the Bank to do its job more energetically –  which would involve getting inflation back to target, and in the process finally delivering an unemployment rate around the (unobservable NAIRU) and even a bit faster real GDP growth.  But Spencer –  with no mandate whatever, but presumably with the support of his colleagues, Bascand and McDermott –  wants to tell us that their idea of putting more focus on “employment and output” than in the past has been to deliberately deliver such weak cyclical outcomes –  ie deliberately accept higher unemployment/lower employment than is strictly necessary.  And the implicit promise is more of the same to come, at least if people like them are left in charge.  I hope the Minister of Finance is paying attention, and that his recent talk of possibly removing the midpoint reference from the PTA wasn’t a sign that he has begun to buy into this Wheelerish mentality (even if given a glossed up public face by his colleagues now that they are minding the store).