Why so secretive?

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

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.