Year: 2017

Why are NZ interest rates so persistently high (Part 2)?

Michael Reddell Interest rates, New Zealand economic performance, Uncategorized

In Friday’s post, I illustrated how persistent and large the gap between New Zealand long-term interest rates and those in other advanced countries has been (and remains).  The summary chart was this one

real NZ less G7

The gap is large and persistent whichever summary measure of other countries’ interest rates one looks at.

It is also there for short-term interest rates.  In this chart, I’ve shown average real short-term interest rates for the OECD monetary areas (17 countries with their own monetary policies, plus the euro-area) for the last 10 years, adjusting average nominal interest rates for average core inflation (the OECD reported measure of CPI inflation ex food and energy).

real short-term int rates oecd

Of the countries to the right of the chart, Iceland and Hungary have had full-blown IMF crisis programmes in the last decade, and Mexico and Poland had precautionary programmes.  That isn’t meant to suggest that New Zealand is crisis-prone, just to highlight how anomalous our interest rates look relative to those of the other more-established advanced economies.

In yesterday’s post I reviewed some of the arguments sometimes advanced to explain why New Zealand interest rates have been persistently higher than those in other advanced countries.   As I noted, these factors don’t look like a material, or compelling, part of the story:

  • size (of the country),
  • (lack of) economic diversification
  • market liquidity,
  • creditworthiness,
  • accumulated external indebtedness,
  • unusually rapid productivity growth

And, as I noted, none of those explanations has as a corollary a persistently strong real exchange rate.  A story that can make sense of New Zealand’s persistently high real interest rates needs to be able to make sense of the persistently strong exchange rate, and also of New Zealand’s persistently poor productivity performance.  As it is, in a country with a poor productivity performance and the disadvantages of remoteness, one might have expected to find persistently low interest rates and a persistently rather weak exchange rate.

At an economywide level, interest rates are about balancing the availability of resources with the calls on those resources.  In principle, they have almost nothing to do with central banks –  we had interest rates millennia before we had central banks.  They also don’t have anything necesssarily to do with “money”, except to the extent that money represents claims on real resources.

In any economy with lots of exceptionally attractive and profitable opportunities, firms will be wanting to do a lot of investment.  Resources used for investment today might well generate really strong returns in the future, but those resources can’t also be used for consumption (or producing consumption goods) today.  Interest rates play the role prices typically do –  acting as “rationing device”.  Higher interest rates today make some people willing to consume a bit less now, and they also help ensure that the only the investment projects with the higher expected returns go ahead.    In other words, interest rates help reconcile savings and investment plans.  (If they couldn’t adjust that way, the price level would do the adjustment –  and that is where central banks these days come in, adjusting the actual short-term interest rate to reconcile savings and investment plans while keeping inflation in check).

Sometimes the strong desire to undertake investment projects will be based on genuinely great new technologies.    Sometimes it might be just based on a pipe-dream (credit-fuelled commercial property development booms are often like that).   Sometimes, it will be based on direct government interventions (one could think of the Think Bg energy projects).  And sometimes, it will simply be based on rapid population growth –  people in advanced economies need lots of investment (houses, roads, shops, offices, schools etc).

Various factors can influence the desire to save.   If firms in your country have developed genuinely great new technologies, it may seem reasonable to expect the future incomes will be a lot higher than those today.  If so, it might be quite rational to spend heavily now in anticipation of those income gains (consumption-smoothing).  Some governments tend towards the spendthrift, and others towards the cautious end of the spectrum.  Tax and welfare rules might affect desire and willingness to save (although my reading of the evidence is that they affect more the vehicles through which people choose to save).   Demographics matter, and compulsion may also play a part.    Culture probably matters, although economists are often hesitant about relying on it as an explanation.  Business saving is often forgotten in these discussions, but can be a significant part of total savings.

But if, for whatever reason, people, firms and governments don’t have a strong desire/willingness to save at “the world interest rate”, then (all else equal) interest rates in your country will tend to be a bit higher than those in other countries.   And if firms, households and governments have a strong desire to invest (building capital assets) at “the world interest rate”, then (all else equal) interest rates in your country will also tend to be a bit higher than those in other countries.      Quite how much higher might well depend on how interest-sensitive that investment spending is (in aggregate).

Of course, we don’t get to observe actual supply curves for savings, or demand curves for investment.  We don’t know how much New Zealanders (or people in other countries) would choose to save or invest at “the world interest rate”.  Instead, we have to reason from what we do see –  actual investment (and its components) and actual savings.

Take savings rate first (and by “savings” here I mean national accounts measure –  in effect, the share of current income not consumed).  Net national savings rates in New Zealand have been similar, over the decades, to the median for the other (culturally similar) Anglo countries, but lower typically than in advanced (OECD) countries more generally.  Savings rates are somewhat cyclical, but as this chart illustrates, for some decades now they’ve cycled around a fairly stable mean (through big changes in eg tax policy, retirement income policy, fiscal policy, financial liberalisation etc).

net national savings.png

All else equal, if tomorrow we woke up and found that somehow New Zealanders had a much stronger desire to save then our interest rates would fall relative to those in the rest of the world.   But that is an illustrative thought-experiment only, not a basis for direct policy interventions.  A relatively low but stable trend savings rate over a long period of time –  especially against a backdrop of moderate government debt –  suggests something more akin to a established feature of New Zealand that policy advisers need to take account of.   A different New Zealand economy might well feature a higher national savings rate –  more successful firms, wanting to invest more heavily over time to pursue great profit opportunities, retaining more profits to reinvest –  but that would be an outcome of a transformed economic environment, not an input governments could or should directly engineer.   Higher saving rates are not, automatically, in and of themselves, “a good thing”.

By the same token, if we all woke tomorrow and (collectively) wanted to build less physical capital (“invest less” in national accounts terminoloy), our interest rates would fall relative to those in the rest of the world.  Actually, that is roughly what happens in a recession: pressure on scarce resources eases and so do interest rates (central banks typically helping the process along).  But less (desired) investment is not, in and of itself, “a good thing”.   Nor, for that matter, is more investment automatically desirable – in the last 40 years, investment/GDP was at its highest in the Think Big construction phase.

Whether over the last 40 years, or just over the last decade, investment/GDP in New Zealand has been very close to that of the typical advanced country.  On IMF data, investment/GDP for 2007 to 2016 averaged 22.0 per cent in New Zealand, and the median advanced country had investment as a share of GDP of 22.1 per cent.

But these investment shares for New Zealand happened with (real) interest rates so much higher than those in the rest of the world.  As I noted earlier, we can’t directly observe how much investment firms, households and governments would want to have undertaken at the “world” real interest rate –  perhaps 150 basis points lower than we actually had.

We might, however, reasonably assume that desired investment would have been quite a bit higher than actual investment.  Both because some investment –  whether by firms, households or (more weakly) government –  is interest rate sensitive, and because we’ve had much more rapid population growth than the typical advanced economy.   In the last 10 years, the median advanced country has had 6 per cent population growth, and we’ve had 13 per cent growth in population.   More people need more houses, shops, offices, road, machines, factories, schools etc.    All else equal, with that much faster population growth we’d have expected more investment here (as a share of current output) than in the typical advanced economy.  But all else isn’t equal, because our interest rates are so much higher.   That population-driven additional demand is one of the reasons why interest rates have been so much higher than those abroad.  Combine it with a modest desired savings rate, and you have pretty much the whole story.

As I noted earlier, some investment is more readily deterred by higher interest rates than others (“more interest-elastic” in the jargon).    Most of government capital expenditure isn’t –  government capex disciplines are pretty weak, and if (say) there are more kids, there will, soon enough, be more schools.  And more people will mean more roads.  A lot of household investment isn’t very interest-sensitive either: everyone needs a roof over their head and (by and large) they get it.    With a higher population growth rate than other countries, on average we devote a larger share of real resources to building houses than other advanced countries typically do (albeit less than might occur with well-functioning land markets).  Business investment is another matter altogether.  Businesses only invest if they expect to make a dollar (after cost of capital) from doing so.  All else equal, increase the interest rate and less investment will occur.  That won’t apply to all sectors, because in the domestically-oriented bits of the economy not only are interest rates higher, but the underlying demand is higher (more people).  And so non-tradables sector investment probably isn’t very materially affected.  But for the bits of the economy exposed to international competition (whether exporting, competing with imports, or supplying firms that do one of those) it is a quite different story.  An increased population here doesn’t materially increased demand, and a higher cost of capital makes it harder to justify investment in the sector.

And all that is before even mentioning the exchange rate.

In an open economy, the floating exchange rate system is what allows countries to have different (risk-adjusted) nominal interest rates.  Without a floating exchange rate, higher interest rates here would offer a “free lunch”, and the interest rate differences wouldn’t last.   With a floating exchange rate, one can have differences in interest rates across countries, but the exchange rate adjusts such that, overall, expected returns are more or less equal across markets.  Higher interest rates here are, roughly speaking, offset by an implicit expectation that one day our exchange rate will fall quite a lot.  It appreciates upfront, to create room for that future depreciation.

The exchange rate, of course, also serves as a “rationing device”.    Some of the high domestic demand spills over into imports.  And the higher exchange rate makes exporting less profitable, all else equal.  And so when we have domestic pressures (savings/investment imbalances at “world” interest rates) that put upward pressure on our interest rates, not only is business investment in general squeezed, but the squeeze falls particularly on potential investment in the tradables sector.  Firms in (or servicing) that sector face a double-whammy: a higher cost of capital, from the higher real New Zealand interest rates, and lower expected revenues as a result of the higher exchange rate.

We don’t have good data on investment broken down between tradables and non-tradables sectors. But we do know that overall business investment as a share of GDP has been towards the lower quartile among OECD countries (whether one looks back one, two, three or four decades), even though we’ve had faster population growth than most.  We also know that there has been no growth at all in tradables sector real per capita GDP since around 2000, and we know that the export share of GDP has been flat for decades (even though in successful economies it tends to be rising).   Those stylised facts are strongly suggestive of a situation in which:

  • lots of government investment takes place (market disciplines are weak),
  • lots of houses get built (even if not enough –  because people need a roof over their heads),
  • a fair amount of investment occurs in the non-tradables sectors, despite the high interest rates, but
  • a great deal of potential investment in the tradables (and tradables servicing) sectors has been squeezed out.

That is, roughly speaking, how we end up with rapid population growth and yet an investment share of GDP that is no different from that of a median advanced economy.  We know that population growth seems to adversely affect total business investment across the OECD (I ran this chart a few months ago)

Bus I % of GDP

And it is surely only commonsense to reason that tradables sector investment will have borne a lot more of the brunt than the non-tradables sectors.

I’m not getting into the details of immigration policy in this post.  Suffice to say that our immigration policy –  the number of non-citizens we allow to settle here –  is the single thing that has given New Zealand a population growth rate faster than that of the median OECD/advanced country in the last 25 years or so.  It is, solely, a policy choice.  Our birth rate is a little higher than that of the median advanced country, but we have a large trend/average outflow of New Zealanders.  So, on average, the choices of individual New Zealanders would have resulted in a below-average population growth rate (again, on average over several decades).  And that, in turn, would seem likely to have delivered us rather low real interest rates and a lower real exchange rate.  Real resources would have been less needed simply to meet the physical needs of a rising population, and more firms in the tradables sectors would have been able to have overcome the disadvantages of distance. And our productivity outcomes –  and material living standards – would, as a result, almost certainly have been better.

You can read about all this at greater length in a paper I did for a Reserve Bank and Treasury forum on the exchange rate and related issues back in 2013.

Why are NZ interest rates so persistently high (Part 1)?

Michael Reddell Interest rates, New Zealand economic performance

On Friday, I illustrated (again) just how large and persistent the gap between New Zealand’s long-term interest rates and those in other advanced countries has been.   If anything, that gap has been larger in recent years (say, since 2009/10) than it was in the previous decade, but there has certainly been no sign of the gap shrinking.    It is at least as large now as it was 20 years ago.

Previous posts have illustrated that the gap is large and persistent however one cuts the data.  It exists whether one looks just at the big advanced economies (my charts on Friday focused on G7 countries) or just at the small ones (places like Norway, Sweden, Switzerland, and Israel).  Short-term interest rates are more variable than long-term ones, but on average the gap exists in short rates as well as long rates.  (If you aren’t convinced of the relationship between short and long rates, here are the average short and long-term interest rates for the last decade for each of the 18 OECD monetary areas –  ie countries with their own monetary policies, plus the euro-area as a bloc).

short and long term rates OECD

(The country on the far right of the chart is Iceland.)

Today’s post and tomorrow’s are about why those large and persistent gaps exist.  They will repeat material I’ve covered in earlier posts over the years, but readers come and go, old posts can be hard to find, and the issue hasn’t shown any signs of going away.   Much of today’s post is about a process of elimination: clearing away various possible explanations that, on my reading of the evidence, don’t take us very far.

10 years ago, the Reserve Bank wrote a short paper on exactly this issue.  It was part of our submission to the inquiry being undertaken into monetary policy by Parliament’s Finance and Expenditure Committee.   I wrote the paper, but it was of course signed out by the powers that be, including the then Governor Alan Bollard and his deputy Grant Spencer.  Rereading it this morning, I don’t now agree with every word of that earlier document –  partly because my own thinking has gone beyond where we had got to then – but it still does a good job of laying the foundations.  I’d be surprised if today’s Reserve Bank sees any reason to disavow that 2007 interpretation.

In writing the earlier paper, one of our main concerns was to distinguish between things the Reserve Bank could sensibly be held responsible for and things that really had little or nothing to do with us.   In particular, so we argued, the Reserve Bank sets the OCR, and expectations about the future OCR affect longer-term interest rates, but that does not mean that over prolonged periods of time the Reserve Bank gets to decide the average level of real interest rates in New Zealand.

In a mechanical sense, then, if short-term interest rates are persistently higher than those in other countries it is because the Bank put them there. However, the OCR is not set arbitrarily. Rather, the Bank looks at actual inflation outcomes, and at all the data on the outlook for inflation, before setting the OCR with the aim of keeping inflation comfortably inside the target range over the medium-term. If the Reserve Bank was consistently setting the OCR too high, we would expect over time to see inflation averaging towards the bottom end, or perhaps below the bottom, of the target range. In fact, inflation has consistently averaged in the upper half of successive target ranges – this decade, for example, inflation has averaged 2.6 percent. If monetary policy had been set consistently too tight, the solution would be easy. But there is no sign of that.

It has, at times, been argued that New Zealand’s inflation target was too ambitious and that this might explain why New Zealand’s interest rates have been persistently higher than those in other countries. In the early years of inflation targeting, our inflation target was lower than those in other countries, but …… our target (midpoint at 2 percent) has been firmly in the international mainstream. The most common developed country inflation target (actual or implicit) is around 2 percent. ……there is no convincing reason why achieving an inflation target of around 2 percent should, over time, be any more demanding in New Zealand than it is in other developed countries.

One thing has changed since then.  (Core) inflation has been averaging a bit below the target midpoint, but even so the average inflation rate here over the last five or ten years has been very similar to that in the typical (median) advanced economy.    Monetary policy settings that have been a bit tighter than necessary can, at most, explain only a small part of the average gap between New Zealand and international interest rates (nominal and real).

As we pointed out 10 years ago, credit risk wasn’t a compelling explanation either.    That story feels even more robust today than it did then.    Our government finances aren’t the very strongest in the entire OECD, but they are among the best.   And the negative net NIIP position (the net indebtedness of all New Zealand entities to the rest of the world) is smaller, as a share of GDP, than it was 10 years ago.  Plenty of observers worry about high levels of private sector credit but (a) as a share of GDP it isn’t much different now than it was 10 years ago, and (b) the crisis literature tends to worry more about quick increases in debt ratios at least as much as high levels.

(Small) size isn’t really much of an explanation either.   There are a couple of possible strands to a story about size.  The first would be something about secondary market liquidity.  The New Zealand government bond market is tiny in comparison to those of, say, the United States, Japan, France, Italy, or even Germany.   That makes it difficult, or expensive, to offload a very large position, and might (in principle) given rise to an additional “illiquidity premium” in our long-term interest rates.

In practice, it doesn’t seem likely to be a material part of the explanation.  Over the last decade, for example, our real interest rates have been about as much above those of the small well-managed OECD countries as they have been above those of the G7 countries.   And the “illiquidity premium” is a story that should apply to bond rates more than to overnight rates and yet over the last few decades our short-term rates have been higher relative to our long-term rates than has been the experience of most other advanced countries.  Over the last decade, interpreting that relationship has been made more difficult as many other countries had short-term rates near-zero and felt unable to take them any lower even if they’d wanted to.    But even over the last decade, there has been no sign that New Zealand’s long-term interest rates have been surprisingly high, given where short-term rates were.

I covered off another possible small country story in a post last November

There is another possible story which hasn’t really entered the mainstream of the New Zealand debate, but should be covered off for completeness.  It notes that New Zealand is a small country, with quite a volatile terms of trade, and that the currencies of such countries offer less-good diversification opportunities, suggesting that anyone investing here would require a higher return than elsewhere.  It sounds initially plausible, but it has a number of problems.  The first is that our interest rates have been persistently higher than those in other not-large countries with their own currencies ……  And the second is that if this were an important channel, it would suggest that small countries face a higher cost of capital than large ones, which would limit the growth prospects of small countries.  But (badly as New Zealand specifically has done) there is no real sign that small countries typically grow (per capita, or per hour worked) more slowly than large ones.  At present, I don’t think it is a particularly strong candidate to explain New Zealand’s persistently high interest rates.  Apart from anything else, if this were the story, why would New Zealand have accumulated –  and maintained – such a large negative net international investment position (NIIP) (still among the largest of the OECD countries)?

Monetary policy doesn’t explain the gaps, and neither do size or credit risks considerations.  Here was the Reserve Bank summary a decade ago

Standing back, it seems unlikely that factors such as credit risk, size and market liquidity help very much at all in explaining the persistent gap between our real interest rates and those in other developed countries. Apart from anything else, if these factors were (collectively) an important influence, we would expect to see New Zealand firms and household taking on less debt than those in other countries. In fact, of course, one of the well-recognised facts about New Zealand is that our households are highly indebted by international standards, and that the nation as a whole has been unusually willing to borrow, and raise equity capital, from abroad.

Productivity growth doesn’t help as an explanation either.

If a country had very strong persistent productivity growth it would, all else equal, tend to have higher interest rates than would be seen in other countries.  There would be lots of profitable investment opportunities in that high productivity growth country, lots of (expected) income growth that people might be consuming in anticipation of, and so on.  And over time, that high-productivity growth country could expect to see its real exchange rate rise.  Unfortunately, high productivity growth isn’t the story of New Zealand in the last few decades.  Indeed, more often rather the reverse.  Over the last five years, we’ve recorded no labour productivity growth at all.  Over the last 10 years, at best we’ve only been around a middling OECD country for productivity growth, and over longer-terms still we’ve had one of the worst records anywhere.      I illustrated a few months ago, the depressing comparisons of productivity growth between New Zealand and the emerging economies of central and eastern Europe.

A more prominent explanation for New Zealand’s persistently high interest rates points to the large negative NIIP position and asserts that the explanation for high interest rates is pretty straightforward: lots of debt means lots of risk, and hence the need for a substantial risk premium on New Zealand interest rates.  Taken in isolation –  if someone told you only that a country had a large negative NIIP position this year –  it might sound plausible.  Once you think a bit more richly about the New Zealand experience it no longer works as a story.

Here was the Reserve Bank commentary on this possible story a decade ago.

But the fact that this correlation exists between net international positions and local interest rates does not explain very much at all. In particular, it does nothing to explain what leads countries such as New Zealand to take on such large amounts of foreign capital in the first place. More specifically (and given that the Crown now has no net debt), what motivates New Zealand firms and households to take the actions that lead to this accumulation of foreign capital? And having accumulated the foreign liabilities (and New Zealand’s, as a share of GDP, have not changed much in a decade), what makes higher interest rates sustainable here for prolonged periods?

First, our NIIP has been large (and negative) for a very long time now –  for at least the last 25 years, and over that time there has been no persistent tendency for the NIIP position to get better or worse for long.  By contrast, 20 years earlier than that New Zealand had almost no net foreign debt.  The heavy government borrowing undertaken in the 70s and 80s had markedly worsened the position.  It is quite plausible that foreign lenders might then have got very nervous and wanted a premium ex ante return to cover the risk. In fact, we know some (agents of) foreign investors got very nervous –  there was the threat of a double credit rating downgrade in early 1991.  But when lenders get very nervous, borrowers tend to change their behavior, voluntarily or otherwise, working off the debt and restoring their creditworthiness.   And in New Zealand, the government did exactly that –  running more than a decade of surpluses and restoring a pretty respectable government balance sheet.  But the large interest rate differential has persisted –  in a way that it did in no other advanced country (including those that went through much worse crises and threats or crises than anything New Zealand has seen in the last 25 years).

As I’ve already touched on, short-term interest rates are set by the Reserve Bank, in response to domestic inflation pressures. But long-term interest rates are set in the markets.  If investors had really been persistently uneasy about New Zealand’s NIIP position, we might not have seen it much in short-term interest rates, but should certainly have expected to see it in the longer-term interest rates. (That, after all, is what we see in various euro countries that have lapsed in and out of near-crisis conditions).   But in one obvious place one might look for direct evidence of such a risk premium, it just isn’t there.

And remember that when risk concerns about a country/currency rise, one of the first things one typically sees –  at least in a floating exchange rate country –  is a fall in the exchange rate.  It is a bit like how things work in equity markets.  When investors get uneasy about a company, or indeed a whole market, they only rarely succeed in getting higher dividends out of the company(ies) concerned.  If the companies were sufficiently profitable to support higher dividends the concerns probably wouldn’t have arisen in the first place.  Instead, what tends to happen is that share prices fall –  and they fall to the point where expected dividends, and the expected future price appreciations of the share(s) concerned, in combination leave investors happy to hold those shares. In that process, an increased equity risk premium is built into the pricing.

At an economywide level,  if investors had had such concerns about the New Zealand economy and the accumulated net debt position, the most natural places to have seen it would have been in (a) higher long-term bond yields, and (b) a fall in the exchange rate (and perhaps a persistence of a surprisingly weak exchange rate). But we’ve seen neither in New Zealand.  Had we done so, presumably domestic demand would have weakened, and net exports would have increased.  The combined effects of those two shifts would have been to have reduced the negative NIIP position, and reduced whatever basis there had been for investors’ concerns.  Nothing in the New Zealand experience over the last 20 years or more squares with that sort of story.

And that is the really the problem with the most common stories used to explain New Zealand’s persistently high interest rates. They simply cannot explain the co-existence of high interest rates and a high exchange rate over long periods.

My story attempts to.  More on that tomorrow.

Can any good thing come from the BIS?

Michael Reddell Reserve Bank

The Bank for International Settlements was supposed to be wound up after World War Two.  That was agreed at the Bretton Woods conference in 1944, partly because the International Monetary Fund was being established, and partly because the BIS –  based in Basle, just over the border from Germany – was perceived to have got altogether too cosy with, and protective of the interests of, the other side.

But the BIS –  originally set up to handle reparations settlements and related issues –  survived.  These days it provides a variety of useful services to central banks around the world, provides a venue for various central bank meetings, and employs some interesting people and publishes some stimulating research.    The BIS was once largely a North Atlantic affair, but these days even the Reserve Bank of New Zealand is a shareholder.

Prior to the financial crisis and 2008/09 financial crisis, the then head of the BIS Monetary and Economic Department, Bill White, was one of the few prominent establishment voices foreshadowing serious problems ahead.  Inflation targeting, he argued, was one of the causes of the looming problems.  Few national central bankers were at all receptive to his views (not all of which, by any means, were correct).

These days, the head of the Monetary and Economic Department is Claudio Borio, a long-serving BIS economist who, individually and with co-authors, has published a series of papers on matters financial and macroeconomic that have also tended to challenge  the current “establishment view”.   Over the last few years he –  and the BIS –  have been sceptical of case for official interest rates being as low as they’ve actually been, arguing that economic outcomes might even have been better if interest rates had been higher, and that monetary policy should be driven more by considerations around ‘financial cycles” than by (the outlook for) inflation.    There is a lot of work resting behind these arguments, and even if I don’t end up agreeing with many of the conclusions, Borio’s articles and speeches are well worth reading for anyone interested in the issues (a recent accessible example is here, which I might back and write about substantively at some point)

The prompt for this post was a column that appeared in the (UK) Daily Telegraph a few days ago, in which their economics columnist Ambrose Evans-Pritchard sought to tie together the BIS/Borio views –  which would have argued for a much tougher approach to monetary policy in recent years (at least on conventional definitions) –  with the New Zealand Labour Party’s (and the new government’s) desire to amend our Reserve Bank Act.   The article, which various readers sent me, appears under the somewhat flamboyant heading “Apostasy in New Zealand spells end of global central bank era”  (the article is behind a paywall, but if you register you can get one article per week free).

It begins

The cult of inflation targeting began in New Zealand in the late Eighties. We may date its demise to a remarkable ideological pivot in the same country thirty years later, and with it the end of central bank ascendancy across the world.

Which would not, I’d have thought, be how Grant Robertson (or his senior colleagues in the new government) would have thought about what they appear to be proposing for New Zealand.  They aren’t proposing to change the inflation target range itself (or even, so far as we’ve heard, move away from the explicit midpoint added in 2012), but argue that in adding a requirement (details to be advised) that the Reserve Bank pay explicit attention to the maintaining something near “full employment” (long-run sustainable rate of unemployment), they are simply converging on the international mainstream.  In particular, they cite Australia and the United States.

And if pushed about what difference such a focus might have made had it been in the Reserve Bank Act in the past, Grant Robertson has suggested that the Reserve Bank would have been less likely to have tightened (as much) in 2014 –  the shortlived, ill-fated, tightening cycle that proved unwarranted by inflation developments.  In other words, if anything  (and no one can be sure that different words, but same Governor, would have made a difference), it would have been towards having interest rates a little lower, a little sooner, than otherwise.   In other words, the diametrical opposite of the approach that Claudio Borio, the BIS, (and Ambrose Evans-Pritchard) would have favoured.  If anything, I suspect that the BIS view may have influenced Graeme Wheeler’s enthusiasm for raising the OCR in 2014 –  with constant references to “normalising” policy.

Evans-Pritchard concludes his article

“[Western central banks] can excuse themselves for runaway asset prices, vaguely talking about the deformities of China’s Leninist capitalism, or the Confucian ethic, or some unfounded exogenous shock from Mars.  It has let them cling to inflation targeting shibboleths for far too long. Premier Ardern is the canary in the mineshaft.  It was the same New Zealand Labour Party back in the Eighties that pioneered so much of what we think of as globalisation [I’m really not sure where he gets that idea from], before it was gamed by the elites and began to go off the rails.  The Party now wants to reassert the primacy of the democratic nation state, and to call time on the excesses –  starting with a ban on home purchases by foreigners.  The global axis is shifting.”

The BIS –  or Evans-Pritchard –  might (or might not) be right about the politics or the economics globally.  But nothing we’ve seen or heard from the new Minister of Finance –  or his colleagues –  suggest that they have anything in mind for New Zealand monetary policy, or the mandate of the Reserve Bank of New Zealand, that steps outside the international mainstream at all.  That might disappoint some –  who actively prefer higher interest rates without first securing the productivity growth and investment demand which would sustain higher real interest rates –  but what those people wish for is nothing like what Labour’s words suggest we in New Zealand are likely to be delivered.

Of course, the first big decision about monetary policy for the new government is who should be the next Governor.   Individuals matter at least as much, arguably more, than the details of formal mandates.   In almost all other countries, political leaders themselves get to appoint directly the head of the nation’s central bank.  Obama appointed Janet Yellen, Scott Morrison (Australia’s Treasurer) appointed Phil Lowe, George Osborne appointed Mark Carney, euro-area heads of government appointed Mario Draghi, and so on.  It is the way democratic societies typically work –  actually, non-democratic ones come to that.  But not New Zealand.

Here, unless he changes the Act, the Minister’s hands are tied. He will have to appoint as Governor someone nominated by Reserve Bank Board.  All the Board members were appointed by the previous government, the advert for the job was framed under the previous government, all the Board members have endorsed the conduct of monetary policy (and the performance of the Bank more generally) in recent years, none has much experience in central banking, financial regulation, and none has any public accountability.  And yet they will decide who will, single-handedly (for the time being) wield the levers of macroeconomic policy.  It is a gaping democratic deficit –  even if you don’t think actual policy should be run even a little differently in future.   The Government could easily change those provisions, and bring New Zealand into line with standard international practice. It requires a simple amendment to the Reserve Bank Act, deleting six words.

Strong candidates for Governor aren’t exactly thick on the ground. But if the Minister were to make a change, or even to make suggestions to the Board, one of the people he shouldn’t go past actually works at the BIS.   David Archer currently holds a senior position at the BIS, but until 2004 had spent a decade as first Head of Financial Markets, and then as Head of Economics (including carrying the title of Assistant Governor) at the Reserve Bank.  He fell out with Alan Bollard and made his escape.

I worked closely with (and for) David across a couple of decades.  Up that close you see both the strengths and weaknesses.  David has a reputation as something of an “inflation hawk”.  That was perhaps most obvious over 2003/04, when he was right –  interest rates were too low for too long, and as a result core inflation got away on us (see the chart in yesterday’s post).   But such reputations (“hawk” or “dove”) usually don’t mean very much –  smart people will sometimes differ on how to read any data, and at different times the same person will end up on the different side of those debates.  David’s greatest strength in my view is a high degree of intellectual curiosity, a demand for rigour, but an openness to debate, to challenge, to exploration of alternative views and ideas. It certainly isn’t the only quality one needs in a Governor, but it is an important one –  perhaps especially in a single-decisionmaker system, but also as the Reserve Bank recovers from the Wheeler years.  He is the sort of person who attracts capable people –  again something the Bank will need in the coming years.

There are drawbacks, or gaps, as there are with all the possible candidates.   David hasn’t had much involvement in bank regulation or supervision –  now a big part of what the Bank does –  and was (rigorously) sceptical of the Reserve Bank getting actively involved in discretionary supervision and regulation.   I’m not sure how his views on these issues may have evolved over the years, but what could be counted on would be a rigorous and systematic approach to the application of the law, and to recommendations on any possible changes to the law.  And, of course, he has now been away from New Zealand for 13 years –  that brings the upside of extensive international contacts, but the downside of reduced familiarity with New Zealand (and the way the Bank’s own role in the public sector has evolved).    That people here still recognise his potential value was seen in Treasury’s choice of him as one of the external reviewers of the recent (as yet unseen) Rennie review –  Treasury is currently fighting to keep Archer’s comments secret.

David wouldn’t be a candidate for the status quo.  If the Minister of Finance is really content with the status quo, he might as well just stick with the Board-led process, likely to end up appointing Deputy Governor Geoff Bascand.  But whether around decisionmaking structures, transparency and accountability, and monetary policy goals themselves, all the public indications have been that the government is looking for change, and a lift in the overall performance of the Bank.   If so, Basle might well, on this occasion, be one of the possible alternative places to look for someone to take on this very influential, powerful, role.

 

NZ interest rates are still remarkably high

Michael Reddell Interest rates, Uncategorized

By international standards that is.   And that gap, between our interest rates and those abroad, is nothing much to do with monetary policy.

If the new government is serious about addressing New Zealand’s dismal long-term productivity growth record –  which has been particularly poor in the last five years – it needs get serious about recognising that one of the key symptoms of our structurally unbalanced economy is that persistent gap between real interest rates in New Zealand and those almost anywhere else in the world.

Of course, the big story about interest rates over the last 25 years or more has been the persistent downward trend in the level of nominal and real interest rates.  In this chart, I’ve illustrated that for New Zealand and the median of the G7 advanced economies, using the OECD’s series of long-term interest rates (usually a 10 year government bond).  To stress, these aren’t central bank policy rates, but market-determined long-term yields.

long-term bond yields Nov 17

Once upon a time, very briefly, our long-term interest rates actually touched those (median) foreign rates.   But the dominant story in both series is the downward trend.  In fact, there is no real sign that the trend has yet ended –  each peak, for example, still looks a little lower than the previous one.

Inflation was falling a lot in many countries in the 80s and early 90s, but for the last 20 years or so core inflation has been pretty low and stable in the core advanced economies. In other words, the falls in international interest rates in the last 20 years or so have almost entirely been falls in real interest rates too.

core inflation G7

What about the gap between New Zealand and world interest rates?   Here is the gap between the two series shown in the first chart above.

gap between NZ and world int rates

The gap collapsed, briefly, in the early 1990s as we got on top of inflation, actual and expected short-term interest rates came down, and NZD assets became very attractive globally.  But the compression didn’t last.  Since around 2004 the gap between New Zealand bond yields and this measure of global rates has fluctuated around 200 basis points, with no obvious trend.   (The gap is smaller than that, typically, relative to the United States, and much larger relative to Japan and Germany.)

(I should stress that there is no single right way to summarily aggregate the various overseas long-term interest rates.   Whichever median of some of all OECD countries I used, the broad pattern was much the same, although the absolute size of the gap differs.)

What about real interest rates.   In this chart, I’ve adjusted the median G7 nominal interest rates using the median CPI inflation ex food and energy (the core inflation measure the OECD reports) for the G7 countries, and adjusted the New Zealand interest rates by the Reserve Bank’s preferred sectoral factor model measure.  The sectoral factor model data starts only in September 1993, so that is when I start this chart.   In principle, one might want to do the adjustment using measures of inflation expectations, but there are no consistent long-term measures available across countries.  Core inflation can be thought of as a proxy for inflation expectations.

real NZ less G7

Not only has there been no sign of the gap between New Zealand and “world” real interest rates closing, but if anything the gap has been wider since around 2009/10 than we’d seen previously.  On this measure, the gap has averaged 190 basis points over the past 8 years.

These are really large gaps.  On this measure, over the life of a 10 year bond they make for a 20 per cent difference in total returns.  That makes it a lot harder for a potential investment project evaluated in New Zealand to stack up than it would be for an equivalent project in other countries.

It is also tends to be reflected in big differences in exchange rates.   Those higher yields in New Zealand, if expected to persist, will look very attractive to overseas investors.  It might even look like a “free lunch”.  What takes away the “free lunch” dimension is an appreciation in the real exchange rate now, such that over the following 10 years the exchange rate is expected to depreciate just enough to leave the investor indifferent between holding NZD assets and those in other currencies.   That isn’t a mechanical relationship, but it is a pretty strong tendency.  It is the bigger-picture of the sort of modest jump (fall) in the exchange rate we often see when a Reserve Bank OCR announcement is surprisingly hawkish (dovish).    Comparing 10 year rates, it could account for a 20 per cent ‘overvaluation’ of the exchange rate.  On even longer-term rates the cumulative differences are even larger.  No wonder we don’t see much new investment in the tradables sector in New Zealand.

Perhaps you still doubt that the real interest rates gaps can really be as large as these summary series suggest.   We can check the sotry by looking directly at yields on inflation-indexed bonds issued by governments in various advanced countries.     Getting time series data for some of these countries can be a pain (unless one is setting in front of a Bloomberg terminal), but these are some of the current interest rates I tracked down a few days ago.

Our longest maturity inflation indexed bond matures in September 2040 (23 years away).  On Monday the Reserve Bank was reporting a real yield of 2.22 per cent on that bond.

The Australian government issues an indexed bond maturing on exactly the same date. The real interest rate on that bond, again on Monday, was (so the RBA reports) 1.18 per cent.

So even relative to Australia –  which also has quite high interest rates by advanced standards –  our very long-term real interest rates are very high.

What about some other countries?

The United States has an inflation indexed bond maturing in February 2040.  According to the Wall St Journal tables that bond opened the week yielding 0.89 per cent, roughly 130 basis points lower than the New Zealand 2040 bond.

Canada has a 2044 indexed bond, which was yielding about 0.75 per cent.

I could only find data for a 10 year Japanese inflation indexed bond, which appeared to be yielding about -0.4 per cent.

And Germany offers a range of maturities for its government inflation indexed bonds.   A few days ago, the 2030 bond was yielding -0.67 per cent, and the 2046 bond –  almost 30 years to maturity –  was yielding -0.34 per cent.

(UK indexed bond yields are not directly comparable because the tax treatment of the inflation adjustment is materially different).

There is certainly a range of real long-term yields across countries.    But ours are extremely high relative to those in other core advanced economies.

A year ago, I wrote a post along similar lines (although looking at the data in slightly different ways).  In that post I concluded

…our interest rates (a) are and have been higher than those abroad, (b) this is so for short and long term interest rates, (c) is true even if we look just at small countries, and (d) is true in nominal or real interest rate terms.  And the gap(s) shows no sign of closing.

All that is as true today as it was then.  It should be worrying anyone seriously interested in lifting New Zealand productivity and long-term per capita income performance.  On Monday, I will review some of the possible explanations for the gap –  partly to back the claim that it is a symptom that we should be worrying about, and partly to point in the direction of possible, and sensible, remedies.

 

 

Foreign bans and CGTs

Michael Reddell Housing

I was going to write about something quite different this morning but I noticed an article by Bernard Hickey suggesting that the presence of a capital gains tax in Australia, and tighter restrictions there on foreign ownership of residential property, explains a substantial difference in performance in the two housing markets, across decades and over the last few years in particular.

Hickey starts from this chart, using a helpful tool The Economist makes available for comparing house price inflation across countries.

hickey chart

But (a) this is a chart of nominal house prices and everyone knows we had much more general inflation than these countries early in the period, and (b) 1980 marked near the trough of a savage correction in New Zealand real house prices (down around 40 per cent over five years or so, as the New Zealand economy went through some troubled times and the exodus of New Zealanders to Australia (not then offset by increases in other immigration) began).   1980 is the starting point The Economist uses, but it isn’t where I’d be starting looking for evidence of the contribution of Australia’s CGT and foreign ownership restrictions.

Australia’s capital gains tax came into effect in September 1985.  The restriction on foreign ownership of residential properties was already in place, but no one thinks that was a material issue in Australia at the time (either there, or here).    Rising concerns about non-resident foreign ownership (actual or potential) of residential dwellings –  especially in New Zealand –  have mostly been an issue for the last five years.

So how have real house prices in the two countries behaved since September 1985, when Australia introduced the CGT?  Using the same Economist  database – which has data only up to the end of 2016 – this is the resulting picture.

real house prices since 85 q3

In total, real house prices have increased a little more here than in Australia.  But at times, even over this period, prices in Australia have been increasing faster and at times here.   In the late 80s for example –  just after the capital gains tax was put in place –  prices in Australia were much stronger (the difference is quite large even if, without a log scale, it doesn’t appear that way).  And real house prices here fell from around 1997 to 2002 while they surged in Australia.

There are, of course, differences in the housing markets in the two countries, but the similarities look a lot stronger than the differences.  Both countries have tight land use restrictions, both countries have had rapid population growth (and although both countries currently have quite low absolute interest rates, both countries have among the highest real interest rates anywhere in the advanced world).  Here is the last 20 years of data (1996 q4 to 2016 q4).

economist index

Over the whole period, New Zealand house prices have increased just slightly less than those in Australia.

Of course, over just the last few years New Zealand real house prices have increased more than those in Australia.  Capital gains tax provisions haven’t changed materially in the two countries, although we did impose the bright-line provisions (on re-sale within two years) in 2015, and Hickey notes that Australia “removed the exemption from its capital gains tax for the main home for overseas investors in this year’s budget” (beyond the end of the data in these charts).

Perhaps the differing approaches to non-resident non-citizen purchases of existing residential property have played a part, at the margin.    We’d need a much more careful study to know, and it may never be possible to conclusively answer the question.  But recall –  the point I made yesterday –  that banning, or taxing, non-resident purchases of existing dwellings does not stop such purchasers buying new properties, or does not remove any of the road-blocks that stand in way of increased supply, of urban land in particular.  In both countries, land price inflation is by far the largest component of urban house+land inflation.

Personally, I’ve got a different candidate explanation for why house price inflation has been stronger in New Zealand just in the last few years than it was in Australia: our population growth has simply been much faster.

popn growth nz vs aus

Those are huge swings –  both in New Zealand’s own population growth rate, and in that growth rate relative to Australia’s population growth rate.     You might think that rapid population growth is a fine thing –  as people at the New Zealand Initiative (probably) do –  or a deeply problematic one, as I do, but no serious observer is going to dispute that when you have the sorts of land-use restrictions that both New Zealand and Australia do, big unexpected changes in population growth will, all else equal, quickly spill into higher house prices.  They did in Australia around the post-recession peak mining investment boom years, and they’ve done so here in the last few years.     Over longer periods of time, the two housing markets look (depressingly) similarly bad.

To be clear, I’m not suggesting that idiosyncratic tax or (eg) credit-restriction changes have no effect on housing market in the short-term. Australia has tinkered with its CGT, we’ve altered depreciation rules, ring-fencing rules etc, and we’ve put up and lowered again our maximum marginal tax rates (all things potentially relevant for investors).  I’m also not suggesting that large enough changes in the foreign buyer rules will have no effect in the short-term.    But the New Zealand and Australian experience over decades suggests that such effects don’t last for very long (and any permanent effects are pretty small), that the similarities in the two markets are much more important than the differences,  and the toxic brew of tight land use restrictions in the face of policies that drive up the population rapidly are a more compelling part of the story in both countries.    Relative economic cycles aren’t always in synch, and waves of intense population growth occur at slightly different times but the divergences in relative housing market performance never seem to have last for very long.   And are unlikely to, unless one or other set of governments sets about seriously fixing the land-use rules (and/or materially pull back on the policy contribution to population growth and housing demand).

Even the government seems to agree.    Asked about the foreign buyers ban the other day, David Parker noted (according to a record of press conference I saw) that “the impact on the number of houses built in New Zealand will be negligible”, and suggested that any price effect now would be pretty modest too.

 

Jian Yang again/still

Michael Reddell China, NZ politics, Uncategorized

In September, a couple of weeks before the election, the Financial Times and Newsroom published a story about the National MP Jian Yang.  The story revealed that Yang, who lived in China until age 32, had been a member of the Chinese Communist Party, and a member of the Chinese military intelligence establishment, and suggested that Yang –  formerly a member of Parliament’s foreign affairs committee –  may have been investigated by the Security Intelligence Service.    Questions were raised as to how much of this background the National Party had been aware of when they first selected him in 2011.  None of it had been known to the voters at the time.

The story got a day’s coverage in various local media and then largely went cold in New Zealand, even though it was just before the election, and although it happened to coincide with the release of a major paper by Canterbury University politics professor (and China expert) Anne-Marie Brady, raising substantial and documented concerns about the influence China was seeking to exert in New Zealand, both through the (former) Chinese diaspora (people in public life like Yang and Labour MP Raymond Huo), among Chinese New Zealanders, and (for example) through the recruitment of various prominent New Zealanders to well-remunerated roles in which they might be either well-disposed to Chinese interests, or at least unable/unwilling to voice any concerns about China’s activities and policies.    Professor Brady herself summarised the issue thus

This policy paper examines China’s foreign political influence activities under Xi Jinping, using one very representative state, New Zealand, as a case study. New Zealand’s relationship with China is of interest, because the Chinese government regards New Zealand as an exemplar of how it would like its relations to be with other states. In 2013, China’s New Zealand ambassador described the two countries’ relationship as “a model to other Western countries”. And after Premier Li Keqiang visited New Zealand in 2017, a Chinese diplomat favourably compared New Zealand-China relations to the level of closeness China had with Albania in the early 1960s. The paper considers the potential impact of China’s expanded political influence activities in New Zealand and how any effects could be mitigated and countered.

Yang himself has largely avoided the media.    But papers released under the Official Information Act confirmed that he had not told New Zealand authorities about his involvement with Chinese military intelligence, instead suggesting he had worked and studied at some quite different institutions.   Asked why, he responded that the Chinese authorities had told him to do so when he had left China (years earlier), and that was the way things were done in China.   That only heightened the concerns.

I wrote various pieces about the issue, noting (for example) that we should no more regard it as acceptable to have in our Parliament a former Chinese Communist Party member, former member of China’s military intelligence, someone who continues to hob-nob with the Chinese embassy, and who has never said a public critical word about Communist China (even as Xi Jinping increases the repressiveness of the regime) than it would have been to have a former KGB/GRU party member, associating closely with the Soviet Embassy, in our Parliament in the 1970s.  No one would have countenanced the latter.  It remains staggering –  and alarming about either the blindness of our elites, or the extent to which they’ve been suborned  (eg Yang is acknowledged as a major National Party fundraiser) –  that the Yang situation still appears to be regarded as acceptable in many quarters.

My own direct involvement was pretty tangential, when at a local candidates meeting a couple of days before the election, I asked a senior National Party minister –  Attorney-General and Minister for the SIS no less – about why it was acceptable to have such a person as a National Party candidate and MP.    Disgracefully, Chris Finlayson suggested that any concerns were just racist and that Professor Brady just didn’t like any foreigners.  Almost as disgracefully, the candidates of the other parties sat mute.

The story has had continued coverage abroad, including a nice New York Times piece a few weeks ago.  Serious –  pretty liberal –  international media such as the NYT and FT have taken the story seriously.    Our own media was slow to.  No doubt that suited the politicians –  at least those of the major parties.

But this week, the story seems to have gathered a fresh head of steam.   Our new Minister of Foreign Affairs, who had  previously talked on the need for an inquiry, by last week was avoiding questions on that topic, suggesting instead that the media could give the issue some more coverage.   And so, no doubt coincidentally, they did.

First, there was a substantial article by Matt Nippert in the Herald. Nippert notes that his article drew on “interviews with diplomatic and intelligence sources over the past month, including several with current security clearances”  –  which is surely less impressive than it sounds, as huge numbers of people in Wellington have security clearances (I did for years) –  but those sources seem to have added only a bit more colour, rather than revealing anything substantially new.    Nippert’s article is organised around what he calls “three unanswered questions” regarding Jian Yang:

  • What is Luoyang University?  This is the institution Yang claimed he had studied and taught at, rather than disclosing from the start that for much of his time he had actually been at a People’s Liberation Army academy.
  • Did Yang have access to sensitive materials (as an MP, member of the foreign affairs committe, and as –  otherwise junior –  MP accompanying John Key and Tim Groser on official trips to China)?
  • Why the official silence?

I’m not sure these really are the biggest issues now.   We know –  because Yang told us –  that his citizenship or residency applications details were (deliberately) misleading.    That is probably quite serious at a personal level, and probably warrants more from government departments than we’ve had to date.

Both Internal Affairs and Immigration NZ have said the revelations about Yang’s background and apparent lack of disclosure were not grounds to review their handling of the matter. A spokesman Immigration NZ went as far as to say “no new information has come to light which would warrant an investigation”, despite the facts being novel enough to warrant front-page coverage last month in the London-based Financial Times.

But, frankly, it seems like a second-order issue.  A man with his background, and ongoing associations, should not be a New Zealand MP, whether or not his citizenship application was all in order.

As for the information Yang may have been exposed to, even Nippert’s sources aren’t really alarmed.

Another source said Yang’s background – and closeness to New Zealand’s PRC embassy – was well-known in senior Wellington circles and had led to self-censorship. “I’m sure everyone is aware of that, and would be careful about what they say in his presence,” the source said.

“Would Jian have seen the briefing papers that were given to John Key? Almost certainly. He sat up the front of the aircraft with the Prime Minister and his advisers – I can’t imagine for a moment he didn’t have access to it.”

The source said this briefing document – unlikely to include top-secret classed intelligence from the Five Eyes network – would have been given a classification of confidential or higher.

In other word, just not that sensitive, even on the government’s own official classifications.

If there was  particular risk to New Zealand interests around his official position it was probably much more about the possibility that he might have one day become a Minister of the Crown.

The Herald tackled the third question –  the official silence –  in an editorial on Tuesday.

International media have rightly shown a keen interest in the affair.  But locally, interest – and answers – have been strangely muted. Neither National leader Bill English nor Prime Minister Jacinda Ardern seemed willing to address the issue during the election campaign. NZ First’s Winston Peters initially demanded an inquiry, but has gone silent on the matter since his elevation to Minister of Foreign Affairs.

Ardern has inherited a role that includes oversight of New Zealand’s intelligence agencies and will undoubtedly have been briefed on the Yang situation. She needs to reassure herself and then, in appropriate fashion, the public that the matter has been – or will promptly be – properly addressed.

But again, the issue of the intelligence services seems to be rather of a red-herring.     Yang, after all, now certainly has no access to anything particularly secret –  he’s an Opposition backbencher.  On the other hand, Raymond Huo –  who appears to also be closely associated with China’s United Front Work Department efforts in New Zealand –  is part of the governing party.    As Professor Brady puts it

Huo also has close contacts with the Zhi Gong Party 致公党 (one of the eight minor parties under the control of the United Front Work Department). The Zhi Gong Party is a united front link to liaise with overseas Chinese communities, as demonstrated in a meeting between Zhi Gong Party leaders and Huo to promote the New Zealand OBOR Foundation and Think Tank.

It was Huo who made the decision to translate Labour’s 2017 election campaign slogan “Let’s do it” into a quote from Xi Jinping (撸起袖子加油干, which literally means “roll up your sleeves and work hard”). Huo told journalists at the Labour campaign launch that the Chinese translation “auspiciously equates to a New Year’s message from President Xi Jinping encouraging China to ‘roll its sleeves up’.”

How sick is that? Invoking associations with Xi Jinping.

As a citizen, what worries me isn’t so much backbenchers giving away New Zealand secrets to China –  apart from anything else, they generally won’t have such access –  as the way in which such Members of Parliament seem to act as if the interests and views of the increasingly oppressive Chinese government and Communist Party are things for them to advance in New Zealand.   That is an issue both main parties look as though they need to confront, rather than being an issue primarily for the intelligence services.  Migrants should be welcome, once they become citizens, to be elected as members of Parliament, but it is probably particularly important for such members to be clear –  not just in words, but in conduct –  that their loyalties are only to the interest of New Zealand and (all) its citizens.  If Chris Liddell  –  a New Zealander on the White House staff –   spent lots of time hob-nobbing with the New Zealand Embassy, the US might reasonably wonder whose interests he was serving.  If Julie-Anne Genter does (which I’m sure she doesn’t) something similar with the US Embassy here, the same concerns would appropriately arise.  And recall that China is not just any country; it is today’s Soviet Union. A threat to all sorts of countries, including the free ones of east Asia.

Our main non-commercial media outlet, Radio New Zealand, was very late to the issue.  But this week they too have done their bit.   First, Bill English finally faced a reasonably searching interview on the subject (on Morning Report).  It was an astonishingly feeble performance, featuring repeated refusals to answer questions in any way other than “you’d have to ask Dr Yang that”, when the leader of the National Party knows that Yang has refused to make himself available for a proper interview, and for weeks has refused to answer any questions (Nippert’s experience as well).    The former Attorney-General, who claimed it was all racist, still holds a senior position in Mr English’s caucus.

And then there was John Campbell, who in his inimitable style last night illustrated the repeated refusal of Yang –  an elected member of Parliament –  to front the media.  According to Campbell, Radio NZ has been trying to get him to talk every day for weeks.  Calls simply go through to voicemail and are never returned.  Radio NZ even went to Yang’s house, but couldn’t get past the (unanswered) buzzer at the gate.

It reflects shockingly poorly on almost everyone in political life involved in this situation:

From the National Party side:

  • Jian Yang
  • Bill English,
  • Peter Goodfellow, President of the National Party,
  • Chris Finlayson, and
  • the rest of the caucus, not one of whom has been willing to break ranks (although Radio NZ did claim senior National Party sources were becoming increasingly uneasy).

And what of the new government?

  • There is the Prime Minister, who has never uttered a disapproving word, in the election campaign or since, about Dr Yang (not even about his silence),
  • The Minister of Foreign Affairs,
  • The leader of the Green Party, a party which appears not to rely on lots of diaspora fundraising, who is often strong on protecting our sovereignty, and yet who raised no concerns,
  • Raymond Huo, who surely some media should ask for a proper interview.

And then, of course, there are the obsequious members of the New Zealand China Council, and former leading figures in the National Party with a personal economic interest in keeping quiet.

Jian Yang’s political career is probably now effectively over.  Perhaps he’ll linger for a while, but it is inconceivable that he could rise any higher.  It is a disgraceful reflection on New Zealand, and on the National Party – and those other parties who could have spoken out and didn’t –  that an unrepentent Communist, unrepentant former intelligence services member of a hostile, expansionist government with a total disregard for human rights, sits in our Parliament still.  And simply refuses to face the media.  But that particular damage is probably done, it is just now a matter of tidying up the mess at some point.

The bigger questions would seem to be about the political and business culture that has been so indifferent to the specifics of Yang, and of Huo, to political fundraising from foreign sources, and to the sort of influence-seeking activities –  both among New Zealand Chinese citizens and in the wider political and economic system –  that Professor Brady has highlighted.    Professor Brady’s paper raises issues that really should be addressed in a proper inquiry, but also in some considerable soul-searching among New Zealand’s political and business elite about how New Zealanders’ interests, and reputation, as a free and independent state are best-served, and how best we –  and similar countries –  resist the inroads the Chinese Communist Party is making and, we can assume from the last Party congress, will only continue to seek to make.  As I noted in an earlier post, trade has muddied the waters: we had a clearer-eyed perspective on the Soviet Union than we seem to have about Communist China, a state on whose fortunes various elite institutions/companies and their chief executives (but not New Zealand’s overall fortunes) depend.   Perhaps our media too might ask themselves some questions, about what took them so long, made them so seemingly reluctant, to ask the hard questions about these issues.  Overseas comentators have been willing to, but the involvement of much of our own media seems quite halting and reluctant at best.

 

Making progress on housing?

Michael Reddell Housing, Uncategorized

I’ve been quite sceptical that either side of politics –  whichever group of parties won the election – would address the fundamental distortions that have rendered urban land and houses so expensive.  After all, successive National and Labour-led governments had enabled us to get, and overseen us actually getting, into this mess.  And for anyone looking to the minor parties, New Zealand First had previously been part of, or supported, governments of both stripes, and the Greens –  with a taste for rapid population growth and restrictive planning laws –  didn’t seem any more hopeful.   Neither the Prime Minister nor the Leader of Opposition, before or after the election, seemed interested in seeing lower house prices.

An optimistic supporter of the Labour Party yesterday put it to me –  it was Reformation Day , and the 500th anniversary of Luther nailing his theses to the door of the church in Wittenberg –  that not even the Pope could stop an idea whose time had come.   As I noted in response, the general point was no doubt true, but plenty of aspirant reformers misjudged when “the time had come”, when the mood and opportunity for change had become irresistible.   Often they paid a dreadful price.   In modern democracies, of course, that usually only means losing the next election, or quailing at the prospect and just not doing anything much of substance at all.

As I’ve noted various times previously –  including in this post a year ago – while there are plenty of examples of successful places (notably now in significant parts of the United States) without tight land-use restrictions limiting housing development, I’m not aware of any country (or even region/major city) that, having once adopted the morass of planning laws and associated restrictions, has ever successfully unwound those controls.  And thus we have house prices as they are in New Zealand, or Australia, or much of the UK, or California (and many other parts of the United States).

Housing was a significant issue in the election campaign, but perhaps less significant than it might have been if Auckland prices had still been rising strongly this year.  Four of the items on Labour’s pre-election 100 day plan were housing-related:

  • Pass the Healthy Homes Guarantee Bill, requiring all rentals to be warm and dry
  • Ban overseas speculators from buying existing houses
  • Issue an instruction to Housing New Zealand to stop the state house sell-off
  • Begin work to establish the Affordable Housing Authority and begin the KiwiBuild programme

 

Whatever the merits of some of them, nothing on that list was seriously likely to address the fundamental regulatory distortions that have stopped the housing and urban land markets working effectively.

Today the headlines are dominated by the announcement that the government appears to have found a way to ban non-resident non-citizens from buying existing homes, by amending the Overseas Investment Act to classify all the land under such dwellings as “sensitive land” (for which we reserved rights to “adopt or maintain any measure that requires the following investment activities to receive prior approval by the New Zealand Government under its overseas investment regime” –  page II-59 of this Annex to the Korea-New Zealand agreement).      Given that the Act requires a “national benefit” for any overseas investment in “sensitive land”, and it is difficult to conceive how a potential non-resident purchaser of a house could demonstrate such a benefit given the criteria set out in the Act, it looks to this lay reader like a clever wheeze that should, largely, be effective.

But to what end, other than political signalling?   At the margin, presumably transactions costs for all purchasers of houses, anywhere in New Zealand, will increase a bit forever (will we all have to verify that we are residents or citizens?).    More importantly, is there any evidence at all that a law change like this will increase housing supply?    And is housing supply, as distinct from land supply, the real issue at all?   The argument is supposed to run that if non-resident foreigners want to buy in New Zealand they will have to build, or buy a newly-built house, instead (as is, indeed, the law in Australia).    If the law discourages foreign purchases in total it will, to some extent, ease overall demand pressures –  although experiences with provisions like the British Columbia stamp duty suggest the effect might be quite shortlived –  but if it simply leads foreigners to bid for new houses rather than existing houses, presumably residents and citizens will –  at the margin –  buy more existing houses rather than new ones.     The law is likely to change, at the margin, who buys which type of dwelling, but why will it increase overall supply?     The land market is rigged, by regulation, to be as unaffordable as ever.  That won’t change as a result of this policy.  Any issues around development finance, council consenting, or infrastructure won’t change either.   In many cases, non-resident non-citizen purchasers –  however many there truly are –  probably already prefer new apartments (if, for example, what concerns them is an easily-maintained and secured store of value).    Perhaps there is evidence from some other places that such a restriction has increased effective supply?  If so, it would be good to have it drawn to our attention.   As it is, as I noted the other day, if the goal is real impact on housing affordability for New Zealand there is probably a stronger case for banning all house purchases by non-resident non-citizens than simply banning purchases of existing dwellings.

For the moment though, it is telling that the sound and fury –  perhaps even lifting the government’s poll ratings –  is around a measure that might dampen demand very slightly, and should do almost nothing to increase supply.    No doubt there is a place for signalling in politics.  But if you want to believe that real structural reform is coming, wouldn’t it have been reassuring to have seen something tangible around land supply in the 100 day plan, or emerging –  together with the non-resident ban –  from yesterday’s first substantive Cabinet meeting?  The Minister of Housing is quoted in the media talking about potentially using the Public Works Act to confiscate private land (and the Public Works Act provisions, while necessary for some limited purposes, never adequately compensate owners).  But not about allowing private land owners to use their own land more freely.     Labour went into the election promising

Labour will remove the Auckland urban growth boundary

Couldn’t that have been made part of the 100 day plan?   Or what about a piece of legislation allowing any geologically-stable private land to be used for housing, up to two storey height, without further resource consent (preferably for the whole country, but at least say in a circle with a radius 100 kms from downtown Auckland)?     Yes, there are still transport and infrastructure issues to be resolved –  so perhaps make the commencement date of the new legislation 12-18 months hence – but changes in this area –  land-use rules –  get much closer to the heart of the problem.    If there is a problem with “land-bankers”, it is a problem created by regulation and legislation, which removes the element of free competition from the market for developable land.  And, perhaps to balance the potential to increase the physical footprint of cities, how about a Working Group to report back within six months on options for allowing groups of residents/existing owners to contract out of existing planning restrictions when collectively those owners judge doing so to be mutually beneficial?

But this all highlights the question as to whether the government is really willing, let alone wanting, to see house and urban land prices fall.    On that score, the evidence is mixed at best.    Both the current Prime Minister, and her predecessor as leader of the Labour Party, have fallen over themselves to deny such an interest, and both have proved very reluctant to talk prominently about land-use reform (although I’m told that in small meetings  –  including during the Mt Albert campaign – the PM can talk fluently on the topic), favouring instead a public focus on (a) tax changes, (b) non-resident bans, and (c) state-driven building activity (much of which is likely to displace other building, since there is little evidence of unmet excess demand at current house+land prices).

On the other hand, Labour’s official housing policy has sounded promising, and both Phil Twyford (Minister of Housing) and David Parker (Minister for the Environment) have a promising track record.  In the previous Parliament, Parker moved an amendment –  which came very close to passing –  that would have removed the urban growth boundary around Auckland.  But Opposition –  when you don’t live with the consequences (gains and costs) – is different from government, and tactical embarrassment of an incumbent government, is different from managing a tri-party government and implementing serious structural reform.   Greens/Labour/New Zealand First agreement was presumably easy around the non-resident ban, but will probably be lot harder around fixing the land market (especially now that the government has recommitted to the “big New Zealand” approach to immigration and population).

I’m not ready to be very critical of the new government yet. But my scepticism about the prospects of serious reform remains.  It isn’t really about individuals or personalities –  as I’ve noted, past governments for 25 years have also done little or nothing –  but about incentives, risks, and precedents.  In that post I wrote a year ago I concluded

Individual political leaders can make a real difference.  It would be great if one would stake a lot on urban land use reform, but anyone considering it needs to recognize the lack of precedents, the potential losers, and the worries and beliefs that underpin the durability of the current model here and abroad. And they probably need to find not only the right language to help frame repeal choices and options, but find a package of measures which helps allay – even if only in part, and for a time –  the sorts of concerns some have.

(If anyone was serious about reform, and lowering house prices, I suggested a possible limited compensation scheme here.)

In a three year electoral term, if serious reform is going to happen it needs to be got under way quite quickly.  Whatever the possible merits of KiwiBuild (and I don’t have strong views) at present it looks as if there is risk that it –  with lots of activity –  will crowd out addressing the real issues around land use law that have, unnecessarily, given us among the highest house price to income ratios anywhere in the advanced world.

 

Towards a definition of the (un)employment objective

Michael Reddell Monetary policy, PTAs, Uncategorized

In my post the other day, I outlined one way in which the unemployment concerns that appear to be behind the Labour Party’s desire to amend the statutory objective for monetary policy could be implemented in a new Policy Targets Agreement, even before the Reserve Bank Act itself is amended.

We still have no specifics as to how the Labour Party (and now the Labour-led government) envisages changing the Act.  But in an interview on Radio New Zealand this morning I heard the Minister of Finance talking about looking to the specifics of the Australian and US legislation.   I didn’t find that very enlightening or reassuring.

The Reserve Bank of Australia was set up in 1959, and the section of its legislation relating to monetary policy goals and objectives was in the original.

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

a.  the stability of the currency of Australia;

b.  the maintenance of full employment in Australia; and

c.  the economic prosperity and welfare of the people of Australia.

In 1959, Australia –  like most countries –  had a fixed exchange rate, so that “the stability of the currency of Australia” meant the external value of the currency.  The provision has since been re-interpreted, and as is now taken as meaning the domestic value of the currency (ie domestic price stability), but no one would write the provision that way today.

This wording is also legitimately subject to the criticism made by those who disagree with what Labour is proposing.  It makes no attempt to distinguish between the short and long run, and thus does not recognise that monetary policy cannot affect the longer-term rate of unemployment at all.    The Australian legislation also has nothing like a Policy Targets Agreement (the document that resembles a PTA is informal and non-binding) and provides far too much discretion to the Reserve Bank.  That discretion has not been blatantly misused in recent decades –  a period when the actual conduct of monetary policy in New Zealand and Australia have mostly been quite similar –  but the legislation should not provide any sort of model for New Zealand as to how best to specify the goals of monetary policy.

What of the United States?   Much is made of the “dual mandate” that has guided the Federal Reserve over the decades.   But even that, mostly quite sensible, conduct of policy rests on a rather slender and unreliable legislative footing.    The statutory objectives in the Federal Reserve Act were set out in 1977, around the high tide of monetarism, and read as follows:

Section 2A. Monetary policy objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

In other words, the Fed is actually mandated to pursue long-term money and credit growth targets, in the belief that doing so will promote (a) maximum employment, (b) stable prices, and (c) moderate long-term interest rates.  Again, no one would write the statutory objectives that way today, and the formulation should offer little or no guide to anyone looking to overhaul the objectives of our own central bank.  In practice, of course, the Federal Reserve works around the statutory formulation, rarely citing it directly.  I think they way they run monetary policy in practice is quite sensible –  and typically not that different to the way the Reserve Bank here has often run policy –  but I bet they wish Congress had written the goal a bit differently in 1977.

In an ideal world, both the Australian and US statutory provisions would be updated and amended.  It isn’t desirable to have powerful autonomous agencies working under the mandates that don’t reflect today’s understandings of policy, leading those agencies to creatively reinvent their own mandates.  Those reinventions probably lead to better policy in the short-run, but the process of doing so undermines confidence in the role of legislatures in mandating, and holding to account, such agencies.

If one looks around the advanced world, there are lots of different ways of specifying central bank objectives. In most cases, the wording is considerably more recent than either the US and Australian examples.  A few years ago a colleague and I did a Reserve Bank Bulletin article reviewing those formulations –  the work initially prompted by the approach of the 2014 election, when Labour was also proposing changes.   As we noted,

Despite the similarities in how monetary policy is operated, there is a wide range of ways in which legislation and supplementary documents specify the medium- and longer-run aims societies have for monetary policy. In some countries the focus is more on the economic outcomes that a successful monetary policy could contribute to over the longer-term.  In others it is more on what monetary policy can more directly achieve. These differences do not seem to primarily reflect very different views of what monetary policy could reasonably accomplish. Specific national circumstances influence how formal documents are written. And older legislation often looks different than legislation adopted in the past 10-20 years, with the latter typically having a more explicit focus on domestic price stability. In some countries, formal documents say relatively little about what monetary policy is expected to achieve, while in other countries the formal documentation is more extensive.

As I’ve noted here previously, I think the sort of statutory change Labour seems to be talking about makes some sense.  In part, that is because monetary policy has –  ever since the late 80s –  been a divisive political issue here in a way that it hasn’t been in other countries.  In part, it is because of the failings of the Reserve Bank –  with many fewer constraints than their peers in many other advanced countries –  over the Wheeler years in particular.    But I’m not sure that the way other countries have worded their legislation is going to be of very much assistance to Treasury and the Minister of Finance as they attempt to come up with some specific proposals.     If I was to offer them specific suggestions, they would involve changes to the purpose clauses , to the clause governing the primary function of monetary policy, to clause 10, and to the clause governing Monetary Policy Statements.

It is perhaps worth remembering that over the life of the Reserve Bank –  now 83 years –  there have been various different formulations of the statutory goals of monetary policy.  Those changing goals were also discussed in a Bulletin article a few years ago.  When the first legislation was enacted in 1933, the statutory goal was simple, if not specific

It shall be the primary duty of the Reserve Bank to exercise control […] over monetary circulation and credit in New Zealand, to the end that the economic welfare of the Dominion may be promoted and maintained (1933, s12).

It is worth remembering that it simply isn’t possible to write down, whether in statute or in a PTA, all that one wants a good central bank to do in conducting monetary policy.  Or, at least, it hasn’t been since we went off the Gold Standard in 1914.     There is no perfect formulation, and good people –  sound judgement and a good understanding of the issues and constraints –  matter as much as precise wording.  Each generation faces differing shocks, differing sets of circumstances, and different things that aren’t well understood.  It is easy, and tempting, simply to set out simple wording like what is in the Reserve Bank Act now.  So long as it is understood not to capture everything –  and successive Governors and Ministers have recognised that –  it may not do much harm, and it keeps a focus on the long-term limitations of monetary policy.  But, equally, we have active discretionary monetary policy because we believe that monetary policy can do other useful stuff in the short to medium term.  Finding ways that reflect that understanding and translating them into legislative wording has its risks –  as not doing so does –  and can’t be done perfectly, but that isn’t a reason for not doing it at all.

And finally, it is worth remembering that, whatever the precise statutory wording, past research has found that, on average, the Federal Reserve, the Reserve Bank of Australia, and the Reserve Bank of New Zealand have tended to conduct monetary policy in much the same way, faced with similar shocks.

 

 

 

Ill omens for our democracy

Michael Reddell Uncategorized

When, on Saturday afternoon, my son mentioned that a National Front protest had been driven out of Parliament grounds I was a bit puzzled.  “Do you mean in London?”, I asked.

But it turns out the event in question was here in Wellington.  I wasn’t aware we had a National Front in New Zealand.  They even have a website (which I am not linking to).

From various media accounts (Newshub, Stuff, Herald, Radio NZ), it seems that the National Front had, some weeks ago, sought and obtained permission to hold a rally in the grounds of Parliament on Saturday.  So far, so unsurprising,  All sort of groups hold rallies there.  Understandably enough, as it is our Parliament.   Some of those groups you agree with, some you disagree with, some are pretty odious, and some rallies you might even be tempted to join in (I never have).

But from the other side of the political spectrum –  far to the other side – there was a group who didn’t just dislike the National Front, deplore their views, disagree with them about almost everything, but thought it was wrong that such people should even be able to hold a rally and express their views.    And so out went a call to stop them.   Not just to hold a parallel rally, in the hope (perhaps) of attracting more attendees than the National Front.    No, the plan was to

We will stop their mobilisation

and

12-1pm: Blockade/stop the National Front

And, sure enough, they did.  (And they got a lot more people along than the National Front did.)   As the Dominion-Post story puts it

“Hundreds of anti-racism protestors chased National Front members from the grounds of Parliament on Saturday.

But this wasn’t just any group of thugs.    This was a rally addressed by two MPs from a party that is now part of the New Zealand government: Marama Davidson and Golriz Ghahraman of the Green Party.   There is no hint that these MPs stood in front of the rally and urged restraint, reminding the rally participants that we live in a free land, in a democracy, where the freedom to speak one’s mind, to protest –   perhaps especially in the grounds of Parliament –  is intrinsic to our liberty.   Or to point out that freedom of speech –  liberty –  means something only if it applies to those with whom one disagrees, perhaps very strongly.   The views might be odious, but the freedoms (should) matter a lot.  But apparently not to these two MPs, both of whose Twitter feeds suggest they were proud to have been involved in this small scale thuggery.

And small scale apparently it was.   At least according to the Dom-Post account, only about half a dozen National Front people turned up to their rally.  Others were apparently “in the pub down the road”.     Hard to imagine six of them would have got any media coverage at all, except perhaps a small, slightly derisive, note somewhere, without the efforts of the Green Party MPs and their fellow protestors.

About six National Front members made their way towards Parliament in pairs, at intervals.  However, each time they did not make it to the gate because the rally of protestors moved them towards Wellington’s railway station [not exactly just over the road].

…..    A few scuffles started but police intervened, surrounding the National Front members to escort them away.

This is our democracy?

Fortunately it was all on a very small scale, but it was disturbingly reminiscent of scenes in the US (and the UK) which have become increasingly violent.  Out of curiosity, I tried to find out whether the Antifa (“anti-fascist action”) group(s) had come to New Zealand.    There were a couple of Facebook pages, one of which was pretty vile indeed.   I hope it isn’t representative of anyone much.

But it does leave questions for (a) the two Green MPs, (b) James Shaw, minister of the Crown and Green Party leader, and (c) the Prime Minister.   Is the freedom to protest –  without fear of a bigger group of thugs breaking up the protest –  something they believe in?  Does it apply even to groups you disagree with strongly, or only to those who support comfortable causes?  And does the Prime Minister regard the involvement of members of Parliament, from a party whose votes she relies on to govern, in such disruptive rallies as acceptable conduct? In the grounds of Parliament no less?   As a reminder, there is no merit in defending the right to speak or to protest of those ones happens to agree with, or whose views one is simply indifferent to.  It only means something if you stand up  for, and respect, the rights of those you strongly disagree with, perhaps even deplore.

These are, after all, MPs who should know better.   Davidson herself participates in protests in support of overseas terrorist organisation.  I count that as pretty despicable, but it is her right (at least in New Zealand).  Ghahraman is apparently a “human rights lawyer”.  I don’t put much stock by the New Zealand Bill of Rights myself, but it is an act of the New Zealand Parliament of which Ghahraman is now a member.  It states, quite simply,

16 Freedom of peaceful assembly

  • Everyone has the right to freedom of peaceful assembly.

Without being disrupted by thugs.  Without being escorted off the premises by the Police (for their own protection?)  And no matter how odious their views.   Our system is supposed to work by airing and debating differences, and then respecting the rights of each others to hold, and express, differing views.   The National Front is not a particularly sympathetic organisation, but in the famous words of the German pastor, Martin Niemoller, regretting, after the war, his own failure to take a stand earlier.

First they came for the Socialists, and I did not speak out—
Because I was not a Socialist.

Then they came for the Trade Unionists, and I did not speak out—
Because I was not a Trade Unionist.

Then they came for the Jews, and I did not speak out—
Because I was not a Jew.

Then they came for me—and there was no one left to speak for me.

Who will Marama Davidson and Golriz Ghahraman, and their supporters, be coming for next?

As it is, Saturday’s affair looks like a win for the National Front and a loss for our democracy, aided –  indeed egged on – by members of Parliament.  That’s sad on both counts.

ADDENDUM: (Wednesday 1 Nov)

I’m hesitant about adding this material, but I had an unsolicited email out of the blue from someone who describes himself as chair of the National Front.  These were the relevant comments.

However I would like to point out something that the media will not report even though they were informed.

The Flag Day attempt at 11:30 was a fake attempt to confuse the anti-White mob

Our actual event went ahead as planned a few hours later, once the mob had been satiated with a fake victory.

And perhaps more interestingly

We received our permit to assemble at Parliament around September 3.

We forwarded our intentions to the NZ Police as we do every year.

We contacted the Green Party before the date of the event to let them know we were receiving violent threats from the group that was going to be fronted by their MP’s.

We asked the Greens to please withdraw from the event.

If those latter comments are a correct description of what went on, they would appear to strengthen the argument that the Green MPs and the Green Party leader owe the public an explanation about their part in this.

If there is any further comment from any of them, I will link to it here.

Towards a Fiscal Council

Michael Reddell Fiscal policy, Uncategorized

Earlier in the year, the Labour and Greens parties released a set of Budget Responsibility Rules, envisaged at time as being the rules that would guide the two parties if they were in a position to form a government.    The actual new government, of course, includes New Zealand First, with the Greens at a partial arms-length.  Then again, James Shaw is now an Associate Minister of Finance.    The status of these rules isn’t clear, but since they haven’t been disavowed I’m assuming they will, at least broadly, provide the basis for the new government’s fiscal policy.

I wrote about the rules at the time they were announced.  I didn’t have too much problem with them, but outlined a number of areas where details might matter quite a lot –  including, for example, the fact that the appropriate prudent level of the fiscal balance should depend, in part, on the expected rate of population growth –  and areas where what look like very well-intentioned rules can be open to being gamed, potentially in quite sub-optimal ways.

My main interest, then as now, was in this item

Measuring our success in government

  • The credibility of our Budget Responsibility Rules requires a mechanism that makes the government accountable. Independent oversight will provide the public with confidence that the government is sticking to the rules.
  • We will establish a body independent of Ministers of the Crown who will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public, and will cost policies of opposition parties.

Labour and the Greens promised to establish a Fiscal Council.

If so, they will have plenty of support.  The OECD has regularly advocated the creation of such a body.  So –  from the right –  has the New Zealand Initiative.   Such entities are pretty common in advanced economies now, especially in Europe.

A few years ago, The Treasury commissioned Teresa Ter-Minassian, former head of the IMF’s Fiscal Affairs Department, to undertake an independent review of The Treasury’s fiscal policy advice.      She looked at the possibility of establishing a Fiscal Council, and wrote as follows:

As regards the possible creation of a Fiscal Council, if it were established, it should probably have a more limited role in New Zealand than in most other countries that have created similar institutions. A more limited remit for the Council would be justified by the degree of operational independence of the Treasury in forecasting and policy analysis, its well-established non-partisan reputation, its sound record of relatively accurate and unbiased macroeconomic and fiscal forecasts, and the already strict fiscal accounting and transparency requirements mandated by the Public Finance Act.

The main purpose of the Council would be to offer an independent expert perspective and commentary on the advice provided by the Treasury to the Government on fiscal policy issues, and on the decisions taken by the Government and the Parliament on those issues. Such a Council would not need to operate on a full-time basis, and therefore would not be very costly.

If the Council was constituted by a small number of well-respected national, and possibly international, figures, with substantial fiscal expertise, previous policy experience, and strong communication skills, its commentaries at key points in the budget cycle, and on such important documents as the Long-Term Fiscal Statement and the Investment Statement, could help increase the resonance of fiscal policy options and choices with the media and the public opinion, and build social consensus on needed reforms.

There are two, quite separable, dimensions to the Labour/Greens proposal.  The first element is that the Council

will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public,

and the second is that it

will cost policies of opposition parties.

In general, I support the establishment of a small body to do something along the lines of the first of those sets of responsibilities.  This is what I wrote earlier in the year

The main area where a fiscal council –  or indeed, a broad macro policy advisory council –  could add value is around the bigger picture of fiscal policy (not just rule compliance, but how the rules might best be specified, and what it does (and doesn’t) make sense to try to do with fiscal policy).

But there are still important caveats.  For example, it is fine to talk in terms of the council having “oversight of government economic and fiscal forecasts”, but quite what level of resource would that involve?  Does the proposal envisage that the core forecasting role, on which government bases its policies, would move outside Treasury?  Even if there was some merit in that, it would be likely to end up with considerable duplication –  since neither the Treasury nor the Minister is likely to want to be without the capability to have their own analysis done, or to critique the work of the fiscal council.  The UK’s experience is likely to be instructive here, but we also need to recognise the small size of New Zealand and the limited pool of available expertise.  Our population –  and GDP –  are less than a 10th of the UK’s.

Again, I think Labour and Greens are moving in the right direction here, so I’m keen to see a good robust institution created, not to undermine the proposal.   The success of such a body over time will depend a lot on getting the right people to sit on the Council, and to keep the total size of the agency in check.   Too large and it will be an easy target for some other future government –  no doubt enthusiastically offered up by a Treasury keen to remove a competing source of advice.  But make it too small, or with too many establishment figures on the Council, and people will quickly wonder what is the point.  As it is, we don’t have a lot of independent fiscal expertise in New Zealand at present (as distinct, say, from specific expertise on eg aspects of the tax system).   I presume that if they form a government later in the year, Labour and the Greens will be looking quickly to the experiences in this area of small advanced countries like Ireland and Sweden.

It would simply not be possible to offer any sort of detailed oversight of the Treasury’s economic and fiscal forecasts –  that went beyond the sort of commentary market economists or even people like me can add to the mix from time to time –  without a reasonably significant staff establishment (people who are over lots of detail, including around revenue forecasts).    And I’m not sure what would be gained by doing so.  We don’t have an obvious problem in that area.  And as the Ter-Minassian report points out, unlike the situation in many countries, the published and economic and fiscal forecasts in New Zealand are those of The Treasury, not those of the Minister of Finance.   One can overstate the importance of the difference –  the Secretary to the Treasury has a lot of irons in the fire with the Minister at any one time and so it is hard to envisage the Treasury forecasts being too different from what a Minister might prefer –  but it does provide some protection.

A Fiscal Council seems more likely to add value if it is positioned (normally) at one remove from the detailed forecasting business, offering advice and analysis on the fiscal rules themselves (design and implementation) and how best to think about the appropriate fiscal policy rules.  The Council might also, for example, be able to provide some useful advice on what material might usefully be included in the PREFU  (before the election, I noted that routine publication of a baseline scenario that projected expenditure using the inflation and population pressures used in the Treasury economic forecasts would be a helpful step forward).

As I noted in the earlier comments, presumably the government will be wanting to look at what is done in other small advanced countries.  Ireland (total cost around NZ$1m per annum) and Sweden are obvious examples.    Having said that, countries that are part of the EU (and especially the euro area) have some distinctive issues that aren’t relevant to New Zealand.  For a country in the euro, fiscal policy is the only short-term cyclical management tool available, and the risks of a tension between the short and long-term are greater, and there is less of an independent check on serious fiscal imbalances from monetary policy.   There is unlikely to be a simple-to-replicate off-the-shelf model that can quickly be adopted here, and some work will be needed on devising a cost-effective sustainable model, relevant to New Zealand’s specific circumstances.  That is partly about the details of the legislation (mandate, resourcing etc), but also partly about identifying the right sort of mix of people –  some mix of specific professional expertise, an independent cast of mind, communications skills, and so on.  A useful Fiscal Council won’t be constantly disagreeing with Treasury or the Minister of Finance (but won’t be afraid to do so when required), but will be bringing different perspectives to bear on the issues, to inform a better quality independent debate on fiscal issues.

I also wonder whether consideration should be given not just to a Fiscal Council but to something a bit broader, what I’ve labelled as a Macroeconomic Advisory Council.   The governance and monitoring model for the Reserve Bank is up for review.   There seems to be pretty widespread support for moving to a (legislated) committee-based decisionmaking model for monetary policy.    Few people seem to have yet focused on the Bank’s financial stability and regulatory functions, but the case for a committee is at least as strong for those functions.   And few people –  other than, presumably past Governor and Board members –  think the Reserve Bank’s Board has done a particularly effective job in holding the Governor to account.     Perhaps that model was always unrealistic –  the Board was inevitably always going to be too close to the Governor that it would focus more on having his or her back than on holding the Governor to account on behalf of the public.  Perhaps it is time to move away from that model, and consider whether the public interest might better be served by asking an independent Macroeconomic Advisory Council to contribute to the debate, and periodic review, of monetary policy and financial stability policy, in a similar way to what Fiscal Council proposals have in mind for fiscal policy.   Again, it wouldn’t be about second-guessing individual OCR decisions or specific sets of forecasts, but offering perspectives on the framework and rules, and some periodic ex-post assessment.    In a small country, it would also have the appeal of offering some critical mass to any new Council.

(I touched on this option in a post written in the very early days of this blog, where I linked to a discussion note on similar issues I had written in 2014. )

The second responsibility of the proposed Labour/Greens fiscal council would be the cost of policies for Opposition political parties.  I’m much more sceptical about that proposal, even though it has recently had support from Peter Wilson (formerly of The Treasury) at NZIER, and from the New Zealand Initiative.  I wrote about this idea at some length when the Greens first proposed a Policy Costings Unit (an idea which attracted quite a bit of support from across the spectrum).    I wasn’t opposed, just sceptical.  That remains my position today, and the recent election campaign –  the first for decades I’ve watched not as a public servant –  hasn’t changed my views.

This is what I wrote last January

In the end, people often don’t vote for one party or another on the basis of detailed costings, but on “mood affiliation” –  a sense that the party’s general ideas are sympathetic to the broad direction one favours.  And I can’t think of a New Zealand election in my time when the results have been materially determined by the costings (accurate or inaccurate) of party promises  – perhaps in 1975 National might have won a smaller majority if the cost of National Superannuation had been better, and more openly, costed, but I doubt it would have changed the overall result.

And then, of course, there is the fact that economists, and public agencies largely made up of economists, have their own predispositions and biases.    The Economist touched on this issue quite recently.  It isn’t that economists are necessarily worse than other “experts”, or that people consciously set out to favour one side or another in politics, but (say) whatever the merits of the sorts of policies the Greens have favoured, it is unlikely that the New Zealand Treasury (1984-90) would have evaluated them in ways that the Greens would have found fair and balanced.  Perhaps ACT might have the same reaction to today’s Treasury?  If it were only narrow fiscal costings an agency was being asked to evaluate, perhaps these predispositions of the analysts would not matter unduly (although even there, much depends on the behavioural assumptions one makes), but the Greens’ proposal includes analysis of the “wider economic implications” of policy proposals.

On balance, I still think there is a role for something like a (macro oriented) fiscal council in New Zealand, perhaps subsumed within the sort of macroeconomic or monetary and economic council I suggested here (but perhaps that just reflects my macro background).   And there is probably a role for better-resourcing select committees.  But when it comes to political party proposals, if (and I don’t think the case is open and shut by any means) we are going to spend more public money on the process, I would probably prefer to provide a higher level of funding to parliamentary parties, to enable them to commission any independent evaluations or expertise they found useful, and then have the parties fight it out in the court of public opinion.  The big choices societies face mostly aren’t technocratic in nature, and I’m not sure that the differences between whether individual proposals are properly costed or not is that important in the scheme of things (and perhaps less so than previously under MMP, where all promises are provisional, given that absolute parliamentary majorities are very rare).  If there are serious doubts about the costings, let the politicians (and the experts each can marshall) contest the matter.

Was there a problem in the most recent election?  There was a big debate around Steven Joyce’s claims of a “fiscal hole” in Labour’s plans.     But it seemed to get sorted out in the ensuing debate.  Various experts weighed in –  including the anonymous group of former senior Treasury officials – and a reasonable consensus seemed to emerge: Joyce had probably over-egged his claim, but that the Labour fiscal numbers would be tight indeed, perhaps very tight.     Was there a need for extra taxpayer-funded analysis to deal with those claims (which were as much about framing as about bottom-line numbers anyway)?  I don’t see the gap.    And arguments about a capital gains tax, for example, don’t really depend on (soft as soap bubbles) revenue estimates, but about the merits (and demerits) of such a possible tax.  That is the stuff of the political debate.  It is up to each side to marshall their arguments –  and experts, to the extent they are helpful –  and for those of us offering independent commentary to play some role in shedding light on the claims and evidence that are put forward.     Treasury officials –  even if seconded to a Fiscal Council –  certainly can’t be regarded as a disinterested voice on such an issue.

And some of the very biggest issues of the election campaign were around emissions reduction, water use and pollution, child poverty reduction, and even immigration.  Policy in each of those areas probably has some fiscal dimensions, but in few of those areas are fiscal considerations likely to be the key factor –  whether in shaping how people vote, or in the potential economic and social ramifications of the options voters are deciding among.    Actually, the same could be said of housing policy –  a costing unit might focus on whether the KiwiBuild costings looked plausible, but that is probably of second order importance to reaching a view on what overall mix of housing. tax, land use, immigration policies might offer the best way back to a functional and affordable housing market.

As it is, election costings unit haven’t become generally established in other countries, and outside the Netherlands, I can’t a single example that seems to be working very well.  NZIER’s (Australian) economist seemed keen on the Australian approach.  Unless I missed something, when I checked their election costings website for the last Federal election, not a single policy of the main opposition party (Labor) had been costed through that process.    Labor ran the incumbent (first-term) government extremely close in that election, and it wasn’t obvious at the time that they paid any price for not utilising that process.  And nor is it obvious why they should: in the end each voter gets just one vote (well, ok, both NZ and Australian systems are a bit more complex than that, but you get my point) and in deciding to how to cast that vote, most of us are probably making some  sort of overall assessment of the values, competence, vision of the respective parties, on whether or not it is “time for change”, and so on.  We simply don’t decide –  and probably are quite rational in doing so –  by attempting to evaluate detailed policy costings, or the regulatory equivalent.  In New Zealand, apart from anything else, we know that the election policies are opening bids, going into government formation negotiations.  We also know that incumbent government are advised, on details, by fairly competent officials, and that successive governments have a track record of managing overal fiscal policy in a fairly responsible way –  sometimes blindsided by events, but usually events that not even the wisest Treasury or Fiscal Council will have foreseen.

If anything, I’ve become more sceptical of the policy costing unit idea than I was when the Greens first raised the option.    Such a unit probably can’t do much harm, but it is hard to see it doing much good either, and risks skewing debate away from the issues that, in any election, matter rather more.  It is, perhaps, a Treasury official’s dream but –  valuable as good Treasury officials are –  not what will help voters evaluate competing visions and aspirations for how best our country should be governed.