Brian Easton and trade agreements

January 31, 2018January 31, 2018 Michael Reddell TPP, Uncategorized

When the original TPP agreement was signed, various New Zealand economists weighed in. There wasn’t a great deal of enthusiasm for the deal. Here was Eric Crampton’s summary of a few contributions.

I think it’s fair to say that Brian Easton sits to the left of the NZ economist punditsphere, and that Mike Reddell sits to the right of the same.

In the past couple days, they’ve both put out their views on the TPPA. Reddell winds up arguing generally against it, though without saying it shouldn’t be signed, and Easton in favour, though not that enthusiastically. Both make nuanced arguments. Easton talks about the flow-on consequences of rejecting the deal at this point. Reddell talks about how the layers of bureaucracy to which we may well be signing up will do nothing to improve New Zealand’s declining productivity, though he falls short of saying NZ should reject the thing from where we’re at. He notes by email that he’d agree with Easton: from where we are, it should be signed. But he’s not all that enthusiastic.

I’ll remain a fence-sitter as it would take just too much work to come to a strong view on it. My confidence interval on whether the thing’s worth signing spans low/mid positive and low negative figures, and it wouldn’t be easy to tighten that up.

On the left, economists like Tim Hazeldine and Geoff Bertram had been sceptical, and from the right Jim Rose argued that the “correct” economists’ reaction to such agreements was generally “lukewarm opposition” – the opening stance of as eminent a trade economist as Paul Krugman – but that there probably wasn’t much harm, and perhaps some modest gains, in signing up to TPP.

And so when I wrote a brief post last week, after the news that the modestly-revised deal had been agreed minus the US, reprising some of my arguments from a couple of years ago, I didn’t think much of it. There looked to be some worthwhile aspects to the deal, some quite troubling ones, and just some puzzling ones as well. And since such an eminent beacon of economic orthodoxy as the Australian Productivity Commission has long been sceptical of such regional preferential deals, mine was as much as anything an argument for some proper robust independent assessment of the costs and benefits of the agreement. When international deals are done behind closed doors, it seems like a reasonable part of open domestic government that a proper independent assessment of the resulting product be done. The actual National Interests Assessment of TPP, done by the same body that negotiated the deal, hardly counted.

And so I was a bit surprised when I saw that Brian Easton had responded to my post (which had been reproduced on Newsroom). Apparently Brian thought he had come to a quite different conclusion. But the differences seem quite small, except on the China FTA (which my post hadn’t even touched on).

For example, we agree when he notes that

Should not a pro-free trader support a free trade deal? The correct answer is ‘not always’.

We also seem to agree that domestic regulation, eg of labour markets, should be a matter for domestic governments, not for international trade/investment agreements.

they are increasingly going behind the borders – in effect moving towards the unification of market regulation between countries. There may sometimes be gains in doing this but 35 years of CER with its incremental steps in regulatory unification shows how difficult it is to do properly. Personally, I favour subsidiarity (that decisions should be left to the lowest level) over global unification.

I am sceptical of – opposed to in fact – ISDS provisions, and Brian seems more relaxed

(For an alternative view of the investor-state dispute settlement provisions, see here. It is not the ISDS which undermines our sovereignty but that we encourage overseas investment.)

But he seems to misunderstand my concern. I largely avoid references to “sovereignty”, because as Brian notes whenever any of us deal with anyone else – overseas trade, employment or whatever, it often constrains our freedom of action to some extent, trading off against the gains from doing the transactions. What bothers me is the fundamental principle of equality before the law – some people shouldn’t have access to remedies not open to other people – as well as a reluctance to make things that seem inherently political subject to the jurisdiction of courts, domestic or foreign. As I’ve noted in earlier posts, ISDS provisions are not necessary to foreign investment – they’ve only been around for 60 years or so, and only became common in the last couple of decades. And there was nothing comparable in the first great age of globalisation prior to World War One.

Perhaps there is a difference around unilateral moves to free trade. I had noted that if the government was serious about its free trade bona fides, it could at a stroke remove the remaining (mostly quite low) tariffs New Zealand has in place. Standard international trade theory tells us that New Zealanders as a whole would benefit from doing so – since our tariffs are on things where we are a price-taker in international markets. Mostly, tariffs are costly to the citizens of the country imposing them. Brian appears to disagree

For example, were we to announce we would drop all our tariffs to zero to the US in exchange for nothing we would be unlikely to benefit, although the US would.

but I’m not sure why. He doesn’t say. But mine had been a (longrunning) rhetorical flourish – repeating a policy recommendation that the 2025 Taskforce had made almost a decade ago – and didn’t really have any direct bearing on an assessment of the costs and benefits of the TPP-1 deal.

Is improved access to foreign markets for our agricultural exporters likely to be beneficial? Indeed. And on this Brian and I seem to be at one. Brian notes that

More subtly, the pastoral terms of trade have been rising since the Tokyo Round of multinational trade liberalisation in the 1970s. It would be foolish to say that the rise was entirely the result of the trade rounds, but it would be as unwise to say that trade liberalisation has had no effect. TPP11 involves a small improvement in pastoral exports access; there will be another (small) boost to export prices and a small boost to effective GDP (real spending power) if we respond sensibly.

There probably isn’t much dispute that the improved access for pastoral exports will be a boost to New Zealand, but that is only one part of the deal, and to be able to point to gains in some areas isn’t to demonstrate net gains for the citizenry from the deal as a whole. And, without claiming any great expertise in the area, I would be a little wary of ascribing too much of the gains in the pastoral terms of trade in recent decades to trade liberalisation. But as I’ve pointed out repeatedly, this isn’t primarily an argument about free trade – which I think is almost always mutually beneficial – but about preferential regional trade, investment and regulatory agreements, where there is no strong theoretical prior suggesting mutual gains.

I suspect that what motivated Brian Easton to write his column wasn’t really differences over the TPP-1 deal (it being neither “comprehensive” nor self-evidently “progressive” I’ll hold off using the new official label) at all. After all, go back and read his take on the earlier deal and if, on balance, he was supportive, it wasn’t very enthusiastic in tone, except perhaps in the sense (which I accept) that if everyone else is in the club we probably should be too. Instead, there appears to be a large difference between us on the China FTA. After noting that I had expressed some scepticism about the evidence base for claims that our various preferential agreements had done much for New Zealanders as a whole, Easton responded.

it is not controversial to say that without the Chinese FTA the New Zealand economy and all those in it, would have suffered greatly from the Global Financial Crisis in a way that others did. (Even so we blew some of the potential benefits by allowing a speculative farmland boom; our trade negotiators were hardly to blame for this.)

Frankly, it was this paragraph that prompted me to respond to his column. If Easton’s claim here isn’t controversial, it certainly should be. I’ve never before seen a serious economist make the claim, only politicians (one of whom I’ll come back to in a moment).

For a start, the timing doesn’t work (at all). The China FTA was signed in April 2008, and came into effect in October 2008. It provided for a 12 year period of phasing down (or out) restrictions previously in place. The dairy land boom (and associated credit boom) had been running for years by then, and global dairy prices had risen sharply from late 2006 (some combination of rising oil prices, rising grain prices, and reduced EU stockpiles), prompting the last wave of OCR increases in the first half of 2007. The New Zealand recession dated from the March quarter of 2008, and in that recession global dairy prices fell savagely: there were real concerns in the first half of 2009 around a possible threat to financial stability from dairy loan losses (and indeed about potential threats to Fonterra’s own finances).

Now quite possibly China’s general demand stimulus helped prompt a recovery in global economic activity in the years following the recession. Quite possibly, the FTA also boosted total New Zealand dairy returns over the following few years – but Chinese babies wanted formula, consumers wanted milk powder products, and the melamine scandal would have happened anyway, whether or not there was a China-New Zealand FTA. The terms of trade have been helpful, but how much that specific deal boosted the terms of trade – and for how long – needs a lot more detailed study than either Easton or I have done.

But Easton’s story also doesn’t make a lot of sense because, actually, our experience in the great recession of 2008/09 was quite bad. I’ve covered this argument before, in a post after a speech outgoing Foreign Minister Murray McCully gave last year

Had it not been for the dramatic expansion of trade and economic relations with China in the early years of the Key Government, New Zealand would have suffered a long and sustained recession, and all of the associated social challenges that we have seen in some European nations.

But there is almost no evidence to support such a view? Actually, over the first two or three years of the recession and aftermath, the path of New Zealand’s real GDP per capita wasn’t much different than that of the US – the epicentre of the financial crisis, and a country that conventionally exhausted the limits of conventional monetary policy. Our initial recession was a bit shallower, but our initial recovery was even weaker. And as I illustrated in the earlier post, over the decade our trade share of GDP has shrunk, while that of the US stayed relatively steady.

What really marked out the crisis countries of Europe from New Zealand (or Australia – no China FTA then, Canada – no China FTA eve now, or the United States, or Norway or Sweden) from the more crisis-hit countries of Europe, wasn’t an FTA with China, but a floating exchange rate and discretionary monetary policy. And even then, don’t forget our increasingly poor productivity performance – almost no productivity growth in the last five years, even as (say) the fast-emerging countries of eastern and central Europe have managed substantial productivity gains.

As I noted in the earlier post responding to Murray McCully’s claims

Perhaps this fawning “China our saviour” line went over well when the Premier of China was visiting recently, but it really doesn’t amount to much at all. The country composition of our exports has changed – and for a couple of years perhaps high prices out of China for milk powder lifted farmer incomes – but as a share of the overall income, exports have been shrinking. We produce stuff (mostly bulk commodities), and someone buys it. In recent years, China has been a more important buyer – although Australia remains our largest export market – and the free trade agreement with China is likely to have been helpful, but it has hardly transformed our economic fortunes.

But, as with the new agreement, hard-headed independent assessments of deals that are always as much about politics, and political signalling, as about economics, would be welcome.

UPDATE: A reader much closer to these things than I am emails to suggest that the biggest gains from the China FTA aren’t to do with reduced tariffs but with improved trade facilitation. Paper work happens more smoothly than it otherwise would, in ways that make a real difference. Sounds plausible.

Some Anglo labour markets

January 30, 2018January 30, 2018 Michael Reddell inflation, labour market, Uncategorized

Having suggested yesterday that it might be time to think about cutting the OCR, or at least firmly committing to not raising it unless or until core inflation has already risen close to 2 per cent, I was reflecting a bit on the handful of countries in which the central bank has raised policy interest rates, in particular Canada, the UK, and the United States.

In the UK case, one could almost discount the single increase, which really only reversed the cut put in place in the climate of heightened uncertainty after the Brexit referendum. But in Canada and the United States there have been several increases – in Canada, the policy rate is now 1.25 per cent, up from a low of 0.5 per cent, and in the United States, the Federal funds rate target is 1.25 percentage points off the lows. In Canada’s case, there has even been signs of a sustained increase in core inflation, although in neither country is core inflation yet at target.

One material difference, if one contrasts New Zealand and Australia on the one hand, and the UK, Canada, and the United States on the other, is spare capacity in the labour market. Since institutional features (labour regulations, welfare entitlements etc) vary from country to country – affecting the “natural” rate of unemployment – one can’t take much from simple cross-country comparisons of unemployment rates. But I’d noticed a headline suggesting Canada’s unemployment rate – at 5.7 per cent – was the lowest it had been in decades, and wondered how that comparison looked for the other countries.

	Current unemployment rate	Minimum since 1986
Australia	5.5	4.1
Canada	5.7	5.7
New Zealand	4.6	3.3
United Kingdom	4.2	4.2
United States	4.1	3.9

Like Canada, the UK also now has an unemployment rate that is the lowest in decades (I started the comparison from 1986 when the New Zealand HLFS started). The United States unemployment rate is getting close to to the multi-decade low. But in both Australia and New Zealand, the unemployment rates are well above the 30+ years lows. Perhaps not very surprisingly, core inflation is weak in both countries – the December quarter data for Australia are out tomorrow, but in September, the trimmed mean inflation rate was 1.8 per cent, against a target midpoint of 2.5 per cent.

Why these five countries? Mostly, because all five have (a) data going back thirty years or more, and (b) have had floating exchange rates pretty consistently (the UK had three years in the European Monetary System). Countries that had fixed exchange rates in the past often had bigger fluctuations in their unemployment rates.

Of course, even this comparison could be overly simplistic. After all, labour market regulation etc can, and does, change over time, as do things like welfare benefit/work test regimes. But over 30 years, both the New Zealand and Australian labour markets are generally regarded as having had more policy liberalisation than many other advanced countries. Our minimum wage policy may be a partial exception, although even there we aren’t alone – the UK, for example, has moved from having no national minimum wage to an increasingly binding (high) one.

And one area suggesting that our “natural” rate of unemployment (or NAIRU) might have been trending down more than in other countries, is the increased participation in the labour force of people 65 and over. The OECD data only start in 2000, but here is how things have changed.

	Labour force participation rate, age 65+
	2000	2016
Australia	6.0	12.6
Canada	6.0	13.7
New Zealand	7.7	23.4
United Kingdom	5.3	10.7
United States	12.9	19.3

New Zealand’s participation rate for old people has increased far more than those of these other Anglo countries. And since the unemployment rate for this age group in New Zealand is a mere 1.2 per cent, almost arithmetically a rising share of the labour force made up of an age group with a very low unemployment rate will tend to lower the average unemployment rate, and the NAIRU. Our NZS system is structured to provide a near-universal modest welfare benefit, but impose no penalty on those who continue to work. If an old person loses their job, they face less immediate pressure to find a new one (than, say, a 21 year old), and it isn’t surprising then that the unemployment rate for that age group – a rising share of the labour force – is so low.

I wouldn’t want to base any strong conclusions on these simple comparisons, but when you hear talk of some other central banks modestly raising interest rates, remember that conditions aren’t the same from the country to country, and that in New Zealand (and Australia) not only is core inflation persistently low, but there is little sign of any intense pressure on capacity in the labour market.

Inflation is the Reserve Bank’s responsibility

January 29, 2018January 29, 2018 Michael Reddell inflation

Late last week Statistics New Zealand released the latest quarterly inflation numbers. For years, the Reserve Bank – explicitly charged with the job – has told us inflation is heading back to settle around two per cent. If anything, most market economists have been even more of that view – typically their forecasts of inflation and/or interest rates have been higher than those of the central bank. Indeed, on the very morning the CPI numbers were to be released one prominent market economist was reported in the Herald as picking that the Reserve Bank would be – indeed, should be – raising the OCR as early as July.

But for years, the Reserve Bank has been consistently wrong. The year to December 2009 was the last time their preferred measure of core inflation was at 2 per cent, the midpoint of the target range (a goal explicitly highlighted in the 2012 to 2017 Policy Targets Agreement). And for six full years now that sectoral factor model measure of annual inflation has been between 1.3 and 1.5 per cent. There is almost nothing in any New Zealand data suggesting any sort of sustained lift in New Zealand’s inflation rate.

There isn’t much in the rest of the advanced world taken as a whole either. Here is the median rate of CPI (ex food and energy) inflation for the OECD countries/regions with their own currencies.

CPI ex OECD jan 18

There is plenty of wishful thinking – among some central bankers, and some market economists – but not much sign of more inflation, even in the handful of countries where central banks have raised interest rates a bit.

Led by the Reserve Bank, a lot of the commentary in New Zealand would have you believe that if there is an issue with low inflation in New Zealand, it is all about tradables inflation – ie inflation in things we import, or produce in competition with the rest of the world. The implication often is that if we just focus on domestically-generated inflation, there isn’t an issue. But mostly that looks like an attempt to muddy the water and avoid responsibility.

Here is one way of looking at that issue. In calculating the sectoral factor model of core inflation, the Reserve Bank actually calculates (and now publishes) separate estimates of tradables and non-tradables core inflation (that’s why it is called the “sectoral” model). In this chart, I’ve shown both those measures and – the bars – the gap between the two of them (non-tradables less tradables).

sec fac model jan 18

The gap between the two series – the extent to which core non-tradables inflation exceeds core tradables inflation – is actually a bit less than average at present.

In looking at the chart, there are perhaps two other things worth bearing in mind.

the core tradables measure is influenced by developments in the exchange rate (as one would expect) – see the surges in 2001 and 2009 after the sharp falls in the exchange rate, and the dip in 2004 after the sharp rise. It is a reminder that although we can’t control world prices for the stuff we import, New Zealand dollar tradables inflation is directly influenced by New Zealand monetary policy choices (as they affect the exchange rate), and
the gap between core non-tradables and core tradables is somewhat cyclical. The peaks in the gap coincide with the periods of sustained pressure on domestic resources (as measured, eg, by the Reserve Bank’s output gap estimates). Perhaps unsurprisingly when, as at present, output gap estimates are around zero, and the unemployment rate has still been above NAIRU estimates, the gap between the two sectors’ core inflation rates is pretty subdued.

And, of course, there is little or no sign in the chart of any sustained pick-up in core non-tradables inflation, the bit most directly responsive to New Zealand economic circumstances. And don’t be fooled by the fact that core non-tradables is itself above 2 per cent: non-tradables typically inflate faster than tradables, and if overall core inflation is to be kept near 2 per cent, core non-tradables inflation would typically have to be around 3 per cent. It isn’t, and hasn’t been for years.

This chart has another of my favourite series: SNZ’s measure of non-tradables excluding government charges and cigarettes and tobacco (now heavily affected by rising taxes).

dom inflation

I’ve also shown the “purchase of housing” component of non-tradables inflation – largely construction costs. Non-tradables inflation, ex taxes and government charges, did pick up a bit (as one might expect) when construction cost inflation was surging (back in 2013, and in 2015/16), but (a) the peaks seem to have passed, and (b) this particularly proxy for core non-tradables inflation is now rising at less than 2 per cent per annum.

Finally, there isn’t much sign that people are really expecting inflation will soon settle back to, and stay around, 2 per cent. The Reserve Bank’s Survey of Expectations will be out next week, and it will be interesting to see what respondents write down for their expectations five to ten years ahead (with a new government and a new Governor, but an uncertain mandate and unknown committee still to come). When I filled in the form the other day, I wrote down something like 1.75 per cent. But perhaps I was too optimistic? There are, after all, market transactions going on where people take a view – actual or implicit – on what average future inflation will be, as people buy and sell government bonds (conventional and inflation indexed).

The gap between indexed and conventional bonds isn’t a perfectly clean read on inflation expectations – but then neither is any other measure. But here is what the data shows, using the Reserve Bank’s data for 10 year conventional government bonds (a rolling horizon) and the indexed bonds maturing in 2025 and 2030.

iib breakevens jan 18

At the start of the period, the 2025 bond was nearer to a 10 year maturity, while these days the 2030 bond is nearer 10 years. And whereas implied expectations of average future inflation were close to 2 per cent four years ago (the start of the chart), now they seem to be only around 1.35 per cent. As a reminder, the Reserve Bank’s sectoral core factor model measure of inflation is currently 1.4 per cent, and has been in a range of 1.3 to 1.5 per cent for years. As expectations, the implied market numbers don’t seem irrational at all.

Why does it all matter? After all, 1.5 per cent isn’t really that far from 2 per cent. I think there are three reasons:

first, the Reserve Bank undertook to keep (core) inflation near 2 per cent, and not only hasn’t done so, but doesn’t have a compelling explanation for their failure, in the area they are supposed to be most expert in,
second, the lost opportunities. Economic growth over the period since the last recession hasn’t been particularly strong, and the unemployment rate has been consistently above credible estimates of a “natural” non-inflationary level. Monetary policy that had been run a little looser not only would have delivered inflation nearer target, but would have allowed some (modest) real economic gains as well, In particularly, some of those unemployed – who most monetary policy commentators seem not to care much about – would have been back in jobs sooner, and even now the unemployment rate could have been lower, and
third, when the next recession comes many countries are going to be in considerable difficulty because they can’t cut interest rates very much at all. Our problem isn’t as severe as that in some countries, but it is hardly a trivial issue either (given that the Reserve Bank cut the OCR by 575 basis points in the last recession). The best contribution the Reserve Bank can make to miminising that threat is to get inflation back up to – perhaps even a bit above – target, and keep it there. By doing so, expectations of higher inflation will underpin higher average nominal interest rates.

Much of the problem in recent years has been that the Reserve Bank has been operating with the wrong model. In particular, we’ve heard repeated claims from the (previous) Governor that monetary policy was extraordinarily stimulatory, and repeated talk about “normalising” interest rates. How much better if our Reserve Bank – with more policy flexibility than many of their northern hemisphere peers – had been willing to declare themselves genuinely agnostic about what was going on with neutral or “natural” interest rates, and been willing to focus – with real intent – on doing whatever it takes to get and keep core inflation back to, or perhaps a little above, 2 per cent. Caution might have been excusable in the immediate aftermath of the last recession, but after years of persistently low domestic inflation, it looks like indifference – which really should be inexcusable.

I saw the other day an article which seemed to suggest that the new Governor’s job (and that of his forthcoming statutory committee) just got harder. To the contrary, it is even clearer now than it was a few quarters ago that if it is time for anything, it is time at last to take a few risks on getting, and keeping, core inflation back to target.

Len Bayliss RIP

January 27, 2018October 12, 2018 Michael Reddell New Zealand economic history

I wasn’t planning to write anything today, but in the death notices of the Dominion-Post I noticed this morning the passing of Len Bayliss, one of the most prominent New Zealand economists of a previous generation (late 1960s to, say, the late 1980s).

I only met Len once, but when I first came to Wellington in the late 1970s he was a prominent public figure, and I was enough of a political/economic junkie to get a bit of a buzz from the fact that one of his sons was in my class at Rongotai College and that, for a year or two while I was at university, Len often caught the same bus into town each weekday morning as I did.

Len was born and educated in Britain, but wanted to get out of the United Kingdom after finishing his degree at Cambridge. Eschewing South Africa for laudable reasons, he wrote to various banks and government agencies in Australia and New Zealand, and after an interview that seemed to be not much more than a cup of tea with a visiting Deputy Governor passing through London he was hired by the Reserve Bank of New Zealand in 1951, where he spent quite a few years in a vibrant economics department.

He moved on to the Monetary and Economic Council, and played a key role in that agency’s 1966 report calling for liberalisation of the financial sector – which wasn’t particularly popular with the bureaucratic establishment. But his most prominent perch was as the long-serving Chief Economist of the (state-owned) Bank of New Zealand, where he openly championed sound economic management and liberalisation. In the early years of Muldoon’s Prime Ministership he served on the Prime Minister’s Policy Advisory Group and appears to have played an instrumental role in the financial liberalisation that government undertook in 1976/77. Of Muldoon in this role he wrote

Excellent. He was the best boss I’ve ever had. Absolutely decisive. I wrote his speech for the Mansion House dinner, the most important speech he’d made after becoming PM. I gave it to him. He said send it to Treasury and see if it’s all right with them. They wrote back wanting something changed and wrote a little memo and he just put ‘No’. And he always was very proper. He may have been tough to his political opponents but as Bernard Galvin used to say, certainly in the time I was there, it was a very happy group. He never tried to force you to do anything. In a sense, he treated you just like a public servant, as a politician should treat them. He was decisive. He would argue very intelligently. Watching him at the Cabinet Economic Committee, he really tore strips off ministers who hadn’t done their homework. And I saw him several times in debates with Noel Lough [Deputy Secretary to the Treasury]. Noel Lough was a lovely bloke but Muldoon really won the debates.

After his secondment ended, Bayliss returned to the BNZ, from where a few years later, having become increasingly critical of the economic management of the New Zealand economy, he was put in a position where – under fire from Muldoon, and with no support from the supine BNZ Board and management – he felt he had no choice but to resign (at considerable financial cost to himself).

In the post-liberalisation year, Bayliss served on the Board of the BNZ, and he recounted in his published works the frustrations of trying to constrain a management gorging on bad credit, and eventually driving the bank to the point of failure.

At a macroeconomic level he had long-favoured liberalisation and stabilisation (cutting inflation, balancing the budget) but in the post-liberalisation decade he was increasingly uneasy about the persistently high real exchange rate – a concern that he (rightly in my view) never lost.

As I said, I only met Len once – although we had corresponded a bit since – when the New Zealand Association of Economists asked me to record, and edit, a long interview with him (as part of a series on the life and work of prominent New Zealand economists). The text of that interview has quite bit that might interest those concerned with the history of New Zealand economic and financial policy.

In preparing for that interview, I had been focused on the earlier decades and didn’t give the attention it warranted to his departure from the BNZ or his later time on the Board. But

…as he records it, that interview and some follow-up questions from me prompted him to put together a volume of documents and recollections – Recollections: Bank of New Zealand 1981-1992 – dealing with his ouster from the BNZ and his later term as a government-appointed director of the BNZ as it descended into crisis and near-failure in the late 1980s and early 1990s.

And I used that material last year for a post on his ouster from the BNZ, having finally got under the skin of the Prime Minister once too often.

When some academic finally writes the definitive history of the financial debacle/crisis in New Zealand in the late 80s and early 90s, I hope they take time to draw on the perspectives and papers Bayliss has apparently lodged at Massey University.

His was a courageous voice, unusual for its day. In an environment in which few could speak – there weren’t many economists outside government – it was a valuable contribution in articulating the increasing unease about New Zealand’s economic underperformance and poor economic management.

UPDATE (Oct 18)): I was asked by the New Zealand Association of Economists to write an obituary. It is on page 6 of the April 2018 issue of their newsletter Asymmetric Information.

A curious suggestion

January 26, 2018February 2, 2018 Michael Reddell deposit insurance, insurance

There was a curious suggestion in the New Zealand Initiative’s new report on the handling of the Canterbury earthquakes and possible ways ahead. Almost in passing they suggested that perhaps one way of handling failed insurance companies might be to consider an insurance company version of the Open Bank Resolution (OBR) scheme, that now sits in the toolkit as one (not terribly credible, in my view) instrument that might be used by a government to help manage a bank failure.

I think I see what motivated the suggestion. After the February 2011 quake, AMI failed, but instead of being allowed to close, with losses lying where they fell, the government (backed by – questionable – advice from The Treasury and the Reserve Bank) launched a bail-out. No policyholder lost anything. It set a terrible precedent – and wasn’t cheap either (final costs as yet unknown). And the OBR scheme had been motivated by a recognition that governments would probably prove relucant to let major banks close – how, for example, would solvent firms make their payrolls next week if their bank, relied on for overdraft facilities, suddenly closed? Rather than jump straight to a bailout – which would be expensive, send terrible signals about future distress episodes, but which would keep the lights on and the doors open – the OBR option was designed to allow a failed bank to remain open without any direct injection of public money. Losses would rest with creditors and depositors, but the payments system and the information-intensive business of business credit needn’t be directly disrupted.

As I say, the New Zealand Initiative people really only mentioned the issue in passing, but interest.co.nz picked up the reference and devoted a substantial article to it, including an interview with my former Reserve Bank colleague Geof Mortlock. So it is worth giving more space to my scepticism than the NZI reference alone would typically warrant.

In doing so, it is worth stressing that:

banks and insurance companies are two quite different sorts of beasts,
keeping a failed company open and operational is, at least in concept, a very different issue than protecting depositors or policyholders once a failure has happened.

Most of rely on banks being there almost every day. Whether we rely more on cash – and thus use an ATM every week or so – or mostly on direct electronic payments, we count on our bank being there. Incomes flow into bank accounts – be it wages, welfare payments, or whatever – and we count on being able to use those accounts to make routine payments, including things as elemental as food. Businesses often rely on bank credit to make routine payments, including such regular commitments as wages or materials. For small businesses in particular, those credit relationships are not easily or quickly re-established (and perhaps especially not if a bank with a quarter of all the country’s small businesses failed).

So there is quite a plausible case that there is some wider public interest in keeping the doors of a (large) failed transactions bank – Lehmans might be quite a different issue – open, even if the bank has been badly managed enough to have failed. There is a basic utility dimension to some of the core functionality. That is the logic of OBR – creditors (including depositors) should take losses, if losses there are, but keep the doors open and the payments flowing (even if the available credit balances are less than depositors had been counting on).

What about insurance companies? I’m sure most of you are like me. You pay your bills each year, and hope never to have any other contact with an insurance company ever. And even when bad things do happen, there (a) isn’t the same immediacy as about buying today’s groceries, and (b) a bad thing happening today isn’t generally followed by another bad thing happening tomorrow.

And banks are prone to runs in ways that insurance companies aren’t. They are just different types of contracts, for different types of products/services.

But focusing on insurance companies, it is worth unpicking the two possible (decent, economic) reasons why people might make a case for keeping a failed insurance company open, even with writedowns of policyholder claims.

The first relates to the immediate interests of people with claims outstanding at the point of failure. Typically that will be quite a small number of people (in which case there is no real public policy interest at all, and the failed company can simply be allowed to close, as was done with one other small insurer after the Christchurch quakes), but not always. AMI was brought low by one specific set of events – the Canterbury quakes – affecting quite a large chunk of their policyholders. Had AMI simply been left to fail, and normal commercial procedures taken their course, what would have happened? The policyholders with claims outstanding at point of failure (including those with houses damaged/destroyed in the quakes) had no particular interest in AMI continuing to trade as a going concern. They just wanted their claims settled, to the maximum extent possible. Wouldn’t a liquidator have needed to work out how large those claims actually were – an issue still in dispute in some cases – and then made a final division of the assets (including reinsurance) assets of the firm among all the creditors, including policyholders with claims?

Policyholders with outstanding claims had two interests:

being paid out (whether in cash, or new home – under replacement policies) in full, or as near as possible, and
being paid out expeditiously.

Liquidation is unlikely to bring about either, but neither is an OBR-type of instrument. The whole point of an OBR is that losses fall on policyholders with outstanding claims, and a statutory manager operating under an OBR faces much the same issues as a liquidator – needing to know the final value of all outstanding claims before final payments can be made and (thus) losses allocated.

So the interests of policyholders with outstanding claims can either be met by a bailout – often at considerable direct Crown expense, and rather bad market discipline incentives (although the role of reinsurance might mean those effects as less bad for banks) – or by a policyholder protection scheme, something similar in conception to deposit insurance. This is an option canvassed in the interest.co.nz article (and which I also favour, as a second best). Such a scheme – funded by levies on policyholders with cover – could be rather better tailored.

As I’ve noted, one reason OBR will probably never be used is because losses will fall as heavily on “innocent” grannies as on sophisticated offshore wholesale investors. There is public sympathy for one group, but not the other. Deposit insurance allows that distinction to be drawn. No doubt the same goes for the creditors of insurance companies. There is likely to be a great deal of sympathy for a poor family with a modest dwelling caught up in an extreme series of earthquakes – and an unwillingness to see them face, say, a one-third write-down in the value of their claim. But probably no one (other those directly involved) cares greatly if a family trust with a $4 million house in Fendalton and an expensive holiday home in Akaroa finds that, after the failure of their insurer, they can afford to spend only $2 million on a new house. It was one of the offensive things about the AMI bailout that everyone – rich and poor, sophisticated and not – was bailed out in full.

And so I probably would favour some sort of statutory policyholder protection scheme. I’d probably limit it to house insurance, fund it through levies on policyholders, and perhaps payout 100 per cent of claims for the first, say, $500000 of a claim, 50 per cent of the next $500000, and then leave people to the market for sums beyond that. It would meet most of the probable and inevitable political demand, if and when a major insurer fails amid a claims-surge such as a natural disaster, would facilitate early settlement of a major chunk of any residential claim, and would keep separate the protection of small policyholders from the managment of the failed business itself.

But perhaps the argument for something like an “insurance OBR” is stronger on another count, which has nothing to do with those with outstanding claims on the failing company at the point of failure. When an insurance company fails, your existing insurance policies with that company are no good. You need to take steps, perhaps quite quickly, to replace the insurance.

Sometimes that will be easy enough. If a small contents insurer failed today, out of the blue, most customers would have no great difficulty getting a new policy in place quite quickly. But in other circumstances it could be quite difficult. The failed insurer might have specialised in a particular type of insurance which few other companies offered (this was an issue when the big Australian insurer HIH failed).

In a domestic New Zealand context, there seem to be two sorts of plausible problems. The first is that one company – IAG, through its various labels – has around 50 per cent of the general insurance market in New Zealand. As the interest.co.nz articles notes, even the Reserve Bank has expressed some unease about this concentration. Should IAG fail, it might be very difficult for customers to replace their policies quickly with other companies. “Might” because other companies, including abroad, might be keen to pick up the customer base, especially if the failure resulted from a well-understood, limited, idiosyncratic event. But even if this is an issue, it looks like an issue that should have been able to be taken into account when the various takeovers that led to IAG’s dominant position were approved.

Perhaps more of an issue is if we were to see a repeat of a large failure associated with a series of destructive earthquakes. In the wake of the Canterbury earthquakes – and indeed, after Kaikoura in 2016 – people kept their existing house cover with their existing insurer, but insurers were very reluctant (typically simply refused) to extend cover. Even alterations to an existing dwelling didn’t get covered, and it was almost possible for a new purchaser to get insurance. It was quite rational behaviour by the insurers – risk (of further quakes) around the affected locality, and unpriceable uncertainty, had increased a lot. That complicated the house sales market for a time – an inconvenience but not the end of the world. But imagine that a large company simply failed, leaving most of their customers needing to replace their policies immediately (from personal prudence as well, typically, as from a requirement of a mortgage lender). There would simply be no takers, at least in affected regions. I don’t suppose banks would suddenly start selling up customers caught temporarily without insurance, but one can’t deny that there would be an issue. Politicians would respond.

Something like an OBR for general insurance might be a remedy to that particular problem. The failed company would remain open, and presumably existing policies would remain in place.

But is it worth it? Personally, I’m a bit sceptical. There is no widespread public interest in the continuity of insurance companies across all products. Housing may well be different – and would no doubt be seen so politically. But in the event of a failure, in circumstances akin to AMI (natural disaster with ongoing extreme uncertainty) but in which the insurer was actually allowed to close, might not a less bad, less intrusive, intervention be something like an ad hoc intervention in which the Crown took over the existing residential insurance policies for six months after the failure, in the expectation that after six months policyholders would have been once again able to make private insurance arrangements. It doesn’t look like a scheme that would materially undermine market discipline – those with outstanding claims at point of failure would still be exposed – but might recognise that in certain rare circumstances markets can simply cease to function for a time. And still allow the salutary discipline of a failed entity passing into history.

In sum, I probably would favour a limited policyholder compensation scheme, funded by policyholders, at least for residential insurance policies. It isn’t a first-best policy, but in a second or third best world it seems better, and fairer, than generalised bailouts such as the AMI one. But an OBR-type arrangement doesn’t seem appropriate for the general insurance industry – it wouldn’t speed final resolution of claims, wouldn’t focus protections where the greatest public sympathies are likely to be. If it didn’t involve the sort of panoply of new controls and provisions the bank OBR system does, it just doesn’t seem well-tailored as a general response.

Land use regulations matter

January 25, 2018January 25, 2018 Michael Reddell Housing

Most local councils don’t employ economists – or at least not ones we hear of. The Auckland Council does have an economics unit, and the previous incumbent did some interesting and stimulating work.

But yesterday on interest.co.nz there appeared an article by two of the Auckland Council’s economists which argued, so the headline proclaimed, that “evidence from across NZ supports conclusion that land use regulation is unlikely to be the main culprit for house price rises”. They even had an estimated empirical model in an attempt to back their claim.

But, frankly, it looks like an attempt to play distraction, and shift responsibility from their employer (and other local governments around the country). And it is as if this is the very first time they had come to the subject and were, thus, unaware of the large number of thriving growing cities in the US with house price to income ratios not much more than a third of those in Auckland or Tauranga.

This is the centrepiece of the article

martin-norman-jan-18-2

Which might look superficially fine, at least until one stops to think about what is going on here.

Firstly, it appears to be an odd model, in that they appear to be explaining changes in nominal house prices, but without any explanatory variables like general prices or wages. Over the best part of a decade, one might expect nominal house prices to rise by around 20 per cent as general costs and prices rose. Perhaps they’ve estimated the model in real terms, but there is no suggestion in the article that they have done so.

Secondly, all else equal, lower real interest rates might indeed tend to raise the value of an asset in fixed supply. But, on the one hand, this proposition doesn’t engage at all with the reasons why real interest rates might have fallen. If, for example, expected future income growth has fallen at the same time – a part of the story in most explanations of the last decade – any such asset price effect will be greatly weakened. And, on the other hand, in a well-functioning housing and land market, the only fixed factor here is unimproved land. And absent land-use restrictions, unimproved land in most places – even most parts of a city – simply isn’t worth much. Perhaps you might think of $50000 per hectare for good rural land. You could see long-term real interest rates fall 300 basis points (more than we’ve actually experienced), with no changes in future income expectations, and it still wouldn’t make that much difference to the free-market price of unimproved land (and the component of that used in a typical suburban dwelling).

Third, what about population increases? Auckland (and Hamilton and Tauranga) have had a lot of population growth – indeed, over decades Auckland has had one of the fastest population growth rates of any largest city in an OECD country. And when regulatory obstacles – land, consenting/construction or whatever – get in the way then shocks to population will boost house prices. There are regular population estimates published, which are easy to drop into a model. And, no doubt, had Auckland’s population growth rate been half the actual rate, house and land prices would be somewhat lower. But all this simply ignores the point – the insight we really get from that swathe of US cities, (as well, actually, as from basic theory) – that population growth alone makes little or no sustained difference to house prices when the land and construction markets are free to work effectively. So ascribing responsibility for house price increases to population growth is largely just cover for the regulatory failures of central and local government.

As a reminder, in fairly substantial US cities – with growing populations – we find median house (including land) prices of around NZ$250000 to $300000 (from the Demographia report: Des Moines US$198000, Louisville US$176000, Omaha $179000).

Noting that across local authority regions places with larger population growth rates have tended to have higher house price inflation, the Auckland City economists attempt to cover themselves this way

To point the finger at land use regulation would imply that all the areas with the largest population increases have the worst land use regulations and those with the smallest gains have the best regulations.

But that simply doesn’t follow. Of course, it is often the interaction between population pressures and land-use restrictions that matters in determining what happens to prices. And it is quite plausible that places with the fastest population growth might even have some of the less worse land-use restrictions, but those restrictions are simply placed under more pressure. Land-use restriction is, to some extent, endogenous.

As the end of their article approaches, they argue that

Council, the Reserve Bank and the Ministry of Business, Innovation and Employment have all estimated Auckland’s housing shortfall at between 43,000 and 55,000 and growing. The Auckland Unitary Plan allows for up to one million potential new dwellings. Yet the plan was implemented a year ago, and there is no evidence of decreasing land prices.

Put another way: If having already zoned to develop 20 times the current housing shortfall is not bringing land prices down at all, can land use regulation in Auckland be the major cause of high house prices?

As I’ve noted here previously, those estimates of a “housing shortfall” are almost meaningless. In the Auckland market as it stands, given the regulatory and other features, effective supply and effective demand appear to be in more–or-less balance. What makes me say that? The fact that prices haven’t moved much for a year or more. No doubt there would be demand for many more houses if the price of land were lower, but at current land prices – regulated and thus artificially scarce – effective demand seems to be largely sated.

And what of the argument that “we’ve done the Unitary Plan and prices aren’t coming down, so the problem can’t be land regulation”? Well, yes, of course it can. If anything, given the manifestly obscene prices people face for land in or around Auckland, Auckland Council officials (and their political masters) should be looking at the failure of land prices to fall back and concluding that their latest planners’ vision had failed. It is all very well to talk of the potential for a million more houses, but these are the sorts of lines local authorities have run for a long time – I recall councils running these lines when the 2025 Taskforce was looking at these issues. I haven’t looked into the “million house claim” in any depth, but as I understand it, much of this potential is about the possibility of increased density on properties that the existing owners are simply never going to sell (they like living in their existing house/location). There was probably a lot of theoretical capacity before the Unitary Plan, and of course there has been a lot more population pressure in recent years.

And the bigger issue is that when Council planners and politicians deem that certain places can be built on and others can’t etc etc, there isn’t much of the market at work. A well-functioning land market would be one in which developers and land owners on the fringes of growing cities were in active competition with each other as to which could supply new sections and new homes more effectively, and where those options in turn competed with realistic options for increased density (according to the tastes/incomes of potential purchasers, not the whims and preferences of officials and politicians). In a competitive market, holding costs are quite substantial – not so where regulation rewards “land-banking” – rewarding bringing land to market early.

The Auckland Council economists’ final line is cute in a way

In the case of Auckland at least, the answer is simple: You can’t live in a resource consent. It is because not enough houses are being built fast enough (for a range of reasons), rather than just the technical availability of developable land, that is keeping prices up. Land may be resource consented for development, but until houses are actually built on it, a premium will be placed on houses that are available.

And, of course, one can’t live in a consent, and we know from other work that the net addition to the housing stock in Auckland has been well less than the number of consents issued for various reasons (including that densification often loses existing houses). But the point isn’t really relevant to the claim the economists are trying to rebut.

I did a brief post last year on one small example of undeveloped land on the fringes of Auckland – property at Dairy Flat, still some years from actual development – where various plots were selling at an average of $1.266 million per hectare. When that sort of land – with no prospect of a house on it for the next few years – is still that expensive – land which for rural purposes might be worth $30000 per hectare – we know there is still something very wrong with land use regulation as it is being applied in Auckland. If one looked, I can only assume we’d find similar examples around Tauranga.

None of this is deny that there might be problems around consenting processes, construction costs (and the construction products supply chain), and/or infrastructure, but please Auckland City stop trying to pretend that black is white and that land use regulation is not a major part of why house price to income ratios are so high in New Zealand – not just in Auckland, or even Tauranga, but in places with few natural obstacles and modest population growth like Napier-Hastings, Christchurch, or even Palmerston North.

demographia 2 2018

Trade agreements and the new TPP

January 24, 2018January 31, 2018 Michael Reddell TPP

And so it appears that agreement has now been reached on a TPP-like agreement, minus the United States. We haven’t yet seen the details (although this MFAT note is useful), but all the comments late last year suggested that the new agreement would stick as closely to the previously-agreed, but not ratified, TPP as possible (but presumably without the Joint Macroeconomic Declaration).

I wrote a few posts a couple of years ago, expressing doubts about the then-TPP agreement. I wrote – and write – from the pro-trade, pro-market side of the argument. Which, of course, is not the same as a “pro-business” perspective.

Sadly, TPP (and its replacement), like the welter of preferential trade agreements various governments have been signing over recent decades, isn’t necessarily a step towards free-trade at all. That is a point the Australian Productivity Commission has long been making about such trade agreements – probably since around the time of the Australia-US agreement which many independent experts concluded made Australia worse off economically (having been signed for political signalling purposes more than anything else). These agreements keep MFAT officials busy, and ministers of trade looking as if they are “doing something”, but there isn’t much evidence (net) that they are making New Zealanders as a whole better off.

There were always arguments about how we couldn’t really afford (in some political sense) to stay out if everyone else in the region did a deal of this sort. And there might be some force to that – we aren’t the United States, say – but it would be good to see the arguments made in the context of a robust independent assessment of the costs and benefits of the deal to New Zealanders. There was nothing like that done here for the ill-fated TPP deal. The new government has claimed to be interested in more-open government. This would be a good opportunity to demonstrate that it was serious.

There were all sorts of things that disconcert me about the earlier agreement:

investor-state dispute settlement provisions should be an affront to every citizen of a functioning democracy with a decent legal system. We allow foreign investors access to binding dispute resolution procedures against the New Zealand government that are not open to our own companies operating here (people complain, sometimes reasonably about discrimination against foreign investors, but the ISDS procedures invert the arrangements, preferencing non-citizens non-residents over our own people). And it is no consolation to argue, as government do, “oh, but our own businesses get the same advantage in other countries”. But if we care at all about nurturing democratic values and the rule of law in other countries, it shouldn’t be a ‘gain’ we are happy with our politicians negotiating. If you want to do business in (communist) Vietnam, that is your affair, not that of the New Zealand government.
then there are the labour provisions (which I wrote about here), under which governments declare that domestic labour market regulation is a matter for international negotiation (and associated dispute settlement procedures). A minimum wage might or might not be a good idea, but there is no sound reason why a requirement to have one should be made part of a binding international treaty. At the more wishy-washy end of the scale there was this sort of stuff

And then we have provisions for Cooperative Labour Dialogue and the new Labour Council (and its associated “general work programme”). It isn’t clear why we would want to enter such arrangements even with other advanced countries, let alone with Vietnam or Peru. A recipe for small and lean government it is not ( and I won’t bore readers by listing the items (a to u) which the parties agree they might “caucus and leverage their respective membership in regional and multilateral for a to further their common interest in addressing labour issues – except to note that “work-life balance” appears on the list, and corporate social responsibility pops up again). Real resources will devoted to paying for all these new bureaucratic and political overlays.

there are unsatisfactory provisions around financial crises. For example, the TPP agreement required any country considering using direct controls (on foreign exchange flows – of the sort used by several countries in the last crisis) to preference all flows associated with foreign investment over any other financial flows (including those relating to an identical asset owned by a resident.
or the weird provision which appears to bind governments to have to compensate foreign investors just as much as citizens in any cases of losses resulting from wars or civil strife. As I noted in an earlier post, it would have appeared to require the British government, after the Blitz in 1940, to have compensated Swiss or Swedish owners of property on the same terms as it helped its own citizens. Sometimes that might be appropriate or prudent, but probably not always, and why should it be subject of a binding international treaty, unable to envisage all contingencies.

It isn’t clear how New Zealanders – or, indeed, citizens of most of the other parties to the new deal – are going to benefit from the new agreement, which seems to extend the regulatory net even further, and further reduce the ability of citizens/voters to direct and control the activities of their own governments.

Among US commentators who were in favour of TPP it was common to talk of TPP as some sort of instrument in the rivalry with China; that TPP would somehow ensure that “we” would “write the rules of trade for the 21st century etc”. I’m not sure these “rules of trade” look particularly attractive anyway, and of course if TPP were in any way a threat to China one could be sure that our craven governments (past and present) would not be in such a hurry to sign.

And, of course, if the government was really seriously about free-trade – itself, a lofty and generally beneficial vision – it could now unilaterally remove the remaining tariffs New Zealand keeps on imports from other countries; imposts that may benefit a few New Zealand firms, but almost certainly at the detriment of the New Zealand population as a whole.

Palmerston North or Des Moines?

January 23, 2018January 23, 2018 Michael Reddell Housing, Uncategorized

I’m still enfeebled by the last of a bad cold – three days of Wellington Anniversary Weekend and I didn’t even get out the front door – so there won’t be much here today. But I noticed that Demographia yesterday released their annual report on median prices relative to median incomes in Anglo countries cities (and a few other places).

As three academics from the London School of Economics put it in their introduction

Before we can have useful debates or even give a balanced assessment of the issues we need good measures. Here Demographia has done wonders over the past decade to focus public debate on the inequity of rising house prices relative to incomes. As Oliver Hartwich in his Introduction to the 13th edition last year said “Demographia’s‘ median multiple’ approach…firmly established a benchmark for housing affordability by linking median house prices to median household incomes. It… is not a perfect measure because it does not account for house sizes or build quality. But it is the only index that allows a quick comparison of different housing markets, and it is the best approximation of housing affordability measures we have to date.” We agree.

(The house size point matters when comparing, say, New Zealand or Australian price to income ratios with those in, say, the UK – where the typical house is notoriously small – but much less so for comparisons across, say, the US, Canada, Australia and New Zealand markets.)

The big strength of the report is the collation of the data. But the authors have policy prescriptions in mind too. This is the more “analytical” of the charts in the report – a variant of one they seem to show most years.

demographia chart 2018

No New Zealand city is large enough to feature, but the general point isn’t reliant on a single observation: by and large, cities with high price to income ratios have restrictive land use laws. And no city – in their sample – with liberal land use laws has particularly high price to income ratios.

As so often, the US offers a high degree of in-country variability. There isn’t just a single large city, or a single large fast-growing city. And there are very substantial differences in the land-use restrictions regime. All within a country that has the same currency (and interest rates), the same banking regulations, and much the same tax system.

So here are the median house price to income ratios for the New Zealand cities in the Demographia sample and a selection of US cities.

demographia 2 2018

Did I cherry-pick the US cities? Well, yes, in some ways I did. If I’d simply wanted to show what can be done in the US, there are 10 cities with populations over 2 million with price to income ratios of 3 and under. But some of them are cities that haven’t done very well economically, and really depressed places with falling populations can have house prices below replacement costs.

Instead, I picked out a selection of cities – of different size, although all larger than the typical New Zealand city – in a different parts of the country. I don’t know a lot about some of them, but many are regarded as pretty nice places to live – at least if one gets over New Zealand priors in favour of cities by the sea (which, of course, Hamilton and Palmerston North aren’t).

As for population growth, I found some scattered snippets:

the Charlotte area is estimated to experienced a 15 per cent increase in population from the 2010 census to 2016,
the Nashville MSA is estimated to have doubled its population in the last 30 years, and had a rate of population increase similar to Charlotte’s in the most recent decade,
the Boise (Idaho) area has doubled its population since 1990,
according to the US Census Bureau, Des Moines has recently been the fast-growing city in the mid-west (at around 2 per cent per annum).

As regular readers know, I’m not a fan of government-fuelled population growth. But in the US as a whole, immigration policy isn’t a large contributor to population growth, and so rapid population growth rates in individual cities are mostly about people and firms locating where the opportunities are. And, perhaps, where the housing is affordable.

There seem to be plenty of examples in the United States in particular showing what can be achieved – functioning affordable housing markets – even in areas with fast-growing populations. Perhaps there is something amiss in our construction (and construction products) markets, but there has to be something seriously amiss with our land use laws and regulations when price to income ratios in what is – for now – by some margin our least unaffordable market are materially higher than those in flourishing US cities, such as some of those shown in the chart.

It would be good to see the urgent report the Minister for Housing commissioned before Christmas on the problems around housing in New Zealand highlight some of these simple, but telling, contrasts.

Some (Chilean) perspectives on monetary policy decisionmaking and communications

January 19, 2018January 19, 2018 Michael Reddell Reserve Bank Act reforms

I’d had more or less enough for this week of thinking/writing about Reserve Bank reform issues, when a (central banker) reader sent me a link to an interesting new survey article by a couple of researchers at the central bank of Chile looking at various institutional arrangements, including decision-making and communications, at 15 inflation-targeting central banks (all from OECD countries). I’d suggest The Treasury, and the Independent Expert Advisory Panel appointed by the Minister to assist with the review of the Reserve Bank Act, take a look at the paper.

It isn’t perfect by any means – and there were a surprising number of small errors of detail or emphasis, including in places about New Zealand – but there is a lot of interesting material nonetheless. For a start, they seem to have chosen pretty much the right group for comparison: the well-established market economies, with reasonably well-governed democratic societies. One might quibble about the inclusion of Poland, or note that if Poland is included perhaps Hungary should be too, but if you are looking for insights and ideas as to how our central bank (in its monetary policy dimensions) should be organised – and wanting something to read to complement the Reserve Bank piece I posted here yesterday – this list of central banks/countries seems about right:

ECB, USA, UK, Japan, Canada, Korea, Norway, Sweden, Australia, Israel, Chile, Poland, Czech Republic, Iceland (plus New Zealand)

I wasn’t too interested in, and won’t comment further on, the detailed material on the specification of the inflation target itself (except to note to the authors that the New Zealand target now has an explicit midpoint reference) – ground well-covered in various earlier Reserve Bank articles.

What of statutory decision-making structures? Of the 15 central banks, only New Zealand and Canada do not have a statutory committee making monetary policy decisions. That is well known. What is less well-known perhaps is that all those 13 central banks with statutory committees operate by vote. The authors note that Canada and New Zealand describe themselves as attempting to operate by consensus, but in fact of course in both places only one vote formally counts – that of the Governor, who has the legal responsibility. And even in New Zealand, although the three man Governing Committee is claimed to operate by consensus – they refuse to release any minutes, even under the Official Information Act, to allow us to really know – the members of the wider advisory group make written OCR recommendations, in effect a non-binding vote.

In some of their writings, the Reserve Bank likes to claim that consensus-building models of decision-making are superior. There may be some arguments on that side of the issue, but actually voting – after examination of the issues, discussion and debate – is typically how we make decisions in free societies: be it in elections themselves, decisions of a local tennis club committee, or our higher courts (five judges on the Supreme Court: the verdict supported by the majority rules). There is no particular reason to think monetary policy decisions are not as well made the same way – indeed, since there is a great deal of uncertainty, and decisions are revisited every eight weeks or so (so there are few irreversibilities) it seems a pretty demonstrably efficient approach.

The Reserve Bank has also sought to claim that small committees are generally better than large committees. Again, at some point no doubt there is truth to that – with all due respect to the Cabinet, the 20th person on any committee is unlikely to be adding much marginal value, and the incentives for any specific member of a committee that large to slack off (put in little effort or fresh thought) can be real. But of the 13 inflation targeting central banks with statutory monetary policy committees, the median number of members is eight. For a smaller country, a statutory monetary policy committee with five or seven members sounds about right for New Zealand (none of these statutory committees in other countries has fewer than five members). Membership numbers don’t seem to be a luxury good: the authors present a chart showing no relationship between GDP per capita and the number of MPC members in an inflation-targeting country.

It is also clear that members of the statutory monetary policy committes are almost entirely appointed by politicians – as most key positions in our societies typically are (from Chief Justice or Police Commissioner down). There are some exceptions – eg regional Fed Presidents in the US (who rotate through voting membership of the FOMC), but even that situation is now raising some concerns among scholars in the US. And almost all of the central banks with statutory MPCs have external members, in some form or another (sometimes part-time, sometimes becoming temporary full-time executives, sometimes full-time non-executive): governments rarely seem to see monetary policy decisions as matters only for some career “priesthood of the temple”.

I was also interested in some analysis the authors had done on the extent of unanimity, or otherwise, among monetary policy committees where voting decisions are published.

To listen to our Reserve Bank, if voting records were published, or minutes in which individual members could outline their views on specific monetary policy decisions, it would be a recipe for mayhem. They’ve talked of it creating confusion, and uncertainty, undermining confidence in, and the credibility of, the central bank.

Here is what the Chilean authors have to say about such individualistic committees.

In individualistic committees each member is held publicly accountable for their decisions, and each member is empowered with one vote. Decisions tend to be reached by majority vote, where the Governor tends to have the deciding vote in case of a tie. The high degree of individual accountability results in regular reservations, dissents, or minority votes against the final policy decision. Two regularly cited examples of this type of committee are those of the UK and Sweden. Importantly, when a certain degree of public disagreement among committee members occurs, market participants are generally not surprised and understand the differences as part of the policy process.

That is more or less the point I’ve been making. One could say the same about the United States. And recall that these authors are themselves from a central bank with a committee more towards the “collegial” end of the scale.

And, in any case, as they illustrate, even in individualistic committees raging dissent is hardly the norm.

central bank dissents

Roughly half of all the monetary policy decisions in the UK and Sweden in the last decade have been unanimous. (On the other hand, even for central banks at the collegial end of the spectrum, not all decisions are unanimous). I’m not sure why they didn’t include the Federal Reserve in this particular analysis, but I suspect the numbers there would show something similar to the UK or Swedish experiences.

There was also some interesting material on communications practices. For example, all 13 of the central banks with statutory monetary policy committees publish minutes – to repeat, every single one of them. The timeliness varies – the UK and Norway publish the same day as the monetary policy announcement, but a more typical lag in about two weeks – and of course the nature of the content differs: some are pretty bland, while others (notably those of Sweden) although a full and careful articulations of the arguments and issues of concern to individual members.

But there was also some surprises (at least to me). Our Reserve Bank grudgingly released background papers to a 10 year old interest rate decision, and consistently refused to release any background papers – no matter how topical – used in the preparation of their interest rate decision or Monetary Policy Statement (eg the recent refusal to provide any background analysis papers on the impact of various policies of the new government). By contrast, and at the other extreme, according to the Chilean paper the central banks of the Czech Republic and Norway “publish a version of the staff MPM [monetary policy meeting] presentations shortly after the meetings”. I struggle to see any good reason why such background analysis should not be released publically with, say, an eight week lag (eg released after the OCR decision one after the decision to which the background material relates)

And a bigger surprise still was the publication of transcripts of monetary policy meetings. I knew that the Federal Reserve was doing so, and had heard the odd mention of it happening elsewhere. In fact, the authors show that seven of their central banks are now doing so (including the Fed, the ECB, the Bank of Japan, and the Bank of England). The lags are quite long – the Fed is the shortest at five years. But, fascinating as some of the old Fed transcripts are, especially from the era before members knew they would be published, even I have my limits around transparency, and this is one of them. As the Chilean authors note

as highlighted by the Warsh Review (2014), the publication of meeting transcripts (and minutes) may to a certain extent impair a candid discussion of policy options among policy-makers, and lead them to limit their interventions to written statements that express their view (and vote) without the consideration of the perspectives of other members. In this context, it is possible that policy deliberations may be driven to other settings where a formal record is not being taken. Moreover, some existing evidence for the U.S (Meade and Stasavage, 2008) suggests that the publication of FOMC transcripts reduced the likelihood of dissent among committee members, and made members less willing to change their positions over time.

But the fact that various major (and minor) central banks are publishing such transcripts again helps give the lie to our Reserve Bank’s constant claim that it is one of the most transparent monetary policy central banks in the world.

One final aspect the Chilean authors covered was the role (if at all) of a Treasury or government representative in monetary policy decision meetings. In the Reserve Bank paper I linked to yesterday, the Bank authors attempted to minimise this issue. They noted that in Australia the Secretary to the Treasury is a voting member of the Reserve Bank (monetary policy making) Board and that in the UK there is a non-voting Treasury observer who attends (statutory) MPC meetings. Of our 15 central banks, that is all they note (although in Colombia, one of the countries they look at, the Minister of Finance is himself a voting member).

But here is part of the fuller Chilean treatment of the issue

In a second large group of central banks, an important authority of the administration, such as the Minister of Finance or his delegate, is invited to attend and speak in the MPMs, but does not have the right to vote on the monetary policy decision. Within this second group, the degree of potential government involvement differs. In Japan for example, the representatives of the government (Minister of Finance, Minister of State for Economic & Fiscal Policy) may propose issues to be discussed in the MPMs, and may even formally ask the MPC to postpone a vote on monetary policy until the following meeting. In the case of the Bank of Korea, the representative of the government (Minister of Strategy & Finance) may publicly request the MPC to reconsider a monetary policy decision if it perceives that the decision conflicts with the government’s economic policy.

Their tables also lists Chile, the Czech Republic and the UK as having non-voting Treasury representatives. In the comments on the Rennie review report from Charles Goodhart (ex UK MPC) and Don Kohn (a current member of the UK FPC) no concerns were raised about this aspect of the UK model.

I don’t have a strong view on the possible role of a Treasury representative on either a monetary policy or financial policy committee in New Zealand. But there is enough precedent in other countries to suggest that option deserves more serious consideration than the Reserve Bank – always keen to keep Treasury out of its hair – gives it. If there was to be non-voting observer, the rules of the game might be quite important – the person would be there to inform, answer questions, and report (as in the UK) and shouldn’t see themselves as having a role to try to shape decisions.

The Chilean piece was interesting and refreshing. They make it clear – without directly engaging with New Zealand issues at all – that if the government reforms our Reserve Bank Act to provide for:

a statutory monetary policy committee,
all appointed directly by the Minister,
with a good mix of internals and non-executive internals,
and timely publication of minutes and vote number,
with perhaps even details of dissenting members’ views, and even
delayed publication of background papers

It would be placing the Reserve Bank of New Zealand’s new model of governance. decisionmaking and communications right in the mainstream of international practice for countries of our type.

As it happens, I saw last night one other snippet reminding us of how far central bank transparency could go. The Financial Times had an interesting piece outlining concerns in some quarters about senior central bankers getting too close to private bankers (in the New Zealand in recent times – but probably not generally – the problem is more the opposite), with particular concerns about ECB head Mario Draghi. Partly in response

The ECB also now publishes the diaries of its six executive board members after officials were found to have met private sector representatives around the time of monetary policy decisions.

It might be a worthwhile model for our new central bank Governor to consider emulating, along with (in time) his deputies and members of the new statutory decisionmaking committees.

Our central bank was once at the forefront of (some aspects) of central bank transparency. These days, it has weak (formal) decisionmaking processes and doesn’t do at all well on the transparency front either. Those issues should be tackled properly as part of the current review.

The Reserve Bank’s case for minimal reform

January 18, 2018January 18, 2018 Michael Reddell Reserve Bank, Reserve Bank Act reforms, Uncategorized

In early December, the Reserve Bank’s briefing to the incoming Minister of Finance (BIM) was released, as part of the general release by the new government of the set of BIMs. I wrote about the Bank’s briefing, and in particular about the appendix they included on the governance and decisionmaking issues. In a departure from the now-common practice of including nothing of substance in BIMs the (unlawful) “acting” Governor – I think I’ve gone a whole month without using that description – took the opportunity to make his case in writing for minimal reform.

The Bank indicated that the appendix was itself a summary of a fuller document that they would make available to the Minister on request. So I lodged an Official Information Act request for the fuller document, which they have released in full to me today. It is really the sort of document that should be included with the collection Treasury has made available as part of the current Treasury-led review of the Reserve Bank Act, but as it isn’t there, I thought I should make it available for anyone interested ( RBNZ Memo – Review of policy decision process 16 Oct 2017 (1) ).

The paper was written by a couple of Reserve Bank managers – Roger Perry, who manages a monetary policy analysis team, and Bernard Hodgetts who head the macrofinancial stability area – and is dated 16 October, a few days before it became clear who would form the next government. The paper itself is not described as Bank policy, but in the release I got today it is stated that

Please be aware that the document encapsulates Reserve Bank thinking at the time it was prepared.

Which suggests that at time it did represent an official view – probably workshopped with senior management before the completed version we now have. There is a pretty strong tone to the document suggesting that the authors did not expect a change a government (with only a couple of footnote references to possible implications of Labour Party policy positions in this area).

But, frankly, I was surprised how weak, and self-serving, the document was. The Reserve Bank has been doing work on these issues off and on for several years – there was the secretive bid a few years ago by Graeme Wheeler to get his Governing Committee enshrined in statute – and yet there was little evidence of any particularly deep thought, and no sign of any self-awareness or self-criticism (over 30 years was there really nothing the authors – or Bank – could identify as not having worked well?).

There was also, surprisingly, no sign of any engagement with the analysis or recommendations of the Rennie report. It is hard to believe that a report, on Reserve Bank governance issues, completed months earlier had not been shown to the Reserve Bank itself. There was no substantive engagement with the models adopted in various countries that we tend to be closest too, or which are generally regarded as world-leaders in the field (by contrast, several references to the Armenian model – to which my reaction was mostly “who cares”). There was no reference at all to how Crown entities are typically governed in New Zealand – that omission isn’t that surprising, given the Bank’s track record, but it should be (the Bank is after all just another government agency). There wasn’t even any reference to how other economic and financial regulatory agencies in New Zealand are governed, even though the Financial Markets Authority is a new creation with a markedly different (but more conventional Crown entity) governance and decisionmaking model.

For what it is worth, on 16 October, the Bank seemed to favour:

enshrining the idea of the Governing Committee in law, but perhaps with slightly different versions of membership for monetary policy and financial stability functions,
legal decisionmaking power continuing to rest with the Governor,
the Governor’s appointment continuing to be largely controlled by the Board,
no publication of minutes or votes,
no external members of the committee(s).

But they make no serious attempt at critical analysis to support their case, let alone to engage with the risks of a system in which a single decisionmaker is key, and where that single decisionmaker is the boss of the other members of (what is really just) an advisory committee. Or the anomalous nature of such a system in the New Zealand system of government, where even elected individuals rarely have such unconstrained authority, where committee-decisions are the norm (from Cabinet, the higher courts, through major Crown entities to school Boards of Trustees) and where Cabinet ministers (or Cabinet collectively) typically have the key role in appointing those who exercise considerable statutory powers.

The management of a central bank that can’t come up with better analysis than this really makes it own case for change – legislative change, personnel change, and cultural change.

croaking cassandra

Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

Month: January 2018