Earlier in the week I wrote about Reserve Bank chief economist John McDermott’s rather strange attempt to distract attention from the Bank’s own GDP forecasts – which some had suggested were a bit optimistic – by suggesting that private bank economists didn’t understand the process the Reserve Bank used, and even using the word “nonsense” in an attempt to bat away what seemed like quite legitimate questions. Somewhat to my (pleasant) surprise, Westpac – one of the banks that had questioned the Reserve Bank’s forecasts – actually went public in response , although being an institution regulated by the Reserve Bank they still seemed to feel the need to express due deference to the powerful, ending their note this way, (emphasis added)
We are comfortable respectfully maintaining that difference of opinion.
After each Monetary Policy Statement the Reserve Bank’s senior staff fan out across the country to do a series of post-MPS presentations (I used to do some of them myself). These events are all hosted, and paid for, by the commercial banks, and commercial clients of those banks are the invited guests. It is an arrangement that is convenient for the Reserve Bank – the banks rustle up an audience – but which has always seemed a bit questionable to me: preferential access to senior public officials, on sensitive policy issues, for the invited clients of particular banks. The tone and thrust of questioning might be a little different if some such occasions were hosted by the Salvation Army or unemployed worker advocacy groups.
These occasions are supposed to be off-the-record, whatever that means. The Bank defends it on the basis that it is supposed to let them speak more freely. But the reason people turn up is to garner information and perspectives from – and ask questions of – senior public officials. And no one supposes that financial markets people in the room don’t (a) use, and (b) pass on to clients anything interesting, any different angles, that are raised when the Governor (in particular) and his leading offsiders are talking. As I’ve noted previously, the contrast with the Reserve Bank of Australia is striking: senior officials will give speeches to private audiences, but the standard practice is, wherever possible, to post the text of the address and a webcast or audio of the address and any question and answer sessions, to minimise the extent to which some have access to Reserve Bank information/views others don’t have.
After my post the other day, a reader who had been at the post-MPS presentation John McDermott had given last Friday got in touch to pass on some of what McDermott had said there. My reader felt – and based on his report I agree – that they didn’t put this senior official, or the Reserve Bank, in a particularly good light. The reports are secondhand (ie I wasn’t there), so I’m relying on my reader to have captured the thrust of what McDermott said reasonably accurately. But having worked closely with McDermott in the past, what I read had a ring of authenticity to it. My reader has given me explicit permission to quote from the email I was sent.
He spent the first five minutes of his short presentation defending their record by displaying a chart showing CPI, broken down into tradables and non-tradables components, over the last 50 years or so. Essentially he was highlighting how insignificant the recent deviations from target look when you compare it to the extreme volatility in prior, pre-OCR, decades. He also claimed the RBNZ can only influence the non-tradables component and was rather self-congratulatory in how well they had done there.
Something didn’t sound quite right about that (the tradables vs non-tradables breakdown doesn’t go back that far), so I asked the Bank for a copy of McDermott’s slides (which, legally required to respond as soon as reasonably practicable, they supplied within 24 hours). In fact, this paragraph was summarising two slides. The first is, from memory, one of McDermott’s favourites.
In the 70s and 80s inflation was very high and volatile, and for the last 25+ years it hasn’t been. It is a worthwhile point to make from time to time, but doesn’t have much bearing on anything to do with how monetary policy should be run right now (a bit looser, a bit tighter or whatever). Apart from anything else, almost every advanced country could show a similar, more or less dramatic, chart. And in the earlier decades, inflation wasn’t being targeted – until 1985 the ‘nominal anchor” was the (more or less) fixed exchange rate.
The second chart was this one
This is presumably what McDermott was talking about when, as my reader reported,
He also claimed the RBNZ can only influence the non-tradables component and was rather self-congratulatory in how well they had done there.
There is no doubt that, in the short-term, the Reserve Bank is a pretty minor influence on tradables inflation, which is thrown round quite a bit, and most obviously, by fluctuations in petrol prices (changes in which closely track international oil prices) and the influence of weather events of fresh food prices. The Reserve Bank can’t do much about those, and is specifically instructed (in every PTA) not to focus on them. Of course, in the very short-term the Reserve Bank can’t do much about non-tradables inflation either – it is quite persistent (ie not very volatile), and inflation right now is a response to monetary policy choices from perhaps 18 months ago, and economic forces (often hard to forecast) from the last year or so.
But it would be nonsense to suggest (if in fact McDermott did) either that tradables inflation is outside the Bank’s influence, or that the track record on non-tradables inflation is just fine. New Zealand can’t do anything much about the world price of tradables, but monetary policy is a direct influence on the exchange rate, and thus on the New Zealand dollar price of tradables. That can’t sensibly produce a stable tradables inflation rate quarter to quarter, but it can (and does) have a material influence on the trend – “core tradables inflation” if you like. And McDermott’s chart seems deliberately designed to avoid focus on the fact that, over time, tradables tend to inflate less rapidly than non-tradables. As I’ve noted previously, the rule of thumb around the Bank used to be that if one was targeting 2 per cent inflation, that might typically involve something nearer 1 per cent tradables inflation and something nearer 3 per cent non-tradables inflation.
As it happens, the Reserve Bank produces estimates (from its sectoral factor model) of core tradables and core non-tradables inflation. I ran this chart of those data a few weeks ago
Not only is this estimate of core tradables inflation not terribly volatile, but the gap between the two series isn’t unusually large or small. Overall (core) inflation has simply been too low to be consistent with the target set for the Reserve Bank. There isn’t anything for current Reserve Bank management to be proud of.
One of the reforms the new government is promising is the addition of some sort of employment objective (non-numerical) to the Bank’s statutory monetary policy responsibilities. We don’t know the details, and probably neither does the Bank – The Treasury was accepting submissions on that point right up to today – but I presume we will get a hint when the Policy Targets Agreement with the new Governor (under existing legislation) is signed and released next month. But it is an obvious area of interest and apparently McDermott was asked some questions about the new environment. You may recall that in the MPS the Bank released, for the first time, an estimate of the NAIRU (the estimated rate of unemployment at which there is neither upward nor downward pressure on inflation from the labour market) – “released”, but in a footnote (repeated in the press conference), citing analysis in an as-yet-unpublished research paper.
My reader reports that McDermott was asked about this, including
whether their estimate of NAIRU came about as a result of the likely addition of an employment mandate to the PTA, and … how they went about coming up with that number. His initial reply was “I’ve got a lot of very smart people working for me” and then he went on to basically say that the analysis and maths involved are too complicated for us to understand. He also highlighted, to the point of seeming rather proud of, the fact his team had decided to come up with the estimate on their own accord without any suggestion from him. It didn’t seem to me that even he knew how they came up with 4.7%, nor that he particularly cared much.
The final sentence is clearly editorial in nature, and may or may not represent McDermott’s actual view, although it was clearly how he came across to this particular member of his audience. As for the rest, when you put out a number in a footnote, don’t simultaneously make available the workings and background research, fall back on “very smart” staff, and won’t even attempt to explain the intuition of the work that has been done, it isn’t a particularly good look from a senior public servant. (I’ve also heard that in fact the “acting Governor” had been all over staff, as a matter of urgency, to produce publishable estimates of the NAIRU.)
I’m still looking forward to seeing the research paper when they finally get round to publishing it. Perhaps the 4.7 per cent estimate of the NAIRU (with confidence bands) will prove to be robust, although it seems implausibly high to me. But it is worth remembering that the Bank has form when it comes to rushing out new labour market indicators in high profile documents endorsed by senior managers, that play down any notion of ongoing excess capacity, without having first adequately road-tested and socialised the background research. Persevering readers may recall the saga of LUCI , touted a couple of years ago by a Deputy Governor as the latest great thing, allegedly demonstrating that the labour market was already at or beyond capacity (and at least in that case the associated Analytical Note had already been published), before the interpretation of the whole indicator was quietly changed, and then it disappeared from view.
The questioner of McDermott apparently continued and
….suggested NAIRU will presumably become a more important consideration for the Bank going forward if they are handed a ‘full-employment’ mandate but he didn’t really address that question and instead spent 5 minutes explaining why it would need to be the Bank, and not politicians, who define what full-employment means at any given time, a suggestion I wasn’t aware anyone had made otherwise. He pressed the point that he didn’t believe the change to the mandate would make any difference whatsoever and sarcastically pointed out that they already consider employment when making decisions.
Since neither we, nor McDermott, has seen the new mandate, and since the new Governor (not yet in office) will be the single legal decisionmaker for a time, and then the new statutory Monetary Policy Committee will take responsibility, it isn’t clear how or why McDermott thinks he can say with any confidence that a new mandate won’t make any difference to policy. Perhaps he wishes it to be so, but then he has been one of key figures in the regime of the last six-plus years that has delivered core inflation consistently below target even while (even on their own estimates) the unemployment rate has been above the NAIRU for almost the whole of that time. As reported, it didn’t seem a very politically shrewd answer either – it is one thing to emphasise that (as everyone agrees) in the long-run monetary policy can only influence nominal things (price levels, inflation rates etc), and quite another to suggest that there aren’t legitimately different short-run reaction functions.
We deserve better from our operationally independent central bank. Lifting the quality, and authority, of the Bank’s work around monetary policy will be one of the challenges for the new Governor, and needs to be borne in mind too by those devising the details of the new Reserve Bank legislation.