Work visa numbers soar

Working my way through the text and tables that make up MBIE’s very-belated Migration Trends and Outlook for the year to June 2017, I found this on the very first page.

Temporary worker numbers continue to grow

At 152,432, the number of temporary workers present in New Zealand on 30 June 2017 was 16 per cent higher than the year before.

That is a staggering increase in a single year.  Perhaps just as well for MBIE –  and political advocates of the status quo – that these data are held so tightly and released so belatedly.  If this was normal economic data –  released, in accessible formats, every month a few weeks after the end of the month –  that sort of statistic would have been a valuable addition to the pre-election debate.      As it is, it is now 31 March 2018, and we have no idea whether the numbers have gone on increasing as rapidly this year.  Even if MBIE gets back to its normal publication schedule, we won’t know for another seven or eight months.    For a government that talks of a commitment to more open government, that should be inexcusable –  whether you support the current immigration policy or not.

There are various different classes to temporary work visas.  Here are the growth rates for each of the main classes, as reported by MBIE.

work visas stock

There were big increases in the so-called Essential Skills category, but far and away the largest increase was in the Study to Work category –  people graduating from tertiary institutions, and granted the right to work here for a year in any job whatever.  Many of these people will, presumably be hoping to graduate to an Essential Skills visa or a residence visa.  Essential Skills (so-called) numbers aren’t capped, but residence visas are managed to a numerical target, reduced a little by the previous government.

Perhaps you had the impression that most temporary work visas were issued subject to some sort of labour market test (to be clear, I don’t favour such tests).  If you thought that, you were wrong.

work visas 2

Of the top 4 categories, only the Essential Skills visas are subject to a labour market test.  And Essential Skills visa holders make up just under a quarter of the people here on temporary work visas.

The number of people here on temporary work visas has increased by 63 per cent since 2009.   For those interested in nationalities, the main countries with large increases have been India and France (the latter presumably mostly Working Holiday visas).  The number of people here from the UK has increased a little, while numbers from Fiji and South Africa have actually fallen.

And these are the occupations where more than 500 Essential Skills visas were granted in 2016/17

Occupation Number %
Chef 2,178 6.6%
Dairy Cattle Farm Worker 1,617 4.9%
Carpenter 1,478 4.5%
Retail Supervisor 961 2.9%
Cafe or Restaurant Manager 942 2.9%
Retail Manager (General) 767 2.3%
Aged or Disabled Carer 748 2.3%
Dairy Cattle Farmer 508 1.5%

There might have been a building boom on, but actually that apparently-chronic shortage of chefs continues to dominate the numbers.   You may recall my pre-election post noting that the actual make-up of migrant numbers was exacerbating –  not easing –  workforce issues in the construction sector.

Here is another way of looking at the skill level of the people getting Essential Skills visas last year, using the broader occupational categories MBIE reports.

Occupations of people granted essential skills visas, per cent of total
Food trades workers 8.9
Hospitality, retail and service managers 7.1
Labourers 17.6
Community and Personal Service Workers 11.9
Machinery Operators and Drivers 4.4
Sales Workers 4.7
Clerical and Administrative Workers 3.2
Sub-total 57.8

When the labourers make up 18 per cent of those getting Essential Skills visas, I think people might reasonably conclude we’ve been sold a pup.   To be sure, only a small number of those people will end up getting permanent residence, but a large stock of imported labourers –  even if the people themselves are rotating –  is still more likely to be depressing New Zealand wages in those particular sectors, than adding to trend productivity for New Zealanders.  For those sceptical of any adverse wage effects, simply listen to the squawks of employer lobbyists when there is any talk of tightening the criteria.  The natural response when particular types of labour is scarce is for the price of that labour (wages) to rise.

On which note, I happened to read the “China Business” supplement that came as part of Thursday’s Herald –  mostly apparently paid for by firms wanting to keep on good terms with the People’s Republic.    One article that caught my eye was by the National Party’s spokesman for foreign affairs and trade, Todd McClay.    It was a curious article in some respects.  There was this claim, for example

Trade flows remain remarkably balanced for two countries whose economies are of such different size. This is not by chance, but a direct result of successive governments, officials and particularly Foreign Affairs and Trade Ministers regularly visiting China, to secure opportunities for Kiwi exporters.

I have not the slightest idea what the first sentence is supposed to mean (and it is only a few weeks since the China Council was touting that New Zealand trade with China was unbalanced –  more New Zealand exports to China than imports from it).  Surely, the Opposition must have some advisers who know some economics?

Then there was this

As a parliamentary colleague often says “words have meaning”. This is particularly true when Ministers speak of our international relationships. In fact when it comes to trade, “words have consequence”.

One certainly hopes words have meaning –  although sadly one fears that with politicians that isn’t always the case.  Quite what point McClay is making here also isn’t remotely clear, although perhaps it is a dig at anyone suggesting that, as regards China, New Zealand politicians might ever stand up for New Zealand values?

Then again, if words have meaning, what did Mr McClay –  Trade Minister at the time –  mean by these words when his government signed on to the People’s Republic Belt and Road Initiative last year?


Or did those words not have meaning?  “Fusion of civilisations” with such a noxious regime……..

But the main reason for linking to McClay’s article was his comment about negotiations to upgrade the New Zealand-China (so-called) Free Trade Agreement.

China can be expected to push for better access for investment and labour. The revised TPP has doubled the OIO investment threshold from $100m to $200m for China under a most favoured nation clause, but this has already been banked. Given the importance of China to the economy you can expect this will be a hot topic for negotiation.

So too will be access for temporary labour. It is a demand they have made of others and it is likely to be a demand they will make of us.

It is a “demand” that our government should simply refuse.   But as successive governments have traded away the interests of New Zealand low-end workers, in the way they’ve run our own immigration and work visa policies, it is difficult to summon much optimism that they will in fact resist.  From the tone of McClay’s comments, the National Party doesn’t seem to believe they should.

The failed economic strategy goes on

MBIE has finally released its annual Migration Trends and Outlook report.   This is an annual publication, in this case covering the year to June 2016.   When it was finally released –  five months later than usual –  it was nine months since the end of the year to which the data related.  And all of this is simply adminstrative data –  in MBIE’s own computer systems and files.  Government agencies manage to collect and publish building permits data within a few weeks of the end of each month.  MBIE’s performance here is inexcusable – the more so, as immigration policy is one of the major instruments of economic and social policy that the government wields.

When I’ve had time to work through the report and associated tables, I will no doubt have some more posts.  In the meantime, I will simply leave you with this extract.  From the roughly half of people granted residence approvals who come under the Skilled Migrant category, these are the top 4 occupations of the principal applicants (typically, almost by definition, any spouses will be less skilled –  if not, they themselves would presumably have been the principal applicant).

Recall the nonsense MBIE –  and to a lesser extent Treasury  –  have run about immigration policy as a critical part of economic transformation strategy (“critical economic enabler” used to be MBIE’s description).    It would be great to see some evidence for the transformative effect –  productivity gains for all, not wage reductions for New Zealanders in these and associated occupations –  of the annual influx of so many people “skilled migrants” to our restaurants, cafe, and shopping sectors.  Or, indeed, the aged care sector, where – as I’ve argued before –  the so-called pay equity settlement looks to have been mostly not a response to gender-discrimination, but to glutting the market with immigrant nurses (and, in work visas categories, other aged care workers).

Main occupations for Skilled Migrant Category principal applicants, 2016/17  
Occupation 2016/17
Number %
Chef 684 5.7%
Registered Nurse (Aged Care) 559 4.6%
Retail Manager (General) 503 4.2%
Cafe or Restaurant Manager 452 3.7%

MBIE is so slow in releasing the data that all these approvals occurred under the previous government. Sadly, there is no sign that things will be any different under the new government. Presumably, buying a franchise for a coffee shop will continue to be a path to –  in effect, buying –  New Zealand residence, and all the associated family immigration this new resident aspires to.  It probably wasn’t what the designers had in mind when they thought of entrepreneurial immigration, but it is the sort of shabbiness that our immigration system has been reduced to.

Real interest gaps remain large

There has been a bit of coverage lately about the fact that New Zealand 10 year bond yields have dropped to around, or just slightly below, those in the United States.    Here is the chart, using monthly OECD data, of the gap between the two.

NZ less US

Since interest rates were liberalised here in the mid-80s, the only other time our 10 year rates have been lower than those in the United States was in late 1993 and very early 1994.  That phase didn’t last long.  Bear in mind that back then we were targeting an inflation rate centred on 1 per cent –  lower than the US, and lower than the Reserve Bank of New Zealand is charged with targeting now.

As the chart illustrates, the spreads moves around quite a bit, but the recent narrowing in the spread looks to be significant –  it is (roughly) a two standard deviation event.  Then again, so is the narrowing in the short-term interest rate spread.  Usually our short-term interest rates are well above those in the United States, but by later this year it is widely expected that their short-term interest rates will be higher than ours.   When that sort of reversal is expected to last for a while, it will be reflected in the bond yield spread as well.

NZ less US short

The Federal Reserve’s policymakers expect to raise the Fed funds rate to, and even at bit above neutral, in the next year or two (“longer-run” in the chart below is a proxy for FOMC members’ view of neutral), while there is nothing similar in our own Reserve Bank’s published projections.

Fed projections

I’ve made considerable play of the persistent gap between our real interest rates and those abroad.    Do these recent developments suggest that if there was a problem it is now just going away?

Well, the gap between our bond yields and those in some other advanced countries has also narrowed.    Even the gap between Australian bond yields and our own –  a gap which has been remarkably stable over 20 years –  is narrower than it was (although all else equal their higher inflation target should be expected to result in Australian yields typically exceeding our own).

But here is the gap between our 10 year bond yields and those in some other small inflation-targeting OECD countries.

nz less scandis

There doesn’t seem to be anything out of the ordinary going on there (and 10 year bond yields in Switzerland –  like those in Japan and Germany –  are a bit constrained by being almost zero already).

And here is the gap between New Zealand’s 10 year bond yields and the median of yields in all those countries the OECD has data for for the entire 25 year period.

nz less median

If one simply focuses on the last 15 years –  when our inflation target was increased to 2 per cent (midpoint) –  the current spread is not very different to the average for that period.

There simply isn’t much sign of the persistent gap between our real long-term interest rates and those in other advanced countries going away.

In fact, dig just a little deeper and even the story vis-a-vis the US is a bit less encouraging.  Both countries now have long-term inflation-indexed government bonds, the yields on which are a pretty good read on long-term real interest rates.  US government inflation-indexed 20 year bond yields are currently about 0.9 per cent (even with pretty wayward US fiscal policy).  The Reserve Bank reports that our 17 year indexed bond yesterday yielded 1.82 and our 22 year bond was yielding 2.0 per cent.    A full percentage point gap on a 20 year bond –  even if a bit less than it was – still adds up to an enormous difference over time.  Markets aren’t convinced New Zealand and US real interest rates are sustainably converging any time soon (and, to those who want to throw in claims that the US is bigger or central to the system or whatever, recall that US bond 10 year yields are currently among the highest in the OECD –  in other words, it is quite possible for small advanced countries to have lower interest rates, over long terms, than the US).

The other thing markets don’t appear convinced about is that the Reserve Bank will achieve the 2 per cent inflation target (set for it again this week).   One can proxy this by looking at the gap between inflation-indexed bond yields (real yields) and nominal bond yields.

Here is the US version, using constant-maturity yields for the real and nominal series.

us breakevens

For the last year or so, markets have again been behaving as if the Fed is likely to deliver inflation around 2 per cent over the next 10 years.

But here is the (cruder) New Zealand version.   I’ve just used data on the RB website –  their 10 year nominal government bond yield, and the yields on the two indexed bonds either side of 2028 –  one maturing in September 2025, and the other maturing in September 2030.  Right now, 10 years ahead is almost exactly halfway between those two maturity dates.

NZ breakevens

Halfway between those two lines, for the latest observation, is a touch under 1.3 per cent.    It is a long way from the target of 2 per cent, and the gap is showing no signs of closing.

There are two challenges it seems:

  • if the government is at all serious about beginning to lift productivity growth and close the productivity gaps, they need to think a lot harder –  and be willing to do something about –  the things in the policy framework that continue to deliver us much higher real interest rates than those in other advanced countries,
  • and the new Governor has some work to do if he is to convince people that he is really serious about delivering future inflation averaging around 2 per cent.  Since the government itself just renewed that target, it should concern them –  and their representatives on the Reserve Bank Board –  that the target doesn’t appear to be taken that seriously by people investing money who have a direct stake in the outcome.

How key appointments are made

After a spate of posts in the last few days about the Reserve Bank reforms, I’d intended to change topics for a while.   But then I noticed that the new Opposition spokesperson on Finance, Amy Adams, had weighed in, expressing concerns about a couple of aspects of what the Minister of Finance had announced on Monday.

This is how reported Adams’ concerns

Under the new Policy Targets Agreement (PTA), [actually, under the amended Act] a seven-member Board – with four internal Reserve Bank members and three external appointees, selected by the Minister on the recommendation from the RBNZ board – will be established.

There will be a Treasury representative who will sit on the committee as well but will not have voting rights.

Adams says the fact that Robertson is able to appoint almost half of the board “creates a live question about the degree to which that allows him to exert political influence.”

Although National supports the introduction of the MPC, she says the Reserve Bank already operates with an informal decision-making committee within the bank and that process was working well.

Adams has also taken a swipe at the fact a Treasury representative will sit on the MPC.

“They are the senior Government official, their job is to deliver on the Government’s objective,” she says.

“So, you’re effectively going to have a senior Government official that reports to the Minister and three people who are appointed by and able to be removed by the Minister, sitting in and influencing those decisions and those discussions.”

I don’t want to spend much time on the issue of having a non-voting Treasury representative as part of the new Monetary Policy Committee (MPC).  Reasonable people can differ on the merits of that, and whether there are any real benefits.  On balance, I favour the model the Minister of Finance has adopted.   But in terms of the concerns Adams raises, it is worth remembering that in Australia the Secretary to the Treasury (in a more politicised public service) is a voting member of the RBA Board, and no one questions the operational independence of the RBA.  And in a more direct parallel to the model proposed here, in the UK –  under a modern governance system established only 20 years ago  –  there is a non-voting Treasury representative at MPC meetings, and that seems to have been generally accepted to have worked well, and not to have undermined the independence of the Bank of England (although the individualist approach –  where MPC members can speak out –  probably provides an added safeguard).    It will be important to look at the specifics of the legislation on this point, and for there to be good protocols in place, but I don’t think that what has been announced to date poses particular problems.   If the Minister wants to put pressure on the Governor (now) or the Committee later on specific OCR decisions, he doesn’t need mid-senior level Treasury officials to do so.

In that article, I’m quoted as suggesting that Amy Adams is “completely wrong” in her point about the appointment process.  That is for two, quite different, reasons:

  • first, Amy Adams’ comments suggest she hasn’t understood that the Minister will only be able to appoint people nominated by the Board (as is the case for the Governor now).  The Minister can reject nominees, but can never replace those names with his own people.   The Minister has no discretion.
  • second, direct and largely unfettered ministerial appointment is the way we typically do things in the New Zealand system of government, including for very sensitive positions for which the integrity and independence of the individuals is paramount.   It is also the way most key decisionmakers on monetary policy in other countries like our own are appointed.

Here is how appointments are made to various key public sector roles in New Zealand

Chief Justice Governor-General on advice of the PM
Other judges Gov-Gen on advice of Attorney-General
Police Commissioner Gov Gen on advice of the PM
Electoral Commissioners Gov Gen on advice of House of Representatives
Auditor General Gov Gen on advice of House of Reps
Ombudsmen Gov Gen on advice of House of Reps
Privacy Commissioner Gov Gen on advice of Minister of Justice
Human Rights Commissioners Gov Gen on advice of Minister of Justice
Commerce Commission Gov Gen on advice of Minister of Commerce
Parole Board Gov Gen on advice of Attorney General
Health and Disability Commissioner Gov Gen on advice of Minister of Health
Broadcasting Standards Authority Gov Gen on advice of Minister of Broadcasting
Electricity Authority Gov Gen on advice of Minister of Energy
IPCA Gov Gen on advice of House of Representatives
Takeovers Panel Gov Gen on advice of Minister of Commerce
Transport Accident Investigation Commission Gov Gen on advice of Minister of Transport
Financial Markets Authority Gov Gen on advice of Minister of Commerce

And, of course, the Governor-General is appointed by the Queen on the advice of the Prime Minister.

Every single one of these really important positions  –  with the potential to do considerable mischief as well as good –  is appointed directly by elected politicians.  It is how we get accountability –  we can toss out politicians, they are forced to take questions in Parliament etc etc.   In some cases, there might be statutory qualifications appointees have to meet –  eg lawyer of seven years standing –  but I’m not aware that in any of these key public roles the relevant Minister, or Parliament itself, is constrained to only appoint someone other people have given them as nominations.

There is no obvious reason why the key decisionmaking roles at the Reserve Bank should be any different  (and the key roles at the Bank aren’t the Board itself –  which is really just a nominating (and cheerleading) committee –  but the Governor and the members of the future Monetary Policy Committee).  These people have a great deal of effective discretion and, if they get things wrong, can cause, or materially exacerbate, recessions or booms.  The standard approach anywhere else in the New Zealand public sector would be for such appointments to be made by the Governor-General on the advice of the Minister of Finance.   We can hold the Minister accountable, but have no way of holding the Board accountable (indeed, when the new MPC is appointed most of the Board members themselves will have been appointed by the previous government).

Direct and unfettered appointment by an elected politicians is also the way for most monetary policy decisionmakers in other countries like ours.     There is a nice summary table in this Reserve Bank Bulletin article from few years back.     As just a few examples:

  • in Australia, all members of the Reserve Bank Board (the monetary policy decisionmaking body), including the Governor and Deputy Governor are appointed directly by politicians,
  • the same is true in Norway,
  • in the UK, seven of the nine MPC members are directly appointed by the Chancellor of the Exchequer (two are senior staff, appointed by the Governor),
  • ECB Governing Board members are all directly appointed by politicians
  • All members of the US Federal Reserve Board of Governors are appointed by the President, subject to Senate confirmation.  (Heads of the regional Feds –  who sit, by rotation, on the FOMC – are not, and there is some question about the constitutionality of those arrangements.)
  • All members of the Swedish monetary policy board are appointed by a parliamentary committee,
  • Bank of Japan monetary policy members are appointed by the Cabinet
  • In Israel, five of the six MPC members are appointed by the government (one by the Governor).

It would be a much more normal approach, and one that provides ongoing democratic legitimacy, for the Governor and Deputy Governor and all external members of the MPC to be appointed directly by (the Governor-General on the advice of) the Minister of Finance.  Those choices shouldn’t be restricted to those on a list delivered by faceless company directors, with no subject expertise and no democratic legitimacy or accountability (and who may well have been mostly appointed by the previous government).  If the MPC is to have more than two internals –  as the Minister proposed in his announcement on Monday – perhaps it would be reasonable for one additional internal to be appointed by the Governor, in consultation with the Minister (the Bank of England approach).     There is no obvious role –  or likely added value –  from involving the Board in the process at all.  Arguably, involving them in appointments not only lacks democratic legitimacy, but also detracts from their primary role of (on behalf of the public and the Minister) holding appointees to account.

As I’ve suggested previously, if there was still unease about the Minister appointing cronies –  though see the long list above of important positions that ministers do directly appoint to –  I’ve suggested there might be merit in requiring non-binding confirmation hearings before Parliament’s Finance and Expenditure Committee before the Minister’s appointees take up their roles.   This approach has been adopted in the UK.

As I hope I’ve shown, the model I’ve argued for –  and will continue to advocate –  is not some radical politicisation of monetary policymaking, nor even some idiosyncratic Reddell scheme.  It is the normal way we do things in New Zealand.  It is the way most democracies appoint most of their monetary policy decisionmakers. (It was also much the model advocated by one other submitter to the review.)  One might have hoped that the Opposition spokesperson on Finance, herself a former senior minister, would know that.

Then again, one might have hoped that The Treasury and the Independent Expert Advisory Panel (appointed by the Minister to assist with the review of the Reserve Bank Act) might have recognised that.

As part of Monday’s announcement, a variety of papers were (commendably) pro-actively released.  One of those papers was the report of the Independent Expert Advisory Panel.   This is their discussion of appointment processes

The Panel recommends that all MPC members are appointed by the Minister of Finance on the recommendation of the Board. This is the current process for appointing the Governor. As each committee member will hold considerable decision-making powers that impact on the wider public, the Panel considers Ministerial appointments necessary to ensure members have democratic legitimacy. Ministerial appointments are consistent with typical international practice, and the arrangement whereby the Minister appoints on the recommendation of the Board should be retained to ensure merit-based selection of external MPC members, and to limit the risk that policy decisions of the MPC are politically influenced.

They don’t seem to have recognised at all the distinction between the Minister being free to appoint whoever he or she wishes – the typical model abroad, or for other government agencies here –  and a situation where the Minister can appoint only those someone else has nominated.  The former has democratic legitimacy (even if it has other risks), while the latter provides little more than a figleaf.  And, frankly, if I were worried about political influence on decisions, I’d probably be more concerned about the Police Commissioner and judges –  see table above –  but the Panel doesn’t even engage with these parallels.  They appear to have been signed-up members (perhaps only implicitly) to the “central banks are different” school of thought, beloved of central bankers.  Central banks are just one of many important official agencies and, without compelling arguments to the contrary, should be subject to much the same appointment, governance and transparency provisions as those other agencies.  The Panel makes no effort to identify the compelling argument for such a different approach.

Then again, it appears that The Treasury was no better, and their failure is even less excusable, given their role as one of the public sector central agencies.       Treasury’s advice to the Minister of Finance on Stage 1 of the Reserve Bank Act review was released, as was the Regulatory Impact Statement that accompanied the Minister’s Cabinet paper.

In the Treasury advice there is only this

the Treasury does not support the Reserve Bank’s recommendation to have internal MPC members appointed by the Reserve Bank Board on the recommendation of the Governor. This is because it would mean decision-makers are not directly appointed by a democratically elected Minister, as is the typical practice internationally, and also because it would introduce a hierarchy into the committee, with the Governor having an explicit power over other committee members.

Treasury shows no sign at all of having recognised the distinction between the fig-leaf approach (Minister can appoint only people others have nominated) and genuine appointment by a democratically elected Minister.  The latter is the typical practice internationally.  The former is the  –  highly unusual –  model for the Reserve Bank.

Perhaps even more astonishingly –  given that the advice document no doubt had length constraints and was highlighting only points where there was disagreement with the Panel –  the Regulatory Impact Statement also shows no sign of recognising the standard New Zealand model for key appointments, or the typical central banking practice, as a serious option for consideration here.    They claim to have restricted the options they evaluate to those “the Treasury considers most appropriate”, and yet they include no discussion at all of what should really have been a default option –  appointment as most key public sector appointments are done in New Zealand, by the Governor-General on the (unfettered) advice of the Minister of Finance.  There might prove to be compelling reasons to depart in some respects from that model, but not to include it at all seems to border on the negligent.

Revisiting 1996

After the 1996 election, and as a small part of the deal whereby New Zealand First went into government with National, the Policy Targets Agreement governing monetary policy was amended.  The first section now read, adding the text I’ve underlined.

1. Price Stability Target

Consistent with section 8 of the Act and with the provisions of this agreement, the Reserve Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices, so that monetary policy can make its maximum contribution to sustainable economic growth, employment and development opportunities within the New Zealand economy.

Going into that election, New Zealand First had campaigned for material changes to the way monetary policy was run.  What it got was an increase in the target range (from 0 to 2 per cent, to 1 to 3 per cent) and those new words.   Inside the Bank, we never paid any attention to the words ever again.   They never came up in policy deliberations.   They were seen as some mix of political rhetoric and a statement of the obvious –  from our perspective, pursuing price stability was the best and only contribution monetary policy could make to those other worthy things.  Note that in negotiating the drafting, Don Brash even got the crucial word “sustainable” in.

In the new Policy Targets Agreement signed yesterday, this is how the equivalent paragraph reads.

1. Monetary policy objective

a) Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices.

b) The conduct of monetary policy will maintain a stable general level of prices, and contribute to supporting maximum sustainable employment within the economy.

All but equivalent I’d say.   Curiously enough, I didn’t see the parallel drawn in the material Treasury released (including the RIS) on the new formulation of the monetary policy objective.

To be sure, as I noted in yesterday’s post on the PTA, the new PTA does include a couple of other references to employment.  Employment is added to the list of things where the Reserve Bank Governor is supposed to seek to avoid “unnecessary instability”.  However, this is the clause the Reserve Bank has been relying on in the last few years to defend its belated and reluctant response to core inflation outcomes persistently well below the target midpoint.  And the Bank will be required to discuss, in each Monetary Policy Statement, how current OCR decisions are contributing to supporting maximum sustainable employment.   The Minister has attempted to suggest that this provision will give bite to the new employment focus.  If he really believes that, then –  despite all the time he spent on FEC  in Opposition –  he obviously hasn’t looked at all carefully at how the Reserve Bank complies with the current statutory provisions governing Monetary Policy Statements –  formulaic at best.  As I noted yesterday, it is easy to predict the formulaic language now –  brand new recruits could write the words, (and may well do so).

I’ve been a bit ambivalent about changing the statutory (or PTA) goal for monetary policy.   Active discretionary monetary policy exists for output and employment stabilisation reasons, and in principle it is worth recognising that.   Since day one of the current Reserve Bank Act, that focus has been implicit in the way Policy Targets have been constructed.  It is not a new thing.    On the other hand, there has been a suspicion that Grant Robertson was more interested in things looking a bit different –  like that wording Winston Peters had introduced in 1996 – than in things actually operating differently, and thus on occasion I’ve suggested this change was more about political positioning and “virtue-signalling” than anything else.

And that might be fine if the Reserve Bank had been doing a superlative job in the last decade, but somehow there was still debate in some quarters as to whether output/employment stabilisation was a legitimate objective at all.  But they haven’t.   Core inflation has been persistently below the target midpoint –  the focus of the PTA –  for years, and even on their own (diverse) estimates –  see their chart below – the unemployment rate was above the NAIRU for almost all the decade.

nairu x2

That combination just shouldn’t have been.    Monetary policy – again on the Bank’s own reckoning –  works much faster than that.  Instead, through some combination of forecasting mistakes and biases towards tighter policy –  recall Graeme Wheeler’s repeated hankering for “normalisation” and his actual ill-judged tightening cycle –  they allowed the economy to run below capacity for years, more people than necessary to stay unemployed for longer, and didn’t even come close to deliver inflation averaging around 2 per cent.

And yet when –  as he was on Radio New Zealand this morning – the Minister of Finance is asked what difference the new PTA (and proposed statutory amendment) will make he flounders, and won’t even refer to the experience of the last decade.    His officials seem to be as bad.  In the Regulatory Impact Statement section on the proposed new objective, here is what The Treasury had to say

The main non-monetised benefit is to ensure that monetary policy decision-makers continue to give due regard to the short term impacts of monetary policy on the real economy. This is intended to improve the wellbeing of New Zealanders by ensuring that monetary policy seeks to minimise, or does not exacerbate, periods of economic decline.

The new Governor’s comments yesterday were along similar lines –  just recognising how things are done already.

So the experience of the last decade is just fine is it?   If so, the proposed law change really must be just about political rhetoric and positioning.

To be clear, there are limits to how much any new words themselves could have changed the Reserve Bank’s approach to monetary policy.  And, as everyone recognises, in the longer-term, monetary policy can only affect nominal variables (inflation, price level, nominal GDP etc) not real ones (employment and output).   But the government –  supported by advice from The Treasury –  appears to have chosen the weakest formulation possible, with little or no effective buttressing elsewhere in the Policy Targets Agreement.   There is, for example, no requirement to publish estimates/forecasts of “maximum sustainable employment” or associated concepts such as the NAIRU, and no requirement to account, look backwards, for how monetary policy has done in effectively minimising cyclical deviations in employment/unemployment.

Individuals and organisational culture matter a lot.   Arguably they matter more, at the margins, than precise wording in documents like the PTA.    The Reserve Bank’s culture appears over the last decade to have backward-looking, constantly fighting the last war –  surprisingly strong inflation in the years running up to 2008 –  insular, and –  as has been the case for decades –  not really much interested in labour market outcomes at all.  In all that, they’ve been backed by the Reserve Bank’s Board.

Adrian Orr is a strong character, and has an incentive –  all those Stage 2 review battles to fight –  to at least sound different than his predecessor Graeme Wheeler.  Then again, he emerged through a selection process undertaken by the Board –  which was explicitly happy with what had happened in the previous decade –  and his Minister has given no indication that he is anything other than happy with the actual past conduct of monetary policy.  A pessimist would suggest that, to the extent we see change, it will be cosmetic more than substantive.  Cosmetics have their place, but substance –  avoiding repeats of situations where at the same time core inflation is well below target and unemployment is well above a NAIRU, including in the next recession – matters rather more.

It is interesting to ponder how the new Governor –  single decisionmaker for now –  will address the question of what “maximum sustainable employment” is.      I’m expecting something reasonably vacuous and circular –  “since we (again) forecast inflation getting back to target in a couple of years time, by definition – by construction of our model –  employment must be close to the sustainable maximum”.    Doing so will be easier because the employment rate has no public resonance in the way that the unemployment (or even underemployment) rates do.

But here is a chart of HLFS employment rates since the survey began in 1996.

employment rates by sex

Female employment rates have been trending upwards, as one might expect as part of social changes.   However, male employment rates (73.4 per cent) are still well below where they were in 1986 (77.2 per cent).   In plain English senses, there is little reason to suppose we are anywhere near maximum sustainable employment rates for the economy as a whole.  I’m sure the plain English sense isn’t intended, but still.

And those male employment rates aren’t just about more young people being in tertiary education –  who are, in any case, outweighed by more old people working.  Here are the three prime-age male employment rates

employment rate prime age males For all three groups, employment rates now are materially below those thirty years ago, in a more deregulated labour market.

It just reinforces my sense that in making changes they’d have been better off using unemployment rates as a reference point, and requiring the Bank to produce a richer array of labour market analysis.   The actual new wording will easily translate to nothing if that is what the Governor wants.

And, finally, almost in passing, there has been coverage of former Reserve Bank chief economist Arthur Grimes’s criticisms of the change in the monetary policy objective, in which he talked of a “disastrous route”, a “crazy target”, the potential for the changes to destabilise the economy and so on.  He went on to assert that most episodes of financial instability in the world have flowed from the the United States, and a lot of that has been caused by their dual objective system.

I’m not quite sure which episodes Arthur has in mind with that latter comment, although I assume that the 2008/09 crisis is the principal one he is thinking of.   It is perhaps worth remembering that our Reserve Bank itself has produced research suggesting that the way it was reacting to incoming data in the decade or two prior to 2008 was very similar to the way the Federal Reserve and the Reserve Bank of Australia were reacting.   That isn’t surprising. In practice, whatever the precise wording of the respective mandates, all three were functioning as flexible inflation targeters.  It hasn’t been easy to rerun the model for the last decade –  since for a prolonged period the Fed was at an effective interest rate floor.       The way the two Antipodean central banks have conducted policy have still been fairly similar and thus –  even though neither reached the effective interest rate floor –  both countries have had below-target inflation in the context of labour markets that haven’t exactly been overheating (the RBA still thinks unemployment there is above the NAIRU).

Of course, these comments are a bit of a double-edged sword.  I think Arthur Grimes is quite wrong in his suggestion that our changes are very damaging and dangerous.  On the other hand, they are also a reminder that individuals and institutional cultures (and blindspots) often matter more than precise specifications of statutory objectives.  Changing the statutory mandate here, in deliberately vague ways, won’t make any helpful difference –  other than perhaps in political marketing –  unless the new Governor is about to lead some material culture change, and bring a fresh focus on avoiding prolonged periods of unnecessarily high unemployment.

It is his first day, so only time will tell.  For now, the signs aren’t encouraging.  But perhaps there will pleasant surprises in store.

Proposed Reserve Bank Act changes – Stage 1

My previous post concentrated mostly on the new Policy Targets Agreement, which will govern monetary policy, under the current Act, for the next year or so.

In this post, I want to concentrate on the announcements made by the Minister of Finance about the first stage of his planned legislative reforms.    There is a summary graphic, and a set of questions and answers.

The proposed reforms represent a step forward.  We’ve been in the peculiar position for almost 30 years in which one individual, not even appointed directly by the Minister of Finance, made all the monetary policy decisions.  It made it easy to know who to fire –  that was the argument made for the model in the late 1980s – but it was a model that was out of step with how almost every other public agency was run and (as became increasingly apparent) with how monetary policy was run in most other countries.   In a free and democratic society, committees –  with ranges of views, and the implicit checks and balances a range of individuals provide –  should be how major public authority decisions are typically made.   It is little consolation that successive Governors drew on advisory committees to assist their decisionmaking: on the one hand, all members of those committees owed their positions to the Governor, and on the other, institutions need to be resilient to bad appointees, not just get along moderately well in normal times.   And if some advisers were happy to disagree (and Governors sometimes even welcomed a range of views), others weren’t –  I recall one Assistant Governor who told us that he saw his role on the OCR Advisory Group as being to back the Governor.

But that particular battle now appears to have been fought and won –  albeit belatedly (Treasury –  and the Green Party –  were calling for structural reform years ago).    The Labour Party campaigned on, and the government has now promised legislation to give effect to, moving to a statutory committee model.  Today’s announcement fleshes out some –  but not all –  of the details.

Here is the summary graphic

rb reform graphic

The key aspects are that

  • there will always be a majority of Reserve Bank staff,
  • there will be a minimum of two externals,
  • appointments will be made by the Minister of Finance but s/he will be able to appoint only people nominated by the Reserve Bank’s Board.

This model is a slight improvement on what the Labour Party campaigned on.  In that model, the Governor himself would have appointed all the MPC members, internal and external.  But the improvement is slight, for two reasons:

  • first, because a majority of the committee will be internal, all appointed to their executive day jobs (eg Assistant Governor, Chief Economist or whatever) by the Governor.  No Board is going to turn down the Governor’s recommendation as to which of his staff should be on the MPC.   Thus, the Governor in effect appoints the majority of the committee.  For a good Governor –  really welcoming diversity and debate –  it mightn’t be a problem.  For more average appointees, it reinforces the risk of continued groupthink and a voting bloc on the committee.  Remember that the executive members have their pay and promotion determined by the Governor,
  • second, because the Reserve Bank Board is likely to look largely to the Governor for advice on who should be the external appointees to the committee.   Recall that the Governor himself is a member of the Board –  even though its prime job is to hold him to account –  and most of the Board members have no subject expertise, no resources, and little reason not to defer to the Governor (whom they themselves appointed).  Perhaps some reasonable people will be found to serve, but it seems exceptionally unlikely that anyone awkward, or with a materially different perspective, will be allowed in the door.  In all likelihood, we’ll end up with something not much improved on the model in place for the last 17 years or so –  in which the Governor has had a couple of part-time external advisers, appointed mostly for their business connections and knowledge, rather than their perspectives on macroeconomic policy.

This simply isn’t the way public appointments should be made.   The Minister of Health appoints people directly to DHBs, the Prime Minister directly determines who will be appointed as the Commissioner of Police, ministers appoint directly members to the board of all sorts of decisionmaking crown entities (including, in the financial areas, the Financial Markets Authority), and so on.

And direct appointment by elected politicians is the way most top central bank appointments are made in other countries.   In Australia, it is true of the Governor, Deputy Governor, and all the RBA Board members. In the UK, all but two of the MPC members are directly appointed by the Chancellor, and in the US all the members of the Federal Reserve Board of Governors are appointed by the President, subject to Senate confirmation.

I hope someone asked Grant Robertson why he resisted bringing the appointment process for the Reserve Bank of New Zealand positions into the international mainstream, because I don’t understand it –  and there is nothing to justify his choice in rhe Q&A material that has been released.    Ministers may not have much subject expertise, but they have legitimacy –  they are elected, and have to front to Parliament each week.  The Reserve Bank Board members have no subject expertise, and no legitimacy –  indeed, at any one time, half will have been appointed in the previous term of government.  They might be competent behind-the-scenes professional director types, but that’s all.  And yet they are being empowered to choose who will run New Zealand macroeconomic policy.  It is a gaping democratic defict that really should have been fixed, not exacerbated.   And it is not as if the Board’s practical track record might persuade one to set aside principled objections to the process –   they’ve just been cheerleaders, more focused on having the Governor’s back, than on serving the public interest.

The appointment process is one reason why I call today’s announcement as a big win for Reserve Bank management.  Committee appointments will safely be in the hands of the Governor and his team (Board and management).

The other reason why it is a big win for Bank management is the announcements about the processes that the new Monetary Policy Committee will be expected, or required, to adopt.

Here is part 2 of the Minister’s graphic

RB graphic part 2

The idea of a charter makes sense.  Arrangements around how the new MPC should work are probably better not legislated –  although I think a requirement to publish minutes (although not the form of those minutes) should be in statute –  and thus able to evolve with experience and individuals.   Beyond that, I think the Minister has made the wrong choices when articulating what he will be looking for, largely caving to the preferences of the Bank’s management, who were horrified by the idea of open debate and a transparent recording of views and associated individualised accountability.

Several of better inflation-targeting central banks are much more open –  notably, those of the UK, the US, and Sweden.  But here is what the Minister proposes

How will the MPC take decisions?
It is expected that the MPC will aim to reach decisions by consensus. Where a consensus cannot be reached, decisions will be taken by a majority vote, with the Governor having the casting vote if necessary.

The Governor will chair the MPC and will be the sole spokesperson on its decisions.

What documents will the MPC publish?
In addition to Monetary Policy Statements, it is intended that the first Charter agreed between the Minister and the MPC will require the MPC to publish non-attributed meeting records that reflect differences of view between MPC members where they exist. It is also intended that the MPC will publish the balance of votes for any decision where a vote is required, without attributing votes to individuals. This approach will balance the need for transparency about the decision-making process with the need for clarity and coherence in communicating the MPC’s decisions.

Frankly, it seems unlikely we will ever see vote numbers.  Recall that the Governor has an internal majority on the MPC, who can – and may well –  caucus before the meeting and agree a collective view.  The externals start out in a minority,  will have already passed some sort of inoffensiveness test to get appointed, and they appear unable to articulate their views in public, so the incentive to record an anonymous dissenting vote seems pretty low.   A management-driven “consensus” seems likely to be the default option, and over time that will become the self-reinforcing norm, because the signal in one external insisting on recording a dissenting vote will be sufficiently attention-grabbing that often enough people just won’t go that far.  Far better to normalise the fact that there is –  and should be –  quite a range of views, whether about how the economy will unfold and how monetary policy should respond to the risks.   As I’ve noted before, it is not clear how the citizens of the US, the UK, or Sweden or worse off for an open and transparent process of individual responsibility and accountability, and an ongoing moderately open contest of ideas.  Bureuacrats don’t like it –  of course – but we should be designing public agencies around the interests of the public, including those scrutiny and accountability, not around the interests of the bureaucrats.  In this case again, Grant Robertson appears to have bowed to the personal interests of the officials.

There are some good aspects to what the Minister has announced:

  • as I noted in my earlier post, the move away from a Policy Targets Agreement model to a system in which the Minister sets the operational objectives, and the associated official advice is pro-actively published, is a step forward, and almost inevitable with the move to a committee.  But there are lots of operational details to be clarified, including (for example) how frequently the Minister can change such objectives (the default PTA has been for five years),
  • on-balance, the inclusion of a non-voting Treasury observer on the MPC is probably a modest step forward, but it depends how it works.  The documents suggest this person is simply there to pass on information about fiscal policy, and given the substantial time commitment the MPC role is likely to entail it could end up filled by a fairly junior Treasury person (by contrast, in Australia the Secretary to the Treasury sits on the RBA Board),
  • the Minister is moving to provide for the appointment of the Board chair and deputy chair to be made directly by him (the normal model) rather than chosen by Board members themselves.  At the margin this will help remind the Board that they work for the Minister and the public, not for the Bank.  To be fully effective, however, the Minister should also amend the Act to allow him to dismiss Board members for failing to be sufficiently vigorous in holding the Governor and MPC members to account.

But there are also lots of issues that aren’t sorted out in the announcement today and which will only become clear when the legislation emerges (or in some cases when the charter is signed).  For example:

  • what are the limits of what the new MPC will be responsible for?    The Q&A material says that “For example, the MPC will also have responsibility for strategic choices around the monetary policy tools used by the Reserve Bank”, but does this include foreign exchange intervention strategy, issues around issuing digital currency, the terms of which the Bank issues physical currency etc (all relevant to zero lower bound issues).  Then again, perhaps these things don’t matter because the Governor has a built-in majority on the MPC?
  • what can individual MPC members be fired for (given expectations of consensus decisionmaking), or will the formalised accountability model –  which never amount to much in practice –  be largely got rid of?
  • whose will the forecasts in the Monetary Policy Statement be?  At present they are, formally, the Governor’s forecasts.

And then there is the Stage 2 part of the review of the Reserve Bank Act.   The Q&A document says

Phase 2 of the Review is currently being scoped. It will focus on the Reserve Bank’s financial stability role and broader governance reform. The Panel is due to give the Minister of Finance its recommendations for the scope of Phase 2 of the Review shortly. Announcements on this will be made in the coming months. Subsequent policy work will commence in the second half of 2018.

But given the increased role for the Reserve Bank’s Board in today’s announcement, the government seems to have already decided to retain something very like the current governance model and in particular the role for the –  historically useless –  Board.  I guess there is still time to reconsider before the Stage 1 proposals are legislated, but they’d be better off splitting up the Bank, setting up a Prudential Regulatory Agency, taking appointment powers directly into the Minister’s hands (perhaps with some non-binding confirmation hearings) and getting rid of the Board altogether.

Meantime, they will be celebrating at the Reserve Bank tonight.  As far as possible, the (effective) status quo has won out, and a more open and contestable system has lost out.

On the new PTA

The last ever Policy Targets Agreement was released this morning, signed by the incoming Governor and the Minister of Finance.  With it came the decisions the government has made on reforms to the legislative framework governing monetary policy (decision makers, governance, transparency etc).  We are now finally getting past the year in which first the outgoing Governor was a lame-duck, and then the period when there was no lawful “acting Governor” or lawful “Policy Targets Agreement” –  and even if you did regard both as lawful, they were no better than caretakers.   With the government’s planned reforms such an unfortunate hiatus should never happen again (as it doesn’t happen abroad).

The Policy Targets Agreement is the key document in short-term macroeconomic management in New Zealand: it is the mandate for the Governor in his role as single decisionmaker on monetary policy, and monetary policy is the active tool for short-term economic stabilisation.   This one isn’t expected to have a long life.  Once the new legislation is in place –  scheduled for next year –  the Policy Targets Agreement will be replaced by a mechanism in which the Minister of Finance unilaterally sets the operational objectives for monetary policy (the UK system), although only after receiving (published) advice from the Reserve Bank and the Treasury.   That is a welcome change –  not only does it put responsibility for goal-setting firmly where it belongs (with elected ministers) but it removes the awkward aspect of the current system, in which an incoming Governor has had to agree targets (sometimes dealing with quite technical points) before being appointed, and often with only limited staff advice.   It was also a necessary change once a committee, with evolving membership –  rather than a single individual –  was made responsible for monetary policy.

The new (shortlived) Policy Targets Agreement has a few changes, although mostly not of great substance.

  • there is an even longer statement of the government’s political aspirations (‘inclusive economy”, “low carbon economy”, an economy that “reduces inequality and poverty”) none of which has anything to do with monetary policy.  Closer to economic policy, there are worthy aspiration (“a strong diversified export base”) which monetary policy can’t do anything about, and government policy isn’t doing anything about.
  • the substance of the document has been shortened a bit, but mostly not in a good way.  For example,
    • if I welcome the deletion of the reference to asset prices added in 2012, I’m uneasy about removing the explicit expectation that in monitoring inflation the Bank shouldn’t just look at the headline CPI.
    • And perhaps it isn’t of much substance, but I’m interested that they chose to remove “average” from the requirement that policy “focus on keeping future inflation near the 2 per cent mid-point”.
    • And I am a little uneasy about the removal of the list of the sorts of event/shocks that might justifiably warrant inflation being away from target, and the removal of the requirement to explain, when inflation is outside the target range, what they are doing to ensure that future inflation remains consistent with the target.  At the margin, it slightly weakens formal accountability (weak enough in practice anyway) and –  in the current climate –  may weaken the impetus to get core inflation back to 2 per cent (after so many years),
  • there are several changes relating to the new employment aspect of the objective (which, contrary to Arthur Grimes, I consider neither ‘disastrous’ nor ‘crazy’, and which risk being more feeble and virtue-signalling in nature than anything else).
    • at a high level there is an expectation that “the conduct of monetary policy will….contribute to supporting maximum sustainable employment”,
    • adding “employment” to the list of in the provision requiring the Governor to seek to avoid “unncessary instability”, and
    • a requirement to explain in Monetary Policy Statements how “current” monetary policy decisions contribute to “maximum levels of sustainable employment”

Quite what, if any difference, these provisions make will really depend on the new Governor’s assessment.   His press release suggests no difference at all

Mr Orr said that the PTA also recognises the role of monetary policy in contributing to supporting maximum sustainable employment, as will be captured formally in an amendment Bill in coming months.

In other words, just formalising what is already there.  An approach that, not incidentally, delivered us an unemployment rate materially above the NAIRU –  on the Bank’s own numbers –  for most of the last decade.   At present, we can probably expect lots of rhetoric –  repeated references to the contribution the Bank is making –  and nothing of substance, although in fairness it may be hard to tell for some time (since the unemployment rate is now closer to a true NAIRU than it has been for some considerable time).  It will be interesting to see the Governor’s first MPS and the associated press conference.

Personally, I’d have preferred that the new requirements were specified in terms of unemployment –  explicitly an excess capacity measure. There probably isn’t a great deal in the issue, except that the current formulation tends to treat high rates of employment as a “good thing”, when there is little economic foundation to such a proposition. By contrast, minimising (sustainably) the rate of unemployment is more unambiguously a “good thing”.

Perhaps more disappointingly, it is fine to require the Bank to explain how current monetary policy decisions are contributing to maximum sustainable employment.  But that is the sort of obligation an undergraduate student of economics could meet without difficulty and without much substance.  It is unfortunate that the Bank is not being required to:

  • explain how past monetary policy decisions have actually contributed to maximum sustainable employment,
  • explain how its future monetary policy plans will do so (the Act requires the Bank to explain policy plans for the (rolling) next five years),
  • publish estimates of the maximum sustainable level of employment.

Finally, with the OCR at 1.75 per cent and the current economic expansion having run for eight or nine years, it is disappointing that the Minister and incoming Governor have not signalled anything about the importance of preparing for the next recession, and reducing the extent to which the near-zero lower bound (inability to take the OCR below about -0.75 per cent) could severely limit the capacity of the Reserve Bank to maintain price stability (or contribute to maximum sustainable employment) in the next recession.  That recession  –  timing unknown of course –  remains much the biggest threat of unnecessarily high unemployment.  And yet it still doesn’t seem to be being taken seriously.

I’ll do a separate post on the planned legislative reforms.   For now, suffice to say that if it is a small step in the right direction, it is a big win for the Reserve Bank establishment.

On aspects of Reserve Bank reform

On Tuesday Adrian Orr will take up the office of Governor of the Reserve Bank and thus become, for a time, the most powerful unelected person in New Zealand.  In some respects he will in fact be more powerful than the Prime Minister, albeit over a much narrower range of functions, because it is much easier to oust a Prime Minister (see Tony Abbott and Kevin Rudd) or to vote her down in Cabinet than it is to constrain, or oust, a Governor.

It is a statutory requirement that a Policy Targets Agreement, governing the conduct of monetary policy, be agreed between the Minister of Finance and any person he is considering appointing as Governor before that person is appointed.  It is less than ideal that, three days out from Orr taking office, 3.5 months on from the appointment being announced, there is still no Policy Targets Agreement.   Have Treasury and the Minister lost sight of the merits of predictability and certainty, and the fact that markets (and individuals and firms) operate on a forward-looking basis?     But, apparently, the PTA will finally be signed/released on Monday, just a day before Orr takes office.   One can only hope that there will also be a pro-active release of the background papers relating to this major component of New Zealand macroeconomic policy.  If not, I will immediately be lodging OIA requests.

We are also told that information on decisions the government has made about “the new decision-making structure at the Bank” and other material on Stage 1 of the review of the Act (focused on monetary policy) will be released on Monday. If the government has done the right thing, before too long Orr will be stripped of much of his personal power, to become primarily an agency chief executive, and perhaps primus inter pares on one or more committees.   That would be a long overdue reform.  Perhaps the Independent Expert Advisory Panel –  which, thus far, has operated totally in secret – might open themselves to questioning?   Perhaps too we might get some hints as to what Stage 2 of the review –  content as yet undefined –  will cover?  You can expect there will be several posts on these issues next week.

As for Orr himself, only time and experience will tell what sort of job he will make of being Governor.  Today’s Herald has what can only be described as a puff-piece profile –  they managed preferential access to the previous Governor (notoriously media-shy), and presumably are targeting ongoing good relations more than serious scrutiny.  After having had monetary policy a bit too tight for most of this decade, we can only hope that their cartoon –  the new Governor appearing to keep money securely locked away –  isn’t inadvertently prophetic.

New Reserve Bank Governor Adrian Orr. Picture / Rod Emmerson

There was another, rather more interesting, piece –  from BusinessDesk –  offering some  thoughts from various economists on Orr taking up his new role.

Hawkesby likened Orr to UK politician Boris Johnson. “The stereotype of a central bank governor is someone whose communication is cautious, reserved and dry. Adrian is more like Boris, with communication that appears more spontaneous and witty,” he said.

TD’s Beacher warned, however, “there is the risk that his ‘good clear communicator’ reputation means he could make a poor choice of words on occasion when explaining the bank’s stance on policy settings.”

I greatly enjoy a good Boris Johnson newspaper or magazine column, but a comparison to Boris Johnson seems a backhanded compliment at best.    My own thoughts on Orr, and some of the opportunities and risks were in these two posts –  here and here.).

But the main prompt for this post was an column from a day or two ago by my former Reserve Bank colleague, and now consultant on things to do with financial regulation, Geof Mortlock.  That website often runs to long headings for their articles.  This one is headed

Ex-RBNZ and APRA official, Geof Mortlock, argues the RBNZ’s regulation of the financial sector is so inadequate this responsibility should be passed on to a new agency

The article is well-worth reading for anyone interested in New Zealand financial system regulation and supervision, or in the governance and conduct of the Reserve Bank.

A few weeks ago I outlined the case (and here) for splitting the Reserve Bank in two, and shifting the regulatory and supervisory functions into a new agency, perhaps called the Prudential Regulatory Agency.   Various other people have supported that sort of change, one senior business figure commenting that, if starting from scratch, structural separation would seem like a ‘no-brainer’.     My case for that reform was summarised this way

In favour of that position is that:

  • it is the more common model in advanced countries today (including Australia),
  • the synergies and overlaps between the various functions of the Reserve Bank are pretty slight (and probably no greater than, say, those between fiscal and monetary policy),
  • structural separation would allow for clearer lines of accountability, and
  • structural separation would allow for the creation of stronger, more effective, cultures  –  with appropriately skilled chief executives –  in each of the two successor institutions.

And so I welcome the fact that Geof Mortlock is also calling for structural separation

In my assessment, the best way to achieve the needed changes is to remove the financial regulation functions from the Reserve Bank and move them to a new, separate agency. I am sceptical of the willingness or ability of the Reserve Bank to change its cultural DNA.  Moving financial regulation out of the central bank was done in Australia with great success. Likewise, this has been done in many other countries, such as Canada, Germany, Japan, Sweden and Switzerland.

At present, we don’t even know whether the government is open to considering this option –  since nothing is yet identifiably included in the proposed Stage 2 of the review –  but they should.  It would be likely to make possible –  although there are no guarantees – a better monetary policy agency and a better regulatory one.

The bulk of Mortlock’s artice is actually about the Reserve Bank’s conduct of its regulatory responsibilities.  On some counts I strongly agree with him, and his observations and criticisms echo points I’ve made here on various occasions

The Reserve Bank’s approach to policy formulation and consultation on regulatory initiatives is deficient. Too often, the Bank has allowed far too short a period for affected parties to make submissions on regulatory proposals. All too often the Bank has often given the strong impression that it has little interest in the submissions it receives – i.e. that it is consulting for the sake of appearance and has no intention of modifying its approach in light of submissions. It generally provides inadequate responses to submissions and insufficient justifications for any decision to reject points raised in submissions. The argumentation for policy proposals is often poorly developed. Cost/benefit analysis is typically provided to justify the Reserve Bank’s preferred option, rather than being objectively and rigorously developed at an early stage in the policy formulation process. There is very little substantive independent assessment of the Reserve Bank’s cost/benefit analysis. In stark contrast, the Australian system provides for much more rigorous independent assessment of all regulatory proposals.

All of these deficiencies need to be rectified by imposing on the Reserve Bank much stricter requirements on consultation and cost/benefits analysis, and by bringing much stronger external scrutiny to the process. Similar arguments can be made for other regulatory agencies.

One could add that the Bank’s regulatory impact statements are typically a joke, with no independent internal or external review –  and thus simply serving to provide support for whatver a particular Governor has chosen to do.

One could also add that the Reserve Bank remains highly averse to public scrutiny of its regulatory role, regularly falling back on statutory provisions –  which themselves should be reviewed and refine –  designed to protect commercially-confidential information obtained in the midst of a crisis, but used much more broadly than that.  Thus, the Reserve Bank recently refused to release any of a consultant’s review of the director attestation regime –  a central element in the prudential system. The utter lack of transparency around the Westpac capital models issue, or the stuff-up around the Kiwibank capital instrument are other examples.    Perhaps more than some other government agencies, the Reserve Bank tends to treat the Official Information Act as a nuisance that really shouldn’t applied to them, rather than as an intrinsic part of our democratic system, and a normal part of being a government agency.   The “but we are different” mindset is a hard one to break.

Quite a bit of the rest of the article –  on the Reserve Bank’s regulation/supervision activities and rules –  I disagree with.   It is nearer territory Geof spent has most of his time on than it is for me.  Then again, Geof has been a regulator for a long time, and appears to make his living in part from providing advice on fitting in with international frameworks and standards.   Of itself, that doesn’t invalidate his views, but it is worth remembering the old maxim that

I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.

And there isn’t much sign of any cost-benefit analysis in his proposals for spending quite a lot more money (or so it would appear) on these functions.  I’m certainly sceptical of governments and bureaucrats wanting to spend more of our money on ‘financial literacy’ (as Geof suggests).  ‘Physician heal thyself’ comes to mind –  as Geof notes, the Reserve Bank will not even produce decent cost-benefit analyses for most of what it imposes on us.

I don’t doubt that the Reserve Bank could do some things quite a bit better –  process and culture included. I have also argued for removing some of the regulatory powers back to the Minister of Finance, and for more standardisation of the regime applying to all deposit-takers.   But I’m more sceptical that even more supervision is likely to be the answer to anything much.  A fair chunk of the global enthusiasm for more regulation, more supervision, over the last decade has been about backside-covering by politicians and regulatory agency officials after the crisis of 2008/09, with little attention to the inevitable limitations of regulation/supervision, including the incentives and constraints that face officials in regulatory agencies.  Action was demanded, and action was delivered, but the analytical basis for much of that action was often thin, and not well-grounded in serious sceptical scrutiny of the causes of the crisis.

And it is perhaps worth bearing in mind that New Zealand’s track record of financial stability has been pretty good.  Geof argues that

The Reserve Bank is also not well placed to proactively identify and resolve emerging problems before they become obvious or the financial institution is about to fail. The recent failure of CBL Insurance is an example of this. In earlier years, the Reserve Bank was slow to detect and respond to problems in DFC (which failed in 1989) and BNZ (which came close to failing in 1990).

Im not sure this is very persuasive.  On the one hand it is worth bearing in mind that it appears the Reserve Bank was onto the CBL problems well before the market was –  including bankers lending CBL new money –  and the DFC/BNZ failures were almost 30 years ago, under different legislation in the earliest days of the Bank having any prudential responsibilities and in the immediate aftermath of far-reaching financial liberalisation (followed by booms and failures in various other countries including Australia and the Nordics).   And on the other hand, we could note the crises and failures/near-failures (of regulated institutions or indeed the system) of the last decade in countries as various as the United States, United Kingdom, Switzerland, Denmark, Belgium, Netherlands, France, Greece, Italy, Spain, Ireland and so on.  In many of those countries, the IMF had previously provided a tick in its FSAP reviews.  Several of those countries will have –  and did –  prided themselves on their regulatory agencies, on-site or in-depth detailed scrutiny and all.     Neither New Zealand nor Australia (nor Canada, nor Norway for that matter) ran into such problems.    APRA may like to flatter itself that Australias avoidance of crisis was down to their fine supervision –  I’ve heard senior people run that line – and that New Zealand, free-riding on fine Australian supervision, was in the same boat.   My response to that claim would be, at best, ‘case not proven’.

It is also worth bearing in mind that the Reserve Bank isn’t the principal in this business, but the agent.  It hasn’t been –  and isn’t –  funded for more intensive regulation and supervision, and that is a choice successive Ministers of Finance –  advised by Treasury over the years –  have made.  In a sense, the Reserve Bank has done what Parliament  –  and Ministers –  asked it to do, and in that sense that question isn’t just about the Reserve Bank’s competence and capability but about choices our political system makes regarding the intensity of regulation.

All that said, if we might differ in emphasis, and in our confidence as to what value regulators and supervisors can add, we seem to be at one in favouring structural separation.  A good part of the case for such a reform is the ability to build a culture dedicated to doing excellently, and only, the regulatory and supervisory functions Parliament delegates to the Bank.  It is telling that, for a function that now bulks so large in the Reserve Banks mandate, recent Reserve Bank Governors have had little background in banking or of financial system regulation (certainly true of Bollard and Wheeler, and to a lesser extent for Adrian Orr).  At best, financial regulation and supervision is a part-time focus for the Governor.  And the new Head of Financial Stability –  an appointment made by Graeme Wheeler as he was leaving, without advertising the position –  has no background in those areas at all.  We can and should do better.  That ball –  structural reform and separation –  is now clearly in the Minister of Finances court.




So much company tax, so little investment

Almost 10 years ago I stumbled on this chart in the background papers to Australia’s tax system review.

Chart 5.11: Corporate tax revenue as a proportion of GDP — OECD 2005

Aus company tax as % of GDP 2008

I was intrigued, and somewhat troubled by it.   New Zealand collected company tax revenue that, as a share of GDP was the second highest of all OECD countries.   And yet New Zealand:

  • didn’t have an unusually large total amount of tax as a share of GDP, and
  • had had quite low rates of business investment –  as a per cent of GDP –  for decades, and
  • as compared to Australia, just a couple of places to the left, New Zealand’s overall production structure was much less capital intensive (mines took a lot of investment).

And, of course, our overall productivity performance lagged well behind.

Partly prompted by the chart, and partly by a move to Treasury at about the same time, I got more interested in the taxation of capital income.   After all, when you tax something heavily you tend to get less of it, and most everyone thought that higher rates of business investment would be a part of any successful lift in our economic performance.  That interest culminated in an enthusiasm for seriously considering a Nordic tax system, in which capital income is deliberately taxed at a lower rate than labour income.  It goes against the prevailing New Zealand orthodoxy –  broad-base, low rate (BBLR) –  but even the 2025 Taskforce got interested in the option.

Flicking through the background document for our own new Tax Working Group the other day I came across this chart (which I haven’t seen get any media attention).

company tax revenue

It is a bit harder to read, but just focus for now on the blue bars.   On this OECD data New Zealand now has company tax revenues that are the highest percentage of GDP of any OECD country.   A footnote suggests that if one nets out the tax the government pays to itself (on businesses it owns), New Zealand drops to only fourth highest but (a) the top 5 blue bars are pretty similar anyway, and (b) it isn’t clear who they have dropped out (if it is just NZSF tax that is one thing, but most government-owned businesses would still exist, and pay tax, if in private ownership).

So for all the talk about base erosion and profit-shifting, and talk of possible new taxes on the sales (not profits) of internet companies, we continue to collect a remarkably large amount of company tax (per cent of GDP).  Indeed, given that our total tax to GDP ratio is in the middle of the OECD pack, we also have one of the very largest shares of total tax revenue accounted for by company taxes.

The Tax Working Group appears to think this is a good thing, observing that it

“suggests that New Zealand’s broad-base low-rate system lives up to its names”

There is some discussion of the trend in other countries towards lowering company tax rates, but nothing I could see on the economics of taxing business/capital income.  It is as if the goose is simply there to be plucked.

There are, of course, some caveats.   Our (now uncommon) dividend imputation system means that for domestic firms owned by New Zealanders, profits are taxed only once.  By contrast, in most countries dividends are taxed again, additional to the tax paid at the company level.    But, of course, in most of those countries, dividend payout ratios are much lower than those in New Zealand, and tax deferred is (in present value terms) tax materially reduced.

And, perhaps more importantly, the imputation system doesn’t apply to foreign investment here at all.   Foreign investment would probably be a significant element in any step-change in our overall economic performance.  And our company tax rates really matters when firms are thinking about whether or not to invest here at all.  And our company tax rates are high, our company tax take is high –  and our rates of business investment are low.  Tax isn’t likely to be the only factor, or probably even the most important –  see my other discussions about real interest and exchange rates – but it might be worth the TWG thinking harder as to whether there is not some connection.

Otherwise, as in so many other areas, we seem set to carry on with the same old approaches and policies and yet vaguely hope that the results will eventually be different.


A couple of Reserve Bank items

I had been meaning to write about a speech given last week by Grant Spencer of the Reserve Bank on so-called “macro-prudential policy”.  It was a thoughtful speech, as befits the man, and the last he will give as a public servant before retiring next week.

That it was thoughtful doesn’t mean that I generally agreed with Spencer’s (personal, rather than institutional) views.  There were at least two important omissions.  First, as it has done over the last half-decade (and more) the Bank continues to grossly underplay the importance of land-use restrictions in accounting for increases in the prices of houses (and particularly the land under them).  Until they get that element of the analysis more central, it is difficult to have much confidence in what they say about housing markets, housing risks, or possible Band-aid regulatory interventions of their own devising.    And second, they constantly ignore the limitations of their own knowledge.  I’m not suggesting for a moment that they are worse than other regulators in this regard –  who all, typically, have the same blindspot –  but it might matter rather more from a regulator than exercises, and wants to be able to continue to exercise, large discretionary intervention powers, with pervasive effects over the lives –  and financing options –  of many New Zealanders.   If they won’t openly acknowledge their own inevitable limitations, and discuss openly how they think about and manage the associated risks, how can we have any real confidence that they aren’t just blundering onwards, fired by good intentions and injunctions to “trust us” rather than by robust analysis.  In respect of both these omissions, I hope –  without much hope –  that the new Governor begins to put the Bank on a better footing.

When someone asked me the other day if there was anything new in the speech, one thing I noticed was how far the Bank’s current senior management appears to have come over the last few months around possible changes to the governance of the Bank’s main functions.   Casual readers might not notice the change, because it is presented as anything but.  Specifically, this is what Spencer had to say.

Given the planned introduction of a new decision making committee (MPC) for monetary policy, the Review should consider establishing a financial policy committee (FPC) for decisions relating to both micro and macro prudential policy. The Reserve Bank has supported a two-committee (MPC/FPC) model in place of the current single Governing Committee, for example in the Bank’s 2017 “Briefing for Incoming Minister”.

Of course, it is only a few months since the Bank’s expressed preference was simply to take the existing internal Governing Committee (the Governor and the deputies/assistant he appoints) and recognise it in statute, as the forum through which the Governor would continue to make final decisions.

And what of the claim that the Bank has –  not just does now –  supported a two-committee model, including in its Briefing to the Incoming Minister late last year?  At very best, that is gilding the lily.

As I noted at the time, both in the main text of that Briefing, and in the fuller appendix (both here) they devoted most of their effort to defending the existing Governing Committee model.    The main alternative they addressed was a Monetary Policy Committee  but even then the most they favoured was enacting the current Governing Committee model, perhaps with a few outsiders appointed by the Governor, and with the Governor remaining the final decisionmaker
“Provided the Governing Committee remains relatively small, we believe it should continue to make decisions by consensus, with the Governor having the final decision if no consensus can be achieved.  “
The only mention of a Financial Policy Committee is (from page 9)

The Reserve Bank considers that some evolution in its decision-making approach may be appropriate.  We recommend that the review of the RBNZ Act be limited to your stated change objectives.  We consider a review along these lines could be completed reasonably quickly and we would be happy to prepare a draft terms of reference, in consultation with the Treasury.  A variety of arrangements are possible and these are discussed, alongside the rationale for the Bank’s preferred model, in Appendix 6.

Other legislative changes that may be desirable over time include:

– Creating separate decision-making committees for monetary and financial policy

Note the suggestion to the Minister to keep the forthcoming review of the Act to the minimum of what Labour had promised (which dealt only with monetary policy), with some vague suggestion that at some time in the future –  but not in this review –  separate committees “may” be appropriate.  It could scarcely be called a full-throated endorsement of change.

Of course, the Bank lost various battles.  The first stage of the review is being led by Treasury (dealing with the monetary policy bits) and the second stage will look at (as yet unidentified issues).   And it seems they must have recognised that the ground is shifting, and that it would be hard to defend the current single decisionmaker models for the Bank’s huge regulatory (policy and operational) powers once momentum gathered behind a committee model for monetary policy.  Whatever the reason, it is a welcome move on the part of the current management.  Of course, we have no idea what the new Governor –  taking office in a few days –  thinks about suggestions to curtail his powers.

And just finally on the speech, one element of good governance is obeying, and respecting, the law.    Once again, Spencer’s speech and press release have been put out under the title “Grant Spencer, Governor”.  He simply isn’t.  At best he is “acting Governor”, a specific provision under the Reserve Bank Act.  A “Governor” has to be appointed for a minimum term of five years.   If it were a lawful appointment, there is nothing shameful in being acting Governor –  the one previous example, Rod Carr for five months in 2002, never purported to be the Governor.   As it is, my analysis stills suggests that the appointment was unlawful, and thus Steven Joyce and the Bank’s Board (by making the appointment) and Grant Robertson (in recognising it) both undermined the law and good governance and marred the end of Spencer’s distinguished career.  At very least, those provisions of the Act should be reviewed as part of Stage 2.

Meanwhile, we are still waiting for the now-overdue results of Stage 1, for the report of the Independent Expert Advisory Panel (which, as far as we can tell, has neither sought submissions nor engaged in consultation) and for the new Policy Targets Agreement which wil guide monetary policy from next week.

Still on matters re the Reserve Bank, there is a column in the Dominion-Post this morning by Rob Stock having a go at the Open Bank Resolution (OBR) and associated hair-cut of creditors and depositors option for handling a failed bank.  Like me –  and many other people, including the IMF and The Treasury –  Stock favours deposit insurance.  But he seems to see deposit insurance and OBR as alternatives, whereas I see them natural complements.  Indeed, the only way I can ever see the OBR instrument being allowed to work, if a substantial bank fails, is if deposit insurance is also in place.

Stock introduces his article with a straw man argument that ordinary depositors can’t really monitor banks and so shouldn’t be exposed to any financial loss if a bank fails.  Not even the first point is really true.  There are, for example, published credit ratings, and any changes in those credit ratings –  at least for major institutions –  get quite a lot of coverage.  A huge amount of information is reduced to a single letter, in a well-articulated series of gradations.   Should one have vast confidence in ratings agencies?  Probably not –  although perhaps not much less than in prudential regulators, based on track records.  But if your bank is heading towards, say, a BBB- rating and you have any material amount of money it would probably be a good idea to consider changing banks, or spreading your money around.    No one thought that South Canterbury Finance or Hanover were the same risk as the ANZ, at least until the deposit guarantee scheme made putting money in SCF rock-solid safe, whereupon many depositors rushed for the higher yields.

But there is a broader point that many risks in life aren’t able to be fully monitored, controlled, hedged, avoided or whatever  One might become a highly-specialised employee in a firm or industry that fails, or is taken out by regulatory changes.  Regions and towns rise and fall, and take house prices with them.  Governments might one day free up land use laws, reducing house and land prices to more normal levels.  Wars and natural disasters happen.  Chronic illness can strike a family. Even a marriage can be hugely risky.    For the median depositor there is typically much less at stake in their bank account (and typical losses –  percentage of liabilities – on failed retail banks aren’t that large).

Are there potential hard cases?  For sure, and Stock cites one of them.   If you’ve just sold your mortgage-free house –  for, say $1 million –  and are settling on another house next week and your bank failed in the course of that week, you could be exposed to quite a loss even though you’d had no desire to be a creditor of the bank.   Cases like that are one reason why I favour the Reserve Bank opening up electronic settlement accounts –  central bank e-cash if you like –  to the general public.  There wouldn’t be much demand, but on those rare occasions like the house settlement example, you might happily pay for the peace of mind of an effective government guarantee.  I’m looking forward to the new Reserve Bank Bulletin article on such matters next month.

I don’t think those few extreme examples warrant full insurance for all individual depositors, no matter the size of their balance.  There are many classes of people struck by not-easily-monitorable illiquid risks (see above) I’d have more sympathy with.  But I’m a political pragmatist, and as I argued previously I just cannot envisage an elected government allowing a major bank to fail, allowing all creditors to be haircut, if there is no protection at all.    That is especially so when, almost by construction, the Reserve Bank –  the government’s agent –  will have failed in its duties (and probably kept crucial information from the public, as in the recent insurance failure case) for the situation to have got to that point.    A full bailout will typically be the path of least resistance.

And a full bailout will mean not just bailing out the grandma with a $30000 term deposit, or the person changing homes with $1m temporarily on deposit, but bailing out wholesale creditors –  domestic and foreign –  with tens or hundreds of millions of dollars of exposure.     Do that –  or set up structures that aren’t time-consistent and encourage people to believe in bailouts –  and any market discipline, even by the big end of town, will be very severely eroded.  And, in a crisis, we’ll be transferring taxpayers’ scarce resources to people   including foreign investors – who really should be capable of looking after themselves.  It has happened before and it will happen again.   But deposit insurance –  funded by levies on covered deposits – increases the chances of being able to impose losses on the bigger creditors if things go wrong.

Perhaps OBR would still never be used.  And there are costs to the banks in being pre-positioned for it.  But we shouldn’t easily give in to a view that any money lent to a bank is rock-solid, backed by government guarantees.  It is not as if there aren’t plausible market mechanisms that could deliver much the same result, at some cost to the depositor (eg a bank or money market fund that held only short-dated government or central bank liabilities).   But there is little evidence of any revealed demand for such an asset –  the cost presumably not being worth it to most people, to cover a very small risk.  By contrast, we voluntarily pay for fire or theft insurance –  often to cover what are really quite modest risks.

There may not be any more posts this week (and if there are, they won’t be of any great substance).   I have a couple of other commitments on Thursday and Friday and, as I’m sure many have discovered before me, broken bones seem to sap an astonishing amount of energy for something so small.