Year: 2018

Towards a statutory monetary policy committee

Michael Reddell Reserve Bank Act reforms, Uncategorized

As part of the review of (parts of) the Reserve Bank Act, The Treasury is inviting comments and suggestions, on how the changes in stage 1 of the review (statutory goal of monetary policy, establishment of a statutory monetary policy committee) should be implemented, and on what else should be reviewed in the forthcoming stage 2 of the review.

Last Thursday I went along to a Stakeholder Engagement Roundtable, in which Treasury had invited various private economists in to offer our perspectives on those issues.  My post on Thursday –  on the statutory goal of monetary policy –  was, in effect, part of my notes in preparation for that meeting.   In the discussion, opinion was fairly mixed on the merits of making a change, but it was generally recognised that the government had committed to change and so the main issue was how best to give it legislative form.

The second chunk of the discussion was about the establishment of a statutory monetary policy committee.  Here there seemed to be greater unanimity that reform was desirable, and that part of any reform should be a greater emphasis on transparency, including individual accountability.

I’ve covered my own views on various of these points in earlier posts, but for ease of future reference, I thought I’d bring them together in a single post.  My model would not replicate that in any single other country, but is probably closest to the monetary policy committees in the United Kingdom and Sweden.

Who should appoint the members of the committee?

All of the members should be appointed by the Minister of Finance.   People who exercise significant statutory power –  and the conduct of monetary policy is certainly that –  sholu.d either be elected themselves or appointed by those who are themselves elected.  That is the general approach we take to governing New Zealand:  whether it is Cabinet, the courts, the boards of Crown entities, the Commissioner of Police, or the Auditor-General.  There is no particularly good reason why members of a Monetary Policy Committee should be different.    There are probably unique aspects to all governance appointments, but nothing around monetary policy marks it out as warranting putting another layer between the elected and the decisionmakers.

This is, of course, in contrast both to the current model (single decisionmaker –  the Governor –  in effect appointed by the Bank’s Board), and to the model Labour campaigned on (where external members would be appointed by the Governor –  putting them at a further removes from someone who has to actually face the voters).  Allowing the Governor to appoint the external members would risk substantially undermining the reasons for the reforms.

In the United States nominees for the Federal Reserve Board of Governors are required to win Senate confirmation.  That isn’t our constitutional model.  In the United Kingdom, appointees are required to face a parliamentary select committee hearing before taking up the role.  The committee can’t block the appointment, but can report on the suitability of otherwise of the nominee.   This might be a useful feature to add here.  It isn’t an approach we take generally, but monetary policy makers exercise wide powers of discretion (much more, say, than a typical Crown entity Board member) and, with ex post accountability difficult to maintain, it seems reasonable that those taking up such roles should face some open scrutiny at the start.

There is a counter-argument that the Governor should be free to appoint his or her own Deputy (as might be normal in a commercial context).  To which my response would be that if the deputy was not serving on a statutory committee, exercising statutory powers, that model would be fine.  But if the Deputy Governor is to exercise statutory powers, they should be appointed by someone who was elected, and who is accountable to voters: as far as I can tell, that is the typical model (including, for example, in Australia and the United Kingdom).

How many members should there be?

I’d favour either five or seven.  Any larger number would make it unduly difficult to fill the roles with good people consistently through time.

Either way, I’d favour having two internals (executives) – the Governor and a Deputy Governor –  with the remaining members being part-time non-executives.  It is highly desirable to have a majority of members who are outside the managerial hierarchy of the Bank.  Put the structure the other way round and there is a high risk that, over time, the non-executive members will be neutered (with management coming to block vote), and that  then good people will be unwilling to put themselves forward to serve on the committee.  Non-executives will always be at some disadvantage –  re access to analysis, and ability to influence the research agenda etc – and only be holding the majority of votes on the committee will they be able, if they choose, to consistently push back against that pressure.

The counter-argument often made is often about technical expertise: the choice between internals and externals is often presented as a choice between experts and non-experts.  To which there are several responses to be made.  First, as the Reserve Bank is currently structured, the internals will often not be “experts” on monetary policy at all –  none of the Governors since 1989 could really be classed as “experts” on monetary policy, although of course over time they acquired considerable experience, and even among Deputy Governors there have been considerable differences of expertise and background.  And the skills of being a good chief executive –  running the organisation, generating the analysis, managing the operations –  also aren’t necessarily those of a leading monetary policy expert.

But perhaps as importantly, while I think it is vital to have expert advice and analysis, as inputs to decisionmaking, it isn’t clear that we want technical experts making policy decisions, and exercising the (inevitable) degree of discretion that monetary policy makers do.  Some people with technical expertise may be able to serve effectively as decisionmakers (and communicators) but the skills aren’t the same at all.  And if the internal members of a Monetary Policy Committee, with all the technical resources of the Bank staff at their command, cannot convince one or two non-executive members of the merits of their case, it seems unlikely that they will be able to convince the wider public.

What sort of non-executive members should be appointed?

I’m wary of making much of an internal vs external distinction, and instead focus on that between executives and non-executives.  After all, there has been no internal candidate appointed as Governor since 1982.

But in considering non-executive appointments (three or five in my model) there are a few relevant considerations:

  • no one should be appointed to represent a particular interest group.  Of course, everyone has a background, but once one takes up a position on an MPC your commitment has to be to implementing the Act and serving the interests of the country as a whole,
  • there should be no prohibition on non-resident or non-citizen members (although I would favour no more than one at a time).   We are a small country, and there can at times be valuable perspectives that people employed abroad can offer (and it is a model the UK has used), as one vote among five or seven,
  • it would be desirable to have one member with some reasonable academic exposure to monetary policy, but undesirable to think of a Monetary Policy Committee as, say, a research conference or an academic seminar,
  • people with sound general Board-level skills can make a valuable contribution to an MPC, regardless of their formal academic background.  One doesn’t typical want an telecoms company Board stuffed full of tech people, and there isn’t any obvious reason why a Reserve Bank MPC should be different.  The ability, and willingness, to ask hard questions, and even just to say “tell me that again, in ways I can understand” is a valuable part of the mix.

How long should MPC members’ terms be?

I would favour five year terms, perhaps with a limit of one reappointment each.  With five or seven members, one appointment would come up every year or so, enabling a government is the course of a three year term to replace gradually around half the members of the committee, but not to launch a purge on newly taking office.   Terms of this length seem reasonably conventional (and are the same as those of the Governor, and Board members, at present).

Individualistic or collegial?

I’ve outlined here previously why I strongly favour the sort of individualistic model adopted in the UK, the USA and in Sweden, in which individual members of the MPC are individually accountable for their votes.  The current management of the Reserve Bank really dislikes the model, but they have never been willing, or able, to articulate –  from the experience of other countries –  what the nature of their concerns is, and how they balance any such concerns against the interests of democratic accountability, in a model in which decisionmakers exercise considerable discretion.

As I’ve documented here over the years, formal effective accountability for monetary policy decisions is hard –  much harder than those who devised the current law thought at the time it was drafted.  In practice, accountability can be exercised only through public scrutiny and challenge, and at the point where a member of the MPC is up for reappointment.  Against that backdrop –  and in a game where there is so much uncertainty – it is highly desirable that individual MPC members’ votes should be recorded and published, and that members should have the opportunity to have their views recorded in minutes that are published in a fairly timely fashion.  The Reserve Bank’s management has at times expressed concerns about this approach –  used elsewhere –  “muddying the message”, but in fact there is so much uncertainty about the way ahead (what is going on with the economy and inflation) that over time it will usually be preferable to have in public the sorts of issues and concerns that were bothering decisionmakers, rather than just some sort of somewhat-artificial consensus about an immediate OCR decision.

In a similar vein, MPC members should all be free to make speeches, give interviews etc articulating their own views on the issues the MPC is facing.  I’m not suggesting some sort of chaotic free for all: it would no doubt be desirable for members to develop protocols in which members ensured that other members were aware of forthcoming speeches and interviews, agreed to circulate draft texts to each other in advance, and perhaps agreed to avoid comment altogether in the week or so (say) prior to an OCR announcement.  Commonsense and common courtesy can resolve many potential issues.

Who should chair the MPC?

The Governor.  I hadn’t particularly thought of this issue, but it came up at the Treasury meeting the other day. There is an argument for a non-executive chair –  the approach in most Crown entities – but provided there is a majority of non-executive members I’m not sure I see the case for departing from the universal international practice, in which the Governor chairs the MPC.    (It is also perhaps worth noting here that in other countries –  including the UK – it has not been a problem if the Governor has at times voted with the minority.  Smart people will often view the same data quite differently.)

Transparency

The amended Act should require the publication of minutes, and the record of individual votes, within a reasonable time –  perhaps to be determined by the Minister –  of the particular OCR decision.  As I’ve noted previously, I do not favour either keeping, or eventually publishing (even with very long lags), transcripts of MPC meetings.

I would also favour moving to a system where the background papers for MPC meetings are routinely and pro-actively published (perhaps six weeks after the OCR decisions to which they relate).  Ideally, I would not consider this something that should be legislated, but given the obstructiveness of the Bank, and the willingness of successive Ombudsmen to aid and abet the Bank in keeping such papers secret even well after the relevant decision, the legislative option may need to be considered.

As I’ve noted repeatedly before, the Reserve Bank is quite transparent about stuff it knows little abour –  eg where the OCR might be a couple of years hence –  but isn’t very transparent at all about what it does know about.  Transparency is valuable in itself –  an essential part of democracy –  but in a small country with limited pools of expertise, the ability of greater transparency to facilitate more informed and debate and scrutiny of the issues is almost instrumentally useful.

Should there be a Treasury representative on the MPC (in a non-voting capacity)?

I don’t have a strong view on this issue, but it is a model that is used in a number of countries, and could help to formalise a recognition of the relationship between various bits of economic policy.    The model appears to have worked, without undue problems, in the UK.     But if it is to be done, it needs to be recognised that it would involvement a non-trivial time commitment by someone reasonably senior in Treasury –  and time/resources are scarce.

The Policy Targets Agreement

At present, Policy Targets Agreements are (a) signed with the Governor personally, consistent with the single decisionmaker model, and (b) have to be agreed with an incoming Governor before that person is formally appointed or takes office.  It is a poor model, and not one that is much imitated abroad.

Under my reform model, the MPC as a whole would be responsible for monetary policy and the onus of a PTA should also rest on them.  To do that probably requires rethinking the PTA model, and might suggest moving to the system adopted in some countries –  eg the UK –  where the goal (PTA) is specified by the Minister of Finance, and the MPC is simply responsible for conducting policy consistent with that goal.  The UK model isn’t ideal – the target can be changed at the Chancellor’s whim in the annual Budget –  but a system in which the target is specified every few years, after  advance consultation with the MPC of the day (and ideally with the wider public, and with FEC), would seem to have some attractions.  To get the right balance between responsibility for setting overall goals –  resting with the elected government –  and a degree of stability, perhaps the appropriate review period might be six months after a change of government (with provisions for other changes to the PTA only in exceptional circumstances –  say with the agreement of the majority of the MPC.)

The final issue Treasury asked us about under this heading was about the role of the Bank’s Board.  There seemed to be pretty universal agreement among attendeees that the Board adds little or no value.  But, as I’ve noted here previously, you can’t really answer the question about the appropriate role of the Board without thinking harder about the overall organisation of the institution (rather than simply one function –  monetary policy).  I’ll come back to that on Wednesday.

And on a completely different topic

Regular readers will know that I live in Island Bay.  Some will have seen the story in yesterday’s Sunday Star-Times suggesting that our local primary school was “New Zealand’s richest primary school”, based on reported donations in 2016 of $490000.    This qualifies as pretty poor journalism.  Island Bay School is a decile 10 school (although I suspect in the poorest 10 per cent of the top 10 per cent of neighbourhoods).  It was reported that

“Island Bay school’s 460 students contributed $490000 donations in 2016 –  an average of $1065.46 per student for the year’s schooling”

In fact, those parents who paid the scheduled annual donation paid around $250 per child, in other words only around a quarter of the total.   But one, very wealthy, old boy made one very generous donation.  Here is the Principal’s newsletter from 10 March 2016

I awoke to the best news ever this morning: Sir Ron Brierley, an old boy of the school, has generously agreed to donate a sizeable sum to the Rimu Block modernisation project. This gift, combined with Ministry of Education funding, gives us sufficient funding to realise our full vision for the modernisation of Rimu. This would not have been achieved without the generosity of Sir Ron, who has been a wonderful friend and supporter of Island Bay School over the years. In 2011 he kindly contributed towards the Learning Hub and now he has made this contribution towards Rimu Block.

As a parent, it always amused me that such a left-leaning school (and successive Principals) were taking such large amounts of money from a generous capitalist.  It is a real gain to the school, but it is almost totally irrelevant to the debate around the “donations” that parents are asked for each year.

 

Handling failed insurers

Michael Reddell insurance

Last week I wrote a post prompted by the New Zealand Initiative’s passing suggestion that something like an OBR scheme might be established to handle failed (large?) insurance companies.  The New Zealand Initiative didn’t like the AMI bailout (neither did I) and the suggestion that an OBR option might be considered seemed to be mainly a way of helping ensure that losses lay where they fell, not with taxpayers generally.

I didn’t think that the OBR type of scheme –  focused on keeping the failed institution open –  made a lot of sense for insurers, but recognised the probable political imperative to limit the losses of at least some of those caught in a failure.   Deposit insurance is the typical, and sensible, response to that imperative in the case of bank failure, and some sort of limited policyholder compensation scheme could make sense for insurer failures.

I ended that post this way

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

I wouldn’t have come back to the topic except that I just noticed a column on the idea of an insurance OBR from a columnist –  Fairfax’s Rob Stock –  who I usually have quite a bit of time for.   And there were a couple of aspects of that column that seemed quite misleading.   Here were some of the concluding sentences.

Taxpayer will end up spending about $1.5 billion rebuilding AMI policyholders’ houses.

That’s a lot of money, and economics think tank The New Zealand Initiative thinks we should consider an OBR for insurers.

In the case of AMI, which had around half a million customers with 1.2 million policies, that’d be around $1230 per policy.

Less OBR than OMG to people already in a financial hole as a result of their homes and belongings being damaged by the earthquakes.

It’s one thing giving bank depositors a haircut. It’s quite another putting families in dire financial straits into deeper holes.

 

Big general insurers fail after natural disasters, which really isn’t the time Kiwis will feel comfortable asking victims to stump up more money.

It also fails the fairness test.

How was any ordinary householder supposed to recognise AMI’s lack of reinsurance if expert regulators didn’t?

But…..losses don’t fall in all policyholders (and certainly not evenly –  someone with a $10000 contents policy, and another person with a $5 million house policy) but on the people who had claims outstanding at the point the insurer fails.   That is the parallel to the bank situation –  in a bank failure, all depositors have a claim on the bank, but in an insurance failure most policyholders have only contingent claims –  if something had gone wrong which could be claimed for under the terms of their own policy.  For some it had gone wrong at the point of failure –  eg a house severely damaged in an earthquake.  Other policyholders –  having paid their premium – will simply walk away from their worthless policies and look for alternative cover elsewhere.

I’m not sure quite how many claims AMI had outstanding at the point of failure, but I assume that the reported Southern Response numbers are a close approximation.    Their website suggests around 30000 claims.     If the bailout cost really does come to $1.5 billion, that would be an average loss –  for those with outstanding claims –  of around $50000 (the median losses would presumably be a bit lower).   That –  not Stock’s $1230 –  is the nature of the political problem: relatively heavy losses on a middling number of people.

Revealed preference –  the AMI experience –  suggests that governments are likely to jump in when a failure of this particular sort occurs (a lot of claims outstanding at point of failure, and the association with a natural disaster).  It might be better, even fairer in some respects, if they didn’t, but they almost certainly will.   (Why might it be fairer not to intervene?   Because there are all sorts of ways in which people experience unexpected, and not really foreseeable, shocks to their wealth and expected lifetime income.    There is serious illness for example, a cheating spouse and the end of a marriage, unemployment, or structural decline for a region of the country one had spent one’s life in.  In many cases, those losses will amount to materially more than the typical loss in, say, the AMI case, and generally we run a welfare system as a safety net against extreme poverty, rather than attempting to compensate people for the unexpected, perhaps uninsurable, losses.)

But if, dwelling in the world of the second-best, governments are likely to respond sympathetically to another failure like that of AMI –  which might well be 100 years away, or never happen –  we should be trying to devise schemes that channel, and limit the cost of, that political sympathy.    That is the point of suggestions like deposit insurance or –  in this case –  policyholder compensation schemes: the protection can be pre-funded, paid for by policyholders receiving the cover, and it can be limited (capped, to provide full or near-full cover to people at the bottom, and little to people insuring multi-million dollar houses or commercial buildings).    General bailouts –  like that of AMI, which Stock seems to have favoured –  are indiscriminate and unfunded.    Even without a pre-established scheme, a general bailout wasn’t the only option in the AMI case.

Stock’s final line also caught my eye

How was any ordinary householder supposed to recognise AMI’s lack of reinsurance if expert regulators didn’t?

Which might be a reasonable argument, except that………in February 2011 there were no “expert regulators”, or even inexpert ones, assessing AMI’s solvency, reinsurance etc.    The Insurance (Prudential Supervision) Act received the Royal Assent just a few days after the first Canterbury earthquakes in September 2010, and the Act came into effect in stages over the following three years.   There had never been prudential supervision of insurers in New Zealand –  and actually, there hadn’t been many failures either (as I understand it, one significant insurance company failure –  and that unrelated to a natural disaster –  in the previous 100 years).

Does that absolve policyholders of all responsibility?  No, I don’t think so.  I gather AMI was one of the cheaper options in the market, and everyone knows that that in itself can be a warning signal.  It was also a NZ-only firm, without any sort of parental support.  And markets develop mechanisms to monitor the strength of firms operating in all sorts of markets.  I’m not unsympathetic to people near the bottom of the heap who might have been caught up in the AMI failure, but the mere fact of the failure doesn’t make a compelling case for a general bailout.

What perhaps concerns me a little more is that (unlike 2010/11) policyholders do now have reason to think that “expert regulators” are monitoring and limiting risks on their behalf.  But I recall a discussion at the Reserve Bank’s Financial System Oversight Committee when the solvency standards for insurers were being put in place.  I asked the experts whether the proposed new standards would have been demanding enough to have prevented the AMI failure, and I was told that they were not.   After all, I was told, the ground acceleration experienced in Christchurch had been the sort of thing that might be expected every few thousand years, and no prudential regime was designed to prevent all failures.    I wasn’t entirely convinced, but I’m no seismologist.  And so it was sobering to read a few months ago that the November 2016 Kaikoura earthquake had recorded maximum ground acceleration substantially larger than that experienced in Christchurch only a few years earlier.   Fortunately, it didn’t occur close to a major residential or commercial area.

There still seem to be real limits to our understanding of the geology of this country.  Perhaps it raises some real questions about just how insurable earthquake (and associated tsunami) risk really is –  at least at prices that are generally affordable.  The idea of an insurance OBR seems to be ill-targeted, and really just a distraction from the real issues.  But a limited, funded, policyholder compensation scheme in respect of failures associated with residential earthquake (and perhaps volcano/tsunami) losses looks like something the government should be looking into.  Better that than rushed indiscriminate bail-outs when –  very rarely –  failures happen.

Of course, if – or when –  the very worst happens and there is another mega Lake Taupo eruption, what remains of the New Zealand government will have bigger concerns to worry about than the fate of specific insurance policyholders.

The statutory goal for monetary policy

Michael Reddell Reserve Bank Act reforms

The government has a review of the Reserve Bank Act underway at present.    It is an odd beast.    There is a rushed process going on to review and amend the monetary policy bits of the Act, led by Treasury and assisted to some modest extent by an Independent Expert Advisory Panel –  itself chaired by someone with no experience in monetary policy.   And then there might be a second stage review, to be jointly run by the Treasury and the Reserve Bank, which might –  or might not –  have the same Independent Expert Advisory Panel.  If well-intentioned, it is pretty unsatisfactory: lightly-resourced, potentially giving too much influence to the Reserve Bank itself, and not working from a coherent overview of the Bank as an institution (thus, part of the first stage review is looking at the role of the Bank’s Board as regards monetary policy, without having engaged properly with how the whole organisation should be structured, managed, and held to account, or even looking at the interactions between the Bank’s various functions).  How much better it would have been to have had a proper independent review, looking at all the roles/functions of the Bank at the same time, with a view to legislating next year.    That was, for example, what was done in Norway recently with central banking legislation of similar vintage to our own.    It would also reduce the chances that, with a patch-protecting new Governor, the second stage of the review will just peter out and come to nothing.

There are two main bits to the first stage of the review:

  • amending the statutory goal of monetary policy to add a focus on maximising employment (or minimising unemployment), and
  • introducing a statutory committee, including non-executive members, to make monetary policy decisions.

For the time being, much of what the government says they want to achieve around the first bullet  (the objective for monetary policy) could be done through a new Policy Targets Agreement  –  one needs to be signed before Adrian Orr can formally be appointed as Governor (and thus will be necessary even before Stage 1 reforms can be legislated.  I outlined some suggested wording in a post last year.   Sadly, with the rushed review focused on the Act, there is no sign of any public process looking at the content of the Policy Targets Agreement, even though it is the main policy instrument for short-term macroeconomic management.

But how should the statutory goal be restated?  Since 1989 the key clause of the Reserve Bank Act (section 8) has read as follows

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.

And 10 years ago, a revised purpose clause was added to the Act, and around monetary policy this is what it said

The purpose of this Act is to provide for the Reserve Bank of New Zealand, as the central bank, to be responsible for—formulating and implementing monetary policy designed to promote stability in the general level of prices, while recognising the Crown’s right to determine economic policy;

Policy Targets Agreements have to be consistent with section 8 –  ie “achieve and maintain” price stability, not just “promote” it.

The Labour Party, in Opposition and now in government, have offered various takes on what they want to do with the statutory goal without (sensibly enough at this stage) specifying a precise set of words.  Presumably they are serious about taking advice.

When the policy was launched last April the suggestion was to broaden “the objective of the Bank from just price stability to also include a commitment to full employment”.

In the terms of reference for the current review, agreed by Cabinet, the phraseology is as follows

recommend changes to the Act to provide for requiring monetary policy decisionmakers to give due consideration to maximising employment alongside the price stability framework;

The Minister of Finance has also talked about looking to the wording used in the central bank laws of Australia and the United States.

As I’ve outlined here previously, I favour changing the wording of section 8, as much as anything because the current wording does not adequately capture why we have a central bank running discretionary monetary policy.   One doesn’t need such an active central bank to maintain a broadly stable general level of prices; indeed, the introduction of fiat money systems over the last hundred years or so has led to less stability in the general level of prices than prevailed previously.

The existing wording of section 8 was an understandable –  and generally helpful –  reaction to the very poor inflation track record New Zealand (and many other countries) had run from the 1960s onwards.  Inflation has been lower and more stable than it was previously –  although not just because of the change in the Act.  But it still didn’t capture what we really wanted the central bank to do.    Active discretionary monetary policy is really about attempting to manage the business cycle –  and especially to be able to respond aggressively to extreme circumstances –  subject to the constraint of not letting inflation get away on us.    To word it that way doesn’t diminish the significance of keeping inflation in check –  any more than saying that fiscal policy should be managed to meet various government goals, subject to the constraint of not letting debt blow-out.

This way of thinking about active monetary policy is quite consistent with what we learned from the Great Depression –  countries that acted earliest to break the golden fetters rebounded earliest and saw resources (including unemployed people) back in work most quickly.  But, more mundanely, it is also consistent with the way in which inflation targeting central banks have (a) run things, and (b) specified their practical mandates.     Thus, from the earliest days of inflation targeting, there have been numerous events –  notably oil price shocks or indirect tax changes –  where the Bank has been expected to let inflation rise (fall) temporarily away from target, to minimise the output and employment consequences of such shocks  (trying to keep inflation on target in face of a big oil price increase would typically be expected to require inducing a recession).  Policymakers recognised that, actually, avoiding unnecessary surges in unemployment –  or recessions –  was locally more important than keeping inflation at, say, 2 per cent all the time.  But that calculus changes if it looked as though inflation was going to drift permanently higher.     The wording of the current legislation is unhelpful if –  and to the extent – it leaves voters fearing otherwise – that policymakers don’t care about unemployment/employment in its own right.

The other thing worth bearing in mind is that no central bank act –  not even something more specific like a Policy Targets Agreement –  can specify everything about how we want a central bank to run monetary policy.  Circumstances change, and the unexpected combinations of shocks happen.    There was a degree of naivete around that in the early days of the current Act, encapsulated in Don Brash’s unconditional answer to a radio interviewer indicating that he would lose his job if inflation went above 2 per cent (the then top of the target range).   But everyone recognises the limits now.

Thus, it is not possible to sensibly write down –  whether in the Act or the PTA – a numerical objective for “full employment”, “maximum employment” or the like (and the government has repeatedly stated that it has no intention of doing so).  But that doesn’t make it less worthwhile writing such considerations into legislation, requiring the Bank to report against them, and expecting those holding the Bank to account to take serious account of them.   And if even that was thought to be impossible, it might sensibly lead to some reconsideration as to whether having an independent central bank set policy –  rather than just advice on it –  was really the best way to organise things.

But how best to word things?  There have been suggestions from the Minister of looking at the specific wording in the Australian and US legislation.  I don’t think that will –  or should –  get people far.   Here is what I had to say on those options from an earlier post.

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

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

a.  the stability of the currency of Australia;

b.  the maintenance of full employment in Australia; and

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

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

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

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

Section 2A. Monetary policy objectives

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

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

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

So we need some fresh wording, and as far as I can tell there are no excellent models abroad to look to.

My strong preference would be to focus any new wording on minimising unemployment (or concepts like “full employment” –  a traditional Labour Party focus) rather than on maximising employment.       The concept of unemployment is about avoiding a situation where people who want to work, and are available for work, are unable to find work.   A simple focus on employment suggests that the more employment there is the better, whether people want (or need) to work or not.     I’ve seen political leaders boast that New Zealand has one of the highest employment rates in the advanced world, but to my mind at least that isn’t a sensible or legitimate boast –  or even a matter of public policy interest (speaking as someone who is, entirely voluntarily, not in the paid workforce).  It has Stakhanovite connotations.  By contrast, situations where people who want work, need work, can’t find work should be a matter of real public policy concern, and it is also something that  – in some but not all circumstances –  monetary policy can do something about, since most of the fluctuations in unemployment are a response to demand shocks.

So I’d suggest wording along these lines

“the goal of monetary policy shall be to promote the lowest rate of unemployment consistent with maintaining a low and stable rate of inflation on average over time”

But that might be too stark for some, too radical for others.   Another way of saying much the same thing, while keeping low inflation first in sequence, might be this sort of wording

“the goal of monetary policy is to maintain a low and stable rate of inflation on average over time. In pursuing this goal. the Bank shall do all that can be achieved by monetary policy to avoid unnecessary deviations of the unemployment rate from the rate that would resulting from those regulatory, structural, and demographic factors beyond the influence of monetary policy”

(You will note that I’ve suggested deleting altogether both the suggestion that monetary policy is the “primary function” of the Bank –  these days it is one of two prime functions –  and the references to a “stable general level of prices”.  The Bank has never targeted the price level, and the price level is not stable.    Some argue for a price level focus rather than an inflation rate focus, but there is no easy way for the statute to encompass both options without using even vaguer language.    Arguably, a “low and stable inflation” rate encompasses options for price level targeting, while “a stable general level of prices” does not really encompass a price level growing on average at up to 3 per cent per annum. )

Of course, the new wording for section 8 –  whichever formulation is chosen –  does not (or should not) stand alone.  Appropriate wording for a Policy Targets Agreement would still need to be found.  I’d have no problem with a continuing focus on a 2 per cent target midpoint –  as some sort of medium-term reference point for people to use in their planning.  But there should be a stronger emphasis in the Policy Targets Agreement on the cyclical management responsibilities –  including, in particular, preparation for the next big downturn (when, at present, monetary policy looks to be quite severely constrained in limiting the output and unemployment consequences).

And, as I’ve suggested previously, in both the Policy Targets Agreement, and in section 15 of the Act (governing Monetary Policy Statements) it would be appropriate to add some explicit wording requiring the Bank to report periodically on its estimates of the long-run sustainable rate of unemployment (and/or the NAIRU), on to report regularly on the relationship between actual unemployment rates and those estimates, and one what the Bank is, and is not, able to do about the gap.  These reports would serve several functions:

  • they would help focus the Bank’s attention (policy and research/analysis) on its raison d’etre  –  doing what it can to avoid unnecessary excess capacity, and
  • they would provide a formal and routine vehicle for articulating the limits of monetary policy.  It won’t, for example, be sensible to focus heavily on the unemployment rate for the time being if inflation really looks to be moving permanently much higher, but even in those circumstances, it is useful to require policymakers to contribute to the conversation about the appropriate balance of short-term focus –  what risks can and should be run (or not) and at what cost, even when everyone recognises the constraint that medium-term inflation needs to be kept in check.

One might even provide for the Bank to offer periodic advice to the Minister of Finance on what measures could contribute to lowering the structural rate of unemployment.    There are risks in such a provision –  many of those sorts of choices are almoat inherently political –  but again they help ensure a recognition that if monetary policy can, and should, do a lot about cyclical unemployment, it is unable to do anything much to alter the baseline structural rates of unemployment, which are mostly about political and social choices.

Those opposing change will emphasise the risks aroud these sorts of statutory changes.  And those risks need to be taken seriously.     But it is hardly as if the status quo is without risks or problems –  after all, we’ve spent the entire decade so far with the unemployment rate above domestic estimates of a NAIRU, and if that is no cost to most economists and policymakers, it has been for many ordinary New Zealanders.

Precisely because one can’t write down all that one wants a discretionary central bank to do with monetary policy in all conceivable circumstances, any particularly specification of the goal will be less than ideal.     So whatever the precise specification the government chooses, it is at least as important that an intelligent conversation be maintained about what monetary policy can and can’t do – not just in general, but in particular circumstances –  and that the Reserve Bank be encouraged (and compelled by law where appropropriate) to maintain an open and transparent approach, not just to the final fruit of its deliberations, but to its research, analysis, and the genuine uncertainty everyone faces in making sense of economic developments and the outlook for resource utilisation and inflation.

 

Brian Easton and trade agreements

Michael Reddell TPP, Uncategorized

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

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

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

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

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

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

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

For example, we agree when he notes that

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Some Anglo labour markets

Michael Reddell inflation, labour market, Uncategorized

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

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

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

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

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

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

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

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

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

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

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

Inflation is the Reserve Bank’s responsibility

Michael Reddell inflation

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

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

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

CPI ex OECD jan 18

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

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

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

sec fac model jan 18

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

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

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

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

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

dom inflation

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

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

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

iib breakevens jan 18

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

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

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

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

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

 

Len Bayliss RIP

Michael Reddell New Zealand economic history

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

A curious suggestion

Michael Reddell deposit insurance, insurance

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

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

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

In doing so, it is worth stressing that:

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

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

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

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

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

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

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

Policyholders with outstanding claims had two interests:

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

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

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

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

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

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

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

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

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

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

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

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

 

 

Land use regulations matter

Michael Reddell Housing

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

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

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

This is the centrepiece of the article

martin-norman-jan-18-2

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

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

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

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

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

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

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

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

As the end of their article approaches, they argue that

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

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

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

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

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

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

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

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

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

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

demographia 2 2018

Trade agreements and the new TPP

Michael Reddell TPP

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

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

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

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

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

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

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

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

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

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

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