Year: 2018

Palmerston North or Des Moines?

Michael Reddell Housing, Uncategorized

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

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

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

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

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

demographia chart 2018

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

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

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

demographia 2 2018

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

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

As for population growth, I found some scattered snippets:

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

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

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

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

Some (Chilean) perspectives on monetary policy decisionmaking and communications

Michael Reddell Reserve Bank Act reforms

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

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

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

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

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

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

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

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

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

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

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

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

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

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

central bank dissents

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

The Reserve Bank’s case for minimal reform

Michael Reddell Reserve Bank, Reserve Bank Act reforms, Uncategorized

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

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

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

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

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

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

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

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

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

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

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

Remote regions, immigration, and prosperity

Michael Reddell Immigration, New Zealand economic performance

A couple of years ago I did a post on some remote and very small places, many of which had quite a lot of land and very few people.  My point was to suggest that New Zealand was quite unusual in having so many people in such a remote spot, all the more so when much of the population growth had been accounted for by deliberate immigration policy.    As readers will know –  apart from anything else, I keep pointing it out –  over at least the last 70 years, productivity growth here has been pretty poor and we’ve drifted a long way down the global league tables.  My proposition is that the two stylised facts aren’t unrelated.

At the time of the earlier post, my young daughter was fascinated by a book on remote islands.   At the moment –  a bit older now –  she’s got really interested in Wales and keeps telling me all sort of interesting snippets.  But talking with her about Wales reminded me that at the time of the Lions Tour last year I’d been meaning to write a post highlighting just how little population growth there had been in some of the outer reaches of the United Kingdom.

More generally, I’d been thinking about how global studies attempting to assess the economic impact of immigration focus on comparing across countries.  In some ways, that makes sense –  data are often easier to come by, and countries control immigration policies.    But I suspect there is information in the experiences of remote regions.   After all, if there were typically really good economic opportunities in remote regions, people in a country are free to move there.  The population of the United States, for example, has risen by over 200 million people in the last 100 years –  through a mix of immigration and (mostly) natural increase.  Those peope have been free to locate themselves where the best opportunities are.   One can think of parts of Canada or Australia in the same way.  And if our politicians had made different choices in the 1890s, we could simply have been part of the Australian Commonwealth, and it seems unlikely that the economic opportunities here would have been much different if that choice had been made.

Here I’ve focused on the last 100 years or so.   Why?  Mostly because just prior to World War One New Zealand had probably the highest (or 2nd or 3rd highest) GDP per capita of any country in the world (per the historical tables put together by Angus Maddison).  But it was also some decades on from the first big waves of colonial settlement (whether here, Australia, Canada, or the mid-west and west of the United States).  At around 1 million people in the 1911 Census, New Zealand was already a functioning country of reasonable size (not large, but there are many smaller countries even today).

In this table I’ve focused on population growth between the Census nearest 1910 and the most recent Census (in most cases 2010 or 2011, but in New Zealand 2013).   The chart shows the percentage increase in population for these remote regions of countries, plus that for New Zealand  (Nebraska gets chosen as a “remote” US area mostly because I happen to have been there a few times.)

remote regions

Australia and Canada (and the US) have had rapid national population growth rates, but these remote regions  (Nebraska, Newfoundland, and Tasmania) have had much lower population growth rates than New Zealand.  (And, on checking, each of those three have lower population densities now than New Zealand does.)   But given that all of these regions have small populations, relative to the respective nation’s total population, there would have been nothing to stop lots of people gravitating to the remote spots if there was real evidence of good economic opportunities for many people in those places.

It has, after all, happened in some remote regions: West Australia for example, now has about 10 times the population it had in 1910, presumably attracted by the mineral resources that mean West Australia has the highest GDP per capita of the Australian states.    And two really remote parts of the United States –  which I didn’t show on the chart, partly because they were settled so much later (not admitted as US states until 1959) –  are Hawaii and Alaska.  Both have had faster population growth than New Zealand over the last 100 years (although between them only around 2 million people in total): in Alaska’s case no doubt the oil resources attracted people (Alaska also has among the highest GDP per capita of any state).

But over that hundred years –  or any shorter period you like to name really –  New Zealand (like Wales, Northern Ireland, Tasmania, Nebraska, or Newfoundland) has had no big natural resource discoveries, or asymmetric productivity shocks specifically favouring our location.   Like those places, we’ve only had the skills of our people and the instititutions we’ve built or inherited (in the case of this group a fairly-common Anglo set) to make the most of, and to overcome what appear to be the resurgent disadvantages and costs of distance/remoteness.  Our birth rates won’t have been much different over long periods, and New Zealand like all these places –  the Shetlands most extremely of the places on my chart –  have seen outflows of our own people.  The big difference here is immigration policy, which has actively sought to substantially boost the population.

Try a thought experiment.  Say the New Zealand and Australian governments had simply combined their respective immigration policies over the last 100 years or so  (eg if New Zealand was offering 45000 residence approvals per annum and Australia 200000 –  similar to the current policies –  the two countries simply said we’ll issue 245000 residence visas and the arrivals can go wherever they like), what would have happened.   By construction, the total population of the two countries would have been pretty much the same as what we actually see (5.4 million in 1910, and about 29 million now) but what would the distribution look like?     We know that in Australia –  given the same choice –  the remote region with a mild climate and no big new natural resources (Tasmania) saw much weaker population growth than the rest of Australia.   Why wouldn’t it be the case that New Zealand would have experienced much the same phenomenon?    At Tasmania’s population growth rate for the last 100 years we might now have a population of around 2.5 million.   After all, for almost 50 years now native New Zealanders have (net) been relocating to (the non-Tasmania) bits of Australia, so why –  given the free choice –  wouldn’t the migrants –  facing a free choice at the point of approval –  have done so too?

Would we have been better off?    The migrants who went to Australia instead presumably would have been –  both judged from revealed preference (they made the choice) and that incomes in Australia are higher than those here.  I’d argue that the smaller number of New Zealanders probably would have been economically better off as well.  Natural resources are still a huge part of the economic opportunities in these remote islands –  perhaps still 85 per cent of our exports –  and those limited resources would be spread across a considerably smaller number of people.  For those who simply prefer “more people” for its own sake, perhaps they’d have been worse off –  but then such people could have self-selected for Sydney or Melbourne (as Tasmanians of a similar ilk do, or people in Newfoundland who wanted to be part of something big self-select for Toronto).

I’m not suggesting something conclusive here, just that people pause for thought, and reflect on what questions the experiences.    For a remote place we aren’t particularly lightly settled, and especially not as a remote place without the sort of abundant natural resources of –  say –  a West Australia.  We’ve had no distinctive favourable productivity shocks, and we’ve long lost any claim to be the richest (per capita) country on earth.  It is no surprise that some people want to move here –  plenty would want to move to Nebraska if it had its own immigration policy like ours – but there isn’t much evidence, from experience of other remote regions, to suggest we benefit from them doing so.   Without big new natural resource discoveries, remote places –  regions, territories  – in the advanced world  tend to have quite weak population growth rates.  It isn’t obvious why in New Zealand we should let immigration policy up-end that otherwise natural outcome.

The Reserve Bank and financial regulation

Michael Reddell Financial stability, Regulation, Reserve Bank Act reforms

Still working my way through the various articles and documents that turned up just before Christmas, I got to a lengthy issue of the Reserve Bank Bulletin, headed “Independence with acccountability: financial system regulation and the Reserve Bank”.   It is, I suspect, designed to fend off calls for any significant reform.

The Bulletin speaks for the Bank, and although as I read through the article I noticed distinct authorial touches and tendencies, when all is boiled down the author was sent into the lists to make the case for how things are done now: powers, governance, and accountability.  He does a pretty good job of presenting the party-line, against significant odds in many areas.    Even where one disagrees with the Bank’s case, it is a useful and accessible addition, in part because the Bank’s powers and responsibilities in regulatory areas have grown like topsy over the years and are scattered across various pieces of legislation.

Much of the first half of the article is designed to make a case for an independent prudential regulator, by reference to the theory and to the writings of the Productivity Commission.  But, for my tastes, it was far too broad-brush to add much value.  Probably no one disputes that we want the rules applied fairly and impartially, with politicians largely kept out of the process.  In the same way, we don’t want politicians deciding which person gets arrested and which not –  we want an operationally independent Police for that –  or who gets convicted  –  independent courts – or which airline passes safety standards and which not, and so on, so we don’t want politicians deciding to look favourably on one bank’s risk models and not on another’s.   There are many independent regulatory agencies –  or even government departments where the chief executive exercises responsibility in independently applying the rules –  but to a very substantial extent they apply and administer the rules, while other people make the policy/rules.

The Reserve Bank wants to make the case that in its area the rules/policy shouldn’t be set by elected people (whether Parliament itself, or ministers by regulation), but by an independent agency, and that the same agency should both make and apply the rules (without any possibility of substantive appeal).  It is the “administrative state” at its most ambitious –  unelected officials (a single one at present, not even directly appointed by a Minister) are lawmakers, prosecutor, judge and jury (and quite possibly the equivalent of the Department of Corrections as well).

The Bank seeks to rest a lot on the notion of time-inconsistency, a notion from the academic literature that is sometimes used to try to explain the high inflation of the 60s and 70s, and to make the case for an independent central bank to make monetary policy.  The idea is that even though one knows what is good in the long-run, the short-term benefits of departing from that strategy (and endless repeats of the short-term) mean that the long-term gains are never realised.  The solution, so it was argued, was to remove the short-term management of the business cycle from politicians.    I’m not particularly persuaded by the model as it applies to monetary policy (a topic for another day), and it is curious to see a central bank putting so much weight on that model after year upon year of inflation below target.  But today’s topic is financial regulation and financial stability, where the Bank would have us believe it is desirable/important to have the rules themselves –  the policy –  set by someone other than politicians.

No doubt it is true that there can be some tension between the short and the long-term around financial stability.  But that is surely so in almost every area of government life and public policy?  Underspending on defence now frees up more resources for other things now, but one might severely regret doing so if an unexpected war happens later.  Skimping on educational spending now won’t make much difference (adversely) to economic performance or the earnings of anyone (teachers aside I suppose) for a decade or two.  Running big fiscal deficits now can offer some short-term benefits, but at the risk of heightened vulnerability etc a decade or two down the track.   But in none of these areas do we outsource policymaking: they are political choices, and we then employ officials and public agencies to administer and deliver those choices.     The Reserve Bank has, as far as I’m aware, never offered any explanation as to what makes their specific area of policy different.   Sometimes they draw on academic authors writing about financial regulation, but many of those specialists fall into the same trap –  they see their own field, but never stand back and think about how democratic societies organise themselves across a wide range of policy.

As it happens, the current system around the Reserve Bank and financial regulation is a bit ad hoc and inconsistent to say the least, a point that the article more or less acknowledges.     Thus, for banks the Reserve Bank can vary the “conditions of registration” to change all sorts of big policy parameters, without any formal involvement from elected politicians at all (all the variants of LVR policy, from the first Wheeler whim were done this way).  But even for banks rules around disclosure have to be done by Order-in-Council, and thus require ministerial approval.  No one would write the law that way –  such different regimes for two different aspects of  bank regulation –  if starting from scratch (the actual legislation has evolved since 1986).

For insurance companies, the Reserve Bank itself can issues solvency standards (effectively, capital requirements for insurers), but for non-bank deposit-takers capital rules (and other main prudential controls) can only be set by regulation, again requiring the involvement and approval of the Minister of Finance.   (Incidentally, this is why LVR rules apply to banks but not non-bank deposit-takers: Wheeler could regulated banks directly, but couldn’t do the same for non-bank deposit-takers.

(And, as the Bank notes, it has “no direct role in developing rules associated with AMLCFT”, even though it administers and applies those rules for banks.)

At very least, there would appear to be a case for streamlining and standardising the procedures for setting the rules.     It isn’t clear why the Reserve Bank Governor should have almost a free hand when it comes to banks, but such limited scope to set policy when it comes to non-bank deposit-takers.   And, if anything, the case for ministerial involvement in settting the rules for banks is greater than that for the other types of institutions because (as the Bank acknowledges) bailouts and recessions associated with financial crises etc have major fiscal implications, and one might reasonably expect elected ministers to have a key role in setting parameters that influence the risk of systemic bank failures.   And, again as the Bank acknowledges, it isn’t easy to pre-specifiy a charter –  akin to say the Policy Targets Agreement –  for financial stability policy.

The Bank attempts to cover itself against suggestions that it might be, in some sense and in some areas, a law unto itself, by highlighting various ways in which the Minister of Finance might have some say.   There are, for example, the (non-binding) letters of expectation, the need to consult on Statements of Intent, and the potential for the Minister to issue directions requiring the Bank to “have regard” for or other area of government policy.     These aren’t nothing, but they aren’t much either –  and as the Rennie report noted, the power to issue “have regard” directions has never been used.    Even budgetary discipline is so weak as to be almost non-existent: there is a five-yearly funding agreement, but it isn’t mandatory  (something that needs fixing in the current review), isn’t particularly binding, and doesn’t control the allocation of spending across the Bank’s various functions.   The Minister of Finance doesn’t even get to make his own choice of Governor –  and all Bank powers still rest with the Governor personally.

The contrast with the other main New Zealand financial regulatory agency, the FMA, is pretty striking.   Policy is mostly set by the Minister (by regulation), advised by MBIE (to whom the FMA is accountable), and the powers of the organisation itself rest with the FMA’s Board, all the members of which are appointed directly by a Minister, and all of whom –  under standard Crown entity rules – can be removed, for cause, by the Minister.  Employees, including the chief executive, only have powers as delegated by the Board.    The FMA model is now a pretty standard New Zealand regulatory model, and an obvious point of comparison with the Reserve Bank.

Somewhat cheekily, the Reserve Bank attempts to present their own model as providing more scope for ministerial input than for the FMA  (see footnote 16, in which they note that for the FMA there is no power of government direction).   As regards policy, it isn’t necessary, since the government sets policy and appoints (or dismisses) the Board.   As regards the application of rules, one wouldn’t want –  and doesn’t have –  powers of government direction in either case.   As regards the banking system, mostly ministers can’t set policy, can’t hire their own Governor, and can’t fire him (re financial system policy) either.   The Governor and the Bank have far more policy power than is typical –  across other regulatory agencies –  appropriate, or safe.

The second half of the article is about accountability.  As they reasonably note, when considerable power is delegated to unelected agencies, effective accountability needs to provided for.    In their words “accountability therefore generates legitimacy and legitimacy in turn supports independence”.

It is, therefore, unfortunate that the Bank’s very considerable powers are matched, in this area in particular, by such weak accountability.   After pages of attempting to explain themselves and what they see as the various aspects of accountability, even they end up largely conceding the point.     These sentences are from the last page of the article

the BIS (2011) argues that financial sector accountability mechanisms should be focussed more on the decision making process rather than outcomes per se. This is because of the more intrusive nature of financial sector policy, and the issues associated with observing outcomes (lack of quantification and very long lags). Put another way, there should be less reliance on ex post accountability mechanisms and more obligations placed on ensuring decision-makers are transparent about the basis for their actions.

I’m not sure I entirely agree –  although there is certainly the well-recognised point that absence of crisis is evidence of nothing –  but at very least a focus on strong process might argue for:

  • a more effective separation between policymaking and policy administration (as is customary for many regulatory entities, but largely not for New Zealand bank supervision),
  • a decisionmaking structure in which power did not rest simply with a single individual, who is himself not directly appointed by an elected person,
  • decisionmaking structures that involve real power with non-executive decisionmakers,
  • effective and binding budgetary accountability,
  • a high degree of commitment to transparency and to ongoing external engagement,
  • a culture that is self-critical and open to debate,
  • perhaps some more effective scope for judicical review (including on the merits, rather than just process),
  • monitors with the expertise, mandate, and resources to ask hard questions and to critically review and challenge choices being made around policy and its application.

At present, as far as I can see, we have none of these for the Reserve Bank of New Zealand as financial regulator.

Take the formal monitors for example.  Parliament’s Finance and Expenditure Committee has little time, no resources, and little expertise.  The Treasury has no formal role, no routine access to Bank materials (or eg Board papers) and is probably quite resource-constrained in developing the expertise.

And what of the Bank’s Board?   By law, they play a key role, as agent for the Minister of Finance in monitoring the Governor, and (now) obliged to report publically each year on the Bank’s performance.    The Bank often likes to talk up the role of the Board –  doing so provides them cover, suggesting the presence of robust accountability –  but the latest article is surprisingly honest.  The Board gets a single paragraph, which simply describes the legislative provisions.  There is no suggestion of the Board have actually played a key role in holding the Bank (Governor) to account – not surprisingly, since in the 15 years they have been publishing Annual Reports, there has never been so much as a critical or sceptical word uttered.  Of course, it isn’t surprising that the Board doesn’t do a good job: it has no independent resources at all (even its Secretary is a senior Bank staffer), the Governor himself sits on a Board (whose main role, notionally, is to hold the Governor to account) and the Board members themselves typically have little expertise in the areas (quite diverse) around which they are expected to hold the Governor to account for.   (Their job is, of course, made harder by the rather non-specific mandate the Bank has in regulatory areas –  there is nothing akin to the Policy Targets Agreement (which has its own challenges in monitoring).)

What of some of the other claims about accountability?  The Bank points out that it is required to do regulatory impact assessments –  but these are typically done by the same people proposing the policies, and there is (or was when I was there) nothing akin to the sort of process some government departments have for independent panels vetting the quality of the regulatory impact assessments.

They are also required to consult on regulatory initiatives, and must “have regard” to the submissions.  But, except perhaps on the most technical points, there is little evidence that they actually do pay any real heed to submissions.    For a long time, they also kept the submissions themselves secret –  even attempting to claim that they were required by law to do so.  They’d publish a “summary of submissions”, which highlighted only the issues they themselves chose to identify.   As they note, and in a small win for a campaign by this blog, they have now started publishing individual submissions, belatedly bringing them into line with, say, Select Committees of Parliament or most other regulatory bodies.  But there is no sign of much change in the overall attitude, or of any greater openness to ongoing debate and critical scrutiny.

Then, of course, there is the Official Information Act.  The Bank is subject to the Act, but chafes under the bit, is very reluctant to release much, threatens to charge requesters, and generally seems to see the Act as a nuisance, rather than an integral part of an open and accountable government.

We had a good example just a couple of months ago as to how unaccountable the Bank is in its prudential regulatory areas.  It emerged that Westpac had not had appropriate regulatory approval for some model changes used in its risk-modelling and capital calculations.   But, as I noted at the time, the short Bank statement left many more questions than it answered, and no one –  including journalists asking directly –  has been able to get straight answers from them, even though capital modelling is at the heart of the regulatory system.

And, of course, if the formal monitors are lightly (or not at all) resourced, there isn’t much other sustained scrutiny.   Banks are scared –  and more –  to speak out: this is where culture matters a great deal, as banks will always have a lot of balls in the air with the regulator, and in an open society should feel free to openly challenge the regulator, without fair of undue repercussions.   Academics with much expertise in the area are thin on the ground, as are journalists with the time or expertise.

Mostly, in its exercise of its extensive financial regulatory powers, our Reserve Bank isn’t very accountable at all.   Providing it jumps through the right, minimal, process hoops it can do pretty much what it likes in many areas of policy, and the public is left just having to take the Bank’s word (or not) that things are okay.  That needs to change –  and thus phase 2 of the current review of the Bank’s Act needs to be taken seriously.    Making the changes isn’t about one single measure, and there are plenty of details that will take a lot of work, and thought, to get right.   Part of it is about building a better internal culture, one that (from the top) really wants to engage, and which welcomes challenge and critical review.

After yesterday’s post I had an email from a reader with considerable senior-level experience in the banking sector noting just how weak much of the formal scrutiny of the Bank is in these areas.

From my perspective the Bank would benefit from independent challenge about their prudential responsibilities, and cost-benefit analysis. I am unsure if they have reviewed this post the Westpac capital model issues.

I am unsure how the Board discharges the independent prudential review role effectively given their experience – two Directors have insurance experience  and no directors have Banking, payments system or other non-bank financial experience. Likewise experience of Insurance/Banking/Payments technology systems and risks. While there are some very good RBNZ executives they are not particularly strong in banking risk experience – funding, liquidity, credit etc.

…. I think it would be useful for the RBNZ at a governance level to have experience of how financial balance sheets, and liquidity operate under stress, they will have some very important decisions to make when the next financial crisis occurs.

Much of that rings true to me.    We have typically had Governors with more experience of macro policy, and perhaps financial markets, than of banking –  and yet financial regulation is a hugely important role in what the Bank does – and now have a new Head of Financial Stability with no background in banking or finance at all.   We have a Board responsible for monitoring the Bank across monetary and regulatory responsibilities, and with little specialist expertise.   The contrast with, say, the FMA is quite stark.

Quite what the right balance of a solution is, I’m not quite sure.   I favour moving to a committee-based decision-making structure, and moving more of the policy back to the Minister (with the Bank as a key adviser), but even a Financial Policy Committee might only have three or four externals on it, and no such group is going to encompass all the right bits of expertise.   As often, I guess it is partly about the willingness to ask the hard questions, and to be willing to commission independent expertise (whether from New Zealand or abroad, from academics or people with industry background) and to engage.   If the Board remains as a monitoring agency –  as Rennie recommends, but I’m sceptical of –  it needs to be provided with resources.   And the Minister needs to be willing to use his statutory powers to commission independent reviews of aspects of the Bank’s stewardship, to enable us (and the Bank) to learn from experience by critically evaluating performance (and process).  Personally, I’m still tantalised by the idea of a small independent agency resourced to pose questions, and commission research, on the stewardship of fiscal, monetary and financial regulatory policy.

If not all the answers are clear, what is clear is that New Zealand is a long way from having got the model right: the right allocation of powers, the right accumulations of expertise in the right places, the right cultures, and the appropriate mix of formal and informal accountability that can really give New Zealanders confidence in the regulation of the financial system.

 

The Rennie report finally sees the light

Michael Reddell Rennie review, Reserve Bank Act reforms, Uncategorized

Almost a year ago now, the former Minister of Finance Steven Joyce asked The Treasury to commission some advice on possible changes to the governance of the Reserve Bank.  We only found this out a couple of months later, and then only when hints of a review seeped out prompting a journalist to put the direct question to the then Minister.  It turned out that Iain Rennie, former State Services Commissioner (and before that former senior Treasury official) had been commissioned to write the report –  indeed, by the time we learned of the commission, Rennie had already largely completed his work.

All along the way, The Treasury has been incredibly obstructive about the review.   The terms of reference have never been released.    They eventually told us (some of) the people Rennie had talked to, and the names of the peer reviewers Treasury had used but refused to release drafts of the reports, comments made by reviewers, or the finished report itself.   They even took to arguing that it had all been Treasury’s idea, and that the report was just to inform Treasury’s own post-election advice, as if Steven Joyce had never been any part of the story.    Frankly, it was a pretty gross case of flouting the Official Information Act –  for what was, when all boiled down, a private consultant’s report, paid for with public money, on matters of organisational design and goverance of a single government agency.

But yesterday The Treasury finally (and quietly) released the report itself, along with comments from the peer reviewers (on an earlier version, itself still secret), some advice on the report from Treasury to the (new) Minister of Finance, and some recent comments from the Reserve Bank on the contents of the Rennie report (all available here).   I appreciate the pro-activity of The Treasury in at least letting me know that the report was now, belatedly, available.    The material is all now presented as background material for the current two-stage review of the Reserve Bank Act, including the contribution of the Independent Expert Advisory Panel.

The Rennie report itself is here.  It isn’t a bad report –  in fact, for a fairly short report done quite quickly, it is a bit better than I had come to expect.   In some respects, the details don’t matter that much –  it is just one person’s view (having consulted not very widely, and mostly with people inside the central bank “club”), and his report has been superseded by the wider review Grant Robertson has commissioned.  Rennie’s report will be just one input to that mix.

Then again, Rennie had been the State Services Commissioner.  And he’d been the Treasury Deputy Secretary responsible for things to do with macro policy and the Reserve Bank (at the time of the last major review, with Lars Svensson, at which time Treasury had opposed any change in the governance and decisionmaking model).

And Rennie is quite clear that:

  • the current single decisionmaker model is far from best practice, whether considered relative to other central banks/ financial regulatory agencies, or relative to the governance of other New Zealand public sector entities,
  • a single committee is not a sensible solution.  Rennie, in fact, ends up favouring three separate committees (a model very similar to the one used now in the United Kingdom –  one for monetary policy, one for (so-called) micro-prudential policy, and one for (so-called) macro-prudential policy),
  • an internal executive committee (or even several of them) is not an appropriate solution.  External, non-executive, members should be involved,
  • the Minister of Finance should have primary responsibility for the appointment of all the members of the decisionmaking committees, given that the committees exercise significant statutory powers.

And on monetary policy he favours a materially greater degree of transparency than exists at present, including favouring (on-balance) the individualistic model –  as, for example, in the US, the UK and Sweden –  where individual members are individually accountable for their advice and their votes.    Existing Reserve Bank management hates –  I don’t think that is too strong a word –  that model: they hated it when I was still at the Bank, and in recent months they have gone public with their intense dislike of it.

There are lots of other details in the report, some of which I strongly agree with (eg the Policy Targets Agreement shouldn’t be tied to the appointment of the Governor, and if the Board is to be retained as a monitoring agency, it needs some resources of its own, and the Governor himself should not be a member), and others of which I’m more sceptical of (eg the proposed role of the State Services Commission in advice on the selection of the Governor and Deputy Governors, or the idea of devising a –  meaningful –  formal charter for the prudential committees).   One of the peer reviewers –  my former colleague David Archer –  is keen on a greater formal role for Parliament in the appointments, something I’m sceptical of (it just isn’t our constitutional system).  But I would probably favour emulating one aspect of the UK system Rennie doesn’t really touch on: hearings by Parliament’s Finance and Expenditure Committee in which nominees to the various committees can be scrutinised by MPs (and reported on), although not a binding confirmation vote (as in the US).

There are also limitations to the Rennie report.   For example, he treats the current assignment of powers to the Reserve Bank as given (perhaps this was inevitable in what he was asked for, but isn’t a limitation of the current review), a particular issue in the area of financial regulation and supervision.   There also isn’t much richness to his treatment of other countries’ models –  and it remains surprising that he made no effort to engage with Lars Svensson, who was not only a former reviewer of the New Zealand system, but a former practitioner (member of the Swedish monetary policy committee) in the sort of system (open contest of ideas) Reserve Bank management hates.  And perhaps partly because Rennie seems only to have talked to insiders –  eg there was three pages of (totally withheld) material in the Reserve Bank Board minutes on his meeting with them, and no attempt at open consultation –  there is no serious attempt to evaluate how effectively (or otherwise) the Board model has worked over the years.

What of the Treasury’s comments on Rennie?  Their report is short and is mostly a summary of Rennie’s recommendation.  But it was good to see this observation

“we are strongly of the view that a committee decision-making model should be codified in the Reserve Bank Act, and agree that there should be multiple committtees which include external experts”

In the first stage of the current review the government has only committed to a committee, with externals, for monetary policy.  I hope Treasury sticks to its guns, and persuades the Minister of Finance that better governance and decisionmaking on the financial regulation side of things is at least as important, and needs it own statutory reforms.    As even Rennie noted, there is –  for example –  a stark contrast between the governance of the other main financial regulatory –  the FMA –  and that of the Reserve Bank.  In the former, a non-executive Board (all appointed directly by the Minister) has overall responsibility for the organisation and the exercise of its powers, with some specific powers being delegated the Board to the chief executive and staff.  That is a much more conventional, and defensible, model than the Reserve Bank model in which all the power is held by the Governor personally.    And the Reserve Bank exercises a much greater degree of discretion over policy itself –  especially as regards banks –  than the FMA does (where big picture policy is mostly set by the Minister on the advice of MBIE).

As I noted, in yesterday’s release there was also a short note by the Reserve Bank commenting on the Rennie report.  Even though the report was completed months ago, this note is dated 11 December, and is prepared for the Independent Expert Advisory Panel assisting the Treasury-led phase one of the current review of the Reserve Bank Act.  Presumably there are rather more substantive comments, which the Bank is keeping secret –  along with all the extensive background work  (Rennie mentions it) done a few years ago on these issues, which the Bank has previously refused to disclose.

The Reserve Bank does not like the Rennie report at all.

we believe that much of the analysis underpinning the report was insufficient, and consequently the conclusions of the report are unreliable, or would require considerable further analysis.

“Sniffily dismissive” was my own summary of the Reserve Bank’s reaction.

In hand-waving mode, the Bank loftily notes

The Report does not define the nature of the problem it is seeking to address and needs a clearer analysis of the current decision-making framework and why it needs amending. In proposing a particular set of changes to the decision-making framework, the Report fails to provide options and does not demonstrate why the particular changes proposed would result in better policy decisions for monetary or financial policy in New Zealand.

You might suppose that having a decisionmaking and governance model designed thirty years ago when

(a) few central banks had updated their laws in these areas for a long time,

(b) our own laws and practices for governing Crown entities had not really been updated,

(c) the prevailing conception in New Zealand was that monetary policy was simple, and that it would be easy to hold a single decisionmaker to account,

(d) when financial regulation was conceived as a small and largely passive part of what the Reserve Bank did and

(e) when open government was still a pretty new concept, largely unknown to central banks and related regulatory agencies

was sufficient grounds for a serious review, and the probability that better models could be designed.   One might be strengthened in that view if one was aware that (as Rennie notes) no central bank has shifted from a committee-based decisionmaking to a single decisionmaker model for monetary policy, or was aware that no other significant regulatory body in New Zealand was governed the way the Reserve Bank is.

Had a five person Commission spent a year on the report, no doubt there would have been a lot more richness to the background material.  But the case for change has come to be pretty widely accepted already, and even the Reserve Bank gives the game away by conceding that committee-based decisionmaking is generally better than that of a single individual.  Once they conceded that –  and they could hardly do otherwise –  much of the rest of the issue is about detail.

But it doesn’t stop the Bank attempting to distract the Independent Expert Panel.

The Report makes no attempt to document the processes that the Bank actually uses to support its decision-making, beyond the high level parameters established by the Act. Nor does The Report attempt to evaluate the mechanisms that the Bank currently has in place to help ensure that its decision-makers confront a broad range of policy perspectives, including a wide range of views of those outside the Bank. There is, for example, no mention of the role of the broader group of MPC members in providing policy advice to the Governing Committee, the use of external advisers on the MPC, the Bank’s programme of business and financial sector liaison, its active public outreach programme, or its participation in the international financial and economic community. These are all ways in which the Bank considers a diversity of external views and perspectives ahead of its monetary policy decisions.

But so what?   All central banks do this sort of stuff in one form or another, and yet almost all of them also have the respective country’s Parliament specify a statutory committee as the basis for monetary policy decisions.  And if it is good enough for the Governor to invite a couple of outsiders into his second-ring of advisers (these days: it was the first tier when the system was established) why shouldn’t Parliament mandate the involvement of external members?   Moreover, the case for reform has rarely been about the problems with an individual Governor, but about a core principle of institutional design –  resilience.  We don’t want a system that works adequately only when a decent Governor is in place, but when that is resilient to bad choices and bad individual appointees (because in human systems there will be some of those).

I don’t disagree with all the Bank’s comments.  They oppose establishing two separate statutory committees for the different aspects of prudential policy, and I agree with them on that (apart from anything else, the whole thrust of bank supervision –  in particular-  is systemic in nature).

Rennie’s report recommended leaving the precise composition of statutory committees as a matter for negotiation through time.  I think that is wrong.  That balance is sufficiently important that it should be specificed in legislation (as, I understand it, is the near-universal practice abroad).   The Reserve Bank is clearly opposed to any suggestion that external members should out-number internal or executive members.

There is a strong argument that external members should not be able to out-vote the internal members if the latter are in agreement. Such an occurrence could severely undermine the influence of the Governors and the credibility of the institution.

I disagree, and was pleased to see that external reviewer Archer took the same view.  He argued  –  noting that the “probability of groupthink increases with the presence of hierarchy”  –  that “the law should restrict the proportion of executive insiders to below half by a big enough margin that these tendencies have a chance to be offset.

On the Reserve Bank’s argument:

  • if the Reserve Bank insiders, with all the resources and professional expertise at their disposal, can’t persuade enough outsiders to their point of view, it suggests they haven’t got a particularly compelling case (and may in turn struggle to convince outsiders),
  • if the system is set up with, say a 4:3 mix of outsiders and internals, it is explicitly designed by Parliament not to make the Governor a dominant figure (let alone any deputies).  The Governor and Deputy Governors have important executive roles in the management of the institution (generating advice and research, implementing decisions etc) and there should be no automatic presumption that the holders of those offices should play the key role in deciding the OCR outcome,
  • other countries have managed situations in which the Governor has been outvoted, without undermining the institution, and finally
  • even if there were such concerns, the Governor (and other executive staff) always have the option of voting tactically, such that there is no a straight insider/outsider split.  In a number of overseas models, the Governor chooses to vote last.

Perhaps anecdotes aren’t worth much, but it is worth recalling that the senior managers of the Wheeler bank were unanimous in their support of the 2014 tightening cycle.  And wrong.   Groupthink among internals is one of the problems reforms should be trying to overcome.

The Reserve Bank is also pushing back against Rennie’s proposal that all members of the decisionmaking committees (all three of them in his case) should be appointed by the Minister of Finance.

As in any other senior management context, it is essential that the Governor has confidence in his or her senior staff. There are few examples where a Chief Executive has no input into the selection of the senior management team.   It is also surprising that the Report does not confront the dangers that could arise in a system where appointments to the Policy Committees were made by the Minister of Finance. While the Report’s recommendation appears to be made largely on the grounds of ensuring decision-makers have democratic legitimacy (as per the discussion in para 102), the potential risks of political appointments are not considered.

The first of those arguments might look superficially plausible, at least in a corporate context.  But this is a situation where people are exercising considerable statutory powers.  And in central banks it is not at all uncommon for senior figures (often “deputy governors”) to be appointed directly  by Ministers with no formal role for the Governor in that decision (in practice, no doubt there is often consultation).   That is the way things work at the Reserve Bank of Australia (although the Governor then gets to appoint all the actual department heads, which seems appropriate), and at the Bank of England (for deputy governors), and at the Federal Reserve, and at the ECB.  It is pretty much the norm in fact.     Things are different in more conventional models like the Financial Markets Authority, where power vests with the Board, not with management (even the CEO, let alone his/her deputies).

As for the second argument, yes of course there are risks with political appointments.  There are risks with democracy in fact.  But if the Reserve Bank criticises Rennie for not covering that issue in great depth –  he touches on it, and to some extent takes it for granted –  the Bank itself never acknowledges that direct political appointment is the norm in other countries, and seems to work.  Certainly, they cite no evidence suggesting that the New Zealand system has produced superior results to those abroad.  As it happens, Rennie does touch on and speaks favourably of consultation by the government with other political parties for some of these appointments (as is apparently required  by the NZ Superannuation Fund board).

The final Reserve Bank concern that I want to touch on today is the one that seems to concern them a lot: the idea (endorsed by Rennie) that individual members of the statutory Monetary Policy Committee should be individually accountable for their views: that votes, and views, should be minuted and disclosed, and that individual members should be able to openly voice their views (in, eg, speeches or interviews).     It is pretty much exactly the model that has been used in the UK, the USA, and Sweden for quite a long time now.

But here is the Bank.

The proposition that members of the monetary policy committee would be able (and expected) to highlight their individual policy views in public is problematic. While this approach is clearly adopted in some countries (notably the UK, US), we believe such an approach could be destabilising in a small open economy like New Zealand. Any perception of a rift between committee members would be likely to add unhelpful noise to the communication of policy as well as inviting outside lobbying around particular views. There are more constructive ways of conveying divergent viewpoints and the balance of risks around monetary policy decisions.

Neither here nor previously has the Bank –  Spencer, Bascand, McDermott, the existing senior management –  ever sought to clearly articulate what it is about the model used in other countries that would not work well here.   I gather they aren’t even able to do so effectively in private and they floundered in an earlier press conference when they tackled the topic.

What makes New Zealand so different from, say, Sweden –  another “small open economy” –  or in these respects different from the US or the UK (UK economists often like to claim it too is a small open economy)?    The Bank makes no effort to tell us.    They never grapple with notions of open government –  as Rennie notes, the principles of the Official Information Act bias towards openness –  but perhaps as importantly they never really grapple with the huge uncertainties that face monetary policymakers everywhere and always.  Differences of view among policymakers shouldn’t be seen as problematic –  and they don’t seem to create great problems in other countries –  but as, if anything, reassuring.  Groupthink is one of the perils of any institution, and it is perhaps particularly risky where so little of the relevant future is known with any confidence.

Here is David Archer –  former chief economist of the Bank, and now head of central bank studies at the BIS.

Apparent unanimity is quickly shown to be untrustworthy spin. The essential reason is that the future is largely unknowable, and it is foolish to pretend otherwise. Consider the records of the few central banks – including the RBNZ – that publish forward policy interest rate paths. Forecast paths are almost always poor predictors of reality, even in the RBNZ case where unanimity about the outlook exists by construction. Being honest about the limited predictive powers of even highly paid specialists is likely eventually to increase their trustworthiness, at least relative to the results of repeated false marketing
of ostensible consensus.

I’d agree with every word of that.  He argues for timely release of good and transparent minutes, which reflect the individual differences of view.

I don’t like to think that the existing management of the Bank are just trying to protect their own position –  although bureaucrats will tend to protect themselves and their bureau, often to the detriment of the public –  but without a more robust articulation of their specific concerns, grounded in the international experience, it is hard to conclude otherwise.    Policymaking is typically better for dialogue, debate, and challenge –  inside the institution, outside in, and across the boundaries between the two.    Where there is so much uncertainty, and no institutional monopolies on wisdom or knowledge, it is perhaps as important in these functions as in any other areas of government.  It might not be comfortable for the bureaucrats, but that isn’t the goal of policy or institutional design.  And excellent officials –  as excellent outsiders –  should thrive on the opportunities that open and transparent contest of ideas and analysis throws up.

For now, I urge Treasury and the Independent Expert Advisory Panel –  not a group of individuals I have huge confidence in –  to reject the Bank’s apparently self-serving arguments, and to make recommendations that would lead to the redevelopment of a leading open, transparent and accountable central bank.

The Reserve Bank and housing collapses

Michael Reddell Housing, Reserve Bank, Uncategorized

In early December, the Reserve Bank published a Bulletin article, “House price collapses: policy responses and lessons learned”.  The article wasn’t by a Reserve Bank staffer –  it was written by a contractor (ex Treasury and IMF) –  but Bulletin articles speak for the Bank itself, they aren’t disclaimed as just the views of the author.   Given the subject matter, I’m sure this one would have had a lot of internal scrutiny.  Or perhaps I’ll rephrase, it certainly should have had a lot of scrutiny, but the substance of the article raises considerable doubt as to whether anyone senior thought hard about what they were publishing in the Reserve Bank’s name.

I’ve only just got round to reading the article and was frankly a bit stunned at how weak it was.    Perhaps that helps explain why it appears to have had no material media coverage at all.

The article begins with the claim that

This article considers several episodes of house price collapses around the globe over the past 30 years

In fact, it looks at none of these in any depth, and readers would have to know quite a bit about what was going on in each of these countries to be able to evaluate much of the story-telling and policy lessons the author presents.

Too much of the Reserve Bank’s writing about house prices tends to present substantial house price falls as exogenous, almost random, events: a country just happened to get unlucky.  But house prices booms –  or busts –  don’t take place in a vacuum.  They are the result of a set of circumstances, choices and policies.

And none of the Reserve Bank’s writings on housing markets ever takes any account of the information on the experiences of countries which didn’t experience nasty housing busts.  Partly as a result they tend to treat (or suggest that we should treat) all house price booms as the same.  And yet, for example,  New Zealand, Australia, the UK and Norway all had big credit and housing booms in the years leading up to 2008 but –  unlike the US or Ireland –  didn’t see a housing bust.  What do we learn from that difference?   The Reserve Bank seems totally uninterested.   Their approach seems to be, if the bust hasn’t already happened it is only a matter of time, but 2018 is a decade on from 2008.

One particular policy difference they often seek to ignore is the choice between fixed and floating exchange rates.  When you fix your exchange rate to that of another country, your interest rates are largely set by conditions in the other country.  If economic conditions in your country and the other country are consistently similar that might work out just fine.  If not, then you can have a tiger by the tail.  Ireland, for example, in the 00s probably needed something nearer New Zealand interest rates, but chose a currency regime that gave it interest rates appropriate to France/Germany.    Perhaps not surprisingly, things went badly wrong.

In the Bulletin article, the Bank presents a chart showing “house price falls in [10 OECD] selected crisis episodes” (surprisingly, not including Ireland).  But of those, eight were examples of fixed exchange rate countries (in several cases, the associated crisis led the country concerned to move to a floating exchange rate).   The same goes for all the Asian countries the author mentions in the context of the 1990s Asian financial crisis.     There can be advantages to fixing the exchange rate, but the ability to cope with idiosyncratic national shocks in not one of them.     And yet in the ten lessons the author draws in the article, there is no hint of the advantages of a floating exchange rate, in limiting the probability of a build-up of risk, and then in managing any busts that do arise.    It is a huge omission.  As a reminder, New Zealand, Australia, Norway, the UK, and Canada –  the latter a country that has never had a systemic financial crisis –  were all floating exchange rate countries during the 2000s boom and the subsequent recession/recovery period.

The author also hardly seems to recognise that even if house prices fall, house prices may not be the main event.   Even the Reserve Bank has previously, perhaps somewhat reluctantly, acknowledged the Norges Bank observation that housing loan losses have only rarely played a major role in systemic financial crises.   But there is no hint of that in this article.     Thus, in the severe post-liberalisation crises in the Nordics in the late 1980s and early 1990s, house prices certainly went up a lot and fell back a lot too, but most accounts suggest that those developments were pretty marginal relative to the boom and bust in commercial property, in particular development lending.  The same story seems to have been true for Ireland in the crisis there a decade ago.  Housing also wasn’t the main event in Iceland –  a floating exchange rate country not mentioned here that did have a crisis.  Even of the two floating exchange rate countries the article mentions –  Japan and the United States –  only in the United States could housing lending, and the housing market, be considered anything like the main event (and the US experience may not generalise given the very heavy role the state has historically played in the US housing finance market).

(And as I’ve noted here before,  even the US experience needs rather more critical reflection than it often receives: the path of the US economy in the decade since 2007 wasn’t much different to that of, say, New Zealand and New Zealand experienced no housing bust at all.)

Some of the other omissions from the article are also notable.  The author seems quite uneasy, perhaps even disapproving, about low global interest rates (without ever mentioning that inflation has remained persistently low), but there is no hint in the entire article that neutral interest rates may have been falling, or that global trend productivity growth may have been weak (weakening before the 2008/09 crisis showed up).   Thus, where economic activity is now –  10 years on –  may have little or nothing to do with the specifics of housing market adjustments a decade ago.   And although he highlights the limits of conventional monetary policy in many countries (interest rates around or just below zero), again he doesn’t draw any lessons about the possible need for policymakers to give themselves more room to cope with future downturns (by, for example, easing or removing the technological/legislative constraints that give rise to the near-zero lower bound in the first place.)

It is also remarkable that in an article on housing market collapses, there is only one mention of the possible role of land use restrictions in giving rise to sharp increases in house prices in the first place.   And then it is a rather misguided bureaucrats’ response: because supply may eventually catch up with demand the public need wise officials to encourage them to think long-term.  Perhaps the officials and politicians might be better off concentrating their energies on doing less harm in the first place –  whether fixing exchange rates in ways that give rise to large scale misallocation of resources, or avoiding land use restrictions that mean demand pressures substantially translate in higher land and house prices.

But in all the lessons the Bank (and the author) draw in the article, not one seems to be about the limitations of policy and of regulators.   There are typical references to short-termism in markets – although your typical Lehmans employee had more personal financial incentive (deferred remuneration tied up in shares that couldn’t be sold) to see the firm survive for the following five years –  than a typical central bank regulator does, but none about incentives as they face regulators and politicians (including that in extreme booms, an “insanity” can take hold almost everywhere, and even if there were a very cautious regulatory body, the head of such a body would struggle to be reappointed).

And nor is there any sense, anywhere in the article, as to when cautionary advice might, and might not, look sensible.  Alan Greenspan worried aloud about irrational exuberance years before the NASDAQ/tech bust –  someone heading his concerns then and staying out of the market subsequently would probably have ended up worse off than otherwise.   Much the same surely goes for housing.  In New Zealand, central bankers have been anguishing about house prices for decades.  Even if at some point in the next decade, New Zealand house prices fall 50 per cent and stay down –  the combination being exceedingly unlikely, based on historical experience of floating exchange rate countries, unless there is full scale land use deregulation –  that might not be much encouragement to someone who responded to Reserve Bank concerns 20 years ago.  (Oh, and repeated Reserve Bank stress tests suggest that even in a severe adverse economic shock of the sort that might trigger such a fall, our banks would come through in pretty good shape.)

The article concludes “housing market crashes are costly”.    Perhaps, but even that seems far too much of a reduced-form conclusion.  The misallocations of real resources that are associated with housing and credit booms are likely to be costly: misallocations generally are, and often it is the initial misallocation (rather than the inevitable sorting out process) that is the problem.  To me, it looks like an argument for avoiding policy choices that give rise to major misallocations (and all the associated spending) in the first place: be it fixed exchange rates (Nordics or Ireland), land use restrictions (New Zealand and other countries), or state-guided preferential lending (as in the United States).   Of the three classes, perhaps land use restrictions are most distortionary longer-term, and yet least prone to financial crises and corrections, since there are no market forces which eventually compel an adjustment.

It was a disappointing article on an important topic, sadly all too much in the spirit of a lot (but not all) of the Reserve Bank’s pronouncements on housing in recent years.

On housing, in late November, the Minister of Housing Phil Twyford commissioned an independent report on the New Zealand housing situation.   According to the Minister

“This report will provide an authoritative picture of the state of housing in New Zealand today, drawing on the best data available.

The report was to be done before Christmas and it is now 15 January.  Surely it is about time for it to be released?

Savings rates in international context

Michael Reddell Australia, New Zealand economic performance, Savings

In putting together yesterday’s post, I stumbled on something I hadn’t noticed previously.  In yesterday’s post I showed only New Zealand saving rates –  in particular, net national savings (ie savings of New Zealand resident entities, after allowing for depreciation) as a share of net national income.  The net national savings rate has picked up quite a bit in the last few years, although not to historically exceptional levels.

But here are the New Zealand and Australian net national savings rates plotted on the same chart.

net nat savings nz and aus

For the last couple of years, the net savings rate of New Zealanders has been higher than that of Australians.  I wouldn’t want to make very much of a couple of years data, and over, say, the last 25 years, the average savings rate of New Zealanders has still been a little lower than that of Australians.  But even that average gap has been much smaller over that period than over, say, the previous 20 years.

It isn’t a story you would typically hear from those who argue that savings behaviour is at the heart of New Zealand’s economic challenges.   Some will point to the compulsory private savings system now in place in Australia (phased in from 1992).  There is no easy way of assessing the counterfactual –  what if the system had never been introduced? –  but there is no obvious sign that the system has led to a lift in national savings rates in Australia, whether absolutely or relative to New Zealand.  Others will (rightly) highlight the big tax changes implemented here in the late 1980s which materially increased the tax burden on income earned by savers (in a way pretty inconsistent with the recommendations of a lot of economic theory).  I don’t think those changes were appropriate, or even fair, and would favour a less onerous regime.  But in the decades since the changes were made, our savings rates have been closer to those in Australia (where a less onerous tax regime applies as well) than they were in the earlier decades.

One policy change that may have made a difference is overall fiscal policy: the improvement in New Zealand’s overall fiscal position (reduction in general government debt) has been larger than that in Australia (largely reflecting the fact that we were in a bigger fiscal hole 25 or 30 years ago).   Higher average rates of public saving may have lifted average national savings rates to some extent.

What about other countries.  In a paper I wrote some years ago for a Reserve Bank/Treasury conference, I illustrated that over time New Zealand’s savings rate hadn’t been much different from that of some other Anglo countries.  Here is a more recent version of that sort of chart.

net nat savings anglo

New Zealand’s national savings rates have typically been below those in the OECD group of advanced countries as a whole (and perhaps particularly some of the more economically successful of those countries –  whether by chance, cause, or effect).   But even on that score the last few years look a little different.   This chart compares New Zealand against the median of the 22 OECD countries for which there is consistent data over the full period.

net national savings oecd

It is quite a striking change, and the reasons aren’t at all clear (see yesterday’s post on the puzzles around the New Zealand data).  Perhaps in time some of the rise in the New Zealand savings rate will end up being revised away.  Perhaps the lift will prove real, but temporary (as, say, happened for a few years around 2000). But if not, the apparent change in the relationship between our savings rate and those in other advanced countries should help keep our real interest rates –  and our real exchange rate –  a bit lower than otherwise.  If sustained, that would be expected to lift our economic prospects a bit, all else equal.

But it is worth remembering that, all else equal, a country with materially faster population growth than its peers should typically expect to have a higher national savings rate over time than its peers.   All else is never equal of course, but New Zealand continues to have a population growth rate well above that of the median advanced country.

 

 

New Zealand savings rate trends

Michael Reddell Savings

Making sense of savings behaviour (the bit of flow income not spent) in New Zealand is a bit of a challenge.  Perhaps that is true of other countries as well, but I know their individual stories less well.  In the New Zealand case, it isn’t helped by the rather limited historical data: we have an official estimate of national savings back only as far as the year to March 1972, we only have a sectoral decomposition of savings (household government, etc) back to 1987, and there is no official quarterly data.  Australia, by contrast, has all this data back as far as 1959.

Our sustained period of high inflation didn’t help either.   A significant chunk of any interest rate is typically compensation for inflation, and on the other hand in inflationary periods depreciation (typically on a historic cost basis) tends to be understated.  Decades ago, the Reserve Bank was pointing out that in that era, inflation was flattering our national savings figures.

Here is the official series of net national savings expressed as a percentage of net national income (“net” in both cases being net of depreciation – or “consumption of fixed capital”, and “national” referring to the income and savings of New Zealand residents, as distinct from “domestic” –  as in GDP  –  being any activity occurring in New Zealand.)

net savings to nni jan 18

If your eye is anything like mine, you are probably drawn to those last few observations, suggesting quite a significant increase in the net national savings rate in the last few years.    It isn’t exceptional by historical standards –  the savings rate averaged just a little higher for several years in the early 2000s –  but is interesting nonetheless.   Of the other potentially interesting observations, I have no good story for why national savings rates were so much higher at the very start of the period (and thus can only lament the absence of a longer run of official data).   One thing is clear: the lowest points in the series (years to March 1992 and March 2009) coincide with severe recessions.   That probably isn’t too surprising.   But there isn’t anything really comparable on the other side: if savings rates have tended to be higher in cyclically stronger periods, the peaks certainly don’t coincide very strongly with cyclical economic peaks.   Perhaps the other thing to note is that for the last 40 years there has been no obvious trend in the series: fluctuations have been around a fairly constant average rate of 5 to 6 per cent.    Perhaps the reduction in the inflation rate masks an underlying modest trend improvement, but even if so, the high inflation era itself ended 25 years ago.

What about the sectoral breakdown of net national savings?   Here is the split between government and private savings.

savings rate jan 18

It is pretty well-recognised that there has been an inverse relationship between the two series.  Quite what that means, or why it occurs, is another question.    Some of it is about the automatic stabilisers built into the tax system (in particular).   Government tax revenue tends to increase more than proportionally in economic upswings, and vice versa (eg on the company tax side, many companies record losses in recession, and it may take a few years of a recovery before they start having a tax payment liability again).      Some may be about government spending taking the place of private spending: if the government suddenly starts paying for, say, childcare costs, households no longer have to and some of that money might now be saved.    Some might be about rational expectations of future fiscal adjustments –  not in some very long-term Ricardian sense, but just that political debate tends to compete to spend large surpluses when they do arise, and people may anticipate that they will soon have more money in their pockets (eg from tax cuts).   Whatever the reason, the pattern has been there over the last 30 years or so.  It is one reason to be a little cautious about the idea sometimes heard that, if raising national savings rates was some sort of national economic priority, it might be enabled by governments simply running larger surpluses.    History –  here and abroad –  suggests that such surpluses aren’t likely to be sustainable, at least when starting from a low debt position, and that the public will relatively quickly recognise that.

Having said that, it is interesting that over the last few years the increase in the national savings rate has been almost wholly reflected in a rise in government savings.  The private savings rate, by contrast, has been pretty stable for some years.

But what about the breakdown within the private savings rate.  This chart shows household and business savings separately, both as share of NNI.

savings rates jan 18 pte

It is useful to be reminded that for some decades now business (net) savings rates have been quite a bit larger than those of households.  Little commentary ever focuses on business savings rates.

Some commentators –  including, at times, the Reserve Bank –  tend to make quite a lot of the role of house prices in explaining household savings behaviour.   I’ve never really found that convincing, and suspect that fiscal policy may be more important an influence on the cyclical swings in the savings rate.  Why?   Well, consumption as a share of GDP has been remarkably stable over 30 years, in the face of huge increases in house prices, and quite substantial swings in house price inflation.   That shouldn’t really be a surprise: after all, higher house prices aren’t a net gain in the community’s real purchasing power, they just redistribute purchasing power a bit (to those just about the downsize and retire to the provinces, and away from those trying to purchase a first home).  And, as it happens, the low point in the household savings rate series came in the year to March 2003, just prior to the first great surge upwards in house prices.

And, of course, one keeps seeing talk –  typically from interested parties –  of the rising tide of Kiwisaver funds.  No doubt, there is a big increase in the stock of funds bearing a Kiwisaver label, but there is nothing in household savings data over the last decade that really suggests any material change in households’ overall rates of savings.   Those rates were very low when the government was running big surpluses, picked up somewhat when the government had big deficits (and the economic climate was uncertain) and have been falling off again in recent years as the budget moved back into (actual and prospective) larger surpluses.

As for business savings, I don’t know how to interpret the data at all.  There has been too little analysis (at least that I’ve seen) attempting to make sense of the swings in the years leading up to 2008 –  that really sharp fall in business savings rates well before the recession itself –  or of the extent of the subsequent recovery.    Terms of trade fluctuations, for example, don’t readily explain the patterns.    Of course, in the end  firms are ultimately owned by households, and the boundaries between the two may be somewhat permeable (and affected, for example, by tax changes and dividend distribution policies.)

I’m not one of those who is alarmed by New Zealand savings rates.   They are towards the low side in international comparisons (a topic for another day), but it isn’t obvious that that is because of specific policy distortions here which materially adversely affecting savings (and more so here than in other countries).   The government accounts have been fairly healthy for decades, our welfare and retirement income system discourages private savings less than those of many other countries, and although our tax system bears materially more heavily on institutional savings than the regimes of many other countries, one has to be cautious about putting too much weight on that argument: it is not, after all, as if savings rates have been materially lower since the late 1980s (when the tax system was markedly reoriented) than previously.   A highly successful economy would be likely –  based on international comparisons –  to see higher average savings rates, but that doesn’t mean that policies designed to boost savings rates could themselves do much to lift the performance of the economy (partly because policies designed to “boost savings” don’t themselves have a particularly good track record).   Rather, when firms are finding abundant investment opportunities, they will tend to be wanting to retain more in the business, and earning the rates of return that support those high business savings rates.

As a reminder, this post has been about flow savings rates.  Some people are keen to talk about asset revaluations, and gains in recorded wealth.     That is, largely, a different topic, but –  as already noted –  bearing in mind that we all have to live somewhere, higher house prices do not make us, as a community, better off.   Higher equity prices may well do so –  and thus US research used to find a stronger wealth effect on consumption from equity prices –  especially if those gains are reflecting underlying improvements in productivity etc.

Workers in a fool’s paradise

Michael Reddell labour market, wages

A couple of months ago I did a post highlighting some little recognised aspects of the New Zealand data on wages and labour income.   They suggested that, given the underlying relatively poor performance of the economy, workers hadn’t done badly at all. I was curious how the latest national accounts data had changed the picture.

The first chart that attracted my interest was the labour income (“compensation of employees”) share of GDP.   The data are only available annually, but they suggested quite a recovery in the labour share of GDP in the 00s, which had been sustained this decade to date.

COE

That was the picture on the previous iteration of data.     Here is the updated version.

COE jan 17

The picture is subtly different, and if anything the labour income share looks to have been shrinking gradually this decade, even if it is still well above where it was in 2001/2 (the historical low).

But the other chart, which I found more striking, was one in which I compared growth in nominal wage rates against growth in nominal GDP per hour worked.   I used the Statistics New Zealand Analytical Unadjusted Labour Cost Index series.  It isn’t widely referred to, but relative to the headline LCI series it is a pure wages series, not one in which SNZ has already tried to adjust for productivity, and relative to the QES, it is much smoother (the way economists typically think of wage-setting behaviour) and produces more sensible and plausible series (some of the problems with the QES were illustrated in the earlier post).

When I did the exercise earlier, on the old data, I found that cumulative wage inflation –  particularly that in the private sector –  had run quite a bit ahead of productivity (GDP per hour worked) since around 2002.    Here is the updated version of the chart.

wages and nom GDP phw jan 18

There is a lot of short-term noise in the series –  and wages last year were somewhat “artificially” boosted by the pay equity settlement – but if the extent to which wages have moved ahead of productivity is less than it was in the previous iteration of the data (GDP has been revised up, and wage rate data are unchanged), the trend I highlighted last year is still there.

In my earlier post, I noted that this chart had been done using GDP itslf, and that to be more strictly accurate I should have taken account of, eg, the 2010 change in GST (which boosted GDP but shouldn’t have affected wages).    Data on indirect taxes and subsidies are only available annually, so here is a smoothed (four quarter moving average) version of the chart, this time comparing wages against nominal GDP per hour worked excluding indirect taxes and subsidies.

wages and nom GDP phw ex taxes and subsides jan 18

What has been going on?   One possibility is that the Analytical Unadjusted wages data are just substantially wrong?   But they are series that have now been published by SNZ for more than 20 years, and I don’t have specific things I can point to suggesting that they are wrong.

If the data are picking up something real, what then might be the story?   Here was what I included in the earlier post.

My explanation is pretty simple: the (real) exchange rate, which stepped up sharply about 15 years ago and has never sustainably come down since.    When the exchange rate is high, firms in the tradables sectors make less money than they otherwise would have done.   The usual counter to that is that the terms of trade have risen.  But the increase in the real exchange rate has been considerably more than the higher terms of trade would warrant, and in any case much of the gains in the terms of trade have come in the form of lower real import prices, rather than higher real export prices.

And why has the exchange rate been so high?  Because the economy has been strongly skewed towards the non-tradables sector which –  by definition –  does not face the test of international competition.  Demand for labour in that sector has been strong, on average, over the last 15 years, and it is the non-tradables sector that has, in effect, set the marginal price for labour.  For those firms, in aggregate, the lack of productivity growth doesn’t matter much –  they pass costs on to customers.  But it matters a lot for tradables sector producers, who have to pay the market price for labour, with no ability to pass those costs on (while the exchange rate puts downward pressure on their overall returns).  Another definition of the real exchange rate is the price of non-tradables relative to those of tradables. Consistent with this sort of story, in per capita terms real tradables sector GDP peaked back in 2004 (levels that is, not growth rates).

It isn’t, to repeat, a story in which labour has done well absolutely.  As I illustrated the other day, over the last five years there has been about 1 per cent real productivity growth in total.  For decades, we’ve been slipping backwards relative to other advanced countries.   But given the weak overall performance, labour doesn’t look to have done too badly.   That isn’t a recommendation for the “economic strategy” the last two governments have pursued.  A climate in which firms don’t find investment attractive –  perhaps especially investment in the internationally-competitive tradables sector –  isn’t likely to be one that conduces to generating sustained high performance and strong medium-term income growth.

And here is the proxy for business investment (total investment less housing and government) as a share of GDP

bus inv jan 18

Despite some of the best terms of trade in decades, business investment has been poor this cycle –  following on from several decades when it has typically been well below that of the median OECD country (despite well above median population growth).  The notion that “investment has been weak in lots of countries”, even to the extent true, should be no consolation: we started so far behind there was (and is) plenty of scope for us to have caught up, not being so affected by financial crises, euro-area ructions, zero lower bounds or whatever.

It is a fool’s paradise model: non-tradables focused businesses (of which there are many) do just fine, supported by continuing rapid population growth, but there isn’t much net investment at all outside those sectors as New Zealand proves to be an increasingly unfavourable place to build and base internationally competitive businesses.  Productivity growth remains weak, perhaps even weakens further.   Wages might well outstrip productivity growth, but in the long-run only sustained productivity growth will support high material living standards here.   It isn’t a model that need end in crisis, but rather in mediocrity.  And New Zealanders could do so much better.