A good time to invest?

A day or two ago I started reading a new book on, among other things, the decline in trust in “experts” that is said to increasingly pervade Western societies.  I’ve written previously about my scepticism that supposed experts are people we should repose much trust in, on things other than the most narrowly technical matters.  I want an expert carrying any surgery I or my family need and when, for example, it comes to house renovations

A good architect, and capable expert builders and other tradespeople, can together enable an outcome that I couldn’t deliver myself. Most of us need, and value, expert advice, and expert execution, but the decision to renovate the house, and how far to go, is the customer’s. It is about choices and preferences on the one hand, and advice from experts who actually usually know what they are doing on the other.

It isn’t clear to me that there are very many areas of public policy where arrangements should be much different.

And I often wonder just how much real expertise –  on matters beyond the most narrowly techical – can be found in most of the public sector agencies in which some encourage us to place our trust.   The Governor of the Reserve Bank is one of those figures in whom the law places a great deal of power.   Doubts about whether that is a wise choice, at least about the incumbent, were given further fuel by his performance on TVNZ’s Q&A last night.

I don’t have the time today to unpick it all, including his continued claim that fiscal policy is adding to demand/activity, when The Treasury’s fiscal impulse measure suggests it isn’t (all that has happend in the Budget update numbers is that fiscal policy is now estimated to have roughly a zero effect on demand over the next few years, rather than the slight drag previously projected).  Orr seems to be champing at the bit to have the government spend more –  especially capital spending – but he was careful and never quite said so last night.

Where he is much less careful is around investment more generally.    Last night he followed up from his claim at last week’s press conference that the country was in a great condition, with the renewed suggestion that now was a wonderful time to invest, that businesses need to “keep going” on investing, and that it was hard to be nervous about investing with such low risk-free interest rates and (so he asserted) such low hurdle rates of return.  (Doesn’t he follow the world news?)    This wasn’t just so in New Zealand apparently: there were global “infrastructure deficits” and generational opportunities.  Closer to home his extraordinary assertion was the New Zealand had only “quality problems” –  the bizarre line John Key used to use about Auckland’s housing and transport problems.

You really have to wonder what insight the Governor thinks he is blessed with that eludes people in the private sector and in government, here and abroad.   It isn’t as if he offers us a detailed piece of argumentation and analysis in support of his story.  It seems to be mostly just handwaving and wishful thinking.   Not exactly a sound basis for policy, or for encouraging us to put any trust in him.

In writing about the MPS last week, I reproduced one of the Bank’s own charts about investment.

bus investment RB

Business investment –  in blue –  has been fairly weak and (if anything) weakening further.  It is not just some sort for post-election blues, businesses not liking having Labour and the Greens in office.  The picture is pretty consistent for years now.   Which suggests it might be reasonable to suppose that people who own,  or are considering starting, businesses have been making rational choices, with the information available to them, about the prospects for investment in New Zealand.  In sum, not particularly good –  and this despite the considerable boost to demand (and need for domestic buildings etc) that a big unexpected shock to the population will have given rise to.

Consistent with that, the Governor may not be aware that productivity growth in New Zealand has also been lousy for years now –  almost non-existent in the last few.  Profitability and productivity are not, at all, the same thing, but they often go hand in hand –  great opportunities, offering high returns to shareholders, are often ones that will tend to lift the overall productivity of the economy.  New productivity opportunities are often only realised through a new wave of investment (which firms will only undertake if they expect those projects to be profitable).

And we could add to the list of symptoms –  perhaps the Governor also counts them as “quality problems” –  things like a tradables sector that has been going sideways, exports as a share of GDP not rebounding at all, the failure of the government to do anything material to fix the housing market, high corporate tax rates, and a range of actual or looming regulatory restrictions on investment opportunities in New Zealand.   Not the sort of things most people would call “quality problems”.

Of course, the Governor is particularly keen on more public capital spending –  infrastructure.   But, here again, if the opportunities were so great, the numbers would be likely to speak for themselves –  really high benefit/cost ratios showing up when projects are evaluated.  Perhaps the Governor is privy to such estimates, but the rest of us are not so favoured.  Too many of the projects that do go ahead seem like borderline cases at best.

Much of any reasoning the lies behind the Governor’s claims seems to rest on little more than the fact that interest rates are low. But in and of itself, that tells us almost nothing.  After all, interest rates are (very) low for a reason, and as I noted in my post yesterday no one –  including the Reserve Bank, at least based on anything they’ve shown or told us –  has a compelling story about just what is going on and why.   But the revealed behaviour of firms doesn’t suggest they’ve seen it as some windfall that means it is a great time to invest –  with perhaps the only challenge being which of the abundance of riches of possible high-yielding projects one might tackle first.

Out of interest I had a look at other advanced countries.  After all, these extraordinarily low interest rates prevail across almost all of the advanced world (and, as I’ve noted previously, implied forward rates are still higher here than in most countries).  The IMF has data on total investment as a share of GDP for a group of 30+ advanced economies.  In all of them, real and nominal interest rates are (of course) far lower than they were in, say, the 2000s prior to the 2008/09 recession.   Notwithstanding that, for the median of these 35 advanced countries, investment as a share of GDP last year was 2.7 percentage points of GDP lower than it just prior to the crisis/recession.   That is a significant reduction, despite the wonderful investment climate the Governor blithely talks of, in which it would be hard for anyone to be nervous about investing.   Only four of the 35 countries had investment now higher than it was then (Sweden, Norway, Germany, and Austria –  only Sweden more than 1 percentage point of GDP higher).

Now, these IMF numbers are total investment not business investment, and I don’t have the time today to recalculate the business investment numbers (for OECD countries), but it isn’t a picture that suggests that most people actually making investment choices share the blithe optimism of the Governor.   It isn’t particularly confidence-inspiring, or suggestive that he knows much on this topic on which he opines so often.

He could, of course, be right.  Perhaps there really are opportunities just left on the table, even though they offer high returns and/or modest risk.  If so, the market is open.  There is nothing to stop the Governor handing over the reins at the Reserve Bank and seeking an appointment as a private sector CEO, or indeed attracting capital from new investors to start his own enterprise.

I imagine most people will be content to respect the wisdom of crowds –  without necessarily fully understanding it –  and to conclude that when investment has been sluggish for years, even as aggregate demand is ok, labour is fairly fully-employed, and credit conditions haven’t been overly constraining that, despite the very low interest rates, there are huge numbers of attractive propositions going begging because people with their own money at stake aren’t persuaded by the Governor’s rhetoric.

We have very serious economic problems in New Zealand.  They aren’t being addressed by our politicians or our officials, and the Governor seems more interesting in playing distraction, whistling to keep spirits up, than getting to the bottom of those really serious and longrunning economic failures.    Fortunately, in his current role the Governor has almost no say over investment –  other than to opine –  but the lightweight rhetoric does nothing to instill confidence about his handling of those areas where he has great (and excessive) power: bank capital for example.

On other matters, an unexpected family death means I’ll be in Christchurch for the next few days and there won’t be any more posts until Monday.

 

Current interest rates really are unusual

Here is a chart of current 10 year (nominal) government bond yields for a selection of advanced economies

current 10 year.png

The median yield across those bonds/countries is about 0.4 per cent.  For two of the three largest economies, long-term yields are negative.  Only Greece –  which defaulted (or had its debt written down) only a few years ago and still has a huge load of debt – is yielding (just over) 2 per cent, closely followed by highly-indebted Italy, which could be the epicentre of the next euro-area crisis.

Of course, you can still find higher (nominal) yields in other countries –  on the table I drew these yields from, Brazil, Mexico and India were each around 7 per cent –  but for your typical advanced country, nominal interest rates are now very low.    One could show a similar chart for policy rates:  the US policy rate is around 2 per cent, but that is now materially higher than the policy rates applying in every other country on the chart.

For a long time there was a narrative –  perhaps especially relevant in New Zealand –  about lower interest rates being some sort of return to more normal levels.  Plenty of people can still remember the (brief) period in the late 1980s when term deposit rates were 18 per cent, and floating first mortgage rates were 20 per cent.    Those were high rates even in real (inflation-adjusted) terms: the Reserve Bank’s survey of expectations then (1987) had medium-term inflation expectations at around 8 per cent.

Even almost a decade later, when low inflation had become an entrenched feature, 90 day bank bill rates (the main rate policy focused on then) peaked at around 10 per cent in mid 1996.  And the newly-issued 20 year inflation indexed bonds peaked at 6.01 per cent (I recall an economist turned funds manager who regularly reminded me years afterwards of his prescience in buying at 6 per cent).

But 90 day bank bill rates are now a touch over 1 per cent, and a 21 year inflation-indexed bond was yielding 0.53 per cent (real) on Friday.

So, yes, interest rates were extraordinarily high for a fairly protracted period, and –  once inflation was firmly under control – needed to fall a long way.  But by any standards what we are seeing now is extraordinary, quite out of line with anything ever seen before, not just here but globally, not just in the last 50 or 100 years but in the last 4000.

A History of Interest Rates: 2000BC to the Present, by Sidney Homer (a partner at Salomon Brothers), was first published in 1963, and has been updated on various occasions since then (I have the 1977 edition in front of me). It is the standard reference work for anyone wanting information on interest rates from times past.  It is, of course, rather light on time series for the first 3700 years or so, and it is western-focused (Sumeria, Babylon, Egypt, Greece, Roman and on via the rest of Europe to the wider world).   But it is a wonderful resource.  And you probably get the picture of the ancient world with this table –  the individual numbers might be hard to read, but (a) none of them involves 1 per cent interest rates, and (b) none of them involves negative interest rates,

ancient

(This brief summary covers much of the same ground.)

All these are nominal interest rates.  But, mostly, the distinction between nominal and real rates was one that made no difference.  There were, at times, periods of inflation in the ancient world due to systematic currency debasement, and price levels rose and fell as economic conditions and commodity prices fluctuated, but the idea of a trend rise in the price level as something to be taken into account in assessing the general level of interest rates generally wasn’t a thing, in a world that didn’t use fiat money systems.   In England for example, where researchers have constructed a very long-term retail price index series, the general level of prices in 1500 was about the same as that in 1300.  In the 16th century –  lots of political disruption and New World silver –  English prices increased at an average of about 1 per cent per annum (“the great inflation” some may recall from studying Tudor history).

But what about the last few hundred years when economies and institutions begin to become more recognisably similar to our own?   I included this chart in a post the other day (as you’ll see, the people who put it together also drew on Homer)

500 yrs

How about some specific rates?

Here is the Bank of England’s “policy” rate –  key short-term rate is a better description for most of the period (more than 300 years).

BOE policy rate

And here is several hundred years of yields on UK government consols (perpetual bonds)

consols.png

And here –  from an old Goldman Sachs research paper I found wedged in my copy of Homer –  US short-term rates

US short-term rates

Harder to read, but just to make the point, a long-term chart of French yields

Fr bonds

The lowest horizontal gridline is 3 per cent.

And, in case you were wondering about New Zealand, here is a chart from one of my earliest posts, comparing consol yields (see above) with those on NSW and New Zealand government debt for 20 years or so around the turn of the 20th century (through much of this period, the Australian economy was deeply depressed, following a severe financial crisis)

NZ bonds historical

UK nominal yields briefly dipped below 2.5 per cent (and systematic inflation was so much not a thing that UK prices were a touch lower in 1914 than they had been in 1800). In an ex ante sense, nominal yields were real yields.

And in case you were wondering what non-government borrowers were paying, the New Zealand data on average interest rates on new mortgages starts in 1913: borrowers on average were paying 5.75 per cent (again, in a climate of no systematically-expected inflation).  That may not seem so much higher than the 5.19 per cent the ANZ is offering today but (a) New Zealand rates are still quite high by global standards (UK tracker mortgages are under 3 per cent, and (b) the Reserve Bank keeps assuring us that inflation expectations here are around 2 per cent, not the zero that would have prevailed 100 years ago.

As a final chart for now, here is another one from the old Goldman Sachs research note

GS short rates

In this chart, the authors aggregated data on 20 countries.  Through all the ups and downs of the 19th century and the first half of the 20th century –  when expected inflation mostly wasn’t a thing –  nominal interest rates across this wide range of countries averaged well above what we experience in almost every advanced country now.

Systematic inflation started to become more a feature after World War Two, but even then it took quite a while for people to become accustomed to the new reality.  And in the United States, for example, as late as 1965 the price level wasn’t even quite double that of 1925 –  the sharp falls in the price level in the early 1930s were still then a fresher memory than (say) the high inflation of late 1970s/early 1980s New Zealand is now.     Here, Homer reports average New Zealand long-term bond yields of 3.74 per cent for the 1930s, 3.18 per cent for the 1940s, and 4.13 per cent for the 1950s (1.1 per cent this morning).

Partly as a result of financial repression (regulation etc) and partly because of a new, hard to comprehend, era, we went through periods when real interest rates were zero or negative in the period of high inflation –  but, of course, nominal interest rates were always then quite high.

I’d thought all this was pretty well understood: not so much the causes, but the facts that nominal interest rates and expected real interest rates across the advanced world (now including New Zealand, even though our forward are still among the highest  in the advanced world) are now extraordinarily low by any historical standard –  going back not just hundreds, but thousands of years.   Term mortgages rates in Switzerland, for example, are now under 1 per cent –  and rates which have been low for years are, if anything, moving lower.  And all of this when most advanced economies now have something reasonably close to full employment (NAIRU concept) and have exhausted most of their spare capacity.

It is an extraordinary development, and one for which central banks deserve very little of the credit or blame: real interest rates are real phenomena, about the willing supply of savings and the willing demand for (real) investment at any given interest rate.  Across an increasingly wide range of countries more new savings (household, business, government) is available at any ‘normal’ interest rate than the willingness to invest at that ‘normal’ interest rate, and so actual rate settle materially lower.  I don’t have a satisfactory integrated story for what is going on.  Sure, there are cyclical factors at play –  which together with “trade wars” –  get the day to day headlines.  But the noise around those simply masks the deeper underlying puzzle, about something that is going on in so many economies (it isn’t just that we all get given “the world rate”).  No doubt demography is part of the story, perhaps declining productivity opportunities, perhaps change in the nature of business capital (needing less real resources, and less physical investment, and there must be other bits to the story.  I find it very difficult to believe that where we are now can be the permanent new state of affairs –  5000 years of history, reflecting human institutions and human nature (including compensation for delaying consumption) looks as though it should count for something.  But can we rule out this state of affairs lasting for another 20 or 30 years?  I can’t see why not (especially when no one has a fully convincing story of quite what is going on).

Thus central banks have to operate on the basis of the world as they find it, not as they might (a) like it to be, or (b) think it must be in the longer-run.  There is the old line in markets that the market can stay wrong longer than you can remain solvent, and a variant has to apply to central banks.  For much of the last decade, central banks kept organising their thinking and actions around those old ‘normal’ interest rates and that, in part, contributed to the sluggish recovery in many places and the weak inflation we now experience (relative to official targets).  They need now to recognise that where we are now isn’t just some sort of return to normal from the pre-inflation era, but that we are in uncharted territory.

My impression is that most central banks are still no more than halfway there.  Most seem to recognise that something extraordinary is going on, even if there is a distinct lack of energy evident in (a) getting to the bottom of the story, and (b) shaping responses to prepare for the next serious economic downturn.

Late last week I had thought that the Reserve Bank of New Zealand had got the picture.  Whatever one made of the specific 50 basis point cut –  my view remains that 1 per cent was the right place to get to, but that doing it in one leap, without any obvious circumstances demanding urgency or any preparation of the ground, only created a lot of unnecessary angst –  I was struck by the way the Governor talked repeatedly at the press conference of having to adjust to living in a very low interest rate world.  As I noted in a post on Thursday, that was very welcome.

And so, when I saw what comes next, I could hardly believe it.   I’d still like to discover that the Governor was misreported, because his reported comments seem so extraordinarily wrong and unexpectedly complacent.   Over the weekend, I came across an account of the Governor’s appearance on Thursday before Parliament’s Finance and Expenditure Committee to talk about the Monetary Policy Statement and the interest rate decision. I can’t quote the record directly, but the account was from a source that I normally count on as highly reliable (many others rely on these accounts).  The Governor was reported as suggesting although neutral interest rates had dropped to a very low level, that MPs should be not too concerned as we are now simply back to the levels seen prior to the decades of high inflation in the 1970s and 1980s.

I almost fell off my chair when I read that, and I still struggle to believe that the Governor really said what he is reported to have said. I’m not the Governor’s biggest fan –  and he has never displayed any great interest in history –  but surely, surely, he knows better than that? He, and/or his advisers, must know better than that, must know about the sorts of numbers and charts that (for example) I’ve shown earlier in this post.

I get the desire not to scare the horses in the short-term (though it might have been wise to have thought of that before surprising everyone with a 50 basis point cut not supported by his own forecasts), and I agree with him that an OCR of 1 per cent does not mean that conventional monetary policy is yet disabled: there is a way to go yet.    But what we are seeing, globally and increasingly in New Zealand, is nothing at all like –  in interest rate terms – what the world (or New Zealand) experienced prior to the 20th century’s great inflation.  Real interest rates are astonishing low –  and are expected to remain so in an increasing number of countries for an astonishing long period –  and interest rates and credit play a more pervasive role in our societies and economies than was common in centuries past.    We all should be very uneasy about quite what is going on, and in questions around how/whether it eventually ends.

And central banks –  including our own –  should be preparing for the next serious recession with rather more options than those they had to fall back on last time when nominal short-term interest rates then reached their limits.  Those limits are almost entirely the creation of governments and central banks.  They could, and should, be removed,and could be substantially alleviated quite quickly if central banks and governments had the will to confront the extraordinary position we are now in –  late in a sluggish upswing that has run for almost a decade.

 

Fiscal policy

Bernard Hickey, of Newsroom, had a passionate piece out the other day lamenting the fiscal conservatism of the Prime Minister and the Minister of Finance, and calling for a  large increase in New Zealand government net indebtedness (albeit over “the next decade or two”) under the ambit of something he calls the “Re-Engineering New Zealand” project.

It was a curious article because it seemed to throw together a variety of different things that don’t necessarily belong together: the cyclical on the one hand (potential limits of monetary policy in the next recession, at least on current technologies) and long-term structural issues (climate change, skills, productivity, infrastructure, housing etc) on the other.

On the cyclical side, Hickey’s case isn’t helped by the claim that monetary policy “did little to solve…the short term…problems facing the economy”, which simply has to be not true.    Unemployment rates, which shot up sharply during the last recession are as low as, or lower than, they were just prior to that recession in most advanced countries (not too far away even in New Zealand).  I wouldn’t recommend the alternative –  places like Spain, Greece, and Italy that had no nation-specific monetary policy open to them.    Central banks were often too slow to ease, and too often looking towards the next tightening (see NZ with two lots of pre-emptive, soon-reversed, tightenings) but monetary policy worked when it was embraced and given a chance.

But, of course, in many of those countries the limits of conventional monetary policy were reached, which slowed the recovery in some countries.  In New Zealand and Australia the limits weren’t reached, but as we head towards the next severe downturn –  whenever it is –  almost every advanced country now needs to be planning on the likelihood of monetary policy reaching its limits (on current laws and technologies).    There are monetary ways through that obstacle –  which I’ve been drawing attention to here for years – although for reasons not entirely clear central banks globally have been reluctant to embrace those sorts of options.   If central banks won’t do anything to free-up monetary policy leeway, then it seems quite likely to me that in the next recession there will be significant discretionary fiscal stimulus –  if politicians are not totally indifferent to the plight of the unemployed.

Since we are not now in a recession in New Zealand (well, we may be, but not a single forecaster is suggesting we yet are), and since conventional monetary policy has probably 175 basis points of leeway to go –  and the real exchange rate is still so high – now isn’t the time for rushing to temporary counter-cyclical fiscal stimulus.  Do it now – on the promise of being temporary –  and you might well find that when it was actually needed the political pressure was already mounting to tighten up again, to unwind the stimulus, just when it might do some good.   It was, after all, the Governor the other day who was openly worrying about additional government spending now either crowding out private sector activity, or being unable to be implemented because private sector activity crowded it out.

I’m sure Hickey is quite sincere about his cyclical point –  and the next serious downturn globally is going to be very tough to get through for many countries – but his real argument seems to be a structural one.  He is a bigger-government man, and one who favours much larger government debt (the two are, of course, separate issues).  He wants governments that do more, and seems pretty confident that he knows what they should spend our money on (and is quite dismissive of anyone complaining about potentially injudicious use of public money).  Interest rates are low on his telling primarily because of quantitative easing –  a strange story to tell in a country where there has been no quantitative easing and yet where five year real government bond rates are now zero or slightly negative –  and thus represent a windfall opportunity for borrowers.

Here is his list of what needs doing

Productivity, which is the only thing that matters in the long run, is slowing globally and has been stagnant here for more than five years. Housing affordability is collapsing in most developed countries because of rising house prices, restrictions on new developments and, tragically, falling interest rates.

Real climate change action is scarce because it requires massive public investment in public transport and new medium density housing close to city centres. Our skills, economies and cities need re-engineering massively if we’re going to restart productivity, make housing affordable for the young and poor and achieve net zero emissions by 2050.

It is a global problem, but even more acute here because we have among the worst housing affordability, productivity and climate change emissions figures in the world.

Massive investment in transport, health and housing infrastructure, education, workplace skills, business technology and research and development is required everywhere, but the central and local governments who are the only ones with the authority and balance sheets to do it are frozen in the headlights of politics and 30 years of austerity and smaller Government dogma.

And yet one was left wondering whether there might not be at least some connection between weak productivity growth and low interest rates –  firms just don’t see the profitable opportunities and so aren’t looking to invest heavily.   And if –  as is so –  regulatory restrictions limit land use and housebuilding why not get on and get government out of the way: remove or greatly ease up those restrictions (as some in the Labour Party suggested they might) and let the private sector get on with building the sorts of houses people would prefer when they are free to choose (rather than the sort some experts might prefer them to adopt).

Quite how this proposed large scale government investment was going to solve the productivity problems wasn’t clear –  when private firms aren’t investing it has the feel of the old line about “fools rush in where angels fear to tread”.  We’ve been that before in New Zealand –  not that long ago with the Think Big programme.  And –  all else equal-  big government investment programmes will push real interest rates and the real exchange rate further against the prospects of large outward-oriented private sector investment.  Perhaps it might be helpful to see some robust empirical evidence or argumentation about the past ability to New Zealand governments to do these sorts of projects wisely and well, in ways that make us consistently better off.

And I’m always uneasy when people suggest that the relevant cost of capital is the borrowing rate on (even the longest-term) government debt.  It isn’t.    The cost of equity has to be factored in, and just because the government doesn’t have a share price doesn’t the issue less relevant.  When the government undertakes projects it is using your money and mine to do so –  either actual (already taken) or potential (the power to increase taxes whenever it likes).  No commercial operation is going to be undertaking projects that seek a zero or one per cent real rate of return –  even if they can raise at that price –  and the standard Treasury advice, which I endorse, is that governments should not do so either.  Given that the incentives on the governments to get things right are relatively weak, and the disciplines when they fail are weaker still, I’d argue that the required rate of return on government projects should be higher than those on a comparable private project.  The relevant hurdle rates are lower than they were, but the cost of capital is still by no means trivial.

Hickey makes quite a play of a claim that the entire New Zealand political and official class is still living under the shadow of the potential double credit-rating downgrade in 1991.  I don’t fully buy that story.  It isn’t that long –  how soon we forget –  since people used to talk a lot about the desirability of the government running a low level of debt as some of counter-balance to the large negative net international investment position (ours still among the more negative in the advanced world), in a country with a fairly modest rate of national savings.  Sure, there was a credit-rating dimension to that story, but it wasn’t the whole story by any means.  Perhaps one can run some sort of over-savings story in places like the Netherlands or Germany (or Singapore) –  and some might even find the argument for more government debt in those places persuasive –  but this is New Zealand we are talking about.   Savings rate haven’t suddenly gone stratospheric, and –  low as our interest rates are now in absolute terms –  the implied long-term forward rates are still higher than those anywhere else in the advanced world (while, as Hickey notes, our productivity growth record is terrible).  And don’t forget the argument that if you run as pay-as-you-go age pension system –  something most New Zealanders support –  there is a good argument for also aiming to keep net government debt lower than one might find in other countries with different state-sponsored retirement income systems.

None of this is to suggest that the world would come to end if, instead of the current level of net general government financial liabilities (about zero on the OECD measure, and a little above the median advanced country rated AAA by Moody’s) we had net public 20 percentage points of GDP higher. It wouldn’t.  All else equal, interest rates would be a little higher.  But, equally, we can only say that we would be better off by doing so with some really hard-headed realistic analysis of the sorts of specific projects people would propose to use the debt for.  I’m sure there would be beneficial projects –  as there are daft and costly ones that happen now –  but across the gamut it is as well to be very cautious.  We’ve been this way before.

(As an alternative we could look at getting out of the way of private investment: freeing-up urban land use, foreign investment law, resource management act constraints, prohibitions on GE, prohibitions on offshore oil and gas drilling, and lowering our company tax rate which –  from a foreign investor perspective – is among the highest in the advanced world.   And here I’m not even going to my story on immigration: since short-term demand effects of immigration outweigh the short-term supply effects even I would be wary of large cuts to immigration right now –  helpful as they would be in the longer–term.)

Having said all that, I come back to what has puzzled me for at least the last couple of years, and where perhaps my story overlaps to a much greater extent with Hickey’s. It is about how small a share of GDP the current government is spending, and is planning to spend.  Here is core Crown operating expenses as a share of GDP, using Budget numbers out to 2023.

CC 1

Spending in every year under this government (or on its fiscal plans) would be smaller as a share of GDP than the average under the previous government –  mostly smaller than the average under the previous Labour government.  By the year to June 2023, spending as a share of GDP would be lower than all but the last two years of the previous government.  And yet in the run-up to the last election we kept hearing talk of critical underfunding in all sorts of areas of government.   I guess the swing voters who just thought it was time for change weren’t looking for lots more government spending, but it is hard to believe the base in Labour and the Greens (and true believers among the journalists) weren’t looking for material increases.

In a way, what staggers me more is this chart.   All that talk about underspending was focused on health and education.  But here is core Crown health and education spending, only to 2019/20, because budget operating allowances haven’t yet been allocated for later years.   The first version goes all the way back to when Treasury’s data start (1972)

cc2.png

and this version just for this century

cc3.png

Education spending this year was last this low in 1988.  Health spending has increased a little, but the share of GDP spent this year is lower than in all but the last two years of the previous National government.  And this in a sector where the ageing population –  and, arguably, advances in technology – could probably make a case for a rising share of goverment spending in GDP.  At least if you were a party making the sorts of arguments Labour was making at the last election.

There is something about their fiscal choices that –  based on their professed values and rhetoric –  doesn’t make a lot of sense to me, a mere centre-right economist.

Of course, one reason why government spending no longer needs to be quite as high is that interest rates have come down.    Finance costs (mostly interest) were almost 2 per cent of GDP in 2000 and were still about 1.5 per cent in the middle of this decade, but are projected to fall to only 0.9 per cent of GDP by 2023.

On the other hand, there is the fiscal burden of New Zealand Superannuation, the age of eligibility not now having been changed for many years, even as more of the baby boomers got to 65 and the life expectancies more generally increased.   In 2008 –  just as the last recession began NZS cost 3.9 per cent of GDP, in 2015 4.75 per cent, and in 2023 the cost is projected to be 5.04 per cent.

Strip out both finance costs and NZS costs and all the rest of the stuff governments do, operating spending as a share of GDP in 2023 is projected to be 2 whole percentage points of GDP less than it was when Labour ended its previous term in government (year to June 2008), and about the same as in 2015 and 2016.  It is a curious achievement for a party that talked so much about underfunding, generational change etc etc.   Perhaps it would be one thing if it were genuinely the result of winnowing out wasteful programmes etc, but there has been little real sign of that.   Perhaps –  whatever your view on the extent to which health should be funded by the state –  it is one reason why our national statistics agency, something close to a public good, appears so badly underfunded.

So sceptical as I am of the Crown taking on another $150 billion of debt –  as Hickey calls for – with net general government liabilities at zero, real interest rates basically zero, and the budget in surplus throughout the forecast period, one could make a reasonable case for a slightly higher level of government spending (or lower taxes).  A small deficit –  consistent with a small primary surplus –  is consistent with keeping net debt at around its current level (share of GDP) in normal times, while providing plenty of leeway to handle the next serious recession (some mix, probably, of automatic stabilisers and discretionary stimulus).

 

Reserve Bank MPS – part 2

This morning I wrote about the choice to cut by 50 basis points and the issues it raised, in context, about the Bank’s communications (non-existent speeches being only the most obvious omission).   In this post, I want to focus on a few other specific issues that came up in the Monetary Policy Statement itself or in the Governor’s press conference.

The first was around fiscal policy.  The Governor is clearly a big fan of the government spending more –  “of course the government has to be spending more”.   As a centre-left voter, I guess that is his personal prerogative, but it isn’t clear that it is his place to use his official office to weigh on highly political issues for which he is not charged with responsibility.  Imagine, if you will, that he was calling for cuts to government spending.  It would be equally inappropriate.

But, much as we shouldn’t just slide past the way he abuses the constraints on his office to advance personal causes, that wasn’t really what bothered me yesterday.   The much bigger concern was the way the Governor blatantly misrepresented the actual fiscal situation.  He claimed to be concerned only that the government wouldn’t be able to spend fast enough (given “capacity constraints”), which might reasonably have prompted a question of why, if government activity would be crowded out, he and his colleagues were slashing the OCR by 50 points in one go.

In fact, it prompted the perfectly reasonable question from Bernard Hickey about whether fiscal policy was actually very stimulatory at all.   The standard reference here is The Treasury’s fiscal impulse measure.  This is the chart from the Budget documents

fisc impulse.png

It isn’t a perfect measure by any means, and in particular one can argue about some of the historical numbers. In my experience, it is a pretty useful encapsulation of the fiscal impulse (boost to demand) for the forecast period. In fact, the measure was originally developed for the Reserve Bank –  which wanted to know how best to translate published forecast plans into estimated effects on domestic demand/activity.

And what do we see.  There was a moderately significant fiscal impulse in the year to June 2019.  That year ended six weeks ago.  For current and next June years, the net fiscal impulse is about zero, and beyond that –  which doesn’t mean much at this stage –  the impulse is moderately negative.    All using the government’s own budget numbers.  And consistent with this, operating revenue in 2023 is projected to be higher as a share of GDP than it is now, and operating expenses are projected to be lower (share of GDP) than they are now.    The Budget is projected to be in (fairly modest) surplus throughout.

And yet challenged on this, the Governor seemed to be just making things up when he claimed that we had a “very pro-active fiscal authority” and that “the foot is on the fiscal accelerator”.    It just isn’t.  Orr must know that (after all, he had Treasury’s Deputy Secretary for macro sitting as an observer in this MPS round).  One even felt a little sorry for the Bank’s chief economist spluttering to try to square the circle, but basically acknowledging that Hickey’s story was right, not the Governor’s.   Perhaps, you might wonder, the Bank thinks the fiscal impulse measure is materially misleading and has its own alternative analysis of the government’s announced fiscal plans. But that can’t be so either: there is no discussion of the issue in the Monetary Policy Statement.

(Incidentally, on Morning Report this morning Grant Robertson tried the same sort of line, only for the presenter to point out to him the fiscal impulse measure, reducing the Minister to spluttering “but we are spending more than the last lot”.  That is true, but the material overall fiscal boost was last year –  and growth and activity were insipid even then, inflation still undershooting the target.)

Was he being deliberately dishonest or simply making stuff up as he went protraying things as he’d like them to be?  You can be the judge, but neither alternative puts our central bank Governor in a good light.

Another joint act –  coordinated or not –  from the Minister and Governor was around investment.  As a nice change, the Bank included a chart of nominal investment as a share of nominal GDP (the approach favoured on this blog)

bus investment RB.png

As I’ve noted here repeatedly, business investment never recovered strongly from the last recession, and if anything (as share of GDP) has been falling back again in the lasdt few years, even as population growth remained strong.    It was good to see the Bank focus on the issue.

But despite the feeble business investment performance, the Bank expects business investment to recover from here.  There is no hint as to why they believe that is likely –  there is talk of more capacity pressure, and yet their output gap forecasts don’t change much from where we’ve been (on their reading) for the last couple of years.  If there is any basis for their beliefs it seems to be little more than the repeated claim by the Governor and the Minister that it is “a great time to invest” in New Zealand.  But firms didn’t think so over the last five years –  even with unexpected population shocks –  and surely the reason the Bank is cutting the OCR has quite a bit to do with deteriorating conditions and investment prospects here and abroad?  In a country that has had almost no productivity growth for the last five years, and with an exchange rate not forecast to change much from here over the forecast period, and with a deteriorating global backdrop (their own words were “global economic activity continues to weaken”) it seems little more than wishful thinking to expect a resurgence in business investment.

Ah yes, productivity, or the rather the lack of growth in it.   Here is my chart, using the two official GDP measures and the two official hours measures.

GDP phw mar 19

The orange line in the average for the last five years.  There is next to no aggregate productivity growth in New Zealand.

And yet somehow the Bank manages to conjure it up. They report a “trend labour productivity” growth variable, which they claim has grown steadily every year since 2012 (averaging perhaps 0.8 per cent per annum growth), and they forecast that productivity growth will continue –  and even accelerate a bit –  from here (averaging in excess of 1 per cent per annum growth).   It hasn’t happened, and it seems most unlikely to start now –  absent any big favourable change in policy or the big relative prices facing firms (eg the exchange rate).   The investment opportunities –  profitable ones –  just don’t seem to be there.   But I guess acknowledging that would upset the Governor’s spin about the “great condition” the country is in.

A wise person would then be very sceptical of the Bank’s  projections that economic growth picks up from here.  In fact, with net migration projected to continue to slow –  and with it population growth – it is hard to see why GDP growth over the next year should get even as high as 2 per cent (even assuming the rest of the world doesn’t fall into a hole).

My final point relates to the prospects for policy if the outlook continues to deteriorate.   I thought it was quite right for the Governor to note that when you are starting from here then, whatever your central forecast, it wouldn’t be too much of a surprise if the OCR were to need to be set at a negative rate at some stage in the next couple of years.  Forecasting just isn’t any more precise than that.

That degree of openness is welcome.  What is much less so is the Bank’s secrecy  –  and perhaps lack of straightforwardness/honesty – around possible options if the limits of conventional monetary policy are reached.    As the ANZ pointed out in a note this morning, just three weeks ago the Reserve Bank responded to an OIA request about unconventional tools by (a) stonewalling, and (b) claiming that the work “is at a very early stage”.  And yet yesterday, the Governor claimed they were “well-advanced” in their work.  Both simply can’t be true (bearing in mind that the last two weeks will have been taken up with this MPS).   Which is true I wonder?  Who were they trying to deceive?

But again, perhaps worse than playing fast and loose were two things that should bother people more.  The first is the way the Bank is keeping all this close to their chest.  Responding to that OIA they refused to release anything (“very early stage” or whatever) on the grounds that to release anything would prejudice the “substantial economic interests of New Zealand” –  one of those OIA grounds the Ombudsman simply doesn’t have the competence or confidence to challenge agencies on.  Yesterday, we were told it all had to be kept very confidential to the Bank, because it was “market-sensitive”.

I’m with the ANZ economists who in a useful note this morning (worth reading, but I can’t see on the website to link to) observed

Let’s hope that a possible plan for unconventional monetary policy is shared publically soon, so that financial market participants and households can be confident of a smooth rollout of extra stimulus. And with the recent cut to 1%, and an even lower OCR widely expected, the clock is ticking.

This isn’t like the situation the Fed faced in late 2008, rushing to make policy on the fly in the middle of crisis, deploying things almost as soon as they were dreamed up.   This is contingency planning.   No one (I imagine) is wanting the Reserve Bank to tell us exactly what conditions would trigger the use of which instrument (the Bank themselves won’t know anyway, and things will be event-specific) but it is highly desirable that the work on options that the Bank and Treasury are doing should be socialised more broadly, so that (a) it can be challenged and scrutinised (officials have no monopoly on wisdom) and (b) as the ANZ says, to help reinforce confidence –  including holding up inflation expectations –  going into any serious downturn.  The Governor tried to claim again yesterday that the Bank was highly transparent around monetary policy, but this is just another example of how they cling closely to anything of much value (as I’ve put it before, they are usually happy to tell us things they don’t know –  eg three year ahead macro forecasts –  but not what they do now, such as background analysis papers that feed into monetary policy, or detailed work on options if the nominal lower bound is reached).

Personally –  and here I might part company from the ANZ – I remain very uneasy about the potential for unconventional instruments. The Governor has consistently talked up the possibilities, but he has never shared any research or analysis to give us confidence about what difference such tools would make to macro outcomes (have I mentioned that he has given no speeches about monetary policy?).   As I’ve noted before just look at how slow the recoveries were in the countries that deployed these unconventional instruments –  not issues of underlying productivity growth, but simply closing output and unemployment gaps –  and you should be very sceptical too.   That is why I keep hammering the point –  in yesterday’s post again –  that the Bank, the Treasury, and the Minister should be doing work on making the lower bound less binding, and taking the public and markets with them to prepare the ground.  All indications are that they are doing nothing.  If that is not so, it would be very helpful if they told us –  it is, after all, official information and in this context the “substantial economic interests of New Zealand” are being jeopardised by them either not doing the work, or doing it and not telling us.

On which note, it is extraordinary that in an entire 52 page Monetary Policy Statement there is not a word about any of these issues and options.  The Governor is right to highlight that we could soon face negative policy rates (as ANZ points, yesterday one of the government indexed bonds almost traded negative – real yield), but he is remiss not to be engaging the public, markets, MPs, and other affected parties (firms and households) on how best to think about handling such an eventuality. “Trust us, we know what we are doing” is a mentality that was supposed to be consigned to history decades ago, but bureaucrats  –  including ones with a poor track record of achievement – will hoard their little secrets and (it seems) ministers will cover for them.  Grant Robertson promised that the reformed Reserve Bank would be more open and accountable. There is little sign of it so far.

 

Mixed feelings, but the MPC really needs to improve its communications

I’m still not entirely sure what to make of yesterday’s OCR decision by the new Reserve Bank Monetary Policy Committee.

This was my first reaction yesterday afternoon.

If I have a problem, it isn’t with the OCR now being at 1 per cent.  At the time of the last OCR review in late June I was mildly critical of the Bank for not having cut the OCR then

Data have weakened here and abroad, inflation is – and has persistently been – below target, the exchange rate is holding up, and there is little real prospect of a sustained reacceleration of growth or of inflation pressures. Oh, and market measures of medium-term inflation expectations are around 1 per cent, not 2 per cent. In that climate, being a little pro-active and cutting the OCR now looks to have been the better choice. It isn’t clear what the risks to moving would have been. It is only six weeks until the next MPS, but (a) the MPC won’t have a lot more domestic information between now and then…and (b) the way the global situation is going one can’t rule out the possibility that another cut could have been warranted by then.

And so half of me is inclined to give the Bank some credit for catching up (I don’t think there is any sense in which they have now got ahead of the game).  It was certainly a fairly courageous call –  although whether that is more in the Sir Humphrey sense perhaps remains to be seen –  when the easier path would have been to have cut by 25 basis points yesterday and strongly signalled the likelihood of a 25 basis point cut in September.

And there was some rhetoric from the Governor at his press conference that I quite liked, including the reaffirmation of the effectiveness of monetary policy, the emphasis on the very low global nominal interest rate environment (which everyone just has to learn to work with) and a sense of being serious about getting core inflation back to 2 per cent, observing that there was worse things in the world to worry about than if the Bank were to look back 18 months from now and see inflation and inflation expectations rising.  In my words, after a decade of undershooting the target, you probably shouldn’t aim to overshoot, but the harm if you happen to is likely to be small.  I also liked the Governor’s affirmation of the point that cutting relatively energetically now may (probably slightly) reduce the risk of serious constraints on conventional monetary policy a bit down the track (by helping to hold inflation expectations up).

And yet conventions and communications matter.

50 basis point moves in interest rates used to be fairly normal (in our first ever tightening cycle. almost 20 years ago now. the OCR was raised by 50 basis points on three separate occasions).  But both here and abroad moving in 50 basis point bites went out of fashion (and I use the word deliberately –  it is a choice, on which not that much hangs, but it was one most advanced country central banks defaulted to).  In New Zealand, we had some very large individual OCR cuts during the international financial crises and recession of 2008/09 when not only was the hard economic and financial data deteriorating very rapidly, but bank funding margins were rising (so that OCR cuts were partly offsetting those incipient higher market rates).  And we cut the OCR by 50 basis points in the immediate wake of the February 2011 earthquake, explicitly as a pre-emptive precautionary strike against the possibility of a very sharp drop-off in confidence and economic activity –  explicitly noting that the cut was likely to be temporary.  And that was it. Until yesterday.  Even when Graeme Wheeler was setting out determined to raise the OCR by 200 basis points, he didn’t do so in 50 basis point bites.

As I noted the choices are partly about fashion and convention (including the choice –  pure choice –  to do things in multiples of 25 basis points: we and most advanced countries do that but in India yesterday they cut by 35 basis points).    Fashions and conventions can change, but roadmaps and markers to observers then take on a fresh importance.

And there were no signals whatever from the Bank that it was shifting to a mode of operating, and setting monetary policy, in which 50 basis point adjustment were back on the table in what are still relatively normal times (from a NZ macro perspective).    Perhaps it is tiresome to make the point again, but the Governor has given not a single substantive speech on monetary policy in the 17 months he has been in office.  No senior official of the Bank, including the new external MPC members, has given a speech this year, let alone in recent months, marking out how they think about the economy, about what is actually going on, about transmissions mechanisms, reaction functions etc, or even how they approach the more tactical issues around timing and magnitude of OCR adjustments.   That isn’t good enough, especially from a Bank which boasts –  as the Governor did yesterday (and wrongly) –  about how transparent the Bank is.

I recall that when the OCR system was introduced Adrian Orr –  then the Bank’s chief economist –  was vocally opposed to having, or using, OCR reviews other than those tied to the release of a Monetary Policy Statement.    I thought that approach was nuts (with 4 MPSs a year, even moving in 50 point bites it restricted us to 200 basis points of changes a year), and the original design (8 serious reviews a year) prevailed).  Is part of the explanation for yesterday’s surprise move –  and when no one picked your move, you should ask again just how transparent you are –  that the Governor still doesn’t like the idea of moving outside the context of a Monetary Policy Statement?    Perhaps not, but they have just not communicated with us, until they emerge with the surprise decree from the mountain-top.

And what makes it a bit more concerning is that it is pretty clear the Bank itself wasn’t intending to move by 50 basis points even a few days ago.  The projections they published yesterday were finalised on 1 August (last Thursday).   On those numbers, the projections for the OCR (quarterly average) were:

September quarter 2019    1.4 per cent

December quarter 2019     1.2 per cent

March quarter 2020            1.1 per cent

With the next OCR review in late September and the following one in md-November, those projections –  adopted by the whole MPC – clearly envisaged not getting to a 1 per cent OCR even by the end of the year.

The bulk of the Monetary Policy Statement itself is written in the same relatively relaxed style, with no hint of a change in policy approach, and thus no proper articulation of the reason for it, or (hence) for how we should think about how the Committee will react, in principle, at future OCR reviews.   The Bank has added to uncertainty around policy, not reduced it.    In a similar vein, there is a new two page Box A in the statement on “monetary policy strategy”, intended to run each quarter, which is so general as to add nothing to the state of understanding of what the MPC and the Bank are up to.

And you will look in vain for any real insight from the minutes of the MPC meeting.   We are told

The members debated the relative benefits of reducing the OCR by 25 basis points and communicating an easing bias, versus reducing the OCR by 50 basis points now. The Committee noted both options were consistent with the forward path in the projections. [a claim that demonstrably isn’t true –  see above] The Committee reached a consensus to cut the OCR by 50 basis points to 1.0 percent. They agreed that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives.

But nothing about the considerations Committee members took into account in belatedly lurching to a 50 point OCR cut, or how they think about the conventions and signalling around using 25 point moves vs 50 point moves (when things aren’t falling apart here –  and it was the Governor yesterday who announced, oddly, of New Zealand that “the country is in a great condition”).

The press conference also offered few insights into what the Bank was up to.   The external members weren’t invited to say anything, and showed no sign of offering to (at least some of them were there), and the staff MPC members the Governor did invite to comment were no more forthcoming or enlightening: they couldn’t or wouldn’t tell us what persuaded the Committee to move by 50 points, beyond handwaving about “the whole story, domestic and foreign”, even as the Assistant Governor noted that it was unwise to react too strongly to any particular piece of news (true, but……you seem to have).   And how seriously are we supposed to take the idea of “consensus” decisionmaking, when allegedly all seven of them suddenly shifted to a quite unexpected –  out of the mainstream – OCR call in just the last few days?

In the end perhaps none of it matters too much. On my reckoning, the OCR ends up where it probably should have been –  just less smoothly than it should have been –  and on the reckoning of some of the more dovish market commentators, it ends up now where they thought it would be next month.   The substance isn’t unduly affected.  But this episode won’t help the Reserve Bank’s reputation for being a steady pair of hands on the tiller.   Observers abroad will look at them oddly –  are things really that bad in New Zealand? –  those at home will be less sure how to read the Reserve Bank, and the Bank must have known it would feed fairly silly stories (from National that the 50 bps cut shows how bad things are, from Labour that the 50 bps cut shows what a great time it is to invest in New Zealand).  They really should do better than that.

If the Reserve Bank’s Board was actually interested in doing its job, rather than covering for their appointees (something of a conflict of interest surely?) they would be asking hard questions now about just what went on: why the Bank didn’t move in July, why they chose to act so unexpectedly yesterday, why they couldn’t have waited until September for the second 25, why the projections are so out of step with the decision, why the MPS itself gives little articulation of the case, and why serious speeches on the economy and monetary policy seem now not to be a thing at the Reserve Bank of New Zealand.   The Governor has an ambition for the Bank to be the best central bank.  On the evidence of yesterday they are very far from that (ridiculously unrealistic) objective.

I have various points on other aspects of the MPS and the press conference but will save them for a separate post.

Keep the focus on monetary policy

As we approach the OCR decision this afternoon and as some market economists are now talking about the possibility that the OCR could be below 1 per cent before too long, there has been more and more talk about whether fiscal policy should be brought to bear, to stimulate demand and (in some sense) assist monetary policy in its macroeconomic stabilisation role.  Just this morning there was an editorial in the Herald, a column on Stuff, and a comment from Bernard Hickey at Newsroom.   Some of the discussion is about what should be done now, and the rest is about contingency planning –  what happens when the next serious recession happens if the OCR is still constrained.

Much of the discussion seems to stem from people on the left who aren’t that happy with the government’s fiscal policy.  As someone not on the left, it has always seemed strange to me that Labour and the Greens pledged themselves to keep much the same size of government (and much the same debt) as National –  especially when, at the same time, you were running round the country talking about severe underspending on this, that, and the other thing.   I’m also of the view that structural budget surpluses are a bad thing, in principle, when net government debt is already acceptably low (on the OECD measure of net general government financial liabilities, New Zealand is now about 0 per cent of GDP, which seems like a nice round number – an anchor – to target).  There is an argument there –  whether from left or right – for some fiscal adjustment (taxes or spending), which might have the effect of a bit more of a boost to demand.

But those arguments really have almost nothing to do with the situation facing monetary policy.    They are fiscal and political arguments that should be made, and scrutinised, on their own merits: the arguments would be as good (or not) if the OCR was still 2.5 per cent as they are now, and you can be pretty sure that people on the left would have been making them then anyway?   The Governor of the Reserve Bank, for example, (a pretty staunch representative of the centre left) seemed keen on more infrastructure spending a year ago.  I guess he is a voter to so is entitled to his opinion, but it really doesn’t have much to do with monetary policy.

The general arguments that led countries around the world to adopt monetary policy more exclusively as the primary stabilisation policy tool have not changed.  Monetary policy can be adjusted quickly (to ease or tighten), operates pervasively (gets in all the cracks, without making specific distributional calls), is transparent, and so on.  If we had a fixed exchange rate –  as individual euro area countries largely do –  it would be a bit different (individual countries don’t have the monetary policy option any longer) but we have a floating exchange rate system which, mostly, works well for New Zealand.

To the extent that there is a monetary policy connection to the current calls for fiscal policy to be used (or the ground prepared to use it), it has to do with the looming floor on nominal interest rates.  International experience suggests that, on current laws and technologies, short-term nominal interest rates can’t be reduced below about -0.75 per cent without becoming ineffective (as more and more people shifted from other financial instruments into physical cash).  We don’t know quite where that floor is, as no central banks has been willing to take the risk of going further, but there is a fair degree of consensus (and it has long been my view too).

But that still means that in a New Zealand context there is 200 basis points of OCR cuts that could be used if required.    That isn’t enough for a typical New Zealand recession (rates have often been cut by 500bps), but is still quite a degree of leeway if what we are entering were to turn out to be a fairly mild slowdown in New Zealand.  It could (I’m not hedging here).   That capacity should be used energetically, not timorously.   So the issue –  monetary policy needing “mates” deployed now –  is not immediate.  It is about preparing the ground.

And there, the best macro stabilisation option remains the one the Reserve Bank –  and other central banks –  have done nothing active about, but really should.  Authorities (and it probably needs political support to do so) should be moving to make the effective floor on short-term nominal interest rates much less binding than it is.   It binds because the practice of central banks –  perhaps backed by law – has been to sell banknotes, in unlimited quantities, at par.   That practice can be changed.  It could be as simple as putting an (adjustable) cap on the volume of notes in circulation (quite a bit above the current level, but not at a level that would be transformative) and then, say, auctioning the right to buy additional tranches of bank notes from the Reserve Bank.  In normal times –  with the OCR at, say, current levels – the auction price would be at par.  If the OCR were cut to, say, -3 per cent (and be expected to stay there for some time) the auction price would move well above par, acting as a disincentive on people to attempt to make the switch from deposits to cash.  There is a variety of other ideas in the literature, as well (no doubt) as much less efficient regulatory interventions that could prevent really large-scale conversions happening.

Unusual as such options may sound, this is where the authorities –  here and abroad –  should really be concentrating their energies: giving monetary policy more leeway, in ways that will buttress market confidence that monetary policy will do the job when it is required.  At present, by contrast, when market participants contemplate a severe downturn they look into an abyss wondering what, if anything, will eventually be done, by whom, and for how long.  In a serious downturn that will just worsen the problem, driving down inflation expectations as economies slow (note that in the RB survey out yesterday, medium-term inflation expectations fell away quite noticeably –  and this while we still have conventional monetary policy to use).   And if there are objections that all this is somehow “unnatural”, bear in mind that had the inflation target been set at zero (rather than 2 per cent), as was the normal average inflation rate for centuries, we’d already have run into these practical limits, and been unable to get real interest rates even as low as they are now.

So there is plenty to be done with monetary policy, and the work programme to do it should be something open and active, drawing in the Bank, the Treasury, the Minister, and other interested parties.  The time to do preparation is now, not in the middle of a surprisingly severe downturn.

I have a few other reasons –  than “it shouldn’t be necessary” –  to be wary of calls for large scale fiscal stimulus now.  Just briefly:

  • there would be little agreement on what should be done –  these are inherently intensely political issues.  There is lots of talk of infrastructure gaps etc, but no agreement on what those are, let alone recognition of the twin facts that (a) the best projects, with the highest economic returns, have probably already been done, and (b) New Zealand government project evaluation is not such as to inspire confidence that new projects would add economic value.    And suppose there were attractive roading projects –  perhaps central Wellington and the second Mt Vic tunnel? – we know the attitude of the government’s support partner to new major roads.  Not a thing.  So what should we then spend on?  Uneconomic new railway lines?  Or what?  Perhaps some just favour more consumption or transfers spending – which might be fine if you are a lefty who believes in permanently bigger government, but if you aren’t the issue has to be addressed of how programmes once put in place are unwound later.
  • I don’t rule out the possible case for discretionary fiscal stimulus in the event of a new severe recession (especially if the authorities refuse to address the monetary policy issues above) but my prediction is that (in many ways fortunately) the political appetite for large deficits would not last very long, and that therefore we should preserve the option for when it might really be needed.  It isn’t now.   I take much of the rest of the world after 2008 as illustrations of my point: in late 2008 all the talk was of fiscal stimulus, but within two or three years all the political pressure was to pull deficits back again.  I don’t see why New Zealand would be any different (and that is to our credit, since low and stable debt has become established as a desirable baseline).
  • And thirdly, a point we don’t often hear from champions of more fiscal stimulus, relying more on fiscal policy and less on monetary policy to support economic activity and demand will, all else equal, put more upward pressure on the real exchange rate, further unbalancing an already severely-unbalanced economy (see yesterday’s long-term chart of the real exchange rate).  In a severe recession –  when the NZD tends to plummet –  that isn’t a particular problem, but it should be a worry now (when the TWI is still a bit higher than it was a year ago, let alone thinking about the longer-term imbalances.

Perhaps the Governor and the (experts-excluded) Monetary Policy Committee will proactively address some of these issues this afternoon. I do hope so. If not, I hope some journalists take the opportunity to push the Governor on why he (and the Minister and Treasury) aren’t actively pursuing work to make the lower bound on nominal interest rates much less binding, in turn instilling confidence in the capacity of New Zealand policy to cope conventionally with a severe downturn if/when it happens.

Oh, and I do hope some journalists might also ask the Governor this afternoon about the justification for ruling out from consideration for appointment to the Monetary Policy Committee

“any individuals who are engaged, or who are likely to engage in future, in active research on monetary policy or macroeconomics”

The Governor is, after all, a Board member and was one of the three person interview panel.    What was it that he –  or the Board generally –  were afraid of?    Expertise?  An independent cast of mind?  Of course, it isn’t only active researchers who have such qualities –  indeed, not all of them do either –  but it simply seems weird, and without precedent in serious central banks elsewhere in the advanced world, to simply disqualify from consideration for the (part-time) MPC anyone with the sort of background that many other central banks (Australia, the UK, the euro area, Sweden, the United States, and so on) have found useful, as one part of a diverse committee.

Wages have risen faster than output per hour

I have a few other things on my plate today, but I thought I’d just share this update to a chart I’ve run before, showing wage growth (using the LCI analytical unadjusted measure for the private sector) relative to growth in nominal GDP per hour worked.

GDP and wages aug 19.png

When the line is moving upwards, private sector wage rates have been rising faster than nominal GDP per hour worked.  Growth in nominal GDP per hour work can be loosely conceptualised as some measure of the economy’s capacity to pay (average overall domestic production is rising that rapidly, leaving to be resolved the extent to which those gains –  whether from the terms of trade, productivity, or just general inflation –  end up going to labour or capital).

The reason the chart has tantalised me since I first stumbled across the idea of constructing it a couple of years ago, is (of course) that private sector wages in New Zealand do seem to have been rising faster than “the capacity of the economy to pay”.  It has happened in fits and starts, and there is a fair bit of noise in the data, but the trend since about 2001 has been pretty clearly upwards.   (The wages data released this morning give us June quarter numbers for the numerator, and hours worked data, and here I’ve assumed nominal GDP rose 1 per cent in the June quarter.)   The cumulative difference over time –  around 15 per cent now –  is not small.

As a reminder, here is the comparable chart for Australia, which I included in a post last week.

wages in aus

The New Zealand numbers do not, repeat not, suggest that people are in some sense overpaid in New Zealand.  Mostly, wage rates are a market outcome (firms and employees, and the respective opportunities etc), and although policy initiatives like pay equity settlements and large minimum wage increases have boosted the New Zealand line in the last few years, those specific measures don’t explain the longer-term trend to anything like the full extent.

The New Zealand numbers also don’t suggest that New Zealand workers are doing particularly well in an absolute sense.  They aren’t.   New Zealand incomes lag well behind those in leading advanced countries.  But although wages can and do wander away from aggregate economywide productivity for a time, in the longer-term only productivity growth can really underpin a closing of those wage/income gaps.  As I’ve highlighted here before, it would take productivity increases of about 60 per cent here to match the leading OECD bunch.  And we’ve had virtually no productivity growth at all in recent years.   All the data is saying is that workers haven’t done too badly given a badly-performing economy: little or no productivity growth and fairly stable terms of trade.

But most people would still have been better off had we actually managed decent productivity growth, and if the economy were not so badly skewed as to have a substantially overvalued exchange rate and, in association with that, non-tradables sectors doing well, but tradables sectors as a whole typically doing poorly.   Reasonably strong domestic demand can result in high demand for labour, and higher wage rates.  But the associated overvalued real exchange rate deters (crowds out) the sort of investment in internationally competitive industries that might have allowed real productivity gains to have been achieved.

On which note, I’ll end with the OECD’s real exchange rate measure for New Zealand, calculated using relative unit labour costs (ie wages adjusted for productivity).

rel ULcs.png

The orange line is the average for the last 15 years:  far higher than for any sustained period in the history of the series, even as our productivity performance has remained pretty woeful.  And, of course, at the end of the period the series is above even that fifteen-year average.