In a post earlier this week, I made passing reference to a new opinion piece on Newsroom headed “Why we need a recession plan”. The article is written by another former Reserve Banker, Kirdan Lees, who these days divides his time between the University of Canterbury and economic consulting. His article is organised around a list of five reasons, although it combines his arguments about the form any such plan should take.
I strongly agree that we need some serious, credible and open planning for the next recession (whenever it comes, but it is now eight or nine years since the last one and neither the foreign nor domestic outlooks are looking particularly rosy). Indeed, in respect of monetary policy, it is a case I’ve been making for about as long as this blog has been running. The case might have seemed a bit abstract four years ago – especially to anyone who paid much attention to the Reserve Bank’s pronouncements (that interest rates were rising, and inflation would soon be getting back to target). It should be much more pressing now, as the growth phase has got old and yet (New Zealand) interest rates are at record lows and inflation still isn’t back to target. But, unfortunately, there has been nothing serious from the Bank – under Wheeler, (unlawful) Spencer, or Orr. They claim to believe there just isn’t a problem; that monetary policy can do as much as ever.
This is, more or less, Kirdan’s first reason.
Reason 1: The outlook now points to recession risk with little room for interest rates to do much
But interest rates have never been so low, leaving little headroom for monetary policy to kick in. Mortgage and lending rates can’t fall by much if the big banks are to retain margins.
As a reminder, the real obstacle is around wholesale deposit interest rates. By common consensus, official interest rates could be lowered to perhaps -0.75 per cent, but any lower and the strong incentives are for people (including particularly wholesale investors) to convert their assets into physical cash and use safe-deposit boxes and strongrooms. Conventional monetary policy no longer works then. That means our Reserve Bank could cut the OCR by up to around 250 basis points – more than many advanced country central banks could – but in typical recessions they’ve needed to cut interest rates by 500 basis points (575 basis points last time, and the recovery then was very muted).
There are ways around this lower bound constraint, but the Reserve Bank and the government have shown no signs of any action (or even any serious analysis). In principle, things could be done in a rush in the middle of the next recession, but that is almost always a bad way to make good policy, and by failing to clearly signal in advance that the authorities have credible responses in hand they are likely to worsen the problem (see below).
Kirdan doesn’t seem to see much scope for doing anything to increase the flexibility of monetary policy. His focus is on fiscal alternatives.
Reason 2: By the time Treasury calls a recession it’s too late to trigger a fiscal stimulus plan
Not just Treasury of course. Economic forecasters and analysts are hopeless at recognising recessions until they are well upon us (among the reasons why no one at all should take any comfort from the latest IMF update – international agencies are among the worst in recognising things before they break).
It would always be better to have good forecasts, even so-called nowcasting (where is the economy right now – given that our most recent national accounts data relates to the July to September period last year, and even that is subject to revision). Kirdan is an optimist and believes we can do (materially) better than just waiting for the GDP data.
Today, a myriad of timely data exists: across transport movements, customs data, privately held data on small businesses (such as Xero) and consumption (such as Paymark). A small panel of experts could use that data to gauge recession risk and tell us when to pull the trigger.
In principle, of course, all these data are available to Statistics New Zealand (which could require them to be provided under the Statistics Act), and if the data could be available to “a small panel of experts” it could presumably be available to the Treasury and the Reserve Bank.
But even if these data can provide a few weeks advance notice of negative GDP quarters, there are bigger questions which more-timely data can’t answer. The first is how long any downturn will last. That matters quite a lot. A couple of weak quarters might sensibly lead the Reserve Bank to consider a cut to the OCR, and probably the exchange rate would be weakening anyway. But that is very different from a couple of weak quarters foreshadowing a deep and prolonged recession. Telling the difference isn’t easy. And who seriously supposes that – in a democracy – we are going to hand over to a panel of experts (self-appointed or otherwise) decisions about when to trigger big fiscal stimulus programmes which – whatever their composition – have huge distributional consequences. These are inherently political choices, which will benefit from technical input, but the accountability needs to rest with those we elect (and can eject).
On which note
Reason 3: Economic theory can help: a fiscal plan needs to follow three principles
When it comes to fiscal stimulus principles, macroeconomists have their own triple-T: stimulus needs to be timely, targeted and temporary.
Which looks fine on paper, but is much less help in practice. If you want “timely”. monetary policy can typically be adjusted faster than fiscal policy – exchange rates, for example, adjust almost instantly to monetary policy surprises, and often in anticipation of monetary policy actions. And monetary policy moves are designed to be temporary, but without tying anyone’s hands: you raise the OCR again when you are pretty sure inflation is going to back to target.
In the UK they tried what looked like a clever fiscal wheeze in the last recession: cutting the rate of VAT for a year, and only a year. It looked like a fairly sensible move at the time it was announced – encouraging people to bring forward consumption. And it probably would have been if the downturn had been short and sharp, but it wasn’t. More generally, people like the IMF championed fiscal stimulus in 2008/09, but again implicitly on the view that economies could rebound quickly. When they didn’t, the mix of economic and political arguments about “austerity” took hold and only complicated the handling of the economy.
Of course, if you get can get your legislation through Parliament you can write cheques (electronic equivalent) quite quickly – Kirdan is keen on focusing temporary additional spending on “poorer families” – but you can’t do the same for the sort of infrastructure spending that those keen on fiscal stimulus often champion.
Kirdan’s reason 4 had me puzzled.
Reason 4: Trotting out the same tired approach will provide the same tired results
One of the enduring traits of fiscal policy is tacking on extra spending in good times and taking away spending just when it is needed.
Hard to disagree too much with that second sentence – pro-cyclical fiscal policy is a problem.
But even if you think there is a role for some active counter-cyclical fiscal policy, I wasn’t clear on the connection to what came next
Governments seeking a labour boost need a better targeted fiscal stimulus. That means targeting labour-intensive industries such as such as health and education, construction, horticulture, accommodation and retail industries. ….
But identifying labour-intensive industries is not enough. Maximum effectiveness comes from targeting the labour-intensity of the entire supply chain: labour-intensive industries that in turn use labour intensive inputs from other industries are the best bets for fiscal stimulus.
It seems to be an argument for, in effect, targeting reductions in average labour productivity – by focusing on boosting industries that are (directly or indirectly) more labour-intensive. Perhaps – just possibly – there is a case for something of the sort, as a pure short-term palliative, in a very deep economic depression, but in an economy where lack of productivity growth has been a decades-long problem (and particularly evident in the most recent growth phase) targeting low productivity industries doesn’t seem a particularly sensible medium-term approach.
Which brings us to the last point in Kirdan’s article
Reason 5: Articulating a trigger for the fiscal plan shapes the expectations of Kiwi businesses
I don’t think ministers can articulate a highly-specific trigger for action – so much will depend on context (what is going on here and abroad) – and attempting to do so is only likely to create a rod for the government’s back. But where I do agree is that there needs to be a clear and credible commitment from both the government and the Reserve Bank that prompt and firm action will be taken if the economy turns down substantially, and particularly if that is in the context of a serious global event.
Kirdan’s focus is fiscal, and I have no problem with his points that (for example) debt to GDP should be expected to rise in a severe downturn, without threatening the medium-term commitment to moderate debt levels. In fact, we would probably agree that there should be some public debate now about how the next downturn should be handled, as there is a risk that we get a serious downturn and the government is still fixated on its medium-term debt target (and avoiding leaving a target for National to attack them), even if that isn’t what is needed in the short-term.
But in my view, the argument generalises. One of the problems we face going into the next severe downturn – whenever it occurs – is that (a) every serious observers knows that monetary policy has limited capacity, even in New Zealand and much more so in many other places (in the euro-area for example, the policy rate is still negative), and (b) that there are real political/social constraints on the flexibility of fiscal policy in many places (partly because debt levels are often high, partly because of distributional considerations, partly memories of post-stimulus austerity). I’m not necessarily defending these constraints, just attempting to identify and describe them.
Faced with these limitations, the quite-rational response to a downturn will be to assume that there isn’t that much authorities will be able to do about it. That, in turn, will deepen any downturn, and be likely (for example) to lower inflation expectations, making the recovery job even harder (it is going to be even harder to generate inflation in the next recession than it was in the last one). Perhaps the general public don’t yet recognise these constraints, but many more-expert observers already do, and the news will rapidly spreads if and when a serious downturn gets underway. What, people in Europe would reasonably ask, can the ECB do? How much, Americans will reasonably ask, will the Fed be able to do? And what appetite will there be for much large scale on the fiscal front. These things matter to us, even if our government has more fiscal leeway than most, precisely because recoveries from serious recessions often result from the combined efforts of many authorities at home and abroad. Many engines are likely to be missing in (in)action next time round.
I’m critical of our own government and Reserve Bank on these issues. It isn’t clear that other countries’ authorities are doing anything much more – there seems too much of simply hoping the situation will never arise and interest rates will get back to “normal” first. But we can’t do anything about other countries, and we can get ready – and have the open conversations – ourselves, taking account of the probable constraints other countries will face. There may well be a place for some fiscal action in the next serious domestic recession, but monetary policy is better-designed for stabilisation purposes and we could be taking action now that would give people and markets much greater confidence that the lower bound won’t bind. To the extent there is a role for fiscal policy, it is more likely to be used well if there is open debate and contingency planning now – although my expectation is that, however much advance discussion there is, political constraints (community tolerance) will bite quite quickly. We shouldn’t need discretionary fiscal policy in a short sharp recession, and it is unlikely to be there long enough in a deep and prolonged recession.
Finally, to anticipate comments about quantitative easing programmes. Reasonable people can interpret the evidence about those programmes differently (I tend towards the sceptical, once we got out of the midst of the immediate crisis) but I’m not aware of anyone who regards even large scale QE programmes as more than pallid supplements to what conventional monetary policy could usually be able to do.
A serious Reserve Bank would be engaging – indeed leading, given its role in stabilisation policy – this sort of discussion and debate. At our Reserve Bank the Governor has now been in office for 10 months and we’ve had not a single speech on monetary policy issues. Quite extraordinary really.
(UPDATE: In my post last Friday about stress tests and the Reserve Bank’s plans to increase bank capital requirements, I referred to a letter the Governor had sent to a journalist who had written a critical article. I noted then that I had lodged an OIA request for the letter, and that the Bank is legally required to respond as soon as reasonably possible. Given that the letter was already in the public domain (the recipient being a private citizen) there were no obvious grounds for any deletions, except perhaps the name of the recipient. The letter had been written only a couple of weeks ago, so there were no search problems, and no good “holiday period” grounds for delay. That request was lodged nine days ago and I’ve still not had a response (and we also still haven’t seen the background papers the Governor promised in the letter that he was just about to release). As it happens, the recipient of the letter – Business Desk’s Jenny Ruth – has now sent me a copy, which I appreciate, but that doesn’t justify this small scale Reserve Bank obstructionism around a major public initiative – capital requirements – in which the Governor will act as a one-man prosecutor, judge and jury in his own case – at potentially large cost to the rest of us.)