Banking without interest

In this morning’s Dominion-Post their personal finance columnist Janine Starks has an introductory article about Islamic approaches to finance.  The key, specific, dimension is the prohibition on interest.

That prohibition, in one form or another, was once common across Judaism, Islam, and Christianity.  It is one of the few aspects of teaching where the Christian church has, pretty much universally, changed its teaching, and personally I’m not convinced the change was well-grounded.  I’ve therefore long been intrigued by experiments with interest-free approaches to finance –  some of which manage it in form not in substance, but others are the real deal.  Once upon a time, having an innocuous New Zealand passport and some interest in the issue, I even participated in an IMF mission to Iran to advise them on the possibilities for a market-based monetary policy consonant with interest-free principles.

This morning’s article reminded me of a couple of posts I had written in the early days of this blog, starting from Islamic banking but focused primarily on the notion of mortgage products that did not involve an interest rate. The first was here and included these extracts

I’ve long been intrigued by the ideas and practice of interest-free finance.  My own Christian tradition for centuries banned, or regarded with intense disfavour, lending at interest.  That drew first on Old Testament provisions, which prohibited Israelites from lending to fellow Israelites in need at interest (while allowing loans at interest to outsiders).  The stance was reinforced by perspectives from Aristotle, rediscovered in the Middle Ages, arguing for the inherent sterility of money.  Prohibitions on lending at interest were eventually removed but  it remains a powerful vision for some (for me).   Within the Christian community, outfits like the Kingdom Resources Trust in Christchurch try to put it into practice.

The injunctions against interest are apparently much stronger and more pervasive in the Koran. In his recent book, Beggar Thy Neighbour, Charles Geisst reports that “of all the prohibitions against undesirable activities in the Koran, usury is mentioned the most.  Interest, or riba, is considered usury and no distinction is made between them”.   This was a distinctly counter-cultural stance, as compound interest had apparently been common among Arabs before the coming of Islam.

If interest is prohibited, profit-sharing arrangements –  equity finance, in effect – are not frowned on at all.  They have a element of uncertain return – economic risk –  for which some reward is appropriate. Predominantly-Muslim countries, and individual Muslims. have grappled with how to apply the prohibitions on interest in today’s world.  The large Muslim minority in the UK and the large financial sector with global connections has led to considerable interest there.  In his pre-crisis heyday, Gordon Brown wanted London to become the global centre of Islamic banking.

and

An alternative type of product might be an equity-based housing finance product.  In conventional housing finance markets, the purchaser puts up some equity, and a lender provides the balance.  The lender receives an interest-rate and is exposed to the (hopefully small) risk that the borrower defaults and that the house can’t be sold for enough to cover all the outstanding debt.  Any increases in the value of the house – whether changes in market prices generally, or as a result of improvements/extensions – accrue to the owner.

But it would be technically quite feasible to envisage a model in which the person wanting a house to live in, and the financier, became equity partners in a joint business venture to own the house.  You, the, resident would presumably pay rent to the joint venture, some portion of which would be passed to the equity finance partner, and when the house was eventually sold gains and losses would be shared, proportionately, between you and the equity partner.  You have risk, the equity financier has risk, and no one is paying or receiving interest –  in form or in substance.  It would be simple enough, technically, to structure the contract to allow the resident’s equity share to rise over time (instead of “principal repayments”, one uses the funds for equity repurchases from the JV partner).

I’m not sure if such contracts exist anywhere in the Islamic world.  In the West, without the theological concerns about interest, there is good reason why they don’t exist.

If I’m a young person in the West buying a first house, a bank might lend me 90 per cent of the value of the house.  Most mortgages are table mortgages and are repaid gradually, so that in time the owner’s equity share is large, heading for 100 per cent.  All the Bank cares about after that is my ability to service the debt.  And that depends largely on avoiding prolonged periods of unemployment.  If house prices fall that poses a risk –  banks can call in a mortgage if the value of the collateral drops below the value of the mortgage –  but it typically only crystallises if the flow debt service isn’t being met, and if house prices fall so far that not all the debt can be repaid when the house is sold up.   Within limits – quite wide limits – banks don’t care about or monitor the maintenance you do on your house.  If you don’t do the maintenance, mostly it is your loss.  And they don’t care at all about changes in market rentals in your neighbourhood, or for your specific type of house.  Conventional mortgages are simple, easy, and cheap to monitor.

But equity-sharing contracts would be enormously costly to monitor and manage, especially in a country with such a variegated housing stock (rather than lots of high-rise uniform apartments).  If you are only an equity partner in a house, your incentive to do maintenance is attenuated –  and likely to weaken especially in periods of personal financial stress.  So a financier providing a large equity stake would probably want to pre-specify maintenance obligations and standards (and would then need to monitor compliance).  You’d need to negotiate all alterations and extensions.  Rental rates vary, as do market values.  Perhaps a real rental yield could be pre-specified in the initial contract, but any arrangement for the resident to gradually buy out the outside equity partner requires an agreement on market value at the time of the transaction.  Transactions costs rapidly start to mount.  They might work within a relatively closed community – say, a local church community where effective monitoring costs might be reduced, or a small mosque-based credit union  –  but it is difficult to see them being effective, and economic, more generally.

In their recent book House of Debt, the US academics Atif Mian and Amir Sufi, argued that equity-sharing contracts should become the norm for housing finance.  They argue that such contracts would materially reduce the risk of financial crises, and that the main reason such contracts aren’t common is because of the tax system and the role of US government agencies.  I’m very sceptical of both claims, and would post the note I wrote on why –  but it would take 20 working days to get OIA clearance.  This post is quite long enough, but if anyone is interested I can explain my scepticism in a later post.

The follow-up post was here.  It is hard to excerpt so I won’t try.

In the last few weeks there has been (understandably I guess) a lot of rhetoric about common values etc etc, but actually there are really important –  and mutually inconsistent – belief systems in our world, or even our country.  As I noted in something else I was writing earlier this week

In fact, the notion of (serious) shared values falls down quickly in the presence of anyone –  secularist, Christian, Muslim –  who takes their faith seriously, as a source of authority and rule for life.  In some of these areas, serious Muslims and serious Christians have more in common with each other than either do with aggressive secular liberals. In others, not –  after all, most of the aggressive secular liberals have grown up in societies still suffused with the legacy of 1500 years of Christianity, and the way it shaped art, literature, government, individual rights and so on.

The approach to interest, and finance more generally, is one of those differences.

 

The Governor’s talk

It was pleasant to walk along Wellington’s waterfront this morning to hear the Governor of the Reserve Bank speaking at a local function centre.  Given the numbers who turned up –  many of them Bank staff –  they could probably have saved a few dollars by holding the event on their own premises, but, I guess, it is other people’s money.

As the Governor explicitly noted that he would “look forward to the blogs”, I should probably do my bit.

A week ago when this event was announced, I devoted a whole (short) post to the announcement of the event, including the indication that they would be filming the speech and making that footage available on the web.   Doing so is a genuine step forward and I hope it becomes standard practice.

In that earlier post I noted

I have been critical of the Reserve Bank Governor for not yet having given an on-the-record speech about either of his main functions, monetary policy or financial regulation/supervision.  Next week marks a year since he took up the job

Unfortunately a year has now passed and we still haven’t had a substantive on-the-record speech about either of his main functions –  the sort of speech that would be standard, and quite expected, under any other Governor and in any other country.

Today’s speech was billed this way

Reserve Bank Governor Adrian Orr will talk about the future of New Zealand’s monetary policy framework  …..The revised monetary policy framework comes into effect on 1 April 2019. It is an outcome of the recent Phase 1 review of the Reserve Bank Act.    Adrian Orr will talk about changes to how monetary policy decisions are made in New Zealand, including greater transparency and accountability.

But there wasn’t very much about the new monetary policy framework (any aspect of it) at all.  You can read the text for yourself (and on this occasion the speech delivered was recognisably similar to the published text, which is not always the case I gather).

The whole event started rather oddly, with a fairly lengthy greeting in Maori from someone whose name I didn’t catch but who had no apparent connection to the Reserve Bank.  Only a small portion of whatever he said was translated, so I suspect very few attendees had any idea what he’d been saying.  He did, however, take the opportunity to make a few digs in English about the Foreshore and Seabed Act – of infamous memory – including at a former Labour MP from that era who was apparently in the room.  That seemed rather inappropriate in a Reserve Bank function.  Not even the Governor has yet claimed Reserve Bank responsibility for the foreshore and seabed.

The Governor did, however, tell us that someone else in the room had just agreed to be a “kaumatua” to the Reserve Bank – a title apparently quite in vogue in trendy government agencies, but not having an obvious place in way Parliament set up the governance of the Reserve Bank.  Isn’t all that stuff –  leadership, nurturing talent, resolving disputes –  among the functions of those tedious prosaic statutory roles such as Governor, Deputy Governor, and Board members?  But there is, we are told, a forthcoming Bulletin article, “RBNZ’s Strategic Approach to Te Ao Maori”.  That will be something to look forward to, no doubt involving more expensive and tortured efforts to explain why a macro-focused government agency, which deals with general public hardly at all, needs such a strategy and not (say) a Catholic one, a secular humanist one, a Pacific one, or an NZRFU one?   For an organisation that claims to be underfunded, they certainly seem to take every opportunity to spend resources on stuff other than their core business.

The Governor keeps on doubling down with his tree god nonsense, urging us to think of the Bank as akin to Tane Mahuta, the mythological forest god.   He delivered his speech flanked by two screens of this cartoonish graphic.

rbnz-tane-mahuta.png

He claimed this myth –  which has precisely nothing to do with central banking – “is” (not “was”) “central to the Maori belief system”.    Those who bothered by such things might suggest it was “cultural appropriation” –  although, ever deferential, he did stress that he asked permission to use the myth – but as I’ve noted in an earlier post

Pre-evangelisation, Maori had their own tree god, Tane Mahuta.    As far as I can tell, not many believe any longer in this local tree god: when I looked up the 2013 Census data, there were lots of Maori recording no religion, and there were plenty of Catholics and Anglicans.  But there wasn’t a category shown for tree gods, or any of the other deities (Wikipedia has a list of at least 35 of them).

As a recent commenter on another post noted

Imagine the reaction if the Bundesbank president started discussing policy in terms of Odin and Thor…. he’d get locked up…

And in addition to those references, we got the same warmed-over inaccurate nonsense the Governor has  run repeatedly about the creation of the Reserve Bank ‘letting the sunshine in” on the New Zealand economy and financial system.  I happen to agree that the creation of the Reserve Bank was, on balance, a good thing, but you’d not know from listening to the Governor that we’d had a stable financial system and a highly prosperous and productive economy without one.

What the speech really tended to show was a Governor with not much interest in the core business of the Bank (price stability, financial regulation, notes and coins, and a few ancillary bits and pieces).    Each of those functions matter.  It is important they are done well.  When they are done well, most people should have little interest in the Reserve Bank.

But, so he told us, the Governor is bothered that when they went out to “the community” (no polling results or the like, but I’ll take his word for it), people said they had significant trust in the Bank, but didn’t really know what it did.   But then they don’t really need to, any more than (say) I need know anything much about many of the dozens of government organisations you can find listed here (and I’m a geeky policy person, and still have no idea what, say, the Accreditation Council does).  How much does the person in the street know about, say, the organisation of our judiciary, or the distinction between the New Zealand Defence Force and the Ministry of Defence.  I’d struggle to even tell you what the Ministry of Housing and Urban Development does.

But it isn’t good enough for the Governor. So, on the one hand, we get cartoon versions of Monetary Policy Statements and Financial Stability Reports.  And on the other, considerably more worryingly, we get attempts by an overtly left-wing Governor to tie himself and the institution he leads to a whole series of trendy left-wing causes.  I’m sure he is not directly partisanly political, but his colours are firmly staked to an ideological mast, in ways that are potentially quite damaging.  After all, if he wants citizens to have confidence in his organisation around its core functions, those who aren’t sympathetic to his overt left-wing agenda will be less inclined to trust him even on the core issues he has responsibility for.  A new centre-right government at some point (ok, just kidding, but at least a new National one) might also be less inclined to trust him.   And, in championing these causes, he creates unrealistic expectations about what central banks can actually do, and opens the Bank up to pressure in future to join in promoting some other government’s set of ideological causes.

As an example of what I mean, here is an extract from the speech.

In the world today, the dynamics of global and national economies are interacting to a greater extent and, at times, working at cross-purposes. Underlying these interactions are social and political movements driven by a desire for greater well-being, both for current and future generations.

More recently we have been confronted with the issue of climate change, and its complex and powerful economic and financial impact.

We have barely scratched the surface in understanding the intergenerational impacts of these developments.

This desire for well-being is regularly reflected in discontent along the lines of economic, gender, racial, and intergenerational inequities – to name just a few. Therefore, ensuring social inclusion as a way forward in capitalist societies is necessary.

The first of those paragraphs barely even makes sense.  The rest do, but none of it has anything to do with central banks doing their jobs.    If this text appeared in a speech from Grant Robertson or James Shaw it might be quite unexceptionable –  it is the sort of stuff left-wing politicians say –  but what is a (supposedly neutral non-partisan) Governor doing spouting off about his views as to how “capitalist societies” should move forward.  Since it is what he is paid for, I’d rather hear him on the New Zealand cyclical economic situation, financial stability risks, positioning monetary policy for the next serious downturn or whatever.  Intrinsically less interesting perhaps, but that is the job he and his institution are paid to do.

The Governor –  particularly in his oral delivery –  was claiming a much wider mandate for himself from the newly amended Reserve Bank Act.  He is wrong to do so.

Even the badly-worded new Remit (replacement for the Policy Targets Agreement) makes that clear

remit

Whatever good monetary policy does –  and it is only the monetary policy bits of the Act that are changed –  it is “by” doing the same old stuff: leaning against cyclical fluctuations and maintaining medium-term price stability.

Here is the purpose statement from the amended Act

purpose RB

Yes, the current government’s waffly rhetoric about “wellbeing: and a “sustainable and productive economy” is enacted, but even this legislation is clear that –  whatever else the rest of government does (or doesn’t) do, the Reserve Bank makes its contribution by doing (well) the same old basics: monetary policy, a focus on a sound and efficient financial system, and notes and coins.

Inclusion –  gender, racial, religious, ideological, socioeconomic or whatever –  just isn’t the Reserve Bank’s territory.  Neither is climate change or other “social or political movements”.  Some of those issues may be quite important. Most are very interesting.  But if the Governor wants to pursue them perhaps he could create a blog in spare time (I wouldn’t recommend it), stand for Parliament, or put in a belated application to be the new Secretary to the Treasury.  All that other stuff will either distract the Reserve Bank’s attention (and perhaps suggest it already has too many resources), and/or skew support for the Reserve Bank along ideological lines in ways that are quite unhelpful in the longer-term (the Governor talked often of “legitimacy” and that dubious left-wing concept “social licence”).  The Governor talked of “our need to be a good global citizen”, but actually the New Zealand Parliament set up the Bank, and resourced it, to be a quite limited New Zealand government agency.

I could go on, but will bring this towards an end.   Three final points:

The Governor did mention briefly his proposals to substantially increase bank capital requirements. Nothing much of the substance, but he claimed that the Bank is open-minded and urged people to get their submissions in.  That is well and good, but it might be helpful to potential submitters –  including those not from the banks, who the Governor claimed to be keen to hear from – if the Bank actually released the supporting material –  for example, the Analytical Note on aspects of the economic impact that the Deputy Governor promised in his speech now more than a month ago, or the supporting information for ad hoc claims the Governor made on this issue at his MPS press conference more than six weeks ago.   It is more than three months since the proposal was released, and process is looking increasingly shoddy, as if they hope to run out the clock rather than provide substantive evidence for their proposals.   (Incidentally, in his delivered speech –  but not in the published text –  the Governor claimed that “we know” that significant bank failures cause significant damage for “all future generations”.  Perhaps that is another claim he might like to substantiate.  But it is probably just another one from off the top of his head.)

As I noted at the start, a former Labour MP was present.  That former MP was Tim Barnett who now leads what looks like a worthy organisation called FinCap which is

a new entity driven by the public good, acting in the interests of New Zealanders seeking budgeting and financial capability advice.

Sounds worthy. The Governor seemed keen on it, and said that the Reserve Bank would be endorsing this organisation in public.  Thus far, probably fine.  What was much less acceptable was to hear the Governor of the Reserve Bank say that he would be “coercing banks” to support it.  One hopes he wasn’t entirely serious, but when a regulator already wields a great deal of power on a wide range of fronts, they have to bend over backwards to avoid even suggesting any pressure (let alone ‘coercing’) on regulated entities to do things the regulator personally might like, but for which he or she has no statutory mandate.

Finally, the Governor ends the speech talking of how he and the Bank are going to “maximise their mandate”. I suspect he has in mind actually doing as much as possible to fulfil the mandate he has been given by Parliament, but it does sound awfully like a bureaucrat looking to expand –  to the maximum-  the role and scope of his bureau.  That isn’t what we need. We need a pretty boring organisation getting on and doing the (important, but quite limited) basics well.  At present, they are some very considerable margin away from the goal he articulates of being the “world’s best central bank” –  and nothing in this speech, or the others the Governor has given (and his term is now one-fifth over already) suggests they are making any progress towards it. If anything – and as evidenced in this speech – they are drifting further away.

But they turned on a good sausage roll, it was a good chance to catch up with a few people I hadn’t seen for a while…..and it really was a nice morning for a walk.

Just a shame about the central bank that was on display.

Deferring to Beijing

The Prime Minister is off to Beijing, to spend April Fools’ Day chatting with Xi Jinping and Li Keqiang, leaders of the brutal Chinese Communist Party regime.

It has seemed as if the carrot and the stick have both been at work in the PRC’s effort to keep the New Zealand government in line.   We had the failure of the Prime Minister to secure a visit Beijing last year.  Perhaps there really were some “scheduling difficulties” but no one really believes that was the whole story.  Only a few weeks ago the impeccably well-connected former New Zealand Ambassador to Beijing, John McKinnon, was telling us that a visit would happen but “not necessarily soon”.   And then suddenly 15 March happened, and suddenly a one day visit is scheduled at short notice.

In the meantime, we’d had the need to cancel the grand opening of the New Zealand-China Year of Tourism, at the PRC’s behest.  No one really supposes it was just “scheduling difficulties” –  even in a modestly sized bureaucracy if the key person does happen to be busy, you find someone else to turn up to significant events that matter to you and your friends.  But the bureaucratic and political “elites” scurried around, made clear their obeisance, and had the PM make coordinated statements with the CCP’s representative in New Zealand, and before long the opening of the year of tourism was back on again.  Lucky us, we were told, we were even getting a PRC government minister.

Who knows quite what really was going on.  Neither government is going to give a straight account.  But no one really doubts that the PRC was more than a little miffed at New Zealand and its government (the National Opposition was meanwhile doing its very best to demonstrate its cowed and subservient approach –  from Simon Bridges and Peter Goodfellow on down through Jian Yang).  Perhaps the New Zealand government hadn’t actually said or done much –  not a word of concern had ever been expressed by the Prime Minister –  but the PRC had previously had New Zealand pretty much where it wanted our government, and it wouldn’t do to let them back away from that silent subservience (on anything that concerns Beijing).   And their approach –  pretty mild in the scheme of things (no apparent deliberate hold-ups of coal deliveries, canola seed orders or whatever) –  seems to have been quite enough to scare the locals and bring the government more or less back into line for now.   The Huawei situation still hasn’t gone Beijing’s way – perhaps it eventually will, perhaps it won’t –  but probably even Beijing recognised that a heavy-handed approach over that specific issue might well enrage the natives and spark a political backlash (against them) at a time when they had other battles to fight (notably Canada).  And they’ve already demonstrated that even the mildest, deniable, expressions of unease can get official Wellington not just jumping, back asking how high.  Of one of the most odious and evil regimes on the planet (which has little substantial clout over New Zealand, except perhaps among a few businesses that have chosen to over-expose themselves to supping with the devil).  Much relief at the New Zealand China Council, in MFAT, among our universities…..and, no doubt, in Beijing.

And so the Prime Minister will head off to Beijing for lunch, tea, or whatever with Xi Jinping.   If anything of substance is on the agenda –  and the main purpose of the visit appears to be being seen in Beijing, so quite possibly nothing will –  we can confident that it won’t be things like:

  • Xinjiang,
  • the South China Sea,
  • the East China Sea,
  • Taiwan (PRC threats to),
  • the abduction, and continued detention, of two Canadians,
  • attempts to use economic coercion on Australia and Canada,
  • state-sponsored thefts of intellectual property,
  • the imprisonment, torture and intimidation of Christians,
  • the organ transplant business (highly dubious acquisition of organs),
  • other domestic repression (such as this, just this week).

And should there be any mention of Xinjiang (which seems unlikely, since she’ll say nothing critical here), it is perhaps more likely to be along the lines of “so tell me about those vocational training camps….”.

Most likely it will be an act of supplication on her part (“please Mr Xi, could we please have some more FTA…….please”), and a beneficient smile from the CCP rulers of Beijing. bestowing some sort of favour on one coming so compliantly.  More of this –  never ever saying anything that might upset Beijing – and perhaps we can be helpful again.

Why would an, apparently decent, person do this?  Does she (and one could ask the same of Simon Bridges) represent no values, no morality?  Is there any sense of national self-respect?

Which brings us nicely to how these parties operate at home.  A few weeks ago there was one day flurry of excitement when Labour MP Raymond Huo got his Labour colleagues on the Justice select committee to agree to block a request from Anne-Marie Brady to appear before the committee as part of its inquiry into possible foreign interference in our election.  This bit of the inquiry had been requested by the government after public submissions on the wider review of the 2017 election had already closed.    National’s Nick Smith, to his credit, took this public.  The Prime Minister’s office initially defended the effort to bar Brady, claiming that government departments could tell the committee all they needed to know (isn’t that a typical minister-captured-by-officials sort of line?).  And then the resistance collapsed and word came that Huo had been told to rethink.

And then the waters closed over the story and no more was heard (even before the 15 March murders).  None of our media seemed remotely interested in pursuing the story –  asking those other Labour MPs on the committee, for example, about what they’d been thinking when they blocked one of New Zealand’s experts on such matters (at least as regards the PRC), or asking the Prime Minister what her office had been doing backing Huo.  Let alone asking pointed questions of Huo, and insisting on answers.  For example, about he can possibly chair the committee, or have even involved himself in the specific decision on Brady, when he himself is the subject of serious concerns identified in Brady’s Magic Weapons paper (reported/excerpted in this post).  They might even have asked the National MPs –  who had done the decent thing in taking the issue public, and who perhaps even warned Huo that his stance would backfire –  why they still seem unbothered about Huo serving as chair on this particular issue.  How come they didn’t insist –  and aren’t now insisting – that he recuse himself?  It would be a quite standard application of any decent conflict of interest policy (even Shane Jones had declared his conflict of interest).

But, as it happens, the Huo-chaired committee has reopened submissions, from anyone. You have until 26 April to make a submission.  This is, quite clearly, what should have happened in the first place, once Andrew Little belatedly asked the committee to focus on foreign interference issues.  They’ve even approached Professor Brady and invited her to submit, and she says she will do so.

But it has hardly been done with good grace by the government members (all Labour in this case.  Here is Raymond Huo in the Stuff article earlier in the week on the reopening.

Huo said reopening submissions and updating the terms of reference had always been the preferred option of the committee.

“I should emphasise, Labour members of the committee did not ‘block’ Prof Brady or anyone from making a submission as the due process is to reopen the submission session, which would allow and encourage anyone who’s interested to make a submission,” he said.

The perception that Labour members, chaired by a Chinese-born MP, blocked her submission was so entrenched that nobody seemed to care about the due process, he said.

How does he even say this stuff with a straight face?  He was chair of the committee.  He was quite at liberty all along to have moved a motion to reopen submissions.  Instead, not ony did he not do that but he persuaded his Labour colleagues –  who should have known better – to go along with blocking the efforts of National members to allow even Professor Brady to submit. And all the time with a clear conflict of interest which it appears that, even now, he doesn’t acknowledge.  It would have been much better for him, at this late date, if he’d just kept quiet –  if he couldn’t bring himself to apologise –  than to open his mouth and further condemn himself.

Then again, it is not as if National MPs are calling on him out on it.

It is also worth bearing in mind that the reopened inquiry is (presumably deliberately) conveniently narrow in focus.  This is the notice from the Committee.

huo inquiry

I suppose people can submit on anything relevant to that broader question of “how New Zealand can protect its democracy from inappropriate foreign interference” (is there “appropriate” foreign interference –  perhaps the committee could offer its thoughts on that point in their eventual report?), but there is pretty clear steer on what members (chaired by Huo) actually want to hear about.

I’m no more keen than the next person on private emails of candidates or political parties being hacked, but to be honest I don’t see it as more or less of a concern than foreign powers hacking anyone New Zealander’s emails.  Official New Zealand government websites etc (as the PRC hack of the US government personnel database) might be more concerning.

As for the second item, I guess I don’t use Facebook, and we’ve all heard of these Russian bot-farms, but it looks a lot like a second-order issue in a New Zealand context (where Russian interests seem slight).  I’ve not heard any credible suggestion that the 2017 election here was influenced by such activity.

And, as for the third item, at present the law allows foreign entities to make (small) direct donations to political parties, and there are (apparently) few/no restrictions on such donations to local election campaigns.    There probably is a real issue there –  and it is one on which the National Party seems to have had a belated conversion –  but it is almost certainly less of an issue than legal donations made by New Zealand citizens and residents (individuals and companies) where there is reason to be concerned that even the ostensible donor has associations with, and interests to pursue with, a foreign power whose interests are not routinely aligned with those of New Zealanders.  But the committee shows no sign of being interested in pursuing that avenue.

I have had an exchange with someone encouraging me to submit, not as any sort of expert in the specific issues, but as a concerned New Zealander. I probably won’t do so, for two reasons.

The first involves the framing of the inquiry.  It is set up in a way that suggests that if there is an issue, around protecting our democracy (not just specific election results) from foreign interference, then (a) the responsibility rests abroad (bad foreign actors pursuing their interests, and innocent put-upon New Zealanders, and (b) that the answers are likely to lie with new laws or new powers for government agencies etc.

Evil regimes –  notably the CCP-controlled regime in Beijing –  will do what they will do.   But in my reading of the situation, very little about what is problematic in New Zealand is down to Beijing, it is about the choices –  quite explicit, and frequently renewed –  made by New Zealand MPs, ministers, and political parties.  Thus, as I’ve noted here before, I don’t (broadly) disagree with many of the policy recommendations Anne-Marie Brady has put forward.  And I do think the foreign donations law  – and donations law generally –  should be explicitly tightened so that only people enrolled to vote in New Zealand can donate (thus no corporate donations), and all donations above, say, $200 will be disclosed in near real-time.  Perhaps –  but I’m not convinced –  there is a place for some sort of register of people working for foreign interests.

But none of this gets near the real issue.  Things like:

  • party presidents of both main parties tripping off to Beijing to sing the praises of the regime and its leader (in public),
  • both main parties having MPs with strong United Front affiliations and widely seen as close to the PRC Embassy,
  • the way governments of both main parties stay almost totally silent on gross human rights abuses, and external threats, committed or posed by the PRC,
  • a National MP who formerly worked for the PRC military intelligence system, is/was a Communist Party member, and who acknowledges –  openly, to the Herald –  misrepresenting his past on his immigration/citizenship forms (and who is very much in the good graces of the PRC Embassy and its affiliate organisations in New Zealand),
  • the fact that no government agency has done anything about those acknowledged misrepresentations,
  • the fact that all political parties are now totally quiet on Jian Yang (none will call out his position as unacceptable), and that no political party seems bother about Huo (not even about him chairing the committee on foreign interference),
  • the fact that our two main parties got together to bestow a royal honour on someone with very strong PRC/CCP affiliations for what amounts to services to Beijing,
  • and the fact that the main parties (more so National in the past, although that may be changing now that Labour is in government) is totally unbothered about raising large amounts of donations from parts of the ethnic Chinese community that are closely aligned with PRC interests.

Decent parties wouldn’t do any of that.  New Zealand political parties do.  Beijing doesn’t make them make those choices.  None of those actions appears to be against the law (well, misrepresentation on the forms may well have been, but my focus is on the response of government and political parties).   Each of those things could be fixed now.  Today. No law changes needed, no inquiries needed, but the word would go out from party leaders –  who’d suddenly had an outbreak of decency –  that this sort of stuff just isn’t on.    But nothing happens.

Instead, we have a half-hearted inquiry, run by the very people – National and Labour Party MPs – who are the source of the problem. Perhaps individually they are decent people, but they are active participants in a corrupted system.  Probably both sides have an interest in appearing a bit open –  Labour is probably keen on playing the (US Democratic Party) card about social media or email hacking, and National seems willing to promote essentially cosmetic change around foreign donations.  But they show no sign of wanting to confront the real issue: themselves, and their party leaders (Ardern, Bridges, Haworth, Goodfellow).  The problem isn’t primarily Beijing – evil states will pursue their interests in whatever way they can –  but them.

And so anyone who submits to this inquiry, let alone appears, risks giving the inquiry a degree of legitimacy it doesn’t deserve.  It is a bit like the choices parties in troubled semi-democracies have to make about whether to participate or not to participate is the least-worst choice.  I won’t criticise anyone for appearing –  and someone of Professor Brady’s stature will likely attract considerable coverage, at “the hearing the chairman tried to ban” – but it isn’t choice people should make without careful thought.

After all, in addition to the bigger picture issues around the two main parties’ complicity (and it isn’t obvious the others are any better, just less important), the inquiry is still being chaired by Raymond Huo, the man with strong United Front connections, the man who adapted one of Xi Jinping’s quotes as the Labour slogan among the ethnic Chinese community, a man who (in a quote from Brady’s paper) apparently said

In 2009, at a meeting organized by the Peaceful Reunification of China Association of New Zealand to celebrate Tibetan Serf Liberation Day, Huo said that as a “person from China” (中国人) he would promote China’s Tibet policies to the New Zealand Parliament.

You really couldn’t make it up.    But no wonder Xi Jinping is happy to host the Prime Minister.  She is the leader of Huo’s party, she controls select committee apppointments and chairmanships.  She, via Andrew Little, controlled the narrow scope of the inquiry.

And all for what?  Deals and flow of donations.  Most people would thought she was better than that.

For anyone who wants another angle  –  to Brady’s – on Huo, here is an article (scroll down) from 2017 by the commentator who goes by the pseudonym of Jichang Lulu.

It should be sufficiently clear that Huo is another United Frontling. There’s nothing surprising about his incorporation of Xi’s personality cult into electoral politics, or his silence regarding the revelations about Yang Jian’s background. Regardless of his views on non-China related issues (which do indeed differ from the National Party’s), Huo isn’t Yang’s opponent as far as the CCP agenda is concerned. For united-front purposes, Huo is simply an egg in another basket.

By focusing on two key individuals from both sides of New Zealand politics, I have attempted to show how successful united-front tactics have been in ensuring permanent control of the Chinese community politics by hedging against democratic power shifts. This is only one of its successes. I refer you to Brady’s work for an overview of the extent of its penetration in politics beyond the Chinese diaspora, business and media. Its pervasive character helps explain why the reaction to the Yang case has been so muted, suggesting a ‘code of silence’, with the most senior figures in the major parties essentially glossing over the problem.

And, more generally, he ends this way

The Brady report isn’t about finding spies. Reactions seem to be addressing a straw-man. Raymond Huo, the Xi-quoter, denied “insinuations against his character”, but it’s not clear that any have been made. If anything, Huo is consistent in his support for CCP policies and increased PRC influence in New Zealand. This is not a spy thriller, but a story about the institutions of a democratic country being coopted to serve the agenda of a much larger state ruled by an authoritarian regime. Most of the people involved may very well have acted legally at all times, and their support for certain policies isn’t necessarily an issue of moral ‘character’. The issue is whether the actions of many members of the NZ elite are a risk for the country’s security, independence and democratic system. The latter has obviously been damaged. …..

The intersection of each of ‘National’ and ‘Labour’ with ‘Chinese’ is firmly under the aegis of the United Front. Perfunctory reactions from top politicians are a sign that UF successes aren’t limited to that community. Such control over an advanced democracy is something the united-front pioneers in the 1920s and 1930s could hardly have predicted.

 

 

Updating the Governor’s OCR view

In the wake of the Reserve Bank’s Monetary Policy Statement in February I wrote

As for the overall tone of the monetary policy conclusions to the statement, count me sceptical.  …for the Governor to suggest that the risks now are really even balanced, even at some relatively near-term horizon, seems to suggest he is falling into the same trap that beguiled the Bank for much of the last decade; the belief that somewhere, just around the corner, inflation pressures are finally going to build sufficiently that they will need to raise the OCR. We’ve come through a cyclical recovery, the reconstruction after a series of highly-destructive earthquakes, strong terms of trade, and a huge unexpected population surge, and none of it has been enough to really support higher interest rates. The OCR now is lower than it was at the end of the last recession, and still core inflation struggles to get anywhere 2 per cent. There is no lift in imported inflation, no significant new surges in domestic demand in view, and as the Bank notes business investment is pretty subdued. Instead actual GDP growth has been easing, population growth is easing, employment growth is easing, confidence is pretty subdued, the heat in the housing market (for now at least) is easing. Oh, and several of the major components of the world economy – China and the euro-area – are weakening, and the Australian economy (important to New Zealand through a host of channels) also appears to be easing, centred in one of the most cyclically-variable parts of the economy, construction. …

From a starting point with inflation still below target midpoint after all these years, it would seem much more reasonable to suppose that if there is an OCR adjustment in the next year or so, it is (much) more likely to be a cut than an increase.

The Governor appears now to have come round to that view.   If his re-think is overdue, it is welcome nonetheless.

I don’t take issue with much about his statement. but two lines did catch my eye.  The first was this one (emphasis added)

This weaker [global] outlook has prompted central banks to ease their expected monetary policy stances, placing upward pressure on the New Zealand dollar.

Perhaps that is correct –  although in the data the effect looks small –  but it is quite a dangerous line to walk down.  Either an easier stance of policy was warranted here on the New Zealand fundamemtals (including our exposure to the world economy) or it wasn’t (it was).   The exchange rate should be largely irrelevant to that choice, and reintroducing it like this risks some sort of MCI mentality taking hold.  He’ll remember those bad old days.

And the second, of course, was this claim

As capacity pressures build, consumer price inflation is expected to rise to around the mid-point of our target range at 2 percent.

To which one can really only say two things, a) yeah right, and b) isn’t this the same story the Bank has been telling for almost the entire decade?  Of course, as the former chief economist used to point out, in one sense they had to believe it –  if it wasn’t something they could say hand on heart then they should have adjusted policy already.  But if they really believe capacity pressures are going to intensify from here, they must now be in a pretty small minority.

Even though the data suggest that the Bank should have an easing bias in place (and perhaps should already have had a lower OCR in place), I was a little surprised that having walked past the opportunity in February, the Governor chose to act now.  After all, this is the last OCR decision that he will take as the Bank’s sole decisionmaker on monetary policy.  On Monday, the new statutory Monetary Policy Committee will take over responsibility.  Even though I’ve been consistently running the line that the Governor will, in effect, control all the appointments to the MPC and will effectively control the overall votes, I’d assumed he’d want to observe the proprieties and at least pretend that the new voters might make a difference –  might see things differently from him.

On paper, the Governor’s statement that

the more likely direction of our next OCR move is down.

doesn’t mean much. I’m sure he made this decision with two of the likely new MPC members (Deputy Governor Bascand and the very new Assistant Governor Hawkesby), but the new MPC will have four other members, most probably the new (as yet unannounced) chief economist, and three externals.  Most likely the externals (in particular) won’t want to rock the boat –  they’ll have been selected partly for that quality – but they might quite reasonably see the data differently than the Governor.  That could get a little awkward.   Perhaps the Governor ran risks whichever tack he took, but he could easily have explicitly noted the regime change and could then have eschewed any sort of bias statement (leaving the rest of the statement pretty much as it was).

(Presumably the Minister of Finance will finally announce the MPC members today or Friday.  When he does, I would be delighted to revise my view that they’ll have been selected for their inoffensiveness, if such a revision is warranted.  But I’m not holding my breath.)

And what of inflation?   As readers will know I have been tantalised by the implied inflation expectations derived from the indexed and nominal government bond markets.  Here is the latest update of that chart, the last observation being yesterday’s.

breakevens mar 19

Implied inflation expectations (for the average over the next 10 years) –  implied by people with money at stake, or the opportunity to stake it to clear out anomalies – have been nowhere near target for almost five years now.  In the last few months they have been dropping away again and now are barely 1 per cent.   The Reserve Bank never references this series, but they really should, even if only to make the case for why they think there is no meaningful information in it.

Perhaps you are thinking this is just a global phenomenon.  After all, nominal bond yields have been falling pretty much everywhere.  But here are the 10 year inflation breakevens for the US

us breakevens mar 19

Not only have the breakevens rebounded (risen) in recent weeks, but they remain near the Fed’s target inflation rate (also 2 per cent).

With core inflation still below target after all these years, market-based expectations measures low and weakening, with increasing unease about the world economy (including the economies of our two largest trading partners), with most of forces that impelled the (productivity-less) growth in recent years having exhausted themselves, and with weak business survey measures, the case for a lower OCR already looks pretty strong.

What, realistically, would be the worst that could happen if the Bank had cut and the cut turned out to be unnecessary?  Unemployment would be a bit lower, even if temporarily, and core inflation might rise to the height of, say,  2,2 or even 2.4 per cent.  Perhaps not desirable outcomes in their own right –  the focus is supposed to be 2 per cent — but after all these years undershooting the target hardly likely to destabilise public or market confidence in the Bank’s conduct of monetary policy and delivery of medium-term price stability.

UPDATE:  The Minister of Finance has announced the appointments to the MPC this morning.  My initial reaction is that there is no need to revise my judgement about the structure and likely dynamics of the MPC.  It is quite disconcerting that one (internal) member has been appointed for only a one year term, which will place that person even more than usually under the heavy influence of the Governor.  The Minister would have been better to have started the committee with 3 internals and 2 externals and made the final external appointment when the new permanent Chief Economist is finally appointed.

The shift from services to goods in NZ international trade

I wrote the other day about the woeful underperformance of our tradables sector, suggesting that it was past time for the Minister of Finance and the Secretary to the Treasury to actually engage with, and respond to, the underperformance.

Instead, this morning I stumbled on a speech given the other day by the Secretary to the Treasury that, in this regard, is not much better than just making stuff up.   The address was to an outfit called the New Zealand India Trade Alliance.   I’m sure there is lots of worthy detailed stuff in it, but my eye fell on this line

New Zealand is taking a more productive and effective path. We recognise the importance of continuing to focus on building a resilient workforce with flexible skills, and that we should expect and enable the economy to adapt to change as it happens.

One of the most positive changes for New Zealand has been digitalisation. It has thrown open opportunities to sell services and deliver them to other countries in a fraction of a second, in addition to selling goods delivered in days or weeks.

This shift in trade from physical goods to services is very evident in the trade between New Zealand and India.

It wasn’t a speech I’d normally have read, but this line –  the “shift in trade from physical goods to services” –  had been highlighted in a tweet retweeted by the (able and respected) MFAT Deputy Secretary responsible for trade negotiations etc.

It appears to be true in respect of the (fairly small) trade between India and New Zealand (Makhlouf quotes some numbers).  But it just isn’t happening for the New Zealand economy as a whole.  In this chart, I’ve shown two lines: for the whole country, exports of services as a share of total exports and exports of services as a share of GDP.

services X mar 19

Services exports now (from New Zealand) are about the same share of total exports as they were 20 years ago.  And, consistent with the fact that total exports as a share of GDP has shrunk over that time, so has total services exports as a share of GDP.

And, as I noted in the post the other day, this is although we are heavily subsidising some parts of services exports –  the film industry notably, but also the export education sector (by bundling work rights, residence points etc together with the sale of education services, an issue that may have been of some salience for services exports to India).

How can we hope to see half-decent analysis and policy advice from the government’s (self-described) lead economic adviser, when the Secretary to the Treasury won’t even face basic facts?  There is nothing intrinsically wrong with goods exports –  in a successful economy we’d probably have more exports (and imports) of both goods and services – but there simply is no aggregate New Zealand shift from good exports to services occurring.

I’m not a mercantilist, and it is important to look at the imports side as well.  Perhaps the Secretary really had in mind imports of services?  But that doesn’t help either.

services M 2

Almost 42 years, and no shift from physical imports to services imports at all.

 

Destroying the economy in one fell swoop

When I got to page 7 in this morning’s Dominion-Post I wasn’t sure at first that my eyes weren’t deceiving me.    I read it again, and even then wondered if what I was reading was a typo.  But these people seemed to be deadly serious.

open letter

Their demand is there in bold: that the government take steps to reduce (net) greenhouse gas emissions to zero by 2025.  Their demand doesn’t appear to be conditional on other countries doing anything.  It is simply flagellation –  but not self-flagellation (in which these individuals themselves commit to reducing all direct and indirect emissions associated with their own consumption and production to zero by 2025)  but a brutal whipping delivered to everyone.   Not even our government, evincing no concern for productivity or for lifting the performance of the underperforming New Zealand economy, would be that stupid or (electorally) suicidal.  (In fact, that left me half-wondering if this was really intended as a piece of political theatre –  get together a group advocating something so recklessly stupid and costly that the government’s own proposed net-zero by 2050 target will seem moderate and reasonable.   But many of the names of the petition –  a couple of hundred visible in the advert, and another 2000 or so who’ve signed –  appear to be “true believer” types.  And all their rhetoric suggests they are in deadly earnest.)

It all comes complete with the typical zealot’s demand –  “this is no time for party politics” (further down the advert) –  as if their propositions (and time frames) were so self-evidently (or by revelation) true, that no further debate should be countenanced.  End of story.   And yet, perhaps not surprisingly, of the key figures in this organisation one is the former leader of the Green Party and another is a former Greens Regional Councillor (I didn’t recognise the other names, but it wouldn’t surprise me if a quick search revealed other strong Green Party ties).  Green Party politics is just fine it seems, but not anyone else’s?

It is now March 2019.  That means these crusaders claim to seriously believe that in just six (and a bit) years we should reduce all (net) emissions to zero.  Sure, the trees that are already growing will offset a bit, and a few more trees will be planted in the coming years (but any tree planted today is still going to be rather small in 2025).    The offsets (the LULUCF bit) just don’t make that much difference (as this MFE chart illustrates).

emissions

They seem to be calling for probably a 70-75 per cent reduction in gross emissions (animal, energy or whatever) in a mere six years.  Being true believers I presume they will also be wanting international air (and sea) travel emissions –  which aren’t included  in the official framework but are just as polluting  –  radically slashed in six years.

I noticed in their advert a comment that “Solutions DO exist”, so out of curiosity I looked up their website.    Here is the Deeper Thinking section.  From the introduction

We will not accept action on climate change that further increases inequality, takes away democracy [but it was “no time for party politics”?], destroys our natural ecosystems, or compromises human rights. Some scientists think they can geo-engineer the planet by blocking the sun or changing the chemistry of the oceans. That is not our vision. In fact, this kind of change will make it even more difficult to reduce emissions.

We need a change of values that puts the everyday rights and needs of people before the profits of corporations. A change that values Nature, and respects its limits. A change that truly honours Te Tiriti o Waitangi, by which we mean recognizing the holistic world views of tangata whenua, their perspective of being intrinsically connected to the earth, the role of mana whenua in discussions and decision making, and the importance of environmental integrity to the health and wellbeing of communities who sustain themselves from it.

Make of that what you will.

There was a promise that one day (before 2025?) their website will have some more concrete material on “better alternatives”, but it isn’t there yet.  In fairness, they do finally mention economics.

Climate change is about economics. That is why it is hard. It is not possible to address climate change without changing our economic system. Resources and the ability to absorb pollution are limited. We cannot keep growing the economy without growing environmental damage. Much has been written over the last 40 years about the economics of ‘enough’ rather than ‘more’ which can give us a better way of life with less damage to the climate, the water, and each other. Aiming at human wellbeing rather than industrial growth, accepting the limits of nature and natural resources and valuing things other than just money is the basis.

Take that third sentence.  It would probably be better, and more honestly, reframed as “it is not possible to cut gross emissions by 70 per cent in six years, especially when half your emissions are from animals, without destroying New Zealand’s economy, severely undermining material living standards and [see the first block of their text], and (most likely) materially increasing inequality”.  But, perhaps, the signatories would feel better.

So what would this involve?  Well, first it would almost destroy our tourism industry (and our export education industry), which relies on air travel, and where there are as yet no commercially viable replacements for emitting fuels.   Then it would destroy our pastoral industries –  animals emit and, whatever the technological innovations, will still substantially be doing so six years from now.

I presume the signatories have dreamy visions about electric cars, trucks, and trains.  But, as of now, almost the entire stock is powered by petrol or diesel.  What do they propose?  Confiscation of all existing vehicles, with or without compensation?   And while it is fine to talk up the possibilities of wind (and the dreadful visual pollution it entails) or solar, we’ve yet to see anywhere the sort of (economic) large-scale battery storage deployed in ways that suggest a quick replacement of the full fleet is in any way sensible, or economic.   Many of us –  old fogies like me, but more importantly poor people – don’t want to buy new vehicles, which are very expensive (petrol or electric).

Presumably much of the building and construction industry is also a gonna –  a lot of emissions involved in producing cement.   That will be a bit of an issue in a country with one of the fastest population growth rates in the advanced world.   Perhaps raupo cottages are an alternative?

One is rather left wondering how New Zealanders earn their way in the world –  literally, profitable activities competing on world markets –  in this vision.  It wouldn’t “just” be a matter of sustaining growth –  a concept that seems distasteful (at best) to these people –  but of sustaining even the material living standards we have now, which lag well behind those in leading advanced economies (and thus constraining all sorts of personal and government choices).  Run through a list of New Zealand exports, and there won’t be that much left (a bit of wine, some fruit, a few services (ones that don’t rely on consultants jetting in to other countries, and……?).  I guess the exchange rate would plummet, but –  given the constraint of zero net emissions –  it is hard to see what viable new outward-oriented business would be likely to spring up here, so far from the rest of the world (and distance means, among other things, emissions).

The current government has talked of a commitment to a net-zero by 2050 target (although after their consultation process we have yet to see the final form of that commtment).  I wrote last year about the potential economic consequences of adopting such a goal, drawing mainly on the NZIER work commissioned for the consultation process by the Ministry for the Environment themselves.

The Minister for Climate Change has made the public claim that his net-zero target (by 2050 –  which would give us six times as long to adjust) would be a “massive economic boost“.    But that isn’t what the NZIER modelling showed.  This quote is from the government’s own consultative document

The analysis by NZIER suggests that GDP will continue to grow but will be in the range of 10 per cent to 22 per cent less in 2050, compared with taking no further action on climate change.

As I noted at the time

Those are breathtakingly large numbers (future GDP gains) for a government to simply propose walking away from. 

The hair-shirt the government proposed to compel all to wear was going to be astonishingly costly.

And then there were the (in)equality implications.  Recall that this was for a net-zero target by 2025 (still 31 years away, not six).

In my previous post, I quoted the MfE text

Our modelling suggests the households that are in the lowest 20 per cent bracket for income may be more than twice as affected, on a relative basis, than those households with an average income.

Which is quite bad enough. But it is all the more stark when you see the chart in the NZIER report, drawn from some work done for them by Infometrics  (in this chart they are looking only at the additional estimated losses from moving from the 50 per cent target to a net-zero target).

emissions distribution

Specifically, people in the bottom two income quintiles will be hit six times as hard as people in the top quintile.    Like MfE in the consultation document, NZIER rush to the client’s defence and suggest that redistribution policies could alleviate this.   You wouldn’t thought that sort of advocacy was their role –  having been commissioned to do modelling –  but more importantly, they should know as well as anyone that when governments adopt policies to materially shrink the economy, it is even harder than usual to persuade voters in the upper quintiles to agree to give up even more to mitigate the losses the worst off are exposed to.   Redistribution tends to win more favour when everyone is getting better off.

But, never mind, I guess, the signatories will feel better, and it is –  so they tell us –  no time for party politics.  Just destroy material living standards with one fell swoop, no doubt hoping –  with the best of intentions no doubt – that something will turn up.

(Of course, if they were at all serious about doing all this, in a way that hurt New Zealanders least, among their policy prescriptions would be a sharp and permanent cut in immigration numbers.  I made that case to the Productivity Commisson inquiry.   But since the Green Party also likes to position itself as the equal-top most pro-immigration political party, one can only assume –  again –  that the point of the exercise, in practice (whatever their best intentions) is to maximise the pain of the sort of adjustment they propose.  Flagellation in other words.)

Did an experiment “deepen and prolong” the Great Recession?

(Long and fairly geeky)

That’s the claim emblazoned on the cover of US academic George Selgin’s 2018 book Floored.   It is a big claim by a smart author, who has written many years (often quite sceptically, to say the least) about aspects of central banking.  And, for once, I won’t bury my conclusion: I wasn’t convinced.

The “experiment” Selgin is writing about is the decision, implemented at the start of October 2008, to pay (effectively a full market) interest rate on excess reserves (over and above the regulatory minimum the Fed persists in requiring) held by banks in their accounts at the Federal Reserve.    The Fed was late to the business of paying interest on these deposit balances (other countries, including New Zealand, had done so earlier).  It required Congressional authorisation –  itself a somewhat unusual feature –  and even having obtained that approval the new regime wasn’t supposed to be implemented until 2011.   And when the legislation was passed the focus had been on required reserve balances (not paying interest on those just represented a federal tax).   But with Fed liquidity operations during the 2008 financial crisis adding lots of excess reserves, the new interest on reserves policy was rushed into effect from 1 October 2008, with the aim of supporting demand for those reserves, and stopping market interest rates falling further than the Fed wanted.

That might seem a bit odd.  But remember that although the Federal Reserve was pretty responsive to liquidity stresses and frozen financial markets, they were slow to grasp the severity of the economic downturn.  This is from an earlier post

For example, the FOMC met two days after the Lehmans failure [in mid-Sept].  Had the Fed thought the Lehmans failure would prove “catastrophic”, or even just aggravating the severity of the recession, a cut to the Fed funds rate would surely have been in order.  There wasn’t one.  And the published records of the meeting show no sign of any heightened concern or anxiety about the financial system or spillover effects to the economy. 

It wasn’t until mid-December 2008 that the Fed funds target range was lowered to 0 to 0.25 per cent (with excess reserves now being remunerated at 0.25 per cent).

Congress had actually specified that any interest paid on reserves was to be at a rate that did not “exceed the general level of short-term interest rates”.   And yet, as various charts in the book demonstrate, the rate paid on excess reserves was to consistently exceed other short-term rates (including LIBOR, GC repo rates, and Treasury bill rates).   Notwithstanding the Congressional mandate, this wasn’t an accidental outcome, but a matter of deliberate design, since the Fed’s explicit aim –  outlined in various policy documents Selgin cites –  was to make excess reserves “attractive relative to alternative short-term assets”.    For that to happen, the interest rate had to be attractive.

Selgin’s argument is that this choice was at the root of much evil.    Specifically, by making excess reserves attractive –  so that banks didn’t want to get rid of them –  the historical link between excess reserves and broader monetary aggregate measures was broken.   Had banks been encouraged/incentivised to use, and (individually) try to get rid of, excess reserves, access to credit would have freed up much more quickly, demand would have expanded, and the economic downturn would have been (a) less deep, and (b) less prolonged.   As far as I can tell, the main channel seems to be a demand one, but he also argues that the productivity growth slowdown would also have been less severe.

Here’s why I’m not convinced.

First, take the counterfactual in which interest had not been introduced on excess reserves.  By 8 October 2008, the Fed funds target rate was still 1.5 per cent.  Without any remuneration on excess reserves, short-term market rates –  at least those that didn’t involve pricing any bank credit risk – would have been heading towards zero pretty quickly.    But by 16 December, the Fed funds target (now a range) was reduced to 0 to 0.25 per cent.   With no interest on reserves, the increasing volume of excess reserves would have reduced more market rates to zero.  But that is a difference of (a) two months and then (b) 25 basis points.    25 basis points rarely makes that much difference.

The argument is that credit conditions would have eased up more quickly.  Well, maybe, but in late 2008 and early 2009, not only was there extreme uncertainty about the creditworthiness of many marginal borrowers, but there was a great deal of reluctance among borrowers to take on new credit (who knew when demand and activity would recover?).  For entirely understandable reasons, most people were in batten-down-the-hatches mode.

I’m quite prepared to concede that lower interest rates could/would have made some difference – by then not so much in altering the depth of the trough, but in supporting the recovery that got underway from about mid-2009.  But (a) the near-zero effective lower bound on nominal interest rates prevented short-term falling to anything like the extent (to say -5 or -6 per cent) that analysts estimated (using Taylor rule frameworks) might, in the abstract have been desirable, and (b) the Fed didn’t want to lower interest rates further.  How do we know that?  Because they made no effort to utilise all the leeway they did have (various other central banks later cut their policy rates as low as -0.75 per cent), or to take emergency steps to ease the effective lower bound.   (In fact, had they been able to take their policy target rate materially negative, introducing interest on effective reserves would have been a prerequisite –  if you could earn zero on funds in the Fed accounts, while all around you rates were negative, the option of just leaving your money at the Fed would have been exceedingly attractive.)

And, of course, it wasn’t just the Fed that didn’t want (or believe it necessary for) short-term interest rates to be lower.    Bond yields for a long time were pricing a pretty quick rebound in short-term interest rates, and it wasn’t until 2012 –  well after the trough of the recession –  that US 10 year Treasury yields got down to around 1.5 per cent.   The Fed and markets were mostly, and repeatedly, focused on the first tightening (which didn’t actually take place until 2015).   That was a mistake, of course, but presumably involved the best expert judgement of the FOMC about where short-term rates neeeded to be.  If they’d read the economy correctly, official short-term rates would have been set lower, regardless of the interest on reserves policies.

The other main reason I’m sceptical is that all of this is a US-specific story, and yet the US experience of the recession and recovery wasn’t unusually bad, even though the US was itself the epicentre of the crisis.    If Selgin’s story was correct, the combination of being the crisis epicentre and adopting the IOR policy in the middle of it all, should have left the US economic performance looking pretty poor relative to, say, (a) other big countries (G7) with their own currencies, and (b) non-crisis advanced countries.  That should be so whether we focus on either real GDP per capita or real GDP per hour worked.

There are three other G7 floating exchange rate countries.  Two –  Japan and Canada –  didn’t have a homegrown financial crisis at all, while the UK was caught up in the US crisis.  Of those countries, all three had slower higher productivity growth than the US over the decade after 2007, and the US also had higher growth in real GDP per capita (although the differences with Japan and Canada are small).    Comparing the US with the smaller floaters who didn’t have a crisis (Australia, Norway, Israel, New Zealand) the US looks to have been pretty much in the middle of the pack.  Precise comparisons depend on which periods and which variables you focus on, but the US experience really doesn’t stand out in the way the Selgin hypothesis appears to require.  Of course, one never knows the (economic) counterfactual, but much as he criticises the IOR policy, Selgin doesn’t (that I noticed) set out one either.

In his book Selgin cites another short piece he wrote last year specifically about New Zealand’s experience with interest on reserves.  He claims our experience supports his case.   I’m also not convinced about that.

Some history.  When the OCR system was introduced in 1999, we designed it as (what is known as) a channel system.  The OCR itself was set half-way between the interest rate paid of deposits (25 basis points below OCR) and the rate at which banks could borrow (collateralised) from the Reserve Bank (25 points above OCR).  Actual settlement cash balances were tiny (of the order of $20 million in total).   Banks were required to keep their accounts in credit at the end of each day, but otherwise they had no real demand for positive balances. $1 each was, in principle, sufficient.    Banks lent and borrowed among themselves to manage the impact of net customer flows between them.

That system worked only because of a strange bifurcation we had (consciously and deliberately) introduced a few years earlier.  Until the late 1990s, interbank settlements were done only once at day (leaving lots of intraday credit exposures which could have led to havoc etc if ever there was a bank failure).  Like most other countries, we replaced that with a real-time gross settlement (RTGS) system, under which large wholesale transactions (mostly fx, but also fixed interest securities) were settled individually during the course of the day.  In a system with perhaps $30-40 billion of daily transactions, $20 million of total reserves wasn’t going to be enough.

To meet these liquidity needs, we set up a system of collateralised intra-day credit (“autorepo”), in which we lent banks billions of dollars during the day and took their securities as (in economic terms) collateral. At the end of the day, all those intraday transactions were unwound, and the system ended each day still with only $20 million or so of aggregate sewttlement balances.  By the mid 2000s, however, there was impetus for change from several sources.  Maintaining the separate software (the “autorepo module” in Austraclear) seemed cumbersome, probably expensive, and unnecessary.  And the stock of government bonds was steadily diminishing (lots of fiscal surpluses, and high offshore demand for NZ government bonds) and the Bank’s appetite for lending on paper issued by banks themselves (mostly bank bills) –  which had never been high – was diminishing.

And so we adopted a radically simpler system.  Instead of lots of lots of intraday repos, and the $20m balances at the end of the day, we just combined the two.  The Reserve Bank injected additional liquidity (billions of dollars of it) and bought various financial assets with the proceeds.  Bank wanted –  or needed – substantial balances to cope with the ups and downs of intra-day settlement flows.    They held more settlement cash balances and fewer securities, and we issued more settlement cash balances and held more securities.  This chart from Selgin’s New Zealand paper illustrates the magnitude of the change.

RBNZ-Settlement-Cash

Since the change was not intended to have any macroeconomic consequences, unsurprisingly there was a considerable change in the ratio of (say) broad money to settlement cash balances.  But for big picture purposes, that change itself was inconsequential.

However, one consequence –  the one that is the focus of Selgin’s note –  was that we no longer had a channel system. If we were paying an interest rate on $8 billion of settlement cash balances, that was going to be the operative Reserve Bank rate (hardly anyone borrowed from us again through the standing facility, except to test that it still worked) and the OCR was redefined as the deposit rate.  We’d moved –  consciously and deliberately –  to a floor system.   Selgin makes quite a lot of the idea that a mere a 25 basis point change had materially altered demand for reserves (hence the parallel he seeks to draw with the US), but in fact what really created the new demand was the Reserve Bank’s decision to end autorepo (and special intraday credit).   Banks could simply not have settled their payments –  sometimes well over $1 billion each  –  without holding a lot more settlement balances.

The simple system was initially introduced didn’t last long, in part because the early stages of the financial crises (abroad) broke upon us relatively soon.   Initially, we’d been willing to pay the OCR rate on any balances banks had in their accounts at the end of each day.   But for a variety of reasons, many people at the Bank were not happy about the consequences of this, including the fact that if a bank wanted to hold more settlement cash balances and couldn’t find any other bank keen to lend to them, we had to respond by increasing settlement cash balances, or see market interest rates potentially move out of line with our target.    I took the view that if there was a higher demand for settlement cash balances –  and macro conditions were where we wanted them – we should simply supply them.  The taxpayer typically profited from us doing so.

From memory I was the lone dissenter on the relevant committee when it was decided to introduce “tiering”. Under these arrangements, we would tell each bank how much they were allowed to hold at a full OCR interest rate, and anything else in their accounts at the end of each day would earn a rate a lot lower.  There were earnest bureaucratic efforts to devise formulae to determine how much banks should be allowed to hold, and through my remaining years in the Bank these were updated very so often.  I could never quite reconcile myself to this sort of (perhaps largely harmless) “central planning” or rationing.

Selgin –  who has written a lot in the course of his career about free banking, and the (not free) pre-Federal Reserve regime –  seems to think that tiering (which made excess reserves quite unattractive to banks) made a material difference, including to our economic performance.  Tiering was actually introduced as part of a package and (at least in my observation) the other component – lending secured on bank bills –  was at least as important, if not more so.  Selgin argues that, in consequence, credit spreads in New Zealand never blew out to the extent in the US and Europe, while somewhat grudgingly conceding what looks to me quite an important difference:

though the difference also reflected the fact that New Zealand’s banks were not so encumbered with toxic assets as some U.S. and European banks.

As in, not at all exposed to the sort of assets creating problems then in the Northerm Hemisphere.

It is certainly true that –  as compared to the US system –  tiering did lead to some new overnight interbank lending. Selgin puts a lot of store on this (and on the death of the overnight market in Fed funds in US), but I think it is a mistaken emphasis.   First, had our banks had anything like the degree of concern about each other that US banks did, there’d have been no interbank lending during the crisis.  And second, and more important, banks have plenty of other interactions in which to monitor the creditworthiness of each other.  Overnight loans have always seemed pretty minor relative to those other exposures (eg collateralisation on net positions in derivatives markets etc).

Selgin’s bottom line about New Zealand is this

The RBNZ’s success in keeping credit flowing may have in turn contributed, if only to a modest extent, to New Zealand’s Great Recession being  both one of the first to end and one of the shallowest.

And yet, with barely any domestic financial crisis ourselves and –  on Selgin’s telling –  with superior monetary management, here is the chart of per capita GDP.

crisis costs 2019

Yes, our recession was a little shallower than that of the United States –  you’d surely expect that when we didn’t have big banks toppling over, or new ones being bailed out almost every week.  A year or so later, we actually had a relapse, and across the whole decade there was rarely more than 1 per cent difference between the total cumulative growth rate.   And this is the chart on which New Zealand looks relatively good.

Here, by contrast, from the OECD data, is real GDP per hour worked for the two countries.

us nz prod

Our underperformance isn’t necessarily much worse than it was pre-crisis, but (a) the US did have the crisis and Selgin asserts it was very costly, and (b) we have the monetary management system that he regards as superior to that in the US.  There just doesn’t seem to be anything in the data to support a story that interest on reserves really made any material difference to macro outcomes.

The bigger issue always was the over-optimism about the outlook that meant that Fed wasn’t as aggressive as it could have been (actually neither was the Reserve Bank).  That remains a concern now when the authorities in neither country have done anything to “fix” the near-zero lower bound constraint.  And, by definition, the next serious downturn is getting closer every day.

For those (geeks) interested in such things, it is an interesting and stimulating book.   And he raises some points which I found more persuasive about the reluctance of the Fed to more actively reduce the size of its balance sheet, even years after the crisis.  That has the effect of leaving the central bank nearer the centre of the credit allocation process than it really should be. In turn, that risks inviting Congressional (or industry) pressure in the next downturn for the central bank to do more of that credit allocation: if there is a role for government in such matters, it is surely one for fiscal policy and Congress itself, not for the central bank.

Those readers with institutional subscriptions can read my, considerably shorter, review of Floored on the Central Banking journal website.