Housing policy failures bear heavily on the poor

Last week a reader sent me the right hand part of this set of charts

aus housing 1

The data are for Australia, but it is hard to believe that, if we had up-to-date census data, the pictures now would be much different for New Zealand.

I’ve seen charts like the left hand one for New Zealand, but what I found sobering –  and frankly scandalous –  were the results for lowest and second lowest quintiles in the right hand chart.

A decent society has to be judged, in considerable part, by how it treats the poorest and most vulnerable among us.    People can run all the clever lines they like about how many of the people in those bottom quintiles have things now that comparable people in 1981 didn’t have.  But it is doesn’t excuse the entirely manmade disaster of the housing markets in New Zealand and Australia (and various other places).

In 1981, when our societies as whole were substantially materially poorer than they are now, (Australia’s real GDP per capita was about 80 per cent higher in 2016 than in 1981), young people at the lower end of the income distribution was just as likely to own their own home as those at the upper end of the income distribution.  But now people at the bottom are less than half as likely to own their own place.  In a well-functioning market that simply wouldn’t have happened. But we –  and Australia –  having housing and urban land markets rigged by central and local government politicians and their officials, and the people at the bottom are the ones who how most severely and adversely affected.

Sometimes people will try to tell you that preferences have changed, such that young(ish) people no longer want to own their own place to the same extent.    But look at how little the home ownership rates for the upper quintiles have changed.  That alone suggests that people are being forced to adjust to new affordability constraints, not that a whole generation of young people – given the opportunity –  no longer prefer to own their own place.

The chart is taken from a pretty substantial report by the Grattan Institute, a centre-left think-tank in Australia.   Flicking through some of the report, I found a couple of other charts.

One of the ways of adjusting to new, artificial, affordability constraints is simply to stay living at home for longer.

aus housing 2

Another is to get financial support from family.

aus housing 3

Back when real incomes were half what they are now (1970s), most people (in all quintiles) buying a first house by the time they were 34.  Now only about 35 per cent of lower income people are buying a first house by the time they are 44, and a much increased share of the (reduced percentage) buying a first home at all are needing financial help from family (presumably mostly) to do so.

There is simply no need for any of this –  the more so in a decade in which interest rates (and thus mortgage servicing costs) are lower than they been for generations.  It is what our governments have done to us, most notably to the poor among us.   It is shameful.

There are no excuses.  One day, those responsible (from both sides of politics) will face the judgement of history for their active complicitly, or quiet indifference.

And no, a capital gains tax would have made no material difference to any of these outcomes –  these are, recall, Australia data, and Australia had no CGT in 1981 but does now.  But perhaps some of the passion that fired those now so upset with the Prime Minister did reflect a sense of the failure of leadership in addressing this fundamental, longrunning, failure of policy around housing and urban land.  There is a real opportunity for the Prime Minister –  or for the Opposition –  to take a decisive policy lead, and actually make a change for the good, for the poor in particular.

(Not) reforming the calendar

A few weeks ago I was pottering in a local secondhand book shop and stumbled on Time Counts: The Story of the Calendar published in 1954 and written by British journalist Harold Watkins.   There was quite a bit of interesting history in the book –  including around the belated British adoption of the Gregorian calendar – but the main purpose of the book was to champion the then-rising cause of calendar reform.   The foreword was by Lord Merthyr, chairman of the British section of something called the World Calendar Association.

I’d never even known there was such a movement, which wasn’t just a marginal group of nutters and obsessives.   Their cause had been taken up by the League of Nations in the inter-war period, and at the United Nations in the late 1940s and early 1950s.    Numerous governments weighed in, mostly either supporting or somewhat indifferent to, the cause of calendar reform (in New Zealand’s case, the Labour government of the late 1940s had declared in favour).   At the time The Story of the Calender was published, it seemed as if there was a real prospect of reform.  But it didn’t happen.

It is hard to get inside the thinking of serious people who championed reform in a cause which has since died away almost completely.  Granting that the Gregorian calendar is an approximation (think leap years, and the adjustments at ends of centuries and of every four hundred years, and it is still an approximation) quite what was the practical concern?    What seemed to bother the advocates of reform was things like the irregular number of days in each quarter, the fact that any particular date falls on a different day of the week in successive years (you can’t immediately know that the 15th of July is, say, a Wednesday) and –  of course (and I’ll come back to this topic) – the moveable feast of Easter.  Oh, and you need a new calendar every year.

The first two of these simply don’t seem very burdensome at all.  But I guess that a key difference between now and 1954 is that we live in the age of ubiquitous computing power (smart phones in almost every pocket or hand-bag).  If, for some reason, I’m signing a contract maturing on 15 July 2099 –  and I wish to avoid weekends – it takes me perhaps five seconds to find that that will be a Wednesday.    If I’m analysing sales or production, seasonal adjustment procedures with trading day adjustments are relatively readily available, and so on.  And, on the other hand, there is something nice about not having one’s birthday celebration fall on, say, a Monday every year of one’s life.  And I rather like the fact that Christmas isn’t always on the same day of the week –  perhaps it is just what one is used to –  even if does mean that every year newspaper stories comparing retail volumes in the days leading up to Christmas are less valid than the publishers like to think because precise retail patterns depend to some extent on how close Christmas Day falls to the preceeding weekend.

Anyway, the reformers thought all these were significant issues worth addressing, and they managed to persuade a fair number of the governments of the world (from east and west, Christian origins and not) to go along.  There were, we are told, a bunch of different reform options, but support was greatest for the so-called World Calendar.    Here is a summary of what they were championing

The World Calendar is a 12-month, perennial calendar with equal quarters.

Each quarter begins on Sunday and ends on Saturday. The quarters are equal: each has exactly 91 days, 13 weeks or 3 months. The three months have 31, 30, 30 days respectively. Each quarter begins with the 31-day months of January, April, July, or October.

The World Calendar also has the following two additional days to maintain the same new year days as the Gregorian calendar.

Worldsday
The last day of the year following Saturday 30 December. This additional day is dated “W” and named Worldsday, a year-end world holiday. It is followed by Sunday, 1 January in the new year.
Leapyear Day
This day is similarly added at the end of the second quarter in leap years. It is also dated “W” and named Leapyear Day. It is followed by Sunday, 1 July within the same year.

The World Calendar treats Worldsday and Leapyear Day as a 24-hour waiting period before resuming the calendar again. These off-calendar days, also known as “intercalary days”, are not assigned weekday designations. They are intended to be treated as holidays.

And so each time 1 January would be a Sunday a few years hence, the reformers pursued their cause with renewed energy.    At the time this book was published, the next such occasion was 1 January 1956.  The transition to the new system would be most seamless if the world moved to the new system on a 1 January that was a Sunday.

It would be fascinating if someone were to write a proper scholarly history of this movement (I can’t find much when I looked), but it seems that all the enthusiasm finally came to naught because of religious objections –  religions, notably Christianity and Judaism – that worship on a seven day cycle.  Each regular week would still only have seven days, but around two additional days, weeks would have eight days.  Gathering to worship on the following (in the Christian case) day labelled “Sunday” would no longer be seven days since the last gathering (or the day of worship – and rest –  would drift off the official weekends).

I presume this was one of those issues on which zealots on both sides cared greatly, and few other people cared very much at all, which left the status quo in place by default.  The US Congress appears to have been responsible for the effective block on any action, when the US recommended in 1955 that the United Nations take the matter no further.   The Wikipedia entry on the World Calendar proposal records this statement from then-Congressman (later President) Gerald Ford.

“… I have received numerous letters in opposition to the proposed world calendar change. I am in complete agreement with the opinions expressed in these letters and I will oppose any calendar change. The Department of State advises me that the United Nations may set up a study group on calendar reform. Secretary John Foster Dulles and our representatives at the U. N. are not in favor of this action and the United States will officially oppose setting up this U.N. study group on calendar reform. I have also been informed that our State Department will hold to that position until there is Congressional authorization for the calendar study. From my observations it seems that Congress is in no mood to tamper with the calendar.”

And that, it seems, was pretty much that.  Apparently there is still a World Calendar Association, but it appears to be almost as unknown as its cause.

But what of the moveable feast of Easter (and associated days such as Ash Wednesday and Ascension, also public holidays in some countries)?   The Christian festival, and associated holidays, move around from year to year in a way that no ordinary person can really fathom, and we all simply have to look up the dates.  Some years Easter marks the end of the school term, others not.  Some years it falls in March and others in April and seasonal adjustment never quite captures all the effects.   And of course even with the wider Christian church (and Christian-shaped countries) there are competing dates for Easter –  the Orthodox churches mostly observe Easter next weekend.

Frankly, there probably is a case for a different model, at least if the (interested bits of the) world could snap their collective fingers and be with that model rather than the current one.  There would be some symbolic advantages for churches –  across the world celebrating Easter, the greatest festival of our faith, on the same day –  and some convenience for the rest of society, residually Christian or totally indifferent/opposed.

I had learned a few years ago that there was a strong movement back in the 1920s and 1930s to standardise the date of Easter.  But until I read Time Counts I was not aware that there is a law on the UK statute books, passed in 1928, to standardise the date of Easter Day to the first Sunday after the second Saturday in April (roughly the middle of the period in which Easter can now fall).  The law (a private member’s bill, following on from a League of Nations report) received the royal assent and sits on the books today (you can read it for yourself –  it is a very short law).  The change would have applied in the UK and its colonies and mandated territories, but not (of course –  but it is explicitly spelled out in a schedule to the Act) in the dominions (New Zealand, Australia, Canada, Newfoundland, Ireland, South Africa) or in India or Southern Rhodesia.

The law sits on the statute books today but the (UK) date of Easter didn’t change, because the operative provision required another vote of Parliament, which never occurred.

This Act shall commence and come into operation on such date as may be fixed by Order of His extent. Majesty in Council, provided that, before any such Order in Council is made, a draft thereof shall be laid before both Houses of Parliament, and the Order shall not be made unless both Houses by resolution approve the draft either without modification or with modifications to which both Houses agree, but upon such approval being given the order may be made in the form in which it has been so approved : Provided further that, before making such draft order, regard shall be had to any opinion officially expressed by any Church or other Christian body.

And that has never happened.  You can read more here about some of what happened (and didn’t) subsequently.  The short answer is that the Christian churches have never reached general agreement on change, and although they don’t have a legal veto, in practice successive British governments have taken the view that legal change can’t run ahead of the churches.  In practice, I guess the law is now really just an historical oddity – not unrelated to the fact that England has an established church.  The British government simply can’t, in practical terms, unilaterally change Easter.

If, in some sense, the (affected bits of the) world might be a little better off with standardisation, it isn’t easy to see a way forward that will actually result in change.  Apart from anything else, it is a coordination issue: change is only likely if all the (major) Christian traditions, and all or most of the countries where Easter-related public holidays are on the books agreed together to make the change.   And in highly-secularised societies such as our own, it is rather more likely that there would be support to scrap Easter public holidays altogether (perhaps replace them with a couple of other days scattered across the year) rather than to legislate new and permanent dates.  And institutional churches are hardly likely to favour change without the assurance that the public holidays would be shifted (even recognising places like the US where Good Friday isn’t a holiday at all).   And there would probably be vocal minorities –  including in the US (recall 1955)  – of Christians opposed to any change to Easter dates at all.  If we knew, with confidence, the exact date on which the crucifixion occurred, perhaps standardisation would be easier…..but we don’t.

(Of course, in a New Zealand context, we get the tiny minority of ACT supporters sometimes championing abolishing statutory holidays altogether, to be replaced with additional leave entitlements, but that is simply never going to happen –  and nor in my view should it (regardless of whether the existing holidays have Christian roots or not).)

And so I expect that even if I live to 100, we’ll still be operating on the Gregorian calendar, and for all its endearing oddity, Easter will still be a moveable feast.

 

 

Critics of the Governor

There have been a couple of media stories this week that were less than flattering about the Governor of the Reserve Bank, Adrian Orr.  I was going to say “new Governor”, but checking the calendar I see that in another month or so he will be a quarter of the way through his first term.

The first story was by Stuff’s Hamish Rutherford, and centred on the Governor’s plan to require banks to greatly increase the share of their assets funded by equity rather than debt.   In the on-line version of the story, Orr is labelled “Mr Congeniality”.  The story begins this way

Since Adrian Orr became Governor of the Reserve Bank of New Zealand he has built a reputation of being someone who likes to be liked.

Charming and jocular, but possibly sensitive to criticism.

But Orr is now in a battle with the bulk of New Zealand’s banking sector in a way which could see him demonised, probably with the focus on lending to farmers.

He knows it. Recent days have seen Orr on a campaign to explain itself.

I’m not sure he seems any different as Governor than he ever was before –  his well-known strengths and weaknesses have continued to be on display.

I’ve written quite a lot here about the substance and process around the Bank’s capital proposals – starting with the apparent lack of consultation and coordination with APRA, through to the weaknesses of many of the arguments the Bank advances, the lack of apparent understanding of how financial crises come to occur, the grudging and gradual release of further supporting material, and (presumably partly as a result) two extensions to the deadline for submissions.

In the article Orr is quoted thus, in perhaps the understatement of the week

The consultation process, in Orr’s words “could have been tidier”.

Done properly there would have been extensive workshopping of the technical material over months before the Governor ever put his name to a specific proposal.   As it is, we have a half-baked proposals, not benefiting from any prior scrutiny, and yet the same Governor who put the proposal forward is now judge and jury in his own case, with no effective rights of appeal for anyone.    And there is big money involved –  not just the additional capital that might need to be raised, but probable losses in economic output that will affect us all to a greater or lesser extent.

Presumably no one in the industry would go on record for Rutherford’s article.  Not upsetting prickly Governors is an art the banks have sought to master (even when it involved pandering to an earlier Governor who wanted a senior bank economist censored), although presumably the banks’ submissions will be fairly forthright.  (But will the public ever see those submissions?)

But some of the tone of the off-the-record concern is there in the article

Sources across several of the major banks are warning that if the bank pushes ahead with its plan it could act as a significant constraint on lending to farmers and small businesses,  sectors which are as economically important as they are politically sensitive

Both sectors are considered risky and when capital requirements go up the impact will be magnified.

Why those sectors?  Well, the “big end of town” (Fonterra, Air New Zealand or whoever) will have no difficulty raising debt either directly (bond market) or from banks that aren’t subject to the Reserve Bank’s capital requirements (which means every other bank in the world not operating here, as well as the parents of the locally-incorporated banks operating here).  And the residential mortgage market is both pretty competitive (including from some local institutional players that are less badly hit by the Governor’s proposals than the big banks), and more open to the possibilities of securitisation (which would then avoid the capital requirements too).   Idiosyncratic small and medium loans (including farm loans) aren’t, and farm loans in particular require a level of industry knowledge that newcomers won’t acquire easily (and offshore parents often won’t have).

Perhaps these effects will be large, perhaps they will be quite moderate in the end. But the point Rutherford didn’t make, but could have, is that none of this was analysed in the Bank’s consultative document.   When a really major change is proposed we should surely expect a serious analysis of transitional paths (not just for the banks, but for customers and the economy) as well as the long run.  But there was almost nothing, and nothing in any more depth has emerged in subsequent material that has seeped out.

It simply isn’t a good policy process, and that should concern both the Minister of Finance (and his advisers at The Treasury) and the Bank’s board.   The Governor simply isn’t doing a good job on this front.  If there is a compelling case for what he proposes, he hasn’t made it.  And that is almost as bad –  in a serious independent regulator –  as not having a good case in the first place.

The second article was by the news agency Reuters.   The focus in that article is Orr’s conduct of monetary policy, and particular his policy communications (which many had expected to be one of his strengths).

There are at least two strands to the article.  There are criticisms of Orr for not yet having given a single substantive on-the-record speech on either of his main areas of policy responsibility (monetary policy and financial regulation).  I’m among those quoted

Michael Reddell, an ex-RBNZ official who served with Orr on its monetary policy committee in the 1990s and 2000s, is critical of Orr for not giving a “substantive” speech on monetary policy in the past year.

“It would be unthinkable in Australia or the United States or even under previous governors here.”

I’ve been more and more surprised at the omission as time went on.  And in respect of monetary policy it is not as if there has been much from his offsiders either.  Sure, we get the rather formulaic paint-by-numbers Monetary Policy Statement every few months, but it simply isn’t the same as a thoughtful carefully-developed speech –  which shows more of how the individual/institution is thinking, and the omission has been particularly significant given that we had a new Governor and a refined mandate.

Orr’s response to this criticism is reportedly that it is “thin”.   Whatever that means, the fact remains that in other countries top central bankers talk, quite frequently, about their thinking in on-the-record speeches.  I’ve suggested, speculatively, that perhaps he doesn’t do serious speeches on core areas of responsibility because he just isn’t that interested (saving his passion for infrastructure, climate change, diversity, and all manner of other stuff he has little or no responsibility for).  I’d  like to be wrong on that, but nothing in this article provides any countervailing evidence.

But the bigger criticism in the Reuters article appears to come from financial market participants, concerned that they aren’t able to read the Governor’s policy intentions well.

Many traders who spoke to Reuters in the past two weeks blame Orr for confusing the message, and some have even been critical of frequent references to legends of the indigenous Maori people in his speeches, saying they served little purpose for financial markets eager for more policy clues.
“I am extremely frustrated at the lack of communications for global market participants,” said Annette Beacher, Singapore-based macro-strategist for TD Securities.
“Since Adrian Orr has assumed the role, he’s managed to surprise the market every six weeks. We don’t hear anything from him in between policy decisions,” Beacher said, echoing similar complaints from others.
“So what do I recommend to my trading desk? I’m saying trade the data but we’re not quite sure what is going to happen at the next meeting. It’s not meant to be this way.”

Here, to be honest, I’m not sure quite what to make of the criticism (I mostly don’t hang out with international markets people).   I’m sure there is a great deal of eye-rolling at the tree god nonsense that Orr continues to champion, but perhaps here the longstanding central banker in me comes out and I wonder if the offshore market people aren’t being a little precious.    Markets should not need their hands held to anything like the extent some of the comments in the article suggest, and if there is a little noise in market prices as a result that isn’t necessarily a bad thing.

It seems that quite a few people the journalists talked to were grumpy about the move to an explicit easing bias at the last OCR review, I couldn’t help wondering how much of that was a disagreement with the Governor’s stance (market economists on average have been more hawkish than the Bank for years, and have been more wrong) and how much a sense that a forthcoming change hadn’t been signalled.  I was bit (pleasantly) surprised myself by the move to an easing bias, but mostly because I thought the Governor wouldn’t want to launch a change of direction days before the new MPC took over.  Perhaps that is one of the circumstances in which advance signalling  might have been appropriate?    And perhaps the two strands of concern come together here: we shouldn’t have the Governor or senior staff giving private previews to select contacts about their evolving thinking.  So it has to be serious interviews or serious speeches –  and, as Annette Beacher notes, we haven’t really had either.

The Bank has probably also suffered somewhat from being in transition. At the start of last year, they lost the ultimate safe pair of hands, longserving Deputy Governor Grant Spencer.  A new top-team took over, and within a few months Orr was restructuring, which included demoting longserving chief economist John McDermott.  He lingered for a few months before leaving entirely, but can’t have been entirely engaged.  The head of financial markets was also ousted, and it was only in late March that the new recruits started to take office.  As I’ve noted previously, on the monetary policy side of the Bank it is very much a case now of a Second XI at play (internals and externals) and there is now quite a challenge in getting communications onto a steady, sustainable, and functional path.   The goal shouldn’t be keeping overseas economists happy, but it is perhaps telling that Reuters couldn’t find a domestic one willing to go on the record defending the Orr approach.

What of the Governor’s response to all this?  I’ve already recorded his response to the concern about speeches.  Here is some of the rest of what he told Reuters

In an interview with Reuters earlier on Tuesday, Orr said he wants to reach out to a wider audience than just currency traders, analysts and bloggers.

“The broad audience for this bank is the public of New Zealand. We are seen as a trusted institution but they don’t know what we do. So that is my communication challenge,” he said.

Orr also defended the Maori references in his speeches as part of the bank’s efforts to reach out to wider groups.

“Metaphors have their limits and metaphors can be over used. I get all that, but metaphors need to be introduced and created sometimes.”

I quite get that he wants to communicate to people beyond just the likes of Annette Beacher or me.    But it is not much short of populism to pretend that the audience of people who do pay close attention to the Bank, and know something about it and other central banks (and can even think through the aptness or otherwise of his metaphors), don’t matter.  He can try to appeal over the head of the relatively knowledgable all he likes, but I suspect he won’t find many listening.  Most people have better –  more interesting and important to them –  things to do with their lives.  As it happens, the Governor released a while ago a record of which audiences he delivered speeches to last year, and despite all the rhetoric –  tree god and all –   I was a bit surprised by how relatively few and conventional the audiences were.  The only novelty seemed to be a lot of mention of the tree god – cue to eyes rolling from many of the audiences no doubt.   How many more readers, I wonder, have the cartoon versions of the MPS and FSRs won?  How many have tried twice?

There is a “retail communication” dimension to the Reserve Bank’s role –  when you are driving interest rate up (or down) and affecting people’s employment prospects, business profitability etc, you have to explain yourself.  Over 30 years of an independent Reserve Bank, successive Governors have done a great deal of it –  Don Brash almost to the point of exhaustion, in his nationwide roadshows.  But the core of the job is actually rather more “wholesale” in nature.  And the Governor doesn’t seem to have been getting that right –  at all re bank capital, and in some dimensions re monetary policy (I’m probably closer to his bottom line on the OCR than many other commentators).  All this should be a concern for the Minister of Finance, and for the Bank’s Board.

There is still time for the Governor to right the ship –  and perhaps the new MPC will end up helping –  but the signs aren’t good. Only this morning, a press release emerged from the Bank championing the cause of climate change.  Action may well be really important, but it just isn’t the core business –  or really any business at all in a New Zealand context, with the sort of loan book New Zealand banks have –  of the Reserve Bank.  It is what we have an elected government for.

Sadly, we can expect to hear more from the Governor on climate change and his tree god (flawed) metaphor, and there is no sign of any contrition around the lack of serious communication from him on monetary policy or (where he is still sole decisionmaker) financial sector regulation.

 

Reading the RBA FSR on bank capital

One of the frustrating things about the Reserve Bank’s consultation on its proposal to greatly increase the amount of capital (locally incorporated) banks have to have to conduct their current level of business in New Zealand, is its utter refusal to produce any serious analysis comparing and contrasting their proposals to the rules (actual and prospective) in Australia.   The larger New Zealand banks are, after all, quite substantial subsidiaries of the very same Australian banking groups.    If there is a case to be made either that the New Zealand proposals are not more materially demanding than those in Australia, or that, if they are, there is a sound economic case for our regulators to take a materially more demanding stance than their Australian counterparts, surely you would expect that a regulator serious about consultation, allegedly open to persuasion (and working for a government that once boasted that it would be the “most open and transparent”) would make such a case.   But months have gone on and there has been nothing.

It is striking that over the entire period when the consultation has been open we have not had a Financial Stability Report from the Reserve Bank (I guess it is just the way the timing worked, but still…).      With proposals out for consultation that would force banks to have much higher risk-weighted capital ratios, working to the statutory goal focused on the soundness of the financial system, you’d have to assume that any FSR would conclude that the financial system at present was really quite rickety.   Perhaps they will when the next FSR comes out late next month, but (a) it would be a very big change of message from past FSRs, and thus (b) I’m not expecting anything of the sort.

A reader pointed out that the Reserve Bank of Australia released its latest Financial Stability Review last week.   The RBA isn’t the regulator of the financial system, but works closely with APRA, and has some systemic responsibilities (including the analysis and reporting ones reflected in the FSRs).   Capital requirements (on both sides of the Tasman) feature in the chapter on the Australian financial system.

The discussion starts this way (ADI = Australian deposit-taking institution).

RBA 1

You’ll recall that the Reserve Bank of New Zealand’s proposal would (a) require major banks to have a minimum CET1 ratio of 16 per cent of risk-weighted assets, and (b) would measure risk-weighted assets in a more demanding way than Australia does.

Here is graph 3.6 –  a really nice chart with lots of information in a small space.

RBA 2

The first panel is the one of most relevance here, relating as it does to the four banks that have major operations in New Zealand.   The regulatory minima are shown in the two shades of purple, and the additional capital held above those regulatory minima is in blue.   Three of the four banks are already at the “unquestionably strong” benchmark level.

I also found the the second panel (other listed deposit-taking entities) interesting.  In a post earlier in the year, I suggested that too-big-to-fail arguments weren’t a compelling reason for higher minimum regulatory capital requirements, as there wasn’t obvious evidence that entities that no one regarded as too-big-to-fail were required by market pressures to have capital ratios materially above those prevailing at larger institutions.   This chart may suggest this point holds in Australia too (deposit insurance muddies the water, but does not apply to wholesale creditors).

The RBA discussion goes on

rba 3.png

with a footnote elaborating the point

RBA 4

Unlike the Reserve Bank of New Zealand, they don’t just claim it is hard to do international comparisons, and then blame copyright to defend not presenting any analysis.    And APRA has actually published its analysis comparing  the way risk weights etc are applied in Australia and other countries.

So the Reserve Bank of Australia (and, presumably, APRA) claims that the capital ratios applying to the major Australian banking groups are in the upper quartile internationally, based on actual CET1 ratios of “only” around 10.5 per cent.   The Reserve Bank of New Zealand, by contrast, has tried to claim –  with no real analysis, just a bit of gubernatorial arm-waving –  that its proposed CET1 minima of 16 per cent (measured materially more conservatively again) would also be inside the range of requirements in other advanced countries, probably also in the upper quartile.

At a substantive level, the two claims are just not consistent.    Perhaps the Australian authorities are wrong in their claims, but I doubt it.  I could advance several reasons to have more confidence in the Australia regulators’ claims:

  • they have a much deeper pool of expertise than the Reserve Bank of New Zealand, and two agencies (RBA and APRA) able to peer review work in the area before it is published,
  • the Australian parent banking groups are all listed companies and there is considerable broker analytical resource devoted to monitoring and making sense of the performance of those banks and the constraints on them,
  • for what they are worth, the credit ratings of the Australian banking groups are consistent with them having capital ratios and risk profiles in the upper (safer) part of the distribution of advanced country banks,
  • the Reserve Bank of New Zealand has simply avoided the Australian comparisons in all the material it has released (so far).

Whatever the absolute position, we can be totally confident that the Reserve Bank of New Zealand’s CET1 minima are far more demanding than those APRA applies to the Australian banking groups  (16 per cent minimum –  perhaps 17-18 per cent actual –  vs the benchmark actual of 10.5 per cent in Australia, where the New Zealand requirements will be measured in a more conservative way.  Not one shred of argumentation has been advanced by the Reserve Bank of New Zealand to explain why they, in their wisdom, think New Zealand banks need so much higher risk-weighted capital ratios.   There might be a case to be made –  something about risk profiles, or reckless Australian regulators perhaps –  but they just haven’t made it  (and it would have to be a pretty compelling case given that the major New Zealand banks have large parents –  to whom the regulator might expect to look in a crisis –  whereas the Australian banking groups don’t).   That simply isn’t good enough.

The RBA goes on to discuss the Reserve Bank of New Zealand’s proposals.

rba 5

That text correctly notes not suggest that the headline CET1 ratios required here would be much larger than those applying to the Australian banking groups, but would be measured in a more conservative way than has been the case hitherto (and more conservatively than APRA will be allowing Australian banks to do).

The rest of the paragraph interested me, especially that final sentence.  It appears to suggest that the rules would apply differently depending whether the capital of the New Zealand subsidiaries was increased through retained earnings or through a direct subscription of new equity by the parent.  In economic substance the two are the same, and regulatory provisions should be drawn in a way that reflects the substance.  But the paragraph is perhaps a reminder that one possibility open to the Australian parents, if the Reserve Bank persists with its proposals, is a divestment in full or in part.  Comments from the Reserve Bank Governor and Deputy Governor have suggested that they would not be averse to such an outcome, and might even welcome it.  I think a much less cavalier approach is warranted and that the New Zealand generally benefits from having banks which are part of much larger groups.

The RBA discussion also has a chart show bank profits in Australia since 2006 (I truncated a bigger chart so the dates aren’t showing).

rba 6

As they note, return on equity is less than it was in the mid-2000s, not inconsistent with the higher capital ratios (reduced variance of earnings) in place now.     The (simple) chart is perhaps consistent with the Reserve Bank of New Zealand’s story that banks will come to accept lower ROEs on their New Zealand operations over time if higher capital ratios are imposed, but (a) the transition may still be difficult (especially for sectors with few competing lenders), and (b) there is no guarantee, since shareholders will focus on overall group risk/return, not the standalone characteristics of one individual unlisted subsidiary.

Part of the Reserve Bank of New Zealand’s attempt to obfuscate the Australian comparisons is to muddy the waters by suggesting something along the lines of ‘total capital requirements will end up being much the same, but our banks will have much better quality capital’.

As you can see from their own text, the Australian authorities put much more weight on the core (CET1) ratios, where Australia’s (quite demanding by international standards) expectations will be a lot less than those proposed for New Zealand.  But the Reserve Bank of Australia text touches on the additional loss-absorbing capital as well.

RBA 7

RBA 8

Here is the summary of the APRA proposals.  These additional requirements, if confirmed, would be able to be met with ‘any form of capital’, including (for example) the contingent-convertible bonds (typically hold by wholesale investors, and which convert to equity in certain pre-specificed distress conditions) which the Reserve Bank of New Zealand has taken such a dim view of (to disallow for capital purposes).  This additional loss-absorbing capacity is typically regarded as much cheaper than CET1 capital, and (coming on top of upper quartile CET1 funding) serves just as well in protecting the interests of creditors in the event of a failure of a major financial institution.   For any banking regulator interested at all in efficiency that should count strongly in its favour, but even more so in New Zealand where the big banks are subsidiaries of the Australian banking groups, failures will inevitably (and rightly) be handled on a trans-Tasman basis, and where most of what matters is securing a substantial share of residual assets for New Zealand depositors and creditors.

But even allowing for all that, look at the nice summary chart from APRA of their proposals

APRA 1

If fully implemented:

  • the APRA proposal for Australian banking groups would amount to a 16 per cent total capital ratio requirement, with risk-weighted assets measured the Australian way, while
  • by contrast, the Reserve Bank of New Zealand proposal would involve a 16 per cent CET1 capital ratio minimum requirement (8 per cent in Australia – the CET1 and CCB components), with risk-weighted assets measured the New Zealand way, and
  • the Reserve Bank proposal include a plan to raise the minimum risk-weights (in a not unsensible way, considered in isolation) that would mean a 16 per cent CET1 requirement in New Zealand might be equivalent to something like 19 per cent range in Australia.  The proposed floor –  risk-weighted assets calculated using internal models, relative to the standardised approach –  in Australia is, in line with Basle III. 72.5 per cent, and the RBNZ is proposing a 90 per cent floor: apply a ratio of 90/72.5 to give an indication of the scale of the possible effect).

The simple summary is that (even if the Reserve Bank of New Zealand ends up scrapping any Tier 2 capital requirements, and it seems quite ambivalent about them in the consultation document) its capital requirements will be (a) materially higher than those applied to Australia to the parent banking groups, (b) materially more costly, because of a largely-irrational aversion to forms of capital other than CET1, even though we have good reason to take seriously the claims of the Australian authorities (and the sense of the rating agencies) that Australian banks are already among the better-capitalised in the world.

In hundreds of pages of material, slowly released over several months, the Reserve Bank of New Zealand has not provided a shred of evidence, or even argumentation, for why locally-incorporated banks operating here should face such an additional regulatory burden, with the attendant economic risks and costs.  Add in the refusal of the Bank to provide a decent cost-benefit analysis as part of the consultation (they promise only at the end of it all, when there is no further chance for public input, and no appeals), and there are few grounds to have confidence in what the Governor (prosecutor, judge, and jury –  with no appeal court) in his own case is suggesting.   We should expect better. The Minister of Finance (and the supine Board) should be demanding more.

For anyone in Wellington next week and interested, Ian Harrison (who used to do a lot of the Reserve Bank modelling work around bank capital) is doing a lunchtime lecture/seminar on the Reserve Bank proposals next Wednesday.   You might think I’m fairly critical of the Reserve Bank. Ian is more so, and tells me he has chased every reference in every document the Bank has published in support of its case, and still isn’t remotely persuaded of the merits of the Governor’s claims.

“We don’t tax businesses highly” and other misrepresentations

As we wait to learn where the government has setttled on the idea of a capital gains tax, Radio New Zealand had an interview this morning in which their presenter Guyon Espiner talked to a business lobby group opponent (John Milford of the Wellington Chamber of Commerce) of a capital gains tax.   I’m someone who is, at best, sceptical of the merits (and potential revenue gains) of a CGT, but it wasn’t the most effective case made against such a tax.

But what really prompted me to pay attention was when Milford argued that business was already quite highly taxed.  The interviewer responded along the lines of “oh, come on, the company tax rate of 28 per cent isn’t high at all”, and Milford simply let it pass and moved off to a claim that regulatory burdens and other costs were high.

We should not lose sight of the fact that we have one of the highest statutory company tax rates of any OECD country.  Here are the OECD’s own numbers for 2019 (incorporating all levels of government –  some countries, including the US, have state level company taxes as well as national ones).

corporate tax 2019

As almost everyone knows, headline corporate tax rates can mask a multitude of exemptions and deductions.  So here is the data on the tax collected on the “income, profits, and capital gains” of corporates, expressed as a share of GDP.  Data on actual tax collections takes time to compile, so these data are for 2017.

corp tax 2017

In this particular year, we took the second highest share of GDP in corporate tax revenue.      That rank bobs around a bit from year to year (in the year the Tax Working Group used in their discussion document, we ranked number 1) and it appears to matter a bit whether countries collect taxes from central government entities or not (we do), but no one seriously questions that however one looks at things, New Zealand is one of the handful of countries collecting the highest tax (share of GDP) from corporates.

The picture is further complicated by the fact that New Zealand (and Australia, but almost no one else) runs a dividend imputation scheme, such that for domestic resident shareholders (only), corporate tax is really a withholding tax, and tax paid at the corporate level is credited against the shareholder’s personal tax liability. In most other countries there is a double taxation issue (profits and dividends are taxed with no offsetting credits), and partly as a result dividend payout rates tend to be lower.  (This, incidentally, is one reason why there is a stronger case for a CGT in other countries than there is in New Zealand or Australia.)

Incidentally, here is how corporate tax revenue (same measure as in the previous chart) in New Zealand compares with that of the median OECD country over 50+ years.

corp tax hist

If anything, the gap appears to have been widening over the last 25 years or so.

It is worth remembering here that New Zealand is not, by OECD, standards a highly taxed country.  Over that entire 50 year period we’ve been around the median OECD country for total tax revenue as a share of GDP (currently just a bit below).   We also have relatively low levels of capital in our production processes (recall low rates of business investment, relative to population growth, over many decades), and yet we raise among the largest share of GDP from companies of any OECD country.

We also get quite a lot of revenue from taxes on good and services (mostly GST here).

G&S tax

We are also a bit above the median OECD country in the share of GDP taken in property taxes (mostly local authority rates, levied on property).

And, by contrast, the area where New Zealand collects hardly any tax revenue at all, as a share of GDP.

soc security taxes.png

I can’t highlight the New Zealand bar.  There isn’t one.  On this definition, we collect nothing (on other definitions one might include ACC levies, but their equivalent is presumably also excluded in the calculations for other countries).

Most advanced countries fund a significant chunk of their welfare systems (unemployment, disability, age pension) with explicit social security taxes, typically levied only on labour earnings (although some are directly paid by employees, and some directly by employers).  Of course, as the chart indicates there is a wide range in practices, but we (and Australia) are at one extreme, and partly in consequence we are the two OECD countries taking the largest share of total tax revenue in corporate taxes.

Does all this have much bearing on the case for a CGT?  Personally, I don’t think so.   A decent CGT –  that didn’t tax pure inflation and allowed proper loss-offsetting –  would be expected to raise very little revenue over time.   If there is an argument for a CGT it is mostly in some conception of “fairness”, which needs to be weighed up against problems such as lock-in, and of the consequent biasing of asset holdings towards big institutional entities and away from individuals.

But don’t try to use as an argument for a CGT that business activity in New Zealand is lightly taxed.  It isn’t.  In absolute terms, business tax revenue as a share of GDP is currently well above the average for the last 50 years.  In international comparative terms, we tax business activity more heavily than almost OECD country –  and perhaps it isn’t entirely coincidental that we sometimes anguish about why we don’t have more business activity.

I listened to more of Morning Report than usual this morning (kneading hot cross bun dough as I did) and had the misfortune to hear Business New Zealand chief executive commenting on government proposals to crackdown on the “exploitation” of migrant workers.  I haven’t looked into the details, so have no view on the substantive merits of the specific proposals (sympathetic as I am to the cause generally).  But people shouldn’t be able to advance their cause with straight-out lies.  Kirk Hope claimed that what the government was proposing was quite inappropriate in part because we currently have “record low” unemployment.   Perhaps his memory is short, but Business NZ used to have an economist who could have briefed him.  In the absence of that person, here are the data

U historical

Perhaps you might want to discount the first 20 years (although it was a real phenonenon), but current unemployment rates haven’t even reached the lows we managed for several years prior to the last recession.   And these days older workers (aged over 65) are a much larger share of the labour force, and naturally tend to have a materially lower unemployment rate (in other words, what might have been unsustainably low 15 years ago, is probably rather more sustainable now).

Speech, schools, and data

Not many things bother me (get inside me and really churn me up) that much.  But an email yesterday did, and in truth still is.  It demanded $1000 of so in Bitcoin within 48 hours or our “secret” would be revealed, in lurid video detail, to everyone (all contacts from all media, all accounts), sent from our very own family email account.  Our “secret” apparently was some pretty sick pornography that we had allegedly been watching, and had (so it claimed) been recorded watching.   When I consulted some tech people the advice was that it was (probably) pure scam –  demanding money with menace, but with nothing actually (creatively concocted of course) to back it up.   I certainly hope so, but in the unlikely event that people receive such icky emails tomorrow……..well, there are some sick people, capable of evil acts, out there.   Some “speech” should be illegal, and is –  not that I expect the Police to be able to do anything about this extortion attempt.    (Meanwhile, the economist in me couldn’t help reflecting on the pricing strategy –  surely almost anyone who actually had this stuff to hide would be willing to pay a lot more than $1000 to prevent exposure?)

Today I wanted to write about a short piece the New Zealand Initiative published 10 days or so ago as a contribution to the debate around the proposals the government is considering for reform of the governance of our schools.  Their short research note got a lot of media coverage, although to me it posed more questions than it really answered, and I wasn’t entirely sure why the reported results had any particular implications for how best to govern (state) schools.  I’d had the report sitting on my pile of possible things to write about for a few days, but I noticed yesterday that the Initiative’s chief economist, Eric Crampton, had devoted a blog post to the report (mostly pushing back against some criticisms from Brian Easton).   That post provided a bit more detail.

I’m not heavily invested in the debate about school governance.  As I noted to one reader who encouraged me to write about it directly, my kids are now far enough through the system that whatever changes the government finally makes and implements aren’t likely to materially worsen the education system for them.    And if I’ve found little to praise in the schools we’ve had kids at (one has been mediocre –  on good days –  since friends were first “forced” to send their kids there 30+ years ago), nothing persuades me that more centralised control would be for the good (of kids, and of society, as distinct from the officials and politicians who might get to exercise more power).  And my predisposition is to be suspicious of anything Bali Haque is involved in, and that predisposition was provided with some considerable support when I read a commentary on the report of the Tomorrow’s Schools Taskforce, by the economist (with long experience in matters around education policy) Gary Hawke.

But I was still left not entirely persuaded that what the Initiative had published really shed much light where they claimed it did.   Perhaps things will be clearer when the fuller results are published later in the year, but for now we can only work with what we have.

The centrepiece of the Initiative’s research note is this set of charts

initiative schools

They’ve taken various measures of NCEA academic outcomes (one per chart) and shown how school outcomes vary by decile with (red dots) and without (blue dots) correction for the “family background” of the student.     “Family background” is the fruit of the highly-intrusive Statistics New Zealand Integrated Data Infrastructure (IDI) –  which researchers love, but citizens should be very wary of –  and in Eric Crampton’s less formal note this quote captured what they got

For the population of students who completed NCEA from 2008 through 2017, there’s a link through to their parents. From their parents, to their parents’ income. And their education. And their benefit histories. And criminal and prison records. And Child, Youth, and Family notifications. And a pile more. Everything we could think of that might mean one school has a tougher job than another, we threw all of that over onto the right hand side of the regressions.

The results are interesting, of course.  They summarise the result this way

initiative 2

But this does seem to be something of a straw man.   Should we be surprised that kids from tough family backgrounds achieve worse academic results than those that have more favourable family backgrounds?  I doubt anyone is.  And I have no problem with the idea that a decile 1 school might do as good a job “adding value” as a decile 10 school, but these charts don’t show what I would have thought would be the rather more interesting difference (at least if governance is in focus): what is the range of outcomes within each decile.  Quite probably there are excellent decile 6 schools and really rather poor ones, and which school fits which category is likely to change over time (leaders and leadership make a difference).

Take, for example, the school my son now attends, and where I also had the last couple of years of my schooling.  60 years ago it was mediocre at best, then a long-serving  headmaster dramatically lifted the performance on a sustained basis, only for the school under yet new leadership to slip back so badly that when our son was born we were contemplating exceedingly-expensive private school options (an option for us, but not for many).  Fortunately, there has been another revitalisation over the last decade and my impression now is that the school does as well as any in adding value.   But, as far I can see, what was reported so far of the Initiative’s work sheds no light on this divergences within deciles at all.     And yet surely questions of governance are at least potentially relevant here: could a plausible and credible different governance model have prevented some of that across-time variance in outcomes for Rongotai College?  If it could have, it would surely have to be seriously considered.

Having noted that it is hardly surprising that kids from homes with more favourable factors emerge from school with better results than those from less favourable backgrounds, I was intrigued by just how flat those red dots are across deciles in each of the charts above.  The message was simple –  adjust for family background and there is no systematic difference across school deciles in the average academic results the students achieve.  And yet, doesn’t the government put in much more money (per student) to low decile schools than to high decile schools?   Is it all for naught?   It would be uncomfortable if true, but that is what the results appear to say.   Perhaps in the end the answer is that the funding differences, although appearing large when translated to the “donations” higher decile schools expect, really aren’t that large (or large enough?) after all?  Perhaps there is something in the possibility that lower-decile schools struggle to get enough capable parents in governance roles (I know both my father and my father-in-law, both Baptist pastors, ended up serving as coopted board of trustee members in low decile schools) or even to attract the best teachers.  Whatever the answer, I hope the Initiative looks into the question as they write about their fuller results.

The other question I was left wondering about was whether what the New Zealand Initiative has produced is really adding much value over and above the less-intrusive, more rough and ready, approaches to assessing school quality that people have used for years.  Here, I don’t mean that straw man suggestion that people think higher decile schools are better academically –  perhaps there are a few who believe that, but I doubt they are many.  My approach to schools for years has been to take the NCEA results, and compare how an individual school has done relative to others (total, and distinguished by sex) of the same decile.  Plot all the schools in Wellington, and I could get a reasonable sense of which had students achieving better results than one might have expected for their decile.   Add in things like ERO reports, and talking to people who’ve had personal exposure to a school, and one gets quite a bit of information.   And people will, rightly and reasonably, want to consider things other than just academic value-added in making the (rather limited) choices they have about schooling for their children (be it sports, arts, behavioural standards, uniform, single-sex vs coed, ethos or whatever).

In the end, however, my biggest concern remains the IDI itself.  It is curious to see the New Zealand Initiative championing its use in evaluating schools (and they are researchers, and researchers are drawn to data as bees to honey) when the Initiative has historically tended to emphasise the merits of genuine school choice.  It is something I strongly agree with them on.    But decentralised markets, with parents deploying purchasing power, wouldn’t have (at least naturally) the sort of highly-intrusive joined up information that IDI provides.

And nor should government-provided school systems.    I’m not sure how Statistics New Zealand matches my son, enrolled at a local school where we provide only our names, phone numbers, and street addresses, to the education levels of my wife and I, let alone our marital status, (non-existent) benefit histories or criminal records or the like.  It is none of the school’s business, and it is none of the government’s business.  As citizens, we should be free to keep bits of our lives compartmentalised, even if all this joined-up data might be a blessing to researchers.

I touched on some of these issues in a post late last year.

Statistics New Zealand sings the praises of the IDI (as does Treasury –  and any other agency that uses the database).  I gather it is regarded as world-leading, offering more linked data than is available in most (or all) other advanced democracies –  and that that is regarded as a plus.   SNZ (and Treasury) make much of the anonymised nature of the data, and here I take them at their word.  A Treasury researcher (say) cannot use the database to piece together the life of some named individual (and nor would I imagine Treasury would want to).   The system protections seem to be quite robust –  some argue too much so – and if I don’t have much confidence in Statistics New Zealand generally (people who can’t even conduct the latest Census competently), this isn’t one of the areas I have concerns about at present.

But who really wants government agencies to have all this data about them, and for them to be able link it all up?   Perhaps privacy doesn’t count as a value in the Treasury/government Living Standards Framework, but while I don’t mind providing a limited amount of data to the local school when I enrol my child (although even they seem to collect more than they need) but I don’t see why anyone should be free to connect that up to my use of the Auckland City Mission (nil), my parking ticket from the Dunedin City Council (one), or (say) my tiny handful of lifetime claims on ACC.  And I have those objections even if no individual bureaucrat can get to the full details of the Michael Reddell story.

The IDI would not be feasible, at least on anything like its current scale, if the role of central government in our lives were smaller.   Thus, the database doesn’t have life insurance data (private), but it does have ACC data.  It has data on schooling, and medical conditions, but not on (say) food purchases, since supermarkets aren’t a government agency.   I’m not opposed to ACC, or even to state schools (although I would favour full effective choice), but just because in some sense there is a common ultimate “owner”, the state, is no reason to allow this sort of extensive data-sharing and data-linking (even when, for research purposes, the resulting data are anonymised).   There is a mentality being created in which our lives (and the information about our lives) is not our own, and can’t even be stored in carefully segregated silos, but is the joined-up property of the state (and enthusiastic, often idealistic, researchers working for it).   We see it even in things like the Census where we are now required by law to tell the state if we have trouble “washing all over or dressing” or, in the General Social Survey, whether we take reusable bags with us when we go shopping.    And the whole point of the IDI is that it allows all this information to be joined up and used by governments –  they would argue “for us”, but governments’ view of what is in our good and our own are not necessarily or inevitably well-aligned.

In truth my unease is less about where the project has got to so far, but as to the future possibilities it opens up.  What can be done is likely, eventually, to be done.   As I noted, Auckland City Mission is providing detailed data for the IDI.  We had a controversy a couple of years ago in which the then government was putting pressure on NGOs (receiving government funding) to provide detailed personal data on those they were helping –  data which, in time, would presumably have found its way into the IDI.   There was a strong pushback then, but it is not hard to imagine the bureaucrats getting their way in a few years’ time.  After all, evaluation is (in many respects rightly) an important element in what governments are looking for when public money is being spent.

Precisely because the data are anonymised at present, to the extent that policy is based on IDI research results it reflects analysis of population groups (rather than specific individuals).  But that analysis can get quite fine-grained, in ways that represent a double-edged sword: opening the way to more effective targeting, and yet opening the way to more effective targeting.  The repetition is deliberate: governments won’t (and don’t) always target for the good.  It can be a tool for facilitation, and a tool for control, and there doesn’t seem to be much serious discussion about the risks, amid the breathless enunciation of the opportunities.

Where, after all, will it end?   If NGO data can be acquired, semi-voluntarily or by standover tactics (your data or no contract), perhaps it is only a matter of time before the pressure mounts to use statutory powers to compel the inclusion of private sector data? Surely the public health zealots would love to be able to get individualised data on supermarket purchases (eg New World Club Card data), others might want Kiwisaver data, Netflix (or similar) viewing data, library borrowing (and overdue) data, or domestic air travel data, (or road travel data, if and when automated tolling systems are implemented), CCTV camera footage, or even banking data.  All with (initial) promises of anonymisation –  and public benefit – of course.  And all, no doubt, with individually plausible cases about the real “public” benefits that might flow from having such data.  And supported by a “those who’ve done nothing wrong, have nothing to fear” mantra.

After all, here the Treasury author’s concluding vision

Innovative use of a combination of survey and administrative data in the IDI will be a critical contributor to realising the current Government’s wellbeing vision, and to successfully applying the Treasury’s Living Standards Framework to practical investment decisions. Vive la révolution!

Count me rather more nervous and sceptical.  Our lives aren’t, or shouldn’t be, data for government researchers, instruments on which officials –  often with the best of intentions –  can play.

And all this is before one starts to worry about the potential for convergence with the sort of “social credit” monitoring and control system being rolled out in the People’s Republic of China.    Defenders of the PRC system sometimes argue –  probably sometimes even with a straight face –  that the broad direction of their system isn’t so different from where the West is heading (credit scores, travel watchlists and so).   That is still, mostly, rubbish, but the bigger question is whether our societies will be able to (or will even choose to) resist the same trends.  The technological challenge was about collecting and linking all this data,  and in principle that isn’t a great deal different whether at SNZ or party-central in Beijing.   The difference –  and it is a really important difference –  is what is done with the data, but there is a relentless logic that will push erstwhile free societies in a similar direction  –  if perhaps less overtly – to China.  When something can be done, it will be hard to resist eventually being done.    And how will people compellingly object when it is shown –  by robust research –  that those households who feed their kids Cocopops and let them watch two hours of daytime TV, while never ever recycling do all sort of (government defined –  perhaps even real) harm, and thus specialist targeted compulsory state interventions are made, for their sake, for the sake of the kids, and the sake of the nation?

Not everything that can be done ends up being done.  But it is hard to maintain those boundaries, and doing so requires hard conversation, solid shared values etc, not just breathless enthusiasm for the merits of more and more linked data.

As I said earlier in the post, I’m torn.  There is some genuinely useful research emerging, which probably poses no threat to anyone individually, or freedom more generally.   And those of you who are Facebook users might tell me you have already given away all this data (for joining up) anyway –  which, even if true, should be little comfort if we think about the potential uses and abuses down the track.   Others might reasonably note that in old traditional societies (peasant villages) there was little effective privacy anyway –  which might be true, but at least those to whom your life was pretty much an open book were those who shared your experience and destiny (those who lived in the same village).   But when powerful and distant governments get hold of so much data, and can link it up so readily, I’m more uneasy than many researchers (government or private, whose interests are well-aligned with citizens) about the possibilities and risks it opens up.

So while Treasury is cheering the “revolution” on, I hope somewhere people are thinking harder about where all this risks taking us and our societies.

Some thoughts anyway.  Not all that can be done should be done, and the advance of technology (itself largely value-neutral) opens up many more things that can be done that shouldn’t be done.

An expert weighed in on Reserve Bank reform

I was exchanging notes last week with someone who is doing research on New Zealand economic policy, and the development of economic institutions, in the 1980s and 1990s.  In the course of that conversation he sent me a copy of interesting short paper –  presumably obtained from the national archives –  from the period when the thinking and debates that led to the Reserve Bank of New Zealand Act 1989 were underway.

Reform of the Reserve Bank had been in the wind for some time.  Loosely, the Reserve Bank tended to be keen on an independent central bank, and recognised that some accountability procedures would be part of the price of that.  On the other side of the street, the Treasury was keen on an accountable and efficient central bank.  Neither institution –  nor the key ministers at the time –  wanted the Minister of Finance to be determining day-to-day monetary policy. (Ministers determining policy adjustment had been the standard practice, by law, for decades – and it was the practice at the time in most western countries, the exceptions being Switzerland and West Germany and (more or less) the United States.)   Everyone involved wanted a much lower average inflation rate than New Zealand had had in the 1970s and 1980s.

The Treasury was heavily involved in work on reshaping the institutional form of much of what central government did.   Of particular relevance was the new state-owned enterprises (SOE) model, adopted for many/most government trading enterprises (NZ Post, for example, is still with us today).    The Reserve Bank, then as now, was a somewhat anomalous organisation and part of the – at times – acrimonious debate between the Reserve Bank and the Treasury over several years reflected the idiosyncratic nature of the institution, and differing views over what parallels or comparators were relevant.    For example, were banknotes or the retail government banking operations, or the sale of government bonds really just commercial activities really just commercial activities.  And might the (apparent) policy goals be achieved better in an organisation given more commercial incentives.

At one end of the spectrum was a proposal out of The Treasury in late 1986 to turn the Reserve Bank into an SOE (it was never quite a final Treasury proposal, but was written by a senior Treasury adviser and taken seriously as the highest levels of The Treasury.  For anyone interested, you can read more about it in Innovation and Independence, the 2006 history of the Bank (bearing in mind that that history was very much written from a Reserve Bank perspective, one of the authors not only having been an active protagonist in the late 1980s debates but at the time of writing serving as chair of the board of the Reserve Bank).

The proposals were stimulating, far-reaching (including allowing for the Reserve Bank to be declared bankrupt and statutory managers appointed) and –  in the views of probably all Reserve Bankers involved at the time (and in my view now) –  quite unrealistic, and failing to really grapple with the reasons for having a central bank at all.  I am one of those who believes that the economy and financial system could function adequately without a central bank –  although on balance I think a central bank can improve our ability to cope with severe shocks –  and in many respects the logic of the Treasury position might have been better developed into a proposal to explore whether we could do without a central bank altogether.  But they didn’t.  (Had the Bank been abolished, my position –  then and now –  is that New Zealand would fairly quickly have become a de facto part of the Australian dollar area, with monetary conditions influenced by the RBA with Australian perspectives in mind.  That is probably clearer now than it was then –  in 1986/87 only Westpac and ANZ of the larger banks were Australian owned.)

But the point of this post isn’t to rehearse all the old debates. I was overseas on secondment at the time, and only got involved in the debates (which lingered in various forms for several years, even after the Reserve Bank Act was passed) a bit later. But I was intrigued by this one particular paper I was sent last week.

The Reserve Bank has received the “Reserve Bank as SOE” proposal in November 1986.  At the time, the Reserve Bank Board was the decisionmaking body for the Bank itself (although not on monetary policy, which was in law set by the Minister).   The Board asked management to obtain independent expert analysis and advice on the Treasury ideas and for their March 1987 meeting the Board had in front of it a six page commentary from Professor Charles Goodhart.

Goodhart is one of the more significant figures in the last 50 years or so in thinking and writing about central banking.   At the time, he was Professor of Money and Banking at the London School of Economics and had previously served as Adviser to the Governor of the Bank of England.  He had relatively recently published an influential book The Evolution of Central Banks: A Natural Development? (and had been the star guest, and guest lecturer, at the Reserve Bank’s somewhat-extravagant 50th anniversary celebrations in 1984).  Goodhart was very smart and thoughtful, but well-disposed to a traditional (British) view of central banks.

A decade later, Goodhart served as one of the first members of the UK Monetary Policy Committee, after the newly-elected Labour government in 1997 gave the Bank of England operational independence in the conduct of monetary policy.  But in 1987, the Bank of England was, to a considerable extent, the executing agent for the policy choices of the Chancellor of the Exchequer –  the Chancellor being advised by both the Bank and the Treasury, and typically being closer to The Treasury (in the UK ministers have their offices in the department for which they are responsible, not something akin to the Beehive).  It is worth noting that by 1987 the UK had successfully lowered its inflation rate very substantially (the UK inflation record in the 1970s had been, if anything, worse than New Zealand’s).

It is perhaps also worth noting that when the Reserve Bank of New Zealand Bill was finally brought to Parliament in 1989, Goodhart played an important role in providing public support (including FEC testimony) for the chosen model.  Part of that involved providing an academic counterweight to the New Zealand academic (macro)economics community, most of which, at very least, sceptical of the legislation.

But that was 2.5 years later, long after the notes for the Reserve Bank Board had been written.  In those notes, Goodhart’s stance –  while useful to the Bank in countering Treasury – was very different to the legislation he later provided public endorsement to.

The first half of the paper (history and theory) is interesting, but not particularly controversial for these purposes. But the second half is about “policy conclusions”, drawing from an analysis that was generally in favour of (a) discretionary monetary policy, and (b) a central bank not influenced by profit-maximising considerations.

Here is his view on who should do what

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Get the Minister of Finance further away from the conduct of monetary policy and let the Reserve Bank itself decide what rate of inflation to target.  (This was more than year before “inflation targeting” itself became a thing, and was presumably just about setting a broad direction for policy –  in New Zealand at the time there was, for example, beginning to be talk about “low single figure inflation”).

I don’t suppose that idea went down overly well with his Treasury readers (including the Secretary to the Treasury who was then a member of the Board).

One of the later mythologies that developed around the Reserve Bank Act (over the years we spent a lot of time rebutting it) was that the Governor’s salary was tied to the inflation target.  It never was.    But until reading this paper I hadn’t realised where the possibility of making such a link had come from.  Here is Goodhart, talking about accountability.

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Wow.  At this stage, there was still no sense of making the Governor the single decision maker, but a leading academic writer on central banking was seriously proposing not just that the Reserve Bank should be able to set a target rate of inflation for itself, but that a range of key executives should be partly paid in the form of options that would pay off if the target was met.    He doesn’t seem to notice, for example, the distinction between a private business (operating in a market it can’t control) and a public agency able to do whatever it takes, at whatever short-run cost, to achieve a target rate of inflation.

At the time, there was still a presumption that decisionmaking at a reformed Reserve Bank would be made (ultimately) by the Board –  as, of course, responsibility in SOEs and many other Crown agencies rested with the respective boards.  The Board was largely non-executive (Governor, Deputy Governor, Secretary to the Treasury plus other members appointed by the Minister) and Goodhart moves on to discuss the issue of whether non-executives could be involved in monetary policy decisions.

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Reasonable points in some respects (how to manage potential and actual conflicts has been an issue even in the recent appointment of members of the new MPC), although note that in Australia the Reserve Bank of Australia Board –  which sets monetary policy –  is very similar in composition to the way the RBNZ Board was in the 1980s.

Perhaps more interesting is about the qualms Goodhart has –  in early 1987 –  about the case for an independent Reserve Bank, in particular around the case for a more active coordination (at least in some circumstances) of fiscal and monetary policy.

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Goodhart’s paper ends with this paragraph.

good8If you were generous, you could interpret the final Reserve Bank of New Zealand model as looking something like that paragraph.  Unlike the Bundesbank, the Reserve Bank of New Zealand never had the power to set any specific policy objective for itself, and there was explicit override provisions built into the legislation allowing the government to (temporarily) override the agreed (Governor and Minister) policy targets.  But this paragraph sounds a lot more like the Bank of England in the 1980s, than the case made in public for the Reserve Bank of New Zealand Act 1989 (much of which was about having as few residual powers for  Minister as was consistent with getting the legislation through the Labour Party caucus).

In fairness, the Bank asked for these comments from Professor Goodhart at relatively short notice. On the other hand, he was at the time a leading academic writer in the area, and a former senior practitioner.  And so I am still struck by the conflicting strands of thought that one finds in this short paper –  on the one hand, the idea of options to reward senior central bank staff for meeting a target they might specify themselves, and on the other a real concern about the potential disadvantages in separating fiscal policy too far from monetary policy, and thus some ambivalence about too much operational autonomy for the Reserve Bank at all.

Having said all that, in a way what struck me most about the Goodhart paper is what wasn’t there.    The UK’s disinflation experience in the 1980s had a wrenching one.  Economic historians will still debate the contribution of monetary policy to the peak of three million people unemployed, but no one seriously doubts it played a part.  At the time, there hadn’t been many economywide costs to the degree of disinflation New Zealand had so far managed –  the credit boom and stock market excesses were still in full swing-  and for a time that was to induce a degree of complacency among New Zealand advisers (I recall a meeting I was in perhaps a year or so later at which the then Deputy Secretary to the Treasury was telling the IMF about how modest he expected the costs of disinflation to be –  the head of the IMF mission politely begged to differ).

But in this paper there is no mention of output costs at all  – either those associated with getting inflation down to a much lower average level, or the short-term deviations of output from potential that would come to play such a large role in central bank thinking in subsequent decades.  Just none.  It is quite extraordinary  (and thus when Goodhart talked about tying staff pay to the inflation target, no sense of the political impossibility of giving central bankers financial bonuses for actions that would, at least temporarily, raise unemployment –  even if one could accurately and formally specify a binding target for the life of the options he proposed).

What of Reserve Bank staff ourselves?  From mid-1987 I was Manager of the Monetary Policy (analysis and advice) section at the Bank, and thus quite heavily involved in clarifying what it was we were going to target, how and when.   If memory serves, I think many of us were probably too complacent, perhaps a little blind, around the short-run issues, and tended to work on an over-simplified mental model in which once inflation was lowered to target all we really had to worry about were things like oil price shocks or GST adjustments (we didn’t explicitly – and probably not implicitly –  think much about significant positive or negative output gaps developing).

On the costs of disinflation itself, we were (on the whole) more realistic, but to some extent that depending on the individuals.  There were “battles” between what might loosely be called “the wets” and “the dries”, the former tending to emphasise the transitional costs and the latter the medium-term goal.   Some of the wets (I was mostly of the other persuasion) probably doubted that the 0 to 2 per cent inflation target, adopted in 1988, was really worth pursuing.  Perhaps what united us was a belief that a lot of other reform –  greater fiscal adjustment and more micro reform –  would reduce the costs of getting inflation sustainably down.

Some 20 years ago now I wrote a Bulletin article on the origins and early development of the inflation targeting regime.  In that article, I tried to capture some of competing models that influenced the legislative framework (a funny mix of independence –  not trusting politicians –  and accountability –  not trusting officials and having ministers hold them to account). I also reported some extracts from some of the papers we wrote (I often holding the pen) as the target came together.    From one early and somewhat ambivalent paper (and I can’t recall why shipping got so much attention that month)

Moreover, the Bank noted that “the potential improvements in living standards to be derived from more rapid and complete removal of import protection, and the deregulation of such grossly inefficient sectors as the waterfront (already under
way) and coastal shipping, far outweigh the real economic benefits of slightly faster [emphasis added] reductions in inflation”. In an early echo of what later became a dominant theme in subsequent years, the Bank argued that if price stability was to be pursued over a relatively short time horizon, everything possible needed to be done at least to try to influence expectations and wage and price-setting behaviour.

This post isn’t about having a go at Charles Goodhart, The Treasury, the Bank, or me and my colleagues who were working on some of this stuff at the time.   Mostly, it is just about history, and the sober perspective that history often provides –  things that seemed clear at the time seem less clear with the perspective of time, and some things –  that one later realises are really quite important –  that hardly get attention at all.  If it is an argument for anything, it is probably for more open and deliberative government and policy development processes, perhaps even for incremental and piecemeal (in Popper’s words) reform.   That probably never appeals to reformers –  perhaps especially not young ones  –  and perhaps there are occasions when it can’t be (practically) the chosen path, but blindspots are all too real.

As for the Reserve Bank Act 1989, if there were mistakes and weaknesses in its design (most especially the single decisionmaker model), it did probably serve New Zealand fairly well for several decades.  It was, almost certainly, superior to the Atkinson/Treasury scheme.   And yet one can also overstate the difference legislation really makes –  Australia having made a similar transition to low and stable inflation under legislation still much as it was first passed in 1959.