Day: August 8, 2019

Reserve Bank MPS – part 2

Michael Reddell Monetary policy, MPC

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

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

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

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

fisc impulse.png

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

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

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

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

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

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

bus investment RB.png

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

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

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

GDP phw mar 19

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

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

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

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

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

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

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

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

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

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

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

 

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

Michael Reddell Monetary policy

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

This was my first reaction yesterday afternoon.

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

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

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

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

And yet conventions and communications matter.

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

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

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

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

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

September quarter 2019    1.4 per cent

December quarter 2019     1.2 per cent

March quarter 2020            1.1 per cent

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

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

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

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

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

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

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

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

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