A month ago there were no commentators suggesting the OCR should be raised at the next review.   Since then we’ve watched day-by-day as the news about the coronavirus (now named “SARS-CoV-2” and the disease it causes “COVID-19.”) has got relentlessly worse.   Against that backdrop, the case for an OCR cut today looks pretty unanswerable. Not because an OCR cut will make any material difference to March quarter GDP – it won’t –  but because the job of discretionary monetary policy is to lean against demand shocks, positive or negative, so long as inflation is well in check.

As I noted the other day, core inflation hasn’t got as high as the target midpoint for the whole of the last decade.  In that context, when there is a clear-cut (if not readily calculable) adverse demand shock, the Monetary Policy Committee would be remiss if it simply sat on the sidelines today, suggesting that they would merely be “watching closely” and be ready to act down the track.  In the current macro climate –  quiescent inflation, flat or falling inflation expectations –  there is simply no downside to acting now.    There is no particular virtue in instrument stability: the instrument exists to lean against macroeconomic instability (doing what it can to maintain “maximum sustainable employment”, in the current jargon).

Even a couple of weeks ago one might perhaps reasonably have reached a different view.  But now we have Chinese inbound tourism cut to almost nothing overnight (first as a result of Chinese restrictions and then our own), and confirmation from the universities that perhaps 60 per cent of their PRC students are still out of the country and unable to travel here.    We have much the same situation in Australia, a key economy for us, and in China itself –  one of the world’s largest economies –  huge economic disruption, and a spreading range of restrictions on movement, social gathering etc etc.  We see photos of largely empty streets or public transports in big Chinese cities that aren’t locked down, quite limited returns to work after earlier shutdowns, and so on. From Hong Kong there are reports of more cases, but again the bigger impact is probably people staying home, avoiding social gatherings etc.  Investment banks doing business in China –  ie quite severely constrained in their freedom to run negative lines –  have been marking down their 2020 Chinese and global economic forecasts.  Even the WHO –  which previously presented as relatively complacent – is now talking of this as

WHO chief Tedros Adhanom Ghebreyesus told reporters in Geneva the vaccine lag meant “we have to do everything today using available weapons” and said the epidemic posed a “very grave threat”.

“To be honest, a virus is more powerful in creating political, economic and social upheaval than any terrorist attack,” Dr Ghebreyesus said.

“A virus can have more powerful consequences than any terrorist action.

I’ll leave the florid rhetoric to him, but if there was a good case for cutting the OCR after the 9/11 attacks and after the February 2011 earthquake (and I think there was) that case is at least as persuasive –  compelling in my view –  now.

It isn’t really clear to me why, faced with a decision to make today (not, say, a week ago as with the RBA), anyone would favour not cutting the OCR.   The OCR (monetary policy more generally) is designed to be flexible and responsive (easing and, if warranted later, reversing such easing).  The OCR isn’t about support for individual adversely affected sectors –  if that is really needed in some areas it is a fiscal policy/government matter –  but about stabilising the overall economy faced with (in this case) clear negative shocks.  The tool is fit for purpose.

One argument sometimes heard is that we shouldn’t do anything because things are so uncertain.  But that argument should run exactly the other way round. The high degree of uncertainty, which is probably now rising by the day, is exactly the conditions in which people put off spending, put off travel, are a bit warier about eating out, and so on. It represents a likely material adverse demand effect on top of the specific channels (tourists, students) we already knew about.  Think of travel.  You might have been planning a business trip into Asia.  You might be happy enough to go today, and yet you look ahead and wonder what things might be like when you want to get home again, let alone what conditions might be like if somehow you got sick.  I reckon we’ll see an increasingly number of non-essential trips postponed, whether business or leisure.  And that won’t be so just in New Zealand.   With each passing week, we’ll also see more spillover effects into spending elsewhere in the economy and the confidence surveys –  whatever we make of them –  are likely to take a hit.

There is also the argument that things will snap back once the virus is behind us.  No doubt that is the most sensible assumption, but an increasing number of commentaries are noting that a full snap back isn’t likely to be a matter of a few weeks: it seems increasingly likely that the level of economic activity over much of this year, in much of the world, will be weaker than otherwise –  perhaps not a lot by the end of the year, but that is still 10-11 months away.    And assuming things will simply snap back risks being a recipe for doing nothing with monetary policy when it was actually needed (there are plenty of things forecasters think will be shortlived, but turn out to drag on rather longer).

I’ve also heard a story that the Reserve Bank cutting the OCR by 50 basis points last August may have instilled in some a sense of unjustified worry, becoming a bit of an own goal. Is there a risk of something similar now?    First, the August cut wasn’t well-handled.  It may have been substantively justified, but was poorly communicated and was not clearly tied to specific and very visible adverse developments here and abroad.  As it happens, I don’t think the “own goal” effects, if they existed at all, lasted for long at all (little sustained evidence in eg confidence surveys).    What about a move now?  Sure it would be unexpected, in that surveys of economists were all picking no change.  But (a) those surveys were often done a week or more ago, (b) economists generally aren’t asked what they think the Bank should do, and (c) there is a very clearly identified adverse event, which every commentator will be focusing on.  It would be quite easy for the Bank to credibly justify a cut today, specifically tagged to the coronavirus (and referring to 9/11 and 2011).  And if in doing so the Bank raised a bit more public consciousness of the mounting economic issues, it would probably be no bad thing anyway.

Perhaps the final caveat I’ve seen is that global equity markets seem quite surprisingly sanguine.  If they aren’t pricing something quite bad –  or even high risk – why should central banks react?  It is a fair question.  One answer is a matter of different time-horizons.  Equity markets are pricing earnings prospects over the life of the firm, while central banks are (by design) supposed to be focused more on the short-term.  A few bad months might not rationally affect the value of most firms much, but might still warrant lower policy interest rates. It is just a different game.  But it is also worth noting that New Zealand markets are pricing an OCR cut by the end of this year.   If it is needed, and likely to be useful, in a coronavirus context, it is much more useful –  and more likely –  frontloaded.

Time (not long now) will tell what the Monetary Policy Committee decides to do.  I am encouraged by two things: first, was the MPC’s willingness to act decisively last August (even if the accompanying communications etc were hamfisted) on much less clear-cut evidence, and second by the fact that one of the external members of the MPC (retired economics professor, Bob Buckle) was heavily involved in The Treasury’s early work on pandemic economic effects last decade.

Whatever the MPC chooses to do, the Reserve Bank has introduced an interesting new exercise in transparency.  If you are on Twitter you can ask the Bank directly a question during the press conference this afternoon.

The Reserve Bank Monetary Policy Committee releases its next Monetary Policy Statement and Official Cash Rate (OCR) decision next Wednesday –  the first we’ve heard from them since November.

Until a couple of weeks ago you could probably mount a pretty strong case for the status quo. If the MPC was right to have left the OCR unchanged at 1 per cent in November,  it probably looked as if that was still going to be the right decision in February.  I thought they should have cut in November, and so was still inclined to think they should cut now –  but it wasn’t a particularly strongly held view.  It is worth remembering that after all these years, the Bank’s favoured core inflation measure still isn’t back to 2 per cent (it was last there in 2009) and there wasn’t a lot in the wind suggesting it was likely to rise further.   But there hadn’t looked to be a lot in it.

The Reserve Bank’s Survey of Expectations, released at 3pm today, looks to be not-inconsistent with that sort of status quo story.  But the survey closed a week ago, and opened two weeks ago –  the Bank doesn’t tell us when responses came in, but I know I completed mine on 25 January.

Since then coronavirus has become a huge story.  From an economic perspective, the issue isn’t so much the number of deaths –  50 or so in total two weeks ago and 640 now, on official figures –  as the policy and personal responses, here (and in other similar countries) and in China.    Two weeks ago, perhaps optimists might have hoped a one week shutdown over Lunar New Year might break the back of the problem.  But then, of course, ever more cities in China were locked down, the PRC authorities banned most outbound tourism, countries starting putting restrictions on arrivals of non-citizens who’d been in the PRC, and finally New Zealand –  apparently dragged along by Australia –  banned the arrivals of anyone other than citizens (and their close family members) who’d been in China recently.  We’ve also seen dairy product prices falling, talking of serious disruption in the logging industry, and so on.   We’ve even seen some more-domestic effects, including the cancellation of the Lantern Festival in Auckland.  Oh, and there seems to be no sign in the PRC responses that suggests they think they’ve already got on top of the problem.

No one knows how long these effects will last, or whether things may yet get (perhaps materially) worse from here (I was talking to a journalist the other day about possible extreme scenarios, and it doesn’t really do to contemplate what would happen to world trade –  perhaps only for a short period – in such scenarios).

When I say ‘no one”, that of course includes the Monetary Policy Committee, who will have not a shred more information on the underlying situation –  and probably very little more on domestic economic effects – than you, I, or anyone else.   Any data available just yet –  perhaps daily air arrivals, or electronic transactions volumes in (say) Queenstown –  will be fragmentary at best, and there won’t even be new local business survey data for a few weeks.  So they have to work with what we know, perhaps how things would be likely to play out if the policy responses (here and abroad) remain much as they are for any length of time, and within a framework for thinking about risk and regret.

All of which looks a lot like the classic sort of shock monetary policy is designed to help manage (lean against).  Aggregate demand in New Zealand will take a not-insignificant hit: tourism and export education from the PRC is about 1 per cent of GDP, and tourist numbers will dry up almost completely for now, and (if our numbers are similar to those in Australia) the export education numbers are likely to more than halve.

These effects might not last long, but they are the situation we face now and no one has any idea how long the adverse effect will last.

But these aren’t the only demand effects.   Australia and the PRC are our two largest overall export markets: economic activity in China is likely to have taken a substantial hit this quarter, and Australian universities are (for example) even more dependent on the PRC student market than the New Zealand ones are.

And how would you respond to uncertainty if you were in business, or were (for example) a lending institution.  The rational response is to put projects on hold where possible.  That seems likely to happen –  perhaps on a very small scale initially (few new projects start each week, but mounting as the situation becomes more protracted (and perhaps doubts grow about just how quickly business might rebound).

Also, although the focus to date has been on services exports (tourism and export education), and a couple of goods export sectors, even if goods can be still shipped out to China, you have wonder how soon the flow of imports is going to be affected –  people who’ve been in China in the last 14 days can’t enter Singapore, Australia, PNG, Fiji, Taiwan or…..New Zealand (and, I understand it, much of New Zealand’s trade is trans-shipped through Australia or Singapore).  Ships need sailors.

I don’t know what the Reserve Bank will have chosen to do about their formal economic forecasts.  In their shoes, I’d probably publish ex-coronavirus forecasts, and then a series of scenarios around coronavirus effects (what else can they do: they usually treat other policies as a given, and in this case the ban of people who’ve visited the PRC is scheduled to lift next Sunday, but I doubt anyone much expects it will be, and more importantly neither they nor anyone else can credibly forecast the path of the virus, including how its is beginning to spread outside China).

But whatever they do in the body of the document is much less important than the policy call they make.     This is the time to cut the OCR. perhaps even by 50 basis points.  It would be a mix of risk-mitigation and responding to a real loss of demand (very rarely do we see such hard early evidence of a specific source of demand drying up so quickly).

The standard counter-argument is something along the lines of “early days”, “likely to rebound quite quickly –  eventually”, and so on.  But here is the thing about monetary policy: it can be adjusted quickly (to cut and to raise); it is the tool designed for short-term macro-stabilisation (unlike fiscal policy) and some of the channels –  notably those to the exchange rate –  work really quite quickly.  I’m not suggesting that cutting the OCR would make more than a trivial difference to GDP in the March quarter (the tourists and students still won’t have come), but if the effects are any longer-lasting we would start to see the benefits.

Twice before the Reserve Bank has cut the OCR is response to truly-exogenous external events.  The first was the unscheduled 50 basis point cut in September 2001 (a week or so after the terrorist attacks).  Here was the case we made then

“It seems more likely now that the current slowdown in the world economy will worsen. In these circumstances, New Zealand’s short-term economic outlook would be adversely affected, although any downturn might well be relatively short-lived.
“New Zealand business and consumer confidence will be hurt by recent international and domestic developments, and today’s move is a precaution in a period of heightened uncertainty.

I still reckon that was an appropriate response at the time, even though we had (a) no new survey or hard data, (b) there were no foreign or domestic government restrictions which would have the direct effect of biting into domestic demand in New Zealand and (c) the exchange rate –  already low –  was by this point almost 5 per cent lower than it had been on 11 September.  It was explicitly precautionary, but in a climate where our best judgement told us that if there was any effect it was going to be adverse (disinflationary).

The second such 50 point cut was in March 2011, after the severe February earthquake.    As the Governor put it at the time

“The earthquake has caused substantial damage to property and buildings, and immense disruption to business activity. While it is difficult to know exactly how large or long-lasting these effects will be, it is clear that economic activity, most certainly in Christchurch but also nationwide, will be negatively impacted. Business and consumer confidence has almost certainly deteriorated.

Going on to observe

We expect that the current monetary policy accommodation will need to be removed once the rebuilding phase materialises. This will take some time. For now we have acted pre-emptively in reducing the OCR to lessen the economic impact of the earthquake and guard against the risk of this impact becoming especially severe.”

We knew that the longer-term impact of the earthquake would be a big positive boost to demand (all that rebuilding activity, which would crowd out other activity in time) but still concluded that it was appropriate to cut early and quite hard to lean against adverse confidence effects etc (and some direct adverse demand effects –  eg to South Island tourism).    Perhaps we just got lucky, but it still looks like an appropriate response to me, even with years of hindsight.

In June 2003, SARS also played a role in the Bank’s decision to cut the OCR then.  I wasn’t involved in that decision –  I was working overseas –  so don’t have as strong a sense of the balance of factors.  One can mount an argument that it was unnecessary to have cut  –  the Governor eventually concluded as much –  but much of that argument was with the benefit of a hindsight that real-time decisionmakers could not have had (about how quickly the virus would be contained).

Set against the backdrop of those three cuts, I reckon the case for an OCR cut now –  even it had to be pullled back in six months’ time –  is stronger than in any of those other cases.  We have clear adverse domestic demand effects, that aren’t just about confidence but about policy choices in China and in New Zealand (and, more peripherally, in other countries), we don’t just have a one-day event which we live with the aftermath of (rather an ongoing situation, which is probably still worsening), the epicentre of the issue is in the world’s largest or second-largest economy which itself is taking a large negative economic hit for now, and Australia –   our other main trading partner, and major source of investment –  faces very similar issues to New Zealand.

Against that backdrop, it isn’t obvious what the downside would be to an OCR cut next week.  Core inflation is still below the target midpoint, and yet the demand shock is adverse.  Perhaps things resolve themselves very quickly in a couple of months and the Bank is slow to pull back the OCR cut.  The worst that could happen then might be core inflation going a bit above 2 per cent.  But since 2 per cent isn’t supposed to be a ceiling, and we’ve haven’t even been to 2 per cent in the last decade, that might count as a gain not a loss, in terms of supporting core medium-term inflation expectations.

Then, of course, think about really bad scenarios, and a world with very limited fiscal and monetary policy capacity to respond to a serious downturn. It really is important to keep those expectations up.  Recall that that was one of the stories the Reserve Bank told for a while after the unexpected 50 basis point cut last August.

But here is the implied inflation expectation measure from market prices, right up to today (the difference between yields on nominal and indexed 10 year government bonds)

There was a bit of lift in this measure of implied expectations late last year (partly global, but a range of central banks were responding similarly).  But now we are pretty much back to where we were before the Bank cut the OCR unexpectedly sharply six months ago (and this even after bond yields have bounced off their lows earlier this week).   I guess we should take some comfort that implied expectations aren’t lower than those in August, but 0.98 per cent is a long way from 2.

And as one last straw in the wind, in 2017 the Bank (helpfully) added a couple of questions asking about respondents expectations for inflation five and ten years hence.  The answers have hewed pretty close to 2 per cent –  I usually put in 2 per cent for 10 years hence, noting that the current MPC/government won’t have any effect on those outcomes –  but when I opened the survey results today I noticed that even these expectations (which the Bank likes to boast of, as a sign of confidence) have been edging down.

The differences are small, and in isolation I wouldn’t put much weight on them.  But not much is moving in the right direction, and these results were surveyed two weeks ago when most respondents thought the policy status quo was just fine for now.

It seems a pretty obvious call to me that they should cut on Wedneday –  absent some startling positive turn in the virus and related news between now and Wednesday morning –  rather than just idly handwringing about “watching and waiting”.  And the Governor/MPC was willing to make some big and unexpected calls (wisely or not) last year.    The Bank wouldn’t be the first central bank to move either.

Who knows whether or not the Bank will actually move on Wednesday – quite possibly not even them yet – but I’m sure the MPC will have been looking for some analysis of past responses to out-of-the-blue shocks and thinking about the similarities and differences here.    Whichever path they finally choose, that thinking should be laid out – not just noted – in the MPS and/or the minutes.