A radical macro framework for the next year or two

The government’s sudden decision on Saturday to substantially close the border seems to have jolted some towards realising just how serious the coming economic dislocation is.   But it has also led to a plethora of comments suggesting that the “border closure” is itself the cause of, or trigger for, the dislocation and huge loss of income and output that is coming.  It wasn’t.  As is well known, willingness to travel internationally was drying up anyway, and was only likely to drop further, amid the progress of the virus and the skyrocketing levels of fear and uncertainty.  Only the marginal additional effect of the border closure, over and above what was already happening any way, is really relevant to assessing the cost of that particular policy.

Personally, I’m still a bit sceptical about border closures now, which seem more akin to political theatre than to serious policy (with hindsight the one –  simply impossible to conceive –  border closure that would have made sense would have been for China to have closed its border, in and out, in November).  But unless they distract attention, including media coverage and analysis, from the real and bigger issues I guess at this point they don’t do much harm either.

On the other hand, there has still been a real reluctance to grasp just how deep and long that economic shutdown/dislocation seems likely to be.  There was the absurdist extreme this morning of the (overwhelmed?) Reserve Bank Governor who was reluctant to even concede a recession.  But if the Prime Minister –  who is usually hopeless on matters economic, including in her Q&A interview yesterday –  and the Minister of Finance have been less bad than that, they’ve still refused to level with the public, in ways that leave one wondering whether even they have yet grasped what we’ve found ourselves in so quickly.

Thus, it was good on Saturday to hear the Prime Minister articulate the “flatten the curve” strategy, but neither she nor any other public figure I’ve seen or heard from has been willing to recognise that if we do flatten the curve a lot, whether by border closures or (more probably) physical distancing, there is no quick or easy exit strategy: in some form or another, perhaps varying through time, the restrictions and behavioural changes (compulsory or voluntary) have to be in place for a long time, unless/until (say) a widespread vaccine is available.    That means a huge economic cost, and huge economic uncertainty, for the (uncertain horizon) future.  Perhaps it is the only sensible strategy now –  notice the pushbacks against the UK “herd immunity”/cocoon the elderly notions – but how does it feel three months hence?  Six months?  Nine months?   There has been no open discussion of the exit strategy, or the implications economic and social.

It is pretty easy to develop scenarios in which real GDP for the next year could be 25 per cent lower than otherwise.   Foreign tourism has evaporated.  There’s 5.5 per cent of GDP gone.   Perhaps a few more people will holiday locally, but more likely reluctance to travel will keep on diminishing, even if we never quite get to the point of being penned in our homes, even just outside working hours.   No new investment project will start, and many of those underway will be halted –  whether because of uncertainty, illness, lack of finance, disrupted supply chains or whatever.  Housing turnover will dry up.  On the expenditure GDP side, investment is about 20 per cent of GDP.   Demand for many of our other exports will also weaken –  as most every other country battens down and experiences big income losses as well as disrupted distribution channels.  Personally, I went to a movie yesterday afternoon, but I doubt I’ll be going to any more for the duration.    Restaurant bookings in other countries are plummeting and so on.  Lock people down Wuhan style – or have them so fearful they won’t venture out –  and of course for a time the losses are even greater.

It is an enormous loss of income and wealth, most of which will never be recouped.  Those losses will be borne –  the only question is who bears them. That is likely to be some mix of law, canons of fairness/justice, and considerations of economics (what will help us eventually emerge with the least semi-permanent damage).

A key aspect of my approach to this issue is that now is not the time to be encouraging more spending and economic activity. In fact, to do so is likely to run directly counter to the public health imperatives.  There will come a time when we do want people to emerge from their shells and be ready, eager, and able to spend. But not only is that time not now, but a realistic take on what “flatten the curve” seems to mean here and abroad, suggests that at best that time will not not be for many months yet.

So talk of stimulus packages is really quite misplaced (much of the Australian package last week will have really just be wasted money).  The focus now needs to be on three things in my view:

  • basic income support for everyone, whether through companies or through the welfare system,
  • throwing all that can usefully be thrown at gearing up health system capability (I have no idea what can actually be done, but the impression so far is that not much has been done, perhaps so as not to muddy the waters of the political message about our “world-class health system”, when it is clear that no health system in the world can cope with very much of this virus at once –  another message politicians have not fronted the public with), and
  • creating a climate of confidence that in time –  as soon as possible, but it won’t be soon – things will get back to normal, including economically, and that the authorities will not stint in helping that happen WHEN THE TIME COMES, which is not now, and cannot be now.  Included among the imperatives regarding confidence are things around medium to long term inflation expectations –  something the Bank used to like to talk about, until it really mattered – and the assurances it takes to create credit and liquidity available.

So here I want to propose a strategy or framework for approaching the period ahead, the period before there really is light at the end of the coronavirus tunnel.    When that light becomes evident, my suggestion of the temporary cut in the rate of GST would be apt, as would a temporary cut in one of the lower income tax bands.  A one-off significant lump-sum cash transfer might even have a place.   And monetary policy would have been fixed in ways that mean interest and exchange rates strongly accommodate any nascent uptick.

But in the meantime here is something along the lines of what I think needs doing.

First, people keep playing down just how much it matters that monetary policy cannot adjust very much.  Even in normal recessions, whether or in the US or elsewhere, cuts in short-term interest rates of 500 basis points or more are quite normal.   This economic dislocations seem almost certain to be larger than anything anyone living has ever experienced in countries with their own monetary policy.   We simply cannot accept the status quo of an effective lower bound on nominal interest rates not far below zero (let alone the rank incompetence that for now has the RBNZ telling us the floor is 0.25 per cent, because they hadn’t ensured banks could cope with negative rates).

This problem can be solved.  The effective lower bound arises because people- and institutions can convert deposits into cash, which yields zero, rather than accept a materially negative interest rate.  It isn’t worth doing so –  insurance, storage, AML laws etc –  for a few tenths of percentage points, but if the OCR were to be set at – 5 per cent (quite plausibly what would be sensible now: there are papers for the US in 2008/09 which suggested -5 per cent would be appropriate then) the general consensus is that such conversion would occur on sufficiently large scale to make it not worth cutting that deeply.

But those restrictions can be eased, temporarily or permanently.    If, for example, the banks had to pay a premium of 5 per cent over face value to purchase (net new) notes from the Reserve Bank, they’d be likely to pass that cost on to customers –  and particularly to any large customers.  If a pension fund (say, and I’m a trustee of two so have thought about these options) considered switching into physical cash and faced a 5 per cent fee, they’d have to think about how long they expected the crisis to last.  If they thought it would be largely over this time next year, you’d rather accept a -5 per cent interest rate in a bank that pay the insurance and storage costs on top of the 5 per cent cash fee.  It isn’t technically hard to do. It is pretty countercultural –  cash and deposits have been essentially interchangeable –  but then so is coronavirus and the attendant economic and social disruption.  There is a bunch of other ways of achieving much the same effect.  They can be done in fairly short order (and announced, for the signalling benefits) even sooner.

Doing so would help ensure we could keep driving the exchange rate down, (as the Governor put it) a standard part of the buffering mechanism in New Zealand.  And it would demonstrate to markets, and anyone else paying attention, that New Zealand authorities were absolutely determined to keep medium-term inflation up  –  in the face, for the next year or so, of an otherwise deeply deflationary shock –  which might even lift inflation expectations, but would at least limit further erosion.

This stuff is geeky and may not make much direct sense to the man in the street.  But it is a reallly important part of a successful macroeconomic framework.  It does not put money in pockets now, but it helps keep the climate right for an effective recovery.

And what it would do is enable us to make a much more brutal and effective start on the appropriate income redistribution to fit the crisis.  Interest rates are really a reward for waiting, and for the opportunities used/foregone over periods of time.  But for the economy as a whole there really is no value in time at present.  And yet we still have deposit and lending rates –  even after today’s cut –  well above zero.   That simply shouldn’t be for the time being.

Of course, there are arguments around negative rates that depositors won’t readily accept negative returns.  Those are arguments –  mostly about slow adjustment of norms –  for relatively stable times, not for the next year or so.    What else are the depositors going to do with their money?   Extreme risk aversion will deter them from purchasing other assets here, and if they either shift abroad or starting spending either effect works in the macro-stabilising direction.

And on the other hand, in deep recessions servicing burdens for floating rate debt typically plummet.  That seems even more imperative than usual (for a recession) now.

In other words, radically lower interest rates would (a) lower the exchange rate, (b) achieve a desirable and typical downturn redistribution from depositors to borrowers, and (c) help create the medium-term confidence in the rate of inflation once we’d emerged.  Those are significant gains even if  no more overall economic activity is induced right now in the midst of the crisis.

If the Reserve Bank won’t act to do this now –  and they’ve shown no sign of any energy thus far, including nothing more than a passing mention in last week’s speech –  the Minister of Finance should insist on it, using his existing monetary policy override powers or, if they aren’t enough, passing special legislation.

Consistent with this, the Bank should –  and quite possibly will within the next couple of weeks –  starting standing in the market offering to purchase any and all government securities at a yield of (for the sake of a round number) 0 per cent.    Doing so would not make much difference to short-run economic outcomes –  frankly little (other than the virus) will or really should – but it would be a strong signal of how committed the authorities are to avoiding a deflationary shock turned into a deflationary underemployed semi-equilibrium. It would also establish upfront that any bond market disruptions – and there may be more –  would not impede the government’s ability to raise whatever it takes over the period ahead.  (And for monetary tragics, yes wouldn’t Major Douglas and Bruce Beetham have marvelled to see such an hour).

The second strand of my adjustment package is a proposal for a wage cut, across the board, of (say) 20 per cent for the coming year.  Remember that I noted that GDP could easily be 25 per cent lower than otherwise for the year ahead.  Someone (lots of people) will bear that loss. Most owners of businesses/shares will take very heavy losses for the time being.   Many people face losing their jobs, or being unable to find one (at a mundane level my son, in Year 13, fairly suggested that finding a holiday job next summer, prior to starting university is going to be…..well, challenging).  They lose out very heavily (recessions never fall evenly).   And at the other extreme, who won’t be losing out at all?    That would be the 20 per cent of so of the workforce employed in the public sector, few or whom will face any material risk of redundancy. (And sure, some public sector workers will be working harder than ever, but so will some private sector workers –  and in case anyone thinks this is beating up on public servants, our main household income is a public service salary.)

In such a dramatic climate, across the board wage rates seem fair, as a way of distributing the (inescapable) losses and pain.   It would have to be done by legislation, which might not be that easy to draft, but it is one of those cases where centralised coordinating devices allow adjustments that couldn’t otherwise readily or quickly occur (the floating nominal exchange rate serves a similar function).

Now, of course the typical high income person can afford to lose 20 per cent of their wage for a year more readily than someone at the bottom.  But in a typical recession the labour income losses are concentrated even more heavily on low income people, so that isn’t a particular argument against what I’m suggesting.  But frankly most people are likely to be spending less anyway over the next year, even if it is just saving the bus fare if people are coming into the office less often (or not at all), or closed bars or movie theatres etc.  But one could tailor the scheme to some extent: perhaps a fulltime equivalent cut of 20 per cent to wage rates, but cappped at $4000 (FTE) for low income workers?

Now one loud objection will be that such a cut will be deflationary: less income, less spending etc.  But (a) I have another big strand to come, and (b) recall that this is mostly redistribution –  instead of most losses falling on firms, more of them would be borne by workers (being as we are all in this together).  And don’t forget that the first strand of my suite of framework policies was a radically expansionary monetary policy, relative to what we have now.

The third strand of my framework –  perhaps the most controversial of all –  starts from asking the question of what we’d have done 20 years ago if we’d really focused on pandemic risk, including at a macroeconomic level.  Presumably the answer is that we would have sought insurance.  It would not necessarily have been available on market – especially not from anyone we’d count on to be around to meet the claims – so we’d have self-insured.  In fact, in the sort of as-if argument favoured by economists you could mount an argument that that is exactly what we have done, across successive governments, by keeping government debt low (and taxes higher as a result –  in effect, the premium).  Now is the time to draw on the policy.

I should say that much of what I’m about to suggest sticks in the craw.  There are some firms that I really have no sympathy with at all: if you are an airline then after 20 years of 9/11,  SARS, H5N1 planning, H1NI, MERS, and the never-long-away risk of major new terrorism, you surely have to plan on the basis that sustained disruption in ability to fly is a core business risk.   But, even if politics didn’t mean any such argument would just get ignored anyway, I think we have to set such perspectives aside, in the interests of a timely restoration when the virus fades as an issue/risk.

At a conceptual level, I am going to propose something like an “ACC for the national economy”.  ACC, you will, recall typically cover 80 per cent of lost earnings.

So how about committing as a country, and by law now –  would be needed to have the effect I’m seeking – that for the tax year 2020/2021 – we would guarantee that everyone taxpayer’s net income would be at minimum 80 per cent of what they received in 2019/2020.  That guarantee would apply to firms and individuals, even foreign-owned firms with substantial operations actually here. (For firms, it might be conditional on –  and scaled to – maintaining at least 80 per cent of the 31 Dec 2019 workforce.)

I’m not here proposing a mechanism to operationalise the payouts of these guarantees, but I don’t believe that would be necessary now.  It would, in effect, be akin to a government bond or guarantee which people and firms could count on and –  as important – their banks could count on.    With such a guarantee, there would be less reason for banks to be reluctant to keep existing loans outstanding, or indeed to extend further credit to cope with the –  often significant cash flow hole.    It wouldn’t avert all failures –  and nor, generally, would that be desirable –  but it would make a huge difference, and provide a high degree of certainty about income floors up front.

The guarantee doesn’t, of course, make people whole (not adversely financially affected) but then all this is on the assumption that 25 per cent of GDP is lost.  Those losses have to be borne by someone (and, as noted above, spending opportunities are going to be fewer anyway).

Recall again that the goal isn’t, and should not be, to stimulate new spending at a time when people have to hunker down, be careful, separate etc.  It is about minimising the longer-term disruption from a totally unforeseen, genuinely exogenous to the New Zealand economy shock.   Done well, firm failures and job losses –  at least of permanent employees –  should be kept to a minimum (as will inevitably be the case in the core public sector anyway), and keeping up something like the required level of credit (much of any addition, secured by a statutory government commitment).   Same applies to household mortgages.

How much would it cost?   It is impossible to tell.  But here’s the thing.  On the OECD net general government financial liabilities series, New Zealand’s net government debt is about 0 per cent of GDP.  That’s right, zero.

Suppose we lose 25 per cent of GDP for a year, but decide to pay every New Zealander (individual and firm) just what they got the previous year, what would that leave net government debt at the end of that year?  Well, that would be something like 25 per cent of GDP.  Not exactly high by international standards, having traversed one of the very worst shocks imaginable outside war.  Of course, the lost output could be larger than 25 per cent of GDP (in Wuhan it will almost certainly have been larger than that so far), or the losses could run longer than a year.  But worry about the second year when we get closer.  For now, an strong demonstrated fiscal commitment should support both credit and jobs.   And, as a society, we pay for it in higher taxes over the following 20 or 30 years.   It is, essentially, ex post pandemic insurance.

(If you wanted you could add some sort of “windfall profits tax”, levying a higher tax rate this year on anyone whose income in 2020/21 was more than 20 per cent higher than in the previous year.)

And that it is it for a big macroeconomic framework package.  It doesn’t obviate lots of short-term issues, including perhaps around sick leave etc. It doesn’t render irrelevant series stimulus effects –  fiscal and monetary – to demand and activity as the virus looks to be sustainably behind us.  What it is designed to do is (a) share the inescapable) losses fairly, if inevitably a bit crudely, without removing all risk from individuals or firms (b) support the existing level of credit and a secure basis on which existing banks could lend to cover shortfalls, (d) dramatically cut servicing burdens (and returns to depositors) as is normal in a deep recession ,and e) support/create confidence in an absolute commitment to keep medium-term inflation up at around 2 per cent, avoiding seeing real interest rates rising into a savagely. deep and at least somewhat prolonged recession and deflationary shock.

I’m sure there are many detailed pitfalls and issues to address.  Perhaps the biggest high level one is the possibility this is all over three or six months hence.  Frankly, I don’t even think that is really worth considering very seriously at present, but even if it were to happen (a) the wage cut could be shortened (new legislation) and (b) the net income guarantee is just that: if it isn’t called because incomes recover very quickly, then that is just great for firms, households, individual and governments.

I commend it to your consideration.

Pretty dreadful

I’m not sure why the Governor chose to hold a press conference this morning after the MPC’s announcement.  Were he an authoritative figure, perhaps it might have been some use.  Such a figure might have been able to offer thoughtful narrative, or framing, for what is going. But this was Orr, a sadly diminished figure, inadequacies fully found out in a crisis.  And the press conference only confirmed that grim assessment.   He should be replaced.

In fact, probably the only worthwhile thing to emerge from the press conference was that Deputy Governor Geoff Bascand is clearly the adult in the room, including that he was the only one of the three MPC members speaking who was willing to call a spade a spade regarding the economic consequences of what is unfolding.  He has chief executive experience.   He’d be a superior Governor to Orr (not ideal, but –  as I noted before the appointment was even made, when Bascand confirmed that he’d applied for the job –  a safe pair of hands).

As for Orr himself, there seemed to be no contrition at all for the February MPS (the one where they moved to a tightening bias) or for all that complacency in speeches and interviews just a few days ago.  He told us we should listen to the health experts etc –  quite possibly, but we should have been able to listen, and count on to act aggressively, economic and financial experts in our Reserve Bank. Instead, we got Orr and Hawkesby last week, given cover by the rest of the MPC and the Bank’s Board.

There were odd lines.  He claimed the exchange rate was acting as a buffer, and yet (a) the fall in the exchange rate is very limited compared to the experience in typical New Zealand recession, and (b) as he was talking, at least against the USD the New Zealand was higher than it was at 7 this morning (not very surprisingly, given that the Fed cut even more than the RBNZ did, on top of an earlier large cut).

And there was the confirmation of the point I highlighted in my earlier post.  They felt they couldn’t cut the OCR below zero because not all the retail banks were  “ready”.   Strangely, no journalists challenged Orr on this.  Isn’t crisis preparedness for the system a core part of what the Bank is going as regards the financial system?  Haven’t they been talking about negative rates as a possibility for a couple of years?  Haven’t other countries had negative rates for longer than that?  There is some legitimate debate about the usefulness of negative rates, but it is a gross dereliction of the Bank’s responsibilities not to have ensured long ago that all players could manage negative rates (in their systems etc).  And, of course, no contrition for that failure either.

We even had attempts to play down the coronavirus experience in New Zealand as well (“only a few very isolated cases”) something he’d surely just have been better to have shut up about.

He claimed they’d provided details of their unconventional policies in his long speech last week, even though that speech was very light on detail, and promised a series of more detailed papers to come. No word on those today.  He gushed about the capabilites of his unconventional instruments, but seemed to have no developed mental model for the relevant transmissions mechanisms.  It wasn’t exactly confidence-inspiring.

And then there was three final points worth noting:

  • asked if he was anticipating a recession, instead of simply saying “yes”, or “yes, a very serious one” –  surely the only honest answers –  he got into a debate with the journalist, apparently hung up on the (supposed) technical definition of two quarters of GDP falling.  He was prepared to concede “a period of very weak economic activity” but when pushed on a recession he would only fall back on “I don’t know”.  Every one else does.   He did finally concede that on some of the Bank’s scenarios –  really only some? – there would be a recession in New Zealand.
  • asked about his response to suggestions that the Bank had moved “too little too late”, his initial response was “Nothing”.  He simply wouldn’t engage.  And then he tried to make a virtue of MPC’s inordinate delay, claiming –  is the man serious to even raise this? –  that acting earlier wouldn’t have stopped the virus.  Then we got rhetoric about the importance of a medium-term framework for monetary policy –  a strange claim on the morning of an emergency cut –  and the value of fuller information, as if any information will ever be enough or definitive.   He then had the gall to claim that New Zealand was now in the “best possible position”.
  • and finally, there was a suggestion in Parliament a short-time ago (early last week?) that the Bank was trying to pressure banks not to be too negative in their commentary.  It was never actually confirmed, although there is reason to believe they were told-  by the Bank –  to exercise a sense of “social responsibility” in their commentary.   That was exactly the line Orr ended his press conference with today, to all the assembled media.  From an organisation that minimised the issue for so long, that really should have been a lot more alarmed and active earlier on, it is simply an unacceptable stance (more so than ever, since powerful government agencies should be welcoming, scrutiny, alternative perspectives etc – especially in uncertain times like this –  not (ever) trying to get happy-talk coverage.

It was a sadly revealing performance, as to just how unfit for office Orr is.  And of how he and Grant Robertson, Neil Quigley, the rest of the Bank’s Board, and the rest of the MPC have let New Zealand down.


Game’s up

I may well have more to write about the Reserve Bank announcement this morning after the Governor’s press conference at 11am – which I hope begins with a formal apology from him and Hawkesby for their appalling complacency and minimisation of the issues as recently as a few days ago –  but these are some initial reactions.

I guess I have three key points:

First, a 50 basis point was warranted at the time of the last  MPS (and doing so would have been entirely in line with past practice of reacting to out-of-the-blue shocks) so 75 basis points now is seriously inadequate.   Everything has got a great deal worse since then including –  though not mentioned in the statement –  medium-term inflation expectations.

Second –  and this was the mindblowing bit to me –  was this extract from the minutes

Staff also advised that an OCR of 0.25 percent was currently the lower limit, given the operational readiness of the financial system for very low or negative interest rates.

This is simply inexcusable if true (which it may not be).  As just one small point, I lead a working group at the Bank in 2012 –  height of the euro crisis – which identified then the need to ensure, as a matter of urgency, that banks and the RB itself were able to operate with modestly negative interest rates.   And for years we have seen various other countries operating with negative policy rates, so if the Bank has not been taking action to ensure the system could operate, when needed with negative rates it is simply an inexcusable failure. For which, frankly, heads should roll.   Neither when they put out their Bulletin article two years ago nor in the Governor’s speech last week was there any suggestion that negative rates could not be used now.  Best surmise, they simply weren’t taking things sufficiently seriously until the last few days.

And, third, they have basically conceded that it is game over and that monetary policy has reached current limit  (which is so wholly because of their failures –  on this narrow point and, like most of their peers, dealing more decisively with the near-zero lower bound.

Note that as part of their statement they formally rule out any further changes –  including cuts –  for at least the next 12 months.  In other words, tbey rule out taking urgent action now to remedy their past failures.  Simply extraordinary.   I guess climate change and the like were taking priority for the Governor and his staff?

But the point I also wanted to focus on was this bit of the resolution.

Agree that Large Scale Asset Purchases of New Zealand government bonds would be the best additional tool to provide further monetary stimulus in the current situation – if needed.

I never got round to writing about the substance of the Governor’s seriously inadequate speech last week, but had I done so one of the points I would have made was that outside immediate financial crisis conditions –  not NZ now –  these asset purchase routes simply did not offer much.    It isn’t as if bond yields are now at the still-high levels they were in most countries in 2009 even after the OCR had been cut (even if they have been rising in the last few days as the global rush to cash has taken hold).

You might doubt my interpretation –  but you really shouldn’t as it is pretty widely shared, even if often in muted language –  but, as it happens, we have the word of one of the MPC members for it.  Again, I’d been meaning to use this in a fuller post this week.  I hadn’t seen this quote elsewhere, but in his column in Friday’s Herald Brian Fallow reported the RB Chief Economist Yuong Ha as saying, of the unconventional options,

“they give you a little more headroom, a little more more and space”

Precisely.  And “just a little more” is not what the occasion demands.

In effect, in this announcement it is a case of “one and done” –  not in sense of “we”ll be bold and not need to move again” –  sort of their justification for the 50 point cut last year –  but “we’ll move now, and then……well, we have to retire from the field and stare into the macro/monetary abyss….because we spent years just not doing our job, distracted by all sorts of pet things, always looking for rates to rise (as recently as the last MPS).

It really is inexcusable.   Personally I think there is a strong case for dismissing the Governor, and probably most of the MPC too –  including those externals we’ve never heard a word from to explain or justify their collective inaction and failure of preparedness.   I don’t suppose it will happen, but it is what often does –  and should –  happen after battlefield disasters and revealed gross failures of preparedness.   Then again, to act would be for the Minister of Finance to concede some of his responsibility –  he appointed them, he is supposed to hold their feet to the fire, hold them to account.  And only a few months ago in a letter to me he indicated how satisfied he was with the Governor’s stewardship.

I plan to have a fuller post this afternoon on some ideas for macro management now and in the months ahead.  As I’ve said in posts last week and on Twitter, now isn’t the time for stimulus per se –  new spending by the public isn’t the goal as the economies of the world deliberately de-power. The immediate focus has to be income support, the health system, and then some assurance about the framework to see us through the period –  perhaps protracted – until genuine stimulus becomes the appropriate focus.