On Monday afternoon I put out a post under the heading “A radical macro framework for the next year or two”. There were four, intended as mutually reinforcing, strands to what I was proposing. Those strands were, with a few marginal refinements relative to Monday’s post:
- urgent action, legislative if necessary, to ensure that the OCR can effectively be cut to at least -5 per cent with substantial flow-through to retail lending and borrowing rates,
- in the meantime, the Reserve Bank should stand in the market to buy any government bonds on offer (at 0 per cent yield for bonds with less than five years to maturity and perhaps 0.5 per cent for longer-term nominal bonds),
- passing legislation to cut all wages by 20 per cent temporarily – at present for the next year (and probably reviewable rentals too – the principle being fixed price contracts other than interest rates, separately dealt with above),
- urgent legislation (or, as a second-best, use of the Minister of Finance’s guarantee powers in the Public Finace Act) guaranteeing that all tax-resident firms and individuals would enjoy net income for 2020/21 no less than 80 per cent of that for 2019/2020. (For firms, that guarantee would be scaled to the extent staff numbers dropped below pre-crisis levels.)
Of these, right now something like the fourth measure is the single most important: to remove much of the downside income risk, in a legally-binding way, such that banks (and other financial institutions, but mostly only banks matter here) should be willing to (a) continue with current credit exposures, and (b) extend further credit as required to accommodate the net revenue shortfalls many businesses and lots of households will face.
No matter how much banks say they want to support customers, and probably genuinely mean it, banks are businesses too. At present, there is no readily discernible date at which banks can assume either business or household net revenues will be back to normal, and no certainty about the nominal environment we/they will face at that point, having gone through a huge deflationary shock. It won’t be problem if someone with a residual mortgage of 10 per cent of their house needs credit, or a firm with little borrowing and substantial physical assets. I’m sure banks will be only too happy to accommodate such customers. But plenty of household borrowers have large mortgages, house prices will be falling (in a highly illiquid market), and many business customers won’t have much to offer by way of collateral at all. In the latter case, the Crown guarantee would be structured to serve as such an asset.
As for really heavily indebted firms or households, some would probably just prefer to close down/liquidate and protect whatever equity the owners still have rather than take on large new debt for an indeterminate horizon of income loss. For a firm with large fixed commitments, the need for additional credit (net cash outgoings in a climate of quite limited revenue) might be really large. The underlying business might be sound, but it simply wouldn’t be worth it to the owners (and it isn’t as if M&A activity is likely to be buoyant in the coming months). Banks know all this. Bigger business borrowers will know it all. Smaller ones will realise it quite soon.
If the goal is to avoid widespread, somewhat indiscrimate, closures and perhaps forced liquidations – leaving the institutions of the economy not too badly positioned to pick up not far from where they left off in perhaps a year or two’s time – the government needs to offer this sort of certainty – ex post pandemic insurance (paid for later in higher taxes across the board). Drip-feeding cash will not cut it, because expectations – looking ahead – matter to all involved. And, of course, there is no serious way the government can directly lend, remotely responsibly, to hundreds of thousands of individual companies.
Is it ideal? No, of course not. But it might not be too far from the sort of model we might have chosen to pay for ex ante had we properly faced up to the nature of pandemic risks decades ago (although even then each pandemic has its own idiosyncrasies, so I don’t really feel the need for us to lament that we did not have such established arrangements in advance). Are their moral hazard risks? Yes, no doubt. There will be pandemics again, but if this one proves to have been a 1 in 100 year event, we may not need to worry too much about the moral hazard point (and frankly, I’d be more worried if what actually happened was that lots of firms went to the wall and the system just bailed out those who happened to be very politically well-connected or able to effectively play up the consequences of letting them in particular fail.)
I regard decisively dealing with the effective lower bound on nominal interest rates as also very important, but for different reasons and (in the particular circumstances of this crisis slightly less urgent). As I’ve pointed out repeatedly in the typical recession in recent decades, the OCR (or equivalent) has been cut by 500 basis points or more, and this recession is likely to be much more severe than any of them. 75 basis points just does not cut it. Similarly, the exchange rate usually falls deeply, and it has not moved that much at all so far – not helped by the Bank promising not to cut further. And, related to both of these, stabilising medium-term inflation expectations is vitally important in the face of a severe deflationary shock if we are not to complicate (perhaps greatly) the eventual recovery phase.
There are nuanced arguments about whether the limited experiments with negative policy rates in Japan and various European jurisdictions have done much good (it was surprising – even more so in hindsight – that the Governor did not even touch on this debate in his speech last week). I find the fairly fragmentary evidence at best inconclusive, but more important not terribly enlightening. These experiments have been adopted in relatively normal economic times (low interest rates to be sure, but economies have generally done okay in the last few years) and they have involved very small changes, still bounded by the risk of large scale conversions to cash. There do seem to have been some psychological hurdles to facing retail customers with negative rates, and in many cases banks did not bother (there wasn’t that much in it).
But we are in quite different times at present. On the one hand, depositors have few practical useful options in a climate of extreme uncertainty, high volatility, and generally declining (variable) asset prices. And on the other, I am talking not about 25 basis points here and there, but about the ability to cut the OCR – and comparable rates in other countries – by another 500 basis points (and even that wouldn’t be exceptional: in the last US recessions some models suggested the Fed funds rate needed to have been able to be cut by 1000 basis points, not the 500 points the Fed actually cut by. We need this policy leeway – to markedly ease servicing burdens of existing borrowers (this tends not to feature in a US context where there is so much fixed rate lending), to help drive down the exchange rate, to support medium-term inflation expectations, and (in time) to help set the scene for a robust recovery in spending and investment. Enable the OCR to be effectively set at -5 per cent and retail interest rates will soon follow. If necessary, given the exceptional nature of the time, I would be happy to see regulatory power used to jolt them down collectively. If we do nothing on this front, we not only leave an enormous vacuum where stabilisation policy used to be, we really jeopardise those medium-term expectations (which appear to have been falling a lot in bond markets, overseas and in New Zealand – albeit accepting that the inflation breakevens are harder than usual to interpret).
The third strand – assuming no instant action on fixing the effective lower bound – would be to have the Reserve Bank standing in the market buying bonds at predetermined yields. The main advantage of this is signalling – absolute determination to keep medium-term inflation up in the face of the most powerful deflationary shock since the Great Depression – but the real advantage (partly in contradiction to the first) is to demonstrate, including to the Governor, that these alternative instruments he talks up (even as his Chief Economist was talking them down) are no adequate substitute for lower interest rates, and will not do much themselves to lower private market interest rates when 0.25 per cent is a floor on the OCR. There is no credible transmission mechanism in the current context that would make much difference, including little or no relief for borrowers – in a climate where time has largely (and currently) lost its economic value. But give it your best shot, quickly, and then got on with fixing the real stuff of monetary policy.
The fourth strand probably appeared rather odd, or even quixotic. I was accused on Twitter of being some sort of right-wing stooge wanting to beat up on workers. In a typical market economy, workers (implicitly) pay firms to accept risk. Wages are contracturally fixed and unless you are laid off or the firm fails you can count on your wages each fortnight. Profits on the other hand are highly variable, down as well as up. It is a good system for most of us, almost all the time. But this year the economy is going to be really substantially smaller than anyone imagined when, for example, they contracted for a price at which they would hire/supply labour this year. It is no one’s fault (at least from the juncture of 2019 – who knows what could have been done differently about pandemic risk in earlier years). We could simply let the losses lie where they (legally) fall. In that world, lots and lots of firms will fail, and lots and lots of employees will lose all their income (and have fewer other options for the time being). Not only that, but large chunks of their fellow citizens – beneficiaries and NZS recipients, and public service employees face almost no income risk at all.
Part of getting through this crisis is going to require a secure (through time) sense that there is some fairness about who bears the losses – and the losses are now large and unavoidable in aggregate. If we’d been told three months ago what this year looks like, almost no private firm would have contracted for this year’s labour at the current price. What I’m proposing – a statutory wage cut of 20 per cent – simply acts as a coordinating device, that allows everyone to lose something (and know that people in similar positions are making similar sacrifices). Of course, in the immediate sense those who benefit from such cuts are firms – unit labour costs are cut – but actually it won’t generally be a transfer to capitalists because of the guarantee I promoted earlier (it is likely to be binding for a majority of firms). In practical terms, the wage cut will probably mostly benefit the Crown finances, and enable the government to deploy resources aggressively as required at different phases of this process. In the current phase, more private sector demand is not what is sought anyway (we are closing down much of the economy). In the recovery phase – which might yet be more than a year away – it will.
The wage (and rent) cut isn’t vital to the rest of the package in narrow economic terms. It is about perceived fairness and sharing the load. I can’t see a world in which large chunks of private sector employees lose jobs, while almost all the public sector sails securely onwards (and, as I noted the other day, our household’s main income is a public service salary, so when I talk about fairness here I really mean it).
Various people who read my post on Monday – often rather quickly – responded by challenging me as to why we should not just adopt a temporary UBI, as even some establishment figures on the right in the US (notably Mitt Romney) have advocated. My answer is really quite simple: in these particular circumstances, a UBI is shockingly badly targeted, and would disburse huge amounts of money while still not addressing the main presenting issues. It would be startlingly unfair – all those secure public servants, for example, would get even more money on top of their secure incomes, in a climate in which the whole country is quite a bit poorer. It would discourage retained labour market attachment (this might be a marginal effect, but it still works the wrong way). And it is focused on maintaining or boosting spending at a time – the present – when that is about the last thing we want to be doing. Recall, we are deliberately shutting down much of the economy more or less rapidly in an attempt to suppress the virus – and that includes not putting more people in shops, restaurants, theatres or whatever. And it would do nothing for medium-term inflation expectations.
Basic income support for those whose jobs won’t exist or be able to be done should of course be provided. That is why we have a benefit system, currently with no stand-down periods. But for most people shortage of cash coming in won’t be the immediate issue – they will barely be able to spend what they are getting anyway. The big focus has to be, first, on those guarantees that keep credit going and help hold firms – and employment – together, reinforced by actions to stabilise medium to long term expectations. But the focus now has to be on stabilisation and relief, not on stimulus – trying to lift the level of activity – per se.
Again, as I’ve said before the time for stimulus will come. If we really fix the lower bound we might not need too much additional fiscal support – the government accounts will have taken a deep (but appropriate) hit during the crisis itself – but if fiscal support is helpful then, there are plenty of options, at a time when people are likely to be showing renewed interest in spending. I’ve touted a temporary cut in GST. I’ve also noted the possibility of a temporary cut in one of the lower income tax rates (which would deliver a similarly-sized boost to most people). But straight lump-sum payments to individuals or households could well have a useful place then – after all, for those who think these things are just playthings of the left, George W Bush used that approach early in the 2008/09 recession.
There are probably some other points/emphases in Monday’s post, with which this could be read together. But action really is urgent, and that need isn’t conditioned on quite how few or many coronavirus cases we happen to have – as I heard one smart medical-oriented person argue this morning – but on the increasingly bleak outlook, as it will appear to banks, firms, and households. Expectations really do affect behaviour, in economies even if not in viruses. Providing a secure foundation for credit is vitally important. Now.