It really is quite remarkable that the government is willing to shred our civil liberties, abandon Parliament, ban funerals – to my mind, the most egregiously inhumane, almost evil, specific of the entire Ardern partial lockdown – and accentuate, for now, the temporary implosion of the economy, and yet the same government is unwilling to act to bring about lower interest rates.
They have a recalcitrant public agency that simply refuses to (has formally promised not to) act, in face of a huge slump in activity and employment, a period when time has no economic value. And yet they just sit politely by, as if this was some minor difference of emphasis over 25 basis points or so. They have all the powers they need to act, but simply refuse to do so. Having chosen not to act, interest rates are current levels are now the direct responsibility of the Prime Minister, the Minister of Finance, and the rest of the Cabinet collectively.
Consider a thought experiment. Suppose that for the last 18 years instead of an inflation target of 1-3 per cent, centred on 2 per cent, we’d actually had a target of 9-11 per cent, centred on 10 per cent. (Note, I do not think this would have been an appropriate or necessary policy, but just humour me for a moment). And pretty much everything else – good and bad – about the economy to the end of 2019 unfolded as it did. Assume that coming out of the Great Recession a decade ago, central banks would still have struggled to (or been as reluctant to) do what it takes to keep inflation at target, but they had more or less got there by 2019. Perhaps core inflation was about 9.7 per cent, perhaps inflation expectations (a mix of survey and market measures) were somewhere between 9 and 10 per cent. And, consistent with that, assume the OCR had been 9 per cent at the end of last year (a full percentage point below the target midpoint just as it was in real life.)
(And, yes, I know all about the interaction between the tax system and inflation which mean these things aren’t exact by any means, but for now this is just a very simple story.)
And then the coronavirus hits, and all that followed around fighting the virus – policy measures here and abroad, personal choices to distance etc here and abroad – happened just as in real life.
Oh, and the economy? Well, serious people would still be talking about the unemployment rate going to perhaps 25 per cent, a really major export industry had simply closed down, investment demand (national accounts sense) was heading for zero, and so on.
Does anyone imagine, for the slightest moment, that in such an alternative world – but a path we and other countries’ could have chosen – that the OCR would have been cut by only 75 basis points?
Of course not. Not only do typical New Zealand (or US) recession see around 500 basis points of cuts, but even in crisis-type events in the past (precautionary responses to 9/11 and the 2011 earthquake) the Reserve Bank has cut by a bit more than that – and the Christchurch earthquakes, after the very brief initial hiatus, represented one of the largest positive, unforecast, demand shocks to the New Zealand economy ever experienced.
Who knows how low the OCR would have been cut in that alternative world where the OCR had started at 9 per cent. But we know that in the 2009/09 recession – when GDP fell by about 3 per cent – the Bank cut by 575 basis points. In the US, where the Fed cut by about 500 points in 2008/09, versions of the Taylor rule later suggested that the Fed funds rate could more appropriately have been cut by another 500 basis points on top of that.
So why (didn’t and) don’t adjustment of this magnitude happen? Because central bankers abroad – but specifically here, where the MPC has set an explicit floor at 0.25 per cent – have becom almost terrified of the possibility of seriously negative nominal interest rates, and have spent a decade doing nothing much about making such outcomes work effectively. Far too much of the focus of central bankers this last decade was on looking to the next tightening, and the idea of “normalisation”, not preparing for the next serious downturn – now upon us in unusual and particularly savage form.
But they would have had few qualms in lowering a nominal OCR of 9 per cent – in the presence of a 10 per cent inflation target – to, say, 1 per cent. It makes no sense. It is bad money illusion in reverse, without any good justification.
Now, of course, everyone knows and accepts that monetary policy isn’t going to stop GDP collapsing over the next month (at least) – perhaps on a scale just without precedent ever (if we ever had the data). But it wasn’t really that much different in the fourth quarter of 2008. Really substantial cuts in official interest rates happened, and rightly so, but in a climate an extreme loss of confidence, fear etc, that wasn’t going to stop GDP falling right then. At the best of times, the lags are longer than that.
But markedly lower interest rates, when massive excess capacity is opening up and the neutral interest rate is falling, still do a number of useful things:
- they signal to markets (and the wider public) that the central bank is thoroughly serious about doing its job, and keeping inflation expectations up very close to target (the risks around this not happening are much greater in our real world than in the alternative, higher inflation target, world I mentioned above),
- they get relative prices positioned as soon as possible in way that puts the economy in as less-bad position as possible for the eventual recovery (not just the bounce back to a, say, 15 per cent loss of GDP if the lockdown itself is eased/lifted),
- and the greatly ease debt servicing burdens, reallocating income from (close to) variable rate depositors to (close to) variable rate borrowers, consistent with the new stylised facts in which time for now has no economic value. As it is, short-term term depositors are still being taken at positive real interest rates – even as the economy is shutdown – while variable rate borrowers, even with rock-solid collateral, are still paying substantially positive real interest rates. All this at a time when the government appears keen to encourage firms to borrow more….
Given the significant margins between the OCR and retail interest rates (lending and borrowing) we really need, and should have, a substantially negative OCR – deeply negative in real terms, and not that inflation expectations have been falling.
You might be wondering if (materially) negative official interest rates is just some hobbyhorse of mine. Even if that we the case, it is still the arguments that should be examined, not the advocates. But it isn’t the case. Over the last decade or more, people like former Bank of England Monetary Policy Committee member Willem Buiter, or US academic Miles Kimball (who was the guest of the RB or Treasury just a few years ago) have been among those pushing the case for ensuring that official interest rates could be taken a lot lower in the next crisis.
As a refresher, the twin obstacles are that (a) central banks now have a monopoly on the issuance of physical currency, and (b) as monopolies do, did not innovate over time so still operate with much the same rules and technology as 100 years ago. If the OCR were to be taken deeply negative, on those rules, it would at some point become attractive for wholesale investors, in particular, to switch from holding securities and bank deposits, to holding physical cash. If so, you can cut the OCR all you like and it won’t make much useful difference to anything, except stocks of zero-interest cash. It doesn’t happen easily: storage and insurance costs are real, AML restrictions are annoying, and it isn’t worth doing if you think the OCR will only be very low for a month or two We don’t know quite where the limits are, but the current consensus has been that no one is really willing to try – on current rules – below about -0.7 per cent.
But those rules and practices can be changed. Ideally, doing so would have been properly consulted on and socialised over a long period by governments and central banks. But in a crisis – perhaps especially a crisis where surfaces, including bank notes, can carry the virus – things can be done very quickly. They should be in this case. Suspend the issuance of net new bills in excess of $50, cap the total currency issuance (for now) at, say, 20 per cent above the current level, and if revealed demand for currency is higher than that, ration by price (run a weekly auction at which banks offer a premium over face value to buy physical currency, which they can pass through to all customers or just those taking a large amount of cash, at their discretion).
Of course, having led to believe for the last couple of years that a modestly negative OCR was an option they were open too, the Governor now tells us that the Reserve Bank simply never got round to ensuring that all banks’ systems would be able to cope with negative interest rates. That’s a pretty stunning indictment, that he/they should be held to account for one day (perhaps the Simon Bridges-chaired select committee could summon him?)
As I’ve noted before, mostly even if what the Governor says is true, it is more likely an excuse for inaction (action they don’t want to take) rather than a real and valid justification. As I’ve noted previously, many wholesale interest rates abroad have been modestly negative for years now. An bank operating internationally has to have been able to cope (even in New Zealand some of our inflation indexed bond yields had gone negative). And even setting all that aside, if the OCR were set to say -2 per cent, that would still only be consistent with term deposit rates near zero and lending rates still positive (business one quite a lot positive). There is material relief that can be given, that really should be given urgently, without the main retail rates even getting to the point of going negative. And, frankly, it is surely time for some naming and shaming. If better banks have systems that can operate negative rates, it will provide a competitive advantage and put pressure on those who just didn’t get ready to fix things quickly (even if initially in an improvised way). In the current climate, an OCR of -5 per cent might be something good to aim for.
A couple of my old colleagues have offered brief dissenting views in comments on earlier posts. I appreciate them taking the time to do so. I dealt with the first comments, from Geof Mortlock, in a post late last week
A former colleague, from mostly a banking supervision background, left a comment yesterday disagreeing with my call for negative rates.
What to make of Geof’s specific arguments?
First, I don’t accept that it would be destabilising to the financial system at all – if anything, at the margin it would assist financial stability by shifting the burden from borowers (increasingly indebted in most cases) to depositors (time is offering no real return right now).
I also don’t belief that there would be anything like the sort of flight to Australia Geof suggests. After all, exchange rates – even NZD/AUD are volatile enough and transactions costs high enough – to swamp any possible small interest gains. Perhaps more to the point, in a floating exchange rate system, unless there is a run to physical cash – and recall that under my model cash would be more expensive to purchase/withdraw – the total deposits in the banking system do not shrink because someone seeks to withdraw money. For every seller of NZD there has to be a buyer. And, frankly, the more people wanted to sell NZD at present, the better – a materially lower exchange rate is one more helpful part of the stabilisation package.
Finally, Geof also notes that lower interest rates won’t do much to boost spending right now. That is, of course, true and a point I’ve been making throughout. The point of policy right now is not to boost spending (the time for “stimulus” will be later) but, in this case, to ease servicing burdens materially, and to help stabilise and reverse the falls in medium-term inflation expectations that risk materially complicating the recovery phase, by starting us off with higher real interest rates than those we went into the crisis with.
Ian Harrison, now of Tailrisk Economics, also weighed in
I think the negative interest rate is a diversion, with several problems and does nothing that can not be done more effectively in most cases by direct interventions in our wartime economy.
Thinking about the flow through to interest rates people are paying – banks have reduced the floating rate to 4.5 percent – a huge margin still. It appears that the fixed rates where the business gets done haven’t moved much at all.
My off the top of the head suggestion is to pretend that time doesn’t exist for one two or three months. Time bound contractual -rents interest wouldnt exist for that period. lots of fishhooks and inequities of course. and it would put the banks under pressure. If that got too much then the OBR could be activated for the entire banking system and owners’ interest effectively confiscated.
But I think this is itself something of a distraction, and (after all) my scheme actually involves some quite direct interventions. I quite like, at a conceptual level, the idea of pretending that time doesn’t exist for contractural purposes in the midst of the crisis, but no one believes that problems are going away in two or three months. When, for example, do we suppose the tourism sector might be back to “normal”. Not next year would be my guess: we need relative prices to signal resource-switching and draw forward demand as recovery begins to beome possible.
As for OBR, it is of course a bank failure/resolution tool, but for now at least the presenting problem is not potential bank failure (that could become a risk in time, as the toxic brew of falling asset prices and collapsing incomes lasts long enough) but the sustainability of borrowers themselves. And using OBR in a bank failure – unlikely to ever happen – does nothing to relieve borrowers or support existing companies holding together.
Ian followed up on Friday with another comment
The problem with relying on a reduction in the OCR is that the transmission to borrowers who actually need the relief is highly uncertain. Some thing as direct as a maximum interest on bank lending would have some of the desired effect. – say 6percent, accompanied by no reduction in lending limits.
To which my response is that yes the transmission is a bit uncertain in the abstract. In concrete terms though, what Ian suggests could be achieved by making it a condition of participation in the governments’s business loan guarantee scheme that any OCR cuts are fully, or almost fully passed through. If necessary – it is an emergency – legislation could be used directly. And we don’t need 6 per cent interest rates for reasonable credit business borrowers at present, but something more like zero or negative (still a significant risk margin over, say, an OCR of – 5 per cent),
And finally, Geof put in another comment
Your continued advocacy for zero or negative interest rates ignores the commercial reality that, in periods of stress, such as this, the risk premium in interest rates will rise. This as true (maybe even more so) in a period of prospective deflation. Lenders will price in the risk of lending such that, even in periods where the zero default rate might be zero or negative, bank lending rates will be positive. Equally, bank funding rates are unlikely to go to zero or negative given that depositors, especially at the wholesale level, are factoring in the increased (but still low) risk of bank default. As credit markets globally tighten further, that risk premium is likely to rise. I therefore view your stance on negative interest rates as commercially unrealistic and inconsistent with how a well functioning market could be expected to operate.
As for Ian’s suggestion of regulatory caps on interest rates, I think that would be daft. Such regulatory responses rarely produce desired outcomes. They distort risk pricing in both funding and lending rates and impede efficient credit allocation.
The smartest way to address borrower stress is to provide targeted income support for a defined period, together with debt servicing holidays. If the lockdown is effective in markedly lowering infection rates to a low level, then we should be able to progressively normalise things after 4 to 8 weeks. Border controls will need to continue for months to come, but if the quick result (15 minute) tests, which are apparently under development, can be deployed as a prerequisite for boarding a plane or ship bound for NZ, or at leadt on arrival here, then maybe the economic damage can be reduced to a significant degree.
What is needed now are the indicators (eg infection rates etc) that will be applied for a progressive easing of restrictions after this 4 week period.
On his first point, as I’ve noted since the OCR in this climate should be deeply negative, retail interest rates that would be zero or slightly negative – not that 6 per cent advertised rates ordinary SMEs face at present – leaves plenty of margin for risk premia.
On his second point, if depositors are so confident about alternative investment options – whether other countries or other assets – as to reluctant to accept negative deposit rates, that is (all else equal) a good thing, monetary policy at work. Either they are spending (ie demand rising), trying to shift abroad (lowering the exchange rate, welcome), or supporting otherwise cheap asset prices (again one way monetary policy works.
On regulatory caps, of course in general they aren’t a good thing. They might not even be needed with a deeply negative OCR, but even if they are sometimes exceptional times call for exceptional measures. We’ve seen a few in the last few weeks….
For the rest, I’m not debating what might or might not be possible on testing etc, but no one supposes that even if the current lockdown is lifted in a month or two, that we will quickly snap back to even a recession of the relative shallowness (by these standards) of 2008/09. We still need, and should want, deeply supportive monetary policy, including because whatever fiscal policy might be able to do as time goes on, it is almost inevitable that there will be pushback before that long about the bills being run up for the future. Monetary policy is designed to be the principal stabilisation and countercyclical tool. If it is allowed to work and used decisively again, it can play that role again once the worst of the virus is behind us.
I’m happy to engage with, or respond to, any other sceptics with specific points. But on the face of it – and thinking much more deeply and practically – we are overdue some vigorous easing in monetary conditions. The MPC could and should do it. But if they refuse, the government should – in these extreme circumstances – simply override them and compel them to act.
(In the meantime, of course, the bigger issue is that of extreme uncertainty and downside risk around business and household incomes. The government has done quite a bit to support households, although quite time limited. On the business side, there isn’t much other than encouraging firms to take more debt, when for most it simply won’t be worth doing so. And there are disconcerting hints of the government helping big firms, but not the vast mass of companies that make up most of the economy. My “ACC for the whole economy”,firms and households, remains the best option to provide some insurance, some certainty, to buy time, all without attempting to lock in firms that really may now have no readily conceivable future.)
16 thoughts on “The government should insist the OCR be deeply negative for now”
Referring to Ian’s comment about the risk premium, we have a metric for that called Sovereign CDS. It’s gone up, from around 15bp end last year to around 45bp today. A meaningful move but certainty not large. Default probabilities on government and banks really aren’t that high. I don’t see this as a constraint on negative rates. Nor is kiwi. If NZD had imploded, maybe there would be a justification to worry, but it remains basically at its post-float average.
ANZ bank just sent me notice that my residential floating interest rates have fallen from 5.15% to 3.70%. This is a 1.45% drop which is very significant for small businesses that rely on this overdraft facility to fund their day to day working capital. Clearly the RBNZ is working hard behind the scenes to close the gap between the OCR at 0.25% and floating interest rates. Thank-you Adrian Orr.
I assume the aim is to keep the economy afloat so workers have jobs and businesses have customers with money to spend. I can understand how in normal times interest rates would act to adjust the amount of economic activity rather like moving your foot on the accelerater pedal in a moving car. But this is not a normal situation; the car has stopped.
Having a case of cabin fever and assuming many other are the same if I had money I would invest it in domestic tourism – it could seriously boom and who else would see this opportunity? However interest rates would have virtually no impact on my decision.
I’ll leave that discussion to wise economists because I’d like to support your point about funerals but from my atheist point of view. About sixty years ago returning from school my mother told me she had been listening to an anthopologist interviewed on the radio and when he was asked “How does modern western society differ from all the other cultures?” he replied “Every single other culture would be shocked by our minimal funeral ceremonies held in connection with the burial or cremation of a dead person.” Living in PNG I learned this was true – funerals and associated ceremonies are a very serious matter. When I first took my Melanesian wife to Europe we arrived about two hours before my father died; we stayed for the funeral. As my father had requested it was a typical quiet non-religious family funeral lasting about 20 minutes at the crematorium and then a post funeral gathering at a local hotel. My wife was deeply shocked and the entire event has changed my opinion of the significance of funerals. I still believe that death is the end, like the fate of a computer program when the computer is switched off. I still think that my father was not at his funeral, only his body. However if life has any meaning and is worth celebration then so should its ending.
For a govt that is so proud of boasting about its multi-culturalism credentials it has made a sad mistake.
This article was painful to read https://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=12320561 and these were Nandita Katira words “”Unfortunately in lockdown people will die. I understand all the protocols. But you are allowed to go to a supermarket, but not your parent’s funeral. Not one person?””
Please can we set up a petition to get a reasonable compromise. Maybe just the body and the nearest relative and anyone who had shared their isolation bubble – then everyone else can view via the internet.
Yes, the horror over the ban on funerals goes to something deep in human civilisation and I don’t see it as primarily religious. My v elderly mother died last year and I’d have been horrified to have been banned even a tiny outdoors service.
As it is, not even Italy has banned funerals, altho numbers are severely restricted.
Some sort of petition is a good idea, altho prob needs to be led by someone with a lot more reach than my little niche.
Your comment did prompt me to write to Simon Bridges and David Seymour and urge them to raise the matter in the context of the special Select Ctte, on which they are the senior opposition MPs.
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I will echo your letters. BTW much deeper than human civilisation; if modern civilisation makes death a matter of insignificance then I prefer to be uncivilised. Even elephants and apes mourn.
Hard to know – do negative rates feed into inflation expectations more than spending intentions (if OCR = -5%, things must be bad, wait until prices are 10% down..). Give it a go I guess.
If you head out and try and buy groceries you will find prices are much higher than pre lockdown. The smart ones stocked up in a frenzy. The ones who listened to the government and not panic buy can be paying 30% higher prices for their groceries now.
It won’t take long for starving jobless people to be dying on streets in the thousands as the winter cold sets in. This dumb government has no idea how many more lives will be lost because of this level 4 lockdown. Lets start counting those dead by the thousands soon versus the one death from Covid19. Ridiculously stupid!
Add to that the suicide numbers. Speaking to my 65 year old neighbour with a small business of 15 staff. They have basically said goodbye to their retirement goals as they see 20 years of hard work building business disappear overnight. They look dejected and depressed saying they will be working into their 80s sadly. It won’t take much for them to contemplate suicide as an option.
The medical dimensions of this crisis are impossible to predict. The virus is evolving, vaccine development is hard to predict. And public perception can change. At the moment the main reason for the lockdown is to protect health workers and public order. Retirees like me are not scared of dying but would be aghast at the idea of killing the people looking after us.
Even if the lockdown is successfully lifted, the way we live will not return to the old normal. A lot of people are expecting change and this will affect financial and voting decisions. Governments may wake up to the very real power of the state.
If negative interest rates can facilitate orderly change in our economy I’m in favour.
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Ex finance minister Sir Bill English made comment to Jarden on KB that could be of interest.
Some comments from the KB summary:
“Risk management is important, risk is being transferred from private to the crown.
It is unwise to assume central banks can control debt markets for long.
This is not a financial market crisis so can not be served by financial market intervention.
This is a real economy crisis.”
As I’ve commented before the most important duty for an “ independent “Reserve Bank is to ensure currency stability.
(It is also of concern that the RB independence seems to be in the past.)
At least funerals aren’t completely banned:
Yes, altho a single discretionary exception. Most of the bereaved won’t kick up a fuss.
Some further comments adding to my previous top of the head suggestions
First we need to distinguish between what to do in the next few months or so when markets aren’t working. The negative rate rate proposals will have an uncertain and not very useful impact over this period.
What to do with the destruction of the tourist and ‘education export industries beyond that is a separate question. Maybe negative interest rates could have a role when markets start to work again. but it need a lot of thought.
One of the problems is that there might be a limited transmission to lending rates – most rates are at the administrative discretion of banks. It the short run they could pocket at least some of the reduction in extra margins citing higher risk. Not likely to be popular so the actual outcomes will be partially politically driven.
i wouldnt use the OBR – simpler to nationalise if it comes to it. Governments generally did well out of this in the GFC.
I don’t think Banks are short of cash. In these troubled times I just moved $200k into cash deposits. Banks like more likely to remove unused bank facility first. Cash is King. Even gold has fallen out of favour in preference to holding cash in deposit.
I suspect you are right but in my case it is a desperate search for $2k into cash deposit. And my fear is waking up and finding my cash is inflating away as per Venezuela or Zimbabwe. How does the US$ keep its value?