A debt jubilee?

In the Western tradition, the idea of the year of jubilee comes to us from the Old Testament.    The idea was to avoid permanent alienation of people from their ancestral land –  in effect, land transfers were term-limited leases, and if by recklessness or bad luck or whatever people lost their land it was for no more than fifty years. In the fiftieth year –  the Year of Jubilee –  all would be restored: land to the original owners and hired workers could return to their land.   It wasn’t a recipe for absolute equality –  the income earned wasn’t returned etc –  but about secure long-term economic and social foundations.

For many –  for me –  it has an appeal, although one could argue that in many respects modern society already reflects some of the vision underlying the original near-eastern ideas: after all, we prohibit slavery, we allow personal bankruptcy (and discharge from bankruptcy without paying all the original debts), we provide education free at the point of use, and a welfare system for those who might otherwise fall through the cracks.

But this post isn’t about exploring those ideas, but about one very specific modern championing of the idea that we hear a bit more of again at present: the idea of some sort of debt jubilee in which, in a highly-indebted system, the outstanding debt is, in some form or another, simply written off.

One person who has been championing such a scheme for some time is Professor Steve Keen, an Australian economist now teaching at a university in London.   He has quite a following in some circles – I used to read his blog moderately regularly for a time, and perhaps 7 or 8 years ago The Treasury hosted a visit here (in the course of which his stocks sank among most officials).  However, he was interviewed a few weeks ago by Gareth Vaughan at interest.co.nz on his ideas for policy in the wake of the coronavirus.  He and I share the view that the biggest macroeconomic risks at present are deflationary rather than inflationary but, it would seem, we agree on little else.   You can read or listen to his other ideas for yourselves if you choose, but one strand of what he was championing was a “modern debt jubilee”.

I do not wish to be seen to be critiquing or attacking a straw man, but I have had difficulty finding anything online that sets out in very specific terms exactly what he has in mind.

Here is what he said in the interview

Firstly, Keen says, they should be implementing a modern debt jubilee now.

“It’s quite feasible to do it [but] I never thought it would happen. People asked me what chance I thought this had of happening. I said it’s less than a snowflake’s chance in hell. We are in hell now and the only way out of hell, as well as getting a vaccine for the virus, is to reduce this burden of private debt otherwise we’ll have a financial collapse after the coronavirus,” says Keen.

The alternative, he argues, is mass loan defaults.

“You simply have to accept that debt can’t be repaid when too much debt has been issued. So we have to reduce private debt and we have to do it now. [We] should do a debt jubilee now, not once we get through this crisis. Otherwise there’ll be many people who can’t pay their rent, as well as people who can’t pay their mortgages,” says Keen.

“If we do it now we’ll enable the payments system to continue functioning. If we don’t do it now then it’s quite possible the payments system will collapse. Small businesses won’t get any cash income, households won’t get wages. Everybody will end up having no money in their bank accounts because that money will be used to pay off debt.”

What Keen’s advocating for is governments’ capacity to create fiat money being utilised to distribute an equal amount of money per person across entire countries.

“And people who were in debt would get their debts reduced, either by an offset account or by actually paying their debts down. People who are not in debt get a cash injection. And that cash injection can also be used to buy newly issued corporate shares which are used to pay down private debt. So as well as reducing household debt, you reduce corporate debt and you also democratise the ownership of corporations,” says Keen.

And although I have found a couple of other references (including here and here)  there is still no sight of some critical parameters.

Nonetheless, it is worth bearing in mind that elsewhere in the interview he describes the large increase in household debt in recent decades as “unconscionable debt” and repeatedly highlights the very large increase in the ratio of household debt to GDP in New Zealand since about 1990 (about 30 per cent then, about 100 per cent now).   And although he talks about “reducing” household debt, “jubilees” have connotations of very substantial writedowns, so he clearly isn’t talking about something like dishing out, say, a mere $10000 per household/person.  The Reserve Bank tells us that as at the end of last year recorded household debt was about $310 billion.

Moreover, Keen also tells us (see extract above) that he thinks the same amount should be distributed to everyone.  I’m not sure whether he really means “everyone” or just adults, but since under-18s can’t contract binding debts there shouldn’t be any need for jubilees for them.  That still leaves 3.8 million residents (and here I’ll just ignore the fact that a significant number of them are temporary non-citizen residents; I just want to get a sense of the plausible scale of what Keen might be calling for, not tie down every detail).

As we all know, recent first home buyers in Auckland typically have to take on fearsome levels of debt.   They appear to be the sort of people Keen focuses on, since he blames the rise in house prices on banks and their over-aggressive (“unconscionable”) lending setting up a house of cards that might otherwise be about to tumble.  I presume a $500000 mortgage isn’t at all uncommon (last year the nationwide average first home buyer mortgage was about $400000) and many will be larger than that.

Now, of course the typical new buyers are a couple, but for those marginal Auckland purchasers that might still be $250000 each.

I presume Keen does not have in mind giving them –  and all the rest of us –  $250000 each, although doing so would certainly allow most (but not all) mortgage debt to be fully repaid.     But even if we wanted to make possible a 60 per cent writedown for those couples with the new unconscionable $500000 mortgage, he’d still have to be looking at $150000 each, as gift/grant from the Crown.  Across 3.8 million adults, that seems to come to $570 billion dollars.

All paid for, in his own words, through the Crown’s ability to create fiat money –  change the Reserve Bank Act and get for the Crown an (interest-free) overdraft of $570 billion.  Halve the payment and it is still serious money.

You’ll have noted that Keen is also concerned about corporate debt –  a big concern at present in some countries (where it has grown rapidly in recent years) but much less so in New Zealand.  For those –  most of us –  without mortgages (whether because we have paid them off, or never been able to get into the housing market in the first place), we get a rather large addition to our bank balances.   Keen notes that the proceeds could be used to buy “newly issued corporate shares which are used to pay down private debt”.

I don’t know about you but I know what I would be doing not just with my $150000 but with all my non-indexed financial wealth the minute I thought that anything like what Keen was proposing was likely to be implemented: I’d be looking to put it into real property (houses, gold, whatever) or getting it into the currency of a country not adopting such a policy.  Anyone with non-indexed debt at present would prudently be doing the same –  and locking in a long-term fixed interest rate – not using the proceeds to pay off debt.  It might be hard to generate inflation at present, under present –  largely self-imposed – constraints, but simply handing $570 billion will do it.

I hope all regular readers will recognise that I am not one of those looking for inflation under every stone.  I worry about deflationary risks at present –  as does the market – and I do not believe monetary policy is doing anything like enough to respond to those risks at present.  Much as I am sceptical of the idea of giving out some modest amount (say $2000) to everyone as some sort of stimulus, in the current climate – large negative output gap, little or no inflation –  such a payment, even funded directly by the Reserve Bank –  would be net stimulatory in the near-term.  There is a considerable amount that can be done to get us back towards full employment as soon as possible.

But not by simply handing out $570 billion, with no obligation to repay.

(Presumably Keen does not think his scheme would dissolve into very high inflation, but I’ve never seen him anywhere articulate the case for why not.)

When I think of debt writeoffs, I think of explicitly recognising that someone has to bear those costs –  on any very substantial scale there are few/no free lunches.  Banks will have to write off some debt –  perhaps quite a lot –  over the next few years, and their shareholders will bear that cost.  That is the business they went into.  Writing off mortgage debt more generally on the sort of scale Keen seems to envisage can only be done by imposing fearsome losses on others.  It is so utterly different from that Old Testament conception (which, in effect, limited the scale of liabilities anyone could run up in the first place).

I have some sympathy with the view that requiring young –  and now not so young –  people to take on multiple hundreds of thousands of dollars of debt to get into a basic house in our cities is pretty unconscionable and deeply unjust. But, frankly, that isn’t fault of the banks but of the central and governments that make land –  a resource we have in abundance – artificially scarce.  In fact, I’ve even gone so far as to argue that if ever we managed a government with the courage to fix the land market, it might be both opportune (building coalitions) and just to offer some compensation to the losers –  those more or less compelled to take on very high debt in recent years just to get a foot on the ladder.   But there would be an explicit, shared, cost to that.

And more generally I’m not persuaded that current debt levels –  public, private or total –  in New Zealand pose any vast threat of economic or financial collapse.  Keen likes to highlight how much debt has risen since, say, 1990, but it isn’t obvious why that is the most relevant benchmark.  In a speech I wrote with Alan Bollard a few years ago, I included a chart showing that mortgage debt (house and farm) was materially lower then  as a per cent of GDP than it had been in 1920s New Zealand,  I rechecked the numbers this morning and the picture today is the same as it was in 2011.  Contrary to Keen, our banking system looks pretty robust, not ricketty.

I also take the view that there is plenty that can and should be done to assist individuals and firms through the next few months.  There is a strong case for income support (broadly defined) or even income insurance (of the sort I’ve championed here) but that is very different proposition than somehow looking to wipe out debt without identifying whose claims to real resources will be wiped out to pay the economic cost of that (as distinct from the “which account to write the cheque on” issue that Keen deals with).

You might be wondering why I bothered with this post, or dealing this extensively with a pretty extreme idea.  The reason is that Radio New Zealand is recording tomorrow (for broadcast on Sunday morning) an interview with both me and Keen. I might have more to say about some of his other ideas –  some of which make Winston Peters championing New Zealand manufacturing seem moderate –  next week. In the meantime I wanted to understand as well as I could what Keen was actuallly championing on the debt front.  As I said, I don’t want to attack a straw man –  that never persuades anyone –  but I simply haven’t yet found an articulation of what he is proposing that looks economically feasible or sensible.


Diverted down historical byways

Get me onto interwar economic history and I can get a little carried away.  I don’t like to think quite how many books on the Great Depression – in all manner of countries – and events either side of it I bought when I first got fascinated by it, and my interest continues.  New Zealand is a fascinating subset of that history/experience, although it is still the case that there is no single comprehensive economic, and economic policy, history for New Zealand in the interwar period, even though so much of interest/importance was going on.

Anyway, after yesterday’s post a reader kindly sent me a copy of a new NBER working paper by two prominent economic and monetary historians, Michael Bordo and Christopher Meissner.  Their topic is “Original Sin and the Great Depression” –  no nothing theological, but rather referring to the difficulty most countries long had (many still have) in borrowing externally in their own local currency.    It is an interesting paper and they’ve used some fascinating high frequency data (by 1930s standards) in some of their estimates, but the key bit from my perspective was the question of how foreign currency debt might have influenced the willingness, or otherwise, of countries to devalue, or allow their currencies to depreciate, during the Great Depression.    This has often been perceived to be an issue in more-recent decades: a currency depreciation greatly increases the local currency value of foreign currency debt, and if much of the debt (public or private) is (a) in foreign currency and (b) not supported by export industries, earning foreign currency, it can act as an obstacle to necessary adjustment.  As it was in places in Latin America in the 1980s, so in places in east Asia in the 1990s.

Bordo and Meissner try to unpick whether this was a constraint on countries in the 1930s –  a consideration that lead them to delay longer than otherwise the sort of break with gold and the exchange rate adjustment that ultimately looks to have been important in the eventual recovery.  They find some suggestive evidence that this was so and that market pricing recognised the issue (thus, a higher risk premium was priced into the yields of countries that depreciated).  They line up data, for example, on when countries defaulted (if they did) and when they went off the Gold Standard.

I wouldn’t be surprised if a more detailed examination of the issue proved that there was something to the thesis.  But it probably needs a more -in-depth treatment to account for the huge variation in what exposure to exchange rate fluctuations actually meant across a wide range of countries.  In some cases it is simple – a country with its own currency, but with much/most of its debt raised on market in foreign currency (whether sterling or USD).  In other cases, it isn’t.  For example, in the United States much debt –  including most government debt –  was denominated in USD, but also contained a gold clause –  guaranteeing that the lender was protected against any exchange rate change (I only discovered yesterday that much Canadian debt also had such clauses).  I wrote here about the recent book on the abrogation of the US gold clauses by Roosevelt.  In effect, it was a sovereign default, and is treated as such by Bordo and Meissner).   But Canada also overturned its gold clauses, and it isn’t treated as having defaulted.      On the US side, public debt going into the Depression was low and I don’t recall ever reading that the gold clause had been a constraint on action prior to 1933.

Also, among advanced countries, war debts and reparations were at the time one of the most important form of inter-country liabilities, and although those obligations generally weren’t expressed in local currency terms, they also were generally not expected to be resolved through market mechanisms (and the debts were not traded, so there is no secondary market pricing).  And although the authors claim to have dealt with these debts, almost all of which were eventually defaulted on (Finland was the exception that paid in full), their tables of countries which defaulted don’t line up well at all with what we know of the defaults on war debt.    Thus, the UK defaulted on its war debt to the US (denominated in USD) and is (rightly) treated as a defaulter.    But neither New Zealand nor Australia is listed as having defaulted, even though neither paid any more on their substantial war debts to the UK.  (Both countries also “defaulted” on domestic debt –  the New Zealand story is here.)

As a matter of interest, this table is from Eichengreen.  The Hoover Moratorium was a standstill on servicing war debts and reparations in 1931, but the table captures annual savings/losses that became permanent over the following few years


In per capita terms, New Zealand was the second-biggest gainer (after only Germany) – we lost reparation payments due but saved a lot on the war debts we never again serviced (and which the UK never pursued us for).

But to an extent this is by way of rambly preamble to my New Zealand specific bugbear with the paper, which includes this table.


Not only did we default –  domestically, and externally (those war debts) –  but we were not on the Gold Standard.   This is a not-infrequent mistake made by overseas academic researchers –  Eichengreen, for example, has a table in which he has New Zealand leaving gold in 1929.

We did not.  We had not been on the Gold Standard since World War One started in 1914 (as I wrote about in an early post here).  We did not return to gold in 1925 when the UK returned.  From August 1914 onwards, bank notes (issued by the trading banks) were not convertible into gold on demand, and banks were not required to keep any particular level of gold.  There was no central bank, buying/selling gold at a fixed parity. We were not on the Gold Standard –  even if that state of affairs was maintained by wartime regulations still in effect years later, rather than by a formal new statute.

In the, perhaps vain, hope of making a small contribution to putting a stake through the heart of this particular myth, here is an extract from Sir Otto Niemeyer’s report to the New Zealand government in February 1931.  Niemeyer was a senior Bank of England official commissioned by the New Zealand government to visit New Zealand and to report on policy options re banking and currency, including around a proposed new central bank.   Here are the opening two paragraphs of his report.


Banks held gold.  The fact that they did so may have given some comfort to depositors.  A solid loan book would generally do that too.  But gold played no continuing part in the New Zealand monetary system after 1914.   To repeat, after that date we were not on a Gold Standard.

Of course, quite what standard we were on is another matter.  There was no central bank. In practice, as Sir Otto goes on to note –  and as everyone recognised at the time –  the key constraint on banks’ activities in New Zealand (lending) was the availability of sterling balances in London, combined with the customary practice –  and it was no more – that banks managed things to keep New Zealand deposits exchangeable into sterling at very close to parity.  In the jargon, there was no nominal anchor in the system – neither metallic, nor a central bank required to keep something akin to price stability.    It was a very unusual system, that perhaps should not have worked, but it did more or less.   Partly as a result there was little real sense –  and I gather this was true in Australia as well –  that a New Zealand pound (a pound liability issued by a bank in New Zealand) was in some sense different from an English pound.

But to revert to the question of debt and the Depression, New Zealand’s government was heavily indebted going into the Depression and the debt ratios got much worse at the Depression went on.  Here is total New Zealand government debt as a per cent of GDP from the IMF’s Historical Public Debt database.

IMF public debt

and here is a chart from a paper Bryce Wilkinson did for the New Zealand Initiative a few years ago showing both public debt (slightly different series) and external debt as a per cent of GDP.

bryce debt

(Around this period the Australian charts are quite similar)

Bordo and Meissner include a chart suggesting that in 1928 our ratio of foreign public debt to exports –  some sense of servicing capacity, and New Zealand was a big exporter at the time – was the fourth largest of the countries they study.

Curiously, and something I learned the other day from another new book, despite these astonishingly high levels of government debt (and heavy external debt) as the Depression began New Zealand had the highest possible credit rating from Moodys.

moodys depn

In a way, it worked out okay.   We defaulted on the war debts, but for the sorts of public issues Moodys’ was rating, no foreign holder lost a penny (not even a (new) New Zealand penny let alone the (more valuable after 1933) UK penny).   But it need not have been that way: the debt burden was punishingly high, markets were temporarily closed to any new issues, and by the end of the 1930s, New Zealand external finances were even more severely constrained, the possibility of default was in the wind.

To some extent, these public debt series overstated the burden on the taxpayer.  Quite a bit of what the Crown borrowed was on-lent, particularly to farmers. On the other hand, farm debt was a pretty major area of difficulty during the Depression, with repeated interventions to ease the burden (on good farmers).  New Zealand was heavily indebted –  government and private (estimates of total mortgage debt as a per cent of GDP then exceed those now).

But if public debt was high going into the Depression it went higher, in two separate stage.  First, the denominator –  GDP –  fell sharply.   Nominal GDP in 1932 is estimated to have been a third lower than in 1929 –  the fall split roughly evenly between quantities (real GDP) and prices.      And then  –  and this is the link to Bordo and Meissner –  the exchange rate was formally devalued at government initiative (even though there was not yet a government-issued currency) in January 1933.    That raised the local currency value of the foreign debt –  more so, at least initially, than it contributed to the recovery of nominal GDP.   Government debt as a per cent of GDP peaked (on both charts) in 1933.

Devaluation had been an option debated for some considerable time.   Most local economists were in favour, as (of course) were the farmers –  the prospect of more local currency for each pound sterling earned was attractive to say the least.  On the other hand, it was something others were more sceptical of –  all such policy choices are distributional in nature.  Importers and associated merchants were one group, but the trade unions were also wary –  whatever you believed about the responsiveness of the economy over time, tradables prices (including food) seemed likely to rise.  Of course, a rise in tradable prices was the whole point.

What is less clear is how much influence the additional debt service costs had on the Cabinet’s thinking.  It was a real factor, at least in the short run.  On the other hand, ministers will have been conscious that earning the foreign exchange to meet the foreign debt commitments was made a bit easier by the devaluation, and those sterling earnings were also critical influences on local banks’ ability to lend, and thus to support any prospects for recovery.  The Bordo and Meissner paper does not seem to take this factor into account.

As I noted earlier, when the New Zealand government coercively restructured domestic debt (in effect, defaulted) they did not attempt the same on the government’s foreign debt.   There are likely to have been a variety of factors at work, including a more generalised desire to have continued near-term access to UK markets (and New Zealand and Australia had both developed reputations as rather over-eager borrowers in the 1920s) and the little-known Colonial Stocks Acts (which I thank a commenter the other day for drawing my attention to again) under which the UK government had –  with our consent –  the authority to disallow specific legislation that disadvantaged holders of New Zealand debt in the UK.   Whatever the combination of factors, the focus of the government’s efforts and rhetoric were instead on raising the world price level –  lifting commodity prices generally, and those denominators (GDP).  That made a lot of sense with so much excess capacity and such a fall in the price level.  It was something Britain and the Dominions joined in committing to in the British Empire Currency Declaration of 1933.

As a final observation in this (discursive) post, when people talk at present about the fiscal costs of responding to the Covid-19 slump you sometimes hear talk of debt getting to “wartime levels”.  People who used those references typically have places like the US and the UK in mind.  As you see from the charts above, public debt kept dropping as a share of GDP through the rest of the 1930s –  mostly rising GDP rather than falling debt –  and even in 1946 New Zealand’s public debt, while high by today’s standards was about 148 per cent of GDP, lower than it had been in 1929.  Between heavy taxes and Lend-Lease obligations the US ran up to us, the war wasn’t one that left us under a heavy burden of debt.  At the end of it all, we’d built up enough unsustainable financial claims on Britain that a considerable chunk were, under pressure, written off.  The UK, in effect, defaulted on us.

Golden fetters and paper chains

In various posts over the years I’ve mentioned how countries finally got out of the Great Depression.  Generally that involved breaking the link between their respective currencies and gold and then being able to adopt more-expansionary macroeconomic policies.  That was relatively easy to do as a purely technical matter, but it took a long time for countries to get there (a handful of significant countries not until 1936).  I’ve worried aloud that given how low the starting point for nominal interest rates was going to be that in the next serious downturn the refusal of central banks –  and it is simply a refusal –  to take policy rates deeply negative would end up as much the same sort of fetter as gold once was.

The definitive book-length treatment of this angle on the Great Depression is Berkeley professor Barry Eichengreen’s  Golden Fetters.  It was published in 1992 – decades ago now – and going by the marks in the margin of my copy I seem to have read it once a crisis since then.  It is one of those books that repays rereading, partly because the contemporary context against which one reads it is different each time.  I read it again last week.

What follows is informed by Eichengreen, although refracted through my lenses.  There are places where Eichengreen’s argument isn’t fully persuasive (and he has one or two facts wrong about New Zealand).

Much of the book is scene-setting for the experience of the Great Depression.  That includes a perspective on the pre-War Gold Standard, which tied together most of the major (and many of the minor) economies of the time, with a leadership role played in particular by the Bank of England.    In many of the core countries –  UK, France, Germany notably –  central banks played an important role, but in other countries operating on a gold standard there was no central bank at all (most importantly, the United States, but also countries like New Zealand and Canada-  all three of whom were net capital importers).    Price levels didn’t change much over time (the British price level was about the same in 1914 as it had been in 1834), capital flowed freely, trade (and migration) was extensive, and if there were periodic crises or threats to the system, central banks worked together to maintain stability.

World War One greatly disrupted the picture.  Some countries formally went off gold, others didn’t formally but there were enough interventions that the pre-war parities didn’t act as any sort of constraint on price levels.  Huge debts –  internal and external – were run-up in the process, and the US moved from being a net borrower to being a net lender to the rest of the world.  And in the aftermath of the war there were reparations obligations established, huge distributional fights (inside countries) as to who should cover what portion of the accumulated costs, and some countries collapsed into hyperinflation sooner (Austria) or later (Germany).   All manner of other countries had much higher price levels than pre-war, and in some –  notably France –  high inflation remained an issue well into the mid-1920s.

Against that backdrop, in many quarters a return to a money convertible to gold was seen as partly as a key confidence-building commitment, and partly as a return to something like normality.  It took a long time –  in one case, Japan, it din’t actually happen until early 1930 – and for good reason.  There were debates about which rate to restore parity at –  the UK eventually, perhaps unnecessarily, chose to re-peg at the pre-war parity, which implied several more years of moderate deflation.  For France, having had so much inflation, the pre-war peg quickly became unrealistic and they stabilised at a considerably devalued exchange rate to gold.  For Germany, of course, hyperinflation made a nonsense of the pre-war parity.

There hadn’t much gold mined in the previous few years, and yet global price levels were much higher than they had been.  That in itself posed some challenges.  But international cooperation and trust wasn’t what it had been pre-war either.  And particular policy choices made by the US and France meant that those two countries’ central banks accumulated an increasing share of the world’s gold are were unwilling and/or unable to let those inflows flow into much looser domestic monetary conditions (France, for example, having just stabilised was understandably averse to a fresh wave of inflation).  The UK –  still operating as a major global financial centre, significant source of long-term foreign lending –  operated with low gold reserves.  Germany, with a populace only too conscious of hyper-inflation just a few years previously, had high minimum gold cover requirements, but those buffers couldn’t be cut into.  Higher interest rates in the US – as in 1928/29 – forced both the UK and Germany to adopt tighter domestic monetary policy.   And so on.

The Depression itself got underway in a variety of countries influenced by various factors, domestic and international.    The 1929 sharemarket “crash” wasn’t particularly important, except perhaps in shaping the mindset of various US policymakers (including at the Fed) who were uneasy about much looser monetary policy because they reckoned the excesses of speculation needed to be purged.    Some countries were affected worse than others early on –  Australia for example on the worse side, and France on the more positive side.

Generally, however, monetary conditions did ease as the respective economic conditions deteriorated.  But the fixed exchange rate system, underpinned by convertibility to gold, severely limited what could be done with either fiscal or monetary policy –  and that was true even in the countries with large gold holdings, the US and France.

The financial crisis aspects really intensified in mid-1931, in Austria and Germany (where there were significant domestic banking system issues) initially, and then spilling over to the UK, where the economic slump itself had been relatively mild –  relative being the word –  but the pressure eventually told on gold parity.   The re-formed National government –  still led by former Labour Prime Minister Ramsay McDonald –  decided not to impose further pain on the domestic economy (which might have been insufficient anyway) and went off gold.    The break in the parity was initially envisaged as temporary, and it was some months before domestic policy itself became much more expansionary.  But the consequence of the lower exchange rate –  although many smaller countries moved to peg to sterling, giving rise to the “sterling area” which persisteed for several decades) and easier domestic monetary conditions meant that the UK was the first significant economy to recover from the Depression.

The US held on to the old gold parity until April 1933, and while that old parity held it acted as a real and binding constraint on the ability of domestic authorities –  including the Fed – to run much easier policy.   Fear of devaluation sparked capital (and gold) outflows.   But as Eichengreen records, many of the senior Fed officials were not that keen on much easier policy anyway, and some saw the roots of the Depression primarily in past speculative excesses.  Even in the US, concern about possible inflation risks – in the depths of a deflation –  were heard, and were evidently sincere.  The US later returned to a gold parity (while prohibiting for decades citizens from holding gold) but at a much-devalued exchange rate.

Those inflation concerns were all the greater on the Continent.  Germany never abandoned the old gold parity, but just rendered it non-binding with an increasing complex of exchange controls and other payments restrictions.   But for the remaining gold countries –  most notably France, Belgium, Netherlands and Switzerland –  the tensions grew between the desire to maintain the parity –  whether as symbol of normality or (more strongly in the French cases) ran increasingly up against the losses of competitiveness producers in those countries faced as other countries devalued, and the market recogmition of those pressures (thus capital flight).  It wasn’t until 1936 that those parities were finally abandoned.

As Eichengreen notes, at the end of it all, by the late 1930s, real exchange rates among the major economies had not changed that much at all.  Some countries had got the initial advantage of moving earlier (the UK notably) but in the longer-term the beneficial effect was not breaking the gold parity and getting a lower exchange rate, but breaking the constraints (domestic and international) on domestic macro policy (fiscal and monetary).  As he also notes, it wasn’t enough just to break from gold, since countries also had to be willing to break with the Gold Standard ethos, and allow/adopt looser macro policies.  One obstacle to that had been the fear of inflation.  That fear might look unreasonable –  whether from this standpoint, or contemplating a country with a deep deflation in the early 1930s –  but the hyperinflationary and high inflation experiences really weren’t that far in the past, and had been utterly destructive for many.

Eichengreen has a nice table late in the book illustrating how industrial production –  the main macro variable at the time, before quarterly national accounts were a thing –  responded in different groups of countries.

eichengreenLook at the last two columns and you can readily see the difference of experience in the countries that went off gold/devalued (sterling area and the “other depreciated currencies” lines) with the experience in the gold bloc countries, where even by 1935 industrial production was still 20 per cent lower than in 1939.

It need not have been.  It wasn’t as if the 1920s and 1930s were a period of underlying economic stagnation.  The US –  by then the world’s leading edge economy – experienced really strong total factor productivity growth in both the 1920s and the 1930s.  I’m sure some economic ups and downs were inevitable, but nothing on the scale and duration of what actually happened in the 1930s was in any way inevitable –  it was largely the consequence of a succession of choices, of almost entirely well-intentioned people, working against the backdrop of presuppositions, presumptions about normality, and the backdrop of some deeply unsettling experiences, that led to those savage and prolonged losses.   When countries broke the golden fetters –  and for many it was regretted initially or felt to be hugely risky – economies started to recover, and the gains in an increasing number supporetd a sustained global recovery in demand.

(You might be wondering where New Zealand fits in all this.  That is mostly another post.  We had no central bank.  We went off gold in 1914.  That left our banks issuing their own currency, in practice loosely pegged to sterling (but not legally so), with banks managing domestic credit based on their holdings of London funds.  Our exchange rate – managed by the banks – was allowed to depreciate a bit, but the big movements were in September 1931 when the UK went off gold and their exchange rate depreciated against the rest of the world and so, thus, did ours, and –  more importantly –  then in January 1933 when the government initiated a formal devaluation against sterling (still not having a central bank) over the objections – and resignation –  of the Minister of Finance (and with not a little domestic unease and debate).  In 1931 and 1932 even after the UK went off gold our economic policy options were very very few, and our devaluation was much more of a turning point (probably helping that it was followed a couple of months later by the beginnings of the US reflation).  I have an old post on New Zealand and the Great Depression.)

Of course, the point of the post is to draw some loose comparisons between the golden fetters of the early 1930s, which proved so costly in the specific circumstances of the time, and what I’ve taken to calling the paper chains, the refusal of the world’s central banks now to do anything about taking official interest rates deeply negative, even though standard macroeconomic prescriptions –  such as the Taylor rule –  suggest that is exactly what should be done.

I’m not suggesting it is some sort of allegory for our age, in which every detail of the 1930s can be mapped to something now.  It can’t.  It is really just about a single point: that self-imposed constraints, which can seem very very important to preserve at the time, can actually in some circumstances prove incredibly costly, and in those circumstances the sooner they are jettisoned the better.

One area in which the parallels certainly aren’t exact is around fiscal policy.  Most countries in the 1930s had very little freedom of fiscal action initally, precisely because of the monetary/gold parity constraints  –  increase your fiscal deficit and the resulting increase in demand will also result in increased current account outflows (of gold).    In some cases – New Zealand –  there was just no effective borrowing capacity at all –  thus, Keynes’s advice to Downie Stewart that I’ve quoted here previously (“if I were you I’d try to borrow; if I were your bankers I would not lend to you).  We have nothing like those sorts of technical constraints.  But that doesn’t mean there are no limits in practice –  as we saw after 2008/09, public tolerance of continued very large ongoing fiscal stimulus, even in badly affected countries, was really quite limited.  In the real world, fiscal policy isn’t any sort of fully adequate substitute for monetary policymakers choosing to sit on the sidelines –  dealing, perhaps, with market liquidity issues, but not doing much about the overall stance of monetary policy, even as deflationary risks mount (thus, real retail interest rates have not fallen at all in New Zealand and Australia this year, despite the huge economic slump).

There is a, perhaps understandable, sense in some quarters that there wasn’t too much wrong with economies last December.  Perhaps, but things have now changed, and if one strand of macro policy – typically the most important for cyclical purposes, and easiest to adjust –  is allowed to sit on the sidelines doing nothing –  and elected ministers have the power to change thatg –  there is risks that this economic downturn ends up much more severe and protracted than it needs to be.  All because central bankers won’t break free of their paper chains and their old mindsets (aggravated in New Zealand’s case by the stunning negligence of a Reserve Bank that talked modestly negative interest rates for some time but did nothing at all to ensure there were no technical/systems obstacles): we pay the price for both lack of preparation and the reluctance/refusal to break the paper chains and put in place quickly the sorts of rules and practices that could allow official rates to be taken deeply negative for a time, in turn supporting demand (directly and via the exchange rate) and supporting medium-term expectations about the economy and inflation.




Social Credit – too timid by far this time

Social Credit ideas have a long history in New Zealand.  The originator, Major Douglas, even visited New Zealand in 1934 and testified to a parliamentary committee.  The ideas influenced Labour in particular in the 1930s, and some who later played very prominent roles in National.  We got our very own political party – the Social Credit Political League – in 1954 and from time to time Social Credit did very well in the polls (and under FPP even managed four MPs at the different times from the 1960s to the 1980s).  I recall a time –  perhaps 1980 –  when Social Credit briefly polled ahead of Labour.  There had been an entire Royal Commission in the 1950s, mostly intended to debunk them, but  they weren’t deterred –  as a young economist at the Reserve Bank, a fair amount of my time was spent responding to letters, to us or the Minister, from Social Credit monetary reformers.  Some of were admirably dogged, and typically very polite, although one particular frequent letter writer once lamented that his letters were getting nowhere with us and felt as if he might just as well jump off a cliff.  Our then chief economist suggested that perhaps writing a book might help, and a year or two later we got the book in the mail.

It is a fascinating history but today I’m not going to wallow further in it.  The key policy plank always used to be cheap Reserve Bank credit as the macroeconomic answer.

It still appears to be so.   Social Credit still exists in New Zealand.   Democrats for Social Credit got 806 party votes at the last election.  And on Saturday I opened both papers – Dominion-Post and Herald – to find full page adverts from the NZ Social Credit Association.

social credit apr 2020

Several economists and various other commentators have extracts of their work presented as supporting the Social Credit vision/platform (to be fair, the advert makes clear that none of the people concerned have any association with Social Credit or with the advert).  It isn’t hard to find such quotes –  as my wife notes, I should probably count myself lucky that none from me appeared (after all, that quote from Shamubeel Eaqub is very much in line with my post the other day noting that there was no real macro difference between the Reserve Bank, at its discretion, choosing to buy bonds on the secondary market and choosing to buy them direct from the government).

Anyway, Social, Credit is trying to gather signatures for a petition (although not, it appears, a real parliamentary one) as follows:

We are calling on the New Zealand government to use the Reserve Bank (which the government owns) to fund the Covid-19 economic rescue package.

It is, they claim

The world’s first fully-funded plan to reclaim our environmental and social well-being

And here is underlying graphic

socred 2

The thing that seems to unite most monetary reformers is that they believe monetary policy and things around “the money supply” are much more powerful, much more important, than most monetary economists and central bankers do.

Before addressing what the Social Creditors are proposing, I should say that I am not one of those who thinks governments can do little or nothing useful in severe economic downturns  (there are a few such people, at least in principle, although few are visible/audible right now).  I’ve been championing here a more aggressive use of fiscal policy in the short-term (the 80 per cent net income guarantee for 2020/21), and for a much more aggressive use of conventional monetary policy.  Macro policy can help get the economy back to work as promptly as possible, but borrowing from the Reserve Bank –  whether at 1 per cent as Social Credit used to call for, or 0 per cent as they may now belief –  is largely irrelevant to the solution.

Note –  and here perhaps I depart from some of my friends on the right –  I did not say reckless and highly inflationary (as, for example, Social Credit prescriptions in the 1950s would have been).     There is far too much jumping at inflationary shadows still –  as there was 10 years ago in some circles (in the US in particular), and (so I was reminded rereading Eichengreen over the weekend) in the depths of the Great Depression –  at a time when the predominant macro risk (reflected in market prices themselves) is deflation.  Just largely irrelevant for now.

There is much talk of the government simply borrowing from “its own bank”, the Reserve Bank.  But the Social Creditors don’t seem to realise that there is really no such thing –  in any substantive sense.  After all, to most intents and purposes the Reserve Bank is just another division of the government –  the bit the banks bank with.

Take a really really oversimplified example.  The government wants to spend $20 billion in the depths of the recession and gets the Reserve Bank Governor to agree to lend it $20 billion (the government’s account at the Reserve Bank goes up by $20 billion and the Bank’s holdings of government bonds go up by $20 billion).  For most macro purposes, the interest rates charged/paid on either leg doesn’t really matter.

Now, assume the government goes and spends the money, perhaps distributing it in something like the wage subsidy programme.  The government’s operating account at the Reserve Bank will drop by $20 billion, and the accounts the banks hold at the Reserve Bank will rise by $20 billion (as recipients of the wage subsidy payouts bank the proceeds).

For the government sector as a whole, the net effect of this set of transactions in that the government sector has borrowed $20 billion from the banks.

Which is just what Social Credit thought they were avoiding.    They weren’t.  And the other relevant detail here is that the Reserve Bank pays interest on those deposits banks hold with them: at present 0.25 per cent per annum on the entire stock.

Banks, of course, have their own liabilities on the other side of their balance sheets, on which they too pay interest.    Some of them might be “wealthy foreigners”.  Others will be Grandma.

And what determines (or is supposed to determine) the rate the Reserve Bank pays on the deposits banks hold with it –  the OCR?  Why, that would be the inflation outlook, since they are required to aim to keep inflation at or near the target the Minister of Finance sets for them.

Perhaps advocates of Social Credit will be saying “ah, but 0.25 per cent is still cheaper than the interest rates the government might pay if it issued the bonds directly on market” (at present, long-term bond yields are a bit below 1 per cent, but would be higher than that if the Reserve Bank were not in the secondary market).   And that is true, but a 10 or 15 year bond yield is capturing, among other things, implicit expectations as to what monetary policy will be doing –  where the OCR will be set –  for the next 10 or 15 years.  Perhaps rightly, perhaps wrongly, at present the consensus view is that on average over that period the OCR will be higher than it is now, once the economy gets back to something more like full employment.

If that is right then, all else equal, even if the government has locked in zero interest funding itself from the Reserve Bank at zero per cent interest, the Reserve Bank would find itself having to pay higher interest rates over time to holders of settlement cash balances (or it might auction off some of its bonds to reduce settlement cash balances, but the macro effect would be much the same).    Reserve Bank interest expenses are a net cost to the Crown just as surely as if the Crown issued the debt directly on market.

And if the Reserve Bank did not make those adjustments –  higher OCR if and when inflation pressures eventually recovered – the result would be higher inflation.  And high inflation would be just as surely a “tax” –  transferring real resources from the public to the Crown –  as the taxes Social Credit claims they offer a path to avoid.

Perhaps the bigger problem still is that the Social Credit proposals are probably inadequate to the needs of the hour.

As I’ve noted in various posts in the last week or so, the Reserve Bank has added a huge amount to banks’ settlement account balances in total (balances last week were more than $20 billion higher than usual).  The “money supply” –  particular aggregate measures the Bank publishes – will also have increased to some extent (we’ll be waiting for weeks to see the end-April numbers).   But the higher settlement cash balances simply don’t mean very much.  For banks, it is just another asset –  a rock-solid one (which must be welcome) paying a reasonable interest rate for now, 0.25 per cent.    It isn’t as if there is much real effective credit demand at present, and the nervousness of many households and firms is probably reflected in quite a strong desire to save.

And whichever mechanism the Reserve Bank uses to buy bonds isn’t itself affecting how much the government is spending.  You might think (I suspect Social Credit do) that the government should be spending more.  That’s fine, but it won’t have any problem raising those funds –  whether it does so by issuing bonds on market, or issuing them to the Reserve Bank.  And it isn’t as if a shortage of settlement cash is constraining bank lending at present –  instead it is primarily weak demand from demonstrably creditworthy borrowers and perhaps an absence of attractive projects to fund (two sides of the much the same coin).

If the Social Creditors wanted a monetary policy that made a real difference in the current climate they’d give up their small ambitions and focus instead on where the big gains might really be on offer.

Perhaps a 1 per cent interest rate sounded really low to Major Douglas back in the 1920s, or to Social Creditors in most of the decades since.     These days it would be a very high interest rate, quite out of line with the needs of the economy.   Same goes for that 0.25 per cent the Reserve Bank is paying on the tens of billions of settlement cash balances.   Same really goes for zero, when so much of the government debt of major advanced economies has been earning a negative yield for some time.  Not surprisingly then, on the one hand our exchange rate is staying quite strong –  really unusual for a serious New Zealand recession –  and expectations about future inflation are falling (in turn raising the real interest rate –  a simply insane outcome in the midst of a deep recession with a highly creditworthy sovereign borrower).  But it isn’t wealthy investors or evil foreign banks who are determining that our interest rates are still so high: instead, it is Adrian Orr (and his Monetary Policy Committee, several of whom share the Governor’s left-wing credentials) and Grant Robertson, he who is always talking about the significance of full employment, but yet who does nothing to bring about the much lower (short-term) interest rates the current situation calls for.   Even in the last US recession, highly orthodox researchers within the Federal Reserve system concluded that a Fed funds rate of more like -5 per cent would have been helpful.  Our starting point this time, is worse than the US’s in 2008 (the Fed funds rate then started at 5.25 per cent).

In this environment, Social Credit is a distraction, but then so is the Governor’s bond-buying programme itself.    As in the Great Depression it was breaking free of the “golden fetters” that eventually allowed robust recovery, so this time it is the self-imposed “paper chains” – the refusal to do anything about seriously negative interest rates, that will impede prospects for any sort of robust recovery (and, not incidentially, worsen the worthy outcomes in the Social Credit graphic above).  Bond-buying programmes at yields well above the current natural rate of interest are just flashy-sounding asset swaps with little macro significance.

(And in case people are worrying about threats to central bank independence, recall that (a) the Bank’s current bond-buying programme, and any purchases it might in future make directly from the Crown, are a discretionary choice for Bank, and subject to the inflation target, and (b) central bank independence is not an absolute, or even always helpful –  the Fed, for example, was independent in the early 1930s and consistently resistant to doing very much of what needed to be done to get the US economy going (statutory powers for the Minister to (a) set the Bank’s target, and (b) override the Bank in some circumstances, but openly, exist for a reason).

And two final historical points:

  • one of the quotes Social Credit use is from Bernard Hickey about the 1930s.  Not only was the macro environment rather different –  fixed exchange rate and all that –  but the experiment did not end well (being used when the economy was already back near full employment) leading to a crisis in which a sovereign default would have been the outcome but for the looming war, and the imposition of tough exchange controls that took decades to get rid off
  • Canterbury economics academic Paul Walker has links here to a couple of pieces on Social Credit from the 1950s, including extracts from the Royal Commission report.


One chart

I was having a bit of an exchange yesterday with a couple of people about the execrable and inadequate President of the United States, and started looking at something that became this chart (of confirmed Covid-19 deaths per million population).

confirmed deaths per million

Which countries?  Basically, the advanced countries (most OECD members plus Singapore and Taiwan).

The exchange yesterday started with noting simply that for all Trump’s manifest inadequacies the US death rate at present is lower than those in most western European countries.   To the extent these data are a roughly representative picture of reality, presumably that largely reflects a decentralised system in which many/most of the relevant powers and responsibilities rest with states, cities and counties.

But what really interested me as I extended the number of countries on the chart is the extraordinary range of Covid death experiences to this point –  and we are surely only in the latter stage of Round 1 of this – across advanced economies.  In some cases, there are stark differences apparent even between countries that share a common border (notably Austria and Slovakia).   And big differences across countries that were all part of the free-mobility Schengen zone.

I’m not using this post to champion any particular view or any particular country’s experience.  For a start, we know that Covid death counts are being done differently in different countries –  Belgium errs on the side of inclusiveness, relative to most other European countries – and none of the numbers (at least for severely affected countries) will be even remotely sound until there are some consistent excess mortality calculations done (deaths at this time of year this year compared with those in more normal years), presumably with some adjustments for other changes in mortality (fewer road deaths, perhaps more from other delayed treatments).

As people start to dig into the cross-country differences (even to this point) presumably there will a range of relevant factors including:

  •  differences in the stage of the virus (when a country first experienced Covid infections –  even exponential processes take time to become very visible, and it was only three months yesterday since even the Wuhan lockdown),
  •  luck,
  •  the extent of testing, tracing and isolating (and consistency of approach/enforcement),
  •  the nature and extent of lockdown policies (and in some countries there will be notably useful differences in those policies in different regions within countries)

And, of course, there are interactions among those –  lockdowns in particular can be endogenous responses to weaknesses in other areas (as, say, champions of the Taiwan experience might suggest).

And with the literature on the Great Depression still active and that on the 1918 flu pandemic resurgent over the last couple of decades, presumably we can expect scholarly debate to rage for decades, perhaps well beyond our lifetimes.

For me, and perhaps mainly because I’ve long been intrigued by their economic performance, I’m interested to learn more about why –  for now at least, and on these numbers –  the former Communist central and eastern European countries are so far down this chart.  The worst of them –  Slovenia –  currently has a death rate less than a quarter of that of, say, Switzerland (and the geographic distance between the two countries is pretty small).  Most/all of them were in the Schengen area right along with (most of) the dreadfully bad performers of western Europe.

No answers, just questions.   And, of course, relief that New Zealand is in that diverse group in the bottom quarter of the chart.



The Minister of Finance spoke

I’m writing something on economic policy options and challenges for New Zealand as it eventually emerges from the shadow of Covid-19, and in doing so was prompted to pull out and reread the speech the Minister of Finance gave to Business New Zealand little over a week ago.

There was even a welcome touch of apparent humility in the Minister’s speech –  without ever quite specifying where the government might have mis-stepped, he did state that

I am not saying for a minute that we have got every single action as a government 100% right

Sadly, I don’t suppose he meant the permanent erosion in the fiscal position –  in an economy that will be poorer –  in his economic package last month, the one dressed up as an emergency coronavirus-response package.

But the main thrust of the speech appeared to be intended to about the path ahead.

What I want to do today is further fill out the detail our plan for the response and recovery from COVID19, through the first wave of the immediate response, to the second wave of kickstarting the economy and the third wave where we reset and rebuild our nation from this once in a century shock.

Which sounded good, although it immediately put me in mind of the three scenario model he was taking to the coronavirus risks not much more than a month previously, which in practice proved to be a justification for not really focusing much at all on the biggest threat just about to overwhelm us.   But set that past to one side for now; on paper the Minister’s three “waves” might be a sensible way to organise thinking.

Unfortunately, as the speech went on there still proved to be not much there, and what was there was really quite concerning.  It seemed of a part with a Minister of Finance who, from the start, hasn’t had a compelling framework for thinking about the issues, the risks, the appropriate responses, and the longer-term challenges.  In that, he probably isn’t helped by the weakness of The Treasury, but their analysis/advice such as it may be, has been largely invisible to outsiders so far (one hopes that in time the OIA will help remedy that).

We’ll take the issues in the same order as the Minister.  First, what he calls “Fight the Virus and Cushion the Blow”.

Here we learn that the Minister would like us to think that they have operated this way

In doing so, we have applied three key principles to our economic approach: First to act swiftly with no regrets. Second to improve cashflow and confidence. Third to act in coordination to secure and support our financial and business sector.

Count me a little sceptical, but in some respects they haven’t done badly at all. It is quite impressive how quickly the wage subsidy money has been got out the door, even if unfortunately it is a scheme that still looks more attuned to the China-shock it was originally conceived for than for what we have since faced.  Thus, you can get a full 12 week payout even if you only had a 30 per cent actual/projected drop in revenue for one month, and there is surely scope for some businesses at least to alter the timing of their revenue flow to ensure they legally qualified.  It is water under the bridge now, but something that needs to be taken a lot more seriously as the government thinks about what comes next, since the wage subsidy covers only the period to June.  Given the need to provide whatever certainty is possible, perhaps they will have those details in next months’s Budget.

For the rest, there has not been that much there.   We’ve had isolated bailouts  (Air New Zealand), contentious sector/firm specific handouts (yesterday’s media package) but little or nothing systematic to instill much confidence or willingness to stay the course.   For example, even though the Governor keeps reciting that “cashflow and confidence” mantra too, he’s refused to cut interest rates very much at all (barely changed in real terms this year), and the Minister of Finance seems unbothered by that.  There is scheme that will allow SMEs under which

Our tax loss carry-back scheme will allow a large number of businesses to access their previous tax payments as cash refunds, at an estimated benefit of $3.1 billion.

That will be a pure gift to the owners/creditors of firms that eventually fail, but simply a loan to firms that somehow survive.    Seems like rather skewed messages/incentives.

There is the business loan guarantee scheme, which seems sensible enough in its way, but really only deals with the subset of businesses for whom taking on more debt actually makes much sense.

We keep hearing talk about the tailormade solutions they are looking at for big firms, but (a) that offers no confidence and certainty, and (b) seems set to reward lobbying/connections/public profile.

And several of their measures will rely on retrospective legislation because the government chose to suspend Parliament –  and its lawmaking capabilities –  through the peak of the crisis.

I remain of the view that the government would have been better to have conceptualised the immediate economic response mainly with a “national pandemic insurance” frame of thinking.   Doing so, in the way I suggested, would have cost more than they are now spending –  a merit in my view, given the scale of the slump –  but would have offered much more certainty, more transparency, and less of sense of favours being granted to individual firms and sectors (eg singling out particular parts of the media for help sends out unfortunate messages that more-generous across the board support would not do).

Perhaps my pandemic insurance approach isn’t the right way to frame things. but it isn’t clear that the government/Minister has an alternative framing at all.

What about the second stage, what the Minister calls “Wave Two: Kickstarting the Economy”?

It is here that the concerns really start to mount.  After all, given the virus management measures not much else governments do make much difference to economic activity right now (indeed the goal in lockdown was to shutdown as much as possible, but get people through).

But if there is a framework for thinking about things beyond that immediate crisis point it appears very statist in orientation and, mostly, quite inward-looking.  That isn’t, historically, a recipe for productivity and prosperity.

Thus we hear quite about the the efforts of two Cabinet stars

Phil Twyford and Shane Jones have tasked the Infrastructure Industry Reference Group to prepare a list of infrastructure projects and programmes from across central and local government, and the private sector, that are shovelready. These could be deployed as part of a stimulatory package as soon as the construction industry returns to normal.

And then we get this list

Phil Twyford and Shane Jones have also continued to work on redeployment support, especially in our regions and they will have more announcements to make about that in the near future.

  • Megan Woods as Housing Minister is working to bring forward projects that will drive not only jobs, but also deal with our long term housing issues.
  • I have asked Chris Hipkins to lead the work on the critical training and employment support programme that has to take place from here.  Thousands of New Zealanders are going to need to retrain, gain new skills and support the kickstarting of our economy.  This work is in partnership with business, with unions and with training providers.
  • The Prime Minister, drawing on advice from her Business Advisory Group, has called for the creation of the world’s smartest border.  Using technology and our ‘natural moat’ as she calls it, to give us not just protection against the virus but a window to a future where we can move people and goods safely again.
  • Winston Peters and David Parker are charting a new course for trade and diplomacy in a radically changed world.  We need to continue to trade, and look again at our relationships to see how we can leverage our natural advantages and excellent progress on controlling the virus.

In every sector of our economy and society we have a need, and an opportunity, to come through the other side of this with a strong recovery plan. We have tasked all Ministers with reaching out to their sector to help develop these plans.

Every sector a plan……isn’t exactly reassuring, in a climate that will inevitably be characterised by extreme uncertainty.   And whatever “the world’s smartest border” means it isn’t clear what it has to do with kickstarting the economy.  And when the Minister talks about “we need to continue to trade”, that is certainly true, but seems barely aware of how dismal our foreign trade was (shrinking share of GDP) through the peak years of that wave of globalisation.   We need a much more outward-oriented economy than we’ve had –  not simply taking in each others’ laundry in the form of inward-focused government “infrastructure” projects.  That inward-focus (in effect, and despite the rhetoric) has been the underwhelming way of the New Zealand economy this century to date –  a century in which the gaps to the rest of the advanced world have kept widening.

What of the Minister’s “Wave Three: Reset and Rebuild”?

Hard to disagree with this

We must also make this the opportunity to reset our economy, to take account of the massive disruption to some sectors, but also to address some of the long standing challenges we face.  In doing so we also must chart a course to return to a sustainable fiscal position.

Although I would observe that most of the fiscal deterioration has been either one-off (specific coronavirus response) or cyclical –  revenue drops when the economy does –  and that getting back towards full employment remains the main salve for any fiscal challenges (and a balanced budget –  not even material surpluses –  for 20 years thereafter will secure big reductions in debt to GDP ratios).

But what the Minister has in mind is this

We must answer the big questions about our economy in these unprecedented times.  What should we make and do here in New Zealand to ensure our sustainability; what institutions do we need to support our economy; what is the role of the State; how do we trade with the rest of the world in this new environment; and how will the financial system, both here and globally, cope?

Climate Change will continue to be a major challenge long after the effects of this pandemic have been mitigated. As Rod Carr raised yesterday, our economic recovery needs to be one where emissions continue to reduce and more sustainable technologies are invested in and taken up.

New Zealand has had a long-run problem of low productivity. We need to look at our uptake of new technology and new ways of working to ensure that this problem does not again become baked into the New Zealand economy through our recovery.

Underpinning all of this, as the Prime Minister said yesterday we must also not allow inequality to take hold in our recovery. In fact we need to take this opportunity to improve the prospects of all New Zealanders and tackle those long standing divisions.

We’ve seen through this virus what happens when sectors and industries are overly reliant on certain markets for their export revenue. New Zealand must always remain a trading nation, but we will need to look at greater diversification of our export markets to make sure we are prepared for any future shocks to trade networks.

The importance of the role of the state has been underlined by this crisis. I hold a strong personal belief in the power of the state to do good. It is through a well-funded, highly functional public service, that we have had the ability to coordinate and provide leadership for New Zealanders, guiding both the public health response and the economic response to this crisis.

I believe it is of the utmost importance that the state continues to play an active part in the economic recovery, providing leadership and direction as we move forward through the challenging times ahead.

I didn’t find any of that encouraging –  no, not even the bit about not being overly reliant of “certain markets”, given that Covid-19 has long since become a global shock.  And while it is fine to talk about “greater diversification” the milk powder demand is where it is, and actually even the availability of potential foreign students is where it is too.   Firms have to be able to manage those concentration risks, but this specific shock was one that shut down businesses almost indiscriminately.   It is a distraction from the real economic challenges.

And inequality, well yes sure, but there doesn’t seem to be any sense that the very worst thing we could do for a lot of people is leave the economy running below potential, unemployment hanging up there for a moment longer than necessary.  These people on the wrong side of that will, in many cases, end up disadvantaged for life, and we know it is mostly the less-skilled, less well-equipped generally who find it hardest to get back into employment.

More generally, there is a great deal there about the role of the state and very little about the power and value of the private sector, market entities pursuing best opportunities, once the big policy signals have been got right.  And for all the passing mention of productivity –  the sort of passing mention (and no more) that Robertson has always given –  there is no sense that he or his advisers have much sense as to why those poor outcomes have happened, or what might enduringly change the business environment for the better.   There is no sense, for example, of a pro-productivity reform agenda (whatever specifics you or I might think should be part of such an agenda).  Nothing at all about a more propitious climate for outward-oriented business investment.

Strangely –  from a Labour minister, in an election year –  there was also remarkably little focus on the imperative of getting back towards full employment just as quickly as possible.  Perhaps that would have required conceding that the starting point would be a high rate of unemployment? Perhaps it had to do with talking to a busines audience?  Whatever the reason, it was a curious omission.    But a relative de-emphasis on that point seems to allow the Minister to get away without focusing on the tool that usually plays the large part in cyclical stabilisation and getting short-term growth rates up to reabsorb unused labour and capital: monetary policy.  The (in effect) complacency about the lack of any material fall in real  interest rates in response to this dramatic economic slump is quite remarkable –  and really rather alarming.  The exchange rate didn’t, I think, get a mention in the speech at all, and yet (a) it hasn’t fallen far, even though one of our major export sectors is just closed off for now, and (b) if the government is serious about doing better on the trade front you’d have hoped that a sustained lower real exchange rate would be a material part of the mix.  For that, a much looser monetary policy is a key upfront part of the initial mix.

(And for those still keen on much more use of fiscal policy beyond the crisis period, recall that generally higher fiscal deficits put upward pressure on the real exchange rate, working against any sense of a more outward-focused highly productive New Zealand economy.  In addition, of course, there are likely to be large cyclical deficits for a few years anyway, and the experience in other countries after 2008/09 is that in well-governed countries there isn’t limitless tolerance for sustained large fiscal deficits.  We need monetary policy back in action –  the Minister should be doing more to get it there.)

Overall, I remain concerned that there is no clear and credible economic strategy for any of the stages ahead we now face –  and the refusal to rule out the wasteful ill-targeted idea of a lump-sum payment to every household (when many households haven’t had much income impairment in the first place, while others are in dire straits) isn’t exactly reassuring.

Perhaps there really is a great deal of hard and serious medium-term thinking going on and in the Budget in a couple of weeks time much –  and much more encouraging –  will be revealed.  We must hope so, because on the evidence of last week’s speech the prospects are for lingering high unemployment, further reductions in trade/GDP (the environment having got tougher and the relative prices not changed in our favour) and no credible prospects of any improvement in our productivity performance.    The world is going to be a tougher place to take on, but we need to focus our energies on policies that might help us successfully do so, supported by making getting macro policy signals right, in ways that help get New Zealanders back to work just as soon as possible.  Turning inward –  which seems to be the default emphasis of the government at present – is no more sensible a strategy now than it was in 1938 (when the government’s hero, Michael Joseph Savage, presided over just such a lurch, part consciously chosen, part driven by misfortune and poor prio management).

From the other side of politics, I noticed this morning a link to a piece by one of National’s Associate Finance spokespeople, Andrew Bayly MP.    I don’t want to comment on it in any detail, but I noticed that same glaring omission as in the Minister’s speech: nothing at all about the combination of an exchange rate hanging up, and real interest rates hardly down at all, in the face of one of the most severe economic slumps in a very long time (even after “Level 4” has passed).   It is no way to get excess capacity reabsorbed –  as people eventually realised, and finally acted, in the 1930s.



Reserve Bank answers to questions from MPs

I haven’t changed my view that suspending Parliament for the duration of the greatest economic disruption, social dislocation, impairment of civil liberties, and assertion of executive power in a very long time (probably ever on at least some of those counts) was a (telling) mistake.  Nonetheless, the Epidemic Response Committee –  which is no real substitute for Parliament (including that it could not pass all the retrospective legislation the government is now promising) –  has done some useful work.

My interest, of course, has been mainly on the economic side of things.  Last Thursday they called the Governor of the Reserve Bank (and offsiders) to appear.  I sketched out here some of the sorts of questions the Bank needs to be asked, whether now or in a subsequent inquiry.  And I wrote about the questionable nature of many of the more important responses the Bank gave to the Committee when they appeared, some of which could only fairly be characterised as some mix of pure spin and just making things up.  That was particularly so around the alleged extent of the easing in monetary conditions, and the promise by the MPC not to cut the OCR further, no matter what.

Anyway, I assumed that was all over and done with, so it was a pleasant surprise when a reader sent me a link to some additional written questions the Committee had lodged and the Bank’s responses, which were quietly released onto Parliament’s website yesterday (the Bank certainly wasn’t drawing attention to this material).   There were a few odd questions at the start, but then the questions got quite meaty and serious, and appeared to draw on some of the lines I’d suggested last week.

Here were the questions that caught my eye:

  1. What steps had the Reserve Bank put in place prior to the Covid-19 outbreak to ensure it could practically implement negative interest rates?
  2. What work did the Reserve Bank undertake, and when, to explore ways in which it could reduce any practical constraints to negative interest rates?
  3. If there was any work or research undertaken to remove any practical constraints to negative interest rates, could any papers or advice be released?
  4. What modelling or research was undertaken, if any, to prepare for the possibility of a significant economic downturn while the OCR was at such low rates?
  5. In the Governor’s speech on March 10th 2020 negative interest rates were discussed as an option for unconventional monetary policy – what changed between that speech and the OCR cut on March 16th 2020 that stated “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”?
  6. When did the Reserve Bank first become aware that not all Banks were operationally ready for low or negative interest rates?
  7. How many banks are not operationally ready for low or negative interest rates and what share of the banking market do they account for?
  8. What are the operational barriers to negative interest rates (for example, are the barriers at the wholesale or retail levels)?
  9. What steps is the Reserve Bank taking to remove barriers to negative interest rates?
  10. When does the Reserve Bank expect any operational barriers to negative interest rates to be removed?
  11. What evidence does the Reserve Bank have that the large scale asset purchasing programme has been an effective substitute for lowering the OCR?
  12. What is the Reserve Bank doing to address falling inflation expectations considering the Reserve Bank’s pledge not to reduce the OCR further?
  13. By how much have retail interest rates fallen this year and how does that compare to every previous New Zealand recession?
  14. Will the Reserve Bank immediately release all relevant papers relevant to Monetary Policy decision-making this year?

For most of the questions they avoided giving straight answers, or even answering at all (which seems unusual, since my impression had been that when, for example, the Finance and Expenditure Committee asks the Bank supplementary questions in normal times they actually get answers).

Of the questions, there is a clear and specific answer to number 14.  That’s a no.  The Bank has no interest in any greater degree of transparency than the (very limited) amount there normally is, and that despite the huge uncertainty, unconventional policy and manifest unpreparedness.

There are no answers at all to questions 2 and 3, suggesting the Bank had done no work at all on these issues (eg limiting the potential for conversion to physical cash to hamstring the transmission mechanism), despite the extensive literature over the years on issues and options.

For question 4 they supplied this answer

The Reserve Bank has been updating internal forecasts for the probability of the Official Cash Rate (OCR) needing to reach negative territory on a regular basis since August 2019, and had been monitoring this probability less frequently before this. The possibility of a significant economic downturn in 2019 prompted the Reserve Bank to begin a closer examination of its alternative monetary policy options, and resulted in the Reserve Bank developing a range of alternative monetary policy options to respond to the COVID-19 event, meaning it would not have to rely on using only the OCR to conduct monetary policy.

Which isn’t very specific, but perhaps they regard as good enough for Parliament. There is simply no indication that they ever engaged with the fact that in typical past recessions 500 basis points of OCR easings had occurred, and by late last year the OCR was only 1 per cent.  And if they’d got to this point –  explicitly updating forecasts for the probability of needing a negative OCR –  by August last year, you’d suppose they’d have checked that there were no remaining technical obstacles, and if they’d found any made it a matter of urgency for them to be resolved.

That is what might have happened in a well-functioning agency –  bearing in mind, that this wasn’t even the first time they’d turned their mind to the issue (having published a Bulletin article in 2018, had an internal working party in 2012 recommend these issues be investigated and resolved, let alone the precedent of several other advanced country central banks for several years.

But as their answers to questions 1 and 6 make clear, that wasn’t the approach of our central bank –  recall, this was the central bank whose Governor keeps talking up his ambition for the Bank to be “the Best Central Bank”.

The Bank provided a page or so of summary response to the questions about negative interest rates.  Here are some extracts (emphasis added).

The Reserve Bank has been undertaking a programme of work on unconventional monetary policy tools, including negative interest rates, for some time. Since late 2019, this work included ensuring that the Reserve Bank’s systems can operate with negative interest rates, and understanding the banking system’s operational preparedness for negative interest rates. The Reserve Bank has the operational and legal ability to implement negative interest rates.

I guess that is good to know, although as I recall it the working paper I chaired in 2012 was told then that the Bank’s own internal systems could handle negative rates.

But what about the wider financial system and banks?  First there was this

Over the second half of 2019, the Reserve Bank engaged with registered banks regarding their ability to operate negative interest rates. This first involved engaging with the Reserve Bank’s counterparties in its open market operations in financial markets.

Okay, but this must have been a pretty minor issue.  After all, plenty of overseas wholesale instruments had been trading with negative yields for years, and according to the tables on the Bank’s website, indexed bond yields here first went negative in August last year, and presumably all those trades were conducted and settled just fine.

The real issue was always going to be banks and other deposit-taking institutions.  Here we learn

More broadly, bank supervisors raised the issue of preparedness for negative interest rates at banking sector workshops in December 2019.

This sounds pretty low-level, non-specific, and not at all urgent.  And this was the end of the pre-Covid era (the timing posed in question 1).

But then, very belatedly, they seem to finally started to get the grips with the potential for problems.

In late January 2020, the Reserve Bank’s Head of Supervision sent a letter to banks’ chief executives formally requesting they report on the status of their systems and capability.

By this point, of course, Wuhan was already in the daily headlines.  All those years, all that talk, and not til late January did they even start to do anything serious.  What did they find?

The responses raised a number of material constraints and concerns regarding operationalising negative interest rates. These included:
 – technical system issues (including front, middle and back office IT systems);
 – required changes to loan documentation;
 – tax and accounting considerations; and
 – market conventions for settling negative interest rate transactions.
Some of the issues affected the entire banking system, while others were limited to particular banks. The majority of banks reported further testing was required, and advised it was being undertaken.

Which is interesting, I guess, but does not answer some of the specific questions.  Thus, if the issues relate primarily to retail systems and retail rates (question 8), most retail rates are still well over zero now, and that is not a constraint to taking the OCR itself negative (and the Bank more or less tells us the wholesale instruments can’t have been the problem –  see the note above about the OMO counterparties).

They also don’t say when they got these responses (question 6) –  although I have an OIA request in that may eventually shed some light on that.

It all seems astonishingly negligent on the Reserve Bank’s part, put on notice of the issue years ago, claiming to be actively looking at it last year (recall the Governor’s major interview talking up his preference for the negative rates option).  This from an institution that has boasted since the last crisis how well positioned it was because it was both the monetary policy agency and the banking regulator (and operator of the wholesale securities settlements system) so that all the synergies should be realised and little or nothing should have fallen through the cracks.  This one –  a big one –  most clearly did.

(Of course, none of this reflects particularly well on the banks either, although quite how many are at fault, and how large those ones are, is still unknown –  the Bank won’t tell us.  They must have heard the Bank talk about negative rates, they must have looked abroad, in some cases their economists even wrote useful pieces on unconventional options….and yet.)

Then note that final sentence in which it is stated that “the majority of banks reported further testing was required, and advised it was being undertaken”.   But there is no sense of time frame there, or any urgency whatever (and recall that the Bank’s previous answers –  and even this one – suggest that “testing” wasn’t the only issue/constraint).   The Bank’s answer goes on

The Reserve Bank is engaging with the banks and expects them to be taking steps to be operationally prepared for negative interest rates.

But there is nothing hands-on or specific about that (and thus there is no answer at all to question 10).

Elsewhere in the answers they include this observation, attempting to justify their relaxed attitude.

As discussed in Preparations and readiness for negative interest rates [the one pager], many of the commercial banks still needed to undertake work to be able to operate with negative interest rates. This would have been disruptive for these banks at a time when they were also adding other new programmes, working remotely, and having to greatly increase customer service capacity.

But even this is playing distraction, and seems more about not inconveniencing the banks, and perhaps a Governor who no longer believed that lower interest rates were even desirable/appropriate.   After all, people weren’t working remotely in late January, in late February (after the  MPS), by 10 March when the Governor gave his speech still listing negative interest rates an option (and talking up the possibility of easing the effective lower bound itself) or even on 16 March when the MPC made its public commitment not to cut the OCR further no matter what happens, and we started to be run the “technical obstacles for banks, wouldn’t want to bother them, sorts of lines” from Bank management.  Instead, it is pretty clear that the Reserve Bank badly dropped the ball, and is now playing distraction to cover for its past and ongoing failures.  The Governor and Deputy Governor (the latter responsible for bank supervision) must bear particular responsibility.

What of the other questions?    There was one (qn12) about falling inflation expectations –  this was a big theme of the Governor and his monetary policy deputy for a time last year.  But this time round, amid actual market price and survey evidence of inflation expectations falling away and, all else up, driving up real interest rate?  Well, we (well, Parliament actually) simply got boilerplate bureau-speak

The Reserve Bank and Monetary Policy Committee are committed to the Remit’s dual economic objectives of achieving price stability and maximum sustainable employment, and will continue to evaluate the use and extension of its monetary policy tools, and enhanced coordination between monetary policy and fiscal policy.

An utter refusal to even engage on one of the core issues of monetary policy.

But my bigger concern, as when I wrote about the appearance at the Committee itself, is how the Bank is attempting to spin its large-scale asset purchase programme.    You can read the detail there, but this extract captures the point

I think there is little doubt that the Reserve Bank’s large-scale asset purchase programme –  which, mostly, I support –  has acted to bring government bond yields back down again (and with them some other interest rates).  In that sense, there is probably quite a large effect in those markets.  But what that has done is to reverse a tightening in monetary conditions that got underway as assets were being liquidated globally; it is not any sort of easing relative to where conditions stood three months or so ago.

In its latest answers, the Bank attempts more of the same sort of spin and distraction.   Thus, in question 11 they were asked about their claim that the LSAP programme had been an effective substitute for a lower OCR.   Mostly they avoid the question, falling back on the questionable claim that the LSAP is equivalent to 150 bps of OCR easing, but acknowledging that there is “considerable uncertainty” about these estimates.  Then there is this bit of the answer:

The LSAP has been successful in offsetting the rise in government bond yields that was observed in the lead-up to the decision to implement it. In addition, LSAPs have stabilised financial markets by providing liquidity and surety at a time when it was needed. These effects would not have been achieved with a negative OCR

Both of which strands are true, but not really relevant, since the MPC made the pledge not to cut the OCR further at a time when bond yields were still falling sharply.   As I noted in the earlier piece, the LSAP successfully reversed the later panicky rise in bond yields, but has done nothing to actually ease conditions relative to where they were on 16 March.   It is also true that the OCR and LSAP are not straight substitutes  –  as the Bank notes in the final sentence –  but in a sense it was them who were claiming otherwise.  Stabilising the government bond market might have been helpful –  although its role in the monetary transmission mechanism is much less important than in, say, the US – but it isn’t a substitute for actually easing monetary policy.

In fact, the Bank more or less gives the game away in their answer to question 13.

Retail interest rates have fallen by considerably less this year than during previous recessions. This in part reflects the OCR falling by less, and dislocations in global and domestic financial markets have also hampered the full transmission of monetary policy. Marginal market funding costs for New Zealand banks have increased due to stress in financial markets, and this has limited falls in mortgage rates. Benchmark short-term interest rates have fallen by around 0.8 percentage points this year, compared to falls of almost 6 percentage points during the Global Financial Crisis (GFC). Deposit rates and 1-3 year fixed mortgage rates have fallen on average by 0.25 percentage points since the beginning of the year, and floating mortgage rates have declined by 0.75 percentage points. By contrast, fixed mortgage rates fell by an additional 2 percentage points on average during the GFC.

I could also help with this extract from my previous post

In December, before anyone in New Zealand had even heard of the new coronavirus, those interest rates were 2.63 and 5.26 per cent respectively.  As of this morning, using the data on current rates on interest.co.nz, the big banks are offering between 2.3 and 2.45 per cent for six month terms deposits (shall we call it 2.38 per cent), and offering between 4.44 and 4.59 per cent for floating rate mortgage (call it 4.5 per cent).   In nominal terms these deposit rates have come down by 0.25 percentage points and 0.75 percentage points.  It is harder to replicate the Bank’s “SME new overdraft rate”, but by March it had come down by 0.59 percentage points.

Here, by way of comparison, is how much those three series fell from December 2007 to April 2009:

Six month term deposit rate:     -4.6 percentage points

Floating first mortgage rate:      -4.1 percentage points

SME new overdraft rate:             -2.4 percentage points

Oh, and inflation expectations have come down, so actually real retail interest rates –  the ones that mostly matter –  have hardly fallen at all in face of the biggest economic slump in a very long time.

They simply have not been doing their job.   Recall that the Remit that guides the MPC, set for them only last year by the Minister of Finance requires them to

a) For the purpose of this remit the MPC’s operational objectives shall be to:

i. keep future annual inflation between 1 and 3 percent over the medium term, with a focus on keeping future inflation near the 2 percent mid-point. This target will be defined in terms of the All Groups Consumers Price Index, as published by Statistics New Zealand; and

ii. support maximum sustainable employment.

When core inflation started below the target midpoint, inflation expectations are falling away, demand is slumping and unemployment is surging, it is time for much more of an effective monetary policy response than modest falls in nominal retail interest rates –  little changed in real terms –  and a small fall in the exchange rate.  Focusing instead on stabilising government bond yields, worthy as it might be, is really a bit of a distraction (whether they realise it or not).

In a way this is the bizarre thing about the flurry of excitement caused by the suggestion from the Governor and the Minister that it might make sense at some point for the Bank simply to buy more new-issue government bonds directly from the market.    For any given stance of fiscal policy –  and realistically, fiscal policy has remained pretty cautious (too much so in my few) since this crisis launched –  however the Bank buys the bonds it is going to hold is really neither here nor there when the  prevailing interest rates are still well above where they should be and when the exchange rate has not fallen much at all.     There is little or no significant risk of a surge in inflation in the next couple of years –  any more than such surges happened in the countries that engaged in large scale bond purchases after the last recession –  and the big presenting risk is on the deflationary side at present.      Lower financial market prices (retail interest rates and the exchange rate) won’t make a huge difference to economic outcomes right now –  heavily constrained by regulation anyway –  but are about (a) relieving debt service burdens, (b) sending the right signals as people think about spending and borrowing for the next few years, and (c) supporting inflation expectations, avoiding rising real interest rates, by giving people confidence that central banks will do what it takes –  and what will make a difference – to get inflation back towards target and keep it there.

There has been much talk about negative oil prices in the last few days.  They really are an unsustainable anomaly –  about storage capacity – and the marginal extraction costs set a floor on sustainable prices.  There is nothing natural or inevitable about positive interest rates.  Interest simply serve to balance savings preferences and desired investment plans: if investment intentions collapse and private savings preferences rise significantly, it is quite plausible for the market-clearing price –  the interest rate – to be negative.  The only thing that stops nominal interest rates being materially negative at present is central bank conservatism, and reluctance on the part of central bankers to simply do their job.

In Orr’s case, playing distraction and pandering to all his other interests is clearly easier and more to taste.  See this account of his speech this week –  a speech for which there is no transcript and no public record of the Q&A session –  for Orr the politician, Orr the philosopher, Orr’s judgement on the public’s desire to consume, Orr on the (alleged) failings of democracy, but little or nothing on Orr charged with getting inflation to 2 per cent and supporting employment in the face of a huge deflationary shock and slump.

It is too bad the Epidemic Committee can’t call the Governor back and insist on some straight answers.  Better still might be if the Minister of Finance and the chair of the Bank’s Board did their job and insisted that the Governor does his.