Questions for the Reserve Bank

Michael Reddell pandemic

Wednesday mornings at present don’t find me at my most relaxed and sanguine. It is the morning I join the supermarket queue at 6:50am (a bit shorter this week than last), and notice that the owners have now erected shelters for customers to queue in the rain –  winter coming and all that.  And I’m reminded of the Prime Minister’s fantasies, when she was urging people not to stock up before the lockdown, that the supermarkets would run normally no matter how intense any lockdown.  When milk is scarce (in New Zealand….?), flour is available patchily at best, there is little or no fresh fish (my supermarket is about a kilometre from where the fishing boats moor), and the availability of almost anything else seems to be something of a lottery, it is a strange definition of normality.  Add to that packing groceries into bags in the carpark –  where it is cold, but not yet wet.   As it is, it is a bit like a bank run…if people come to doubt,  rationally or otherwise, that the bank can meet its debts, it is an incentive to get out entirely while you still can.  Here, the medium-term risk probably isn’t the New Zealand produced basics, which will eventually get sorted out, but the foreign-produced non-perishables (not much affected by New Zealand government choices).  Which year will supplies of those get back to normal?

Anyway, having got that off my chest, it is time to turn back to monetary policy and the Reserve Bank of New Zealand.  The Governor is scheduled to appeared before Parliament’s Epidemic Response Committee tomorrow.  If the Committee is serious about holding the government and powerful independent government agencies and figures to account, there should be a whole series of hard questions posed to the Governor (and to his colleagues on the Monetary Policy Committee, the external half of whom never seem to face any scrutiny, challenge, or questioning.  There are important questions about the past, the present, and (a few) about planning for the future, and only a few can be addressed in a short session (many are likely to need to wait for a Royal Commission or a later external review of the Bank’s handling of the crisis).

At an overarching level, there should be much the same question for the Bank as for the rest of government: why is there so little transparency, so little pro-active release of relevant background and decision documents.  Anyone would think we didn’t have a central bank that likes to boast about how transparent it is, or a government that used to boast that it would be the most open and transparent ever.    Say it often enough and it still doesn’t change the (quite different) reality.

The first set of questions might reasonably be about the past and Reserve Bank preparedness.

For example, Committee members might consider asking the Governor about the state of preparedness of unconventional monetary policy when he took office (in March 2018), many years after other countries had already been undertaking such activities and, in some cases, dealing with negative official interest rates.

And as it is now almost two years since the Bank published an article on options around unconventional policy, including negative official interest rates.  In that article, the authors observed

Overall, it appears that the Reserve Bank could implement negative interest rates, with the potential leakage into cash relatively small in value terms at modestly negative rates.

So the Bank might reasonably be asked what steps the Bank had put in place by this point to ensure that there were no technical obstacles to using a modestly negative OCR (eg checking out whether bank systems were readily able to cope and, if they were not, prioritising getting them ready)?

Since the Bank was well aware of the limits to how deeply the OCR could be cut –  because of the possibility of conversion to zero interest cash –  what work programmes did the Bank have in place to explore options for easing, or even removing, the constraints (all of which were under the Bank’s direct control).   If there are such papers, the Committee might ask for them to be released.

It might be reasonable for the Committee to ask what modelling and scenario-based work the Bank had undertaken in recent years to prepare for the possibility of a new serious economic downturn while the initial starting level of the OCR was still very low?  How, for example, did they factor in the observation that in typical recessions the OCR (or equivalent) has been cut by 500+ basis points, in turning often helping generate a large reduction in the exchange rate.   Macrostabilisation in the face of deep adverse shocks being, after all, at the heart of why we have a central bank with discretionary monetary policy.

In a lengthy interview last August, the Governor indicated his preference for using a negative OCR before using large scale asset purchases etc.  As late as his speech on 10 March 2020, a negative OCR was still being presented as a live option.  What changed?  When?

At the February Monetary Policy Statement the Bank was quite upbeat about economic prospects here and abroad, even moving to a mild tightening bias.  Almost two weeks later, in a tweet approved by the Chief Economist, the Bank was still talking up economic prospects for 2020.   Doesn’t this suggest an extraordinary degree of blindness, backward-lookingness, and complacency about the risks just about to break over us?  To what extent, if at all, had the Ministry of Health or The Treasury been alerting you by this time to the scale of the health and economic risks?

In your speech on 10 March and in interviews immediately after that, the Bank was still coming across as extraordinarily complacent and reluctant to do anything with monetary policy.  Given the way the Bank had responded to past exogenous shocks threats, how do you justify the refusal to act for so long, perhaps the more so when you knew the limits of conventional monetary policy were approaching and (in various statements/interviews last year you were alert to the threat of inflation expectations falling away in any renewed downturn).  The Governor might also be asked if the technical working papers promised in his speech are now ever going to be released.

And finally, in the pre-action, phase, it might be reasoanable to ask whether the Bank’s Chief Economist was correctly quoted in the  Herald on 13 March, when he is reported as saying  –  of the various possible unconventional instruments (asset purchases and the like) – that “there are limits to some of these additional tools.  They give you a little more headroom, a little more time and space.”

The Present

The Monetary Policy Committee finally acted on Monday morning 16 March.   The OCR was cut by 75 basis points to 0.25 per cent, but a floor was put in place at that level. The Committee pledged not to change the OCR “for the next twelve months”.     It was an extraordinary commitment to make amid so much uncertainty, and again suggested a degree of misguided complacency or comfort that something close to the worst had already been seen.

But, most importantly, the new floor came completely out of the blue.  There had been no hint of it in the speech or interviews the previous week and we have still seen not a shred of analysis in support of a floor at that level.  Various central bankers were wheeled out to tell us that not all banks’ systems could cope with negative rates and that the Reserve Bank didn’t now want to put any pressure on those banks.

So, a reasonable question might be when did the Governor and the MPC first learn that not all banks’ systems could cope with negative interest rates?  (For that matter, when did they ask?)  How many banks had this system failure, and roughly what share of the banking market do they account for?    Are the issues with retail or wholesale systems bearing in mind that many overseas wholesale rates have been negative for several years)?  If retail, given that term deposit rates are still mostly above 2 per cent, and lending rates higher (often much higher) than that, why couldn’t the OCR have been cut further?

Another reasonable question might be to ask what steps is the Bank now taking –  and at what level of the organisation – to insist that banks either get ready for negative rates or risk being left to one side in favour of those that are ready? (Bank spokespeople have suggested a negative OCR might be an option some time down the track.)  What deadlines have been given by the Bank?  What commitments made by the tardy banks?  Why is there no naming and shaming (in fairness, it might be easier for a journalist to ask each bank and do the “naming and shaming” that way).

The Governor has indicated that urgent work is proceeeding on details of a deposit insurance scheme. What, if any, urgent work is underway on easing or removing the constraints that give rise to the effective lower bound on nominal interest rates?  If none, why not?

The Bank has announced a large scale purchase programme of government (and now local authority) bonds.  How would the Governor evaluate the effectiveness of that programme.  It is easy to see that it has limited the sell-off in government bond yields, and perhaps in some other asset markets, and thus limited any tightening in monetary conditions.  But relative to the conditions the MPC delivered on 16 March, is there any credible evidence that the asset purchase programme has eased conditions, and thus materially substituted for a lower OCR itself?  If so, what are the relevant transmissions mechanisms.

The Bank has injected huge amounts of settlement cash to the banking system. Given that all settlement cash balances are now being remunerated at the OCR itself –  the previous tiering system has been scrapped for now –  aren’t you at risk of further holding up market interest rates by offering almost unlimited risk-free investment at 0.25 per cent?  (This is a concern that, for example, George Selgin had posed in the US in the wake of the Fed’s earlier large scale asset purchases.)

The Governor might reasonably be asked about the falls in inflation expectations observed in both surveys and market prices, and invited to offer his thoughts on how those expectations are likely to be returned to around 2 per cent when (a) his asset purchase programme is achieving little overall loosening, and (b) MPC has pledged not to cut nominal interest rates further, no matter how bad the economic and inflation situation gets.

Relatedly, the Governor might be invited by the Committee to tell it how much real retail interest rates (borrowing and lending) have fallen since the start of the year, and to contrast that with the scale of the reductions in each previous New Zealand recession.  Hint: there has been almost no reduction at all (and, at a wholesale level, the real five year government bond rate is at the same level now it was in early December).

Since the Reserve Bank’s last economic projections were completed in early February, perhaps the Governor might be invited to comment on the inflation numbers in The Treasury’s economic scenarios published yesterday (the Secretary to the Treasury is, after all, a non-voting observer at the MPC table).  The best of those scenarios had inflation at 1.25 per cent for each of the next two years (several scenarios had negative inflation), outcomes which –  if realised –  would risk further entrenching lower medium to long term inflation expectations.  Are such outcomes consistent with the Bank’s own thinking, and if so would they be acceptable to the Committee?  If not, why won’t they ease monetary policy further?  And if the Governor thinks the Treasury numbers are too pessimistic, what channels does he expect to be at work to avoid such low inflation?

Perhaps time might be spared for a hypothetical: what does the Governor think would be worse, in terms of the economic responsibilities the Bank has, if the OCR were able to be set at,say, -5 per cent and retail lending and deposit rates were commensurately lower (modestly negative)?  Inflation?  Employment?  What? How?

Given the Governor’s enthusiasm for the employment dimension of his new mandate, how does an adamant refusal by the MPC to cut the OCR further no matter how bad the economic situation gets square with all that rhetoric?

Does the Governor (and MPC) now regret the “no change for 12 months” commitment?   What positive stabilisation value did it add, given that no serious observer has ever supposed that OCR increases were at all likely in the year after 16 March?

Here it is perhaps worth adding that the Governor is well known as an enthusiast for the active use of fiscal policy, to pursue all sorts of personal agendas.  However, he is Governor of the Reserve Bank, responsible for monetary policy, and his refusal to actually use the tools he has –  and is statutorily charged with using –  seeems little short of dereliction of duty.

The Governor might also be asked about the foreign exchange intervention option. Very unusually for a New Zealand recession, the exchange rate has fallen very little at all (even though one of our major export sectors is just shutdown completely for the time being).  The Bank has indicated that foreign exchange intervention is one of the tools open to it to attempt to ease monetary conditions further. Why has this tool not yet been deployed?  How effective does the Governor expect that it could be?  (For what it is worth, I’m sceptical as to how much difference it will make, but (a) we won’t know until we try, and (b) if it is tried and failed, it would help turn the spotlight back on the adamant refusal to adjust the OCR.)

And finally for this section, there was that op-ed of the Governor’s a couple of weeks back that concluded with this injunction

Support each other, think beyond just the next six months or more, and visualise the role you can and will play in the vibrant, refreshed, sustainable, inclusive New Zealand economy.

Just which planet was he on as he touted this vision of a “vibrant, refreshed” New Zealand economy as the wreckage mounts of one of the biggest economic shakeouts, and losses of wealth, ever?

Oh, and when he was stating at about the same time that New Zealand had perhaps the strongest banking system in the world, how does he square that with his relentless rhetoric last year in favour of much higher ratios of bank capital, all the time suggesting that even if that were done our banking system would not then be out of step with international norms?

The Future

Why will the Reserve Bank not publish all relevant background and analytical papers relevant to monetary policy decisionmaking this year?

The Reserve Bank’s balance sheet has been hugely increased by the interventions undertaken in this crisis.  Experience in other countries, after the last recession, suggests that getting back to normal size is likely to be a long slow process.  One of the risks of very large central bank balance sheets is that central bankers then become part of the credit allocation process itself, favouring some sectors, disfavouring others (in ways usually more appropriate to fiscal policy).  What protections do citizens and taxpayers have against balance sheet choices being made by the Governor  –  still the single decisionmaker in key areas –  in ways that advance his personal political agendas.

What approach are you planning to take to economic forecasting for the May Monetary Policy Statement?  Can any central forecasts be particular meaningful or instructive in such a climate of extreme uncertainty?

 

32 thoughts on “Questions for the Reserve Bank”

  1. I started watching those Committee meetings and then gave up. The people asking questions often spend longer asking them than the experts do in answering them. They seem to ask a question and then expand on what they’d like to hear in an answer. Very frustrating. So I’m hoping they questions are succinct and to-the-point, and particularly focus on the future role of the RB in relation to its dual mandates of price stability (i.e., how will they respond in the event of high inflation) and employment (i.e., how will they respond to high unemployment).

    I suspect in the aftermath of this we’ll get both.

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  3. I realise that Orr’s Stuff op-ed looks weird by all means. But you may have noticed the RBNZ lowered funding requirments as well as an article in the AFR where the RBA admitted liquidity was stressed for some time: “Millions at a time: RBA reveals … on cash during panic”.

    A question that should be asked tomorrow is if Adrian Orr actively appraoched Liam Dann and Stuff to reach the masses and calm them down – to prevent the mother of all nightmares in banking.

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  4. “Oh, and when he was stating at about the same time that New Zealand had perhaps the strongest banking system in the world, how does he square that with his relentless rhetoric last year in favour of much higher ratios of bank capital…”
    I agree the disparity between Orr’s new-found enthusiasm for the banks’ robustness compared to last year’s concern makes his current statements seem insincere (and pro-forma) but I noticed in a recent tweet (April 8), Michael, you seemed to back off your previous enthusiasm for the strength of the banking system and be much more cagey: “Relatively speaking the Aus/nz banking systems shld be more robust than most, but falling asset prices & sustained sharp rises in unemployment are a toxic brew. Most demanding RB stress tests had unemployment at 13% (but for some considerable time).”
    Do you think the banks aren’t as strong as you thought when you were adamantly against Orr’s capital proposals?
    The qualifications in your tweet (eg “should be…”) seemed to be far less sanguine than I remembered you being last year.
    This question is not intended to be a “gotcha” query but rather an attempt to assess your current thinking. One Australian commentator I read is fond of saying: “This crisis didn’t start with the banks but it will end with them.”
    I’d like to know how far the RB will go to backstop the banks — and not just via say the $50k de minimis mooted as a deposit insurance but, say, the funds from a house sale travelling through them, even if only briefly.
    Fear of banks going down is widespread right now and one thing that will keep the housing market stagnant is sellers’ fear their money won’t be safe.

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    • Entirely fair question

      As you may recall, I’ve often used the Bank’s own stress tests to make the point that the banking system, as then configured, appeared readily able to cope with the combination of a 50% fall in house prices and the unemployment rate rising to, as I recall, 13% and staying there for several years. Note that those stress tests mostly relate to periods before LVR restrictions really started to bite on large chunks of the portfolio.

      That remains my view. That scenario was really quite extreme – in a post world war 2 (discretionary monetary policy) era, no country with its own currency has had an experience worse than that. Also note that no bankng system in which govt has kept out of housing finance has had residential mortgage loans as a major source of banking system failure (and our banks are mostly either lending to houses or to dairy farms).

      There is a chance – still a remote one – that this crisis could be really materially worse. That risk is accentuated by the refusal of central banks to do anything about easing mon policy very much. But even on the Treasury scenarios – and thet don’t forecast house prices – it would be only the one with a 12 mth level 3/4 restrictions that really starts to come close. Now, in my post yesterday I noted that I thought Tsy was too optimistic, so there is a non-zero risk our banks get towards trouble.

      But even if that is so, it would not change my view about appropriate capital levels. After all, faced with an extreme tail event shock of this sort, a large proportion of all businesses in the country would be heading towards insolvency, and there will be govt support for them (as I think there should – on my 80% proposal, more generous than the govt is being). That doesm’t lead me to think that private businesses were undercapitalised, simply that limited liability is generally a good thing, and for many firms it isn’t rational to plan to survive a really really extreme event – this one looks as though it could be Adrian’s 1 in 200 year event (even if the deaths etc don’t reach 1918 levels, it will be mostly because of the mix of govt and private actions taken to shutdown personal and economic interactions.

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      • The 2% deposit rate keeps the $190 billion in cash savings sitting in banks, bank accounts. It also allows savers a bit of discretionary spending which helps keep people calm. The key is that there are more savers in number of people than there are borrowers. Don’t forget most investment funds including Kiwisaver do have at least 40% invested in savings. Given that sharemarkets have gone negative returns from 17% positive return at one stage, that 2% is looking very attractive. You certainly do not want the NZD collapsing any further otherwise the 30% inflation already seen in supermarket food prices will jump further upwards.

        Those mass redundancies are already starting. Negative interest rates will not help companies whose business revenues have completely disappeared. I have only 1 troubled tenant out of 11 investment properties seeking no rents for 12 weeks. With lending interest rates falling fast on overdraft facilities, I am thinking about either moving that funds into the share market or buying distressed Auckland property. What surprises me is there has been no drop in house prices for me to buy.

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  5. Your comment re Supermarket queues and produce.
    As all Restaurants, cafes, takeaways, “Binn INNs”, butchers, greengrocers, farmers markets, Hotels, school lunches (plus others you can think of) are closed down, the demand on Supermarkets has got to increase to “pre-Christmas” levels at least every day. Where else is there to get food from now? (unless you grow it but that was happening before lockdown so will not enter the calculation.)
    You note this may sort itself for NZ produce….. but is it a failure to see comprehend “the big picture” here too?

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    • In many ways the queues/shortages are inevitable (and would not be much dented even if butchers and green grocers had been able to open), but what really irked me was that attempt by the PM to suggest otherwise. You end up with shortages of flour in supermarkets because packaging is an issue( generally households don’t buy 25kgs at a time but bakers do) or people who usually supply restaurants etc don’t have the contacts/contracts with supermarkets etc. if there was going to be a lockdown, there were going to be problems.

      Of course it didn’t help that there was no serious advance planning by the govt and govt agencies.

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      • Jacinda Ardern is a habitual liar. Her motto is, it is never a lie when it is aspirational.

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  7. Very good post Michael. The questions are very apt. I assume that someone in Simon Bridges’ office and Paul Goldsmith’s office regularly read your posts, but just in case, I encourage you to email the link to today’s post to both Mr Bridges and Mr Goldsmith. And to David Seymour. I think they would find this very helpful in advance of the Committee meeting.

    Cheers

    Geof

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    • Presumably the Governor also reads/has someone read these posts, so should have well prepared and considered responses.

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    • Simon is a waste of space. Not in any way a leader. Small town public service Lawyer. He hasn’t asked any hard questions so far so why would he start now. He didn’t put the heat on the man when he first appeared before the committee.
      The only person earning his keep is David Seymour. We can thank him for most of the rebuttals and harassment of the govt. so far. Better you email him.
      Simon couldn’t even decide if he should take a wage cut even though Seymour had prompted them all a month ago. If the Nats don’t find someone with a backbone they will lose the winnable election. But, who have they?

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      • The Opposition has been weak. They have bought into the necessity of the Emergency powers that have set aside parliament and made NZ a Police State.

        Construction workers should be allowed back into construction sites. I can’t see why social distancing and other health measures cant be brought into sites. They are pretty much already isolated and locked up from the public anyway.

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  8. Can’t get my head around negative rates.

    I thought qe was supposed to stimulate lending by giving banks more reserves? But with negative rates you want to tax them back out? Didn’t work in japan did they?

    Also, as always i think economists get human psychology wrong. If my deposits get culled by negative rates i am definitely going to think things are really bad and save more of my income rather than spend more. My balance sheet needs to improve to spend again not deteriorate.

    The interest rate route has reached a dead end. No matter how low they go businesses invest when demand is good and capital stock can’t meet it. People buy houses when they have jobs. Not cause rates are 2% instead of 3.

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    • Some early conceptions of “QE” were that they worked by creating additional reserves. In pure financial crises that can be helpful at times. More generally, though, to the extent large scale asset purchase programmes work, it is more by lowering int rates in that particular market, creating liquidity in the mkt for that security itself, and perhaps by stimulating demand for other assets. Mostly those are pretty small effects – hence that quote (quite correct in substance) from the chief economist. asset purchase programmes are generally a pretty weak and inadequate substitute for the interest rate instrument.

      On negative int rates, recall the distinction between retail and wholesale rates. We could lower the OCR by another 2.5% and we would still only have term deposit rates around zero and retail lending rates materially positive. On your specific point, recall that the same arguments have been made whenever int rates are cut (savers will if anything save more) and yet in aggregare int rate effects work. Negative rates themselves have not been tried very aggressively at all – just enough that there is no excuse for not having systems ready! – and there may well be some threshold effects around zero. Recall that for every saver who responds by cutting their spending, there will be a borrower with a bit more to spend. Perhaps more importantly, the more negative int rates go the more attractive it is, for example, to try to shift money abroad, lowering the exch rate, one of the typical ways mon pol works.

      Recall too that no one is suggesting that even much lower int rates would make much difference to the state of the economy now – it is all about the virus and regulatory response – but as things stabilise the lower int rates are all else equal the more willing people are to spend, invest, buy shares etc(lowering the cost of new capital) or whatever. They also help support inflation expectations, and stop real rates rising (for fixed nominal int rates).

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      • Ok so as a borrower lower rates mean i have more cash left over to spend or save. If my newfound deposits that i have now that I’m not paying so much in mortgage interest are being culled I am still going to save more. Or pay down debt. How does that increase spending on gdp transactions?

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  9. Michael, picking up on your final para, has it turned out that asking how much capital banks need to be able to absorb a “1:200 year event” was the wrong question? Does that assume that the banking system can be more of a ‘shock absorber’ than it ever really can be?

    Banks incur losses only when their borrowing customers ‘fail’. But in a 1:200 year event, the breadth and depth of potential customer failures is such that allowing the losses simply to “lie where they fall’ – that is, with bankrupted households and firms, and through them, with the banks – is not really (much of) an option? Imagine what that currently would look like – a monetary and economic contraction like no other? At times like these, it seems to me that governments need the banks as much as the banks need the government – otherwise we all “go down together’?

    Which causes me to wonder whether, in the current kind of circumstance, what’s needed is ‘open borrower resolution’ more than ‘open bank resolution’. That seems already to be accepted, with large scale fiscal interventions to, if not to ‘bail out’ firms and households, at least to put them on life support. Perhaps what’s not there is any mechanism by which banks too can be ‘bailed in’ to their customers (a bit different from customers being ‘bailed in’ to their banks)?

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    • This is certainly a 1-100 year event from the sound of it. Imagine things worse worldwide (and we’re just getting into it)

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      • It comes down to Solvency and where values reside. Insolvency is very simply Asset values are lower than Liabilities which translates to negative Shareholders Equity.

        Asset – Liabilities = Shareholders Equity.

        A Open Borrower Resolution that increases Borrowers liabilities has already come in the form of Mortgage Holidays. Interest only loans, Emergency overdraft facilities and loan deferrals increase Banks asset values. That of course improves Banks solvency but it has to be balanced with maintaining or even increasing house prices.

        I must admit Adrian Orr is actually doing a great job as the RBNZ governor. I got $30,000 overdraft top up at 2.9% interest rates which rolls into a Term Loan after 6 months if used. It took one phone call and a confirming email that one of my 11 investment property tenants was in strife and the Bank overdraft facility was setup in 2 hours. Not days. Hours.

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    • Interesting way of looking at it.

      Although I don’t favour it, a “let losses lie where they fall” model, in conjunction with accommodative macro policy – esp mon pol, might not end up vastly more costly in econ terms over the longer-term, but it will fail all canons of fairness etc.

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  10. Thanks for your response – the “let losses lie where they fall” comment was to suggest that would be the wrong response; but that it is implicit in bank capital being there to absorb a 1:200 year event. So I think we are in agreement?

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  11. I heard (from someone who had been queuing at a bank) that two men in a flash car came racing into the bank demanding to withdraw their investments. The staff told them they were not allowed to and they argued. The story teller had been going around all the ATM’s with his wife drawing out $500 at a time?

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    • Occassionally I agree with Adrian Orr. If there are going to be problems with our banks it will take several years of significantly doubel-digit unemployment AND sharp sustained falls in asset prices. It is simply not today’s issue.

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      • If there is a short term risk to which banks are exposed more today than in any other time it is probably operational risk. More than the dreaded credit risk. NZ banks are well-capitalised and will not suffer a lot in the short term. But … with bank employees working from home, changing routines, and perhaps an elevated pressure to make money to avoid losses, financial institutions may suffer because of cyber risk, sloppy behaviour, and just the human factor: e.g. bank employees may use Windows 7 on a bubble laptop to access their virtual office. What could possibly go wrong ….

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