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:
- What steps had the Reserve Bank put in place prior to the Covid-19 outbreak to ensure it could practically implement negative interest rates?
- What work did the Reserve Bank undertake, and when, to explore ways in which it could reduce any practical constraints to negative interest rates?
- If there was any work or research undertaken to remove any practical constraints to negative interest rates, could any papers or advice be released?
- 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?
- 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”?
- When did the Reserve Bank first become aware that not all Banks were operationally ready for low or negative interest rates?
- How many banks are not operationally ready for low or negative interest rates and what share of the banking market do they account for?
- What are the operational barriers to negative interest rates (for example, are the barriers at the wholesale or retail levels)?
- What steps is the Reserve Bank taking to remove barriers to negative interest rates?
- When does the Reserve Bank expect any operational barriers to negative interest rates to be removed?
- What evidence does the Reserve Bank have that the large scale asset purchasing programme has been an effective substitute for lowering the OCR?
- What is the Reserve Bank doing to address falling inflation expectations considering the Reserve Bank’s pledge not to reduce the OCR further?
- By how much have retail interest rates fallen this year and how does that compare to every previous New Zealand recession?
- 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.