Guest post by Geof Mortlock: coronavirus response

What follows is an article on various issues around the New Zealand coronavirus policy response by my former Reserve Bank colleague, and now consultant, Geof Mortlock.     The views are Geof’s alone, but I thought it was interesting and clear articulation of a case that deserved a wider audience.   Geof and I certainly don’t always agree –  sometimes we differ quite strongly.  And so it is in this article where there are bits I strongly agree with, others I’m more open-minded about, and others I’m pretty sceptical of (eg I don’t have a great deal of confidence in the value added by hands-on bank supervisors), but to repeat they are Geof’s views and not necessarily mine.

Coronavirus response: More clarity on objectives, response options and recovery strategy is needed

Geof Mortlock¹
Last week, the government released a paper that summarised its objectives for combatting the coronavirus pandemic in New Zealand. The paper, entitled ‘Written Briefing to the Epidemic Response Committee’, prepared by John Ombler, the All of Government Controller, noted that the government’s coronavirus response strategy is now aimed at ‘stamp it out and elimination’. Previously, the objective had apparently been to ‘flatten the curve’, also known as ‘mitigation’ – not that one would have known it, given the inadequate transparency and clarity in the government’s strategy to date. Despite the attempt at clarifying the objectives for the coronavirus response strategy, Mr Ombler’s paper perpetuates ambiguity, given that it refers to a strategic objective of ‘elimination’, but then goes on to suggest that the strategic objective is ‘suppression’ – i.e. keeping infection levels to a low-enough level as to minimise the risk of exceeding the health system’s capacity to deal with Covid-19.

The Ombler paper is too vague and insufficient in scope to satisfactorily explain the government’s coronavirus response objectives and the inherent trade-offs involved in different response options. The paper does not clearly explain what ‘elimination’ means. It provides no quantifications of what elimination or suppression translate to in terms of infection levels or mortality rates. It contains no information on the assumptions the government has made in arriving at these objectives. It offers no insights into the economic and wider benefits and costs of alternative objectives and associated response options.

I fully appreciate that the government – like us all – is operating in a fast-moving situation, and in the swirling mists of uncertainty. I also appreciate the immense pressures that ministers and officials are under. I have no doubt at all that their intentions are sound and that they are working extremely hard for the good of the country. I commend them in that regard. However, the lack of clarity in the government’s objectives, the lack of a clear set of graduated response options, the lack of a well-defined exit from lockdown, and the absence of meaningful cost/benefit analysis of the different objectives and response options is unacceptable. It risks imposing even greater costs on the economy and community than those that have already been incurred. If we are not careful, it risks creating a ‘cure’ that is worse than the disease itself.

The government’s decision to impose a lockdown – and especially one as relatively comprehensive in scope as the one that has been implemented – imposes massive costs on the economy and is severely impacting the livelihoods of millions of people. The costs are not likely to be short-term. We will certainly not be looking at a short ‘V’ shaped recession and recovery. The contraction in economic activity will be very deep – without precedence in living memory. A significant degree of recovery could be expected once some form of normalisation occurs, depending on the response path adopted by the government, but the reality is that this is more likely to be an elongated ‘U’ than a “V’ shaped recession and recovery. It is unlikely that economic activity will get back to pre-pandemic levels for at least a couple of years. Many businesses will fail. Many jobs will be lost.

I am not at all suggesting that these economic costs are solely, or even principally, attributable to the decisions of the government. They are not. Much of the impact on our economy arises from the actions of foreign governments and the associated contraction of economic demand, with flow-on impacts to New Zealand. Nor am I suggesting that severe economic costs would have been avoided had the government done nothing. Taking no action to restrain the spread of infection would have had a serious impact on the economy and welfare of New Zealanders through sharply reduced economic activity. And, of course, taking no action would place the health system under an intolerable strain and create an unacceptably high level of mortality. Some form of temporary lockdown was unavoidable and is necessary if we are to keep infection levels and mortality rates within reasonable bounds.

However, had the government moved earlier than it did to close the borders, and had it applied a mandatory quarantine requirement on all arrivals, then it is very arguable that the scope of the lockdown could have been much less restrictive than it is. That, in turn, would have materially reduced the damage done to our economy and the community. Taiwan is a good example of a country that imposed tight border controls early, adopted broad-based testing and tracing, and achieved a level of infection that is currently around one third of New Zealand’s, despite Taiwan having around five times the population of New Zealand. Those measures meant that they did not impose lockdown on anything like the draconian scale adopted by our government. There are salutary lessons in that for us all. I certainly hope that, once this pandemic is largely over, the government (or its successor) will hold a commission of enquiry into the response actions to draw lessons for any future pandemic response strategy.

What is needed now is a fundamental review of the existing lockdown arrangement. Keeping the basics of it in place for the remainder of the one-month period is probably justified until testing reveals that community transmission of infection is very low. However, there should urgently be a reassessment of some of the parameters within it. There is considerable scope to relax some elements of the lockdown without sacrificing the ultimate objective. In particular, the government needs to reconsider the boundary between ‘essential’ and ‘non-essential’ services. The classifications developed by the government are clumsy, arbitrary and inadequately thought-through. A good example is the very odd decision that butcher shops and vegetable/fruit shops are ‘not essential’, despite the fact that they are significant providers of staple and healthy parts of our diets. The exclusion of hardware shops is another oddity, given that they provide a wide range of items that households typically need. Similarly, the arbitrary line between ‘essential’ and ‘non-essential’ building construction is very arbitrary and hard to justify. Lockdowns in these areas could have been avoided – and economic and social costs reduced – so long as strict social distancing requirements were applied. If strict social distance requirements are maintained in businesses, there is no logical reason to keep them closed. In that regard, it is worth looking at the parameters of the lockdown arrangements in other countries to see whether some sensible relaxations can be made.

Another matter that requires attention – urgently in my assessment – is the state of national emergency (which is separate from the lockdown itself). The declaration of a national emergency, with the associated extreme powers that accompany it, goes well beyond what was needed to ensure effective lockdown. It confers extremely wide powers on the Police, with very few safeguards. The Police have been given an extensive array of powers that New Zealand has not seen since the mid-20th century. Many countries have not found it necessary to do that. This aspect of the arrangements needs to be fundamentally re-assessed. There is absolutely no justification for this country to slide into some kind of ‘police state’. The Police should be acting within tightly specified constraints to enforce lockdown arrangements. They should require a court order to enter premises. And they should be subject to additional independent scrutiny during the lockdown period to hold them to account. The very wide powers under which the Police now operate are not necessary, not justified and are a serious affront to the cornerstone of democracy – our civil liberties. The state of national emergency should be ended. That it could be invoked so easily without something like a two-thirds vote in Parliament is an indictment of the way successive Parliaments have allowed such laws to exist. No government should have the power to declare a state of national emergency without specific authorisation from Parliament and without very close scrutiny by independent parties, such as the judiciary.

Equally worrying is the extent to which this government has allowed the Director-General of the Ministry of Health to call the shots on matters that go well beyond the proper jurisdiction and expertise of the Ministry. The sweeping powers currently vested in the Director-General or medical officer of health, under the Health Act, should not rest with unelected officials. The powers exercisable by officials should be subject to approval by Cabinet or at least a Cabinet committee, with appropriate transparency, and with regular review. As things currently stand, the declaration of emergency simply leaves the powers – extreme as they are – in the hands of a few officials, without even the need for the approval of the Minister of Health.

What is needed now is a comprehensive and transparent assessment and articulation of at least the following matters:

– The objectives of the response to Covid-19. The notion of ‘elimination’ is unrealistic and inappropriate. To my knowledge, such an objective has not been adopted by other governments. It comes with huge costs, and yet the government has failed to articulate what the benefits and costs of this objective versus alternative objectives are. An objective of ‘elimination’ is a bit like saying we want to achieve a ‘zero’ road toll. That could be achieved. But it would require the virtual banning of vehicles on the road or speed limits set to 30 kph or something equally absurd. We do not pursue a zero road toll because we all know that the costs of doing so far outweigh the benefits. Likewise, we do not design building codes to achieve a zero death toll in earthquakes. To do so would impose absurdly high costs on everyone – vastly disproportionate the benefits. Instead, we accept that some deaths in a severe earthquake are unavoidable and we calibrate the building standards to achieve a low but far from zero expected death toll. We apply cost/benefit trade-offs in many aspects of public policy, such as in the funding of cancer medicines, hospital funding, education funding, health and safety regulation, and banking regulation. What we need in the case of Covid-19 is a similar approach – i.e. an objective in terms of infection levels and mortality rates that can be regarded by society as acceptable, given the economic and wider trade-offs involved. We need to see much more comprehensive and transparent analysis by the government of the alternative objectives, and the benefits and costs of each.

– Exit from lockdown. There needs to be clearly articulated forward path for transitioning from the current lockdown to normalisation, in progressive stages. This needs to be informed by a cost/benefit analysis of different transition steps. The progressive move through to normalisation should be informed by indicators that are transparent to all, such as infection levels, percentage of positive test results from wide-sample testing, and community-linked infections. One near-term option – maybe in two weeks’ time – might be to move from lockdown to a combination of requirements that would help to keep infection levels to within defined upper limits, such as:

o continued mandatory social distancing;
o businesses to operate to a maximum number of persons per defined floor area;
o businesses to continue to encourage work-from-home arrangements where feasible;
o mandatory quarantine for all arrivals into New Zealand until a reliable quick-result test can be performed at ports of entry or until global infection rates are below defined levels or vaccines are widely available in New Zealand;
o ensuring that all health workers are regularly tested for coronavirus;
o limiting and screening of visitors to medical facilities, retirement homes, hospices and other places where there are cohorts of vulnerable people;
o encouraging those in vulnerable categories to self-isolate where practicable and providing them with assistance to facilitate that, such as food deliveries and the like; and
o comprehensive testing and tracing practices on an ongoing basis.

Regional variations in the progression from lockdown to various stages of normalisation will need to be considered, based on regional infection levels.

– Extended fiscal support. The sooner we can transition from lockdown to some form of normalisation, the sooner the economy can begin the gradual process of recovery. However, it is inevitable that many businesses, self-employed and employees will be severely impacted for months to come. The government’s support package helps in some respects. However, it is narrower in scope and less generous in quantum of support than the packages put in place in some countries, including Australia and the UK. There is a pressing need to reassess the support packages going forward, including by considering a higher-level of income payment for at least six months, based on the income level of the business/person that prevailed before the pandemic. There is plenty of fiscal headroom to facilitate this. But we need to be sure that any such measures are appropriately targeted to those most in need (based on loss of income and ability to self-sustain) and monitored; this is not a time for a scatter gun approach to fiscal support. Creating new job opportunities for those whose jobs and businesses are unlikely to recover for a long time, if at all, is imperative. Infrastructure spending provides on such avenue, and is already on the government’s agenda. However, this too needs to be subject to robust cost/benefit assessment, and done in a very transparent manner. Any fiscal outlays for infrastructure projects need to satisfy meaningful cost/benefit tests if they are to proceed.

– Central bank support. We have seen some sensible moves by the Reserve Bank in response to the coronavirus situation, even if some of the rhetoric from the governor has been questionable at times. The quantitative easing program will help to keep interest rates low and facilitate bank liquidity. The encouragement of bank lending to their customers, with the backing of a partial government guarantee, is clearly desirable. So too is the relaxation of the timetable for moving banks to higher capital ratios. However, more needs to be done. In particular, it would be desirable for the Reserve Bank to finally recognise that its unjustified capital ratio requirements on banks – extremely high by international standards – has been fundamentally mis-calibrated. It will exert a very unhelpful and economically damaging procyclicality on the banking system and economy by impeding the ability of banks to lend at the very time when we want them to do so. A 12 month suspension of the transition to higher capital ratios falls well short of what is needed. A much smarter move would be to suspend the proposed increase in banks’ capital ratios completely – for at least 3 years. That would give banks greater scope to lend than the 12 month suspension permits. It would also buy much-needed time for a fundamental re-think of what is, frankly, one of the most poorly thought-through and most costly banking supervision policies I have seen from any central bank. The Minister of Finance needs to take a much more active interest in all of this. This is where there needs to be a clear distinction between preserving operational independence of the Reserve Bank for the implementation of policy, as opposed to the setting of policy. In the latter case, the high-level setting of policy should be subject to much stronger oversight by the Minister.

Monetary policy also needs to be further considered. The Reserve Bank has ruled out any further change to the OCR for 12 months. Why on earth would it do that? No other central bank on the planet, to my knowledge, has said they will not be altering monetary policy settings for a further 12 months. No sane person would. In a situation such as this, policy settings need to be kept under constant review and adjusted where appropriate as circumstances change. In these circumstances, it is highly likely that a further easing of monetary policy will be needed as part of the package of measures to support a recovery in the economy. That includes a recognition that the OCR might need to be lowered further. Negative interest rates, while possibly not yet needed, should be further considered (with considerable caution) in this context. Again, the Minister needs to be far more engaged on these matters than he appears to be. Section 12 of the RBNZ Act gives the government the power to direct the Reserve Bank on monetary policy matters. Mr Robertson therefore has the legal avenue to take action if the government (advised by Treasury) sees the need to do so. Although one would not wish to see a trigger-happy intervention by the government, it needs to at least demonstrate that it is closely scrutinising the Reserve Bank and stands ready to intervene should it see the need to do so. The Reserve Bank needs to be under very much closer scrutiny than it is.

The supervision of the banking and insurance sectors also need to be strengthened. Greatly. The Reserve Bank has still not implemented recovery planning requirements for banks or insurers. They have still not adopted a conventional form of on-site assessments of banks’ and insurers’ risk management systems. They have no comprehensive assessment framework for banks’ and insurers’ systems and controls for risk management. They are behind the eight ball on much of what is needed from a supervision authority. The IMF assessed them in 2017 with what could be described as a C- grade. In effect, we have a standard of banking and insurance supervision in New Zealand that is akin, in some respects, to something I see frequently in third world countries. Much closer oversight is needed of the Reserve Bank to ensure that it does what it is paid to do. This is especially necessary now, given the high likelihood that banks and insurers will come under severe asset quality and cashflow strain in the months and years ahead. Proactive monitoring of early warning indicators, closer scrutiny of financial institution risk management and asset quality, and the preparation of contingency plans should be key elements in the Reserve Bank’s approach to its job. Instead, it continues to place emphasis on imposing draconian capital ratios on banks when they are not needed and will badly hurt our economy. And they continue to rely on the ill-considered ‘Open Bank Resolution’ policy for dealing with failing banks, which, if it were ever used, would be like throwing a lit match into an explosives factory. It is time Mr Robertson took greater leadership in the overhaul of the Reserve Bank’s capacity and policy direction in all of these areas. The current review, which is, perversely, being co-led by the Reserve Bank itself, is simply not good enough.

These are just a few issues for the government to be looking carefully into as they develop the strategy to respond to one of the most severe crises we have faced. We need to see a much more focused, thorough, transparent and consultative approach by the government on all these issues. The Opposition also needs to play a strongly proactive role in scrutinising and putting forward its own proposals for handling the coronavirus situation. Now, more than ever, we need a whole-of-Parliament leadership on the response to one of the most damaging crises of our time.

  1. Geof Mortlock is an international financial and economic consultant based in Wellington.

Central bankers in another world

The government’s economic policy, such as it is, in response to the coronavirus situation has the distinct feel of inadequacy.  Hamish Rutherford did a big piece late last week on the Minister of Finance, but interesting as it was what was most notable was the utter absence of any overarching narrative or strategy.    Of course, we have the wage subsidies –  now apparently being paid in respect ofmore than a third of the entire employed population – but that is about it.   There is the business loan guarantee scheme, and although time will tell I suspect that won’t be very much used (not many businesses will sensibly support much more debt).   There is much talk of special deals for favoured big firms, but Air New Zealand (first round) aside we’ve seen nothing more on that front.  And more generally there is no sign of anything systematic to assist the broadly-defined business sector, the bits that don’t necessarily grab headlines or have strong political connections.  The Minister appears utterly unbothered by the high interest rates firms and households are paying, in a climate in which time currently has no (and probably negative) value.   With a lockdown that, while far from total, is still more stringent than those in many countries, the economic dislocation is going to be enormous.  And yet weeks pass and the government appears to have nothing systematic to offer.  Sadly, they still no sign of recognising that an “income loss insurance” model remains the best way to think through this episode and organise the economic policy response.

But today I wanted to focus on the Reserve Bank again: two lots of comments in recent days from the Governor, and one from the Bank’s chief economist (who is appointed by the Minister of Finance to serve on the Monetary Policy Committee).  None of it is reassuring.

On Friday, there was an interview with the Herald’s Liam Dann.  It was pretty soft stuff: Dann gets interviews with the Governor (and his predecessor) and maintains access by never asking searching questions.  As I noted to someone the other day, that approach has the advantage (I suppose) of providing a platform for the Governor, but has the disadvantage for the wider public of only providing a platform, and never challenge or scrutiny.  The Governor, of course, doesn’t like challenge or scrutiny, despite being a very powerful public official.

And so, for example, the Governor was never once asked why the Monetary Policy Committee promises not to cut interest rates any further (even though the economic dislocation must be much more savage than envisaged when they made the pledge) or why retail interest rates that are substantially positive in real terms makes any sense whatever in an economy like that we face now.

It was a soft interview so most of what he said wasn’t very noteworthy.  But a couple of things caught my eye. Orr was asked about the Bank’s $30 billion government bond buying programme,

The RBNZ has committed to up $30 billion worth of QE in the next year.

Where does that money come from?

It was effectively drawing down on New Zealand’s current and future collective wealth, Orr said.

“The Government, whenever it spends, it has to raise its own money through taxes and borrowing. Bonds are a form of IOU that the Government writes,” he said.

But that is to confuse two quite different things.  The bond-buying programme itself is nothing more nor less than an asset swap.  The Reserve Bank buys government bonds on which it earns a yield to maturity probably averaging a bit under 1 per cent, and in exchange banks end up holding deposits at the Reserve Bank, currently paying 0.25 per cent.  There is no particular expected value cost of that operation at all.  What is drawing down New Zealand’s “current and future collective wealth” is the fiscal policy responses to the crisis, but they have nothing whatever to do with the Reserve Bank.

And then there was the claim, by the Governor mind, that New Zealand had the “best banking system in the world”.    On this occasion, I happen to agree with him that our banking system will prove one of the best-capitalised and soundest around (which doesn’t mean that the toxic brew of rapidly rising unemployment and falling asset prices could not yet lead to some difficult times).    Even if our headline bank capital ratios are not super-high by international standards, the way the rules are applied mean that the effective buffers are high here even by international standards (and our banks have pretty vanilla assets).

It is just that none of this is what the Governor was saying last year when he was pushing to double the capital ratios applying to banks.  Then we heard about inadequate current capital levels really were for severe shocks, and a reluctance ever to produce, or engage with studies suggesting that bank capital ratios here were already high by international standards.  Strong parent banks also help New Zealand, but again last year Orr was often heard rather cavalierly almost championing the case for disinvestment and local listings.

When people who are supposed to be serious public figures just spin like this, and flit from one convenient line to another as suits, it is important that they are called out and challenged. But, in truth, were it not for Orr’s op-ed in the Sunday Star-Times  (reproduced here), I’d probably have let in pass: one can’t write about everything.   But then there was the op-ed, the one that prompted one correspondent to head his email


followed by the suggestion that

The guy’s on drugs!!!

If only, because then we might hope for better the next day.  Instead this seems to have been the calm lucid thoughts of one of the most powerful public officials in New Zealand.  Spare us then.

Anyway, what does the Governor has to say?

He opens this way

Working at the Reserve Bank for the people of New Zealand is a privilege and at a time like now there is no shortage of motivation. We are working both as a skeleton crew at our premises and remotely. Productivity has been high, as is the case across all essential services, and I have personally appreciated and needed the connectivity.

To date our ‘bubble’ has mostly included the Government, Treasury, and New Zealand’s banks, non-bank deposit takers, and insurance companies. We have proved we can work together for a common goal – cash-flow and confidence – at pace. We recognise the threat of COVID-19 to our collective well-being and have responded accordingly to ensure we address the issues at hand and reduce the impact on future generations.

One can probably skip over most of that, although do note that strange final sentence.  Probably the best way to “reduce the impact on future generations” would be to do very little now, especially around fiscal policy.  But most people –  rightly in my view  – don’t think that makes much sense, and are encouraging governments to adopt policies that do spread much of the economic impact onto future generations (that is what increased government debt means).

Then he gets more specific

To maintain commitment to our future prosperity, we have ensured that the cost of borrowing is very low through reducing the OCR to 0.25 percent and undertaking ‘Quantitative Easing’ (QE). The latter involves us buying Government Bonds (public debt) from banks and swapping it for cash – so that the banks can on-lend. This activity keeps long-term interest rates low, where we need them, as well as helping the Government to fund its own expanding activities.

Perhaps he simply hasn’t noticed quite where retail interest rates are, but by no reasonable standards can those rates be called very low in the specific context we now face.  Perhaps he hasn’t noticed that the OCR cut was a mere 75 basis points, belatedly, and that by contrast in the much less significant economic shock of 2008/09 the OCR was cut by 575 basis points.  As for “keeping long-term interest rates low, where we need them”, it is certainly true that Bank announcements have limited any rise in bond yields, but had the Governor not noticed that even a five year real interest rate (and probably most would still think things would get largely back to normal by the end of five years) is still no lower now than it was late last year, or even in mid-February when the Governor and the MPC were talking up the outlook for the world economy?

five yR IIB

And, of course, no mention at all of the way medium to long-term inflation expectations have been falling away.

Then the spin changes tack

Further assisting banks is the ‘capital relief’ we provided them, encouraging banks to use their rainy day funds given that it is raining. We insisted banks hold large capital buffers despite their considerable consternation. They can now use them as necessary.

Except that, as the Governor knows, the new capital requirements had not yet come into force, and banks had done little yet to increase actual capital.  Actual capital ratios now are almost certainly much as they would have been had the Governor never embarked on his crusade.

But it is at the end of the piece that the Governor seems to become simply detached from reality.

Income support, mortgage relief, business lending, tax relief, and a broad range of regular welfare assistance is available and needs to be used. 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.

It is as if the pandemic is a refreshing shower of rain on a hot summer’s day, clearing the air, helping the garden etc.  Perhaps in lockdown the Governor has been digesting some bastardised version of Schumpeter’s creative destruction, with a dose of Andrew Mellon (“liquidate, liquidate, liquidate”) thrown in for good measure.  We’ll emerge, it seems, better for the experience?

Wasn’t this the same Governor who only months ago was regaling us with stories (often overblown) of how terrible economic crises were –  mental health, inequality, or whatever, as well as the economic costs –  and in particular how his aggressive bank capital proposals were to spare us from all this.   Not a “crisis as refreshing shower of rain” then as I recall.

But who really knows what he is going on about.  These are going to be unbelievably tough times for many individuals and firms –  but not, of course, for central bankers and most core public servants –  which it is going to take years to fully recover from (some just never will) and yet still the Governor is chanting from the Labour playbook with his mantra of the “sustainable, inclusive” New Zealand.  I suppose dead economies don’t emit, but they don’t tend to be very sustainable or inclusive (whatever those words actually mean either).  Apart from anything else it is unbelievably tone-deaf.

For those who simply want cheering up (there were a few in the comments section on Stuff), find an old episode of Dads’ Army or a more-modern comedy act.  From a central bank Governor we should hope for seriousness, rigour, and a gravitas fitting to the moment.  We simply don’t get it from Orr.

Sadly, of course, the poor quality of our current crop of senior central bankers doesn’t stop with the Governor.     Yesterday, Bloomberg reported on some written answers to questions on monetary policy that they had managed to extract from the Bank’s chief economist Yuong Ha.  One had to wonder why the Bank insisted on questions and answers in writing (isn’t a phone call typically quicker) but perhaps the Governor wanted to ensure that his chief economist stayed on message: it was after all only a few weeks ago that Ha hadn’t kept up sufficiently and acknowledged that things like large scale asset purchase programmes aren’t really much of a substitute for conventional monetary policy

yuong ha

Just “a little more headroom, a little more time and space”, which doesn’t quite cut it in the biggest slump in modern history.

Anyway, Bloomeberg’s Matthew Brockett apparently asked about the MPC’s refusal –  pledge, promise –  to cut the OCR any further.  And the written response was as follows

The main reason the Reserve Bank committed to keeping its benchmark rate at 0.25% for at least a year “was to take away the imminent distraction of needing banks to prepare their systems for a negative OCR,” Chief Economist Yuong Ha said in written responses to questions from Bloomberg News. “That situation will change over time,” but the RBNZ was not working with banks on the issue at the moment, he said.

So they’ll leave the OCR hundreds of basis points above where any guide, such as a Taylor rule, might suggest it needs to be because they don’t want to inconvenience some of the banks.  Poor borrowers, but apparently never mind because Messrs Orr and Ha don’t want to put the banks to any trouble.  It is simply extraordinary.

As I’ve discussed previously, in 2012 an internal working party on preparing for a new crisis recommended that the Reserve Bank work with banks to ensure their systems could handle negative interest rates.  That was almost eight years ago. For several years not only have various advanced country central banks had negative policy rates, but much of the sovereign debt in advanced countries has been trading at negative yields.

And yet it appears our central bank did nothing, and is still doing nothing.   I’ve been impressed by stories of government agencies standing up whole new electronic systems in a day or so in the midst of this crisis.  Perhaps for those banks  –  protected by the RB –  who weren’t ready, it would take a bit longer than that, but there is just no apparent sense of urgency.  As, of course, has been true of the Monetary Policy Committee since this crisis first began.

Even if some banks –  and Orr or Bascand told us previously it was only some –  aren’t ready for negative rates, there is still the question of why the Bank has set a floor on the OCR at 0.25 per cent.  Why not 0?  (After all, the OCR is a deposit rate not a mid-rate).  25 points isn’t that much, but in a climate where every little bit helps, there is simply no good reason at all for sitting at 0.25 per cent.

Brockett appears to have asked Ha whether the OCR could be cut in increments less than 25 basis points.  Ha noted, rightly, that such moves aren’t common, and then fell back on another weird line of argument

“We also have to avoid unnecessary volatility in interest rates and exchange rates in setting monetary policy,” Ha said.

Well, yes, sure…..but precisely what, if anything, does that have to do with the question of whether the OCR should be cut to, say, 0.1 percentage points, even if for some arbitrary reason they won’t take it zero.     And this wasn’t even the first thing that came out of a flustered official’s mouth; recall that these were written responses to written questions.

The lot of them seem badly out of their depth, playing distraction, and not doing what we should expect from a capable central bank in the heart of our economic crisis of such magnitude.  That isn’t just Orr or Ha, but the other members of the Monetary Policy Committee: the internals (probably the best of them) Deputy Governor Bascand, and Christian Hawkesby, and the three stooges (sorry, externals) of whom, from whom, we never hear anything and for whom there seems to be not the slightest accountability: Bob Buckle, Peter Harris, and Caroline Saunders.  To which one could add the Reserve Bank Board, especially their chair, Neil Quigley.

There really is almost no point in a discretionary monetary policy central bank if in the biggest crisis, and deflationary shock, any of us are ever likely to see, monetary conditions aren’t materially eased by the central bankers.

But, of course, ultimate responsibility rests with the Minister of Finance, Grant Robertson.  He appointed Quigley.  He endorsed Board recommendations to appoint all the other MPC members.  He has the power to have any of them dismissed if they aren’t doing their job, which by any reasonable interpretation they haven’t and aren’t.  He has the power to directly override the MPC and insist, say, on a much lower OCR, and the moral suasion capability to insist that such cuts were passed through to retail interest rates (easing servicing burdens, redistributing income in ways consistent with the nature of the crisis, supporting medium-term inflation expectations, lowering the exchange rate, and setting signals about the conditions potential borrowers will face when we finally begin to emerge).  But, lacking any obvious strategy, and always reluctant apparently to do anything that isn’t conventional wisdom, the Minister of Finance sits on his hands and does nothing.  I doubt it is the case that the Minister doesn’t care, but it comes to the same thing when he is unwilling to demand action or to take the steps open to him to break out of the central bankers’ straitjacket.


Looking to the past

It was tempting to devote the whole of this morning’s post to the two latest utterances from the Governor of the Reserve Bank (perhaps together with the column in the Herald by the Governor’s chief journalistic channeller).  Particularly egregious was Orr’s sunny upbeat piece in the Sunday Star-Times yesterday.  Perhaps I still will write such a post –  it is frightening that such powerful senior officials are capable of such pap, and yet face very little accountability – but for now perhaps  I’ll just copy the heading of the email someone sent me yesterday about the SST column.


But in this post I wanted to look at a couple of papers that came out a week or so ago trying to look at some of the economic effects of past pandemics.  One of these appeared even to have been cited or referred by the Prime Minister in her press conference yesterday.    For those comments I’m relying on the report this morning in the Politik newsletter.  On several points it appears that there was quite a lot of spin in her remarks, but I suspect that on the narrow economic point she will simply have been relying on something she’s been told, whether from The Treasury or her own department.

Of the spin, two things in particular caught my eye. The first was the continued boasting about the government’s initial economic package (size/timing), when a large chunk of that package had little or nothing to do with the coronavirus, or the economic effects thereof, and those parts instead just represented a permanent worsening in the underlying fiscal position at a time when the rapidly deteriorating economy was in any case about to cut rather severely into the revenue base.   Little of the package was really cognisant of what was just about to break over them (recall that this package was a mere three weeks ago).  For all the advertising urging us to “Unite”, when politicians continue to play politics they can’t expect to go unscrutinised or citizens simply to fall in behind them.

The other point that I wanted to comment on briefly was the Prime Minister’s use of work by Rodney Jones’s firm to justify the lockdown. I heard her on RNZ this morning say that the government had had work suggesting that we might soon be at 4000 cases and that since we had only 1039 it showed the lockdown had worked.    But that is the same sort of all-or-nothing reasoning I criticised in my post on Friday.   As I understand it, that work essentially applied estimated aggregate reproduction rates as they were up to when the numbers the PM referred to were calculated.  Such an approach would also have generated predictions of 4000 cases in New South Wales by early April (up from about 400), and yet New South Wales was only at around 2200 cases by then.  But all that was before really widespread voluntary behavioural change had cut in. And New South Wales is still not in the equivalent of the Prime Minister’s level 4, and in significant respects is not as restrictive as New Zealand.  I don’t doubt the government’s lockdown has made a difference to the path of the virus in New Zealand, but it is highly misleading to imply that the move to Level 4 has made anything like all the difference in those numbers the PM was referring to.   For now, growth in case numbers in Australia also seems to be levelling off, and the total confirmed cases in the two countries are now much the same in per capita terms (Australia previously having had consistently higher numbers). Ideally –  and it might not be possible –  in thinking about the merits of retaining the current highly restrictive approach a truly marginal analysis (of both costs and benefits) would be desirable.

But it was the economics I wanted to focus on.  According to Politik, mostly direct quotes from the PM

“A strategy that sacrifices people in favour of supposedly a better economic outcome is a false dichotomy and has been shown to produce the worst of both worlds loss of life and prolonged economic pain. “

Ardern quoted “research available” on the Spanish flu which underlined her point. That research is presumably a paper published last week by three New York Federal Reserve researchers [actually two Fed researchers and one from MIT] which showed that areas that were more severely affected by the 1918 Flu Pandemic saw a sharp and persistent decline in real economic activity.

“We find that cities that implemented early and extensive non-pharmaceutical interventions suffered no adverse economic effects over the medium term,” they said.

“On the contrary, cities that intervened earlier and more aggressively experienced a relative increase in real economic activity after the pandemic subsided.”

There is a link to the full paper here.  For geeks, it is a fascinating exercise, and must be a testimony to the resources available to US researchers, that they managed to pull together so much data –  even if often a bit fragmentary –  and make sense of it in such a short space of time.

The centrepiece, including in shorter write-ups of the paper, is this chart.

npi chart 1

For the cities for which they could data, it shows on the x axis the influenza death rate in 1918 and on the y-axis growth in manufacturing employment over the period 1914-1919,  The red dots are the cities which use non-pharmaceutical interventions (eg shutdowns on public places) more and the green dots are the cities that used such interventions relatively less.    In the chart you can see two things:

  • first, cities with a lower flu death rate had higher growth in manufacturing employment (differences statistically significant and economically material), and
  • second, cities that use NPIs more intensively and earlier had, on average, low flu death rates.

And on this chart appears to rest the communications line applied to today used by many, including by our Prime Minister.

As I said, I thought it was a pretty impressive exercise to pull all this data together and make sense of it.  The authors report a number of checks and controls they used suggesting that the relationship they report, for one country in 1918, was something real.

On the other hand, it is only fair to point out that when they look at some other economic variables –  bank assets, bank loan losses, and motor vehicles registration –  the results, attempting to relate city-level mortality to later economic outcomes are mostly not statistically significant.   And I haven’t seen this line in the paper much referred to either

Several studies explore the long-run implications of the 1918 Flu. Brainerd and Siegler (2003) find that states with higher 1918 influenza mortality experience stronger per capita income growth in the long-run, from 1919 to 1929.

So count me a little sceptical as to just how generalisable the specific result in the chart above was for 1918, let alone now.   For 1918, there was huge variability across countries in mortality rates, and although the data on death rates is not particularly robust, I’m not aware of papers suggesting that differences in mortality rates across countries were an important explanatory factor in relative economic performance over the following decade or two.  Perhaps I’ve missed something, but if the literature existed I imagine these researchers would have cited it.

But there are some more important caveats around the ability to apply this study re 1918 to the current situation and use it to justify a claim –  of the sort the PM seemed to be making –  that a pretty severe lockdown is a net positive in terms of economic outcomes.

Among those caveats:

  • note that all those cities in the chart above had really quite substantial death rates from the flu, (as distinct from, say, the current situation in New Zealand or even Australia),
  • the deaths in the 1918 pandemic were unusually heavily concentrated among men in the 20-40 age group (prime working age, and at a time when female labour force participation was lower).   In other words, a higher death rate directly reduced manufacturing labour supply (and presumably output).  By contrast, in all the countries we’ve seen much data of so far, for this virus deaths are very heavily concentrated among those out of the labour force,
  • and perhaps most importantly, none of the NPIs cited in the paper the PM referred to were anything like as stringent as what is being applied in New Zealand at present.    The paper lists many examples of the approaches adopted in different cities, but the restrictions imposed seem to have been mostly limited to things like schools, large public gathering and parades, places of entertainment, and in some cases staggering working hours to allow greater physical distancing on public transport.  In some places, shopping hours were limited.  But I could not see a single example cited – either here, or in the various other 1918 books/papers I’ve read –  of the sort of restrictions New Zealand has, which simply forcibly close almost all shops, and most workplaces (to the extent work can’t be done from home).

I am not, repeat not, here taking a view on whether the New Zealand approach is the correct one (it is similar to those in some other countries), simply noting that whereas in 1918 disruptions to production were mostly about absences due to sickness, and the restrictions were around the margins for most firms, on this occasion – including in New Zealand – the restrictions go much more consciously and deliberately to the heart of the production process.    Not only are the short-term GDP/income losses almost inevitably deeper, but given the shock to households and the additional failures of many firms, there is little or no reason to think that the specific 1918 result in this Fed/MIT paper would be of general applicability to lockdowns like those in New Zealand.    It might turn out to be so, but nothing in the paper really gives us any specific reason for confidence –  and it should not be cited to that end by our Prime Minister.  That is all particularly so because –  as the Prime Minister herself noted on RNZ this morning –  even if we manage to largely stamp out each new outbreak, the disruptions, restrictions and uncertainties are likely to be with us for some considerable time.

(In addition, it is worth noting that nothing in the paper offers any insight on, say, whether the Australian approach at present is likely to produce better/less-bad economic results, over say a 1-2 year horizon, than the New Zealand approach.  Again, I am not taking a view on the answer to that issue, but it is where (say) Treasury officials and ministers should be concentrating some of their analytical resource right now.)

The Prime Minister doesn’t appear to have been referencing the other paper I wanted to write about. It is a short piece by several of my favourite economic history/crisis authors trying to look at some of the longer-run economic consequences of pandemics, back to and including the Black Death.

Here is the key bit of the abstract

 Significant macroeconomic after-effects of the pandemics persist for about 40 years, with real rates of return substantially depressed. In contrast, we find that wars have no such effect, indeed the opposite. This is consistent with the destruction of capital that happens in wars, but not in pandemics. Using more sparse data, we find real wages somewhat elevated following pandemics.

They look at twelve “major pandemics”


It is a pretty heroic effort to make what they can of the very limited data.  But it is worth bearing in mind that dreadful as these events must have been for those directly affected, only two stand out as likely to have been large enough to have had the substantial macroeconomic effects that the fragmentary data might support: the Black Death (which killed probably a third of the population) and the Spanish flu (bad as it was still on a much much smaller scale).

And I’m not sure the experience of the Black Death is likely to be very enlightening at all.  As is, I think, fairly well understood, in an economy where land and labour were the two main factors of production, and in an early economy where most adults worked because they had to to live (no widespread concept of retirement), if you take out a third of the available labour, returns to the remaining labour (wages, for the moderate proportion of the population who were wage labourers, rather than tilling their own –  or rented – land) were likely to rise, and returns per unit of land were likely to fall.    And that that is exactly what happened in the standard reading of the evidence, which the authors of this paper share, noting a doubling of real wages and a sharp fall in rates of return on land, effects that persisted for decades.

The authors produce results suggesting that a pandemic has the effect of lowering the natural rate of interest by up to 2 percentage points, effects unfolding over to a maximum effect 20 years out.    They contrast this to the effects of major wars

plagues 2

I guess my first caveat is that none of the results are statistically significant over the first 10 years (beyond that not only do connections inevitably become more tenuous, but even the more recent events often overlap).  And while authors try to distinguish a pandemic from a war by arguing the destruction of physical capital stock in wars, my impression-   perhaps wrongly – is that that destruction is far from universal.  Take, as an example, the war in the West in World War One.   I guess there was a great deal of physical destruction in north-eastern France and parts of Belgium, but almost none in the UK, much of France, Germany, let alone Canada, Australia, New Zealand and the United States.  World War Two, of course, was different, and yet our most destructive modern war was also followed by a sustained period of pretty low real interest rates (by most standards other than the last few years).

More specifically, if we try to think about the current situation, the strategies being adopted by all or almost all advanced countries at present are based on the assumption that the total death toll can be kept very low (relative to anything like per capita death rates in 1918 for example).  If that proves to have worked, we will –  mercifully –  have lost few people (and those mostly not in the labour force) and yet taken on huge amounts of new debt, especially public but also private.  Next to none of the capital stock will have been scrapped/destroyed either, and the capital stock is not now fixed natural resources, but reproducible/scalable machines, ideas etc, and who knows what dynamic the political/economic policy process will yet loose upon us.

None of this is to criticise the paper. I’m glad the authors put it together for us to read.  But however much light is shed on some past events (and collections thereof) I’m a little sceptical that we can garner much insight on how some of those key economic variables will be affected by this coronavirus and the policies being adopted to fight it, and to counter some of the worst of the individual and firm level economic losses. In fairness, the authors’ own final words are “this time may be different” (although even then it isn’t clear whether this is economists’ irony –  it is a standard dismissive response to people trying to explain why this time will be different – or a real uncertainty: quite probably the authors aren’t quite sure either).



The OECD stylised estimates of direct GDP effects

Earlier this week the OECD put out a useful little note Evaluating the initial impact of COVID-19 containment measures on economic activity.  

It is less than five pages long, including a couple of charts, and isn’t even attempting to offer definitive answers.   And what it offers isn’t an assessment of the impact of the differing containment measures being adopted in each country, but of the likely impact of the initial economic structure of each country’s economy to a set of common assumptions about the extent of containment and associated changes in economic activity.   Thus when, as local media have reported, this chart shows that New Zealand is one of the most adversely affected economies

oecd covid 2

it isn’t telling you anything about the impact or intensity of New Zealand policies, but simply about the pre-existing structure, given the (common across countries) assumptions OECD staff make about which sectors are most hit as containment measures take hold.  We don’t have many high-tech online services firms and, on the other hand, we have a lot of construction and a lot of production accounted for by tourism. (If you are wondering about Ireland –  far left –  remember that GDP in Ireland is massively inflated by some of the corporate tax distortions, and the loss of national income will be much larger than is shown here).  I was interested in the number of central European countries close to us on the chart, which appears to reflect the importance of the motor vehicle manufacturing and supply chains in those economies (and Germany), and of course car sales –  and production – have collapsed.

It is also important to remember that these are direct effects only.  That might not much affect the cross-country comparisons but will affect the absolute magnitudes of the likely falls in activity.  On the numbers in the chart, the direct effects alone crunch GDP by about 25 per cent for the median country shown.  Indirect effects, including confidence effects, credit availability effects, uncertainty effects, income effects and so on will probably amplify these numbers greatly.  I struggle to see how a fairly extensive lockdown will not reduce GDP while it is in place by up to perhaps 60 per cent (I noticed the comments yesterday by the chair of ANZ Bank in New Zealand, John Key, who was using numbers of that sort of order of magnitude).  Measurement is going to be a huge challenge –  and it may be several years down the track until, say, SNZ can offer us fairly definitive estimates (especially in the absence of quarterly income –  profits –  data) –  but reality (even if not accurately measured) is more important than whatever the published headline numbers.     Even in most industries deemed “essential” activity levels are going to be very significantly reduced (not many new mortgages being written for example, production capacity in meat works reportedly half what it was in norma times, and so on).

The OECD’s second chart –  using the expenditure approach to GDP –  is consistent with these sorts of really large numbers.  It focuses on consumer spending (rather than total GDP), and they show estimates for only a few countries.

oecd covid 3

Read the footnotes, and if anything these look as though they could be underestimates, at least in a New Zealand context (eg pretty sure car use here has dropped by more than half, and hotel/restaurant spending by more than three quarters (since all restaurants are closed and hotels must have little more than a few residual stranded tourists).

Of course, imports will be lower, which offers some offset.  But so are exports, most notably our tourism and business travel exports.  And, in any properly measured sense, a fair bit of public consumption spending is going to be affected too – teachers might be getting fully paid, but no one supposes school online is going to be anything like the extent/quality of the normal product.

And then there is investment.   Last year, almost 24 per cent of GDP was accounted for by investment spending (gross fixed capital formation).  60 per cent of that in turn was construction (residential and other).  None of that is happening this week.  Very little of any other investment spending will be occurring either, whether because it is simply illegal for firms (or bits of government) to operate or because of the extreme uncertainty of the environment, sharp reductions in forecast demand, or whatever.

It is difficult to get anything like a fully comparable estimates of the extent of the “containment measures” various countries have taken, partly because there are so many dimensions to most countries’ restrictions (and in places like the US, restrictions are at a state or county level), and because whatever the headline how the rules are applied in practice also matters (who knew, for example, the Arobake’s luxury baked goods counted as “essential”?).   But relative to at least the other Anglo countries –  with whom we often compare ourselves –  New Zealand’s partial lockdown seems to be more extensive.  If so, the immediate economic costs here are likely to be greater, especially as –  first chart – if the OECD rough and ready analysis is right then our production structure meant that for any given set of restrictions we were more exposed than the other Anglo countries.

That isn’t a commentary (at all) on the merits of the extent of the New Zealand lockdown. It also isn’t a commentary on whether a tougher approach now will, or won’t, reduce the overall economic costs across time (there are a couple of papers around on that latter issue which I will try to write about next week).  It is simply to make the point that many of the estimates that are around for the extent of the fall in New Zealand’s GDP –  including the sorts of numbers the Ministe of Finance alluded to at the select committee on Thursday – still seem on the light side.   We don’t have monthly GDP data (they have such estimates in Canada and the UK) but if we did then for the period of the current partial lockdown I’d have thought you would have to struggle to produce estimates of a fall as small as 50 per cent.



Choices that matter are often hard.  That is one of the messages of Matthew Hooton’s lengthy column in the Herald this morning, which people really should read if you possibly can.  It isn’t that Hooton is saying anything particularly new, but he is putting it firmly in a contemporary New Zealand context.  He poses the choices around handling the coronavirus pandemic as primarily those for the Prime Minister (and Cabinet), but really we should think of them as choices for New Zealanders as a whole, for which elected leaders –  none of whom here was seriously chosen for their ability to confront the gravest crisis in many many decades – really should primarily be there to facilitate and articulate, but perhaps help shape too, our collective view; the choices we wish to make on matters that affect life and death –  perhaps for many – and the functioning of our society and our economy.

As it is, the government has already failed us.  What other conclusion can we reach when much of the country is in lockdown, officials and ministers are deciding by the hour whose businesses will and won’t survive, with no apparent exit strategy?    There appear to have been alternatives (see Taiwan and South Korea).  It isn’t as if this virus became an issue in New Zealand with no notice –  Taiwan drew it to the attention of the WHO in December, Wuhan was locked down two months before our own lockdown, and so on.  All the evidence is that the government (political and official) simply did not take the threat very seriously at all for far too long (whether reflected in complacent commments from the PM, minimising tweets from the Ministry of Health, the casual approach of the Reserve Bank (with the Treasury Secretary sitting on the key committee).  And even if they would like to claim they did take the threat seriously –  if so, perhaps they could produce the draft detailed lockdown plan from even, say, three weeks ago –  they certainly did not level with the public, did nothing (as basic as, for example) to alert supermarkets that the public might soon be wanting more and different stuff (eg basics like bags of flour to bake our daily bread).

Worse, they still aren’t levelling with the public.   We finally had the Ministry of Health release earlier this week various background modelling exercises done for them on contract by academic researchers –  including one dated 27 February (itself labelled a “revised preliminary report” so presumably the government had the guts of it earlier.  That report notes

We estimate likely deaths to be between 12,600 and 33,600 people in our “plan for” scenario

Did the public see or hear any of this from the Prime Minister, the Minister of Health, or the Director-General at the time?  There was no hint of any of it –  let alone any greatly accelerated planning –  in thePM’s press conference a few days later.   And at the time the Ministry was still playing down not only the risk of asymptomatic transmission, but of any sort of community outbreak more generally.  If they were taking it all very seriously, they chose to treat us like children and keep us in the dark.  More likely, most of them weren’t very serious, and of course that was reflected in the way they were then setting about designing their (backward looking China focused) support package (before events began to overwhelm them).    Since the government and officials never acknowledge any of this, and still refuse any semblance of pro-active transparency, it is hard to trust a word they say any longer –  no doubt, some of what they is useful, but who can tell the difference? Who knows whether they won’t lurch again –  as they’ve done several times already.

This was the government that some time ago committed itself to much greater transparency around the release of Cabinet papers.  It was a pretty good initiative at hte time.  But as far I’m aware we have not seen a single Cabinet paper or any of the key officials papers on any aspect of the unfolding crisis, whether health or economic.

And in particular we’ve seen nothing that sets out any sort of cost-benefit framework that is influencing the government’s decisions (thus the Otago health modelling is useful in its way, but in isolation it adds not much to our ability as citizens to either evaluate the choices/processes the government is using, or to reach a view on the best way forward).    We just get the latest lurch.  A few weeks ago it became apparent that the government had adopted a mitigation approach – the PM was on a stage waving around a “flattening the curve” graphic.  But we’ve seen no serious analysis of what led them to that option.  Now a senior official –  not even the PM or an elected Minister –  tells the select committee that the government is set on an elimination approach.   But we’ve seen no serious analysis of the costs and benefits, risks and potential mitigants, of that either.    And then yesterday, the Director General of Health –  again not even the PM –  appears to double down, telling us that there is no Plan B, and that suppression will simply be maintained however long it takes.  But again, no papers, no analysis, no nothing, just rhetoric.  Not even a hint of what considerations our politicial masters took into account, what weight they put on them or of any fallbacks or contigency plans.   It isn’t like a real war – the enemy isn’t listening.  And we are supposed to be citizens, not children.  It is our country, economy, society,  and lives, not those of the politicians and senior officials?

I don’t have a particularly strong view on the appropriate policy at this point, given where the government complacency and lack of planning got us to.   It is the process, the total lack of transparency, lack of engagement, and –  frankly –  lack of any evidence of a robust disciplined policy assessment (yes, even under quite some time pressure) that really bothers me right now.  No one made any of these officials and politicians take their current positions: they sought them and accepted them, and they simply do not seem to be doing even an adequate job, let alone displaying the sort of excellence one would hope for in a crisis.  It is revealing about the degradation of our political and official systems and agencies in recent years, but confirming worst fears is no consolation. People can rise sometimes rise above themselves in a crisis, but there is no visible evidence of that from any of the key political or official players so far.

From an economist’s perspective there is no sign of any attempt at a serious cost-benefit analysis of possible alternative strategies.    Did Treasury not insist on one, or did Ministers refuse to have any such work done?  Or is there such a document lurking, hidden from citizens?  Whatever the answer, the Prime Minister has offered us nothing, just flat assertions and  – presumably on her behalf –  “there is no alternative” rhetoric.    There are always alternatives and choices.  Even in wars that pose near-existential threats, surrenders eventually happen, when things go badly enough different from plan.

All we’ve been offered so far –  and even that not released for days after the Prime Minister claimed to be relying on it –  was some modelling by researchers at Otago University.  This is where the central estimate of the “worst case” of 27600 lives lost comes from.  Of itself, this number doesn’t seem terribly enlightening –  it involves a similar share of the population getting infected, and the proportion of the infected dying, – that people were talking about at least a month earlier.   Intelligent readers of the ongoing debate would have got to numbers in a similar ballpark.  But it makes good headlines, which seems to be the main use the report has been put to.

The biggest problem with the report, from a disciplined policymaking perspective, is that it offers precisely no marginal analysis.  That probably isn’t a criticism of the report, since most likely that sort of analysis wasn’t asked for by the Ministry of Health.  But it matters quite a lot in evaluating current policy choices.   Thus, we have no analysis at all –  or so it appears –  of the likely death toll if (for example) the over-70s put themselves into isolation for six months.  No analysis, that I can see, of the likely death toll if the public were seriously alarmed about the risk and chose extensive physical distancing themselves.  No analysis, I can see, for what difference the actual partial lockdown might make relative to variants on it (tighter and looser).  No analysis of what difference a very aggressive test, trace and isolate strategy might make, perhaps in the context of a less severe lockdown.   Nothing. It is almost all framed in an “all or nothing” way.

And then there is just nothing anywhere about the economic and social costs.  Again, doing so isn’t easy.  As I noted to someone who emailed me yesterday, it is easy enough to produce huge numbers for the economic cost –  GDP could easily be $75 billion lower this year than last (roughly 25 per cent), with further losses (but smaller) next year and beyond. It is really easy to get to a $100 billion figure.

Some sceptics of the government’s substantive approach will then compare $100 billion to the value of the lives saved.  Suppose we could save all 27000 people in the Otago modelling only by the approach we are adopting.  For general government cost-benefit analysis we know that the assumed value of a life saved is around $5 million dollar, but if that is – in principle –  roughly the price we’d pay to save someone of median age, we know that the very elderly are most at risk of dying from this virus.  If we halved the value of the statistical life of those most at risk –  using say $2.5 million per person (which would probably be generous) one could tot up expected savings of $67.5 billion and conclude the strategy just does not make sense.

But that would also be all or nothing thinking, not focusing on the bits of the equation the New Zealand government choices actually affect.    The case for any particular intervention by the New Zealand government can really only sensibly be evaluated looking at the marginal benefits (lives saved, mostly in this case) and the marginal costs.  To illustrate, consider the economic side.  If our government were to lift all domestic and border restrictions tomorrow (an absurd proposition, but this is for illustrative purposes only) it isn’t as if those $100 billion economic costs would just evaporate.   There would be hardly any foreign tourists (apart from anything else, most governments are strongly advising their citizens not to travel abroad, if there are even flights), and probably not many new foreign students.  And what of New Zealanders?  The risk of the disease wouldn’t go away –  in fact, it would probably be greater than it is right now – and plenty of people would choose to be extremely cautious – whether about work, schools, social occasions, air travel or whatever. Oh, and the uncertainty around future policy –  and global economic activity –  wouldn’t change one iota, and extreme uncertainty is the great enemy of most spending and investment.    We would still have a very serious recession on our hands.   Those losses simply aren’t relevant to the case for the lockdown (present or possibility of extensions, perhaps without foreseeable limit).

Quite how then one puts a number on the marginal cost of the lockdown, or variants to it, is a challenge. It is clear that if it were removed tomorrow, some firms would spring back into operation, but how many?  How many would have many customers?  I don’t know the answer, but it isn’t clear that the government –  with all its resources –  has made any effort to either.  And that is pretty inexcusable.

And, as noted, there is no analysis of the lives saved at the margins either.  And absolutely nothing on what it means for a society to be simply shutdown by order of the state –  individuals (many live alone) consigned to, in effect, solitary confinement home detention for an indeterminate horizon,  funerals/committals totally banned (for all intents and purposes), people dying alone with spouses or children simply banned from making their own choice to be at the bedside, and so on through the less dramatic implications.  If the Director General really speaks for the Prime Minister in his “no Plan B” rhetoric, are they open to Christmas –  community, society, festivity –  being scratched this year, even though it is still almost nine months away.

It is as if the government is afraid of confronting and dealing with real hard choices –  and being honest on what they value, what they don’t –  and just prefers now to deal in simplistic rhetorical absolutes, when not much is very absolute at all.  We deserve a great deal better from our Prime Minister, her Cabinet, and the phalanxes of highly-paid officials and agencies who surround them. In the end, these are our choices –  our lives, societies, economies – and the government system is supposed to be our servants not our masters.  When, with all the resources at their command, they simply don’t do the analysis, and aren’t open with us –  radically so, given the gravity of the crisis – they betray our trust.  That is something governments can ill-afford in times like these.

Measure what is measurable, and make measurable what is not so

Late last year a (long ago) former Reserve Bank economist closed down his blog just like that. I didn’t have anything quite so dramatic in mind.  But after my elderly mother died last August, I got to thinking about the next stage in my life and how I could best use what skills and talents I have.  And before Christmas I’d decided that today would be my last day of high-frequency blogging.  Why today?  Well, for all practical purposes it is the fifth anniversary of the blog; five years today since I left the Reserve Bank.  It wasn’t that I’d run out of ideas or energy, but there is always the opportunity cost to consider, and I’d begun to map out a series of archival-research-based projects (mostly in New Zealand economic history) I wanted to pursue, as well as making more space for some other interests and priorities.   I’d planned to keep writing here perhaps once a week or so.

That is still what I want to move towards at some stage.  But in the middle of the most dramatic economic developments, and wrenching dislocations of economic policy, of our lifetimes it doesn’t quite seem the time to change course just yet.  We’ll see how things go, but for now, quite probably for at least the rest of this year, normal service continues (and in the meantime thanks to all of you who’ve become readers –  numbers that, for a fairly geeky New Zealand focused blog, I never imagined – and to (almost) all who’ve commented, either on the blog itself or directly to me).

And today I’m indulging the inner geek.

One of the most frustrating (to me) aspects of the response to the massive economic dislocation by the government and the Reserve Bank is their utter complacency, bounded by some deep-seated conventional wisdom, that interest rates can’t, shouldn’t, and won’t move down from here –  the OCR having been cut, in the biggest slump in modern history, by a mere 75 basis points.    The Minister of Finance was at it again in his testimony to the epidemic select committee yesterday highlighting the “certainty provided” by the MPC’s commitment not to change the OCR for some considerable time.  I presume he had in mind the idea that the MPC wouldn’t raise the OCR – as if anyone has supposed such increases were at all likely in the foreseeable future –  but he seems totally uninterested in the idea that considerable relief could be provided, and desirable income rebalancings achieved, with much lower interest rates.

Sadly most of our media also seems more interested in channelling conventional wisdoms rather than challenging them.  So I’ve heard MPs and journalists ask the Minister of Finance about commercial rents, but never once about interest rates, even though commercial rents are based on private contracts, whereas the OCR –  which influences a wide range of variable private interest rates – is directly under official control.   If the Reserve Bank refuses to act –  as it appears they do –  the Minister has existing statutory powers to simply override them.  They aren’t powers that should be used lightly, but they were put in the Act for a purpose, and these are pretty extreme times.  If the Minister refuses to use his powers, he makes himself directly party to the choice to hold New Zealand retail interest rates well above where they should be at present.   All while facilitating/encouraging firms and households to take on more debt at these interest rates.

Still, for the time being at least, the MPC’s floor is the floor, and markets have to take that into account in pricing other securities.  This has been an issue in a variety of other markets for some considerable time, particularly since the last recession when various central banks got a point where they were simply not willing to cut further, no matter the economic conditions, or to make the changes (around physical currency) that would have made further deep cuts –  of the sort Taylor rule estimates in the US, for example, suggested economic conditions warranted –  effective.   Central banks fell back on trying to do what they could –  often not much –  with other “unconventional” instruments.

And years ago, a Reserve Bank of New Zealand researcher Leo Krippner, got interested in the question of how one might represent the effectiveness of such policies in a single number.  Whereas in normal times, the OCR itself readily expresses the stance of policy, if there is a self-imposed floor on the OCR but other things are being tried, how best to express the overall stance of policy.

Leo is an expert in yield curve modelling, and got to try to estimate how different the interest rate yield curve was –  especially in the US –  in the presence of the floor on the Fed funds rate, as a result of unconventional policies (“QE”, loosely).     He has published various technical papers in journals, but I think his first paper in the area was published in 2012 in the Reserve Bank’s Analytical Notes series.  I was the editor of that series, and one of my priorities was to ensure that as much as possible was accessible to intelligent lay readers, and my impression is it still remains a good introduction to the work Leo is continuing to do and to update.

One can think of a yield curve of government bond interest rates (from overnight out to, say thirty years) as, broadly speaking,  a series of market implied expectations about the future setting of the official overnight interest rate (the OCR in New Zealand).  All else equal, if the central bank sets a floor on the OCR –  which is regarded as binding and credible – markets pricing say a 10 year bond will rule out any chance of an OCR below that floor, and the 10 year bond rate will be higher (all else equal) than it would be in the absence of such a floor.  On the other hand, if large scale bond purchases by the central bank –  even actively targeting a bond rate (as Japan and now Australia are doing) –  may succeed in lowering to some extent where the bond yields settle, relative to the floor-constrained normal market price.    Leo’s work, calculating what he calls a Shadow Short Rate, attempts to combine the OCR and this effect into a single number.

This work wasn’t very relevant to New Zealand itself for a long time (there were internal sceptics as to whether it should even be done)….and yet now it is. (In his speech a couple of weeks ago the Governor even suggested the Bank might publish a semi-official series of such a measure.)   Leo’s work has been recognised in various places abroad –  cited in public by at least one Fed Reserve president, and honoured by the house journal of the central banking community, Central Banking magazine (for whom I do some reviewing: my light lockdown reading is here).  Leo left the Reserve Bank last year, but is continuing to update his work and earlier this week circulated a note with a Shadow Short Rate series for New Zealand, now that we operate with a formal OCR floor and in the presence of the MPC’s commitment to buy $30 billion of government bonds over the coming year. (The quote that heads this post, from Galileo, appears upfront in Leo’s note.)

Leo’s modelling estimates that the overall stance of monetary policy is “approximately equal to an OCR of -0.48 per cent”, compared to an OCR itself of 0.25 per cent.    If so, that suggests a small but somewhat useful contribution from the “unconventional monetary policy” or UMP.  Small because even a total of 150 basis points of effective easing is tiny by comparison to the scale of the economic shock.

There are a number of caveats to this modelling.  Leo articulates some of them himself

  1. The SSR is an estimated value rather than a setting like the OCR or an observed market short rate. Hence, any SSR series will (unavoidably) vary with the model specication and data used for its estimation. The choices I have made for the SSR series in this note have produced more favorable properties than alternatives for the United States,4 but the magnitudes of negative SSR estimations can easily vary by fractions of a percentage point on re-estimations, and sometimes more for UMP periods if the lower-bound setting in the model needs revisiting in light of central bank communications and/or actions. My model for New Zealand currently uses a lower-bound setting of 0.25%, consistent with the RBNZs 16 March 2020 forward guidance.
  2. Related to estimation, in the present global UMP environment compared to previous years (e.g. for the United States easing/tightening cycle) yield curves may no longer capture sufficient information to quantify the stance of monetary policy. The reason is that yield curves in New Zealand and around the world are now very at(i.e. longermaturity rates are close to shorter-maturity rates). Only time (and updated analysis) will tell on this aspect, and model refinements may be needed.
  3. The SSR is not a market rate at which borrowers and lenders can transact, particularly in UMP times when the OCR and short rates will remain close to zero while the SSR may become increasingly negative. Hence, SSR declines in UMP times will not result in the same cash flow effects from interest payments and receipts as OCR cuts in CMP times, so the SSR transmission to the economy may differ from at least that perspective.

I went back to Leo and asked about how safe it was to use a floor of 0.25 per cent for New Zealand (after all, we’ve seen more than a few policy lurches from the Reserve Bank over the last year, in fact over the last few weeks, and some other central banks have – eventually –  shown a willingness to take their policy rates lower, in the Swiss National Bank’s case as low as -0.75 per cent.  Leo noted that if one were to assume the New Zealand floor was anything like that low, the SSR for New Zealand would still be much the same as the OCR itself.

He went to say (with his permission to quote)

The longer answer is: should one use an assumption of the effective  lower bound in the model (perhaps something like your -0.7, but also  see further below), or should one use a value that central banks have  indicated they would go to? Across the different economies I’ve  modeled, I’ve noticed that the different yield curves seem to use the latter. For example, the US yield curve data has pretty much respected  the lower point of the 0-25 bp range, and the euro area data (OIS  rates) has pretty much respected the incremental settings of the ECB  policy rate. In particular, neither have had longer-maturity yields  rush to, say, the -75 bps of Switzerland.

So, based on what I’ve seen with the data, I set the lower-bound for  each economy according to the central bank’s indications. And then I  lower that if/when the policy rate gets set lower (which, again, seems  to be how the yield curves behave – perhaps not rational though, I agree).

To which my response in turn was to note that in at least some of those overseas central banks –  the Fed in particular –  the stated floor has been consistently applied for a decade, while the Reserve Bank of New Zealand has no track record in this area at all –  indeed in that same speech a few weeks ago the Governor was openly talking of negative rates as a possibility.  A rational investor in the current climate, with a Governor prone to lurches (and, actually, in the presence of override powers), might not price in a 100 per cent chance of the MPC sticking to its word.  Time will tell.

My bigger unease about this work, stretching all the way back to that 2012 paper (where I recognise a couple of sentences I insisted on being added) is the third in Leo’s own list of caveats above: the SSR is not a rate that can be transacted, and if much of borrowing and lending in an economy is either at (or swapped back to) or very close to a floating rate, the actual OCR (self-imposed constraint and all) will be a lot more important than the SSR estimate might suggest.  In the US, for example, a lot of mortgage lending takes places at very long-term fixed rates (and so what happens to very long-term bond and swap rates has a direct transmission mechanism).  That is much less so in New Zealand (or Australia or the UK).  That is consistent with some of the doubts I’ve expressed in earlier posts around quite what difference the Bank’s large scale asset purchase programme really makes where it matters (thus, on my telling, the main advantange of that programme is that it should reveal quite quickly how severe those limitations are and turn the focus back on the OCR and that self-imposed floor).

This stuff won’t be everyone’s cup of tea, but I’m really glad to see that Leo is continuing with this work –  he says he will provide updated estimates on his website each month for the time being –  and will be interested to see whether the Reserve Bank follows through on the suggestion of a quasi-official series (for what its worth, I would suggest they not do so, and use work such as Leo’s as a reference point for commentary/research when it is relevant).

Coronavirus economics and policy: April Fools’ edition

Sadly, of course, we don’t wake up this April Fools’ morning and learn that the last quarter has simply been a huge and dreadful illusion.  We really are in the midst of a pandemic.

Unfortunately, we also wake up and realise afresh just how irresponsible some of the economic policy choices the New Zealand government has made in recent weeks have been, as they lagged badly behind in recognising the severity of what was breaking over us.   The government’s key economic figures, the Minister of Finance, the Secretary to the Treasury….oh, and Phil Twyford….are apparently fronting up to the Epidemic Select Committee this morning.  I hope ministers are grilled on these points.

First, we had the decision to push ahead with a further large increase in the minimum wage (from today), in a country where the ratio of minimum wages to median wages is already among the highest in the OECD, at a time when unemployment is rocketing upwards and the earnings capacity of the country has plummeted (partly, most recently, as a result of government choices, but realistically mostly because of stuff simply outside New Zealand’s control).   Perhaps one might have been able to defend such a decision six weeks ago when it might have seemed to wishful ministers not taking the threat seriously –  as indeed the Ministry of Health evidently was not – that it was just a China thing and any adverse economic effects would be small, concentrated, and shortlived.  It makes no sense whatever today.  It is a pure act of ideological self-assertion –  from a government that at the same time runs relentless propaganda urging us all to “unite”.

Things are so bad right now that perhaps the higher minimum wage won’t lead to many additional job losses right now: if your revenue has fallen 90 or 100 per cent, a higher wage rate for staff you can’t afford anyway is more or less irrelevant.   But it is an additional cost on employers at a time when for most firms profit is non-existent, at a time (as it happens) when it is very difficult to spend much money at all anyway on anything other than food and rent.

But where the increase will start to matter a great deal more is in the months and years to come.  Again, if the government once assumed the unemployment rate would barely rise, they’ve known for weeks now that any such view was simply deeply deeply wrong.  We’ll be trying to get people back into work, starting from a peak unemployment rate that may soon surpass even the Great Depression peaks, and as I noted yesterday it is ludicrous to suppose that getting back to full employment is going to be easy or quick.  The minimum wage decision makes it that much harder, and the burden will fall most heavily on the people least equipped to do well in the labour market, whom employers just won’t need to, and typically won’t be willing to, take a punt on.  Oh, and realistically the whole economy is going to be on a lower path of income per head or labour productivity (earnings capacity) than any ministers envisaged when they first rashly promised these successive increases.

If anything, we want to get price signals positioned in a way that is most supportive of as fast a return to full employment.  There are macro policy aspects to that –  eg interest and exchange rate – but minimum wage rules are also part of the mix.  On current policy settings, the government seems determined to hamstring the private sector led rebound.

And then there were those permanent worsenings in the fiscal position implemented as part of the economic package a bare two weeks ago.   In the face of what was very obviously coming, both the bulk of the business tax changes and the permanent increases in welfare benefit rates were almost reprehensibly irresponsible.  Here is what I said at the time

But the increase in welfare benefits now is much more pernicious than that.  Life on a benefit isn’t easy (and before anyone scoffs about what do I know, that isn’t just rhetoric: I have a close family member living on a long term benefit).   But what beneficiaries at least had going for them this year was certainty of income: the government was not going to default or closedown, unlike many private sector employers (with the best will in the world on their part).  They and public servants were safe.  And yet the government chooses to lock-in a permanent boost to its spending commitments (a) to those with the least degree of income uncertainty now, and (b) when the country is in the process of becoming a lot poorer and scarce resources need to be used wisely.   Raising benefits might or might not have been a reasonable luxury in settled times.  It is simply irresponsible and evidence of fundamental unseriousness to do so now.  (And before anyone tells me about the high marginal propensity to consume that beneficiaries have, let me remind you that now is not the time for stimulus or encouraging people to spend more: instead we are entering a phase of deliberately choosing to shrink the economy to give us the best hope of fighting of the effects of the virus).  Oh, and the unemployment rate is going to rise a lot, and one of the big challenges after this is all over is going to be reconnecting people with the labour market, at a time when wage inflation will have been depressed anyway.  In that context, higher benefit replacement rates (relative to wages) is really the last thing that makes sense in getting the economy back on track.

We are poorer as a nation –  very considerably poorer so for the time being –  and yet the government splashes permanent increases on one of the only groups in the country whose real incomes this year are actually secure.

But it isn’t some April Fools’ joke, it is fiscal and economic policy as delivered to us by the Labour/NZ First (and Greens) government.

I could go on, reprising themes from recent posts.   In many ways Grant Robertson has always just been Mr Conventionality when it comes to economic policy –  happy to go along with whatever establishment thinking is for the moment.    That was true pre-crisis –  whether, for example, you liked the Budget Responsibility Rules or not, the conventional wisdom did; whether you thought something really needed to be done about our utterly dreadful productivity growth record, the conventional wisdom was content to tinker (and The Treasury was worse, content to play with its Living Standards Framework distractive toys).

But exactly the same Mr Conventionality is one display now.  He is content to sit by, not even saying a word let alone using his statutory powers, about his Monetary Policy Committee simply refusing to cut interest rates in face of the biggest slump in modern history –  because establishment thinking tells him there is nothing there, the same sort of establishment figures so wedded to the Gold Standard pegs in the early days of the Great Depression.    Sure, fiscal policy today looks very different than it did even a month ago, but not in any surprising, bold or innovative ways.  The wage subsidy scheme doesn’t run for long, is now quite ungenerous by international standards, and there is no sign at all that the Minister has grappled at all with the nature of the extreme uncertainty that all businesses are facing.   And perhaps as bad, the government seems much more interested in bail-outs for big and prominent companies than it does in something systematic and economywide.   But it is those big companies who will have the ear of ministers and senior officials, who will get the media coverage.    Small firms typically don’t (in the same way grieving families barred from any sort of funeral, no matter how small or distanced, outdoors, don’t command the attention of this government).  That big company focus –  case by case consideration of individual big firms, presumably with little transparency and no accountability –  is reflected in stories online this morning (sorry, can’t immediate re-find the link).

And if there is a strategy it appears to be infrastructure, infrastructure, infrastructure…..without much regard for the twin facts that (a) whatever infrastructure projects might have passed decent cost-benefit tests six months ago now (a subset of those actually approved), fewer will today, and (b) relatedly, whatever we thought we needed six months ago, we will need less in the next few years.   I’m not opposed to sound infrastructure projects getting accelerated go-ahead, in principle, but if the government believes high-speed rail from Auckland to Tauranga or Hamilton, or lots more Island Bay cycleways, are the answers, they will simply be on the path to making us poorer.

There has been much comment from Labour ministers evoking Michael Joseph Savage in recent weeks. I know he is some sort of Labour icon –  I’m always surprised that some friends of ours still have his photo on their wall – and no doubt there were a handful of good things done on his watch. But, as a reminder, the Savage government had almost nothing to do with New Zealand recovering from the Great Depression – it was almost wholly over in New Zealand by December 1935 –  and its reckless macroeconomic policies ran New Zealand into such a serious financial crisis in late 1938 that we ended with tight exchange controls –  government permission for your overseas magazine subscription or your holiday or your retirement investment portfolio –  for the next 45 year, and only narrowly averted a much more serious default on the government’s debt that anything that actually occurred during the Great Depression itself (and we weren’t spared that by decent New Zealand management, but by the grace and favour of the UK government, concerned not to severely dislocate New Zealand when the war was likely to be only months away).   Labour might have a sentimental attachment to the man –  who seems mostly to have been a decent sort as an individual –  but it is distinctly unnerving when one reads senior government figures, including Grant Robertson, evoking those times and policies as an example for now.  Did I mention that part of what that government kicked off was the retreat from the world –  going into the 1930s we had probably the highest per capita exports of any country.  This time we start already having the lowest share of GDP accounted for by exports of any modestly-sized advanced country.   We need an outward focus, as much as possible, to whatever extent is reasonably possible, not a guiding philosophy that thinks we can get rich mostly, as a very small country, simply by taking in each others’ washing.

The government has done very poorly so far on the economic response to the crisis.   That needs to change urgently.  It isn’t promising when media report, as the Herald did this morning that the focus is still on a Budget six weeks away.

They have also been extraordinarily non-transparent.  One might think that the best way to build and retain trust, and develop confidence in your strategy, would be to pro-actively all the advice and memos the government has received in formulating policy –  it would also be less labour intensive than responding to the avalanche of OIA requests that is becoming increasingly inevitable.   But, as far as I can see, we’ve seen nothing at all of The Treasury’s analysis and advice on the economic implications and options.