Not in narrow seas

That’s the title of a new book, published this month, by veteran economist and commentator Brian Easton.   The title is borrowed from a collection of poems, published in 1939, by New Zealand poet Allen Curnow,  but presumably also keys off the author’s previous book published in 1997, In Stormy Seas: The Post-War New Zealand Economy.

The full title of the new book, published by Victoria University Press, is Not in Narrow Seas: The Economic History of Aotearoa New Zealand.      It is a curious title in a number of respects.  First, there is that reference to the place –  so beloved of public servants and the Wellington liberals –  that is no place: New Zealand is the name of the modern country, and there was – so far as we know –  no collective name for what went before.   Then there is the definite article “the” – not “a” –  suggesting a definitive treatment that just isn’t on offer, even in this big (655 pages of text) book.   And then there is the suggestion that it is an “economic history”.

When I saw the title of the finished volume last month I was reminded of hearing Brian telling people –  the book has been many years in the making –  that it wasn’t going to be a conventional “economic history”, but something different, more of a “history of New Zealand from an economic perspective”.   And it is somewhat reassuring that, however the publisher has chosen to present the finished book, the author still seems true to  his earlier vision –  he begins his final chapter thus “This is a history of Aotearoa New Zealand, centred on the economy”.     Six years ago, seeking a new funding grant, he told interested parties

Not in Narrow Seas, as its title, suggests is an ambitious history of New Zealand . It is written from an economic perspective.

In fact, an extract from that document, written when the book was two-thirds done, probably gives you a good flavour of what is covered

As such it covers many issues which are often neglected by most general histories. These include:

– the interactions between the environment and the economy (and society generally); the book starts 600 million years ago at the geological foundation of New Zealand;

– the offshore origins of New Zealand’s peoples and the baggage they brought with them;

– there are seven chapters on the Maori plus further material in numerous other chapters;

– there is a whole chapter on the development of the  Pacific Islands (after the proto-Maori left)  in preparation for the account of the Pasifika coming to New Zealand;

– there are specific chapters on the non-market (household) economy in preparation for an account of mothers entering the earning labour force (one of the radical changes in the 1970s);

– there are five chapters on the evolution of the welfare state;

– the book pays attention to external events and globalisation;

– it could be argued this is the first ‘MMP history’ of New Zealand because it looks at how people voted as well as electoral seats won. (If this seems odd, it is rarely mentioned that when Coates lost power to Ward in 1928 his party won far more votes but fewer seats);

– this is not yet another history of the ‘long pink cloud’. It takes a critical view of the more extreme versions from this perspective, in part because it puts a lot more weight on the farm sector as a progressive force (albeit with its own kind of progressiveness);

– it synthesises the rise of Rogernomics with the events before, showing both the continuities and the disruptions;

– while not a cultural history, it integrates culture and intellectual activity into the narrative.

And, of course, there is a fair amount of more-conventional “economic” material as well.

Easton was economics columnist for the late lamented Listener for decades (I think I saw a reference to 37 years, a remarkable run) and you don’t hold down a slot like that without being able to write in a clear and accessible way, and make comprehensible what sometimes some economists almost seek to make imcomprehensible.    That carries over to this book.  If one were looking for straight economic history you might expect lots of tables and charts, but there is only a handful of either (by contrast, around 100 tables and charts in the much shorter In Stormy Seas).   And breaking the text into 60 chapters means bite-sized chunks.    For a serious work of non-fiction it is a relatively straightforward read (and, for better or worse, there are no footnotes).    For those who don’t know much about how the story of New Zealand fits together, especially with an economic tinge, it is a useful introduction –  especially when one recalls that the last comprehensive economic history of New Zealand, that by Gary Hawke, was published in 1985 (and had gone off to the publisher before any of the reforms of 1984 and beyond were even initiated).

But talking of “tinges” note that line in the extract above “this is not yet another history of the ‘long pink cloud’ “. He notes

Much of our history has indeed been written from a leftish perspective. However, the pink cloud obscures the total story of New Zealand’s development.

And he has some useful correctives to perspectives offered by other “leftish” authors, but make no mistake this is a book from the liberal-left as well.   If he occasionally has positive things to say about National governments, for example, it is largely when they initiated things – ACC as an example –  that were radical for their time.  His is a “progressive” vision in which, to a first approximation, things have only got better and better as they’ve approached today’s state of affairs –  even while there is still some way to go to get to the desired “progressive” end.

I always find it interesting to read the Acknowledgements sections, perhaps especially of New Zealand books.  Easton has well over 100 names listed, some of people long dead (such as Bill Sutch). I recognised only half or two-thirds of them but the great bulk were people of the liberal-left (plus Winston Peters).  That isn’t a criticism; just an observation about where the author’s central Wellington milieu is.   In some respects, the book may be best seen as a distillation of Easton’s decades of thinking and debating about New Zealand (not just its economy).

I’m not going to attempt a full review of the book –  I’d say that I’d leave that to the New Zealand Review of Books, except that that publication too has now passed into history –  but I wanted to highlight just a few scattered points that struck me as I read.

First, in his earlier history of the post-war economy (mostly up to 1990) there was much to like.  One of the key areas I disagreed with him on  – I’ve dug out a published review I wrote at the time  – was around macroeconomic policy since 1984.   He reckoned the conduct of monetary policy, and in particular the handling of the nominal exchange rate, played a big part in explaining New Zealand economic underperformance.  Here were my 1998 comments.

easton 1998

In the new book, although less space is devoted to it, this continues to be Easton’s view.   I continue to think his case isn’t compellingly made, but then this is one of those issues where I’m closer to the New Zealand conventional wisdom than on most (I reckon macro management –  fiscal and monetary policy – has been among the better bits of New Zealand economic policy in recent decades).

Having said that, one line in the new book that got a big tick next to it was his observation that the real exchange rate was probably the most important relative price in New Zealand (arguably the terms of trade).   In that regard, I was a little surprised that with the benefit of another 20-25 years, there was nothing in the new book about the extent to which New Zealand’s real exchange rate had –  over decades now – moved (risen, stayed high) in ways inconsistent with the productivity performance of the New Zealand economy, even adjusted for the improvement in the terms of trade, and the associated decline in the relative significance of the tradables/exportables sector of the economy.    It is the same curious de-emphasis we now see from our officials and ministers faced with a really major adverse economic shock and apparently unbothered that a key stabilising relative price –  the real exchange rate –  has barely moved at all.   Since one of the key elements in Easton’s economic history of New Zealand is the collapse in the wool price in 1966 –  at the time wool was a third of our exports –  it is all the more surprising.

Relatedly, I was quite surprised by how little mention there is in the book of the continuing relative decline in New Zealand’s productivity and material living standards over many decades, to today.  Brian is well-known for asking hard questions about just what official statistics are actually measuring, so perhaps he doesn’t think we’ve continued to drift far behind –  but I doubt that is the explanation (he explicitly highlights data for the late 30s that suggests that at that time our material living standards were still among the highest in the world).  On the one hand, he seems to work with a model in which government policy doesn’t really make much difference –  unless it is messing up “Rogernomics” and associated macro policy – but even if that is his model, he doesn’t make clear what he thinks is driving our relative decline (let alone –  and perhaps one can’t ask for this in a history – what might make a difference). I wonder too if there isn’t an element of the point I’ve suggested over the years, that the powers that be in Wellington (political, bureaucratic, and other) finding our structural economic performance too hard to explain prefer no longer to talk about it much?

In passing –  which is more or less how he treats it here –  it may be worth noting that Easton here (as in the previous book) seems less than persuaded by the notion that large scale immigration to New Zealand since World War Two has done anything beneficial for the productivity or material living standards of New Zealanders.  Here, as I’ve noted before, he stands in continuity with earlier authors on New Zealand economic history.

And two final points.

The first relates to the Productivity Commission.  Commenting on developments this century, he notes of the Clark government

Curiously the government often reappointed or promoted those closely associated with Rogernomics, and they did little to create institutions to provide alternatives to neo-liberalism. By contrast, the National-ACT Government established the Productivity Commission, one of whose members was not only a “Rogernome” but had stood as an ACT candidate [former Treasury secretary Graham Scott].

and moving a decade on, he notes

…the Key-English Government, nudged by the ACT Party, established a Productivity Commission to help pursue its economic objectives. This agency remained in existence under the Ardern-Peters government.  More generally, the Ardern-Peters Government had followed its predecessor’s habit of assuming a milder version of the neoliberal framework.  Like the previous Labour Government it gave important jobs to former neoliberal enthusiasts.

I imagine one of the people Easton has in mind here is the current chair of the Productivity Commission, Murray Sherwin, who was head of the International Department of the Reserve Bank back in the days of the float of the exchange rate –  an issue Easton has long written about and strenuously challenged how things were done –  and, of course, a key figure at the Bank in the years when price stability was becoming established.  I guess he must be almost the last of the people who held reasonably significant positions in those reforming days to still be in public office.  But his term expires early next year, and it will be interesting who the government (I’m assuming Labour leads the next government too) chooses to replace him, and telling about the interest (if any) the government has in addressing longstanding economic failures, and how.  [UPDATE: Brian tells me he didn’t have Sherwin in mind.]

But, to be blunt, if the Productivity Commission is the institution for the propagation of continued “neo-liberal excess” (my words, not Easton’s), those on the left wouldn’t seem to have that much to worry about.  In addition, of course, to the fact that the “Key-English Government” seemed to have no serious structural “economic objectives” –  do you recall them fixing the urban land market, addressing productivity underperformance etc? –  the Commission itself has increasingly tended to reflect the same sort of “smart active government”, technocratic wing of the European social democratic movement, that we see in –  notably –  the OECD.   Since governments appoint the Commissioners, the Commission will over time tend to reflect the preferences of governments of the day –  and we’ve seen that already in the rather different tinge of appointments under this government.  The Commission is certainly nearer in inclination –  if better-resourced –  to the old New Zealand Institute (former executive director, David Skilling) than to, say, the Business Roundtable or the New Zealand Initiative.  To survive –  as always a peripheral player, and rather small –  I guess they have to meet the market one way or another.

Economists are renowned –  sometimes fairly, sometimes not –  for acting as if they believe that economics is some sort of universal discipline without which almost everything and everyone is poorer.  But one rarely sees it quite so breathtakingly expressed as on page 75 of the book, discussing 19th century New Zealand, when Easton observes

Perhaps most of the settlers did not have well-formed opinions –  economics was then a new discipline, even among the well-educated.

In summary, almost everyone reading the book will learn something, and perhaps on a few points be challenged to think a bit differently.  It is fairly easy to read, but it isn’t “the economic history” of New Zealand.   Then again, it doesn’t really aim to be.  I noticed that back in 2014 Easton talked of wanting to have these appendices available on the publisher’s website (I presume the numbers refer to word count)

APPENDICES

I. The Course of Population                            3850

II. The Course of Prices                                  4200

III. Measuring Economic Activity                  2100

IV. The Course of Output: 1860-1939           3250

V. The Course of Output: 1932-1955 2700

VI. The Course of Output: 1955-                   3400

VII. The Structure of the Economy                4050

VIII. The Course of Productivity                   1450

IX. Patterns of Government Spending           4850

X. Transfers                                                    5650

XI. Debt and Deficits                                     3300

VUP doesn’t seem to have been receptive to that. I hope that in time Easton might be able to make this material available on his own website, and past such notes (including appendices in the 1997 book) were useful and interesting to the geekier of his readers.

 

 

 

Two charts

….on unrelated matters.

One of the objections sometimes raised to my advocacy of a deeply negative OCR is along the lines of “it will only lift asset prices”, with the implication –  and sometimes directly stated –  that that is what has happened in the last decade or so, even as policy rates in most of the advanced world fell from materially positive numbers to somewhere near zero.   In 2007, policy rates in the US and the UK had been over 5 per cent, in the euro-area 4 per cent, and in New Zealand and Australia higher than all those rates.   Only Japan was then in the extreme low interest rate club.

The asset price that tends to attract most attention in New Zealand is house prices (really house+ land).  The Bank for International Settlements maintain a nice quarterly database of real house prices for a large group of advanced and emerging economies.

Here is what has happened to real house prices for the largest advanced economies, and for the advanced economies as a whole, over the 12 years from the end of 2007 to the end of last year.

house prices to end 2019

Very little change at all.

The aggregate advanced economy measure only starts in December 2007, and for quite a lot of countries the data starts getting thin for earlier periods.   But for the UK, the euro-area, and the US, I had a look at the previous decade –  over which period policy interest rates hadn’t changed much at all (ups and downs of course during the period) – and in each case real house prices increases were much more rapid in that period than in the more recent (extremely low interest rate) one.   The US had experienced a 53 per cent increase in house prices –  and they had already fallen back from peak by the end of 2007 –  and the euro-area a 40 per cent increase.  In Japan –  very low interest rates throughout –  real house prices had fallen substantially over the 1997 to 2007 period.

Of course, within these aggregates for the last decade or so there is a lot of cross-country variation.  We all know real house prices in New Zealand and Australia have risen a lot.   In some other countries, they’ve fallen a lot.    But even in New Zealand, Australia and Canada, the rate of increase has been less in the last (low interest rate) 12 years than it was in the previous decade.

That shouldn’t really be a surprise.  After all, in principle, houses are reproducible assets (some labour, some timber, some concrete, some fittings) and in few countries is very much of land built on.   Moreover, interest rates aren’t where they’ve been as the result of some toss of a coin, or a draw from a random number generator; they reflect underlying changes in savings/investment imbalances, which central banks adjust policy rates to more or less reflect.

When a wide range of countries have had fairly similar interest rate experiences (and inflation outcomes; the check on whether monetary policy is out of step), and yet have had very different house price experiences, it probably suggests that some non-interest rate factors have been at work.   Of course, in some cases, that might just mean working off past crises –  although if you want to cite the US there (a) recall that by the end of 2007 real house prices had already fallen by 15 per cent from peak, and (b) that in the boom years nationwide real house prices in the US never rose as much as they did in, for example, Australia and New Zealand.

A more plausible story is that some combination and land-use restrictions and population pressures continue to explain a lot about differential house prices performance in the years since 2007.   In New Zealand and Australia, for example, we have had tight planning restrictions and rapid population growth.    I don’t know much about planning rules in central and eastern Europe, but there isn’t much population growth (deliberate understatement here) in countries with strong economic growth such as Bulgaria, Romania, Slovenia, Slovakia and the Baltics.   It isn’t a simple one-for-one story, but taken across the advanced economies as a whole it just doesn’t look as though low interest rates are a credible part of the house price story –  house prices, in aggregate, not having done much at all.

Of course, had central banks completely ignored the market signals re savings/investment pressures and simply held policy rates up then no doubt house prices would have been lower.  Then again, we’d also have had persistent deflation and (more importantly) unemployment rates that stayed much higher for longer and more persistent losses of output.

On a completely different topic, I found myself yesterday on an email exchange with some fiscal hawks, very worried about the future level of public debt.

I’ve noted previously that on the Treasury budget numbers our ratio of net debt to GDP in 2023/24 would still be sufficiently modest by international standards that if we had had that high a debt ratio last year, we’d still have been (narrowly) in the less-indebted half of the OECD.

Another way of looking at things is to take the government at their word and assume that by the end of the forecast period the Budget is more or less back to balance, such that the nominal level of debt stabilises at the level forecast for the end of 2023/24.

If that were to happen that what happens to the debt ratio depends on how much growth in nominal GDP the economy manages in the years ahead.   If we assume that the terms of trade is stable (or that the only safe prediction is that we don’t know, so assume no change), then there are three components to the rate of growth of nominal GDP.    As an illustrative experiment I jotted down a range of possible average outcomes for each.

Average annual growth
Low High Average
Population 0 1 0.5
Productivity 0 1.5 0.75
Inflation 1 2 1.5
2.75

So I’d assume growth in nominal GDP averaging 2.75 per cent over the decades beyond 2024.  Of course, there will be booms and recessions in that time, but this is just an average.   And then I’ve taken two alternative scenarios –  one in which nominal GDP growth averages 2.25 per cent, and one in which it averages 3.25 per cent.   Those aren’t extremes, and one could envisage even higher or lower numbers.

But this is what a net debt chart looks like out to 2064.

net debt scenarios

Even on the worst of these scenarios this (exaggerated, because it excludes NZSF assets) net debt measure is back to 30 per cent of GDP by 2050.   That doesn’t seem too bad to me for a one in a hundred year shock (as the government likes to claim) or –  less pardonably –  a one in 160 year shock as the Reserve Bank Governor was talking up the other day.

Of course, fiscal hawks will say, “but what if another really nasty shocks happens in the meantime?”.  Well, of course we would have to face that if it comes –  and it could –  but, as I noted, our net debt at peak is not high by pre-crisis international standards, and isn’t even high by our own longer-term historical standards.

Governments might choose to lower the debt faster, although if real servicing costs remain low it is difficult to see why one would, since faster consolidation involves either higher taxes than otherwise (with real deadweight costs) or less spending than otherwise (and while each bit of spending has its own antagonists, there is a case to be made for most of it).   There is precisely no evidence that anything important would suffer if our net public debt took a trajectory something like the central scenario in that graph.

(Of course, it is a purely illustrative scenario, and the composition of nominal GDP growth does matter to the budgetary implications –  eg faster population growth means more infrastructure demand, faster inflation might mean some unanticipated inflation tax, faster productivity is more like pure gain –  but there is no reason to suppose that if governments can get back to balance (as they repeatedly have now for decades) that we will need anything much beyond that.  Getting back to balance will require discipline and focus –  and a strong credible recovery would help –  but since most of the fiscal measures to date have been avowedly temporary, doing so should not be beyond our political system, whichever group of parties happens to be governing by then.

Doing more

I had a long chat yesterday to a reader who’d read a forward-looking piece I’d written recently and was concerned that in the halls of power there might be insufficient appreciation of just how serious the economic situation is.  My caller was just about to lay off a fairly large chunk of the staff in his company.

I was inclined to share his view –  although it is hard to know what ministers/officials really think, as distinct from the official happy-talk – and have been uneasy that, for example, official forecasts of the unemployment rate getting to, perhaps 7 or 9 per cent were giving some a sense that really things weren’t so bad, and that more or less enough was being done at a policy level.  After all, actual headline unemployment rates are much higher in some other countries (US and Canada), and the unemployment rate here was higher than those forecasts back in 1991/92.  Just this morning on RNZ, the Governor of the Reserve Bank seemed to be suggesting that everything was in hand, and not much more needed to be done by policymakers as a whole.

I went straight from that call to a Zoom seminar put on by the Law and Economics Association on economic policy responses to Covid-19.   There were three economists speaking, none of whom I would usually associate with calls for a more active and interventionist state –  Eric Crampton (New Zealand Initiative), Andreas Heuser (Castalia consultants, and formerly Treasury), and Richard Meade (of Cognitus, also consultants).  The slides for all three presentations are here (and I think they said they are planning to put the video up as well).  None seemed remotely comfortable with the current situation or content that what needed to be done had been done.

I found it interesting that all three were advocating more-liberal state-sponsored/provided access to interest-free credit.

Heuser’s focus was on business credit, noting the risks (of widespread insolvency) that our more onerous lockdown (relative to Australia) had created and the lack of success of the government’s business loan guarantee scheme (and that the new interest-free scheme is available but offers meaningful amounts only for quite small businesses).  He seemed to be arguing for more generous bank-administered schemes (in which, for example, any government credit is more directly subordinated).

Eric Crampton’s focus was mostly on other aspects, but he repeated his enthusiasm for the scheme the Initiative was proposing a couple of months ago, allowing individuals to borrow from the state quite readily.  Repayments would then be made over many years through the tax system –  akin to the way student loan repayments are done – with borrowings to be interest-free up to a reasonable threshold (linked to your past taxable income) and carrying an interest rate for amounts beyond that.

My main interest, though, was in Meade’s proposal, which has apparently been around for a while but which I’d not noticed previously.  He starkly puts the problem this way

meade 1

And goes on to note that both firms and households rely on each other, and (in the large) none could really be confident of their own viability if they cannot be confident of the other’s.  He argues that the numerous support measures rolled out since mid-March have been too scatter-gun and selective to provide any widespread confidence or (thus) willingness to spend.   And they do this, on his telling, even as they rack up a huge fiscal costs, which will be paid (directly, or through foregone options) by generations to come.

His proposal has these features.

meade 2

(Note that his second line means big businesses and existing beneficiaries/public servants would not be eligible.)

As Meade notes, in an ideal world, such a framework would have been put in place three months ago, so that as we headed into the worsening Covid downturn everyone would have had much greater clarity about the buffers that would be in place.  But not having done so then does not mean, so he argues, that it should not be adopted now.

It is an interesting proposal, and among its features Meade sees these

Importantly, they replace government-imposed qualifying criteria and favoured cost lines with “self-selection criteria” and “self-prioritised cost lines”:

– They are “incentive compatible” in that taking out loans is a choice to personally pay higher taxes, which protects against over-borrowing (likely a lesser evil anyway);

– They otherwise rely on households using their private information to determine how much “income insurance” they need to remain able to pay their priority bills, keep their house(etc), and obviate the need for bluntly targeted subsidies.

Relative to the status quo, what Meade is proposing has some appeal, especially around certainty.  If you can’t know what the wider economic environment will look like, at least you can have a sense of what buffers you might have available, and those your customers might have available to them.

But I don’t see what Meade is proposing as viable, in least in the way he proposes (as a substitute for really big additional fiscal outlays).

The first reason is that while he presents it as “ex post income insurance”, it is really nothing of the sort.   When you buy income insurance –  whether privately or through ACC –  you pay your premium along with everyone else and hope you never collect on the policy.  If you do have to collect on the policy, the cost is covered a little by your previous premia, but mostly by the premia of the people who will never claim.

By contrast, Meade’s suggestion isn’t income insurance, but simply “liquidity insurance” –  as he notes, anti-slavery laws mean you can’t generally borrow secured on your future income, but Meade’s scheme ensures you can borrow if your income takes a sharp hit (his concern here is mostly for people for whom the welfare system provides a very low income replacement rate). But you, and only you, will pay every cent of the amount you borrow –  secured, through the tax system, secured against your estate, so really only written off in extremis.    

And he wouldn’t even make it available to big companies, even though big companies employ lots of people, make lots of investment choices etc etc.

And although his aim is to support confidence and demand  –  by giving everyone a sense that everyone else has access to liquidity and, thus, spending power –  I don’t think it would have done that very effectively (even relative to the policies the government has adopted), particularly note for households.  Lots of people –  having just lost their job, or fearing doing so –  would be very very reluctant to take on lots of new debt in the middle of a crisis, and instead would choose to cut their spending to the bone –  precisely what Meade hoped to avoid.    For small and (particularly) medium businesses, what Meade proposes is better than what we have, but still suffers from the weakness that (a) many firms probably won’t be coming back, and there is no particular public interest in them doing so (one motel in Rotorua is much the same as another, and so on) and (b) many businesses simply will not support more debt.

And the political system would just not be willing to stand by and say “well, you are on your own –  you had the option to borrow and chose not to do so”.  It would intervene with grants as well (as it has done, is doing).   That is actually more like (although still not close to) what a risk-pooling insurance scheme looks like –  those of us lucky enough not to lose our jobs help fund the support for those who did lose theirs (in, as Meade puts it, an “unprecedented correlated shock” where people find themselves in deep strife (again in his words) “through no fault of their own”.   (I could also note that many households –  any with significant equity in their house –  have significant borrowing capacity anyway, without a new scheme).

I wrote about Meade’s scheme for two reasons.

The first is that I was struck by the fact that all three speakers at yesterday’s seminar favoured interest-free loans, including to businesses.  Meade’s was the most developed model presented, and encompassed both households and businesses.  The government seems to agree that zero interest is about the right rate at present –  that is the rate it is lending at to those SMEs borrowing under its latest facility, and these won’t be the safest conceivable borrowers around.    So these market-oriented –  perhaps even “right-wing” – economists reckon zero interest makes sense at present, and the centre-left Minister of Finance seems to think so too (his revealed preference). The one person who doesn’t, of course, is the Governor of the Reserve Bank, who was heard on RNZ this morning  saying that retail rates were “about right at present”.    We all have a pretty good idea of where mortgage rates are at present –  nowhere near zero –  but check out interest.co.nz’s table of the multiplicity of business lending rates.     We are in weird position where, faced with a huge deflationary adverse shock, the central bank’s Monetary Policy Committee is holding interest rates, for existing and new customers, well above where they should be.

The second reason for highlighting Meade’s scheme is that it gives me an opportunity to champion again my own proposal, first outlined in mid-March, which was designed to achieve quite a lot of what Meade was looking for.    That was the proposal that the Crown would guarantee 80 per cent of last year’s net income for 2020/21, for individuals and for firms.  Unlike Meade’s scheme, it would be quite costly to the Crown –  although I believe no more costly than the scattergun approach currently being rolled out will end up costing –  but it also offers genuine insurance, in which over time all chip in to cover some of the losses of those who were most severely adversely affected.

The most recent write-up of that proposal was in this post.   That was a while ago now.  I still reckon the basic framework remains the best option for conceptualising assistance (I saw other assistance as, in effect, credits that would be netted off against the “income insurance entitlement”).

In the spirit of ACC, if I were devising the scheme from scratch now, I might consider capping the payout at 80 per cent of individual incomes of up to $150000, with no compensation for losses on the income above that threshold.  I might also consider guaranteeing not 80 per cent of last year’s net income for companies, but guaranteeing company net income at zero (or last year’s reported loss) –  in other words, insuring that hitherto profitable companies did not go deeply negative, while recognising that profit variability is a much more natural phenomenon –  every business every year – than labour income extreme variability.  Each of those refinements would save money, but they would also complexify the system in ways that would have to be carefully considered if any government were to think the broad approach had merit.   The broadbrush simplicity and certainty of the scheme –  not playing favourites, not distinguishing large and small, simply buying time and providing some certainty –  was the appeal of the scheme.

Of course, many of these schemes  –  and the government’s own interventions – are focused on the immediate situation, stabilising things in the short-term.  But a year from now it is most unlikely that the economy –  ours, or those in other advanced countries –  will be anything like right again.  There won’t be huge new fiscal capacity –  not because of technical limits, or market constraints, but the realities of public tolerance –  and that is where monetary policy should be doing its job.  Much lower interest rates now aren’t mostly about boosting demand/activity now (the lags are simply longer than that) but about putting in place the right price signals –  cost of domestic credit, returns to domestic depositors, and (perhaps most importantly) the exchange rate –  that will support bringing private demand forward, and drawing private demand towards New Zealand producers, to get as back to full employment just as quickly as possible.

A mixed bag

The Reserve Bank’s Financial Stability Report this morning was something of a mixed bag, to say the least.

I’ll deal with the positive bits first. the discussion of stress tests of bank balance sheets, in the face of the very severe adverse economic shocks (of the sort we are seeing now –  whether the more optimistic takes of official agencies, or rather more severe economic loss/slow recovery scenarios).

Here is their summary take

Stress tests

Which is good, both the prominence of the discussion (this clip is from the cartoon summary) and the bottom-line conclusion.

The Bank discusses three scenarios

stress 2

And here was the summary commentary

stress 3

As they note, these conclusions – now in the midst of an actual unfolding event –  are not dissimilar to those from past stress tests. In at least one of those, house prices falling almost 50 per cent and unemployment staying around 12 per cent for several years didn’t create too many problems.  And it is a combination of a deep, reasonably sustained, fall in house prices AND a substantial sustained rise in unemployment that gives rise to substantial losses on residential loan books.  If just house prices fall, people will usually keep on paying their mortgage (including because few can effectively just walk away), and if just unemployment rises (and house prices fall only say 10 per cent), people might be in trouble, but banks can still recover most of their money.

So all of this is good –  the discussion, and the robust banking system.  It was the standard message the Bank used to tell people.  But then it became inconsistent with the other “causes”.  Wheeler wanted to put on LVR restrictions, for which stress test results were inconvenient.  And then the new Governor got a bee in his bonnet about wanting banks to have much more capital in their overall funding mix.  So for a year or more, while he tried to make his case for much much higher effective bank capital ratios, the stress test results –  consistent over years –  were played down, and often almost dismissed.

Then, of course, reality interjected itself, and now the Governor is quite content to run lines about how sound and robust our banking system is –  in the face of such a savage shock –  and how enlightening stress test results, preliminary as the current ones are, can be.

I would encourage people to believe the Governor on this one.  But changing your tune so dramatically, when it also happens to suit –  central bank Governors and supervisors will always want to play down risk once a crisis looms – isn’t that great for your longer-term credibility.  If the Board and Minister were doing their jobs, it is an issue they would take note of, and seek to remedy.

That was the good bit of the FSR.

There was also lots of spin.  It is old ground and I’m not going to repeat it all here.  Suffice to say that they continue to claim that monetary policy has done a lot, both through the OCR and the LSAP.   That means they are keen to emphasise the current level of the OCR, but not how little it has changed since the economic situation changed –  surely the only relevant metric, even in their modelling.  They talk about falls in interest rates, but never once mention the drop in inflation expectations, which means real interest rates haven’t changed much at all.  And they continue to hype the benefits of the LSAP, far beyond anything a careful reading of the data will support.

And then there was the notable omission.   Despite “efficiency” appearing in all their governing legislation as a consideration in shaping and applying prudential policy, there appeared to be no mention at all of the huge and persistent margin between retail term deposit rates in New Zealand and rates on other domestic liabilities with the same credit risk.  I discussed the issue at some length in a post last week.

retail and wholesale margins

(Yes, it was a little embarrassing to end that post suggesting that the Bank look again at its Core Funding Ratio requirement, only to learn shortly after that they had already done so quietly in March.  I should have remembered that, although in my slight defence I had checked on the Bank’s Core Funding Ratio page which then –  and still today –  does not mention the reduction, suggesting that the CFR is still 75 per cent.)

There appears to have been a further fall in term deposit rates overnight.  But if ANZ –  offering the lowest rates of the main banks at present –  is offering 1.8 per cent here for 6 month term deposits, six month bank bill rates are about 0.25 per cent. one year swap rates are also about 0.25 per cent.    And at the same time, ANZ in Australia is offering 0.9 per cent for six month AUD term deposits.   Here is chart using data from the RBA website.

RBA retail

Over the last decade, retail rates have been very close to wholesale rates, and although there is a gap at present, it is far smaller than the comparable New Zealand gap.  (And, of course, Australia’s inflation target is higher than New Zealand’s, so if depositors treated that target as credible, retail deposit rates in Australia (inflation target midpoint 2.5 per cent) would be deeply negative, while even with those new ANZ rates New Zealand’s would be barely negative at all.)

Given that the Reserve Bank has eased the CFR it is a bit puzzling why such a large wedge endures: it cannot be an sustainable equilibrium market outcome for instruments of identical credit risk (and at the margin, retail term deposits may have less credit risk than wholesale, given that bailout probabilities range from very high to almost certain).

In the circumstances one might have hoped for some analysis of this issue from the Bank in the FSR –  it being relevant both to the efficient functioning of the financial system, and to the effective stance of monetary policy (given MPC’s refusal to cut the OCR further).  It cannot be about credit ratings or ratings agency insistence (given that these are the same banking groups).  Perhaps there is some small element of customer resistance to lower rates here, but that doesn’t really stack up given how far retail rates have fallen over the years in Australia.

One possibility is that the Bank’s cut in the OCR is not being treated by the banks as credible relief for any material period of time.  The easing was announced at the height of the mid-March panic, and no timeframe was put on it.  There is still no timeframe, and no discussion in the FSR of how banks’ funding managers and Board might treat such indeterminant regulatory relief.  If, for example, banks thinks the Reserve Bank might snap the CFR back to 75 per cent once offshore funding conditions ease –  and a chart in the FSR suggests that might not be too far away, at least in price terms –  they’d be very hesitant about changing their entire funding, and marketing, strategy, and risk alienating customers they might need to court very soon.  I don’t know if that is the explanation, but it would certainly be consistent with what we’ve seen (movement not seen) in markets.  If the Bank was serious about closing these gaps –  and perhaps it isn’t  –  the sort of multi-year commitment to a lower CFR –  as I proposed in last week’s post –  would be a better approach to take.  As it is, we seem stuck with this gross inefficiency in our markets, and with retail interest rates well above those in (notably) Australia, despite the very difficult economic times and (on the Bank’s own telling) below-target inflation outlook.

And if there was no discussion of how banks might behave when given no timeframe (re the CFR) , I could also see no discussion of how banks might respond when there is a timeframe.  The Bank has removed the LVR restrictions for a year, and delayed the commencement of the higher capital requirements for a year.  In Covid-time, a year might seem an awfully long time, but it really isn’t if you are running a business like the big banks.    If the Governor is really going to insist next year that minimum bank capital requirements have to start rising again, that will very soon –  if not already –  be affecting bank behaviour, pricing, and so on.

The Governor has made much of buffers, and leeway, (all supported by no specific calculations), but if he is determined to stick with 2019’s plan, just delayed a year, that will impede credit availability to support the recovery.   Again, given the Governor’s confidence about stress tests etc, it would be far better to simply scrap the higher capital requirements –  perhaps keep a few useful detailed refinements –  and suggest the Bank will take another look in  five years’ time.  If the Governor is right about the stress tests, in a really savage adverse shock, those proposed higher capital requirements will prove never to have been needed.  And if he is wrong, the next five years will be spent working through loan losses and gradually rebuilding capital ratios to current levels –  much higher ones still can wait quite a few years (by when, on current government plans, new legislation will have provided a better governance framework for bank regulation, and removed the Governor’s sole power to pursue regulatory whims).

Just how little interest rates have fallen

There was a little flurry of media coverage over the weekend about the latest set of cuts in retail mortgage interest rates.  But it is worth keeping these changes in some perspective.

The Reserve Bank publishes monthly data for the “special” rates advertised for new borrowers (or those moving to another bank) and we can get a read of current rates from bank websites, as summarised in the tables on interest.co.nz.

So how much have residential mortgage rates fallen since the coronavirus slump began?  As it happens, rates had been pretty stable for several months up to February, so this chart compares the latest rates on offer with the average for the period November to February.

special mortgages

For most maturities, that’s not nothing.

On the hand, these are nominal interest rates.  And we know that the expected future inflation rate has fallen.   There is a variety of measures, survey-based and market.  The one the Reserve Bank has typically paid most attention to is the two-year ahead measure in its quarterly Survey of Expectations.  On that measure, inflation expectations have fallen by 0.62 percentage points since the pre-crisis period (the one year ahead measure shows a larger fall, the ANZ one year ahead measure a smaller fall).

Apply that fall in inflation expectations to those “specials” and the real –  inflation-adjusted – version of the chart now looks like this.

specials 2

I guess there is still a slight reduction in longer-term real rates, but…..not many people in New Zealand fix for four or five years.  The market is concentrated on the shorter-term fixed rates (at present, it appears, the 18 month term) and there has been no reduction in real interest rates there at all.

Term deposit rates have come down a bit more too.  But here is how the chart of those rates looks if we compare current rates with those around the turn of the year.  I’ve shown the nominal rates and real rates (using the same drop in inflationn expectations as above) on the same chart.

TD may 20

Pretty much across the board, real term deposit rates have risen slightly since the crisis began (including at what appears to be the most competitive part of the market, for terms of 6-12 months).  It is an odd response to a really serious economic slump.

Don’t blame the banks, or depositors for that matter; this is about choices made by the Reserve Bank Monetary Policy Committee – the prominent ones (Orr especially) and those faceless unaccountable external ones (Buckle, Harris, Saunders), all appointed by the current Minister of Finance.

The Governor keeps talking about getting interest rates as low as possible.  But they clearly aren’t – term deposits are mostly still a bit above 2 per cent (and far higher than in Australia) –  and yet the MPC has pledged, and repeatedly reiterated its dogmatic commitment based on no published analysis, to not cut rates any further until at least next March, still 10 months away.

And yet this is a really serious downturn.   Everyone seems to agree on that.  All the unemployment predictions –  even with the temporary cover (keeping people out of the official statistics) of the wage subsidy scheme –  involve higher peaks than we saw in the 2008/09 recession.  Even with big fiscal commitments, nominal GDP is expected to be way lower than previously expected, and the Bank expects to undershoot the bottom of its inflation target for a couple of years (for which there was nothing comparable in 2008/09).

How, then, did retail rates (real and nominal) behave over 2008/09?  Recall that that was an event that had its foundation in financial system problems, and even if the credit concerns weren’t specific to New Zealand the problems affected our banks’ access to funds, pricing etc.

The data are bit thinner for that period.   The Reserve Bank was only publishing “standard” mortgage rates, and single (six month) term deposit rate.  Oh, and it is a bit less clear when to date comparisons from.  Retail rates had gone on rising into 2008 (with the Bank’s acquiescence) as offshore funding costs were rising, and at the other end, shorter-term rates kept dropping further into 2009 than longer-term fixed rates did.    Inflation expectations also fell during that recession, on the Bank’s two-year ahead measure perhaps by about half a per cent.

But this is what happened from the end of 2007 to April 2009. (Changing start or end dates changes some of the numbers –  either way – by up to perhaps 50 basis points, mostly small on the scale of this chart.)

0809 retail

In other words, falls in retail rates (at the horizons where most of the business was written) of hundreds of basis points.   And that, in the Bank’s view (correctly as it turned out) was consistent with keeping inflation in the target range, even if not quite as high as they would have liked).

The Governor keeps claiming that his Large Scale Asset Purchase programme –  buying huge amounts of government bonds now yielding less than 1 per cent, in exchange for issuing huge amount of Reserve Bank deposits currently yielding 0.25 per cent –  is hugely effective and a fully adequate substitute for choosing not to do more with the OCR.    One can get down in the weeds of detailed arguments about what the LSAP may or may not be doing at the margin to bond rates or swaps rates, but whatever those effects may be –  and I reckon we are pretty safe in concluding that they are mostly small –  the rates that firms and households are actually receiving/paying is the bottom line.

In real terms, the household rates shown above have hardly moved at all, and there is little or nothing to suggest that picture facing businesses will be materially better (eg headline SME rates have fallen no further, and many larger businesses have facilities on which they pay a fixed margin over bank bill rates.  Bank bill rates have fallen by about 1 per cent since the start of the year, so in real terms a fall of perhaps 0.4 percentage points.  The contrast to 08/09 remains striking.

Of course, there is also the exchange rate.  The Governor claims to be successfully influencing it as well.   It is always difficult to know where to date comparisons for exchange rates, but here I’ve shown the fall in the exchange rate in the last two recessions:

  • for 08/09 the average in April 2009 relative to the average for the second half of 2007, and
  • for the current event, yesterday’s TWI relative to the average for the second half of 2019

TWi recessions

Monetary policy just is not doing its bit, even once all the fiscal support is factored into the projections.  That is a pure choice by the MPC.

We don’t know why they’ve just chosen not to do their job –  aiming for 2 per cent inflation and, as much as they can consistent with that, supporting a speedy return to full employment.  Last year, MPC seemed to embrace their mandate with some gusto. Now they appear like stunned animals caught in the headlights, uninterested in doing what they are paid for –  all while their spokesman keeps claiming to be doing a lot.

It is pretty reprehensible, and I find it quite remarkable that the MPC –  all of them, not just the Governor –  have not been asked harder questions about their failures.  Instead, much of the media seem to treat their acknowledged failure to ensure that banks’ operational systems etc were ready for negative rates as just “one of those things”, as if it could happen to anyone –  never for example drawing the contrast with Y2K, when the Bank proactively ensured it and the banks were ready, with contingency plans as well.   And notwithstanding that all of the data in this post are readily available, none has been yet heard to ask the Governor –  and his MPC –  why they are content with such trivial changes in real interest rates even when, with all their avowed enthusiasm for it, in combination fiscal policy and monetary policy in combination still have the Bank quite openly acknowledging that inflation will undershoot, and apparently not very bothered about the unemployed either.

Of course, the Minister of Finance bears responsibility for all this, and for all the individuals involved. Perhaps an Opposition that wanted to ask hard questions about the government’s stewardship at present –  even perhaps flag a different more pro-active approach –  might ask him just why he thinks it is appropriate for real interest rates to have hardly changed at all (and the real exchange rate not much more), even as he is willing to lend to the weakest business credits are far lower rates than his central bank’s monetary policy would support more generally.

Financing the government

In normal circumstances governments finance themselves primarily with visible legislated taxes, with a bit of additional debt on the side.

In New Zealand, over the last complete 10 years, core Crown revenue was $715 billion (mostly taxes) and debt contributed between $10 and $40 billion –  depending which gross or net measure you prefer.    That borrowing was almost all from the private sector, again as one would expect.  The Reserve Bank’s holdings of government bonds. for example, hardly changed at all (nor did bank settlement cash balances at the Reserve Bank).   And the government mostly had credit balances in its account at the Reserve Bank.

In the last couple of months, everything has been thrown up in the air.   On the Budget numbers I mentioned in Friday’s post, almost a quarter of government spending over the five years (including 2019/20) is expected to be financed by increased debt.   And on the Reserve Bank’s own numbers we could easily see at least half of that increase in debt take the form of Reserve Bank lending to the Crown (the forecast rise in net debt is $134 billion, and the Governor has talked of the possibility of raising further the current $60 billion limit on the LSAP programme).

That the Bank is buying those bonds on the secondary market, rather than getting some or all direct from the government (as some advanced country secondary banks are now doing to an extent), is a second or third order issue, making little or no macroeconomic difference.   The important point at present is that (a) the Bank is buying the bonds, and (b) the Bank is sterilising the liquidity effect on those purchases by paying an at-or-above market rate on the resulting settlement cash balances.

Oh, and the most important points of all were that the decision to buy bonds at all is (a) wholly a decision for the Monetary Policy Committee, and (b) working with an unchanged (from pre-crisis) mandate: delivering inflation near 2 per cent and, as much as it can consistent with that, supporting employment.  The government has given the Bank an indemnity, which makes the Bank feel more comfortable taking the associated interest rate risk, but if the government had not done so, it need not have stopped the Bank making the purchases if the MPC felt that was what the monetary policy mandate required.

I wrote about all this a month ago when there was first a flurry of concern about reported comments suggesting that at some point the Bank might buy bonds direct from the Crown, in a post intended to be basically supportive of the Bank.

Now, as you know, I don’t think the LSAP is making much difference at all now to anything that matters much to macroecononomic outcomes.  It is slightly perverse in that it involves shifting the duration of the Crown’s effective debt portfolio much shorter –  swapping long-dated government bonds for on-demand instantly repriceable settlement cash liabilities –  but if you believe interest rates are going to be low for quite some time, you might even downplay that.  Other than that, it probably does little harm –  and adds to our database of monetary experiments for future analysis – if little good.

But in the last couple of weeks there have been a number of comments from the Governor that suggest that something much more troubling is afoot.

The first hint I heard of it was when the Bank turned up to Parliament’s Finance and Expenditure Committee on the day after the Monetary Policy Statement.  This is an extract from the post I wrote then.

Goldsmith asked the Governor about those comments a few weeks ago that the Bank could consider buying government bonds directly from the Crown, rather than (as at present) in the secondary market.  He seemed to just be wanting to close off the issue, but the Governor opened it up all over again, in a way that seems to have attracted no attention.

The expected answer would probably have been along the lines that there were no plans at present, the secondary market was working well, but if there ever were dysfunction there was really no macro difference in the Bank buying direct, so long as the decision rested with the Bank, consistent with the inflation target.   In backing the Governor on this point previously, that is what I have said.

Instead, the Governor launched into a discussion noting that while the Bank did not rule out lending direct to the Crown, that was really fiscal policy not monetary policy, that the central bank can always lend as much as fiscal policy requires, but that that would be a matter for the government to decide, not the Bank.

Goldsmith then challenged him on that, asking whether he was really saying that the Minister could decide whether the Bank would lend direct.  Orr reiterated the possibility of market dysfunction, while noting that at present markets were functioning well, but then repeated that what he called “pure monetary financing” would be a matter for the Minister of Finance to decide.

At this point, the Governor invited the Deputy Governor Geoff Bascand –  usually the safe pair of hands in that senior management cohort –  to comment.  He indicated that it would be a matter of ministerial direction, but which would involve a substantial process including looking at whether what the minister might be directing would still be consistent with the existing price stability etc target.  And then he tried to close things down by suggesting that this was all just an “esoteric discussion”.

Reasonably enough ACT’s David Seymour reacted to that, suggesting that if the Bank was seriously saying the Minister of Finance could direct them to lend to the government, in any amount he chose, it was “anything but esoteric”.

I went on to articulate the (possibly) relevant provisions of the Act as I saw them, concluding

But……there is no hint in this provision [section 12 override powers], or anywhere else in the Act, suggesting that the Minister of Finance can direct the Bank to lend to the government.  Perhaps the Bank and its lawyers think/worry that “lend to the government at zero interest up to $…billion” is an alternative “economic objective” within the meaning of section 12 of the Act.   But, at very least, it would be a stretch –  it isn’t an “economic objective”, but an instrument,  and favouring one specific party in the economy.    And note that if a government did attempt to impose such an “economic objective” there would still be nothing to stop the Bank setting interest rates for the rest of the economy at a sufficiently high level to counter the inflationary effects of this coerced lending.

I’m at a loss to know what the Governor and Deputy Governor mean.   I’m tempted to lodge an OIA request, but am not sure I’ll bother, as they would find myriad ways to refuse to release anything.  But journalists could directly ask the Bank what the Governor/Deputy Governor were on about?   MPs could use parliamentary questions to ask the Minister of Finance whether (a) he has received any advice as regard his direction powers over the Reserve Bank, and (b) whether he or Treasury believe he has the statutory power to compel the Bank to lend to the Crown.  Most everyone I’m aware of has always assumed they can’t –  and took great reassurance in that –  so if the powers that be now believe differently we deserve to know?    (Of course, if the government just wants more inflation, it can always raise the inflation target, but that is a rather different issue).

And there I left it, a bit puzzled, none the wiser, and even wondering whether Orr had perhaps confused some details and there really wasn’t anything to worry about.

At least until over this last weekend.  Then I happened to listen to a post-MPS presentation Orr had given to clients of Jardens (on 15 May), in which he touched on the issue and noted that (paraphrasing from my notes) “if we were to take a direction from the government to finance it directly – as distinct from what monetary policy needs might imply – we would have to have different legislation”

I then read an interesting interest.co.nz article reporting comments the Governor had given to their journalist Jenee Tibshraeny late last week in which this topic was addressed at some length.

Orr said it was up to government to decide if it wanted to go further and give the RBNZ the mandate to buy bonds for fiscal policy purposes, rather than monetary policy purposes – IE buy bonds to help pay for government spending initiatives rather than to keep inflation and employment in check.

“There’s no right or wrong,” Orr said.

“It’s just that it is different and you would need legislative and/or institutional instructions, because when I last looked at my job description, I’m not allowed to go off and buy whatever I feel like because I’ve got the ATM…

“That would take some significant transparency as well as operational structures to ensure everyone knew who was doing what, why, how, where, when.”

Asked whether he would be hesitant to go down this path if Robertson asked him to, Orr responded: “Yes, I mean, it really depends to what purpose… and under what conditions is this managed.

“Because you could take it to the extreme immediately and you’ve gone back in time 30, 40 years and the central bank is being used as the ATM for a government and it’s unclear whether we can control inflation anymore, and it’s back in the hands of the elected officials…

“It’s not for me to choose the policy. I would implement the policy, but I would be extremely cautious about making sure the risks are understood, managed and mitigated wherever they could be.

“And I imagine I would be surrounded by many many people with free and often unsolicited advice around whether it did or didn’t work… which is good…

“People are very passionate about the structures that have been built and you don’t muck around with them lightly.

“These things are achievable; they’re just different.”

On the one hand, it is good to know that the Governor seems to think that under current law he can’t just go and buy anything he likes (he probably can, but it has to be consistent with the Bank’s statutory functions, including the monetary policy Remit the Minister has given him, which in turn is subordinate to the Act).   But then note those Bascand comments earlier suggesting the Bank thinks it could be directed under existing legislation, even if that might involve overriding or changing the Remit.

The Bank has clearly been giving such radical options quite a bit of thought, not just as extreme contingency plans (Parliament, being sovereign, can empower almost anything) but as something they are quite openly talking about.    That suggests something that they are either keen on themselves, or which the Minister and/or Treasury has raised fairly seriously as a possibility.

Given the Governor’s longstanding belief in a bigger government and a more aggresssive use of fiscal policy, it wouldn’t be entirely surprising if this were something he was championing (indeed, it would be the best explanation for why (a) he is the only one talking about it, and (b) doing so in a non-negative sort of way).

Going down such a path would, however, be a seriously retrograde step. Perhaps it might lift inflation expectations a bit –  governments acting to direct the central bank to lend to them will create some concern – but in a quite undesirable sort of way (even if Social Credit and the more rabid MMT enthusiasts might be salivating at the prospect).

For a start, there is no obvious need for such a mandate.  The New Zealand government is a highly creditworthy borrower which, on current government plans, will remain one of the least-indebted of all the advanced countries.   One can never rule out a new extreme global crisis that might seize up markets for a few days, but the prospects of the New Zealand government not being able to issue on market the quantity of debt believes it requires is slim indeed.   And the Crown already has an overdraft facility at the Reserve Bank that it can draw on to smooths ups and downs.

More disconcertingly, although technically the Reserve Bank could be required to lend to the government –  beyond anything consistent with the Remit –  and that wouldn’t immediately tip us into serious inflationary problems, it would be a highly distortionary policy.  In principle, the Bank could lend lots of money to the Crown at zero interest, and the government then further increases its spending beyond what would normally be consistent with the inflation target. If that happened, you would expect the MPC to start raising the OCR, to keep overall demand in check.  And then we’d be in the bizarre throwback world in which the government was borrowing for zero and the rest of the economy faced really quite high interest rates, squeezing out private sector activity to favour the government.

I’m not going to allow myself to be drawn into an inconsistency here.  At present, if anything, the presenting issue is that the Reserve Bank is not doing its core monetary policy job sufficiently well that either the market, survey respondents, or the Bank itself believe that inflation will be consistent with the target set for them.  If they persist in that stance, amid a really savage recession, I believe the Minister of Finance should act, using existing powers either to replace the key individuals (to ensure the current Remit is being followed) or to explicitly direct the Bank to adopt an easier monetary policy (consistent with the current Remit over the medium term).  Those powers are in the Act for a reason, to protect citizens.   There is no such power to direct the Bank to lend to the government and there has long been an international consensus that it would be quite unwise to provide for such a power.  It would be to step away from any sense that monetary policy operates in a neutral way, not setting out to favour or disadvantage any particular party or sector (private or public), and into a world where governments could regard control of the “printing press” as an acceptable way for them to finance their spending (or reluctance to tax) preferences.  With reasonable people, it isn’t some immediate path to hyperinflation, but it would be undesirable on numerous counts and further increase the politicisation of the Reserve Bank.

One can make an argument against central bank operational autonomy –  I sometimes come and go and whether there are real advantages that justify the costs and lack of accountability (part of the reason why I keep on about enhancing real central bank transparency) – but giving the government reason to think control of the printing press is a legitimate tool has nothing going for it at all.

We need some answers as to just what is going on.   When I tweeted about this on Saturday, Tibshraeny responded

That is encouraging, and I will look forward to her story.  But if Robertson –  who always seem conservative and risk averse (sometimes beyond what is warranted) – is not interested, then what cause is Orr championing, to what end, and why?

If he thinks more macroeconomic stimulus is required, try conventional monetary policy (would have helped, of course, if he’d sorted out those alleged “operational issues” some banks are claimed to have, but even those obstacles exist they can be overcome).  If the governments thinks it needs to spend more, the conventional options are still open to them –  higher taxes (probably not a great idea at present) or tapping the global market for public debt.  Maintaining that borrowing capability was, as you’ll recall, one of the main reasons why successive governments kept net debt low and stable.  (Of course. it also has a $40 billion fund –  which it insists on putting more money into, even as its new borrowings are large, to speculate on world markets –  much of which could be quite readily liquidated.)

 

 

Still avoiding scrutiny and accountability

I’m not one of those inclined to join the new Leader of the Opposition in describing the government’s handling of the coronavirus situation as “impressive”, but sometimes other people are just determined the make the Cabinet and core government departments (notably Health, Treasury, DPMC) look not bad at all.

Transparency is one of those issues.  I was critical –  and still am –  about how slowly the government released key official documents relevant to the crucial decisions taken at various stages in March and April.    Difficult decisions made, inevitably, with partial information, and with consequences (either way) that are huge by the standards of any typical government decision should have been accompanied by the near-immediate release of all the significant relevant analysis and advice.

Nonetheless, and to their credit, the government is slowly getting there.  There was a big proactive release a couple of weeks ago of all sorts of central government documents (mostly advice to ministers and Cabinet papers) – individually important or not – on the coronavirus situation from the start of the year until mid-April, and there is a promise of another batch presumbly sometime next month.   What is done is now done, but the release of those papers –  many of them written to very short deadlines and in the fog of war – helps us, as citizens and voters, assess the quality of the central government advice and decisionmaking process.  And since Covid hasn’t gone away, it may even help clarify where improvements might be made –  even demanded –  in government contingency planning against the risks of further problems.

But, of course, there are other public sector agencies operating at arms-length from ministers, exercising a great deal of discretionary power (including through the Covid crisis), and not covered by the government’s own pro-active release.   I’m thinking most notably of the Reserve Bank and, these day, the Monetary Policy Committee, a statutory body –  members each appointed by the Minister of Finance –  charged with the conduct of monetary policy.

Without any great optimism about a positive response, and fully expecting the request would simply be the first step on the path to an appeal to the Ombudsman I lodged an Official Information Act request on 20 April.

I am writing to request copies all papers prepared by or for staff or
management of the Reserve Bank for the Monetary Policy Committee in
2020.

I am, of course, well aware of the Bank’s typically obstructive
approach to releasing such official information in normal times.
However, given the scale of the events the Committee has been
grappling with this year, the magnitude and unusual/unprecedented
nature of many of the interventions (and decisions on occasion not to
act), the scale of the economic and financial risks the wider public
and the taxpayers are being exposed to, there is a clear and strong
public interest in the release of these particular papers, without
necessarily creating a precedent for more-general release of MPC
papers.  In addition, I would note that the succession of meetings
this year, and the fast-moving nature of events, means that papers
written even a month ago are already likely to have aged beyond the
point of immediate market sensitivity much more quickly than would
normally be the case.

Public accountability demands much greater transparency.

“Typically obstructive approach” refers to the Bank’s adamant refusal to release any papers relating to monetary policy decisions, at least unless they are perhaps 10 years old (they did once release a set of those, and I haven’t tested whether the effective threshold is 3, 5, 7 or 10 years past).

“Public interest” is in reference to the provision of the Official Information Act which states that for many of the possible withholding grounds

Where this section applies, good reason for withholding official information exists, for the purpose of section 5, unless, in the circumstances of the particular case, the withholding of that information is outweighed by other considerations which render it desirable, in the public interest, to make that information available.

I had a reply on Thursday. In fairness, at least it was only a day or two beyond the 20 working day deadline, although I doubt it took the Bank any time at all to decide its response.  The substance didn’t really surprise me at all, even if it was a disappointing reflection on the continued refusal of the Reserve Bank to accept that the principles of open government, the principles of the Official Information Act, apply to them and to the Monetary Policy Committee as well.

They pointed to the various press releases and Monetary Policy Statements (which, personally, I wouldn’t have thought were in scope, although that is beside the point) and went on

We are withholding all remaining information within scope of your request under the following grounds:
 section 9 (2)(d) – in order to “avoid prejudice to the substantial economic interests of New Zealand.”
 section 9 (2)(g)(i) – to “maintain the effective conduct of public affairs through the free and frank expression of opinions by…members of an organisation or officers and employees of [an] organisation in the course of their duty.”

We have considered your views regarding the need for the information to be released including, the scale of the events the Monetary Policy Committee has been grappling with this year and potentially, strong public interest in the release of these particular papers.

The Reserve Bank is currently conducting monetary policy in an environment of great uncertainty and market volatility. In these circumstances it is especially important that the MPC has the space to assess all the available information, select monetary policy tools, convey clear messaging through its Monetary Policy Statements, and evaluate its actions as it proceeds. The release of such recent MPC papers would be likely to interfere with the effective implementation of monetary policy.

As you are aware the Reserve Bank has a statutory duty to make official information
available unless there is good reason for withholding it. In this instance the Reserve Bank believes that there is good reason for withholding the requested information and that the public interest in releasing it does not outweigh the reasons for withholding we have listed above.

Note that the request was not for every casual email staff and management might have loosely exchanged over the months, it was for the papers prepared for the Monetary Policy Committee, a statutory body that the Governor (who also sits on the Committee) and staff advise and service.

There is a close parallel to the way (a) government departments advise individual ministers, and (b) the way an individual Minister’s Cabinet paper seeks the approval of his/her colleagues.  Advice and recommendations and analysis flow to decisionmakers, and decisionmakers decide.  Sometimes that advice is poor, sometimes good, sometimes necessarily rushed, sometimes not.  But to their credit, the government has released the significant bits of advice/recommendations –  whether or not each of those pieces of advice make advisers or decisionmakers look good, whether or not decisionmakers accepted that advice or not, whether or not the advisers might now wish they’d advised something different?

What make the Reserve Bank –  the Governor as chief executive, or the statutory MPC he chairs –  think it should be exempt from that sort of scrutiny and transparency, through one of the most dramatic periods of modern times (including as regards monetary policy)?

One of the excuses the Bank has sometimes advanced for withholding monetary policy materials is that releasing them might give away information about future strategy.  Even if that were true, it is really grounds for selective redaction, not broadbrush refusal, but at present it is a particularly absurd argument.  For example, my request encompassed papers relevant to the February MPS –  you’ll recall that that was the one in which they played down coronavirus and were rather optimistic about the rest of the year, adopting a very slight tightening bias.  Whether or not those were reasonable views at the time, they were long since overtaken by events. Nothing in the advice and analysis provided to the MPC for that MPS has any possible bearing on actions the Bank or market is taking now.

But take more recent events.  The MPC issued, and has since reaffirmed, their pledge to not cut the OCR for a year.  They provided no supporting argumentation or analysis for that stance, but presumably there must have been some analysis and advice, perhaps around these mysteroius “operational obstacles” that the Governor, as the MPC’s spokesman, keeps referring to.

Or the LSAP programme?  Surely there must be staff analysis and advice, provided to MPC under the imprimatur of the Governor, on the likely effects of such a programme?  What possible grounds can there be for simply refusing to release any of it (as distinct perhaps from withholding specific paragraphs touching on the implementation plans for example)?

All the excuses about

In these circumstances it is especially important that the MPC has the space to assess all the available information, select monetary policy tools, convey clear messaging through its Monetary Policy Statements, and evaluate its actions as it proceeds. The release of such recent MPC papers would be likely to interfere with the effective implementation of monetary policy.

could no doubt equally be argued by officials in Health and Treasury etc, or by Ministers.  But to their credit, ministers have recognised the importance of openness and put the advice out there – rushed and perhaps inadequate, rapidly overtaken by events, as sometimes it inevitably was.   And at least Ministers have to face the electorate in September, but the only effective accountability for the Governor and his MPC (many of whom refuse even to be interviewed) is the sort of openness and transparency that the OIA has long envisaged.

The Bank likes to claim that it is very transparent, but solely on its own terms and its own definitions. Transparency does not mean telling people what you want them to hear when you want them to hear it –  everyone does that, in their own self-interest.  Transparency is about the stuff you sometimes find uncomfortable, even embarrassing, or just very detailed, but which you put out anyway.   Had she wanted to the Prime Minister could have run the sorts of excuses the Bank did –  claiming that she held a press conference every day and ran full page adverts in newspapers every day telling people what she thought they needed to know then –  but to her credit she is better than that, and recognised the very strong public interest in much greater transparency –  some of which might put her or her officials in a good light, some not.  It is what open government is about.

I’ll be referring this to the Ombudsman, and perhaps seeking from the Bank all material relevant to their consideration of this particular request, but if the government is serious about its commitment to openness and transparency, it is past time for the Minister of FInance to have a word with the Governor and with the others he himself appointed to the MPC, and with the chair of the Bank’s Board –  whom he appointed –  and strongly urge, come as close to insisting as he can, that extraordinary times, extraordinary monetary experiments, call for a much greater degree of openness that the Bank has, hitherto, been willing to display.

If The Treasury’s advice to the Minster of Finance on these matters is open to scrutiny in these exceptional fast-moving circumstances, why not the Reserve Bank’s advice to their decisionmaking body?  As it happens, the Secretary to the Treasury is now a non-voting member of the MPC, so perhaps she might have a word with her colleagues and draw attention to what transparency and accountability are supposed to mean in New Zealand.

 

 

 

Losing $128 billion

I don’t usually pay much attention to forecasts of nominal GDP.  Not many people in New Zealand really seem to.  But The Treasury takes nominal GDP forecasts more seriously than most, since nominal GDP (in aggregate) is, more or less, the tax base.

Out of little more than idle curiosity I dug out the numbers from last December’s HYEFU forecasts –  the last before the coronavirus –  and compared them to the numbers published in last week’s BEFU, accompanying the Budget.  And this was what I found.

Nominal GDP ($bn)
HYEFU BEFU Difference
2019/20 319.8 294.2 -25.6
2020/21 336.4 294.2 -42.2
2021/22 354.1 328.3 -25.8
2022/23 371.5 352.3 -19.2
2023/24 389.2 374.3 -14.9
Total 1771 1643.3 -127.7

Over the full five years, New Zealand’s nominal GDP is projected to be $128 billion less than The Treasury thought only a few months ago.

Recall that changes in nominal GDP can be broken down into three broad components:

  • the change in real GDP  (the volume of stuff produced here),
  • the change in the general price level (inflation), and
  • the terms of trade

On this occasion, changes in the terms of trade make only a tiny difference over the five years taken together.

General (CPI) inflation is expected to be lower than previously thought.    On average over the five years, the price level in the BEFU forecasts is about 1.8 per cent lower than in the HYEFU forecasts.  That accounts for about $33 billion in lost nominal GDP.

The balance –  the overwhelming bulk of the loss –  is real GDP.

I haven’t written anything much about The Treasury’s forecasts, which were done quite a while ago, and could not fully incorporate the final fiscal decisions the government made.  But for what it is worth, I reckon Treasury’s numbers were on the optimistic side –  quite possibly on all three components of nominal GDP.  On inflation, for example, they are more optimistic than the Reserve Bank (which finished its forecasts later), even as they assume tighter monetary conditions than the Bank does.

But the point I really wanted to make was that these forecast GDP losses will never be made back (in the sense that some future year will be higher to compensate –  resources not used this year mostly represents a permanent loss of wealth).  And that these losses occur despite all the fiscal support (and rather limited monetary support).   And fiscal here includes both the effects of the automatic stabilisers (mainly lower tax revenue as the economy shrinks) and the discretionary policy initiatives (temporary and permanent).

How large are those fiscal numbers?  Well, here is core Crown revenue (more than 90 per cent of which is tax)

Core Crown revenue ($bn)
HYEFU BEFU Difference
2019/20 95.8 89.5 -6.3
2020/21 101.6 87 -14.6
2021/22 106.5 94.6 -11.9
2022/23 112.7 104 -8.7
2023/24 117.7 109.9 -7.8
534.3 485 -49.3

Almost $50 billion the Crown was expecting but which it won’t now receive.  Some of that will be the result of discretionary initiatives –  the corporate tax clawback scheme, much of which will result in permanent losses, and the business tax changes announced in the 17 March package –  but the bulk of the loss will be the automatic stabilisers at work.

And on the expenditure side?

Core Crown expenses ($bn)
HYEFU BEFU Difference
2019/20 93.8 114 20.2
2020/21 98.8 113.5 14.7
2021/22 102 119.8 17.8
2022/23 106.3 118.6 12.3
2023/24 109.2 113 3.8
Total 510.1 578.9 68.8

Almost $70 billion of current spending the Crown didn’t expect to make only a few months ago.  A small amount of this will be the automatic stabilisers at work (the unemployment benefit), but The Treasury is pretty optimistic about unemployment.  Most of the change is discretionary policy initiatives (announced or provided for).

And here is the change in net debt

Net core Crown debt (incl NZSF) as at year end  ($bn)
HYEFU BEFU
2018/19 14.1 14.1
2019/20 14.6 47.6
2020/21 17.6 82.8
2021/22 17.1 111.7
2022/23 12.3 131.7
2023/24 3.9 138.2 134.3

That will be almost $135 billion higher than expected.

As I’ve noted in earlier posts, I don’t have too much problem with the extent of overall fiscal support (although I would have structured it differently and made it more frontloaded –  consistent with the “pandemic insurance” model).

But even on this scale, fiscal policy is nowhere near enough to stop the losses.  Some of those losses are now unavoidable.  It is only five weeks until the end of 2019/2020, so we can treat $26 billion of nominal GDP losses (see first table) as water under the bridge now.   As it happens, fiscal policy looks to have more than fully “replaced” the income loss in aggregate (whether $27 billion from operating revenue and expenses in combination, or the $33 billion increase in net debt) –  not as windfall, but as borrowing (narrowing future choices).   (UPDATE: Even in quote marks “replaced” isn’t really quite right there, as without the fiscal initiatives it is near-certain that actual nominal GDP would have been at least a bit lower than The Treasury now forecasts, even for 19/20.)

But there is a great deal of lost income/output ahead of us, even on these (relatively optimistic) Treasury numbers.

Which is really where monetary policy should be coming in.   The Treasury assumes that monetary policy does almost nothing: there is no further fall in the 90 day rate (the variable they forecast), and as they will recognise as well as anyone inflation expectations have fallen, so real rates are little changed from where they were at the start of the year.  And although the exchange rate is lower throughout than they assumed in the HYEFU, the difference is less than 5 per cent –  better than nothing of course, but tiny by comparison with exchange rate adjustments that have been part of previous recoveries.  It isn’t entirely clear how The Treasury has allowed for the LSAP bond purchase programme, but whatever effect they are assuming…….there is still a great deal of lost output.

The Governor has often been heard calling for banks –  private businesses – to be “courageous”.  It is never quite clear what he means, but he apparently wants to risk other peoples’ money.  But the central bank is ours –  a public institution.   A courageous central bank, that had really grasped the likely severity of this slump, could have begun to make a real difference.  If they’d cut the OCR back in February, and taken steps to ensure that large amounts of deposits couldn’t be converted to physical cash, and then cut the OCR to deeply negative levels (perhaps – 5 per cent) as the full horror dawned, we’d be in a much better position now looking ahead.     Wholesale lending and deposit rates would be substantially negative at the short end, and even real rates on longer-term assets might be as low as they now, without much need for bond purchases.   Retail rates might also in many case be modestly negative –  perhaps for small depositors achieved through fees.   And, almost certainly, the exchange rate would have fallen a long way, assisting in the stabilisation and recovery goal.  There are winners and losers from such steps –  as there are from any interventions, or from choices just to sit to the sidelines –  but it is really just conventional macroeconomics: in a time of serious excess capacity and falling inflation expectations, act to seek to bring domestic demand forward, and net demand towards New Zealand producers.    Working hand in hand with the substantial fiscal support (see above), we’d be hugely better positioned to minimise those large future nominal GDP losses –  losses that at present, we risk never making back.

But neither the Governor nor, apparently, the Minister of Finance seem bothered.

Finally, if nominal GDP appears to be a slightly abstract thing, it is worth recalling that almost all debt is nominal and it is nominal incomes that support outstanding debt.  There is about $500 billion of (intermediated) Private Sector Credit at present (and some other private credit on top of that).  Most likely that stock won’t grow much over the next few years. But government debt will –  on Treasury’s numbers net debt rises by $134 billion.   Against those stocks, a cumulative loss of nominal GDP of $128 billion over five years is no small loss.  As noted earlier, amid all the uncertainties, the precise numbers are only illustrative, but the broad magnitude of the likely losses (on current policies) are what –  and that magnitude is large, if anything perhaps understated on The Treasury’s numbers.

 

A practical suggestion for the Governor

A commenter on a recent post left the reasonable question

if the RBNZ is flooding banks with deposits/reserves to pay for its QE, why are the banks still paying 2.5% to raise term deposits from the public ? Surely the banks have more cash than they know what to do with ?

Well might she ask.  And her question prompted me to think a bit harder about useful steps that could be taken in response to what looks like quite a glaring anomaly.    At present, the Reserve Bank pays 0.25 per cent on settlement balances banks hold at the Reserve Bank, banks are paying much the same rate on (wholesale) 90 day bank bills, but when I checked this morning the average retail rate on offer for a six month term from our five largest banks was about 2.15 per cent.

It wasn’t always so.  Here is a chart showing the 90 day bank bill rate and the 6 month term deposit rate (the one the Reserve Bank provides a long time series for) back almost 30 years.

retail and wholesale

Short-term wholesale rates used to be a bit higher than comparable maturity retail rates.  That made sense.   The marketing and admin costs associated with one $20 million bank bill are going to be a lot lower than those associated with 400 retail deposits of $50000 each.  The margin ebbed and flowed a bit, but it was rare for retail rates to be below wholesale.  All that changed at the time of the 2008/09 recession and financial crisis, and the old relationships have never resumed.

In this chart I’ve taken a shorter period –  since the start of 2007 –  and have also shown the rate on a 1 year interest rate swap (for which the Bank has only published data since mid 2010).

retail and wholesale 2

The maturities differ a bit, but despite that you can see how similar the two wholesale rates have mostly been and how different they’ve been to retail rates.    And here, for the same period, are the margins between the 6 month retail rate and the 1 year swap rate respectively and the 90 day bank bill rate (itself usually moving very similarly to the OCR).

retail and wholesale margins

The gaps that sometimes open up for a while between the swap and bill rate just reflect the maturity differences – eg in 2013 and 2014 the Bank was strongly expected to raise the OCR so swaps yields rose in anticipation.  Over time, the differences have been small and non-persistent.    By contrast, the margin between retail and wholesale rates has typically been large and somewhat variable.

What accounts for this weird situation in which Michael Reddell private saver can get, pretty consistently, 150 basis points more for my smaller deposit than Michael Reddell trustee of the Reserve Bank staff pension scheme can get for the much larger amounts of money he (and other trustees) formally own (on behalf of the members)?

(Totally parenthetically, hasn’t policy been pushing people into collective savings vehicles –  where they can only get the lower rates – ever since Kiwisaver was set up?)

It has a great deal to do with the 2008/09 crisis conditions, and perceptions and regulatory responses thereto.    In New Zealand in the run-up to 2008/09 banks had had a very large share of their funding in the form of very short-term foreign wholesale instruments.  That funding was cheap and easy to raise –  times were good, money was easy, the mood was exuberant – and banks simply did not believe those markets could ever seize up  (I’ve told the story previously of one very senior risk manager of one of the big banks who when we were doing pandemic planning in about 2006 asserted that very strongly).  They did.  More generally, wholesale runs were the catalyst for the failure of various major institutions abroad.

And so, perhaps understandably, there was a quite a reaction, by banks themselves (scares change behaviour, for a time at least), rating agencies, investors in bank debt, and regulators.  In this post I will be focusing on the New Zealand regulatory intervention, but I don’t want to be read as suggesting it was the whole story (in fact, some readers may have memories long enough to recall my arguing 10 years ago that the regulatory effect then was probably small, relative to the private market response in those early post-crisis days).

Prior to 2008/09, the Reserve Bank had never had minimum liquidity requirements for banks.  It was talked about from time to time –  we used to worry, some more than others, about the macro risks associated with very high levels of short-term foreign debt –  but in a small organisation it had never been a top priority, and there was Basle II to implement.

The Reserve Bank, The Treasury, and the banks got a fright in late 2008.  It generally wasn’t totally impossible for our banks to borrow abroad but for a time it was very difficult to borrow (including on terms that didn’t send an atrocious signal) for much longer than overnight.  Even with their prior fondness for fairly short-term debt, that was troubling for banks.  (None of this, of course, was about the health of our banks or their parents; it was all about global markets seizing up.)

There were immediate policy responses to get through that episode –  Reserve Bank liquidity provision, Crown guarantees for new wholesale borrowing – but also a fairly quick Reserve Bank policy response to try to reduce or substantiallly eliminate the risk of finding ourselves in that situation again.   For a bank with a sound asset base, it is almost a given that a central bank will eventually lend if necessary, but the idea was to put buffers in place that meant we weren’t the port of first resort if things got tough, and (since banks’ board never like relying on central bank funding) to reduce the extent of pro-cyclical shocks to credit availability.

There are a number of strands to Reserve Bank liquidity policy but the bit I want to focus on is the one-year Core Funding Ratio (CFR) requirement: now that “core funding” must equal at least 75 per cent of each bank’s total loans and advances.  In practice, as banks do with capital buffers, they typically hold a considerable margin above the regulatory minimum.     Here are systemwide numbers since 2013, when the minimum ratio was raised to 75 per cent.

CFR data

And what counts as “core funding”?

Well, here is the summary from the policy document

CFR defn

Simplifying a bit, core (Tier 1) capital counts, as does all funding with a residual maturity in excess of one year, half of any long-term securities in the period between six months and one year to maturity, and (per the table) “short-term non-market funding”.

There is quite a lot of other detail defining “market funding”, but suffice to say that long-term wholesale (market) funding is attractive for these purposes (sell a 7 year bond, and the bank can count it as core funding fully for six year, and half for six months), but so is money from the little person –  you and me.  Anything we hold, so long as it less in total than $5 million per bank, counts at 90 per cent as term funding, even if the relevant account is fully liquid and the deposit are withdrawable on demand without question.  It isn’t just individuals; corporate cash holdings are treated the same (not on an instrument by instrument basis but based on the total holdings of that firms and all its related parties).  And other financial institutions – even small and passive ones (like the Reserve Bank superannuation one) – are explicitly excluded.

It is just great if you are an individual depositor.  But it is really rather anomalous, and not based on any terribly-robust analysis.

Now the missing bit in all this is the cost of that long-term wholesale funding, which is more or less as valuable as a retail term deposit for CFR purposes.  It is hard for outsiders to get a reliable fix over time on those costs, but from time to time the Reserve Bank includes a chart like this in the MPS, as it did last week.

fundingcosts

Quite how they put it together isn’t that clear (and the underlying data aren’t disclosed), but the line to focus on is really the grey one –  the estimated all-in cost of long-term foreign funding (issuing the debt in foreign currency and hedging it back into NZD for the term of the loan).  The margin between the grey line and the OCR is both large and variable.  Much of that typically has to do with the hedging costs –  again not something easy for outsiders to track routinely, but which have typically been more adverse, and more variable, over the last decade or so than was typically the case in the years prior to 2007.     If the hedging costs were consistently low, the grey line would be a lot closer to the OCR and the cost of domestic wholesale short-term funding, which in turn would mean banks would price term deposits much closer to the OCR/bank bill or to those domestic interest rate swaps.

Perhaps the other relevant consideration here is that the New Zealand economy as a whole is still quite heavily dependent on foreign capital, and in particular on foreign debt intermediated through the banking system.    If our net international investment position was different, there would be a larger stock of domestic retail/corporate deposits, and the relevance of the offshore funding costs (including hedging) might be a lot less.

But as it is, the banks are compelled to have –  in total – a lot of funding from retail and long-term wholesale sources.  A rational bank will price term deposits so that the cost of that form of core funding is typically and roughly equivalent to the cost of equivalently-useful long-term wholesale funding (the latter mostly from abroad).

When the CFR was put in place there was a recognition that core funding would be a bit more expensive that other funding, and that was a price judged worth paying. By the time of the increase in the minimum ratio to 75 per cent, this huge margin between the cost of “core funding” and the cost of other liabilities seems –  from the relevant RIS –  to have come to be accepted as some sort of new-normal, perhaps even desirable.  At the time, the Bank even toyed with the idea of the CFR as a so-called macroprudential tool (it appears in the MOU on such things agreed in 2013), and there was a view afoot that a higher CFR might enable us to tighten overall conditions without pushing up the exchange rate.

But, frankly, it all looks a bit daft at present.    The policy is premised on the notion not only that Michael Reddell as personal depositor is less likely to run on his bank than Michael Reddell the super fund trustee and that – even if granted that that was true –  that stickiness (possibly not even rational, since I might just be slacker about my finances than about my fiduciary responsibilities) was so valuable from a financial stability perspective to be worth driving such a massive wedge between the rates available on two products with absolutely the same credit risk.    More generally, if you were around in 2007/08 you may recall (a) the retail runs on domestic finance companies,  and (b) Northern Rock and the queues down the streets in the UK.     There probably is some value in encouraging banks to have a reasonable volume of longer-term funding, that can’t be encashed on demand by the holder, but there is little obvious basis for distinguishing deposits of the same maturity held by individuals, by companies, by other small financial institutions and so on.    A cost-benefit analysis simply could not support the sorts of –  inefficient –  wedges we have come to see.   I emphasis the “inefficient” because (a) the Governor likes now to refer to efficiency, and (b) more importantly, because the provisions of the Reserve Bank Act governing the exercise of prudential powers still do, as an important constraint on what the Bank does.

From a macroeconomic perspective, none of this much mattered when the Bank was freely able and willing to adjust the OCR as required, to more or less keep inflation towards target.  If term deposit rates were going to be a little high, the OCR would be lowered, and although there would still be much the same wedge between retail and wholesale rates, the level of retail lending and borrowing rates could be more or less managed to what the Bank regarded as consistent with the inflation target.

These days, however, the Bank seems to regard itself as bound to an exceptionally rash commitment it made in a hurry on 16 March, not to reduce the OCR further.  And the Governor and Deputy Governor are reduced to asking really really nicely (or not so) for the banks to lower lending rates, even as they say they can ‘rationalise’ –  in terms of those funding costs –  why they don’t.  To me the answer is straightforward: if as a central bank you think retail rates need to be lower, consistent with your inflation target, then cut the OCR until retail rates get there.  Simple as that.

But if the Governor really does regard himself as honour-bound –  like some teenager’s promise to a dying parent that he’d never ever partake of the demon drink – there are still options, and ones that might make a real difference where it matters to depositors/borrowers.   Specifically, the CFR.

For example, the Governor –  and this is his decision, not the MPC’s –  could lower the minimum CFR to, say, 65 per cent (and commit to keep it no higher than that for, say, the next five years).  Do that and the pressure would come off term deposit rates very quickly and the relevance of those marginal foreign term funding costs would abate.  He could do more complicated things as well – options we looked at a decade ago –  of imposing a minimum requirement only on the share of foreign funding that is long-term (recognising that we don’t have largely repo-funded investment banks as they had in the US). I wouldn’t recommend the more complex changes in the short-term –  action is what is called for, and not things that take lots of careful drafting and consultation.

You might  –  perhaps especially if you were a bank supervisor –  think it strange to propose such a relaxation in the middle of a very troubled period.     But bear in mind several points:

  • we aren’t in the exuberant phase of the cycle (unlike, say, 2005 to 2007), where banks are just pursuing whatever is cheapest regardless of rollover risk,
  • we’ve already got to the point where the Bank is happy to provide almost limitless funding to the banks.  They are running term loan liquidity auctions, and for now getting no takers.  And although the wholesale deposits that arise through the bond purchase are technically pretty short-term, I heard the Governor on the radio yesterday stating that he thought the Bank would be holding the bonds to maturity (in which case the funding will also be there for years).  None of this funding counts as ‘core funding” for CFR purposes,
  • there was no robust cost-benefit analysis of just what was being gained from the CFR, let alone the specific parameter settings (nothing even to match what was done for capital last year). In other words, the current 75 per cent is no less or more ad hoc than a 65 per cent ratio for a few years would be.
  • the Bank has already wound back its capital requirements (delayed the start of the increase in required capital), so there would be no particular inconsistency in doing the same for liquidity, given the anomalous pricing the Bank’s rules are producing.

The Reserve Bank was a fairly early adopter of a core funding requirement after the last recession.  Many other countries now have something called a net stable funding requirement as part of their bank supervision arrangements.   The rules are a bit different, and no doubt each country has its own specific calibrations (and I’m not that familiar with the details of any of them).  This post is not an argument for getting rid of a funding requirement rule –  although in the end it is the quality of bank assets that matters mostly –  but for recognising how large a wedge our specific rules have driven, and the way that now (with the self-imposed OCR floor) contributes to holding our retail lending rates up.

I’ve noted in a couple of posts, including yesterday’s, that even though the New Zealand and Australian policy rates are essentially the same, retail term deposit rates in Australia are much lower than those –  offered by the same banking groups –  in New Zealand (and by much more than any slight differences in credit quality might explain).  As I noted earlier, it isn’t just regulatory provisions that explain the wedge between core and non-core funding of the same term and credit, but it seems likely that the specification of the NZ rules explains the bulk of the difference between New Zealand and Australian term deposit rates.

If the Governor is determined to stick to his crazy OCR promise for now, action on the CFR offers the fastest surest mechanism to materially lower domestic retail interest rates.  The Governor says that is a priority for him.  This decision is entirely his.

It is fair here to point out that the Governor’s prudential regulatory powers have to be used for prudential regulatory purposes –  soundness and efficiency of the financial system –  and can’t just be used as a monetary policy tool (any more than LVRs could).    But on this occasion that should not act as a constraint: after all, that large wedge between returns on instruments of the same maturity and credit, dependent solely on who holds the instrument, doesn’t look good on any sort of efficiency test, and I’m sure I’ve heard in recent weeks the Governor suggest –  quite credibly –  that lower retail lending rates were likely to be, at the margin, a positive contribution to financial stability.   When efficiency and soundness ends are both served it really should be an easy call.  There is a Bank Financial Stability Report due next week, which would be a good opportunity to announce such a change –  or for MPs and journalists to grill the Governor on why he would continue to oversee a policy that drives such a wedge into the interest rate structure.

UPDATE:   Shows how many initiatives there have been that one can lose track of.  A reader draws my attention to the fact that the Reserve Bank had already cut the CFR in late March.   I must have read that at the time and then forgotten it.  Will have to reflect further then on why term deposit rates are still so high relative to wholesale rates.  One possibility might be uncertainty about how long the relief will last.

 

Monetary policy again

One way of looking at developments in New Zealand’s monetary policy is to compare what has been done, and how that has affected market prices, in the country that is in many respects most similar to New Zealand, Australia.

There are no perfect comparators –  and in many ways everyone is flying a bit blind at present – but the two economies do have many of the same banks, similar institutions (variable or short-term fixed mortgages) and a fairly similar experience of the virus.   Sceptic that I am of the Reserve Bank of New Zealand, I am not starting from a view that the Reserve Bank of Australia’s monetary management is some sort of standard to which we should aspire.  Coming into this crisis, for example, both central banks have presided over core inflation undershooting the midpoint of their respective inflation targets, the RBA by more than the RBNZ.      And for reasons that are not very clear (at least to me), the Reserve Bank of Australia is more resolved not to adopt a negative policy rate than our own central bank.

What was the starting point at the end of last year (a time when no one in either country had the coronavirus in focus)?  Recall that Australia’s inflation target (centred on 2.5 per cent) is a bit higher than ours (centred on 2 per cent).  Here are the interest rates I could find, all from the respective central bank websites, except the Australian interest rate swaps yields.

31 dec 2019 int rates

Every single one of the New Zealand rates was higher than the comparable Australian rates –  the smallest gap of all being in the two policy rates, and by far the largest being in term deposit rates.   Note that at the end of last year, markets were looking to the prospect of a cut in the RBA cash rate later this year, while in New Zealand attention was beginning to turn to the possibility of an OCR increase at some point.

So what has happened since then?

  • the RBA cuts its cash rate by 50 basis points to 0.25 per cent, while the RBA cuts its OCR by 75 basis points to 0.25 per cent,
  • both central banks have massively increased the volume of settlement cash in the respective systems.  At the RBNZ, all those balances (currently around $28bn) are remunerated at 0.25 per cent, while at the RBA balances are remunerated at 0.10 per cent (both central banks changed their rules for remunerating large balances),
  • the RBNZ announced its large-scale asset purchase programme, concentrated on government bonds, currently with a limit of $60 billion,
  • the RBA announced a target rate of 0.25 per cent for the yield on three year government bonds, indicating that they would operate in the market (primarily that for government securities) to maintain market rates at or near that target.

And here is how much those rates have changed to now (latest available data)

int rate changes

Tracking down old mortgage rates for Australia is beyond me, but note that both variable and fixed mortgage rates in New Zealand are well above those in Australia.    But so are term deposit rates: averaging across the big four banks, in Australia for AUD six month term deposits the banks are paying about 0.8 per cent, and in New Zealand for NZD six month term deposits the banks are paying about 2.2 per cent.

As you can see from the table, wholesale rates (bills, bonds, swaps) have fallen by more in New Zealand than in Australia.  That is not inconsistent with the fact that the Reserve Bank of New Zealand cut its effective policy rate by more than the RBA cut its effective rate.  Here are the current wholesale rates (Australia in the second column)

wholesale 3

It is notable that longer-term rates are now lower in New Zealand than in Australia –  quite a contrast to the situation at the end of last year.

Consistent with all that, incidentially, the NZD/AUD exchange rate fell by about 4 per cent over this period.

What might explain these developments?

On the one hand, quite possibly people trading the markets in the two countries may reckon the New Zealand recession will be more severe and/or longer-lasting than Australia’s.    It is certainly true that forecasts of the decline in June quarter GDP are much steeper for New Zealand than for Australia, although beyond that –  looking ahead a year or two –  it isn’t obvious at this stage why things might be so very different at the sort of horizon more relevant to longer-term rates.  So for now I’ll just note that possibility and pass on.

What about central bank words and choices?

The Reserve Bank of Australia has apparently been pretty clear that it will not lower than cash rate from here.   The market seems to more or less believe them (the OIS rates on the RBA website are consistent with the current effective cash rate).  By contrast, the Reserve Bank of New Zealand has opened the door to the possibility of a negative OCR next year. I don’t have access to New Zealand OIS data, but I did notice this chart in a Westpac market report, dated yesterday, that someone sent me.

NZ OIS

Markets here are pricing a negative OCR throughout next year.  In other words, our longer-term interest rates price in even more conventional monetary policy easing.  Consistent with that, a reasonable chunk of the fall in the exchange rate has occurred since the Reserve Bank’s MPS last week.

All of which then leaves the question of quite what difference the Reserve Bank’s vaunted long-term asset purchase (LSAP) programme is making.  The Reserve Bank repeatedly tries to suggest the answer is “a lot”.  But there is reason to be more than a little sceptical that it is making much difference where it matters.

As I noted above, both central banks launched novel asset purchase programmes.  The RBA’s approach involved purchasing whatever it took to keep the three year government bond rate around 0.25 per cent.   In the early days –  amid the global bond market liquidation –  achieving that goal took a lot of purchases.  But here are the RBA’s total bond purchases

A$mn
Total 51348
March 27000
1st half Apr 17500
2nd half Apr 5748
May 1100

You’ll recall that the Australian economy is quite a lot bigger than New Zealand’s.  A$51 billion in bond purchases there might be akin to perhaps NZ$7-8 billion purchases here.

But note what has happened: after heavy purchases in late March and early April, the RBA’s bond purchases have almost completely dried up.  Despite the heavy expected federal government bond issuance, expectations about short-term rates are now sufficiently subdued that the three year government bond rate is holding at the target rate with no material bond purchases at all.  And the purchases the RBA has been doing have been heavily concentrated in relatively short-dated government bonds, consistent with reinforcing monetary policy signalling and with the fact that, as in New Zealand, most private sector borrowing tends to be on variable or short-term fixed terms.

What about the Reserve Bank of New Zealand?    Here is the same table for them (government bonds only –  there is a small amount of LGFA purchases also).

NZ$m
Total 11,228
March (from 26th) 950
1st half April 3,833
2nd half April 2,845
May 3,600

Relative to the size of the economy, total purchases here have been somewhat larger, but the real difference is that the Bank is buying just as heavily as ever.  And as I noted in my post on Monday more than two-thirds of all their purchases have been for maturity dates from 2027 and beyond –  and virtually no one I’m aware of, other than the government itself, takes funding exposed to rates that long.

In other words, it seems plausible that the LSAP programme might be knocking 20-30 basis points off long-term government bond yields and swaps rates, while making almost no difference at the short-end (where the RBA would seem now to provide a reasonable benchmark).  And yet it is the short-end that influences borrowing costs for most households and corporates.  At the long end……well, there is the government.    It all looks quite a lot like a programme designed to do two things:

  • by waving around very big numbers to suggest that monetary policy is doing a lot when it actually isn’t really doing that much at all, and
  • to lower the marginal borrowing costs of the Crown, at a time when the Crown has a very big borrowing programme.  At very least, that is a questionable use of monetary policy – not at all consistent with the MPC’s Remit (since fiscal policy will be what it will be whether or not bond yields are 20 points higher or lower) –  and all while exposing the Crown to a really high degree of unnecessary degree of interest rate risk (if the authorities really believe interest rates are extraordinarily low they should be markedly lengthening the duration of the Crown’s debt to the private sector, not skewing it dramatically shorter by buying in government bonds and issuing variable rate settlement cash in exchange).

And, on the other hand, if the Bank were really serious about getting retail interest rates down –  rather than anguishing in public and suggesting that commercial banks aren’t doing their job –  it would just get on and cut the OCR quite a lot further.  As it is, go back briefly to the changes table (the second one from top): nominal rates have fallen to a moderate extent this year, but survey and market measures of inflation expectations suggest that expectations of future inflation have fallen by probably 0.7 percentage points.  Real rates generally haven’t fallen much at all, while retail deposit rates –  held up by the combination of the Bank’s core funding requirement regulation (their choice) and the continuing relatively high cost of offshore terms finance (illustrated in the MPS last week) –  have actually risen in real terms.

Quite a claim to fame that: to be the central bank, in a country with a highly safe banking system (as the Governor now repeatedly avers), that presided over a rise in real deposit rates in the face of the biggest economic slump in decades.  Extraordinary.

Meanwhile, in the last 24 hours we’ve had the Deputy Governor offering interviews to both Stuff and the Herald reaffirming the MPC’s commitment to stick to its bizarre promise on 16 March not to cut the OCR further before next March, come what may.   Apart from anything else, it has the objective effect of tightening monetary conditions relative to where they were –  in effect, urging markets to price out those early negative OIS prices and, all else equal, push up the exchange rate.

There is, of course, something to be said for sticking to one’s word.  But rash promises generally should not be followed through on.  I suppose we should be thankful that the MPC in February –  recall, they were upbeat about the rest of the year then –  had not offered “forward guidance” committing not to cut the OCR this year, come what may.  Perhaps they’d have felt obliged to stick to that rash pledge as well?  As it is, this was a pledge made on 16 March, at a time when the Governor was reluctant to even concede that a recession was happening, at a time when the Secretary to the Treasury (observer on the MPC) was telling the PM that things might be not much worse than the 2008/09 recession.   Perhaps (or not) those were pardonable calls at the time, but they were clearly mistakes, and not small ones.   Sticking to a rash pledge made in some highly uncertain and fast-moving circumstances is almost akin to the suicidal person talked down from the edge, but still averring that “I promised I’d jump, I even left a note, I need to stick to my word”.  Among the sick, such misperceptions might be pardonable.  From highly-paid public figures charged with conducting a nation’s monetary policy, it is simply stubborn, verging on the crazy –  the more so if the MPC thinks that sticking to that pledge in any way enhances the sort of credility that matters.  After all, it was the MPC last week that published projections showing inflation below the bottom of the target range for two years, and unemployment unacceptably high.  Those were supposed to be the considerations people judged the Bank on.

Finally, I see that Stuff’s Thomas Coughlan in his column this morning has picked up my call that if the MPC won’t move –  won’t do the job that is really needed, to provide a lot more stimulus, to get us on the path back to full employment and price stability –  that the Minister of Finance should use the override powers Parliament has long provided him with.  They aren’t powers that should be exercised lightly, but these are exceptional times, and the Bank seems to be content to do little of substance, while pretending otherwise.  Of course, the Act was initially written primarily to protect us from inflation-happy politicians, but also has to protect us from central bankers just not doing their job –  in this case, on either the employment or inflation dimensions.  If he fails to act –  as surely, risk averse as he is, the Minister of Finance will fully share responsibility for the unncessarily slow recovery that he and his MPC seem set to risk.   To what end?