Helping achieve a robust economic recovery

I suggested last week that I might devote a post to picking through the arguments that the New Zealand Initiative’s Bryce Wilkinson and the Social Credit group have been making –  including in attacks on each other – about fiscal policy, monetary financing etc.  Even with another round of full-page adverts from Social Credit in the weekend papers, I’ve decided to set that to one side for now.  I guess my bottom line is that I think Social Credit is quite wrong in the longer-term.   I disagree with them less about the near-term, in fact there (as I put it in my previous post) I think they are insufficiently ambitious.  Anyone interested can read that previous post (I had a polite and engaging email from the leader of Social Credit who thought the post was “most even handed”, even though he disagreed with my bottom lines).

Instead, I want to work through a post on how one might best respond to a really sharp and substantial economic contraction – partly government-induced, but increasingly just a response to seriously adverse exogenous events.  In this case, of course, the issue is, the global pandemic, the effects of which seem likely to be with us for some time (quite possibly at least several years).

Before doing so, while there will be lots about governments and central banks here, it is worth remembering that economies (firms, households etc) can and would adjust themselves anyway.  But there is a fairly strong consensus that macroeconomic policies, done reasonably well, can asssist in getting the economy back to full employment faster (perhaps quite a bit faster, but we don’t know the counterfactuals with any certainty) than by simply leaving people to sort things out themselves.  That won’t always be the case –  there is a reasonable case that governments made things worse for quite a bit of the Great Depression – but I’m happy to take it as a starting presumption.   And whether or not you or I agree, government agencies are going to do stuff anyway.  This is an attempt to contribute to debate about what they should do.  My worry, to put my cards on the table, is that they won’t do enough, and that what is done will be quite misfocused.

In a really severe downturn we typically look to some mix of monetary policy and fiscal policy to help out.  In the case of fiscal policy, the default is mostly about being helpful by sharing the losses.   In effect, our tax system makes the government something like an equity partner in all economic activities:  when times are good government revenues rise strongly and when times are bad revenue falls away a lot.  Typically, we look to governments to position themselves to ride through most of the cyclical fluctations, such that debt ratios fall (somewhat) in good times and rise (somewhat) in bad times.  That is what is known as “letting the automatic stabilisers work”.  The biggest effects are on the revenue side, but there is some expenditure impact as well: more unemployed people means more spending on unemployment benefits.

On the monetary policy side, central banks have to actually act to be helpful.  That is because our system works through central banks setting a short-term policy rate (here the OCR) at a level economic conditions (including inflation) call for.  When circumstances change, only the central bank can change that policy rate.  Longer-term rates are, of course, free to move, but they are influenced not just be savings and investment preferences –  the core fundamentals that drive where interest rates should be –  but by what people think central banks will do.

For really big adverse shocks, those fiscal effects (the “automatic stabilisers”) aren’t small.   Suppose that GDP for the year to March 2021 were to be 15 per cent less than normal –  not a forecast, but not a wildly implausible number either.  If there was a balanced budget at the start of the period, it would be easy to envisage a  deficit of 5-6 per cent of GDP, just by doing nothing.   That would, typically, be regarded as a “good” deficit –  the sort any well-managed government should certainly be willing to run in such circumstances.

Then again, think about the –  quite serious –  recession we had in 2008/09.  The level of GDP fell then by about 3 per cent.  Underlying trend growth might have been about 2 per cent per annum, so a gap of about 5 per cent of GDP (similar to the peak output gap estimates for that period).   Automatic stabilisers might then be worth only 1-2 per cent of GDP.

By contrast, the OCR was cut by 575 basis points during that period.  Short-term retail rates fell by less than that, and inflation expectations also fell during the period, but there were significant reductions in real retail interest rates.  In addition, the exchange rate fell, by 25 per cent or more.   As was typical in floating exchange rate countries –  ie ones that could set their own monetary policy –  the bulk of the adjustment burden was put on monetary policy.

In quite a few countries there were also quite big discretionary fiscal stimulus packages as well, on top of the automatic stabilisers.   Nothing of that sort was done in New Zealand after the recession became apparent,  However, as it happens, the Labour government (in office until November 2008) had put in place a fairly stimulatory fiscal policy anyway, when they (and their Treasury advisers) assumed times would stay good.  On OECD metrics  –  cyclically-adjusted and underlying balance estimates – those measures generated a fiscal impulse equivalent to 4 per cent of GDP (the change in the structural balance from the position in 2007 to that in 2009).  It was a larger stimulatory effect than seen in some countries that launched crisis discretionary stimulus packages.   If it hadn’t been for that fiscal stimulus that happened to be in place anyway, the case for even deeper OCR cuts would have been strong.

In combination these were really quite large effects:

  • 575 basis points of OCR cuts,
  • a 25 per cent fall in the exchange rate,
  • a four per cent of GDP fiscal impulse

as well as all sorts of guarantees and liquidity measures to limit the extent to which monetary conditions tightened.

And yet it is worth remembering that it was 10 years before New Zealand’s  unemployment rate got back to about the sort of rate many economists –  and the Reserve Bank I think –  would think of as the normal level (or NAIRU) given labour market restrictions etc.  It took seven years for the employment rate –  which has been trending up over time –  to get back to pre-recession level.

And that was even with the fair winds of a robust terms of trade and a big boost to demand from the Canterbury repair and rebuild project.   And from a starting point in 2007 in which there was not that much cyclically wrong with the New Zealand economy.

What about our previous really severe recession –  worse in almost every regard for us than 2008/09 – at the end of the 1980s and early 1990s?  Of course, there was lots else going on –  lots of reforms and structural change that were shaking loose from the labour market, and a mania that had huge amounts of very bad lending, and misallocation of investment resources, in the run up.  In addition, policy was still trying to drive inflation down.     And, of course, there were structural tightenings going on in fiscal policy –  although by this time less than is often supposed (perhaps a couple of percentage points of GDP, on OECD numbers).    The unemployment rate rose from about 4 per cent to about 11 per cent.

In response, and in real terms, the short-term interest rate fell by probably 700 basis points (over several years).  The exchange rate fell by 20 per cent.   But even then it took years to get us back to something akin to full employment.

So typically with very nasty recessions we see very big macro policy responses, sometimes passive (those automatic stabilisers, which are weaker in New Zealand than in many OECD countries).

Monetary policy typically does the bulk of the work.  There is good reason for that:

  • official interest rates can be adjusted very quickly (basically instantaneously) and –  as it happens –  can be unwound quickly too,
  • interest rate “get in all the cracks” –  affect people and firms across the economy,
  • at a time when the economy has got poorer (even if just for a time), interest rate cuts spread losses, taking income away from existing savers and redistributing it back to existing borrowers (at least those among both classes who have voluntarily contracted to live with the risk of variable interest rates).
  • lower interest rates tend to draw spending forward in time (to the period now where there is excess capacity and a shortfall in demand) –  not just, or even primarily, by encouraging new borrowing from banks, but simply by prompting people to think that the reasons to put off spending aren’t as strong as previously,
  • particularly for a country like New Zealand (it is different in the US, or countries with big positive NIIP positions like Switzerland or Japan) lower interest rates also tend to lower the exchange, encouraging New Zealanders (at the margin) to consume locally, increasing returns to those selling abroad, and attracting some demand from abroad towards New Zealand producers rather than foreign ones.

In fact, big reductions in (real) interest rates are what would happen in a market economy if a central bank were not setting a policy rate.  In the end, what interest rates do in an economy is to reconcile savings preferences and investment intentions.  In severe downturns, all else equal, investment intentions at any given interest rate plummet (whether by firms or households), and private savings preferences (firms or households) also tend to increase at any given interest rate.  The reconcilation of those two forces is that the equilibrium interest rate –  including the one consistent with promoting a speedy return to full employment –  will fall, quite a lot.  Broadly speaking, the job of the central bank is to follow those changes, and get market rates into line  (that might involve specific liquidity interventions in quasi-crisis conditions, but it will certainly involve OCR adjustments).

And the beauty of relying –  as countries were typically doing previously –  on interest rates and monetary policy is that no one is compelled to do anything.  If you didn’t want to be exposed to interest rate risk, you’d have taken a fixed-rate contract.  If you didn’t want near-term exchange rate exposure, you’d hedge as much as you could.  And if the interest rates fell sharply and you didn’t want to change your behaviour in response, you didn’t have to.  Those with the most flexibility, those with the best opportunities, did the adjustment.  It might be unsatisfying to politicians – no big announceables, no specific identifiable spender –  but there is nonetheless a pervasive stabilising and supportive effect.

But this isn’t at all what is going on in the present savage recession –  the one that, even as the most severe of the regulatory restrictions is lifted, is likely to see us left with a recession, and excess capacity in the economy, as severe as anything we’ve seen for a very long time almost nothing is happening with monetary policy.    Real interest rates have barely moved: that’s true whether one looks as short-rates and adjusts for the fall in surveyed inflation expectations, or looks at the yields on the range of inflation-indexed bonds the government has on issue (where yields are no lower now than they were late last year).   Oh, and the exchange rate hasn’t fallen by much at all either.

Sure, there has been plenty of activity to support liquidity in financial market.  That has stopped conditions tightening, but done nothing material to ease conditions.

Instead, all the talk is of fiscal policy.

The automatic stabilisers will be at work, and although we haven’t yet seen much of that effect in the numbers it will be real in time.   Plausibly, the automatic stabilisers alone could yet add 15 percentage points to the ratio of public debt to GDP over the next few years.

But the talk isn’t really of those pre-set conditions, but off the discretationary measures already announced with the prospect of more to come (perhaps including in Thursday’s Budget).

We’ve seen big dollops of money already, notably the $10 billion of so (just over 3 per cent of pre-crisis GDP) for the wage subsidy programme paid out already.   Amid the numerous other big numbers tossed around, it isn’t clear how much else has actually been paid out (let alone how much of that will represent net fiscal costs over time).   There have been additional real resources committed to the health sector, but in the macro scheme of things those effects are likely to be fairly small.

Probably no one really begrudges spending of that sort over recent weeks (even if there might be reasonable debate over some of the parameters of the wage subsidy scheme), but big as the numbers are, they also aren’t really the issue now:  the money has already been spent, and probably even held up (to some extent) actual spending (on the little that was permissible) during the “Level 4” and “Level 3” periods.

But that issue is where to from here, as we head out of the worst of the restrictions into an environment where even later this year GDP might still be 15 per cent below normal –  stop and ponder that gap; it is too easy to get too used to really big numbers.  An environment where the world economy is in deep recession, where the virus and uncertainty about it still stalks the earth (and even affects directly New Zealanders, who can’t safely assume there will be no return of the virus or restrictions) and where there is little prospect of our borders being very open at all.  It isn’t as if it looks likely that we can simply count on animal spirits or even just the rest of the world to lift demand quickly in a way that would promptly get us back close to full employment.

Almost certainly, a prompt return to full employment will take a great deal more policy stimulus.   But there is little sign it is likely.

The Reserve Bank is clearly reluctant to cut the OCR further, and has actually pledged not to do so before March.  They talk (a lot) about their bond purchase programme being in some sense equivalent to substantial OCR cuts, but frankly that is just unsubstantiated nonsense (when neither the exchange rate nor real interest rates –  anywhere along the curve – have fallen much if at all, all they’ve done is limit any unintended tightening).   What scarces me is that people who count –  notably the Cabinet, and the Minister of Finance in particular – may believe them.

And there seem to be a growing number of signals suggesting not that much can be expected from fiscal policy – whether comments from the Minister of Finance and the Prime Minister or, for example, the thoughtful column on the Herald  website by Pattrick Smellie (once upon a time press secretary to Roger Douglas as Minister of Finance).  I’m sure there will be baubles thrown around, old programmes repackaged, and some genuine stimulus proposals (some of which may never actually begin before the economy is pretty close to fully-employed anyway, even if that takes years).  But this is a huge recession, it isn’t going away quickly, and for now the Minister of Finance seems content to have the Reserve Bank do nothing.   It is a recipe for economic activity lingering unnecessarily below capacity for years, for unemployment lingering high for years –  permanently scarring the lives of many of those affected.

At one extreme of the current debate there people who reckon going big on fiscal policy is something closely akin to a “free lunch” (Social Credit may actually believe it, but others come close).   That almost certainly is not true.

If, perchance, monetary policy does nothing and stimulatory fiscal policy could speed up the recovery somewhat, then there is a modicum of truth in the “free lunch” concept –  at least some resources which would never otherwise have been used will have been employed and productive.  Even then, of course, the people who gain and the people who pay will be two different groups.

Ah, but some say, the additional debt just never needs to be repaid.   And it is certainly true that (a) a well-governed market economy with a flexible exchange rate can run reasonably high levels of public debt, and (b) with very low long-term interest rates there may be a reasonable argument that the sustainable level of public debt (share of GDP) is higher than it was.  It is also true that in a growing economy, so long as the budget gets back to balance (even if it takes five years from now), the debt to GDP ratio will gradually erode (with 2.5 per cent nominal GDP growth, the debt ratio would halve in 30 years).

(Oh, and ideas about the Reserve Bank somehow “writing off” the government debt it holds also change nothing –  there would be just an intra-government book-keeping entry.)

But even having made all those points, there is still an opportunity cost to consider.    Suppose that it really was now prudent to aim for a public debt to GDP ratio of 60 per cent, rather than something like 20 per cent hitherto.   That gives government some additional deficit capacity for some years –  getting to the new higher level –  but surely we should want that capacity used for the highest returning projects.   To some, that might (for example) be lower taxes on business income.  To others, it might be better quality schools, or investment in public R&D, or even just higher benefit levels for those genuinely unable to provide for themselves (views will differ).   Simply throwing money willy-nilly now at things that might help return to full employment quickly will preclude those options being exercised.

That is especially so when the monetary policy option is on the table.  If the Governor and the MPC refuse to use it aggressively, the Minister of Finance could simply insist.  The law was written that way 30 years ago, and the provisions were reaffirmed when this government reviewed the monetary policy aspects of the Act just a couple of years ago.    Or he could get a new Governor/MPC, since the incumbents clearly aren’t doing their jobs.  Shocking?  Perhaps, but so should persistent high unemployment be.

All that is especially so when there are a variety of reasons why using monetary policy aggressively now should be attractive:

  • savings just aren’t very valuable to anyone else right now (what should drive the returns), when there is a strong desire to save, and little willingness to invest, and yet term depositors are still earning positive after-tax real interest rates on very low risk investment (as the economy goes backwards),
  • the government finds it appropriate to lend to businesses at zero interest rates (via the IRD, to people who presumably can’t fund themselves elsewhere) and yet the typical retail interest rate for existing borrowers –  most of whom will be highly creditworthy taken together –  is still significantly positive,
  • for all the reported angst about commercial rents –  which mostly are fixed-term commitments –  there seems to be little focus on lowering explicitly variable-rate interest rates (plenty of attention on deferring interest, even though –  as above – the market would naturally lower those interest rates significantly),
  • the biggest winners from avoiding using monetary policy are (a) the relatively older segments of the population (those with the largest term deposit base, directly or through managed funds), (b) while the opportunity cost of using up fiscal space now will fall most heavily on the relatively younger segments of the population, as does the burden of servicing the existing private debt at interest rates the Reserve Bank refuses to cut.   Not to be too delicate about these things, the older segements of the population were/are most at risk from the virus,
  • all else equal, heavy reliance on fiscal policy will hold up the real exchange rate and tends to advantage (a) urban consumers, and (b) inwards-focused New Zealand firms relative to those in the tradables sector.  Given that foreign trade as a share of GDP has been falling this century, that skew would not seem well-aligned with what we might need to be a more highly productive economy longer-term.
  • and, as noted above, monetary policy takes effect immediately and has a pervasive effect, while leaving individual choices open to each individual and firm.

By contrast, fiscal policy involves politicians’ grubby fingers all over choices about who benefits and how (for example, the proposed temporary RMA reform which might empower projects that get the imprimatur of the Minister, but do nothing for genuine private sector opportunities), and serious policie/projects often taken rather a long time to implement, especially if done well.  I was exchanging notes with Tony Burton, until last year deputy chief economist at The Treasury  –  and occupying a very different spot on the political/social spectrum than I do.   He has a fairly brutal and succinct style when he chooses and his comment this morning (passed on with permission) on the notion of national-level “shovel-ready projects” as “complete drivel”  caught my eye.  It was hard to disagree.

Of course, it is fair to ask if there are things fiscal policy could usefully do that monetary can’t right now (after all, there will inevitably be some fiscal component to any effective and aggressive policy response).

One possibility is that banks might be more hesistant than usual to lend at present.  Of course, additional private spending does not have to involve more borrowing, but some would.  Governments can take risks private banks might not be willing to, but…….the caution of banks is likely to be largely quite rational (they don’t know the future any more than the government does), and that in turn should be a caution to governments rushing in where the private sector (with more on the line) would not.

Perhaps there really are some very high value projects all ready to initiate –  things the government was planning to do next year anyway. To the extent there are some such things, it might be perfectly rational to bring them forward (just as someone who was planning to buy a car next year anyway might bring the purchase forward if the forecast glut of rentals really does hit the market, or someone planning to paint the house next year might do it this year if painters are cheaper).

And, of course, the government may be able to offer something like the sort of “national; pandemic income insurance”, of the sort I’ve proposed: a bit more certainty, paid for through the “premium” of slightly higher taxes in normal times, might support private spending and credit now, complementing what monetary policy could achieve.

As I come to the end of this (long) post, which was partly for me about getting some lines straight, I want to stress that I am not opposed to the use of fiscal policy in this crisis –  if anything, in the short-term I have argued for an approach more generous than the government’s to date, and I’ve also suggested another pervasive instrument (a temporary reduction in GST) as one possible component of a whole-of-government stimulus approach.

But when monetary policy options are open but policymakers simply refuse to use them, I worry that too little will be done in aggregate (monetary policy has always been a key part in countering any serious downturn).  Perhaps there will be a really big fiscal policy push but, as above, that has a lot of downsides, including that it would materially constrain future policy options in a wide range of areas.

But I suspect that perhaps heeding all the caveats about fiscal policy, the authorities will simply be content to let unemployment linger at unnecessarily high levels for years.  That happened after 2008/09, from a relatively low peak of unemployment.  It would be shameful if it were allowed to happen again –  perhaps especially so if it happened under a Labour-led government.

Fiscal policy should not, and probably cannot, effectively carry the main burden of the huge additional policy stimulus the current situation calls for.

Monetary policy needs to be set to do its job, and do it aggressively.  At present, it is simply playing distraction theatre (here and in most other countries).  As the golden fetters had to be broken in the early 1930s, so what I’ve called the “paper chains” (so easy to break, and yet central bankers won’t do it) that stop interest rates going deeply negative as they should be for for time need to broken decisively, here and abroad.





30 thoughts on “Helping achieve a robust economic recovery

  1. That’s a really appreciated analysis, Michael. I become more convinced by the day that this is much more than a recession we are facing. And I think we have to factor in far more NZers living overseas returning. Additionally, we have some 300,000 foreign nationals here on work visas.

    I noted this morning, a further $200m budgeted to address family violence. Seems like an ambulance at the bottom of the cliff type measure. It’s a concern that much of what might come out in the budget will address these sorts of persistent social problems. Not good.


  2. Michael, bearing in mind the Governor’s comments last year about the effectiveness of negative rates vs bond buying programmes, has he ever shown any hint of these wrong-headed tendencies?

    I suppose as former Chair of the Cullen Fund, his instincts are different to yours, but as different as he’s now apparently demonstrating himself to be?


  3. He is very hard to make out on these issues. In general, my impression has been that if anything he leans towards the “dovish” side, including all that rhetoric about supporting employment (now in his formal mandate). The unexpected big OCR cut was consistent with that, as were those comments last year about preferring the negative rate option.

    On the other hand, he has also been consistently keen on using fiscal policy and heavy govt infrastructure spending.

    I guess my provisional view of this year is that he missed the significance of the coronavirus threat (in common with most of the top tier of the public sector) and may have ended up making an unwise commitment he now regrets. They make a lot of this “banks not ready” line, but it isn’t one we have heard anywhere else in the world, and so far they’ve refused to provide specifics.

    Then again, I suspect he must really believe that the asset purchase programme is doing a lot more good than I think the evidence suggests.

    It is a puzzle. It is also why almost nothing would surprise me about what comes out in the MPS on Wednesday.


  4. “”the biggest winners from avoiding using monetary policy are (a) the relatively older segments of the population (those with the largest term deposit base, directly or through managed funds)””

    When I was a single worker in the ’70s and by instinct a saver I knew that savings would become worth less – my rough memory was having savings invested at ~10% but inflation was higher (reached 26%) and that 10% return was taxed. My conclusion at the time was not to worry since having money was better than the alternative, so I paid off my mortgage faster and retaining about 6 months savings because it gave me a sense of freedom. Retiring in NZ and discovering a term deposit even after tax was giving me a small but postive return was a pleasant surprise. If govt policies leaves most of my money intact I’ll be happy. It never seemed fair to live on interest – it is unearned income. So negative interest on deposits wouldn’t worry me; I intend gradually spending my wealth. “”It is easier for a camel to go through the eye of a needle than for someone who is rich to enter the kingdom of God””

    Liked by 1 person

  5. It never seemed fair to live on interest – it is unearned income.

    I disagree. You’ve earned the capital and deposited it with a bank. You could’ve spent this capital instead of depositing it. Now, said bank lends your money to someone in order to purchase something, be it a house or a business investment. Just as banks charge borrowers they have to pay the lenders. Imagine that there’s no money deposited and your capital is stuffed inside a mattress, and every other depositor decides that their mattresses are the best place for their money…


    • Yes, putting a price on conversion to physical cash has to be part of any plan allowing retail int rates to go materially negative. Most likely any materially negative rates would not last for long – in a sense that would be the point of the strategy.


      • Michael, gambling with Bank stability with negative interest rates is the unintended consequence. It is the same mon pol gambling disregard for Bank stability and engineered a NZ recession before the GFC in 2009 when the RBNZ pushed interest rates to almost 10%. What you did not even understand that banks were desperate to lend as interest rates went higher and higher. Low documentation loans were common from 2006 to 2009 allowing you the borrower to self declare your income without proof of income.


      • What are the channels by which you think financial stability might be threatened? My prior would be that financial stability would be improved, but with some possibility (I don’t think it v likely but it is a risk) that bank profit margins would be narrowed and banks might become more reluctant about extending new credit.


      • We are in a phase where savings rates are already too low. The lower interest rates divert funds away from savings and into higher risk investments. Retail investments in the sharemarket is sky rocketing. Banks need those savings in order to lend out. I was offered 10% interest to borrow $100k from my unused bank Overdraft facility by a young person because she had run of savings to invest in the NZX and ASX.

        Mon Pol intervention can be far too extreme trying to force a result. Give the market a chance to adjust otherwise we get really awful distorted outcomes.


  6. I get the feeling that we really are like rats in a massive lab experiment… the problem being that those holding the levers don’t have the stones to make the tough calls…

    Word on the street is that the infrastructure spend is going to be a damp squib and the just announced pay rises for early childcare works is just so wrong when everyone else is going to see their pay packets shrink.

    I see the Budget as being more of an old fashioned lolly scramble than a strategic plan to get us our of the hole we now find ourselves in. RB seems to be missing in action and the student politicians seem far more focused on micromanaging than on solving for the big important problems…

    I’m not hopeful.

    Liked by 2 people

    • The RBNZ has done a really good job so far. Overdraft interest rates have fallen from 5.4% pre covid to 3.9% currently and Term loan is now offered at 2.89% from 4.5% pre Covid. Emergency OD is being offered at 2.9% which I secured $30k to fund one troubled tenant seeking a rent reduction to whom I offered a deferred rent. The tenant thanked me but declined as he can go back to work now.


  7. Thinking about the government as an equity partner: yet, it has a decent slug of debt on its balance sheet – a portion of which is owned offshore (??). Once we cancel domestic financial assets / liabilities, is it the offshore investor that is really the equity partner (owner) of claim to real wealth?


  8. Governments use of monetary policy to redistribute citizens wealth is morally wrong.

    It has been used in the past for this purpose and destroyed many of our most productive industries .
    Manufacturing and Primary industries including .Fisher and Paykel and our sheep industry.
    All to ensure an Auckland housing bubble did not hurt those in it..

    The deliberate distortion of market returns was an absolute disgrace.

    Savings have been promoted for individuals to secure their futures (eg Kiwisaverr ) .To wilfully reduce the value of these is theft..

    The misuse of Monetary Policy through the nineties and beyond is the major reason for NZs appalling productivity.

    What is needed now is stability in financial settings,and more reliance on fiscal measures.(At least then the theft is transparent.)

    And individuals ,entrepreneurs can rebuild their lives and businesses around some certainty..No government can do that for them.



    • I’d argue that such redistribution is exactly what is happening at present because the Rb/govt are acting to stop real int rates falling as low as the savings/investment pressures would otherwise take them.

      That is then exacerbated by the use of fiscal policy, which is much more overtly and discretionarily distributional.


      • Our elderly 90 year old widowed granny has informed us, after a life-time of frugality, she is going to take out a reverse mortgage on her home, put her glad rags on and go to the high-roller-room at the local casino. $1000 a hand. To heck with it.


      • That is good news. I have started buying Sky City Shares to add to my direct share investment portfolio.


  9. I can’t say that after a break from this site I’ve caught up with everything you’ve written over the last few months but what I have noticed is the level of vituperation has gone up making you sound increasingly fixated on something (i.e. negative OCR) that in my observation:

    (i) overseas central banks aren’t rushing to do;
    (ii) market economists are sceptical about benefits;
    (iii) to the extent that the exchange rate is affected will increase the value of overseas debt;
    (iv) won’t make a lot of immediate difference in a structural sense or to business investment in the current environment;
    (v) could weaken confidence as the expected lower exchange rate makes us feel relatively poorer – reducing consumers’ disposable income through higher prices, and tends to be perceived as symptomatic of an economy in distress (which the 50bpts cut last year showed could be self-fulfilling);
    (v) will reduce further the interest income of savers;
    (vi) given the sensitivity of house prices to interest rate falls and in the absence of LVRs is likely to further encourage investment in property ahead of productive assets;
    (vii) will put those firms who can’t survive the artificially lowered exchange rate out of business (this seems to be a deliberate aim of your policy?).
    (viii) seems will hurt those “consumers at the margin” – the lower paid – disproportionately more.

    Why do you never acknowledge the inherent costs/risks of your policy position?

    On the exchange rate I am curious why you feel exporters who have already enjoyed a 30% decline in the USD exchange rate over the last five years are apparently still so inefficient that they need intervention (via OCR) to drag the exchange rate “significantly” lower still.

    A much lower exchange rate will not just impact the disposable incomes of “consumers at the margin” but pretty much everyone who wants to consume things that we don’t produce here or have a comparative advantage to produce in NZ (also will affect exporting businesses who use imported components). In the midst of a “savage” downturn you seem to want to deliver another blow to the large group of people who are already financially distressed as a result of this crisis, in the form of higher prices.


    • On the exchange rate, I focus on the TWI, which currently isn’t much below the average of the last decade.

      More generally, a lower real exch rate during deep downturns has for decades proved an effective part of stabilisation policy. Like almost everything, there are distributional impacts.

      As a matter of interest, how would you propose that authorities should act to give us the best chance of restoring something like full employment as quickly as possible. What alarms me is that we won’t, and that is a dreadful prospect for those directly affected.


      • The best thing authorities should do is just stop burdening business with regulation. The mother of all regulation is Jacinda Ardern driving a Emergency Level 4 lockdown that decimated the entire economy. It was not necessary and certainly over the top.


      • Yes you’re right on a TWI basis the drop is much less, about 16% (but still reasonably significant) and about 5% lower than the 2010s (6% with the real exchange rate). I’m guessing many people still look to the USD as a gauge of the strength of the currency (and I suspect a lot of our trade outside of the US will still be denominated in USDs).

        I may be misunderstanding you here… in referring to the real exchange rate as part of “stabilisation policy”… I can’t think of a time since the exchange rate was floating, other than the MCI regime, when the exchange rate was directly targeted, something fraught with difficulties I would think. I think the current PTA requires the Bank to behave in such a way as to not cause unnecessary volatility – i.e. stability is preferred.
        The problem for me is that for some years, long before Covid-19 you have been pushing for a low exchange. I don’t see that your policy proposal, at least as far as it concerns significantly weakening the exchange rate, will quickly reduce unemployment, in my view it will more cause job losses – if what you are proposing is a sustained significant weakening of the exchange rate to instigate economic restructuring. The rebalancing you want to occur (if successful, which is not assured) would be a medium-term outcome, but again the short-term outcome would I think most likely be lost jobs.

        I’m pretty happy with the approaches taken by the Bank and Treasury to date. In my view the very best thing the authorities could do and should have done weeks ago is fully reopen the economy. Open the trans-Tasman bubble now, don’t wait more weeks. When the death rate of this illness is so low – the vast majority of people of working age recover – doing this in my view is the best thing that could be done to reduce further employment losses and ensure a quicker recovery. (By all means retain mitigation actions and targeted attention to cluster groups, but recognize there are non-economic costs to the shutdown meaning more lives could lost as a result of the shutdown than those saved.) Re fiscal actions, the combination of lost tax revenue along with tens of billions of new spending is scary but the targeted, long term approach seems reasonable. Hopefully the recovery, with all of this massive stimulus will be faster than anyone thinks.

        Something I don’t think you’ve commented on are the implications post-crisis for our trading relationship with China. There have been calls in several countries to weaken dependence on the Chinese market generally and supply chains for critical goods particularly. The CCP’s inherent nature during this time has been on full display both in deliberately allowing the virus to spread and in its bullying threatening behavour towards Australia and other countries. Not to mention the full-on attempt to spread misinformation through its state run propoganda arms… to me anyway, these are far more serious and significant issues and NZ doesn’t seem ready to grapple with them in the way Australia is having to.


      • On your final para (I suspect we are mostly talking at cross purposes on the rest), you are right I have been quiet on the PRC issues. I suppose my take is that what NZ is now going thru has little/nothing to do with the extent of trade with the PRC – since it is a global shock now – so it would be opportunistic to push my longstanding lines re China at this point. But even in the longer-term there is a need for some nuance – it isn’t really as if universities get to choose where their foreign students come from (China is just the biggest market) and the same goes for various primary industries. Every firm needs to think hard about to protect its exposure to relationship problems re big customers, and it does disturb me when these firms try to make their risks our (the public’s problem), but there aren’t any very easy outs.


  10. Michael, when you say of the bond purchase programme “all they’ve done is limit any unintended tightening” does this imply that you think if the RBNZ did substantially more or this sort of QE – say 2x, 3x, even 10x the amount of bond purchases – with newly “printed” money, it would at some point eventually result in the desired easing of monetary conditions?

    Or is QE fundamentally not able to generate the sort of easing that deeply negative rates would?


  11. I don’t think we are talking at cross purposes. In my first comment I provided a list of reasons why weakening the exchange rate and promoting inflation is at best not helpful and at worst damaging for growth and employment as we emerge from a lockdown and you have not engaged with any of my points.

    You still never acknowledge the harmful costs of your proposals to large chunks of the population. And with regard to productivity you seem to have nothing to offer apart from weakening the exchange rate and increasing inflation – inflation hurts productivity. If you have empirical evidence that (effectively) manipulating the real exchange rate “significantly” lower will produce a sustained improvement to productivity and not have (at the very least) short term impacts on employment I would be pleased to see it.


    • But here is the thing: in this series of posts I have been consistently arguing for much more policy stimulus to boost employment and activity prospects. Now of course every policy has some adverse effect on someone, but few of those are even remotely comparable to the long term scarring effects of prolonged high unemployment. On productivity my recent SSANSE policy brief highlighted business tax cuts, easing foreign investment laws, avoiding inward focused policies as among the things that could usefully be done.

      As far as I can tell – and perhaps I’m missing something – whatever your concerns are about my proposals more generally they seem to relate most to doing something sudden from a starting point of full employment. At present, of course , we are nowhere near that position.


  12. I am referring specifically to your monetary policy prescription, I agree with fiscal policies such as temporary fall in GST and several other things you have proposed or floated, but I’m not referring to those here.
    I am talking about initiating restructuring via a low exchange rate from a starting point of much *higher* unemployment and on some reports suggesting that unemployment will continue to worsen before it improves. So implementing the restructuring/rebalancing (via low exchange rate) under the guise of implementing monetary policy at a time when the economy has already taken a significant knock doesn’t seems to me to be the wrong choice for getting full employment up as soon as possible. You note here that there will be “adverse effects” and I with you would be upfront about these rather than skirt over them.

    On my point (i) ” overseas central banks aren’t rushing to [implement negative interest rates]
    Fed chair said just this week “On the question of negative interest rates, he reiterated the unanimous view of the FOMC that it is not an appropriate or useful policy…”there’s no clear finding that it actually does support economic activity on net…it introduces distortions into the financial system which I think offset that”.
    Last week BoE said negative rates weren’t being planned or contemplated, (as reported by BNZ)..Although, like NZ it sounds like they haven’t been ruled out. As far as I’m aware Australia and Canada, also with rates around 0.25% aren’t enthusiastic over negative rates (NZ commentators have also said the level of larger level of QE than expected made negative rates a less likely prospect The BNZ if I remember correctly used the term “treacherous” to describe them.) Underlying these comments would seem to be legitimate reasons for being cautious over negative rates and I I’m not sure why we, according to your rhetoric, desperately need them while other countries don’t. There are still unknowns in the minds of policy makers and that is reflected in the central banker comments. Since you have not identified empirical evidence supporting the outcomes you expect this suggests what you are proposing is at least partly ideological, making the incredible vitriol directed at the Bank seems misplaced.

    Fair enough re PRC, for me I am inclined to think in years to come whether interest rates were +0.25% or -0.25% (or whatever) will be of far less significance than whether we alter the trajectory of our relationship with CCP after the enormous damage they have done to the world economy and actively try to diversify, disengage economically.


    • Well, of course, a lower exch rate will raise the price of imports – sort of the point. Generally, it will promote domestic production and employment.

      You are right that some overseas central banks are negative on negative rates. Others already have them. I have linked previously to research suggesting that those modestly negative rates have proved useful, but since no one has broken thru to deeply negative rates we can’t know how that would work. I engage privately with plenty of serious people, including former central bankers, who think negative rates are the way to go. If you favour much heavier use of fiscal policy, that is certainly an option: what really concerns me is that overall stimulus is seriously inadequate, and I doubt the political capacity to do much more on fiscal, and push back against those who want to cut back fiscal stimulus without favouring much more monetary stimulus. As i’ve pointed out in past posts, in the Great Depression central bankers were an obstacle to the sort of support that was really needed – prisoners to a conventional wisdom that no longer served.

      My sharpest criticisms of the RB is the current context are of (a) the utter lack of preparedness for negative rates, given that they themselves had talked up the option, and (b) the strange commitment, constantly reiterated, to not cut the OCR more this year come what may, even though they themselves claim to have nothing against negative rates.

      And then there is the pretence that the LSAP is making a huge difference, which it clearly isn’t (I had a post on this earlier in the week, and another later in the day).

      And, of course, I agree that fixing the PRC issues is vital to our future, but it was important last year and will be important five years hence. There are lots of important issues, and for the moment this blog is focused mainly on the macrostabilisation issues, and the imperative of a prompt return to full employment,


  13. [typo corrected “… at a time when the economy has already taken a significant knock seems to me to be the *wrong* choice for getting full employment up as soon as possible.”]

    “Well, of course, a lower exch rate will raise the price of imports – sort of the point. Generally, it will promote domestic production and employment.”

    I can only restate my position that inflicting higher prices and a lower exchange rate on businesses and consumers already bruised by Covid is unlikely to be conducive to domestic production and employment, confidence, spending or anything else in the short term. I can think of the scenario where importers will face the dilemma of price rises (in a situation where demand is already likely to be weakened) or margins squeezed further. If they can’t do one or the other all else equal they will likely go out of business. And the much weaker exchange rate will be bad for consumer and business confidence, it makes everyone feel poorer to some degree (even exporters I suspect since they consume imports) but especially those on fixed incomes.

    Boosting domestic production is a great thing to do, but I am sceptical that a much lower exchange rate is the only way to achieve it. As we have seen over the last few years the US economy has boomed, even recreating manufacturing jobs that everyone thought was gone forever. And yet they did it all while maintaining a relatively strong exchange rate. Is there something we could learn there before inflicting the pain on the economy you seem to want to do? Are there any other countries afflicted by Covid that are proposing to significantly push their exchange rates down as a means restore employment quickly?

    (It still seems to me you are trying to co-opt Covid to push your long held views on how to improve productivity, which always comes back to the exchange rate.)

    Re fiscal policy, $60 odd billion seems a huge amount. You may be right that it’s insufficient but on the other hand you may be wrong, the economy may recover more quickly than what people expect – because all people can do at the moment is guess. I have given you a long (incomplete) list of things that could go wrong with negative rates. You even acknowledge that deeply negative rates are untried and “we can’t know how they would work”. Surely in an uncertain situation like this some display of risk aversion is prudent from decision makers and commentators who have responsibility to the public, the electorate, their customers? (Which I’d note you and those such as the former central bankers you consult with don’t). So when the Bank says a strong case would need to be made for going negative before the commitment next March (when hopefully the worst is behind us anyway), that seems eminently reasonable to me. Again it is not clear to me why in your view NZ desperately needs negative rates but other central banks seem confident in their cases they don’t.


    • I don’t think this exchange is getting anywhere, so probably now point taking it much further for now.

      But I guess I would see my prescription as simply std macrostabilisation policy, in which (as Goldman Sachs puts it in a new note), the case for negative rates now is the same as the case for lower positive rates previously.

      As for all too many central bankers, these were the same institutions that presided over the painfully slow return to full employment after the much shallower recessions from 2008.

      The Great Depression experience continues to shape a lot of my thinking. In that episode it wasn’t that politicians or cen bankers were indifferent to the econ or social losses but they left themselves hamstrung- pure choice – for far too long.


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