After each Monetary Policy Statement (and Financial Stability Report – there is another of those along very shortly), Parliament’s Finance and Expenditure Committee invites the Governor and his colleagues along. They tend not to be particularly searching appearances – when times are more or less okay, MPs seem more interested in securing soundbites for media coverage than in serious scrutiny. In principle, the Committee takes the process seriously – they even hire a local economist as a part-time adviser to brief them and suggest questions – but any real scrutiny is pretty rare. I haven’t been along to one of the hearings in the time I’ve been writing this blog, and although I had become vaguely aware that the hearings were being livestreamed, I hadn’t even bothered to track down those.
But some members of the Epidemic Response Committee had been willing to ask the Bank some fairly specific questions a few weeks ago (my write-up on the Bank’s responses is here). And many of the issues around the Bank’s handling of the current situation haven’t gone away, so I found the link to the footage of the Bank’s appearance on Thursday morning, As far as I could see, there was almost no subsequent coverage (the Budget and all that), which was a shame as some significant issues surfaced.
In this post, I want to focus on the questions/comments by three MPs, and the responses of Bank officials to them.
The first was a question from Labour MP Duncan Webb, who took a longer-term perspective and asked the Bank about the exit strategy from the Large Scale Asset Purchase programme. It was a good question, because it is easy to get into these things, and not always easy to get out again. The Governor’s response was also straight, and really the only one he could give. He noted that he would love to be in the position, a few years hence, where the economy was running strongly, inflation pressures beginning to build, when the Bank could sell its bond holdings gradually back into the market (“tapering”). That is clearly a first-best situation from here. On the other hand, the Governor noted that in other countries it has more usually been the case that the bulk of bonds purchased have been held by the central bank until maturity (the longest current New Zealand government bond matures in 2040). There is a variety of reasons for that observed behaviour, some defensible, others not. My point here is not to disagree with either the Governor or Mr Webb, but to welcome the fact that an MP raised the longer-term issues, and to hope that the Committee and the Bank continue to engage on the issue. It would not be ideal if the Bank ends up holding half of all the government bonds on issue for the next decade, and to support that has to maintain unusual liquidity management arrangements on the other side of its balance sheet.
The most serious questions about the immediate situation were asked by National’s Finance spokesman Paul Goldsmith. He seems, reasonably enough, to have become a little troubled at (a) the lack of much sign of an easing in monetary conditions as they affect real people, and (b) the apparently rather relaxed approach the Bank has taken, and appear to continue to take, to the option of a negative OCR.
This time he succeeded in getting a slightly more specific response from the Bank. You’ll recall that Orr has claimed that some banks are ‘not ready’, without ever being specific as to which banks, what the specific issues are, or even why some banks allegedly not “being ready” should hold back the entire economy. (On this note, I happen to have had credible reports of two bank chairs this week each stating that they don’t understand the issue either, and that of course their banks are quite ready.)
As I’ve noted in previous posts, this “not ready” claim has always been a bit fishy. We never heard it a decade ago in other countries that dipped their toes into negative policy rate territory. And most of the banks operating here are part of overseas banking groups, at least parts of which will be operating in countries with negative policy rates. And if the issue was really about retail rates and retail systems, most of our retail rates are still so positive that any “readiness” issues wouldn’t arise even for OCR levels much lower than those at present.
Anyway, Orr finally clarified his claim, which is now that “some banks” (“some” presumably being less than “most” or “a large number”) still had systems problems that meant they could not cope with “a negative OCR or negative wholesale rates”. He went on to add that banks were quite busy at present, but that only last week the Reserve Bank had written to banks, indicating that banks needed to show that they would be “ready to go” should negative rates prove to be needed, by “towards the end of the year”.
It still somewhat defies belief. When much of the government bond markets in the rest of the world have been trading with negative yields for some time, when our first (indexed) bond yields went negative last year, surely every bank with any sort of wholesale operation must be capable of coping with negative wholesale rates – be it small (here) Chinese banks or big (here) Australian banks, or Citi, HSBC, JP Morgan or whatever. Is all this somehow about SBS and Heartland Bank (or even tinier NBDTs)? If so, isn’t that their problem, not something appropriate macro stimulus should be held back for?
Anyway, I have now lodged a request for a copy of the letter sent to banks last week, and for the letter the Bank sent out in late January and responses (without names, or tabulated again anonymously) to it. In the meantime, here is the list of NZ-registered banks: perhaps some enterprising journalist could ring them each and ask if they have any systems obstacles to a negative OCR and if they do, what those obstacles are?
Goldsmith also asked the Bank about the rather limited extent of the fall in retail interest rates (especially lending rates, whether for business and households), asking why the Bank had chosen to emphasise the large-scale asset purchase programme (LSAP) as its tool. In response, in addition to the alleged “operational problems” Orr ran through a litany of considerations: they looked, he claimed, at what would be most efficient, most effective. most easily operated, and with fewest distortions to markets and the LSAP had won ‘hands down’. He claimed – as he had on Wednesday at the release of the MPS – to be very pleased with the effectiveness of the LSAP so far.
I went through some of the problems with that argument in my post on Thursday. But Goldsmith himself also persisted. The gist of his response was to say ‘well, yes, it is all very well to say you’ve lowered government bond rates – no one disputes that – but retail rates haven’t come down much at all have they?”.
And at this point the Bank started floundering. The Governor turned for an answer to his chief economist Yuong Ha – who had been quoted in the Herald as recently as the 13 March observing that programmes like these don’t really achieve that much, buying just a little space, a little time etc. The gist of Ha’s response was “well, that isn’t really our issue is it? We don’t control the margins over wholesale rates banks set.” He went on to accept that wholesale rates had come down around 100 basis points – presumably here he meant the swaps yields I illustrated on Thursday – but that retail (deposit?) rates had only fallen by 20-30 points. He noted that the Bank “understood” the lack of passthrough so far”, but they would expect to see a lot more “as the economy recovers”. That didn’t seem to be much consolation, in an economy that needs monetary policy support now not in six or twelve months time? And, of course, Ha made no mention of the fact that – whether it is surveys or market prices one looks at – inflation expectations have come down a long way so that even real wholesale rates haven’t changed that much at all.
Then Orr weighed in again suggesting that he was “very pleased” with the wholesale rate impact, but “less pleased” about the retail rate response. He too ran the line about ‘we can rationalise why that is” – as they did in the MPS, noting that effective marginal funding costs remain high. But neither he nor Ha seemed willing to entertain the otherwise-obvious conclusion that if wholesale rates had fallen but retail rates hadn’t much, and you can understand why that is, the usual – wholly conventional – response is some more easing in wholesale rates. That is exactly what happened in the 2008/09 recession, when funding costs also remained under heightened pressure. But not now: instead, there is just handwringing and hope.
Goldsmith also challenged the Governor on his call to the banks to be “courageous”, suggesting that “courageous” lending might easily be rather risky or dangerous lending. The Governor had not much more than bluster in response, but it isn’t my focus.
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”.
The thing is, I am not at all sure what the Bank is talking about. As I’ve noted here previously, in the 1989 Reserve Bank Act there were no prohibitions on the Bank lending to the government, directly or indirectly, but it was entirely a matter for the Governor to agree, or not. His constraint was the inflation target he was required to pursue, and he had the ability to adjust other instruments to offset any inflationary impact of lending to the government. Such lending has happened at the past, including through a priced overdraft facility at the Bank (although the Crown tends to prefer now to operate with credit balances). But there was no explicit power for the Minister of Finance to direct the Bank to lend to the Crown. I’m less familiar with the fine details of the 2018 amendments, but I cannot see any change to that position in the current legislation either. It is as it should be. I’m pretty sure that no modern advanced country central bank’s enabling legislation empowers the Minister of Finance to direct the central bank to lend to the government. The government can of course choose to spend (run deficits) as much as it likes, and as a technical matter the Bank can finance any amount, but if the initiative for fiscal deficits rest wholly with the government, the ability of the Bank to say no to funding those deficits is pretty foundational to modern central banking.
There are two sets of directive powers in the (monetary policy bits of the ) Reserve Bank Act, one or other of which are I presume what the Governor and his Deputy were talking about. The Minister can direct the Bank to deal in the foreign exchange market and can even direct them to set a fixed exchange rate (sections 17 and 18) and if the MPC considers that giving effect to such directions would be inconsistent with the existing mandate (the Remit), it can (sec 19) require the Minister to either issue a new mandate consistent with the direction, or it does not give effect to the foreign exchange market directive. That sounds quite a lot like what the Deputy Governor was talking about – and every so often Bank officials refresh their understanding of these provisions (I recall writing at least one such paper myself) but………a direction under these sections of the Act has nothing at all to do with compelling the Bank to lend to the government.
The other, better-known, directive/override power is section 12 of the Act. Under that provision – a directly parallel provision was in the 1989 Act as well – the Minister of Finance can, for up to 12 months at a time (and transparently), override and replace the existing Remit (the 1-3 per cent inflation target and requirement to support maximum sustainable employment) with one or more other “economic objectives” and the MPC is then required to conduct policy in accord with that new mandate. I’ve long held that this power could be used to directly compel the MPC to, say
- target short-term interest rates of -0.5 per cent (or even -5 per cent), or
- to target the nominal exchange rate at, say, 20 per cent below current levels, or
- to use monetary policy with the goal of getting the unemployment rate below, say, 5 per cent in two years’ time,
or a variety of other alternatives.
The Bank, the Governor and the MPC have no choice in the matter. They are required to run monetary policy consistent with devoting their best efforts to achieving the target the Minister has set. If they tried to avoid taking the new target sufficiently seriously, it would be clear grounds for the Governor and Deputy Govenor to be dismissed, and other members of the MPC to be removed from those statutory offices.
But……there is no hint in this provision, 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).
This post has gone on quite long enough, so I won’t devote the space I was going to to David Seymour’s extraordinary attempt to out-New Zealand First in defending old people. Weirdly, Seymour – who is usually quite wary of loose use of fiscal policy – declared himself all in favour of bigger government, aggressive use of fiscal policy – while expressing great concern about the way savers were being “penalised” by interest rate cuts, and currency being debased, all while accusing the Bank of deviating from its mandate. I thought the Governor showed commendable – admirable – restraint in his response, stepping through how monetary policy works (“one interest rate for all” etc) and even came close to (but couldn’t quite do so explicitly) pointing out to Seymour that real deposit rates are now HIGHER than they were a few months ago. That’s perverse, of course….but then the Governor and MPC could do something about that – this tool called the OCR.
And there was the extraordinary claim late in the session from the Deputy Governor (with responsibility for bank regulation and financial stability) that there was “no reason for banks to tighten up credit” amid a really deep recession and huge uncertainty about the future, whether for individual sectors, firms or individuals, or for the economy as a whole. But perhaps I’ll come back to that breathtaking claim another day. Perhaps the banks could reply to Bascand with that old maxim Keynes invoked; “when the facts change, sir, I change my mind. What do you do?”.
To repeat, if the Bank/Governor/MPC will not do their job, and act aggressively in ways that credibly keep forecast inflation, and expectations of future inflation, on target, the Minister’s extraordinary (but clearly specified, there for a purpose) powers should be used. But there should be no question of compelling the Bank to lend to the Crown.