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.)