Writing off the Reserve Bank’s government bonds

From time to time I’ve been asked about the idea that the government bonds the Reserve Bank is now buying, and will most likely be holding for years to come, might be written off.   I thought I’d written an earlier post on the idea but I can’t find it –  perhaps it was just a few lines buried somewhere else – and the question keeps coming up.

The Reserve Bank’s own answer to the question –  I’ve seen it recently from both the Governor and the Chief Economist (the latter towards the end of this) – is to smile and suggest that, since they are the lender, it really isn’t up to them.    That, of course, is nonsense.  It is quite within the power of a lender to write-off their claim on a borrower, and that doesn’t require the borrower first to default or to petition for relief.   To revert back to some old posts, that is how ancient debt jubilees worked.

I guess that, in answering the way the do, the Bank is simply trying to avoid getting entangled in controversies that they don’t need.  I have some sympathy for them on that, and so just possibly it might be a tactically astute approach.  A better approach would be for them – as the specialists in such things, unlike the Minister of Finance – to call out the idea of that particular debt being written off for what it is: macroeconomically irrelevant.

In reality, of course, if the debt held by the Reserve Bank were to be written off, it would only be done with the concurrence of the government of the day.    Apart from anything else, if the Governor (or the Board, when the new Reserve Bank legislation is enacted) were to write off the Bank’s claims on the government, it would render the Bank deeply insolvent (very substantial negative equity).  You can’t have management of a government agency just deciding – wholly voluntarily – to render the agency deeply insolvent.

And that is even though the Reserve Bank is quite a bit different than most public sector entities, in that life would go –  operations would continue largely unaffected –  if the Reserve Bank had a balance sheet with a $20 billion (or $60 billion) hole in it.   The Bank isn’t a company, its directors don’t face standard penalties and threats, and –  critically – nothing about substantial negative equity would adversely affect the Bank’s ability to meet its obligations as they fall due.   The Reserve Bank meets its obligations by issuing more of its own liabilities (notes or, more usually, settlement cash balances).  People won’t stop using New Zealand dollars, and banks won’t stop banking at the Reserve Bank, just because there is a huge negative equity position.

(This isn’t just some hypothetical.  Several central banks have operated for long periods with negative equity; indeed I worked for one of them that had so many problems it couldn’t even generate a balance sheet for years at a time.  It also isn’t materially affected by arguments that seignorage revenue –  from the issuance of zero interest banknotes –  means that “true” central bank equity is often higher than it looks (much less so when all interest rates are near zero, and not at all if other interest rates are negative).)

The big reason why writing off the claims the Reserve Bank has on the government through the bonds it holds wouldn’t matter much, if at all, for macroeconomic purposes is that the Reserve Bank is –  in substance – simply a branch of the government.  Any financial value in the organisation accrues ultimately to the taxpayer, and the taxpayer in turn is ultimately responsible for the net liabilities of the Bank.  Governments can –  and sometimes do – default, but having the obligation on the balance sheet of a (wholly government-owned and parliamentarily-created) central bank doesn’t materially change the nature of the exposure.  If anything, governments have tended to be MORE committed to honouring the liabilities of their central bank –  their core monetary agency, where trust really matters –  than in their direct liabilities (thus, in New Zealand  –  as in the US or UK – central and local governments have –  long ago –  defaulted, but the Reserve Bank has never done so).

It is worth remembering what has actually gone on in the last few months.  There are several relevant strands:

  • the government has run a huge fiscal deficit, (meeting the gap between spending and revenue by drawing from its account at the Reserve Bank, in turn resulting in a big increase in banks’ settlement account balances at the Reserve Bank, as bank customers receive the net fiscal outlays),
  • the government has issued copious quantities of new bonds on market (the proceeds from the settlement of those purchases are credited to the Crown account at the Reserve Bank, paid for by debiting –  reducing –  banks’ settlement account balances at the Reserve Bank,
  • the Reserve Bank has purchased copious quantities of bonds on market (paying for them by crediting banks’ settlement accounts at the Reserve Bank).

In practice, the Reserve Bank does not buy bonds in quite the same proportions that the government is issuing them.  But to a first approximation –  and as I’ve written about previously – it does not make much macroeconomic difference whether the Reserve Bank is buying the bonds on market or buying them from the government directly.   In fact, it would not make much difference from a macroeconomic perspective if the Reserve Bank had simply given the government an overdraft equal to the value of the bonds it was otherwise going to purchase.     There are two caveats to that:

  • first, under either model the Reserve Bank has the genuine power to choose, and
  • second, that the fiscal deficit itself is not altered by the particular mechanism whereby the funds get to the Crown account.

But that seems a safe conclusion for now under our current institutional arrangements and culture.

From a private sector perspective, the net effect of the various transactions I listed earlier has been that:

  • private firms and households have been net recipients of government fiscal outlays, (which, in turn, boosts the non-bank private sector’s claims on banks)
  • banks have much larger holdings of (variable rate) settlement cash balances at the Reserve Bank.

Those settlement cash balances are the (relevant) net new whole-of-government debt.

By contrast, quite how the core government and the Reserve Bank rearrange claims between themselves just doesn’t matter very much (macroeconomically) at all.

Suppose the Minister of Finance and the Governor did get together and agree no payment needs to be made in respect of the bonds that Bank holds at maturity.  What does it change?   It doesn’t change is the appropriate stance of monetary policy –  determined by the outlook for the economy and inflation.  It doesn’t change the nature and extent of the Reserve Bank’s other liabilities –  which still have to be met when they mature.   And it doesn’t change anything about the underlying whole-of-government fiscal position.

I guess what people are worried about is that the government might feel it had to raise  taxes –  or cut spending –  more than otherwise “just” to pay off those bonds held by the Reserve Bank.  But remember that the Reserve Bank is just another part of government.  What would actually happen in that scenario is that settlement account balances held by banks at the Reserve Bank would fall (as, say, net taxes flowed into the government account at the Reserve Bank) –  and those are the new claims the private sector currently has on the government.    In other words, the higher taxes or lower spending still extinguish net debt to the private sector.   And if the government didn’t want to raise taxes/cut spending, it could simply issue more bonds on market.  In the process they would (a) repay the bonds held by the Reserve Bank, and (b) reduce settlement cash balances at the Reserve Bank, but (c) increase the net bonds held by the private sector.    Total private claims on whole of government aren’t changed.

(Now it is possible that at the point where the bonds mature, the Reserve Bank still thought that for monetary policy reasons settlement cash balances needed to be as large as ever.  If so, then of course they could purchase some more bonds on-market, or do some conventional open market operations. Neither set of transactions will change the overall claims of the private sector on the government sector –  net fiscal deficits are what do that.)

And what if the bonds were just written off?   As I noted earlier, write off the bonds and the Reserve Bank has a deeply negative equity position.   I don’t really think that is a sustainable long-term position.  It is a bad look in an advanced economy. It is a bad look if we still want to have an operationally independent central bank.  And we can’t rule out the possibility that, for example, risk departments in major international financial institutions might be hesitant about continuing to have the Reserve Bank of New Zealand as a counterparty, including for derivatives transactions, if it had a balance sheet with a large negative position –  even though, as outlined above, the Bank could unquestionably continue to pay its bills.  So at some point of other, the Bank would have to be recapitalised. But again that has little or no implications for the rest of the economy –  or the future tax burden.   The government subscribes for shares…and settles them by issuing to the Bank…more bonds.  The government, of course, pays interest to the Bank –  whether on bonds or overdrafts –  but, to a first approximation, Bank profits all flow back to the Crown.

This post has ended up being quite a lot longer than I really intended, as I’ve tried to cover off lots of bases and possible follow up questions.  Perhaps the key thing to remember is that what creates  the likelihood of higher taxes and lower spending (than otherwise) in future is unexpected/unscheduled fiscal deficits now.

Those deficits might be inevitable, even desirable (as many, perhaps most, might think of those this year as being), but it is they that matter, not  what are in effect the internal transactions between the core government and its wholly-owned Reserve Bank.   That is true even in some MMT world, provided one takes seriously their avowed commitment to keeping inflation in check over time.  You could fund the entire government on interest-free Reserve Bank overdrafts and the consequence would be explosive growth in banks’ settlement cash balances at the Reserve Bank.  But real resources are still limited (see yesterday’s post).  Over time, if you are serious about keeping inflation in check, you still have to either pay a market interest rate on those balances, or engage in heavy financial repression of other sorts, imposing additional imposts on the private sector just by less visible means.

Perhaps the other point worth remembering is the relevance of focusing on appropriately broad measures of true whole-of-government indebtedness, not ones dreamed up from time to time for political marketing purposes.



So-called Modern Monetary Theory (MMT) has been attracting a great deal more attention than usual this year.  I guess that isn’t overly surprising, in view of (a) the severe recession the world is now in, and (b) the passivity and inaction (and the ineffectiveness of what actions they do take) of central banks, those with day-to-day responsibility for the conduct of monetary policy.

Until about three years ago I had had only the haziest conception of what the MMTers were on about.  But then Professor Bill Mitchell, one of the leading academic (UNSW) champions of MMT ideas, visited New Zealand, and as part of that visit there was a roundtable discussion with a relatively small group in which I was able to participate.  I wrote about his presentation and the subsequent discussion in a post in July 2017.   I’d still stand by that.  (As it happens, someone sent Mitchell a link to my post and he got in touch suggesting that even though we disagreed on conclusions he thought my representation of the issues and his ideas was “very fair and reasonable”.)  But not many people click through to old posts and, of course, the actual presenting circumstances are quite a bit different now than they were in the New Zealand of 2017.  Back then, most notably, there was no dispute that the Reserve Bank had a lot more OCR leeway should events have required them to use it.

Among the various people championing MMT ideas this year, one of the most prominent is the US academic Stephanie Kelton in her new book The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (very widely available – I got my copy at Whitcoulls, a chain not known for the breadth of its economics section).   Since it is widely available –  and is very clearly written in most places – it will be my main point of reference in this post, but where appropriate I may touch on the earlier Mitchell discussion and this recent interview on interest.co.nz with another Australian academic champion of MMT ideas.

As a starting point, I reckon MMT isn’t particularly modern, is mostly about fiscal policy, and is more about political preferences than any sort of theoretical framework (certainly not really an economics-based theoretical framework).     But I guess the name is good marketing, and good marketing matters, especially in politics.

The starting proposition is a pretty elementary one that, I’d have thought, had been pretty uncontroversial for decades among central bankers and people thinking hard about monetary/fiscal interactions: a government with its own central bank cannot be forced –  by unavailability of local currency –  to default on its local currency debt.  They can always “print some more” (legislating to take direct control of the central bank if necessary).  So far so good.  But it doesn’t really take one very far, since actual defaults are typically more about politics than narrow liquidity considerations and governments may still choose to default, and the actual level of public debt (share of GDP) maintained by advanced countries with their own currencies varies enormously.

A second, and related, point is that governments in such countries don’t need to issue bonds –  or raise taxes – to spend just as much as they want, or run deficits as large as they want.  They can simply have the central bank pay for those expenses.  And again, at least if the appropriate legislation was worded in ways that allowed this (which is a domestic political choice) then, of course, that is largely true.  That means governments of such countries are in a different position than you and I –  we either need to have earned claims on real resources, or have found an arms-length lender to provide them, before we spend.    Again, it might be a fresh insight to a few politicians –  Kelton spent a couple of years, recruited by Bernie Sanders, as an adviser to (Democrat members of) the Senate Budget Committee, and has a few good stories to tell.  But to anyone who has thought much about money, it has always been one of the features –  weaknesses, and perhaps a strength on occasion – of fiat money systems.

Kelton also devotes a full chapter to the identity that any public sector surplus (deficit) must, necessarily, mean a private sector deficit (surplus).  Identities can usefully focus the mind sometimes in thinking about the economy, but I didn’t find the discussion of this one particularly enlightening.

It all sounds terribly radical, at least in potential.  One might reinforce that interpretation with Kelton’s line that “in almost all instances, fiscal deficits are good for the economy. They are necessary.”

But in some respects –  at least as a technical matter –  it is all much less radical than it is sometimes made to sound.   As a matter of technique and institutional arrangements, it is mostly akin to “use fiscal policy rather than monetary policy to keep excess capacity to a minimum consistent with maintaining low and stable inflation”.    Supplemented by the proposition that advance availability of cash –  taxes, on-market borrowing –  shouldn’t be the constraint on government spending, but rather that the inflation outlook should be.

Quoting Kelton again “it is possible for governments to spend too much. Deficits can be too big”.

What isn’t entirely clear is why, as a technical matter, the MMTers prefer fiscal policy to monetary policy as a stabilisation policy.    In the earlier discussion with Bill Mitchell, it seemed that his view was the monetary policy just wasn’t as (reliably) effective as fiscal policy.  In Kelton’s book, it seems to reflect a view that using monetary policy alone there is inescapable sustained trade-off between low inflation and full employment (a view that most conventional macroeconomists would reject), and that only fiscal policy can fill the gap, to deliver full employment.    Kelton explicitly says “evidence of a deficit that is too small is unemployment” –  it seems, any unemployment, no matter how frictional, no matter how much caused by other labour market restrictions.

I can think of two other reasons.  The first is quite specific to the current context.  Some might prefer fiscal policy because they believe monetary policy has reached its limits (some effective lower bound on the nominal policy rate).   Kelton’s book was largely finished before Covid hit –  and US rates at the start of this year weren’t super-low –  but it seems to be a factor in the current interest in MMT.     The other reason –  not really stated, but sometimes implied by Kelton – is that central bankers might have been consistently running monetary policy too tight – running with too-optimistic forecasts and in the process falling down on achieving what they can around economic stabilisation.  Since 2007 I’d have quite a bit of sympathy with that view –  although note that in New Zealand prior to 2007 inflation was consistently too high relative to the midpoint of the target ranges governments had set.  But it is, at least initially, more of an argument for getting some better central bankers, or perhaps even for governments to take back day-to-day control of monetary policy, than an argument for preferring fiscal policy over monetary policy as the prime macro-stabilisation tool.

But in general there is little reason to suppose that fiscal policy is any more reliably effective than monetary policy.  Sure, if the government goes out and buys all the (say) cabbages in stock that is likely to directly boost cabbage production.  If –  in a deep recession – it hires workers to dig ditches and fill them in again that too will directly boost activity.  But most government activity –  taxes and spending (and MMTers aren’t opposed to taxes, in fact would almost certainly have higher average tax rates than we have now) –  aren’t like that.  If it is uncertain what macro effect a cut in the OCR will have, it is also uncertain how  –  and how quickly – a change in tax rates will affect the economy, and even if governments directly put money in the pockets of households we don’t know what proportion will be saved, and how the rest of the population might react to this fiscal largesse.  In principle, there is no particular reason why fiscal policy should be better, as a technical matter, than monetary policy in stabilising economic activity and inflation.  But Kelton just seems to take for granted the superiority of fiscal policy, and never really seems to engage with the sorts of considerations that led most advanced countries –  with their own central banks, borrowing in local currencies –  to assign stabilisation functions to monetary policy, at arms-length from politicians, while leaving longer-term structural choices around spending and tax to the politicians.

These probably shouldn’t be hard and fast assignments. In particular, there are some things only  governments (fiscal policy) can do.  Thus, if an economy largely shuts down –  whether from private initiative or government fiat –  in response to a pandemic, monetary policy can’t do much to feed the hungry.  Charity and fiscal initiatives are what make a difference in this very immediate circumstances –  just as after floods or other severe natural disasters.    And we consciously build in some automatic stabilisers to our tax and spending systems.  But none of that is an argument for junking monetary policy completely, whether that monetary policy is conducted by an independent agency, or whether such agencies (central banks) just serve as technical advisers to a decisionmaking minister (as, for example, tended to be the norm in post-war decades in most advanced countries, including New Zealand).

The MMTers claim to take seriously inflation risk.  This is from the Australian academic interest.co.nz interviewed (Kelton has very similar lines, but I can cut and paste the other)

“They should always be looking at inflation risk. Because when we say that our governments can never become insolvent, what we are saying is that there is no purely financial constraint that they work under. But there is still a real constraint. So New Zealand has a limited productive capacity. Limited by the labour and skills of the people and capital equipment, technology, infrastructure and the institutional capacity of business organisations and government in New Zealand. That limits the quantities of goods and services that can be produced there is a limitation there. Also it depends on the natural resources of a country,” says Hail.

“If you spend beyond that productive capacity it can be inflationary and that can frustrate your objectives, frustrate what you’re trying to do. So it’s always inflation risks that’s important. Within that productive capacity, however, what it is technically possible to do the Government can always fund. So yes, you can fund any of those things but there’s always an inflation risk and that inflation risk is not specific to government spending. It’s specific to all spending.”

There is a tendency to be a bit slippery about this stuff.  Thus Kelton devotes quite some space to a claim that government spending/deficits can’t crowd out private sector activity.  And she is quite right that the government can just “print the money” –  so in a narrow financing sense there need not be crowing out –  but quite wrong when it comes to the real capacity of the economy.  Real resources can’t be used twice for the same thing.  When the attempt is made to do so, that is when inflation becomes a problem –  and the MMTers aver their seriousness about controlling inflation (and I take them at their word re intentions).

Partly I take them at their word because Kelton says “the economic framework I’m advocating for is asking for more fiscal responsibility from the federal government not less”.     And it certainly does, because instead of using monetary policy, the primary stabilisation role would rest with fiscal policy.  That might involve easy choices for politicians flinging more money around to favoured causes/people in bad times, but it involves exactly the opposite when times are good, resources are coming under pressure, and inflation risks are mounting.  Under this model, a government could be running a fiscal surplus and still have to take action to markedly tighten fiscal policy because –  in their own terms –  it isn’t deficits or surpluses that matter but overall pressure on real resources.  And they want fiscal policy to do all the discretionary adjustment.

Maybe, just maybe, that is a model that could be made to work in (say) a single chamber Parliament, elected under something like FPP, so that there is almost always a majority government.  Perhaps even in New Zealand’s current system, at a pinch, since to form a government the Governor-General has to be assured of supply.

But in the US, where party disciplines are weak, different parties can control the two Houses, and where the President is another force completely.     What about US governance in the last 30 years would give you any confidence in the ability to use fiscal policy to successfully fine-tune economic activity and inflation, while respecting the fundamental powers of the legislature (no taxation without representation, no expenditure without legislative appropriation)?   In a US context, I’m genuinely puzzled about that. [UPDATE:  A US commentator on Twitter objected to the use of ‘fine-tune” here, suggesting it wasn’t what the MMTers are about.  Perhaps different people read “fine-tune” differently, but as I read MMTers they are committed to maintaining near-continuous full employment, and keeping inflation in check, and even if some like rules –  rather than discretion –  it seems to me frankly no more likely that preset rules for fiscal policy would successfully accomplish that macrostabilisation than preset rules for monetary policy did.  “Successfully managed discretion” is what I have in mind when talking about “fine-tuning” in this context.]

But even in a relatively easy country/case like New Zealand using fiscal policy that way doesn’t seem at all attractive.    It takes time to legislate (at least when did properly).  It takes time to put most programmes in place, at least if done well –  and don’t come back with the wage subsidy scheme, since few events will ever be as broad-brush and liberal as that, especially if fine-tuning is what macro-management is mostly about.   And every single tax or spending programme has a particular constituency –  people who will bend the ear of ministers to advance their cause/programme and resist vociferously attempts to wind such programmes back.  And there are real economic costs to unpredictable variable tax rates.

By contrast –  and these are old arguments, but no less true for that  – monetary policy adjustments can be made and implemented instantly.  They don’t have their full effect instantly, but neither do those for most fiscal outlays –  think, at the extreme, of any serious infrastructure project.   And monetary policy works pretty pervasively –  interest rate effects, exchange rate effects, expectations effects (“getting in all the cracks”) –  which is both good in itself (if we are trying to stabilise the entire economy) and good for citizens since it doesn’t rely on connections, lobbying, election campaign considerations, and the whim of particular political parties or ministers.  And what would get cut if/when serious fiscal consolidation was required?  Causes with the weakest constituencies, the least investment in lobbying, or just causes favoured by the (at the time) political Opposition.     Perhaps I can see some attraction for some types of politicians –  one can see at the moment how the government has managed to turn fiscal stabilisation policy into a long series of announceables for campaigning ministers, rewarding connections etc rather than producing neutral stabilisation instruments –  but the better among them will recognise that it is no way to run things.  It is the sort of reason why shorter-term stabilisation was assigned to monetary policy in the first place.

Reverting to Kelton, her book is quite a mix.  Much of the first half is a clear and accessible description of how various technical aspects of the system work, and what does and doesn’t matter in extremis.   But do note the second half of the book’s title (“How to Build a Better Economy”): the second half of the book is really an agenda for a fairly far-reaching bigger government – (much) more spending, and probably more taxes.    There is material promoting lots more (government) spending on health, welfare, infrastructure, and so on –  all the sort of stuff the left of the Democratic Party in the USA is keen on.

That is the stuff of politics, but it really has nothing at all to do with the question of whether fiscal or monetary policy is better for macro-stabilisation.   I guess it may be effective political rhetoric –  at least among the already converted –  to say –  as Kelton does –  “cash needn’t be a constraint on us doing any of this stuff”.  But –  and this is where I think the book verges on the dishonest (or perhaps just a tension not fully resolved in her own mind) – the constraint, or issue, is always about real resources, which  – per the quote above –  can’t be conjured out of thin air.    Resources used for one purpose can’t be used for others, and even if some forms of government spending (or lower taxes?) might themselves be growth-enhancing in the long run, that can’t just be assumed, and almost certainly won’t be the case for many of the causes Kelton champions (or that local advocates of MMT would champion).

I can go along quite easily with much of Kelton’s description of how the technical aspects of economies and financial systems work, but the really hard issues are the political ones.   So, of course, we needn’t stop government spending for fear that a deficit will quickly lead to default and financial crisis, or because in some narrow sense we don’t have the cash available in advance.   But we still have to make choices, as a society, about where government programmes and preferences will be prioritised over private ones –  the contest for those scarce real resources, consistent with keeping inflation in check.    And we know that rigorous and honest evaluation of individual government tax, spending and regulatory programmes is difficult to achieve and maintain.  And we know that programmes committed to are hard to end,  And that government failure is at least as real a phenomenon as market failure –  and quite pervasive when it comes to many spending programmes.    And so while Kelton might argue that, for example, balanced budget rules (in normal circumstances, on average over the cycle) are some sort of legacy of different world, something appropriate and necessary for households but not a necessary constraint for governments, I’d run the alternative argument that they act as check and balance, forcing governments to think harder –  and openly account for –  choices they are making about whose real resources will be paying for the latest preferrred programme.

Kelton tries to avoid these issues in part by claiming that “outside World War Two, the US never sustained anything approximating full employment”,  and yet she knows very well that real resource constraints still bind –  inflation does pick up, and was a big problem for a time.  Hard choices need to be made –  not by the hour (government cheques can always be honoured) but over any longer horizon.

There are perfectly reasonable debates to be had about the appropriate size of government. but they really have nothing to do with the more-technical aspects of the MMT argument.  Even if, for example, one accepted the MMT claim that there was something generally beneficial about fiscal deficits, we could run deficits –  presumably still varying with the cycle –  with a government spending 25 per cent of GDP (less than New Zealand at present) or 45 per cent of GDP (I suspect nearer the Kelton preference).

This post has probably run on too long already.  Perhaps I will come back in another post to elaborate a few points.  But before finishing this post I wanted to mention one of the signature proposals of the MMTers – the job guarantee.  There is apparently some debate as to just how central such a scheme is –  that is really one for the MMTers to debate among themselves, although it seems to me logically separable from issues around the relative weight given to fiscal and monetary policy.   I covered some of the potential pitfalls in the earlier post and I’m still left unpersuaded that the scheme has anything like the economic or social benefits the MMTers claim for it, even as I abhor the too-common indifference of authorities (fiscal and monetary to entrenched unemployment.  In the current context, one could think of the wage subsidy scheme as having had some functional similarities, but it is a tool that kept people connected to (what had been) real jobs, and which works well for identifiable shocks of known short duration.  That seems very different from the sort of well-intentioned job creation schemes the MMTers talk about. From the earlier post

It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the private market?

And much of Kelton’s idealistic discussion of the job guarantee rather overlooked the potential corruption of the process –  favoured causes, favoured individuals, favoured local authorities getting funding.  It is a risk in New Zealand, but it seems a near-certainty in the United States.

Choices and options, public and private

I was going to move on to another topic, but last night University of Waikato economics academic John Gibson sent me the links to a couple of other papers I hadn’t seen, and I thought it might be worth writing about them. Gibson is one of New Zealand leading empirical research economists and during the lockdown I wrote about one of his efforts to think through, and put numbers on, the costs and benefits of the lockdown, linking lost GDP to possible reductions in life expectancy.

The first of the links Gibson sent through probably won’t appeal to most readers. In this paper, two Motu research economists, Arthur Grimes and Benjmain Davies, set out to formalise how one would apply what is known as “real options analysis” to the choices the government made in late March.   Real options analysis was an addition to the economics literature in the 1990s.  In many ways, it was one of those blindingly obvious ways of looking at things that was probably second nature –  often unconsciously so – to many people making all sorts of decisions in life, but which hadn’t been part of the formal economics toolkit until then.   As Grimes and Davies describe it

A standard result from real options theory (Dixit & Pindyck, 1994; Guthrie, 2009) is that delaying decisions to act can be valuable when (i) decision timing is flexible, (ii) some outcomes are partially or fully irreversible once action is taken, (iii) uncertainty exists about the evolution of an exogenous process that impacts the outcomes of interest, and (iv) the decision-maker can learn about the evolution of the exogenous process over time. Delaying action preserves the option to make a future decision without locking in irreversible costs prior to new information arriving.

It is often applied to private sector investment decisions, but can just as much be applied (and probably should be more often) to some government investment or regulatory etc decisions (or other private choices –  one might think, for example, of a proposal of marriage).

But as Davies and Grimes note, in the choices the government faced in late March, there was uncertainty and potentially irreversible losses whichever direction the government took. In their words

Conditions (i)–(iv) were all met at the outset of COVID-19. However, the two-sided uncertainty at that time made it unclear which option should be preserved: the option to protect economic output initially (by avoiding lockdown) or the option to preserve the chance to eliminate COVID-19 (by entering lockdown).

This is, of course, something of an oversimplification, since there were degrees of possible regulatory responses (and “elimination” itself was not yet the government’s stated goal at the time),  and many –  but probably not all –  of the economic losses would have happened anyway, as individuals and firms responded to perceived risks –  but the point of the short paper is to illustrate the framework, not to offer empirical answers.   The authors chose the March lockdown decision to illustrate the framework, but they could just as well –  or so it seems to me –  have applied it to, for example, the decision to close the border to travellers from the PRC in early February, or to the decisions the government took last week regarding the latest Covid outbreak.

It would seem, also, to be a useful framework in which to think about the way ahead from here –  not in any mechanical sense, but as a way of helping to organise thinking.

The second paper, by Gibson himself, is likely to be of more general interest and –  since it does reach a specific conclusion –  controversial.  I’m a little surprised it doesn’t seem to have been covered elsewhere already.  An earlier version of Gibson’s paper is available here as a University of Waikato Working Paper, and although I will be quoting from a more recent version that Gibson sent me, the abstracts of the two versions are word-for-word identical.

On this occasion the conclusion is well-captured in the title of the paper, “Government Mandated Lockdowns Do Not Reduce Covid-19 Deaths: Implications for Evaluating the Stringent New Zealand Response”.    Capture your interest?  It certainly did mine.

It is an empirical paper using US county-level data, and thus taking advantage of the fact that regulatory powers on these matters typically do not rest at federal level.

Gibson begins by noting that epidemiologists’ simulation models are simply not fit for purpose when it comes to evaluating likely deaths (and, thus, deaths saved from interventions).  Writing of the apparent influence such models had –  whether for support or illumination –  in New Zealand, Gibson writes

It is unfortunate that epidemiological simulations had such impact. The Susceptible,
Infected, Recovered (SIR) epidemiological model, and variants with Exposed and Dead (SEIRD), have infectious people mixing (homogeneously) with others; each person has equal chances to meet any other, regardless of their health status. Yet in reality, people engage in preventative behaviour to reduce risk of exposure; allow for this, and some public actions designed to reduce disease spread may do more harm (Toxvaerd, 2019). These models also have too many degrees of freedom, so are poorly identified from short-run data on cases. For example, Korolev (2020) shows long-run forecasts of U.S. COVID-19 deaths from observationally equivalent SEIRD models ranged from about 30,000 to over a million.

Forecast deaths depend on arbitrary choices by researchers, and data at the time cannot show which forecast is right as so many models are observationally equivalent in the short-run. Elsewhere, Swedish researchers using the Imperial College approach forecast (in mid-April) 80,000 Covid-19 deaths by mid-May (Gardner et al, 2020). In fact, just 3500 died by May 15, with the forecast more than 20-times too high. A final example is the Otago forecasts, which had assumed no case tracing and isolation; using the same simulation model, Harrison (2020) set tracing and isolation success at 50% and forecast deaths fell by 96%.

Harrison(2020) is Ian Harrison’s paper that I have previously written about here.

Gibson’s approach is different

My research design exploits variation among U.S. counties, over one-fifth of which just had social distancing rather than lockdown. Political drivers of lockdown provide identification. If the Prime Ministerial claim, that sans lockdown tens of thousands of New Zealanders would die, is correct then one would expect to see more deaths in places without a lockdown. This may explain global fascination with Sweden, as a country without lockdown. However a within-country research design has two benefits; less variation in measuring Covid-19 deaths than for between-country comparisons, and it better suits the highly clustered nature of Covid-19. For example, Lombardy’s Covid-19 death rate was 1500 per million versus 300 per million elsewhere in Italy. The New York death rate (by May 15) was 1410 per million but just 190 per million in the other 49 states. Taking China’s data at face value, Hubei’s death rate was 76 per million versus 0.12 per million elsewhere. With such clustering, analyses using national averages may mislead.

In practical terms, his regression model is as follows

The regressions use 22 control variables, including county population and density, the elder share, the share in nursing homes, nine other demographic and economic characteristics and a set of regional fixed effects. These controls explain about two-thirds of variation in log deaths (as of mid-May). Even with these controls, the errors for the log death equations may correlate with treatment status, if selection into the treatment group (77% of counties) is due to unobservables. Political drivers of lockdown are plausible instruments; counties without lockdown are all in states with Republican governors and if a gubernatorial election is set for November 2020 (11 are) lockdown was more likely. Conditional on the state-level factors, the extent a county became more partisan between the 2012 and 2016 Presidential elections, relative to the state-level change, affects odds of lockdown. It is hard to think of other paths for these variables to affect Covid-19 deaths than via political calculations about lockdown.

There is a fair amount of technical detail in the paper. Many of the expected things do turn out to have mattered.  Thus

…almost two-thirds of variation is explained by early May. The models show deaths are higher if the elderly or those in nursing homes are more of the population; patterns noted in popular discussion of Covid-19. Deaths are higher if whites are a lower share and blacks a higher share of the population, as noted by Millett et al (2020). Counties with higher inequality and more people without health insurance experience more deaths. Fewer deaths occur if the smoking rate is higher, similar to what is found in the U.K. for 17 million NHS patients, where Williamson et al (2020) find current smokers less likely than others to die (as hospital in-patients) with confirmed COVID-19

But this is Gibson’s summary of his results

So the firmest conclusion is that over more than two months after New Zealand’s March 23 lockdown decision, there was no evidence of more Covid-19 deaths in places without lockdowns.

Moreover, he suggests that this was apparent from data that would have been available to New Zealand policymakers when they made lockdown decisions from March to May (and, presumably, of course for this month’s decisions).

Some readers may be inclined to instantly dismiss Gibson as some sort of off-the-planet person simply out to get the government.  I have no idea of his personal politics – and, as I’ve noted, he is a highly regarded New Zealand economists who seems to go where the data lead – but in any case as he notes it isn’t as if he is the only one to find similar results

This ineffectiveness has several causes: real-time activity indicators suggest threat of Covid-19, rather than lockdown per se, drives behaviour (Chetty et al, 2020). Just one-tenth of the 60% fall in consumer mobility in the U.S. was from legal restrictions, with the rest from people voluntarily staying home to avoid infection (Goolsbee and Syverson, 2020).

I don’t suppose anyone has Raj Chetty pegged as (say) a Trump supporter, and as for Goolsbee, that is Austan Goolsbee, former chairman of the Council of Economic Advisers in the Obama administration.  In addition to his paper, there is an accessible interview with Goolsbee here.   This bit captures the point

Adi Kumar: You and Chad Syverson recently published a paper with the National Bureau of Economic Research called, Fear, lockdown, and diversion: Comparing drivers of pandemic economic decline 2020.1 There you attribute most of the drop in business activity in the United States to people’s own decisions to stay at home, rather than government-imposed restrictions. Can you explain your hypothesis and its implications for policy makers grappling with strategies to reopen the economy?

Austan Goolsbee: We looked at phone records that tracked the locations of 2.3 million businesses around the country. These were mostly retail and services, the kinds of places people physically visit. When we plotted business activity against lockdown timelines through the pandemic, we found that consumer behavior was not aligning with lockdown orders. The visits had trailed off before these were imposed.

We began asking whether government orders drive behavior or not. It’s the classic “identification problem” in economist language—was it causation or just correlation? The disease triggered fear and led people to stop going outside. Then authorities passed laws requiring that they stay at home. So it’s important to figure out how much of what happened next—the sharp fall-off in consumer activity—came from individual choice and how much from public policy.

Our basic idea is to compare places where policies are different on either side of a state border. In Illinois we had shutdown orders, but across the border in Iowa they didn’t. Several metro areas span that border and we have 110 different industries. Take barber shops as an example. If the policies were driving the activity, then we should have seen people still getting haircuts in Iowa but not in Illinois. But that didn’t happen. In the same week, everyone stopped getting their hair cut by similar amounts. That kind of evidence leads to the conclusion that the 60 percent drop in consumer activity from pre-COVID-19 times to the depths of the pandemic was more about individuals’ own decision to stay home. We found that only about 7 percent of the fall-off was due to the policy. Everything else we attribute to other factors, mostly fear.

Those results aren’t about deaths directly, but about mobility and economic activity, but of course the logic of the case for lockdowns is that it is those reductions – forced interpersonal distancing –  that reduces future case and death numbers.

We saw this in New Zealand itself before official restrictions were put in place.  I guess everyone has their own story: mine was of a trip to Auckland on 19 March, before there were any domestic restrictions in place.  Flights were already being cancelled, Wellington airport mid-morning was largely deserted, and my taxi drivers in Auckland told of the hours they had spent waiting for a single fare.

So what are the implications?  This is from Gibson’s abstract

Instead, I use empirical data, based on variation amongst United States counties, over one-fifth of which just had social distancing rather than lockdown. Political drivers of lockdown provide identification. Lockdowns do not reduce Covid-19 deaths. This pattern is visible on each date that key lockdown decisions were made in New Zealand. The ineffectiveness of lockdowns implies New Zealand suffered large economic costs for little benefit in terms of lives saved.

He is, at least implicitly, arguing that we’d have had just as much distancing, in aggregate, without lockdowns (in this case he refers to so-called Level 3 and Level 4 restrictions), as with them.  (As he and others –  including Grimes and Davies – have noted, official advice later released reveals that as late as 20 March official advice to the government had been to stay at the new “Level 2” for 30 days.)

From the final page of his paper

In terms of implications for the future, these results add to the evidence that lockdowns are ineffective. This was also the prior view in public health; for example Inglesby et al (2006: 371) noted: “It is difficult to identify circumstances in the past half century when large-scale quarantine has been effectively used in the control of any disease.”  So when the next pandemic occurs, the Covid-19 lockdowns should not be considered a success that should be replicated. …..If decision-making from March and April is reviewed, any claim that lockdown was necessary to save lives can be treated with strong scepticism. It is especially concerning that there were data available, on the dates of those key decisions, to show that lockdowns are ineffective at reducing Covid-19 deaths.

How plausible is all this?   Perhaps experts in the specific data Gibson uses, or specialist econometricians, can pick some holes and raise some specific doubts.   But as Gibson notes his isn’t the only paper pointing in this sort of direction (and he tells he is finishing another paper suggesting that for a major emerging country “the mobility declines predated the local lockdown orders by two weeks”.   One should probably never revise one’s view too much based on a single set of results, but they can’t be discounted either.

Note also that these results are about “lockdowns”, and are not a direct commentary on the role and value of things like enforced isolation of those found to have the infection or, at least as I read it, on border closures and associated managed isolation policies.  If so, perhaps it is plausible to suppose that private choices –   firms, households, rest homes, community, sporting and religious groups etc –  would have brought about sufficient distancing in New Zealand to have resulted in eventual (domestic) elimination, perhaps at no more deaths than actually occurred in New Zealand.   Perhaps.

If that were so, of course, it would pose questions about the value of the partial lockdown Auckland is currently experiencing.

As Gibson notes, the response of some people is likely to be along the lines of saying that even if his results are (a) robust and (b) applicable to New Zealand, why does it matter?  We (and those US counties that saw deaths fall) got there anyway.

A non-economist might say “what difference does it make?” If people would reduce
interactions anyway, due to perceived Covid-19 risks, having government force them to stay home would seem costless. Yet as economists know, a government diktat approach runs into the central planning problem; no central planner has all the information (collectively) held by parties involved in voluntary exchange (Hayek, 1945). For example, absent lockdown, if a butcher felt they could operate safely and if customers felt they could safely shop at this butchery, voluntary and beneficial exchange could occur. Instead, under the central planning approach applied in New Zealand, butchers were shut but supermarkets selling meat were not. Potentially, much economic surplus (for both consumers and producers) was lost.

And that would seem to be just a small part of it (Gibson was tightly word-count constrained).   We currently have massive overlays of officials deciding who/what is or isn’t a permitted exception to the internal border restrictions –  the sort of thing that should have been sorted out months ago, given the lockdown policy was always potentially regional –  and associated delays, rather than private firms and households making their own choices about what risks to run, or not.   Or we had the official gross over-reach that prohibited you from going for a quiet solo swim at a calm suburban beach in mid-autumn, that makes rules on where, when and what you could hunt  –  none of which had anything to do with public health.  Or that prohibited a priest attending in person to a dying – or bereaved – parishoner, or that prohibited funerals altogether for a time.  Or that banned people from making choices to have small distanced outdoor services –  having advice to hand about risks –  to celebrate Easter, because presumably such things were too hard for officials, unimportant to our ministers etc.   Or –  in my case, and perhaps trivially –  the lockdown rules prohibited me taking my son out for driving lessons, again with no public health implications for anyone.

All that of course, assumes that Gibson’s results are robust.  But it all goes to the more general point that proper marginal cost-benefit analyses should have been being done by officials and ministers –  should now be being done –  and aren’t.  It has been known from the start that private distancing choices would make a material difference, but those rational private choices have too rarely been seen factored into New Zealand official decisionmaking.

There is, however, one area in which I think Gibson overstates his case, perhaps quite materially, and that is on the economic consequences of the lockdown choices.   He notes that

Treasury assume that output at Level 4 was reduced by 40%, at Level 3 by 25%, and
at Level 2 by 10-15% (Treasury, 2020). So even with a V-shaped shock and recovery rather than a U or L shape, 33 days of Level 4 and 19 of Level 3 (that ended May 13) would reduce output by ten billion dollars (ca. 3.3% of GDP) compared to staying in Level 2 throughout.


 In terms of the (recent) past, the ineffectiveness of lockdowns implies that New Zealand suffered large output losses, of ten billion dollars or more, for no likely benefit in terms of lives saved as a result of the decision to move almost immediately from Level 2 to Level 4.

But this is almost certainly wrong, and in fact inconsistent with many of the other sorts of results re mobility etc that Gibson cites.   We simply do not know how large a share of those (guessed) Level 3 and Level 4 losses would have occurred anyway, as people and firms wound back their own activity.  I know that I had already decided that our children would not have been going to school the next day, if the government had not pre-emptively closed the schools.  Not many people would have been at restaurants, cafes, movie theatres or perhaps even churches in late March and early April, no matter what the government had decided (perhaps especially if they’d still been waving around scary death predictions).   Quite possibly much of the construction sector would have stayed working throughout –  even officials wanted to keep that open in Level 4 but ministers refused –  but a large chunk of the lost output would have happened anyway, at least for several weeks.  From my exchange with him last night, I get the impression Gibson is more optimistic about the economic difference than I would be, but the 3.3 per cent of GDP number must be seen as an overstatement of the economic cost of the lockdown itself.

As I’ve said repeatedly in this series of posts, I’m not championing any particular policy approach from here (although I have been inclined to the view –  in March and now – that the government itself has been inclined to over-react, using sledgehammers (at little or no cost to themselves and officials, in fact possibly feeding saviour narratives) when something more nuanced could credibly have done the job).  I’m not even fully convinced by the Gibson story but  –  in particular coming from someone of his stature –  it deserves to be taken seriously, tested and critiqued rather than –  as some will be tempted to, for a variety of different reasons –  dismissed out of hand.



Reflecting on choices and options

In my post late last week I wrote about Martin Lally’s attempt at a cost-benefit analysis around the current government’s strategy of eliminating Covid from (the wider community in) New Zealand.    I was interested in it as much as anything because there was, and is, no sign that the government –  or official agencies (notably Health and Treasury) – has attempted anything of the sort.  As I noted in the body of the post, whatever view one takes on events of the last six months, decision-making from here requires a genuinely marginal analysis, setting aside sunk costs and benefits and focusing just on things that can be controlled or influenced from here on, by New Zealand.

Prompted by that observation, Martin Lally modified his paper slightly to introduce an explicit forward-looking dimension (both versions are now linked to in the earlier post).  He ended up with this strong conclusion

“Switching to a Sweden-style approach is therefore clearly warranted.”

For various reasons, I didn’t think his analysis supported such a strong conclusion.  But as I said in the earlier post, and will no doubt reiterate at the end of this, I don’t have a strong view myself on what the appropriate approach for New Zealand now to take is.    And that is so even though if a coordinated global lockdown for six weeks would in fact wipe out the virus –  and I don’t purport to know if it would – I could imagine endorsing such an approach.   New Zealand voters, New Zealand governments, have to take the rest of the world as it is, not as we might wish it to be.

Probably like quite a lot of other people, I’ve spent a fair amount of time over the last few days trying to think through even how to think about the best answer to the “what approach should New Zealand take?” question. I was prompted initially by the columns by Matthew Hooton and Kate MacNamara in Friday’s Herald, but I’ve been trying to work through my own thoughts, not theirs.

There are too-easy approaches on both sides of the arguments.  As one extreme, there was this the other day from a Nobel (Memorial) Prize winning economist.

Which demonstrates about as little as, say, contrasting New Zealand’s expected fall in June quarter GDP (about 15 per cent) with the (much smaller) reported fall in Swedish GDP, and in turn contrasting those numbers with the respective number of Covid deaths.    Neither set of comparisons sheds almost any light at all, even on the handling of the last 5-6 months, let alone on the way forward.    Samples of one comparator rarely do, unless you are really confident that in all other respects your comparator is near-identical to your country.

But I’ve increasingly come to wonder whether GDP comparisons can tell us much at all for these purposes.    Perhaps they would do so, at least in principle, if governments only took –  or failed to take – public health measures, but in fact they do palliative economic stuff as well.    In principle, it isn’t that hard to keep measured GDP up even in a tight lockdown –  all sorts of government-funded make-work activities could achieve that (measured) effect.  But even without going to that extreme, a government that throws huge amounts of income support at people whose normal business/work is impeded by lockdowns –  or private social distancing –  will, in the short-run, generate more GDP than an alternative strategy (simply not letting people starve).    And yet in doing so it constrains future fiscal policy choices –  real choices around government goods and services and future income support and taxes –  in ways that won’t show up in short-term GDP calculations, perhaps not even in long-term ones.

No actual advanced country government has gone to either extreme –  keeping GDP all the way up “artificially”, or providing just enough support to avoid starvation –  but there is quite a range of support measures that have been put in place, differing in generosity,  duration, incentives effect, etc etc.   And it is very hard to do good cross-country comparisons.  I noticed on Stuff an op-ed from the local economist Shamubeel Eaqub.   He seems to be a supporter of the current elimination approach,  and believes it is a win-win (health and economics approach).   In many respects his short article is a not-unreasonable discussion of some of the issues.  But then notice this line, used in discussing this year’s economic outcomes for New Zealand and Sweden

The scale of fiscal stimulus has been larger than in Sweden. The IMF’s tallies show Sweden’s stimulus of 11 per cent to 17 per cent of GDP, compared to 21 per cent in New Zealand. It is difficult to tell how much of the difference is because of the public health approach versus other considerations. But the fiscal stimulus is around $15b to $33b larger, some of which will be simply spent (for example wage subsidies), while others will add infrastructure and future economic growth. These are not yet possible to tease out – but gives a sense of the difference in government response.

Which on the one hand acknowledges that our economic outcomes might in part simply reflect a choice to put more of a fiscal mortgage on our future, but on the other fails to distinguish what has been spent over recent months, what is just provisions either uncommitted or for future years, let alone the composition of that support.   The New Zealand government’s total commitments might be 20+ per cent of GDP, but what has been actually paid out this year is some relatively modest fraction of that.  Presumably there are similar issues with every country’s numbers.   In New Zealand the immediate relevance is the point many commentators have made: as the wage subsidy ends it is likely our economic activity will fall away, independent of any different choices around public health interventions.

There are similar issues down the track.  For example, Lally attempted to use the comparison between The Treasury’s December 2019 and May 2020 economic projections as a base for thinking about what economic difference the health intervention might have made.  But if fiscal policy can support incomes/GDP in the short-term, as it has done this year, macro policy more generally (fiscal and monetary policy) can support demand and activity over the sort of multi-year horizon (a) Treasury’s forecasts looked at, and (b) that we realistically face on current policies, given the needed border restrictions.  A sufficiently aggressive macro policy could get us back to full employment fairly quickly, and if Treasury or the Bank don’t forecast that that is a reflection on expected stabilisation policy choices, not on the merits, cost, or otherwise of the elimination strategy.     And, on the other hand, even achieving full employment that way might result in its own distortions.

It is likely that a national elimination strategy will lower potential output relative to the pre-Covid counterfactual but that effect might be quite modest, relative to the gains from getting actual output and employment quickly back to potential.    And it still doesn’t answer the question –  the important economic question – of whether, for New Zealand, a national elimination strategy will lower potential output (including per capita) over (say) the next five years in total by more or less than some mitigation strategy would.  And again, specifics are likely to matter.  If you are in an economy in which foreign tourism matters enormously the answers may differ somewhat than if your economy is one that prospers almost entirely by exporting things (without needing much people movement).   “May” in part because we don’t know how much travel would occur voluntarily even if travel were relatively unrestricted among a (hypothetical) group of countries pursuing something less than elimination.   European evidence this (northern) summer suggests that would not be close to zero.

And as I noted the other day, one of the biggest problems in all this is that no one –  certainly no one championing the elimination strategy –  can articulate a credible exit strategy from the regime of tight border controls, with –  in effect – heavy effective taxes on people who do move.  I read an interesting piece on Newsroom this morning by a journalist who appears to have fully convinced himself of the case for the status quo.   But there was no discussion at all as to where and how it all ends.   We cannot –  it seems from all I read –  simply assume a widely available fully effective vaccine in short order.  We cannot, it seems, simply assume the virus will go away in short order.  And we cannot assume the rest of the world suddenly adopts strategies that might lead to general suppression and/or elimination.

Now perhaps we can move to a model in which the testing at the border is finally being done consistently, competently and comprehensively –  as we were promised a couple of months ago – so that the threat of lurching into fresh lockdowns with no notice (and, evidently, with grossly inadequate preparations by ministers and officials) is largely, if never completely removed.    That sounds more or less plausible.  But it had better be true, since the fresh uncertainty that last week’s episode reintroduced is itself no small thing.

But even managing that won’t change the border being largely closed, indefinitely (even if at some point there is a pleasing travel “bubble” with Taiwan and the Cook Islands).   At a personal level, the border doesn’t greatly affect me now.  I wasn’t planning on going anywhere any time soon, and I’m among what might be a small minority of New Zealanders (let alone resident foreigners) with no close relatives living/working overseas (very few distant ones either).  No one in my family depends on the tourism sector.  But some 28 per cent of people resident in New Zealand are foreign born, and a fair chunk of those born in New Zealand in recent decades are now living overseas.  A large chunk of people work in businesses that depend on foreign tourism, export education etc.

Personal connections matter, even if they don’t show up in GDP numbers.   Weddings missed, funeral missed, Christmases not shared, grandchildren/grandparents not hugged all matter. They are the sort of things that make for a full life.  And sure technology helps, but no one really thinks it is the same, not for years and years anyway.

Now, a reasonable counter to these points is a reminder that New Zealand can only control what we do.  The rest of the world will do what it will.  Australians aren’t even free to leave the country at present –  whether for New Zealand or anywhere – and won’t let New Zealanders in anyway.  They’d presumably be even less likely to if we took a mitigation path instead.

If I were really forced to make a pick, I would probably go with the view that a well-managed  elimination approach will have a lower GDP cost (even with all the caveats above) than a mitigation approach.  But no one really knows do they?   As an example, case numbers and deaths have tailed off in Sweden too, but no one knows whether that is sustainable, or what the longer-term costs of their (private and government) restrictions and distancing measures might be (or what they might be applied to another country, like New Zealand.

And then one is still left trying to weigh the other costs and risks and implications of what maintaining the elimination strategy might mean, especially if we continued to have a government that didn’t do the basics well and then relied on extreme measures to contain relatively limited outbreaks (as happened in April –  recall the toughest lockdown in the world, the ban on swimming, the ban on funerals).     Tough restrictions might be tolerable in a very time-limited scenario –  the big wave of the 1918 flu in New Zealand swept through in about six weeks – but we are already months into Covid and, to repeat, there is no obvious end in sight.

There is a group of people –  presumably mostly on the left –  who seem only to happy to coerce populations without limit, talking (for example) of mandatory masks apparently indefinitely, or constraining capacity on individual buses and trains while doing nothing to increase capacity, or having lockdowns on a whim (even with compensation).  These same people are probably also quite happy to have people increasingly dependent on the grace and favour of governments, for handouts (new wage subsidies), for favoured stimulus programmes (the reward to lobbying and connections), and who are quite unbothered by –  for example –  banning the public celebration of Easter this year, even outdoors, even in modest gatherings.   Or banning funerals, some of the sorts of things that define our culture, our humanity.   There are people, even on the right, who seem only too happy to have privacy protections tossed out the window, allowing the state to track us all for the (indefinite) duration.  Of course, Covid is not some conspiracy to enable bigger more powerful governments –  any more than, say, World War Two was – but it, and the indefinite elimination approach, tends to have that effect anyway.

There don’t seem to be easy answers.  I –  unaffected much by the border – might prefer something like a highly-capably managed version of our elimination approach for now.  If it works, we mostly keep our freedoms, even if we are poorer.  There is also the option value of waiting –  if we abandon the elimination approach, it would be expensive to reinstate it later, and there are no commitment mechanisms to keep a government to a mitigation path after once it decided to try it.

But I can understand that for many the freedom to travel – without huge effective taxes –  is one of the important freedoms.   And again not one really captured in GDP.

I haven’t said much here about the likely increase in lives lost (and impairment of quality of life for some who didn’t die) were we to move to a mitigation strategy.  That is not because those effects are unimportant.  I touched on them in the earlier post, but I don’t purport to have a distinctive perspective on anything around how the virus itself might then progress through New Zealand.  But again, the absence of a credible exit strategy puts those costs, those people (who could be you, or me, or our families) in a different light.  One parallel that struck me some months ago were the lives we put on the line in World War Two.   No one really wanted a war, but in the end no one could see a satisfactory outcome unless we committed to war, knowing that would involved –  almost certainly –  large losses of lives of young men (mostly).    The parallel isn’t exact by any means, but I still find it worth reflecting on.

This has all been rather discursive, and inconclusive –  as much about helping to sort through my own thinking as anything else.  To repeat, I am not championing any specific strategy for New Zealand at present.  And I remain worried about the apparently weak levels of capability in our public service and political system to evaluate options and/or effective and efficiently operate whatever option is chosen from time to time.

For those interested in understanding Sweden itself, I saw a link the other day – I think on Marginal Revolution –  to this interesting, but avowedly incomplete, look at some of the distinctive features of the Swedish experience and system.

Evaluating choices

Back in the last “lockdown” I linked to various pieces of work by other economists attempting to make sense of, evaluate etc, choices the government was making.   There was Ian Harrison’s work challenging some of the modelling estimates the Prime Minister liked to wave around and some aspects of the “Level 4” restrictions.  There was an early attempt at a cost-benefit analysis by Bryce Wilkinson of the New Zealand Initiative, and another exercise looking at a similar question in a different way by John Gibson at Waikato University.  There was another exercise that I never wrote about, but which is reported and linked to here, by Martin Lally, a consultant economist and former Victoria University academic.

What was striking, even at the time, was that there was no sign that the government had commissioned from officials, or officials had undertaken anyway, any sort of serious cost-benefit analysis of the sorts of intervention they were looking at and imposed.  It always seemed likely at the time that there was nothing of the sort –  the public sector had, after all, been woefully underprepared, sluggish in getting any serious planning underway, and complacent for too long that this was largely someone else’s (PRC’s) problem  Anyway, when the government finally got round to publishing the relevant documents, sure enough there was no serious structured attempt to cost and evaluate alternative policy options.  (It is not, I hasten to add, that any cost-benefit analysis can give one “the” answers, but it provides a disciplined framework to analyse the options, assumpions and sensitivities.)  But there was nothing –  even though the New Zealand authorities had the best part of two months of lead time.

These issues take on a fresh salience with this week’s out-of-the-blue partial lockdown of Auckland, and the government decision later today.  It prompted me to finally go and take a look at an exercise undertaken by an economist at the Productivity Commission in early May, illustrating for the benefit of The Treasury –  who we used to assume were the champions of robust cost-benefit analysis –  how the decision in late April on whether to extend “Level 4” for another five days might have been rigorously analysed in a careful cost-benefit framework, looking only at the marginal costs and benefits of the two options the government had had in front of it.    The author concluded that, with the information available at the time, the extension was probably not justified, but that is less relevant than the fact that an economist at another agency was having to do this for The Treasury after the event.  Apparently neither The Treasury nor ministers had been interested in getting such analysis done when the decisions were being made.

Restrictions –  border restrictions –  have remained in place, but there seems to have been relatively little interest in evaluating the costs and benefits of those choices.  But this week’s restrictions have brought the issue back into focus.     There have been a couple of newspaper articles, notably in today’s Herald: this by Kate MacNamara, and a column by (newly returned from working for the National Party) Matthew Hooton.  MacNamara explicitly ends her piece with the argument

“There will be a time when the best option is to ease border restrictions, abandon lockdowns, and let our health system, including tracking and tracing, do the heavy lifting. We need credible analysis to help us know if that time is now.”

I’d say “perhaps” to the first sentence –  and it remains troubling that there is no identified or championed (by the government) credible exit strategy from our current eliminationist/closed-borders model – but would strongly echo the call for serious, open, analysis on the issue and options.

Martin Lally’s latest paper on a cost-benefit approach isn’t that analysis –  we need proper marginal analysis on the costs and benefits from here, with what has happened to now in principle largely irrelevant (sunk costs and all that).  But Martin’s paper, which he has given me permission to share

Martin Lally cost-benefit assessment of Covid lockdown August 2020

is still a useful look back at the merits of choices made over recent months, and probably sheds at least some light –  poses some questions –  on how the choices going forward might look.

His conclusion is as follows (QALY = “quality-adjusted life year”)

This paper considers the effect of the New Zealand government adopting a suppression policy versus a milder mitigation policy, with the actions of other governments taken as given. The cost per QALY saved from doing so would seem to have been vastly in excess of the currently used value for a QALY of $45,000. Consideration of alternative parameter values and recognition of factors omitted from the analysis would not likely reverse this imbalance in cost per QALY saved versus currently accepted figures for the value of a QALY. The suppression policy was therefore dramatically inconsistent with long-established views about the value of a QALY.

The broad approach is to look at lives saved by the government’s elimination approach and the (primarily) economic costs of that strategy.   Neither is necessarily straightforward.  On the economic side, one sometimes hears champions of the government touting a view that there is no such economic cost –  in fact, I heard former Labour leader Phil Goff make exactly that claim this morning. Locking down hard, while costly initially, is –  these champions conveniently claim – its own reward; initial losses more than outweighed by the subsequent gains (faster sustained recovery etc).  But there is no actual evidence for these claims –  at best such an outcome could be considered as one scenario.  (In the early days, the PM was claiming support from 1918, suggestions I looked at here.)

Perhaps that line might have seemed more plausible to some just a few days ago.  But then, with essentially no notice, our largest city was flung back into a partial-lockdown, and whatever choices the government announces today, we are told to expect more of these events, timing and size of course unknown and unknowable.    So we take further real output losses now and –  perhaps at least importantly – fresh huge uncertainty (affecting all manner of firms, and households too).    Perhaps the government can finally fix up border testing –  isn’t it just staggering that two-thirds of people working at aiports/MIQ facilities etc haven’t been tested at all? – reducing the chance of further outbreaks/lockdowns.  But even if that were done as best as humanly possible, it wouldn’t change the limitations of the closed border itself.

And the difficulty for champions of the “own reward” model is the absence of a compelling exit strategy.   If we could count on the virus simply dying out, going away, by some clearly defined date next year, the calculations change quite a lot.  There is a credible exit strategy then, and we just have to hold on til then.  Similarly it we could count on a highly effective vaccine being generally available by some clearly defined date next year, again things look more encouraging for the “own reward” story.   Perhaps those too are scenarios to add into a serious evaluation of the strategy.  Along with scenarios in which there is never a very effective vaccine and/or the virus remains much as it is indefinitely.

In any case, what Lally does is to assume that some –  quite moderate –  proportion of the difference between the Treasury’s GDP forecasts from last December and those from this year’s Budget should be treated as the cost of the elimination approach.  His central case assumes 25 per cent.  That may be too high.

The other side of the equation is, of course, lives saved (and reductions in impairments to the quality of life, of those with serious but non-fatal Covid).  Of course, some of that early modelling suggested catastrophic losses if we hadn’t gone to a fairly severe lockdown.  But if, as Harrison suggested, those numbers didn’t look that plausible at the time, they look much less so now.    Lally focuses on the case of Sweden, which has pursued –  not always well –  something closer to a mitigation policy.

To date Sweden has suffered 570 deaths per 1m of population and the increase in the rate is tailing away to zero.  New Zealand’s population of 5m implies 2,850 deaths under a Sweden-style mitigation policy. The QALYs saved would then be (2,850 – 22)*5*0.5 = 7,070.

It is a sample of one, but again he illustrates that you can assume a materially higher numbers of QALYs saved and the calculations still don’t end up very favourable to the New Zealand approach.   A further caveat is that, although he notes the point, Lally does not explicitly allow for the QALYs saved in respect of the people with serious non-fatal Covid cases.  The Productivity Commission piece does include some estimates, and if I’ve read document correctly, the effect is to double the overall QALYs saved.

Lally is very conscious of the sensitivities in his analysis. This is the last extract I’m going to quote.

The parameters used in this analysis are debatable. The death rate under a mitigation policy may be much larger than estimated here. If it is doubled, the cost per QALY saved would halve to $4.25m, but would still be 94 times the usually accepted figure. The GDP loss from the current path relative to that if there is no curtailment in economic activity could be smaller. If it were halved, in addition to the death rate being doubled, the cost per QALY saved would fall further to $2.12m but this would still be 47 times the usually accepted figure. The remaining parameter is the proportion of the GDP loss due to lockdown rather than mitigation, which is unknown. However, any reasonable proportion will produce a cost per QALY saved well in excess of the usual figure of $45,000.

(Incidentally, I prefer a high number for the value of a QALY –  the Productivity Commission paper discusses some of the options.)

My point in this post is not to articulate a strong personal view on what the government should have done, or should do now.  As I’ve said in past posts, my visceral reactions tends to be more cautious than my analytical one, and one shouldn’t discount visceral reactions.  And in the last lockdowns, my bigger concerns were about the overreach in many of the non-economic restrictions –  remember the government that totally banned funerals, or a solitary swim at a quiet suburban beach.

But I reckon there is crying need for more analysis –  open and transparent, disciplined analysis, exploring a wide range of asssumptions and scenarios.  As I noted, Lally’s paper isn’t that for the period ahead –  we need marginal analysis from here, that explicitly takes account of the uncertainty of the relevant end dates –  but it is still worth reading, perhaps especially so in conjunction with the (slightly longer, more detailed, and better-tabulated) Productivity Commission piece, which represents the sort of analysis we should be expecting from our core government officials –  notably The Treasury –  were they adequately (well, excellently) doing their job.   And as the government ploughs on –  apparently supported by all other parties –  with their eliminationist approach, we deserve a credible, carefully evaluated, exit strategy.  At present, there is none.

UPDATE: Lally has responded to my point that his paper is not a marginal approach (costs and benefits from here) and so can’t shed light on choices from here, and has added a paragraph (in this version) offering one way of looking at that question concluding that

“Switching to a Sweden-style approach is therefore clearly warranted.”

Those who believe that virtue is its own reward (as above) will certainly not be persuaded.   My own reaction is that  –  as per my final paragraph –  more analysis is needed, drawing on the combined expertise of economists and epidemiologists.


Abdication of responsibility

There was stuff to like in yesterday’s Monetary Policy Statement and the associated press conference.

There was the remarkable statement from the Governor that “we don’t comment on government policy”, which we can only hope –  unrealistically –  heralds a new policy for the Governor (as it was it simply got him off the hook of answering an inappropriate question about lockdown policy etc).

More seriously, there was some sense that the MPC and the Bank were beginning to appreciate just how poor the world economic outlook is. I wouldn’t go quite as far as ANZ”s chief economist whom I saw reported in the paper this morning saying “it was hard to imagine a more dovish sets of policies and commentary today”, but my own initial comment to a journalist re the commentary etc was

The overall tone –  downside risks, worrying world economy situation –  is encouraging

It is a step in the right direction, even if there is little depth to the analysis (and, for example, no links to more-rigorous supporting analysis).   And of course even the Bank was caught out between the projections being finalised (on the 5th) and released: they’d idly assumed a “level 1” regime from June on.  Perhaps they had little choice in the central track, but there was far too little about the risks of new “lockdowns” and (a) the associated real income/output losses, and (b) associated addition to the already high level of uncertainty facing firms and households –  whether about the virus, the wider economy, or the government’s chosen response.

There was even some recognition that inflation expectations had been falling, usually a sign –  at least if starting at or below the inflation target midpoint –  that people don’t think the Reserve Bank is doing its job. It was all rather played down –  with more emphasis on risks of further falls than the large falls we’ve already seen –  and, as almost always, they chose to totally ignore whatever information is in the inflation breakevens derived from the government bond market.

And yet what did the Bank actually do, that might affect real interest and exchange rates, credit conditions or whatever –  in ways that might make a real difference to the inflation and employment/output outlook?  Nothing.  And that is the problem.

There was plenty of renewed talk of the possibility of negative interest rates. (This was  in conjunction with some possible new instrument – Funding for Lending –  which is unlikely to have very much effect at all: the Governor nicely articulated in the press conference why buying foreign assets wasn’t a good  –  likely to be effective – option at present, and a very similar analysis could be presented for his scheme of lending to banks –  banks (a) not notably being short of funds, and (b) not being known for being keen on dependence on central bank funding, at least outside the immediate white-heat of a crisis. )

But there was no action (not even on the new idea tool).  In fact, the Governor reiterated the commitment that the MPC had made back in mid March not to change the OCR for a year.   And that is even though, as the Governor himself noted, “March feels like a long time ago”.  It isn’t of course, but a great deal has changed since the MPC made that rash commitment –  notably, the MPC itself has belatedly come to appreciate the severity and duration of the economic downturn.    No one expected them to walk away from the commitment yesterday, but it would have been good –  good policy –  if they had. Central bankers should no more be encouraged to keep rash promises than moody teenagers who in a moment of upset threaten to run away from home, or perhaps kill themselves, should be encouraged to keep those rash promises.  From the evidence we have –  what the Bank choses to make available –  little more thought seem to go into the former pledge than into pledges of the latter sort.

Of course, the MPC did pledge to buy a whole lot more government bonds, over the next couple of years.    They still to seem to believe that such actions make a real-world difference to things that affect the inflation/output outlook. But they are wrong to do so. As it happens, I’ve this week been reading Stephanie Kelton’s  MMT tract. The Deficit Myth.  Much of it is a socialist tract, beloved no doubt by Bernie Sanders (her former boss) and Alexandria Ocasio-Cortez, but a fair bit of the first half is a (really clearly written, if somewhat loaded in interpretation) articulation of how fiat money systems work.  It is all stuff most serious central bankers know, even if they don’t use her language.  One of her arguments that it really doesn’t make much difference whether the government pays for its activities by creating settlement account balances at the central bank or by selling bonds (she calls one “yellow Treasurys” and one “green Treasurys”).  And in the current context that is much the same as my argument: the Reserve Bank buying tens of billions of government bonds (generally yielding less than 1 per cent) and issuing tens of billions of dollars of settlement account balances earning, currently, 0.25 per cent just doesn’t –  and wouldn’t reasonably be expected to –  make much useful difference to anything.  It is just an asset swap, doing little more than shifting around interest rate risk (the Crown is now quite highly exposed if something dramatic happens and interest rates need to rise a lot in the next few years).

The Bank continues to claim otherwise. But it is just a claim.  They have a substantial research and analysis operation but have published nothing that would support their claim, nothing that could be externally scrutinised. I guess they believe it, but they’ve gone out on quite a limb with the LSAP so of course they would.

The Bank claims that “the LSAP has [note the certainty] helped keep the New Zealand dollar exchange rate lower than it would have been otherwise”.  They do acknowledge that it is hard to tell but then tell us –  with no supporting analysis – that they think “the exchange rate is 4-10 per cent lower than it would have been without the LSAP programme”.    To which my response would be:

  • well perhaps, but the real exchange rate is still –  as you yourselves acknowledge –  where it was at the start of the year, so that even if the LSAP has kept the exchange rate down a bit, there is no absolute easing in this component of monetary conditions (despite a really big slump, and a shutting down of two major export industries),
  • much depends on the counterfactual.  I reckon there is a reasonable argument that the LSAP has left the exchange rate higher than otherwise, since the prime alternative policy – a zero or negative OCR – would have taken the TWI lower, and
  • yesterday’s announcement wasn’t great for the Bank’s story: the exchange rate barely moving.

They also claim that the LSAP has made a big difference to bond yields: “we estimate that NZGB yields are at least 50 bps lower, and potentially more than 100bps lower, than they would have been without the LSAP programm”.   They present no analysis – at all – in support of this claim, not even telling us which point on the yield curve they are referring to (the shorter-end will be strongly anchored by the expectation that the OCR won’t be raised for several years).   And perhaps more importantly:

  • if it is the long end they are referring to (where the LSAP has been concentrated) they’ve never articulated a convincing story for how, in New Zealand, long-term bond rates affect the transmission mechanism (long rates may be lower –  probably are to some extent –  but so what, and are we sure this isn’t an unwise distortion, at least if the Bank believes monetary policy is going to work and in a few years we will be back to a neutral OCR, according to them in excess of 2 per cent?), and
  • even if the LSAP has somehow imparted a great deal of stimulus –  and yesterday’s announcement didn’t move market prices much further, the Governor acknowledging diminishing returns to LSAP –  there is the small point of a pretty worrying outlook for the economy and inflation.  With all that estimated stimulus included, inflation is still at or below the bottom of the target range until the end of 2022, and the unemployment rate was still forecast to be 6 per cent by then.  And the Bank was emphasising downside risks, even before the new lockdowns.

I’m pretty sure I heard the Governor say that there was quite a bit more to do.  And yet, they did nothing.

At the last MPS the MPC chose not to publish projections for the OCR itself, but instead to publish a chart showing an “Unconstrained OCR”, apparently estimated by letting the forecasting model run and give us an estimate of “the broad level of stimulus needed to achieve the Reserve Bank’s employment and inflation objectives”.  This was yesterday’s chart.

unconstrained OCR 2

Throw in a whole lot more fiscal deficits and a whole lot more announced bond buying since May and the model still reckons the OCR should be at some below -2 per cent.   Instead, it sits and sits and sits at 0.25 per cent.  On their own numbers, they aren’t doing their job.  In the presence of self-acknowledging downside risks to activity, inflation, and inflation expectations.

So I discovered this morning, it was a year yesterday since the Governor’s extensive interview with Newsroom was published, in which he championed negative interest rates as the preferred policy tool in the next serious downturn.  It was a good –  informative, thoughtful – interview and we’ve never had an explanation for why he changed his mind (or, less probably, was overruled).  We do know, of course, that he and his staff did nothing to ensure that banks’ systems were ready and able, despite years of advanced notice, and now we are left with any serious monetary policy apparently dependent on how accommodating the Governor is of bank preferences –  and we know banks aren’t keen.   There is evidence that the Reserve Bank now has a serious work programme –  see this response to an OIA request someone else lodged (which the Bank said it was going to post on its website but did not do so)

OIA negative interest rates

but they fiddle –  move banks slowly ahead –  while the economy –  real people, real firms –  suffer unnecessarily.

It is simply inconceivable that at any other time, presented with projections this weak, downside risks, and serious new adverse news on the eve of the announcement, that the Bank would not have cut the OCR, perhaps by quite a lot –  not just fooling around with handwaving instruments that they can’t even demonstrate are making a material difference especially at the margin.

Jim Bolger has been in the news briefly this week –  for his irrelevant suggestion that the government bonds held by the Bank be “written off”, which would change precisely nothing of macroeconomic significance –  but he was Prime Minister in early 1991 when the Bank was very reluctant to ease monetary conditions.   There was significant political pressure – with hindsight quite warranted really – brought to bear on the Bank –  and Don Brash had been advised to watch his back when he went overseas.   But this time?  We have a Prime Minister and Minister of Finance who simply seen indifferent, whose innate conservatism seems to extend to not rocking the boat even when officials aren’t doing their job (and when the Minister of Finance has formal delegated intervention powers).

Once again yesterday, the MPC seemed keen to fob off responsibility to fiscal policy. But whatever the MMTers may wish, under New Zealand law fiscal policy does its own thing and then monetary policy –  the MPC – is charged with the residual stabilisation (full employment and all that).   The Bank has the effects of huge fiscal deficits included in its projections –  including that unconstrained OCR chart –  and it presents a nice chart showing that the estimated fiscal stimulus peaks this quarter and tails off from there (with neither main political party appearing keen on further increases in deficits from here).  Fiscal policy has played the ball –  wisely, responsibly, appropriately or not – and responsibility now rests with the Bank and the MPC.  Who are doing nothing, and seem more interested in giving little lectures to banks are to how they should run themselves than in using the tools Parliament has put at their disposal.   Perhaps they’ll do so next year –  still seven months away at least –  but they should have been acting much more decisively not just now but months ago.

Two final notes:

  • it was interesting to see the updated Bank forecast for the GDP contraction in the June quarter.  They expect a fall of 14.3 per cent following the March quarter fall of 1.6 per cent.  No one really knows and there are likely to be big revisions through time, but it was sobering to contrast these estimates with the falls in hours worked recorded in the HLFS, up 1.0 per cent in March and down 10.3 per cent in June.  That is a cumulative estimated fall in GDP of 16.1 per cent and a cumulative fall in hours worked of 9.4 per cent.  In other words, on the face of it, a huge fall in productivity.  Since both sets of numbers are probably not that much more than educated guesses, perhaps the truth was less bad, but –  properly measured – it seems almost certain that productivity in the June quarter would have been far lower than usual.  And yet, optimistic as ever, if anything the Bank is forecasting trend productivity growth in the next couple of years a bit higher than it has been in recent years,
  • I mentioned Stephanie Kelton’s book, MMT and all that.  This morning I recorded an interview with Radio New Zealand’s Jim Mora on monetary policy, fiscal policy, MMT, the Bank and so on, in the current New Zealand context.  It is scheduled to be broadcast on Sunday morning, although at present I’m not sure when specifically.   My previous post on MMT still seems about right to me, although Kelton’s approach is more radical than the presentation from,  and discussion with, Bill Mitchell that the previous post was built on.  There is a macro policy dimension to Kelton, but her real agenda is big government across the board –  an explicitly political agenda that doesn’t have much to do with the best design for macro policy.


The Reserve Bank’s Monetary Policy Statement is due out on Wednesday.  It will be interesting to see what tone the MPC comes out with.   Quite a bit of the recent media commentary in New Zealand has been rather upbeat, for reasons that aren’t fully clear.  No one seems to expect the MPC to do much that might make a difference, although there will be interest in what the Committee has to say on its handwaving supplementary tools (that do little useful), the Large Scale Asset Purchase programme and, for example, the idea of buying foreign assets.  The latter, if launched at some stage, might get them some headline effects for a day or two – as happened when we tried fx intervention back in 2007 – but beyond that is likely to be even less effective than the LSAP.

Where the MPC could still be of us,  even if they aren’t going to change the OCR, is to apply to refreshing dose of bleak reality to the discussion of New Zealand’s economic situation.  I don’t suppose they will go very far in that direction –  after all, doing so wouldn’t help their ideological allies in the current election campaign –  but they might still help that they shift the ground somewhat.  Even the Minister of Finance has been heard recently reporting that The Treasury –  whose own PREFU numbers are due out next week –  are now really quite pessimistic on the world economy.    And a small, moderately open, economy isn’t that well-positioned if (a) the rest of the world is doing poorly, and (b) domestic macro policy is doing less than usual in a downturn.

The latest expectations data was a reminder as to just how little monetary policy has done this year.  Take inflation expectations as just an example.

The ANZ’s survey of the year-ahead inflation expectations of a reasonably large sample of their business customers hasn’t produced a result as high as 2 per cent since May last year.   As recently as their February survey –  mostly taken before the February MPS when the Reserve Bank was sufficiently upbeat they adopted a slight tightening bias – year ahead expectations were as high as 1.89 per cent.  Now those expectations are about 1.4 per cent, a long way below the target midpoint the MPC is supposed to focus on.

What about the Reserve Bank’s own survey of a smaller sample of supposedly relatively expert observers?  We got the latest read on that last week.

RB infl expecs

As expected, there is a slight recovery in the latest survey, but both lots of expectations are a long way below the target midpoint.  If you were charitable you might argue that the year ahead outlook was at least in part still beyond the Bank’s control, but there is ample opportunity for the Bank to have inflation back to 2 per cent by the year to June 2022.  But respondents don’t believe they will.

And what about market-based measures?   These are the five year breakevens (from the indexed and conventional government bond yields) for the United States and New Zealand.

five year breakevens

The breakevens fell sharply in March, especially in the US –  the focal point for the stresses in government bond markets.  But since then US breakevens have retraced most of this year’s falls.  The New Zealand picture is very different: not only did the implied breakevens start the year miles below the inflation target, but that gap has widened substantially further this year, with little sign now of any convergence/correction.    These implied expectations are 55 basis points lower than they were at the end of last year, or than they were when the MPC was setting policy in February.

Perhaps the best thing about the Reserve Bank’s Survey of Expectations is that it asks the same respondents about a bunch of macro variables, not just about inflation.   If we assume those people are each answering somewhat consistently, we can look at one set of answers in light of others.    For example, we know that the OCR has been cut by only 75 basis point this year, but there is also a question about where respondents think the OCR will a year ahead.  Since the survey done in early February, those expectations have fallen by 78 basis points.  That is actually a bit less than the fall in those same respondents’ year-ahead inflation expectations.  Even if you think (as the Bank typically did) that the two year-ahead measure is more important, you are left with results in which these respondents think real interest rates have fallen only perhaps 25-30 basis points.  It is a derisory change in the face of a shock of this magnitude.

What about government bond rates?  Well, we hear a great deal from the Bank –  and some of their market acolytes – about the difference the LSAP is making.    But how much have year-ahead expectations of the long-term bond rate fallen since February, even taking account of the LSAP (actual and expected)?   A mere 54 basis points.    To be sure, we do not know the counterfactual –  without the bond-buying actual and expectation bond yields might be higher, but the bottom line remains that yields have not fallen much, especially in real terms.

Respondents are also asked about GDP growth and although these responses seem to have got no media coverage in some respects they are the most disconcerting of them all.  Respondents expect real GDP growth of 4.24 per cent in the four quarters to June 2021 (the median response is actually much lower at only 3 per cent) and 2.77 per cent over the following four quarters.   Those numbers might not seem so bad until you realise that the (generally expected) trough in GDP will have been in the June quarter 2020.  It is quite likely that GDP in the four quarters to June 2020 will have fallen by perhaps 15 per cent.    A rebound of only 7 per cent over the following eight quarters would be alarmingly bad.   The question is quite clearly posed: it is not an annual average growth rate that was asked for, although I suppose some may have misinterpreted it that way.    However respondents answered the GDP question-  and there is a huge range of estimates for the year ahead (from -18  per cent to 24 per cent) – respondents expect the unemployment rate to remain high.

The Bank introduced a couple of interesting new questions to the latest survey (I hope they become standard features, and that the results are reported on the main tables on the website).  First, they asked respondents what they expect the OCR to be in June 2030 –  ten years’ hence.  The point here is not that there is anything very special about the specific June 2030 date, but that it is far enough ahead that one could expect respondents to look beyond the current crisis or evident cyclical pressures and think mostly about the long-term structural features of the economy.    The range of estimates was wide –  from 1 per cent to 4.5 per cent –  with a median of 2.5 per cent.    My own response to that question was 2.25 per cent, but since my 10 year ahead inflation expectations (1.5 per cent) were  lower than those of the median respondent (2 per cent) I was a bit surprised to find that I had an above-median estimate of the neutral OCR.

(It would be interesting to invite the MPC members to follow the lead of the FOMC and publish their individual –  unnamed –  estimates of the neutral OCR.)

The other new question asked respondents to estimate the average OCR for the next 10 year.  Again, the median response (1.5 per cent) was higher than my response (1 per cent), a difference likely to be mirrored in a difference in inflation expectations).

If these responses to the Reserve Bank survey capture anything useful at all, they should really be quite concerning to the Governor, to the Monetary Policy Committee, and to those with the legal responsibility for holding the Bank to account (that’s you Reserve Bank  Board and Grant Robertson).  Inflation is expected to be well below target, unemployment is expected to remain worryingly high, the recovery in GDP is expected to be pretty feeble at best, and hardly anyone expects that the Bank will manage to establish any material policy leeway in the period before the next economic downturn hits.    It is a pretty clear case where the informed respondents do not act (write down expectations) as if they believe the Bank is adequately doing its job.

Now perhaps on Wednesday the MPC will come out with some much more upbeat story, and tell us reasons why the views of survey respondents should be discounted.  But if anything at the time of their last MPS, the Bank was more pessimistic than survey respondents, even though their official line has been the monetary policy is providing large amount of stimulus.

Now, of course, the Committee likes to abdicate its responsibilities and put everything on fiscal policy.  But that isn’t the way the regime is supposed to work.  Rather, governments set fiscal policy and then the MPC is supposed to do whatever it takes (loosening or tightening) to deliver the inflation target the government has set out for them.  Respondents to the Bank’s survey know all about fiscal policy, and yet they conclude that the Bank is not acting to do its job, isn’t acting consistent with getting inflation promptly back to 2 per cent or –  for that matter –  with quickly re-establishing full employment.   The peak contribution to fiscal policy is already passing, monetary policy could have been aggressively deployed months ago to be in a position to take up the slack.  Instead, we sit here now with real interest rates barely down much at all, a real exchange rate that hasn’t budged, and yet with really worrying  –  and remediable –  economic and inflation outcomes in prospect.

I’m sure many readers are inclined to discount the significance of inflation expectations.  I’m not one of those who runs a model in which inflation expectations directly set inflation outcomes, but when both expectations (all measures) of inflation are below target and unemployment is well away from full employment, what it tells us is that monetary policy simply isn’t being used to the full.  There is a reasonable debate to be had about whether some countries, or the world,  might emerge from this crisis with much higher –  troublingly high, or (to some) usefully high – but when there is no indication at all, from surveys or market prices, that inflation is even likely to be at target, let alone far overshooting it, we should be able to expect more from the Reserve Bank, not just some handwringing exercise –  from the macro-stabilisation agency –  suggesting that the unemployment is someone else’s problem.

In this case, notably, we need deeply negative interest rates. I’ve seen some banks suggesting that interest rates will eventually go a bit negative because more stimulus is needed.  But it is clear –  including from those banks’ own commentaries –  that that stimulus/support from monetary policy is needed now, not –  even then in half-measures –  sometime next year.



Perhaps they should start a bank?

In the last few days speeches by two of the Reserve Bank’s senior managers have been published.   The first was from the Deputy Governor Geoff Bascand –  delivered on no obvious occasion to “banking industry representatives in Wellington” –  and the second by Toby Fiennes, formerly head of supervision (operations and policy) but now reduced to Head of Financial System Policy Analysis, at one of those commercial training ventures that are always keen to have (free) speakers from places like the Bank.

Bascand and Fiennes have often been among the better people in the upper reaches of the Reserve Bank.  I’ve been on record suggesting –  before the appointment and since –  that Bascand, if not ideal, would have been a better appointee as Governor.  His speeches have typically been quite materially better than those of his senior management colleagues –  more akin to what we see from people at Deputy Governor level in other advanced country central banks –  although that is true more of his speeches on economic topics than those on banking and financial stability.    Perhaps that isn’t surprising –  his background was in economics, and he had no background in financial stability or regulation until he took up something like his current job three or four years ago.

In this post I want to focus mostly on Bascand’s speech.  He is the more senior figure and is across all the functions of the Bank –  including apparently enjoying the confidence of the Minister as a member of the statutory Monetary Policy Committee.   And if Fiennes’s speech raises one or two points, Bascand’s is really quite egregious in places.

As befits one of Orr’s deputies, the speech pays due obeisance to the public sector employees’ campaign to change the name of the country.     The title?  “Banking the economy in post-COVID Aotearoa”.    As it happens, they the drop one more “Aotearoa” into the first page before reverting, almost without exception, to “New Zealand” (actual name of the country, actual name of the Reserve Bank of New Zealand) for the rest of the speech.

The bottom line message of the speech, however, seemed to be an injunction to banks to lend more.  So much so that, as per the title of this post, one was left wondering why if Messrs Orr and Bascand know so well what the profitable risk-adjusted opportunities are they don’t step down from their secure and quite highly-paid public sector perches and start a bank, or at least offer their services to the credit and risk departments of some existing insurgent bank.

It starts on the first page

In the face of these challenges, the banking sector could choose to hunker down and seek to ride out the storm until the good times roll again. Or, the banking system could continue to step up and play a crucial part in supporting New Zealand’s economic recovery and maximise its potential competitive advantage of relationship lending and customer information. …..

Maintaining institutional resilience while continuing to serve customers in an uncertain environment will demand expertise, courage and an unwavering belief that the people and businesses of Aotearoa will find a way to come out of these challenges.

In periods of extreme uncertainty, isn’t the rational –  and prudent – response of most people to “hunker down”?   And this is an environment of really quite extreme uncertainty –  a point I’m sure we will hear emphasised (again) by Orr and Bascand next week when they put their monetary policy hats on and deliver the Monetary Policy Statement.

But here –  playing with other peoples’ money – they want bank managers to ride blindly –  but “courageously”-  into the cannon fire, as if they (Orr and Bascand) either know better than the shareholders what is in those shareholders’ interests, or just don’t care.   And it is pretty rich coming from people who, with their monetary policy hat on (the tool actually designed to support recoveries) are doing almost nothing.

It is really remarkable for the lack of nuance and subtlety.  I scrawled in the margin against that first paragraph “presumably some mix?”     I doubt there has ever been a market-oriented banking system that-  in a severe downturn – has ever either called in every loan possible at the first sign of trouble, or rushed out boldly to encourage a wide range of borrowers to take more credit.    But there is nothing of this in Bascand’s speech, nothing either about how serious downturns should prompt both lenders and borrowers to reassess the assumptions they were working on, in turn prompting greater caution –  the more so, the more uncertain the path ahead.     Thus it is fine for central bankers to fling out rhetoric about “unwavering belief”, but no one knows which forward path the economy will actually take, how long it will take to get securely on that path, or what crevices there might yet be along the road.  It will make quite a difference to plenty of credit assessments –  whether for existing debt, or those interested in taking on new debt (around many of whom there may be adverse selection risks).

A bit later on there is an entire section of the speech on “Reserve Bank actions to support bank lending”.    It is about as thin.

For example, we get overblown claims like this

Cash flow and confidence became key to New Zealand’s financial stability.

I know “cash flow and confidence” was a mantra of the Governor’s but –  and as the Bank itself would tell us any other time –  the financial system’s soundness was much greater than implied by this assertion of Bascand’s, reinforced a sentence later when he tries to claim that various initiatives had “kept the financial system stable”.   These measures, apparently, included the small cut in the OCR (virtually no change in real terms), whatever the LSAP did to long-term rates, and a list of other regulatory measures which –  useful as most may have been –  will have done little or nothing to “keep the financial system stable”.   System stability is mostly about disciplined lending in the good times.  All evidence suggests –  and other Reserve Bank commentary suggests they agree –  we had that.  One of the risks at present is that if anyone in the banks paid much heed to the Reserve Bank’s rhetoric, those lending standards could be considerably debauched now.

Bascand goes on, being really rather self-congratulatory

Taken together – and without being too self-congratulatory – these initiatives have had a significant impact on supporting the short-term financial needs of households and businesses. This was important to limit failures of businesses with good long-term income prospects, and prevent mortgage defaults and foreclosures for borrowers facing temporary decreases in income.

All this without a shred of evidence to support his claims to have made much difference at all.   In this Bascand world, banks would have been rushing into mortgagee sales, closing businesses galore, without any regard at all for longer-term relationship prospects etc, if it hadn’t been for the Reserve Bank.    It is the same spin we used to get from the Governor, and the same lack of evidence.     We’ve had fairly sound and well-managed banks for 100 years or more –  recall that the closest to a bank failure in the immediate post-liberalisation period were two government-owned entities-  but the Governor and his Deputy believe that they are the hope and salvation.

Bascand goes on to talk threateningly about banks retaining their “social licence to operate” –  if there is such a thing, it is really no business of a central bank charged only with prudential supervision of banks.  And then we get to what seems to be the climax of his lecture on lending

But a key determinant of the success of New Zealand’s economic recovery to come will be the willingness of banks to lend to productive, job-rich sectors of the economy so that we can collectively take advantage of New Zealand’s enviable position of having eliminated community transmission. Now is the time for banks to prudently drawdown on their buffers to support their customers. Shareholders will have to be patient for longer-term payoffs, but this forward-thinking, long-term approach will stand bank customers, banks, shareholders, the financial system and Aotearoa in the best position.

Given banks are anticipating a deterioration of their loan portfolios, hunkering down and tightening lending standards may seem to them to be the optimal response to perceived increased risk. However, given banks dominant role in New Zealand’s financial system a synchronised lending contraction across the banking sector would risk a ‘credit crunch’ amplifying the economic downturn (Figure D). Therefore ultimately it is in banks’ own interest to maintain the flow of credit and contribute to the long-term stability of the banking system by preventing large scale borrower defaults and disorderly corrections in asset markets.

There is so much problematic about this it is difficult to know where to start.  There is. for example, the small point that highly productive sectors tend –  almost by definition, and it is a good thing –  not to be ‘job rich”.  For the rest, as noted earlier, you get the impression that people with no experience in banking at all –  or indeed in Bascand’s case any in business at all –  are best-placed to tell private businesses and their shareholders what is in their own best interests.  Based on what evidence, what analysis?   And isn’t it all rather lacking in nuance, since few of these sorts of decisions are ever all or nothing.   And despite the wider economic responsibilities of the Bank, it isn’t even obvious where Bascand thinks these profitable creditworthy projects are to be found –  or how he could be confident of his judgement even if he and his staff could identify some.     Surely a more general answer would be that private agents (banks and other firms and households) are best placed to make their own assessments about choices and risks, but that macro policy (and perhaps now public health policy) can provide the best possible supporting climate for those private decisions to be made.  As it is, even later in this speech Bascand concedes that “our economic challenges remain severe”.   Not exactly a climate for much private sector risk-taking, whether by banks, firms or households.  But it might, for example, be time for a monetary policy central bank to start doing its job.

Risking other peoples’ money was the theme of that bit of the speech. But Bascand also took the opportunity to comment on the Governor’s bank capital review –  the one that will require a huge increase in bank capital to support the existing level of business.   The one that banks, and many outside experts –  not, contrary to the Governor’s claims, just those paid by banks –  warned would lead to some credit contraction, some disintermediation from the banking system, and some higher costs.

Likewise, capital metrics were strong going into this crisis, boosted by Basel III regulatory requirements, a number of years of favourable economic performance, and preparations for the impending implementation of the Reserve Bank’s Capital Review. The COVID-19 crisis has underscored the importance of banks having sound capital buffers; increased provisions for expected credit losses have, so far, been easily absorbed by existing capital buffers. Healthy capital buffers are necessary not only to ensure banks survive crises, but to ensure banks survive ‘well’ and are able to continue to lend to creditworthy borrowers throughout a downturn. The Reserve Bank remains committed to fully implementing the outcomes of the Capital Review. However, as we indicated this past March, this will be delayed one year and not occur until July 20212. We expect to communicate further on the implementation of the Capital Review by the end of the year.

There are really two main points here.  The first is the claim –  that Orr has made repeatedly –  that banks were well-positioned this year partly because they had been acting preemptively to raise more capital in anticipation of the higher capital requirements, which were supposed to be phased in from this year.  Victoria University banking academic Martien Lubberink has addressed directly this claim in a post on his blog.   As everyone recognises, capital ratios have increased since prior to the previous (2008/09) recession, under the influence of some mix of regulatory and market/ratings agency pressure.  But here is Martien’s chart showing total capital ratios for several of main banks operating here for the period, in early 2018, since Orr took office.

total capital ratios

He has another chart showing core (CET1) capital ratios, which also suggests no lift in capital ratios over the last couple of years.

The Bank has been attempting a difficult balancing act: trying to assure us (of what is almost certainly true) that the local banks are very sound, but at the same time trying to get cover for the scheduled large increase in capital requirements.  There would be some reconciliation if banks had been raising actual capital in anticipation of those new requirements but….the Bank’s own data, the useful dashboard, confirms that it just isn’t so.    It is just spin, it is a lot worse than that.

Oh, and note that Bascand reaffirms that the Bank is still committed to moving ahead with the higher capital requirements –  even though it expects the banks to come through the current severe test just fine.    The implementation was delayed by a year back in March, but that is now five months ago, and July 2021 really isn’t far away –  particularly in a climate of heightened uncertainty, including about likely loan losses out of the current recession.  So on the one hand the Deputy Governor and his boss are out their urging banks –  almost suggesting it is some sort of moral duty –  to lend more freely, and on the other hand they are still pushing ahead with their plans to hugely increase actual capital requirements, something even their own modelling suggested would have adverse transitional effects in more-normal times. (Oh, and did I mention all while doing nothing to actually lower real interest rates across the economy, in ways that might improve servicing capacity on current debt, and provide a boost to aggregate demand and –  over time – to credit demand.)

And here I want to refer to the other speech, by Toby Fiennes; in particular this extract (emphasis added)

At the end of May we released our six monthly Financial Stability Report (FSR) which assesses the health of the financial system. This assessment presents particular challenges during more volatile and uncertain times; we want to report openly and fully about the state of financial stability and the risks that we see, but we have to be mindful of the risk of exacerbating the situation, and further undermining confidence.

We used stress tests to inform ourselves and our audience about banks’ and insurers’ resilience. We developed two scenarios to test the banking system, which had similar economic projections to the Treasury’s COVID-19 scenarios 4. Results from our modelling indicated banks would be able to maintain capital above their minimum capital requirements under a scenario where unemployment increased to over 13 percent and house prices fell by a third. However, a second more severe scenario showed the limits of bank resilience. Under this scenario with unemployment of over 18 percent and house prices falling by half, banks would likely fall below minimum capital requirements without significant mitigating actions.

I should note that bank capital buffers have increased significantly in the past decade, in response to actual and forthcoming increases in regulatory requirements; therefore the banks entered the Covid-19 pandemic in a sound position. Additionally, since early April the Reserve Bank has prohibited banks from paying dividends to their shareholders, which further supported the capital positions of New Zealand banks. This gives banks headroom to continue to supply credit, which will play a large role in supporting the economic recovery.

Note that he repeats the same outright misrepresentation –  the bolded phrase –  as his boss.

But it was the rest I was more interested in.  He highlights again the updated stress tests reported in the FSR.    I might be more pessimistic than most economists, so I reckon the 13 per cent unemployment scenario sounds like a good and demanding test.  As with previous similar RB stress tests, Fiennes reports that the banks come through just fine –  at least so long as they don’t markedly lower their lending standards in response to regulatory pressure.  But again –  as was argued during the capital review debates last year –  if the system is resilent to such an adverse shock before capital ratios are raised, what possible credible case can their be for markedly further raising capital requirements?  Especially when the Bank is trying to twist banks’ arms to maintain/increase new lending?   There is just no apparent rigour or coherence to the Bank’s position.

Much the same goes for the line about prohibiting dividends.  I didn’t have too much problem with the temporary ban when it was announced  – on good prudential grounds that in the very unlikely event that our banks got into serious trouble we didn’t want resources being transferred back to the parent, leaving larger losses for New Zealand creditors and taxpayers.   But it is just bizarre to suppose that banning banks from paying dividends will increase their willingness to make new good loans.  If anything, it is only likely to reinforce unease about doing business in New Zealand (at the margin), and since credit demand has fallen notably –  a point Bascand acknowledges-  and actual capital ratios were well above current regulatory minima it isn’t obvious that some shortage of capital in the New Zealand business was likely to be a big influence on lending policy just now.  The suggestion that suspending dividends will “play a large role in supporting the economic recovery” is without support, and if seriously intended is almost laughable.

There is more in Bascand’s speech I could devote space to.   At least what I’ve covered up to here is within the Bank’s statutory mandate re the soundness of the financial system as a whole.    The same can’t be said for this stuff, pursuing the Governor’s personal political agendas on issues where there may be real issues, but they have nothing to do with the Bank’s mandate or powers.

Financial inclusion has become an increasingly important part of the Reserve Bank’s policy agenda in our capacity as a Council of Financial Regulator member and our own Te Ao Māori strategy. The Strategy helps to guide the bank in understanding the unique prospects of the Māori economy, how Māori businesses operate, and what lessons the Bank may learn in setting systemically-important policy with this view in mind. An important part of the Strategy is making clearer the unintended consequences of our policies on unique economies like the Māori economy.

Or one of the Governor’s favourites, climate change.  Here I will just quote one line from the speech

Managing major and systemic risks to the economy, such as climate change, sits squarely within our core mandates.

It simply doesn’t    The Bank has an important, but narrow, statutory role and set of powers around the soundness of the financial system.  Climate change(and policy responses to it) may well represent a significant threat to our economy, our way of life, and so on. But unless –  and even then only to the extent –  it poses a threat to financial stability, not taken account of by private borrowers and lenders, it is really no particular business of the Bank.  Any more than other serious risks –  management of Covid itself as just a contemporary example –  are anything much to do with the Bank.

But the Governor has personal ideological agendas to pursue, and (ab)uses public resources and staff to pursue them.

Standing back from the Bascand speech, what is really rather striking –  and disappointing –  is the lack of an overall framework, the lack of any real rigour or discipline, and a lack of straightforwardness.  Clearly his boss has a cause –  more lending –  to pursue, but like Orr Bascand offers no reason to suppose, or evidence to support the implication, that banks are not acting prudently or appropriately.  And never seriously engages with the implication that if the banking system is sound now and has plenty of headroom, why would it make sense for the Bank to be imposing big new capital requirements, which will assuredly be reducing the willingness of banks to lend.

But, as I noted earlier, if the opportunities are so real no one is stopping Orr and Bascand leaving their safe official perches and starting –  or joining –  a risk-taking bank.  A good supervisor would, however, be keeping a very close eye on any bank riding courageously into the cannon fire –  of extreme economic uncertainty, severe challenges –  in the way Bascand appears to suggest.

Perhaps better if Orr and Bascand turned their minds, and attention, to using monetary policy in the way it was designed to be used, instead of sitting idly by six months into a severe economic shock, with real interest rates barely changed, and the real exchange rate not changed at all.