There has been a flurry of commentary in the last couple of weeks about the (alleged) impact of the Reserve Bank’s Large Scale Asset Purchase programme. Much of it has seemed to me really quite confused. I don’t really want to pick on individual people – none of whom, as far as I’m aware, is a macro or monetary economist – although, for recency if nothing else, Bernard Hickey’s column yesterday is as good an example as any. But the Reserve Bank itself has not helped, tending to materially oversell what the LSAP programme has actually done.
There is, for example, a complaint (there in the headline of Hickey’s article) that “printed money being parked, not invested or spent”. But this seems to completely ignore the fact – it isn’t contested – that really only Reserve Bank actions affect the stock of settlement cash. All else equal, when the Bank buys an assets from someone in the private sector, that purchase will boost aggregate settlement cash, and only some other action by the Reserve Bank will subsequently alter the level of settlement cash. When private banks lend (borrow) more (less) aggressively, that may change an individual bank’s holding of settlement cash, but it won’t change the system total. Some of my views and interpretations may be idiosyncratic or controversial, but this one isn’t. It is totally straightforward and really beyond serious question. For anyone who wants to check out the influences on the aggregate level of settlement cash balances, the Reserve Bank produces a table – only monthly and too-long delayed in publication – detailing them (table D10 on their website). I’ll come back to those numbers.
Now, of course, the transactions that give rise to changes in settlement account balances aren’t always – or even normally – primarily with banks themselves. If the Reserve Bank bought a government bond I was holding, that would increase – more or less simultaneously – (a) my balance in my account at my bank, and (b) my bank’s balance in its account at the Reserve Bank. And because the government banks with the Reserve Bank, the same goes for (say) government pension payments: all else equal, they add to the recipient’s own deposits at his/her bank, and also to that recipient’s own bank’s deposits at the Reserve Bank (in normal times, the Reserve Bank does open market operations that roughly neutralise these fiscal flows – revenue or spending).
Much of the coverage of the LSAP purchases suggests that there has been a big net transfer of cash (deposits, settlement cash) from the Reserve Bank to private sector bondholders in recent months. Thus, we get stories and narratives about what “rich people” and other bond holders are (and aren’t – often the point) doing with all the cash they are now holding. But it simply isn’t a narrative relevant to New Zealand over recent months. The Reserve Bank publishes a table showing holdings of government securities (Table D30). Again, it is only monthly and we only have data to the end of July. But over the five months from the end of February to the end of July, secondary market holdings of New Zealand government securities (ie excluding those held by the Reserve Bank and EQC) increased by around $10 billion. It simply is not the case that funds managers, pension funds and the like (private bondholders generally) are suddenly awash with extra cash. In fact, collectively they have more tied up in loans to the Crown than they had back in February.
None of which should be really very surprising. After all, the government has run a massive (cash) fiscal deficit over the last six months – a reduced tax take and programmes that put lots of extra money into the accounts of businesses and households.
We can get a sense of just how large from that Influences on Settlement Cash table (D10) I referred to earlier. In the five months March to July the government paid out $23.8 billion more than it received. There is some seasonality in government flows, but for the same period last year the equivalent net payout (“government cash influence”) was $4.5 billion (and $4.9 billion in the same period in 2018). That is a lot of money put into the accounts of firms and households – the largest chunk will have been the wage subsidy payments, but there was also the corporate tax clawback, and various other one-offs, as well as the effect of the weaker economy in reducing the regular tax-take.
Over those five months the government has also issued, on-market as primary issuance, a great deal of debt (bonds and Treasury bills) offset by maturities (and early repurchases of maturing bonds by the Reserve Bank). Over the five months, the net of all these on-market transactions was $34.4 billion – as it happens, a whole lot more than the cash deficit for that period.
Now, of course, we know that the Reserve Bank – another arm of government – has been entering the secondary market to buy lots of government bonds. For the five months, the cash value of those purchases was $27.2 billion.
Take those two debt limbs together and issuance has exceeded RB LSAP purchases by about $7.2 billion.
And those are almost all the main influences on aggregate settlement cash balances. Other Reserve Bank liquidity management transactions can at times have a significant influence, but over these five months the net effect was tiny, at around $300m.
So broadly speaking, over the five months from the end of February to the end of July, the total level of settlement cash balances increased by about $16.4 billion (to $23.8 billion at the end of July). Roughly speaking, a cash deficit (also, coincidentally) of $23.8 billion, and net debt sales by the NZDMO/RB combined of $7.2 billion. And a few rates and mice.
Another way of looking at it is that the $23.8 billion “fiscal deficit” has been financed by $7.2 billion of net debt sales to the private sector, and by the issuance of $16.4 billion in Reserve Bank demand deposits (another name for settlement cash balances).
(And thus the biggest effect of the LSAP programme itself has really just been to change the balance between those last two numbers – consistent with the line that I keep running that to a first approximation the LSAP is just a large-scale asset swap, exchanging one set of low-yielding government liabilities (that anyone can hold) for another set of low-yielding government liabilities (that only banks can hold, while banks themselves assume new liabilities to their own depositors).
But taking the private sector as a whole what has happened over the last few months is that the fiscal policy choices (spending and revenue) have put lots more money in the pockets (and bank accounts) of firms and households. And the government as a whole (NZDMO/RB) has offset the settlement cash effects of that in part by (net) selling really rather a lot (by any normal standards) of net new bonds to private sector investors/funds managers etc. They, in turn, have less cash. Firms and ordinary households have more (at least than they otherwise would).
There have been strange arguments – and the Reserve Bank Governor sometimes feeds this silly line – that banks are not “doing their bit” by lending more to businesses, even though – we are told – they have so much more settlement cash. But this is a wrongheaded argument, because systemwide availability of settlement cash has rarely, if ever, in recent times (last couple of decades) been a significant constraints on bank lending. Aggregate settlement cash balances barely changed over the previous decade and plenty of lending occurred. In a severe and quite unexpected recession, it would generally be more reasonable to suppose that lack of demand from creditworthy borrowers, some caution among banks as to quite what really is creditworthy, and sheer uncertainty about the economic environment would explain why there wasn’t much new business lending occurring. In fact, sensible bank supervisors would typically welcome that outcome. And remember my point right at the start, even if banks were doing lots of new business lending, it would not change the level of settlement cash balances in the system as a whole by one jot.
So then we get to the question of house prices. Many people – me included – expected that we would have seen house prices beginning to fall already. Severe recessions and considerable uncertainty tends to have that affect. Often, tighter bank lending standards reinforce that. So what did we miss? I can’t speak for anyone else, but for me:
- I have not been surprised by the extent of the fall in retail interest rates. That fall has been small in total, and modest by the standards of significant past recessions. When people idly talk about lower lending rates driving up house prices, they seem completely oblivious to the way – whether over 1990/91, after 1997/98, or in 2008/09 – falling interest rates initially went hand in hand with flat or falling house prices. Interest rates were, after all, falling for a reason in the middle of a recession. One can argue that trend lower interest rates are raising trend house prices (I don’t think so, but that is for another day) but there isn’t really a credible story that this modest fall in interest rates – amid a big and uncertain recession – is raising house prices now, in and of itself,
- we also know that people who usually hold bonds are not suddenly finding themselves at a loose end, unable to invest their cash in government bonds and having to fall back on buying a house instead. The aggregate figures tell us instead they are holding a lot more bonds than they were (and as a trustee of super funds that do have substantial bond exposures, I know our advisers have not come and urged us to sell out and buy houses).
- but we’ve also had a highly unusual combination of events that together probably do explain why, to now anyway, house prices are holding up in most places, perhaps even rising.
- we’d never previously gone into a recession with binding LVR limits in place. The Bank removed those limits when the recession began – sensibly enough – for a flawed policy – and consistent with the way they’d always talked of operating, enabling some people who regulation had forced out of the market to get back in. Regulatory credit constraints were eased.
- We also had the mortgage holiday scheme, which had two legs to it. The first was that banks generally agreed to show forbearance to people who would have otherwise had trouble servicing their mortgage over this period, allowing them to defer to later payments due now. Mostly that was probably pretty sensible, and banks might done something along those lines for most customers even with no heavy-handed government involvement. But then the Reserve Bank engaged in questionable regulatory forbearance, telling banks that even though the credit quality of their residential loan books had deteriorated – people unable to pay, even if perhaps just for a time, but with threats of rising unemployment – they could pretend otherwise, at least for the purposes of the capital requirements the Reserve Bank imposes on locally-incorporated banks.
- And, third, we’ve had an unprecedented series of fiscal support measures, putting lots (and lots) of taxpayer money into the accounts of businesses (mostly, directly) and households, to offset to a considerable extent the immediate substantial loss of market incomes and GDP.
My approach then is to reason from the counterfactual. Suppose these actions had not been taken, what then would we have expected to have seen in house prices?
I reckon it would be a safe bet that house prices would have fallen. Sure, retail interest rates would still have come down, but as I noted earlier that happens in almost every recession, and the falls are typically larger than those we’ve seen this year. But even just suppose the virus had done as it did, here and abroad, and that the anti-virus choices (policy and private) were as they were. There would have been a huge increase, almost immediately, in unemployment, and a large number of households would have been thrown onto no more than the unemployment benefit, and many of those that weren’t would have running very scared. The cashed-up might still have been interested in buying, at low interest rates, but there would have lots of sellers – whether forced by the bank, or people just needing to cut their debt urgently – and that wave of desired selling would have fed doubts that would have left buyers more wary than otherwise. But it was the fiscal policy choices that put additional money in the pockets of those who might otherwise have been rushing to sell.
The thing is, that for all the moans and laments about house prices rising a little, no one seems to have been arguing that we should not have taken a generous approach to supporting households through recent months. Given the logic of the LVRs, probably most people think it reasonable that those restrictions were suspended. Few people think banks should have been more hard-hearted (even if a few geeks like me might be uneasy about the capital relief the RB provided).
And it is those that are the choices that really mattered. (They are also why I remain sceptical that any strength in the housing market will last much longer, given that the fiscal support is rapidly coming to an end, unemployment is rising (and is expected to continue to do so), the world economy looks sick, we’ve been reminded afresh of virus uncertainty, and deferred debt has not gone away. Time will tell.)
Now none of this is to suggest we should be at all comfortable with the level of house prices in New Zealand. They are a disgrace, and the direct responsibility of successive governments of all stripes, and of their local authority counterparts. But given that all of them refuse to address the real issues – opening up land use on the fringes of our towns and cities in ways that would bring land prices dramatically down – they can’t really be surprised by where we are now.
And it is has nothing whatever to do with the LSAP programme:
- which has not put more money in the hands of people who buy houses,
- has not made any material difference to wholesale or retail interest rates over the relatively short-term maturities most New Zealand borrowers borrow at (even if there is a case that the might have a material difference to long-term rates, benefiting really only the government as borrower),
- may have actually held short-term interest rates up a little, if the Reserve Bank is being honest in its claim that it preferred using the LSAP to cutting the OCR further this year,and
- which has not enabled, empowered, or encouraged the government to run any larger deficits than it would otherwise have chosen to run (which could readily have been financed on-market, except perhaps in the torrid week or two in late March when global bond markets were dysfunctional. Government deficits put money in the pockets of people. Most people – me included – think they were right to do so (even if we might quibble about details).
Observant readers may have noticed that the government issued much more debt over those five months than the deficits it ran. Without the LSAP, these transactions in isolation would have tended to drain the level of settlement cash. But that would not have happened in practice. Either the NZDMO would have spread out its issuance a bit more, or the Reserve Bank would have done (routine for it) open market operations to stabilise the aggregate level of settlement cash balances at levels consistent with their target level of short-term interest rates.
Other observant readers might wonder how the LSAP can be so relatively unimportant (in many ways almost as unimportant as the MMT authors might suggest). A key issue here is that the yields the (whole of) government is paying on bonds is very similar now to the yield (the OCR) it is paying on unlimited settlement cash balances. One could imagine a different world in which things would work out differently. It used to be common for settlement cash balances to earn either zero interest, or a materially below market rate. So if, say, the Reserve Bank was buying bonds at yields of 10 per cent – where they were in the early 1990s – and paying zero interest (or even a significant margin below market) on settlement cash balances, each individual bank would be very keen to get rid of any settlement cash building up in its account. They still couldn’t change the total level of settlement cash balances but they could, for example, bid deposit rates down aggressively, which would (among other things) be expected to materially weaken the exchange rate. But on current policy – only adopted in March – the Bank pays the full OCR on all and any settlement cash balances. 25 basis points isn’t a great return, but it is probably high enough – relative say to bank bill yields – that banks aren’t desperate to offload settlement cash. The transmission mechanism is then muted, as a matter of policy choice.
Finally, note that – because of the inadequacies of the Bank’s data publication (influences on settlement cash really should be daily, published daily, in times like this) – all my numbers refer only to the period to the end of July. But note that since the end of July the level of settlement cash balances has fallen further ($19 billion as of last Friday). I haven’t tried to unpick what specifically has gone on in any detail, but my guess is that the cash fiscal deficit has diminished, while heavy bond and bill issuance by DMO has continued. The Reserve Bank has stepped-up its own purchases but the bottom line remains one in which (a) if anything the Bank is draining funds from banks, although in doing so not really constraining any one or any thing, while (b) it is fiscal choices – pretty widely supported ones – that have still been putting money in the pockets of people who might, for example, be holding houses (and owing the attendant debt). Unsurprisingly, bank deposits have risen in recent months, exactly as one should have expected.
And there endeth the lecture, My son (doing Scholarship economics) asked about this stuff the other day and I ran him through most of this material. My wife suggested I’d had my best schoolmaster’s voice on at the time. I suspect the tone of this post is somewhat similar. I hope the substance is some help in clarifying some of the issues.