Bleak passivity

Reading last week’s statement from the not-very-transparent, not-very-accountable, Reserve Bank Monetary Policy Committee I was struck by both the bleakness of the statement and the do-little-or-nothing passivity of the monetary policymakers.

I guess you could argue it wasn’t much different than the previous month’s statement – which wouldn’t be much consolation, since that statement itself was pretty downbeat – but the relentlessness struck me. There was almost nothing positive in the commentary, even six months on from when the Committee belatedly recognised the Covid economic risks and started adjusting policy. The risks, both globally and domestically, are deemed to be to the downside – which seems right to me – and this around a base scenario in which the “the Committee expects a rise in unemployment and an increase in firm closures”. There is, again rightly, an emphasis on the susbstantial uncertainty firms and households face, again here and abroad, as the future course of the virus is really little more than anyone’s guess. We are told – in, I think, materially stronger words than they’ve used before – that “monetary policy will need to provide significant economic support for a long time to come to meet the inflation and employment remit”.

And yet what did they actually do? Nothing.

Seven months on from when they should have been first easing monetary policy, we still have an OCR that is only 75 basis points lower than it was at the start of the year. The Committee continues to cling to their bizarre March pledge – made in a climate of extreme uncertainty – not to change he OCR for a year, a pledge that has/had no solid economic foundations to it. They would prefer people to believe that in some sense they “can’t” move, but all it takes to know that is simply false is a look across the Tasman to Australia where, with a higher inflation target, and higher inflation expectations, short-term wholesale interest rates are 20 basis points lower than those here. Even if you buy the Bank’s claim that the OCR can’t be taken negative yet, there is no obstacle at all to them cutting the OCR to zero now. It should have been done months ago. It should be done now – their own outlook (all that downside talk) tells you as much. (20-25 basis points is, of course, not that much, and not a macro game-changer in and of itself, but in an all-hands-to-the-pump scenario, every little helps – and it would be a third more OCR easing than we’ve had to date.)

And, of course, the claim that the OCR can’t be taken negative now should itself be taken with a considerable pinch of salt. If true, it should of course lead to serious questions of the Bank’s competence and basic preparedness, which don’t yet seem to have been asked (although the Board’s Annual Report must be due out in the next few days, so perhaps…..unlikely as it is …..there will some sign of holding management to account). But it was never very convincing. For a start, had the Reserve Bank simply taken the OCR negative a few months ago it would have (a) rewarded the institutions that had read the – all too visible – international signs and got ready, and (b) encouraged the others to adapt very quickly. Even if the argument was partially defensible in February/March, it is now September….they’ve had months to get it right, and (on the MPC’s own reckoning) the economy could have done with more stimulus over that period. More generally still, a significant part of the way monetary policy works in an open economy is through (a) signalling and (b) the exchange rate: had the MPC moved aggressively months ago, or even now – not next March/April – it would likely have generated a lower exchange rate, supporting the New Zealand economy, and underpinned inflation expectations.

(As a reminder, the exchange rate has barely changed from where it was at the end of last year, real (1 and 2 year fixed) mortgage rates seem to be down perhaps 20-30 basis points since the end of last year, and the inflation expectations – whether survey measures or market measures – seem to be down about 50-60 basis points. Oh, and in case people hadn’t noticed, the unemployment rate has risen and the MPC expects it to rise further. Their August inflation projections – including all that fiscal policy – was also well below target. It is hard to imagine in any other circumstances a central bank doing nothing.)

Now defenders of the Reserve Bank will, of course, point out that the MPC is talking up some sort of “Funding for lending” scheme that it now says “would be ready before the end of this calendar year” (while also noting that “the design of the programme would be agreed and published ahead of deployment” – but there is only one more scheduled MPC meeting before the end of the year). The idea of this scheme is to lend to banks directly at a rate close to the (unnecessarily high) OCR, with the aim to “lower the financial system’s funding costs, and therefore borrowing costs for firms and households, and support the availability of credit to the economy”.

I don’t greatly like these sorts of schemes – although the details, which apparently won’t be consulted on, may matter. By contrast to the OCR, which is an instrument that works pervasively and unconditionally, FFL-type schemes are often available to some market participants but not others (undermining a core principle of efficient policy design, around competitive neutrality), and are often tied to some officials’ preferences around increases in lending to the private sector, whether or not such lending makes much sense in the prevailing economic climate (hint: in an environment of extreme uncertainty, of the sort the MPC talks of, not many firms are going to be voluntarily taking on much debt, and banks would generally be rightly cautious – even if not with the added uncertainty about the Bank’s new capital requirements next year). And an FFL is no substitute for an OCR adjustment when it comes to influencing the exchange rate, typically a really important part of the New Zealand transmission mechanism.

But here’s the thing. They’ve had a scheme like this in Australia since March. Term deposits rates in Australia have for a long time been closer to wholesale rates than has been the case in New Zealand, but – on checking this morning – are still materially higher than Australian wholesale rates. And although our Reserve Bank has been talking up an FFL scheme for some time now there is no hint in the schedule of retail rates banks are offering that, for example, 3-6 months are holding up but that longer-term rates (relevant to the period when an FFL will be deployed) have fallen away sharply, or at all. Big banks seem to be offering much the same rates for six month retail term deposits as they are for 1 to 5 year term deposits, just as they were at the start of this year. It just isn’t obvious that a realistic FFL is likely to make much difference to retail rates – and actual term rates suggest banks rather share that perception. It would be good to be wrong on this – all the evidence and the MPC comments suggest the economy needs the additional support – but nothing at present suggests it is likely.

Meanwhile, of course, months and months into this severe recession, there is no sign that the MPC or the Bank is doing anything about removing the real effective floor on the OCR (at perhaps -0.5 or -0.75), that results from the official provisions – regulatory interventions – that mean deposits are convertible to cash at par in unlimited quantities, with cash paying a zero interest rate. We have interminable debates and commentary on what macro difference a small further cut to the OCR – to just slightly negative – might make, but nothing on making feasible and useful the sort of deeply negative interest rates the economy might actually need. It is a cavalier indifference to the state of the economy and the plight of the unemployed – and to the health of the public finances – that seems to be shared by most central banks – which makes it no more excusable. One can, reasonably, haggle about whether threshold effects mean that,say, a -0.25% OCR would make much difference – although (a) the ECB seems persuaded, and (b) retail deposit rates in NZ would still be well above zero in such an environment. There should be much less room for doubt about the gains from a deeply negative OCR, including for the exchange rate and inflation expectations.

Of course, those on the left are often keen on fiscal policy substituting for monetary policy – especially while they are in power and get to choose the goodies being handed out – but that isn’t a path to an efficient allocation of resources, a wise evaluation of investment options (what do politicians have on the line?) and does nothing at all for promoting the health and growth of the tradables sector of the New Zealand economy. Whatever the merits of something like the wage subsidy scheme initially, fiscal policy initiatives seem to have become over recent months increasingly dependent on who you know, who is in favour, which project rings political bells, and not on a pervasive, fairly neutral, support framework in which politicians aren’t using your resources and mine to pick winners (unlikely to be so in actuality), rewards favourites and so on. Monetary policy operates much better as a countercyclical stabilisation tool for many reasons, if only central bankers would use it aggressively, or their political masters simply insist they do. It is fit for purpose, and respects the proposition that private firms and households are generally better at spending wisely than governments, in a way that handouts to Green schools, Pacific churches, this or that council, or whatever do not.

7 thoughts on “Bleak passivity

  1. You raise a number of useful points Michael.

    I have argued several times with them that: 1) their March forward guidance is in complete conflict with their remit and serves no useful purpose, 2) they can cut the OCR to zero now given the magnitude of settlement balances, 3) they have the capacity to set up an FX tender auction and do unsterilised FX intervention if they wish, and: 4) they already have a TAF/TLF but no one is using it so they need to firstly ask, why?

    A funding for lending program can displace foreign debt issuance, but only to the extent it is allowed (or prudent) under macro prudential regulations, much of which is ultimately controlled by APRA. So the FLP might lower bank funding costs, by perhaps 20-30bp, that’s helpful but not a game changer. It still leaves the need to cut the OCR and for some reason they seem loathe to do it. I now have clients genuinely asking me whether the Bank is sincere in its desire to ease policy further.

    And probably there are some in the Bank questioning this. I was in wellington last Friday and Courtney place was heaving. This is what the young economists who prepare the bank forecasts are seeing. To them – on secure government pay and increments – things look pretty much back to normal. Meanwhile, in Auckland …. the place is a morgue and people are wondering what happens during this summer’s non-tourist season. I mentioned to the owner of a major restaurant in downtown Auckland that my chicken scratches suggested the loss of the cruise liners would take about $120-150m out of the F&B sector in downtown auckland this summer and he thought that was about right….

    Unemployment is rising and the housing pop isn’t going to be sustained.

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    • Thanks Peter. The other reason why an FFL scheme won’t displace term deposits or offshore wholesale borrowing to any great extent is banks looking to the future, wanting to keep their name in front of potential investors etc.

      But the passivity,,,esp running hand in hand with such bleak official commentary, is astonishing, almost reprehensible. It would be one thing if they had a deluded upbeat econ view…..but they don’t seem to.

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  2. Hi Michael, I enjoyed your article. Can you please explain to me the mechanism that supports growth stimulation via negative interest rates and has the been observed working in real life in countries with high debt be that Government debt or Private debt or both.. Thanks

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    • The mechanisms are pretty clear. All else equal, the more negative a country’s official interest rate the lower its exchange rate will be. In addition, lower domestic interest rates will – again all else equal – bring forward some investment spending, and are likely to boost expectations of future inflation, keeping real interest rates lower than otherwise. From my reading, there is evidence of all these types of effects in countries that have had negative policy rates.

      That said, (a) all the countries that have had negative rates have had rates only very modestly negative – none has tried the “deeply negative” route people like Ken Rogoff and i have been calling for now, and (b) it is also hard to get a clear sense of how much difference the last 50bps of cuts has made, whether across time in an individual country, or looking across countries. That said, if I look across the euro-area, Japan, Denmark, Sweden and Switzerland in, say, the 5-7 years leading up to Covid there is nothing obvious in the macro data suggesting monetary policy worked less well at modestly negative rates than it did in countries that didn’t try them (or perhaps need to try them). All, eg, have unemployment rates that had fallen sharply.

      As I noted in the post, it is possible there may be threshold effects with retail rates around zero. But NZ retail rates are typically higher, relative to the OCR, than we see in many other advanced countries, so even a -50bps OCR – the sort of thing the market now expects next year – would not bring the main term deposit rates near zero. Against that backdrop it is difficult to see why another 75bps OCR cut here would not work similarly to previous 75bps OCR cuts.

      Sadly, in the end the track record of experiences involves such a small sample of countries and really only one observation each that people will tend to read into those experiences a lot of what they hope to find (especially given identification issues).

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  3. Hi Michael, I enjoy your informative posts here. Can you please explain to me the mechanism, via which negative interest rates would support the economy and is their evidence of the strategy’s success?

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