Month: November 2020

Robertson playing distraction

Michael Reddell Housing, Monetary policy

On Tuesday afternoon we learned that the Minister of Finance had written to the Governor of the Reserve Bank about housing and monetary policy. At his press conference yesterday, the Governor told us that the first thing he knew about it was on Monday, suggesting that the government had become worried over the weekend that it was on the political backfoot on housing and felt a need to be seen to be doing something/anything, to change the headlines for a day or two at least.

There wasn’t much to the Minister’s press statement. Perhaps it might even have seemed not-unreasonable if he’d come into office for the first time just a few days ago, but he’s been Minister of Finance for three years, and the housing disaster has just got steadily worse over that time. Little or nothing useful has happened in that time to do anything other than paper over a few symptoms of the problem. And no one believes any agenda the government has is likely to markedly change things for the better: if they did, expectations would already be shaping behaviour and land/house prices would already be falling. Why would one believe it when the Prime Minister refuses to talk in terms of materially lower house prices, and even the Minister of Finance yesterday could only talk about wanting “a sustained period of moderation in house prices” – ie enough to get the story of the front pages, not to actually fix the problem? That makes them no better than their National predecessors.

And so he made a bid to play distraction, writing to the Governor and suggesting that he (the Minister) might change the Remit the Monetary Policy Committee operates under. The Minister can make such changes himself (he does not need the Bank’s consent), but must seek comment from the Bank first.

It was a limp suggestion, as the Minister must have known when he wrote the letter (and as The Treasury would almost certainly advised him, if he asked for advice from them). In the Remit, consistent with the Act, the MPC is required to use monetary policy to keep inflation near 2 per cent, and consistent with that to do what it can to support “maximum sustainable employment” (in practical terms, low unemployment). And then there is this

4b

The Minister suggested in his letter that he might like to add “and house prices” to the end of the worthy grab-bag phrase in b(ii).

b(ii) has been in the Bank’s monetary policy mandate (the old Policy Targets Agreements –  which I’d link to, but the Bank seems to have removed them from their website) since the end of 1999.    It was inserted when Labour became government that year and the new Minister of Finance, Michael Cullen, wanted some product differentiation.  The Bank had had a bad run over the previous parliamentary term, including the period when it ran things using a Monetary Conditions Index operating guideline, which led to us actively inducing a wildly unnecessary degree of variability in short-term interest rates.  Cullen had also, for some years, been somewhat exercised about the cyclical variability of the exchange rate.

It was cleverly-crafted wording.  Don Brash agreed to some new words that sounded worthy –  who, after all, wants “unnecessary” variability in anything – but which really changed nothing at all.  Better (or worse) still, no one has ever known quite what it meant, or if it meant anything at all beyond what was already implicit in a medium-term approach to inflation targeting (looking through short-term price fluctuations –  per b(iii) now –  had always been integral to the way we’d run thing).  A lot of time and energy was spent trying to articulate what it might mean –  the Bank’s Board were particularly exercised, since they were supposed to hold the Governor to account, and it wasn’t clear how, if it all, b(ii) changed anything.  For practical purposes, in all the years I sat on the OCR Advisory Committee, with b(ii) as part of the mandate we were advising against, I’m not convinced it ever made any material difference to any specific OCR decision.   If the Governor didn’t want to tighten much anyway, it was sometimes a convenient reference point –  wanting to avoid “unnecessary instability” in the exchange rate –  but a more hawkish Governor, or a more accurate set of forecasts, might just as easily have determined that any resulting pressure on the exchange rate, while perhaps a little regrettable, was nonetheless, “necessary”.    And then there were the tensions –  avoiding a bit more upward pressure on the exchange rate might actually contribute to increasing the variability in output, and so on.  

The clause was, and is, largely meaningless in any substantive sense.  From a purely substantive perspective I’ve argued for some years that it should simply have been dropped, but the fact that it lives on is a reminder that documents grow not necessarily because the substance requires it, but because there is a political itch to scratch. 

So Grant Robertson’s suggestion that he might change the Remit to add “and house prices”  to b(ii) should be seen in exactly that light. It is about scratching political itches – and distracting from the government’s own failures on housing –  not about substance.     We know this also because the Minister was at pains to reassure people that he wasn’t proposing to change the operational objectives the MPC is required to pursue.   If not, then adding “and house prices” is really no more than getting the MPC to add another few lines to the occasional MPS, to imply that they had paid ritual obeisance.  It might do no harm, but it will do no substantive good either.

But it won Robertson quite a few headlines, and even got the markets excited for a while, temporarily prompting the sort of lift in the exchange rate that might otherwise appear appear out of step with the government’s alleged desire to promote investment in more “productive assets”. 

But if there was anything real to it –  if the aim was actually to make the MPC set monetary policy differently (tighter at present) –  it would, of course, have to have come at the cost of a more sluggish recovery, lower than target inflation, and cyclical unemployment higher than necessary.  Which would have seemed very odd coming from a Minister of Finance who had explicitly introduced to the Act –  what was always implicit –  the cyclical unemployment dimension just a couple of years ago, complete with reminders of the importance his Labour forebears –  notably Peter Fraser –  had placed on full employment.    (I suppose, charitably, it could have involved some more fiscal stimulus to offset less monetary stimulus, but if the Minister had been serious about that he could do it anyway – the RB sets monetary policy in the light of government fiscal choices whatever they are.)

But of course it wasn’t serious. It was political theatre, and distraction, including an attempt to distance himself from monetary policy policy that he had explicitly authorised.  Thus he claims 

mof letter

But as the Minister knows very well, not only was the Bank well advanced in thinking about unconventional monetary policy options by then – they’d published a whole Bulletin article about it in May 2018 – and much of the rest of the world had been using them for some years, but that the LSAP programme (the one actually in effect this year) has been inauguarated with the explicit and repeated consent of the Minister of Finance himself (through the guarantees he has provided to the Bank). Unconventional monetary policy is, in any case, yet another ministerial distraction, since no supposes that whatever contribution monetary policy might have made to this year’s house price developments, it would have materially different if the Minister had ensured that the Bank had its act together in ways that meant that they used a negative OCR this year.

Anyway, the Minister’s letter prompted a quick response from the Bank. Perhaps some wonder if that was necessary – these things could be dealt with to a greater extent in private – but I’m with the Governor on this one. It was the Minister who chose to issue his letter the afternoon before the Bank’s long-scheduled FSR press conference. The Bank had no effective choice but to respond, and better to put things in writing than just rely on throwaway comments at a press conference.

I thought the Governor’s letter was mostly a fairly sensible and moderate holding response. He promised to come back to the Minister with more considered thoughts on the suggested addition to b(ii). There were a couple of bits that could be read more pointedly. For example, the Governor noted that

We welcome the opportunity to contribute to your work programme aimed at improving housing affordability. As I’ve said publicly on many occasions, monetary and financial regulatory policy alone cannot address this challenge. There are many long-term, structural issues at play.

The Bank had, in fact, had some nice lines to that effect in its Monetary Policy Statement just a couple of weeks ago

RB on housing

This is a government failure, not a central bank one. But I guess I wouldn’t expect any central bank Governor to be quite that pointed in public.

Several have also noted that the Governor pointed out that the Bank already considers house prices in setting monetary policy.

I can assure you that the MPC, in making its decisions, gives consideration to the potential impact of monetary policy on asset prices, including house prices. These are important transmission channels that affect employment and inflation. Housing market related prices are
also included in the Consumer Price Index, for example rents, rates, construction costs, and housing transaction costs.

But actually that was a bit cheeky. On those terms, at times like these the Bank positively welcomes higher house price inflation because of the beneficial spillovers they think that leads to in raising CPI inflation. Recall just a few weeks ago their chief economist was actively welcoming higher house prices, distinctly averse to falling prices.

Out of that first round, I’d suggest that the Governor came out ahead on points. The Minister got his headlines – lots of them in some media – but the Governor gave no hint of believing that there was likely to be anything of real substance there.

But the Governor must have over-reached yesterday. At the FSR press conference he expansively declared his pleasure that the Bank has been invited to share its expertise in advising on the wider issues of supply and affordability. In an interview with Stuff – now the frontpage story in the Dom-Post – Orr went further, talking about the tax advice they might also offer. It wasn’t clear what expertise the Governor thought the Bank had in these areas – there is nothing in their research publications or speeches in recent years that suggests any – but I guess that doesn’t often deter the Governor.

But all that talk can’t have gone down well with the Minister, as the newsroompro newsletter this morning includes this

milnes rb

Ouch.

All seems not to be sweetness and light between the Governor and the Minister. But then they deserve each other really. Robertson was engaged in a transparent attempt to distract briefly from the three years of failure of his own government, writing to the Reserve Bank – sure to get headlines – rather than putting the hard word on his own boss and his ministerial colleagues. And Orr, who surely knows there is nothing there and how empty b(ii) really is – and who genuinely seems to think monetary policy should be focused on boosting aggregate demand in ways that lift inflation and employment, can’t help himself in openly trying to embrace a much wider role as adviser on all manner of things that really have nothing much to do with the Bank. Meanwhile, through this period we have had precisely no serious speeches or research papers on monetary policy, we have a central bank that fell back on LSAP partly because it didn’t think to do the basics and check that banks could operate with a negative OCR, and (of course, still) the invisible external members of the Monetary Policy Committee. A high-performing central bank and Monetary Policy Committee would have done a much better job over months of articulating a story, and explaining the place of monetary policy in the mix.

Then, of course, there was the question as to whether had the proposed amendment to b(ii) been in place back in March anything about monetary policy this year would have been different. Orr – probably diplomatically – avoided answering that, but of course the straightforward answer is no. That is so for two reasons. First – and this is a point Orr made in his MPS press conference – the threat to output, employment, and inflation in March was so large that the operational objectives the Minister has given the MPC would simply have impelled a significant easing in monetary policy. But the other reason – actually more an explanation for monetary policy choices than is often realised – is the forecasts. Back in March, hardly anyone (no one I’m aware) would have forecast the rise in house prices we’ve actually seen. Most probably expected – I did – something more like 2008/09, with a dip in prices for a time. So sitting in an MPC meeting in March with an amended b(ii) the house price issues would have appeared moot. Monetary policy would have been conducted just as it was. Oh, and not to forget my point earlier: no one knows what b(ii) means in practice anyway.

But of course if the Minister took any economic advice at all before sending his political theatre letter, he’d have known that too.

So change the Remit, or don’t, in this way and (a) it won’t make any difference to the conduct of monetary policy, and (b) it won’t change the fact that the reforms that might make a real difference now to land/house prices are all matters under the control of ministers already, backed by their majority in Parliament. If my kids can’t buy houses 10 years hence, it is going to be the fault of Ardern and Robertson, and not at all that of the Reserve Bank.

Funding for lending and other myths

Michael Reddell pandemic, Reserve Bank

There is a huge number of stories around at present on various aspects of monetary policy and the (successive) governments-made housing market disaster (the two being, in fundamentals, quite unrelated). Were I in fine full health and energy I’d no doubt be writing about many of them. Instead, I’m going to focus here just on the controversy around the Reserve Bank’s so-called Funding for Lending programme, the details of which were announced last week.

It isn’t always inviting to defend the Reserve Bank, since they are often (as here) their own worst enemy, but on the essence of the FLP programme I’m mostly going to. That doesn’t mean I think it is a particularly good scheme – there is a perfectly straightforward way to lower interest rates (the OCR), which influences the exchange rate as well, that they simply refuse to use. And they have named the scheme in a way that actively misleads and invites misunderstanding from those who haven’t thought hard about monetary systems.

All the FLP programme really is is a scheme to lower interest rates a bit more without changing the OCR. That isn’t just my take; that is the official Reserve Bank view. Here is the graphic from the MPS last week as to how they think the thing works

FLP 2

Even that is a bit inaccurate since – as the Governor explicitly noted in his press conference the other day – the expectation that the Bank will be willing to offer funds (not a dollar has yet been transacted) has already done the job. Retail deposit interest rates have fallen relative to the OCR.

But you will note that nothing in that graphic talks about a channel in which additional funds are now available in ways that enable banks to lend in ways, at rates ($m), they couldn’t otherwise.

There are at least two good reasons for that.

The first is that banks are simply not funding constrained. In fact, they are awash with central bank provided funding/liquidity: total settlement cash balances that were about $7bn pre-Covid are now about $24bn. If lending is not occurring at present to the sort of borrowers that some politicians or commentators might prefer – and you have to wonder what such private transactions have to do with them – it isn’t because banks are facing some sort of funding constraint (actual or prospective – there is no uncertainty that adequate funding will be available, including because the Reserve Bank’s core funding requirements – on precise types of funding – have been markedly relaxed for the duration). The Governor made basically that point in his press conference the other day: if not much new business lending is happening at present that is most likely because there is considerable (much larger than usual) economic uncertainty – not anyone’s fault, not anything that can quickly be allayed. That uncertainty affects both prospective lenders and prospective borrowers. Market reports – and the RB credit conditions survey – indicate that banks have tightened their effective credit standards, which is surely what one would expect – probably even hope for, from prudent bankers – in such a climate. There will always be chancers, keen to borrow, but in such a climate banks should probably be particularly cautious about potential business borrowers without strong collateral who are particularly keen to borrow.

So at a system level (and we have no reason to suppose it is different at an individual bank level), settlement cash – which is what the Bank is willing to supply – simply isn’t a constraint on lending. (It wasn’t really even in the 2008/09 recession here, although then New Zealand banks and their parents had reasonable concerns about ongoing access to specific classes of desirable funding.)

As importantly, at an aggregate level any Funding for Lending programme lending does not replace other funding/deposits. In the normal course of bank business in a floating exchange rate economy, and for the system as a whole, deposits arise simultaneously with lending. All bank lending either results in a reduction in someone else’s loan or adds to deposits. That is true within the banking system as a whole, although not for any individual bank (if Bank A increases lending particularly aggressively most of the new deposits may end up at other banks in the system). Any Funding for Lending loans to banks add to their liabilities, but they (collectively) don’t need those liabilities to increase lending. What FFL loans will do, in direct balance sheet terms, is to increase bank borrowing from the Reserve Bank, and increase bank lending to the Reserve Bank (settlement cash balances). And that is it. All the other deposits will still be there.

Now this isn’t to suggest that the FFL scheme is futile. It is not. As the Reserve Bank notes, it is a way of lowering interest rates a bit more. And that is really all. It does that partly through signalling effects and partly (ultimately) because each individual knows it can compete a bit less aggressively in the term deposit market and still be sure (individually) of having ample funds. If all banks respond similarly, there won’t be systematic drains from any of them. And there won’t be much need for many actual FFL loans to occur at all. Time will tell whether the scheme is much used, but if it isn’t that is almost a bonus: it worked (lowering term deposit interest rates relative to the OCR) by the Bank’s willingness to provide, without needing actually to provide much at all.

From banks’ perspectives they’d probably prefer (at least in aggregate) not to use FFL much at all. After all, they borrow at the OCR and then the additional settlement cash (in aggregate) just earns them the OCR, and in the process they just blow up their balance sheets a bit more. But they probably like the option value of knowing the Bank is willing to lend at the OCR – which happens to be roughly where short-term interest rates are.

Which is a (perhaps longwinded) way of saying that the controversy over whether the Bank should have tied these loans to “productive lending” – a weird notion in itself, but that is a topic for another day – is strange and largely empty. I suppose the Bank could have insisted it would only lend under FFL to the extent banks increased their business lending, but had they done so there would have been a very real prospect that the mechanism would not have worked at all. As noted above, banks are not funding constrained and – as almost everyone seems to agree, with the possible exception of Andrew Bayly – to the extent business lending is not growing (it doesn’t usually in recessions), it has little or nothing to do with availability of funding. The scheme is designed to lower interest rates, and seems to have done that. Tying eligibility to particular types of lending – that just aren’t attractive at present, to most borrowers or lenders – would have markedly reduced the effectiveness of the tool, with no gains for the actual lending the politicians purport to champion. That, in turn, would have been a recipe for deepening and lengthening, a bit more than necessary, the recession. Some seem not to mind that, but one would have hoped that neither the government (which made employment an explicit focus for the Bank) nor a responsible Opposition would want that.

But to repeat, the Reserve Bank are supposed to be experts in this stuff, and yet they directly contributed to the problem by so egregiously mislabelling the scheme, in a way that led laypeople to think that somehow “funding” was the constraint on lending (or that up to $28 billion would be pouring into new lending, when in fact the simple availability of new settlement cash will probably no difference whatever to the stock of loans on bank balance sheets). Had they called it a supplementary short-term interest rate management tool it would have been more accurate – but I guess would have sounded less glamorous at the time.

Finally, note that unlike the LSAP programme, the FFL does not involve any material financial risk to the Crown or the Bank, so there was no need for a Crown indemnity. Any FFL loans are fully-collateralised on highly-rated securities, and the Bank’s haircut requirements are usually quite demanding, and all the loans are on floating rate terms (the OCR, as it potentially changes), matching the floating rate liability the Bank will also be assuming (the additional settlement cash balances).

Not doing their core job

Michael Reddell Uncategorized

This isn’t going to be one of my usual lengthy post-MPS posts. I really just wanted to make one point about the disconnect yesterday between the words and the actions of the Governor and the MPC.

There were more than a few good words and phrases from the Governor, and even a few in the document itself. There was, for example, the reiteration of the MPC’s so-called “least regrets” framework, under which for now they say they’d rather run the risk of inflation being a bit high than run the risk that they (continue to) undershoot the target the government has laid down for them. And there was the Governor’s response to Stuff’s Thomas Coughlan about whether the Bank’s new mandate – the employment bits – had made any difference to monetary policy decisionmaking this year: he said not, since both unemployment and inflation indicators/outlooks had pointed to the need for much easier monetary policy, even highlighting the risks of inflation expectations settling below target. On Radio New Zealand this morning, Orr even allowed himself to say yes when asked if monetary policy would do “whatever it takes” to lean against a cyclical economic slump.

All of which sounded great. It was pretty much standard inflation-targeting cyclical stabilisation stuff, especially when overlaid on a background of the last decade when – as the Governor put it – central banks hadn’t demonstrated such a good track record in getting inflation back up to the target (recall that in our case in particular that target is set by elected governments, and that set by the current government is much the same as that of their predecessors.

But what do the MPC’s forecasts show? Recall that these published forecasts include all the expected effects of the monetary policy stance announced yesterday (although perhaps not the proposed new LVR controls), including the new Funding for Lending scheme (which, as the Governor noted, the Bank thinks market pricing for retail deposits has already anticipated).

Here are their CPI projections.

RB forecasts CPI

Inflation does not get back above 1 per cent – the very bottom of the target range – for two more years, at which point it will have been more than 2.5 years since the Covid-related severe downturn got underway. It is three years from now until inflation is forecast to get back to 2 per cent.

What about the unemployment rate, still probably the best indicator of excess capacity (at least in a forward-looking context)? They expect that the unemployment rate will keep rising and will be still 6.3 per cent by the end of next year. And at the end of 2023 – more than 3 years away – they still think the unemployment rate will be 5.2 per cent, barely lower than the current 5.3 per cent. Their output gap estimates for the year to March 2022 are slightly larger (negative) than their – inevitably wildly imprecise – estimate for the latest quarter.

And then there are inflation expectations. In a distinct step forward yesterday there was quite a bit of discussion of inflation expectations in yesterday’s MPS, including in the minutes of the MPC meeting. At least some members must be getting quite worried, even if staff gallantly try to play down the issue by refusing to engage with direct estimates of breakeven inflation from the government (indexed and conventional) bond market.

They included this chart in the document

RB inflation expecs nov 2020

On this measure – which deliberately excludes all market-based measures – inflation expectations are below target for the next several years and well below the target midpoint. The longer those low expectations persist the harder it will be for monetary policy to do its job. (Note that the latest of the RB’s own expectations surveys still has medium-term inflation expectations well below target, even though respondents now believe the OCR will be taken negative next year, and presumably included that expectation in their in responses about inflation too.)

And yet what did they do in response to this outlook? Nothing. Simply nothing. And in the process pushed the exchange rate – usually a key adjustment mechanism in New Zealand downturns – even further above the level it was, whether yesterday morning or at the start of the year.

There is simply no sign that they take their own rhetoric seriously. There is no sign of a central bank acting as if it really believes it would be better to run the risk of a temporary overshoot of the inflation target. There is no sign of a central bank that acts as if it thinks cyclical unemployment is a scourge that should be countered aggressively, at least while the inflation outlook allows it. And there is no sign of a central bank acting as if it takes the slump in inflation expectations as something it needs to take seriously.

Instead they are content with rhetoric (sometimes quite good rhetoric) and handwaving, and throwing around big dollops of money in ways that make little useful difference (and whatever good effects the Bank thinks those tools are having are already baked into the forecasts). Oh, and of course no serious accountability either: it is now 19 months into the new MPC and not one of the external members – the ones who don’t work directly for the Governor – has given a speech or a serious interview.

Oh, and remaining wedded to that bizarre commitment made in March – before the severity of the crisis was apparent to them – not to touch the OCR for a year, come what may.

(Of course, some readers may want to defend the RB on the basis that they – readers – don’t believe a negative OCR could help. There is an argument to that effect – I’m among those who resolutely disagree – but the point here is that it is not an argument the Bank itself is relying on. They claim monetary policy is still capable of doing useful and important stabilising stuff….and yet won’t even cut the OCR to zero, let alone negative, despite (a) such weak foerecasts, and (b) averring that a lower OCR would do good stuff.)