Not doing their core job

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.)

29 thoughts on “Not doing their core job

  1. Yes, “And in the process pushed the exchange rate – usually a key adjustment mechanism in New Zealand downturns – even further above the level it was”.

    That fact seems counter-intuitive to me;

    https://www.fitchratings.com/research/banks/central-bank-actions-support-aspects-of-nz-bank-credit-profiles-11-11-2020

    https://www.bloomberg.com/news/articles/2020-11-09/japanification-stalks-new-zealand-debt-that-s-37-owned-by-rbnz

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    • On the positive side, our economy appears to be doing a bit less badly than some. But – on the Bank’s own forecasts – there is plenty of room for more policy support, which would – if mon pol used – typically lower the exch rate and make nZ firms more competitive thru this difficult period.

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      • At $0.68 to USD that is still a 32% discount to the USD. Talking about a FTA with the US or with Europe is just a wasted effort. It is never happening whilst our currency is considered at the level of product dumping in the US or in Europe. We are not very good produces if we tie our fortunes with begging for a further drop in the NZD.

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  2. Yes to some extent. The direct effects are quite small: 10% drop in the TWI might raise the level of the CPI 1%, but the indirect effects – boosting domestic activity etc – are, if slower working, typically more important.

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  3. NZ Herald headlines that RBNZ says “House prices not our concern”
    Time for Grant Robertson to step up and do something radical.
    Stop mortgage interest being tax deductible for residential investors would be a great start.
    Nil effect for fully owned property and a wake up call for those high geared speculators.
    Stop profiting on the use of other peoples money.

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    • Adrian Orr is partially correct. He should have said, slow steady rising house prices are not the concern of the RBNZ, it is fast rapid rising and then the subsequent falling house prices that are the concern of the RBNZ. Slow steady Rising is good for bank stability. It is when house prices rise too fast and then crashing fall
      that it starts to affect bank stability and therefore a bank stability concern.

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    • Tax deductibility of interest rates is outside of the RBNZ mandate. Also the government does rely on private rentals to house social welfare dependents. The accommodation supplement is already $2 billion. Remove tax deductibility equates to a $5 billion accommodation supplement. More taxes or less tax deductibility equates to higher social welfare spending by the government.

      Don’t forget the social housing waitlist under Jacinda Ardern is now 20,000. Under John Key that waitlist was 8,000 and journalists was screaming housing crises. Note that journalists have been extremely kind to Jacinda Ardern showering hugs instead of criticisms.

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  4. I am one of those who thinks that lowering interest rates further would be wrong. I believe that they are having little impact on economic decisionmaking right now – they are dwarfed by other factors. i.e. lowering them further would have little or no impact on activity and employment, but would add further fuel to asset prices. The house price boom is a disaster. Why do a King Canute stunt with LVRs when you can lower the tide in other ways? A reminder that the RB Act’s purpose is still “stability in the general level of prices”.

    Furthermore, while we are returning towards normality in some respects, there are still enough singularities, perverse incentives, and modelling deficiencies around to think that conventional approaches may not work as intended. One example of this is depositors reducing their expenditure as interest rates fall. When the science fails, the art of central banking needs to kick in.

    I am also bemused by the balance sheets hi-jinks that have been going on, and are proposed. I am not sure that there have been liquidity shortages anything like enough to warrant these interventions, and doubt that they have had any useful effect. I find it a bit ironic that the Bank has driven rates down enough to destroy its seigniorage income (reminding me of Governor Hobson’s central banking experiment with the Colonial Bank of Issue). Grant Robertson may not be getting his accustomed large dividend cheque from the Bank for some time.

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    • In this post, of course, I was only dealing with the Bank in terms of its own arguments and mental models.

      Without getting into the debate at length, I guess I would rather attack land prices at source – regulatory restrictions – than risk driving unemployment higher for longer by trying to use mon pol to lean against house prices.

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      • “Without getting into a big debate, bear in mind that your proposal would substantially raise real int rates and with it the real exch rate, in turn worsening real economic outcomes in the middle of a recession.”

        I completely agree with Peter L. Lowering interest rates is completely the wrong thing to be doing to stimulate the economy when (i) current interest rates aren’t a barrier to business investment – business surveys have shown this (ii) it will have an even more devastating impact on asset prices.

        I feel we are witnessing the greatest transfer of wealth from a younger to an older property holding generation that we have perhaps seen in a long time. While at the same time it is increasing the class divide between property owners and those who will never be able to own property. Not to mention decimating the income of those who rely on low-risk investments for a portion or all for their income. You can’t just ignore the impact of monetary policy on asset prices and say it’s someone else’s problem – asset price inflation is a problem that exists right now, an unsustainable bubble, that will only be further inflamed by yet lower rates. Yes land supply is still a problem but that’s irrelevant in the current situation. I don’t know how you can’t see these things.

        No one but a few pointy heads want higher inflation especially in the middle of a crisis/recovery. The RBNZ policy target agreement needs a serious overhaul to prevent these damaging distortions from monetary policy actions happening again in future. And kill off this ridiculous obsession with higher inflation. Perhaps the first step would be to set the policy targets agreement to 0-2% again and review the employment objective.

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      • The wealth transfer is utterly inexcusable and should be addressed, at source, by freeing up the land market. The govt could, if it were so minded, make a strong start on that very quickly. It – and its predecessors – consciously choose not to.

        High or persistent unemployment is also a scandal. Monetary policy is designed to deal with temporary deviations of unemployment from a NAIRU (-like concept), and inflation is the check that not too much is being done. With rising U and falling inflation, clearly more could be done with monetary policy. I think we owe it to the most vulnerable to do so (and more immediately relevantly, that is the mandate the current govt has given the MPC).

        Using mon pol to lean against house prices is a recipe for more persistent unemployment, something I would not wish on anyone.

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      • Everyone is a bit right here

        Of course monetary policy should not be targeted at redressing fundamental housing market imbalances. They need to be attacked in other ways, and the work should have started a decade or two ago. I am not convinced that the problems are wholly regulatory either. I think there are private sector market failures too. Obviously there are no quick fixes.

        In the meantime we are stuck with the unpleasant truth that a whole lot of monetary stimulus is generating few if any additional jobs, but rather fuelling the asset price fires.

        I don’t know exactly how to do the wellbeing maths, but I think that a long-term jump in house prices is more socially corrosive than unemployment. It hits a much larger number of people, is probably more long-lasting, and there is no compensation for the erosion of housing deposits. There is some fiscal compensation for unemployment.

        So – I think it is certainly appropriate to question the Bank’s mandate, and the way it is being interpreted, in current circumstances.

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      • It is probably the third para we differ on. I’m not convinced that there is much monetary stimulus at all (LSAP is just a big asset swap) – perhaps a 50bps fall in real interest rates and no change in the real exchange rate. Whether the typical transmission mechanisms are working is an open question – the Bank says it thinks so but (a) it is hard to tell with a relatively modest change in key fin mkt prices, and (b) even on typical lags it is too early to tell (eg re unemployment effects).

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      • When giant global producers like China, Vietnam and India with mega factories have excess inventory and excess production capacity, consumer products will not rise no matter how low negative interest rates get. Gone are the days of our manufacturers actually producing anything that it can monopolise and drove up prices.

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  5. Off topic, but what did you make of the FLP structure and likely impact on retail deposit and/or wholesale funding rates? $28bn isn’t much relative to consolidated NZ bank funding liability amount and given QE has left the banks flush with reserves, how will this pull down existing funding rates for banks? Thinking marginal vs average funding costs for the consolidated banking sector but quickly get a headache…..

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    • It looks to have been quite effective already in narrowing the spread between retail deposit rates and the OCR. The way I think of it is that it isn’t replacing any funding in aggregate (none of the private deposits is going away) but will enable each bank to compete a little less aggressively for deposits, and cumulatively that will lower deposit rates. Probably many depositors are fairly passive price-takers, so I guess this provides a buffer for the risk to an indiv bank of losing some of the more aggressively competitive depositors to other banks. In the end, banks in aggregate will end up with (roughly) up to $28bn more funding – when funding isn’t really a system constraint – on which they will earn net nothing (they will pay the OCR and earn the OCR on the resulting additional settlement cash balances).

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      • With a build up of liability Deposit settlements owed to Banks on the RBNZ books well in excess of $41 billion mainly due to bond buying from Banks, the RBNZ lending to Banks of $28 billion will have to rise to $41 billion to clear the amount already owed to banks. The RBNZ should come clean and inform the public they have no choice but to lend to banks up to the $100 billion if they plan on buying up $100 billion in bonds to get clear of the deposit settlements owed to Banks.

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  6. In these extraordinary times the government and RBNZ should simply adopt a 0% inflation lower bound target which does not require interest rates to be quite so low.

    The 2% target is simply a nice trade off between the unemployment rate & deflation of purchasing power of the NZD in “normal” times.

    The RBNZ is simply blowing up the asset bubble even further.
    Risk weighted lending and recourse mortgages favouring housing, skyrocketing land prices and unproductive use of capital.

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    • Without getting into a big debate, bear in mind that your proposal would substantially raise real int rates and with it the real exch rate, in turn worsening real economic outcomes in the middle of a recession.

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  7. Why is it that none of the media commentary around this issue focuses on the likely reality that there are almost no business investments worth pursuing in New Zealand? (Hence the low demand for business/commercial loans)

    Seems to be quite a problem in terms of future prosperity does it not?

    Either that or New Zealand businesses are already so highly leveraged they can’t take on anymore debt.

    In either case it hardly seems like a positive thing and may in fact be a bigger issue than the housing debacle.

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    • Debt is actually cheaper than equity. NZ has a very shallow equities market and therefore businesses are more likely to fund through debt. Also with debt you have more control rather than having to give away profit to equity partners and loss of control.

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  8. What are your thoughts on helicopter money Michael? In particular targeted at low income individuals, doesn’t it make sense if we’re trying to boost inflation to target stimulus at those with the highest marginal propensity to consume?

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    • I guess I have two takes on it:

      – if the govt is going to use fiscal policy as a direct countercyclical stimulatory tool, I would not be that uncomfortable with a near-universal payment (at least leaves the choice whether to spend, and on what, to individuals, and treats people fairly equally), but
      – generally I still prefer to use monetary policy for countercyclical purposes, because it does not involve the govt pre-empting choices about use of real resources. Instead, the relative prices (int and exch rates) adjust much as they might in a market economy without a central bank, and those best-placed to do more spending, or to shift spending locally, make their own choices. Also experience suggests that interest rate changes are easier to unwind than fiscal adjustments, at least if the latter involve more than very short-term or one-off outlays.

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