The Money Illusion

Or to give the book its full title, The Money Illusion: Market Monetarism, the Great Recession and the Future of Monetary Policy.

I was engrossed in the 2008/09 recession – and the associated financial crises – at the time it happened, as an official at the New Zealand Treasury, and it must have been very early in the piece that I started reading Professor Scott Sumner’s then new blog, also The Money Illusion. I’m not a regular reader now, but found much of what Sumner had to say about the conduct of monetary policy – mostly in the US – stimulating and thought-provoking, even (perhaps especially) when I didn’t end up agreeing. So I was keen buyer when his 400 page book appeared.

It is an interesting mixture of a book – partly textbook, partly personal intellectual autobiography, and partly a tract championing a different approach to policy (and history). It would be well worth reading for anyone interested in monetary policy, with a particular focus on the recession of 2008/09 and it aftermath, and possible reforms for the future. Were I an academic teaching a monetary economics class I’d encourage all my students to read it (and have commended it to my economics-student son), not as replacement for a textbook but as a practically-oriented complement to it.

I usually read books of this sort with a pen in hand. But flicking through the book again I see that the pen was hardly deployed at all in the first 60 per cent of the book, which is a really clear and useful introduction to how the monetary system works, through a slightly different lens than most will be used to. If I didn’t agree with it all – and there were a few straw men tackled – people coming to grips with the system and concepts and history will almost inevitably see things more clearly for having read it. It is an achievement in its own right.

The second part of the book is focused much more on the policies adopted, mostly by the Fed, in 2008/09, and on the way ahead (bearing in mind that the big was largely finished before Covid, although I doubt the thrust of Sumner’s arguments would have been much changed by the experience of the last 18 months). And it is there I start to differ (and thus have lots of marginal notes).

It isn’t, I think, that we differ that much on how the economy works (or even how monetary policy works). Like Sumner I’m a champion of the potency of monetary policy. It can’t make countries rich, or solve things like New Zealand’s decades-long productivity failure, but it can – and should – do all it can to keep the economy as fully-employed as (labour market regulation etc makes) possible consistent with keeping inflation in check. It really matters, given the pervasiveness of sticky wages and prices in the economy. Sumner’s previous book, on the US experience of the Great Depression, was a really nice illustration of both the potency of monetary policy, and the way that misguided regulatory interventions (in that case much of the New Deal) can mess up economic performance.

And I’d also endorse two of his specific criticisms of choices the Fed made in 2008.

The first was the failure to cut official interest rates at the FOMC meeting a couple of days after the Lehmans failure. I think everyone – including Bernanke – now recognises that it was a mistake, but it really was an almost incomprehensible one. The justification was that the FOMC saw the risks of higher inflation as balancing the risks of lower growth. Now, as I noted in my post yesterday, headline inflation in September 208 was high – oil price effects mostly – but it is still hard to see how smart people could have reached the conclusion that a cut in the Fed funds rates was more risky than sitting tight. There was, for example, nothing disconcerting about the medium-term inflation outlook revealed in the breakevens in the government bond market (and by this time the Fed had already cut the Fed funds rate by quite a lot over the previous year. This is, of course, consistent with one of Sumner’s themes: central banks really should be taking more of a lead from market-price indications (which embody more wisdom and perspectives than a few dozen economists in any central bank can, and – he hopes – with less risk of (eg) groupthink).

It was a bad call. But in isolation it can’t have mattered much. After all, the FOMC went on to cut over the next couple of months, reaching their (self-identified) floor in December 2008.

The second questionable call was the move to pay interest on excess reserves held at the Fed (“settlement cash” in New Zealand parlance). I’ve written about this move in an earlier post, reviewing a book by George Selgin. This step was taken to stop short-term interest rates falling further…..in the depths of the most serious recession in decades…..by underpinning the demand for (willingness to hold) settlement cash. Selgin argued that this move deepened and extended the US recession – an interpretation I challenged in the earlier post – but it certainly dramatically changed any relationship that had previously existed between money base measures and wider nominal variables (nominal GDP, inflation, or whatever) – one of Sumner’s points – and did nothing to assist in getting inflation and activity back on course. (Our Reserve Bank made a similar decision last March, moving to pay the OCR on all settlement cash balances and thus underpinning short-term rates, at a time when the Bank also thought it needed to do massive bond-purchasing programmes.)

And while Sumner constantly (and rightly) cautions about simplistic reasoning from price changes, one of his other points about this period – and how the Fed was too slow and unaggressive in its approach – is how surprising it was to see real interest rates trending up over much of 2008. Discount the extreme surge if you like – though Sumner will argue that changes in market prices like that (tied in with risk aversion, market illiquidity) probably in any case support monetary easing – but that real yields were higher in January 2009 than in January 2008 does not sit that comfortably with a story of an aggressively-easing Fed.

TIPS 08

(At the time New Zealand had only a single indexed bond, then with about 7 years remaining to maturity. Yields on that bond did not start falling until November 2008, even though the economy had been in recession all year.)

But there is a tension in Sumner’s book. At least early on there is a sense that he thinks the Fed could have avoided the recession together if only they’d done a better job, but the specific failings he explicitly highlights cannot credibly have been large enough in effect to have avoided the recession (and further on in the book he notes that they might only have dampened the severity of the recession, which is a much weaker – and harder to test – claim).

In many ways his starting point is that the responsibility of a central bank is (or should be) to manage nominal spending in ways that avoid big and disruptive fluctuations (which often involve recessions, and sometimes exacerbate periods of banking stress). I have no particular problem with that. I still prefer something like inflation targeting (at least in countries like New Zealand and Australia) as the operational form that responsibility takes, while Sumner now prefers nominal GDP targeting (preferably in levels form, but in growth rates still better than nothing.

His bolder claim seems to be that if there is a recession – and he makes explicit exceptions for one where, as in March 2020, governments temporarily close down economies/societies – it is the fault of the central bank. And that is a step far too far for me. He might be right that in an ideal world no one would ever unconditionally forecast a recession, since they would also forecast that the central bank would take the steps required to forestall it. And so he might be right to say that neither the housing bust nor the associated financial crisis caused the US recession – central bank failure to react in time did – but that seems to me to simply assume away the problem, in a way that there are no easy or quick substantive or technical fixes for.

Here is a chart of US nominal GDP growth (note, as we see it now, not as people first saw it at the time).

us ngdp

Sumner thinks the Fed should aim to keep nominal GDP on a path consistent with about 5 per cent annual growth. Clearly that did not happen in 2008/09. Nominal GDP fell by more than 3 per cent in the worst 12-months and (consistent with then policy) there was never a later overshoot to get back on that 5 per cent annual growth levels track.

Here is a similar chart for New Zealand (from the low inflation era)

nz nom GDP

Our nominal GDP path is a lot noisier than that of the US – commodity price fluctuations are a key reason why NGDP targets are not a good idea for New Zealand (or Australia) – but you can see how much nominal GDP growth fell away in the two recessions (1997/98 and 2008/09) – and actually in the double-dip recession in 2010 too. Broadly speaking that doesn’t count as a successful outcome – but then nor does the real GDP recession, the rise in the unemployment rate, and (the extent of) the sharp fall in the core inflation rate.

But here’s the thing though. Had Alan Bollard – then the sole decisionmaker – been presented with credible forecasts at the start of 2008 that nominal GDP growth was going to go negative over the coming year, I have little doubt that he would have been prepared to cut the OCR sharply (he wasn’t exactly an anti-inflation hardliner). But he wasn’t. Not just from the internal forecasters, but from the wider forecasting community or the financial markets. Inflation breakevens weren’t plummeting, long-term real interest rates weren’t falling, the exchange rate wasn’t falling much (as late as May 2008 it was still higher than it had been at the end of 2006). The share market was falling back but (a) the New Zealand share-market wasn’t very representative of the wider economy, and (b) few if any one in New Zealand has ever put much weight on local share prices as an indicator. The Bank did not cut early or hard enough (and I was one of Bollard’s advisers until August 2008 and although I was one of those more focused on global risks I wasn’t recommending deep early cuts)….but we did not have the information on which to do so. I would argue that no one did. In a sense, it was the point of that period…..for a very long time no one understood quite how bad some of the lending had been, or who was exposed, or what the macro consequences (absent monetary offset) would be.

From all I read or saw of the US at the time, and since, I don’t think anyone in the US did either. It wasn’t as if the Fed was totally blind: they had been taken by surprise in 2007, but actually starting cutting in September (you can see in the chart above, nominal GDP growth was beginning to slow).

Could the Fed or the RB have done better? Almost certainly (some identifiable Fed mistakes above), but it is inconceivable that they could have prevented the recession – not because the techniques weren’t there, but because the information and understanding wasn’t.

One of my criticisms of Sumner’s book is that he largely avoids this issue, and more or less assumes much more was achievable over 2008/09 (the issues re the recovery are different but note that in NZ and in the US markets were often keener on tightenings than either central bank – and Sumner urges paying more attnetion to market prices). An example of what I have in mind is his treatment of Australia.

We are told that

Among all the developed countries, Australia was the one with that sort of devil-may-care attitude, and it breezed through the Great Recession with only minor problems. And yet from a conventional point of view the Aussies did the least aggressive monetary stimulus. Unlike most other developed countries, they did not cut interest rates to zero.

He goes on to present a table showing that average nominal GDP growth in Australia for 2006 to 2013 was much the same as in the previous decade (unlike the US and the euro-area).

And yet….the RBA was still raising interest rates into 2008 (I recall a conversation at a conference in early 2008 at which a very senior RBA figure expressed astonishment at what the Fed thought it was doing keeping on cutting), the RBA ended up cutting by 425 basis points, there was a huge fiscal stimulus, and yet here is the Australian nominal GDP growth chart.

aus nom GDP

And yet look how much nominal GDP growth fell away in that downturn (a bit more than in the US). And it wasn’t as if there were no real consequences, with the unemployment rate rising 2 percentage points.

I’m not saying it was a bad performance…..it might even have been about as good as the authorities could have managed. But that is sort of the point. Limitations of knowledge, understanding etc…..not just in central banks, but much more broadly.

I could go on, exploring some of this points and Sumner’s specific policy prescriptions in more depth. But this post has probably gone on long enough already. He favours targeting a futures contract on nominal GDP, which may be a reasonable idea (at least in the US context), but it isn’t going to change the basic problem around knowledge. In countries like New Zealand (as Sumner notes) something like an aggregate wages series would probably make more macroeconomic sense (but would have its own political problems). I’m all for using monetary policy aggressively, but there are limits to what short-term stabilisation can be hoped for, no matter the indicator, the specific target, the instruments, or the individuals.

(Rather than labour points about nominal GDP targeting, I’ll link to some remarks I made on the topic at a conference a few years back.)

Good books make you think, and think harder. The disagreements are often where the most value lies in forcing one to think harder about one’s own view. This one is worth reading and reflecting on. And I’m going to finish where the book does with a quote I endorse (even if a bit more relevant in the US than here):

In other words, the goal is a world in which policy makers don’t view fiscal stimulus or the bailout of bankrupt firms as a way of “saving jobs”, but rather as a sort of crony capitalism that favors one sector over another.

But there will still be recessions, real and nominal.

Inflation and monetary policy

No posts here for a while as I’ve been bogged down in trying to make sense of some events – little more than one week in history – from 30 years ago, where the uncertainty as to what actually happened (a precondition for making sense of what the events mean) is greatly magnified by really poor documentation and recordkeeping by….the Reserve Bank.

I was planning to return with something a bit more longer-term (perhaps tomorrow) but wasn’t yesterday’s inflation number interesting? It seems to have taken almost everyone – notably the people who do detailed components forecasts, including the Reserve Bank – by surprise to some extent.

Almost all the media focus has been on the headline number – 2.2 per cent increase for the quarter, 4.9 per cent for the year – because (I guess) it makes good headlines. (Excluding the two quarters when the GST rate was increased) it was the largest quarterly increase since June 1987 – an unexpected rise of 3.3 per cent, at a time when the Bank thought inflation was falling away, and when the Bank’s chief economist, Grant Spencer, was interviewed about the number that night he declared himself “flabbergasted”. That one number helped prompt an overhaul of, and marked improvement in, the Bank’s short-term inflation forecasting (not previously much of a priority).

But in annual terms, it is only 13 years since we had an inflation rate about this high. It was 5.1 per cent in the year to September 2008, a rate that may be beaten when the next CPI number is released in January, since last December’s (relatively modest) 0.5 per cent quarterly increase will drop out of the annual rate. Note that in the September 2008 quarter, the Reserve Bank had already (and appropriately) started cutting the OCR.

But my main interest is in core inflation. There are all sorts of different measures, from simple ones (useful for cross-country analysis at least) like the CPI ex food and energy, through varying degrees of complexity (and occasionally even special pleading by the people constructing them). For New Zealand though, my favourite measure – and the one the Bank openly favoured for some years (it is less clear how the current Governor and MPC see things) – is the sectoral factor model measure of core inflation. It was developed a decade or so ago by one of the Bank’s researchers, and initially got little attention even inside the Bank (mostly because the Governor and his advisers on the then Official Cash Rate Advisory Group were not really advised of it). I’ve been something of a lay evangelist for this measure ever since I realised it existed, and had some small role in getting this explanation of the measure published. The gist of what is going on is this

The sectoral factor model estimates a measure of core inflation based on co-movements – the extent to which individual price series move together. It takes a sectoral approach , estimating core inflation based on two sets of prices: prices of
tradable items, which are those either imported or exposed to international competition, and prices of non-tradable items, which are those produced domestically and not facing competition from imports.

Using very disaggregated data, it is an attempt to get at the systematic elements in the annual inflation numbers, recognising that tradables and non-tradables can be influenced by different systematic influences (notably the exchange rate in the case of tradables).

But the best argument for the series has been its usefulness – in some sense it “works”, telling useful stories, not subject to much revision, about what is going on in ways that square with what is going on with other things (notably capacity pressures, but also expectations) that are thought likely to be important influences on the trends in inflation, abstracting from the noise.

And the “noise” can be considerable. Here is annual headline inflation and the annual sectoral factor measure for the period since 1993 (as far back as the sectoral factor measure has been taken).

core oct 21

Big deviations have not been uncommon (although less so in the last decade), and spikes in headline inflation have never (yet) foreshadowed a commensurate increase in core inflation (as,say, stickier prices caught up with more flexible prices). If you did want a prediction of where core would be 12-24 months from now, historically today’s core inflation has been a much less bad (far from perfect of course) predictor than today’s headline inflation.

And so from here on I’m focusing solely on the core inflation measure. There are a few observations worth drawing from simply this chart.

First, the range in which core inflation has moved over 28 years has been 1.1 per cent to 3.5 per cent. And although the inflation target was centred on 1 per cent until the end of 1996 and 1.5 per cent until September 2002, the low in the series wasn’t then, but in late 2014 (a time when, curiously, the then-Governor was raising the OCR).

Second, over the 28 years not much time has been spent very close to the midpoint of the respective target range. In fact, the median gap between the core inflation estimate and the target midpoint has had an absolute value of 0.7 per cent over the history of the series. As it happens, yesterday’s core inflation estimate was 2.7 per cent, 0.7 percentage points above the target midpoint.

Third, for the first 15 years of the series core inflation was almost always at or above the target midpoint, and for the decade until last year it had been consistently below.

Now it is worth pausing here to note that prior to about 2012 the Reserve Bank (a) did not have the sectoral factor measure readily available to policy advisers, and (b) was not explicitly required to focus on the target midpoint. However, neither point really diminishes the usefulness of such comparisons because (a) sectoral core inflation was simply trying to put in a single measure something the Bank had constantly thought and written about since inflation targeting began, and (b) if Alan Bollard was personally disinclined to give much weight to the target midpoint, Don Brash certainly was (and revealed evidence – see those sectoral factor numbers from 2014 – suggests that Graeme Wheeler was more focused on where he thought in principle the OCR should be heading than on the target midpoint.

There are a couple more relevant observations. First, core inflation now (2.7 per cent) is about the same as it was (2.6 per cent) in the last year or so of Don Brash’s term (2001/02), and back then the target midpoint was 1.5 per cent, not the 2 per cent the Bank is now charged with. And, second, core inflation is still well below the 3.4/3.5 per cent seen in late 2006 and throughout 2007.

But perhaps the change in the inflation rate has been unusually sharp.

I put this chart on Twitter yesterday before the Bank published the sectoral core numbers.

core change

On the series now published, the sectoral core inflation rate rose by 0.3 percentage points in the latest quarter (so large but not exceptional). However, this sort of model is prone to end-point revision issues – new data leads the model to, in effect, res-estimate which recent prices moves were systematic and which were not. The previous estimate for sectoral core inflation for the year to March 2021 was 2.2 per cent. But that has now been revised up to 2.4 per cent. I don’t have (but the Bank should really publish) a database of historical real-time estimates, but a change from a previous estimate of 2.2 per cent in the year to March to one of 2.7 per cent for the year to June is likely to have been large by any standards.

What about changes from year to year? Again, I don’t have a real-time database, but here is how the annual rate of core inflation has changed from that a year earlier.

change in core

What we’ve seen so far – on current estimates which are subject to revision – is not exceptional. The rise in the rate of core inflation over the last year has been less than we saw around the turn of the century, and the magnitude of change is less than than the fall seen over 2009. But it isn’t a small change either.

When (last quarter, per the Bank’s published estimates) annual core inflation was estimated at 2.2 per cent, I was prepared to say (and did) that that rate of core inflation was unambiguously a good thing, given the target the government had set. After a decade of core inflation below the target midpoint, it was good to finally see an outcome on the other side, which would help to underpin medium-term expectations near the goal set for the Bank. That was doubly so because 2.2 per cent inflation went hand in hand with an unemployment rate right back down to pre-Covid levels (4 per cent) and probably pretty close to the NAIRU (itself a rate the Bank can’t meaningfully do anything about). I’d not have been uncomfortable with a core inflation rate going a bit higher still – not as a desired outcome, but not something to be too bothered about for a short period (as the MPC raised the OCR, which works with a lag). 2.7 per cent is somewhat less comfortable.

But quite a lot might have depended on where the unemployment rate (or other measures of excess capacity) was going. There have been two previous troughs in the unemployment rate. The first was in the mid 1990s, when the NAIRU appeared to be around 6.2-6.5 per cent. Core inflation reached its cyclical peak then at much the same time unemployment dropped into that range, and showed no signs of going higher. The second was just prior to the 2008/09 recession, when the unemployment rate was in the 3.4-3.9 per cent range. Core inflation had risen as the unemployment rate fell, but core inflation was not going higher in 2007, nor was it forecast to into 2008. In both cases, the Reserve Bank had been raising interest rates (or allowing them to rise) and things stayed more or less contained (before core inflation fell away in the two following recessions).

One of the great unknowns now is how things might have unfolded here without the Delta outbreak and the ongoing restrictions and lockdowns. We will get the HLFS numbers for the September quarter early next month, and the unemployment rate there is unlikely to have been much affected yet by the lockdowns etc. Most likely, the unemployment rate will be lower than 4 per cent, but how much?

But the outbreaks and restrictions did happen, and so even if the unemployment rate for the September quarter was in fact 3.6 or 3.7 per cent, it probably isn’t safe to assume anything of the sort as a December quarter starting point. Yes, most likely economic activity will eventually rebound when controls are finally lifted but (a) there isn’t the fresh policy impetus there was last year, and (b) for those who believe in house prices stories, the worst of this particular house price boom has most likely passed. It isn’t implausible that the unemployment rate for December and March could be back at or above 4 per cent.

What does it all mean for policy? No doubt the MPC is feeling vindicated in having raised the OCR at the last review, even amid the-then extreme Covid uncertainty, and even though the MPC is likely to have been very much taken by surprise by yesterday’s core inflation number. Absent Covid there was a strong case for a robust tightening of monetary conditions – reversing the LSAP bond purchases, ending the funding for lending programme, and getting on with OCR increases – and that case would have been considerably strengthened by yesterday’s outcome.

Perhaps fortunately, the MPC does not need to make another OCR decision until late next month, and that review will come with a full MPS which will allow them space to provide some careful and considered analysis of their own. We might hope that by late next month, something close to normality has returned or is on the brink of returning. There are no guarantees, but if that is the situation, the MPC should be starting to sell off the bonds, and ending the FfL programme (most likely they will do neither), and should probably still be considering seriously a 50 basis points OCR increase (albeit with one eye on the emerging China slowdown). We were told they had considered the option in August. There isn’t a need for panic or headless-chookery about the Bank having lost the monetary policy plot. But a fairly robust response does seem likely to be warranted next month, especially as the MPC has (most unwisely) scheduled decision dates in a way that gives them a long summer holiday with no OCR review at all in December and January.

Finally, I have been highlighting for a long time how the market-based indications of inflation expectations (from the indexed bond market) had consistently undershot the target midpoint for some years. Yesterday’s data seems to have prompted a move to (or above, depending on maturity) 2 per cent for the first time in a long time. That isn’t concerning – rather the contrary – but it will be worth keeping an eye on how those spreads – the breakevens – develop over the period ahead.

Monetary policy, expectations etc

I’ve been reading a few books lately on aspects of monetary policy, and might come back to write about some or all of them. But there has been quite a bit of discussion recently – on economics Twitter, and blogs – about a new working paper from a senior Federal Reserve researcher, Jeremy Rudd.

Judd’s paper runs under the title “Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)”, which seems like a worthwhile question, especially at the moment when – and especially in the US – debates rages as to how just how transitory (or otherwise) the recent surge in inflation rates will prove. It is common to hear central bankers opining about how much may turn on whether these higher headline rates get into (alter, affect) the expectations about future inflation of firms and households.

If you come at these things from a New Zealand perspective, the most remarkable thing about the paper is probably that it was published at all. How well I recall getting rapped over the knuckles, with severe expressions of disapproval from Alan Bollard, when I used a quiet New Year’s Eve in the office a decade ago to write a short discussion note, circulated in that form only among a dozen or so senior colleagues, in which I had the temerity to suggest that we might consider advancing the case for a legislated Monetary Policy Committee. Not exactly radical stuff, given that it was the way most countries did things (and NZ now does things). When somewhat later word of the paper got out – a Treasury official who had a copy mentioned it in a reference in a paper that was OIAed – the Bank insisted on fighting all the way to the Ombudsman (where the Bank won) to prevent release. Sceptical perspectives on LVR restrictions, before they were put in place, were equally unwelcome, even internally. And when I say “unwelcome”, I don’t mean anything of the sort of “interesting arguments, but I’m not persuaded because of x, y, and z”, but much more of a “back in your box” sort of thing.

And both of those examples are just about internal circulation. I’m pretty sure that no Reserve Bank analyst, economist, researcher or the like has ever published anything that made the hierarchy even slightly uncomfortable in the entire 31.5 year history of the modern (operationally autonomous) Bank. Consistent with that, of course, even though we now have a Monetary Policy Committee with non-executive members, it operates totally under the thumb of the Governor and nothing of a diversity of view is ever heard. The contrast to, say, the Bank of England, Sweden’s Riksbank, or the Federal Reserve is stark.

I don’t want to appear all starry-eyed and naive here. Every institution – every central bank – has its limits, and even the more-open places seem to be quite a bit more open than they were. But it is inconceivable that anything like Rudd’s paper could have been published by the Reserve Bank, even though in many respects it is much less radical than some commentary has tried to suggest, or than the tone Rudd affects on page 1, with his

Economics is replete with ideas that “everyone knows” to be true, but that are actually arrant nonsense.

And

One natural source of concern is if dubious but widely held ideas serve as the basis for consequential policy decisions.2

I have no idea of Mr Rudd’s politics, but like many readers I was intrigued by the footnote to that sentence

2  I leave aside the deeper concern that the primary role of mainstream economics in our society is to provide an apologetics for a criminally oppressive, unsustainable, and unjust social order.

To be honest, I used to edit Reserve Bank research and analytical papers etc for publications and – keen on openness and diversity as I am (see above) – I’d have insisted that sentence come out. Attention-grabbing but quite unrelated to the substance of the paper (or the functions of the Bank) would no doubt have been the gist of my comment.

But what of the substance of the paper? There isn’t really much there that is new. Quite a bit of it is about the limitations of how formal macroeconomic models capture, and ground, a role for inflation expectations. I don’t think any of that will have surprised most readers, or disconcerted anyone who has been associated with the actual conduct of monetary policy in recent decades. Perhaps you might be slightly disconcerted by his point that the models often seem to put more weight on short-term expectations (where surprises/shocks can generate real consequences) but that “one of the few shreds of empirical evidence that we do have suggests that it is long-run expectations that are more relevant for inflation dynamics”.

But even then I’m not sure that you should be disconcerted, in part because nowhere in the entire paper are interest rates mentioned, or financial instruments, and I (at least) have always thought of the role of inflation expectations as potentially most important in the context of a willingness to borrow (in particular) given the prevalence still of long-term nominal debt contracts (particularly so in countries such as the US where long-term fixed rate debt is a large chunk of the market). A 5 per cent mortgage rate is one thing if I’m working with an implicit, perhaps even unconscious, sense that normal inflation is 5 per cent, and quite another if I’m working with 0 per cent inflation as my norm.

There is a school of thought (class of economic rhetoriticians) who will assert, sometimes quite strongly, that in the long-run inflation expectations are the only determinant of inflation. I had a boss for some years who regularly ran that line. And, to be sure, you can set up a model in which it is true, but that model typically won’t be very enlightening at all, since “inflation expectations” (however conceived or measured, and measurement is a real challenge) don’t occur in a vacuum. If we had the data in the early 1980s, New Zealand inflation expectations might well have been about 12 per cent (say), but inflation expectations were that high because of some mix of (a) the government and the Reserve Bank not having done much to get inflation any lower, and (b) the government and the Reserve Bank not being thought likely to do much in future to get inflation much lower. Policy tended to validate the expectations, but it wasn’t the expectations that determined inflation, but the policy itself. When policy stopped validating those high expectations, they came down (albeit often quite slowly, sensibly enough (on the part of those forming the expectations).

Those misperceptions can matter. When we were trying to get inflation down (to something centred on 1 per cent) in the late 80s and early 90s, no one put much weight on the chances of success. Quite probably many of us didn’t either (I recall a conversation with the-then Westpac chief economist in which I suggested that I’d be reluctant to bet on inflation averaging below 3 per cent for the following 20-30 years). That made it harder (and costlier) to get actual inflation down, but – through some mix of good luck, bureaucratic resolution, and close-run-thing political commitment – we did. And indications of expectations about future inflation followed. A 14 per cent bank bill rate by the mid 1990s no longer meant what it had in 1988, when the inflation targeting scheme was first hatched.

On the other hand, it seems likely (but I’m more open on this) that during the period over the last decade when core inflation was persistently low – repeatedly surprising the Reserve Bank, among others – the fact that indicators of inflation expectations mostly tended to hold up nearer the target midpoint may have helped, a little, avoid more of a fall in inflation itself (although even this is arguable since had inflation expectations fallen away more sharply and obviously, the Reserve Bank might well have used policy more aggressively than it did, including getting unemployment down earlier/further).

One of the other limitations of Rudd’s paper is that there is barely any mention of any country’s experience other than that of the United States. Of course, he is American, writing in an American institution for a primary audience that is America, but…..data. In truth, there just is not that much data in any individual country (because no matter how many series and how high-frequency the data, there are only so many genuine cyclical episodes to study). In almost no other country in the world is it conceivable that someone would write such a paper without looking beyond their own borders, and own central bank. Even for the US, it should be more important, since the Fed focused on an index which doesn’t have a great deal of general public visibility, whereas many other inflation targeters will at least start from the CPI.

For me – as someone with (mostly) a policy focus – the most significant part of Rudd’s paper was the last few pages on “Possible practical implications” and “Possible policy implications”. I had a tick beside this paragraph

Another practical implication is rhetorical. By telling policymakers that expected inflation is the ultimate determinant of inflation’s long-run trend, central-bank economists implicitly provide too much assurance that this claim is settled fact. Advice along these lines also naturally biases policymakers toward being overly concerned with expectations management, or toward concluding that survey- or market-based measures of expected inflation provide useful and reliable policy guideposts. And in some cases, the illusion of control is arguably more likely to cause problems than an actual lack of control.

But for all the glib rhetoric that sometimes comes from senior central bankers, I wonder how many – if any – practical central bankers operate as if they really believe that everything (about future inflation) rests on inflation expectations. I’ve had many criticisms of the Reserve Bank of New Zealand over the years, but not even Don Brash acted and operated policy as if that was his view, and certainly none of his successors have.

Perhaps more interesting was this

Related to this last point, an important policy implication would be that it is far more useful to
ensure that inflation remains off of people’s radar screens than it would be to attempt to “re-anchor” expected inflation at some level that policymakers viewed as being more consistent with
their stated inflation goal. In particular, a policy of engineering a rate of price inflation that is
high relative to recent experience in order to effect an increase in trend inflation would seem to
run the risk of being both dangerous and counterproductive inasmuch as it might increase the
probability that people would start to pay more attention to inflation and—if successful—would
lead to a period where trend inflation once again began to respond to changes in economic
conditions.

It harks back a bit to the definition of price stability Alan Greenspan once used to give, that it is when inflation isn’t a consideration for people (firms and households) in the ordinary course of their lives, but also seems to be a bit of dig at the current FOMC policy of aiming to run core inflation above target for a time. I’m probably more sympathetic to that approach than Rudd – including for New Zealand after a decade of undershooting the target – but his comment is a perspective that should be taken seriously.

HIs final main point is this

A related issue is more pragmatic. In some ways, the situation that arises from a focus on
long-term inflation expectations is similar to one in which a policymaker seeks to target a single
indicator of full employment—for instance, the natural rate of unemployment. Like the natural
rate, the long-run expectations that are relevant for wage and price determination cannot be directly measured, but instead need to be inferred from empirical models. Hence, using inflation
expectations as a policy instrument or intermediate target has the result of adding a new unobservable to the mix. And, as Orphanides (2004) has persuasively argued, policies that rely too
heavily on unobservables can often end in tears.

People (including central bankers) fool themselves if they think that survey responses, or implied breakevens from inflation-indexed bond markets, “are” inflation expectations (for the economy as a whole) themselves. They are what they are, and always have to be taken with at least some pinches of salt. In New Zealand, for example, household surveys regularly produce numbers suggesting households expect to average between 3 and 5 per cent over periods 1 to 5 years ahead, but no one has ever taken those absolute numbers seriously (there is little or nothing else anywhere in the economy suggesting that whatever people tell surveytakers they act as if they think inflation will be this high). At best, they are indicators, straws in the wind, and sometimes what look like good relationships then no longer do.

As an example of the latter, the Reserve Bank economics department at times articulated a line that the two-year ahead measure of inflation expectations in the Bank’s survey of informed observers) almost was a measure of core inflation itself.

expecs and core inflation

It held up quite well over the best part of 15 years, until it didn’t. It left the Bank too complacent through the following decade (but the error could equally have run the other way).

I guess my bottom line is that one should rarely put too much weight on any specific indicator, and perhaps especially ones that are hard to observe (or to know what one observes actually means). If we see medium-term inflation expectations – among informed observers – at 5 per cent, we (and central bankers) should be disconcerted, but it is highly unlikely that such an inflation expectations number will have been the first sign of trouble.

Changing tack, what of current monetary policy in New Zealand? There is an OCR review tomorrow. Expectations measures here don’t appear troublesome at all – even the inflation breakevens are getting nearer the target midpoint than we’ve known for some years. But core inflation has been rising, unemployment had fallen quite low, and a lot of indicators pointed to emerging capacity pressures. All that was, of course, before the latest Covid outbreak.

I still think there is a very good case for things the Reserve Bank MPC will not do tomorrow: discontinue the Funding for Lending programme, and start a well-signalled programme of bond sales to reverse the LSAP programme. But what of the OCR itself? I won’t be particularly critical of the MPC if they do raise the OCR by 25 basis points tomorrow, but I think if I was in their shoes I wouldn’t. There is a full forecast round and full MPS at the next review and a lot of uncertainty about the Covid outbreak and is its implications (as well as some emerging downside global risks, notably from China). Yes, monetary policy works with a lag, but the starting point for (core) inflation is not so high that we need to be in a hurry to raise the OCR in such an uncertain and unsettled climate. We will know a great deal more – including about vaccinations, and hopefully about exit pathways – on 24 November than we do now. If all is going really well by then, or if core inflation in the CPI later this month is really troubling, there need be no problem with going 50 basis points then, if the data support such a call. But I wouldn’t be rushing right now.

Vaccinations by age

Still on health matters, I’ve been intrigued for a while at what was happening to vaccination rates stratified by age. For all that politicians and the media burble on, emote even, about differences by ethnicity, the data on Covid itself seem crystal clear: by far the biggest demographic risk factor for getting seriously ill or dying of Covid (and thus of resulting in pressure on the health system) is age. The Hendy et al modelling used this data (from this 2020 paper).

age factor covid death

I’ve seen people suggest these absolute numbers may be out of date, and epidemiologists can argue about that, but my point simply is that no one seems to dispute the significance of age. It isn’t just a linearly increasing risk: the risks for (say) the over-80s are far far higher than those for even people in their 50s.

The government of course recognised this initially in allowing old people to get vaccinated before (progressively) most of the rest of us. If you are my age, it is only about six weeks since one could get a first dose, and so many (like me) will be getting second doses only in the next few weeks. But the very elderly have had a lot of time to have had both doses of the vaccine. And, so you would think, people in that age range would generally have a strong personal incentive to get vaccinated – and their children to encourage them to do so. Public spirit might be necessary to help encourage the young, but for the very old death from Covid is a non-trivial risk (and thus the strict rules one hears rest homes have in place). The rest of us have a strong interest in these old people getting vaccinated because pressure on the health system is one of the key perceived constraints on opening up.

And so I’ve been a bit surprised that the vaccination rates among the elderly have not been higher. The Ministry has come and gone a bit on how much information it makes available, but for now it seems to have settled on promoting this chart.

moh vaccine by age

None of the elderly age bands have yet got to a 90 per cent second dose vaccination rate, and only one (the 80-84 group) has got to 95 per cent for even a first dose. And these people have had months.

But the real situation seems to be even less good than the Ministry of Health portrays it. The denominator they use in all their charts and tables is not the population in that age group as estimated by our official statistics agency, SNZ, but something called the “Health Service User population” (HSU), which is defined thus

The Health Service User population estimate counts the number of people who received health services in a given year. Someone is counted in the population if their associated National Health Index (NHI) number received public health services; or was enrolled with a primary health organisation (PHO). 

I suppose they must have their reasons, but using this HSU measure seems to assume away part of the problem – people unknown to the health system seem, all else equal, less likely to be turning up (to the health system) for a vaccine. Of course, it is a hard count (administrative data) and the SNZ population numbers are only (informed) estimates. But some people just don’t go to the doctor very often (I know in my 20s I prided myself on not having been for a decade).

Anyway, here is the difference it makes

hsu popn

There are some anomalies. I’m not sure how there can be so many more 90+ health service users than SNZ think there are in the country (and they keep track of deaths, and there can’t be that much migration among the over 90s), and the 80-84 band is a bit of a surprise too, but the key point is that both for older ages (65+) and the the 12+ population as a whole, the HSU appears to undercount the population by 3.5 per cent. All else equal then, vaccination rates are a bit overstated.

Here is how the two measures look for first doses for the older age groups

vaccination rates hsu vs snz

Using the SNZ population numbers, not quite 90 per cent of the elderly have yet had a first dose. And yet we hear almost nothing about this from our government, our health bureaucrats (who seem to champion the messaging of politicians) or even – so far as I could see – in the perspectives provided by the opposition political parties.

Here is the same chart for second doses.

2nd dose vacc rates by age

Not much more than 80 per cent of even the 75+ population have had two doses, many months into the programme. And this is the demographic most exposed to serious illness death, and the demographic that thus poses the greatest threat to the health system if/when Covid gets more established here.

Using the SNZ population estimates here are the vaccination rates for each age-band.

vacc rates by SNZ age

Can better be managed? Well, it would appear so from the experiences of other countries. At an aggregate level, for example, Portugal has about 85 per cent of the population with two doses (about 95 per cent of the 12+ population). I’ve been keeping an eye for some time on NHS data for England (and remember that a lot of people in England have already had the virus itself), and they appear to be showing close on 100 per cent of those 70-74 having had two doses (albeit rates tail off somewhat above that age band).

But when it comes to Covid, Australia still appears to be the country most similar to us, including in that they were slow to get their vaccination programme going. This is the latest set of charts

aus vacc rates

Of course, Australian states and territories have a quite diverse range of experiences with Covid (ACT, NSW, and Victoria with ongoing outbreaks) but their record in getting the elderly vaccinated seems to be consistently (NT aside perhaps) better than New Zealand’s, with particularly impressive numbers in ACT (where all but one age-band over 40 have 95 per cent first dose rates, and most second doses done).

Perhaps there are denominator issues in those other countries too, but even if so the bottom line remains one in which the New Zealand elderly vaccination rates are just not that good, given the risks (to their own health, and – indirectly – to the wider freedoms and opportunity of the community more generally).

And there is no sign our politicians are taking this very seriously.

On a final note re age, the Hendy et al modelling released last week (and touted by the government) assumes the same vaccination rate for all eligible age bands. That seems somewhat unrealistic, even if at some point in the middle distance all age bands were to eventually converge to very similar vaccination rates. It seems unfortunate that model estimates using a range of different assumptions about the age pattern of vaccination rates have not been published. Superficially, it would seem that very high vaccination rates among the very old might be more valuable – in reducing death and serious illness, and facilitating opening up – than very high rates among some of the younger cohorts. In a brief exchange on Twitter last week with one of Hendy’s co-authors, he indicated that (a) they had done some such modelling, and (b) that sometimes one could get counter-intuitive results. Which is fine, but it would be helpful for the public to be able to see this sort of material, especially when the government itself if touting the modelling of these particular researchers. In its absence, it looks as though the government should be putting a lot more emphasis on getting elderly vaccination rates well up than is evident at present.

Health spending

Over the last few days I’ve noticed a few political partisans on Twitter squabbling about health spending under various governments. I’m not exactly sure what triggered it, although perhaps it had something to do with John Key’s op-ed at the weekend.

Not being a political partisan myself – let alone a recent supporter of either National or Labour – I decided to have a quick look at the data myself. The Treasury publishes a quite useful long-term set of annual fiscal data, including a breakdown of spending. It is all in nominal dollars, but they also show those numbers as a percentage of nominal GDP. Here is how health spending has changed, as a per cent of GDP, since 1972 (bearing in mind that the years shifted from March to June years about 30 years ago). The data for the year to June 2021 should be out shortly (one would hope).

The trend over time is upwards. That shouldn’t surprise anyone. There is a lot more medical technology can now do for us, expectations are higher, and a larger proportion of the population is now relatively old. Oh, and as far as we can tell productivity growth in the government health sector has been pretty unimpressive.

And if the trend is upwards, there are quite material fluctuations around the trend. But note that they won’t always tell you much about health policy. After all, the ratio has a numerator (health spending) and a denominator (GDP), and nominal GDP growth can be quite variable, even in the low inflation era of the last 30 years.

The state of the economy influences what can be spent on health (and other things) but you wouldn’t expect this year’s health spend to be affected much (if at all) if the terms of trade happened to fall sharply this year, perhaps after the Budget was set.

And thus, to revert to the first chart, you may already have noticed the two big increases in health spending as a share of GDP – neither of which were sustained – happened in the 1970s (when our economy badly underperformed after 1973 for several years), and over the first few years of the last National government, when we went through a severe recession (not caused by that government) that took quite a few years to recover from. Note that part (but not all) of the reason health spending rose as a percentage of GDP in the year to June 2020 is that GDP plummeted in the first half of 2020.

Now, of course, recessions should be expected to slow the growth of health spending – even if not necessarily the volume of health services delivered. After all, a big chunk of the health budget, directly and indirectly, is salaries, and real wage inflation tends to slow (often quite sharply) in significant economic slowdowns. But it isn’t a mechanical or immediate connection, especially as much of the health workforce is unionised and sometimes on multi-year collective contracts. Equally, of course, in relatively good times, the government may be willing to settle more generously with the health workforce, boosting spending (if not necessarily the volume of health services delivered).

Comparisons across governments aren’t just affected by denominator issues. There is also the facts that (a) government fiscal years don’t line up with the dates of changes of governments, and (b) even if they were, it is hard to change spending immediately (at least if purchasing more/less health services is the aim). But, for what it is worth, here is my best effort – using annual data only – at average health spending as a percentage of GDP for each government since 1972

To be clear, it is not some gotcha effort at the current government. You can see from the first chart that health spending as a share of GDP has been rising under this government from the levels they inherited, although are still below – for good or ill, for whatever reason – the percentages run during the previous recession and immediate aftermath.

That chart involved multi-year averages and (at least for the three nine-year governments the numbers aren’t so sensitive to the choice of first or last years). The same can’t be said for crude changes from the beginning to the end of the government. But for what they are worth:

Labour 72-75: Fiscal years were March, governments changed in December. In the March 1973 year, health spending was 4.2 per cent of GDP, and in the March 1976 year it was 5.3 per cent.

National 75-84: March years. National took office in Dec, and left office in July (hot having delivered a Budget). In the March 1976 year, health spending was 5.3 per cent, and in the March 1984 year it was 4.8 per cent.

Labour 84-90: Data change to June years in 1990. Labour left office in November 1990. Health spending was 4.8 per cent of GDP in the March 1984 year, and 5.0% in the June 1990 year and 5.2% on the June 1991 year.

from here on June fiscal years, and government changes in the Dec quarter. I assume outgoing government is responsible for health spending in the June year it leaves office (Budget having been passed etc)

National 90-99: 5.2% in June 1991 year and 5.4% in the June 2000 year.

Labour 99-08: 5.4% June 2000 year, 6.5% for June 2009 year

National 08 to 17: 6.5% for June 2009 year, 5.9 per cent for June 2018 year

Labour 17 to present: 5.9 per cent for June 2018 year, 6.5 per cent for June 202 year

Here is one more chart, this time showing health spending by the government as a percentage of total primary (ie non-interest) spending.

The two big trends seem to be about welfare spending. Up to the early 1990s not only were numbers unemployed rising (latterly sharply) but NZS eligibility at age 60 was becoming a heavier fiscal burden. Both trends were reversed from the early 1990s. The sharp drop in the 2020 year is, of course, mostly a reflection of the huge wage subsidy spending in the first half of last year. For those wanting to play gotcha about the previous government, health spending increased as a share of total (primary) government spending over the entire course of that government.

What do I take from all this? Not a great deal. Economic fluctuations happen, and there are limits to what governments can do about them quickly. Productivity slowdowns occur, and if there is more governments can do about them, they make it harder to manage health demands. And raw spending on its own doesn’t necessarily mean a great deal anyway, at least in terms of the health outcomes the wider public probably care about – and that is especially so if the changes in spending substantially reflect (say) a few years of being stingy or generous with the public sector health workforce.

Still on health, this post might be a good opportunity to introduce a couple of cross-country charts I showed on Twitter a couple of weeks ago. The OECD gathers data on total health spending (public and private) as a percentage of GDP, mostly for OECD countries.

This was the OECD’s chart, useful because it shows the splits across countries between government (or compulsory private) and voluntary private spending on health. I was interested in it partly because there seems to be much more difference across countries in the public/compulsory spend (per cent of GDP) than there does in the voluntary spend, and there is no sign (for example) that countries with a high government/compulsory spend (per cent of GDP) spend less voluntarily.

You’ll notice it is labelled “2020 or latest available”. Usually that might be fine, but of course 2020 not only saw big increases in health spending in many countries, but also saw significant drops in GDP in many, so comparisons that involve 2020 for some of the countries and 2019 for others aren’t going to be reliable.

Here is total health spending for 2019 for the OECD countries from the earlier chart.

The US is, of course, something of an outlier. But, focusing on New Zealand, mostly the countries that spend more on health (public and private) as a percentage of GDP are richer and more productive than we are (Chile is the exception), and countries that spend less of health (percentage of GDP) are similar productivity/income to us, or poorer (Luxembourg is the exception, but much of Luxembourg’s GDP is generated by people who work there but live in neighbouring countries). We look to spend about as much of health – public and private – as you might expect if you knew our productivity/income performance.

FInally in that group of charts, I lined up total (public and private) spending on health with total primary government spending (both as a percentage of GDP) for the OECD countries (most) that have data for both series. I’ve marked New Zealand in red. You can see that government spending as a share of GDP is well towards the lower end of the range for these OECD countries (as people on the left often bemoan) but also that there is no cross-country relationship between the two series. Countries – all in Europe – in which the government spends a great deal more of GDP (15-20 percentage points more than New Zealand) don’t spend greatly more (public and private) on health as a percentage of GDP. To the extent they do, it appears to be mostly because they are richer and more productive than New Zealand, and richer and more productive countries choose (public and private) to devote a larger share of that higher income to health.

I’m much more interested in productivity (under)performance than health spending per se. As far as I can see, we devote about what one might expect to health in a country of our productivity/income. A much better productivity performance – something that seems to seriously interest neither side of politics – would open up lots more opportunities (public and private), including the likelihood that we would choose to devote a larger share of our higher incomes to health.

Economic underperformance – over many decades now – has real consequences.

Illusions of History

That is the title of a new New Zealand Initiative report out yesterday, with the subtitle “How misunderstanding the past jeopardises our future”.

I’m no fan of this government, including its economic policies, and often lament how little New Zealand economic history is taught (none at all for example in our capital city university), so I should have been favourably predisposed towards such a report, which appears to have been prompted (specifically) by a couple of recent quotes from the Minister of Finance. This is how the report starts

And here is how it ends

You’ll get the drift.

I’m very sympathetic to the story that both Robertson and his boss are keen on a “bigger and more intrusive and directive government”, and it is clear that they have no serious ideas about (and demonstrate little interest in) reversing the decades of relative productivity decline. Most likely, their approach will see New Zealand outcomes worsen relative to those in the rest of the world. I’ve also been quite critical of this year’s Budget and the huge cyclically-adjusted deficits the government was choosing to run at a time when their forecasts suggested the economy was running at pretty much full capacity.

And yet, and yet.

There seem to be two themes or driving concerns to the report. The first is to re-present aspects of New Zealand’s economic (policy) history in ways less sympathetic to Grant Robertson’s rhetoric, and the second is alarm – I would probably call it alarmism – about the current and prospective global situation. On that latter, these paragraphs also come from the last couple of pages of the report.

I’m probably not much more keen on big debt and big deficits than the report’s author – Bryce Wilkinson – is, but this sort of broad-brush rhetoric seems set to discredit useful and important points that could be made, especially in the New Zealand context.

Are there “unresolved fiscal problems that followed the 2008 global financial crisis”? Most probably there are, in some countries anyway, although even in the United States – exemplar of chaotic fiscal policy surely – the problems were evident before 2008, were worsened again by the Trump tax package, and are now being worsened again by what the Democrats are now trying to push through. It is a sorry picture – and the US is still a consequential country – but it isn’t the New Zealand story. We ran into big deficits for a time after 2008 – some mix of a late spend-up by the previous government, poor macro forecasts, the recession itself, and the earthquakes – but we pulled ourselves out of that hole, with (in the main) bipartisan support for doing so. On the OECD’s net general government financial liabilities measure (the broadest and most internationally comparable) we were at zero net debt just prior to Covid (and almost a quarter of OECD countries had positive net general government financial assets).

As Bryce acknowledges, the New Zealand government’s own fiscal projections have debt stablising and then slowly falling as a per cent of GDP. And if the level the socialists are happy to see it stabilise at might be higher than either Bryce or I would prefer…it is hard to get very excited about that level. Whichever measure you prefer, on none of them is there any risk of New Zealand running into a public debt crisis. Of the government’s range of debt indicators, I like the net debt one that includes NZSF assets: Treasury see that being 25 per cent of GDP in 2025.

And what about “monetary excesses”? Well, I’m not fan of QE-type programmes, but mostly because they make little sustained macroeconomic difference, but provide central banks some feeling of “doing something”. And perhaps the world really is about to see a sustained break-out of inflation, but……nowhere in the advanced world, not even in the US, are financial markets (with money at stake) suggesting that is the most likely outcome. Our own central bank, having presided over 10 years of undershooting the inflation target, was actually on the brink of tightening just last month, and may yet do so next month. At the moment, markets think governments will allow central banks to (and central banks will act to) keep any sustained lift in core inflation pressures in check. Markets may be wrong – it has been known – but I’m not sure our Minister of Finance has a strong ground for thinking they are.

And what about the history, the central part of the report’s title?

There is a rather weird reverence in some circles for the first Labour government, at least the period under M J Savage in the late 1930s. Labour seem particularly prone to it, which I suppose is somewhat understandable, but it even infects the other side of politics at times (In this post I unpicked some Todd Muller rhetoric on similar lines, during his brief stint as Leader of the Opposition). It seems to be sentimental rather than rigorous, and the NZ Initiative report is a useful quick canter (albeit with a historical error or two) through material on the macroeconomic mess that Labour government ran us into by 1938/39. At a macro level, we were simply saved by the war, but then lived with the panoply of microeconomic restrictions and controls in one form or another for the next 45 years. But it is rather light on some significant differences from the present: not only was the New Zealand government very highly indebted in the late 1930s (well over 100 per cent of GDP, not primarily the fault of the Labour government), but we were also running a system of fixed exchange rates. And we did not have a monetary policy run consistent with the demands of the exchange rate system

There is more (also with some arguable interpretations/emphases) on the macroeconomic mess New Zealand was in by 1984. That mess can be overstated – partly because inflation itself overstated the severity of (notably) fiscal deficits – but the truth was messy enough. But it wasn’t primarily a fiscal crisis – there was no question of default, no question of lenders being unwilling to lend to us – but a productivity underperformance one and (in the immediate) a monetary policy crisis. We had a fixed exchange rate regime, and we did not have a monetary policy run consistent with the demands of the exchange rate system.

By contrast, at present we have a long-running woeful productivity performance – basically the enduring theme of New Zealand economic history at least since World War Two – but we know (including because we experienced it for the last 25 years) that that isn’t inconsistent with macroeconomic stability.

We have large fiscal deficits for this year and next (on the Treasury’s best interpretation of government policy as communicated to them) but public debt ratios that are low by any standards (cross country or historical) at a time when servicing costs, while not as low as in some countries, are very low by historical standards. The effective duration of the government’s debt portfolio is shorter than desirable – and the LSAP programme is responsible for that – but crisis material it isn’t (and it wouldn’t be even if we had another bad earthquake in the next few years).

And, we do have a central bank that – for all its many weaknesses (mostly the key people) – still operates, by law (and it seems in practice) at arms-length from the government, and (for all its florid rhetoric about other stuff) shows every sign of easing policy when core inflation falls away and tightening policy when core inflation looks like rising. And which has a target, set by the government, that is totally conventional internationally. And if nothing else, having a monetary policy that runs that way – consistent with our exchange rate regime and with the inflation target – makes things utterly different, in macroeconomic stability terms, than in 1938/39 or in 1984.

Having said that, I suspect the real thing that drove the report was the opportunity to litigate Grant Robertson’s take on the 4th Labour government. Personally I tend to take that sort of Robertson rhetoric with a considerable pinch of salt, since a great deal of his style seems to involve the appearance of product differentation from the 4th Labour government even when the substance barely changes (the Reserve Bank Act amendments are a classic examples). Feelings around the late 1980s are clearly still raw, especially in the Labour Party, and it seems to be good politics to pander to that.

But Bryce Wilkinson frames six “myths” about the 1984-93 reforms. He summarises them thus

Personally, I think the truth is probably somewhere in the middle. Take for example, the first one. The Robertson quote emphasises the damage to communities, and even Wilkinson in the report acknowledges the pain of the reforms for many. He might argue it was unavoidable by then, and Robertson would have been better not to have talked about “economic carnage” (especially when the basic economic model now isn’t that different).

Were the reforms “extreme”? I don’t think so, but they were unusually far-reaching, and in places went where few other countries had yet gone. For better or worse (I think mostly better) they positioned us very well in many international policy/institutional comparisons by the 1990s having started well behind. And I recall the time we spent in one OECD review of New Zealand urging them to take out language (which they intended as a compliment) suggesting that our reforms were unusually ambitious.

Were the reforms “undemocratic”? At one level, clearly note. They were undertaken by democratically-elected governments. But Wilkinson’s specific rebuttals risk inviting derision. He suggests that the snap election “gave no time” to Labour to articulate its ideas…..which more or less concedes the platform was never campaigned on. I have a bit more sympathy for the 1987 re-election argument, except…..that Labour’s manifesto that election, with talk of further significant reforms, was published after the election. And the 1990-93 Bolger government story was also a mixed bag – labour market reform was a significant part of their campaign but (for example) benefit cuts were not, let alone the amped-up superannuation surcharge. Call it democratic or undemocratic as you like, perhaps even call it unavoidable, but it wasn’t very transparent ex ante.

Call my overly literal, but “decimated” probably roughly accurately describes the welfare system effect – it was still there and, rightly or wrongly, just quite a bit less generous than it had been before.

And then there is myth 2. Bryce and I have debated this point on many occasions over the years, and I’ve written about it here before. I can’t prove that he, or Roger Kerr, have not been surprised at how poorly the New Zealand economy has performed over the last 30 years, or by the failure to even begin to close the gaps with the OECD leaders, or by the widening productivity gaps to, notably, Australia. But I’m pretty sure most people who supported the reforms don’t think outcomes have lived up to their expectations and hopes. I recall the very first time I ever appeared before a select committee it was with the Bank’s then chief economist to tell MPs our story about how as we emerged from the reforms we would expect multiple years of above-average growth, consistent with closing the gaps to the rest of the world.

But to me the single best illustration of the point was this photo, from 1989 but rerun in the Herald a decade ago

For the younger among you, that is David Caygill, then Minister of Finance and one of the foremost reformers. It is pretty clear he expected the reform programme – which was extended after his time – to pay off in closed productivity/GDP gaps. It is also clear that it didn’t.

Bryce Wilkinson thinks more should have been done, and could have been done. He was a member of the 2025 Taskforce a decade ago on closing the gaps to Australia. But even if he is right on that – and on some specifics I agree with him – I’m not sure what is gained by continuing to run the line that the economic outcomes really weren’t disappointing or unexpected at all.

To close, the New Zealand Initiative’s report ends up being a funny beast. For better or worse, most people probably won’t care about the pre-84 history, and it isn’t clear how much relevance the specifics have to today anyway. And if there is a lot wrong with this government’s economic policy (and there is) this report is too once-over-lightly (and a little florid in places, given our relative macro stability) to add much value or get much traction. Perhaps there is still a place for debates about the 1984-93 period – in fact there definitely is, even granting that to many younger people it is (my daughter’s phrase) “ancient history” – but to do so usefully probably needs more space, more nuance, and more data than is in the relevant section of this report.

Puzzling over the New Zealand macro data

I have no doubt that our labour market has been tight and that core inflation has been rising (finally above the target midpoint). It won’t make that much difference in the long-run, but it is a shame the “Level 4 lockdown” didn’t come a day or two later because if it had the Reserve Bank would, appropriately enough, have raised the OCR. I also don’t have any reason to doubt that there was a lot of GDP growth in the June quarter.

But that doesn’t mean there aren’t some puzzles.

According to the official data the New Zealand economy is quite a lot bigger than it was pre-Covid, Of the two quarterly measures of real GDP, one was 5.3 per cent higher in the June quarter than it had been in the December 2019 quarter and the other was 4.3 per cent higher. Average the two and the best guess is a lift of 4.8 per cent. That’s a lot, especially for a country that has (a) had at best mediocre productivity growth in normal times, and (b) has had the borders largely closed to new migrants (and quite difficult even for returning New Zealanders) for almost all of that period.

Ah well, perhaps it is all the cyclical stimulus, with fiscal and monetary policy “finally” (as some might put it) coming to the party and giving the economy a well-overdue boost. But……according to SNZ, the unemployment rate in the June quarter was exactly the same as it had been in the December 2019 quarter, and so was the employment rate, so there was no sign that suddenly we’d been able to get hitherto-unutilised resources producing.

So where might the reported growth have come from? Statistics New Zealand does not publish an official quarterly series for labour productivity, but we can derive one ourselves. In this chart I’ve shown growth in labour productivity, using a measure in which the two measures of real GDP and the two hours measures (HLFS and QES) are all set to equal 100 at the start of the chart, and the resulting real GDP per hours worked indicator is calculated and shown.

New Zealand’s productivity growth has been mediocre for a long time – little over 10 per cent in total in almost 15 years – and yet according to this indicator, calculated entirely with official statistics, closing the border (with all its ramifications), and for that matter diverting material resources into testing, MIQ, enforcement etc) has resulted in no deterioration in productivity growth. If anything, productivity growth over the last 18 months has been a bit higher than usual (but such is the noise, and routine potential for revisions we probably should not make too much of that lift).

How can this be? In the depths of lockdowns there was some sign of “averaging up” – low productivity workers (notably in tourism and hospitality) will have been disproportionately likely to have lost jobs/hours, and even if everyone else was only as productive as ever, the economywide average would have risen. But if, as there probably was, there was something to that story 18 months ago (and perhaps right now), it can’t really have been the story in June when – as a already noted – employment and unemployment rates were right back to pre-Covid levels.

So if less than half the reported real GDP growth came from labour productivity, and none came from a reduction in the unemployment rate or increase in the employment rate, where did it come from? The only other possibility is more labour inputs. And (unusually) the HLFS and the QES happen to agree: whether hours worked (HLFS) or hours paid (QES), hours in the June quarter were about 3 per cent higher than they’d been in December 2019 (all data seasonally adjusted). And that isn’t (mainly) individuals working longer hours, as both the HLFS (people employed) and the QES (filled jobs) suggest quite a significant increase in the number of people working.

And why is that? Because SNZ tells us that the population has been growing still quite rapidly: the “working age population” for example is estimated to have been 2.5 per cent higher in June 2021 than in December 2019. The official total population is estimated to have risen by 1.9 per cent over the same period.

How come? Well, this is the story SNZ currently tells.

The orange line represents natural increase (births less deaths), which will be measured accurately. Natural increase is quite stable, and quite modest, at just over 0.5 percentage points contribution per annum. The variability – and the huge measurement uncertainty – comes with the net migration numbers.

According to SNZ we had the three biggest quarterly net migration inflows in the 30 year history of the population series in the September and December quarters of 2019 and the March quarter of 2020 (something not showing in their contemporaneous estimates). And on their reckoning, net migration has been positive throughout the entire Covid period, dipping very slightly negative for a single quarter.

Perhaps it is all true. But here, on the other hand, is the monthly series of net arrivals and departures from New Zealand (all citizenships, all purposes) since the start of last year.

As one might have expected, there were really big net outflows over the three months to April (Covid having first become a significant issue near the peak of the tourist season), but there has also been a steady outflow ever since. In the year to June, for example, a net outflow (all purposes) of 35226 people, with only a single month seeing a net inflow. (The net outflow continued in July and August). SNZ, by contrast, estimate – and it is an estimate, not a full count unlike the air traffic numbers – net migration inflow of about 5000 over that year.

You wouldn’t expect the two series to match exactly. There will have been people (New Zealanders and foreigners) going and coming who were not away for long, but in any sort of net sense those numbers must have gotten very small as the months went on – hardly any holidaymakers for example. Whatever the precise composition we know that there were few people in New Zealand in June 2021 than there had been either in June 2020 or in December 2019, even if SNZ claims that the official resident population has kept on increasing.

If so, it is a bit of a mystery where all those extra hours/jobs are, given that the employment and unemployment rates haven’t changed. One might reasonably suggest that the GDP (and hours/jobs) numbers themselves build on estimates of the population that are more than usually uncertain.

One other way of looking at things is to see how Australia is reported to have done. It helps that the ABS reckons that by the June quarter of this year, Australia’s unemployment rate was also back to pre-Covid levels. As it happens, labour productivity is also estimated to have risen quite a bit in Australia – up by 2.1 per cent over the 18 months to June 2021. Of course, Australian productivity growth has typically outstripped New Zealand’s, but it still seems surprisingly high given that their borders were also closed.

But the ABS also reckons that real GDP in Australia in the June 2021 quarter was only 1.6 per cent higher than it had been in December 2019. And before anyone mentions Victorian lockdowns, NSW Delta, or whatever…..this was June, when things were looking good across Australia and New Zealand (remember the “bubble”).

And if GDP growth was less than productivity growth then….hours worked are estimated to have fallen. by about 0.5 per cent.

So what explains the difference?

Here is the ABS version of the population growth components chart.

Again, natural increase has been low but stable, but (a) Australia doesn’t show anything like the NZ net migration spike pre-Covid (the Australian 2019 numbers looked much as they had for the previous few years), and (b) net migration since the middle of last year has been consistently negative. These data are only to March 2020, but the population number implicit in Australia’s June GDP and GDP per capita numbers is consistent with a small quarterly net inflow in the June quarter.

I don’t have answers, only questions. But recall that (a) over the 18 months from December 2019 to June 2020 Australia had much the same experience of Covid as we did, (b) in both countries, unemployment was back to pre-Covid levels in June 2020, and (c) Australia had very stringent restrictions on its nationals leaving Australia (unlike New Zealand) so it seems a little hard to believe that Australia (the much richer country) has had material net migration outflows while we have had modest inflows. The total arrivals and departures data for Australia also show big net outflows, except in the June quarter of this year.

Perhaps it is true. Perhaps too productivity growth (in both countries) really held up rather strongly through the uncertainty and disruption of Covid. Or perhaps – perhaps especially in the New Zealand case – much will just end up getting revised away. The biggest annual revisions are due over the next three months, and often they have been big indeed. There are other challenges, such as the 3 per cent levels gap between the production and expenditure measures of GDP.

On the productivity front, it would defy almost all conventional economic models if productivity growth was really no worse than usual amid closed borders, rampant uncertainty etc etc (with no discernible cyclical effects either). Those firms in today’s media sending staff abroad uncertain when they can come home clearly don’t believe travel and face to face contact don’t matter.

And then, of course, we have all the uncertainties about SNZ measurement of the latest lockdown to look forward to. As I recall last year, their estimates for last June treated school inputs and outputs as having continued largely unchanged, a story that probably won’t have rung true to most parents, and doesn’t now seemed backed by literature on loss of learning in lockdowns.

Tightening LVR restrictions

The Reserve Bank’s faux “consultation” on tightening LVR controls closes today. If you felt so inclined the consultation document is here, but it isn’t clear why you’d bother except for the record. Poor performance by powerful government agencies shouldn’t go unremarked.

I have put in a a short submission, simply to document some of the many problems with the consultation.

submission to RB on tightening LVR restrictions Sept 2021

Much of the text simply elaborates points I noted in a post last week. But here are a few extracts

More substantively, there is no discussion at all in the consultation document of the Reserve Bank’s capital requirements or the capital positions of the banks you are putting more controls on. As you will be well aware, the risk-adjusted capital ratios of New Zealand banks are high by international standards, and will be increased further – as a regulatory requirement – over the next few years.   Capital is, and always should be, the key buffer against loans going bad, and we know that the New Zealand framework imposes relatively (by international standards) high capital requirements in respect of housing loans, including high LVR ones.   It is simply unserious – or a desire to operate ultra vires – not to engage with the capital position of the banking system.  That is especially so as your consultation document acknowledges that tighter LVR controls will impair the efficiency of the financial system.  Given that acknowledged cost, there has to be a clear gain to financial system soundness (the other limb of your statutory goals/purposes) from any new regulatory impost, but your document makes no effort to quantify such a gain (reduced probability of failure), or to demonstrate that tighter LVR controls are the least-cost way to generate such a reduction.   There is not, I think, even any attempt to engage with the “1 in 200 years” failure framework that the Bank dreamed up a few years ago to support the capital proposals it was then consulting on.

….

The Bank’s consultative document also attempts to make quite a bit of an argument that somehow LVR restrictions now can dampen the size of future “boom-and-bust cycles” in the economy, even going so far as to claim these incremental restrictions will improve the medium-term performance of the economy. But none of this argument engages with the (very healthy) capital position of the banking system and at times it seems internally contradictory.  Thus, in paragraph 47 the Bank worries about dampening effects on consumption and economic activity from “increased serviceability stress” as a result of some future increase in interest rates, but never seems to recognise that the reason the monetary policy arm of the Bank would be raising interest rates is to dampen demand and inflationary pressures.  If anything, the Bank’s argument would seem to suggest that more high-LVR lending would, if anything, and in those circumstances increase the potency of monetary policy, and reduce the extent of any required OCR increases.    More generally, the Bank continues to place a considerable reliance on claims about a significant housing wealth effect on consumption that appear inconsistent with New Zealand macroeconomic data over many decades, and which appear to over-emphasise existing homeowners while largely ignoring the loss of wealth/purchasing power for those who do not (yet) own a house.

….

In conclusion, the Bank has simply not made any sort of compelling case for further tightening of LVR restrictions. At very least, such a case would have to involved a careful and documented cost-benefit analysis, that included engagement with the bank capital regulatory regime.  There is no pressing financial stability risk, and so this proposal – in practice, these new rules – has the feel of action taken for the sake of action, perhaps to provide some cover for a government that fails to address the house price issue at source, or to fend off (misguided) critics of the Bank’s LSAP monetary policy programme.   That isn’t a good or acceptable use of the powers of the state. 

To the extent the initiative is about protecting borrowers from themselves – as your communications sometimes suggests – it may be nobly intended but is no part of the Bank’s statutory responsibility (and thus not a legitimate basis for use of regulatory powers). Perhaps as importantly it seems to assume the current crop of central bankers and regulators knows more about the risks of house prices falling substantially and sustainably than (a) borrowers and their bankers (each with money on the lines) and (b) than their central banking predecessors over 30 years did (each Governor having at some point or other anguished about the risks of falls, even as central and local government policy continued to underpin the decades-long scandalous lift in real house prices). No evidence is advanced for either proposition.

 

My former Reserve Bank colleague – now Tailrisk Economics – Ian Harrison had a similarly cynical view on the consultation process but also put in a short submission, which he has given me permission to quote from.

Ian makes a number of serious analytical points about the substantive weaknesses in the Bank’s document

Introduction

It is clear that, from the content of the consultation paper and the time given for submissions, the consideration of submissions and final decision making, that this is not a serious consultation, and that submissions will mostly be ignored.  In that vein not all of this submission is entirely serious.  Part A discusses some key elements of the Bank’s analysis.  It shows that the Bank’s concerns appear to be driven by a data error and a lack of understanding of how loan portfolios evolve over time.

The Bank has suppressed lending to housing investors following the Minister’s wish to give first time homebuyers a better chance of securing a property.  Now that this demand has emerged the Bank wants to choke it off. 

This is based on an almost irrational obsession with housing lending risk.   Even when high LVR loans are a small part of banks’ portfolios, and its own stress testing shows that housing losses will account for a relatively small part of overall losses in fairly extreme stress events (about 28 percent), it does not seem to be able to resist tinkering with quantitative interventions.

The easiest and most effective solution to the identified problems would be to increase housing interest rates, but that option is not even mentioned.

Part B of this submission provides a different professional perspective on the Bank’s behavior.

But sometimes points are made more potently – at least in responding to unserious spin masquerading as policy analysis – by satire. And this is Ian’s Part B

Part B 

Meduni Vienna, Department of Psychiatry and Psychotherapy

Währinger Gürtel 18-20
1090 Vienna, Austria 

Consultation report

 Patient : R. Bank 

Date:   7/9/2021

Diagnosis:

From our consultation with the patient R. Bank we observed the following clinical symptoms.  Our consultation conclusions are based on the patient’s writings (in particular the document loan-to valuation ratio restrictions) and our observations of behavior over the last three years.

Moderate paranoia: The patient had a tendency to blowup the risks of everyday life into impending disasters.

Hyperactivity: There was a pronounced tendency to do things when nothing needs to be done.

Megalomania: The patient exhibits the classic signs of megalomania: overestimation of one’s abilities, feelings of uniqueness, inflated self-esteem, and a drive to maintain control over others.

Misplaced empathy:  The patient exhibited some concern that others may make mistakes but uses this as a reason to exercise control over them.

Irrationality: There was a lack of capacity to identify real problems and connect them with solutions.

Unwillingness to listen to others:  The patient will pretend to listen to alternative views but this is almost always a sham.

Treatment:

  • Heavy sedation
  • Counselling

The patient should be removed from positions of authority until there is a pronounced improvement in behavior.

Albert Pystaek Phd., Dip. A.E.M, Fm.d, Head of Clinical Psychiatry

USSR, Russia, and China

I’ve been reading a couple of books in the last week or so about the decline and fall of the Soviet Union (USSR). The first is Armageddon Averted: The Soviet Collapse 1970-2000, by Stephen Kotkin a Princeton historian who has since gone on to write an (as yet unfinished) three-volume life of Stalin, and the second The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, by Chris Miller, another US academic historian.

Both are quite short, but for anyone interested in the era they are well worth reading. Kotkin’s book was first published in 2000 so really rather close to the events he was trying to make sense of (the revised edition I read dates from 2008), while Miller’s book is much more recent, published in 2016. Kotkin attempts to synthesise and offer an overall interpretation, while the Miller book draws deeply on Soviet-era archives, up to and including minutes of Politburo meetings. I found Kotkin interesting for a number of points, including the (obvious once you think about it) way in which this heavily armed behemoth, heir to hundreds of years of Russian imperial expansionism, dissolved so peacefully. He highlights the contrast, not far away and at much the same time, with the wars of the Yugoslav succession, but also with the unwinding of European empires a few decades earlier. Another point he emphasises is that the dissolution of the empire was, at least in part, a consequence of way the Soviets had set up their system. The tie that bound the individual republics (set up after the Revolution) together was not, so he argues, the central state itself (republics were not legally subservient to the central state) but rather the Communist Party, and once the Party’s monopoly on power was reduced/eliminated by Gorbachev there was little left to hold the Union together – other perhaps than brute force which by 1991 no one was willing to consistently use (not even those who staged the feeble coup of August 1991).

The Miller book was much closer to the usual concerns of this blog. It was a fascinating discussion of economic policy in the last years of the Soviet Union, with a particular emphasis on what the Soviets were learning from China. I hadn’t known how closely and carefully Soviet officials and scholars were studying the Chinese experiments with economic liberalisation after the late 1970s, or the extent to which (a) they were recognised as successful and (b) especially after 1985 were imitated. Miller also highlights how Soviet officialdom already knew what gains could be on offer from reform, from previous (abortive, short-circuited) experiments, including under Brezhnev in the 1960s. The macroeconomics was also enlightening – both the extent to which the Soviet Union had maintained macroeconomic stability and fiscal discipline up to the early 1980, but then the extent to which budget discipline was thrown to the wind in the Gorbachev years. That was partly bad luck – falling oil prices, partly the consequences of ill-thought-through initiatives (eg loss of tax revenue from the assault on heavy vodka drinking) – but much of it was in an attempt to buy off reluctance to reform from the powerful interests and patronage networks which – so Miller argues – by this time dominated the Soviet system (be it the agriculture sector, oil and gas, the military and the associated industrial complex or whatever. Miller argues that those around Gorbachev thought of this partly as a reasonable gamble – if they could materially accelerate growth, as in China, they could grow their way through the deterioriating fiscal (and hence monetary) position. It was not, of course, a gamble that worked, and the first few years after 1991 saw widespread economic chaos.

Miller argues that the strategy was never likely to have worked, and contrasts that with the experience in China. Why couldn’t it have worked? In the end, his claim reduces to the proposition that those who really favoured reform simply did not have the political clout to make it happen, even if one of those was the General Secretary himself. For decades after Stalin – under whose reign of terror many were shot, senior people were moved around frequently – the patronage networks (within which people often spent an entire career) were able to grow to become a force they simply weren’t in China (just after the further upheaval of the Cultural Revolution). Add to that things like the fact that life in the USSR was relatively comfortable in 1985, in a way that it hadn’t been in China in the late 70s. The imperative for change was much weaker, whether near the top, or at the grassroots (he contrasts the attitude to agricultural reforms of Chinese peasants and Russian farm workers). And there was the military, consuming a huge proportion of GDP in the USSR and reluctant to adjust, in contrast to the reduced military expenditure in China in the first years of economic reform.

There is one contrast between the USSR and the PRC that emphasises that in China the Communist Party kept hold on power and Russia it gave up power. For the CCP that is a clear victory (whatever it means for the Chinese people). But the other often attempts to tell a story about relative economic performance, with an emphasis on those first few severely disrupted years after 1991 in the (former Soviet Union) and, of course, the high growth rates the PRC continued to report for a long time. In this part of the world, New Zealand politicians and business people are nauseatingly prone to praising what they see as the economic success of the PRC (as if somehow this covers for the innumerable abuses of the regime).

China was, of course, richer than Russia for a long time. For not inconsiderable periods of history China was at least as rich – or richer – than anywhere on the planet. Russia never was. But here is the (rough) picture of GDP per capita comparisons for various years, drawn from the (widely-used) Maddison database.

russian and china

By 1913 – the eve of World War One – estimated GDP per capita for the “former USSR” (of which Russia is the largest chunk) was almost three times that of China. The “former USSR” in turn enjoyed real GDP per capita less than a third that of the leading bunch of countries (including New Zealand), and less than a third that of (say) France and Germany

By 1980 – several decades each of Communist Party rule – real GDP per capita was about six times that in China (as noted above, the starting points for reform were very different). China really was an utter basket case.

But where do things stand now, after decades of fairly rapid growth in China, and decades on from the chaos of the immediate post USSR period?

Here are the IMF’s estimates for real GDP per capita for the former Soviet Union countries and China.

former USSR

Even using these official numbers – and people like Michael Pettis will argue compellingly that GDP in China does not mean what it does elsewhere – China currently has real GDP per capita a bit less than Belarus, a bit more than Turkmenistan. The Baltic states are stellar performers but even authoritarian Russia, heir to all that 1990s dislocation, has real per capita incomes 55 per cent higher than those in China.

And what about labour productivity? The IMF doesn’t produce estimates for that, but the Conference Board does. Here are their latest estimates for the whole former Soviet bloc, and China.

former eastern bloc

China makes Belarus look really rather good, and on these estimates China is still lagging behind Moldova. The gap between China and Russia is huge and – as best as can be told from these estimates – Chinese productivity growth has slowed sufficiently it is no longer obvious they are even closing the gap.

Russia, of course, is hardly a stellar performer. You can see it even on these charts, and in GDP per capita terms it is still only about half the incomes earned per capita in France and Germany/

And then one last set of comparisons.

prod comparisons russia

China pales by comparison with all of these economies, even grossly-underperforming New Zealand.

There were things the USSR was able to learn from the PRC 40 years ago. But how to generate a high income country, that might match the material living standards in the West – a constant aspiration – was not then, and is not now, one of them.

Housing

I hadn’t paid much attention to the renewed wave of restrictive regulation of the housing finance market being imposed by the Governor of the Reserve Bank this year, but a journalist rang yesterday to talk about the latest proposal which prompted me to download and read the “consultative document” the Bank released last Friday.

Why the quote marks? Because quite evidently this is not about consultation at all, simply trying to do the bare minimum to jump through the legal hoops to allow the Governor to do whatever he wants. The document was released on Friday 3 September. The consultation period is a mere two weeks, which is bad enough. But then they tell people who might be inclined to submit that ‘we expect to release our final decision in late September’ – at most nine working days after submissions close – with the new rules to come into effect from 1 October. And if you were still in any doubt there is that line they love to use: “we expect banks to comply with the spirit of the new restrictions immediately”.

WIth that sort of urgency and disregard for any serious bow in the direction of consultation and reflection, you’d have to assume the Bank had a compelling case for urgent action, such that (for example) a delay of even as much as a month would pose an unendurable threat to the soundness and efficiency of the financial system (still the statutory purposes these regulatory powers are supposed to be exercised for). And since the Bank is quite open about the fact that the new restrictions will impede the efficiency of the system, you’d expect an overwhelming case for a soundness threat, complete with a careful analysis indicating that these new controls – directly affecting huge numbers of ordinary people – were the best, least inefficient, response.

But there is nothing of the sort. Instead they are actually at pains to stress that the financial system is sound at present, so the worry is about what might happen if things went on as they are. But that can’t possibly be an issue that rides on a one month, it must be something about several more years.

But even then their case amounts to very little. For example, they point that if house prices were to fall 20 per cent from current levels some $4 billion of lending would be to borrowers who would then have negative equity, But that is hardly news. The typical first-home buyer has always – at least in liberal financial systems – borrowed at least 80 per cent of the value of the home they are purchasing. It is usually sensible and rational for them to do so (indeed 90 per cent would often be sensible and prudent). So a fall of 20 per cent in house prices would always put a lot of recent borrowers into a negative equity position. Note, however, that (a) $4 billion is not much over 1 per cent of total housing lending, and (b) it is $4 billion of loans, not $4 billion of negative equity. If I borrowed 82 per cent of the value of the house, the house fell in value 20 per cent, and I lost my job and had to sell up, the loss to the bank might be not much more than 2 per cent of the loan.

More generally, in the entire document there appears to be not a single mention of the capital position of banks operating in New Zealand, or the Reserve Bank’s capital requirements. You might recall that New Zealand banks have some of the highest effective capital ratios anywhere in the advanced world, and that the Bank is putting in place a steady increase in those capital requirements. Moreover, if you read the Bank’s document – at least as a lay reader – you might miss entirely the point that the capital rules, and the internal models banks use, require more dollars of capital for higher risk loans than for lower risk loans. It is how the system is supposed to work. There are big buffers, those buffers are getting bigger (as per cent of risk-weighted assets), and the dollar amount of capital required rises automatically if banks are doing more higher-risk lending.

Of course, the Bank says a significant fall in house prices is more likely now. But we’ve heard that sort of line from every Reserve Bank Governor at one time or another over 30 years now. As it happens – and for what little it is worth – I happen to think house prices may be more likely to fall than to rise further over the next 12-18 months (even put a number consistent with that in the Roy Morgan survey when their pollster rang a few days ago), but I don’t back my hunch by using arbitrary regulatory restrictions that – on their own telling – will force many first home buyers back out of the market.

And it might all be more compelling if the Bank showed any sign of understanding the housing market. Thus, we are told (more or less correctly) that immigration is currently low (really negative) and lots of houses are being built. But, amazingly after all these years, there appears to be no substantive discussion of the land-use regulations and the land market more generally. Perhaps there will be something of a temporary “glut” in dwelling numbers – at current prices – but unless far-reaching changes are made to land-use rules that won’t change the basic regulatory underpinning for land prices. We know the government’s RMA reforms aren’t likely to help – may even worsen the situation – including because if these were credible reforms, the effect would be showing through in land prices now. And we know from the PM and Minister of Finance – and possibly the National Party too – that they don’t even want to do reforms that would materially lower house/land prices.

It all just has the feel of more action for action’s sake. Perhaps the government isn’t too keen on first-home buyers being squeezed out, but at least when they are criticised for not fixing the dysfunctional over-regulated housing/land market they can wave their hands and talk about all the things they and their agencies do, however ineffectual. As even the Bank notes, LVR restrictions don’t make much difference to prices for long. And if there is a compelling financial stability case, it isn’t made in this document – which, again, offers nothing remotely resembling a cost-benefit analysis for respondents to address. This despite bold – totally unsubstantiated – claims in the paper that their new controls would be beneficial for “medium-term economic performance”.

Then again, why would they bother with serious analysis when the whole thing is a faux-consultation anyway.

At which point in this post, I’m going to turn on a dime and come to the defence of both the Bank and the government. A couple of weeks ago the Listener magazine ran an impassioned piece by Arthur Grimes arguing that the amendment to the Reserve Bank Act in 2018 was a – perhaps even “the” – main factor in what had gone crazily wrong with house prices in the last few years. Conveniently, the article is now available on the Herald website where it sits under the heading “Government has caused housing crisis to become a catastrophe”.

Grimes was closely involved in the design of the 1989 Reserve Bank Act, and for a couple of years in the early 1990s was the Bank’s chief economist (and my boss). He left the Bank for some mix of private sector, research, and academic employment, but also spent some years on the Reserve Bank’s board – the largely toothless monitoring body that spent decades mostly providing cover for whoever was Governor. These days he is a professor of “wellbeing and public policy” at Victoria University.

However, whatever his credentials, his argument simply does not stack up, and given some of the valuable work he has done in the past, on land prices, it is remarkable that he is even making it.

There is quite a bit in the first half of the article that I totally agree with. High house prices are a public policy disaster and one which hurts most severely those at the bottom of the economic ladder, the young, the poor, the outsiders (including, disproportionately, Maori and Pacific populations). But then we get a story that house prices have been the outcome of the interaction between high net migration and housebuilding. As Arthur notes, immigration has hardly been a factor in the last 18 months (actually it has been negative, even if the SNZ 12/16 model has not yet caught up) and there has been quite a lot of housebuilding going on.

And yet in the entire article there is nothing – not a word – about the continuing pervasive land use restrictions (and only passing mention about the past). If new land on the fringes of our cities – often with very limited value in alternative uses – cannot easily be brought into development (if owners of such land are not competing with each other to be able to do so) there is no reason to suppose that even a temporary surge in building activity will make much difference to a sustainable price for house+land. Instead, any boost to demand will still just flow into higher prices.

Remarkably, in discussing the events of the last year there is also no mention of fiscal policy – the boost to demand that stems from a shift from a balanced budget just prior to Covid to one that, on Treasury’s own numbers, is a very large structural deficit this year.

Instead, on the Grimes telling the problem is a reversion to “Muldoonism” – not, note, the fiscal deficits, but the amendment to the statutory goal for the Reserve Bank’s monetary policy enacted almost three years ago now. Recall the new wording

The Bank, acting through the MPC, has the function of formulating a monetary policy directed to the economic objectives of—

(a) achieving and maintaining stability in the general level of prices over the medium term; and

(b) supporting maximum sustainable employment.

The main change being the addition of b).

Grimes has been staunchly opposed to that amendment from the start, but his assertion that it makes much difference to anything has never really stood up to close scrutiny. It has long had more of a sense about it of being aggrieved that a formulation he had been closely associated with had been changed.

He has never (at least that I’ve seen) engaged with (a) the Governor’s claim (which rings true to me) that the changed mandate had made no difference to how the Bank had set monetary policy during the Covid period, (b) the more generalised proposition (that the Governor is drawing on) that in the face of demand shocks a pure price stability mandate (and the RB’s was never pure) and an employment objective (or constraint) prompt exactly the same sort of policy response, or (c) the extent to which the New Zealand statutory goals remains (i) cleaner than those of many other advanced countries and yet (ii) substantially similar (as the respective central banks describe what they are doing) to the models in, notably, the United States and Australia. Similarly, he never engages with the straight inflation forecasts the Bank was publishing this time last year: if they believed those numbers, the purest of simple inflation targeting central banks would have been doing just what the RB did (and arguably more, given that the forecasts remained at/below the bottom of the target range for a protracted period).

Grimes seems to be running a line that the LSAP was the problem

The central culprit has been monetary policy that has flooded the economy with liquidity. This liquidity in turn has found its way into the housing market.

But there is just no credible story or data that backs up those claims. Banks simply weren’t (and aren’t) constrained by “liquidity”. The LSAP was financially risky performative display, but it made no material difference to any macro outcomes that matter, including house prices.

There is quite a lot of this sort of stuff.

Grimes ends on a better note, lamenting the refusal of governments – past and present – to contemplate substantially lower house prices, let alone take the steps that would bring them about (his final line “And no politician seems to care enough to do anything about it” is one I totally endorse). But in trying to argue a case that a change to the Reserve Bank Act – that had no impact on anything discernible as it went through Parliament or in its first year on the books – somehow explains our house price outcomes (especially in a world where many similar price rises are occurring, and where there was no change in central bank legislation), seems unsupported, and ends up largely serving the interests of the government, by distracting attention from the thing – land use deregulation – that really would make a marked difference and which the government absolutely refuses to do anything much about.