Reading Michael Cullen

There aren’t many New Zealand political memoirs/autobiographies – and even fewer diaries (although I was recently reading John A Lee’s for 1936-40) – and most of them aren’t that good. Voracious book buyer that I am, I usually don’t buy them until they turn up very cheap in a charity shop or community book sale. After all, sometimes there are interesting snippets and you never know when some angle on some event might prove at least somewhat enlightening.

But I thought I’d make an exception for Michael Cullen. He had, after all, been an academic historian in an earlier life, and was unquestionably smart and funny, and had been Labour’s finance/economics spokesman for 17 years and Minister of Finance for nine years (terms really only rivalled in modern New Zealand by Walter Nash and Rob Muldoon). I’d probably have been better off waiting for the charity shop copies to turn up.

There were interesting bits and pieces. Early chapters of autobiographies are often complained about but I almost always like them. There was, for example, the ancestor who was the last person burned at the stake in England for heresy (twice actually). Or the snippet of Cullen and his first wife buying their first house in Dunedin in 1971 for $10500 – “only twice my annual gross salary” as a new lecturer (lecturers at Otago now seem to start at about $82000). Or the prize he won at about the same time for the best University of Edinburgh PhD history thesis that year – enough to pay off in full the 30 per cent deposit they’d borrowed from his wife’s parents. Or the picture of the Dunedin Labour Party in the 70s – including the raffle organiser (“Labour used to be a raffle-funded party”) who “made a Ponzi scheme look positively generous” by offering a first prize in one raffle a full book of tickets in the next raffle.

And there were the national politics snippets, including the observation/claim that David Lange had persuaded Roger Douglas to stay in politics in 1981 by promising that if/when Lange became leader Douglas would be his Minister of Finance. As Cullen notes, some things might have been quite different…..although it is interesting to wonder just how much. Cullen’s perspectives – as senior whip and then junior Cabinet minister (often written in counterpoint to Michael Bassett’s book on the period) – on the Lange/Douglas tensions over 1978/88 were worth having, including his suggestion that (given the tensions, that only built further) perhaps Lange should have sacked Douglas in April 1987.

But it tended to go downhill from there, dramatically so for his treatment of the nine years of the 5th Labour government, which takes up almost half the book. Much of it has about it the character of a family Christmas letter from proud parents who just don’t know when to stop. If you want a canter through the things the government did during those nine years, trivial and not, I guess this is the book for you. Almost everyone did everything ably. But to anyone who was around New Zealand at the time, you simply aren’t going to learn very much (although I was surprised to read that Jim Anderton had been – so Cullen claims – one of the ministers most keen on lower company taxes late in the government’s term).

Two things in particular struck me. The first was that while Cullen was a Labour Party MP and minister, clearly he was not a Labour Party person (consistent with this in the early days his then wife had been more active than he was), and there is very little on the internal ructions that convulsed the party a few decades ago. More generally, there is little insight anywhere in the book on the many really significant political figures Cullen worked with over the years, none at all on Helen Clark (or Heather Simpson for that matter). There was almost no insight on some of the key public servants, or anything on the tensions. interactions etc. And this 12 years after he left office. Cullen seems to have reasonably kind words for most people – exceptions I think being Richard Prebble, Don Brash and (mixed with some admiration/envy at his success) John Key – but no insights. And if he ever worked with Grant Robertson, Jacinda Ardern or Chris Hipkins when he was Deputy Prime Minister and they were in Clark’s office, you wouldn’t know it from the book.

Presumably Cullen kept no diaries, and he notes somewhere in the book that he hadn’t been very good at answering questions from researchers over the years about past events because his mental approach was to compartmentalise and then move on (and of course he carried a formidably huge load during those Clark years). And writing the book can’t have been helped by the knowledge that his time might be very short (as it turned out to be) and that between illness and Covid he was only able to make a single trip to Dunedin to consult his papers in the Hocken Library. In a bigger country, he’d almost certainly have had a research assistant he could have drawn on. As it was, he tells us he drew heavily on what happened to be available on the web.

But there is also a sense of someone who – despite the training as an historian (which he often reminds us of) – just wasn’t that reflective. 50 years on from that house purchase he told readers about, house prices are appallingly high – and these developments were going on on his watch too – but there is nothing on how, technocratically and politically, his generation bequeathed that disaster. He was Labour’s finance spokesman for 17 years, beginning as the reforms (which he mostly supported) were supposed to be starting to pay off in reductions in the productivity gaps between us and the rest of the advanced world. Under his watch there were various bows in the direction of aspiring to make a difference. And yet here we are, with the gaps wider than ever. There is no sign anywhere in the book of any reflection, self-questioning, or even curiosity about the failure. Perhaps the only note of regret about policy I recall is a regret that the government had not been more active in determining the strategy of Fonterra, the behemoth they enabled but which also failed to deliver.

Perhaps it would have been different if he’d had more time. Even on the text he did write it is not hard to see where a good editor could have insisted on cutting out at least 50 pages (of a 400 page book) – perhaps including the line that knighthoods were a good thing because they gave a lot of pleasure to the recipients.

Of course, part of my interest in the book was in its treatment of Reserve Bank issues, he having been the Minister responsible for the Bank through nine sometimes difficult years, and Opposition spokesman beginning little more than a year after the 1989 Reserve Bank Act had come into effect. The Reserve Bank monetary policy framework has not, shall we say, been without its controversies over those 30 years – including the often very antagonistic approach taken by Jim Anderton whose party at times rivalled Labour on the left in the 1990s.

But again, it was curiously bloodless. You’d not have known, for example, that in his early days (perhaps as late as the 1996 election, as I recall us debating it at the Bank at one election and I was working overseas in 1993)), he (as Labour’s spokesman) championed a change to the inflation target (then 0-2 per cent annual inflation, with caveats). But Labour’s proposal – they needed product differentiation from National, the Alliance, and New Zealand First – was to adopt a target range of -1 to 3 per cent inflation. As I recall it, part of the aim was to capture more of the headline inflation shocks (oil prices, tax changes etc etc), but it could have led to the curious world in which the Bank was supposed to be more or less indifferent to inflation going negative, which didn’t seem as though it would prove very robust at first confrontation with experience.

Perhaps charitably, Cullen does not mention the (frankly fairly incompetent) way we ran monetary policy over 1997 and 1998 (the infamous monetary conditions index) but nor does he mention his oft-expressed (and somewhat valid) concerns about the volatility of both the exchange rate and interest rates, or his calls for changes to the Policy Targets Agreement and/or for an independent inquiry into the conduct of monetary policy. As it happened, the PTA was changed when Cullen took office, to add a new form of words that was supposed to appear substantive but which, to this day, no one really knew what the words actually meant for policy (I’ve long argued “precisely nothing”). At the Bank we were sufficiently uneasy that in the first few weeks of the new government I was sent on a whistle-stop 10 day tour of the RBA, the Monetary Authority of Singapore, the Bank of Japan, the Bank of England, the Bank of Canada, the Federal Reserve and the US Treasury to brush up our knowledge of, and perspectives on, operationalising foreign exchange intervention.

Out of office Cullen had called for an independent inquiry – which went over well with the left of his own party, and with the Alliance, with which Labour was mending fences. In office, he commissioned an inquiry, but consciously and deliberately chose as his reviewer someone who could be counted on not to make trouble – a leading academic author on inflation targeting, Lars Svensson (he could quite readily have chosen as reviewer any number of other quite reputable people – just one example being Bernie Fraser the former Governor of the RBA (and known as somewhat left-leaning). As it was, Svensson predictably made no difficulties and at times we (I was one of the small secretariat) had to talk him into revising down his effusive praise of Don Brash. He did propose adopting an MPC – but made up solely of executive staff of the Bank – a proposal that Cullen rejected, and what came out of the review were very minor changes indeed (the Governor to no longer chair the Bank’s Board, the Board to write an Annual Report). But he’d been seen to have had a review.

If there were ongoing government niggles re the Bank’s monetary policy they must have been quite limited for a while. In 2001 we’d been quite pro-active in easing monetary policy (somewhat burned by 1997/98) both in response to the global tech slowdown and after 9/11 (decisions I still think were warranted, but which some more hawkish people differ on). But Don Brash was still a bit of an issue. He’d made a high profile controversial speech to the government’s Knowledge Wave conference in 2001, stepping well outside areas he had any policy responsibility for (and, not surprisingly, championing policy approaches that weren’t really to Labour’s liking). Powers that be in the Beehive were understood to be not best pleased.

Nothing of all this in in the book.

Don Brash resigned as Governor on 26 April 2002 to seek selection as a National Party candidate at the forthcoming election (having been pro-actively recruited and given to understand he’d get a high list place, and perhaps a reasonable chance of being Minister of Finance – in the unlikely event National was to win). Cullen writes about this resignation, but comments only that he was “flabbergasted”, proceeding to write some generalised negative comments about Brash and his self-belief. As Don records in his own autobiography of his conversation with Cullen “I don’t think he was pleased but he was polite”, but he goes on to note “much more polite than Helen Clark was later in the day”. As I understood it, the PM had been (understandably in my view) outraged, felt it was something of a betrayal (to step straight out of high public office onto the campaign trail) and was specifically very aggrieved at the Bank’s Board (and specifically the then chair of the non-executive directors) – responsible to Cullen – for having written an employment contract that did not enforce a decent stand-down period. All of which might have been useful points for Cullen to have included, rather than just glib remarks (true or not) about Brash’s “extraordinary sense of self-belief”.

Appointing a new permanent Governor was a challenge. Under the law, the Governor had to be someone the Board nominated, but the Minister could reject a nomination and ask (endlessly, in principle) for another. Brash’s deputy, Rod Carr, filled in as (statutory) acting Governor including through the election campaign period, and assiduously sought to get the permanent role. Cullen records – and this I did not know – that the Board had formally recommended that Carr be made Governor.

I had nothing personal against Rod, but he was so dry that he made even Brash look slightly moist. I was not in the least convinced that he could adopt the somewhat more flexible approach I was looking for. I rejected the recommendation….Finding a replacement posed a problem, especially if my action was interpreted to mean a lack of commitment to the basic principles of the Reserve Bank Act. I was saved by Alan Bollard. He offered to put his name forward.

Of course, it would not have been hard to have found someone else, except that the understanding was that the word had gone out that no one associated with the Brash Reserve Bank was to be appointed. Thus, Murray Sherwin – until recently Deputy Governor, then Director General of Agriculture – would have made a good Governor, but he’d been of the Brash era. Less plausibly – though probably with politics more akin to Labour’s – another former Brash Deputy Governor Peter Nicholl (then Governor of the central bank of Bosnia) might have been keen (although I know the Bank’s Board wasn’t).

Again, what Cullen doesn’t record was the fascination with the RBA in the Beehive (including the 9th floor at the time). In some ways it was understandable – the RBA was run by a succession of competent people, the Australian economy was generally doing better than New Zealand’s, real interest rates were generally a bit lower (visiting RBA people would even encourage us to be more like them and we might get our interest rates down to “world” levels) and had been less volatile. My diary records a conversation with someone who had been to visit Peter Harris – now an MPC member, then Cullen’s main economic advisor – during this period, and Harris had apparently even toyed (perhaps not fully seriously) with the idea that they could get Glenn Stevens (then Deputy Governor of the RBA) as Reserve Bank Governor. The Prime Minister was known to want a policy target mirroring the Australian one (centred on 2.5 per cent inflation), something that Alan Bollard successfully resisted).

(Cullen goes on to record that he also knocked back SSC’s recommendation of Mark Prebble to be Secretary to the Treasury, primarily on ideological grounds. That was interesting but he never tells his readers that at the time – when Cullen was deputy PM – Prebble was chief executive of DPMC, that Clark had attacked that appointment in 1998 (again on ideological grounds) but had acquiesced in Prebble’s reappointment in 2000). It might have been interesting to have read some reflection on what changed.)

The period from late 2003 to the end of Labour’s term was a difficult one for monetary policy. Cullen does a little bit of sniping in the book – mainly at the idea that the Bank was engaged in targeting inflation forecasts (he words it a little differently but it is the implication of his repeated comments about an output gap focus) – but he displays almost no awareness of what was going on (including the sustained and significant rise in actual core inflation, the demand effects of rapid growth in population, the demand effects of the housing market (prices and volumes), the strong growth in the terms of trade, or the implications of fiscal policy. And I don’t think he once mentions the exchange rate, which became an increasing bugbear through this period, both for him and for his handpicked Governor. The best evidence for the proposition that throughout those years we did not tighten aggressively enough early enough is that core inflation moved to and beyond the top of the inflation target range (as benchmark, in the subsequent decade core inflation undershot, but never quite fell outside the bottom of the band).

There was an increasing search for some sort of circuit-breaker, with a particular focus then on things that might help dampen housing market pressures without necessitating further OCR increases and further rises in the real exchange rate. This culminated first in the Supplementary Stabilisation Instruments project, which Cullen claims to have known almost nothing of. This is the relevant extract from his book.

Both the Reserve Bank and the Treasury realised that in that situation [economic imbalances] the use of the official cash rate as almost the only means of dealing with such imbalances was far from satisfactory. It was rather like many anti-cancer drugs in causing significant collateral damage, so they had decided to work on what they called a Supplementary Stabilisation Instruments Project. This was their initiative, not mine, but it got John Key excited and he managed to invent all kinds of malign intentions the government had. I have no idea where the project went since it did not seem to produce any results.

Which simply wasn’t true. House prices became such a political problem there was a special unit set up in DPMC to look at what might be done, and John Whitehead and Alan Bollard agreed with Cullen to commission the SSI work. In a release at the time, Cullen claims that

He expressed concern at the impact of the high dollar on the export sector but said the Supplementary Stabilisation Instrument Project, the terms of which were drawn up by the Treasury and the Reserve Bank and released without reference to the government, would explore options to reduce pressure on the exchange rate by reducing monetary policy reliance on the OCR.

I can’t remember if the precise Terms of Reference were cleared by his office, but it was made very clear (from the Beehive) that difficult political options (capital gains taxes, public sector savings programmes, anything around the welfare system) were out of scope. These specific exclusions are mentioned in the published Terms of Reference (page 39 here). Cullen’s hands were all over this commission (my diary records a week or two prior an observation that Cullen, Bollard, and Whitehead had all apparently been keen on some particular tweaky tool I’d devised – I can’t recall what it was but am embarrassed that it seems to have been an LVR-based control).

The Minister goes on to claim that “I have no idea where the project went since it did not seem to produce any results”. Except that, readily available on the web, is our report to him on the analysis and possible tools, from March 2006.

And did it go no further then? Well hardly. Instead there was some considerable interest in the idea of a Mortgage Interest Levy – a scheme under which we might raise the cost of mortgages without raising the OCR – and I and a Treasury counterpart spent (what seems like) months devising something that might be workable, exploring fishhooks etc etc. That paper is here, as is the report to Dr Cullen.

And was this simply a bureaucratic conceit, or no interest to a busy Minister of Finance? Well, no. Actually, Cullen tried to persuade the National Party to go along. I knew this was so, but looking through some old papers found a press release from Michael Cullen, as Minister of Finance (9 February 2007), saying so and attacking Bill English (new National finance spokesperson) for not being willing to go along.

National leader John Key and finance spokesman Bill English are clearly at odds over the concept of a mortgage levy, which could potentially ease pressure on exporters, Finance Minister Michael Cullen said today.

…I can now reveal that Mr Key and Mr English were invited to a meeting in my office before Christmas to discuss alternatives to existing monetary policy instruments to tackle inflation.

…At that meeting Mr Key took a balanced and serious approach. Mr English though largely remained silent and his body language spoke volumes about his willingness to embrace new measures that may have a chance to help the New Zealand economy 

And so on.

And at that Cullen requested that further work be discontinued.

Cullen was a busy man, but it wasn’t as if this was an isolated project. The Minister continued to express concerns – quite serious ones. Not six years after his Svensson review had reported, Labour initiated a full-scale Finance and Expenditure Committee review of monetary policy (quite possibly intended more for shown than substance). More than once Cullen opened mused about the powers open to him under the Reserve Bank Act (but never used) to direct the Bank to pursue a different target (I wrote the internal paper musing on how we should respond, what options the Minister had, what constraints there were on him) and he also became increasingly critical of our public line that fiscal policy was adding to demand and inflation pressures, all else equal putting the real exchange rate and the OCR higher than they otherwise would be. Labour was on its late-term fiscal splurge (helped by Treasury advice that concluded the boom-time revenues were mostly permanent) and although the budget was still in surplus, running down that surplus actively added to the imbalances in the rest of the economy. For Cullen no doubt it was politically awkward – Labour was well behind and the polls, and the money was there. We were reduced to (among other things) writing boxes in the Monetary Policy Statement to explain our (entirely conventional view).

My point here is not that Cullen would necessarily have remembered all of this – busy man etc – but there is not even a hint of any of it. The book would have been much better with at least some of it, rather than the Christmas letter type of account.

Out of curiosity, I also looked for Cullen’s account of the genesis of deposit guarantee scheme. It is a somewhat self-serving account, including his attempt to blame the entire South Canterbury Finance situation on the National government that took office the following month. I wrote my own account of those few days here (I was very closely involved), and included this paragraph.

The main, and important, area in which Dr Cullen departed from official advice was around the matter of fees.   We’d recommended that the risk-based fees would apply from the first dollar of covered deposits (as in any other sort of insurance).     The Minister’s approach was transparently political –  he was happy to charge fees to big Australian banks (who represented the lowest risks) but not to New Zealand institutions (including Kiwibank).  And so an arbitrary line was drawn that fees would be charged only on deposits in excess of $5 billion.   Apart from any other considerations, that gave up a lot of the potential revenue that would have partly offset expected losses.  The initial decision was insane, and a few days later we got him to agree to a regime where really lowly-rated (or unrated) institutions would have to pay a (too low) fee on any material increases in their deposits. A few days later again an attenuated pricing schedule was applied to deposit-growth in all covered entities.   But the seeds of the subsequent problems were sown in that initial set of decisions.

They were his calls to make, and it was an election campaign, but perhaps a political memoir would be more helpful in revealing some of the tradeoffs, tensions, risks etc (or even the fact that – especially with Parliament dissolved – a Minister of Finance could issue such blanket guarantees with few/no checks and balances.

These were just the areas that I know something about in depth. So I’m left wondering what weight I should put on any of the rest, other than as chronology (which I too could get from the web).

On the front cover of the book, Helen Clark describes Cullen as “one of our greatest finance ministers”. There aren’t that many (relatively long-serving ones) to choose from but I’d hesitate to endorse the accolade. Running down the public debt was an achievement but (a) demographics, (b) a prolonged, but productivity-lite, boom, and (c) the terms of trade ran strongly in his favour, and the dam burst in the final three years of his term. I guess he has monuments to his name – Kiwisaver and the NZSF (“Cullen fund”) – but then so does Bill Birch from his time as Minister of Energy, and the best evidence to date is that Kiwisaver has not changed national savings rates, and it isn’t clear what useful function the big taxpayer-owned hedge fund has accomplished. Meanwhile Cullen – and Clark herself of course – bequeathed to the next government (who in turn bequeathed it to this one), the twin economic failures: house prices and productivity (the latter shorthand for all the opportunities foregone, especially for those nearer the bottom of the income distribution).

In that sense, what marks him out from a generation or two of New Zealand politicians, who have spent careers in office, and presided over the continuing decline?

Costs, benefits, etc

Any sort of serious cost-benefit analysis undertaken by officials to advise ministers and inform the public has been notably absent over the 19 months now since Covid has been an issue for New Zealand. You may hazily recall last year that neither Treasury nor the Ministry of Health ever attempted any such disciplined analysis – presumably in the spirit of the senior minister in the previous government who responded to a question I once asked about some expensive initiative he was implementing observing that a cost-benefit analysis wasn’t needed because he already knew the correct answer. There were, of course, a few outsiders who made the effort – from the sceptical side consultant and former academic Martin Lally, and also an analyst at the Productivity Commission (whose efforts seemed to rile up those who already knew the right answer). Earlier in the year when the government extended its regulatory Covid reach, I OIA’ed the Ministry of Health for any cost-benefit analysis undertaken in conjunction with this new restriction. I was quite surprised to get a very prompt response, making it clear that none had been undertaken. Only later did it become clear that the Ministry of Health itself had opposed the initiative.

Of course, for any remotely-complex issue the best cost-benefit analysis in the world won’t produce a single definitive answer that everyone agrees on. But it forces proponents of a course of action (or inaction) to identify and write down their assumptions, think in a disciplined way about how people are likely to behave, think about a wide range of costs, and so on. It should sharpen the thinking of decisionmakers and those advising them, and aid the public scrutiny of ministers and officials,

The thinking that results in this post was initially sparked by seeing a comment in an interview earlier in the week by the Reserve Bank’s deputy chief executive responsible for economics and monetary policy where he claimed that

“Lockdowns have been about delaying the timing of spending rather than taking away spending in total”

and then yesterday I noticed the government’s adviser, and eminent epidemiologist, David Skegg suggest that we might as well push on with the elimination strategy as (words to the effect of) there was no real cost to doing so.

I don’t suppose the Reserve Bank has any real input into Covid policy – and his comment was mostly in the context of output gaps and inflation outlooks perhaps a year out – but Hawkesby is a smart guy, and it was a weird comment, tending to minimise the costs of restrictions.

This chart is an illustration of what I have in mind.

covid GDP losses

Quite clearly what happened was that spending/production returned to more or less normal levels relatively quickly, but “the hole” was never filled in. Real GDP per capita was about 12 per cent lower than otherwise in the June quarter of last year, and 2 per cent lower than normal in March quarter. GDP just prior to Covid had been about $80 billion a quarter, so almost $12 billion of GDP (value-added) we would normally have expected to have occurred in the first half of last year never happened. And there is no sign it was ever made up for later (not surprisingly, since few of the people who couldn’t work at all in April would have gone on to work twice the hours in June). These are really big losses – rather swamping the most recent derided example of planned government waste, the proposed walking/cycling bridge across Waitemata harbour. And those GDP outcomes were held up – to an extent not yet clear – by really huge fiscal outlays, which represents a future burden on New Zealand taxpayers.

Note that I am not citing these numbers to get into a debate about last year’s lockdown, and in thinking about the regulatory restrictions in that period it is vital to recall that many of those losses would have happened anyway (at least given the rest of policy up to mid-March), as individuals were already beginning to take their own precautions. But that was then when – if one wanted to be charitable – one could note that the government and officials were to some extent flying blind.

My concern is more about this year. Ministers and officials now had a good basis for knowing that lockdowns (of the draconian New Zealand sort) did not come cheap. There are all sorts of costs other than the ones captured in GDP – read the heartrending example in Matthew Hooton’s column this morning – but the GDP ones are real enough. I’ve seen mentions that The Treasury is working on an assumption of 25 per cent of GDP lost under “Level 4”, so we’ll use that assumption. Applied to last quarter’s GDP that represents a loss – unlikely ever to be recovered (see above) – of $1.6 billion dollars a week. After 10 days of nationwide level 4 that is already about $2.3 billion – and on a best-case scenario there is probably the best part of another couple of billion to come. $4bn might do as a rough estimate (five cycling bridges) in economic costs alone (and preservation of basic freedoms should itself be valued highly).

Again, I cite these numbers not to question the current lockdown (callously and deliberately cruel and inhumane as parts of it are), but to highlight that officials and ministers have known the cost of this sort of scenario all year. So you’d have supposed they’d have done absolutely everything possible, including spending lots of money if necessary, to make sure it didn’t happen. After all, Parliament had appropriated lots of money in the Covid fund.

Now people might push back and say that it was only in the last few months that the enhanced threat of the Delta variant became apparent, and no doubt that is true. But our politicians and officials are entrusted – paid – with the responsibility to prepare against a wide range of contingencies (just as, say, in a defence and foreign policy context). Similarly, we heard for months public health people bemoaning the alleged “complacency” of the public, but the public aren’t charged with preparing against all such contingencies and the government (politicians and officials) is. And the idea that a more troublesome variant might arise was hardly a new one no one had ever contemplated before Delta.

The only reasonable conclusion is that this draconian lockdown – and the extreme intrusions/restrictions should be priced quite highly – was preventable and the government objectively chose not to prevent it. I don’t suppose they wished it, but – having decided firmly on elimination (and quite probably sensibly so) – with all the resources of the public sector – and the wider base of expertise beyond it – they chose not to do the things that would have made it unnecessary (whether by preventing Delta arriving in the first place, or having the population and systems in a position where much less onerous and costly restrictions might have been appropriate). And I don’t suppose anyone anywhere in the public sector stopped and did some serious cost-benefit type of thinking. Frittering away the Covid fund on wider Labour political preferences must have been so much easier and more fun for the politicians. And as for the officials, who can say, but presumably the quiet and comfortable life suited them. It wasn’t as if they did nothing ever, but that is hardly the test when faced with such a threat.

What might the government have done (and been reasonably expected to have done, not just with the benefit of hindsight)?

There is a pretty standard list by now of things that could have been put in place over months, some of which would have made a difference with certainty, some just probabilistically (but this is a game of probabilities):

  • the astonishing lack of urgency the government displayed in securing vaccines (whether that is about when orders were placed, whether anything could have accelerated Pfizer deliveries, or the choice  – pure choice – to put themselves in the hands of a single supplier),
  •  the neglect of saliva-test options (now widely used abroad, and cheap –  to individuals and governments),
  • the now-apparent failure to put in place systems to prioritise testing (and processing of test of) close contacts),
  • the clear failure to have stress-tested and war-gamed the contact tracing system to ensure that it could really cope with what was being promised.

There were, of course, small things even last week.   Knowing by then, with utter confidence, of how threatening Delta was, when a community case was discovered in Auckland first the Prime Minister and her Covid minister hightailed it out of Auckland (how could they then know whether or not they had been contacts?) but more generally people were allowed to leave Auckland –  with no isolation requirements at all –  for almost 2.5 days after the first Auckland community case was known about.  Now, sure, there would have been contacts outside Auckland anyway, but the government’s choice knowingly added to the problem (some of the Wellington cases were people who left after the initial case was known) –  the numbers, the testing, the processing, the risks (that lockdowns are now designed to contain).

And then there is the border.  They knew the border was not totally secure –  after all, there had been several breaches here over the months.   And it probably could not be made 100 per cent secure –  for every person arriving (by air, or as crew on ships) there was some chance, however individually small, of a breach.  If it wasn’t obvious to them, the Skegg report was telling them a breach was inevitable at some point.   

And yet the government did nothing to reduce to an absolute minimum the number of people arriving.  If anything, it seemed to be constantly giving in to pressures to allow more in (not even compassionate cases, but discretionary sports, business and entertainment priorities of the government).  Just a few days before this lockdown there was the extraordinary proposal to allow home isolation for some (big end of town) vaccinated people, even as the government quite openly told us that any Delta breach would be likely to have an immediate Level 4 lockdown (with attendant cost).  Perhaps there was a case at the time for allowing quarantine-free travel from Australia, but even there they were astonishingly slow –  given what they knew of the cost of lockdowns –  to close down that travel when community cases arose in one or other of the Australian states (they seemed to rely on advice from Australian officials rather than taking the pro-active precautionary approach), and then kept allowing New Zealanders to leave Australia for a time even when the QFT was finally suspended altogether (sure, there was pre-departure testing, but that was more theatre than anything, given that the test could be taken up to three days prior to departure –  and many of them weren’t checked anyway).

(Of course, in any cost-benefit analysis you would want to include the costs to the individuals left unable to travel by a tighter approach at the border at the margin. It is likely to be a small number, relative to the costs imposed on five million of us.)

Given the commitment to elimination (which I am not questioning), it is simply inexcusable that ministers and officials were not doing this sort of cost-benefit calculation/analysis, and routinely updating it in the light of new information (including about Delta). One might not a year ago have put a 100 per cent chance of a new Level 4 lockdown a year ago, but perhaps it would have been prudent even then to have planned for a 30 per cent chance, with that probability clearly rise (to near inevitable in the Skegg report) as the year went on, and planned and prepared accordingly. Perhaps by mid this year it really was too late to do anything much to fix the vaccine problem, but – knowing the likely extreme costs of a lockdown (output never recovered, really high non-economic costs too – it should have led to even more of a focused drive to do everything to stop Delta getting in, and having foolproof, tested and robust, plans to immediately contain the spread (including beyond whatever area the first case was found in), Instead, it is if the lives, fortunes and freedoms of New Zealanders are just playthings for the government and officials – “it doesn’t really matter if we didn’t do our job well, after all, we can simply keep everyone shut up for days longer”. Hundreds of millions of dollars (and equivalent) lost/wasted? Never mind, we are well practised at that. After all, look at where the Covid fund went.

None of this bears on what choices Cabinet should make today, but it has real implications for the path ahead. If the government is committed to elimination for the time being, and holds over us constantly the Damoclean sword of Level 4 lockdowns, they need to take much more seriously minimising to the utmost the risks of future breaches.

$4 billion really is a lot of money – $800 per man, woman, and child – simply gone, and that on relatively optimistic estimates (and many of the costs not dollar-valued at all).

UPDATE 28/8: This Matt Nippert piece from today’s Herald, on the dawning awareness of the Delta variant, despite drawing on authorised officials in the Prime Minister’s own office presumably keen to provide cover for the government/officialdom, really makes my point. Even though the variant (then known as the Indian variant) was first identified late last year, was ravaging India in February, there is no hint in the article that ministers or officials were planning for really bad scenarios, and taking aggressive steps to prevent them being realised, until very late in the piece. It is one thing to hope for the best, but in officials/ministers charged with crisis management – and having themselves deliberately and consciously adopted the elimination strategy – it is no basis for planning. One wonders if there is any dedicated group anywhere in the official system charged with championing alternative (bad) scenarios, with a direct line to ministers.

MPC members speaking

When I finished yesterday’s post I realised there was plenty else that could have been said.

First, of course, is the way that the Reserve Bank’s housing graphic feeds a narrative that a fall in house prices would itself be a bad thing, at an economywide level. After all, presumably their mental model is symmetrical.

As I noted yesterday, their framing totally ignores the context in which house prices change. Were a government ever to summon up the intestinal fortitude to free up land use, we would expect to see house/land prices fall, and fall a long way. This would, of course, be tough for some individuals, but their losses would be largely offset by gains to others (the young, the poor, the renters), and for many people – owner-occupiers with modest or no mortgages – it would really make no difference at all. Speaking personally, I would cheer the day nationwide policy reforms meant real house/land prices dropped back, say, to where they were when I first entered the market in 1988. It would make no difference to my consumption, but would make the prospects of my children a great deal better.

It is just possible that such a reform might even spark a whole new wave of housebuilding, and perhaps even help lift economywide productivity (since land is better able to be used for things people – not governments – value most). But, of course, none of this appears in the Reserve Bank’s spin.

Wealth effects (at an economywide level) are generally thought of as much more powerful re non-housing assets. There was a nice piece yesterday by Michael Pettis, who writes mainly about China, headed Why the Bezzle Matters for the Economy. The “bezzle” is a phrase dreamed up by J K Galbraith to capture the notion that if someone has defrauded you and you don’t yet know it, both you and he think you have the wealth, and collectively society thinks it is wealthier than it really is. Until the fraud is discovered. Pettis generalises the point to apply to grossly-overvalued equity markets, or to physical investments that might have been put in place – by firms or governments – that in the course of time will just never pay off. One could think too of housing booms in which far too many physical houses end up getting built. The waste has already happened but it can take a considerable time, sometimes a specific shock, for societies to wake up, and adjust. Anyway, it is a good read – although quite unrelated to things RB.

But what I was really planning to write about today was the round of media interviews granted to various media outlets by the Reserve Bank senior management following last week’s MPS. The round of interviews seems to have become something of a ritual. FIrst there was the Governor (in Stuff). He seemed typically loose, not very rigorous, but also not very controversial.

Then the Deputy Governor popped up in an interview at Business Desk. You’ll recall that in a post late last week I took the Governor to task for having suggested to FEC that somehow the Bank was contractually bound to keep offering the Funding for Lending scheme for the next year plus, even as the MPC was saying it wanted to tighten monetary conditions quite a bit. It looked as though Bascand had been sent out in part to tidy up after the Governor (a job that, as a safer pair of hands who’d have made a less bad Governor, he seems to do a bit of). In that interview we learned that – at least in Bascand’s view – actually it wasn’t a matter of contract at all, but of “keeping our word”. He went on to add that

“I do place quite a lot of weight on RBNZ’s words being listened to and us being true to what we say. That’s where our credibility comes from,”

The same daft argument they adopted for sticking to their odd pledge in March 2020 not to change the OCR, either way and come what may, for a year. And on the other hand, the one they obviously discounted when (sensibly if belatedly) choosing to stop LSAP purchases. If you want to be credible, stick to making few (and sensible) pledges, and only ones that respect the extreme uncertainty every monetary policy maker faces when contemplating future policy moves.

Bascand went on to try to articulate a substantive case for keeping offering the Funding for Lending scheme (although never actually engaged with the distortions that accompany it), arguing about the FfL scheme that “one doesn’t really know” what impact changes in the scheme would have. But that is hardly a satisfactory answer both because (a) it is an implied admission that they are running a crisis-intervention instrument that they don’t really understand the effects of (but is having those effects now), and (b) because on their own telling the scheme will end next year, policy now is set on forecasts, so those forecasts must already be building in some view on what impact the end of the FfL scheme will have. But even if there was anything much to the Bank’s concern about precision – and there isn’t, since exchange rate reactions to OCR changes are never that predictable – nothing would stop them phasing the scheme out over a few months, enabling any observed effects to be taken account of as the OCR itself was being set.

So, to recap. To this point, we’d had the Governor suggest a contract and the Deputy Governor disavow that notion (and word). But then the Bank’s Chief Economist – who has not been let loose to do a single speech on-the-record in the 3+ years he has been a statutory officeholder – was interviewed by And up popped the idea of a contractual obligation again

Furthermore, Yuong confirmed the RBNZ would keep its Funding for Lending Programme (FLP) in place until the end of 2022 to uphold the “contractual arrangement” it made with retail banks last year.

His words, no paraphrasing.

Ha’s interview seemed to focus on the future of the LSAP, and here he seemed back on-message with all this talk about unpredictability and lack of precision.

Hesitation over going down an untrodden path

As for the LSAP, Ha said the RBNZ’s initial thinking is that it isn’t keen to actively sell the $54 billion of New Zealand Government Bonds it has bought from banks, fund managers, etc since March 2020.

By buying these bonds it put downward pressure on interest rates. Actively selling them before they mature would tighten monetary conditions.  

Ha said, “We know a lot more about how to calibrate tightening policy through an OCR. We know less about how you would do that through selling down government bonds.”

He was also wary of the RBNZ not flooding the market with bonds at a time Treasury’s bond issuance remains elevated ($30 billion of issuance is planned for the 2021/22 year).

“The key thing to remember is, on the way down, you sort of made a big splash about the LSAP. Markets are dysfunctional, you want to keep interest rates low,” Ha said.

“On the way out, you want to be quite methodical and want to be operational in the background. We’re not intending to send massive policy signals through the withdrawal of the LSAP programme.

“We largely see it now as just managing… the holdings of those assets on our balance sheet.”

So last year they were all gung-ho on how much they were achieving by buying bonds, but now it is all too hard, and they propose to simply sit on their hands (and risk more large losses to the taxpayer). And if the bond market was a bit dysfunctional briefly last March, it wasn’t through most of the period the Bank was buying heavily and it isn’t now. It simply defies belief that they can seriously believe that a pre-announced sales programme of, say, $2billion a month would create any difficulties for the market at all. What is more likely is that, in their heart of hearts, they know that LSAP bond sales wouldn’t make any material macro difference it all. They wouldn’t tighten conditions any more than the purchases – heavily focused at long maturities of little relevance to anyone much in the New Zealand market – themselves did. But it would a bit awkward to concede that, after all the spin last year.

The fourth policymaker interview (at least of those I noticed) was by the Assistant Governor (the deputy CE responsible for monetary policy) Christian Hawkesby with Bloomberg. Bloomberg seemed more interested in getting comment on the likely stance of policy, rather than details of which instrument. I was encouraged that Hawkesby told his interviewers that the MPC that a 50 point OCR increases was “definitely on the table” last week and “actively considered”, even as I wondered why we learned this from an interview with a specific paywalled proprietary outlet and not from, say, the minutes of the MPC meeting (or even, at a pinch, the Governor’s press conference). In an update to their story, Bloomberg reports that their story – and a sense that Hawkesby was still hawkish – moved both the exchange rate and the market pricing on an October OCR increase.

I’m left with a number of concerns:

  • on the specific of communications around the FfL scheme, three top managers over three days couldn’t even keep their lines consistent (“contract” or not),
  • the poor quality of what argumentation these highly-paid supposedly expert monetary policymakers are putting up about getting out of the crisis programmes, and
  • none of this (whether crisis programme arguments or the possibility of a 50bps OCR increase) was in the MPS or the minutes of the MPC meeting, which are supposed to be at the heart of the transparency and accountability around monetary policy, including because everyone has equal access to those public documents and knows when they will be released.

It really isn’t good enough.

One could go on to note that we’ve (again) heard nothing from the three “independent” non-executive members of the MPC. Of course, in a way that isn’t surprising: one has no relevant expertise at all (and never been heard from once) and all three were clearly carefully selected to not make waves and to provide reputational cover for the Governor’s continued control, despite the formal Committee structure, and formal commitments to greater transparency.

And, to be clear, if I am criticising the different lines Orr, Bascand, and Ha are running it is simply because they are supposed to be representing a decision already made, presumably with justifications agreed at the time. I’m all in favour of much more openness and diversity of view – both what should be captured in serious minutes, and that which serious speeches and lectures can provide. There is (always) real uncertainty about how the economy is working, and we should be able to see evidence of a serious contest of ideas and evidence. That sort of openness actually helps stimulate debate (internal and external) and scrutiny ex ante, as well as ex post accountability. Thus, you can see why the MPC members, perhaps the Governor most of all, just prefer to keep things the half-baked way they are.

Rising house prices do not make New Zealanders better off

I didn’t really read the housing section of last week’s Reserve Bank MPS – housing isn’t their responsibility and their analysis of it has rarely been up to much, often lurching unpredictably from one story to another. And their new material on house prices in each MPS only stems from the Remit change Grant Robertson foisted on them early in the year, knowing it would make no substantive difference to anything, but designed to look as though the government cared.

So it was only when the Herald’s Thomas Coughlan tweeted this chart yesterday that I noticed it.

RB house prices

The chart is prefaced with this text

The MPC sets monetary policy to achieve its inflation and employment objectives in the Remit. It considers the outlook for the housing market because house prices can influence broader economic activity, employment, and consumer price inflation (figure A5).

So we are presumably supposed to take this as the best professional view of the seven members of the Monetary Policy Committee. After all, it isn’t a throwaway line from a single member in an ill-considered press conference or interview comment. There is a bunch of different channels identified (and no obvious space constraints – they could easily have added more if they thought others were important), and nothing of substance gets into a Monetary Policy Statement without a fair degree of senior management scrutiny and review.

There are so many problems with this graphic it is difficult to know where to start. But perhaps first with the clear impression a casual reader would take away from this that the seven Robertson-appointed members of the MPC think that higher house prices are “a good thing”. After all, for most of the last decade inflation undershot the Bank’s target (unemployment lingered disconcertingly high for a disconcerting period of time too). More would have been better on both counts. Perhaps a charitable reader might wonder if the MPC really only had some short-term effects in view, but there is nothing in the substance of the chart or its title to suggest that.

And then there is the problem of the left-hand box: they start from “house prices” and “housing market activity” but these things never occur in a vacuum (as, for example, they would no doubt – and rightly – point out if they were talking about any other price (say, the exchange rate). Most often, surges in house prices (at least in New Zealand) have been associated in time with surges in economic activity driven by a range of different (policy and non-policy) factors.

But perhaps the biggest problem is with the claim – almost explicit in the top box of the second column – that higher house prices leave New Zealanders as a whole (remember, this is a whole-economy macroeconomic agency) better off. They don’t.

That they don’t, in principle, is easy enough to see. Everyone in the country needs a roof over his or her head. If I need a roof over my head for the rest of my life, ownership of one house meets my housing consumption needs. What matters is the shelter services the house priovides not the notional value the house might be sold at. Whether my house is valued today as $0.5m (roughly what I paid for it years ago), $1.75m (roughly what an e-valuer site tells me it is worth today) or $3.5m makes not the slightest difference to me. I still want to consume the bundle of services (location, size, sun etc) that this particular house provides.

Now, I might feel differently if I had a large mortgage: after all, negative equity gives the bank the right to foreclose (which can be both expensive and inconvenient), and even if the bank didn’t foreclose (mostly they don’t) it might also make it impossible for me to buy a similar house elsewhere if job opportunities suggested a move.

But this is where one needs to step back and think about the population as a whole. To a first approximation, for every apparent winner from higher (national) house prices there is a loser and for most – perhaps especially middle-aged owner occupiers – it makes no difference at all. There is no more economywide purchasing power created. And real gains that accrue to some people are offset by real losses to others. Owners of rental properties really are better off when real house prices go up. After all, they don’t own houses to live in them, but mostly for the profit they expect to make and the future consumption opportunities for themselves and their families. They can realise their gains and move on, or simply borrow against them.

But on the other hand, there are a lot of people made materially worse off by higher house prices – the people who don’t own a house now who either want to buy one in future or who are, and expect to, keep on renting. Consider someone just graduating from university who, a few decades ago, might have expected to buy a house after a couple of years working. But with real house prices in New Zealand as they are now not only does the deposit requirement push back any feasible purchase date, but the total amount of the lifetime income of the young graduate will have to devote to house purchase costs is so much greater. (Of course, real interest rates are lower than they were decades ago but recall that in the Bank’s scenario we are just thinking about house prices.) Earnings that are (eventually) used for the acquisition of a house can’t be used for other things. Earnings saved now to accumulate a deposit are not spent.

The story isn’t so different for long-term renters since in the medium-term (the adjustment isn’t instantaneous) if house prices are higher one can expect rents to be higher (than otherwise). In latter day New Zealand that has taken the form of rents holding up, or rising a bit, even as real interest rates have fallen a lot, which would otherwise have been expected to lower rents. Earnings spent (and expected to be spent) on rents can’t be spent on other things.

What (mostly) happens when house prices rise is that purchasing power is redistributed – usually towards those who have (houses) and away from those who have not (houses). Of course, it is further muddled by things like the Accommodation Supplement which shifts some of the losses onto the Crown……but that only means that taxes will be higher than otherwise in future. There is no net new purchasing power for society as a whole. (Were one inclined to an inequality story one might note that wealthier people tend to have lower marginal propensities to consume than poorer people.)

Are there possible caveats to this in-principle story? The story I used to tell was that, in principle, we might be better off from higher house prices if we all sold our houses to foreigners (at over the odds prices) and rented for the rest of our lives. But it was a story to illustrate the absurdity (and marginal relevance) of the point, and that was before the current government made such foreign house-buying illegal.

I’ve told you an in-principle story. The Bank likes to claim that the data don’t back this sort of story, And it is certainly true that there will often be a correlation between increases in house prices and increases in consumer spending. But that is mostly because – as I noted earlier – in the real world something triggers house price increases, and that something is often strong lift in economic activity and employment (in turn with triggers behind those developments). When the economy is running hot – and especially when land supply is restricted – buoyant demand, buoyant employment, rising wage inflation, increased turnover of the housing stock, and surges in house inflation are often happening at the same time. And in recessions vice versa. It isn’t easy to unpick chains of causation in the data.

Since higher house prices do not add to the lifetime purchasing power of New Zealanders as a whole, the Bank’s wealth effect story has to rest largely on some sort of view that households are systematically fooled by the house price changes. It is possible I suppose, at least the first time prices surge, but it doesn’t seem very likely. It isn’t as if surges in house prices – nominal and/or real have been uncommon in modern New Zealand.

The Bank also sometimes likes to highlight a story (it is there in that graphic) that even if the population doesn’t feel any wealthier, rising house prices might also boost consumption – at least bring it forward, without boosting lifetime consumption – by easing collateral constraints. In principle, a bank would lend even more to me secured on the value of my house than they might have done a couple of years ago. But again my ability to borrow a bit more has to be set against the reduced ability to borrow of the young graduate who now has to save even more in a deposit to get on the (residential mortgage) borrowing ladder at all. Sadly, in today’s bizarrely distorted housing market, we often find parents with freehold or lightly-indebted houses gifting or lending money to children, net effect on consumption probably roughly zero. With real house prices surging to fresh highs each cycle for decades now, it doesn’t seem that likely that many people are very collateral constrained.

For years I’ve been running a commonsense test over the Bank’s claims. This chart is of New Zealand real house prices

house prices aug 21

This series ends in December last year, so as of now we can probably think of real New Zealand house prices being four times what they were in December 1990 (I chose the starting point because that quarter was just prior to the 1991 recession getting underway, but you can see that real house prices hadn’t moved much for several years).

These are huge increases in real house prices, some of the very largest (for a whole country) seen anywhere over a comparable period (notably a period in which productivity growth was underwhelming). Were there to be much to the Reserve Bank’s wealth effects story (or its collateral constraints story) at the whole economy level mightn’t one have expected to see consumption as a share of national income rising, savings as a share of national income falling?

Of course there is all sorts of other stuff going on, but this is a really big – unprecedented in New Zealand – change in real (and nominal) house prices. But here is consumption as a share of national disposable income, back to the late 80s, just before house prices began to surge. The data are for March years.

consumption and NDI

The orange line is private sector (households and non-profits) consumption, while the blue line adds in public (government) consumption spending.

Of course, there are cycles in the series. There are two peaks, during the two big recessions (1991/92 and 2008/09): consumption tends (quite rationally) to be smoother than income. There is quite a dip in the early-mid 2000s, which can readily be shown to line up with the really big surpluses the government was running at the time – the country was earning a lot of income, but the Crown was temporarily sitting on a disproportionate share of that income.

And what of the house price booms. There were three during the period in the data (so not including the last year) – the few years running up to 1996, the period from 2003 to 2007 (particularly the early part of that period), and the period from about 2013 to about 2016. There is nothing in the consumption/savings data over those periods that would surprise someone who didn’t know about the house price surges.

And across the period as a whole, at best consumption has been flat as a share of income over 30 years of unprecedented house price increases. Looked at in the right light perhaps it has even been trending down a bit (private consumption as a share of income was as low in the March 2020 year as it was 16-17 years early when not only was the Crown running huge surpluses but real house prices were much lower.

I’m not suggesting any of this is definitive but when there is (a) no reason to think that New Zealanders as a whole are any wealthier when real house prices rise, and (b) no sign over decades in the macroeconomic data of the sort of effect the Bank likes to talk up, it might be safer to conclude that the effect just isn’t there to any meaningful macroeconomically significant effect.

Of course, as noted earlier there are all sorts of short-term correlations, typically resulting from common third factors at work, but the story the Bank seemed to be trying to tell in that graphic was neither representative of the economy as a whole, nor helpful.

The line I’ve run in this post is not new. In fact, 10 years ago now the Reserve Bank itself published an article in its then Bulletin discussing many of the same issues, and suggesting very similar sorts of conclusions (with, of course, 10 years less data). I was one of the authors of the article but – as was the norm – Bulletin articles carried the imprimatur of the Bank, and were not just disclaimed as the views of the authors.

Funding for lending

I was, conditionally, sympathetic to the Funding for Lending programme the Reserve Bank put in place late last year. At the time they thought (and it seemed plausible they were right) that more monetary stimulus was needed, and – through their own neglect and incompetence over several years – they asserted that a negative OCR could not yet be implemented. The announcement of the scheme clearly narrowed the gap between wholesale and retail interest rates, lowering the latter. This chart from this week’s MPS is one way of illustrating the point.


The effect was achieved by making it known the scheme was coming, and then available. Relatively little was actually borrowed, especially early in the piece.

The scheme works by offering funding to banks (only) at an interest rate equal to the OCR (floating rate, so the rate changes as the OCR does) for terms of three years. The loans are secured, but that isn’t much of a burden to the banks as (eg) they are allowed to simply bundle up their own residential mortgages into bonds the Reserve Bank will take as security (with a significant haircut – ie the value of the bonds has to exceed the value of the FfL loan).

It was a jerry-built scheme, but one could mount a reasonable third-best argument for having announced and deployed it last year. Among the problems with the scheme from the start:

  • it was offered only to registered banks, and not to any other (regulated) deposit-takers  (at odds with any notion of competitive neutrality, a principle that for a long time was important to the Bank),
  • by focusing on driving down retail rates (rather than both retail and wholesale) then it may have meant the exchange rate staying higher than otherwise,
  • lending for a three-year term at a floating OCR rate was, most likely, subsidised funding (it is highly unlikely any bank would have borrowed that cheaply on floating rate terms on market).

But perhaps one could tolerate those problems for a few months, while the negative OCR option was (so they said) not available.  And consistent with that I had not been particularly critical of it (even though by the time the scheme was officially deployed –  as distinct from announced, and announcement effects mattered –  the Bank was also telling us that the negative OCR obstacles had all been sorted out).

All that, of course, was many months ago, back when monetary policy tightenings looked a long way away, and the focus was still more on the risk of unemployment lingering high and core inflation staying very low.   The data moves, but the Bank doesn’t –  or is very slow to.

Where we stand now –  or at least earlier in the week –  was that core inflation was (a bit) above the midpoint of the target range, and the unemployment rate was so low even the Bank suggested (by implication) it was now at or below the NAIRU.   Tightening monetary conditions is clearly called for, and the Bank’s own numbers suggest they envisage quite a lot of tightening over quite an extended period.

So you might suppose that jerry-built interventions cobbled together late in a crisis would be among the very first things withdrawn.  As the Bank’s own document states

The FLP offers secured term central bank funding to registered banks, with the aim of lowering funding costs to stimulate lending growth across the economy and help reduce interest rates for borrowers.

Is the aim of monetary policy any longer to lower funding costs, stimulate lending growth or reduce interest rates? It certainly shouldn’t be, judging by the Bank’s own forecasts and statements.

And yet they insist they are going to keep right on offering the FfL scheme for the next 16 months. It makes no sense.

I was prompted to write this post after reading a Business Desk story this morning by Jenny Ruth. In it we were told that some banks had been borrowing more money this week, including on Wednesday. The amounts involved – $1.5 billion – aren’t huge but (a) the amounts haven’t usually been the issue, and (b) monetary policy works at the margin. But there was also this report of some comments the Governor had apparently made at FEC yesterday in which he ‘described the FLP as “a contract” that the RBNZ won’t break. “We have a clear contract. We thought it was best to honour that. We’re comfortable with honouring that contract,”

This was a new line.  When Jenny Ruth had asked the Governor at the press conference on Wednesday about FfL (and selling back LSAP bonds) we were simply given a line about preferring to use understood and predictable tools.  And so it prompted me to look up the Reserve Bank’s page on the Funding for Lending scheme.

On my way there I had to pass through a “Tools to support the economy” page, which –  still – is full of talk about what the Bank is doing to boost spending, boost jobs, encourage borrowing etc etc.  At very least the page needs updating – things have moved on from last year. 

The Funding for Lending programme page is here, with operational details here.  

And sure enough I found this

Participants may access the funding over a 2-year transaction period. The Bank reserves the right to extend (but not shorten) the transaction period.

Presumably this is what the Governor had in mind when he talked about a “contract”, but it is of course nothing of the sort (unless there are further signed documents the Bank isn’t disclosing, which I doubt).  It is a policy programme, much like the LSAP.  Recall that the LSAP was originally going to be kept going much longer, but circumstances changed and even the MPC concluded it was time to change policy and stop the bond-buying.  It didn’t betray anyone, no one regarded it as a breach of trust or anything of the sort.  If the Governor really regards himself (and his Committee) as somehow bound by that two-year period, it is even sillier than that pledge they made last March –  when they had no idea what was going on – not to change the OCR for a year come what may.

Now, just to be clear.  I am not suggesting that three year loans once made could or should be revoked.  The issue here is access to new loans, from a crisis programme, long after the crisis has past, and in a climate when the Bank itself says it expect to tighten steadily over a couple of years.

Does any of this matter?   I think it does, for a several reasons:

  • the MPC should not be making commitments it regards itself as bound by to periods well ahead where it has no idea what the economic circumstances will be.  Perhaps an initial six-month commitment might have been pardonable at launch, but another 16 months from here is simply indefensible.
  • since the MPC itself expects to raise the OCR steadily over the next couple of years (conditional of course on the economy) short-term market rates will tend to be above the OCR over that period.  Continuing to offer the FfL lending at OCR is not only cheap (subsidised) funding for banks (and recall only banks, not their competitors), but directly tends to undermine the effect of the market-led tightening that is going on.  Overnight rates really should apply to overnight money (or least money that reprices overnight not every 6-8 weeks).
  • and the longer the scheme runs the more it is likely to conflict with the MPC broader policy intentions.  This is so because under the rules from June next year banks can only borrow from the FfL to the extent that they are increasing their lending.  Perhaps there was an (arguable at best) policy goal to have banks increase lending this time last year, but on their own numbers and plans there is no such goal next year when (on their numbers) inflation will be near target and unemployment very low.  If the scheme continues to have any effect at all it will mean the OCR itself having to be pushed a little higher than otherwise.

The macroeconomic implications are probably pretty small, but it is simply bad policy by the Governor and Committee, grossly inadequately explained (if he really thought they were bound by honour or contract he should have developed the case in the MPS). The FfL scheme served a purpose – although given how the economy recovered more in prospect (from when first flagged) than by the time it became operational. But that time has long past now. The window should be closed, retail rates left to find their own level relative to wholesale rate, and the OCR should be deployed only after this abnormal crisis tool has been suspended.

On the MPS

In the end, of course, the bottom line of yesterday’s Reserve Bank announcement was unsurprising and perhaps inevitable – action deferred on account of Covid. It wasn’t as if they were on some statutory schedule, so they could easily have postponed the decision for a couple of weeks, but in the scheme of things the difference between that and waiting for the next scheduled review (6 October) isn’t great. It is clear from the Bank’s forecast numbers they had not been minded to raise the OCR by 50 basis points this time, so if need be they can always catch up by acting a bit more firmly in October.

There was even something to praise. The Bank had revamped the look of the document and – bad-wig new logo aside – it was a definite improvement, even if it is hard to be sure what (if anything) the front cover art might be supposed to represent. And there were, perhaps, a couple of more-interesting graphs than usual. Quite a bit of the media coverage seemed more focused on things the Bank isn’t responsible for – house prices – than on the things it is responsible for.

I guess I had two concerns about the document.

The first was about the analysis. Three months ago the Bank – with more macroeconomic resource than any other agency in the country – thought that well into next year the unemployment rate would be 4.7 per cent and seemed to see core inflation only converging very slowly on the target midpoint (from below). Instead, the unemployment rate is now 4 per cent and core inflation is above the target midpoint, but unless I missed something I saw hardly a mention of this forecasting error and no serious discussion or analysis of it.

Why does it matter? After all, the best of people make mistakes – even in recognising where the economy is at the time you were writing (the May forecasts weren’t finalised until 21 May, and both the CPI and HLFS are centred on the middle of each quarter (in this case 15 May). It isn’t so much the mistake itself I hold against them – although they should have done quite a bit better – but that if there is no analysis of how they made that mistake, and what the fact of the mistake has taught them about how the economy is working at present, how can we have any more confidence in the latest forecasts than in the last (wildly wrong) ones? And the MPS is supposedly an accountable document, not just an opportunity to brush the last set of numbers under the carpet and have another go at the dartboard to generate some new numbers. In particular, why when the momentum of the recovery in demand and activity (and inflation) took the Bank by (considerable) surprise do they think it has suddenly come to an end – implicit, for example, in unemployment rate projections that are 3.9 per cent for next March and 3.9 per cent for the following March (from 4 per cent at present). Or why, with core inflation having picked up quite strongly do they think it will settle as easily and quickly as implied in their numbers (bearing in mind that monetary policy has its greatest effect on inflation with a 12-18 month lag)? It was also a little surprising that there was no serious analysis of the role fiscal policy is, and is expected to, play in supporting (or dampening, as deficits are closed) demand and activity.

I am not running a strong alternative view here. They may prove to be right (and even by more than just chance, so for the right reasons) but there is no supporting analysis – no sign they understand the last 18 months or the last quarter – that should give anyone any more reason for confidence that in an amateur’s shot at a dartboard.

And, of course, if there is nothing in the body of the MPS, there are no speeches, no (searching) interviews, and the so-called minutes are as bland as ever, offering nothing even hinting at hard questioning, challenge, debate, or openness to alternative perspectives. No insight, no understanding, no challenge, no research, no scrutiny, all adds up to no authority. There is no sense that these people are any more than bureaucratic administrators.

The second concern was about policy, although perhaps in practice that boils down to absence of any serious analysis as well. The MPC has chosen to keep going with its jerry-built crisis funding programme, the Funding for Lending programme and to not do anything about reducing the stock of bonds it bought when it was trying to ease monetary conditions (ie until a few weeks ago, although mainly last year), decreeing that the OCR is its “preferred instrument”. Perhaps there is a case for leaving these crisis interventions on the books and jumping straight to the OCR, but if there is a serious case neither the Committee nor the Governor (as, supposedly, their spokesman) made it. Rather belatedly the Committee has now asked staff to prepare a paper on what to do about the LSAP, but why wasn’t that commissioned – and consulted on or published – months ago. When a journalist asked the Governor why MPC wasn’t acting first on the FFL and LSAP schemes, she was fobbed off with a spurious answer about the MPC preferring to operate with tools that were widely understood and which they themselves had a better, more precise, sense of how they would work.

Neither excuse seemed adequate. First, they are already having to factor into their forecasts now their views (implicit or explicit) on what impact the FFL and LSAP are having (and remember that most of the literature says that if there are material effects from schemes like the LSAP they are stock effects not flow effects). Second, the FFL is an explicit crisis intervention, when there is now no crisis, designed for an inability to use negative OCRs which no longer exists. Third, the FFL is explicitly discriminatory (only banks can access it). Fourth, you’ll recall how confident the Governor was last year about the power of the LSAP to influence monetary conditions – rhetoric that now seems to have disappeared completely. And fifth, there was no mention of the large losses (to the taxpayer) that the LSAP scheme has run up, and the substantial market risk the taxpayer is exposed to each day the scheme is left in place (by contrast conventional monetary policy instruments pose little or no financial risk to taxpayers ever).

Perhaps there is a case for their stance (although I doubt it) but it wasn’t made yesterday. The public should expect better from its highly-paid powerful officials.

And finally, two charts. I don’t have any confidence in the Bank’s analysis of house prices, or the new requirement the Minister foisted on them to talk about “sustainable prices”, but amid the breathless talk of the Bank picking a 5 per cent fall in house prices, it is perhaps useful just to focus on this MPS chart.

house prices MPS

Their scenario C is one in which nominal house prices hold steady. Their actual projections (line B) are less hopeful than that. Is it perhaps telling that the MPC shows line A – further strong price growth – out indefinitely – but line D (modest falls) only for a couple of years. Whatever the immediate cyclical situation – and some fall in the next 12-18 momths doesn’t seem that unlikely to be – nothing the government has done even begins to fix the structural failure (which the truncated y-axis in the chart minimises) and all the RB activity in this area is simply papering over cracks and running defence for the government.

The other chart doesn’t show anything new, but it is just nice to see it from a government agency.

MPS productivity

It is a dismal portrayal of the utter failure of successive governments (both National and Labour led). They simply use it as one part of a story as to why New Zealand neutral interest rates might have been falling – inadequate a story as it is, since our long-term real interest rates remain well above those elsewhere, even as productivity growth is worse than in most places. As it is, between things the government has little or no control over (Covid, abroad and here) and those things that are pure policy choice, it is more likely that the next few years will show even worse productivity growth outcomes than the last couple of a decades. The Bank itself – like a true believer – nonetheless projects that trend productivity growth in each of the next three years (ie including the one we are in) will be stronger than in any of the previous six years. That Tui ad springs to mind.

Looking towards the MPS

The Reserve Bank’s Monetary Policy Committee will release its Monetary Policy Statement tomorrow afternoon. We can expect substantial changes from the rather complacent, perhaps even dovish, statement/forecasts they released in May. The hard data have moved quite a lot and the Bank – with phalanxes of macroeconomic analytical resource – was far too slow to recognise what was going on.

Of course, it is anyone’s guess what the MPC will do. Unlike serious countries, or serious central banks, we’ve had no speeches from MPC members, and no position papers outlining how (and why) the MPC was likely to respond if and when the data indicated that tightening in monetary conditions was warranted. Normally, it isn’t much of an issue, since there is usually only a single moving part (the OCR) but we are now still living in the wake of last year’s extraordinary interventions. My focus here isn’t on what the Bank will, or won’t, do, but on what they should do, given the Remit the Minister of Finance has given the MPC.

NZIER run their Shadow Board exercise, in which a mix of (mostly) economists and (a few) people working in business or lobby groups offer their view on what the MPC should do. It is an interesting exercise, if only because respondents are asked to assign probabilities to their view (eg 25% chance the OCR should be 0.25 per cent, 50% it should be 0.5 per cent, and 25% it should be 0.75 per cent – an exercise the Governor used to ask his internal advisers to do, accompanying each of our specific recommendations). They’ve also this time asked not just about tomorrow’s OCR decision but about appropriate policy over the next year. Here are the last assessments.

shadow board aug 21

I’ve always struggled with the idea of 100 per cent certainty about any macro view, especially one about periods a year ahead. If I learned anything in decades of working on monetary policy it was how pervasive uncertainty (and unforecastability) is. If I were answering this particular survey I’d probably run with something like an 80-90 per cent view that the OCR should be higher now, but not much more than a 50 per cent view that it should be higher over 12 months. We just don’t know, and can’t know.

And that would be my first recommendation to the MPC: do not act as if you know more than you possibly can. The Bank insists on publishing economic projections several years ahead, but they rarely contain any useful information about what will happen over the following few years. But the key thing is not to become wedded to your own numbers, or desire to offer more certain than is sensibly possible. The last OCR tightening cycle the Bank undertook in 2014 was a mistake – the case for it was very weak at the time (as I and a couple of others argued internally, a few externally) and even more so with hindsight – but part of what led them astray was that the Governor had become entranced by his own numbers (projections and trend assumptions) and went round openly talking of a programme of OCR increases that would raise rates by a couple of hundred basis points. It creates something of a self-fulfilling momentum, complete with a feeling of needing to follow through.

So whatever the MPC decides on actual policy adjustments tomorrow, the words should emphasise how uncertain and changeable the environment (here and abroad) is, and that the Committee will be guided primarily by hard data (on core inflation and excess labour market capaciity) rather than by castles-in-the-air projections or programmes of tightening. We just do not know what is happening to natural/neutral interest rates – the belief that people did led central bankers, and markets for a time, astray last decade. And when data change there is no harm or shame in changing course; rather than is what central bankers doing their job are supposed to do. The job of the MPC is not to give a clear steer about the future, but (in a stylised way) to adjust short-term interest rates consistent with overall incipient savings/investment imbalances (normally, doing what the market would do if we didn’t have central banks).

The situation at present is complicated because the Bank last year deployed three distinct tools:

  • the OCR,
  • the Large-scale Asset Purchase programme (LSAP), and
  • the funding for lending programme, designed to narrow the wedge between wholesale and retail funding rates.

On the Bank’s own stated logic, I think an OCR adjustment should be the final step chosen if –  as seems to be the case – policy tightening is warranted.

Take the LSAP as an example.  The Bank has repeatedly claimed that the LSAP was highly effective in loosening overall monetary conditions, lowering both wholesale interest rates and the exchange rate.  If so, surely an obvious response now would be to start selling the bonds back to the market, at scale if need be?  After all, every day the Bank holds the bonds the taxpayer is exposed to unnecessary market risk (remember that they have lost us $3 billion or so to date), and there is no obvious good reason for the central bank’s balance sheet to be as bloated as it is for any longer than is strictly necessary. 

Now it is true that other central banks have been reluctant –  after the bond-buying of the last decade – to start actively offloading their bond holdings (although the Fed was doing so), but that was surely was mostly because economies and (in particular) inflation never recovered sufficiently robustly to warrant/require tighter monetary conditions.  By contrast, in New Zealand right now there is a pretty strong case for such a tightening.

Of course, if the Bank really doesn’t believe its own rhetoric (about the efficacy of the LSAP) it would still make sense for them to be getting a sales programme in place, but then they couldn’t claim that bond sales were a substitute for other actions.  As I’ve outlined in previous posts etc, my own view is that the New Zealand LSAP did little or nothing of any macroeconomic significance, but that isn’t what the Governor keeps telling us. 

The next step the Bank should be taking is to end the Funding for Lending programme.  It was a jerry-built crisis intervention that worked –  at a time when the MPC reckoned it could not take the OCR negative –  but we aren’t in a crisis now.     It isn’t a competitively neutral instrument –  only banks have access to it –  and if an efficiency mandate is disappearing out of the Reserve Bank legislation, the concern with economic efficiency and minimising favourable treatment for particular types of counterparties shouldn’t.   It should be discontinued now and the market left to settle the relationship between the OCR and retail and wholesale funding rates. 

What isn’t clear is quite how much impact ending the Funding for Lending programme would have on deposit rates.    The large positive margin between term deposit rates and either the OCR or bank bill rates that has prevailed over the last decade –  often 150 basis points –  is hard to make full sense of (and is larger than the comparable margin in Australia).   But the best guess has to be that removing new Funding for Lending might see that margin widen out from the 50 basis points it got down to back to something at least somewhat wider (perhaps another 50 basis points).

I don’t think I’ve seen mention of selling down the LSAP bonds or ending the Funding for Lending programme in any of the commentaries I’ve seen. I presume that is a sign the Bank has either suggested to banks no change is coming there any time soon or (at least) by silence left that impression.  But these crisis interventions really should be dealt with, and incorporated into the forecasts, before the Committee moves to consider OCR increases.

My read of the economic data is that there is a reasonable case for the MPC to validate quite a significant tightening in monetary conditions (I express it that way because both wholesale and, to some extent, retail rates have begun to move in anticipation).  I don’t think that is even a particularly difficult call.  I don’t base it on forecasts, but on where things stand right now (including, but again not to over-emphasise forecasts, how different things clearly are now from how most thought they would be late last year).     

What are the key variables in that story?  First, of course, is inflation itself –  but core inflation, not the (currently high) headline CPI numbers. On the Bank’s sectoral core factor model – a pretty smooth and persistent series – core inflation is now above the target midpoint for the first time in a decade.    That is a good thing –  (core) inflation should fluctuate around the target midpoint, and not have the midpoint treated as either a ceiling (as it seemed at times in the last decade) or a floor (as it sometimes seemed the previous decade).  But since the general sense was that it would take longer to get inflation back up, and we know policy works with a lag, it is a prima facie case itself for underpinning real interest rates at a higher level. 

And then there is the unemployment rate, at 4 per cent (for the June quarter, centred in May) down to pre-Covid levels.  I’m not going to run a strong independent view on what the NAIRU is for New Zealand but whatever it was a few years ago it is likely to be somewhat higher now, between things like higher benefit levels, higher minimum wages, higher statutory holiday provisions, reduced emphasis on getting people off benefits, and the disruption to labour-market matching from closed borders (both reductions in demand for certain roles and disruption in access to migrant labour).  To be clear, I’m not taking a view here on the wider merits of any of these policies, just noting as a macroeconomist that they are, taken together, likely to raise the unemployment rate consistent with stable inflation.

As it happens, in that same June quarter data we’ve already seen quite an acceleration in private sector wage inflation.  It could, I suppose, be random noise, but it doesn’t seem sensible now to assume so (given that it isn’t out of line with anecdotes, surveys or the unemployment rate itself).LCI private

Even if there is a bit of seasonality in the series, it is the highest quarterly increase since the peak of the labour market boom in the 00s –  when core inflation was definitely accelerating, and when there was still a bit more productivity growth to underpin wage increases than is likely to be evident right now (borders closed and all that).

June quarter data is centred on the month of May (SNZ survey throughout the quarter), but we also have the SNZ new monthly employment indicator that they take from hard (tax) data.  The number of filled jobs is reported to have risen by a further 1.1 per cent in the month of June. and in a series that goes back to 1999 there have been only a handful of months with faster growth in this series.  And over the last 22 years inward migration has mostly been quite strongly, adding to both demand for and supply of labour.  Since Covid, we’ve had consistent modest net outflows of people.    And yet according to SNZ there are now 2.1 per cent more jobs than there were at the end of 2019 (when the unemployment rate was also 4 per cent).  With fewer people here now than then (despite some natural increase), it all points to the unemployment rate heading lower again this quarter. 

Then, of course, there is inflation expectations.  In the Bank’s latest survey of semi-experts (I’m usually included, but somehow the survey email ended up in my Spam folder) , two year ahead expectations rose quite a bit to 2.27 per cent –  the highest the survey has recorded since June 2014.   Since shocks happen, these expectations measures aren’t great forecasts (nothing is) but as a read of how people are feeling and seeing things now they are what we have.

The Bank also does a survey of household expectations, which gets very little coverage. Again, there is no information in the survey on what future inflation will be, but what people think about inflation affects how they think about any specific level of nominal interest rates.  In the latest survey, a larger percentage of respondents expect higher inflation over the next year than at any time in the survey’s history.

household expecs 21

Point estimates –  which are harder for household respondents –  have also moved up quite a bit, for both 12 month and five year horizons.

It is a fairly elementary part of thinking about monetary policy that, all else equal, if inflation expectations move up and you don’t want inflation itself to go much higher, you want interest rates to move up at least as much as the expectations themselves have risen.

If I wanted to mount a counter-argument to my own case, I might cite –  as I often have over the years –  the breakeven inflation rates calculated using nominal and indexed government bond yields.   Very long-term breakevens are still well below 2 per cent (but have moved up) but using the 2025 indexed bond, implied inflation expectations for the next four years are now almost exactly 2 per cent –  not troublesome in a level sense, but far far higher than we were seeing pre-Covid.

The case for not acting now seems, frankly, threadbare.  Will the Australian economy be weaker this quarter and perhaps next?  To be sure, but it isn’t obvious there is a substantial impact on New Zealand (especially as travel flows were already very modest).  Sometimes there is a case for seeing how low the unemployment rate can be driven –  there was a good case for that for much of the pre-Covid –  but not when (core) inflation is already at or a bit above target, and most of the demand indicators suggest that core inflation would –  all else equal – rise further from here.

That doesn’t mean it is time to panic either.  Full employment and inflation near-target are good outcomes in themselves –  especially against the backdrop of the previous decade.  It isn’t time to over-react, or for whippings about how policy settings were too loose for too long, but simply for calmly and deliberately getting on with the job.

For me –  and given the rapid easing last year – that would mean a policy package tomorrow of (a) a programme of bond sales back to the market of $2 billion a month (which over two years would clean out the holdings), (b) a discontinuation now of the Funding for Lending programme, and (c) a 25 basis points OCR increase.

But if they don’t do either (a) or (b)  –  the former more symbolic on my telling than substantive, but wouldn’t be on their own –  the case for a 50 basis point OCR increase tomorrow looks pretty strong.  Not to foreshadow a string of future increases, but simply because we are at full employment, perhaps going beyond, and inflation is at or a bit above target, and perhaps looking to go beyond.  It would simply be a good solid sensible response to some good cyclical economic data (note that the structural fundamentals of the economy are as poor as ever, but that matters to the Reserve Bank only in, eg, interpreting wage inflation data).


Perspectives on New Zealand immigration policy

Several years ago the Law and Economics Association hosted an event in Wellington in which the New Zealand Initiative’s Eric Crampton and I each told our stories about New Zealand immigration policy. My account is here, and a link to the talk I gave is here.

A few months ago a couple of Victoria University of Wellington academics responsible for a Masters class (in a programme I didn’t even know existed (Masters in Philosophy, Politics and Economics)) invited us to do something similar for their class. We did that today.

My text (a bit fuller than what I actually used) is here (if Eric chooses to link to his slides on his blog I will include a link) (UPDATE: link here). My focus was solely on the economic dimensions of immigration policy, and in particular on the implications for economywide productivity (as the best proxy for whether large-scale policy-led non-citizen immigration has been beneficial for New Zealanders). My focus was primarily on the long-term programme, and entirely on the situation in normal times (ie I was not addressing the current Covid mess, which reflects poorly on the government but has no necessary connection to the appropriate medium-term approach).

My approach tends to start from a series of stylised facts about New Zealand’s economics performance in recent decades. This was the list I used this time.

But first, the gist of my story, which starts from a set of stylised facts about our economy.  Most of them are not in contention, even if the meaning and implications are debated:

  • New Zealand’s productivity growth has continued to languish, and even after the reforms of the 80s and early 90s (including a return to large-scale immigration) there has been no narrowing of the gaps. We’ve fallen further behind Australia, and increasingly behind central and eastern European OECD countries.  It would now take a two-thirds lift in the level of productivity to catch the OECD leading bunch,
  • Foreign trade as a share of GDP has stagnated, and this century has gone backwards. This in the new great age of globalisation,
  • New Zealand’s exports have remained overwhelmingly reliant on natural resources (whether agriculture, tourism or whatever).
  • Consistent with this, the rapid growth areas in our economy have been the non-tradable, not internationally competitive, sectors,
  • Also consistent with this, our real exchange rate has remained high, even as productivity has declined relative to other countries over decades,
  • Even as real interest rates have fallen, they have remained persistently higher than those in other advanced economies,
  • Business investment as a share of GDP has been weak (OECD lower quartile),
  • Indications are, globally, that if anything distance has become more important not less, with high value economic activity increasingly clustered in big cities near the major markets of the world,
  • Unlike what we see in the US and Europe, GDP per capita in by far our biggest city isn’t much better than that for the country as whole – if anything the gap has been narrowing.
  • Over the last few decades, no country has aimed to bring more migrants (% of population) than New Zealand did – although Canada and Australia have come close to matching us, and Israel too.   
  • OECD data show the NZ migrants also have the highest average skills levels (but still a bit behind natives) of migrants to any OECD countries.

Not one of the expected economywide benefits of a large-scale immigration promotion policy has shown up. Not one.   And we aren’t five years into this experiment, by 25 to 30.

I stepped through my standard arguments for why large scale immigration here may have been damaging to our medium-term economic performance. I noted that of the handful of OECD countries that have tried anything on the scale of New Zealand’s experiment (Canada and Australia and – in a slightly different context – Israel) none stands out as a productivity leader, and yet very little of the literature on the economics of immigration looks specifically at this group of countries. What isn’t always appreciated is that New Zealand has much more experience of large scale immigration and emigration (the latter, of nationals) than almost any other country – the sustained outflow of natives has been a thing since at least the mid 1970s, while our governments have actively promoted large-scale non-citizen immigration for all but about 15 years since World War Two.

When we’ve considered the economic performance over recent decades of the active immigration-promoting countries, and the countries experiencing outflows of their own people, the ball should really be in the court of the pro-immigration economists to show us, concretely, where and how large-scale immigration is lifting the productivity and incomes of the natives.   That is particularly so in New Zealand, given the disadvantages we can enumerate in advance – distance and continued natural resource reliance – and the signal implicit in the decades-long outflow of natives.

I talked about a number of other problems, and (in particular) gaps, in the existing literature before ending with this conclusion.

There might be all sorts of reasons for favouring high immigration – better ethnic restaurants[1], defence, a liking of big cities, or trains. If your country has prospered greatly, you might be happy to share the gains widely.  But the economic case for large scale immigration, as a way of boosting the productivity outcomes for natives in already advanced economies[2], looks thin at best.  Not many countries have run the experiment in modern times, notwithstanding the models that are claimed to support such an approach.  New Zealand has been at the forefront – actively promoting large scale immigration for all but 15 years since World War Two.  Unfortunately, New Zealand has had the worst relative economic performance of any advanced economy over those decades – we haven’t just come back to the pack, but now languish well down the rankings, have led the GDP per capita tables just 100 years ago (when abundant land, small population, and asymmetrically favourable technology shocks combined in our favour).

As I review the experience of advanced countries, if one wanted to take a punt on policy promoting large scale immigration (and few have) the best places to try look to be countries:

  • Close to the centres of global economic activity (whether Europe, North America, or East Asia),
  • Having experienced an asymmetric productivity shock – whether from the market or other policy reforms – favouring longer-term economic prospects in your country,
  • With economies with substantial reliance primarily on sophisticated manufactured products and high-tech services,
  • With their own people coming back home

And it looks like a highly risky strategy if your country is

  • Very far from anywhere,
  • Heavily dependent on (fixed) natural resources,
  • And has seen little sign of asymmetric favourable productivity shocks for your industries in a quite a long time,
  • Somewhere your own people have been leaving in large numbers

These look to be quite general insights.  And yet few if any of the countries that have three or four of the first characteristics have gone in heavily for policy-led immigration (perhaps Ireland or the UK might have been the closest- but UK immigration per capita was also about a third of New Zealand’s (per capita), and the UK is no productivity star).   Of the countries that went heavily for policy-led immigration, even Canada and Israel each meet only one of the three criteria – and neither can readily show the economic gains from large-scale migration. Australia and New Zealand meet none.

As for New Zealand, we can (sadly) tick all four items in that second class of conditions.  This was – and is – perhaps the least propitious advanced economy on earth to experiment with a large-scale immigration strategy.  And yet we did. If it was perhaps defensible in 1946, and optimistic in 1990, persisting now it just stubbornly wrongheaded, defying experience and evidence.    It isn’t quite as wrongheaded as a strategy to promote mass migration – however able the people – to Kerguelen, the Chathams or the Falklands, but not far short of it.  Australia has coped better with its experiment only because they were able to bring to market lots of natural resources previously lying idle.

It isn’t that people are any different here – locals or migrants.  And water still flows downhill.   But the opportunities just aren’t very good at all.  It is an old line but no less true for that: a definition of insanity is doing the same thing again and again and expecting a different result.  We’ve tried this one far too many times for our own good.

[1] I recall Eric Crampton once suggesting an Ethiopian quota

[2] The contrast, say, to the economic gains New Zealand Maori may have received from 19th C immigration.

Should have done better

A couple of months ago the Institute of Directors approached me about doing a talk to their members in Wellington on monetary policy as it had been conducted by the Reserve Bank over recent times. Somewhat to my surprise, my name had apparently been suggested to them by Alan Bollard.

I gave the talk this morning, and although the date was set ages ago it could hardly have been more timely given the labour market data yesterday, which in a way finally marks the completion of not just the last 18 months’ of monetary policy, but in some ways the last 14 years (for the first time since the 2008/09 recession we have core inflation a little above the Bank’s target midpoint and the unemployment rate back to something that must be close to the NAIRU.

The full text of my remarks, and a few more points I didn’t have time to deliver, are here

Monetary Policy in Covid Times IoD address 5 Aug 2021

What I set out to do was to review how the Bank had done, and what monetary policy had (and hadn’t) contributed over the last 18 months or so.  While I was quite critical in places, and headed the overall talk “Should have done better”, I was also willing to defend them, noting that the surge in house prices had little predictably to do with monetary policy, and was neither sought nor desired.

I’m not going to reproduce the full text in this piece, but here are a couple of sections from towards the end

The unemployment rate is now 4 per cent and the inflation rate – the sectoral core measure the Bank tends (rightly) to focus on – is 2.2 per cent.  Those are really good outcomes – first time in 10 years that core inflation had crept above the target midpoint.  After the last recession it took 10 years to get unemployment back down, not 10 months.

But those outcomes to celebrate aren’t much credit to monetary policy, since when the MPC was setting the policy that was having an effect now they thought their policy was consistent with much worse outcomes. 

But where to from here?  The MPC has belatedly terminated the LSAP.  They really should be ending the Funding for Lending programme, which was explicitly a crisis programme, a stop-gap for when they couldn’t cut the OCR further, and which was not operated on a competitively neutral basis.   But more likely the next step is the OCR.

One possible reason for caution is that coming out of the 2008/09 recession, central banks (and markets) were too keen to start getting interest rates back to what was thought of as “normal”.  The RBNZ made that mistake twice, and quickly had to reverse themselves.  But both times there was no sign of core inflation rising and the unemployment rates were still quite high, so quite different circumstances than we have now. 

[Figures 7 and 8]IOD2


Some will doubt whether 4.0 per cent is the lowest sustainable rate of unemployment but it is getting pretty close to the cyclical lows of the last two cycles (and some measures may have raised the NAIRU a bit).  Wage inflation is rising faster than at any time since 2008, at a time when there is no productivity growth.    But the real guide – especially amid considerable ongoing uncertainty – is core inflation itself.  If it is above 2 per cent, and no one thinks it is about to drop back, then it is time to start tightening – not necessarily aggressively (there is no harm if core inflation goes a bit higher for a while, as it is likely to do), not part of some predetermined programme, but step by step, review by review, keeping a close eye on fresh data.   They need to be tightening at least a bit faster than inflation expectations are rising (on which new data next week).  And since the world economy could be derailed again, and fiscal policy (here and abroad) may start tightening, and very long-term interest rates are still at or near multi-decade lows, be ready to stop or reverse course if the data warrant that.  The great thing about monetary policy is that when the data change, policy can be altered quickly and easily.

The same can’t be said for fiscal policy.  There are plenty of things only government spending can do.  For example, income support to those rendered unable to earn because of pandemic restrictions.  There are plenty of other programmes for which one might make a careful well-analysed and debated medium-term case for spending taxpayers’ money on.  But cyclical stabilisation policy is a quite different matter.    Many fiscal programmes are – rightly or wrongly – hard to get underway, and slow to start (many of those “shovel ready” projects), some are easy to start but hard to stop.  And almost all involve playing favourites, rewarding one group or another – with other people’s money – according to the political preferences of the particular party in power.   Fiscal announceables, once announced, are very hard to take back off the table. 

By contrast, the MPC can and does act overnight, it can reverse itself, and it coerces no one, and picks no winners. Market prices shift and people and firms make their own choices whether or not more or less spending is now prudent for them.  There has rarely been a better illustration of how much more suited monetary policy is to short-term cyclical stabilisation than the surprises of the last year.  

And an overall assessment

How then should we evaluate the MPC’s performance?

It is clear they were poorly prepared.  There is really no excuse for that. It was always only a matter of time until the next severe shock came along.

When they finally began to appreciate the severity of the Covid shock their actions were in the right direction. 

But they can’t be credited with the good outcomes we are now experiencing – inflation and unemployment – because when policy was being set last year they expected their policy to deliver much worse outcomes, and did nothing about it.  We can’t blame them for the economic uncertainty, but they should be accountable for their own official forecasts and what they did with them[1].

The overall contribution of monetary policy to how things have turned out was pretty small.  Mostly what has happened was down to private demand reorganising itself and holding up much more than expected – notably by the Bank – greatly reinforced by the really big swing into structural fiscal deficits. 

As for monetary policy, the OCR cut was modest, and the exchange rate barely moved. The Bank claimed far too much for the LSAP, which was more noise than substance, and in the process they fed a narrative (“money-printing”) that made trouble for them and the government.  If they really believe the LSAP is as potent as they’ve claimed, perhaps they could make a start on tightening by first selling ten billion of bonds back to market.

And if they accomplished little buying lots of long-term bonds at the very peak of the market in the process they have run up big losses.  They dramatically shortened the duration of the overall public sector portfolio and then rates went back up.  These are real losses – at about $3 billion currently, four times the cost of the Auckland cycling bridge, without even the sightseeing bonuses.

We can’t realistically expect policy perfection but we can and should expect authoritative, open, and insightful communications. But MPC’s communications have been poor:

  • They never published the background papers they promised.
  • They never explained their weird ‘no OCR change for a year’ pledge.
  • There has been no pro-active release of relevant papers (unlike the wider central government approach to Covid).
  • They refuse to publish proper minutes – that actually capture the genuine uncertainties and inevitable, appropriate, differences of view, and which would allow individual members to be held to account.
  • Little serious research is published, and insightful analytical perspectives are rare.
  • From not one of them have we had a single serious and thoughtful speech on how the economy and policy are evolving.

In its first major test, the best grade we could give the MPC “could try harder, needs to avoid other shiny distractions, can’t continue to count on good luck”. Oh, and just as well for them that the individuals aren’t on the hook for those huge losses.

As with so many of our public institutions now, we deserve better.

[1] Note that just under three months ago, in the May Monetary Policy Statement, the MPC unanimously concluded that “medium-term inflation and employment would likely remain below its Remit targets in the absence of prolonged monetary stimulus” going on to note that “it will take time before these conditions are met”.

Those huge losses they have incurred for the taxpayer in running the LSAP – which by their own lights would have been unnecessary if the Bank had been better prepared – have not had much attention. They should. Some are inclined to downplay them on grounds of “think of all the macro good that was done”, but as I argue there is little evidence the LSAP made any useful macroeconomic difference to anything. Others downplay them on the feeble grounds that if the bonds are held to maturity the bond portfolio itself will not realise any losses (bonds are paid out at face value). But we can already see the cash cost to the taxpayer beginning to loom rather directly. The LSAP was simply an asset swap – the Bank bought long-term fixed rate bonds, and issued in exchange variable rate settlement cash deposits, on which it pays the OCR. The strong consensus now is that the OCR is about to rise quite a lot. Even if the OCR rises by 1 per cent and settles there indefinitely, the Bank (taxpayers) will be paying out hundreds of millions a year in additional interest. Of course, it could avoid those payments by selling the bonds back to the market – which it should be doing – but that would simply crystallise the losses on the bonds themselves. The taxpayer is materially poorer for the poor policy and operational choices of the Bank – they could have focused on short-term bonds (which are the maturities that matter in New Zealand), they could have had the banking system ready for negative rates, but instead they choice the flamboyant performative signalling routine of buying huge volumes of long-term bonds at what was (reasonably predictably) close to the very peak of the market. All while accomplishing little or nothing macroeconomically.

In a couple of months we’ll see the last Annual Report from the Bank’s old-style board (to be replaced next year). The Board has spent 31 years providing public cover for management. It is hard to envisage them changing approach at this later date. They really should, but the fact that they almost certainly won’t tells you why it was such a poor governance approach (even if the government’s replacement model if something of, at best, a curate’s egg sort of improvement).

(Circumstances, data, and perspectives do change. Some, but not all, of my views have shifted over the 18 months – as I’m sure everyone else’s has. The text of another lecture on monetary policy and Covid, from last December, is here.)