Central bank digital currencies

Why have people used Reserve Bank of New Zealand physical notes?

The simplest, and almost entirely complete, answer is that almost 90 years ago Parliament banned any other notes, creating a statutory monopoly for the newly-created central bank. It wasn’t a necessary part of setting up a central bank – although it was a common restriction elsewhere too – but simply a political choice, not to out-compete the note offerings of the trading banks, but simply to outlaw them.

The Reserve Bank is currently consulting on a couple of documents, including one specifically on the possibility of them, at some stage in the future, beginning to issue an additional digital Reserve Bank liability (a “central bank digital currency”) that, in one form or another would be accessible to individual members of the public. Somewhat strangely, in all those many pages there is no discussion at all of how demand for their existing liabilities arose or was sustained.

I’ll come back to the Reserve Bank documents later in the post, but first I wanted to talk about a nice lecture on central bank digital currencies given, at a University of Auckland hosted event a couple of weeks ago by Professor Barry Eichengreen, a prominent US economist based at Berkeley. It was part of a post-APEC conference, so I’m assuming taxpayer cash went to getting Eichengreen – who can’t have come cheap and (surprisingly) didn’t seem (judging by Zoom numbers) to attract a vast audience. Anyway, the recording of his talk is here. (For anyone who wants some more reading, you might also consider Cornell professor Eswar Prasad’s new book, The Future of Money: How the Digital Revolution is Transforming Currencies and Finance.)

[UPDATE: One of the organisers kindly got in touch to tell me that not only was there no public money involved, but that Eichengreen provided his time free, in the interests of encouraging debate on these issues in New Zealand.]

It would be fair to say that Eichengreen is not a fan of central bank digital currencies (CBDC). He structured his task around five arguments sometimes made in favour.

The first is the claim that a CBDC might “be useful for improving the efficiency of payments”

But as Eichengreen noted, there are already lots of digital payments options (he cited Paypal, Visa, Apple Pay, and Venmo – the latter apparently good for peer-to-peer payments, at least if you don’t mind your payments being visible to everyone). Central banks apparently like to claim that they could offer a cheaper service (he cited various numbers for the cost of each the products he mentioned), but he argued that even if central banks charged lower headline prices (a) this would only be a social gain if, over time, they were really more efficient than private providers, and (b) it wasn’t at all obvious that payments technologies of this sort were, or should be, a natural monopoly. Not all payments media are accepted by everyone, or are used for all purposes, and in his view a “diverse eco-system” was likely to be more robust, noting (for example) the recent Facebook outage. It seemed unlikely, he argued, that over time central banks would be at the leading edge of innovation. Even if a CBDC co-existed with private payments media etc – which seemed the most likely scenario – then the savings to consumers would still be much less than was suggested by the headline numbers (he made quite a bit of the fact that a Visa card might involve an annual fee, but also provides a credit line, and the ability to block payments for defective etc merchandise, so a bundled product that can’t just be compared to a basic payments service).

The second argument sometimes advanced was that CBDCs should be issued to help keep control of the payments system, including visibility of payments flows/data etc. He didn’t find this story remotely convincing (and neither do I), pointing out that there are plenty of regulatory oversight and data-gathering powers that either exist already or could be put in place. He wasn’t unsympathetic, for example, to seeing stablecoin products regulated like banks.

Financial inclusion was the third argument Eichengreen addressed (it is one our Reserve Bank seems keen on). As Eichengreen noted, in the UK apparently 2 per cent of the population doesn’t have a bank account, a number rising to 7 per cent in the US. In principle, everyone could have access to a downloadable central bank “wallet”. Such a product might, it is argued, make it easier for things like Covid lump-sum grants to be distributed. He argued, however, that this was a solution in search of a problem, and that other methods are available – including (I suppose) that one might require banks to offer simple deposit/transfer products to all comers. (In a New Zealand context it seems even less likely to be an issue, since one can only get a welfare benefit with a bank account, suggesting that access to a basic bank product is not a major obstacle.

The fourth argument Eichengreen addressed was the idea that a CBDC – or a linked network of them – might enhance the cross-border payments system, which is still typically very expensive at the retail level.

But as he noted, other providers are already experimenting including (he said) SWIFT, and Visa & Mastercard are experimenting with stablecoins. Moreover – and I think was his more important point – it was hard to envisage a global governance (and security) model across 120 or more central banks and their CBDCs. His assertion was that “it won’t happen in our lifetimes” (he is 69).

The final argument that Eichengreen addressed in his talk was that CBDCs – presumably some international linked model – could be a vehicle for reforming the international monetary system (itself typically a shorthand for “reducing the dominance of the US dollar – itself with at least two dimensions (the denomination of foreign reserves, and the use by the US of the dominant position of the dollar to impose and maintain sanctions). The model being addressed here seemed to be some very ambitious international model – and thus not very relevant to the New Zealand discussion – in which the IMF might issues something akin to the SDR, backed by a basket of national CBDCs with similar weights to those for the SDR). Some have argued that such an instrument might be attractive for holding foreign reserves.

He noted that the US Congress would be unlikely to agree to such issuance, but even if it did it simply wasn’t obvious there was the demand. The SDR itself never lived up to expectations and serves now as little more than a disguised system of foreign aid from time to time. There are few SDR-denominated products and the SDR is no one’s natural habitat. As he noted, the initial Facebook proposal for LIbra had been based on the idea of a basket of currencies, but that had now been scrapped and the current proposal is for a dollar-linked stablecoin.

At the end of his talk, Eichengreen’s summary observation was that “the case for CBDCs remains to be made”.

An interesting q&a session followed. Former Reserve Bank Deputy Governor Grant Spencer asked Eichengreen if he saw any arguments for a CBDC. Eichengreen’s response was that there were no strong arguments in favour, that the financial inclusion arguments were “all specious”, and that a range of private payments options already provided a superior mix of services. Spencer followed up asking about a scenario in which private and CBDC solutions co-existed. Eichengreen’s response was that one would need a proper cost-benefit analysis, but that he still wasn’t convinced of the case, noting risks such as botched software updates, hacking of central bank systems, and concerns about disintermediating commercial banks and increasing the risk of bank runs.

Another questioner asked about Eichengreen’s preference for regulation over direct central bank provision, noting “repeated failures of bank regulation”. In response, Eichengreen noted the concentration risks if a CBDC became a dominant product [as central bank notes did], but did note that there was no ideal solution and inevitably regulators would struggle to keep up.

A questioner asked about the US sanctions issue. Eichengreen repeated his scepticism that CBDC could make much difference any time soon, and noted that there were other innovations that were perhaps more likely to reduce the salience of this issue (apparently China is currently developing an alternative to SWIFT.

There followed a private roundtable session. I won’t write much about it because the Chatham House rules were so tight that I can’t even tell you who was speaking. But one speaker did take the opportunity to push back on the notion that CBDCs would increase the risk of bank runs, and should not be adopted for that reason. This speaker made a point (I have long shared) particularly vividly that the way to deal with the risk of a panicked rush out of a crowded theatre was not to bolt the doors, adding that avenues for runs had in any case increased enormously in recent decades and (for example) much about the 2008/09 crisis was wholesale runs. Perhaps the most I can say is that people closest to government agencies seemed most upbeat about what value a government product might add.

What of my own position? It is probably a bit more open to the possibility of a CBDC than you might expect, even as I don’t regard it as a high priority, and am a bit surprised at the resources the Reserve Bank is putting into the issue, even as it has done nothing about dealing with the effective lower bound o nominal interest rates that arises (at present) solely because of (a) the Reserve Bank’s monopoly on the note issue, and (b) its standing offer to convert settlement cash to physical currency at par. That still looks likely to be a big problem in the next serious economic downturn brought on by a persistent or sustained slump in demand.

But, for what it is worth (and I will try to flesh some of this out in a submission in the next few days, which I will post here in due course), my approach is that if banks have access a central bank (risk-free) digital form of the New Zealand dollar (as they do, through exchange settlement accounts), the public should have access to something similar. When I was a central banker, I used to strongly favour open access to exchange settlement account services, and although that wasn’t quite the same thing, it was consistent with this philosophy that we should not be privileging banks (or financial services providers or large players). It is also the only reason I favour the Reserve Bank being open to offering a CBDC. They will never have a technological advantage. Financial inclusion arguments don’t wash (in New Zealand). So-called monetary sovereignty arguments also don’t wash – the issues there are much more about what currency people contract labour in than what products payments are made with. But there is a reasonable case for a barebones safe digital store of value.

But – and here we come back my introductory remarks about why we have used Reserve Bank notes for decades – I don’t believe there would be much demand for such a product. Why would there be? Most people are clearly content to take a modest amount of credit risk and deal in bank liabilities. Most of us give little thought to the modest risk in holding bank account deposits and using those accounts to make most of our payments. Moreover, banks often market bundled products that no central bank would or should be competing with. For particularly risk-averse savers the government has long offered Kiwi Bonds, but very few people buy them. So whether as store of value or means of payment I see no reasons to suppose that a New Zealand CBDC – issued in a country with one of the best-capitalised banking systems on earth – would find many takers. Perhaps I might get myself an account as a curiosity, but I couldn’t imagine using it at all (actually in days one by the Reserve Bank used to offer cheque accounts to its staff, and I kept that account mainly as a curiousity and talking point).

What of the risk of runs? Well, as already noted there are lots of ways to run, and it isn’t obvious we should make it harder for ordinary people than for large investors. More to the point, runs are often quite rational, and the potential to run can be a valuable market discipline. In fact, signs that people were beginning to move into a CBDC might offer some (small) further useful information for bank supervisors. We can’t worry endlessly about moral hazard and assumptions around too-big-to-fail, and still lament products that might enable people to better respond to changing perceptions of individual bank risk.

There is no real analysis of the likely demand for a CBDC in the Reserve Bank material (and not much discussion elsewhere that I’ve seen), assuming governments didn’t try to corner the market for a new central bank product. But if I’m right about the limited demand, it would enable us to set aside one of the real concerns some have raised about a marked increase in the size of central bank balance sheets: we do not want central banks in the business of allocating credit in the economy, by their choices about what assets to invest proceeds of their currency issuance in. If there were no additional demand, it wouldn’t be an issue.

Were I a central banker, however, one concern I might still have – and again the Bank doesn’t appear to treat it – Is the potential for the central bank to be caught up in questions of who should be allowed an account.  Cash is anonymous.  Central bank bank accounts are not. When “the mob” looks askance on some person or group, it isn’t hard to envisage demands coming from some quarters for this that or the other group to be denied access to a CBDC. Even if the Bank successfully resisted – in an open society surely accounts would have to be open to all – it is the sort of controversy they might well prefer to avoid.

That is probably enough for now. I hadn’t thought much about these issues for a few years, but was pleasantly surprised to find that the views expressed in this 2017 post seem fairly consistent with those in this post today.

UPDATE: My submission

Central Bank Digital Currency submission 4 December 2021

Not really up to the job

I was tempted to head-up this belated MPS post “Je ne regrette rien”, as that – I regret nothing (about last year’s monetary policy) – was what Orr told yesterday’s press conference as he was getting rattled towards the end. He should regret quite a bit – notably the $5.7 billion of taxpayer losses on the LSAP, and the ongoing huge risks (neither were points he was willing to engage on, whether in the MPS, in the press conference, or at FEC this morning – indeed he actively played distraction). But that isn’t really where I want to focus my thoughts on the Monetary Policy Statement.

I thought the MPC should have raised the OCR by 50 points. The MPC disagreed, and moved by only 25 points. That is their choice of course, but – once again – I was struck by just how lacking and inadequate the supporting analysis and argumentation were, on their own terms (ie relative to their own published forecasts). No informed reader – and there won’t be many other readers of their 56 pages – will have come away feeling persuaded by the insights and analysis the Bank’s big team of macroeconomists had generated. There was nothing new or insightful, at least that I could see. And much that wasn’t convincing.

As I’ve noted on various previous occasions, when there are big starting point surprises, surely we expect to hear from the MPC (a) why they think they got things wrong, and (b) what that mistake – and mistakes are inevitable in such areas – has taught them about how the economy is behaving and how, if at all, it changes their view about the road ahead. But once again, there was none of that (in fact, in the press conference again played distraction suggesting that the surprise was the lockdowns after August, whereas the September quarter unemployment and (core) inflation surprises really had nothing much to do with those lockdowns (which will, of course, have a big impact on September and December GDP). Their August projections/discussion had suggested something fairly unproblematic on core inflation, and instead they suddenly found themselves with outcomes near the very top of the range, and so on.

Their discussion of inflation expectations also lacked structure, consistency, and any sense of authority. In the minutes of the MPC meeting we were told

The Committee noted that near-term inflation expectations tend to move with actual inflation. Medium-term measures provide a better gauge of whether inflation expectations remain anchored, and these remain close to the target midpoint.

The message seems to be one of nothing to worry about at all. But even the story is misleading, at best. It is certainly true that year-ahead survey measures of inflation expectations seem to be very driven by fluctuations in headline inflation, but here is the two year ahead measure (from the Bank’s own survey) lined up against their (historically) preferred – and most stable – measure of core inflation. Inflation expectations – over almost 30 years – have typically fluctuated through materially narrower ranges than core inflation itself. The exception – potentially important exception – has been the last two years. If anything, the two year ahead expectation could be disconcertingly high already, given the extent of the rise in core inflation itself.

core and expecs

Then there is that claim that all is fine because long-term inflation expectations haven’t changed much. The Bank asks about expectations five and ten years ahead, and outcomes are not far from 2 per cent – as you would hope, given the target, but only because respondents presumably expect the MPC to act sufficiently aggressive to keep inflation near the centre of the target range. If those five and ten year expectations started moving up sharply there really would be cause for concern, but the fact they are still near 2 per cent shouldn’t be telling MPC anything about the appropriate policy stance now.

At the press conference one offshore questioner asked the Governor about the MPC’s response to the big increase in inflation expectations, given the Risk Appetite Statement included in the MPC in which they asserted that “they had a low appetite for policies or decisions that could cause inflation expectations to become unanchored”. This was greeted with a glib and dismissive response from Orr along the lines of “we have reacted and raised the OCR”, not even engaging with the fact that (for example) two year ahead expectations are now a full per cent higher than they were in February, and yet the OCR has been increased by only 50 basis points over that time, there isn’t another review until February, and the MPC has stated that they prefer to move in 25 point bites. At best, it will be the end of March before the OCR will have been raised by 100 basis points, but even that won’t have raised real interest rates at all relative to the start of this year (let alone relative to the start of last year). Perhaps expectations will have moved even higher – outside the target range in the meantime. Perhaps not, but surely we should have expected a more thoughtful nuanced and engaged treatment of the issues and risks? Core inflation has, after all, already increased a lot (and – which we will come to – even they seem to expect it to increase further).

Similarly, we are told that the Bank’s projections have the OCR rising to above (the Bank’s estimate of) the neutral OCR. They seem to base that on this portrayal of neutral.

neutral nov 21

But this chart seems not to have taken any account at all of a jump in inflation expectations. The Governor said they mattered – and that the Bank had responded – but there is no sign they do so in this estimate of neutral. Given the Bank’s inflation forecasts it seems unlikely that medium-term inflation expectations will be dropping any time soon, and if those survey numbers are capturing something real, doesn’t that mean the OCR needs to go (quite a bit) higher than they might otherwise have thought. Now personally I’m very sceptical of the value of medium-term projections, but it is the Bank that uses them as a storytelling device and yet quite a material (and identifiable) part of the story seems to be have been left out.

And so it goes on. The best question I’ve heard about yesterday’s MPS was from a first year economics student, who wanted to know how the Bank could claim to be fulfilling its mandate when it projects that inflation next year will be 3.3 per cent. I haven’t seen any attention paid to what that number means. Recall that it is now November 2021. Nothing about the year to December 2022 has happened yet. So the Bank’s forecasts for inflation next year must be very close to a forecast of core inflation (they don’t know the inevitable one-off shocks – up or down – and they assume the exchange rate is fairly stable). Core inflation is currently about 2.7 per cent and the Bank is quite content to see it rise to 3.3 per cent – outside the target range. When a press conference questioner asked a similar question, she again got a dismissive (and obfuscatory answer). It might be one thing to take things slowly if the unemployment rate was still lingering high, but the Bank is quite open that at present the unemployment rate is below a sustainable level. So raising the OCR more and more quickly wouldn’t be kicking the economy into recession – the Governor’s claim – but would just get both dimensions of their dual mandate back towards desired levels sooner (and with less risk to those pesky inflation expectations). As it is, the Bank’s forecast for the unemployment rate in March 2022 is a tough lower than it was in the latest official release. This is an economy that – on their numbers – has been overheating, and they can’t even manage of Taylor principle scale of response, not even when the unemployment rate is – on their telling -unsustainably low. Perhaps there is a case to be made for their choice, but neither the MPC nor the Governor made it.

I could go on at some length on other matters, but just a few bullet points instead:

  • it is sobering to see how pessimistic the Bank now is about productivity prospects  (0.5 to 0.6 per cent for annum across the forecast horizon).  The Bank has no particular expertise in productivity, but they just now take for granted our woeful performance
  • it was curious to see a lengthy Risk Appetite Statement in the document.  Doubly curious in that more space was given to (for example) the risk of an MPC member missing a meeting than to (nothing at all) the huge financial risks decisions like the LSAP programme expose the taxpayer too,
  • the Bank is all over the place on the LSAP (all while refusing to seriously address the losses, just waving the hands about “overall gains).  They seem oblivious to the international research that suggests the stock of bonds held is what makes any useful macro difference, asserting that the programme was previously making a big difference, but now makes only a small difference.  And once again they refused any serious answers about the future of the LSAP, claiming that a document is coming in February.   Similarly, they make laughable claims about why the Funding for Lending Programme needs to be kept open, Orr even suggesting to FEC that were they to close this crisis tool now (a year or more after the crisis) it might pose a future financial stability threat,
  • there were pages and pages on climate change.  As far as I could tell, all they seemed to focus on was direct price effects, and even then had nothing to say other than “some relative prices will rise”.  No doubt and –  by definition –  others will fall.  Orr claimed there was going to be unusual volality in headline inflation relative to core, but offered not a shred of analysis in support of his claim (we’ve had lots of shocks and policy reforms in decades past).  And, somewhat surprisingly, they didn’t even touch on any effects on the neutral interest rates –  if there is any effect (and I suspect that any effect will be vanishingly small) it is likely to lower neutral rates a bit.
  • remarkably, there was almost nothing in the document offering insights based on the experiences of other countries.  Again, with a big team of economists and access to overseas central banks you’d hope that the Bank’s thinking would be informed by the diverse experiences other central banks are observing.  But there was nothing.   

All in all, it was a fairly typically poor Reserve Bank performance, perhaps undershooting even my low expectations.  It was good that some questions were asked –  at the press conference and at FEC –  about the high turnover at the top of the Bank, even if Orr was allowed to get away much too easily with ludicrous claims about what a desirable place the Bank was to work, what an abundance of talent they had available etc etc.  It certainly wasn’t on display in this document.   

(On the turnover question, one almost had to feel sorry for the Chief Economist who has been restructured out:  asked by MPs about what was going on Orr rashly talked about how Yuong Ha “has chosen to go into a far more challenging role. What are you going to be doing?”  There was a noticeable, whereupon Ha lamely responded “Coaching my son’s cricket team. Taking a break”.   Orr seemed to display all the sensitivity and personnel management skill of, say, a Judith Collins.)

Interest rates

The Reserve Bank Monetary Policy Committee has had an unchanged membership for its life so far, but tomorrow’s decision (and MPS) will be the last for this group. The Deputy Governor Geoff Bascand moves on in January, the Chief Economist moves out in February, and the terms of two externals expire shortly thereafter (although one or both could be reappointed). On those changes, interest.co.nz had an interesting article yesterday which more or less confirms that the chief economist had been restructured out as the Orr permanent-revolution (at least until he finds a suitable mix of lackeys) rolls on, reports on Orr openly insulting a fellow speaker at an event they were both speaking at, even as it ends up (seemingly) trying to retain at least a little RB favour/access with this line

Nonetheless, Orr is community-minded and isn’t afraid to stand up to those with corporate interests, who spinelessly try to discredit their regulator by attacking his personality.

In days gone by surely a sub-editor might have questioned the unqualified unsupported used of a term like “spinelessly”, especially when it is well known that Orr has been on record abusing people who criticise his approach or policies, including those with no “corporate interests” whatever.

Critical as I am of Orr (in particular) and the upper levels of the Bank more generally, I continue to more or less expect them to do “the right thing” on basic monetary policy stuff. It won’t be well done, it won’t be well-communicated, it won’t typically be supported by robust or insightful analysis, but this group don’t seem like the sort who are going to wilfully let core inflation get away on them. That must be a pretty common view, because although shorter-term inflation expectations (measured in the Bank’s survey of semi-experts etc) have increased markedly, five-year ahead expectations are little changed from where they were 3 or 4 years ago.

Were I in their shoes I would increase the OCR by 50 basis points tomorrow. There are really two reasons for that. The first is simple: there is not another review until February (because a few years ago the Bank rashly decided to give its monetary policy function a long summer holiday). With two reviews during that period perhaps it might have been okay to have done two 25 point moves (not that there is any particular problem with 50 point changes, especially when the possibility is openly being canvassed). But there is also the underlying macro situation. Core inflation took the Bank by surprise a lot over recent months, and if it is not now outside the 1 to 3 per cent target range, neither is such an outcome that should be contemplated lightly. And inflation expectations measures have moved up a lot. There is no guarantee that the numbers reported in surveys are actually the numbers firms and households have in mind when they themselves are transacting, but it wouldn’t be wise to jump to the conclusion otherwise. Here is the two year measure.

2 yr ahead nov 21

The level of expectations is back to around the peaks in the 00s (prior to that the target itself was lower) and the increase over the last 12-18 months has been sharp. Early last year we needed lower nominal interest rates just to stop real rates rising. Now, we need rising nominal rates to stop short-term real rates falling – such falls would be undesirable in a climate of full employment and high/rising core inflation. One of the basic precepts of inflation control is that, all else equal, short-term rates need to be increased (decreased) as least as much as any rise (fall) in inflation expectations. Since even a 50 basis point increase tomorrow would only take the OCR back to where it was at the start of last year, and on almost every measure expectations are materially higher than they were then – and core inflation itself is much higher – the prudent response would be a substantial increase in the OCR now.

And I say that as someone who is quite open-minded about where the OCR gets to next year and beyond. As a matter of general principle I don’t think forecasting beyond the next quarter or two makes much sense, and the pandemic uncertainties here and abroad only compound that (we still have no firm take on output losses in the September quarter and it will be December next week). But not all the straws in the wind necessarily point in the direction of repeated or substantial further increases. It isn’t obvious that the wider global environment is persistently different – in ways that would support higher neutral real interest rates – than it was two years ago (and recall that global policy rates were being cut in 2019), fiscal policy (here and abroad) seems more likely to be a contractionary influence (fiscal impulse) than an expansionary one over the next few years, and for New Zealand reopening borders could still be more of a drag on domestic demand than a boost, at least for as long as it is very difficult for Chinese tourists to travel. Government policy generally is hardly set to promote a sustained acceleration in productivity growth (and associated investment) – if anything, we will be lucky to avoid a worsening set of outcomes. And if you believe in housing wealth effects – I don’t at an aggregate level – there could be some drag from that source next year. And so on. 50 points now and then approach each review next year with a genuinely open mind seems to me the most sensible, and prudent, approach.

For all the talk of how low interest rates are at present, it is worth remembering that New Zealand rates remain high by international (advanced country) standards. Very long-term interest rates – one silver lining to the higher government debt is that we now have a few more indicators – are the best place to look, abstracting from short-term cyclical effects.

As of yesterday, our 30 year government bond rate was 2.93 per cent. The comparable US rate was 1.91 per cent. The inflation targets in the two countries are all-but identical (over horizons like that) and the US has a far worse public debt position – actual and outlook than New Zealand. And the US is, by advanced country standards quite a high interest rate country: the German government 30 year bond yield is about 0.0%.

What about real interest rates? The market in inflation-indexed bonds is less deep but the amounts on issues are not now small. The longest New Zealand indexed bond has 19 years to maturity, and yesterday was yielding 0.71 per cent. By contrast, a US 20 year inflation-indexed bond was yielding about -0.71 per cent (30 year indexed bonds were yielding -0.52 per cent). But, to repeat, by advanced country standards the US is a high interest rate country. Germany has a 30 year inflation-indexed bond currently yielding -1.98 per cent.

These are really large differences, which have implications for how we think about the exchange rate: expected risk-adjusted returns tend to equalise across countries through the exchange rate, and whether the difference is 100 basis points (on a 30 year nominal bond) or 140 basis points (on a 20 year indexed bond) they point towards an overvaluation relative to the USD of perhaps 30 per cent, and something even larger relative to the euro. You’ll recall that New Zealand exports and imports as a share of GDP have been increasingly sluggish this century. There is a connection.

The bond yield differences have been around for a long time and show little sign of closing on any sort of sustained basis. You might think there was some evidence to the contrary for the US, at least if you look just at the most-common comparison, that of 10 year nominal bond rates.

us and germany

But for some years now both countries have had 20 year inflation-indexed bonds (the US numbers are the US 20 year constant-maturity yield, and for New Zealand the closest of the 2035 and 2040 bond yields).

20 yr yields

Our rates did look to be converging on those of the US for a time – by the time we went into Covid US short-term rates were much higher than those in New Zealand (and even more so relative to most other advanced economies). But as emerge, the gap now seems to be right back to where it was (the last observation on the chart is a spread of 1.41 percentage points). It is a really large difference, and not at all out of line with differences (New Zealand rates higher) than we’ve experienced over most of the last 30 years.

These are differences that cannot reflect default risk or (credibly) inflation risk. They seem to reflect differences – actual and expected – in the savings/investment pressures in the two economies, which in turn explain the respective neutral interest rates (ie rates consistent with inflation being at target while the economy is fully employed).

Finally, a chart that intrigued me when I generated it, but in which I don’t place much confidence. One advantage of a wider range of government bonds is that one can back out of the resulting yield curve implied forward interest rates. Thus, with 2035 and 2040 indexed bonds, one can back out the implied 5 year real rate for the period between 2035 and 2040 (ie far into the future, and not influenced – in principle – by current cyclical pressures, or even current members of the MPC or current government ministers).

Yields on both bonds look very low at present (0.56 per cent and 0.71 per cent yesterday), but what about that implied five year forward rate? Here is that chart for the last few years.

implied forward 5 year rate

Earlier in the year it might have looked as though the “new normal” might have been expected to involve much higher real rates in the medium-term future. But as things stand right now, the implied forward rate is just a bit lower than it was in early 2020. I’m reluctant to put very much weight on this – thin market, quite sensitive to small changes in individual 2035 and 2040 yields etc – but for what it is worth – and for now – markets seem to be pricing a medium-term return to the sorts of real interest rates (strangely low, in many ways) we had a couple of years ago.

Markets have, of course, been known to be wrong (often), but I don’t feel blessed with the insight to offer a view on whether this implied view is right or wrong, let alone whether if it were to be wrong, in which direction any error might be. Used as we are to positive real interest rates, there is nothing natural or inevitable about them.

Lally’s paper on a cost-benefit analysis of Covid vaccine “mandates”

Earlier in the week I did a post that included economist (and former Victoria University academic) Martin Lally’s sketch outline of an approach to thinking about applying cost-benefit analysis techniques to Covid vaccine “mandates”. In that post I included a few suggestions, questions, and thoughts on aspects of Lally’s note and the wider issue of coercion in a Covid context.

Since then, Lally has extended his note into a fuller short paper. I offered to make it more widely available here


Here is his Abstract


Covid-19 vaccine mandates for the general population must trade off the rights of those who object to being vaccinated against the costs that the unvaccinated impose upon the vaccinated, most particularly the increased risk to vaccinated people of death by covid-19.  This paper provides a methodology for doing so.  It is then applied to the case of New Zealand.  It reveals that even if the adverse impact of penalties on vaccine objectors (at least some of whom may have rational grounds for objecting) is as small as a reduction in their quality of life of 1% per year for a period of five years and the existence of unvaccinated people is entirely responsible for covid-19 infections amongst the vaccinated, the number of additional deaths amongst the vaccinated resulting from not adopting a vaccine mandate is too few to justify a policy of mandating.  However, unlike the general population, health workers come into frequent and close contact with large numbers of sick people, who are prime targets for covid-19, and therefore the vaccine mandate may be justified for these workers.

The paper largely speaks for itself. Lally lays out his assumptions (and sources) quite clearly, so anyone who disagrees can identify where (specifically) their disagreement arises and what alternative assumptions/approaches they would use.. As per the Abstract, he concludes that cost-benefit analysis does not support vaccine “mandates” in general, but one of the extensions of the earlier note is to explore the specific case of health care workers where his numbers suggest a cost-benefit analysis for compulsion may stack up. There is also a section at the end exploring the risks and incentives facing the young and the old faced with the offer of the vaccine.

To me, the most interesting part of the paper was his attempt to estimate how many lives (among the vaccinated) would need to be saved by coercing part of the population to be vaccinated to make such a policy pass a cost-benefit assessment. On his numbers (you can read the reasoning in the paper)

So, vaccine mandating would be warranted only if failure to do so leads to a pool of unvaccinated people who thereby induce at least 5,200 additional deaths from covid-19 amongst the vaccinated. 

And how likely is that?

I now consider whether at least 5,200 additional such deaths amongst the vaccinated could occur.  The worst case scenario for the 90% of the over 12s who vaccinate without mandating (4.2m*0.9 = 3.8m) is that they are all infected as a result of the existence of the unvaccinated people who might be induced into vaccinating.  In the absence of an effective vaccine, the proportion dying is the Infection Fatality Rate (IFR).  Recent surveys suggest figures of 0.3 – 0.4% for Europe and the Americas (Ioannidis, 2021, page 10), and 0.70% for Europe and 0.58% for the Americas (Meyerowitz-Katz and Merone, 2021, Figure 2).  The midpoint is about 0.5%, which implies 3.8m*0.005 = 19,000 dead.  However, this IFR relates to the entire population rather than only those over 12, and the latter IFR would be higher because the IFR is monotonically increasing with age.  Correction for this raises the IFR for the over 12s to about 0.60%.[1]  This implies 3.8m*0.006 = 23,000.  The vaccines reduce the risk of death by 85% to 88% on average over the first six months but rapidly wanes beyond that point (Nordstrom et al, 2021, Table 2 and Table 5).  If a booster is used at that point, the average reduction in the death rate would then be at least 85%.  This implies 23,000*(1 – 0.85) = 3,400 deaths amongst the vaccinated. 

This is the worst case.  It is inconceivable that all of the 3.8m vaccinated would be infected.  Amongst those infected, it is inconceivable that all would be infected as a result of the pool of unvaccinated people, i.e., some of the vaccinated would be infected even if there were no unvaccinated people because the vaccine does not eliminate the risk of its recipients transmitting the virus and therefore vaccinated people could be infected by other vaccinated people.  In fact, all of the vaccinated might become infected even if the unvaccinated pool did not exist, through the virus transmitting through the vaccinated.  Amongst those vaccinated who were infected as a result of the unvaccinated pool, some would be infected as a result of the vaccine objectors who will not succumb to the penalties, and a mandating policy cannot eliminate this group.  Taking account of all three of these points, the additional covid-19 deaths amongst the vaccinated in the absence of vaccine mandating would be significantly less than 3,400.

[1] Steyn et al (2021, page 14) cites age-related IFR data from Verity et al (2020, Table 1) and matches it to the New Zealand population proportions by age groups, which implies an IFR of 0.95%.  The same data can be used to estimate the IFR for the 12+ group, at 1.13%.  Both figures are unreliable because they are based upon IFR data from March 2020 from only one paper (Verity et al, 2020) rather than from recent surveys of the literature (as with Ioannidis, 2021 and Meyerowitz-Katz and Merone, 2021).  However, the increase of 19% (0.95% to 1.13%) can be applied to the preferred IFR estimate for the entire population of 0.5%, to yield 0.6% for the 12+ group.

It is quite simple, but illuminating, reasoning.

My point in running this post, and hosting Lally’s paper, is not to endorse all his reasoning or his conclusions. But it seemed like an interesting attempt to look at the issues rigorously – in a way that there is no sign officials and ministers have – which deserved to be available to a wider audience.

$5.7 billion

A few weeks ago I wrote a fairly discursive post on the losses the Reserve Bank had run up on its Large Scale Asset Purchase programme. I know some readers found the basic point a little hard to grasp (no doubt a reflection on my storytelling), so today I’m going to do a very stylised representation of what has gone on.

But first, as I noted in that post, as market interest rates rise losses mount. The Bank has now released its end-October balance sheet and this is the line item representing their claim on the Crown (the Minister of Finance indemnified the Bank for losses incurred).

lsap losses

So the losses have now reached $5.7 billion (roughly 1.6% of annual GDP). Market interest rates fluctuate each day, but as of yesterday’s rate current losses are likely to be very similar to those as at 31 October. Perhaps Covid has inured us to big numbers, but these are really large losses, which were quite avoidable.

Now I want to step you through a very stylised illustration of roughly what has gone on.

A severe shock hits (call it Covid, but it could be anything) and the government determines that it needs to run a large fiscal deficit. Say that (cash) deficit totals $70 billion. The government finances that deficit prudently by issuing (selling) long-term bonds, issuing $70 billion at par, and thus raising $70 billion in cash.

Once the government has borrowed and spent, its bank account balance (at the Reserve Bank) isn’t changed. And after recipients of the deficit spending and purchasers of the government bonds have all made their transactions, the aggregate balances held by banks in their settlement accounts at the Reserve Bank also haven’t changed.

But now assume the Reserve Bank enters the fray, deciding that it will launch a large scale bond purchase programme, in which it buys $50 billion of long-term government bonds (for simplicity, assume the same bonds the government just issued on market). The Bank pays for those bonds by issuing on-call liabilities (settlement cash balances), on which it pays the OCR interest rate.

What does the Crown’s overall debt exposure look like under those two stages?

Financing the fiscal deficit

Floating rate debt held by the private sector (settlement cash) $0

Long-term government bonds held by private sector $70bn

Add in the effect of the LSAP

Floating rate debt held by the private sector (settlement cash) $50bn

Long-term government bonds held by the private sector $20bn

The total amount owed by the Crown (government plus Reserve Bank) is $70 billion in both cases, but the risk to the Crown is substantially different.

The emergency having finished (by assumption in this stylised example), the Reserve Bank now has two choices. It can hold the bonds it purchased to maturity or it can sell them back to the market. One choices closes out the risky position they chose (rightly or wrongly) to run during the emergency, while the other leaves it running (for years).

Now assume that market interest rates rise sharply, across the curve (so long-term bond yields rise but so – perhaps gradually – does the OCR itself.

When market interest rates rise, the market value of a portfolio of long-term bonds falls. That is what has happened in New Zealand over the last year or so, reflected (in respect of the LSAP portfolio) in the chart at the start of this post.

If the bonds were sold back to the market, the Reserve Bank (and Crown as a whole) would realise less on the sale than they paid for the bonds. On present rates, a lot less. Selling the bonds back to the market would, however, restore the balance sheets as under the “Financing the fiscal deficit” scenario above. The private sector would hold no floating rate government debt (settlement cash) but lots of long-term bonds. All the risk would be with the private sector, although the Crown would have crystallised the large loss it let the Reserve Bank run up.

But what if, instead, the Reserve Bank just stuck the bonds in the bottom drawer and held them to maturity (last maturities not for 20 years)? The bonds would mature at par, and there might be little or no claim under the indemnity (depends on the initial purchase price relative to the face value). But, if things play out as current market prices envisage, the OCR would rise by quite a lot and (on average) stay much higher over the remaining life of the portfolio. Since the Bank is still holding the bonds, settlement cash would also stay high, and the Bank pays the full OCR on all settlement cash balances. Under that scenario, the Reserve Bank – having issued lots of floating rate debt, and having no matching floating rate asset – will be up for much higher interest costs.

Either way, the Crown (the taxpayer) has lost a great deal of money. If market rates play out as the yield curve currently predicts, either there will be a large payout under the indemnity, or the Reserve Bank’s future dividends to the Crown will be reduced. But the loss has already happened, it is just a matter of how it ends up being recorded/realised. $5.7 billion dollars of it. The Crown could probably have funded quite a few ICU beds for quite a few years with that sort of money…..but it has gone.

You’ll notice that I bolded some words in the previous paragraph. Even if the best estimate of future short-term rates is something like what the market currently prices, that is a very weak standard, and it is exceptionally unlike that actual short-term rates will follow exactly that path. They could be lower, but they could be higher (perhaps quite a bit higher or lower).

If the Reserve Bank sold the bonds it holds back to the market we (taxpayers) wouldn’t need to worry. The overall Crown would be back to having funded itself with long-term debt, and fluctuations in rates wouldn’t affect us (at least unless/until the bonds need rolling over years down the track).

But if the Reserve Bank keeps the bonds, we (taxpayers) keep the risk. Having had them drop $5.7 billion of our money so far, they keep the position open. From here, they could make us a bit of money, or they could lose a bit of money (well, actually “a lot” in either direction). But there is no obvious reason to have some bureaucrats speculating on bond markets – because that is what the LSAP portfolio now purely is – at our risk. It isn’t even as if these people – the MPC – have some demonstrated track record of generating attractive Sharpe ratios (returns relative to risk) for their punts. And if as individuals we do want to take punts, the market already has products for us.

Perhaps the key point here is that the $5.7 billion has already gone – that is what mark-to-market accounting measures – but the risk remains. From here we could lose another (say) $5.7 billion, or make a great deal of money, but there seems to be no effective accountability, for activities which – at this point, well beyond the crisis – is simply not a natural business of government. Monetary policy in a floating exchange rate system like ours normally involves next to no financial risk to the taxpayer.

Are there caveats to all this, or alternative approaches?

One possibility is that the government chooses to neutralise the risk the Reserve Bank continues to run. They could do that relatively easily, by issuing new bonds on market with the same maturity dates as those the Bank holds. All else equal that would eliminate the future floating rate exposure. They could probably do something similar (but hedging less effectively) with interest rate swaps. But it doesn’t seem terribly likely, or terribly sensible (including because it would simply further inflate balance sheets).

Since this is an entirely stylised exercise, I’ve been able to dwell in the simplified air of “sell” or hold”, as if “sell” was akin to selling a single excess car or house. But the Bank has more than $50 billion in bonds and it would not make sense to offload them all at once (doing so would be likely to push the price unnecessarily against the Bank/Crown). So when I say “sell” what I really have in mind is a steady pre-announced programme that would unwind the entire portfolio over 1-2 years. That means assuming quite a lot of risk in the menatime, but unfortunately that is the hole Orr and his colleagues dug for us.

Observant readers will have noticed that so far I’ve not mentioned at all any macroeconomic effects of the LSAP programme. The LSAP was launched with the intention of having stimulatory macroeconomic effects. I’ve always been sceptical there was much to the story, especially in the New Zealand context. The proceeds of the bond purchases were fully sterilised (that is what paying the OCR on all balances does), short-term rates were held low by (a) the OCR itself, and (b) some mix of RB statements and market expectations about the economic/inflation outlook, and long-term rates just don’t matter much to the transmission mechanism in New Zealand. But remember that the LSAP was explicitly sold as a substitute for the Bank last year not having been able (so it said) to take the OCR negative. It is now quite clear – even if it wasn’t at the time – that any such need had dissipated by this time last year. This year, inflation and unemployment have been overshooting and the OCR has begun to be raised. So even if you think – with the Bank – that the LSAP had a useful macroeconomic effect, any useful bits must have been concentrated in a few months last year. And it simply isn’t credible that any such gains were as large as the 1.6 per cent of GDP of our money that the Bank has….. lost. (Note that the literature on LSAPs suggests that any beneficial effects come from the stock of bonds hold not the flow of purchases, but the Reserve Bank continued its purchase programme well after it was clear the OCR itself could take any slack and now – when looking to tighten conditions – refuses to reduce risk to the taxpayer by making a start on reducing the Bank’s bond holdings.)

And all this from a weak and not very transparent, or accountable, institution. As per yesterday’s post, two of those responsible – MPC members – are moving on, and the Minister has to make various new appointments shortly. One of those most responsible – the MPC member responsible for monetary policy and financial markets – has just been given a big promotion. But none of them – internal, external, Governor or more specialist expert – has given any sort of adequate accounting for the public money they have lost.

(Where does the Minister himself fit into all this? I’m not particularly sympathetic to Robertson, who seems the epitome of a minister uninterested in holding anyone to account, but realistically on the dawn of a crisis, no Minister of Finance was likely to have turned down the Bank’s request for an indemnity, at least if The Treasury was onside with the Bank. No, the substantive blame here rests first and foremost with the Governor, the MPC, secondarily with the Bank’s Board and the Secretary to the Treasury, and only then with the Minister of Finance. But it is the Minister who is accountable to Parliament and the public, and who had failed to ensure that the Reserve Bank was fit for purpose (people, preparedness) going into a crisis like Covid.)

UPDATE: For those who have pointed out, or noticed, that I did not discuss here issues around actual settlement account balances over the last 20 months (or developments in the Crown account), they are discussed in the earlier post linked to above.

Reserve Bank people

There is a lot of personnel change going on at the upper levels of the Reserve Bank. It has been an ongoing process since Adrian Orr took office as Governor only just over 3.5 years ago. It seems to be the way with new public sector CEOs – clear out the previous lot, and then churn until you get the tolerable set of loyalists – perhaps compounded in Orr’s case by a reputation over the years for not tolerating dissent and really only welcoming true believers (or those who can simulate the appearance and live by the lies/rhetoric/spin). He seems to be in the midst of a second clear out….in under four years. Compare, for example, the senior management group in the first Orr Annual Report (2018) with the group Orr will have gathered around him by early next year (when recently announced departures take effect). There isn’t much overlap, and not one of the changes – I’ve seen – has involved people moving on to bigger and better jobs.

A couple of months ago it was announced that the Deputy Governor, Geoff Bascand, was leaving. Bascand is probably in his early 60s but there was no hint that he was retiring. I guess he was old enough that, if Orr gets a second term, he was never going to be Governor, and perhaps some mix of a bit more golf, some consulting, some directorships (and no more involvement in the trying Reserve Bank superannuation scheme) had its appeal, but on paper it looks like quite a loss to the Bank. Of the internal people on the Monetary Policy Committee (and it is an internals-dominated committee) he seems to be the most capable – thoughtful, fluent, and with the intellectual capability to churn out, say, a somewhat-respectable speech. Did he come to find working for Orr all a bit too much?

Who knows. But then yesterday there was a second curious departure from the upper ranks of the Bank, and the Monetary Policy Committee. And that brought to mind the Oscar Wilde line from The Importance of Being Earnest”, in whic Lady Bracknell remarks, “‘To lose one parent, Mr Worthing, may be regarded as a misfortune; to lose both looks like carelessness.”

The unexplained departure of one senior monetary policymaker might not be very interesting, but when two (of four) leave in quick succession, it looks like more of a story, and probably not one reflecting entirely well on the Governor.

The latest departure is Yuong Ha, the Bank’s Chief Economist, who has been in the role for less than three years (an Orr appointee) and is only about 45. The Bank’s press release gives no hint of what he will be doing next, suggesting that he does not know.

It was a curious appointment in the first place. Ha may have been a competent section manager, but had never been seen as one of the Bank’s thinkers or intellectual leaders (and surely the Chief Economist should normally have been where the MPC looked for such leadership). It was always possible that he could have surprised and stepped up in the role, but sadly it wasn’t to be. There were a succession of (often individually small) mis-speaks – my favourite was when he suggested in public that things like the LSAP couldn’t offer much, about 10 days before the Governor/MPC went all-in on their new and very expensive toy, claiming a great deal of effect. And in almost three years, he had not been allowed to do a single on-the-record speech, through some of the most difficult and turbulent times for monetary policy in quite some time. If Orr has now engineered his departure, it is probably for the good of the institution. But it doesn’t speak well of Orr’s judgement in having appointed him in the first place – especially as the vacancy arose only after Orr engineered the departure (by demotion, and then resignation) of Ha’s predecessor, John McDermott.

Of course, in the public sector one can’t just buy-out people you no longer want around, suggesting that some further restructuring has been used to achieve the outcome. McDermott was got rid of by creating a new rank between McDermott and the Governor, and (presumably) telling McDermott he wasn’t going to get the more senior one (the one that carried the title he already had). The Assistant Governor role is soon to be vacant – Christian Hawkesby having been appointed as Deputy Governor – so perhaps Orr is going to collapse the two jobs into one again, with Ha being given to understand he wouldn’t get the more elevated (direct report) position. We’ll see soon enough I guess (more adverts to follow after the raft of Assistant Governor positions advertised a month or two back).

But whichever way Orr goes, there are now two vacancies on the Monetary Policy Committee (and, which we’ll come to shortly, two of the three external members have terms which expire early next year). This is, supposedly, a very powerful and important statutory body, and you might hope for a bit more media and parliamentary scrutiny (there almost certainly would be if more than half the committee was potentially changing in the US or the UK). It isn’t as if there are outstanding candidates for the two internal positions – whether outside economists or internal people who buy their research or other intellectual leadership cry out to be appointed. And of course, anyone appointed has to be willing to work with and for Orr, independent thought discouraged. One possibility is that Orr (and the Minister) appoint the head of the financial markets department and the new chief economist, but who (really capable) will want the chief economist job is an open question.

For a serious, open, and accountable central bank, the first wave of external members of the MPC have been something of an embarrassment (for a Governor who wanted to keep control, and a Minister happy to go along, all has probably been fine). Not one of the three has given even a single on-the-record speech, and I’m pretty sure that among the three of them there has been only a single media interview. There is no transparency, no accountability, and little reason to suppose these three have added any value. One (probably the least qualifed for the role) was, so the papers revealed, appointed primarily for diversity reasons. The other two – Bob Buckle and Peter Harris – have terms that expire early next year. Buckle is the only one of the three with a focus on macroeconomics, but recall that Orr, Robertson and the Board chair got together to ban from the Committee anyone likely (now or in future) to be doing any active work or research on macro/monetary issue – one of the more ludicrous (if revealing) aspects of the entire RB reform process. Unless, the Minister – perhaps encouraged by Treasury – has had a rethink, presumably the incumbents will be reappointed. The title looks good on the CV, and the fees make reasonable retirement pocket money. But taxpayers and citizens deserve more and better. At present, not one of the remaining members of the MPC commands – and demands – respect as a key thought leader in a powerful independent government agency.

But it isn’t just the MPC and management where change is afoot. Parliament has recently passed amending legislation that means that from the middle of next year the current Bank board – a largely toothless beast, notionally charged with monitoring and holding management to account – will be replaced by a real Board, in which will be vested all the powers given to the Bank, other than those explicitly assigned to the Monetary Policy Committee. On paper, it is a step forward, and will finally put in end to the 30 years in which the Governor alone held huge discretionary policymaking powers. And the Bank wields huge powers, as policymaking agency in many areas of financial regulation (as well as implementing agency). The new Board – despite its primary focus being organisational and financial regulatory – will also be charged with the appointment of the Governor and the MPC members (subject only to ministerial veto).

Even the government and Parliament recognised that – on paper at least – they were handing a lot of power to these people, and in the new law there is explicit provision that the Minister of Finance can’t just appoint his mates, but must consult with other political parties in Parliament before making an appointment. They don’t get a veto, but the consultation requirement is presumably supposed to act as something of a dragging anchor.

Some weeks ago, with no fanfare, the first appointments were announced (or appeared well down a Bank web page). The Governor and these first three appointees are acting as a “transitional board” to oversee preparations for the new regime, but all three have been apparently appointed by the Governor-General, and presumably have been consulted on. Unfortunately, the three appointees are at least as underwhelming as the government’s MPC appointments.

The current Board chair, Neil Quigley (Vice-Chancellor of Waikato University) is staying on as chair of the new Board and the two other appointees are both professional director types, each with a long list of (present and past) directorships but no obvious expertise in the matters they are to be responsible for. There are, we are told, five more appointments to be made, but it is hardly confidence-inspiring (unless your model is one in which everything changes but everything stays the same, with all power in Orr’s hands). It doesn’t seem like good practice – and must be quite unusual now – to keep on a chair who has already done almost a decade on the Board, especially when that Board had a reputation for doing little but providing cover for the Governor.

But the bigger issue is that no one involved – management or Board – has any reputation for excellence as practitioner or thinker on these important areas of policy the Board will be responsible for. Take management. Orr and his new deputy (and head of financial stability) are both economists by trade. Nothing wrong with that of course, but to the extent they have wider experience it is solely in funds management (Orr as head of NZSF, Hawkesby a few years at a local funds manager). Neither has any real background in the core business of banking, or in regulation. And neither have any of the new Board members announced to date. Those with long memories might think of Quigley as something of an exception, in that earlier in his career he did some interesting (mostly historical) work on banking regulation, but…..that was probably 25 years ago, and in recent decades he has largely been an enterprising university manager, skilled at playing the PBRF game etc. It could have been a good opportunity to have found some really good people, including perhaps one from overseas, who could have added gravitas and standing to the new institution. A former top banker perhaps? A leading thinker on financial regulation? Instead, so far, we have a typical group of the sort of people who end up on all manner of government boards, supposedly playing a key role in setting an important area of policy, of appointing future key monetary policy makers, all with a management team that is underwhelming at best, and evidently subject to frequent churn. One can only wonder if any of the other political parties pushed back at all.

I write more about the Reserve Bank because it is the organisation (and policy areas) I know best. I don’t suppose the Bank is much worse than most other New Zealand government agencies, and perhaps it is unrealistic to expect it to for long ever be much better than the rest, but what a lost opportunity the expensive and longrunning reform process of recent years has been. The government could have laid the foundations for an excellent and highly-regarded institution. Instead, it seems only interested in the appearance of change, the shadow not the substance.

A cost-benefit approach to thinking about vaccine coercion

One of the (many) disillusioning aspects of the Covid response of the New Zealand government (politicians and public service) has been the apparent total absence of any use of cost-benefit analysis techniques to help inform thinking about policy responses. No cost-benefit analysis on any aspect of the policy response has ever been published (or hinted at), on the couple of occasions I’ve OIAed any such analysis (just to be sure) agencies have been quick to deny any such analysis exists, and when one independent agency (the Productivity Commission) did do a little exercise along these lines at one point last year it was shunned as almost “unclean”. And if there had been any slight excuse early last year about “no time” – not convincing even then – officials have had 22 months now to get toolkits in place. But they (and their political masters) seem to prefer seat-of-the-pants thinking, all with minimal transparency. (On that latter note, it is now three months since the current lockdowns began and not one piece of official advice, not one Cabinet paper has yet been released, despite the enormous economic and social costs of the choices the government has made.)

The point about cost-benefit analysis is not that using those techniques, or that way of thinking about the issue, will generate “the” right answer. On many of these things there is no “the” right answer. The merit lies in a combination of (a) forcing people to write down their assumptions, including which variables (even hard to estimate ones) should be relevant to a particular decision, and (b) then enabling users to get a sense of how much difference a different set of assumptions might make to the bottom line. Using the techniques facilitates disciplined thinking and transparency, the latter itself supporting scrutiny (especially important when such costly and often intrusive/restrictive decisions are involved.

Consultant economist and former Victoria University academic Martin Lally has been one of those attempting to apply a cost-benefit approach to thinking about Covid policy responses. I wrote here about one of his pieces from last year. I haven’t always agreed with his conclusions, but (as above) that isn’t the point. The value in such exercises is to prompt people to think harder about which assumptions they might disagree with, why, whether all the right variables are being taken into account, and what differences different assumptions might make.

On Saturday Lally sent out a short piece he had done, attempting to sketch how one might apply a cost-benefit type of approach to thinking about vaccine coercion (or – ugly Americanism – “mandates”). He has given me permission to reproduce it here, which I will then follow with my own thinking. It is a sketch outline, towards the sort of fuller cost-benefit analysis one might hope government agencies – with access to much more resource – would routinely be doing and revising.

Lally notes that he – like me – is fully vaccinated “without coercion”.

Vaccine mandates for the general population are proving to be extremely controversial.  Opponents point to the right to choose.  Proponents point to the costs that the unvaccinated impose upon the vaccinated, in particular the increased risk of death to some vaccinated people (because the vaccine is not perfect and the more so as the time since the vaccination increases) and the increased load on the health system from unvaccinated people leading to some (vaccinated) people receiving an inferior level of care for non-covid conditions than they otherwise would.

This is yet another example of the trade-offs we face in life, individually or socially, and is therefore capable of being illuminated (and possibly resolved) by cost-benefit analysis. 

To illustrate this, suppose that 400,000 New Zealanders will not be vaccinated unless coerced (10% of those above the age of 12).  This corresponds to the 10% of the over 12s who have not yet had a first dose, and therefore could reasonably be viewed as a lower bound on those for whom coercion will be required to achieve their vaccination.  Standard CBA for health issues involves discounts to QALYs [quality-adjusted life years] for imperfect health status.  For example, a person suffering from type 2 diabetes warrants a discount of about 20% per year of their remaining life.  The same principle applies to coercion, i.e., it reduces the quality of life of the coerced person.  These 400,000 objectors are likely to be of about average age and in good health, which implies about 40 years of remaining life.  Let W denote the annual discount on their quality of life arising from being coerced into vaccinating.  The QALY loss from the coercion is then 400,000 [people]*40 [individual years] *W = 16,000,000*W.

Now consider the costs that the unvaccinated impose on the rest, of the types mentioned above.  Let D be the estimated deaths from the existence of unvaccinated people, if coercion is not adopted compared to adoption of coercion.  The deaths here are of people likely to have low residual life expectancies and health problems that would lower their quality of life even if they didn’t die due to the existence of the unvaccinated.  Suppose the average residual life expectancy is ten years (generous as covid victims [fatalities] have an average of about five years), and the discount for health problems during this ten year period is 20%.

If coercion is adopted, the 400,000 people alive today who will suffer the coercion will experience a QALY loss of 16,000,000*W whilst the vaccinated avoid a QALY loss of D*10*0.8.  So, coercion is warranted if and only if D*10*0.8 exceeds 16,000,000*W. 

For example, suppose W is 5%, i.e., coercion is equivalent to a quality of life discount of 5% per year.  The parameter D would then have to exceed 100,000 for coercion to be justified, i.e., there would have to be at least 100,000 additional deaths amongst those alive today and vaccinated resulting from catching covid from an unvaccinated person or from inferior hospital care resulting from hospital overload due to unvaccinated people requiring covid treatment.  This is not plausible.  Alternatively, if W is 1% (coercion is equivalent to a quality of life discount of 1% per year), then D would have to exceed 20,000 for coercion to be justified, i.e., there would have to be at least 20,000 additional premature deaths amongst those alive today and vaccinated resulting from catching covid from an unvaccinated person or from inferior hospital care resulting from hospital overload due to unvaccinated people requiring covid treatment.  This too is not plausible. 

It is implausible that W is less than 1%, and it is implausible that D would be more than 20,000.  It follows that coercing people into being vaccinated does not seem to be a good policy choice.

If you think I am wrong, I invite you to supply a CBA consistent with your view.  Simply saying that unvaccinated people inflict damage on the rest of us is not enough.

It is a reasonable challenge.

In my case, it isn’t that I think his policy conclusion is wrong. I don’t think either vaccine coercion or the associated (coming) pass laws can be justified by the scale of the threat Covid poses. But I think Lally’s initial exercise – while illuminating – may overstate the case, at least on cost-benefit grounds (there are some – few – things no price should be placed on, or which we should be very reluctant to do so in the face all but the gravest threats).

Perhaps my greatest unease is around time horizons. The approach seems to treat Covid as something that within a few years will settle down to be either non-threatening or chronic/endemic or something society will choose not to do anything much about. Why do I say that? Because otherwise we have no basis for reaching any judgements (plausible or not) for many lives coercion might save – over, say, 50 or 100 years – but also because if it was to be treated as a permanent issue one would have to include effects not just for the current population cohort but for those yet to be born.

It seems a reasonable approach to me for now – and this is a place where real options analysis is relevant, taking account of irreversibilities – but if so then how credible is it to suppose (assume) that those subject to coercion will experience the same reduction in their quality of life for their entire remaining life (40 years on Lally’s assumption)?

As Lally notes when we exchanged (brief) notes on this, there are two classes of people subject to coercion, those who give in to it, and those who don’t. Lally’s approach does not seem to incorporate the effect of or on the latter group at all. I’ll come back to them.

But what of those who do give in to the coercion and get vaccinated? It seems quite plausible that, at least initially, many will be quite resentful and experience the reduced quality of life Lally mentions (a few may be relieved as coercion gets them out of a corner they’d boxed themselves into). Quite how intense that loss is may depend a bit on what motivated each individual resister. But if Covid settles into being a chronic thing that no one pays that much attention to in a few years hence, how plausible is that those coerced now will be still experiencing a significant (same annual) loss of wellbeing 30 years from now? If we, arbitrarily, allowed for this loss of quality of life for just the next five years then that cost would be reduced to only 1/8th of the scenario Lally uses.

What about what the coercion saves? Lally’s initial approach looks at lives saved this way: “additional premature deaths amongst those alive today and vaccinated resulting from catching covid from an unvaccinated person or from inferior hospital care resulting from hospital overload due to unvaccinated people requiring covid treatment”.

Again, this points to an implicit assumption about the issue being medium-term but not long-term. The potential impact on the health system – and thus on mortality risks for non-Covid conditions – is a real one at present, but surely can’t be with (say) a 10 year horizon, since healthcare capability can be added in that sort of timeframe. But although Lally highlights the potential deaths avoided, he does not factor into this simple model the losses from either severe Covid cases among the vaccinated, or the loss of quality of life to those whose treatment for other conditions is delayed. On our current understanding, he is no doubt right to play down the mortality risks from Covid to the vaccinated (probably quite few in number, and most likely to be people with remaining life expectancy well less than 10 years), but I have less of a sense of how large those other numbers might be.

As I noted, Lally’s approach does not take account of those on whom coercion will not work. That number might be small, at least after a few months, but what if it isn’t? And even if most of the resisters eventually given in (a) they are probably the ones who will face the greatest and longest-lasting loss of wellbeing (people who resisted from conviction rather than just hesitation), and (b) we know that people who lose their jobs in recessions can experience lifetime losses of income, a result that could well translate to some of this group.

And although repressive enough pass laws can probably reduce the risk of these resisters (a) getting Covid, and (b) passing it on to other (vaccinated) people, that is going to be a reduced risk not an eliminated one. A full cost-benefit analysis would need to include an assumption as to how many lives the compulsion exerted over this group might save. I’m not in a position to offer a number myself.

The other factor that would need to be taken into account in a fuller cost-benefit assessment is the cost-benefit of alternative options. For example, what if instead of vaccine “mandates” and pass laws, the government mandated the use of rapid antigen tests in places where particularly vulnerable people were present (eg rest homes, hospitals), or – at times when there was much Covid in a community – at the entrance to any large indoor event? Antigen tests are, after all, focused on identifying infectiousness, presumably the main (health) concern. That testing would have costs – there are no cost-free options – but relative to the vaccine coercion options some real savings (re issues discussed above). The Ministry of Health still appears to have some mysterious aversion to antigen tests, but there is no sign their distaste has ever been properly costed.

I don’t purport to know the appropriate parameter values for each of these variables. But it is the sort of exercise – done more fully – that officials should be presenting to ministers, and making available to outsiders for information and scrutiny.

Productivity Commission at sea

Were I writing yesterday’s post now I would word some things differently. Yesterday afternoon the Productivity Commission drew my attention to their supplementary paper called “The wider wellbeing effects of immigration” which – despite the title – turns out to be mainly about core economic dimensions of the issue, including a substantive discussion of some of the macroeconomic arguments I have been making. Strangely, there had been no cross-referencing to this document in the parts of the body of the main report where, as discussed yesterday, these issues were briefly discussed. I had seen an earlier draft of the macroeconomic bit of this supplementary paper and had provided some comments on it to the Commission.

Awareness of that supplementary paper does not change my main concern about the overall draft report. There is still little or no compelling analysis or insight on any of wider economic issues, no arguments or evidence or reasoning that anyone serious (on either side of the debate or in the middle) is likely to look back to in future and suggest that they saw things a bit differently as a result. There is quite a lot of description but not much in the way of serious evaluation or critique. And this for one of the largest economic policy interventions the New Zealand government undertakes.

But it now flows into a bigger concern that the Commission – despite months of work – really does not know what it thinks, and thus was reduced to highlighting a bunch of second or third order issues. Recall their own summary of their recommendations

I had thought the Commission was largely endorsing the pre-Covid high (non-citizen) immigration status. I reread the main report last night in the light of the “Wider Wellbeing” paper, and I still reckon that is where their heart is. And that is hardly surprising when the chairman of the Commission had been on record as a vocal champion of using policy to create an ever-bigger New Zealand, and had for years run a story in which monetary policy was the main culprit in any sustained economic underperformance. And thus, as I noted yesterday, in one of their supplementary papers they rely on some modelling done back in 2009 by the chairman’s firm (BERL) which has been touted by some (including ministers in the previous government) as demonstrating the wider economic gains from New Zealand immigration – even though the modelling both assumes away some of the questions required to be answered (the response of business investment), is structured to impose on the model no productivity gains (or losses), and where any gains that do flow (in aggregate) flow entirely to the migrants themselves.

But then in the “wider wellbeing paper” at the end of the macroeconomics chapter we find these “findings”

I wouldn’t frame things quite that way myself, but it is interesting that the Commission chooses to do so. You wouldn’t know of anything like this if you just read the Summary (as probably most politicians will only do) or even get much of a hint of it in the main draft report itself. There is no attempt to reconcile it with other material or arguments they cite (including that 2009 paper by the chairman). They might be right or they might be wrong, but the answer should matter materially. Just prior to these “findings” we find this

So, continuing with high immigration has a potentially costly regret whereas (whether the Reddell hypothesis is correct or not), it has no offsetting large benefit. Cutting back on migration will cause short-term disruption to some businesses and loss of small benefits but no large regret even if the Reddell hypothesis is incorrect. In the latter case, a small benefit would be discovering that Reddell’s hypothesis does not hold the answer to New Zealand’s productivity problems. As Fry concludes:
…least regrets suggests that at some point, there may be value in risking the seemingly small benefits from existing immigration targets in order to determine whether larger benefits may be obtained via reduced interest and exchange rates following the adoption of a lower immigration target. (Fry, 2014, p. 26)

That first sentence is quite strong language. It would be news to at least some champions of the policy pursued here over the last few decades. But again it is hardly hinted at in the main report, let alone those higher profile summary documents.

As for the “Reddell hypothesis” itself , the Commission says

At this stage of its inquiry, the Commission is not taking a definite view on the Reddell story

Which, I suppose, is a legitimate stance for them to take, but there is nothing much in the report even indicating where their key uncertainties are, let alone a provisional overall interpretation that submitters could scrutinise and review. I don’t suppose that will seem very satisfactory to anyone, from any side of the debate, considering making a submission. It speaks of a Commission that just has not exercised the intellectual grunt to critically analyse, assess, research and review conflicting arguments and interpretations.

And when they have made the odd tilt in that direction, they seem to end up confused. Again, rereading the papers last night – and recalling some of the discussions I’ve had with them – it is clear that they are quite exercised by problems/delays in building “public infrastructure” and housing. And there are probably – well almost certainly – reasonable points to be made there, even if most of those issues could be addressed directly and thus do not necessarily have connections to immigration policy (although perhaps in a second or third best sense they might).

But they seem to have conflated those issues with the real resource pressure arguments I have been making, even though the two arguments have quite different implications.

Why do I say that? Well, straight after that line above about the “Reddell story” follows this sentence

For example, it notes that policies to improve housing and infrastructure supply and to invest in them prior
to migrants arriving, could do much to avoid the problems of ongoing excess demand in those areas.

(There is something of a similar, unjustified, flow in the main report too).

And I’m just shaking my head and going “no, no, no” to that. I’m all for freeing up land use (especially on the outskirts of our existing urban areas), properly corporatising water services, building promptly roads etc (that pass credible cost-benefit tests) but – all else equal, and on the Commission’s own arguments – these reforms would boost investment spending. But at the heart of the bit of my story which they seem to take most seriously is the simple proposition – from Stage 2 macro really – that real interest rates in an economy are largely determined by the adjustments required to reconcile ex ante desired investment and desired saving. Getting more houses built might well ease house price pressures – itself generally a good thing – but there is no reason to suppose it will do anything positive about lifting New Zealand private business investment, expanding the tradables sector, or lifting economywide productivity. If anything, the risk is that the effect would run a little in the other direction.

Perhaps there will be more analysis in the final report, including looking at the insights we might gain from a careful comparison of our experiences with those of other countries (including the handful of other high-immigration advanced economies). What, for example, does the Commission make of the cross-country evidence that rapid population growth over decades – and ours is mostly now the result of immigration policy – is associated with a larger share of GDP being devoted to housebuilding (naturally and as one would expect) but not with any commensurate lift in the share of GDP devoted to the business investment required to support ongoing growth in productivity and incomes? And so on. But shouldn’t we have been able to have expected a more developed, and robust, story by the time the Commission was publishing several hundred pages of draft reports, not just when the final report lands on the desks of ministers?

Mightn’t we, for example, have hoped to see compare and contrast of the view (with which I largely agree) that high levels of immigration don’t make wage-earners worse off relative to others in society (in fact, the excess demand pressures I’ve highlighted seem to have boosted NZ wages relative to growth in nominal GDP per hour worked), and the view – that the Commission seems at times sympathetic to – that high immigration to New Zealand may nonetheless have damaged economywide productivity growth, and thus held back the improvements in living standards that all of us might have aspired to. They aren’t at all inconsistent (and similarly if the optimists are right high immigration could be boosting economiywide productivity growth, and yet in such a world we might still see wage-earners getting a slightly small share of a much larger GDP per capita).

As it stands at present, the Productivity Commission’s work on immigration just really isn’t fit for purpose. No wonder what they presented us with highlighted those third order or bureaucratic process points rather than offering something offering genuine New Zealand specific insight on how this major tool of public policy has, or has not, worked for the economic wellbeing of New Zealanders.

The Beehive will have been happy, I suppose

[Note significant UPDATE at the end of this post.]

The only good case for having an entity like the Productivity Commission is if it delivers serious in-depth research and analysis – insight – on significant public policy issues, and does so without fear or favour. In principle, there might have been a decent argument for such an institution (I used to be persuaded) given the weaknesses of academe (at least on New Zealand policy issues), the relative absence of think-tanks, and the deterioration in our core public service advisory agencies. But it is hard to fix just one small part of organisational mix, and even more so when those (a) holding the purse strings,and (b) making key appointments demonstrate no appetite for, or interest in, serious research and analysis. And thus, 10 years into its existence, we have the diminished Productivity Commission.

It was never likely to be easy to create and sustain a good entity of that sort, with no critical mass (unlike the much larger Australian equivalent which initially inspired the creation of the New Zealand one), and just up the street from key ministries (the Australian equivalent is an Melbourne, so an attractive option for people who do not want to live in Canberra). But this government seems to have basically given up trying. But then they’ve consistently indicated little or no interest in reversing the decades of relative productivity decline, even though fixing this failure would provide the best long-term support for fixing many of the things they often claim to have gone into politics for.

That was all exemplified with the appointment a year ago of their mate Ganesh Nana as the new chair of the Commission. Doubts that I and others expressed at the time have been more than vindicated since (be it speeches, interviews, or other public statements).

But if there was still any doubt, the diminished state of the Commission was fully on display with the release yesterday of the draft report on the immigration policy inquiry. Immigration (of non-citizens) is a huge government intervention lever, deployed in New Zealand on a scale far larger than in almost any other countries, with (potentially) significant economic, social, and cultural implications. In New Zealand, champions of the large-scale non-citizen immigration policies – run for much of the last 150 years – repeatedly claim that there are significant economic benefits to New Zealanders from such policies, even as for decades now our position in the global economic league tables has kept on dropping away. Perhaps the advocates are right, perhaps they are not. But you might suppose it was a topic warranting some serious and in-depth research and analysis, New Zealand specific but engaged with diverse cross-country experiences, that really engaged with the issues and experiences and offered compelling insights on what might work best, for what end, and how.

But if that was the sort of report anyone was hoping for, it bore no resemblance to what the Commission has delivered. I’m sure there may even be a first-rate case that could be made for how New Zealand’s immigration policies of recent decades have made (or will soon make) most or all of us economically better off – that is, after all, the thrust of the rhetoric from successive governments, and ministries like MBIE (that used to tout New Zealand immigration policy as being a “critical economic enabler”). It would be fascinating to read – and engage with – such a document. But even though it largely champions something like the (pre-Covid) status quo, the Productivity Commission’s piece offers nothing serious to engage with. I wasn’t a great fan of the New Zealand Initiative’s report on immigration policy/experience a few years ago (and offered extensive commentary in a series of posts collated here), but it was a worthier effort – on fewer resources – than the Productivity Commission’s.

The essential vapidity of the report – most especially on anything relevant to productivity and economic performance – seemed well-captured in this extract from the final page of the Commission’s four page summary of the report.

prod comm summary

So the very first recommendation – one of three in that shaded box – is that ultimate Wellington-insider type of recommendation: more jobs for bureaucrats writing policy statements for the governments. Nothing about the substance, all about process. It isn’t necessarily a stupid idea, but surely as about item 25 on a list of second-tier recommendations?

I suppose every Wellington bureaucrat these days feels obliged to invoke (or conjure up) Treaty of Waitangi dimensions, and so the Commission also has it in its top-3. But the focus of the Commission is – or was supposed to be – primarily economic in nature (there is something of a clue in the name) and all the commissioners – and probably all the professional staff – are economists so one if left wondering what they have to add on Treaty issues, at least beyond their personal politics (quite far left in the case of the chair). Same goes for that weird suggestion that learning Maori might be made a factor in granting residence – I suppose some might think it a good idea, but you might have thought there would be at least some attempt to highlight potential trade-offs (in which, for example, some of the more potentially valuable migrants might find learning a niche language – or least jumping through hoops appearing to do so – something of a deterrent).

I don’t have any particular problem with something along the lines of a couple of the recommendations. Providing more flexibility for those of time-limited work visas to change employer makes some sense (although would make more sense as part of my scheme whereby employers would pay a significant fee to hire short-term migrant workers), and the suggesting about limiting the rights of return of permanent residents who leave seems sensible (if niche), as might a provision to allow only citizens to vote (a more normal practice overseas). But relative to the scale of the intervention immigration policy represents these are second or third order issues at best.

And all that is left, which might have some substance (for good or ill), is the second of those highlighted recommendations, but even there is less to it than meets the eye. Net migration flows (in, out, New Zealander, other) are volatile, but that isn’t mostly because New Zealand policy is volatile. Instead, most of the volatility arises because when the Australian labour market is strong the net outflow of New Zealanders to (higher-paying) Australia increases, and when the Australian labour market is less strong the net outflow diminishes (often quite sharply). There isn’t anything much New Zealand governments can do about that – other than (which would be grossly against the interests of New Zealanders) begging the Australian government to limit our escape option. It is disconcerting that in the draft report the Commission still seems to be hankering to attempt to smooth the net flow (without changing the average rate of immigration over time) and says it will be thinking more about options before presenting their final report. I suspect that if there is one thing the champions of high immigration and the sceptics (like me) agree on is that attempting to use policy to fine-tune flows is a daft, and probably unworkable, idea (it always used to be MBIE’s line to me when I was still an official – and not championing such fine-tuning – and I was at a meeting at the Commission within the last couple of months at which a strongly pro-immigration economist and I (united on almost nothing else in that discussion) strongly urged them not to try. If the Commission thinks they, or MBIE, can forecast the Australian labour market that well, that far in advance – and then adjust policy and movement that quickly – then the macro authorities in Australia probably have jobs on offer for them. And if the government does want to encourage large average migration inflows – to an underperforming remote economy – changing the rules frequently (with forecasts and mis-forecasts of the economic cycle) simply isn’t a sensible way to be attractive to the few really able people likely to be seriously interested in settling here.

The draft report (at 68 pages) is much shorter than many of the Commission’s reports over the last decade. Unfortunately, with the greater brevity has come an absence of much serious analysis or engagement, or even a framing of the issues. The report is accompanied by a series of special topic papers, and I turned, hopefully, to the one headed “Impacts of immigration on the labour market and productivity”. That alone is 98 pages, but (a) the text runs out after 48 pages (the rest is mostly just charts) and (b) most of the rest is boilerplate description of the data, offering no insight to anyone who knows the New Zealand story. And when we finally get to a few pages on productivity – and you will recall that over the years the Productivity Commission has consistently highlighted New Zealand’s long-running poor outcomes – the Commission’s treatment involves no serious engagement with the New Zealand data or experience, no fresh analysis or research (commissioned or in-house) but rather (a) on the global picture a description of one academic paper, and (b) on New Zealand specifically, a single paper done for the old Department of Labour by the Commission’s chair some years ago, in which sure enough gains to per capita income show up, but solely by construction (it is a CGE model) and in which any possibility of productivity gains (or losses) is assumed away by construction. Nana has long been on record as a champion of large scale immigration, and juicing the population of our cities (he was my interlocutor in this RNZ discussion) but his paper sheds no light (and really can’t do so by the technique used).

Overall, the report is the sort of thing an average MBIE policy team could have churned out. It offers little or no insight, no fresh analysis or research, but offers a few tweaks (some sensible, some not) which a government that likes mass migration (and Labour has for several decades now) can nod sagely at and perhaps make the odd change (and of course some red meat to the Labour Maori caucus).

Now regular readers might be wondering how the Commission has treated the arguments I have been making over the last decade or so about New Zealand’s immigration policy and our disappointing economic performance.

I noticed that a recent speech was shown in the list of references so I searched the document to find out where they had referred to it. The solitary reference was here

This raises the question of whether overall resident approval numbers (the “planning range”) should be reduced or linked to
other factors, such as outflows of New Zealanders or the state of the economy. If other changes are not made to ease restrictions on housing construction and to boost investment, a “least regrets” approach implies setting the planning range at lower levels
than has been the case in recent years. Some commentators and submitters argued for setting the planning range at much lower levels (Reddell, 2021).

Which is, to say the least, a bit naughty, as neither in that speech nor in anything I’ve written in recent years, have I suggested tailoring the residence approvals numbers to housing construction, the cyclical state of the economy, the outflow of New Zealanders, and the “least regrets” framing is one that I have not used (I think it originates with the economist Julie Fry).  But, however they describe it, the Commission simply presents the idea of lower numbers of residence approvals, makes no comment and moves on.

A few pages earlier, the Commission does devote half a page to a discussion of “arguments from a macroeconomic perspective suggesting that fast population growth may have suppressed New Zealand’s productivity growth”.   I recognise some aspects of some of my arguments and analysis in what follows, and I suppose it is welcome that –  without further analysis or testing – they comment that 

Aspects of New Zealand’s economic performance over the past 30 years are consistent with these arguments, including a persistent high real exchange rate (despite poor relative productivity growth which would tend to push the exchange rate down), a flat or falling share of exports to GDP, slow rates of productivity growth, and high real interest rates compared with other developed countries. Immigration is unlikely to be the sole cause of these trends, but the symptoms are consistent with it being at least a contributor.

But that is it. Which is strange, because the story has implications. If it is right (in whole or in part), it argues for much less trend immigration (at least to the extent economic outcomes matter a lot), and if it is wrong, well it should be exposed and demonstrated as wrong. Instead, we get “symptoms are consistent with it being at least a contributor” and then they move on to the next topic. It does not create much confidence that they have thought hard or engaged much. Instead, as they move to the next paragraph, they seem to confuse and conflate these arguments with quite different issues and arguments (that I’m certainly not making) about housebuilding and construction of public infrastructure.

When people refer back to this report in years to come – as no doubt some will – no doubt the champions of large scale non-citizen immigration will find support. But no one – pro or con – will find illumination. But with nothing challenging, nothing troubling, no doubt the Beehive will have been happy, and the powers that be at the Commission will have rewarded the trust ministers showed in appointing their mates.

I have tried to look at the report not just through the lens of my own views on a sensible immigration policy for New Zealand. If one is evaluating the quality of a report, what matters isn’t just (or even mainly) if the authors end up agreeing with you, but how. I can’t believe that any serious champion of large scale immigration to New Zealand (and there are some, not just among the self-interested) would regard this report as a serious and useful contribution to a better understanding of the issue in New Zealand. If those were my views – and of course they aren’t – I’d be a bit embarrassed that this was the best the government’s Productivity Commission had managed to come up with.

As it happens, I am very curious as to how the Commission ended up where it did. I chose not to make a submission, on some combination of lack of confidence in the Commission, health, and a sense that staff and at least some commissioners were well aware of my arguments, which had been documented extensively over the years. But about three months ago I had an approach from a senior staff member asking if I would write a paper for them, which they would have reviewed and would then publish, articulating the “Reddell hypothesis” and reviewing the experiences here and abroad that might help shed light on the issues etc.

I declined almost immediately, and after some further engagement not only declined but suggested that such a paper would not necessarily be in their best interests even if the Commission was to be sympathetic to my story (they’d have been much better off getting someone not precommitted to review the arguments and evidence). But I have since had a couple of sessions with staff and commissioners on the issues and arguments, and while I’m not going to go into detail on the substance of those discussions, suffice it to say that it was something of a surprise to read the report, and the lack of serious engagement with the issues and experiences.

It is, of course, up to the Commission what issues and arguments and experiences it addresses. But for anyone interested in exploring mine further

this was the speech the Commission (somewhat misleadingly) linked to

and these were notes for a recent lecture at Victoria University

and this is a longer version of a recent book chapter in which I explore New Zealand’s longer-term economic underperformance, distance, and the inconsistency between our immigration policies and producing first world living standards at this distance from the world.


Silly me. I assumed that any substantive discussion of effects of immigration policy on productivity might appear either in the main report or in the supplementary paper I linked to earlier “Impacts of immigration on the labour market and productivity”. However, the Commission has just pointed me to another supplementary paper which – because it was under the heading “The wider wellbeing effects of immigration” and I am mainly interested in economics and productivity – I had not read. It turns out that “the wider wellbeing effects” is mostly about economic effects, and that there is a whole chapter (pp12-19) on macroeconomic issues and arguments, including a sub-chapter on the “Reddell hypothesis”. I had seen an earlier draft of that chapter and had provided some comments on it.

It is a little strange to have (a) published this core economic material in a chapter under such a heading and then (b) not to cross-reference it in the main report, but for what it is worth the chapter includes this specific official “finding”.

Reddell hypothesis

House and land prices

The local Wellington magazine, Capital, which seems to be a curious mix of the serious and the lifestyle, earlier in the year asked if I would write a piece on house prices. That article outlined the story I’ve run here repeatedly, that durable and very large reductions in house and land prices are quite possible – we see everyday examples in perfectly pleasant urban areas in the United States – but are only likely to happen if there is genuine aggressive competition among owners of land beyond existing urban areas. It is that sort of competition, from land whose best other use is probably for something agricultural in nature, that would durably lower land (and house) prices in existing urban areas.

That article ran in April. In late September the editor got in touch and asked if I was interested in doing another piece. Since there had been numerous policy announcements around housing this year – from the government, from the Reserve Bank, sometimes from the government to the Reserve Bank – I suggested that a piece along the lines of “sound and fury, signifying not much at all other than some new inefficiencies and distortions” might be in order. That article is in the issue on sale in Wellington now, and the text is here. I will include the full text at the bottom of this post.

I wrote the article four weeks ago. It isn’t quite the article I would write today because since then we’ve had the joint Labour-National announcement on new legislation that is being rushed through which will allow more intensive (but still relatively low-rise) development in existing urban areas of our larger cities, but appears to do nothing of substance to free up land-use beyond existing urban areas (and, as I noted in both articles, there is lots of undeveloped land in greater Wellington, much of it with little economic value in alternative uses). But if I’d write a slightly different article today, the bottom line does not change: there is no sign (from ministers, Opposition spokespeople, city councillors or whoever) that those who hold power have any interest at all in delivering much lower house prices on a durable basis. They refuse to express any such interest, and nothing they have done or are now doing seems likely to bring about such an outcome. Urban density may be all very well and good, for those who like that sort of lifestyle (and good luck to them), but the international evidence offers no example I’m aware of in which allowing much-greater density in cities has been followed by move towards house/land prices dropping back towards what we see in (typically quite low-density) cities in much of the US.

In the article I suggested that much of what had been announced this year was little more than “performative display” – doing stuff for the sake of being seen to act, seen to care. That seems right for most of the initiatives, since typically the supporting advice that has been published doesn’t suggest any likelihood of a sustained impact on prices. It is possible that the parties to the latest deal actually believe that this initiative might actually make a difference – partly because they have been cheered on by some people from the genuinely pro-liberalisation side of things. But even if they do believe that – and refuse to openly say so for fear of scaring some heavily-indebted voters – they are almost certainly wrong.

The second reason for scepticism I included in the article was this

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen). If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see to
see it in the prices of the assets already. That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets. But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land

I still reckon that is basically right, but were I writing today I might put more emphasis on the possibility of quite a shakeout over the next year or two, even while the structural problems are unchanged. In a way, this is just the sort of point the Reserve Bank has been making in its discussion around “sustainable” house prices. “Sustainable” in their terms does not mean affordable, or US-style normal. It really just means where a market might be expected to settle given all the policy-settings and distortions in the system (that underpin land prices well above best alternative use price). One can see material, even significant, falls in house prices in such markets without the longer-term structural fundamentals being fixed at all. Such falls aren’t likely to last (and in New Zealand aren’t likely to pose a financial stability threat) but they could get the headlines for a time. Many of the falls in house prices that happened around 2008/09 were of that sort – whether those in San Francisco (now incredibly expensive), New Zealand (now incredibly expensive), or even Dublin.

Building activity in and of itself does not solve the underlying problem – land prices – but it can still lead to shorter-term overhangs in the market. There has been quite a lot of housebuilding going on.

Interest rates have risen and seem likely to rise further. A return to rapid population growth, from immigration, still seems some way off. The fiscal stimulus which has helped boost economic activity will be fading, and there are all those tax and access-to-credit restrictions. None of these address the longer-term problem of a rigged market that renders peripheral (developable) land incredibly expensive in a land-abundant country, but in combination they could be a recipe for a non-trivial fall at some point soon. Of course, prices ran up so much in the last year or so that even such a fall is unlikely to take prices back to real levels even two years ago, but…..falls of that sort would grab the headlines, and would probably lead some politicians to want to claim credit for having solved a problem they haven’t really even begun to address.

Without further indenting or block-quoting here is the full text of that article.

Lots of action, but none that will fix the housing market

Michael Reddell

(Published in Capital magazine, November 2021)

October 2021

Even before Covid, house prices in much of New Zealand were very high.  Over the last year or so they’ve again risen sharply almost everywhere, putting home ownership further beyond the reach of most, and underpinning rising rents.  This dreadful situation, transferring resources (wealth) from the relatively poor and young to the relatively rich and the risk-takers, is utterly unnecessary and deeply unjust. 

In a well-functioning market, times like these should be a renter’s dream.  Purchasing a house should never have been cheaper, and rents should be lower (in real terms) than ever.

That’s because interest rates are at record lows.  The New Zealand government’s 20-year inflation-indexed bond currently trades at about 0.8 per cent.  25 years ago the comparable rate was about 5 per cent.  Basic finance theory suggests that when rates of returns on one long-term asset fall so will those on other long-term assets. And in a well-functioning market, rents are the main source of return to the owner of the rental property.

But a well-functioning market is one in which it is easy to bring to market and develop new land and new houses. In that sort of market, developing the new land (building the new houses) would now be easier and cheaper than ever.   It takes time to develop a subdivision and build houses, and finance costs are one of the major costs those in that business face.   New Zealand has abundant land, that could readily be converted to urban uses. So, of course, does Wellington, and much of the land surrounding Wellington isn’t worth much in alternative uses.   But if regulations make land artificially scarce, then lower interest rates (or other sources of higher demand) can translate quite quickly into higher house/land prices.

The alternative isn’t just some theoretician’s dream.  When I wrote here six months ago, I highlighted Little Rock, Arkansas, as one example of the many growing, pleasant and highly-affordable US cities.  Real house prices in Little Rock hadn’t changed much in 40 years and median house prices appeared to be about NZ$300000.  Interest rates are at least as low as those here.  Check any website and you’ll easily find modern townhouses to rent in Little Rock for no more than NZ$1000 per month.   Try that in Wellington.

In a well-functioning market, when interest rates fall and prices look like beginning to rise, owners of land (whether existing sites in the city or new areas at the periphery) should be falling over themselves to get new land, and then new houses, to market, and owners of rental properties should be competing aggressively to get and keep tenants.  The alternatives would be a vacant property (earning nothing) or money in the bank (earning little more).

But this is New Zealand where, absent a well-functioning market, house/land prices have surged again, where rents have been rising, and where price to income ratios –  which should be less than 4 in well-functioning markets –  are now more like 10.

There has been all manner of policy announcements this year, some substantive and others little more than rhetorical.   The government has extended the “bright-line test”, so that investors selling properties within 10 years will pay a sort of capital gains tax, and – in one of the more bizarre moves – is legislating to stop businesses owning investment properties deducting their interest costs against taxable income.  A select committee is looked into new resource management legislation.    And, of course, some councils – including Wellington’s – are moving to allow some more intense development in some parts of the city.     Bureaucrats have got in on the act too, with renewed loan-to-value (LVR) restrictions from the Reserve Bank and the threat of more restrictions to come.  And the government has insisted that the Reserve Bank should talk more about house prices.

But there are two pointers that none of this amounts to much more than performative display. The first is that government ministers – from the Prime Minister down – refuse to express any interest in lower house prices.  Instead, they talk repeatedly about just lowering the rate of increase. Councillors, and Opposition parties, are rarely much better.

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen).   If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see it in the prices of the assets already.  That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets.  But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land.

This year’s measures aren’t designed to fix the broken housing market, just to throw some sand in the wheels, be seen to be doing something, and perhaps to buy a bit of temporary relief.  Nothing done or promised is likely to make very much sustained difference at all, because none of it gets to the source of the problem.

Some put a lot of hope in provisions allowing for greater urban density – even as our cities are already quite densely populated by New World standards.  They are probably wrong to do so.   Increasing density has already been a feature of the last few decades – think of all the infill housing a decade or two back – and, of course, the physical footprint of our cities has also expanded.  But in the face of rapid population growth – likely to resume once Covid passes – these grudging changes have only been enough to avoid house prices rising sooner to even more outrageous levels.  

Without a radical freeing-up of land use at the periphery, creating aggressive competition between development options in cities and those at the margins, simply allowing a bit more densification will not bring land prices down. It may even bid up the prices of some sections, now able to be developed more intensively.  A lot of houses are being built right now, but there is no prospect of enduringly much lower prices unless or until owners of vacant land, on the peripheries of our city, are free to bring that land into housing and other urban uses.

New Zealanders should be able to count on a well-functioning housing/land market and ready access to finance.  Increasingly we have neither; just more complexity, more inefficiency, and more-unaffordable house/land prices.