Reviewing monetary policy

Way back in 1990 Parliament formally handed over the general responsibility for implementing monetary policy to the Reserve Bank. The government has always had the lead in setting the objectives the Bank is required to work to, and has the power to hire and fire if the Bank doesn’t do its job adequately, but a great deal of discretion has rested with the Bank. With power is supposed to come responsibility, transparency, and accountability.

And every so often in the intervening period there have been reviews. The Bank has itself done several over the years, looking (roughly speaking) at each past business cycle and, distinctly, what role monetary policy has played. These have generally been published as articles in the Bank’s Bulletin. When I looked back, I even found Adrian Orr’s name on one of the policy review articles and mine on another. It was a good initiative by the Bank, intended as some mix of contribution to debate, offering insights that were useful to the Bank itself, and defensive cover (there has rarely been a time over those decades when some controversy or other has not swirled around the Bank and monetary policy).

There have also been a couple of (broader-ranging) independent reviews. Both had some partisan intent, but one was a more serious effort than the other. When the Labour-led government took office in 1999 they had promised an independent review, partly in reaction to their sense that we had messed up over the previous few years. A leading Swedish academic economist Lars Svensson, who had written quite a bit about inflation targeting, was commissioned to do the review (you can read the report here). And towards the end of that government’s term – monetary policy (and the exchange rate) again being in the spotlight – Parliament’s Finance and Expenditure Committee did a review.

When the monetary policy provisions of the Reserve Bank Act were overhauled a few years ago this requirement was added

It made sense to separate out this provision explicitly from that for Monetary Policy Statements (in fact, I recall arguing for such an amendment years ago) but the clause has an odd feature: MPSs (and the conduct of monetary policy itself) are the responsibility of the MPC, but these five-yearly longer-term reviews are the responsibility of “the Bank”. In the Act, the Bank’s Board is responsible for evaluating the performance of both management and the MPC, but the emphasis here does not seem to be on the Board. It seems pretty clear that this is management’s document, and of course management (mainly the Governor) dominates the MPC. Since the Board has no expertise whatever in monetary policy, it is pretty clear that the first of these reports, released last week, really was, in effect, the Governor reporting on himself.

And although plenty of people have made scathing comments about that, there isn’t anything necessarily wrong about a report of that sort. After all, it isn’t uncommon (although I always thought it odious and unfair given the evident power imbalance) for managers to ask staff to write about notes on their own performance, as part of an annual performance appraisal, before the manager adds his/her perspective. The insights an employee can offer about his or her own performance can often be quite revealing. And it isn’t as if the Bank’s own take on its performance is ever going to be the only relevant perspective (although, of course, the Governor has far more resources and information at his disposal than anyone else is going to have). The only real question is how good a job the Bank has done of its self-review and what we learn from the documents.

On which note, I remain rather sceptical about the case (National in particular is making) for an independent review specifically on the recent conduct of monetary policy. Some of those advocating such an inquiry come across as if what they have in mind is something more akin to a final court verdict on the Bank’s handling of affairs – one decisive report that resolve all the points of contention. That sort of finality is hardly ever on offer – scholars are still debating aspects of the handling of the Great Depression – and if there was ever a time when choice of reviewer would largely determine the broad thrust of the review’s conclusions this would be among them. Anyone (or group) with the expertise to do a serious review will already have put their views on record – not necessarily about the RBNZ specifically (if they were an overseas hire) but about the handling of the last few years by central banks generally. There is precedent: the Svensson review (mentioned above) was a serious effort, but the key decision was made right at the start when Michael Cullen agreed to appoint someone who was generally sympathetic to the RB rather than some other people, some of equal eminence if different backgrounds, who were less so. It would be no different this time around (with the best will in the world all round). A review might throw up a few useful points and suggestions, and would probably do no harm, but at this point the idea is mostly a substantive distraction. Conclusions about the Reserve Bank and about its stewardship are now more a matter for New Zealand expert observers and the New Zealand political process (ideally the two might engage). Ideally, we might see some New Zealand economics academics weighing in, although in matters macroeconomics most are notable mainly by their absence from the public square.

That is a somewhat longwinded introduction to some thoughts about the report the Bank came out with last week (120 pages of it, plus some comments from their overseas reviewers, and a couple of other background staff papers).

I didn’t think the report presented the Bank in a very good light at all. And that isn’t because they concluded that monetary policy could/should (they alternate between the two) have been tightened earlier. That took no insight whatever, when your primary target is keeping inflation near the middle of the target range and actual core inflation ends up miles outside the range. Blind Freddy could recognise that monetary policy should have been tightened earlier. When humans make decisions, mistakes will happen.

The rest of the conclusions of the report were mostly almost equally obvious and/or banal (eg several along the lines of “we should understand the economy better” Really?). And, of course, we had the Minister of Finance – not exactly a disinterested party – spinning the report as follows: “It is really important to note that the report does indicate that they got the big decisions right”. It should take no more than two seconds thought to realise that that is simply not true: were it so we would not now have core inflation so far outside the target range and (as the report itself does note) pretty widespread public doubts about how quickly inflation will be got down again. It would be much closer to the truth to say that the Reserve Bank – and, no doubt, many of their peers abroad – got most of the big decisions wrong. It has, after all, been the worst miss in the 32 years our Reserve Bank has been independent, and across many countries probably the worst miss in the modern era of operationally independent central banks (in most countries, after all, monetary policy in the great inflation of the 1970s was presided over by Ministers of Finance not central banks).

But there is no sense in the report at all of the scale of the mistake, no sense of contrition, and – perhaps most importantly in my view – no insight as to why those mistakes were made, and not even any sign of any curiosity about the issue. The focus is almost entirely defensive, and shows no sense of any self-critical reflection. There are no fresh analytical insights and (again) not even any effort to frame the questions that might in time lead to those insights. And no doubt that is just the way the Governor (who has repeatedly told us he had ‘no regrets’) would have liked it. And here we are reminded that this is very much the Orr Reserve Bank: the two senior managers most responsible for the review (the chief economist and his boss, the deputy chief executive responsible for monetary policy and macroeconomics) only joined the Bank this year, and so had no personal responsibility for the analysis, preparation and policy of 2020 and 2021 but still produced a report offering so little insight and so much spin. Silk, in particular, probably had no capacity to do more, but the occasional hope still lingered that perhaps Paul Conway, the new chief economist, might do better. But these were Orr’s hires, and it is widely recognised that Orr brooks no dissent, no challenge, and in his almost five years as Governor has never offered any material insight himself on monetary policy or cyclical economic developments. Even if they had no better analysis to offer – and perhaps they didn’t, so degraded does the Bank’s capabilities now seem – contrition could have taken them some way. But nothing in the report suggests they feel in their bones the shame of having delivered New Zealanders 6 per cent core inflation, with all the arbitrary unexpected wealth redistributions that go with that, let alone the inevitable economic disruption now involved in bringing inflation a long way back down again. It comes across as more like a game to them: how can we put ourselves in the least bad light possible with a mid-market not-very-demanding audience (all made more unserious as we realised that the Minister of Finance had made the decision a couple of months ago to reappoint Orr, not even waiting for the 120 pages of spin).

At this juncture, a good report would be most unlikely to have had all the answers. After all, similar questions exist in a whole bunch of other countries/central banks, and if the Reserve Bank has the biggest team of macroeconomists in New Zealand, there are many more globally (in central banks, academe, and beyond) but it doesn’t take having all the answers to recognise the questions, or the scale of the mistakes. In fact, answers usually require an openness to questions, even about your own performance, first. And there is none of that in the Bank’s report.

Thus, we get lame lines – of the sort Conway ran several times at Thursday’s press conference – that if the Bank had tightened a bit more a bit earlier it would have made only a marginal difference to annual inflation by now. And quite possibly that is so, but where is the questioning about what it would have taken – in terms of understanding the economy and the inflation process – to have kept core inflation inside the target range? What is it that they missed? (And when I say “they” of course I recognise that most everyone else, me included, also missed it and misunderstood it, but……central banks are charged by Parliaments with the job of keeping inflation at/near target, exercise huge discretion, carry all the prestige, and have big budgets for analytical purposes, so when central banks report on their performance, we should expect something much better than “well, we acted on the forecasts we had at the time and, with hindsight, those forecasts were (wildly) wrong”.) The question is why, what did they miss, and what have they learned that reduces the chances of future mistakes (including over the next year or two – if your model for how we got into this mess was so astray, why should the public have any confidence that you have the right model – understanding of the economy and inflation – for getting out of the mess? At the press conference the other day the Governor and the Board chair prattled on about being a “learning organisation” but you aren’t likely to have learned much if you never recognised the scale of the failure or shown any sign of digging deep in your thought, analysis, and willingness to engage in self-criticism. We – citizens – should have much more confidence in an organisation and chief executive will to do that sort of hard, uncomfortable, work than in one of the sort evident in last week’s report.

With hindsight one can make a pretty good case that no material monetary policy action was required at all in 2020. One might be more generous and say that by September/October 2020 with hindsight it was clear that what had been done was no longer needed. But that wasn’t the judgement the Reserve Bank came to at the time – and it is the Bank that has been tasked with getting these things right. Why? (And, of course, the same questions can be asked of other central banks and private forecasters, but the Reserve Bank is responsible for monetary policy and for inflation outcomes in this country.)

I may come back in subsequent posts to look at more detail at a number of specific aspects of the report (including a couple of genuinely interesting revelations) but at the big picture level the report does not even approach providing the sort of analysis and reflection the times and circumstances called for (in some easier times a report of this sort might have not been too bad, although you would always look for some serious research backing even then).

And if you think that I’m the only sceptic, I’d commend to you the comments from the former Deputy Governor of the Bank of Canada. On page after page – amid the politeness (and going along with distractions like the alleged role of the Russian invasion) – he highlights just how relatively weak the analysis in the report is, how many questions there still are, and a number of areas in which he thinks the Bank’s defensive spin is less than entirely convincing.

New Zealanders deserved better. That we did not get it in this report just highlights again that Orr is not really fit for the office he holds. In times like those of the last few years – with all the uncertainties – an openness to alternative perspectives, willingness to engage, willingness to self-critically reflect, and modelling a demand for analytical excellence are more important than ever.

Economic management in years gone by

Last week I reread Victoria University historian Jim McAloon’s history of New Zealand economic policymaking from 1945 to 1984, Judgements of all Kinds, first published a decade or so ago. Good works of economic history, let alone of the history of economic policymaking, aren’t thick on the ground in New Zealand, and as McAloon himself notes in a journal article published a year or two later:

“Economic history has a relatively low profile in New Zealand. Few economics programmes offer much in the way of economic history, and none of them offer courses in New Zealand economic history. Very few academics in New Zealand economics programmes publish in economic history. Victoria University, once boasting the only New Zealand chair in economic history,
has largely abandoned the field.”

(Actually, when I was at Victoria in the early 80s – and not wise enough myself to have done much economic history – there were two professors of economic history)

Against this background of rather slim pickings, McAloon’s work is a useful contribution, including because he has gone back to at least some of the relevant archives. If you are at all interested in this period of New Zealand history – the backdrop in time to the post-1984 reforms and upheaval – I’d recommend the book, not because it is great or comprehensive but because it is (ie exists). In truth, although the title advertises coverage starting from 1945, there is quite a bit of material on economic policymaking in the 1930s and during the war too.

There is lots of interesting material, including about episodes few people now are particularly aware of (notably around the sterling area after the war). McAloon has his bugbears – not having much time for the British generally, or New Zealand farmers more specifically. And the phrase “the settler economy” keeps popping up, even when referring to events and developments decades after such a label had any more than rhetorical weight. I think he envisages the book as serving a somewhat revisionist purpose, in redeeming the tarnished reputation of the policymakers and advisers of the pre-1984 decades. I’m partial to a little of that sort of thing myself – for all his faults, for example, Muldoon clearly faced some of the most very adverse times to be a Minister of Finance almost throughout the 17 years that his terms spanned – but my sense is that McAloon sets himself rather too easy a target, in pushing back against some of the more florid rhetoric one still sometimes hears (from older politicians, economists, and business people) about the post-war New Zealand economy, and in the process acquits the policymakers, and most of their advisers, rather too readily. There is no doubt that the New Zealand economy in 1984 was a very different thing than it had been in 1945, and there had been plenty of sensible changes of policy made over the intervening decades. But the overall story remains one of deep relative decline, with no evident prospect of reversing that deterioration. And it wasn’t as if policymakers and advisers were innocents, unaware of the decline: by the very early 1960s serious independent reports from respected New Zealand economists were explicitly highlighting the extent of the relative productivity decline.

I’ve show numerous graphs here over the years highlighting New Zealand’s relative decline. But perhaps this simple one captures a significant aspect of what was going wrong. Read any book writing about inter-war New Zealand economic developments and it will make the point that per capita exports from New Zealand then were thought to be the highest of any country. That reflected a high level of GDP per capita and a high export share of GDP.

Consistent data over many decades is a challenge, but here are exports as a share of GDP as they were on the brink of the Great Depression (using as the GDP denominator the average of the three historical estimates on Infoshare) and by the early 1970s (using data from the OECD database).

By the early 1970s, not only had exports shrunk markedly as a share of New Zealand’s GDP, but that share was only around the median of the OECD countries (for which the OECD has data back that far), and that despite small countries typically trading more than large ones and New Zealand being in the smaller population grouping of OECD countries. One can debate the various possible causes of this steep relative decline, but New Zealand government policies did not, to say the least, help.

Anyway, the prompt to reading McAloon’s book again was that my son had been enrolled in McAloon’s second year New Zealand history course. If there are no specialist economic history courses at Victoria – which almost beggars belief given the way the university (and especially its commerce etc faculty) used to try to tout itself as preparing young people for careers in the public sector – at least there is some exposure to economic history topics in some of the history courses. Among the many essay topics students could choose from was one about New Zealand economic management from 1929 to 1975, and when my son chose to do that topic I suggested that reading the lecturer’s book might be worthwhile.

And here I divert into proud parent mode. I’ve included below the essay that Jonathan wrote on economic management over that period. I don’t agree with all of it (and had not read it until after the lecturer’s (high) marks came back) but – like the lecturer – I thought it was a pretty strong effort for a second-year student, and some of my readers may find the subject matter of interest. (And if anyone wants to hire a budding macroeconomist, he’ll probably be on the market in a couple of years.)

Controlling into Decline: Assessing government management of the New Zealand economy, 1929-1975.

by Jonathan Reddell

The period from 1929 to 1975 was an age of evolution in the New Zealand (NZ) economy. The upheavals of the Great Depression created a new consensus, while the economy continued to undergo the transition from a colonial to an independent economy. It cannot be said, however, that the period was an age of success. New Zealand’s relative decline during the period should not be understated. In 1939, New Zealand’s GDP per capita was $10,297, ahead of the Netherlands’ $7,079 and Canada’s $7,600. By 1975, both had surged ahead of New Zealand, as had others including Sweden.[1] New Zealand’s per capita growth rate lagged about 1% behind that of other developed market economies throughout the post-war period.[2] From 1929-1975, the performance of governments has been mixed, but that the economy was more often ill-managed than not. There are success stories, such as the diversification from Britain, and New Zealand remained one of the most prosperous countries on the planet, but on balance it was a drift into (relative) decline.

The role of the Great Depression in reshaping consensus economic thought in advanced capitalist economies is well known. The dislocations caused by the worst recession in modern history created the post-war consensus on full employment and the role of the state. This consensus would endure until the 1970s, when it was overturned by another crisis. New Zealand was no exception to this.[3] The following paragraphs will discuss government management of the Depression, and the new economic thought that was put into practice by the First Labour Government. The essay will then discuss the post-war consensus policies and assess how well governments managed the economy to achieve them.

The Depression’s impact on New Zealand was severe. A primary exporter, New Zealand was hard-hit by a shock whose hardest blow fell on commodities. Exports fell between 55-60% between 1928-29 and 32-33.[4] Rankin has estimated that joblessness peaked at over 35% of the workforce in 1932.[5] To compound matters, the New Zealand economy had been weakened by Britain’s anaemic economic performance in the 1920s due to the overvaluation of sterling from 1925.[6] Meanwhile the government’s ability to respond was constrained by the immense burden of public debt. In the 1931 Budget, public debt charges were by far the largest component of state expenditure, amounting to £10.9 million out of £24.7 million.[7] The debt burden and global loss of confidence severely constrained the government’s ability to borrow in London, while the inelastic debt payments meant that other sources of expenditure had to be cut, as a balanced budget was considered key to stability.[8]

While New Zealand did devalue against other currencies when Britain went off gold in September 1931, it did not devalue against sterling until 1933, prolonging the pain for exporters. From 1933, recovery was relatively rapid, as reforms including devaluation and the creation of a new monetary system under the Reserve Bank which allowed the Indemnity Act to lapse and monetary expansion while agricultural exports improved; by 1935 GDP per capita had recovered to the 1929 level.[9] Overall, the Coalition government’s management of the Depression was mixed. Belief in the desirability of a balanced budget constrained policy, as did the debt burden. On the other hand, the recovery was eventually strong, and as Hawke notes, actions were generally “sensible and sometimes imaginative.”[10] While it can be argued that the government could have taken more steps after Britain went off gold, overall, it is hard to argue with his judgement that, given the circumstances, the government did about as well as anyone else would have.[11]

By the time Labour came to power in 1935, the economy had generally recovered. Members of the new government had been greatly affected by the Depression and came to believe in the importance of boosting demand and that unemployment should never be allowed to reach such levels again.[12] Policy would be aimed at stabilisation, at security, at protecting the populace from the swings of the global economy. This would be achieved through polices such as expanded welfare and guaranteed prices for exporters. Nash wrote that the government, “intended to protect the producer…from the uncertainties of price.”[13] For dairy, this was done through the 1936 Primary Products Marketing Act. Labour perceived that the Depression illustrated New Zealand’s excessive vulnerability to the world economy, and aimed to counteract it, to ensure long term full employment. The state would lead industrial development to achieve both full employment and a less dependent economy. Labour’s policies marked a profound departure from the pre-Depression economy and created the basis of the post-war consensus which would last until 1975.[14] Stabilisation policy was locked in through the experiences of World War II (WW2), when the state took strong direct action and was generally successful.[15]

The post-war economic consensus consisted of several elements. National accepted the focus on full employment, and the welfare state, with Holland professing a belief that everyone had the right to employment and necessities.[16] A 1956 Royal Commission laid out the objectives of economic policy as: full employment, price stability, development, and promoting economic, social, and financial welfare of New Zealanders.[17] Governments from 1935 looked to manage the economy in pursuit of these goals, particularly full employment. The following paragraphs will assess their success regarding the economy.

The 1938-39 crisis was important in setting in the controls that would characterise the economy to 1984. From 1935 recovery continued apace, with GDP per capita one of the highest in the world in 1939. This would lead to crisis. The 1938-39 balance of payments crisis was a problem of the government’s own making, and a sign of things to come. Labour’s demand policies had resulted in a red-hot domestic economy, while a slowdown in the world economy resulted in a significant fall in export receipts. The trade balance fell from £10.5 million in 1937 to £2.9 million a year later.[18] Labour, unwilling to take actions that might harm workers like devaluation or fiscal retrenchment, opted for capital and import controls, which in some form would last until 1984. According to Hawke, the controls symbolised Labour’s move to an ‘insulationist’ economy.[19] The story of an overheated, full employment economy leading to a balance of payments crisis would be repeated periodically throughout the consensus period, including the crises of 1957-58 and 1966-67. The controls gave rise to a distorted economy and would have significant future negative impacts. Labour’s stabilisation policies undoubtedly had some value, but the obsession with full employment resulted in mismanagement in the 1930s, as it would again.  

Post-depression governments would manage the economy with full employment front of mind. For Labour,  it was, according to McAloon, “not negotiable.”[20] Speaking on the Employment Bill in 1945, Fraser said that “there is no greater tragedy than…being denied the opportunity,” to work, and being prevented from “contributing…to the production of goods and services.”[21] This undoubtedly succeeded, at least until the 1970s. From the late 1930s, the number of registered unemployed was incredibly low, bottoming out at 38 in 1950 and 1951.[22] While this number understates the true unemployment rate, estimates of that are as low as 1%.[23] This was a very low number by international standards.

While other countries also looked to achieve full employment, New Zealand’s unemployment was extremely low. For example, the United States, through the 1946 Employment Act declared a goal of “maximum employment.” However, even when the 1960s governments sought to make it a reality, unemployment never fell below 2.5%.[24] Therefore successive governments succeeded at managing the economy to achieve a level of full employment that was very low compared to other countries. A low unemployment rate has obvious benefits, but it also has costs. As was discussed, running a full employment economy with unemployment below the natural rate required import controls, to prevent domestic demand resulting in balance of payments crises. If unemployment had been allowed to rise to its natural level, which, as Gould notes, was likely quite low[25], the economy would have been less prone to fluctuations, whether in fiscal policy or the terms of trade, as demand for imports would have been generally weaker and there would have been less need for controls. Another negative of New Zealand’s extremely low unemployment rate was that fears of unemployment levels like other countries, particularly on the left, delayed NZ’s entry into the International Monetary Fund (IMF). Kirk exemplified those sentiments when he declared during the debate that NZ had “built up a social order that is unique,”[26] which IMF membership would imperil. In fact, non-membership of the IMF raised the cost of dealing with crises, while it did not prevent or cause higher unemployment.

Related to the full employment goal were import controls. As has been noted, successive governments looked to defend full employment while staving off balance of payments crises with import and capital controls, which would minimise the ability for New Zealand’s foreign reserves to drain. While National attempted to liberalise after 1949, controls were reimposed in 1951-52. These stop-go policies would repeat themselves, as the perceived foreign exchange constraint remained strong.[27] Import controls had major negative impacts. One was that import controls gave rise to import-substituting industries like textiles. These were often inefficient and misallocated resources away from potential export sectors. The high capital-output ratio of the economy through the 1950s and 1960s suggests inefficient usage, as it indicates a high level of capital was being used for low levels of output.[28] A 1968 World Bank report argued that “import restrictions are a hidden form of protectionism, which tend to result in a misallocation of resources,” and that they have failed to result in net exchange savings.[29] This seems believable as other sources have identified the high level of effective protection on NZ manufacturing, perhaps as high as 70% by the mid-1960s, and as a result, a functional tax on productive farmers, which weakened the NZ economy.[30]

While some level of control was understandable, particularly after WW2 given dollar shortages, New Zealand’s controls outlasted those of other OECD countries. Australia abolished import licencing in 1961.[31] A significant issue with New Zealand’s approach was the unwillingness to regard interest rates as a meaningful stabilisation tool. While many central banks abandoned interest rate control after WW2, New Zealand did not use interest rates even into the 1970s, while Australia had done so since the 1950s, due to factors including social credit influences and the sensitivity of farmers.[32] This had significant drawbacks because it meant more heavy-handed, distortionary controls were necessary to manage the economy. If interest rates, rather than direct controls, had been utilised as a policy tool, it seems likely that New Zealand’s relative decline would have been less marked. Easton argues that other OECD economies suffered from high protection of their agriculture sectors.[33] However, this mainly held up a dying industry and didn’t constrain the growth of industries like technology, while in New Zealand, controls raised the cost of inputs, effectively taxed agriculture, a growth sector, and allocated industrial capacity away from exports to import substitution.

The management of price stability is a mixed picture. An overheated economy continuously exerted inflation pressure. However, these pressures were mostly well constrained from the late 1940s. Condliffe observed that the New Zealand economy came out of WW2 “taut with supressed inflation.”[34] As wartime controls eased, inflation picked up to about 10% in 1947-48.[35] The government enacted several sensible measures to ease demand pressures and bring inflation down. These included a continued emphasis on national saving rather than overseas borrowing, which took money out of circulation, and the revaluation of 1948, which lowered the prices of exports and imports.[36] The New Zealand experience continued to be shaped by global conditions, as the Korean boom drove inflation to new heights in the early 1950s. While inflation fell and was generally relatively low between 1955 and 1970 it continued to be perceived as a threat. Hawke has observed that “prices rose by 2-3% in most years…worrying to many contemporaries.”[37] This perception is illustrated by a farmer, writing to the Press in 1961 that, “for the genuine farmer inflation is the worst thing that can happen.”[38] Thus, to the extent that governments are responsible for assuaging the fears of their citizens, NZ governments failed in that regard.

However, from a macroeconomic perspective, inflation was well managed until the late 1960s. The breakdown of the consensus between government, employers, and unions, particularly with the Nil Wage Order of 1968 was significant.[39] It combined with the overheated economy to produce significant levels of inflation that was managed inadequately through blunt instruments like freezes, due to ongoing full employment commitments. On balance, controlled inflation with overfull employment endured for a surprisingly long time. It is not clear, however, how much credit can be given to governments. New Zealand’s experience continued to be shaped by the global environment, and the  inflation experience was similar to other countries, albeit at a lower level of unemployment.[40] A stronger factor seems to be the enduring legacy of Depression leading to a moderation of union militancy, which constrained wage, and thus price, inflation. However, governments do deserve at least some credit for keeping inflation as low as it was.

The third objective of economic policy was industrial development, which, from the mid-1950s linked with the need to diversify export markets as bulk purchase agreements ended in 1954 and Britain desired to join the European Economic Community. McAloon notes that “industrial development, trade development…were closely related over the decade after 1957.”[41] Industrial development was viewed as desirable from the late 1930s, as part of the quest to make New Zealand more insulated from price swings. This received greater focus under the Second Labour Government from 1957, particularly under the influence of Bill Sutch. Sutch wrote that “rapid and radical action is needed to readjust our economic structure,” towards manufacturing.[42] Sutch’s ideas reflected the flawed but orthodox view that there was a long-term decline in the terms of trade of commodity producers relative to industrial producers, known as the Prebisch-Singer thesis.[43] Its orthodoxy is illustrated by the World Bank’s report which argued that New Zealand’s fundamental problem was being “still too narrowly dependent on a few export commodities.”[44] Successive governments believed that industrial development was a priority, both for reducing balance of payments difficulties and maintaining prosperity.

The success of industrial development is a mixed picture. There were successful developments, such as the Kawerau pulp and paper mill and the wider forestry industry, and the domestic economy diversified throughout the 1960s. However, as was already noted, import controls resulted in misallocation towards import substitution, and experiments such as a cotton mill in Nelson were highly problematic.[45] The belief that too much agriculture was making New Zealand poorer seems particularly strange given that it remained the most productive industry.[46] The dominance of sheep and cow products did decline, from 90% of receipts in the 1930s to 53% in 1977/78, as new industries picked up: manufactured and forest products made up 23.4% of exports.[47] However, these exporters were often heavily subsidised, illustrated by the large incentives put on machinery in 1972.[48] These subsidies created their own inefficiencies. Again, governments were deploying distortionary solutions to questionably real problems. On the other hand, management of the diversification from Britain was successful. Trade agreements were signed with Japan in 1958, and significantly, with Australia in 1965.[49] Britain’s share of New Zealand exports fell from 51% in 1965 to 34% in 1971.[50] While there is much to criticise governments for how they handled the economy, they managed this landmark transition well, even if Britain’s relative economic marginalisation made trade readjustment inevitable.

In conclusion, the Depression shook the New Zealand economy, establishing a new order which sought full employment, price stability, and industrial development. While these were, for a time, achieved, it came at the cost of extensive controls which were a leading contributor to New Zealand’s relative decline. While successes like trade diversification cannot be overlooked, overall government management of the economy cannot be said to have been successful. The fundamental duty of government is to deliver prosperity and while New Zealand remained prosperous, it could have been much more so.

Bibliography

Primary Sources

Forbes, G.W., Minister of Finance. “Financial Statement.” Appendix to the Journal of the House of Representatives. (1931) https://paperspast.natlib.govt.nz/parliamentary/AJHR1931-I-II.2.1.3.8

New Zealand Parliamentary Debates. Vol. 270 (1945) & Vol. 326 (1960).

“Inflation.” Press, 6 July 1961, p. 3. https://paperspast.natlib.govt.nz/newspapers/CHP19610706.2.19.5?end_date=06-07-1961&query=Inflation&snippet=true&start_date=06-07-1961&title=CHP

Royal Commission on Monetary, Banking and Credit Systems. Report of the Royal Commission on Monetary, Banking, and Credit Systems. (1956). https://paperspast.natlib.govt.nz/books/ALMA1956-9915984483502836-Report-of-the-Royal-Commission-o?page_number=1&items_per_page=10&snippet=true

World Bank. The World Bank Report on the New Zealand Economy 1968. (1968).

Secondary Sources

Bernanke, Ben S. 21st Century Monetary Policy. New York: W.W. Norton & Company, 2022.

Bertram, Geoff. “The New Zealand Economy 1900-2000.” In The New Oxford History of New Zealand, edited by Giselle Byrnes, pp. 537-572. Melbourne: Oxford University Press, 2009.

Bloomfield, G.T. New Zealand: A Handbook of Historical Statistics. Boston: G.K Hall & Co., 1984.

Bolt, Jutta,and Jan Luiten van Zanden. “Maddison Project Database 2020.” 2020. https://www.rug.nl/ggdc/historicaldevelopment/maddison/releases/maddison-project-database-2020

Condliffe, J.B. The Welfare State in New Zealand. London: Allen and Unwin, 1959.

Easton, Brian. In Stormy Seas: The Post-War New Zealand Economy. Dunedin: University of Otago Press, 1997.

Gould, John. The Rake’s Progress? The New Zealand Economy Since 1945. Auckland: Hodder and Stoughton, 1982.

Greasley, David, and Les Oxley. “Regime Shift and Fast Recovery on the Periphery: New Zealand in the 1930s.” The Economic History Review 55, no. 4 (2002): pp. 697-720. https://doi.org/10.1111/1468-0289.00237

Gustafson, Barry. From the Cradle to the Grave. Auckland: Reed Methuen, 1986.

Hawke, G.R. The Making of New Zealand: An Economic History. Cambridge: Cambridge University Press, 1985.

Holland, Sidney. Passwords to Progress. Christchurch: Whitcombe and Tombs, 1943.

Kindleberger, Charles P. The World in Depression, 1929-1939. Revised Edition. Berkeley: University of California Press, 1986.

McAloon, Jim. Judgements of all Kinds: Economic Policy-Making in New Zealand 1945-1984. Wellington: Victoria University Press, 2013.

Nash, Walter. New Zealand: A Working Democracy. London: J.M Dent & Sons., 1944.

Rankin, Keith. “Workforce and Employment Estimates: New Zealand 1921-1939.” In Labour, Employment and Work in New Zealand, pp. 332-343, 1994.

Reddell, Michael, and Cath Sleeman. “Some perspectives on past recessions.” Reserve Bank of New Zealand, Bulletin, 71, no. 2 (2008): pp. 5-21.

Singleton, John, Arthur Grimes, Gary Hawke, and Frank Holmes. Innovation + Independence: The Reserve Bank of New Zealand 1973-2002. Auckland: Auckland University Press, 2006.

Statistics New Zealand. “Consumer Price Index.”  https://infoshare.stats.govt.nz/Default.aspx

Sutch, W.B. “Colony or Nation? The Crisis of the Mid-1960s.” In Colony or Nation? edited by Michael Turnbull, pp. 163-183. Sydney: Sydney University Press, 1966.

Toye, John, and Richard Toye. “Origins and Interpretations of the Prebisch-Singer Thesis.” History of Political Economy 35, no. 3 (2003): pp. 437-467. muse.jhu.edu/article/46958.


[1] Figures in 2011 constant prices (USD). Jutta Bolt and Jan Luiten van Zanden. “Maddison Project Database 2020.” (2020) https://www.rug.nl/ggdc/historicaldevelopment/maddison/releases/maddison-project-database-2020

[2] John Gould, The Rake’s Progress? The New Zealand Economy Since 1945 (Auckland: Hodder and Stoughton, 1982), p. 25.

[3] Jim McAloon, Judgements of all Kinds: Economic Policy-Making in New Zealand 1945-1984 (Wellington: Victoria University Press, 2013), p. 22.

[4] Charles P. Kindleberger, The World in Depression: 1929-1939 revised edition (Berkeley: University of California Press, 1986), p. 189.

[5] Keith Rankin, “Workforce and Employment Estimates: New Zealand 1921-1939,” Labour, Employment and Work in New Zealand (1994), p. 338.

[6] McAloon, Judgements of all Kinds, p. 34.

[7] G.W. Forbes, Minister of Finance “Financial Statement” (1931) AJHR B-06, p. 4. https://paperspast.natlib.govt.nz/parliamentary/AJHR1931-I-II.2.1.3.8

[8] Michael Reddell and Cath Sleeman, “Some perspectives on past recessions,” Reserve Bank of New Zealand: Bulletin 71, no.2 (2008), p. 7.

[9] David Greasley and Les Oxley, “Regime shift and fast recovery on the periphery: New Zealand in the 1930s,” The Economic History Review 55, no.4 (2002), pp. 709-710.

[10] G.R. Hawke, The Making of New Zealand: An Economic History (Cambridge: Cambridge University Press, 1985), p .158.

[11] Ibid., p. 159.

[12] Barry Gustafson, From the Cradle to the Grave (Auckland: Reed Methuen, 1986), pp. 146-147.

[13] Walter Nash, New Zealand: A Working Democracy (London: J.M Dent & Sons, 1944), p. 130.

[14] McAloon, Judgements of all Kinds, pp. 51-52.

[15] Ibid., p. 52.

[16] Sidney Holland, Passwords to Progress (Christchurch: Whitcombe and Tombs, 1943), p. 7.

[17] Royal Commission on Monetary, Banking, and Credit Systems, Report of the Royal Commission on Monetary, Banking and Credit Systems (1956), p. 19. https://paperspast.natlib.govt.nz/books/ALMA1956-9915984483502836-Report-of-the-Royal-Commission-o?page_number=1&items_per_page=10&snippet=true

[18] G.T. Bloomfield, New Zealand: A Handbook of Historical Statistics (Boston: G.K Hall & Co., 1984), p. 269.

[19] Hawke, The Making of New Zealand, pp. 163-164.

[20] McAloon, Judgments of all Kinds, p. 44

[21] NZPD, 1945: Vol. 270, p. 249 (Rt. Hon P. Fraser)

[22] Bloomfield, Handbook of Historical Statistics, p. 146.

[23] Gould, The Rake’s Progress, p. 56.

[24] Ben S. Bernanke, 21st Century Monetary Policy (New York: W.W. Norton & Company, 2022), p. 18.

[25] Gould, The Rake’s Progress, p. 58.

[26] NZPD, 1960: Vol. 326, p. 1130 (Kirk)

[27] Hawke, The Making of New Zealand, p. 205.

[28] Ibid., p. 176.

[29] World Bank, The World Bank Report on the New Zealand Economy 1968 (1968), pp. 44-45.

[30] Geoff Bertram, “The New Zealand Economy: 1900-2000,” in The New Oxford History of New Zealand, ed. Giselle Byrnes (Melbourne: Oxford University Press, 2009), p. 557.

[31] John Singleton et al., Innovation + Independence: The Reserve Bank of New Zealand 1973-2002 (Auckland: Auckland University Press, 2006), pp. 17-21.

[32] Ibid., pp. 23-26.

[33] Brian Easton, In Stormy Seas: The Post-War New Zealand Economy (Dunedin: University of Otago Press, 1997), p. 178.

[34] J.B Condliffe, The Welfare State in New Zealand (London: Allen and Unwin, 1959), p. 99.

[35] Statistics New Zealand, “Consumer Price Index,” https://infoshare.stats.govt.nz/Default.aspx

[36] McAloon, Judgements of all Kinds, p. 75; Gould, The Rake’s Progress, pp. 52-53.

[37] Hawke, The Making of New Zealand, p. 174.

[38] “Inflation,” Press, 6 July 1961, p. 3. https://paperspast.natlib.govt.nz/newspapers/CHP19610706.2.19.5?end_date=06-07-1961&query=Inflation&snippet=true&start_date=06-07-1961&title=CHP

[39] McAloon, Judgements of all Kinds, pp. 135-136.

[40] Hawke, The Making of New Zealand, p. 174.

[41] McAloon, Judgements of all Kinds, p. 110.

[42] W.B. Sutch, “Colony or Nation? The Crisis of the Mid-1960s,” in Colony or Nation?, ed. Michael Turnbull (Sydney: Sydney University Press, 1966), p. 183.

[43] John Toye and Richard Toye, “The Origins and Interpretation of the Prebisch-Singer Thesis,” History of Political Economy 35, no. 3 (2003), p. 437.

[44] World Bank, Report on the New Zealand Economy, p. 20.

[45] McAloon, Judgements of all Kinds, pp.112-115.

[46] Hawke, The Making of New Zealand, p. 176.

[47] Gould, The Rake’s Progress, p. 159.

[48] McAloon, Judgements of all Kinds, p. 146

[49] Ibid., pp. 121-123.

[50] Ibid., p. 143.

The Spencer precedent

Over the last couple of months, the National Party has been running the line that a Reserve Bank Governor should not be appointed to the normal full five-year term when Orr’s existing term expires in late March, but that rather an appointment should be made for just a year so that whichever party takes office after next year’s election can appoint a Governor of their preference. We are told (although we have not yet seen the letter) that they made this case to the Minister of Finance when, as he was required to, he came consulting on his plan to reappoint Orr.

It is a terrible idea, on multiple counts.

But what is also irksome is the idea that in making a five year appointment, for a term beginning probably at least six months prior to the election, the Minister is breaching some established convention. That is simply a nonsense claim. This clip (from Bernard Hickey’s newsletter, this one opened to everyone) has some relevant quotes

There is simply no foundation to what Luxon is saying about what happened in the past. Since the Reserve Bank was made operationally independent in 1990, there have been two cases in which a Governor’s term has expired in election year but before the scheduled election. The first was in 1993, when Don Brash’s term expired on 31 August. The 1990 election had been held on 6 November 1990, so presumptively any new term was going to start within three months of the 1993 election. As it is, and partly to allay any possible market concerns (these were still fairly early days), Don’s reappointment was made and announced very early (if memory serves correctly in late 1992). I don’t recall any particular controversy about that reappointment (although the then Prime Minister had not been a huge Brash fan), but then Brash had initially been appointed by a Labour government (and the then Labour leader and finance spokesman had both sat in the Cabinet that had appointed him).

Of the next few (re)appointments:

  • Don Brash was appointed to a third term commencing in September 1998, not an election year
  • Don Brash resigned suddenly in April 2002, about three months before the general election.  The then Deputy Governor was immediately appointed (lawfully) as acting Governor, both to run the Bank in the interim and to enable a proper search process to take place.  Recall that under New Zealand law, the Minister of Finance cannot simply appoint his or her own person as Governor, and in those days the Bank’s Board used to guard its prerogatives (right and responsibility to nominate).  The eventual appointment of Alan Bollard was not made until after the election.
  • Bollard was reappointed in 2007 (not an election year) and Wheeler was appointed in 2012 (also not an election year)

Which brings us to 2017.  In 2016 Graeme Wheeler had advised that he would not be seeking a second term (probably to the general relief of both government and opposition parties at the time).  Documents later released show that The Treasury (and the Board and minister) envisaged making a permanent new appointment some time early in 2017, well clear of the likely election date.  However, those same papers also show that when the relevant authorities (in this case, Cabinet Office) were consulted it was established that the convention now (though perhaps not in 1992/93) was that permanent appointments should not be made when the new appointment would commence very close to (within three months of) an election date.  In other words, the government could not get round the fact that Wheeler’s term expired close to the expected election date simply by making an early announcement of a permanent replacement.   And thus they more or less had to settle on the idea of an acting Governor (Grant Spencer).  Unfortunately, the then law was badly written (did not envisage the circumstances), and Graeme Wheeler (who could lawfully have been extended for six months) seemed keen to get back to commercial life ASAP, and the actual solution they landed on was almost certainly unlawful (I wrote a lot about it at the time, but here is a post that comments on the best arguments the Crown’s lawyers could make in defence).

So there is a precedent for an acting appointment (which, since the law was amended, could now be done lawfully) when the Governor’s term expired within three months of the election.  That same convention, about not making permanent appointments, isn’t just about the central bank.  But Orr’s term expires on 27 March, and the election seems likely to be at least six months after that, in a system with a three-year parliamentary term.  It simply isn’t very serious or credible to argue that the government –  otherwise still governing fully –  should be unable (or even unwilling) to appoint a permanent Governor six or more months out from an election.  You might argue, and I might have a bit of sympathy for such a view, that perhaps it would be better to give a Governor a six year term (the RBA Governor has a seven year term), so that overlaps with election years happened much less often, but the law is as it is, and I don’t recall the Opposition opposing five year terms when the reform bills were before the House.   But there is no established precedent or convention about not making permanent appointments that start that far out from a likely election.

In passing, one might note that whereas with past appointments all powers of the Reserve Bank rested with the Governor, the various reforms put in place by this government have (at least on paper) considerably diminished the extent of the Governor’s powers, and created other appointments (notably external MPC members) which (at least on paper) provide avenues to shape and influence the Bank.  I don’t want to put too much weight on this argument – I’ve spent years arguing that many of these changes in practice have been largely cosmetic – but not only could those provisions be used more aggressively by an incoming government that cared, but it would be quite legitimate for an incoming government to amend the legislation further (at the margin) to reduce the relative dominance of any particular individual serving as Governor.  Our system would be better for such changes.  (To be clear, like various other commenters, I would not support law changes designed directly to remove Orr: that way lies Erdogan type central banking.)

Whatever the law and precedent, it would also be a bad idea to be making acting appointments in circumstances like the present one.  Our whole system around the Reserve Bank –  and central banks in other advanced economies of our type –  is set up around the idea that incoming governments don’t just get to pick their central bankers as soon as it suits.  Instead, the system of operationally independent central banks has been built on (among others) the notion of technically capable, respected, non-partisan figures serving (whether as Governor or MPC members) for terms that do not align with the parliamentary term.   Consistent with that vision, New Zealand’s legislation went further than most (too far in my view) in not even allowing the Minister of Finance to choose a Governor (or MPC members), but rather requiring that the Minister only appoint people who had first been nominated by the Board of the central bank, itself appointed for staggered terms by the Minister of Finance.     Legislation was recently amended to even further reinforce this vision – of technically competent, respected, non-partisan appointees – when Labour explicitly added provisions requiring that other parties in Parliament be consulted before appointments are made (whether as Governor or Board members).  

You could mount a counter-argument that this approach is a bit wrongheaded.  After all, the legislation has also been amended recently to make it clear, that in monetary policy at least, the target the Bank works to is directly set by the government of the day.  But notwithstanding that, the central bank still has a lot of practical policy discretion, and not just around monetary policy.   Most advanced countries have made the choice that we do not want key central bank decisionmakers changing routinely when the government changes.  That still seems, on balance, prudent to me, and in their calmer moments I’d be surprised if National really disagreed.

So the big problem in the current situation is NOT that an appointment has been made for five years. That should be the norm, whether or not it is six months from an election.  The problem is specifically with the appointment (at all) of Adrian Orr.   National seems reluctant to say that (perhaps because they may well be stuck working with him) but it is the main issue.  There would be no such concern had a (hypothetical) generally highly-regarded (professionally, and among politicians), technically excellent, respected, non-partisan figure been appointed to the role.  Specifically, National (and ACT) would not be raising concerns about the term of the appointment if they had any confidence in Orr.  They do not.    One can perhaps debate whether or not they should have such confidence, but in our system respect and confidence are earned, they are not something anyone can simply be forced to adopt.    As I noted in yesterday’s post, the rank politicisation that has happened this week is not of National’s or ACT’s making, but of Robertson, in pushing ahead with an appointment –  to a long-term position, where cross-party respect etc is important for the institution and its functioning – that the main Opposition parties seem to have been quite clear in opposing.   It is not the job of Opposition parties to simply go along with whoever Robertson (and his, technically ill-equipped, board (itself, in some cases appointed over Opposition objections) determine).  All the more so when Robertson himself was the one who introduced the formal consultation requirements, seeming to establish an expectation that strong (and reasoned) objections would be taken seriously.    The responsibility was on Robertson – who holds the power to appoint or not – to respect the notion of only appointing someone who commands (even grudging) professional and personal respect.  Orr no longer qualifies on that count.  It is hard to think of any advanced country central bank Governor who will start a new term commanding so little respect, support, and confidence.  That is really bad for the institution, and the institutional arrangements.

(Having said all this it would be good if National and ACT would pro-actively release their responses to Robertson’s consultation, rather than making us wait for OIA releases. It would be helpful to see what grounds the parties objected on, and whether they actually raised substantive concerns, or just relied on ill-founded process arguments.)

UPDATE: Having been sent a copy of the National letter of 30 September, it is now clear that National did not raise any substantive concerns about Orr, and focused wholly on the non-existent “convention” about not appointing a substantive Governor even 6-7 months out from an election.

 

Reappointing Orr

Yesterday’s announcement from the Minister of Finance that he was reappointing Adrian Orr as Governor of the Reserve Bank was not unexpected but was most unfortunate. I was inclined to think another commentator (can’t remember who, so as to link to) who reckoned that it may have been Robertson’s worst decision in his five years in office was pretty much on the mark.

When Orr was first appointed, emerging out of a selection process kicked off by the Reserve Bank’s Board while National had still been in office, it seemed to me it was the sort of appointment that could have gone either way. I captured some of that in the post I wrote the day after that first appointment was announced, and rereading that post last night it seemed to at least hint at many of the issues that might arise and come to render the appointment problematic at best. Some things – a good example is $9.5 billion of losses to the taxpayer – weren’t so easy to foresee.

The timing of the reappointment announcement itself was something of a kick in the face for (a) critics, and (b) any sense that the better features of the new Reserve Bank legislation were ever intended as anything more than cosmetic. The Reserve Bank is tomorrow publishing its own review (with comments from a couple of carefully selected overseas people) of monetary policy over the past five years. Adding the statutory requirement for such a review made a certain amount of sense, but if there is value in a review conducted by the agency itself of its own performance, it was only going to be in the subsequent scrutiny and dialogue, as outsiders tested the analysis and conclusions the Bank itself has reached. But never mind that says Robertson, I’ll just reappoint Adrian anyway. Perhaps the Bank has a really compelling case around its stewardship of monetary policy – and just the right mix of contrition and context etc – but we don’t know (and frankly neither does Robertson – who has no expertise in these matters, and who appointed a Reserve Bank Board -the people who formally recommend the reappointment – full of people with almost no subject expertise).

But, as I say, the reappointment was hardly a surprise.

It could have been different. I’ve seen a few people say it would have been hard to sack Orr, but I don’t think that is so at all. No one has a right to reappointment (not even a presumptive right) and Robertson could quite easily have taken Orr aside a few months ago and told him that he (Orr) would not be reappointed, allowing Orr in turn the dignity of announcing that he wouldn’t be seeking a second term and would be pursuing fresh opportunities (perhaps Mark Carney would like an offsider for his climate change crusades?) Often enough – last week’s FEC appearance was just the latest example – Orr’s heart doesn’t really seem to be in the core bits of the job.

There are many reasons why Orr should not have been reappointed. The recent inflation record is not foremost among them, although it certainly doesn’t act as any sort of mitigant (in a way that an unexpectedly superlative inflation record in a troubled and uncertain world might – hypothetically – have).

There is nothing good, admirable, or even “less bad than most” about the inflation record. This chart is from my post last week

A whole bunch of central banks made pretty similar mistakes (and the nature of floating exchange rates is that each central bank is responsible for its country’s own inflation rate). Among the Anglo countries, we are a bit worse than the UK and Canada and slightly less bad than the US and Australia. Among the small advanced inflation targeters – a group the RB sometimes identified with – we have done worse than Switzerland, Norway, and Israel, and better than Sweden and Iceland. In a couple of years (2021 and 2022) in which the world’s central bankers have – in the jargon – stuffed up badly, Orr and his MPC have been about as bad on inflation as their typical peers.

You could mount an argument – akin to Voltaire on the execution of Admiral Byng – that all the world’s monetary policymakers (at least those without a clear record of dissent – for the right reasons – on key policy calls) should be dismissed, or not reappointed when their terms end, to establish that accountability is something serious and to encourage future policymakers to do better. You take (voluntarily) responsibility for inflation outcomes, and when you fail you pay the price, or something of the sort. Inflation failures – including the massive unexpected wealth redistributions – matter.

Maybe, but it was never likely to happen, and it isn’t really clear it should. As I’ve noted here in earlier posts until well into 2021 the Reserve Bank’s forecasts weren’t very different from those of other forecasters, and I’m pretty sure that was also the case in other countries. Inflation outcomes now (year to September 2022) are the result of policy choices 12-18 months earlier. With hindsight it is clear that monetary policy should have been tightened a lot earlier and more aggressively last year, but last February or even May there was hardly anyone calling for that. Absent big policy tightenings then, it is now clear it was inevitable that core inflation would move well outside the target range. There are plenty of things to criticise the Bank for – including Orr’s repeated “I have no regrets” line – but if one wants to make a serious case for dismissing Orr for his conduct of monetary policy it is probably going to have to centre on (in)actions from say August 2021 to February 2022 (whereafter they finally stepped up the pace) but on its own – it was only six months – it would just not be enough to have got rid of the Governor (even just by non-reappointment). The limitations of knowledge and understanding are very real (and perhaps undersold by central bankers in the past), and even if Orr and the MPC chose entirely voluntarily to take the job (and all its perks and pay) those limitations simply have to be grappled with. Were New Zealand an outlier it might be different. Had the Bank run views very much at odds with private forecasters etc it might be different. But it wasn’t.

I am, however, 100 per cent convinced that Orr should not have been reappointed. I jotted down a list of 20 reasons last night, and at that I’m sure I’ve forgotten some things.

I’m not going to bore you with a comprehensive elaboration of each of them, most of which have been discussed in other posts. but here is a summary list in no particular order:

  • the extremely rapid of turnover of senior managers (in several case, first promoted by Orr and then ousted) and associated loss of experience and institutional knowledge
  • the block placed –  almost certainly at Orr’s behest –  on anyone with current and ongoing expertise in monetary policy nad macroeconomic analysis from serving as an external member of the MPC
  • the appointment as deputy chief executive responsible for macroeconomics and monetary policy (with a place on the MPC) of someone with no subject expertise or relevant background
  • $9.5 billion of losses on the LSAP – warranting a lifetime achievement award for reckless use of public resources – with almost nothing positive to show for the risk/loss  
  • the failure to ensure that the Bank was positioned for possible negative OCRs (having had a decade’s advance warning of the issue), in turn prompting the ill-considered rush to the LSAP
  • the failure to do any serious advance risk analysis on the LSAP instrument, as being applied to NZ in 2020
  • the sharp decline in the volume of research being published by the Reserve Bank, and the associated decline in research capabilities
  • the way the Funding for Lending programme, a crisis measure, has been kept functioning, pumping attractively-priced loans out to banks two years after the crisis itself had passed (and negative OCR capability had been established)
  • lack of any serious and robust cost-benefit analysis for the new capital requirements Orr imposed on banks (even as he repeatedly tells us how robust the system is at current capital levels)
  • repeatedly misleading Parliament’s Finance and Expenditure Committee (most recently, his claim last week that the war was to blame for inflation being outside the target range), in ways that cast severe doubts on his commitment to integrity and transparency
  • his refusal to ever admit a mistake about anything (notwithstanding eg the biggest inflation failure in decades) 
  • the fact that four and a half years in there has never been a serious and thoughtful speech on monetary policy and economic developments from the Governor (through one of the most turbulent times in many decades)
  • Orr’s active involvement in supporting and facilitating the appointment of Board members with clear conflicts of interest (Rodger Finlay especially, but also Byron Pepper)
  • his testiness and intolerance of disagreement/dissent/alternative views
  • his often disdainful approach to MPs
  • his polarising style, internally and externally
  • all indications are that he is much more interested in, and intellectually engaged by, things he isn’t responsible for than for the things Parliament has charged him with
  • organisational bloat (think of the 17-20 people in the Communications team or the large number of senior managers now earning more than $400000 pa)
  • the distraction of his focus on climate change, but much more so the rank dishonesty of so much of it – claims to have done modelling that doesn’t exist, attempts to suppress release of information on what little had been done, and sheer spin like last week’s flood stress test. It might be one thing for a bloated overfunded bureaucracy to do work on things it isn’t really responsible for if it were first-rate in-depth work. It hasn’t been under Orr.
  • much the same could be said of Orr’s evident passion for all things Maori –  in an organisation with a wholesale macroeconomic focus, where the same instruments apply to people of all ethnicities, religions, handedness, political affiliation or whatever.  What “analysis” they have attempted or offered has been threadbare, at times verging on the dishonest.
  • the failure to use the opportunity of an overhaul of the RB Act to establish a highly credible open and transparent MPC (instead we have a committee where Orr dominates selection, expertise is barred, and nothing at all is heard from most members)

And, no doubt, so on.  He is simply unfit to hold the office, and all indications are that he would have been so (if less visibly in some ways) had Covid, and all that followed (including inflation), never happened.   

But the crowning reason why Orr should not have been reappointed is that doing so has further politicised the position, in a most unfortunate way.

In the course of the overhaul of the Reserve Bank Act, Grant Robertson introduced a legislative requirement that before appointing someone as Governor the Minister of Finance needed to consult with other parties in Parliament (parallel provision for RB Board members).  It was a curious provision, that no one was particularly pushing for (in most countries the Minister of Finance or President can simply appoint the Governor, without even the formal interposition of something like the RB Board), but Robertson himself chose to put it in.  The clear message it looked to be sending was that these were not only very important positions but ones where there should be a certain measure of cross-party acceptance of whoever was appointed, recogising (especially in the Governor’s case) just how much power the appointee would wield.  That provision never meant that governments could not appoint someone who happened to share their general view of the world and economy, but there was a clear expectation that whoever was appointed would be sufficient to command cross-party respect for the person’s technical expertise, non-partisan nature, dispassionate judgement and so on.  Robertson simply ignored Opposition dissents on a couple of the Board appointees.  That was of second order significance, but it is really significant in the case of the Governor.  It isn’t easy to dismiss a Governor (and rightly so) so for a Minister of Finance to simply ignore the explicit unease and opposition of the two main Opposition parties in Parliament is to make a mockery of the legislation Robertson himself had put in place so recently.   The Opposition parties are being criticised in some places (eg RNZ this morning) for “politicising the position/appointment” but they seem to have been simply doing their job –  it was Parliament/Robertson who established the consultation provision –  and the consultation provisions, if they meant anything, never meant giving a blank slate for whomever the Minister wanted to offer up, no matter the widely-recognised concerns about such a nominee.   No one has a right to reappointment and when it was clear that the main Opposition parties would not support reappointment, Robertson should have taken a step back, called Adrian in and told him the reappointment could not go ahead, in the longer-term interests of the institution and the system.  If you were an Orr sympathiser, you might think that was tough, but….no one has right to reappointment, and the institution matters.

And, of course, now the position of the Governor has inevitably been put into play, with huge uncertainty as to what might happen if/when National/ACT form a government after the election next year.    (And here is where I depart from National’s stance –  I never liked the idea of a one year appointment, made well before the traditional pre-election bar on new permanent appointments.  We want able non-partisan respected figures appointed for long terms (it is the way these things work in most places), not for each incoming PM to be able to appoint his or her own Governor.)

A few months ago, anticipating that Orr would probably be reappointed, I wrote a post on what an incoming government next year could do about the Bank.    The key point to emphasise is that a new government cannot simply dismiss a Governor they don’t like (or nor should they be able to).  I saw a comment on a key political commentary site this morning noting that the process for dismissal isn’t technically challenging, which is true, but the substantive standards are quite demanding (the Governor can be dismissed only for specific statutory causes, and for (in)actions that occurred in his new term (which doesn’t start until March)).  Generally, we do not want Governors to be able to be easily dismissed (in most countries it is even harder than in New Zealand).   More to the realpolitik point, any dismissal could be challenged in the courts, and no one would (or should) want the prolonged uncertainty (political and market) such actions might entail.   Moreover, senior public figures cannot just be bought out of contracts.   

We still don’t know –  and perhaps they don’t either –  how exercised National and ACT would be about any of this were they to form a government next year, but unless Orr was himself minded to resign (as the Herald’s columnist suggests might happen) things would have to be handled carefully and indirectly (perhaps along lines in that earlier post of mine) to change the environment and the incentives around the institution.   Most of those changes should be pursued anyway, to begin to fix what has been done over the last few years    And if Orr were to be inclined not to stick around for long, perhaps an offer of appointment as High Commissioner to the Cooks Islands might smooth his way? 

Money supply

In my post last Friday I highlighted how the Governor of the Reserve Bank had just been making up stuff, and apparently knowingly misleading Parliament, to distract from the Bank’s own responsibility for New Zealand’s current very high core inflation. There may well be a case to be made that central banks did about as well as could reasonably be expected over the last couple of years – “reasonably be expected” here set by reference to the general views at the time of other expert observers (none of whom, admittedly, had chosen to take on statutory responsibility for inflation) but simply making stuff up blaming the Moscow bogeyman helps no one, and detracts from any serious conversation about what went on with inflation – core and headline – and why. To put my own cards on the table, there are many reasons why Adrian Orr should not be reappointed, but the poor inflation outcomes are not the most important of those reasons (of course, a superlative performance on inflation might have covered over a multitude of other sins and shortcomings).

After Friday’s post, someone got in touch to point out that I had not mentioned one other episode in that FEC appearance which could also reasonably be described as “making stuff up” and misleading Parliament. Opposition members were asking questions that included that rather loaded phrase “printing money”, to which Orr responded – apparently in reference to the LSAP – that the Reserve Bank did not create money, that all they did was to lower bond yields, and that banks etc were the people who increased the money supply.

In normal circumstances, the Governor’s comment would not be far wrong. The “money supply” – deposits with financial intermediaries (those included in the Bank’s survey) held by “the public” (ie people and firms not themselves included in the survey) – mostly increases in the process of private sector credit creation. For example, each new mortgage to purchase a house results simultaneously in the creation of either a deposit or a reduction in another mortgage as the house seller deals with the proceeds of the sale. Monetary policy operates typically by adjusting interest rates to influence, among other things, the demand for credit.

Some of the Reserve Bank’s emergency crisis tools don’t have any direct effect on the money supply measures the Reserve Bank compiles and reports. The Funding for Lending programme – a crisis programme that bizarrely is still injecting cheap liquidity now – simply lends money to banks (against collateral). That transaction boosts settlement cash balances held by banks at the Reserve Bank, but those balances aren’t part of “money supply” measures (they are deposits held by one lot of surveyed institutions – banks – at another surveyed institution – the Reserve Bank).

The LSAP is different. If, for example, a pension fund had been holding government bonds and had then sold those bonds to the Reserve Bank. the pension fund would receive payment from the Reserve Bank in a form that adds to that pension fund’s deposits at a bank. Settlement cash balances increase in the process, but so does the money supply (the pension fund’s deposits count in the money supply just the same way that your deposits do). Had the Reserve Bank bought all those tens of billions of dollars of bonds from local banks, the transaction would have boosted only settlement cash and not the money supply measures. But it didn’t. There were plenty of sellers – the Reserve Bank was eagerly buying at the top of the market – and some were local banks, and others were not. And so when the Governor suggested to Parliament that the Bank’s bond-buying did not increase the money supply, he wasn’t really being strictly accurate.

If you are now drumming your fingers are thinking this is all very technical and not really to the point, then in some respects you are correct. We’ve heard a lot about “the money supply” in the last couple of years. Most of it isn’t very accurate, but in many respects the difference doesn’t matter very much. “Money supply” measures (the formal ones referred to above) have not mattered very much to central bankers for decades, and that has been so whether inflation was falling sharply and undershooting inflation targets, or (as at present) proving very troublesome on the high side. The general view has been that money supply measures have not contained consistently useful information about the outlook for inflation, over and above what is in other indicators.

That does not mean – to be clear – that inflation is anything other than a monetary phenomenon for which central banks (and their masters) are responsible. It also does not mean that in extreme circumstances, in which say the government/central bank is flinging huge amounts of money at households without any intention of paying for those handouts now or later through higher taxes, that straight-out government money creation will not be a problem, paving the way for something that could end in hyperinflation. It is simply that specific official measures of the money supply have not proved very useful as inflation forecasters. Decades ago we hoped they did – and money supply growth targets were the rage for a decade or more in some central banks – but they didn’t.

And perhaps you can begin to see why if we go back a couple of paragraphs to the LSAP purchases. If the Reserve Bank purchases bonds from you and me (or our Kiwisaver fund) that will add to the money suply measures the Reserve Bank compiles and reports. If the Reserve Bank instead buy bonds from banks who bank with the Reserve Bank, it won’t add to the money supply measures. Does anyone really suppose there are materially different macroeconomic implications from those two different scenarios? The Reserve Bank doesn’t (from all they have said and written about how they think the LSAP works) and – for what it may be worth – I agree with them. You could add a third scenario, in which the Bank buys a bond from a non-bank entity that itself had bought the bond on credit. In that case, even RB purchasing from a non-bank won’t add to the money supply measures, but will (presumably) reduce any credit aggregates that captured the initial loan.

It might all have been different decades ago when, for example, central banks paid no interest on settlement cash balances, sometimes (as in New Zealand) banks were forbidden from paying interest on short-term or transactions deposits, and where banks were subject to variable reserve asset ratios. That was the world I started work in, but none of that is true today. Money supply measures usually aren’t very enlightening about inflation prospects, and these days neither even is the level of settlement cash balances (since the Reserve Bank pays the full OCR on whatever balances have accumulated). Thus, the LSAP may have been a dumb idea (and a very expensive one so it proved), but not because it may or may not have boosted official measures of the money supply to some extent. The pension fund that sold a government bond and now has bank CD in its books instead is no better or worse off because one asset wasn’t in the money supply official measures and the other one is. Neither are its members.

What matters is (mostly) two things: first, level and structure of interest rates, and second whether or not more purchasing power is put in the hands of public. The LSAP purports to change the former – which it seems was probably what the Governor was trying to claim at FEC the other day – but does not, and does not purport to, change the latter directly.

(By contrast, when for example the government sharply ran down its cash balances at the Reserve Bank and paid out at short notice a huge level of wage subsidy payments, not only did those payments boost the money supply measures (in most cases) but they put more purchasing power in the hands of the private sector (households supported by those payments). That isn’t a comment about the merits or otherwise of the wage subsidy scheme – I thought it was mostly great, directly counteracting what would otherwise have been a huge loss of purchasing power – just a description of how things work technically).

What about some numbers and charts?

This is a chart of annual growth in the Reserve Bank broad money measure

Annual growth rates have fluctuated a lot. There was a surge in the annual growth rate in 2020 (and a 3.5 per cent lift in the month of March 2020 alone, presumably largely reflecting the wage subsidy payments) but (a) it proved shortlived, (b) the peak was still materially below peaks in the 90s and 00s, and c) core inflation in the mid 90s and mid-late 00s did not get near the current core inflation rates (depending on your measure somewhere between 5 and 7 per cent).

For those of you who remember studying money in your economics courses, here is a measure of the velocity of money (in this case, quarterly nominal GDP divided by the broad money stock at the end of each quarter.

This measure of the money supply has been been growing faster than nominal GDP pretty much every year since 1988 (mostly just reflecting the fact that regulatory restrictions on land use have inflated house prices to absurd levels, driving up both money and credit as shares of GDP). You can see a bit of noise in 2020 – the big initial increase in the money supply I mentioned earlier and the temporary sharp reduction in GDP – but two years on there is nothing now that looks unusual.

Here is a chart of the level of broad money, expressed in logs (which means that if the slope of the line is unchanged so is the percentage rate of growth in the underlying series).

Nothing particularly out of the ordinary in money supply developments (on this formal measure) over the last few years.

But for anyone out there who still wants to put some weight on this official measure of the broad money supply, here is the chart of quarterly percentage changes.

Eyeballing it, the most recent three quarters (to September this year) appear to have had the weakest growth since 2009. a period when nominal GDP growth and core inflation falling away sharply. Since I don’t put much weight on money supply measures, as offering anything much about the inflation outlook, I wouldn’t emphasise the comparison myself.

Inflation is primarily a monetary phenomenon, and a national phenomenon (that was why the exchange rate was floated, to make it so), and something for which central banks are responsible and should be accountable. Core inflation has been – and still is – at unacceptably high rates, as a result of choices and misunderstandings by our central bank (their misunderstandings were widely shared, among private sector economists and in other countries, but that does not change the responsibility even if it might mitigate the appropriate consequences for those central bank decision makers). Monetary policy choices matter, a lot. But official measures of the money supply don’t usually shed much additional light, and have not done so over the last couple of years.

Making stuff up and misleading Parliament

Legislatures typically take a dim view of efforts to mislead them or their committees. This is from our own Parliament’s online “How Parliament works”

The Governor of the Reserve Bank seems just not to care, treating Parliament’s Finance and Expenditure Committee with as much contempt, and disregard for basic standards of honesty and care as some juvenile delinquent.

Yesterday the Governor and a couple of offsiders fronted up to the FEC, as they always do, following the release of the six-monthly Financial Stability Report. Were one of a particularly generous cast of mind one might almost have felt a little sorry for the Governor at times: the report was about financial stability not monetary policy, and yet most of the serious questioning was more about monetary policy, and then there was the old game of MPs attempting to get officials to say something (whether on tax, spending, immigration policy or whatever) that helps their party in its partisan jostling, even if such matters were nothing to do with the Bank’s own responsibilities. But Orr is paid a lot of money and given a lot of power, and doesn’t even make an attempt to treat elected MPs – from whose legislation flows his power and his office – with even a modicum of respect. As it was, no one forced him to answer monetary policy questions – he responded to most of them by referring MPs to their internal review of the last five years of monetary policy, to be released next week. But when he chose to answer, he had some fundamental obligation to give straight answers, not trail red herrings and other outright spin (or worse) across the path.

Orr has form. Last December, he fronted up for the Bank’s Annual Review and he and a senior offsider actively misled the committee about senior staff turnover (something that became very clear very quickly). It took a little longer, and an OIA request, to show that he had also actively misled the committee with claims that the Bank had done modelling of its own about the (supposed) climate change threat to financial stability, when in fact they’d done none.

You can watch the full hearing here, or you read an account of the relevant bits here. Orr was on the backfoot over the stewardship of monetary policy – and there is at least an arguable connection to financial stability (more so to individual financial stress) given the cycle in both interest rates and house prices, and the likely cycle in unemployment). There are some things Orr (and the MPC) can and should be held accountable for – floating exchange rates mean that what happens with inflation in New Zealand is largely a New Zealand monetary policy (passive or active) choice – and others that the central bank has never been expected to counter (the most obvious example is the price effect of GST increases, but you could think too of exogenous shocks like sudden oil price changes).

Orr’s first claim in his defence was that New Zealand has one of the “lower inflation rates in the OECD”. That is probably defensible. The ways CPIs are calculated differs across countries but on the headline numbers reported by the OECD for the year to September 2022 there were eight OECD countries with lower inflation rates than New Zealand’s 7.2 per cent (and Australia’s was almost the same at 7.3 per cent). Even if one were to treat the euro-area countries as a single unit (they all have the same monetary policy), the picture doesn’t change much. Not, of course, that we should care too much what inflation rates other countries have when we are so far from target – the exchange rate was floated 37 years ago to give us effective monetary policy independence – but when a bunch of countries have made similar mistakes (not that Orr yet concedes to regretting anything), it is better to be on the less-bad side of the pack.

But not all countries experience the same shocks the same way. Wars, rumours of war, and associated sanctions/boycotts etc have affected energy prices in particular this year. No one has ever expected inflation targeting central banks to prevent the direct price effects of immediate energy price shocks – indeed, mandates (including in NZ) have often explicitly urged central banks to “look through” such effects and focus or core measures and/or any spillover into generalised future inflation).

The CPI ex food and energy is the most commonly used measure for international comparisons of core inflation (not because it is ideal, but because it exists), and is well-suited this year when fuel and (to a lesser extent) food have been in the spotlight in the context of the Russian invasion etc. Some countries are very very heavily exposed to changes in gas prices in particular, and others (notably including New Zealand which for better or worse is not linked into a global LNG supply chain) are not. But here is how CPI ex food and energy inflation for the year to September looked (chart scale truncated – Turkey is worse than that).

New Zealand? Middle of the pack, and almost identical to the numbers for Australia and the United States (a bit higher than the UK, and a lot higher than the euro-area). This is closer to the stuff central banks individually are responsible for.

But this is really just scene-setting. Orr’s most egregious claim – and it was particularly egregious for being repeated twice perhaps 40 minutes apart – was that for New Zealand’s inflation to have been inside the target range now, the Bank would have had to have forecast the Russian invasion back in 2020.

It was just a mind-boggling claim – not that any MP on the FEC seemed to be alert enough to notice. It seemed to be implying that if we abstracted from the direct price effects of the war, inflation would otherwise be in the 1 to 3 per cent per annum target range. But here is what those data show, using the SNZ exclusions covering both fuel individually and fuel and food.

For the year to September, all those exclusion measure of inflation were still in excess of 6 per cent, more than double the rate of inflation envisaged by the very top of the target range.

Oh, and when did the war start? The invasion began on 24 February. The March quarter CPI is centred on mid-February, and all those exclusion measures were already between 5.7 and 6 per cent by then. Before the war began. Now, it is certainly true that oil prices had risen in the preceding months as rumours of war mounted but (a) that wasn’t until late last year, and b) these are exclusion measures (ie excluding the direct effects of higher fuel prices). And the best indicator of domestic cyclical stress – the unemployment rate was already at 3.2 per cent in the December quarter last year (and again in March), also before the war began.

And what about more analytical measures of core inflation here in New Zealand?

For what it is worth, the highest rate of quarterly inflation on these core measures had already been recorded in the March quarter CPI, which (need I remind you) is centred on 15 February (most prices are surveyed mid-quarter), before the war began. Perhaps unsurprisingly, the worst of the (core) inflation was around the time the unemployment rate was falling to its lowest level (at a time when monetary policy was being particularly slow to act – recall that it was not until February that the OCR got back to pre-Covid levels). High core inflation – in annual terms on these measures now between 5 and 7 per cent – is a domestic phenomenon, for which monetary policy is (by default, being the last mover) responsible.

Of course, Orr knows all this (and, linking back to that parliamentary document, ought reasonably to have known it – having chosen to take the job, and accepted the $830000 salary for it). And his staff knew all this. The Governor was appearing at FEC remotely from his office, and it would have been easy for his economics staff to have slipped him a note saying “Governor, you really can’t make those claims about inflation and the war”, but (a) Orr is known to be intolerant of dissent and correction, and (b) if perhaps some brave staffer did slip him such a note, he went ahead and repeated the big and preposterous claim again later in the same appearance.

There are many many reasons why Orr should not be reappointed but simply making out stuff, that he knows – and certainly should know if he holds that job – to be simply false is not one of the least of his offences. Misleading Parliament really should matter, if we care at all about good governance any longer. On the further evidence of yesterday’s performance Orr seems not to. Just imagine if one of the institutions he regulated tried that sort of performance on him.

Profits

A couple of weeks ago I wrote a post here, prompted by a paper by the former Bank of England Deputy Governor Sir Paul Tucker. Tucker’s paper was written in the context of the huge losses central banks in many countries, including his own UK, have run up through their large scale asset purchase programmes, especially those undertaken in 2020 and 2021 when bond yields (actual and implied forwards) were already incredibly low. While central banks continue to hold the bonds, the losses are seen every year now as the funding costs on those bond positions (the interest paid on the resulting settlement cash balances) swamp the low earnings yields on the bonds themselves. Bond positions purchased at yields perhaps around 1 per cent are financed with floating rate debt now paying (in New Zealand) 3.5 per cent (a rate generally expected to rise quite a bit further).

Tucker explored the idea that central banks might in future choose not to fully remunerate all settlement cash balances (while still applying the policy rate at the margin), and that if they did not then politicians might in future be reluctant to authorise future LSAPs and associated taxpayer indemnities (this seemed like a bonus to me, but Tucker is a bit more open to the potential of QE generally than I am (for New Zealand). With $60 billion or so of settlement cash injections still in the system (although with other offsets, total settlement cash balances are less than that), there is a lot of money potentially at stake.

My post was pretty sceptical of the idea – it seemed like arbitrary “taxation” by an entity with no mandate and little accountability – and in a Herald article at about the same time I was pleased to see several former colleagues also expressing considerable scepticism. In the wake of my post I had a bit of an email exchange with Tucker and while that didn’t change my mind it did help clarify the importance of reaching a view on whether the LSAP additions to settlement cash balances had resulted in something akin to a windfall boost to bank profits or not. Here is Tucker

Now, reaching a definitive view on a matter like this isn’t easy. Formalised models might even help, although I’m a bit sceptical even they could ever offer anything very definitive, and – in arbitrary taxation at least as much as criminal justice – we might reasonably expect something close to a “beyond reasonable doubt” test to be applied (especially when no one compelled the state to ever do LSAPs at all). You could think of a hypothetical world in which such a windfall might appear to rise – central banks buy the bonds from pension or hedge funds who simply deposit the proceeds with banks and happily (or resignedly) just accept zero interest on the resulting deposits – but it doesn’t seem very plausible. Perhaps there are other hypotheticals, but it still seems a stretch (and we aren’t in the world decades ago where, for example, banks were forbidden from paying interest on transactions balances).

I don’t have the resources or data for the sort of in-depth analysis that might be required if governments and central banks were to be seriously considering the Tucker option. But what do the high-level indicators we do have show? This, inevitably, bleeds into the recent (and annual or semi-annual) ritual in which the political left and the popular media bemoan the profitability of the banking system more generally.

The first increase in the OCR was in October 2021. Until then, settlement balances had been earning 0.25 per cent per annum, so that even if banks had somehow been paying nothing on the counterpart deposits, the amounts involved would have been too small to have shown up in the aggregate data (0.25 per cent per annum on $60 billion is about $150m per annum). But we have aggregate data now up to and including this year’s June quarter.

I’m including some long-term charts here (from the Reserve Bank website data, going as far back as their data go), as background to some comments on bank profitability too.

There is return on assets

return on equity

and the net interest margin (shown on the same chart as the average interest rate earned on interest-earning assets)

It is early days – the much higher OCRs for the September and December quarters may shed more light in some months’ time – but at present there isn’t anything much pointing to windfall earnings, whether directly from the Tucker effect or from the LSAP or other Covid interventions. Returns dipped during the 2020 deep (if brief) downturn, and then seem to have returned to about pre-Covid average levels. If the net interest margin has risen a bit, in the June quarter it was at about the average level for the previous 15 years.

On the other hand, supporters of the Tucker story could point to this chart. It is interesting that interest-bearing liabilities have dropped to a record (over this 30 year period anyway) low but (a) perhaps it is less surprising given that, at least to June, the absolute level of interest rates remained very low (and well below the prolonged period 20 years earlier when the interest-bearing share of total liabilities was also unusually low) and (b) as yet, there is no sign of this reflected in unusually high bank returns (see earlier charts).

Time will tell, but to this point there is no smoking gun, in New Zealand anyway. Tucker does note that (at least in the UK context) windfall returns could be paid away in management bonuses, so that they wouldn’t show up in after-tax profit figures, but (a) that seems more like a UK issues (big bonuses in the City etc) and (b) you would expect to see it showing up in bank disclosures (eg CEO salaries etc) and I’m not aware of any sign it (yet) has.

More generally, what to make of the bank profits story? On a cyclical basis there were reasons one might have expected the last year to have been the best for some time: the economy was extremely overheated, unemployment was extremely low, and although house prices have been falling more recently they only peaked in November last year, having risen to an extraordinary extent over the previous 15 months or so. Banks tend to make lots of money in circumstances like that (and, on the other hand, to do poorly in deep recessions). Perhaps reflecting the abnormal and uncertain state of the Covid world over 2021/22, in fact none of those charts above suggest anything exceptional about bank profitability (at times, really high reported bank profits can themselves be a worrying financial stability indicator – lots of poor quality loans with high upfront fees and/or dodgy accounting can produce very flattering short-term numbers, all while storing up big future losses. Cyclically, the year ahead looks a lot less favourable for banks (as the ANZ CEO noted they are now writing a tiny fraction of the number of new mortgages they were doing at peak) and a recession (with all the attendant reduction in demand for products, reduction in servicing capacity, and outright losses) is generally agreed to be looming.

What about overall average rates of return? When they left aren’t making cyclical complaints, this tends to be where they focus. And of course the return on equity is better than you are going to get on a bank deposit, but it is also a great deal riskier.

One obstacle to analysing the issue in a specifically New Zealand context is that hardly any New Zealand banks are listed on the stock exchange as such, so we don’t have a good read on the value the market puts on them. But the big-4 banks are the dominant players in Australia too, housing lending makes up almost two-thirds of credit in Australia, and Australia has similarly absurd house price to income ratios in its largest cities. Historically, rates of return have also looked quite high

(One might also add that in recent decades the New Zealand and Australian banking systems have been amongst the most stable anywhere).

Then again, the market seems less impressed with the Australian banks than the New Zealand political left are. Price to book value ratios don’t look particularly impressive – for long-established “licence to print money” entities – and of the four big Australian banking groups, in three cases the first time the current share price was reached was well over a decade ago.

We (and Australia) have big banks. When regulation renders house prices absurdly expensive, you need entities that will facilitate very large amounts of debt. Big banks require lots of capital, and on lots of capital lots of money can and should be made. But if the left is so convinced there is money for jam on offer there is a readily accessible market response: buy more shares with their own savings.

Instead, from the party that wants to make us all poorer, force people to live in expensive townhouses, and do all they can to discourage cars and planes (oh, and free speech too), yesterday we got a proposal that there should be an “excess profits tax”. The Green Party’s discussion document is here. I guess it is mostly just political spin to try to keep up the radical left vote, but it really was an astonishingly threadbare document.

For precedent, we are reminded on a couple of occasions that there were excess profits taxes in World Wars One and Two. And since we actually conscripting people – and ordering them into the military or directed service – and restricting all manner of other economic activity probably few people had much problem with that (the idea of “conscripting capital” was (understandably) big on the left in New Zealand. But while the left may like to claim we are now in some “moral equivalent of war”, in fact we are running a market economy in which firms and individuals are free to come and go, invest or not, as they choose. We are also told about windfall taxes on energy companies in Europe at present, but again these are rather more equivalent to an actual wartime situation (very high returns to lower cost renewables producers for example are arising out of the foreign policy choices of governments around the Russian/Ukraine situation).

But nothing in the Greens’ document establishes a serious case for New Zealand now (eg for better or worse we aren’t tied into the global LNG supply chain)

And then there are the basics. This appears early on.

I followed the footnote to be sure I was using the same sources. From the Annual Enterprise Survey

So you can see the $103.3 billion. But you might also note the sharp fall in this measure of profits the previous year (Covid disruption and all that), and the smaller fall the year prior to that. Actual profits before tax on this measure were about 5 per cent high in the 2021 years than in the 2018 years.

And nominal GDP? Well, it was up 17 per cent over roughly the same period (calendar 2021 over calendar 2018).

Then we get charts like this.

I have no idea where any of the lines comes from but note (a) the orange line, which claims to be taken from the AES, has a latest observation LOWER than the one a couple of years earlier, and (b) while the Greens claim that “the graph below demonstrates that profits are already exceeding prepandemic levels; and are several times higher in real terms than in the 1990s” they fail to point out that real GDP is a lot higher than it was in the 1990s too.

How do those ratios look? From the national accounts we have a breakdown between compensation of employees on the one hand and returns to business (including labour income for self-employed operations). Wage and profit shares have ebbed and flowed but nothing about the last few years looks very unusual.

The same data are now available on a quarterly basis, but only since 2016 (and inevitably the more recent observations are subject ot revisions). This time I’ve just shown the two series as cumulative growth rates since 2016

Labour costs and non-labour components of the income measure of GDP have risen over the full period by almost exactly the same percentage (seasonally adjusting through the Covid lockdowns is a real challenge so I wouldn’t pay much attention to those particular quarters).

We are left wondering where all these excess returns the Greens are on about really are. If they mean house prices rising in 2020 and 2021, well of course I can quite understand (and we know they like the idea of a capital gains tax) but……house prices are now falling quite a lot, and excess profits taxes aren’t usually aimed at Mum and Dad (indeed the rest of the document is all about th rapacious capitalists).

One could go on, but I won’t. The Greens seem keener on planning to spend the proceeds of their tax than provide firm analytical underpinnings to it, and of course while feeding the narrative that somehow there is money for jam being left on the table, there seemed to be no mention of countervailing reductions in business taxation if/when there is a deep recession or windfall losses (and in the nature of windfalls, losses are as likely as gains). But why would anyone really be surprised?

The document has this line: “The Green Party considers that record profits during a time of economic hardship for many New Zealanders are immoral and unsustainable”. Except that whether one uses their AES measure, or national accounts measures there isn’t anything very remarkable about profits in recent years – except of course that there is lots of inflation, but even then as that final chart shows returns to labour in total have been growing at about the same rate of returns to providers of other resources.

Rodger Finlay

If you have long since lost interest in my series of posts as to how Christchurch company director Rodger Finlay came to be appointed by the government as a director of the Reserve Bank (in its new governance model where the powers, including bank regulatory ones, rest with the Board) while, it was envisaged, he would keep on as chair of NZ Post, the majority owner of a bank (Kiwibank) the Reserve Bank prudentially regulates and supervises, and the spin around it, feel free to stop here. The title of the post was due warning. But sometimes you have to see things through to the end.

A couple of weeks ago, I wrote here about (and excerpted) The Treasury’s incident report about the Finlay affair, and specifically the events that led to the Secretary to the Treasury providing a written apology to the Minister of Finance for the failure of her staff and organisation to explicitly draw to the attention of ministers the conflict of interest issues around Finlay’s appointments, either when he was being appointed to the Reserve Bank Board a year ago, or when Cabinet was agreeing to his reappointment as chair of NZ Post in June this year.

Yesterday I had two more OIA responses. Appointments to SOE boards are on the joint recommendation of the Minister of Finance and the Minister of State-owned Enterprises, and I had asked both ministers for material relevant to Finlay’s NZ Post reappointment (and withdrawal from that post) in June. Megan Woods had been the SOE minister responsible, but she apparently declared a potential conflict of interest, around her personal and professional relationships with Finlay, and so formal responsibility was shifted to Kris Faafoi (as it turned out, by the end of this he was in his last few days in office). Faafoi having left office, his papers on the issue are coming only slowly (early next year I’m told) but The Treasury did yesterday release the papers they had relevant to the appointment process Faafoi was involved in.

Treasury OIA response re acting Minister of SOEs and reappointment of Rodger Finlay as NZ Post chair Oct 2022

and Grant Robertson also provided his response to a similar request, but which also covered contacts with journalists on the Finlay appointments.

MoF OIA response re Rodger Finlay and the NZ Post board Oct 2022

In total there is about 50 pages of material

Taking the Treasury response first, there isn’t a great deal that is new.  The relevant paper to the Cabinet Appointment and Honours (APH) Committee is included in full.  It doesn’t note any conflict of interest issues (but we knew that from the Secretary to the Treasury’s apology and their report) but their description of NZ Post itself is a little surprising.

with no mention that NZ Post is also the majority owner of the 5th largest bank in the country.

I was slightly amused by what was, and wasn’t, kept secret about Finlay’s personal details

and the fussing around in the paper about whether the board was going to be suitably “representative”

But perhaps the point of substance was an email to Treasury officials from Faafoi’s private secretary on 8 June after the APH meeting noting that “Finlay’s reappointment went through APH today with no issues”.

While The Treasury had clearly been remiss in not including the conflict of interest issue in the papers, quite where were ministers (whether those proposing to make the appointment – and especially Robertson – or those deliberating on it)? Did it not occur to any of these people – either then, or when the RB Board appointment was made – to question whether it was really quite right to have someone responsible for bank regulation also chairing the majority owner of a bank. It is hardly as if Kiwibank’s ownership was a secret, and the APH paper does note that Finlay had been appointed as a Reserve Bank Board member (and from the Robertson bundle of documents we find talking points The Treasury had prepared for Faafoi, one (of a handful) of which explicitly states that he has been appointed to the Reserve Bank Board)? Or do conflicts of interest, real or apparent, just not matter to this government?

Most of the interest in the Robertson bundle is in the exchanges by members of his staff with various journalists about the Finlay issue.

But there is also an email exchange on 10 June, the day my first post on the Finlay issue appeared. We know from The Treasury’s incident report that prior to 8 June (the day of the APH meeting) Finlay had approached Treasury suggesting that he could take leave of absence from the NZ Post role until the (then not known to the public) reshuffle of Kiwibank ownership went through – it had initially been planned, so the documents show, to have had this reshuffle wrapped up by 30 June).

Anyway, on 10 June my post went out at about 8:30am (it is in my email inbox at 8:32) and at 9.34am Finlay himself sent a link to the post, without further comment, to four Treasury and NZ Post addressees. At 3:21pm, Treasury is emailing people in the relevant ministers’ offices, cc’ing the NZ Post people

I found it interesting that the official states “This potential concern has been on our radar” – what, just waiting for someone (whether me or another observer) to notice the egregious conflict involved in having the chair of the majority owner of a bank sitting on the governance board of the bank regulator? And so they suggest rolling out what Finlay himself had proposed – that he temporarily step aside from the NZ Post role – and had gone far enough to get the agreement of another director to act in Finlay’s place if ministers were to go with this option.

But that didn’t happen. The Treasury report says Finlay himself called the Minister of Finance, and the Minister took the view that as the potential conflict had been considered when the initial (RB) appointment was made and nothing had changed, there was no reason for Finlay to stand aside. Except, of course, that we know that the advice to Ministers and Cabinet in late 2021 had not mentioned the conflict, and neither had the advice to other political parties when, as the RB Act requires, they were consulted on Finlay’s RB appointment.

It is also pretty extraordinary – and this isn’t picked up in Treasury’s report – that there was no sign that these Treasury officials (or perhaps Finlay) really recognised the character of the Finlay conflict. He could have temporarily stepped aside as NZ Post chair and would still be responsible for bank regulation and supervision around Kiwibank during that period, and almost all regulatory decisions have effects longer than a few months standdown might imply. To address the conflict by means of temporary stand-down it would have to have been the Reserve Bank Board he stood down from, but the Reserve Bank role isn’t even mentioned here, and nor were Reserve Bank officials copied on the emails from either Finlay or Treasury.

And so Cabinet went ahead and on 13 June reappointed Finlay for three years. And on 14 June Finlay wrote declining the appointment.

The first journalist to have asked Robertson anything about the Finlay issue was the Herald’s Jenee Tibshraeny.

At the time of this phone call and email, it was full steam ahead. Cabinet had approved Finlay’s reappointment and the letter of offer was going out.

It took the best part of two days, and multiple reminders, to get an answer out of Robertson.

The delay was convenient as by this time – and against the wishes of the Minister – Finlay had stepped aside, and finally personally resolved the conflict issue. Against that backdrop, the Minister’s answer to the Herald was pretty much active and deliberate disinformation.

The next lot of media inquiries worth mentioning was on 1 July (the day after the rest of the new Reserve Bank Board was announced, including reference to Finlay as “previously” chairing NZ Post. Stuff’s Rob Stock asks Robertson’s senior press secretary

Who, in a series of email exchanges also engages in an active attempt to put the journalist off the trail (pretty sure the government would call this “disinformation” if anyone else was doing it).

First, the Minister was sick and couldn’t comment, but there was no news because Finlay’s term was due to end on 30 June. Stock responds that he didn’t recall either the RB, the Minister or Finlay “mentioning this was the plan for managing the conflict”, to which Bramwell responds disingenuously “I’m not sure if it was the ‘plan’…..you’d have to talk to Mr Finlay about that – or perhaps the RBNZ?”. Stock immediately responds (presumably of attempts to get others to comments) “No comment, not available, talk to Minister”. Whereupon Bramwell (for the Minister) again avoids answering the actual question with this response

Stock must have given up at that point. But if Bramwell’s last response was a non answer, it was nonetheless interesting since (a) it points us to Reserve Bank involvement in the political spin, and b) tells us that the Bank concedes that there may well have been “material conflicts of interest” from 1 July had the government gone ahead with its plans and Finlay not, at the end, done the decent thing.

There is a final rounds of exchanges between Tibshraeny and Robertson’s office at the end of August. These requests came after some earlier OIAs had begun to shed more light. You can read the exchange for yourself. On Finlay, the key question is “How was it ever ok for Rodger to be NZ Post chair and on the new RBNZ Board at the same time? [as the government deisred and intended]. Even [if] this would’ve been within the law [which it was] it surely would not have been within the spirit of the law”. There is never a straight answer from the Minister, just a deflection to the Reserve Bank who, she was told, concluded that “any conflict of interest…could be managed”.

Tibshraeny’s final question is about an issue I was not aware of until she identified it: that Finlay is a director of Ngai Tahu which now owns a 24.94% stake in Fidelity Life Assurance, an insurance company regulated by the Reserve Bank. That deal was not settled until early 2022 but had been agreed on before Finlay was appointed to the Board (and “transitional board”) late last year. That appears not to have been disclosed or discussed when his appointment was made. In Tibshraeny’s final email she notes “So, not great…..”

There have been so many issues to keep track of – including the other new director who when appointed was also on the board of an insurance company that for some reason was not regulated by the Reserve Bank (before there was a belated rethink and he resigned from the insurance company board) – and the Fidelity stake isn’t controlling so that on its own I can’t get too excited about it. But it does tend to speak to a pattern – running across all those involved here – that all that matters is the letter of the law, and nothing at all about the appearances, and the potential for actual or apparent conflicts. Finlay should, right upfront, have identified both the Kiwibank and Fidelity stakes as potential conflicts – and should never have put himself forward if he intended to stay on at NZ Post. In combination, they should have been disqualifying – to The Treasury and to Ministers.

As far as I can see no one emerges very well from this whole saga, with some slight brownie points to Finlay who did after all finally step aside. The Treasury did poorly, perhaps so too did their recruitment consultants, the Brian Roche interview panel (for the RB roles) did really poorly (and that includes the head of APRA who sat on the panel), ministers did poorly (Grant Robertson most of all). No one called stop at any point, and all seemed to be focused (if at all) on the letter of the law rather than the substantive issues that mean it would not be acceptable anywhere to have as director of the bank regulator the chair of a majority owner of a bank.

But if any of these people or groups of people should have stood up and called a halt (before Finlay finally did), so too (and perhaps above all) so should the Governor of the Reserve Bank. the chair of the Reserve Bank Board, and all their attendant senior managers and Board colleagues. Every one of them should have known the conflict was untenable and unacceptable (it was the immediate reaction of a whole bunch of former central bankers after my first post appeared), and quite damaging to the credibility of the institution.

But if you have been following this story since June, you may have noticed that there have been OIA responses, fairly timely ones, from the Minister and from The Treasury, and nothing at all from the Bank (just references to them and their involvement in some of the other documents). It isn’t for want of trying.

On 1 July, the day after the full Board was appointed, I lodged with the Reserve Bank a request for

…copies of all material relating to appointments to the new Reserve Bank Board, including all material relating to appointments to the “transition board”. 

Without limitation, this request includes all papers and other material generated within the Bank (other than of a purely administrative nature), any advice to/from or discussions with The Treasury, and any advice to and interaction with the Minister of Finance or his office on these issues.

It was directly parallel to similar requests lodged with the Minister and with The Treasury (both of whom responded substantively).

On 13 July, one of the many communications staffers got in touch to tell me

We have transferred your request to the Treasury as the information is believed to be more closely connected with the functions of the Treasury. In these circumstances, we are required by section 14 of the OIA to transfer your request.

You will hear further from the Treasury concerning your request.

I rolled my eyes – it was evidently a ploy (note I explicitly asked about material generated within the Bank, which other agencies would not necessarily be expected to have) and no doubt the Bank knew by then of my other requests – but did nothing more while I waited for responses from the Minister and The Treasury.

Having received those responses, on 3 September I went back to the Bank to renew my request (all on the same email chain, so there was no ambiguity about what the request was)

I am writing to renew my request.  You transferred the request to The Treasury, but (as I’m sure you know) their release provided nothing on anything the Bank, its staff or management, Board or “transitional board” members said, wrote or did.  I now know from the responses to similar OIAs to The Treasury and to the Minister of Finance, that the Board chair was involved in the selection of new board and transitional board members, Rodger Finlay (then a “transitional board” member) served on the interview panel for the second round of Board appointees, that RB legal staff had discussed issues around potential conflicts of interest for Rodger Findlay.    Against that backdrop (and the media coverage of the Findlay situation in late June), it is inconceivable that there were no papers, emails or the like on any matters relating to the selection and appointment of Board members, whether or not such material was conveyed to The Treasury or to Minister.

That was almost two months ago. It was only yesterday I thought to check up on it and have sent them a note pointing out that I did not yet appear to have had a response. It increasingly appears as though the request will have to be referred to the Ombudsman.

But no doubt the Governor and his colleagues will keep on with the spin about being a highly transparent central bank. At this point, you really wonder what they can have left to hide, but perhaps the secrecy and obstructiveness is just some point of unprincipled principle?

UPDATE: About 40 minutes after this post went out I had an email from the Reserve Bank offering what appears to be a fairly abject apology for allowing this request to have fallen through the cracks, promising process improvements etc. Accidents happen, system aren’t foolproof (even with 20 comms staff), so I am inclined to take them at their word, but I guess it means I might finally get a response by Christmas.

A bad idea

There is increasing attention being paid (among a certain class of nerdy central bank watcher) to the scale of the losses to the taxpayer central banks have run up as a result of their large-scale bond purchases (particularly those) over the time since Covid broke upon us in early 2020. In New Zealand, the best estimate of those losses was about $9.5 billion as at the end of September (to its credit, the Reserve Bank of New Zealand marks to market its bond holdings – and thus its claim on the Crown indemnity – something many other central banks don’t do).

A particularly interesting paper in that vein turned up a couple of days ago, published by the UK Institute for Fiscal Studies and written by (Sir) Paul Tucker, formerly Deputy Governor of the Bank of England and now a research fellow at Harvard. The 50+ page paper has the title Quantitative easing, monetary policy implementation and the public finances. (Public finances are quite the topic of the month in the UK, but although many of the numbers in the paper are very up to date, I suspect the paper itself was conceived before the fiscal/markets chaos of recent weeks.)

Tucker is particularly clear on what QE actually was: it was a large-scale asset swap in which the Crown (specifically its Bank of England branch) bought back from the private sector lots of long-term fixed rate government bonds, and in exchange issued in payment lots of (in our parlance) settlement cash balances held by banks and on which the (frequently reviewed) policy interest rate (here the OCR) is paid in full. When such an operation is undertaken, the entities undertaking the swap (and the taxpayer more generally) will lose money if policy rates rise by materially more than was expected/implicit when the swap was done. It is not a new insight – and I’ve been running the asset swap framing here since 2020 -but Tucker puts its very clearly, and in a context (UK) where the focus is less on the mark to market value of the bond position, and more on the annual cash flow implications (over time they are two ways – with different emphases – of putting much the same thing).

Tucker seems, at best, a bit ambivalent about the 2020 QE, illustrating nicely that whereas the early UK QE was done when actual and implied forward bond yields were still quite high, that was by no means the case by the start of 2020. But as he notes, that is water under the bridge now. Big bond purchases did happen, partly because few central banks have really got rid of the effective lower bound (although here he is too generous to many central banks, including the BoE, since few sought to reach the practical limits of negative rates (on current technologies) when they could have in 2020). But whether or not QE could have been avoided, given the macro outlook as it stood in March 2020, (whether by more reliance on fiscal policy or deeper policy rate cuts) it wasn’t. Central banks now have large bond positions, purchased at exceedingly low yields, being financed at increasingly high short-term rates.

In New Zealand, for example, total settlement cash balances have just been hitting new highs, in excess of $50 billion

Not all of this is on account of the LSAP (New Zealand’s QE). Weirdly, the Reserve Bank is still making concessional funding available to banks under the crisis Funding for Lending programme, but at least they are paying on the resulting settlement cash balances what they are earning from the loans. And fluctuations in government spending, revenue, and borrowing also affect the level of settlement cash balances.

But you can think of the approximately $50 billion of LSAP bond purchases (over 2020 and the first half of 2021) as having a counterpart in the level of settlement cash balances. On $50 billion of settlement cash, the Reserve Bank pays out interest at a current annual rate (OCR of 3.5 per cent) of $1750 million per annum. All the conventional bonds were bought at much much lower yields than that (unlike the Bank of England, our Reserve Bank did buy some inflation indexed bond, but they were less than 5 per cent of the total purchases.) This is a large net cost to the taxpayer.

The policy thrust of Tucker’s paper is to explore the idea of cutting those costs by changing policy and not paying interest on the bulk of settlement balances (or paying a materially below-market rate). Central banks did not always pay market rates on settlement cash balances, but it has become the practice over the last 20-25 years (in the Fed’s case being rushed in in late 2008 to hold up short-term market rates, consistent with the Fed funds target, when large scale bond purchases began). New Zealand followed a similar path.

Paying different rates on different components of settlement cash balances is quite viable. For some years until early 2020, for example, the Reserve Bank paid full market rates on balances it estimated each bank needed to hold (to facilitate interbank payments etc), while paying a below market rate on any excess balances (which were typically small or nil). The ECB and the Bank of Japan introduced negative policy interest rates some years ago, but protected the banks by paying an above-market rate on most of their settlement cash holdings, only applying the negative rate at the margin.

As a technical matter there would be no obstacle to the Bank of England (or the Reserve Bank of New Zealand) announcing that henceforth they would pay zero interest on 80 per cent of balances – some fixed dollar amount per bank – while only paying the policy rate (the OCR) on the remaining balances. Since the OCR would still apply at the margin, that part of the wholesale monetary policy transmission mechanism should continue to function (compete for additional deposits and you would still receive the OCR on any inflows to your settlement account). The amounts involved are not small: in the UK context (they did QE a lot earlier) Tucker talks of “the implied savings would be between 30 billion and 40 billion pounds over each of the next two financial years” – perhaps 1.5 per cent of GDP. In New Zealand, if we assume the OCR will be 4 per cent for the next couple of years, applying a zero interest rate to $40 billion of settlement cash would result in a saving of $1.6 billion a year (almost half a per cent of GDP). You could pay for quite a few election bribes with that sort of money.

It is an interesting idea but it seems to me one that should be dismissed pretty quickly, even in the more fiscally-challenged UK (where they already impose extra taxes on banks). It would be an arbitrary tax on banks, imposed on them because it could be (no vote in Parliament needed), by a central bank that would be doing so for essentially fiscal reasons (for which it has no mandate). Tucker rightly makes the point that central bankers should not seek to do their operations in ways that are costly to the taxpayer when there are cheaper (less financially risky) options available, but the time to have had those conversations was in March 2020 (preferably earlier, in crisis preparedness) not after you’ve taken a punt on a particular instrument and the punt has turned out badly (and costly).

It might be one thing to decide not to remunerate settlement cash balances, and thus “tax” banks, when those balances are tiny (for a long time we ran the New Zealand system on a total of $20 million – yes, million – of settlement balances) and quite another when those balances are at sky-high levels not because of any choices or fundamental demands by banks, but solely as a side-effect of a monetary policy operation chosen by the central bank (and in both countries indemnified by the Crown). Even central banks have no particular interest in there being high levels of settlement balances (it isn’t how they believe QE works); it is just a side effect of wanting to intervene at scale in the bond markets. But central banks have a choice, while the banking system as a whole does not (banks themselves can’t change the aggregate level of settlement cash, which is totally under the control of the central bank). The Tucker scheme – which to be fair, it isn’t entirely clear he would implement were he in charge – forces banks to hold huge amount of settlement cash, and then refuses to remunerate them on those balances.

To implement it would be a fairly significant breach of trust. Here, the Reserve Bank has kept on (daftly) offering Funding for Lending loans arguing that it needs to keep faith with some moral commitment it claims to have made, despite the crisis being long past. I don’t buy the “anything else would be a betrayal” line there – where in any case the amounts involved are small (this funding might be 25 basis points cheaper than they could get elsewhere) – but it would much more likely to be an issue if the Bank (or overseas peers) suddenly recanted on the practice of paying market interest on all or almost all settlement balances. $1.6 billion a year, even divided across half a dozen banks, would attract attention.

I’ve heard a couple of suggestions as to why an additional impost on banks might be fair. One was that QE may have helped set fire to the housing market, boost bank lending and bank profits, and thus an additional tax now might be equivalent to a windfall profits tax. I don’t buy either strand of that argument – I don’t think the LSAP made that much difference, but if it did it was supposed to do so (transmission mechanism working) – but even if I did in 2020, we are now seeing the reverse side of that process: house prices are falling, housing turnover is falling, new loan demand is falling, and there will be loan losses to come. Most probably any effects will end up washing out.

The second was the bond market trading profits the banks may have made in and around the LSAP. Perhaps there were some additional gains, but it is hard to believe they were either large or systematic (and won’t have come close to $1.6 billion per annum).

And the third was the Funding for Lending programme. No one can pretend that was not concessional finance for banks (were it otherwise banks would not have used the facility at scale), but the amounts involved don’t compare: $15 billion of FfL loans might have a concessional element over three years of $100m or so, not really defensible, but not $1.6 billion per annum either.

The taxpayer is poorer as a result of the LSAP and how market rates turned out (as Tucker rightly notes, it needn’t have turned out that way, although by 2020 the odds were against them – and as I’ve pointed out often there is no sign in NZ at least that a proper ex ante risk analysis was done). Those costs have to be paid for and will mean, all else equal, that taxes are higher over time. But conventional fiscal practice is not to pick on one sector and put the entire additional tax burden on them (“broad base, low rate” tends to be the New Zealand mantra). And that is so even if some in the New Zealand political space – sometimes including the Governor – seem to have a thing about (evil and rapacious) “Australian banks”.

Tucker devotes some space to the question of how banks would react (other than heavy lobbying on both sides of the Tasman and fresh pressure for the Governor to be ousted). Even if short-term wholesale rates – the policy lever – aren’t likely to be changed, banks are unlikely to just sit back and take the hit: they may not be able to recoup all or even most of it, but it isn’t hard to envisage higher fees, higher lending margins, tighter credit conditions across the board, including as boards become more wary about New Zealand exposures. Non-bank lenders – who hold no settlement balances – would be at a fresh competitive advantage (akin to what we saw with financial repression of banks decades ago)

But unfortunate as it would be if a change of this sort of made now – essentially an ex post tax grab so focused it would come close to being a bill of attainder – I might almost be more worried about the future. One might have hoped that the episode of the last couple of years would have made central banks more cautious about using large-scale bond buying instruments (and finance ministries more cautious about underwriting them), with a fresh focus on removing the effective lower bound on nominal interest rates (or if they won’t do that then looking again at the level of the inflation target). But knowing that big bond purchases could be done freely, with the taxpayer capturing all of any financial upside, and banks (and customers) wearing all/most of any downside, skews the playing field dramatically (and also further reduces the financial incentive on governments to keep inflation down – since the real fiscal savings on offer rise the higher nominal interest rates are. And what of banks? If there really is a place for future QE – I’m sceptical but I’m probably a minority – up to now banks have had no really significant financial stake one way or the other, but adopt the Tucker scheme once and banks will know it could be used on them again, and they will become staunch opponents (in public and in private) of any future large scale bond buying operations for purely their own financial reasons. And that is no way to make sensible policy.

Tucker has produced a 50 page paper which will repay reading (for a select class of geeky reader – although it is pretty clearly expressed). Since it is 50 pages there is plenty there I couldn’t engage with in depth in this post, but in the end my bottom line was initially “count me unpersuaded”, and then the more I thought about it the more I hoped that no one here would seriously consider the option (ideally not in the UK other). Far better to accept that losses have been made, that those costs will have to be paid for by taxpayers’ generally, and to redouble the efforts to ensure that in future crises there is less felt need for central banks to engage in such risky operations. Central banking, well done, really should involve neither large risk nor large cost to the taxpayer, and there are credible alternatives, even if neutral real interest rates stay very low (as Sir Paul assumes, and as still seems most likely to me).

UPDATE: Thanks to the reader whose query made me realise that in my haste to produce some stylised numbers, I forgot that the LSAP bonds had been purchased at price well above face value. The actual settlement cash influence from all LSAP purchases (central and local government bonds) was $63.9 billion. The rest of the analysis is unchanged, but the numbers (floating rate financing cost) are larger.

Inflation and monetary policy

In a post a couple of weeks ago I outlined some reasons for scepticism about the case for increasing the OCR by 50 basis points specifically at the then-forthcoming OCR review. My point was mostly about the data hiatus – the OCR decision would be taking place almost 3 months after the most recent CPI data and more than 2 months since the last main labour market data. It seemed (and seems) foolish for the MPC to stick to its schedule of review dates, including the long summer holiday it will give itself after next month’s MPS. It remains highly problematic that New Zealand governments have penny-pinched on core statistics and as a result we have such slow and infrequent macro data (we got the September quarter CPI inflation data yesterday, Switzerland by contrast released September month data on 3 October).

But there were also some considerations in the macroeconomics

  • the reasonably long lags in monetary policy (the OCR really only having been aggressively tightened fairly recently)
  • weakening commodity prices,
  • relatively subdued nominal GDP growth, among the very lowest in the OECD,
  • and some indications in core inflation measures that at least things had not been getting worse (continuing to spiral upwards)

All the inflation rates were, of course, unacceptably high.

Of course, as was universally expected the MPC did raise the OCR by 50 basis points in their October review. And yesterday we got the September quarter CPI data, which took by surprise all those who’d published forecasts (and, I guess, almost any of us who’d heard their headline forecasts). The outcome was higher than the Reserve Bank’s last published forecast, but since that forecast was more than two months old and anyway isn’t broken down into headline and core components – and they’d given us no sense of an update in the October review – not too much weight should now be put on that particular aspect of the surprise.

I don’t do short-term components forecasting, so what follows isn’t about the extent of the surprise (immediate prior expectations vs outcomes) but about what to make of the actual outcomes and current inflation. First, I’ll step through and update the charts from the earlier post.

These two – commonly used abroad – core inflation measures might suggest a little room for encouragement. Both quarterly changes are still high (far too high), and the gap between them is unprecedented, but they both look as though they could be past their respective peaks.

Monetary policy always takes time to work, and as this Reserve Bank chart reminds us it was only late last year that new mortgage rates really started rising.

But then there are these two exclusion measures

neither of which offers any reassurance.

And the picture here is similar

and from these monthly food price components, a bit of a mixed bag, but at least nowhere near as bad now as a few months ago.

The building market has been one of “hottest” areas of the economy and the labour market, with staggering rates of increases

Those numbers are still high but seem to be beginning to move in the right direction.

And then there are rents. Rents now make up just over 10 per cent of the CPI. On a quarterly basis the rents item in the CPI increased by 1.2 per cent in the September quarter, as high (equally high) as it has been this cycle. On an annual basis, this is the picture

In the CPI rents are included using a stock measure – the rate of increase in the average rents being paid by all tenants. And there is a certain logic to that, but we also know that new rents are falling (not just the growth rate slowing, but the level of rents dropping)

The flow measure – new rents – is (naturally) noisier but it (also naturally) leads the stock measure. There is a lag from monetary policy to the CPI for numerous reasons, but one is the choice to include average prices rather than marginal prices for rents. New rents – the ones policy and market developments affect most immediately – have now been falling for several months.

For completeness, I’m including this chart of the Reserve Bank’s sectoral factor model measure of core inflation.

It used to be the Reserve Bank’s preferred measure (and mine too – I championed it when I was still at the Bank), and it is probably still the single best guide to historical core inflation, but (in the nature of the technique) it is prone to big and lagging revisions when inflation is moving a lot. When the September 2021 CPI came out last October the model estimated core inflation then to have been 2.7 per cent (high, but still inside the target range), but the model – learning from what has happened since – now reckons core inflation last September was already up to 3.8 per cent. At this point, there really isn’t any information (good or ill) in the latest quarterly observations (which in any case use annual rather than quarterly data).

Moving beyond the specific inflation data series, there are a few other considerations that seem relevant to me. The first is to remember the lags (something notably absent from any of the media coverage I heard or read). There are at least two that are relevant. First, the September quarter CPI is really a mid-August measure: there are some noisy components – notably petrol – sampled weekly, and food is captured monthly but the whole thing is centred on 15 August, which is now a bit more than two months ago. So we (and the RB) aren’t exactly using real-time data. And second, the OCR takes time to work – this isn’t in dispute and shows up in all the modelling work – and on 15 August the OCR was 2.5 per cent (it was raised at the MPS a couple of days later). In fact – and it is easy to forget this now – until 12 April, the OCR was no higher than 1 per cent, the level (designed to be somewhat stimulatory) it had been at immediately prior to Covid. Now, of course markets and market pricing anticipated OCR increases to come to some extent, but the market (let alone firms and households) have been repeatedly surprised, constantly revising up their view of what OCR would be required.

I’m also not about to take a view on what the Reserve Bank could or should do in November. Market economists have to, I don’t. There is another round of really important labour market data due out in a couple of weeks (of which the most important bits should be the employment and unemployment numbers rather than wages). Of course, it lags too – centred on mid-August (and I really don’t understand why a household survey collected by phone within a quarter can’t be processed much more quickly than SNZ manages) – but it will still represent an addition to our knowledge. If, for example, the unemployment rate were to have dropped further, the argument for a big OCR increase would inevitably strengthen, all else equal – people will cut central banks less slack now than they might have if we were dealing with core inflation at, say, 3.5 per cent.

But is always going to tempting to just ignore the lags, even after increases in the OCR of unprecedented pace this year. And the lags are real, the lags matter. Robert MacCulloch, macroeconomics professor at Auckland, yesterday reminded us of Milton Friedman’s take on that issue almost 55 years ago.

There was a time for 75 or even perhaps 100 basis point OCR increases – last November or February perhaps – but for now it is much less clear that now is one of those times (and few if any of those now calling for such large increases now were calling for them then).

Of course, it doesn’t help that the MPC chooses to take a long summer holiday. That really should be revisited now.

And just one last graph, since air travel prices were a non-trivial influence in yesterday’s headline (and exclusion) measures. More than a little noise in those series.