National’s tax and spending plan

August 30, 2023August 30, 2023 Michael Reddell Fiscal policy, National Party

National announced its tax and spending plans this morning. You can read the full 29 page document.

In the way of all parties and bureaucratic agencies these days, everything gets quoted as a four year figure: $14.7 billion sounds like a lot but it about $3.7 billion a year, which is about 0.8 per cent of annual GDP. Cost things over 10 years and you could if you wanted call it a $35 billion plan, with no more or less meaning (and, to be clear, all parties and agencies engage in this headline-inflating exercise).

Today’s plan is sold as being fully separable from National’s fiscal plan, which we will apparently get to see after they’ve had time to digest the PREFU numbers (coming on 12 September). It is a clever wheeze – it seemed to work – in allowing Willis and Luxon to deflect all and any questions this morning regarding the deficit and the possible/eventual/one day return to budget operating balance or surplus. They sold this line on the basis that today’s package was itself fully-funded from new initiatives of one form or another, so that in principle the net impact on what fiscal numbers The Treasury comes up with this package could just be slotted in with no net fiscal effect.

I’m not close enough to any of the line by line numbers to know whether each of them is solidly costed. Their economic consultants say they have been, and (assuming there were no silly mistakes made by accident) National does have a pretty strong incentive to ensure the numbers are each reasonably robust. So, for now, I’ll assume they are (with a few possible caveats about the foreign buyers tax, see below).

But the overall argument – “this isn’t our fiscal plan, come back next month for that” – doesn’t really wash. It might if the budget now was pretty near balance, or even in surplus. No one would, or perhaps should, be very worried about modest changes in a comfortable fiscal position.

But we don’t have a comfortable fiscal position.

These were the fiscal numbers the International Monetary Fund put out yesterday in their annual New Zealand review

The blue numbers are more or less solid (actual fiscals are, but the cyclical adjustments could still change a bit), while the red numbers – calendar 2023 and 2024 – are going to be heavily influenced by choices and decisions the government has already made. The best advice from the IMF is that no progress has been made in reducing the deficits first run up in the Covid disruption years, even though actual Covid spending is no longer a thing. The Fund includes projections for the further-out years in which the operating balance goes back to respectable surplus for calendar 2027 and 2028, but those are really just assumptions, and don’t rely on specific identifiable tax or spending decisions that would bring about such an adjustment. I should stress that these are cyclically-adjusted numbers, so the ebbs and flows of the economic cycle don’t provide either the problem or the solution. These sorts of numbers led to the IMF recommending – in really quite pointed language for a diplomatic agency talking of a country that has been among the star fiscal performers for decades – “frontloaded fiscal consolidation” and steps to ease the fiscal pressure on monetary policy.

(The government’s control of the timing of the release of the IMF report, kicked to after Monday’s modest fiscal announcement, means these sorts of lines have had almost no media coverage. And of course no one seems to have gone and asked the Governor “what is this fiscal pressure on monetary policy/inflation the IMF talks about; you have claimed in the last two MPSs that there was none?”)

Last week I ran a post here using the OECD’s fiscal numbers. Those numbers will have been finalised a bit earlier than the IMF’s but are available on a consistent cross-country basis. Using that data you can see how large our (cyclically-adjusted) general government deficits now are relative to other OECD countries (and to our own past). The picture of recent years is a little different, but the final year deficit is also large.

Or here (not cyclically-adjusted)

We have a primary deficit that is large in absolute terms, and among the largest in the OECD.

These international comparisons aren’t done on the New Zealand operating balance definition. On that metric, the cyclically-adjusted operating deficit will be a smaller percentage of GDP, but there is little case for a cyclically-adjusted operating deficit (paying for the groceries etc) at all.

These structural deficits do not heal themselves. And while fiscal drag has been a bit of a help in limiting the deterioration in recent years, the forecast return to lower inflation means not even much of that support will be on offer.

Both Labour and National profess allegiance to the idea of an operating surplus…….but seem to have not the remotest interest in telling us what choices they are going to make to get us there. Discretionary choices/adjustments of perhaps 3 per cent of annual GDP might be required.

Today, however, is National’s day. This was their big tax and spending plan. Willis told reporters this morning that “your tax cuts are coming no matter how much Labour proves to have wrecked the joint”. So the tax cuts are iron-clad, and having bitten the bullet – after railing at Labour’s new taxes for years – and put several new tax increases on the table, it is hard to see they are suddenly going to pull a whole bunch more tax increases from their hat a couple of weeks hence to close the deficit.

It is always possible, they could announce some big new expenditure cut – killing off a few big wasteful specific programmes – but it doesn’t really seem in character, and would completely blunt the message from today that “tax cuts are coming”.

It is much more likely that – having announced their big tax and spending plan today – that is largely it. It may be fiscally neutral in its own right, which is better than the alternative of adding to the deficit, but they aren’t going to do anything much about the deficit at all. No doubt Labour won’t either – it will just handwave around whatever the PREFU shows, having cut (with no accountability whatever re eg likely cost pressures) future operating allowances on Monday. It will be a case of “trust us”, without even any credible evidence from either that ‘we know what we are doing” or really care one way or the other. We are at risk of sliding towards the normalisation of operating deficits, of borrowing to pay the grocery bill. The sort of really poor fiscal management you see in places like the United States federal government.

If asked, perhaps National will talk up cutting public sector bloat. I’m sure there is a fair amount to go round (and no one has mentioned the big increase in Reserve Bank spending that the government snuck out last week), but (a) in this morning’s announcement they ruled out a whole bunch of agencies, both because of Labour’s own vapourware announcements on Monday, and because they want any savings redirected to frontline services those agencies provide. That latter might be laudable but it doesn’t represent fiscal savings.

And, in any case, today’s package already relies on unspecific cuts in public sector bloat.

That is $4bn of the $14.6 billion cost of the overall package (30 per cent). I’m not disputing that there are (substantial) savings to be made, but savings made to finance tax cuts (as in this morning’s package) can’t then be used to also close the deficit. Both Labour and National talk of cutting consultant spend. That is cheap talk, unless (a) it amounts to a reduction in total spend, not just taking people onto the permanent staff (shifting the line item, but not changing the total, and b) identifying what work future governments don’t want done.

To the extent there is genuine bloat, the tax cuts package will have grabbed it. To cut further – cut the deficit – they would need to cut deeper and that would mean harder choices, which so far they’ve shown no inclination to be willing to make (nor Labour, but this is National’s day). And all this assumes that cost pressures are adequately captured in current baselines (which I doubt – citing for example the real wage cut forced on teachers despite apparently very real recruitment and retention challenges).

Finally a few thoughts on specific items. Childcare subsidies aren’t really my thing (better to collapse house prices), but both parties seem to like them. I like them cutting back the brightline test tax (less good than abolishing it, but…) and the restoration of interest deductibility for residential rental property owners (like any normal business). On the other hand, there is no commitment to inflation indexing income tax brackets even going forward (if they’d committed they’d have to have costed it).

But what got my goat were the first two of the new taxes.

Is it marginally better to have no ban on foreign buyers buying very expensive houses but having to pay a high tax to do so than to have an absolute ban? I might grudging acknowledge that, but any gain is marginal at best, and it is a policy that David Parker might have dreamed up in a moderate moment. It is an unprincipled revenue grab, which is wildly inconsistent with the party’s rhetoric (mostly good rhetoric) that freeing up the responsiveness of housing supply is what matters, and that we should be encouraging and facilitating more foreign investment generally. And from a party which claims to be – and historically has been – keen on immigration, it just seems weird (conflicting messages) again to not be allowing anyone who moves here, even on a work visa for several years, to buy a house. They are all over the place with barely a hint of philosophical consistency. It is all made more weird by this line from their document in which they seem to argue that their foreign buyer tax policy will itself somehow dampen property price growth.

As for the revenue estimates ($750 million a year), they seem quite high, and the tax rate seems high by most international standards (Singapore is a lot higher). Only time will tell how many people not living here so want a New Zealand house they will pay a 15 per cent tax to do so.

And then there was the other unprincipled revenue grab, the removal of tax depreciation for non-residential buildings. This measure – which increases the tax rate on businesses – was first introduced by National in 2010 to help fund that tax switch package, with no credible or rigorous underpinnings at all. Buildings depreciate (land doesn’t). In 2020 Labour restored this depreciation provision, and was supported in doing so by their own Tax Working Group. And now both Labour and National are campaigning on getting rid of it again, with no more rationale than that they need revenue (and no doubt tax depreciation provisions won’t show up in the focus groups). The intellectual bankruptcy behind this is evident in National’s document

No rationale at all beyond claiming it was a “tax break”. They rightly pushed back when Labour called interest-deductibility a tax break – it wasn’t, business operating expenses are generally deductible – and depreciation is no different. (Arguably, simply calling it a tax break is no worse than Labour pretending the 2020 change as a temporary Covid stimulus measure when they were quite clear at the time it was permanent, but…..it is a close call. Our political parties………)

Finally just a fairly small technical point. Willis claimed this morning that the National package would not add to inflation pressures. The justification for this claim is that the package is fiscally neutral. That isn’t necessarily sufficient for there to be no net demand impact. For example, the tax cuts etc are skewed towards people who probably have a very high marginal propensity to consume, and the revenue sources probably less so. Perhaps more important, and as someone pointed out over lunch, 20 per cent of the revenue is coming from the foreign buyers tax. Since the higher end, most lucrative, foreign buyers – some billionaire wanting a luxury mansion – mostly won’t be paying the tax out of New Zealand income that additional tax revenue may not represent any diminution of demand in New Zealand. These are small points – the whole (funded) package is less than 1 per cent of GDP – but all else equal I would expect it to be slightly stimulatory. Those compiling Treasury’s fiscal impulse measure might think the same.

The IMF probably wouldn’t think it was a step in the right direction. Perhaps the same will be able to be said for Labour’s plans as they unfold?

UPDATE: On the fiscal impulse issue, the removal of the regional petrol tax in Auckland has the potential to be net stimulatory, at least for a time, as the Auckland local authorities had to wind down projects or identify alternative revenue sources. Re the foreign buyers tax, there may be an incidence question (purchasers of mansions may be able to push the tax incidence back onto vendors, but probably not purchasers of $2.1 million houses in Roseneath or Epsom (where there would normally be more potential domestic purchasers)). In any case, I think most estimates of spending from capital gains – by fairly well-off vendors- probably assume a lower MPC than spending from income.

Does any political party care?

August 30, 2023August 30, 2023 Michael Reddell New Zealand economic performance, Productivity, Uncategorized

I had to check up a specific productivity number this morning and noticed that it had got to the time of year when the OECD finally has a complete set of real GDP per hour worked (labour productivity) data for 2022. Data for 2020 and 2021 had been messed around by Covid disruptions, and measurement challenges around them, but if the illness was still around in 2022 the direct disruptions mostly weren’t.

Anyway, here is how the chart of labour productivity levels looks across countries

If you want, you could ignore the countries at the very top (notably Ireland, where the data are badly messed up by international tax distortions) and the Latin American OECD diversity hires at the very bottom. But it is not an encouraging picture for New Zealand.

Last year, the Secretary to the Treasury commented on some measurement work that Treasury and SNZ had been doing that suggested, on plausible grounds, that our hours worked numbers may overstating how they would look on a properly internationally comparable basis. She suggested that if such an adjustment was made – and it was for a variety of other countries last decade – it could lift GDP per hour worked by up to perhaps 10 per cent (wouldn’t change GDP per capita or wage rates of course). If we were to add 10 per cent to the New Zealand number in the chart above we’d be around where Slovakia, Slovenia, Japan and Israel are now.

But if there is something to that point – and there appears to be – any such adjustment would affect all the historical data as well, so that the growth rates over time won’t be materially affected, or (thus) comparisons of how New Zealand has or has not dropped down the OECD league tables.

A little arbitrarily, I wondered how New Zealand had done on that count over the last 10 years. Ten years is a nice round number, but it also happens to encompass a period half governed by Labour and half by National

Here I’ve shown the (ranked top to bottom) levels of real GDP for 2012 and 2022, and in the final column I’ve identified where a country has changed by more than two rankings over that decade.

Most of the material movements are in the bottom half of the table. There are some stellar performers, most notably Turkey and Poland. And there are some really really mediocre ones: Portugal and our own New Zealand. We’ve dropped six ranking places in a club of only 37 members in just a decade. It took me a little bit by surprise, and I think partly because the New Zealand debate (such as it is) rarely focuses on the countries that are now most similar to us in productivity terms.

Just as context, I then dug out the numbers for 2000. As it happens, the New Zealand ranking in 2012 was exactly the same as it had been in 2000. It is over the last decade that the decline down the OECD league tables has resumed.

Productivity growth is, ultimately, the basis for so much that people want for themselves and from their governments. “Productivity” isn’t the language of the focus groups or polls that seem to drive our politicians these days, but it is a critical New Zealand failing. We aren’t getting poorer in absolute terms, but we drift behind more and more advanced countries in the wages we can support, in the public services we can offer our citizens, in the private goods people can afford to purchase and enjoy.

But there is no sign that either of our major parties (well, or the minor parties) care, or have any ideas, any credible narrative, to reverse our economic decline. It is followership at its worst: competing in the race of “I am [aspire to be] their leader; I must see where they are going and follow them”. Real leadership would be something quite different than just rearranging the deck chairs, competing as to who can offer the best handouts.

I’m occasionally inclined to defend our politicians on the basis that our economic agencies don’t have much to offer them, but (a) those agencies have been degraded by much the same sort of politicians (in some cases, one lot did it, and the other lot keep quiet), and (b) real leadership seeks out, draws out, invites, examines, tests, scrutinises ideas and evidence, drawing around him or her advisers who could inform a better way, that a leader might champion, persuade and so on.

But neither Hipkins nor Luxon – or most of either’s predecessors – seem cut from that sort of cloth, perhaps not even interested or aware of what they don’t do or offer. Both seem content to preside over drift, just so long as they and their mates get to hold office rather than the other lot.

But we haven’t had a three year negative output gap

August 29, 2023August 29, 2023 Michael Reddell LSAP

One of the great things about being a prominent organisation that releases complex material to select media under embargo is that you can get uncontested coverage in the first (and probably only) news cycle. Adrian Orr will have been glad of that when it came to the embargoed release yesterday (the public only got to see it at 5:43 this morning) of the IMF’s Article IV report, and in particular the short (600 words) annex on the fiscal implications of the Reserve Bank’s LSAP programme – the one on which the Reserve Bank has so far lost $11bn.

It was 10 days or so ago that we first heard that some such paper was coming. The Governor was being interviewed by the Herald‘s Madison Reidy after the Monetary Policy Statement. She asked Orr about the LSAP losses and noted in contrast the fiscal costs of the storms/cyclone this year. In his usual effusive style he responded that the LSAP itself had already more than paid for the cyclone recovery costs, moving on to suggest that only accountants could think otherwise “who know the cost of everything and the value of nothing”. He then went to say that the IMF had a paper, which he hoped would be published, showing that the LSAP had actually improved the government’s finances, and that it would offer the “proper story” not some “piecemeal accounting story”.

That caught my eye. Knowing that the IMF Article IV report was due before long, I wondered if they’d have a Selected Issues paper on the topic. These are supplementary research pieces, usually 15-20 pages or so, undertaken by Fund staff (often on topics requested by the authorities) as part of the Article IV review process. The latest two such papers are here.

But it proved not. Instead, we got only a little annex on the topic (600 words and two pictures) on pages 64-66 of the main report. The “proper story” it certainly isn’t – and in fairness to the Fund, as distinct from the Governor, it doesn’t really purport to be. What it is is a little exercise by a few researchers (not working specifically on New Zealand) using a model, as yet unpublished, that they have developed for work on central bank exit strategies, showing that on certain assumptions something like the LSAP could end up producing net fiscal benefits. Surprise, surprise. Of course. It could. The question really is about the realism of the assumptions etc.

Orr, and probably the Fund, will have been pretty happy with the Herald‘s coverage this morning, under the headline “Reserve Bank’s money-printing buoyed Govt books, says IMF” (well except that – rightly – the Governor and IMF would disavow the suggestion that the LSAP was “money-printing”: it was just an enormous asset swap). The results could be read as backing the Governor’s claim – a year ago in an interview with the same journalist – that the benefits to the economy had been “multiples” of the direct cost (although she seems not to have realised that because she contrasts these results with Orr’s 2022 claim).

The first of the two charts really captures the gist of why the little model analysis sheds no useful light at all (SS here simply means steady state).

I showed the top left chart to a 3rd year economics undergraduate, who immediately spotted the problem. It isn’t very hard.

You’ll note that in this example real GDP falls materially below the steady state, or potential, and stays there – converging ever so slowly – for years. By construction of the model, the LSAP intervention – about the scale of the actual LSAP programme – lifts real GDP, but again throughout the entire forecast period real output is at or below potential. There is, in other words, a negative output gap right through the period in the scenario. As the model is constructed, the LSAP intervention boosts real GDP, so that there is a smaller negative output gap. But it is always either negative or zero. Thus, the LSAP has unambiguously boosted real GDP, and thus tax revenues. Working back from the (few) numbers in the little note, and knowing the tax/GDP ratio in New Zealand is about 30 per cent, the total GDP difference must be of the order of 7-8 per cent of GDP. The current LSAP losses to the Reserve Bank are just over 2.5 per cent of GDP, so on those numbers the gains from the LSAP would be “multiples” of the Reserve Bank losses.

But have we had a negative output gap throughout the last 3+ years since the LSAP got underway at the end of March 2020?

Not according to the Reserve Bank, or to any other serious macroeconomic analyst. But since it is the Reserve Bank making the bold claims, and because their numbers are easy to find, here is the Reserve Bank’s current view of the output gap over the period since the start of 2019. I’ve also shown their projections from the last (pre Covid, pre LSAP) MPS.

The output gap is now estimated – several years on – to have been negative for only two quarters, March and June 2020. Every quarter from September 2020 onwards has been positive.

Doesn’t that just mean even more tax revenue and more net benefit?

No, it doesn’t. What went with the persistently positive and large output gap? Why, that was the sharp and now sustained rise in inflation. And how do the Reserve Bank’s modelling and forecast efforts envisage that core inflation comes back to target again? Why, via (raising the OCR and engendering) a fairly protracted negative output gap

and when output is running below potential for several years (and on these projections it isn’t even back to potential by 2026), tax revenue will, all else equal, be running lower than it would otherwise have been. In fact, the way the forecasting models are set up, things are pretty much symmetrical – it will be take roughly as much excess capacity as there was excess demand. We simply haven’t been in the world the IMF’s little desk exercise assumed/portrayed. And thus the numbers are just pretty meaningless when it comes to making claims about the fiscal or other net costs/ benefits of the LSAP. In his day, the Governor would have recognised that once he read the short note and thought for a minute or two.

There are many other limitations to the analysis, even on its own terms. First, the subsequent inflation seems to be treated as quite unrelated to the (with hindsight excessive) stimulus that had gone before. Second, while they assert that the LSAP was a better (net cheaper) intervention than anything else they make no attempt to show this. Thus, had we wanted to throw another $11bn at the economy we could instead have simply given the money to households ($2000 or so per capita). That almost certainly would have engendered a significant demand response (and more than what most New Zealand economists outside Bank believe the LSAP actually did). And we know that actually the OCR hadn’t been lowered to any sort of effective floor, just to the 0.25 per cent the MPC had chosen to set it at. So at least some of any stimulus the LSAP provided could have been done simply by setting the OCR lower – at no risk to the Crown at all. The Funding for Lending programme, used long and late by the Bank, seemed to be an effective tool for stimulus…..and involved no financial risk to taxpayers at all. Had the Bank been doing its job in the run-up to Covid, the negative OCR tool would have been available from the start. You might not like that tool, but the Governor had told us before Covid that he did, and it could have been used at no financial risk to the Crown.

And all this simply assumes – no serious attempt has ever been made to show – that in the specific circumstances of New Zealand (where shorter-term rates are overwhelmingly what matter, and they were anchored by OCR expectations), the LSAP had any material (even inflationary) stimulus at all, to justify the huge financial risks that were taken with no serious advance scrutiny, and which ended up going very bad.

I could take the opportunity to run through all the arguments around LSAP effectiveness again, but I won’t. About a year ago Orr made a strong play to defend it, and the alleged benefits, and I spent a long post then unpicking his arguments. Sometimes – there are so many – one just forgets occasions when Orr has just made stuff up. He was at it again this week.

As for the IMF piece, it is what it is. If you ever find yourself in a deep economic hole, seemingly intractable, you want all the monetary policy stimulus you can get. Best of all, use the OCR and use it aggressively. Perhaps QE can add some value on occasion (probably not much in New Zealand, but perhaps anything might help then in such a scenario). But that – we now realise – just isn’t where the New Zealand economy – or most other economies – found themselves after March 2020. In fact, it is the Reserve Bank itself that now reckons the economy was already overheating – GDP above potential – by the second half of 2020.

Fiscals and elections

August 29, 2023August 29, 2023 Michael Reddell Fiscal policy

In his (paywalled) newsletter this morning Richard Harman compares the current fiscal situation, with yesterday’s last minute fiscal announcements, to the 1972 Budget and election campaign, when Robert Muldoon, then Minister of Finance, was reputed to have said that he’d spent it all and there wasn’t anything much left for the Opposition. Surpluses and deficits were measured differently in those days (cash-based and including capex but not depreciation) but the Treasury long-term fiscal tables tell us in 1972/73 the government accounts ended up with a (very) modest surplus, 0.1 per cent of GDP.

The outgoing Labour government’s fiscal policy around its 2008 Budget is also often heavily criticised. And there is plenty to criticise it for, but as I’ve documented here in several posts (here and here) at the time The Treasury was producing forecasts showing that the operating balance would remain in surplus over the entire forecast period (tiny surplus by the end of the period, but still). It wasn’t Treasury’s finest hour, but you can’t blame Cullen and Clark for Treasury’s forecasting problems. Now, by the time of the PREFU that year things had deteriorated quite a bit – the recession was recognised to be underway – and there were no longer surpluses in prospect. But even then for the fiscal year they were actually in – 2008/09 – the best Treasury projection was a balance of 0.0 per cent GDP. A couple of years beyond that date, a deficit of 1.5 per cent of GDP was projected.

In this year’s Budget the operating balance for 2023/24 – the year we are in, the one where the government makes actual specific tax and spending decisions – the operating deficit was forecast at 1.8 per cent of GDP. There is no good case for running operating deficits at all in an economy that is more or less fully employed (Treasury’s 2023 Budget forecasts for the unemployment rate were 3.7 per cent for June 2023 and 5 per cent for June 2024, suggesting an average roughly equal to many NAIRU estimates).

Fiscal numbers for years beyond the immediately current year are substantially vapourware, but never more so than just prior to an election. The Secretary to the Treasury is required to take as given what the Minister of Finance tells her is government policy. If the Minister of Finance decides to cut future operating allowances those new lower allowances will be what is used, regardless of how plausible the numbers are (it isn’t for Treasury to inquire into that in doing the PREFU numbers). But statements of future intentions don’t bind anyone – and this is true of any Minister of Finance, of any political stripe – and need have no regard to actual budgetary pressures. The vapourware character is perhaps especially so when the plausible political allies for the incumbent party, were it to form the next government, tend to be even less keen on fiscal/spending discipline. Something like the PREFU is a good idea in principle, but there are severe limitations to what it is useful for (a few years ago I posed some suggestions that might make it more useful and might come back to those another day).

It is also easy to forget that it was only 15 months ago – last year’s Budget – that the Minister of Finance was touting his new “fiscal rules“, that were to – he claimed – “ensure New Zealand continues to maintain a world-leading Government financial position”. Among them was this

Surpluses will be kept within a band of zero to two percent of GDP to ensure new day‑to‑day spending is not adding to debt

Just a shame there were, and are, no surpluses. St Augustine’s famous prayer (“Lord, give me chastity and continence, but not yet!”) has a certain resonance for current New Zealand fiscal discipline (or lack of it).

The focus of yesterday’s announcement – months after the expansionary Budget, weeks before the election- was on spending cuts. So I took a look at how this government’s spending plans for this year have evolved over the course of this electoral cycle.

Here is (nominal) core Crown expenses projections for 2023/24 for every EFU starting with the 2020 PREFU. The 2020 PREFU forecasts were done in August 2020, after the first and worst lockdown, but at a time when economic projections generally were pretty bleak (back then, for example, they thought the unemployment rate now would still be around 6 per cent).

The last observation takes account of yesterday’s announcement which may have knocked $1 billion or so off this year’s spending.

Even now the plan seems to be to spend $20 billion more this year than they said they intended at the end of 2020.

Now, no doubt the government would respond “ah, but inflation”. That is a pretty shaky argument, to say the least, when (a) you are the government and the central bank is one of your agencies, and (b) there has never been uttered, not once, by the PM or Minister of Finance, any sort of critical word about the central bank’s stewardship, and you went on to reappoint all the central bank decisionmakers when their terms expired, even (in the case of the Governor) when the main Opposition parties explicitly objected when (as the newly-passed law required) they were consulted. Inflation has been savage. (But of course, just the other day Robertson allowed the Bank a huge increase in its own spending with, as yet, no published rationale or justification.)

But set inflation to one side, and focus instead on projections as a share of GDP (again allowing for $1 billion off this year’s spending, per yesterday, but no reduction since this year’s Budget in expected nominal GDP)

In the first EFU of the majority Labour government (December 2020), they said that they planned to spend 30.1 per cent of GDP in 2023/24. In fact, their latest revised plans would involve spending about 32.75 per cent of GDP this year, and even with lots of fiscal drag to help them, still substantial operating deficits. Note that even after yesterday’s announcement, operational spending this year as a share of GDP is still likely to be a bit larger than they told us they’d planned even in the HYEFU late last year, a mere 9 months ago. (In HYEFU 2021 – less than two years ago now – they expected to spend just over 30 per cent of GDP this year and record a small operating surplus. Now, not so much.

It will be interesting to see the PREFU numbers (at least for this year) on 12 September, but it seems almost certain whereas in 1972 Muldoon actually delivered a tiny surplus in his final year, and whereas in 2008 Clark/Cullen went into PREFU thinking that at least the operating balance for their final year (2008/09) would be literally in balance, this year – and notwithstanding yesterday’s announcement – we will again see forecasts of a material operating deficit for 2023/24. That is all on Hipkins and Robertson.

(It will, of course, also be interesting to see National’s plan and numbers. I’m pretty sceptical based on what we’ve heard so far, but we’ll see. But when the operating balance is in material deficit, it is quite depressing to see both major parties competing on who has the best giveaways – be it GST carveouts, extra subsidies for this or that, and whatever tax plans National has – rather than on restoring promptly a record of fiscal balance. There is no good economic reason for running operating deficits this year – it is like a family overspending its income on consumption items in a year when it has been fully employed – but politics seems to say otherwise. Similarly, there isn’t a really good reason for cutting spending because of a cyclical slowdown – there are Keynesian bones in me – when the real point is that a substantial operating deficit shouldn’t have been budgeted this year in the first place.)

Finally, I remind you of last week’s post, in which the OECD numbers revealed that New Zealand has recently had one of the stimulatory of fiscal policies and now has among the largest general government (primary) deficits of any advanced country.

Misgovernment and other things

August 28, 2023August 28, 2023 Michael Reddell Uncategorized

A while ago, after the post I wrote prompted by my return visit to Zambia, a reader suggested I might like to read Cobalt Blue: How the Blood of the Congo Powers Our Lives. The relevant bit of the Democratic Republic of Congo (DRC) is right next to Zambia, and the two countries share the geological Copperbelt, rich in copper (biggest export for both countries) and cobalt. There is now huge demand for cobalt as a component in lithium-ion batteries, and more than half the world’s fast-growing output currently comes from the DRC. It is no secret now (various reports in recent years) that, shall we say, labour conditions in cobalt-mining in the DRC are not the best. The focus of attention is around so-called artisanal mining, in which rocks with cobalt ore are gathered, broken, washed etc by hand (large scale industrial mining isn’t in focus at all). Wages (or earnings) are low, safety standards usually barely existent, injury and death rates apparently quite high,

The author of the book, Siddarth Kara is a professor in human trafficking and modern slavery at Nottingham University in the UK, and the book is based on several trips to the Katanga region of the DRC, with observations and interviews (often in some secrecy, and now with anonymity, given the very real risks that interviewees in particular often seemed to be running in talking to him.). Much in the book is pretty harrowing.

The author’s focus seems to be on big international companies that are keen to shield themselves from reputational risks and loudly proclaim their commitment that (for example) no child labour is being used in the mining of the cobalt that is so necessary to the batteries that power their products (be it phones, EVs, lawnmowers, or whatever). It is pretty demonstrably clear that any such claims are simply false, and are knowably false (any company board or executive that claims a child-labour free supply chain is almost certainly either consciously lying or consciously choosing not to look any more closely). The amounts of cobalt obtained from rocks collected, broken etc by “artisanal” labour are not marginal, peripheral or incidental. They seem to be a significant chunk of total Congolese production. As the book explains, it is often more economic to get some of the higher grade cobalt-rich rocks this way (lots are very near the surface) than through more traditional industrial processes. The conventional mining and processing companies are typically the buyers for these rocks.

If Kara is harsh, and probably fairly so, on the companies producing products that use cobalt, there are glimpses of recognition in the book that the responsibility runs more widely. He’d really like to be able to tell a relentless tale of the unremitting evils of global capitalism, destroying Congo since the first Portugese explorers arrived in the 15th century, on through the simply-evil phase of Leopold’s turn-of-the -20th-century Heart of Darkness immensely lucrative private estate. Colonialism and all that.

But he does recognise that a whole variety of interests are at work, and that successive Congolese governments and their factotums have scarcely shown (or show today) much sign of unremitting dedication to advancing the interests of the Congolese people. And while Patrice Lumumba is his hero, heroes who were killed before their own record in government was really able to be tested are handy rhetorical devices but not much more.

The DRC is staggeringly rich in natural resources. And yet (perhaps partly because of it?) it is one of the worst failures of modern post-colonial Africa. Here is real GDP per capita for the sub-Saharan African countries, from the IMF’s latest WEO database.

Africa is the world’s poorest and least productive continent, but there are poor performers, really bad performers, and then countries like the DRC – 4th lowest per capita incomes anywhere in sub-Saharan Africa. As it happens, the three poorest countries happen to border the DRC, but so do Angola, the Republic of Congo, Zambia, and Tanzania which are in the top half of countries in the chart.

Some will want to blame empire and colonialism for Africa’s overall performance, but it was a widespread story across Africa, and simply cannot credibly explain why the DRC has done so poorly. Independence came 63 years ago now, and actually – evil as earlier Leopold regime was – in the late 1950s what is now the DRC had fairly high rates of literacy and average GDP per capita is estimated to have been not much lower than Zambia or Zimbabwe or Kenya. South Korea wasn’t that much richer. Then.

For that longer-run of data we can turn to the Maddison Project database.

Barely two-thirds of the real GDP per capita of 1960. Only five countries seem to have gone backwards over that period, and not even Haiti has done as badly as the DRC. To the extent such long-term comparisons across countries make sense, real GDP per capita in the DRC now is about a fifth that of New Zealand 150 years ago.

It isn’t all bad. Life expectancy is about 50 per cent greater than it was for the hugely increased population

But the material living standards for ordinary people have gone backwards over 60+ years.

And this is a dimension that got not a mention in Kara’s book. I’m not really criticising him for not writing a different book – his real focus is companies in the West – but consider that the countries ranked 2-5 in cobalt production last year were Indonesia, Russia, Australia and Canada. You don’t hear alarming stories about artisanal cobalt mining in those countries – even in neighbouring, much richer, Zambia artisanal mining seems to be mostly for gemstones – not first and foremost because such activities would be regulated out of existence, but because they are priced out of existence. Workers in Australia or Canada have much more remunerative options than grubbing for cobalt-bearing rocks at, for many in the DRC, something like US$1 a day (a bit more if you take risk of tunnelling underground in tunnels with few/no supports for veins of cobalt). In the DRC they seem to not have such options. That is what long-term mismanagement, misgovernment, and productivity failure means (in extremis). Given the chaos and failure around them people do what they have to do, for themselves and for their children, even when that means children having to drop out of school very early, even when injury, illness, sexual assault, even death are foreseeable and realistic risks.

I’m not sure what Cobalt Red’s author would propose in response to the situation uncovered in his book. There are suggestions that the artisanal mining be properly regulated, regular wages paid, safety standard and equipment put in place and provided. Which sounds all well and good, but this is the deeply corrupt PRC where most often the financial interests of those around those in power, or able to pay them off, are really what matter. Kids are taken out of primary school mostly not because parents don’t want them to have schooling but because state revenue is used for other things (personal enrichment) – often never reaching the state coffers – rather than more-conventional basics. Rules already in place are blatantly circumvented, for just a few dollars. When your country has been gotten into such a deep mess by its own leaders, it is very hard to dig yourself out again, and quite impossible for other countries to do it for them (even more so, when as the DRC is, the rivalry between the West and China is very much in play, Chinese companies doing most of the cobalt processing). Heart-wrenchingly sad as it for ordinary people of the DRC.

I’m not one of those who ever runs the line about people being “lucky” to be born in particular places or times. Cultures are built and sustained, not just magicked into existence. We are heirs to what our ancestors built or adapted. But reading the book is a helpful occasional reminder that for all the faults, failings and frustrations of New Zealand, we shouldn’t take lightly, or dismiss readily, the cultures and cultural disciplines that still put us in top quartile of countries in terms of GDP per capita, that mean we can be pretty confident that losing parties will turn over the keys of office when they lose elections, that public officials mostly can’t be bought, and so on.

Prescriptions

August 25, 2023August 28, 2023 Michael Reddell Fiscal policy, Monetary policy, New Zealand Initiative

It is the time of the cycle when plenty of groups are keen to have their policy ideas and prescriptions be heard. After all, parties may still be finalising policies and there seems to be a reasonable chance of a new government and different set of ministers before long.

Many are just self-interested (no doubt the authors mostly believe there might be wider benefits, but the fact remains that they are championing policies to help their firm/industry/sector). As an example I found a link in my email this morning to one called a “Blueprint for Growth”. It was this from the covering press release that made me rashly open the handful of slides:

“Today’s announcement is just the beginning, as we know that good, evidence-based, bipartisan policy leads to better outcomes for all New Zealanders. This is part of the key to unlocking the future prosperity and productivity in New Zealand.

Instead it was a bunch of suggestions from the Financial Services Council, some probably worthy, others purely self-interested, that were primarily going to be good for member firms of the Financial Services Council and which, whatever their merits, were going to do nothing at all for productivity,

Yesterday the New Zealand Initiative released a rather more substantive effort, an 86 page collection of proposals and recommendations across a wide range of areas of government policy (nothing on foreign policy for example, and no references to China at all, except perhaps by allusion when discussing the proposed foreign investment regulatory regime, and no mention at all of company tax). (I wrote about their Manifesto 2017 here.)

In some parts of the left, the New Zealand Initiative is looked on as some sort of lobby group for big business, and anything they say is, accordingly, to be dismissed without further examination. The Initiative would sometimes have you believe that it was the opposite: simply public-spirited disinterested people, focused only the well-being of all New Zealanders, who put up their money (in some cases, although mostly their shareholders’ money) only to produce research and analysis without fear, favour, or predisposition. The truth is probably in the middle, but it really shouldn’t matter because the Initiative is transparent about (a) who their members are, (b) their staff and the views of those staff, and (c) their analysis and research. Their stuff should be taken on its merits, and critically scrutinised in the same way as any other contributions to debates. Topics chosen will presumably reflect, to some extent, members’ interests (in both senses of that word) but that is a different matter than what is said on those topics.

I probably agreed with half the proposals in the latest Prescription. I often find myself agreeing with them on second order issues, while profoundly disagreeing with them on the diagnosis and prescription for New Zealand’s long-running productivity failure. But it is a fairly serious collection of ideas and I was a bit surprised not to have seen any media coverage.

In this post I wanted to comment only on their fiscal and monetary policy recommendations, summarised here (and discussed in a bit more depth on page 20-22 of the PDF.

Take fiscal first.

While I generally agree with the first recommendation (no new or higher taxes) – since there is plenty of room to close the (large) deficit by cutting out low-value spending over several years – some of the arguments adduced in support don’t stand much scrutiny. Take, for example, this paragraph

It is certainly true that Singapore and Taiwan have markedly lower rates of tax to GDP than New Zealand (or other advanced countries). On the other hand, OECD data for taxes and social security contributions as a share of GDP show that these days both Japan and Korea have about the same or higher tax shares than New Zealand does. Switzerland, Australia and the US are certainly lower than New Zealand, but then Canada is higher. And “Europe aside” does tend to rather overlook the fact that most of the world’s advanced economies are in Europe. (The Ireland line was fairly disreputable, it being well-understood that Ireland’s GDP numbers are seriously distorted by international tax factors. Using as a denominator the one the Irish authorities recommend (modified GNI), Ireland’s tax share is much the same as New Zealand’s).

I largely agree with their proposals around retirement income, and was surprised to realise that Kiwisaver subsidies now cost about $1 billion per annum. The text suggests that they envisage a pretty slow increase in the age of NZS eligibility, which does fit with what National is promising but should not be necessary in a first-best set of recommendations. Lift the age of eligibility by one quarter a year and it would be at 67 in eight years’ time.

There is quite a difference between suspending contributions to the New Zealand Superannuation Fund (the headline recommendation) and the alternative they moot in the fuller text of simply winding up the Fund. Do the former and Labour is likely to simply resume contributions again. There is no natural place for the government taking your money and mine (or, worse, borrowing it) to punt in international markets at our risk. The NZSF was initially designed for two things: to keep Michael Cullen’s colleagues’ spending sticky fingers off his early large surpluses, and to help buttress an NZS age of 65. We’ve not now had regular surpluses for a long time, and there is no good reason – with improvements in life expectancy – why the eligibility age for the universal state pension should be the same now as it was set at, for the then means-tested age pension, in 1898. NZSF should be wound up and the government’s gross debt substantially reduced.

The third bullet – comprehensive expenditure review – is fine, even admirable. But specifics, and willingness to actually cut, will matter. I like the idea of getting rid of interest-free student loans (my kids look at me reproachfully) but…..what hope?

I have long favoured a (small) Fiscal Council, or perhaps a slightly wider Macroeconomic Policy Council. This is a quite different thing than the policy costings office National, Labour and the Greens are all keen on (as a public subsidy to political parties). That said, if one were serious about austerity in the next term of government – and for my money the NZI doesn’t give sufficient weight to the scale of the fiscal challenge – I’m not sure I’d be treating new nice-to-have agencies (even very small ones) as any sort of priority. I’d rather focus on replacing the Secretary to the Treasury (whose term is up next year) and revitalising the analytical and advisory capabilities of The Treasury.

What of the monetary policy and Reserve Bank proposals. In several places, they overlap with ideas I’ve pushed here over the years.

I was in favour of something like the change to the statutory monetary policy mandate to the Reserve Bank, and am actually on record (in my submission to FEC in 2018) as having favoured going further. The change to the way the mandate was expressed was never envisaged as materially altering how monetary policy was run (from Robertson’s perspective it mostly seemed to be political product differentiation), and I don’t think there is any evidence it has actually done so. The Reserve Bank has made big mistakes in recent years but they have been analytical and forecasting mistakes, not things that can be sheeted home to the change in the way the mandate was expressed (here I imagine the Governor and I would be at one, although of course he’d be reluctant to get anywhere near the world “mistake”). All that said, since making the change made no substantive difference and was mostly about product differentiation, so would undoing it. We need real change at the Bank (and in how it is held to account) so I won’t argue strongly about symbolic change, a least if it markets/headlines real underlying change.

On the other hand, I have long favoured splitting up the Bank, and leaving a monetary policy and broader macro stability focused central bank, and then a New Zealand Prudential Regulatory Agency (probably comprising the regulatory functions of the Bank and much of the FMA’s responsibilities). That such a model would parallel the Australian system is not a conclusive argument on its own, but it is a real benefit when the biggest banking and insurance players in New Zealand are Australian-based. The Initiative argues that

Separating the functions into two organisations would improve governance and reduce the risk of political interference in the RBNZ’s core mission of price stability.

I agree (strongly) with the former. The current (reformed) Reserve Bank has a dogs’-breakfast of a governance model. I’m (much) less persuaded by the latter argument. I have seen no sign – in my time at the Bank or in recent years – of political interference in the operation of monetary policy. The mistakes have been Orr’s, and if there are valid criticisms of Robertson they are that he has showed little interest in doing anything about holding the Bank (and its key personnel) to account. Monetary policy and financial institution regulation are just two quite different functions, and need different skill-sets in CEOs. It isn’t impossible to make the current combined model work – though it would need big changes, including some legislative overhaul – but it simply isn’t the best model for New Zealand. (Such a reform would, done the right way, also render the Governor’s position redundant, with two new chief executive positions to fill.)

Should the Bank’s budget be cut? Yes, of course (and that comprehensive spending review shouldn’t overlook opportunities there), and since the NZI document was finalised we’ve seen an egregious increase in approved Bank spending without even the courtesy (or statutory obligation) to provide any documentation in support. But the budget is only one lever. As important will be finding expert people to lead the institution and monetary policy function who are really only interested, in their day job, in thinking about macroeconomics and doing and communicating monetary policy excellently, without fear, favour, or suspicion of either partisan allegiance or using a public role for private ideological purposes.

I have written here previously that I favour returning the inflation target to 0 to 2 per cent. That said, I don’t find the Initiative’s reasoning very persuasive

A lower target range would encourage the RBNZ to pursue more prudent monetary policies,
minimising the risk of excessive inflation and promoting sustainable economic growth.

But there is no evidence for these claims. Adrian Orr and his minions would have made more or less exactly the same forecasting mistakes in recent years with a target centred on 1 per cent as with the actual target centred on 2 per cent.

Perhaps more importantly, I don’t think the New Zealand Initiative team has ever taken sufficiently seriously the current (regulatorily-induced) effective lower bound on nominal interest rates. That constraint can and should be fixed but unless it is fixed it would be irresponsible to recommend lowering the inflation target.

On deposit insurance, I have long favoured deposit insurance, as a second-best way of reducing the scale and risk of government bailouts of banks (if no one is protected a failing big bank will almost certainly be bailed out, whereas with (retail) deposit insurance it is more credible to think that wholesale funders might be allowed to lose their money in a failure. That said, my argument was primarily about the big banks, and the deposit insurance regime will not cover only them. I do worry about heightened moral hazard risks around the small institutions. One could, I suppose, argue that capital ratios are now high enough there is very little risk of a large bank failing, to a point where it is credible that depositors could face material losses, but that argument cuts both ways in that with high capital ratios moral hazard risks are much smaller even in the present of deposit insurance.

The second to last item on the monetary policy list is a curious one. The Reserve Bank has run up losses of about $11 billion dollars through an LSAP conducted almost entirely in government bonds. So while I agree with limiting what NZ assets the Bank can buy, I don’t think it gets near the heart of the issue. New Zealand legislation is generally for too lax in allowing huge risks to be assumed with no parliamentary approval (whether the Minister of Finance issuing guarantees, for which there is no limit, or the Reserve Bank – which cannot default on its debts – buying risky assets. While there is a need for some crisis flexibility, the scale of the intervention undertaken (over more than a year) should not again be possible without parliamentary approval. That, incidentally, does not impair monetary policy operational autonomy both because the LSAP is a very weak (just risky) instrument and because (see above) the effective lower bound on the nominal OCR itself can and should be fixed.

I have no particular problem with something like the final item on the list, but as regards the LSAP expansion it would seem to be already there. The Bank’s holdings of government bonds are being slowly but steadily sold back to The Treasury (and others are maturing in RB hands). One can argue that the mix of sales might have been different or that the pace should have been (much) faster, but the domestic monetary policy bit of the balance sheet will shrink a lot. There are debates to be had about how much of an “abundant reserves” approach is taken in future – I’d probably favour not – and there are issues that should have had more scrutiny around increases in foreign reserves that the Minister has approved this year, but they are probably second order in nature.

With only 86 pages and lots of policy areas to get through, the NZI document was never going to cover all the significant issues in any subject area. I have quite a list of others, both as regards fiscal policy and around monetary and financial regulatory policy, but this post was about engaging the debate on the ideas NZI has proposed, not tackling all the ones they didn’t or didn’t have space for. Overall, I’m mostly sympathetic to the direction they suggest, but any incoming government actually interested in change should subject the specifics to some serious critical scrutiny.

Fiscals: we used to keep good company

August 24, 2023August 24, 2023 Michael Reddell Uncategorized

There are plenty of egregious examples of public sector waste (think lavish welcomes and farewells for senior public servants) or lack of discipline combined with questionable – well, really poor – process (think this morning’s post about the sly but huge increase in approved Reserve Bank spending).

But my core interests are macro in nature. There have been a series of posts in the last couple of weeks about aspects of the inflation and monetary policy story in the last few years, including yesterday’s on the external economy backdrop which should, if anything, have made New Zealand better placed than some to have kept core inflation near target (and that without even mentioning our lack of exposure to last year’s extreme European gas price shock).

It occurred to me that it might also be interesting to look at how fiscal balances and public debt levels had changed across the group of advanced countries (with their own monetary policies) that I’ve been using for comparison in these posts. I was less interested in the specific pressures put on monetary policy, since I’ve already written a couple of pieces dealing with the spin the Governor is (yet again) engaging in, trying to downplay fiscal impulse measures (developed for monetary policy purposes) in favour of ones that seem to have no macroeconomic foundation at all. I’ve asked the Bank for all/any analysis research in support of what looks to be a highly questionable alternative view, but am not holding my breath (if there were anything much they’d either have referred to it in the MPS, or they might even have been keen to send it to me by return of email to allay my doubts). So my focus was on fiscal developments in their own right.

Sometimes when one heads off to OECD databases to download lots of cross-country comparative data I already more or less knows the story and just want the hard numbers to illustrate it. Other times I’m taken by surprise. This trawl was one of those surprising ones, and not in a good way at all.

But first the good news. This is my preferred (since all-encompassing) measure of net debt. The OECD doesn’t have data on quite all the countries (and Norway data isn’t up to date, but at last read was about -350 per cent of GDP). These are the OECD’s mid-year estimates for 2023

We have lower debt than the median country. Many people (including me, but certainly not everyone) count this as a pretty good thing. But a debt stock is an accumulation of choices by successive governments over a long time. And I was more interested in looking at how things had changed over the Covid period, so since 2019. After all, every government faced some big spending in 2020, and when economies were temporarily closed down tax takes fell too.

So here is how net general government financial liabilities is estimated to have changed from 2019 to 2023 for this same group of countries.

And this is where the surprises started.

The median country in this chart – Sweden – saw basically no change in net debt to GDP over this period. New Zealand, on the other hand had the third largest increase. Australia had a slightly larger increase, but interestingly that was concentrated in the actual Covid period: from 2021 to 2023 net debt in Australia is expected to have risen by 1.5 percentage points while in New Zealand is estimated to have risen by 7.5 percentage points. Of course, for highly-indebted countries the unexpected surge of inflation typically lowers net debt to GDP – helping the US notably among these countries – although in the UK’s case having a large proportion of inflation-indexed debt on issue prevented that happening (as it was designed to do).

The OECD forecasts include 2024 as well, so we can see how they think net public debts levels will have changed across these countries from 2021 (the end of the big Covid spends) to 2024, which they base more or less on policy as at the time the forecasts are done (so mid 2023). Here’s that chart

No comment needed really.

That’s debt, but what about flow measures? Deficits and the like.

Here, we can’t look at the operating balance measures we in New Zealand usually focus on. And all the measures are for “general government” (all layers) rather than just central government (although of course in New Zealand central government absolutely dominates the numbers). There are two sensible metrics to look at:

the primary balance (ie excluding financing costs) as a per cent of GDP, and
net lending (so saving minus investment) as a per cent of GDP

Both are available either cyclically-adjusted or plain, and the OECD also identify idiosyncratic one-offs to go beyond the cyclically-adjusted measures to something more like structural balances. Covid was a common shock, and there are very few identified one-offs for the years focused on here.

The primary balance is a deficit measure pure and simple. Excluding finance costs makes sense for these purposes not because they aren’t real costs, but because a country with higher inflation will tend over time to have higher interest rates and much of those higher nominal interest rates aren’t a real burden, but just maintain the real purchasing power of the debt. At present, 6 per cent inflation and 4 per cent bond rates gives you negative real financing costs, but still a significant line item of expenditure on interest. The other reason for excluding them is that a basic maxim in public finance is that if you are running a primary balance or material surplus, your debt won’t be escalating as a share of GDP (precise definition depends on the relationship between the interest rate and the GDP growth rate). Countries don’t need to run headline surpluses to see debt ratios stabilising or falling, but sustained primary deficits (especially in cyclically-adjusted terms) are typically a bit of concern – the sort of thing the IMF might focus on in struggling countries.

Anyway, here are the OECD’s primary balance estimates for 2023 (Norway, as so often at present, runs off the scale)

So that would be the third largest primary deficit this year or any of these advanced economies. Japan is….well….Japan when it comes to public debt and deficits. Poland is dealing with a big influx of Ukrainians and a huge increase in defence spending, and then there is New Zealand. By far the largest primary deficit of any of the countries we are more prone to comparing ourselves to (Anglos and other north Europeans), in an economy where this calendar year the output gap will be about zero (in other words the deficit isn’t exaggerated by a deeply below-capacity economy). I did check the cyclically-adjusted picture and it looks very much the same, altho the Czech Republic just sneaks past us.

And while the median country in this grouping has seen its primary balance deteriorate (into small deficit – see above) over the Covid period since 2019, New Zealand has had the third largest widening (again, cyclically-adjusted numbers are similar, although we are second worst on that measure)

Adjusting the New Zealand numbers for the OECD’s series of estimated one-offs (mostly around the earthquakes) produces this time series chart.

From which I take two points:

We have never (outside Covid peak itself) run primary deficits anywhere near as large as those run last year and (estimated) this year.
In almost every year in the history of the chart we have a stronger (cyclically adjusted) primary balance than the median advanced country in this grouping. Not only were our primary deficits materially larger in 2020 and 2021 (the Covid outlays years), they are still materially larger now.

The other set of measures is for net lending. I haven’t used these data often here, but they are totally standard framework for analysing macro (im)balances (the Reserve Bank even had a nice chart of these sectoral balances, for firms, households, and general government in the latest MPS. It is a measure of savings less investment, saving (in the public sector context) typically arising with operating surpluses. It is set within a national accounts framework, unlike the primary balance (which is more of a pure fiscal thing, since OECD primary balances typically include capital spending).

Here are the OECD’s numbers for 2023

We are fifth from right here, with a rather large gap between government saving and the government deficit, but even that position flatters us because the saving numbers take finance costs into account, and (as discussed above) in the presence of high inflation the numbers for highly-indebted countries (think US and UK) show as worse than they really are. Simply paying out interest equal to the inflation rate is not a real burden (or hence real dis-saving), they just maintain the real purchasing power of the bondholders without worsening the real position of the government. (If you want to know more about this issue in a New Zealand context Google work Grant Scobie did at The Treasury.) Since economies are getting back towards balance this year, the cyclically-adjusted picture isn’t much different for New Zealand.

And here is the change since just prior to Covid

Third from the right when even the median country’s position has deteriorated – and remember almost all of these countries have been grappling with high inflation – is probably not the ideal place for New Zealand to be.

I could, but won’t, show you the time series chart for this measure cyclically-adjusted and with adjustment for earthquake one-offs. I won’t because the picture is so similar to the time series comparative chart for the cyclically-adjusted primary balance. We used to be better than the median, our government sector used to be net lender most years, while now we are a net borrower and quite a bit more so than the median of these advanced countries.

As I suggested towards the start of this post, I was genuinely surprised by these numbers for the last few years. I knew, of course, that New Zealand’s position had deteriorated, and have banged on here about the lack of any robust economic case for running operating deficits last year and this while the economy was overheated or (this year) getting back to balance, and the Reserve Bank was belatedly grappling with the inflation challenge. But if you’d asked me, I guess I’d have assumed that other countries had probably had similar deteriorations. Mostly, they haven’t.

None of this – except the initial debt charts – are materially influenced by the costs of Covid – lockdown support etc- themselves. Those costs were borne, and often were very heavy, in 2020 and 2021, while my charts have focused on the changes in balances from 2019 (pre Covid) to 2023 (post big Covid expenditures and with fully employed economies). They are pure political choices.

I can see an arguable case for a country that had rapid productivity growth and rapid population growth to be a net borrower (investment in anticipation of future income gains). But other than the central European countries, rapid productivity growth has been scarce among advanced countries, and although our population growth rate is now rapid again, so are those of Australia and Canada, neither of which is running anything like our net lending deficit.

And in a fully employed economy (as ours is this year) there is just no good case at all for running any sort of operating deficit (the New Zealand specific measure), let alone a material primary deficit.

In flow terms, our public finances now – fully employed economy, and terms of trade which have still been high by historical standards – just aren’t what they once were (under governments of either stripe) until quite recently. And the numbers are still flattered by that boost an unexpected surge of inflation gives to the public accounts – but which you never hear either government or Opposition parties engage with – in that public sector wages (with a considerable element of central control) tend to be slow to adjust. The government recently more or less forced secondary teachers to accept a material real wage cut. They are trying to do the same now with senior doctors. And it is probably the case, in a bigger way, for any moderately well paid public servant who hasn’t changed jobs in the last three years. None of those cuts is likely to prove sustainable (when private sector real wages are flat or rising) longer term if we care at all about the capability and quality of the services we expect governments to provide. Pressures like that really should, but won’t (given the way these things are done), be reflected in next month’s PREFU as part of the big fiscal challenge facing whoever takes office after the election.

There are lots of numbers and concepts in this post. Apologies for that but it is largely unavoidable in trying to do meaningful cross-country comparison. The bottom-line, through all the charts and numbers, is that first sentence of the previous paragraph.

Spending (lots) more….with no parliamentary authorisation

August 24, 2023August 25, 2023 Michael Reddell Reserve Bank Act reforms, Uncategorized

Late yesterday afternoon someone sent me the link to this

Almost two months into the Reserve Bank’s financial year it authorises a 41.7 per cent increase in spending for the current financial year and a 26.3 per cent increase the following year, both relative to the amounts approved in the current five-year Funding Agreement signed in June 2020.

The variation had, apparently, been slipped onto the Reserve Bank’s website the previous day (22nd).

I’m signed up to the Bank’s email notifications. These were the ones from the last week

There was no press release from the Bank, and none from the Minister of Finance either. For huge increases in the spending of an institution whose performance has been under a great deal of scrutiny in the last year or two, the institution actually charged with keeping domestic demand in check to keep inflation at/near target.

The Funding Agreement model, which governs how much of its income the Bank can spend, itself is very unusual. I wrote about it, and the background to it, in a post a few years ago, before Orr took office, when the Reserve Bank Act review was being kicked off. The Funding Agreement model was better than what had gone before – not hard, since previously there were no formal constraints at all on Reserve Bank spending – but not very good at all. The model was set up when the Bank was (overwhelmingly) conceived of as a monetary policy agency, with a few other peripheral functions. The five-year horizon, with nominal allocations fixed in advance, was seen as having the (modest) advantage of providing a bit of financial incentive for the Bank to meet its inflation target: if it didn’t its real spending constraint would be tighter than otherwise. These days, the bulk of the Bank’s staff are devoted to policy and regulatory functions. Most such government agencies are funded by annual appropriations, approved (and scrutinised) by Parliament through the annual Budget process. In that earlier post, I’d come round to thinking that model should be applied to the Reserve Bank too.

The variation slipped onto the website a couple of days ago exemplifies what is wrong with the current system (perhaps especially under the current players – Orr/Quigley and Robertson – but they are only egregious abusers of a poor system).

This is public spending on public functions. We have a Budget for that. There is no obvious reason why, if there really was a compelling case for more money for the Reserve Bank, it could not have been announced at the same time as the Budget. After all, governments have to prioritise, and voters have to make judgements about what they do and don’t choose to spend money on. Taxpayers are the poorer whether or not the spending is through some agency subject to parliamentary appropriation or the Reserve Bank. As it is, the Bank’s financial year began on 1 July, so why the delay in agreeing/announcing this big increase in approved spending?

But then note the specific timing. The Minister of Finance signed the variation on 31 July. Orr and Quigley only signed it, and then had it slipped onto the website, on 22 August. It doesn’t take more than five minutes to get a document across the road to the Reserve Bank, and even if they wanted Quigley’s signature on it (it just needs any two Board members), and they wanted a physical rather than electronic signature, a return courier to Hamilton could no doubt have been done in 24 hours. Most probably, they didn’t want the variation to be known any earlier because……last week was the Monetary Policy Statement, when the Bank was having to acknowledge it hadn’t yet made much progress in getting core inflation down and that interest rates might be higher for longer, when the Bank would face a press conference and an FEC hearing, and when they’d do the quarterly round of making some internal MPC members available for interviews. It came on the back of those stories a couple of weeks ago [UPDATE: the week MoF signed the variation] about the Minister and the Public Service Commissioner having meetings with government department chief executives urging upon them fiscal restraint. The last of those Bank media interviews appeared a couple of days ago. It was bureaucratic gamesmanship, presumably abetted/approved by the Minister, to minimise budgetary scrutiny and accountability on what is a huge increase in allowed spending.

By law, they had to publish the Funding Agreement variation on the Bank website as soon as possible after it was signed. They did that, even if you had to be eagle-eyed or lucky to spot it. The Minister must present a copy to Parliament within 12 sitting days. Had the agreement been signed on 31 July (when Robertson signed it, but not the others) that would have been this month. As it is, perhaps he’ll do it in the next few days, but it could be November/December, after the election.

Under the old Reserve Bank Act, Funding Agreements were subject to parliamentary ratification. In a way, it was a bit of a charade, as there were no consequences if it was voted down (it isn’t mandatory for there even to be a Funding Agreement) but it did establish a principle, and did allow a parliamentary debate and a spotlight on proposed Bank spending). In one of the very worst parts of the Reserve Bank Act reforms – that genuinely took things backwards, rather than just made botched or inadequate improvements – the government removed the provision from the Act requiring parliamentary ratification, and thus the platform for parliamentary debate (about a level of spending which in absolute terms is no longer small).

We also, at this point, have no real idea what the Minister has approved this spending increase, in straitened times, for, or why he approved it. There is, of course, no ministerial press statement, and there is no hint of a huge spending increase in the Minister’s latest letter of expectation (although this must have been underway for months, and I had a clearly well-informed email months ago encouraging me to ask questions and lodge OIAs then, which I didn’t get round to doing).

All we have at present is this

which is clearly designed to emphasise the new functions, but there is just no way they can be costing any significant part of the extra $48m. And in any case, we simply can’t take as trustworthy anything Orr and Quigley say any longer, abetted by Robertson, without explicit verification.

(One problem with the Funding Agreement model is that it includes capex so we don’t even know yet the split between ongoing operational spending and capex items).

There should, eventually, be some transparency. One positive aspects of the recent legislative reforms was a requirement that the Bank must publish a budget (previously I had pointed out the Bank’s funding was an untransparent as that of the SIS)

By law, the variation to the Funding Agreement slipped onto the website on Tuesday had to accompanied by an updated budget. But, so far, there is no sign of one. There are budget numbers in the 2023/24 Statement of Performance Expectations released a while ago, but they bear no relationship to the numbers in this variation (and there is no substantive mention of the Funding Agreement, or any variations to it, in that document). I’ve searched their website and can find nothing else.

We have no details, Parliament has no say, and the Minister and Governor and Board chair arranged to ensure the really big increase in funding was (a) kept just as low profile as possible, and (b) wasn’t disclosed at all until the quarterly round of scrutiny for the Bank had conveniently passed.

It is a travesty on multiple counts. The system is bad enough – spending should be occurring only with parliamentary approval, but the law doesn’t require that – and the application seems, if anything, to have been worse.

Since I assume that they will, after their fashion, eventually obey the law no doubt a “budget” will eventually appear. Even then it is unlikely to be very revealing, although might give a hint of a sense of the breakdown between bloat and actual increased statutory responsibilities. I’ve lodged Official Information Act requests with the Bank, The Treasury, and the Minister of Finance to understand better just what is going on, including how much (if any) pressure there was on the Bank to cut back on non-priority spending. One day, in a month or two, we should have some answers to that.

UPDATE (Friday)

This appeared in the comments last night

If I’m looking at the right page this detail now appears to have been removed. It was interesting that Quigley’s signature was affixed electronically, so that (of course) the long delay was not a matter of waiting for him to come to Wellington. Re the final point, there may well have been a Board meeting recently, but since the variation document itself reflected an agreement between the Bank and the Minister it would be (very) surprising indeed if the Board had not already approved the variation before MoF signed it on 31 July.

What did the RB have to deal with?

August 23, 2023August 23, 2023 Michael Reddell Adrian Orr, inflation, Monetary policy

I’ve used this chart before to illustrate how diverse the (core) inflation experiences of advanced economies have been in this episode. It isn’t as if they’ve all ended up with similarly bad inflation rates, and the point of focusing on those countries with their own monetary policy and a floating exchange rate is that core inflation outcomes are a result of domestic (central bank) choices (passive or active) in each country.

Yesterday’s post focused on the rapid growth in domestic demand that the Reserve Bank had facilitated and overseen. But, it might have occurred to you to ask, what about foreign demand? It all adds up.

And if you look more broadly you might reasonably have thought New Zealand would be a good candidate for being towards the left-hand end of this chart.

The central banks in Australia, Canada, and Norway have faced big increases in the respective national terms of trade (export prices relative to import prices) over the last 3+ years. All else equal, a rising terms of trade – especially when, as in each of these cases, led by rising export prices – tends to increase domestic incomes and domestic consumption and investment spending and inflation. It isn’t mechanical or one for one (in Norway, for example, they have the oil fund into which state oil and gas revenues are sterilised) but the direction is clear: a rising terms of trade is a “good thing” and more spending, and pressure on real resources, will typically follow in its wake.

Here is the contrast between New Zealand and Australia over recent years.

In Australia a 25 per cent lift in the terms of trade is roughly equal to a 5 per cent lift in real purchasing power (over and above what is captured in real GDP). A 10 per cent fall here would be a roughly equivalent to a 2.5 per cent drop in real purchasing power. As it happens, over the last couple of years (since the tightening phases began) the terms of trade have been weaker than the Reserve Bank expected, all else equal a moderate deflationary surprise.

But the other big deflationary influence was the closed borders. I’m not here getting into debates about the merits of otherwise of such policies. Central banks simply have to take whatever else governments (and the private sector) do as given and adjust monetary policy accordingly to keep (core) inflation near target. The fact was that our borders were largely closed to human traffic for a long time, New Zealand has more exports of such services (tourism and export education) than imports, and exports of services are far from having fully recovered pre-Covid levels.

We don’t have easily comparable tourism and export education data across countries, but we can look at how exports of services changed as a share of GDP. From just prior to Covid to the trough, New Zealand exports of services fell by 5.7 percentage points of GDP, a shock exceeded only by Iceland (-12.7 percentage points) – the fall for Australia was just under half New Zealand’s, and for most advanced economies (of the sample in the chart above) the fall was 1-2 percentage points of GDP. In most countries, that trough was in mid 2020, while in New Zealand it was not until early 2022.

Some ground has been recovered (most starkly in Iceland) but New Zealand (and to a lesser extent Australia) are still living with a material deflationary shock from this side of the economy. Real services exports in 2023Q1 were 26 per cent (seasonally adjusted) lower than in 2019Q4, just prior to Covid.

Now, again you will note that this isn’t the entire story. After all, New Zealanders couldn’t travel abroad easily for much of the time either, and money they would have spent abroad seemed to be substantially diverted to spending at home (probably more so than was initially expected). That reduction of imports of services was large (3 percentage points of GDP, with Australia 4th largest of this advanced country grouping) but early – the trough for New Zealand as for most of these advanced countries was as early as 2020Q3.

But that was then. This chart shows the change in imports of services as a share of GDP from just pre-Covid to our most recent data (2023Q1). That share has fully recovered here, with an increase very similar to that of the median country.

So, relative to pre-Covid (and pre-inflation surge), imports of services as a share of GDP are about where they were, and exports of services were still materially lower as at the last official data.

With a deflationary shock like this you might have reasonably thought that the Reserve Bank, if it was to keep inflation near target, would need to induce or ensure faster growth in domestic demand (than some other countries). Yesterday I showed this chart (remember, GNE is national accounts speak for domestic demand). New Zealand was at the far right side of the chart (strongest growth in domestic demand as a share of GDP).

But what if we treated the change in the services exports share of GDP as an exogenous shock that, all else equal, the central bank legitimately had to respond to? In this version of the chart I’ve subtracted the reduction in services exports as a share of GDP.

It makes a material difference to the New Zealand numbers, but even so we are still left with an increase in the share of GDP that is third highest on the chart, about the same as the UK which (as is well known) is really struggling with inflation. (In case you are wondering Korea has relatively modest core inflation now – so first chart – but still about 3.5 percentage points higher than it was just prior to Covid; for us the increase has been about 4 percentage points.)

There are lots of numbers and concepts in this post and it isn’t always easy to keep them straight. But the key points are probably:

echoing yesterday’s post, don’t be distracted by the Governor’s spin about Russia or the weather or whatever (they just don’t explain core inflation to any material extent) or spin (probably more from the Minister) that every advanced country is in the same boat (they aren’t, see first chart),
more than other advanced countries, we should have been predisposed to being able to have kept inflation in check a bit more easily, having had both a fall in the terms of trade (very much unlike Australia and Canada) and a sustained fall in exports of services that as a share of GDP is materially larger than any other advanced economy has seen. To be clear, those are bad things, making us poorer, but all else equal they were disinflationary forces,
and yet, core inflation here is in the upper half of the group of advanced economies and (as the MPS acknowledged) is not yet really showing signs of having fallen (unlike some other advanced countries, notably Australia, the US, and Canada),
the difference is about Reserve Bank choices and forecasting errors. The Reserve Bank can’t control the terms of trade or exports of services, but its tool – the OCR – is primarily about influencing domestic demand. They ended up producing some of the strongest growth in domestic demand (absolutely or relative to nominal GDP) anywhere in the advanced world. It wasn’t intentional, but it was their job, and their mistake resulted in high core inflation.

The Reserve Bank doesn’t publish forecasts of nominal GNE – and note that my charts have shown a big increase in GNE relative to GDP – but even their nominal GDP forecasts, even just starting from two years ago when they first thought it was time to start tightening, have materially understated domestic demand growth

and over this period they have actually over forecast real GDP growth.

Again, I’m going to end on a slightly emollient note. Macroeconomic forecasting is hard, and especially in times as unsettled as these. I heard an RB senior person the other day noting (fairly) that they couldn’t tell when the borders would fully reopen, or how quickly people flows would respond when they did. Personally, I’m less inclined to criticise them for getting their forecasts wrong (“let him who is without sin cast the first stone”) than for the sheer lack of honesty and straightforwardness, and the absence of either contrition (in respect of failures in a job they individually chose to accept – no one is compelled to be an MPC member) or hard critical comparative analysis. But…..relative to other countries they had advantages which should have given us a better chance of keeping inflation near target, and things ended up as bad or worse as in the median advanced country.

If forced to confront these arguments the Governor would no doubt burble on about “least regrets”. But the least regrets rhetoric a couple of years ago was really about – and they know this – the risk that inflation might, if things went a bit haywire, end up at 2.5 per cent or so for a year or two, rather than settling immediately around the target midpoint of 2 per cent. It wasn’t – was never even suggested as being – about the risk of two or three years of 6 per cent core inflation, and a wrenching adjustment to get it back under control.

They may still claim to have no regrets. They should have many. We certainly should. They took the job, did it poorly, and now won’t even openly accept (what they know internally) that it wasn’t the evil Russian or a cyclone or….or….or…it was them, Orr and the MPC. They made mistakes (they happen in life), with no apparent consequences for them, and not even the decency to front up, acknowledge the errors, and say sorry.

Excess demand

August 22, 2023August 22, 2023 Michael Reddell Adrian Orr, inflation, Monetary policy

Particularly when he is let loose from the constraints of a published text, the Reserve Bank Governor (never openly countered by any of the other six MPC members, each of whom has personal responsibilities as a statutory appointee) likes to make up stuff suggesting that high inflation isn’t really the Reserve Bank’s fault, or responsibility, at all. It may be that Parliament’s Finance and Expenditure Committee is where he is particularly prone to this vice – deliberately misleading Parliament in the process, itself once regarded by MPs as a serious issue – or, more probably, it is just that those are the occasions we are given a glimpse of the Governor let loose.

I’ve written here about just a couple of the more egregious examples I happened to catch. Late last year there was the line he tried to run to FEC that for inflation to have been in the target range then (Nov 2022) the Bank would have to have been able to have forecast the Russian invasion of Ukraine in 2020. It took about five minutes to dig out the data (illustrated in the post at that link) to illustrate that core inflation was already at about 6 per cent BEFORE the invasion began on 24 February last year, or that the unemployment rate had already reached its decades-long low just prior to the invasion too. It was just made up, but of course there were no real consequences for the Governor.

And then there was last week’s effort in which Orr, apparently backed by his Chief Economist (who in addition to working for the Governor is a statutory officeholder with personal responsibilities), attempted to brush off the inflation as just one supply shock after the other, things the Bank couldn’t do much about, culminating in the outrageous attempt to mislead the Committee to believe that this year’s cyclone explained the big recent inflation forecasting error (only to have one of his staff pipe up and clarify that actually that effect was really rather small). See posts here and here. Consistent with this, in his interview late last week with the Herald‘s Madison Reidy, Orr again repeated his standard line that he has no regrets at all about the conduct of monetary policy in recent years. It is consistent I suppose: why regret what you could not control?

It is, of course, all nonsense.

But there is, you see, the good Orr and the bad Orr. The bad – really really bad, because so shamelessly dishonest – is on the display in the sorts of episodes I’ve mentioned in the previous two paragraphs.

The good Orr – some of you will doubt you are reading correctly, but you are – is a perfectly orthodox central banker informed by an entirely orthodox approach to inflation targeting. You see it, even at FEC, when for example he is asked about the role the “maximum sustainable employment” bit of the Remit plays. He has repeated, over and over again and quite correctly as far I can see, that there has not been any conflict between it and the inflation target in recent years. That is how demand shocks and pressures work. And whereas in 2020 the Bank thought inflation would undershoot target and unemployment be well above sustainable levels, in the last couple of years the picture has reversed. He told FEC again last week that when inflation was above target and the labour market was tighter than sustainable both pointed in the same direction for monetary policy: it needed to be restrictive. There was, for example, this very nice line in the MPS, which I put big ticks next to in my hard copy.

The Bank doesn’t do many speeches on monetary policy, and those few they do aren’t very insightful but this from the Chief Economist a few months ago captured the real story nicely

and this from the Governor, describing the Bank’s functions, was him at his entirely orthodox

We aim to slow (or accelerate) domestic spending and investment if it is outpacing (or falling
behind) the supply capacity of the economy

Demand management, to keep (core) inflation at or near target is the heart of the Reserve Bank’s monetary policy job, assigned to it by Parliament and made specific in the Remit given to them by the Minister of Finance.

Domestic demand is known, in national accounts parlance, as Gross National Expenditure (or GNE). It is the total of consumption (public and private), investment (public and private) and changes in inventories.

I’ve been pottering around in that data over the last few days, and put this chart (nominal GNE as a percentage of nominal GDP) in my post last Thursday.

This ratio has tended to be low in significant recessions and high around the peaks of booms – investment is highly cyclical -but for 30+ years it had fluctuated in a fairly tight range. The move in the last couple of years has been quite unprecedented, in the speed and size. There was huge surge in domestic demand relative to (nominal) GDP.

One of the points I’ve made a few times recently is that country experiences with (core) inflation have been quite divergent over the last couple of years. The Minister of Finance in particular is prone to handwaving about “everyone faces the same issue” around inflation, and the Bank isn’t a lot better (doing little serious cross-country comparative analysis). But the differences are large.

And so I wondered about how those domestic demand pressures had compared across countries.

One place to look is to the change in current account deficits as a share of GDP. This chart, using annual data from the IMF WEO database, shows the change in countries’ current account balance from 2019 to 2022 (Norway is off this scale; what happens when you have oil and gas and another major supplier is being shunned)

There has been a fair amount of coverage of the absolute size of New Zealand’s current account deficit, and even a few mentions of the deficit being one of the largest in any advanced country. But for these purposes (thinking about monetary policy and demand management) it is the change in the deficit that matters more. Over this period, New Zealand’s experience has not just been normal or representative, instead we’ve had the third largest widening in the current account deficit of any of these advanced countries (those with their own monetary policy, and thus the euro-area is treated as one). Both Iceland and Hungary have slightly higher inflation targets than we do, but they have a lot higher core inflation (see chart one up).

The current account deficit is analytically equal to the difference between savings and investment. Over that 2019 to 2022 period investment as a share of (nominal) GDP increased in all but two of the advanced countries shown. Of the four countries where it increased more than in New Zealand, three are those with core inflation higher than New Zealand.

National savings rates (encompassing private and government saving) paint a starker picture. Somewhat to my surprise, of these advanced countries the median country experienced a slight increase in national savings over the Covid/inflation period.

Norway is off the scale again, because I really want to illustrate the other end of the picture. That is New Zealand with the third largest fall in its national savings rate of any advanced country.

What about that chart of nominal GNE as a share of nominal GDP? How have other countries gone with that ratio? There is a diverse range of experiences, but that sharp rise in the New Zealand share really is quite unusual, equal largest of any of these advanced countries.

(If you are a bit puzzled about Hungary – I am – all the action seems to have been in the last (March 2023) quarter’s data).

But lets get simpler again. Here is a chart showing the percentage change in nominal GNE (growth in domestic demand, the thing monetary poliy influences) from just prior to the start of Covid to our most recent data, March 2023.

It looks a lot like that earlier chart comparing core inflation rates across countries. In this case, New Zealand had the fourth fastest growth in domestic demand of any of these countries over this period (and those with higher growth are not countries with outcomes we’d like to emulate). And in case you are wondering, no this wasn’t just a reflection of super-strong GDP growth: over this period New Zealand’s nominal GDP growth was actually a little below the growth in the median of these advanced economies. The economy simply didn’t have the capacity to meet the nominal demand growth the Reserve Bank accommodated and the imbalance spilled into a sharp widening of the current account deficit and high core inflation. It wasn’t Putin’s fault, or that of nature (the storms), it was just bad management by the agency charged with managing domestic demand to keep core inflation in check.

I’ve also done all these chart etc using real variables. The deviations are often less marked, but no less substantive for that. Real GNE (real domestic demand) growth from 2019Q4 to the present in New Zealand was third highest among this group of advanced economies, and only Iceland (see inflation and BOP blowouts above) had a larger gap between growth in real domestic demand and real GDP.

I don’t really want to divert this post into an argument about fiscal policy over recent years (monetary policy has to, as the Governor often notes, just take fiscal policy as it is, as just another demand/inflation pressure) but for those interested the government share of GDP has been high (which usually happens in recessions since government activity isn’t very cyclical) but private demand is what really stands out).

Bottom line: all those stories trying to distract people, including MPs, with tales of the evil Russian or the foul weather or whatever other supply shock he prefers to mention, really are just distractions (and intentionally misleading ones by the Bank). The Bank almost certainly knows they aren’t true, but they have served as convenient cover for the fact that the Bank simply failed to recognise the scale of the domestic demand (right here in New Zealand, firms, households, and government) and to act accordingly. We are now still living with the 6 per cent core inflation consequence. It is common – including in the rare Bank charts – in New Zealand to want to compare New Zealand with the other Anglo countries. But what the Bank has never acknowledged – and just possibly may not have recognised – is much larger the boost to domestic demand happened in New Zealand than in the US, UK, Canada or Australia. And domestic demand doesn’t just happen: it is facilitated by settings of monetary policy that were very badly wrong, perhaps more so here than in many of those countries.

Perhaps one could end on a slightly emollient note. Getting it right in the last few years has been very challenging, and it wouldn’t entirely surprise me if when all the post-mortems are done some of relative success and failure proves to have been down to luck (good or bad). But as in life, central banks help make their own luck, but digging deeper, posing and publishing analysis even when they don’t know all the answers, and by taking a coldly realistic view, not attempting to hide behind spin, misrepresentations, and what must come close to outright lies. Even by acknowledging errors, the basis for learning better, and being able to feel and display those most human of qualities, regret and contrition. We need a Governor and MPC members doing all this a lot more than has been on display here in the last year or two. Our lot show little sign of trying, or of even being interested in feigning seriousness.

croaking cassandra

Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

Month: August 2023