Month: October 2023

Perhaps unsurprisingly, there was nothing there

Michael Reddell Adrian Orr, Fiscal policy, Monetary policy, MPC

I’ve written a few posts in the last few months about the strange approach that the Reserve Bank has been taking to thinking and talking about the impact of fiscal policy on demand since May’s Budget. Background to the material in this post is here (second half, from July), here (mid-section, commenting on the August MPS), and here (September, in the wake of PREFU.

Up to and including the February MPS the Reserve Bank’s approach to fiscal issues was pretty much entirely conventional. What mattered mostly for them – and for the outlook for pressure on demand and inflation – was not the level of spending or the level of revenue or the makeup of either spending or revenue, but discretionary changes in the overall fiscal balance. Adjust the headline numbers for purely cyclical effects (eg tax revenue falls in economic downturns) and from the change in the resulting cyclically-adjusted surplus/deficit from one year to the next you get a “fiscal impulse”. That is/was an estimate of the pressure discretionary fiscal choices were putting on demand and inflation. For a long time, The Treasury routinely reported fiscal impulse estimates – and estimates they always are – along these lines, and had developed the indicator specifically for Reserve Bank purposes twenty years ago.

If the cyclically-adjusted deficit (surplus) is much the same from year to year the fiscal impulse will be roughly zero. A central bank typically isn’t interested that much in whether the budget is in surplus or deficit, simply in those discretionary changes. Back in the day, for example, we upset Michael Cullen late in his term when he was still running surpluses, but shrinking ones, when we pointed out that the resulting fiscal impulse (from discretionarily reducing the surplus) was putting additional pressure on demand and inflation, at a time when inflation was at or above the top of the target range. Whether or not what he was doing made sense as fiscal policy, it nonetheless had implications for the extent of monetary policy pressure required, and it was natural for us to point this out (as with any other major source of demand pressure).

Among mainstream economists none of this is or was contentious. International agencies, for example, routinely produce estimates of cyclically-adjusted fiscal balances, partly to help readers see the direction of discretionary fiscal policy choices. Plenty of past Reserve Bank documents will have enunciated this sort of approach.

It was also this sort of thinking that led to an amendment to the Public Finance Act in 2013

(NB: The Treasury has made analysis of this sort harder in recent years, as in 2021 they changed the way they calculate and report the fiscal impulse, in ways that make little sense and reduce (but don’t eliminate) the usefulness of the measure as they report it. These changes further undermined the usefulness of New Zealand official fiscal indicators – already generally not internationally comparable – but do not change the fundamental economics, which is the focus in this post.)

But suddenly, in the May Monetary Policy Statement – a document released just a few days after the government’s election-year Budget – there was a really major change in the approach the Bank and the MPC were taking to fiscal policy.

No one much doubts that the Budget was expansionary. Here, for example, was the IMF’s take in their Article IV review of New Zealand, published in August but finalised just 6-8 weeks after the Budget

There also wasn’t much doubt that the Budget (and thus demand pressures over the following 12-18 months – typically the focus of monetary policy interest) was more expansionary than had been flagged in the HYEFU at the end of last year. As I’d noted in the first post linked to above

For the key year – the one for which this Budget directly related – the estimated fiscal impulse had shifted from something moderately negative [in HYEFU] to something reasonably materially positive [in the Budget]. The difference is exactly 2.5 percentage points of GDP. That is a big shift in an important influence on the inflation outlook – which in turn should influence the monetary policy outlook – concentrated right in the policy window.

But how did the Reserve Bank treat the issue?

They were at it again in the August MPS, and in the next day’s appearance at FEC.

These sorts of lines – including one of the Governor’s favourites that fiscal policy was being “more friend than foe” – helped provide cover for the Minister of Finance, who was fond of suggesting to reporters that after all the Reserve Bank wasn’t raising any issues.

Some mix mystified and frustrated, I lodged an OIA request with the Bank seeking

If they really did have a thoughtful and well-researched new approach to thinking about fiscal policy and the impact on demand pressures, surely they’d be keen to get it out there. It didn’t seem likely there was anything – there were no footnoted references to forthcoming research papers etc – but….you never know.

But we do now. The Bank responded last month (I was away, and then distracted by election things so only came back to it last week). Their full response is here

RBNZ Sept 23 response to OIA re fiscal policy impact on demand and inflation

They withheld in full the relevant sections of the forecast papers that go to the MPC prior to each OCR review. This is a point of principle with the Bank whereby they assert that to release any forecast papers from recent history would “prejudice the substantial economic interests of New Zealand” (I did once get them to release to me 10 year old papers, from my side as point of principle too). It is a preposterous claim – and needs to be fought again with the Ombudsman (or perhaps a Minister of Finance seriously committed to an open and accountable central bank) – in respect of documents that are many months old, but for now it is what it is.

That said, it would be very surprising if there was anything at all enlightening on the Governor’s change of tack in those withheld papers. The Bank’s economic forecasters rarely did fiscal analysis very well and those sections of the forecast papers were often fairly perfunctory (recall that the Bank takes fiscal policy as conveyed to them by the Treasury, just adjusting the bottom line deficit/surplus numbers for differences in macroeconomic forecasts (eg affecting expected revenue for any given set of tax rates)). More importantly, in the documents released there is nothing else from prior to this change of official approach in May – no internal discussion papers, no draft research papers, no market commentaries circulated approvingly, no overseas academic pieces, just nothing.

In fact, the first document dates from 31 July this year, a 14 page note from analysts from a couple of teams in the Economics Department with the heading “Fiscal policy – seeking a common understanding”. Had there been a serious analytically-grounded push for a new approach, you might have expected such a paper to have been prepared and presented to internal groups and to the MPC well before such a change featured in the MPS. But that change was in May…..and the document dates from the end of July (may have been prepared with the then-forthcoming August MPS in mind). It has a distinct back-filling feel to it.

Here is the paper’s summary

You notice that again they are invoking alleged potential jeopardy to New Zealand “substantial economic interests” to tell us which fiscal indicators these two analysts favour – rather weirdly given that the Governor has already told us (in MPSs) and told Parliament’s FEC which ones he thinks matter most.

But that withholding quibble aside, there isn’t anything really to argue about in that summary. I’m not entirely convinced that a fiscal multipliers approach is the best way of tackling the issue, but having done so they report nothing – not a thing – suggesting that what matters for monetary policy is primarily government consumption and investment spending (as distinct from transfers, taxes, or overall fiscal balances). It is an entirely orthodox position, but quite at odds with the line the Governor and the MPSs had been spinning.

(The paper does have a short box noting in the Bank’s economic model – NZSIM – government consumption and investment are identified separately, while the model itself does not have explicit components for tax rates or transfers but – sensibly enough – this gets no further comment in the paper, and does not mean that changes in tax or transfer policy make no difference to the projections the MPC is considering).

There isn’t very much in the paper on the interaction with monetary policy, but there is this

which is all fine and shouldn’t be at all contentious, but none of its suggest that changes in fiscal deficits don’t matter for the extent of monetary policy pressure and that – as the Governor took to claiming in the wake of the expansionary Budget – that all that mattered was government consumption and investment.

At the back of the paper there is a five page Appendix on all the Treasury measures of fiscal policy. Each appears to have been scored for “usefulness for monetary policy purposes” and while the comments have been released they appear to have withheld – jeopardising those substantial economic interests again apparently – scores or rankings of each item.

They do have items for Government Consumption and Government Investment. Under “usefulness for monetary policy purposes” the comment – on both – is simply “Government consumption [investment] provides information about the type and size of government activity”. Quite so, but…..not really about monetary policy.

But then we come to the item “Total Fiscal Impulse”. Here is what they say

These analysts from the Bank’s Economics Department are entirely orthodox. I would qualify their comments slightly because – as alluded to above – this new “Total Fiscal Impulse” measure is clearly inferior for purpose than the previous Fiscal Impulse, but they are clearly on the right track. They recognise that changes in fiscal balances can affect the outlook for demand and inflation (and hence monetary policy pressure). They go on to briefly note that the impulse was estimated to be strongly positive in the 2023/24 fiscal year (the primary focus for monetary policy at the time).

It isn’t a startlingly insightful paper, but that is fine. It is largely rehearsing long-established conventional perspectives, and if it was at odds with anyone……well, it was only with the Governor and the MPC. And I guess one can’t really expect junior analysts to take on the powers that be. But it is still just a little surprising perhaps that this 31 July paper contains no reference – not one – to the strange new Orr model that had suddenly overtaken the MPS. One might, for example, have hoped that the Chief Economist might have provided a lead, and even perhaps affixed his name to the paper…..but then he is an Orr-appointee and must have signed up to the weird MPS approach too.

There is one more document in what the Bank has released to me. It is undated, has no identified author, and is headed “Fiscal policy in the August 2023 MPS”, suggesting that there is a reasonable chance it was written specifically for the purposes of responding to my OIA.

There are two parts to this 1.5 page document. The first page lists four statements on matters fiscal from the August MPS and outlines “supporting evidence”. Of those, three are simply irrelevant: there has never been any dispute about the fact that in the 2023 Budget real government consumption and investment was expected to fall as a share of GDP over the next few years (although note that for setting monetary policy in mid 2023, what might or might not happen to some components of the budget in 2026 is simply irrelevant – monetary policy lags are shorter than that).

The fourth is “interesting”

You might have supposed that this statement had appeared in the August MPS. It doesn’t. “Fiscal policy” hardly appears at all (and nothing about what it will be doing over the period monetary policy is focused on) and “discretionary fiscal policy” doesn’t appear at all.

But beyond that it is still just spin. What happens by 2027 is (again) irrelevant to today’s monetary policy, and even if the cyclically-adjusted deficit is still forecast to narrow in the shorter-term the extent of that narrowing by Budget 2023 was materially less than what had been envisaged – and included in the RB forecasts – at HYEFU 2022. Fiscal policy is putting more pressure on inflation and demand than had been envisaged at the end of last year, exacerbating pressures on monetary policy. That was – and apparently is – the point the Governor still prefers to avoid acknowledging…..something Robertson was probably grateful for.

The second half of this little note is headed “Why haven’t we referred to other measures of fiscal policy?”

Of the four bullets, again there is no real argument with three of them

To which one can mostly only say “indeed”, but then no one suggested the central bank should look at either of the allowances – which in any case are only on the spending side of the balance. As for the operating balance, I’m not going to disagree, but……mentioning it would be typically less bad than the highly political mention of only one bit of the overall fiscal balance (direct government consumption and investment).

What of the fourth?

That is just weird. Take that penultimate sentence: it is a change measure that you want when it is monetary policy and inflation you are responsible for. The change is what changes the outlook for demand and inflation. But then there is the rank dishonesty of the final sentence. They prefer to “supplement the total fiscal impulse” do they? But there was no reference to it – or to words/idea cognate to it – in either the May or August MPS. And the claim that they can somehow sensibly supplement as fiscal balance based measure – which already includes taxes, transfers, and real spending – with “real government spending” is, it seems, simply plucked from thin air. It doesn’t describe what they’ve actually done these last two MPSs, it isn’t an approach even mentioned in the Economics Department’s July note (see above), and as far as I can see it has no theoretical or practical basis whatever.

It is just making stuff up.

We’ve had several previous attempts by Orr to actively mislead (Parliament or public) or make claims that prove to have no factual analytical foundations. There was the claim to FEC that the Bank had done its own research on climate change threats to financial stability, claims trying to minimise the extent of turnover of senior managers, claims regarding the impact of this year’s storms on inflation, claims that inflation was mostly other people’s fault (notably Vladimir Putin). Each of these has been unpicked in one way or another – the first via the OIA, the second via a leak, the third via one of his own staff piping up to correct things in FEC, the fourth simply be patiently setting down the numbers and timing. There have also been entirely tendentious claims around the LSAP, including his attempt – repeated in the recent Annual Report – to assert that the LSAP made money for taxpayers, despite the simplest review of the exercise he used in support of this claim showing that it simply didn’t provide any serious support for his view.

Every single one of those was bad, and should have been considered unacceptable, by both the Minister of Finance and the Bank’s Board. A decent and honourable Governor would simply never have done them. But bad as they were, those were self-serving misrepresentations.

What has gone on around fiscal policy this election year seems materially worse. We make central banks operationally independent in the hope that they will do their job without fear or favour, and without even hint of partisan interest. But faced with a Budget that complicated the task of getting inflation down, that was materially more expansionary than had been envisaged just a few months previously, Orr (and his MPC colleagues, reluctantly or otherwise) chose to completely upend the traditional approach to thinking about fiscal impacts on demand and inflation pressures, and tell a story – and a story it was – that tried to gloss over what the Minister of Finance had done, ignoring what mattered in favour of what was at best peripheral. Whether that was for overt partisan purposes is probably unknowable from any documents likely to exist, but it is hard to think of any other good explanation for what was done, espeically when – as this release shows – it was all based on no supporting analysis or research whatever.

The Official Information Act plays a vital role in helping expose events like this. It was never likely there was anything of substance behind Orr’s fiscal spin. But now we know.

(As to the attitudes of other MPC members, who clearly all went along since not a hint of a conventional perspective is in the minutes of the meetings around either MPS, there is a tantalising bit that was also withheld

Only one of the three relevant MPC meetings during this period, but the most recent.  Was there some gentle unease from perhaps one member?  We may never know, but at least this withholding appears to confirm that there are fuller minutes of MPC meeting, not just the bland summary published with each OCR announcement.)

PS.  It is perhaps no surprise that the Reserve Bank has chosen not to put this OIA release out on their  OIA releases page, even though that page was updated just a couple of weeks ago.  It does not put the Bank in a good light.  

Monetary policy and estimated excess demand

Michael Reddell Fiscal policy, IMF, Monetary policy

In my post last week on ANZ’s note on the balance of payments, I included this chart from the latest IMF WEO (numbers finalised late last month). On the IMF’s read we had the most overheated advanced economy this year taken as a whole.

ANZ themselves followed up with this chart

So as they see things now, New Zealand had the most overheated of any of the advanced economies for two years in succession.

(As a reminder, the output gap is the difference between actual GDP in a period and the analyst’s estimate of potential GDP – loosely, the level of GDP in a particular period consistent with avoiding imbalances emerging (be it inflation pressures or current account ones). Since potential GDP is unobservable (and actual GDP is forecast and subject to revisions), “the output gap” isn’t directly observable, even well after the event. But the numbers that forecasters put in their tables are still useful, because they tell us how those forecasters, and the organisations that employ them, are seeing capacity pressures in the economy. They might prove to be right, or be proved wrong, but it is the view they are signing on to. And the great thing about a collection of national forecasts like those in the IMF WEO is that it is a single organisation with a single broad methodology at a single point in time.)

When there is a large output gap (positive or negative) it is reasonable to start asking questions about the performance of the central bank. The reason we set up central banks with discretionary monetary policy is to reduce the extent or duration of those imbalances, while keeping inflation in check. Sometimes there can be tensions between those goals but in the presence of demand surprises one tends to see both positive (negative) output gaps and high or rising (falling) core inflation at much the same times. A large output gap and inflation well away from target in such circumstances is a mark that the central bank has not done its monetary policy job well.

But it was all very well to spot that the IMF now believed the New Zealand economy to have been more overstretched than any other advanced economy for which they run these numbers – not that the IMF itself made this point in their recent Article IV report on New Zealand – but I was curious to see how their own thinking had evolved. Was this a new take on New Zealand’s relative position or not? And so I dug out the IMF output gap estimates/forecasts back to those published in April 2021.

And from here on I’m mostly going to concentrate, and illustrate, only the 10 countries/regions for which there is an output gap estimate and where there is a central bank with its own monetary policy. Most of those European countries in the earlier charts are subsumed in the euro-area estimate.

It is also important to mention that IMF projections are done on a current policy basis, so each of these charts is showing how the Fund thought economies would behave if the policy rate was left as it was at the point the forecasts were finalised.

Here is what the output gap estimates as at April 2021 looked like

New Zealand didn’t stand out, and if anything the Fund thought our output gaps for both 2021 and 2022 would be more negative than for most other countries. Recall that as this time, our domestic economy was recovering quite strongly, but perhaps the Fund was influenced by the likelihood of prolonged border closure (recalling that New Zealand has been a much bigger exporter than importer of both tourism and export education services). Locally, the Reserve Bank estimated in both its February and May 2021 MPSs that we’d have a negative output gap in 2021, but they expected – using endogenous policy rate forecasts – a positive output gap in 2022.

By the next WEO, the IMF’s view on New Zealand had changed quite sharply

By then – still amid the extended lockdown of Auckland – New Zealand was standing out as having, in both years, the second largest positive output gaps, behind only the US. (The Reserve Bank’s forecasts for New Zealand – which included some policy adjustment effect on the 2022 numbers – were pretty similar.)

I’m not going to show you the individual charts for the April and October 2022 and April 2023 WEOs because…..in all of them New Zealand is shown as having the largest positive output gap in both years (eg by 2022 forecasts for 2022 and 2023) of any of those any of these central banks were facing. Here is the October 2023 version though.

Here is how their New Zealand forecasts/estimates have evolved

Recall that all of these numbers were done on policy rates as they stood at the time (0.25 per cent in April 2021, 5.5 per cent in the latest forecasts), and yet the estimates of 2022’s output gap have just kept being revised up and there is no sign yet of their estimates for 2023 (or the few observations for 2024) being revised down, as one should have hoped.

So on the IMF’s telling all last year and this not only have we had consistently the most overheated economy in this set of advanced countries, but if anything the extent of the overheating has been revised upwards. If that was even close to being an accurate description of how things are it would add to the case (already evident in core inflation itself) that the Reserve Bank MPC has done a poor job, both absolutely and relative to its advanced country peers.

Here is the Reserve Bank’s own take over successive MPSs since the start of 2021.

It is telling that as early as February 2021 – eight months before they actually started raising the OCR – the Reserve Bank thought the economy would be stretched beyond capacity (which is basically what the output gap is) for each of the following three years.

It is also worth noting how stable their estimates for 2022 have been for a couple of years now, even as it passed from prospect to history. It isn’t a perspective you hear about from the MPC – a severely overstretched economy, and stretched to a magnitude that (on IMF reckoning) hadn’t been seen in any of these other advanced countries. As time has gone on they’ve increasingly revised up their view of how stretched things were in 2021 as well. None of these advanced economies are thought to have had 2 per cent positive output gaps two years in succession. But New Zealand did.

When we come to 2023 there is a big difference between the IMF view and the Reserve Bank view. Believe the IMF and 2023 as a whole still looks pretty bad – yet another 2 per cent plus output gap. But if you believe the Reserve Bank, for this year as a whole the output gap will have been almost zero (0.2 per cent on average), before the output gap goes deeply negative next year. The IMF of course does not agree with the Reserve Bank – there is a radical difference between the Fund’s view (0.7 per cent positive) and the negative output gap of 1.7 per cent of GDP the Reserve Bank expects for next year. If we simply slotted the Reserve Bank’s number into the IMF table/chart, the New Zealand output gap next year would be more deeply negative than those for any of the other advanced economies.

Now you might be thinking, “well, even if they got things wrong initially, hasn’t the Reserve Bank done a lot since?”

This chart shows the policy rate adjustments for all the OECD central banks in the BIS policy rates database, shown both relative to the Covid trough and relative to the immediately pre-Covid starting level in January 2020

Unfortunately we do not have IMF output gap estimates for the six countries furthest to the right on this chart, but even if we set them to one side there is nothing very startling about the extent of the Reserve Bank’s policy rate adjustment, even though – on its own numbers and those of the IMF – it was dealing with a really severely overheated economy, both in absolute terms and relative to advanced country peers. For what it is worth, in past cycles New Zealand has typically had policy rates quite a bit higher at peak than places like the US, Canada, and the UK. Thus far – and despite the severely stretched economy – that hasn’t proved to be the case this time.

Looking ahead, it is an open question whether the Reserve Bank’s (now-dated) August outlook will prove nearer to the mark than the IMF’s. We (and they) must hope so, given that inflation is still such a long way now from the 2 per cent target midpoint the MPC is supposed to be focused on. This week’s labour market data may provide some helpful hints. If we took the unemployment rate as it has been over the last couple of years and added in the consensus estimate for the September quarter (out on Wednesday) you’d certainly take the view that capacity pressures in 2023 will have been less than those in 2022. But even the IMF numbers tell such a story. But is it plausible to suppose that for 2023 as a whole the output gap will have closed almost completely as the Reserve Bank reckons? It seems a stretch to me, since no one much believes that an unemployment rate averaging below 4 per cent – which now seems almost certain for 2023 – is anywhere near a New Zealand NAIRU. We’ll see, and we’ll see what the Reserve Bank has to say later this month, before the MPC shuts down for their long summer holidays.

Finally, it is worth reflecting a little on quite why New Zealand might have had the most overstretched economy in the advanced world in 2022 and 2023. There were some positive factors, eg we weren’t in the Ukrainian war zone or directly affected by gas supply/price issues. But, on the other hand, despite the reopening of our borders, net services exports have remained pretty weak, acting as a drag on demand.

A good candidate hypothesis for what went on here was fiscal policy. I’ve pointed previously how unusual discretionary fiscal policy has been here in the last couple of years. Most countries ran quite big deficits in 2020 in particular around providing Covid support. We did too. But the median advanced economy also then saw deficits closing quite a lot (the IMF median projection for next year is getting close to primary balance).

By contrast, the (now) outgoing government here chose to run to materially expansionary budgets in both 2022 and 2023. That compounded the challenges facing the Reserve Bank’s MPC, since even if the direction of policy was reasonably signalled, the magnitudes were not. Expansionary fiscal policy puts more pressure on demand (showing up in output gaps and current account deficits) and inflation, which proved very unhelpful when the Bank itself was still realising how badly it had earlier misread underlying pressures anyway.

One might have more sympathy with the Reserve Bank had they beeen upfront about these pressures. But this year in particular they have repeatedly sought to minimise the role of fiscal pressures and fiscal surprises, to the point of attempting to reinvent macroeconomics in apparent service of the political interests of themselves and their masters. But that is topic for another post.

Finding external balance

Michael Reddell Balance of payments, Fiscal policy, Monetary policy, New Zealand economic performance

That was the title of a ten page piece published last week by the ANZ economics team (chief economist Sharon Zollner and one of her offsiders, who appears to be a temporary secondee from the Reserve Bank). You can find a link to the paper here.

The gist is captured in the paper’s summary

I found the first line of that final bullet rather jarring – the balance of payments not having been any sort of policy focus for decades now (really since the shift to a floating exchange rate) in 1985.

But what really puzzled me about the note was how little macroeconomics there seemed to be in it, or behind it. It isn’t that there was no interesting material in it; in fact there were a variety of interesting charts on developments and issues in individual sub-sectors, and for anyone interested in these issues it is worth a read. But I thought I’d throw in a few macro perspectives.

The paper starts with this chart

which is a rather different picture than the one (for the current account) we usually look at. The current deficit as a share of GDP got to about current levels in 2007, but looking just at the goods and services balance what we’ve seen in the last couple of years is without precedent for many decades. Here is the same chart with the longer run of annual data.

I’m not entirely sure why ANZ chose to focus on the good and services balance. It is akin to the primary balance in a fiscal context, which I argued here a few weeks ago it made sense to give more prominence than is often done in New Zealand for a number of reasons. If as a country you are running a goods and services balance (or surplus) it is unlikely that the NIIP position (as a share of GDP) is going to get away on you. (Of course, there isn’t anything necessarily wrong with a widening negative NIIP position – as so often, it depends what is causing the change.)

But one other positive feature of focusing on the good and services balance is that it helps to make clear that the recent sharp widening in the current account deficit – to one of the widest among OECD countries – is down to the spending choices of New Zealanders. The other big component of the current account is the income deficit (primarily in New Zealand, investment income – interest and profits). Interest rates have risen a lot in the last couple of years. But I’d have to confess I hadn’t really noticed that, thus far, the income deficit has not widened much at all as a share of GDP. If interest rates stay around current levels for long that will probably change.

So if it is spending choices that – compositionally – explain the sharp widening of the current account, where do we see that.

Well, the badly mis-forecast sharp increase in core inflation is one place. But step back a little further.

Here, from the IMF WEO database, are investment and (gross) national saving as a per cent of GDP, in annual terms included estimates for calendar 2023.

Another way of looking at the current account deficit is as the difference between saving and investment. And here you see that investment as a share of GDP last year and this has been at the highest we’ve experienced in decades (since the days of Think Big), and while the savings rate isn’t at any sort of record level it has been quite a bit lower than what we’d seen in New Zealand over half decade or so pre-Covid. Saving here is national savings – household, business, government – and we know that government dissaving – substantial operating deficits – has been a feature of the last few years, never more so than in 2022 and 2023 by when the economy was already running beyond capacity.

Beyond capacity? Well, we know the labour market has been stretched beyond sustainable (in the RB Governor’s own words) and both the Reserve Bank and Treasury have talked of positive output gaps.

But absolute numbers for local output gaps don’t get much coverage or grab the imagination. But this chart is from the IMF’s World Economic Outlook a couple of weeks back. The good thing about the IMF numbers isn’t that they are right – few forecasters consistently are – but that they take a fair common approach across a whole bunch of countries. And on their reckoning even this year on average the New Zealand economy is seen as the most overheated – “overheated” means prone to larger than usual balance of payments deficits and higher than usual inflation – of any of the advanced countries they do such estimates for. And that without any surge upwards in the terms of trade of the sort we were enjoying when the economy was last this stretched – in output gap terms – in 2007.

And then here is another chart I’ve shown before to highlight just how unusual domestic demand has been here in recent years.

Domestic demand needed to increase to some extent to fill a void left by the slump in net exports (most notably net services exports) if the economy was to remain fairly-fully employed, but policy (mostly monetary policy, which takes fiscal policy as given) was set so badly that we’ve ended up with astonishing levels of domestic spending, and with it……high core inflation, and a really marked widening in the balance of payments current account and goods and services deficits.

But, and here’s the thing, we still do not need specific balance of payments. Not from government, and not even from you and me thinking we’d best do our bit for the nation. Rather, as the government (eventually) gets the deficit back down again, and as the Reserve Bank eventually does its job, we can expect these imbalances largely to sort themselves out, and certainly not to end up posing severe risks to anything much. And if perhaps Chinese tourism exports never fully recover, we can expect private domestic spending to adjust, as it tends to when (for example) the terms of trade fall and people find themselves less well off than they had thought.

Of course, we shouldn’t rule out an exchange rate adjustment at some point, but we’ve come to forget how common they used to be in New Zealand – common, without being highly disruptive or prompting higher interest rates again. For a couple of decades at the RB we used to spend huge amounts of time trying to make sense of some of the biggest real exchange rate swings in the advanced world…..and then they just stopped (the reasons for that aren’t, I think, well understood or even extensively studied).

The ANZ paper ends with this line

The bottom line is, ‘something’s gotta give’, as the saying goes. We can either be the collective architects of that change or we can wait for changes to be imposed on us by foreign creditors and
financial markets.

That seems overwrought, but we should expect our macro policymakers to do their jobs rather better than they have in the last 3 years or so. But perhaps it isn’t the done thing for market economists to call out policymakers too vocally?

UPDATE: Oh, forgot to include this chart, which does put the last couple of years’ external imbalances in some perspective.

The rest of the world’s net claims on New Zealand residents have, if anything, shrunk a little further as a share of a GDP over the Covid years. It seems unlikely the creditors will be dunning “us” any time soon……which is not to say that if our interest rates end up lowish relative to the rest of the world there might not be some fall in the exchange rate.

Israel’s economic performance

Michael Reddell Israel

The grim events of the last couple of weeks, and a note from a reader last week about a short post I’d written several years ago comparing the economic performance of Israel and New Zealand, prompted me to take another look at the data.

This was the chart from the earlier (2018) post

As I summed it up then “We’ve done badly, and they’ve done even worse”.

Given the inevitable margins for error, especially in estimating PPP conversion rates, the main story was just that neither country had done very well relative to other advanced economies.

How do things look now? I’ve shifted over to using OECD data (for a number of reasons, including that the Conference Board estimates now only start from 1990 for both countries).

This chart shows the ratio of New Zealand’s real GDP per hour worked to that of Israel (both series also converted at PPP exchange rates).

The last few years seem to have been quite good for Israel’s productivity growth, but I wouldn’t put too much weight on it yet. Not only has this ratio fluctuated over the years with no clear trend, but the biggest single lift in Israel’s reported productivity was for 2020 – the year of the lockdowns, when many countries saw a rise in measured average productivity (as eg low-paying low-productivity tourist jobs were lost) – and more recently many countries (including New Zealand) have seen a reversion to trend. (And it seems unlikely that the final quarter of 2023 is going to be a stellar one for Israeli average productivity.)

The wider story remains one in which both New Zealand and Israel are productivity laggards. In this chart, again using OECD data, I’ve shown the average for New Zealand and Israel relative to eight leading (on productivity) OECD economies (Belgium, Denmark, France, Germany, Netherlands, Sweden, Switzerland and the US).

It would take a 60 per cent lift for New Zealand and Israel to match the average of those eight leading economies. Neither New Zealand nor Israel is a high-performing economy.

As for GDP per capita comparisons, depending on which data source one turns to the time series charts look a little different, but all three (OECD, IMF, and Conference Board) suggest that GDP per capita in the two countries is much the same. Here is a chart of the OECD data

Historically – and now – the two countries have had very similar rates of investment as a share of GDP, but increasingly divergent national savings rate patterns

The difference is reflected in quite different current account outcomes (Israel’s last current account deficit was in 2001).

But if Israel never seems to manage a better economic performance than laggard New Zealand for long, by regional standards it remains the stellar performer.

For real GDP per hour worked, here are the Conference Board estimates for Israel and (a) its immediate neighbours, and (b) its nemesis, Iran

And here are the IMF estimates for real GDP per capita for the same group of countries, plus an estimate for West Bank and Gaza. (The IMF doesn’t have a current estimate for Syria so I’ve used the ratio of Syria to Lebanon in the Conference Board database. Before the civil war, Syria was still materially less productive than either Lebanon or Jordan).

The economic performance gaps here are materially larger than those (above) for productivity.

(In case anyone is wondering about the oil and gas rich countries of the Arabian Peninsula, the Conference Board productivity estimates for those countries, they are mostly around the current estimates for Israel (and for New Zealand).

Israel is the star economic performer in its sub-region, but that can’t be any cause of complacency given how far behind it lags the leading advanced economies.

And in the longer run, much as I champion and support Israel including as the only functioning democracy in its part of the world, I struggle to be optimistic about its long-term prospects. This was from my 2018 post.

Israel has not lost any of the wars it has fought. But it has to keep doing so indefinitely.

The manufacturing sector

Michael Reddell MBIE, New Zealand economic performance

I’ve written a few sceptical posts here over the years about the annual (or so) Technology Investment Network’s (TIN) boosterish reports on the New Zealand tech sector. The overall story was just even close to as upbeat as the reports liked to make out.

Yesterday a link to a new TIN report turned up in my email inbox. This was the bit in the email

There is a clue right there in the reference to chocolate chips. This wasn’t going to be a report about what most people have in mind when they think “advanced manufacturing” but about the manufacturing sector as a whole. All firms in the sector use technology of one form or another, some of it very advanced.

Anyway, I downloaded the full report (you have to register to get it, but it isn’t onerous, and the report itself isn’t overly long, at about 30 pages of substance). It turned out to be the product of a bunch of outfits I’m pretty sceptical of. There was TIN itself which did the work, there was the co-chair of the Advanced Manufacturing Industry Transformation Plan Steering Group (ITPs being that throwback to the 1960s that the outgoing government became keen on) who supplied the Foreword talking up both his group and document, and then there was MBIE which is said to have “commissioned this report” and presumably paid for it. Money was being thrown around in all too many areas under the outgoing government.

Both the Foreword (by Brett O’Riley) and the Welcome (by the Managing Director of TIN) are pretty upbeat. O’Riley makes the bold claim that manufacturing is “the backbone” of the economy (to which I responded on Twitter this way

After noting that the manufacturing sector will soon drop to being only the third biggest greenhouse gas emitting sector (behind households and agriculture) the Welcome ends this way

It all sounds good quite upbeat.

That is, until you read on.

There is a helpful Executive Summary. It also attempts to start upbeat

Advanced manufacturing is a critical engine of Aotearoa New Zealand’s long-term prosperity, making a vibrant contribution to the nation’s economy

But then the pesky data start getting in the way

There are still lots of workers

But if your sector is 9.1 per cent of GDP and 11.9 per cent of the workforce, what does that say about productivity?

Low level, and low growth rate. Ouch.

And, unsurrpisingly wage rates in the sector as a whole are below the economywide average.

You might have noticed in that clip at the top reference to 60 per cent of New Zealand’s exports. That is because many of New Zealand’s agricultural exports are processed (dairy factories really are big and sophisticated operations, even if the share of that processing in total dairy value-added is not huge). Anyway, exports….

Not exactly a positive story either.

The puff piece at the front was upbeat on R&D (‘over a quarter of national R&D spending comes from manufacturing’) but by the time you get to the Executive Summary a less rosy picture emerges

So that is quite a big drop in the share of national R&D spend, and manufacturing sector R&D staff are almost the same share of total R&D staff as manufacturing employees are in the total workforce (although to be fair one has to wonder a little about whether the comparisons here are all apples-for-apples, since if manufacturing does 27 per cent of the national R&D spend with only 12 per cent of the R&D employees, those manufacturing R&D employees must be doing a lot of work/spend each).

What of FDI? Manufacturing does seem to represent a larger-than-representative share of inward and outward FDI, but…

By my reckoning that compound annual growth rate for inwards investment was less a bit less than the growth in nominal GDP over that period, so not exactly a very positive story for “the backbone” of the economy, “a critical engine” of New Zealand’s “long-term prosperity, making a vibrant contribution to the nation’s economy.

The report would really quite like to be upbeat about new technologies, but….

And those were the last words of the Executive Summary.

There are some more detailed sections that follow. A new snippets:

On international trade:

in addition to that wonderfully-understated last couple of lines, note “in many case, the total volume of locally manufactured products actually decreased”, and “[various factors] beckon fewer orders and lower production for 2024 and beyond”

On R&D etc:

Nominal GDP rose faster than that.

And this grim observation

The exciting news is that emissions have dropped, and not just because of a dismal GDP performance, but that is an input, not the sort of outcome firms go into business to achieve.

What of profits? They grew more slowly than nominal GDP over this period, and represent 7.6 per cent of economywide profits even though the sector is 9.1 per cent of GDP.

The best you could really say for this report is that, underwhelming as the data are, perhaps it provides some sort of benchmark against which to measure where things go from here. But why the spin upfront, and why was the taxpayer paying for the report in the first place?

None of this is intended as a criticism of any specific company in the sector. Companies that survive and thrive in New Zealand, selling to world, deserve a fair bit of admiration and in the case studies at the back of the report there are some really inspiring stories (I don’t include taxpayer-subsidised NZ Steel among them, nor perhaps the company that has been running since 1981 and has a grand total of 115 employees). In all my years at the Reserve Bank one of the best things I ever did was to participate in the regular business visits programme, and it was rare not to come away from each and every company we visited admiring people – often owner-operators – who had everything on the line to make and sustain a business (it was hard not to think they were doing something better or more useful – certainly much more risky – than we were).

But the aggregate story just doesn’t seem to be a very positive one, if such aggregates (“the manufacturing sector”) make much sense at all (the New Zealand “manufacturing sector” is a very diverse thing, including new and cutting-edge firms and legacy companies from the eras of protectionism and Think Big). Beyond the puff pieces at the start, there is a certain grim realism about many of the comments on the numbers (see above), but perhaps it would have been better to have had that upfront, grabbing the headlines.

There is no right or wrong answer as to how much of a “genuinely” advanced manufacturing sector a successful New Zealand economy might be expected to have, but it isn’t surprisingly the sector struggles here when you combine things like distance, high company tax rates, obstacles to foreign investment, and a real exchange rate that for decades has been out of line with relative productivity fundamentals

What should be done about the Reserve Bank?

Michael Reddell Adrian Orr, MPC, Reserve Bank Act reforms, Reserve Bank Board

Monday’s post was on the important place effective accountability must have when government agencies are given great discretionary power which – as is in the nature of any human institutions – they will at times exercise poorly. My particular focus is on the Reserve Bank, both because it is what I know best, because it exercises a great deal of discretionary power affecting us all, and because in recent times it has done very poorly in multiple dimensions (be it bloated staffing, demonstrated loss of focus, massive financial losses, barefaced lies, or – most obvious to the public – core inflation persistently well above target).

What has happened under the current (outgoing) government is now an unfortunate series of bygones. What has happened, happened, and some combination of Orr, Robertson, Quigley (and lesser lights including MPC members and the Secretary to the Treasury) bear responsibility. Not one of them emerges with any credit as regards their Reserve Bank roles and responsibilities.

But in a couple of weeks we will have a new government, and almost certainly Nicola Willis will be Minister of Finance. The focus of this post is on what I think she and the new government should do, if they are at all serious about a much better, and better governed and run, institution in future. It builds on a post I wrote in mid 2022 after someone had sought some advice on a couple of specific points.

Thus far, we have heard very little from National on what plans they might have for the Reserve Bank. When they were consulted, as the law now requires, they opposed Orr’s reappointment (although on process grounds – wanting to make a permanent appointment after the election, something the legislation precluded – rather than explicitly substantive ones). And anyone who has watched FEC hearings over the past 18 months will have seen the somewhat testy relationship between Orr and Willis (responsibility for which clearly rests with Orr, the public servant, who in addition to his tone – dismissive and clearly uninterested in scrutiny – has at least once just lied or actively and deliberately misled in answer to one of Willis’s perfectly reasonable questions). In the Stuff finance debate last week I noticed that when invited to do so Willis avoided stating that she had confidence in Orr, but she has on a couple of occasions said that she will not seek to sack him, stating that she and he are both “professionals” (a description that, given Orr’s record, seems generous to say the least).

Even if she had wanted to, it would not be easy to sack Orr.

From last year’s post, these are the statutory grounds for removal

Note too that his current term in office started only in March this year, and the more egregious policy failures occurred in the previous term (and thus probably not grounds for removal now). I have my own list of clear failures even since March – no serious speeches, no serious scrutiny, no serious research, actively misleading Parliament, and so on – such that it would be much better if Orr were gone but seeking to remove him using these provisions would not be seriously viable, including because any attempt to remove him could result in judicial review proceedings, leaving huge market uncertainty for weeks or months.

Were the Governor an honourable figure he would now give six months notice, recognising that the incoming parties do not have confidence in him and that – whatever his own view of his own merits – it actually matters that the head of an agency wielding so much discretionary power should have cross-party confidence and respect (which does NOT mean agreeing with absolutely everything someone does in office).

Historically (and even when I wrote that post 18 months ago) I would have defended fairly staunchly the idea that incoming governments should not simply be able to replace the central bank Governor. The basic idea behind long terms for central bank Governors was so that governments couldn’t put their hand on the scales and influence monetary policy by threat of dismissal. But many of those conceptions date from the days before the modern conception of the government itself setting an inflation target and the central bank being primarily an agency implementing policy in pursuit of that objective. Even when the Reserve Bank of New Zealand legislation was first overhauled in 1989 the conception was that Policy Targets Agreements should be set and unchanged for five year terms, beyond any single electoral term. That (legislated) conception never survived the first election after the Act was passed, but these days the legislation is quite clear that the Minister of Finance can reset the inflation target any time s/he chooses (there are some consultation requirements). If the government can reset the target any time they choose, then it isn’t obvious that they shouldn’t be able to replace the key decision-makers easily (when the key decisionmakers – specifically the Governor – have influence, for good and ill, much more broadly than just around pursuit of the inflation target).

(There is a parallel issue around the question of whether we should move to the Australian system where heads of government departments can be replaced more easily, but here I’m focused only on the Reserve Bank, which exercises a great deal of discretionary policy power, and isn’t just an advice or implementation entity.)

By law they can’t make such changes at present. They could, of course, amend the law, but to do so in a way narrowly focused on Orr (ie an amendment deeming the appointment of the current Governor as at the passage of this amendment to be terminated with effect six months from the date of the Royal Assent) would smack rather of a bill of attainder. Governors have been ousted this way in other countries, but I don’t think it is a path we should go down.

Some will also argue that Orr should simply be bought out. If the government was seriously willing to do that – and pay the headline price of having written a multi-million-dollar cheque to (as it would be put) “reward failure” – I wouldn’t object, but it isn’t an option I’d champion either. (Apart from anything else, a stubborn incumbent could always refuse an offer, and once this option was opened up there really is no going back.)

So the starting point – which Willis has probably recognised – is that unless Orr offers to go they are stuck with him for the time being.

The same probably goes for the MPC members and the members of the Bank’s Board. The incoming Minister of Finance could, however, remove the chair of the Board from his chairmanship (this is not subject to a “just cause” test). The current chair’s Board term expires on 30 June next year, and it might not be thought worth doing anything about him now, except that he is on record as having actively misled Treasury (and through them the public) about the Board’s previous ban on experts being appointed to the MPC, and he has been responsible for (not) holding the Governor to account for the Bank’s failures in recent years. Removing Quigley would be one possible mark of seriousness by a new government, and a clear signal to management and Board that a new government wanted things to be different in future.

The current Reserve Bank Board was appointed entirely by Grant Robertson when the new legislation came into effect last year. It was clearly appointed more with diversity considerations in mind than with a focus on central banking excellence, and several members were caught up in conflict of interest issues. The appointments were for staggered terms but – Quigley aside – the first set of vacancies don’t arise until mid 2025. It would seem not unreasonable for a new Minister to invite at least some of the hacks and token appointees to resign.

There are three external appointees to the Monetary Policy Committee. None has covered themselves in any glory or represented an adornment to the Committee or monetary policymaking in New Zealand. All three have (final) terms that expire in the next 18 months, two (Harris and Saunders) in the first half of next year. This is perhaps the easiest opportunity open to a new Minister to begin to reshape the institution, at least on the monetary policy side, because appointments simply have to be made in the next few months. As I noted in a post a couple of weeks ago, OIAed documents show that the current Board’s process for recommending replacements is already largely completed, with the intention that once a new government is sworn in they will wheel up a list of recommendations. If the new government is at all serious about change, this should be treated as unacceptable, and the new Minister should tell the Board to rip up the work done so far and start from scratch, having outlined her priorities for the sort of people she would want on the MPC (eg expert, open, willing and able to challenge Orr etc). It would also be an opportunity for her to revisit the MPC charter, ideally to make it clear that individual MPC members are expected to be accountable for, and to explain, their individual views and analysis. Were she interested in change, it is likely that the pool of potentially suitable applicants might be rather different than those who might have applied – perhaps to be rejected as uncomfortable for Orr at the pre-screening – under the previous regime.

The Reserve Bank operates under a (flawed) statutory model where a Funding Agreement with the Minister governs their spending for, in principle, five years at a time. The current Agreement – recently amended (generously) with no serious scrutiny, including none at all by Parliament – runs to June 2025. The incoming government parties have been strong on the need to cut public spending by public agencies on things that do not face the public. They need to be signalling to the Reserve Bank that they are not exempt from that approach, and if the current Funding Agreement cannot be changed it should be made clear to the Board and management that there will be much lower levels of funding from July 2025. Indulging the Governor’s personal ideological whims or inclinations to corporate bloat are not legitimate uses of public money.

If she is serious about change, the incoming Minister also shouldn’t lose the opportunity to deploy weaker but symbolic tools at her disposal. Letters of expectation to the Governor/MPC and the Board can make clear the direction a new government is looking for, as can the Minister’s comments on the Bank’s proposed Statement of Intent. Treasury now has a more-formal role in monitoring the Bank’s performance, and the Minister should make clear to Treasury that she expects serious, vigorous and rigorous, review.

All this assumes the incoming Minister is serious about a leaner, better, more-excellent and focused Reserve Bank. If she is, and is willing to use the tools and appointments at her disposal, she can put a lot of pressure on Orr. If that were to lead to him concluding that it wasn’t really worth sticking around for another 4.5 years that would be a good outcome. But at worst, he would be somewhat more tightly constrained.

I haven’t so far touched on the two specific promises National have made. The first is to revise the legislation (and Remit) to revert to a single statutory focus for monetary policy on price stability. I don’t really support this change – the reason we have discretionary monetary policy is for macro stabilisation subject to keeping inflation in check – but I’m not going to strongly oppose it either. The 2019 change made no material difference to policy – mistakes were ones of forecasting (and perhaps limited interest and inattention thrown in) – and neither would reversing it. Both are matters of product differentiation in the political market rather than a point of policy substance. The proposed change back risks being a substitute for focusing on the things that might make for an excellent central bank – as it was with Robertson. I hope not.

The other specific promise has been of an independent expert review of the Bank’s Covid-era policymaking. It isn’t that I’m opposed to it – and there is no doubt the Bank’s own self-review last year was pretty once-over-lightly and self-exonerating – but I’m also not quite sure what the point is, other than being seen to have done it. Action, and a reorientation of the institution and people, needs to start now, not months down the track when some independent reviewer might have reported (and everyone recognises that who is chosen to do the review will largely pre-determine the thrust of the resulting report). It isn’t impossible that some useful suggestions might come out of such a report, but it doesn’t seem as though it should be a top priority, unless appearance of action/interest is more important than actual change. I hope that isn’t so either.

What of the longer term, including things that might require more-complex legislative change?

I think there are number worth considering, including:

  • how the MPC itself is configured.   I strongly favour a model –  as in the UK, the US, and Sweden –  in which all MPC members are expected to be individually accountable for their views, and should be expected routinely to record votes (and from time to time make speeches, give interviews, appear before FEC).  I’m less convinced now than I once was that the part-time externals model can work excellently in the long haul, even with a different – much more open, much more analytically-leading – Governor.  One problem is the time commitment, which falls betwixt and between. External MPC members have been being paid for about 50 days a year, which works just fine for people who are retired or semi-retired, but doesn’t really encourage excellent people in the prime of life to put themselves forward (I’m not sure how even university academics – with a fulltime job –  can devote 50 days to the role).  In the US and Sweden all MPC members are fulltime appointments, and in the UK while the appointments are half-time they seem to be paid at a rate that would enable, say, an academic to live on the appointment, perhaps supplemented with some other part-time (non-conflicted roles).    I also used to put more weight on the idea of a majority of externals, which I now think is a less tenable option than I once did.  External members can and should act as something of a check on and challenge to management, but it will always be even more important to have the core institution functioning excellently (at senior and junior levels).  We should not have a central bank deputy chief executive responsible for matters macroeconomic who simply has no expertise and experience, and is unsuited to be on any professional MPC.
  • I would also favour (and long have favoured) moving away from the current model in which the Board controls which names go to the Minister of Finance for MPC and Governor appointments.  It is a fundamentally anti-democratic system (in a way with no redeeming merits), and out of step with the way things are done in most countries.  We don’t want partisan hacks appointed to these roles, but the Board – itself appointed by (past) ministers –  is little or no protection, and Board members in our system have mostly had little or no relevant expertise.  Appointments should be made by the Minister –  in the case of the Governor, perhaps with Opposition consultation – and public/political scrutiny should be the protection we look to.  I would also favour all appointees to key central bank roles have FEC scrutiny – NOT confirmation- hearings before taking up their roles (as is done in the UK).
  • I would also favour (as I argued here a few years ago [UPDATE eg in this post]) looking again at splitting the Reserve Bank, along Australian lines, such that we would have a central bank with responsibility for monetary policy and macro matters and a prudential regulatory agency responsible for the (now extensive) supervisory functions.  They are two very different roles, requiring different sets of skills from key senior managers and governance and decision-making bodies.  Accountability would also be a little clearer if each institution was responsible for exercising discretion in a narrower range of area.  Quite obviously, the two institutions would need to work closely together in some (limited) areas, but that is no different than (say) the expectation that the Reserve Bank and Treasury work effectively together in some areas.  (Reform in this area might also have the incidental advantage of disestabishing the current Governor’s job).  Reform along these lines would leave two institutions with two boards each responsible for policymaking (and everything else) the institutions had statutory responsibility for.  The current vogue globally has been for something like having a Board and an MPC in a single institution, the former monitoring the latter.  But the New Zealand experience in recent years is illustrative of just how flawed such a model is in practice: not only is the Board still within the same institution (thus all the incentives are against tough challenge and scrutiny) but typically Reserve Bank Board members have no relevant expertise to evaluate macro policy performance or key appointments in that area).  Monitoring and review matter but if they are to be done well they will rarely be done within the same institution with (as here) the chair of the MPC (Orr) sitting on the monitoring board.  The new Board’s first Annual Report last week illustrates just how lacking the current system is in practice, and although a new minister might appoint better people, we should be looking to a more resilient structure.

As I said at the start of this post we – public, voters, RB watchers – really don’t have much sense of what National or Willis might be thinking as regards the Reserve Bank. I tend to be a bit sceptical that they care much, but would really like to be proved wrong. There are significant opportunities for change, which could give us a leaner, better, much more respected, central bank. It is unfortunate that these matters need to be revisited so soon after the legislative reforms put in place by the previous government, but they do – we need better people soon, but also need some further legislative change.

UPDATE: A conversation this afternoon reminded me of the other possible option for getting Orr out of the Reserve Bank role: finding him another job. There might not be many suitable jobs the new government would want someone like Orr in, but I have previously suggested that something like High Commissioner to the Cook Islands might be one (having regard to his part Cooks ancestry, and apparent active involvement in some Pacific causes). More creative people than me may have other (practical) suggestions.

Accountability

Michael Reddell LSAP, Monetary policy, MPC, Reserve Bank Board

On Saturday dozens of candidates for the governing Labour Party stood for election to Parliament. The aim was to form (at least a big part of) the next government. They didn’t succeed. People will debate for decades precisely what motivated the public as a whole to vote as we did, but having governed for the last three years, they (Labour) lost. It is perhaps the key feature of our democratic system, perhaps especially in New Zealand with so few other checks and balances. You (and your party) wield great power, and if we the public aren’t satisfied – think you’ve done poorly, think another lot might be better, or simply wake up grumpy on election day – you are out. It is your (and your party’s) job to convince us to give you another go. If you don’t convince us you are out (and typically when a party loses power a satisfying number of individuals – even if rarely Cabinet ministers – actually lose their job (as MP) altogether). And if you are a disappointed Labour voter this morning, the beauty of the system is that no doubt your turn will come again. It is accountability – sometimes crude, rough and ready, perhaps even (by some standards) unfair or wrong – but the threat and risk is real, and the job holders keep it constantly in mind.

Many other people in the public employ also wield considerable amounts of power. In some cases, that power is quite tightly constrained and often (for example) there are appeal authorities. If a benefit clerk denies you a benefit you are clearly legally entitled to you will probably end up getting it, and if the clerk’s mistake is severe or repeated often enough they might lose their job. Less so at more exalted levels. When, for example, the wrong person is put in prison for decades typically no one responsible pays a price. When the Public Service Commissioner engages in repeated blatant attempts to mislead to protect one of his own, it seems that no pays a price.

And then there are central banks.

Every few months I do a book review for the house journal of central bankers, Central Banking magazine. They are often fairly obscure books that I otherwise wouldn’t come across or wouldn’t spend my own money on (at academic publishing prices). A few months back I reviewed Inflation Targeting and Central Banks: Institutional Set-ups and Monetary Policy Effectiveness (hardback yours from Amazon at a mere US$170 – yes, there is a cheaper paperback if anyone is really interested), by a mid-career economist at the Polish central bank, in turn based on her fairly recent PhD thesis. The focus isn’t on the question of what difference inflation targeting makes but on what institutional details, which differ across inflation-targeting central banks, seem to make a difference. Sadly for the author – these things happen – her thesis was finished before the outbreak of inflation in much of the advanced world in the last 2-3 years.

At the core of the book is a set of painstakingly-compiled indexes on various aspects of inflation-targeting central banks which might be thought to be relevant to how those central banks might perform in managing inflation. There are ones for independence, ones for transparency, and so on, but the one that stuck with me months on was the one for accountability. Accountability used to be thought of as an absolutely critical element – the quid pro quo – for the operational independence that so many countries have given to central banks in the last few decades. With great power goes great responsibility, and ideas like that. The Reserve Bank itself was very fond on that sort of rhetoric. In fact, there used to be a substantive article on that topic by me on their website, in which I waxed eloquent on the topic (after it was toned down when my original version upset the Bank’s then Board by suggesting that for all the importance of accountability it was more difficult in practice than in theory). At a more casual level my favourite example has always been a radio interview then-Governor Don Brash did in 2003, the transcript of which the Bank chose to publish, in which there is a snippet that runs as follows:

Brash: ….we were concerned……we were running risk of inflation coming in above 2 per cent which is the top of our target

Interviewer: And then you’d lose your job?

Brash: Exactly right.

I was working overseas at the time, and can only assume my colleagues gulped when they saw it put so unequivocally. But it wasn’t inconsistent with a meeting the handful of senior monetary policy advisers had with Don in one of his first days in office. He eyed us up – chief economist, deputy chief economist, and manager responsible for monetary policy advice – and said (words to the effect of) “you know we are going to introduce a new law in which if inflation is away from target I can lose my job. Just be sure to realise gentlemen that if I go, you are going too.” Not ever taken – at least by me – as a threat, but as a simple statement of the then-prevalent idea (crucial in the public sector reforms being done at the time) that operational independence and authority went hand in hand with serious personal responsibility and potential personal consequences. It was part of the logic of having a single decision-maker system (an element of the New Zealand system that no one chose to follow and – in one of Labour’s better reforms in recent years – was finally replaced here_.

But that was then.

By contrast, these are the components of the Accountability sub-index in the recent book I mentioned

There is nothing very idiosyncratic about the book or the work in it; indeed, she seeks to be guided by the literature and current conventional understanding. And if you look down that list of items – which is the sort of stuff central bankers often now seem to have in mind when they ever mention “accountability – you’ll quickly realise that there is really a heavy emphasis on transparency (a good thing in itself of course) and almost none of them on any sort of accountability that involves real consequences for individuals, anyone paying any sort of price. The only one of these items that represents anything like that sort of accountability is item 6.7 but even there the provision is about whether Governors/MPC members can be dismissed for neglecting their work (not turning up to meetings etc), not for actual performance in the job.

But if there are no personal consequences for failure and inadequate performance, why would we hand over all this power? I’ve written here before about former Bank of England Deputy Governor Paul Tucker’s book Unelected Power – which ranges much wider than just central banks – where his first criterion for whether a function should be delegated to people voters can’t themselves toss out (eg central bankers) is whether the goal – what is expecting from the delegatees – can be sufficiently specified that we know whether outcomes are in line with what was sought. If there is no such clear advance specification either there will be no effective accountability or such accountability will at best be rather arbitrary.

As it happens, almost no one believes the over-simplified accountability expressed in that 1993 Brash quote above makes sense, even if expressed in core inflation terms (I don’t think most people involved really did even in 1993 – although there was a brief period of hubris where it all seemed surprisingly easy – and certainly as soon as inflation went above the target range in 1995 there was some hasty rearticulation of that sense).

But if we have handed over all this power – and central bank monetary policy decisions, good ones and bad, have huge ramifications for the economy as a whole and for many individuals – we should be able to point to behaviours or outcomes that would result in dismissal, non-reappointment, or other serious sanctions. Or otherwise in practical terms central banker inhabit a gilded sphere of huge power and no effective responsibility at all. And central banks aren’t like a Supreme Court, where we look at judges to be non-corrupt (including conflicts of interest) and able……but the desired products are about process – judging without fear or favour – not about particular outcomes, or decisions in a particular direction. It is right that it should be hard to remove a Supreme Court judge. It is less clear it should be so for central bank Governors, MPC members etc. The jobs are at times difficult to do excellently, but no one is forced to take the job, with its associated pay, power, prestige and post-office opportunities.

The problem – power has been handed over, but with no commensurate real accountability – isn’t just a New Zealand phenomenon, but one evident across the entire advanced world (the ECB at the most extreme, an institution existing by international treaty rather than domestic statute).

When I wrote my review I noted that “it isn’t clear that any central bank policymaker has paid any price at all for the recent stark departures of core inflation from target. It tends not to be that way for corporate CEOs or their senior managers when things go wrong in their bailiwicks.” It is possible there is now one exception to that story – the decision by the Australian government not to reappoint Phil Lowe on the completion of his seven year term – but even there it isn’t clear how much is about specific policy failures and how much about a more general discontents with the organisation and a desire for a modernised etc RBA structure, and the desire for a fresh face atop it. The promotion of a senior insider – not known to have sharply dissented from what policy mistakes there were – is at least a clue.

It increasingly looks to me as though delegation of discretionary monetary policy to central bankers should be rethought. I have long been fairly ambivalent but when the system is faced with its biggest test in decades – in all the years globally of delegating operational independence – central banks fail (the only possible to read recent core inflation outcomes relative to the targets given them) and no one pays a price (with just possibly a solo Australian exception) it begins to look as though we should leave the decisions with those whom we can toss out – Grant Robertson’s fate on Saturday – and keep central banks on as researchers, expert advisers, and as implementation agencies, but not themselves being unaccountable wielders of great powers.

The outgoing New Zealand government has made numerous bad economic choices in the last couple of years. Prominent among them were the decisions to reappoint MPC members, to allow the appointment to the MPC of someone with no relevant professional background or expertise, to reappoint the chair of the RB Board (while surrounding him with a bunch of non-entities, none of whom had any relevant expertise) and (above all on this front) the decision to reappoint the Governor. The latter decision was most especially egregious because it was Robertson himself who had amended the law to require parliamentary parties to be consulted before a Governor was (re)appointed, and when the two main Opposition parties both objected, Robertson went ahead anyway. If the operational independence of a Governor, appointed to a term not aligned with parliamentary terms, means anything, it surely should at least mean that the person appointed commands respect – for their capability, integrity etc – across political party lines. By simply ignoring dissent – that his own reforms formally invited – Robertson made Orr’s reappointment a purely opportunistic partisan call. At the time – 11 months ago – I outlined a list of 22 reasons Orr should not have been reappointed (and at that I wasn’t convinced simply missing the inflation target was one)

I’ll come back – probably tomorrow – to a post on what I think the incoming government and its Minister of Finance (presumably Willis) should do about Orr and the Reserve Bank now.

But this rest of this post is to illustrate that not even the rituals Parliament forces them to go through – in this case the production of an Annual Report – amount to any sort of accountability at all. (One day. perhaps next year now, they will have to front up on it to the new FEC, but sadly select committee scrutiny – committees being seriously under-resourced – is hit and miss at best, the more so in this case if Grant Robertson is the key Opposition figure on the new FEC reviewing the performance of the man he appointed and reappointed.)

It is difficult to know where to start on the Annual Report that was released last week.

It might be quite useful if you care about the Bank’s emissions, as there is several pages of material, but you shouldn’t (since we have an ETS for that). It is almost utterly useless for anything much that the Bank is responsible for. There are administrative things like why the Bank has 22 senior managers earning more than $300000 a year, or why it has 36 people shown in the senior management group (in a total of 510 FTE), or why staff numbers have risen sharply yet again, or why – having signed up to a very generous five year funding agreement in 2020 – they were coming cap in hand for lots more funding (much of which they got) this year. Or why the part-time chair of the Board – who has a fulltime job running a university, and where many of the key powers are statutorily delegated to the MPC – is pulling in $170000 a year; this the same chair who has been shown to have actively misrepresented – and led Treasury to make false statements about – the past ban on expertise on the MPC (issues he has never addressed). Or why the Governor gets away with actively misleading FEC. Or how seriously (or not) conflicts of interest are taken (even how the Board sees itself relative to the recent lofty words in the RB/FMA review of financial institutions’ governance).

But on policy matters it is arguably even worse. In a year when core inflation has – again – been miles away from the Bank’s target, the Board chair’s statement is reduced to 1.5 emollient pages uttering no concerns at all (recall that the Board does not do monetary policy, but it is charged by statute with reviewing monetary policy and the MPC and making recommendations on appointments of MPC members and the Governor). We learn nothing at all from the highly-paid chair as to why he and his Board of unqualified non-entities considered, in the circumstances, that reappointments had been warranted (nothing in Board minutes has provided anything more).

We do however learn of the Board’s effort to indulge the political whims of the Governor and Board members, the Treaty of Waitangi (a) not being mentioned in the acts supposedly governing the Bank, and b) not itself mentioning anything even remotely connected to monetary policy or financial stability.

There is a couple of page section on monetary policy in the body of the report. But in itself this is a reminder that the MPC – which wields the power – publishes no Annual Report, and exposes itself to no serious scrutiny. In this central bank not only does the deputy chief executive responsible for economics and monetary policy never give a serious speech on the subject, she is never seriously exposed to either media or parliamentary scrutiny. External members are so sheltered we have on idea what any of them think, what contribution they make, and so on. They never front FEC or any serious media. Perhaps it isn’t surprising that the total remuneration of these three ornamental figures isn’t much more than what the chair of the Board himself is paid.

But then surely the Board would be doing a rigorous review (it is after all the Board’s job, by law)? That would be difficult when most of the Board has no relevant expertise (the Governor is the main exception, and he chairs the MPC….).

But what we actually get in no sign of any serious thought, challenge or questioning, no attempt to frame the MPC’s achievements and failings. Instead we get this process-heavy but substantively-empty little box

It might be interesting to OIA that “self-review” MPC members are said to have carried out, but you’d just have no idea from any of this that the biggest monetary policy failure in decades had happened on the MPC members’ watch – even as all expiring terms were renewed. It is Potemkin-like “accountability”, with barely even that level of pretence. (Note here that the weak internal review last year wasn’t even an MPC document but rather a management one.)

If that is all rather weak it gets worse when the LSAP comes into view. This, you will recall, was the bondbuying programme in which the MPC’s choices cost taxpayers now just over $12 billion, a simply staggering sum of money, swamping all those “fiscal holes” of the recent election campaign. There are lot of LSAP references – it is the Annual Accounts after all – but none from the Board chair, and here is the one substantive bit.

I’ve highlighted the utterly egregious bit. As they say, IMF staff did put out a little modelling exercise. but it has no credibility whatever, as the scenario described in the exercise bore no relationship to what actually happened in the New Zealand economy in 2020 and 2021. It was a scenario under which, even with the LSAP, the New Zealand economy languished underemployed for three years (but a bit less so because of LSAP) rather than an overheated economy with very high inflation and – in the Governor’s own words – employment running above maximum sustainable employment. I critiqued the piece in a post here, and I know of no economists who read the IMF piece and concluded “ah yes, of course, notwithstanding that the LSAP had a direct loss of $12bn, in fact the taxpayer was really made better off by that intervention after all”. I’m sure no serious economist at the Reserve Bank – there still are some – believes it either. But there seems to be a premium on keeping quiet, and keeping your head down, in the Orr central bank. It was dishonest when the Governor first ran this line in an interview with the Herald but perhaps then he’d seen no critiques (or asked for one); it is materially worse when the Board chair (and the Governor’s 35 senior colleagues) let him get away with it and repeat it, without any scrutiny or further attempt to make a case, in what is supposed to be a powerful public institution’s premier accountability document.

Any serious accountability for the Bank seemed to be dead, at least under the outgoing government. Whether it will be any less bad under the new government it is far too soon to tell. But if it isn’t, serious questions needed to be asked about whether the model is any longer fit for purpose in the sort of democracy New Zealanders typically aspire to have – we’ll delegate power, but if you take up that power and stuff things up then you should personally pay some price. In this document not only in there is serious scrutiny, no personal consequences, but not even a glimpse of contrition from any of them. Never mind the huge losses, never mind the arbitrary deeply disruptive inflation, never mind the lies……after all, the government hasn’t seemed to mind.

Almost any private sector CEO, committee or Board that had stuffed up as badly as the Reserve Bank – with corporate excess and loss of focus thrown in – would have been sent packing some time ago. The stock price would have been falling, investors demanding change, and the business press all over the situation. But not here, not our central bank………

One last pre-election fiscal post

Michael Reddell Fiscal policy

A few weeks ago I wrote a post surveying the range of fiscal indicators (local ones and IMF/OECD metrics) to look at recent New Zealand fiscal policy across time and across countries.

I included in that post this chart, which I had cobbled together using IMF April data for other countries and their estimates for New Zealand reported in the recent Article IV review (it was the indicator they specifically cited in suggesting a need for “frontloaded fiscal consolidation” in New Zealand.

A new IMF Fiscal Monitor has been released in the last few days. We now have consistent cross-country estimates, including numbers for New Zealand which will have taken account of the government’s sudden “get religion” line-on-a-chart cuts of a few weeks ago.

With those updates all round New Zealand is now “only” projected to be third-worst among the advanced economies next year, on current policy (ie assuming the government’s top down cuts are effectively implemented).

And how about over time?

We used to be better than the pack. But now we are a lot worse.

You can see that New Zealand’s primary deficit are barely smaller than those at the height of the Covid spend, a quite different picture than the median country. Out of curiosity I wondered where we ranked.

Most countries have very substantially improved their cyclically-adjusted primary deficits/surpluses. New Zealand, by contrast, is way to the right of the chart.

But what of The Netherlands and Denmark? They seemed a little puzzling. I wasn’t aware they had recent fiscally reckless governments. It turns out that Denmark ran primary surpluses right through the Covid – look at just a fiscal chart and you’d barely know there had been a pandemic – and is now running a roughly zero primary balance (cyclically adjusted). The Netherlands has gone from primary surplus pre-Covid to deficit in Covid and subsequently. But the IMF estimates that next year they will have a cyclically-adjusted primary deficit of 1.8 per cent of GDP. Not great, but nothing like as bad as New Zealand’s projected 3.4 per cent of GDP deficit.

Whichever party leads the next government there is a huge amount of fiscal work to do – including real the “cuts” already included in the IMF numbers – all thanks to the extravagant fiscal choices of the current government in the last two (post big Covid spend) budgets.

Productivity growth….or lack of it

Michael Reddell New Zealand economic performance, Productivity

Earlier in the week a journalist asked me for some thoughts on which political party in government had managed the economy better – in overall macroeconomic terms – over the years since we moved to MMP.

My initial response was that the answer would be pretty dull. Pressed to write something anyway, I outlined briefly why really there was not a great deal between them, at least without a great deal more in-depth study. And that shouldn’t be very surprising. After all, external shocks happen (overseas, or physical/climatic ones here), and cyclical macroeconomic management has been outsourced to the Reserve Bank over all that period, with very similar targets set by successive governments. Crude partisans might point out that (core) inflation went outside the target zone at the end – or so it appears likely – of both Labour governments over that period, but those failures are first and foremost on the Reserve Bank. Other crude partisans might point out that unemployment has been at its lowest right towards the end of both Labour governments, but……since that is basically the same phenomenon as the overheated economies that gave rise to the inflation problem, you are back with it being the Reserve Bank’s mistake again. One can argue, say, that the current government should have done more to sort out, punish, or even support (via fiscal policy) the Reserve Bank, but…..it is a sample of one event.

When I wrote something a bit fuller on this topic a few years ago, I noted that fiscal policy had also largely been a bipartisan success story. We might not have had a very successful economy, but when deficits have emerged governments of both parties have restated their commitment to surpluses, and had delivered. You could argue that National deserves a better rating there, having inherited large deficits in 2008 (as I’ve argued here before Labour had been badly advised by Treasury and did not think it would be leaving deficits) and returned to surplus. But actually if you look back at the 2009 and 2010 Budgets, contemporary Treasury estimates were that – starting from a deficit – they were expansionary. I’ve been quite critical of this government’s fiscal stewardship over the last couple of years, but…..nothing much in the campaign suggests any more urgency for or conviction about a return to surpluses from the other side.

But the backdrop to it all was that while, until quite recently, New Zealand – under governments led by either party – had done reasonably well on the stabilisation side of things (monetary and fiscal, and even with structural policies that kept the non-inflationary rate of unemployment fairly low), productivity (or the lack of it) was the elephant in the room. It has been for a long time, and still is (or should be).

We don’t have an official quarterly labour productivity series, but it is easy enough to construct one’s own. In this chart, I’m showing the average of production and expenditure GDP measures, divided by hours worked from the HLFS, all normalised and expressed in log terms. Expressing things in logs means that a slowdown in the growth rate is mirrored in a flattening of the curve. We don’t have long runs of official historical data in New Zealand, but this goes back to 1987Q2.

If you can easily see any great difference from governments of one party to governments of the other you are more eagle-eyed (or perhaps “motivated”) than I am.

But I did check anyway. One could go from the last quarter of the previous government to the last quarter of the next one, but….there is clearly noise and measurement error in the data, and nothing is that precise, so although I checked both, this little table uses annual data (eg average change from 1990 (last year of that Labour government) to 1999 (last year of that National government) and so on. Now, no one really believes that changes of government make a difference immediately, so this is illustrative more than anything.

Average annual growth in real GDP per hour worked (%)
1990-1999 National 1.1
1999-2008 Labour 1.4
2008-2017 National 0.9
2017-2023 Labour 0.7

Much the biggest story isn’t the difference between the parties, but the difference over time. Productivity growth in the last decade or more – under both governments – has been materially lower than it was earlier in the period – under governments of both parties. This is consistent with the factoid I’ve thrown around a few times in recent weeks: in OECD league tables for labour productivity we dropped six places – in a club of only 37 – in the last decade.

Here is the deterioriation illustrated graphically. Eyeballing the data it looked to me as though there was a break around mid 2010. So what I’ve shown is (a) the actual data per the previous chart, and (b) an extrapolation to now of the trend in the data from 1987 to 2010.

Roughly speaking the gap between the two lines as of now is equivalent to a 10 per cent loss of productivity (growth we would have seen if the previous trend had continued).

Note that all of this is simply New Zealand data. I have repeated often charts showing our deterioriation – or at best lack of catch-up – relative to other advanced countries. But this is us. And remember that we are so far behind the productive frontier economies – it would take perhaps a 60 per cent increase to catch them – that even to the extent world productivity growth slowed down (and it did, in the US from about 2005) there is no necessary reason why New Zealand productivity growth needed to slow. Our slowing was about New Zealand policy choices, passive or active.

It is depressing how little serious attention has been paid to these failures – and challenges – in the election campaign, and since politicians mostly display little interest our bureaucratic institutions don’t bother doing or supplying the hard analysis. Some are simply emasculated to that end – one could think most notably of what the current government has done at the Productivity Commission. Productivity really matters for our future material living standards, and even for the shiny baubles both main parties try to woo us with.

I’m not an ACT supporter – on quite different grounds – but here I would give that party some credit. Their policy document on productivity evinces a degree of seriousness about the issues that nothing from any of the other parliamentary parties has even hinted at. I don’t agree with all the specifics, and would probably disagree substantially on some, but….they write as though it matters. And that isn’t nothing (even if it can’t overcome my scruples about the party leaders’ values etc). In fact, a week or two back a reader not otherwise known to me got in touch and asked who I thought they should vote for if it was housing affordability and productivity that mattered most to them. Making clear that I was definitely not an ACT supporter myself, I nonetheless gave them an analyst’s answer: probably ACT, on both counts.

GDP and GDP pc: where does NZ rank in the IMF numbers?

Michael Reddell New Zealand economic performance

It was one too many mentions of Equatorial Guinea that prompted me to pull together this very quick follow-up to my post yesterday showing some snippets from the newly-released IMF WEO.

For my tastes, these comparisons of forecast growth in real GDP per capita for New Zealand and the group of advanced countries are most useful and enlightening

But it was easy enough to download the data for both GDP and GDP per capita (both in constant price – “real” – terms) for all the countries and territories in the Fund’s database (roughly 190 of them, depending on the precise variable and year). I did it for both variables and for the three years, 2022, 2023, and 2024. The forecasts are annual not quarterly, so (for example) the growth rate for 2023 is GDP generated in the whole of this year relative to that in the whole of last year.

Take real GDP growth first:

In 2022, New Zealand is shown as having 2.2 per cent growth. That put us 130th of 192 countries (in case you are wondering, and to no one’s surprise surely, Ukraine did worst).

In 2023, the Fund expects real GDP growth here of 1.1 per cent. That would put us 152nd of 190 countries (Sudan doing worst).

In 2024 – and for these forecasts the Fund basically assumes constant policy – the Fund forecasts that New Zealand’s real GDP growth will be 1.0 per cent, 180th of 190 countries (and here Equatorial Guinea really is last).

As context, here are the five countries either side of New Zealand for 2024

But headline GDP isn’t even close to a measure of economic wellbeing. Some countries have rising populations and some falling populations. New Zealand’s population has tended to rise faster than most advanced countries, particularly so right now. Real GDP per capita data/forecasts are typically more useful, as being a bit closer to the average experience of an individual in a country.

How does the IMF see New Zealand doing on that count?

In 2022 the IMF shows us as having had growth in real per capita GDP of 2.2 per cent, 98th of 192 countries/territories (Macao did worst)

In 2023 the IMF expects that New Zealand will have had real per capita GDP growth of -0.1 per cent, ranking us 156th of 190 countries (Timor-Leste did worst).

And in 2024 the IMF forecasts that New Zealand will have real per capita GDP growth of 0.0 per cent, ranking us 177th of 190 countries (and there Equatorial Guinea is projected to be worst).

Here are the five countries/territories either side of us this year (an eclectic mix it would be fair to say)

and here is the same snippet for the 2024 forecasts

To repeat, macroeconomic forecasters aren’t very good, and the IMF is no better than most of the others. But these are consistently compiled numbers, and for 2022 the numbers are reasonably firm and for 2023 almost three-quarters of the year had gone when the numbers were finalised.