It didn’t used to be terribly controversial that powerful independent government bodies and powerful statutory officeholders should “stay in their lane” or “stick to their knitting”. Those entities/individuals typically have a pretty narrow set of official statutory responsibilities and if they are exercising power independently of the naturally-partisan governments of the day, they should focus their energies on those official responsibilities and keep quiet about, and keep out of, other stuff. Central banks are a classic example. Independent central bankers exercise enormous delegated power in some narrow and specific areas (monetary policy, banking regulation). Part of the way they build and retain trust – our willingness to delegate that power to them – is by doing the day job excellently. But one of the other ways is by staying out of other highly contentious and/or party political stuff. We need to be able to be confident that these very powerful people aren’t using their (rather limited) official position to advance personal ideological or political agendas. And, frankly, that should be so whether or not we as individuals might happen to agree with a particular cause the powerful decisionmaker happens to be advancing (I’ve written here previously (see link above) about Orr in this respect, but also the very dubious case of Don Brash – as Governor – and the Knowledge Wave speech, some of which I did agree with). As I noted in an earlier post
We should value a good independent central bank, but the legitimacy of the institution – and its ability to withstand threats to that independence – will be compromised if Governors play politicians or independent policy and economic commentators.
And that applies to statutory members of the Monetary Policy Committee too, especially ones employed fulltime in the service of the Reserve Bank.
(Here I would note that, rightly or wrongly, central bankers have tended to be given more societal leeway to weigh in on this, that or the other policy issue when the central bank itself is perceived to have been doing its day job excellently. No serious observer would accord that description of the Reserve Bank of New Zealand in the last few years,)
I opened The Post this morning to find a headline “Cutting a $20b fossil fuel bill”, and read on. It was a report on a new paper from a think tank called “Rewiring Aotearoa” championing widespread electrification and all sorts of policy levers in support of that end. Fair enough you might suppose, were it coming from the Helen Clark Foundation, or really anyone independent. They are welcome to present their arguments and make their case. But it wasn’t until I got halfway through the article that I learned that “it was co-written by Reserve Bank chief economist Paul Conway”.
The chief executive of this think tank, one Mike Casey, was at pains to assure us that
So, at least according to Casey, the Reserve Bank didn’t “endorse” the document, but had it seems done enough checking to know that it was all “economically viable”. Quite whether that is how the Reserve Bank would see it – having its imprimatur asserted by Casey – is not clear (one would hope not). Casey himself seems like a pretty entrepreneurial guy – and was featured on Country Calendar last year around his impressive central Otago cherry orchard – but……he isn’t a central bank statutory officeholder wielding considerable power/influence over the macroeconomy and not supposed to be using his office, or associations, to advance personal agendas.
I went and downloaded the report, which was apparently released yesterday at an online event in which the two speakers were an Australian entrepreneur/author and Conway. There were four authors of the paper but Conway is one of the two used to market the release.
I opened the report and the concerns grew. On the first page I found this
So Conway’s involvement in this report is explicitly linked to his rather important day job as chief economist of the Reserve Bank. Conway must have been aware of this, highly inappropriate, linkage being drawn (he is a co-author, it is on the very first page).
Then I went looking for any sort of disclaimer. Often enough, when official agencies publish their own research reports there is a standard disclaimer noting (generally not very credibly) that views expressed are those of the individual and not necessarily those of the institution they work for and which is publishing the research. Here, as illustration, is an example from a recent Reserve Bank research Discussion Paper
But there is no disclaimer at all on the Rewiring Aotearoa paper that Conway co-authored and fronted, even as he is presented by them as the chief economist of the Reserve Bank. Conway simply cannot be unaware of this lapse: even if he was authorised by the Reserve Bank to get involved in this project in whatever spare time he has, surely they and he would have been bending over backwards to ensure that there was no association between this involvement and the Bank? A disclaimer would have been the bare minimum. At least among central bankers with any regard at all for appropriate boundaries.
Perhaps you wonder if all this is just very technical and not worth bothering about. Well, here (from Rewiring Aotearoa’s LinkedIn)
This is a highly political project. And there is nothing wrong with that – it is how policy debate goes – but not the place for the central bank’s chief economist (and even less when pro-actively identified as such, with not even a hint of a disclaimer in the official report, even while the champion of the project claims that the Reserve Bank thinks it is all very robust or they wouldn’t have let their chief economist get involved.)
Or there is this from the report itself
I’m sure parts of the political spectrum will really welcome the report and be cheering on its state-led approach. But senior central bankers aren’t supposed to be championing divisive causes – at least not ones other than those Parliament has specifically assigned to them.
You’ll note earlier that the report described Conway as having given his “personal time” to working on this report. One does wonder quite how much spare time a senior manager of the Reserve Bank actually has. After all, this is an agency that has been coming off the back of the biggest policy failure, in Conway’s own area, in decades (the sustained outbreak of inflation, only just now getting back inside the target range). It was Conway himself who was on record after the May Monetary Policy Statement lamenting potential problems with either the modelling tools or the Bank’s use of them (both things the chief economist might be thought primarily responsible for). Mind you, this was the same Conway who chose to take his holidays and miss the (July) Monetary Policy Committee meeting where the MPC executed perhaps its biggest U-turn in decades in such a short space of time. Very few people looking at the conduct of monetary policy over the last six months (hawkish lurch in May, quick reversal in July, rate cut in August, all on not much new data) would think that all was well in the economics functions of the Reserve Bank, and that it was appropriate for the Bank to be signing off on its senior officeholder getting heavily involved in any other project, no matter how non-political or innocuous.
And is if all that wasn’t enough, it is worth remembering the Code of Conduct governing MPC members
Conway’s boss is the underqualified Karen Silk, but it is hard to believe that this involvement wasn’t signed off by the Governor himself. It shows remarkably poor judgement by all three of them (Silk, Conway, and Orr), around both the initial involvement and the active identification of Conway’s involvement in the Rewiring Aotearoa report and the absence of any serious disclaimer (not that the latter would have materially allayed concerns).
I’m sure work in the area of this report was after Conway’s own heart. His inclinations seem to be to the technocratic left, and his professional experience has been most strongly in these microeconomic areas and issues around productivity. But he chose to take up a role as a senior statutory officeholder, wielding huge influence over the near-term performance of our economy. That needs to be his focus, and we need to be able to trust that he – and his colleagues – are using their professional endeavours only for the narrow task Parliament has given them.
In a serious world, the Minister of Finance and the chair of the Reserve Bank’s Board would be asking hard questions about all this, including around the judgement of those involved. In latter day New Zealand (with Quigley and Willis in those offices) it seems sadly unlikely. And so standards degrade even further, and there is a bit less reason still to have any trust in or respect for our central bank.
As the executive members of the Reserve Bank’s MPC have fanned out in an attempt to put a favourable gloss on what everyone else recognises as a really sharp change of view between May and July/August (call it a U-turn or a flip-flop, or just a change a view sharper in a short space of time than ever seen from the Reserve Bank absent an exogenous external shock) there have been various rather dubious attempts to rewrite history. There was the Governor of course, but in the last couple of days we’ve also heard from Deputy Governor Christian Hawkesby, and from the deputy chief executive responsible for macroeconomics and monetary policy, Karen Silk. Whether these MPC members, really highly-paid senior officials, actually believed what they were saying when they said it (most likely) or were deliberately setting out to deceive, it really isn’t good enough.
As regards Hawkesby, interest.co.nz’s Dan Brunskill captured in this Twitter thread and the article he links to there.
Had an enjoyable but confusing interview with Dep Gov Hawkesby on Friday.
The news-y bit was that the committee would have taken a different stance in May if it had the revised GDP forecasts.
And then there was Silk. In almost any other advanced country central bank, the holder of a position like her’s would be a highly-regarded economist who, if one didn’t always agree, could at least be counted on to be on top of the facts. Not so Silk, on either count.
She gave an interview to NBR and someone sent me a link to the article. It included these lines, attempting to explain the shift of view
That highlighted bit didn’t sound right, but…….she is the highly-paid statutory officeholder. So I thought I should look up the Bank’s own numbers.
The May MPS was finalised in the middle of the June quarter. In that set of forecasts their best guess was that the output gap had been negative in the March quarter, and was substantially negative in the June quarter. In fact, since May they’ve become less optimistic on when the crossover (to negative output gap) occurred, and for the first half of 2024 as a whole there is no material difference in the output gap view. It is really pretty basic stuff that commentators shouldn’t have to go round fact-checking, as if it was a politician on the campaign trail they were dealing with. (And yes, the Reserve Bank has become more pessimistic – larger negative output gaps – for Q3 and Q4, which is a point she could legitimately have made, but wasn’t (at all) the one she actually tried to put over.)
But digging into my table of old output gap estimate prompted me to look again at how they’d evolved, and when the Bank first estimated that the economy was really quite badly overheated (ie published a real-time estimate of a big positive output gap). They now reckon the output gap peaked in the September quarter of 2022 at about 4.5 per cent of GDP. That’s a dreadful reflection, but it is also an estimate with the benefit of hindsight.
What counts as “big”? If we look back to the 00s – and by 2007 there wasn’t much doubt that the economy was really overheated – the Reserve Bank now estimates a peak positive output gap then a 2.8% (of potential GDP).
As early as the November 2021 MPS, the Bank estimated that in the June quarter of 2021 the output gap had reached 2.6 per cent of GDP. Now, things got messed up by the lockdowns in the second half of 2021, but even in November 2021 the Bank thought the output gap would be back up to 2 per cent by the following quarter (March 2022).
Perhaps more strikingly, by the May 2022 MPS, the Reserve Bank estimated that the output gap for the quarter they were actually in was 2.7 per cent of GDP. As time passes it is so easy to lose sight of what happened when, but the May 2022 MPS was the one in which the Bank raised the OCR to the giddy heights of 2 per cent, pretty much bang on the midpoint estimate of the neutral nominal OCR (as published in that same MPS). Why would you (MPC) consider it appropriate to have the OCR only at neutral when the economy was already, on your own estimates, badly overheated? As an independent check on overheating, the unemployment rate for the March quarter (which the MPC had when they made their decision) was a multi-decade low of 3.2 per cent.
Now, it is certainly fair to note that the May 2022 MPS included a projected track of further OCR increases over the following year to a peak of around 3.9 per cent. But – as we’ve just seen again since May – forward tracks are to a considerable extent vapourware; the hard decision was the OCR decision made that day by that committee (which incidentally included both Silk and Hawkesby, and the then new chief economist Paul Conway).
It is easy to look back and criticise historical forecasts that turn out to be quite wrong. But that isn’t my point here. On the Reserve Bank’s own forecasts and estimates – of two unobservable variables (neutral interest rates and output gaps), but ones that play a significant part in the Bank’s rhetorical framing – things were badly overheated and yet the OCR had barely got to neutral. And it wasn’t as if there was no inflation evident: in May 2022 the latest estimate from the Bank’s own slow-moving sectoral factor model measure of core inflation was already at 4.2 per cent (later revised a bit further up), miles above the top of the target range, let alone the target midpoint that the MPC was supposed to have been focused on.
There really isn’t much excuse. On estimates the Bank had in front of them – and was willing to publish – the inflation drama could by now have been over a year ago had they adopted an OCR that their own forecasts/estimates pointed to. But the MPC chose not to (just as, for some weird reason, they kept on pumping out modestly-subsidised (so-called) Funding for Lending loans to banks – a Covid support measure, designed when the concern was deflationary risks – for many months more. Remarkably, there are still $15 billion of these loans outstanding.
The MPC’s stewardship of monetary policy in the last few years has been pretty consistently bad. If you might reasonably make allowances for 2020 – it was a very unusual event and set of circumstances and almost everyone found it hard to read (but the MPC is paid to be more expert than most) – nothing really justifies the delayed start to OCR hikes, or the sluggish response even at a point (mid 2022) when the Reserve Bank itself told us the economy was grossly overheated and core inflation was already well outside the target range. Against that backdrop, one can mount a reasonable case that this year’s policy flip-flop doesn’t matter hugely in macroeconomic terms. But it shouldn’t have happened – its view in May was not only clearly wrong, but it was clearly an outlier (views of other economists don’t provide them much cover – and when it did, we shouldn’t have to put with supposedly expert powerful officials just making up lines, apparently indifferent to the facts. Nor, of course, with a Governor who treats both facts and MPs (at FEC, the committee charged with scrutiny of the Bank) with such disdain whenever challenged.
Over the last few years, The Treasury seems to have been toying with bidding for a more significant role for fiscal policy as a countercyclical stabilisation tool It seemed to start when Covid hubris still held sway – didn’t we do well? – and the first we saw of it in public was at a Treasury/Reserve Bank conference in mid 2021, at which both the Secretary and some of her staff were advancing thoughts of that sort (I wrote about it here). More recently, this mentality has shown up in the commissioned report from US economist Claudia Sahm (post here) and in the consultation for The Treasury’s forthcoming long-term insights briefing (post here).
Last week they issued three papers in this vein (all carrying standard disclaimers that the views presented are not necessarily those of The Treasury itself, let alone the government).
The first one (long, and I haven’t read it yet) appears to be a fuller and final version of something presented at the 2021 conference. The second, quite short, is Sahm’s report (how much did the taxpayer pay for it?). The focus of this post is the third paper.
In the interests of full disclosure, the author is a former colleague and was my first substantive boss decades ago at the Reserve Bank. We have ongoing connections through the troubled Reserve Bank superannuation scheme, where Bruce has been a dogged campaigner for the trustees (appointments of most controlled by Orr/Quigley) to do the right thing, fixing some pretty egregious historical errors, and he was for a time a trustee himself. We have spent many many hours over the decades debating issues around macro stabilisation, in the 20+ years our Reserve Bank careers overlapped and since.
It is a 40 page paper covering multiple decades and so I’m not going to try to review the entire document, but rather to pick out a few themes that struck me, including revisiting my ongoing scepticism about Treasury (or Treasury staff/consultants) bids for a new and bigger role. Doing core fiscal policy, and associated analysis, seems quite challenging enough – and if ever that was in doubt the last couple of years should have brought it back into focus. Sticking to your knitting (and doing your own core job excellently) is typically good advice for government agencies.
Particularly if you are young, or haven’t followed New Zealand macro policy developments closely, there is useful background material in Bruce’s paper. It is easy for detail and institutional context to be lost as time passes, memories fade, (and embarrassing episodes – think the Monetary Conditions Index – are quietly swept under the carpet, the place the Reserve Bank would probably now like the LSAP losses to disappear to).
But I’m inclined to think that the paper is mis-titled. On my reading of things – and I was reasonably close to macro policy from the inside for much of the period – there was very little of what could properly be described as “fiscal – monetary coordination” over the last 35 years. That was mostly by design, and in my view was (and is) mostly a good thing. There have at times been tensions, but that isn’t necessarily a bad thing, but not usually much coordination. It generally hasn’t been needed. The approach was, and is, pretty standard among countries of our sort. So the paper is more of a retrospective on the parallel developments in each of fiscal and monetary policy, with some added thoughts on whether, and if so how, there might be room for more in future.
Contrary to one claim in White’s paper, active monetary policy isn’t new. But for a long time, in those countries that had central banks (we didn’t until 1934), interest rate (and related instrument) policy adjustments were mostly about defending exchange rate pegs (Gold Standard or simply fixed exchange rate choices). In the post-war decades fiscal policy sometimes played a part in that (think of prominent episodes like the 1958 “Black Budget” or adjustments following the wool price collapse in 1966), and through those decades in New Zealand both fiscal and monetary instruments were directly in the hands of the Minister of Finance.
Floating the exchange rate (in 1985) and making the Reserve Bank operationally independent in conducting monetary policy (formalised in law from 1 February 1990) opened the way for what we call the “consensus assignment” of tasks. The Reserve Bank would focus on delivering inflation at or around target, and in the process – and particularly in the presence of demand shocks – would do something towards leaning against big swings in real economic activity. And the Bank would be accountable for its stewardship. Fiscal policy would be made as transparent as reasonably possible (so that the Reserve Bank could properly take fiscal developments into account), but that fiscal policymakers (ministers) could concentrate on doing stuff voters expect with the public purse (schools, hospitals, Police, Defence, roads or whatever) while keeping debt to tolerable and sensible levels. There were, of course, the “automatic stabilisers” (mostly, the fact that taxes are proportional or progressive, and so government revenue shares some of the gains/losses when times are particularly buoyant or subdued) but they operated in the background, not overly strongly. Any macro stabilisation dimension was an incidental nice-to-have (eg we don’t pay unemployment benefits to try to keep GDP up, but because we don’t think people should simply be left to their own devices and whatever private charity can offer when times get (perhaps very) tough).
The separation was pragmatic and practical in the world New Zealand has chosen. People will rightly point out that fiscal choices can, in the extreme, end up dominating monetary policy (hyperinflations are always political – and fiscal – phenomena), but not when government debt as a share of GDP is in the sort of ranges it has been for (say) the last 80 years in New Zealand.
And so it has largely proceeded, really since the late 1980s (ie before the changes to the Reserve Bank Act or to the Public Finance Act (or what was initially a standalone Fiscal Responsibility Act). Sometimes the stance of fiscal policy has been working in the same direction (affecting demand) as monetary policy, and sometimes in opposite directions. Sometimes those similarities or differences have been helpful, sometimes not. But there really hasn’t been much co-ordination, in the sense of the Governor and the Minister of Finance getting together and agreeing which party (which policy) would do what when.
In his paper, White often conflates “working in the same direction” and “co-ordination”. He recognises that it is his definition, but I genuinely don’t find it helpful and, if anything, I think that usage muddies the water.
For example, if there is a really big earthquake at a time when the economy is badly overheated, you’d expect the aggregate effect of the resulting fiscal choices and pressures to be adding more to demand/activity but at the same time would expect that monetary policy would be acting to dampen overall demand (in practice, squeezing out some private sector spending/activity to make room for the post-earthquake repair and rebuild spending). That is a good example of both sets of policies doing what they do best, within a policy framework recognised by both the Minister (and her Treasury advisers) and the Governor (and his MPC colleagues). There is no particular for any further coordination because both parties know how things work. You might – as always – expect that Reserve Bank and Treasury officials would be exchanging notes (understanding respective models and analytical frameworks, and ensuring the RB is well aware of the fiscal plans, including timing) but the ground rules are clear.
And if the huge earthquake happened to come when there was a great deal of slack in the economy then we might have a very stimulatory fiscal policy (all that rebuild spend) but monetary policy might still need to be expansionary (just less so than otherwise). Policies now look like they are both working in the same direction, but in fact it is exactly the same framework – no more or less coordination – with the only difference being the (macro) starting point. I was bit surprised that in his account of how fiscal and monetary policy have operated over recent decades, including following shocks, there was little no reference to output gaps (or, less technically, to the starting point, whether of excess demand or excess capacity). It really matters: in 2007/08 for example the Bank’s best estimate was that economy had been badly overheated and thus contractionary monetary was required, whatever fiscal policy was doing, while by 2010/11 (earthquakes) economywide excess capacity was again a thing. But neither earthquakes nor pandemics (or foreign financial crises/downturns for that matter) can be counted on to conveniently time themselves to the state of the NZ business cycle.
White covers what is probably the closest example of fiscal-monetary coordination over the 30+ years he looks at.
It is good for governments to be conscious of where their fiscal choices might put pressure on monetary conditions but…..as both Brash and White note…..it often isn’t a particularly robust basis for making fiscal choices. Macro forecasting is notoriously challenging.
I don’t think the exercise has been repeated in quite that way. And perhaps, for various reasons, it is better not to. One could think of this year’s tax cuts for example. The government knew that, all else equal, tax cuts would put a bit pressure on demand and inflation but actually neither they, nor their Treasury advisers, nor the Reserve Bank knew whether by the time any cuts came that would be particularly problematic or not. And to, in effect, invite the Reserve Bank to exercise a yea/nay call on whether the political promise of tax cut proceeds seems to risk undesirably politicising the Bank.
White structures his discussion of history around four sets of shocks: the Asian crisis in 1997/98, the “global financial crisis” of 2008/09, the Christchurch earthquake(s), and the Covid pandemic.
I wasn’t fully sure how helpful this was. Discretionary countercyclical fiscal policy really didn’t play a material role in either of the first two episodes. In the late 00s, fiscal policy had moved into a quite expansionary mode but that had more to do with politics (Labour’s position was slipping, and large surpluses over many years had become an appetising opportunity for the Minister of Finance’s colleagues) and a rather belated – and, it turned out, erroneous change of heart by Treasury, which advised governments that revenue had moved sustainably high – than anything designed to be deliberately countercyclical. As it happened, fiscal policy was expansionary into the recession, but that was more by chance and poor forecasting than by design. Beyond the 2008 Budget, the Crown offered guarantees (for retail deposits and new wholesale bank funding), and that was an area in which the RB and Treasury worked closely together, but the overwhelming bulk of the macro policy discretionary adjustment was monetary policy. We ended up with one of the very largest cuts in our Tpolicy rate of any advanced economy (partly because our economy had been more overheated, and inflation more troublesome, than many other advanced economies).
Treasury officials (and advisers/consultants) seem more enamoured with the earthquake and pandemic stories. I don’t think either has much to offer in favour of more coordination. The series of earthquakes from September 2010 created fiscal obligations (legal and political), for spending that needed to happen over a succession of years. At the Reserve Bank, we knew that the earthquakes (especially from February 2011 on) represented a substantial positive shock (positive in a “pressure on resources” sense; serious earthquakes are themselves not positive events) over several years. It wouldn’t have made sense for the government to have tried to hold back the repair and reconstruction effort because there was going to be pressure on whole-economy resources; rather they got on and got things done, and the Reserve Bank was left to manage economywide pressures (and all the uncertainty around them) to keep overall inflation more or less in check. As per the earlier discussion, as it happened, the output gap was negative and the unemployment rate was high at the time, so the OCR stayed pretty low. But bad earthquakes can happen in badly overheated economies too.
What of the pandemic? Officials are – probably rightly – proud of the fact that they could roll out the wage subsidy scheme so quickly. They needed to. Their political masters had decreed that we all had to stay home for weeks on end – likely time initially unknown – and thus that many people would have no way of earning an income. The wage subsidy scheme was (largely) an income replacement scheme, with a leavening of “keep existing firms together as far as possible”. The point was not to maintain GDP, or to avoid people being (in economic substance) temporarily under or unemployed (not actually working) – the sort of traditional countercyclical stabilisation goals. If anything, the goal was to shut down a lot of the economy for a while, but to ensure not too much damage (including to individual ability to feed their kids and pay their mortgage) was done in the meantime. It was probably a worthy goal (certainly a politically necessary one) but it really does not have implications for countercyclical stabilisation policy. After all, if the pandemic had struck when the economy was grossly overheated (eg the 4.5% positive output gap the Bank now estimates for late 2022) no serious person would have said “oh never mind about a wage subsidy, it is a good chance to get inflation down”. Any more than we cut off unemployment benefits at the peaks of booms. They are instruments and tools for particular purposes (eg some sense of fairness), but those purposes just aren’t primarily countercyclical macro stabilisation. We have monetary policy to do that.
The pandemic is also a good example where the “both pulling in the same direction” approach to coordination is flawed. With hindsight it is pretty clear that the best policy mix in March/April 2020 would have been a stimulatory fiscal policy (the macro effects of the measures governments needed to take to assist the populace – notably the wage subsidy) and a contractionary monetary policy (a higher OCR). Again, that wouldn’t have been a case of policy being at odds, but of the framework working – governments being free to do what the circumstances demanded (and having the balance sheet capacity to do it), while not having to worry about what if anything it might mean for inflation because the Reserve Bank had that covered. (As it is, both the Reserve Bank and The Treasury misread the macro situation and what was really warranted from monetary policy, but that doesn’t change the conclusion. But just think if the Reserve Bank had done its job better – and been raising the OCR in mid 2020 – how much pressure they might have come under from the fiscal – political – authorities, had their been a more-formally coordinated model.)
You could imagine a half-respectable case being made back in 2019. Back then, the public finances were in reasonable shape and (after far too long) inflation was also back to around target. If someone had been doing a scenario exercise around a pandemic it would have been easy to talk about fiscal policy: yes, we can do something quickly (timely), temporary and targeted. And, as noted earlier, on the narrow issue of the wage subsidy they did. But what happened to fiscal policy subsequently? It was thrown badly of course, and we now sit here in 2024 – having come thru post-Covid booms and busts still with not the slightest idea as to when the operating balance might be returned to surplus. There was a decent case for some big fiscal outlays in 2020 and 2021, but…..we are years on now, and nothing of the fiscal predicament is directly caused by Covid. But the legacy is still problematic, and the record suggests that Treasury advice was (to put it mildly) not always helpful in that regard. Officials don’t seem to have been focused on the basics – getting back to balance. As a matter of realpolitik it is simply much more difficult to change track on fiscal policy than it is on monetary policy. The Reserve Bank did badly over recent years, but by late 2022 monetary policy was on a contractionary footing and inflation has now largely been beaten. As for fiscal policy, this year’s Budget was still expansionary and no one knows when we might next see a surplus. How much riskier if we were to empower ministers and officials to use fiscal policy more routinely for countercyclical purposes (in reality, almost inevitably, much more enthusiastically to boost demand than to restrain it)? The temptation should be resisted by officials, not encouraged.
If there hasn’t been much fiscal and monetary policy coordination over the years, that doesn’t mean there haven’t been tensions between them, and between ministers and the Bank. It also doesn’t mean there haven’t been times when reasonable people have argued that a different fiscal policy might help ease some of the burden on monetary policy and monetary conditions. Decades ago, before the RB become legally operationallly independent, I ran a small policy team that wrote a monthly memo to the Minister of Finance on monetary policy and conditions: every single one of them ended with what became almost a ritual incantation that faster progress in reducing the fiscal deficit would ease pressure on monetary policy. I doubt our view ever made much difference – it was hard enough to get the deficit down just focused on fiscal issues and associated political constraints.
White notes that one of the big presenting issues over the years was the exchange rate. Intense upward pressure on the exchange rate would reawaken these issues: all else equal, a tighter fiscal stance would mean slightly lower interest rates and less pressure on the real exchange rate. It was an issue for decades, until it wasn’t. One of the little appreciated aspects of the last decade or more is how much less volatile our real exchange rate has been than it was in the period from 1985 to about 2010 (for reasons that I don’t think are that well understood by anyone).
The last such period of angst was in about 2010. After the recession the exchange rate rebounded very strongly, and there was quite a sense of “oh no, here we go again”, including among senior ministers. At about that time, then private citizen Graeme Wheeler encouraged the government to move faster on fiscal consolidation, to take pressure off the exchange rate, citing experiences from 1990/91. It came to nothing much, but did prompt me to write a paper for my colleagues on that earlier experience. After I left the Bank I OIAed that document and wrote about it here.
Over the years, there was angst on both sides of the street. Don Brash was well known (to his colleagues and others) for his hankering for “tweaky tools” – things that might ease the exchange rate pressures. After his departure, Michael Cullen became increasingly exercised about the exchange rate implication of our tightenings in the mid 00s, to the point where we and Treasury were commissioned to provide a joint report on Supplementary Stabilisation Instruments, and then a follow-up report on a scheme for a Mortgage Interest Levy (taxing mortgages to keep down the extent of OCR adjustment). I wrote about that episode in a post on Cullen’s autobiography. Very late in his term, Cullen became quite vocal – even talking of overriding the RB – and in particular was exercised by our public view that expansionary fiscal policy was exacerbating pressures on interest and exchange rates (his claim was that this could not be so since the budget was still in surplus, but it is changes in balances not the levels of them that matter for these purposes). An open clash of view culminated in a two page box in the December 2007 MPS, articulating our approach to these issues.
The established framework does rest partly on the willingness of the Reserve Bank to identify honestly fiscal pressures as they arise. A couple of decades ago The Treasury developed the fiscal impulse measure specifically for the Reserve Bank, to help provide a common framework. Over the last 18 months there have been signs of considerable slippage. I wrote last year about how the Bank had suddenly stopped referring to overall fiscal balance measures and fiscal impulse type indicators, and had switched to focusing on just one part of the overall fiscal mix, the level of real government consumption and investment spending. OIAs revealed, unsurprisingly, no serious analytical basis for such a switch, and the most likely story seemed routed in opportunism: government spending was projected to fall as a share of GDP (including from Covid peaks), which distracted attention from the fact that last year’s Budget was really quite expansionary (as the IMF pointed out in public even as the Reserve Bank refused to) and this year’s was also modestly expansionary. Those are political choices open to the politicians, and we shouldn’t expect the Reserve Bank to make a song and dance about them (whether the budget is in surplus or deficit) but we should expect some honest, balanced, and calm analysis of fiscal pressures on demand (as for any source of pressure). We aren’t getting it at present.
This has ended up being a long post and only partly focused on the White paper. My view remains pretty strongly that both the Reserve Bank and the Minister/Treasury should continue to specialise; that countercyclical macro stabilisation is best assigned to the Reserve Bank (for various reasons, notably around reversibility, but illuminated by the dubious record of the last 2-3 years), and with the Reserve Bank held to account for its performance in that role. One of the developments of the last half dozen years was the addition of a Treasury observer (formally the Secretary but usually a deputy) on the MPC, as a non- voting member. I championed such a move and welcomed the change that Grant Robertson introduced. That said, I have been struck over the years by the lack of any evidence in the record of MPC meetings that the Treasury observer or the Treasury presence has made any difference (positive or negative) whatever. Perhaps that is just about how the record is written, but perhaps not either. And yet the presence of senior Treasury officials in the MPC meetings must, at the margin, fix them with some sense of ownership for the resulting policy, and in turn impede their willingness and ability to ask hard questions of the Bank – when things turn out poorly, as they have in recent years – and to be part of supporting the Minister of Finance in holding the Bank to account.
Tantalising as it might be to Treasury officials to be more active in the countercyclical space, it isn’t a good idea. They have quite enough to do in just sticking to their knitting and doing that excellently.
It has been yet another bad week from the Governor of the Reserve Bank. He was on the defensive about the huge change of policy view between May and July/August, and instead of smiling and ruefully admitting that perhaps the May MPS wasn’t one of their best, we saw repeated episodes of thin-skinned bluster and defensiveness, whether at his press conference, in radio interviews (eg with Hosking) and – perhaps most egregiously since public officials are answerable to Parliament – his reactions to questions from the chair of FEC on Thursday morning. People who refuse to ever acknowledge a mistake are very dangerous, including because it tends to go with a very real unwillingness to learn (including from mistakes).
It was a bad (but perhaps pardonable – I was reading this week my own ambivalent posts at the time, here and here) call to have appointed him in the first place, and a scandalously bad one (a decision that Grant Robertson and Jacinda Ardern should be accountable for) to have reappointed him in 2022. By then, not only were the policy failings (worst core inflation in decades, billions of dollars in losses to taxpayers from punting in the bond market) evident, but the Governor’s thin-skinned bullying operating style was all too evident. It was Robertson and Ardern who’d added the requirement to the Reserve Bank Act that other political parties in Parliament needed to be consulted on a gubernatorial (re)appointment, and when the two main Opposition parties opposed the reappointment that should have been the last straw. Reserve Bank Governors wield so much power (with so little effective accountability) that we should expect a holder to be some one who commands confidence/respect (which doesn’t mean agreeing on everything) across the spectrum. Orr clearly hasn’t for some years now.
Well before last year’s election I pointed out (I’d been asked by various people) that any incoming government was going to be stuck with Orr unless he went voluntarily. There were plenty of things that could be done to build pressures (change the board chair, change the Board charter, use letters of expectation including to put pressure on the Bank’s bloated spending and so on), but in law removing the Governor of the Reserve Bank was a great deal harder than removing (say) a board member or chair from some routine crown entity. On balance, and in most circumstances, that is probably a good thing, even if it creates hard situations like the present, in which we are left with a Governor who commands no respect, but isn’t going anywhere. He is pretty secure in his position until his second and (by law) final term expires in March 2028. Apart from anything else, even if a brave government thought it had found grounds for dismissal, Orr could challenge any such decision in the courts and no sensible government would risk months of uncertainty like that for any but the most egregious breaches.
As a reminder, these are the grounds on which a Governor can be removed
It is actually harder to dismiss a Governor now than it was pre 2019, because in those earlier decades the Governor was the sole decision maker and so (in principle at least) it was easier to sheet home to him personally policy failures (inflation, $11 billion or so of losses). These days, while he is clearly the dominant voice (3 of the MPC work for him, and he has an effective veto on the appointment of the outsiders), policy decisions (and failures) aren’t his personally. The single decisionmaker model wasn’t great (not used anywhere much else in our system of government) but it did leave it very clear who was responsible.
Bad as Orr’s behaviour is – and we’ve seen it again this week, including his astonishing performance in the last few minutes of his FEC appearance – I’ve always been sceptical that anything since March 2023 (when his current term started) really rose to the level of (see 92(1)(a) above) “misconduct’ or “neglect of duty”. It might be the sort of rude and dismissive behaviour one would not tolerate from a teenager, but would a court really regard it as “misconduct”? It seems unlikely.
I also had a look at 92(1)(e). Here is what it says (applies to all MPC members)
The Code of Conduct for the MPC is required by law but decided by the Bank’s Board. Much of it is about managing or preventing conflicts of interest, but it also includes this section
Unfortunately, it is very inward focused (for a committee that wields a great deal of external-facing power and (notional) accountability). But did the authors of this document, five years ago, really envisage that they’d have an MPC member (in this case the Governor) who would repeatedly mislead FEC, be utterly dismissive of any challenging questions from MPs at FEC, who’d never ever admit a mistake, and whose usual response to disagreement or challenge would be thin-skinned bluster, supported only by simply unsupportable assertions (the sort of thing younger generations seem to use the word “gaslighting” for)?
And, in any case, given what we know of how Orr operates in public around monetary policy (avuncular and engaging when not challenged or disagreed with; the complete opposite otherwise) and reports of how he treats staff who dare to disagree, how likely is it that Orr operates in MPC in the way described (“treating others’ contributions with respect at all times, and exchange ideas freely to promote excellence in MPC’s deliberations”)? And has (5th bullet) there really been evidence that, over five years, he has continually sought to improve the effectiveness of his contribution as an MPC member and spokesman? If so, it certainly isn’t evident in his public-facing activities.
Note that the Code of Conduct requirements also have to be read subject to the MPC Charter, a document issued by the Minister and the Governor jointly (a weird arrangement when the Governor himself is one of those supposed to be governed by it). The Charter includes this section
Does anyone get the impression that, whenever challenged, Orr ever operates in a way that would show respect for the “reputation of the Reserve Bank”? If anything he has been the primary agent of driving down that institution’s reputation.
Both documents (Code of Conduct and Charter) look as though they could do with updating, to make it clear that the expectations of behaviour apply in outward-facing activities, engaging with Parliament, commentators, journalists etc, as well as inward. But once again, Nicola Willis has shown no sign of doing anything about the Charter, or putting in place a better board chair who might overhaul and extent the Code of Conduct.
As things are currently written I still reckon it would be a stretch to conclude that Orr had reached the dismissal threshold, and not worth the prolonged uncertainty and legal risk around attempting dismissal (in the unlikely event, on evidence to date, that Luxon and Willis cared a jot about anything other than claiming personal credit for the OCR starting to come back down). But even on what is written – in fact even without anything written – it should be clear that Orr’s conduct in office simply does not meet the basic standards we should expect from a powerful and (notionally) accountable public office holder. Frankly, it doesn’t meet the behavioural standards of a well brought up teenager. And that is so whatever you think of the actual narrow conduct of monetary policy (inflation, LSAPs, subsidised funding for lending and all). It is hard to think of any area of New Zealand public or private life where such conduct might be acceptable, let alone in one so powerful. If it is reminiscent of anyone in public life elsewhere it is Donald Trump. By accident the other day, I stumbled on this comparison from Orr’s now handpicked deputy from March 2018.
I guess that was the upside of the (pre-PM) Johnson. It didn’t end well, but he was easier to remove than Orr.
Digging around in this stuff yesterday I was reminded of a post from a few weeks back, prompted by reading the Bank’s plans and budgets. There was this chart
They claim they are going to spend $35 million this year on “engagement with the public and other stakeholders”. It remains a complete mystery what this huge sum of money is actually being spent on. 27+ comms staff don’t even come close to costing that much.
This is what they tell us they are seeking to achieve
Quite how “Parliament…is supported to conduct effective oversight of RBNZ” when they have repeatedly misled Parliament and the Governor’s own style is frosty and dismissive around any sort of serious challenge or questioning is beyond me. How is the reputation of the Bank advanced when, as he did this week, the Governor not only denies the evidence of everyone’s eyes (there really was a very big change of view in a very short period of times) but suggests that anyone who didn’t buy his interpretation didn’t really deserve to be called a commentator? We don’t bring up our kids to behave like that. But for this Governor of the Reserve Bank……? They spend $35m of our money on what, for what?
If we can’t get rid of the Governor for another 3.5 years – and even if the government wanted to they probably can’t if he wants to stay – perhaps we could at least insist on a small amount of that $35 million being spent on some remedial training programmes for the Governor. I’m pretty sure not a single media training programme, or government relations firm’s advice on handling select committees, would counsel anything like the Governor’s style/conduct. And they would be right to take such an approach. It is simply unacceptable behaviour from anyone, let alone someone with so many question marks around the narrower technical performance of the powerful institution he leads at our expense.
There is a lot one could write about the Reserve Bank’s Monetary Policy Statement and the Governor’s (sadly all-too-typical) thin-skinned and defensive responses to questions since, whether from journalists or a lone MP at the Finance and Expenditure Committee this morning. He never ever acknowledges a mistake and seems utterly unable to cope with criticism or disagreement whether (as reports suggests) inside the Bank or (as we can all see) outside it. In a field where there is inevitably huge uncertainty, it renders him simply unfit for office. It remains appalling that Grant Robertson reappointed the Governor and that Nicola Willis just reappointed the chair of the board responsible for holding Orr to account and for having recommended – presumably captive to management – his reappointment. How much more honest – and frankly reassuring – had Orr simply stood up yesterday and noted ruefully that “perhaps our May MPS wasn’t one of our better efforts”. At least in my book, a bit of contrition and humility goes a long way.
While I want to focus on yesterday’s statement, the contrast with May, and the outlook from here, it is worth remembering that simply unacceptable as the huge flip-flop from May to July/August should be – the sort of episode that further undermines whatever respect the Reserve Bank, the MPC, and Orr himself, might command – in macroeconomic terms it matters much less than the really big mistakes from a few years back that still get far too little scrutiny, and for which there has been no accountability. Losing $11 billion of taxpayers’ money on an ill-considered huge punt in the bond market remains simply staggering. How much difference would $11bn make in, eg, our hard-pressed health sector? And then there was the small matter of the worst outbreak of core inflation in many decades, the most overheated economy in the advanced world, and the massive dislocations and redistributions that that glaring policy failure brought about. And if many other central banks made mistakes in similar directions (a) we can only hold our central bank to account (other central banks are the problem for their citizens/governments) and b) our central bank did a worse job than most (see “most overheated economy in the advanced world”). If you take the pay, prestige, and the power, there should be some serious accountability. There has been none. But to get back to the MPS.
Sometimes small things make you proud of your kids. My son is an honours student in economics, with a keen interest in monetary policy and macro. Within minutes of the release yesterday he’d spotted this and pointed it out to me
Does it matter? Not in substance of course (and if you check now, they have fixed it), but it seemed revealing of an institution that struggles to even get the basics consistently right. Excellent it is not.
That there was a huge shift from May to August isn’t really in doubt. Here are the two OCR tracks
There has been no nasty external shock in that time (global financial crisis, pandemic, collapse in commodity prices etc) but we’ve gone from a “hawkish hold” (best guess, no easing until this time next year, and possibly some tightening late this year) to not only an OCR cut now, but a really large (at peak 130 basis points) change in the projected forward track for the OCR. I can’t recall another change that large that quickly, in the absence of a major external shock, in the 27 years since the Bank started publishing these forward tracks. It was simply because Orr and the MPC badly misread how the economy was unfolding now (Orr himself made this point yesterday, when he noted that the change of stance wasn’t about the medium-term outlook, but about partial data etc about where the economy is right now.) Other commentators have used the label “U-turn”. I prefer flip-flop myself (and in reality that change wasn’t even from May to August, but was largely between May and the July OCR review just six weeks later). Getting the medium-term right is a challenge for everyone, but an MPC – delegated so much power, allegedly as technical experts – simply should not get the near-term so wrong. And its communications should be a lot of more assured and authoritative than they are (eg recall the chief economist in May attempting to blame his tools). Instead we have a central bank and MPC that no one has any confidence in or respect for – be it local observers or international markets. They wield the power of course (they still set the rates) but no one serious looks to them as an authoritative guide or interpreter, despite all the budget and analytical resource at their disposal.
What about some of the numbers? I’ve been banging on for a while about how IMF estimates suggested that New Zealand’s economy was the most overheated of any of the advanced economies in 2022. The Reserve Bank has largely avoided until now any such comparisons, so it was interesting to see this chart
accompanied by the explicit comment that “New Zealand’s output gap reached a higher level than other countries in our sample [wider than those shown in the chart] during the COIVD-19 pandemic, indicating higher capacity pressures relative to our sample countries.” As it happens, in this set of forecasts they revised further upwards the extent of that peak excess demand (“output gap”) – a really damning commentary on MPC’s stewardship a few years back.
Right now (September quarter) the Reserve Bank estimates that the output gap is about -1.8 per cent of GDP. That number will inevitably be revised, but it represents the MPC’s best guess of where we are now. There is a lot of slack in the economy (or so they think). And it is unusual for the easing phase to start when the MPC believe that so much excess capacity has already built up. The Bank hasn’t always published real-time quarterly output gap estimates, but I cannot think of a time when the first easing would have come so late (eg the first easing in 2008, in July, appears to have been when we thought the output gap was about zero, the easings in 2015 were against the backdrop of a zero output gap, and there was no negative output gap when the easing came in 2019).
The fact that the first easing is late, relative to real-time output gap estimates, is not itself a criticism. There had been a huge inflation shock, that wasn’t overly well understood, and anyone in the Reserve Bank’s shoes might understandably have been a little cautious. My concern is less on how we got here (there isn’t much point quibbling now as to whether – as I thought – the OCR should have been cut in July rather than August) but on where to from here.
In my commentary after the May MPS I included this chart and comment
Quite how was growth expected to rebound was a complete mystery then.
And although the Bank has pulled down its estimates of growth for the rest of this year, in their dramatic change in OCR track, the same puzzle remains.
Here is growth in real GDP per working age population from yesterday’s MPS (red, SNZ data, green remaining 2024 quarters, and blue beyond that)
After two years of really lousy GDP growth (sadly, needed to get inflation securely down), the Reserve Bank expects that everything on the growth front will be back to normal from the March quarter of next year. Those projected growth rates are above the Bank’s own estimates of potential GDP growth, and so the output gap is projected to close gradually.
But how? On their assumptions, the world economy remains pretty subdued, net immigration settles to a fairly low level not doing anything much to growth, reflecting the government’s numbers fiscal policy (after being slightly expansionary this year) is expected to be quite contractionary for the couple of years beyond that. Whatever useful micro reforms the government is doing don’t look large enough to make a material difference, and aren’t something cited by the Bank.
Ah, but perhaps you are thinking, monetary policy must be the answer. After all, the OCR has been cut and is projected to be cut quite a bit more over the next couple of years.
But that can’t be the answer either, because the Governor was quite explicit in his press conference yesterday that the OCR remains at or above their estimate of neutral throughout the entire forecast period (several years ahead). Easing the OCR might reduce the extent of downward pressure – and recall that the lags mean that economic activity well into next year will already be being dragged down by policy as it stood until yesterday – but it isn’t going to generate anything like above-potential growth rates. Absent other shocks (which the Bank doesn’t forecast) and by construction (the Bank’s own articulated model) you get that sort of stimulus only when the OCR is taken somewhat below neutral. (Note that as inflation expectations are likely to carry on falling as headline inflation gets back to near 2 per cent, real interest rates may still be flat or rising even when the nominal OCR is being cut).
Look back at the output gap estimates since 2000 (the period the Bank publishes for) – or even back to the 1990s – and you simply do not find a time when a negative output had emerged when it has been closed again without the OCR being taken below best estimates of neutral. It was so in the early 1990s, it was so around 2001, it was so (for far too long) after 2008, a period which encompassed the 2015/16 easings. There is simply no reason to think the economy is operating any differently now (and again the Bank has often recent years repeatedly reaffirmed that it thinks transmission mechanisms are operating normally). The economy has been taken into a hole – to get inflation down again – and to get out of the hole anything other than very very slowly needs some external intervention. That is what active discretionary monetary policy does.
And that is why, as I’ve said a few times over the last 24 hours, I wouldn’t be surprised if a year from now the OCR was 2.5 per cent, or perhaps even lower. In fact, I will be a bit bolder and say that I will surprised if it is not that low. People have looked/sounded puzzled when I’ve said it, but the logic – of the Bank’s own frameworks and projections – seems pretty clear. I don’t think it is a big call at all. On the Reserve Bank’s own numbers, the best guess of the longer-term term neutral OCR is 2.8 per cent. No one knows what the neutral OCR is with any precision whatever – it really only be revealed over time, after the event – but I don’t see any reason why, give or take say 0.5 percentage points, the Bank’s estimate should be so very wrong. My own guess is probably a bit lower, but stick with theirs for now: if neutral is 2.8 per cent then even an OCR of 2.5 per cent by this time next year is (a) barely stimulatory, and b) will have to be dealing with more disinflationary pressure that will have built up between now and then as in the meantime the OCR has been above neutral.
Frankly, it shouldn’t be a terribly controversial view (and market pricing is already well below the Bank’s projected path). Of course, there are risks to both sides, and almost inevitably some shocks (positive or negative) will change the outlook between now and then, but the simple point remains that if you run monetary policy in a highly contractionary way to get a nasty bout of inflation back down again, and in the process generate a big negative output gap, a period of stimulatory policy is likely to be required to settle back on a more normal path. On RB numbers that would mean 2.5 per cent or below, and before too long.
I’m not a big fan of central banks publishing medium-term macro forecasts – about the largely unknowable future – but when they choose to, they really should follow through on the logic of their own mental models. A significant rebound in economic growth from the start of next year simply doesn’t seem consistent – with all their other assumptions – with continued materially contractionary monetary policy settings. Stick with those settings and the recession is only even more likely to deepen.
(And finally, but fairly briefly as this post has gone long enough, could the Reserve Bank please stop playing games around fiscal policy. As I highlighted last year, they had then shifted to focusing on government consumption and investment spending, rather than deficit measures, seemingly to avoid putting any heat on the then government. They aren’t much better now. Most macroeconomic analysis around fiscal policy, here and abroad, uses measures like the cyclically-adjusted or structural balance estimates that The Treasury and the IMF/OECD produce. Those measures exist precisely to aid assessments of the impact of discretionary fiscal choices on demand, activity, and inflation pressures. On the Treasury Budget estimates, this year’s Budget means the cyclically-adjusted deficit in 24/25 is slightly larger than the estimated deficit for 23/24. It isn’t the Reserve Bank’s place normally to weigh in on what should or shouldn’t be done with fiscal policy, but they should be consistently straightforward and honest about the impact of the fiscal choices any government makes. That simply hasn’t been happening last year or this. It may be convenient for MPC members, but serving their convenience is not either our concern or their job.)
UPDATE: Finally, finally…..monetary policy (OCR) cycles, whether in New Zealand or the US, have tended to involve swings in policy rates of 500 basis points (on average, albeit with variance). We had a 525 basis point rise to deal with the inflation outbreak. We shouldn’t be at all surprised if most of that proves not something that needs to be sustained. Big lifts in policy rates are almost always followed by big cuts, and when those cuts come they usually come much more quickly than forecasters – public or private – had allowed for.
The Minister of Finance has, over the last couple of weeks, been trailing various possible changes in the financial system. At the National Party conference there was the suggestion of trying to beef up Kiwibank, including by the injection of some additional capital from other than direct central government sources. And last Friday, there was an interview with the Herald’s Jenee Tibshraeny in which the Minister talked up the idea of overriding various bits of policy that are now squarely the legal responsibility of the Reserve Bank. Commentators suggest all this talk is to a considerable degree about preparing the ground for the release next week of the final report of the Commerce Commission’s report on elements of the banking sector, perhaps trying to ensure that there is little plausible ground for Labour or the Greens to attack the government on banking profits, access to services, or whatever.
I’m not going to respond in depth to all the Minister’s suggestions. On Kiwibank, I largely agree with VUW banking academic (and former regulator) Martien Lubberink’s column, and (rarely, and as it happens, even with John Key). If it were me, I would sell 100 per cent of Kiwibank tomorrow, simply because there is no good reason for a government to own a commercial bank, but I am even more wary of partial privatisation of a bank than of the status quo).
The Minister also suggested that she might change the law to force the Reserve Bank to (a) lower bank capital requirements, and b) provide carveouts for some or other favoured groups. Now, as it happens, I have long argued that prudential regulatory policy settings should be decided by the Minister of Finance, on the advice of the Reserve Bank and The Treasury. As Willis notes, she is accountable, and the Reserve Bank is not (although the Minister decided to reinforce that effective unaccountability recently by further extending the term of the chair of the Reserve Bank Board – and it is the board that now wields the prudential policysetting powers). But if you really want to make a change like that you do it after wide and serious consultation, or perhaps even as part of a well-trailed campaign promise, not simply (as it seems) to play distraction because another government agency might be about to release a briefly awkward report. I’m also inclined to think bank capital requirements are higher than is really warranted (that was my view when the policy was being set five years ago and remains so today) but if you want to be taken seriously as a Minister of Finance, you don’t just drop such a view into an interview – with, it appears, nothing in support – you outline carefully your case, or commission some reviewers to look into the matter carefully. Martien Lubberink also addressed this set of Willis comments, including this apt line.
But the item in the Minister’s grab-bag that I wanted to comment on was around the remuneration of settlement account balances held by banks at the Reserve Bank. On these balances – the aggregate level of which is determined wholly and solely by the Reserve Bank – banks are paid the OCR (currently 5.5%). The level of settlement cash balances is currently around $43 billion – off its highs, but still hugely higher than the $7bn or so that was more common pre-Covid. The reason for the difference? LSAP bond purchases by the Reserve Bank, and the subsidised direct lending (under the so-called “Funding for Lending” scheme) from the Reserve Bank to banks.
In the Herald interview the Minister is reported as saying that “she had asked officials for advice on the way the RBNZ manages banks’ settlement accounts”, and in further comments in the same interview making clear that she was referring to how interest was paid. She goes as far as to suggest that it might be appropriate to amend the Reserve Bank Act to compel any change in approach that she considered warranted.
The issue of remuneration of the high settlement cash balances has been around for a couple of years. I think I introduced it first to the New Zealand discussion with a post in late 2022 on a paper by a former Bank of England Deputy Governor in which, among other issues, he suggested a possible case for paying below market rates on some portion of the large (at present) settlement cash balances in the UK. My post was headed “A bad idea”, which remains my view. That October 2022 post prompted Tibshraeny to give the issue a bit of coverage, which in turned seemed to prompt the then Minister of Finance Grant Robertson to ask for some official advice on the matter. Tibshraeny OIAed that advice, and I wrote about it in another post in March 2023. Neither the Reserve Bank nor The Treasury were at all enthusiastic, and there even Grant Robertson – who, we later learned, had at the same time been toying with windfall profits taxes on banks – left it. It was, after all, on current legislation simply a matter for the Reserve Bank (the OCR, the rate paid on settlement cash balances, is the primary instrument of monetary policy, and the Reserve Bank has operational independence).
There is a bit of a view around in some quarters that changing remuneration practices could undermine the effectiveness of monetary policy (in fact, it was one of the lines the Reserve Bank used on Robertson). That isn’t necessarily so. Tiered approaches have been used elsewhere (including by the ECB when they had negative interest rates, as a subsidy to banks in that case), and so long as one clearly distinguishes between a first tranche that received a nil or below market rate from the marginal balances on which the full OCR would be paid, effective monetary control would not be impaired. But that doesn’t make the policy option the Minister was openly toying with a better idea. In fact, it is still a very bad idea. Bank settlement account balances don’t just arrive in a vacuum – rather they are a counterpart to a change in some or other items on bank balance sheets (eg a bank increases its settlement account balances when it wins deposits from another bank, or (in this case) when (say) a customer sells government bonds to the Reserve Bank and deposits the proceeds in a bank account, on which the customer will normally and reasonably expect a return). Running a tiered approach to remuneration of settlement cash balances, of the sort Paul Tucker first proposed a couple of years ago, is simply an arbitrary tax on banks, and financial intermediation more generally, without any analytical foundations or – if the RB simply did it – without any parliamentary scrutiny. Taxes should be imposed by those whom we elect, our MPs sitting in Parliament.
But changing the law to enable the Minister to direct the bank on policy on remuneration of settlement accounts, or simply to mandate a completely different model, would be hardly any better than the RB just arbitrarily making such a change. There would be some formal democratic legitimacy, but for a policy that has just no substantive merit. As there was no good case for a windfall profits tax for banks, so there is no decent case – not even a shred of one – for a targeted ongoing tax specifically on banks. It would be arbitrary, inefficient, largely borne by New Zealand depositors and borrowers, and would send a simply dreadful signal, at a time when international markets are already looking askance at the Reserve Bank and the conduct of policy – and the policy “debate” more generally.
I don’t suppose it is very likely that Willis and the government will end up doing any of the things she trailed in last week’ Herald interview. Doing them probably wasn’t the point – rather the pursuit of a good headline with a certain sector of the New Zealand audience, narrowing room for Labour and the Greens, seems to have been the point. Empty populist rhetoric seems a description closer to the mark than serious considered policy options and analysis (note that not a hint of any of this appeared in the election campaign, less than a year ago). Perhaps the rhetoric plays well with some focus groups, but it hardly enhances any reputation Willis aspires to to be (and be seen as) a more serious Minister of Finance (focused on things that might make a real difference) than her predecessor.
I’ve already noted that Willis could readily have changed the chair of the Reserve Bank board when his term expired (her government has been happy to replace various other chairs in agencies where dismissal at will as an option). She could have filled the vacancies on the board with people better qualified than those Robertson appointed but hasn’t done anything about that either. It remains almost beyond comprehension that she didn’t move on either front, and suggests she isn’t really serious about any of this. In the same vein, each year the Minister of Finance writes a Letter of Expectation to the Board, an opportunity to highlight her priorities or things she wants the board and Bank to have regard to etc. The 2024 letter is sitting on the Bank’s website, and has not a hint of any of the sorts of issues/concerns Willis was raising in the Herald interview. She also hasn’t revised the Financial Policy Remit (a new tool) issued by Robertson a couple of years ago. There are things around the Reserve Bank that the Minister can’t easily or quickly fix (eg she is stuck with the Governor, unless he chooses to go early, for another 3.5 years), but she has shown no sign of doing any of the things she could (eg Board chair and vacancies, unwinding new indemnities the Bank has been given) or of using any moral suasion (eg through the letter of expectation) around financial policy issues or the Bank’s budgetary excesses.
So it all just looks a lot like a search for a good headline, and political operatives managing tactical risks for a couple of weeks, rather than a Minister with any sort of serious interest in, or intent towards, a much better central bank, whether in its monetary policy or financial regulatory roles. Perhaps in that sense she and the Governor – who seemed to have such a testy relationship when National was in Opposition – deserve each other. It is just that New Zealanders deserve much better from both roles.
(I have submitted an OIA this morning for the advice etc around remuneration on settlement cash balances. It will be interesting to see if either Treasury or the Bank are giving Willis even slightly different advice now than they gave Grant Robertson last year (but it seems unlikely).
croaking cassandra 