Fiscal and monetary policy

August 19, 2024August 19, 2024 Michael Reddell Fiscal policy, Monetary policy, Treasury

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.

$35m per annum and this is the sort of “engagement” we get?

August 17, 2024August 17, 2024 Michael Reddell Adrian Orr

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.

Heading for 2.5% (or less) by this time next year?

August 15, 2024August 15, 2024 Michael Reddell Adrian Orr, Monetary policy

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.

Still a bad idea

August 13, 2024August 13, 2024 Michael Reddell Prudential regulation, Reserve Bank

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).

Treasury says one thing in a speech but quite another in the BEFU

July 27, 2024July 27, 2024 Michael Reddell Treasury

I picked up The Post this morning to find the lead story headlined “Recession hits homes harder than businesses”, reporting a speech given earlier this week by Treasury’s deputy secretary and chief economic adviser Dominick Stephens. There was an account of the same speech, but with some different material, on BusinessDesk a couple of days ago. Astonishingly, despite being an on-the-record address, on what are clearly high profile macroeconomic issues, including touching on monetary policy, The Treasury has not issued the text of the address, so the rest of us – not the Auckland “business crowd” who heard it live – are entirely reliant on journalists’ reporting of what the chief economic adviser to the government’s principal economic adviser (which is how Treasury likes to style itself) actually said, let alone the context within which he said it. That seems less than ideal (to say the least).

The remarks, as reported, were no better, and seem remarkably loose from a very senior Treasury official. They also seemed at odds with – if probably somewhat more accurate than – the story Treasury was telling in Budget Economic and Fiscal Update (BEFU) only two months ago. I have long defended New Zealand’s system, in which the BEFU documents and forecasts are the best professional view of The Treasury, and are not the views of the Minister of Finance. The Secretary to the Treasury has to affirm this with each EFU

On the basis of the economic and fiscal information available to it, the Treasury has used
its best professional judgement in preparing, and supplying the Minister of Finance with,
this Economic and Fiscal Update.

Ministers spin, while public servants – a fearless Treasury – is supposed to be providing the Minister and the public with an unvarnished best professional view. That isn’t always easy for public servants – who have to deal with ministers and their offices every day on multiple matters – but if they aren’t up to that standard, they shouldn’t take the jobs.

Take this from the BusinessDesk report

It seems pretty clear that Stephens is claiming that they knew there was a quite serious recession underway running into the Budget, including as context for decisions ministers were making then, and that they knew things were getting quite a bit worse.

But….here are The Treasury’s quarterly GDP forecasts (quarterly per cent changes) from the BEFU

What they actually told the public (and ministers presumably) is that they thought that there had been positive GDP growth in the March quarter and that growth would be picking up – to at least semi-respectable levels – over the rest of the year. Now, in fairness, the economic forecasts are finalised quite early (in this case 5 April), but the text of the BEFU wasn’t finalised until 23 May (well after ministers had made their decisions and just a few days before delivery on 30 May). So there was plenty of opportunity to ensure that this view – a deepening recession – made it into the text, as an update to the older numbers.

So I went and checked the text. In dozens of pages of text, the word “recession” does not appear once – whether about the past year or the period ahead – and neither do “recessionary” or “downturn”, let alone perhaps more loaded words like “slump”.

So there seem to be three choices. Either The Treasury wasn’t providing us (or ministers) with their best professional forecasts and commentary, or Stephens is now rewriting history (consciously or not) to make Treasury look more prescient than it really seems to have been, or that Stephens – the chief economic adviser – had a quite different view from his boss, the Secretary, at the time the BEFU was done. My money is on the second of those explanations….which, frankly, if true is a pretty poor show from such a senior public servant. Perhaps there is something to the third story, but if there were such differences they shouldn’t be showing up like this.

There seems to have been another interesting contrast between BEFU and the Stephens speech. The Post’s report says “Stephens also confirmed the finance minister’s position that her Budget was disinflationary despite giving Kiwis more cash through tax cuts”. That description is reported, rather than a direct quotation, but if it is accurately reported it seems at odds both with The Treasury’s own published estimates in the BEFU, in which the structural deficit actually increases a little in 24/25 over the previous year, and also somewhat at odds with these words from the BEFU itself. This is from the very first page of the BEFU Executive Summary

Treasury expected that GDP would be picking up (see chart above) partly because of the boost to private sector incomes from the tax package. All else equal, that adds to inflationary pressures (and recall those structural balance estimates). (Note that the Minister of Finance is still stonewalling, deliberately delaying the release of actual Treasury advice in this area.)

Then there was this – the big text extract readers of The Post will have seen this morning –

Really? One of the biggest recessions we’ve had? This from the same agency – principal economic adviser to the government no less – that reckoned that GDP growth would be positive all this year. (Incidentally one wonders what the Minister of Finance, her office, or PMO thought when they read this story this morning.)

From later remarks in the article it would appear that Stephens is talking about per capita GDP – which has already fallen about 4 per cent from peak – but no one, no one, is going to compare the sort of economy we are now facing with the experience in, say, the 1991 recession. The big difference isn’t just that the economy had been subdued then for years before the specific 1991 downturn, but that the unemployment rate rose from just over 4 per cent to just over 11 per cent. Last we saw, Trreasury was picking the unemployment rate will peak next year at not much over 5 per cent. Perhaps there has been a radical change of view since BEFU, but if so perhaps Treasury could lay out some numbers, in a text or document we all have access to.

Stephens’ commentary on other matters also seems very very loose. Take those comments about the “fiscal response to Covid”. He seems not to give any weight to monetary policy, which in the way our system is set up is supposed to move last to keep overall economic activity close to potential and inflation close to target. Governments can spend freely or not, and it isn’t supposed to lead to a grossly overheated economy followed by a nasty recession. And while Stephens claims that we had a “really very big boom”, it really wasn’t that big – incomes just didn’t grow that much (real gross disposable income per capita at peak was just 3 per cent above the March quarter 2020 level), and while the economy became very stretched for a time (on RB estimates the biggest output gap in decades), the peak was really very shortlived. It was as nothing compared to past booms (whether the 2000s or the mid 1980s).

Somewhat surprisingly, Stephens was also apparently – description of his comments rather than a quote – offering a Treasury view on the OCR (“The Treasury is sticking to its guns and predicting interest rates will start to fall in September because there’s still work to do on bringing down non-tradeable inflation, said Stephens”). Which seems a bit odd given that the Secretary to the Treasury is herself a non-voting member of the Monetary Policy Committee. I’m all in favour of MPC members generally offering their views and analysis in public, but even in more transparent systems overseas it is rare for MPC members to be quite that blunt about specific forthcoming OCR decisions. And if Stephens wasn’t speaking conscious of Treasury’s MPC spot, he really shouldn’t be second-guessing, or perhaps implicitly pressuring, the independent central bank MPC in public. Frankly, it all seemed a bit half-baked.

Now, and to be fair, there was one bit of his reported remarks that I really liked (as which I have heard him articulate before at a Treasury seminar)

In principle that is exactly right (in practice, there is inevitable uncertainty about just how much, how deep, and how long will prove to have been required). (Incidentally “slowdown” does appear in the BEFU, but about productivity growth and about events abroad.) There is a price to be paid when our macroeconomic policymakers stuff things up, and unfortunately that price is paid by us and not by them.

But although that “this is the recession we had to have” type of sentiment is quite right, I’m then left wondering why Stephens was muddying the water by suggesting – reported in both articles – that events in China explain our recession (expected or otherwise). They simply don’t. The rest of the world – and China is a major source of demand globally, not just re New Zealand – is just one of the many factors the Reserve Bank has to take into account in setting monetary policy. So far they have judged that this downturn is what we had to have (rightly or wrongly, but if they thought otherwise they’d already have cut the OCR). Our policymakers did it to us – and given the stuff-up in 2020/21 it had to happen – not people or countries beyond our control.

There is a suggestion (this from Matthew Hooton’s column yesterday) that ministers have joined the club of those underwhelmed by The Treasury

but you’d like to think that a Kaikohe bookkeeper would keep matters rather tidier and more disciplined that what was on display this week from Treasury and its chief economic adviser.

Not a good case for a CBDC

July 26, 2024July 26, 2024 Michael Reddell Cash, e-cash

The Reserve Bank’s latest round of consultation on a possible central bank digital currency (CBDC) closes today.

The thick and probably expensive (at least one of the documents was produced jointly with the consultancy firm Accenture) set of consultation documents came out a few months ago. I thought I had run out of time to read and submit on them because somehow I’d got it into my head that the deadline was last week. It was nice of the Reserve Bank to send out a reminder to interested parties that the deadline was in fact today.

Until I read the documents yesterday I still wasn’t sure I’d bother. But when I did read them I was astonished at how thin (in analytical etc substance) they were, and how weak the case seemed to be for the rather limited CBDC they were proposing (as well as how little thought seemed to have been given to how things might evolve, beyond the Reserve Bank’s control, once a CBDC was introduced (which, in fairness to the Bank, they envisage as still being some years away, beyond even the terms of Adrian Orr and Neil Quigley)).

I wrote a short submission on an earlier (2021) Reserve Bank consultation on these issues. The submission I lodged this afternoon was not much longer (5.5 pages). With more time I might have treated some of the issues in more depth, but really the onus is on the Bank to make their case, and to this point they have not done so.

My full submission is here.

The introduction and final paragraphs follow

It might make an interesting OIA for someone to ask the Reserve Bank how much money has been spent on CBDC analysis and proposals over the last five years. That sum seems unlikely to have been small.

Treasury wanting to use fiscal policy more

July 23, 2024July 23, 2024 Michael Reddell Fiscal policy

Government departments are now all required by law to write and publish a Long-term Insights Briefing at least every three years.

and they have to consult the public on both choice of topic and the draft report

The Public Service Commission gives its take on these provisions here

Count me more than a little sceptical. Good agencies, addressing significant issues/challenges, would in days gone by been offering serious analysis and free and frank advice in Post-Election Briefings, which used to be written with a clear expectation that the same advice/analysis would be offered no matter which party won (I still remember finalising one such Reserve Bank briefing at about 6pm on election day, with a clear expectation that we had to be finished by the time the polls closed). Good agencies, dealing with complex analytical issues, will also often be publishing research from time to time. So I’m at a bit of a loss to understand what the Long-term Insights Briefing provisions are meant to add, other than more bureaucratic overlay. And if, perhaps, good agencies could readily find a first topic, churning out something different every three years feels like it will quickly become a compliance burden and little more.

But government department chief executives are stuck with the law as it is, including no less than the outgoing Secretary to the Treasury. Her staff are currently consulting on a proposed topic for their next Long-term Insights Briefing, complete with the somewhat pointed observation that resources available for “department stewardship work” are “finite” (presumably, “so don’t expect too much”). Submissions close on Friday, for anyone interested in sending them some comments (I sent in a few quick comments yesterday).

The proposed topic is focused on “sustainable and resilient fiscal policy over economic cycles”, and thus is quite (and probably appropriately distinct from the long-term fiscal pressures that Treasury addresses in its (also now somewhat repetitive) statutorily-required Long-term Fiscal Statement.

Ever since 2020, The Treasury has seemed to be hankering to use fiscal policy more actively for counter-cyclical stabilisation purposes. In a speech in 2021 (which I wrote about here), the Secretary (and those around her) were talking up what fiscal policy could do in this area. Those were the days before it was clear that both inflation and fiscal deficits had gone badly off the rails. But the enthusiasm still seems to be there. There was the work Claudia Sahm has been doing for them on so-called semi-automatic stabilisers, which I wrote about a few weeks ago. And now there is this consultation document, which has in it a very strong flavour of wanting to see fiscal policy used more actively for countercyclical purposes. If it was perhaps pardonable to think about that in the abstract five years ago, you’d have hoped that the actual experience of the last four years would have prompted a rethink, and some fresh humility. But there is no sign in Treasury’s consultation document that they plan any sort of hardheaded review of the experience of fiscal policy here since the start of 2020, or the use of active fiscal policy in other countries either in the 2008/09 recession or since 2020. You’d certainly get no hint that years after the shock – that did warrant deploying some government expenditure resources – we are now stuck with structural deficits, and successive governments repeatedly extending the horizon for a return to surplus.

Treasury repeatedly, and after all this time I can only conclude deliberately, choose to conflate counter-cyclical macroeconomic stabilisation (a role that has long been assigned primarily to monetary policy) and other natural or established functions of government (eg income support in crises, or tail risk insurance). Treasury officials like to talk up the wage subsidy scheme. And it isn’t unreasonable that they should do so, as income support (even if it was, arguably more generous than was really needed). When the government compels people to stay at home and directly or indirectly shutters their businesses, it isn’t an unreasonable quid pro quo (citizens might reasonably demand it) that governments ensure people can keep body and soul together (perhaps even keep together established employment relationships). Income support is something governments can do, and do quickly. Macroeconomic stabilisation policy isn’t primarily about income support, and typically doesn’t, and doesn’t need to, operate that fast. And income support might be needed even if the economy as whole was overheating (eg production was cut but expenditure demands stayed high). They are simply too different functions, and shouldn’t be conflated, either conceptually or in practical policymaking. One can think too – Treasury does – of things like the fiscal consequences of severe earthquakes. Such activity is likely to be net stimulatory for the economy as a whole (this was something the RB recognised way back in the first days after the 2011 quake). If the severe quake happens to come at a time when the economy has a lot of excess capacity – as was the case in 2010/11 – there is no tension between the two. But earthquakes don’t conveniently time themselves to fit the state of the economic cycle. The next severe one might hit when the economy happened to be already overheated for other reasons. In those circumstances, what it was right (or legally obligatory) for governments to do wouldn’t materially change. Managing the overall macroeconomic consequences – crowding out other spending to make way for this combination of government and private activity – would then just be the Reserve Bank doing its job. Two quite separate jobs, two quite separate set of tools. And yes, big government spending commitments have macro consequences, but the system is set up for the Reserve Bank to take those into account, to move last, and – as far as they are capable – maintain price stability.

One might think it was a bit of a fool’s errand to defend monetary policy after the experience of the last few years. But, if anything, I think it is to the contrary. What the last few years actually show – and I suspect the Governor would agree (he used to say it in 2020 and 2021) – is the potency of monetary policy. When mistakes are made it can do a great deal of damage (viz, the most severe outbreak of inflation in decades) but it can also be turned around very quickly (see the 525 basis point rise in the OCR in 19 months) and inflation is on course for being at target again before long. It would, clearly, have been better if they’d not made the mistake in the first place, but that is a forecasting and macroeconomic comprehensions issue not one about the tools – and an issue that faced The Treasury just as much as the Reserve Bank (noting that the Secretary to the Treasury now sits on the Monetary Policy Committee). Reversing fiscal policy is just evidently a great deal harder – not just here, but in most countries at most times. So-called “shovel-ready” projects, designed to provide short-term stimulus, were still going on years later, having exacerbated inflation pressures in the meantime.

Treasury has also appeared to be hankering for a greater role for itself using as justification the effective lower bound on nominal interest rates. This was an issue the Reserve Bank saw itself facing in 2020, belatedly realising it had done nothing for years to even alleviate the self-imposed problem. But it is also an issue that is quite easily fixed technically, and you might think that a Treasury – both sitting on the MPC, and concerned about unnecessary fiscal pressures, difficulty of reversing fiscal imbalances etc – would have been at the forefront of insisting that the Reserve Bank and the Minister of Finance get this technical issue fixed. It isn’t of course a problem today – with the OCR still at 5.5% – but no one has any great confidence where the neutral rate is, or how deeply below it the OCR might need to go in the next severe recession.

Treasury may think my comments are a little unfair. There is other stuff in their (short) consultation document, but nothing in what they have presented suggests anything like an appropriate degree of critical scrutiny of options for more active use of fiscal policy, or of their own fiscal policy advice in the last few years.

Perhaps it doesn’t matter that much. The new government seems unlikely to be interested in more-active fiscal policy (with asymmetric risks), and in some respects the Long-term Insights Briefing has the feel of a compliance burden they simply have to jump through. But if the work is going to be done it needs to be done in suitable critical and hard-headed way.

One of the questions Treasury poses is around “what rules and strategies can be used to support a credible commitment to rebuilding fiscal buffers after negative shocks”. Personally, I think there is a fairly simple response to that. Severe adverse shocks will come, and they will tend to be asymmetric, but fiscal policy is unlikely to knocked off the rails if there is a strong and shared commitment to a modest structural surplus. There will be one-offs that mean that in the year of a disaster (pandemic or earthquake) the cyclically-adjusted balances will be in deficit, but keeping the structural balance in modest surplus – and quickly restoring surpluses if there are unanticipated deviations – is the simplest and surest way to keep fiscal capacity able to do stuff only governments can do, while leaving countercyclical macro stabilisation to monetary policy, the tool best suited (and largely costless to the Crown) to doing that job. Unfortunately, the Treasury of the last decade – and more specifically the last four years – has tended to talk and write in ways that leave political parties more comfortable in deviating from that sort of standard.

Public sector bloat: Reserve Bank edition

July 13, 2024July 13, 2024 Michael Reddell Reserve Bank

A week or so back I did a post, prompted by some tweets by @Charteddaily, about the Reserve Bank’s big-spending plans for the current (24/25) financial year – the financial year, that is, in which many Wellington bureaucracies are facing quite some considerable expenditure restraint/cuts, most particularly those that don’t really do stuff that directly faces members of the general public.

There was the 20 per cent planned increase in spending on staff salaries – with inflation coming down it must be a big increase planned in staff numbers, and the really extraordinary $35 million planned spending on “engagement with the public and other stakeholders” (this on top, apparently, of the item further down about communication of MPC decisions).

No one seems to have any clear idea what this $35 million is (nothing they’ve published gives any real sense) and although, as I noted to someone the other day who asked if I had any idea, it just can’t be quite as bad as it sounds, it sounds pretty bad indeed.

Today, @Charteddaily was at it again, having dug out from Parliament’s website the Reserve Bank’s responses to their 2022/23 financial year Annual Review undertaken by FEC. There are all sorts of gems apparently, from the $5500 spent at the Maranui cafe in Lyall Bay for offsite planning/team-building (lots more on other such events). Perhaps, and just possibly, some level of expense on those sorts of things is necessary and even warranted (it was, after all, 2022/23 a year of Labour fiscal excess), but when I scrolled through the documents what really caught my eye was the bloated spending on communications functions. Here are the permanent staff numbers

So that was eleven full-timers on “content and channels”, and six for internal communications alone (this is an organisation with only two offices and about 500 staff). @Chartedaily checked and found that The Treasury has only six communications staff in total……. Now, the Reserve Bank is a little more public facing than The Treasury, so you might expect a few more, but….more on internal comms than Treasury has in total? Really? Well, apparently so on the Orr/Quigley/Robertson watch (and Robertson gave them a second big boost to their funding agreement during this period).

Then there is some time series data

Note that on top of the 27 permanent staff there were 4 contractors (although a later table suggests they mostly work on other stuff). 27+ communications staff (and they still can’t even commuicate monetary policy competently – see last two OCR reviews). Oh, and the salary budget in 22/23 was five times what it had been in 2018/19, Orr’s first full year. (I recall doing an OIA several years ago when the comms staff were around 18, and that seemed flabbergasting enough……but 31 of them now).

What has the Board and Board chair been doing? Presumably just what Nicola Willis wanted given that (a) she just reappointed the Board chair, and (b) raised no issues around spending restraint in her letter of expectation to the Board.

One part of the communications empire is responsible for OIA requests, so you’d assume that with so many resources they’d be just superb in responding to those requests. But….whereas in 2019/20 78 per cent of their 100 OIA requests were responded to within the statutory 30 days, in 2022/23 only 54 per cent of their 94 requests were. That won’t greatly surprise anyone who has ever dealt with them, but is still striking to see it in print.

It is a great deal of money being spent by an organisation with very weak accountability, and without even the excuse/rationale that they do a lot of direct public-facing stuff. They don’t sell stuff to the general public, or grant things to the general public. They mostly deal with banks, financial institutions, other government agencies, and various vendors. Their policies affect many or most of us indirectly in various ways but – mercifully – we aren’t yet subject to massive billboards of Orr and the MPC, or full page newspaper adverts etc. Not even a mea culpa for losing taxpayers a mere…..$11 billion (which swamps even the comms budget).

And it isn’t even as if their communications is that good. It just isn’t obvious what they – and more importantly we – are getting for the money they are spending. Their main documents seem okayish, but nothing spectacular. They seem not (mercifully again) to be running a TikTok account, and although they do have an Instagram account it doesn’t seem to have very many followers (as you might expect: central banking done well is supposed to be pretty dry and boring; grey men and women operating technocratically and (supposedly) expertly). You are rather left wondering what these 27+ people actually do all day? But that is probably just a failure of imagination….always meetings to attend, coffee catch-ups to hold, and so on.

It really is quite extraordinary. Not so much that Orr and Quigley would do this if they could (bad bureaucrats will, and recall that in his day job at a university Quigley was spending $1m on a lobbyist), but that ministers enable it and now, apparently, endorse it. It was Robertson-era excess in 2022/23 – the stuff National rightly complained about – but…..the chair has just been reappointed, the budgets are expanding again.

And that is now on the new Minister of Finance who seems to have done nothing about it. (You rather hope The Treasury monitoring reports to the Minister are doing something about highlighting such excess.)

Flip flop flip flop

July 11, 2024July 11, 2024 Michael Reddell Uncategorized

The Reserve Bank’s Monetary Policy Committee yesterday delivered their latest OCR review.

In my post on Tuesday, in which I suggested that an OCR cut was appropriate now, I’d noted

As it happens, yesterday was another reminder that it is unwise ever to bet against Reserve Bank induced volatility, sometimes intended, sometimes not.

You’ll recall that the May MPS (forecasts and words) was a lurch in the hawkish direction. This was their OCR track, revised out and up, showing an on-balance probability of OCR increases for the rest of this year, and nothing below the current rate until the August 2025 Monetary Policy Statement.

and this was a chart I’d constructed from the same projections:

Real interest rates kept on rising until the second half of next year, but somehow – as if by magic (given the absence of domestic or external macro stimulus) – the economy gradually recovered anyway.

The MPC then seemed to have barely understood what it was doing, and a couple of days later the chief economist was indulging in the old bad workman’s excuse (blaming his tools). We weren’t really meaning to suggest possible rate hikes, they claimed. but if so why publish the projections that showed exactly that, when any half-competent MPC member would have known precisely how they’d have been read? And in the end the markets seemed all rather underwhelmed and unconvinced and didn’t really move much at all.

But say what you like about the May MPS, at least it was done in the context of a full set of economic and inflation forecasts. And it was finalised with the full MPC present.

By contrast, what of yesterday’s statement? Not only wasn’t there a full set of forecasts (internally, let alone published), but the Bank’s chief economist – who is presumably primarily responsible for both sets of forecasts and economic analysis – had been allowed to go off on leave and wasn’t even at the meeting (they only happen seven times a year). And there really hasn’t been that much data since late May, and none of it that (to my eye anyway) seemed particularly surprising or game-changing. Most notably, especially in the context of all the explicit concerns in the May MPS, there hasn’t even been another CPI outcome (and the Bank rashly chooses to do these reviews a week before the CPI comes out).

Now, as it happens I think the view articulated in yesterday’s statement is much better and much more likely to accurately reflect what is going on, and is likely to go on, in the economy and inflation than the one delivered in May. And in that sense, and in isolation, I welcome it. Perhaps the two new MPC members have begun to make some useful difference (although in the culture, and under the obligations of silence they’ve assumed, we may never know – we get much more openness from our Supreme Court justices than we do from MPC members).

But we should be able to expect better than such policy lurches, that are neither signalled in advance (none of the frequent speeches we see in the better and more open central banks) nor evidently grounded in big shifts in hard data. Take as just one example: the May MPS was full of worries about and references to non-tradables inflation. The chief economist’s speech just a few weeks ago was in the same vein, and if anything more stark. By contrast, in yesterday’s two page statement there was not a mention, and barely even an allusion. And did I mention that in meantime we haven’t had a CPI outcome (in fact since April)?

It really isn’t good enough. In fact, it is amateur hour stuff from a statutory committee, allegedly with some expertise, which has been delegated by Parliament a huge amount of power and influence and yet seems to face almost no real accountability (apart perhaps from an ever-growing lack of respect, as if that seems to matter to Orr et al).

This time it seems that they did move the market (significant changes in both the exchange rate and short-term interest rates). And you can see why that might be the case. This was the concluding line in May

and this was yesterday’s

One is a great deal looser, leaning towards easing, than the other. That is especially so when they chose to frame yesterday’s statement in terms not of inflation itself, but of “inflation pressure” (usually a reference to the economic imbalances – output gaps, unemployment etc – that precede changes in inflation).

Combined with a unqualified statement that they are confident inflation will be under 3 per cent this year, and rather gloomy comments on the state of activity and demand, it would normally be a pretty strong signal of the likelihood of an OCR cut really rather soon (perhaps even in August).

But this is the MPC we are dealing with. Having lurched in one direction in May, in the other direction (without much data or a full set of forecasts) in early July, who knows where they will be by late August? No doubt next week’s CPI should be quite important, perhaps even decisive now in a normal MPC, but…..this is the Orr/Quigley MPC.

It really isn’t good enough. A couple of weeks ago the Associate Minister of Finance was defending the weird reappointment of Neil Quigley (as if everything had just been fine in the Bank), with a claim that too much “chopping and changing” wasn’t a good thing.

Quigley has been chair, through all the various mishaps, for eight years already. The MPC that he is responsible for – the Board determines who ministers can appoint or reappoint – can’t hold a stable view for even six weeks at a time.

But there is no sign any of it bothers the Minister of Finance, primarily responsible for the Bank and for Quigley/Orr, or presumably her boss or the rest of the Cabinet.

And perhaps again it is time to reflect on the monolithic approach to the MPC put in place by Orr/Quigley, with the imprimatur first of Grant Robertson and now apparently (since she has done nothing to change it) endorsed by Nicola Willis.

Monetary policy is an area of legitimate and real uncertainty. As I noted in the post earlier in the week, if ever a policymaker isn’t conscious of much uncertainty, either they aren’t thinking hard enough or they’ve left things far too late. But go back and read the May MPS, and you will search in vain for any sign of intelligent differences of opinion. There simply is none. In fact this is the only use of “some members” in the entire document

Nothing at all of different models of how things are playing out here, or how monetary policy might best respond. These are matters of real uncertainty (at least among sentient thinking people).

And as demonstrated by the fact that only six weeks later the Committee had lurched to a materially different position. And again unanimously. This time the only “some members” was this statement of the blindingly obvious.

This is a Committee that simply has not earned anything like deference. It, like any powerful goverment entity but perhaps especially after the record of recent years, deserves constant scrutiny and real accountability. Instead, we get lurches and bluster….and a government so unbothered they reappoint the man directly responsible for the MPC (appointments and performance) to yet another term.

On a slightly lighter note to end, the Committee yesterday expressed unconditional confidence that inflation will be under 3 per cent this year. You may recall this, little-reported, line from the Governor, captured by an ODT reporter just after the last MPS

From my comments at the time

We should be getting, and really need, something much better, much more commanding of respect and confidence, from our central bank. That is on the Minister of Finance. But she shows no sign of caring.

Still avoiding responsibility

July 9, 2024July 9, 2024 Michael Reddell Uncategorized

I was away when Reserve Bank chief economist Paul Conway gave his recent speech, “The road back to 2% inflation”, and since I didn’t see any material commentary on it I didn’t bother going back to it when I got home. But my son – honours student researching monetary policy (anyone wanting a young economist at the end of year, get in touch…..) – prompted me to finally do so. And since I’ve been quite consistently critical of the lack of serious speeches from the MPC members, I shouldn’t overlook the handful (even if they are just selling a party line, rather than really opening up issues and alternative perspectives) that do emerge.

First, some kudos. With the speech on the Reserve Bank website there was a transcript of the following Q&A session (the speech was apparently delivered as a webinar). That should be standard practice, since the unscripted remarks of policymakers can be at least as informative as the scripted and carefully negotiated ones are, and we know central bankers can go off reservation. I’d link to the transcript but can’t now find it again (no doubt there somewhere, but not on their speeches page).

The speech seemed to mainly be an opportunity to report some recent research results from Reserve Bank staff (several Analytical Notes). It is good to see some of those coming out (in a telling comment on how bad things had been, in the Q&A session Conway himself highlights that it was good that they are now “really cranking out” research again).

Conway wasn’t at the Reserve Bank when the big and really costly mistakes were made by the Monetary Policy Committee, joining only in May 2022. One might therefore have hoped that he’d be able to take a more detached and objective view on what had gone before. After all, even though in his management role he works for the Governor (and his grossly underqualified direct boss, the DCE responsible for macroeconomics and monetary policy, with a marketing degree), he does actually hold a statutory position as a member of the Monetary Policy Committee, and isn’t supposed to simply defer to the boss (or institutional interests) in reaching his views and votes.

Conway’s speech is presented as forward-looking in nature (“the road back to 2%), but there is quite a lot of history in it too, and it is the historical dimensions that got my goat. In particular, there is a persistent and repeated refusal to accept (at least in public, which is where it counts in terms of accountability) that monetary policy mistakes and misjudgments are primarily responsible for the severe inflation outbreak, the aftermath of which we are still living with. All the arbitrary and never-to-be-reversed redistributions of wealth, all the dislocations of markets and businesses, and now the recession and significant rise in unemployment which the Bank, no doubt rightly, tells us is necessary to get inflation comfortably back down again.

To repeat one of my consistent lines, human beings are fallible, they make mistakes. Central banks – here and abroad – are made up of humans, so they make mistakes. Really serious ones, of the sort seen in the last few years, shouldn’t happen but they do. One might even offer perspectives in mitigation: the pandemic was something quite extraordinary, and many people (here and abroad) misread the macroeconomics of it for too long. But those responsible need to take responsibility for the mistakes that were made. Those who now hold office who weren’t even there at the time have even less justification for not detachedly owning that those who were there made (really serious and costly) mistakes. Plus, in most human affairs, contrition goes quite a long way…..including (but not limited to) as a sign that one is even interested in learning from the mistakes and doing less badly next time.

Instead, there is avoidance and minimisation right through the speech.

At one point we are told that during the Covid period interest rates were “relatively low”. Not the lowest they had ever been, just “relatively low”.

Then we get attempts to minimise Reserve Bank responsibility by highlighting (correctly) that fiscal policy was also expansionary (“at upper end across OECD economies”) and bemoaning that insufficient attention has been paid to the role of fiscal policy. But Conway knows very well that the system is set up in such a way that monetary policy is the last mover: fiscal authorities do what they will, do it transparently, and then the Reserve Bank does whatever is necessary to keep inflation in check. The responsibility for the high (core) inflation rests with the Reserve Bank, not with fiscal policy.

And so it goes on. Several times we find attempts to blame the labour market, or even border closures, as if the Reserve Bank MPC was not set up to be….the last mover, to respond to all other pressures and risks in a way that keeps core inflation in check. In the Conclusion, Conway articulates it this way

“Inflation spiked higher during the pandemic due to a range of factors, with a shortage of labour and materials in a period of strong demand being particularly important”.

But no mention of monetary policy, which is by design the main tool for influencing aggregate demand and capacity pressures to keep inflation at or near target. There are plenty of references to “demand” in the speech, but hardly any (backward looking) to the demand manager.

To read Conway in isolation, you would have absolutely no idea that the Reserve Bank itself now estimates that the economy got materially more badly overheated than at any time for decades. That is on them: minimising or avoiding such situations is an integral part of successful inflation targeting.

Or that on IMF estimates New Zealand in 2022 had the most overheated economy of any of the advanced countries/monetary areas. It was the result of what were, with hindsight, glaring monetary policy mistakes and misjudgments. But Conway – and no doubt his bosses – would simply prefer we looked the other way, and accepted that it was all somehow out of their control (except no doubt when they will take credit when inflation eventually comes down again).

What of the way ahead? There is an OCR review out tomorrow, continuing the weird RB choice to hold a review the week before the key (especially at present) quarterly CPI data are out. The Bank has signalled that Conway, their chief economist, is away and won’t be attending the meeting (which doesn’t seem like particularly good leave planning). Given that and the weirdly hawkish tone of the May MPS – the one picking an economic recovery even as the OCR is unchanged, or even rise, for the next year – one can’t expect much from the MPC tomorrow (although RB communications flip-flops haven’t been unknown).

I’m less interested in what they will do than in what they should do, and have come to believe that, on balance, an OCR cut would be appropriate. These are – or should be – almost always matters where risk and uncertainty are real considerations. If a monetary policymaker is 100% sure of their stance, they either aren’t thinking hard enough or have left things far too late, given the fairly long lags with which monetary policy works. I’m certainly not mounting an argument for a move to a neutral monetary policy stance – wherever the neutral nominal interest rate might currently be (itself highly uncertain) – but simply for taking the foot a little off the brake, and easing back a little on the extent of the disinflationary pressure. As I said, uncertainty is a pervasive factor in any forecast-based monetary policy regime. Quite possibly, time will show that by now the OCR should already be quite a bit lower, but I don’t think that is yet a view one could reach with great confidence, so mine is simply a call to begin edging in that direction (and to reverse May’s curious hawkish rhetoric and numbers).

Why? Annual inflation is still above the top of the target range after all. But it is clearly falling, and there are numerous indicators – hard data and surveys – pointing in the direction of a further material accumulation of excess capacity and disinflationary pressure, which will play out – even just on today’s policy – over the next 12-18 months. The worst of inflation is clearly past, and with it fears that some new and really bad rate of inflation was going to become embedded. And while the RB likes to talk up non-tradables inflation – which has no special role in the Remit – it is also true that a fair proportion of those pressures (insurance and rates) are resulting from non-monetary shocks (one clearly a supply shock, one about government charges), which really should be “looked through” by an inflation targeting central bank, unless (and to the extent that) they were spilling into public expectations of medium term inflation and wider price-setting and spending behaviour.

A move now to a 5.25 per cent OCR would not, of course, be game-changing in macroeconomic terms. It would, however, be a step in the right direction. One can understand the personal incentives on the Governor – who cares about the excess capacity so long as I finally am 100% sure inflation is back down again – but perhaps it would be easier for him and the MPC to take some of the risk, that is an integral part of the business they are in, if they hadn’t spent so much time and effort blustering and minimising the extent of their own mistakes from several years back.

croaking cassandra

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

Year: 2024