Year: 2025

Or not

Michael Reddell NZ politics

“Time has come for a four-year term of govt”, or so declared the editorial in yesterday’s Sunday Star-Times. I voted against the idea in the 1990 referendum, and would do so in any conceivable future referendum.

Four-year electoral terms (which is at issue, not – at least directly – “four-year terms of govt”) appeal to politicians and bureaucrats (on the latter, see how voters in Karori/Wellington Central/Ohariu were among those least opposed to four year terms in the two referenda we’ve already had). The reasons aren’t particularly hard to fathom: more time and less accountability will almost always sound good to those being held to account (think students with assignments and lecturers with a reputation for granting extensions easily), and since most Wellington head office bureaucrats tend to be more attuned to the interests and perspectives of ministers – and “getting stuff done” – than to those of pesky voters (often actually assuming they know better the interests of those voters and their families than the voters do themselves).

But what caught my eye most in the SST editorial was a claim from a representative of a business lobby group (in this case Infrastructure New Zealand) that “three years is just not enough time to develop policy, implement legislation, and embed the necessary system changes and begin to measure results”.

It isn’t an approach most of us would settle for in other areas of life

Representative democracy can helpfully be seen as an agency problem. We (the voters) are the principals, who elect/employ agents to act on our behalf. But it is difficult to ensure that they do so, especially over such a wide range of issues, and the most powerful lever by far available to us is simply the ability to toss them out. They can at times simply pursue their own ends (in some cases, simply holding office might be enough), or pursue ends, or by means, which we come collectively to think are not the best way forward. Circumstances change too, in ways that neither voters nor MPs can envisage with any confidence. And while there are some other checks on what governments and Parliaments do, they are often pretty thin (the more so in New Zealand where governments form from a parliamentary majority, and Parliament is sovereign and can if it chose reverse or override the effect of any judicial rulings).

Agency problems aren’t unique to democratic politics. Another good example is widely-held public companies, listed on a stock exchange. There are many shareholders, who delegate power to a board of directors and, through them, to management. Those agents can do a good or bad job, and they can pursue shareholders’ interests or their own (managers, for example, tend to like bigger empires which tend to raise executive remuneration whether or not they add to shareholder value). Of course, in tightly-held companies these issues are much less severe – at the extreme a founder may be both CEO and the dominant shareholder. That person might do a good or a bad job, but the main wealth affected is his/her own. Representative democracies are much more like widely-held public companies, but our exposure to things going wrong or being done badly is much greater, because for most of us there is little or no scope for diversification, and even when there is (eg dual citizenship) exercising that option can be both costly and disruptive. This is our country. We have only one.

Listed companies are traded on the stock exchange. For companies of any size there will be transactions – and a fresh market-clearing price – each day. When management and the Board are seen to be doing a capable job – have a credible strategy to add shareholder value – the share price of the company concerned will match or outstrip the market. When doubts arise, the share price underperforms. It doesn’t tend to be too good for the chief executive’s career prospects if that underperformance becomes entrenched. Here’s one example of a New Zealand underperformer.

A day to day fluctuation in the share price won’t usually affect the Board or management much. Noise happens, market trends will be at work. In the political sphere, a single opinion poll typically won’t matter too much either. But over time a weakening share price is going to raise doubts among existing shareholders as to whether capital should be left in the business (retained earnings), and make it more difficult and expensive to raise fresh capital (each dollar of fresh capital dilutes existing shareholders’ interests to a greater extent).

What can shareholders do? They can, of course, as individuals sell some or all of their shares and thus reduce or eliminate their exposure to the firm and the agents (Board/management) it had been employing. But they can also vote out some or all of the directors, or create a climate where some incumbents think it might be best if they stepped aside and did not seek re-election.

And how often do directors come up for re-election? Well, in New Zealand the stock exchange listing rules require each director to face re-election at least every three years.

A person I mentioned this to wondered if the three years had been inspired by the three year electoral term for our government. I don’t know the history of the NZX listing rule, but I thought I’d check the situation in some other countries. The ASX also requires directors to face election at least every three years, but then Australia also has three-year federal parliamentary terms. But what about Canada and the UK, both of which have parliamentary terms of up to five years? Listing rules in Canada appear to require annual election of all directors (a practice that was apparently common there even before the rules changed in the 2010s). In the UK, the corporate governance code appears also to require annual elections for directors, at least for larger listed companies.

There is simply much less at stake as regards the governance of any individual listed company than in respect of our Parliament and government (and bear in mind that no government in 100 years or more has fallen inside the three year parliamentary term, although there have been a couple of discretionary early/snap elections). And there are far fewer checks and balances (let alone easy exit options). I cannot for the life of me see why we would delegate so much greater power to MPs and ministers (and their supporting bureaucrats) for terms longer than shareholders and the market generally choose to do for those who run public companies. Parliament is sovereign, individual companies are not. Individual companies also have much clearer benchmarks for performance (something around maximising shareholder value) than is ever conceivably possible for a Parliament or government.

Of course, there are plenty of democratic countries with longer electoral terms but (for all NZ’s faults) it is far from obvious that the general quality of government and policymaking has been any better in the UK or Canada (federally) than in Australia and New Zealand. And I don’t think either an upper house or a written constitution is any sort of solution that should make New Zealanders more comfortable with the idea of a four-year electoral term – you can’t create an alternative legitimacy simply thru a different voting (or worse, appointment) method for an upper house, and the written constitution simply hands over (lots) more power to the whims of unelected and unaccountable judges.

When we’ve had governments that really wanted to do bold stuff (a) they’ve managed to do a lot in three years, and b) in all case I can think of they managed to persuade voters to give them (at least) one more electoral term, to either carry on the work, consolidate results or whatever. It will be 50 years this year since we last decided not to give a government a second term (and that government had lost its biggest electoral asset to death halfway through). And in that sense, things aren’t so different from a company and CEO devising and putting in place transformational strategies for a company. These things take time, and especially take time to produce secure longer-term bottom line results. But shareholders are putting their money on the line each day, directors face re-election each year, and chief executives are probably more prone to being ousted early than Prime Ministers (the last PM to be forced out by his colleagues on anything other the health/age grounds was almost 30 year ago [perhaps Palmer too, but he’d not become PM at an election], and he was I think the only one in at least a century). Part of the skill of being an able PM/Cabinet or Board/CEO is to convince your publics (voters or shareholders) that you have the skills and the plans and that you warrant being allowed to stay.

And although, at a political level, it is easy to overstate the extent to which incoming governments typically reverse what their predecessors had done (not that much very quickly even after the 1984-90 or 1935-49 governments) it is also true that there are genuine contests of values and ideas – indeed, to a considerable extent it is what politics is about. In that sense, it is different than the listed company situation, where differences are much more about means rather than ends. On many things at any one time there are real differences across the public in values and priorities. And if public opinion shifts sharply or political leaders lose our confidence I can’t see strong reasons why they should simply have a claim to hold office for longer. They are, after all, our agents, not the principals. Good agents are really really valuable and can make a huge difference for the better. But good help can hard to find, and difficult to monitor that they are pursuing the preferences/priorities of those who voted them in.

And if the idea of a four-year term for Parliament has no appeal whatever with the present or any recent crop of politicians (I find it hard to think of any government in my adult life that I’ve felt with conviction really warranted even a second term), the suggestion that it would have to be accompanied by longer term for local government is positively alarming. Perhaps there are good local bodies – whose councillors should then readily win re-election – but I live in Wellington.

PS I’d also commend on this topic a column by Rob Campbell in Newsroom (paywalled today, but not I think from tomorrow). I suspect he and I would disagree on a huge proportion of policy issues, but that is his point (and mine)

Forty years of floating

Michael Reddell Exchange rate, Monetary policy, New Zealand economic history

Last year there was an interesting new book out, made up of 29 collected short papers by (more or less) prominent economists given at a 2023 conference to mark Floating Exchange Rates at Fifty. The fifty years related to the transition back to generalised floating of the major developed world currencies in 1973 (think USD, JPY, GBP, and the West German deutschemark, plus the Canadian and Swiss currencies). It was quite an interesting collection and even has some discussion of emerging markets. What was striking, reading it at this end of the world, was the almost complete absence of any discussion of the experience of smaller advanced countries – this isn’t just a matter of places like New Zealand or Norway or Israel or Iceland, but not even Australia gets a mention in the index.

As it happens, this weekend marks 40 years since New Zealand floated our exchange rate. It was announced at 10:30am on Saturday 2 March 1985 (timing set for after the Friday close of the New York foreign exchange market), and trading commenced on Monday 4 March.

I was working in the Monetary Policy Section (all 3 or 4 of us) of the Reserve Bank’s Economics Department at the time but although there had been talk of floating for months (pretty much since the devaluation in July 1984) and real policy challenges around maintaining the fix, the actual timing of the move was successfully kept very tight (I was never quite sure even whether my boss had known), and I learned of the news when later that afternoon I wandered down to the Hataitai dairy to buy my Evening Post.

It was the same day as David Lange’s Oxford Union debate on nuclear issues, and the Reserve Bank’s Deputy Governor, Rod Deane, had had to fly to London to brief Lange and secure his final agreement to the move (my diary the following week records him telling us that he had been most impressed with Lange’s questioning etc).

The Evening Post’s journalists must have been pretty busy as they’d managed to get comment from all manner of people in the couple of hours they had. Some of them are still commenting today

Bob Jones was another whose views were reported, claiming that by floating “New Zealand has now joined the rest of the world as a sophisticated economy” which wasn’t really true as by this point there were still lots of smaller advanced countries who weren’t floating at all (Australia had done so only a year or so previously), and many of the European countries were running their collective Exchange Rate Mechanism, designed to severely limit fluctuations.

The comments in that old paper that most caught my eye ((bottom right story in the first photo above) were from my old macro lecturer Merv Pope who was very critical, stating that in his view “the economy would suffer severely”.

There are books and articles that discuss the politics and bureaucracy of the period leading up to the float, and I know there are some people who read this blog who were closely involved in it all (who are welcome to add comment/context), so I’m not going to attempt to cover that.

The journey to floating mainly dates to the events around the July 1984 devaluation and the early days of the 4th Labour government. The establishment view in early-mid 1984 was that the New Zealand dollar was seriously overvalued in real terms, and in that sense the mid 1984 devaluation had been welcomed. All that said, as was perhaps necessary in the market circumstances, the extent of the devaluation – 20 per cent – had been set to eliminate the likelihood of further downward pressure, and thus to some extent probably represented an adjustment larger than the medium-term macroeconomics might have warranted.

Going pretty much hand in hand with the devaluation was the removal of the interest rate controls that the previous government had put in place over the past year, combined with a new willingness to fund the government’s deficit primarily by wholesale domestic debt sales, taking whatever price the market charged. With the prospect of rising inflation (if only from the devaluation itself) and large fiscal deficits, it had the makings of considerable difficulties in achieving effective monetary control. Exchange controls on capital transactions were still in place but they were porous (and more designed to limit outflows than inflows) and one of my tasks in August 1984 had been to sift carefully through the records of foreign exchange inflows looking for evidence of capital inflows drawn by the combination of high interest rates and a, possibly, undervalued exchange rate. A fixed exchange rate meant that we – the RB – were committed to buying whatever foreign exchange was offered at the fixed (against the TWI) rate, and all those purchases immediately added to domestic liquidity.

In an earlier post some years ago I noted

One of the starkest memories of my first year at the Reserve Bank, fresh out of university, was being minute secretary to a meeting in late 1984 attended by the top tiers of the Reserve Bank and The Treasury.  It was a just a few months after the big devaluation that ushered in the reform programme: senior officials were explicitly united in emphasising how vital it was to “bed-in” the lower exchange rate, and ensure that the real exchange rate stayed low.

The risk was that if we didn’t succeed in getting monetary conditions under control, all the pain of the devaluation might go for nothing (ending up with no real devaluation at all, as in a number of past devaluations here and abroad). And yet with high market-determined interest rates, it was going to be difficult to stop capital coming in. We still had tools like reserve ratios but (a) the goal was to move away from them not become more reliant, and b) they became much less effective in a deregulated interest rate market. We sold government debt aggressively, aiming to mop up the excess liquidity, but the more debt we sold, the more tended to come in (those yields were attractive, and the exchange rate was fixed).

Among the various Ministers of Finance (Douglas and associates) there was a desire to float, but when? It didn’t make a lot of sense to contemplate floating the exchange rate while exchange controls were still in place (although the UK had in the 1970s), and exchange control removal didn’t happen until the Friday before Christmas 1984. And no one really had a good sense as to what the market would deliver (particularly in terms of liquidity and volatility) when the float happened (I’m pretty sure no countries as small as New Zealand were floating were by then, and although Switzerland wasn’t hugely larger it was home to a fairly major banking and financial centre).

Short-term interest rates began 1985 in the mid-teens (the Reserve Bank’s data has the overnight cash rate at 13.4 per cent and the 90 day bill rate at 15.3 per cent in early January. Capital inflows tended to dampen rates, while our monetary policy actions sought to underpin them or push them up (the medium-term goal being to consolidate fairly low and stable inflation, after 10-15 years of high and volatile inflation).

But the backdrop turned fairly quickly. This is from the Bank’s June 1985 review

Pressures built further in February and by 15 February short-term rates had increased by another full percentage point. But it was in the final week of February that things culminated, with significant foreign exchange outflows, reflecting at least in part a sense that a float was likely sooner rather than later, and that when it happened the exchange rate was likely to fall. As the Bank’s Bulletin article records, foreign exchange outflows had been particularly heavy on 28 February and 1 March, transactions due for settlement two working days later. By Friday 1 March, overnight cash rate were at 38 per cent and the 90 day bill rate was at 25 per cent. If you really thought the exchange rate was going to depreciate quite a bit in short order, paying interest rates of under 10bps a day to fund a position taken on the back of that view wasn’t too much of a problem.

(Meanwhile in the Monetary Policy Section we were hard at work devising projections and policies designed to keep inflation in check, all based on a continuation of a fixed rate.)

While the exchange rate was fixed, the Bank was committed to buying and selling whatever it took to maintain the rate, and each such transactions had counterpart domestic liquidity consequences (the Bank was not then doing routine daily open market operations to stabilise the level of settlement cash). Those fx outflows just prior to the float sharply lowered liquidity in the banking system. And once the float happened, the door was closed.

On the first day of trading (4 March) the exchange rate did fall (down around 2 per cent against the USD, which itself was stable against the JPY and DEM) but the dynamic changed pretty quickly. Those liquidity pressures really started to bite, and anyone who wanted to bring funds back to New Zealand needed to find a market seller of NZD, rather than a fixed price central bank. Short-term interest rates skyrocketed

and although the official data has a peak cash rate of 265 per cent, my memory (and my contemporary diary records) suggests peaks in excess of 500 per cent (still only around 1 per cent day per day). Within a couple of days the NZD exchange rate was 4 per cent higher than it had been just prior to the float, and probably would have jumped even further had the Bank not eventually intervened. By 20 March, short-term rates were down to about 24 per cent. It had been a wild ride.

Could the float have been avoided back on 2 March. Most likely it could have. The big problem in July 1984 had been a combination of a) perceptions that the exchange rate was fundamentally overvalued, b) perceptions that Roger Douglas, likely finance minister if Labour won, wanted to devalue, and c) the fact that interest rates were controlled, and so sales of foreign exchange by the Bank had no countervailing interest rate effect. But the broad direction of economic policy was to free up financial market prices, and so there would have been little good reason to delay further.

It is interesting to ponder what might have happened had the government decided instead to a) liberalise interest rates, and b) remove exchange control but c) to keep on with a fixed exchange rate, at the post July 1984 level. The monetary policy trilemma says that in the world you lose control of domestic monetary conditions (and thus the ability to control your own inflation outcomes). By 1984/85, the inflation rates in most major western economies were already more or less in check (think UK, US, West Germany, Japan), and with a fixed exchange rate we might have been expected to have seen New Zealand converge in time to around the average of our trading partners. But I suspect it would have been a wild ride, and would not have ended well. For example, in March 1985 the effective Fed Funds rate was 8.5 per cent and three month rates in Germany were about 6 per cent. With those sorts of interest rates in New Zealand through that period – and that is what a credible exchange rate peg would have delivered – the credit boom, commercial property boom, sharemarket boom etc might well have been even larger, and ultimately messier to resolve, than what we were actually to experience a few years later (the Nordics, for example, went that sort of route, only to float some years later). (It also isn’t wildly different that what Ireland and Spain experienced in the 00s, except that – in adopting fit-for-Germany interest rates they may have been less badly prepared than New Zealand firms/banks might have been in the mid 80s.)

This isn’t a post to review New Zealand’s experience with floating. Perhaps I will attempt something like that over the next few weeks. There have been persistent critics, even beyond the Day 1 ones cited above, perhaps most notably the economist Brian Easton. There were endless debates in the late 80s under the broad heading of “sequencing”: there were models under which things might have been less messy if the order of liberalisation had been different: external trade and labour markets before financial markets (and particularly the capital account and exchange rate). We’ll never know, although (as just one illustrative example) it was never plausible that even the 4th Labour government was ever going to lead with labour market reform, so perhaps there was never a real choice.

Back in one of those early quotes, Rob Campbell commented critically about the increased room for “speculative moves” around the New Zealand dollar. I suspect that many of those who broadly supported the move to floating will still have been taken by surprise by the amplitude of the cyclical fluctuations in the exchange rate, and the incidence of large single day movements over the following few years. Then again, another mystery of the New Zealand experience is why an exchange rate that was so variable until about 15 years ago hasn’t been since. Perhaps that will be the topic for another exploratory (because I don’t think I know the answer) post

Why is such rank dishonesty tolerated?

Michael Reddell Adrian Orr

“We were one of the first central banks in the world to be tightening; we were one of the first central banks in the world to be easing”

Those were Adrian Orr’s words last Thursday to Parliament’s Finance and Expenditure Committee at their hearing on the Bank’s latest Monetary Policy Statement. He’d been asked by National MP Dan Bidois what the Bank was doing to learn from too slow tightening a few years back and, perhaps, too slow easing last year. Orr’s words above are at about 23.50 here.

Orr has run the “we were one of the first to tighten” lines repeatedly in the last few years, but I hadn’t heard the (even more preposterous) claim about being one of the first to ease before.

In various posts I’ve noted that his claim re tightening is simply false. But that point has often been buried in longer posts. So this post is devoted solely to those two factual claims.

I’ve focused here mainly on the central banks of OECD countries. There are 37 (more or less) advanced economy countries belonging to the OECD. But a fair number of those use a single currency (the euro), and one other (Denmark) pegs its exchange rate to the euro, and thus has monetary policy in effect set by the ECB.

That leaves 21 central banks responsible for setting monetary policy.

Of those central banks, two did not cut policy rates as Covid broke over the world in 2020 (Japan and Switzerland). So questions of reversing the Covid policy rate cuts didn’t arise there (and, for example, in Switzerland core inflation was to peak at just over 2 per cent).

The Reserve Bank of New Zealand’s first OCR increase, beginning to reverse the Covid easing, was on 6 October 2021. On the same day (but 12 hours or so later, given time zones) the central bank of Poland also put in place its first post-Covid tightening.

The following OECD countries had already increased policy rates by then

So that was nine OECD central banks moving before the Reserve Bank did, and quite a range of countries too: Latin Americans (in the case of Chile, a longstanding inflation targeter), both old and new OECD European countries, and Turkey. Countries richer and more productive than us and countries poorer and less productive than us. You might be inclined to discount Turkey, as having had some really crazy monetary management in the last few years (and I’d probably agree) but it still leaves eight of 20 moving in advance of the Reserve Bank.

So that leaves 10 moving after the Reserve Bank (including the two central banks – Switzerland and Japan – that had never cut in the first place).

The Governor’s claim that the Reserve Bank was “one of the first in the world to tighten” is simply false. And when I looked around a few other (non-OECD) countries with floating exchange rates, and thus their own monetary policies, it wasn’t hard to find several of them that had also begun to tighten before the Reserve Bank (eg Brazil in Feb 2021, Uruguay and Paraguay in Aug 2021, and my old stamping ground Zambia in Feb 2021).

It is just made-up stuff. Said once it might have been pardonable – anyone can make mistakes, and a few Anglo-centric market commentators abroad had run similar lines (noting that the RBNZ had moved before peers in the UK, Canada, US, the euro-area, and Australia) – but when run repeatedly and shamelessly it is really inexcusable.

What about “we were one of the first central banks in the world to be easing”?

Well, that one doesn’t stack up either. The Reserve Bank’s first OCR cut was 14 August 2024.

Among OECD central banks, the following had already cut by then (the first five of them in 2023)

That’s 12 central banks (including the Bank of Canada, Bank of England, and the ECB)

Turkey had also cut early but that was getting into their really crazy period, so I’ll simply leave them out.

So of the 20 OECD central banks ex Turkey only 7 hadn’t cut by the time the Reserve Bank of New Zealand made its first cut in August.

You can believe the Governor, or the hard data (and all this is really easy to check).

As I’ve pointed more than once, the whole thing is absurd anyway. It isn’t as if every country faces the same pressures or inflation risks, so it isn’t as if there is some unconditional cross-country race to tighten or cut first.

But, as it happens, the Reserve Bank probably isn’t too keen on people digging even a little below the surface either. As I’ve noted previously, on IMF estimates New Zealand had the most overheated economy post-Covid of any advanced economy they do estimates for. That was on the Reserve Bank – monetary policy is supposed to be adjusted pre-emptively to minimise such overheats (and deep slumps) – and all else suggests they in fact should have one of the very first central banks to tighten. They weren’t.

On the Bank’s own estimates, they let an output gap of almost 4 percentage points (at peak) of GDP build up, so that excess demand enabled by them was a big part of the New Zealand inflation failure.

And, as just one illustration, consider the situation faced by the Bank of Canada and the Reserve Bank of New Zealand in late 2021 (I choose BoC mostly because they make their data readily accessible).

This BoC chart shows their estimates for the output gap at the end of 2021. At the time, they thought there was still a small negative output gap, and even now with the benefit of hindsight they think the output gap was about 1.2 per cent of GDP.

What of the RBNZ? They thought at the time (November 2021 MPS) that the output gap was already slightly positive (having fallen back from mid-year estimates in excess of 2 per cent due to the fresh lockdowns) and they now estimate – again with the benefit of hindsight – that the output gap then was about 3 per cent of GDP. If the output gap was already positive there was no good justification for policy rates still being well below neutral. If the output gap was really highly positive, they had simply badly misread in real-time the inflation pressures in the economy (note also that the NZ unemployment rate by late 2021 was far below any estimates of NAIRU).

Very few central banks handled the last five years particularly well. The Reserve Bank of New Zealand was not among them. Possibly, on substance, it was not that much worse than the median of its peers (time will still tell on emerging on the other side successfully).

But what marks the Reserve Bank out is the repeated fabrications. The Governor just makes stuff up, running the same misleading or false stuff repeatedly, including to Parliament. And his (past and present) fellow MPC members – statutory officeholders all of them – let it pass (none of them speaks). As, it seems, do those charged with holding Orr to account, notably the Reserve Bank’s Board and the Minister of Finance (who last year reappointed the Board chair after the policy failures and outrageous attempts at misleading the public and Parliament of the Governor and MPC were already well known, and who has chosen not to fill vacancies on the Bank’s Board).

It is, sadly, an age when a US President can simply lie about who was responsible for invading Ukraine. We shouldn’t have to put up with such Trumpian debauched behaviour from anyone in New Zealand public life. But that is what we get from the Governor. It reflects poorly on all those who accommodate him. It reflects poorly on New Zealand. But most of all it reflects poorly on the Governor himself, who repeatedly shows himself just not fit to hold the office.

Is compulsory saving the answer?

Michael Reddell Australia, New Zealand economic performance, Productivity, Savings, Superannuation

Economic growth – and the lack of the sustained productivity growth that underpins it – is again briefly in focus. 70 years of relative economic decline still shows no sign of being durably reversed, but the last few years have been particularly tough and there is an election next year, and so the government’s rhetorical focus has turned to growth. Time will tell whether it is supported by any serious policy changes equal to the magnitude of the problem.

Over the decades, whenever the conversation has (usually briefly) turned to growth and New Zealand’s fairly dismal longer-term economic performance, advocates of compulsory private savings emerge to some fresh prominence. The late Brian Gaynor used to argue that if only we’d kept on with the 1974 Roger Douglas scheme all would have been well. Other funds manager types refer us to the Australian compulsory savings system. And others champion Singapore (including former NZ Initiative and National Party adviser, Leonard Hong who recently devoted an entire dissertation to it [and whose Herald op-ed is here]). Over the last decade, Roger Douglas and Auckland university economics professor Robert MacCulloch have been championing an overhaul of our entire system of health and welfare (including superannuation) provision, which would involve a lot more compulsory private saving. Just this week, MacCulloch is quoted in the Listener’s (flawed) feature article on New Zealand economic decline putting a big emphasis on lack of national saving, suggesting that the difference between New Zealand and Australian wealth/productivity is substantially explained by the differences in savings policies. On his blog yesterday MacCulloch reminds us of one of those empirical regularities of macroeconomics – the correlation between savings rates and investment rates – and claims that much of Singapore’s economic success is down to their compulsory private savings policy; that without something similar National’s growth aspirations aren’t likely to come to much.

One can be a bit cynical about funds managers championing compulsory private savings – Kiwisaver, after all, has been good for funds managers – but I’m sure all these people believe their stories. I’ve become increasingly sceptical over the years,

I don’t want to focus here on what is the best way to do retirement income policy (let alone the political feasibility of different models). One can mount arguments for a variety of different models. But my focus is on overall macroeconomic performance and outcomes, and my starting point is that the design of your country’s retirement income system is most unlikely to be a dominant factor in explaining your country’s overall economic performance.

Let’s take Australia first. As a reminder, 30 years or so ago the Australian government introduced a compulsory private retirement savings scheme (employer contributions), starting at 3 per cent of income then rising to 9 per cent, and this year getting to 12 per cent. Sceptics note that, as yet, Australia still isn’t spending much less than New Zealand as a share of GDP on public pensions, but the focus here is macroeconomic outcomes.

The first place one might look for evidence of the transformational macroeconomic possibilities is the national savings rate.

Champions of the scheme have occasionally produced papers claiming a positive impact, and the counterfactual is – as almost always – impossible to know, but if there has been a positive effect it doesn’t exactly look transformational.

Thoughtful Australian observers also worry about productivity growth over there (Australia is now richer and much more successful than New Zealand, but average productivity lags a long way behind the OECD leaders). There is always lots more going on in both countries but….there is no sign of Australia catching up with the US in the decades since large-scale compulsory private saving became a thing.

Australia is, by the way, the most culturally and behaviourally similar country to New Zealand in the world.

But what about Singapore? It is a stellar economic success story that has seen real GDP per hour worked in Singapore reach levels not that far behind the most successful European economies and the US (although note that experts reckon that Singapore is one of those economies – like Ireland and the Netherlands – where international tax distortions (not just differences in company tax rates) are flattering the data more recently. No one serious uses headline GDP numbers in Ireland.)

Singapore has also had a compulsory private savings system since colonial times (introduced in the mid 1950s).

But it would be very hard indeed to argue that national savings played any very substantial part in Singapore’s economic emergence.

I couldn’t find a very long-term series for Singapore’s national saving rate but the current account is just the difference between saving and investment.

Investment as a share of GDP took off in Singapore from about 1970, averaging about 40 per cent of GDP for 15 years or so, and translating into rapid growth in the aggregates that count (real GDP per capita, productivity growth etc). Throughout almost all that period, Singapore ran really large current account deficits (ie relied heavily on foreign savings).

The IMF’s WEO database has a (directly observed) national savings series since 1980,

where the peak in the national savings rate (at times in excess of 50 per cent of GDP) came well after the peak in investment in a share of GDP. (As a curiosity, and if one takes the numbers in face value, investment as a share of GDP in Singapore and New Zealand have been roughly the same in the last half dozen years or so.) It looks as though, as one might expect, domestic investment tended to respond to opportunities rather than primarily, or to any great extent, to savings.

And that shouldn’t be in the least surprising, since it was, after all, how countries like our own emerged to around the top of the world GDP per capita tables in the late 19th and early 20th centuries (eg there is an estimate for New Zealand for 1886 in which the net international investment position – net reliance on foreign capital – was almost 300 per cent of GDP). Not only New Zealand, but Australia, places like Argentina and Uruguay, and indeed the freshly settled parts of the US itself. Britain, by contrast, ran massive current account surpluses (national savings far exceeding domestic investment), and its lead in the world economic tables began to fade. There is a vast literature on this sort of stuff. More recently, you can see similar pictures for places like Ireland and South Korea (large account deficits in the early phase of emergence, as high investment rates start occurring, followed by later increases in savings rates).

Robert MacCulloch’s post yesterday makes a lot of the Feldstein-Horiaka “puzzle”, first identified in a paper 45 years ago. Across countries, domestic investment rates (national accounts investment concept here as throughout) tend to be correlated with national savings rates. MacCulloch includes in his post this chart, covering (as I understand it) all countries

I did one just for the IMF’s group of advanced countries covering the last 30 years (the period for which the IMF has comprehensive data). Each dot represents a country

It isn’t a tight correlation (check the range of savings rates for countries with investment rates averaging between 25 and 27 per cent, but it is definitely there. The question is what it means.

The thrust of MacCulloch’s claim is that investment in New Zealand is (national) savings constrained. I’m sure he doesn’t mean it in a tight mechanical sense but the implication is that we couldn’t durably get from 23 per cent of GDP in investment to (say) 27 per cent – the sort of market-led change that would make a huge difference over time – on current policies around saving.

I don’t see it. I’ve already illustrated how some current account balances have swung through enormous ranges over time – Singapore is one of the most glaring examples, now accumulating massive claims on the rest of the world, even as domestic investment rates are no longer anything out of the ordinary. Taking that IMF advanced economies grouping over the same 30 year period in the chart above, the median range within which current account deficits have fluctuated over that period has been 12 percentage points of GDP (over that 30 year period Spain, for example, has had both a 3 per cent of GDP current account surplus and a 9 per cent current account deficit). Several countries have had fluctuations within a range of 30 percentage points of GDP, and there are now multiple advanced countries (Europe and Asia) experiencing persistent and large current account surpluses – national savings well outstripping domestic investment.

A fair amount of that correlation between domestic investment and national savings is likely to be because savings themselves are endogenous. When people think casually about saving rates they often have in mind household saving, or perhaps government saving (fiscal deficits and all that). But actually business saving matters a lot. Most of the series above are gross (ie including depreciation effects). Materially higher business investment is accompanied by higher depreciation provisions which firms need to fund. And economies in which the returns are high, where firms are finding plenty of opportunities, are also likely to be ones where firms find shareholders agreeing to higher rates of retained earnings. Much of the capital stock is either houses (always likely to be predominantly owned nationally, and where an increased stock also draws forth over time increased savings to pay for those houses) or government assets (and governments will tend to own physical assets almost exclusively in their own country), which also tend to be paid for domestically over time.

There are some genuine and interesting puzzles as to why the ownership of firms displays more of a “home bias” than a simple model might suggest. But there isn’t much evidence -historical or contemporary – to suggest that if the opportunities were there a much higher sustained level of business investment could not occur in New Zealand without some step change (voluntary or coerced) in household saving rates. (And if that claim were true then given the Australian experience – see above – we might as well give up now.) One indicator of New Zealand’s ongoing ability to attract foreign capital is that with (a) some of the largest current account deficits (over many decades now, but including that 1995- 2014 period, and b) on average very low government deficits, the real exchange rate has remained very strong (puzzlingly so on some models, given the deterioration in our relative productivity performance).

Opportunities? Some of the discussion around saving – and indeed mention of “capital intensity” from ministers and officials – seems to imply that private firms (ones actually operating here, or potential entrants) are leaving opportunities unexploited, leaving money on the table as it were. Frankly, that seems unlikely. They have strong incentives to produce good returns for their investors (& sharper incentives than those facing ministers and officials in this regard). I list among the reasons why there might be relatively few exploitable opportunities here things like high business tax rates, foreign investment restrictions, restrictions on exploiting natural resources (minerals etc), RMA-type obstacles, distance, and the persistently high real exchange rate.

How might higher national savings help? Take a rather extreme example in which we all woke up tomorrow and decided that we were going to save another 5 percentage points of our income hereafter forever (well, for just the next two or three decades). You would then expect to see the real exchange rate move sustainably lower (still with cyclical fluctuations). That would be likely to make more outward-oriented business opportunities look attractive (although fewer domestically-oriented ones would, because we’d all be spending less, and most of our spending is local). That might well be a good and helpful thing, in response to a change in private preferences. (And if local opportunities really were even worse than I thought then New Zealanders would – like Singaporeans now – be accumulated assets abroad and our future incomes would rise, even if domestic productivity didn’t.)

But changes in private preferences are one thing, while attempted state coercion is another (and these days the state might well first look to itself and close those operating deficits that we’ve been inflicted with all decade now). And if the real exchange rate was really the only macro thing that might be susceptible to changing savings behaviour, wouldn’t we want to first understand why it remains so persistently high before leaping to try (perhaps ineffectually) to attack symptoms? I’ve got a story for that, but ministers and officials hardly ever engage with the stylised fact.

There might be a decent case for a different approach to retirement income – I’m sceptical, although I’d raise the NZS age quite a bit, and change the tax treatment of savings (as part of a better tax system all round, with less emphasis on taxing returns to capital) – but retirement income policy should be approached on its own terms, with a focus on individuals and their own ability to manage retirement (thus I was also very sceptical of Andrew Bayly’s desire to hijack Kiwisaver funds in pursuit some politicians’ growth stories). Perhaps a better retirement income model would have useful macroeconomic benefits, but for decades whenever politicians and officials – and economists – wanted to focus on savings it has so often had the feel of “lets force the great unwashed to do something different with their money, to suit our ends” rather than the hard graft of actually getting the obstacles the growth that governments themselves pose out of the way.

If I have one final summary point it is that higher national savings rates have rarely, if ever, been a prelude to durably higher rates of domestic productivity or investment growth.

Orr at it again

Michael Reddell Adrian Orr, CBDC, Monetary policy

I decided not to bother listening to the Reserve Bank’s appearance at FEC yesterday morning. After all, the OCR decision had been much as expected and foreshadowed, the forecast tracks etc hadn’t changed much, and – with all due respect to some new FEC members – how searching was any questioning really likely to be?

But an old colleague listened in, and was rather concerned to hear Orr’s deputy chief executive for macroeconomics and monetary (the one with no qualifications or background in either subject) Karen Silk making what appeared to be the claim that the Bank and MPC had got the trends in inflation about right. On listening to the relevant section myself I reckon she was trying to claim that the Bank had been broadly right last year that inflation would come down a lot last year. If so, I’d give her a pass, or perhaps half a one. After all, the questioning just prior to her comment had been about how much the Bank’s overall forecasts had changed in recent quarters, and as I illustrated in yesterday’s post there were really big changes

when the underlying state of the economy and estimates of inflation pressure weren’t changing much at all. So, yes, they were right that inflation would at last come down, but quite at sea on what monetary policy it would take.

The questioning was coming from National MP Dan Bidois who is, I think, the only economist in Parliament. He started by asking about the change from the August 2024 MPS. Orr, either getting things wrong or simply playing distraction knowing what he was saying simply wasn’t true, claimed that actually the August MPS projections for monetary policy had been pretty much bang on. In August the Bank projected that the OCR for the March quarter would be 4.62 per cent (4.36 per in the June quarter). In fact, the OCR will average about 4 per cent for the March quarter and no more than 3.75 per cent for the June quarter.

Orr went on to suggest that Bidois probably really meant the May 2024 MPS – at which point the MPC was actually talking of possibly raising the OCR further. That, of course, looks even worse for the MPC. Back then – only 9 months ago – they reckoned the OCR for this quarter would be 5.62 per cent.

Orr attempted to explain it away by data problems. And it is certainly true that historic GDP numbers have been quite materially revised by SNZ late last year. But changes to historic GDP numbers also change estimates of potential output. On the Bank’s own numbers – their published projections spreadsheets – their view of the size of the negative output gap as at early last year (say March quarter 2024) in the May 2024 MPS (-1.6% of potential GDP) was barely different from their current estimate of the output gap as at March quarter 2024 (-1.4 per cent of potential GDP). Back in May the chief economist was blaming his tools, now he and his boss are blaming the data. What is pretty clear is that the Bank still has had an inadequate understanding of what is going on with inflation, and what it would take to keep it in check (back in 2020 to 2022) or to bring it back down.

Bidois’s questioning had actually started with something more general, encompassing the whole of the last five years. He noted that people had observed that the Bank had been both too slow to tighten and, perhaps, more recently too slow to ease. What changes, he wanted to know, had the Bank made to be more accurate in its forecasts (and, presumably, appropriate in its policy calls). It was a pretty good question from a new member of the committee.

Orr’s response? Handwaving, bluster, and what are little more than outright (repeated) lies. He really wanted to be able to “move on” from the last five years – I’m sure he would, so bad and expensive were the calls made by his MPC – but in any case, he claimed, it was all okay because the Bank had done its own review of experience and all the answers were in that report, and the lesson had been adopted he said. Orr was referring to their (required statutory) review of themselves, covering the period 2017 to 2022. It had big problems and deficiencies, not least of which was that the Bank management was reviewing themselves (as it happens, 2+ years on I am still waiting for the Ombudsman to rule on a request for the input of external MPC members on this review – such is the Bank’s commitment to (anything but) openness).

And it was published on 10 November 2022. By then – the November 2022 MPS – they’d decided that the OCR would need to go to 5.5 per cent, but they reckoned that by now (early 2025) it would still be over 5 per cent. Now, over a horizon of 2+ years that might not be thought to be a huge error, except that – see graph above – they were still well off the mark 18 months on in the middle of last year.

To be clear, making sense of the last five years has been hard. Many private forecasters have probably, on average, been about as bad as the Bank. But the private forecasters a) aren’t paid to run monetary policy, b) tend not to boast about that period, and c) don’t just make things up, and actively seek to misrepresent things and thus mislead Parliament (in ways that now can only be considered knowing and intentional).

Orr also claimed that the Reserve Bank had been among the first central banks to tighten and among the first central banks to ease. On the tightening point, I’ve previously documented that they were in fact about 7th of the OECD central banks to tighten (out of about 20 separate monetary authorities) but that – much more importantly – the positive output gap they had allowed to build up in New Zealand was materially larger than that of any other OECD country for which the IMF produces estimates. On the Bank’s own numbers it was huge (almost 4 per cent of GDP), and monetary policy isn’t a cross-country race, but is about dealing with your domestic circumstances, and the excess inflationary pressures they allowed to build up before slowly beginning to tighten was huge, and the seeds of many/most of our subsequent cyclical problems. As for easing again, and again what matters is not a cross-country race but domestic inflation (actuals and forecast), I found at least 11 OECD central banks had cut before the RBNZ Monetary Policy Committee did. Orr has to have known this. He simply made stuff up for the MPs, counting on the high likelihood that none of them would have enough data at their fingertips to contradict him there and then. Simply egregious behaviour. (But he has misled FEC so often in recent years – many episodes documented on this blog – with no apparent consequences that, if such is your approach to integrity and transparency (lack thereof), then I guess, why not.)

And then it was just more of the cavalier dismissal of the last few years. It was, he claimed, a great achievement to get through with inflation peaking at “only” around 7 per cent (core inflation probably peaking around 6 per cent, the target the committee had agreed to take on when they accepted appointment was 2 per cent). No mention at all of the arbitrary income and wealth redistributions or of the massive dislocations in both inadvertently grossly overheating the economy and then having to squeeze the inflation out again (let alone the $11 billion of taxpayers’ money simply lost, to no useful macroeconomic end). Never mind, stuff happens, was the impression we got – just keep on paying me $800000 a year, reappointing me and my MPC members, and boosting my budget.

An appropriate contrast, he suggested, was the Great Depression, in which he – weirdly – claimed that there had been hyperinflations (where precisely?) Things hadn’t been that bad really.

[UPDATE 11/25. Reading the transcript it seems likely Orr was listing a series of different economic disruptions rather than suggesting hyperinflations had occurred during the Depression itself].

Then he had the gall to suggest that really the Bank was quite budget-constrained. They’d been doing what research they could on their “limited budgets”. Now, it is true that the resources they have chosen to devote to monetary policy in recent years haven’t increased – perhaps they should have – but this is the organisation whose staff numbers have more than doubled on Orr’s watch, still rising now, with an abundance of positions advancing management’s ideological causes rather than the Bank’s quite limited statutory objectives.

Orr also mentioned the closed-door conference they are holding in a couple of weeks’ time, inviting in experts to help assure themselves that their research was at the cutting edge and up with the state of play in other central banks or academe. That should be a short conversation. This is their entire list of published Discussion Papers (the peer-reviewed work) in the last five years

not one of which is directly relating to inflation or monetary policy, and one of which was primarily written by authors from other agencies. It is slim pickings indeed, compared (say) to the previous five years (33 such papers).

It was all pretty extraordinary, at one level, but also all too ordinary for Orr. Orr and his offsiders blustered and made stuff up again, and laughed along with the committee members in a very chummy sort of engagement. When there were decent questions (and Bidois’s were good but rare for FEC)….well, they just made stuff up again and actively misled Parliament. That is supposed to be a very serious offence – as Parliament’s website tells us (and a year or so even an MP was reprimanded for misleading the House) – but such is the diminished state of things in New Zealand, I don’t suppose there will be any more consequences this time than all the previous times. In a well-functioning democracy you might hope that the Minister of Finance would take to task a Governor who so obviously and deliberately misled MPs (including one of her own) but……no one now expects anything of Willis when it comes to the disreputable central bank and its Governor. One might even hope that the external MPC members – who do not work for Orr – might distance themselves from this shabby and dishonest conduct. But they seem to prefer the quiet life, and just go along with Orr, by default associating themselves with his standards.

At the end of the session the discussion moved to productivity. It isn’t really the Bank’s field, and Orr’s own contributions on the subject tend to veer between mechanistic growth accounting stuff and the “failures” of this, that, or the other group of people in the private sector (today’s villains appeared to be people who took dividends from companies rather than reinvesting). His chief economist, who knows more about productivity, has already shown his hand as a bigger-government statist, advancing personal political agendas under his Reserve Bank title.

But today Orr was claiming that the Reserve Bank has a lot to offer on productivity (policy). Not, you understand, anything to do with the risk-weighted bank capital requirements (where he was blustery and dismissive without even being asked any direct question), sectoral risk weights etc (and where I suspect he is probably about half right in substance). No, what he had to offer was a central bank digital currency (CBDC). It was in development, could be in place by 2030, and would – he claimed – make a great deal of difference. It wasn’t at all clear how, despite his mutterings about how it would enable the state to deal directly with people – unlike, say, the way it pays welfare benefits now, and isn’t a CBDC a liability of an independent Reserve Bank, not something governments have access to? It would, we were told, “fundamentally change this society” – which is sort of what scares many of the more conspiratorially-minded sceptics, even though there is little reason to think such a product would meet with any material demand, or be at all widely used. It remains, in the words of successive submissions I’ve made on the issue, a solution in search of a problem, and a bigger-government one at that.

Orr’s words clearly excited one National backbencher who wanted to know when it would be in place, and what it would take. Orr’s response (in addition to the 2030 date) was “significant government support”. One can only imagine how much money (scarce taxpayer money, adding to the deficit) they are spending on this work (of course no one asked that) and wonder why it is that Nicola Willis has not closed it down already.

Quite sad what officialdom has been coming to in New Zealand, and the apparent indifference of those whom we elect to hold officials to account.

The MPC returns from its summer holiday

Michael Reddell Monetary policy, Reserve Bank

It is almost never an (unconditionally) good thing if an official policy interest rate (in our case the OCR) is being adjusted in large bites, whether that is (for example) 175 basis points of cuts in the last six months or 375 basis points of increases in just twelve months a couple of years back. One can think of rather hypothetical exceptions: a civil war ends and the reckless central bankers who financed it are suddenly sent on their way (so actual and neutral rates fall a lot), or a bold reforming government takes office with an immediate policy programme likely to dramatically lift potential growth, and involving lots of new investment (pressure on resources) in the transition (so actual and neutral rates rise a lot). But that isn’t the story of New Zealand in the last few years (or any of our advanced country peers). Really big changes in official interest rates are usually a reflection of bad stuff having happened: that might be a really nasty external shock (as in late 2008) or past mistakes by the central bankers responsible.

But of course you get no hint of this from the Governor speaking for the MPC. The general gist I’ve seen in headlines reporting his comments in the last 24 hours is to talk things up. Rather than watch the Governor’s FEC appearance I went for a walk this morning, but as I was walking I happened to note this

It might be necessary at this point (almost certainly was) but it isn’t an unconditionally good thing, and it would be good if he (and the political cheerleaders trying to muscle in and claim credit – Luxon, Willis, Seymour) showed even some sign of recognising it. But I guess contrition is a bygone word. (Opposition political parties tend to use the point – big cuts generally mean something bad happened – only to switch rhetoric when they in turn hold office.)

In truth, the Reserve Bank and its MPC really does not know what it is doing. Their own successive forecasts show it. In this chart I’ve taken their projections for the OCR in the June quarter of 2025 for each of the last five MPSs. Only 9 months ago they thought the OCR in the June quarter would average more than 200 basis points higher than they now think.

That might be pardonable if some really big external shock had hit the New Zealand economy. But there hasn’t been any such shock. Commodity prices haven’t plummeted, fiscal policy hasn’t suddenly tightened, no financial crisis has broken upon us

The MPC’s output gap estimates for around now have bobbled around a little, but haven’t really changed a lot (and recall that monetary policy works with a lag, so for example the December data – the GDP input for which we finally get next month – won’t have been materially affected by OCR cuts late last year).

The MPC might respond – if they ever engaged – that perhaps they haven’t usually been much worse than the typical market forecaster. But we – citizens – don’t employ those forecasters, while we delegate a great deal of power and prestige to this supposedly expert committee.

They might also argue that they are doing their best. No doubt, but their best isn’t very good. And what that means is that we are still in a phase – as we have been for the last five years – where neither we nor they can have any confidence whatever in their numbers or statements about what comes next or where the OCR might be at, say, the end of the year. After all, that is 10 months away, and 10 months ago they thought the OCR now would be 5.6 per cent. They simply do not have a good understanding of the inflation process – a big part of the job they are charged with doing. Perhaps we’ll still be at 3.75 per cent, or perhaps we’ll be at 2 per cent: neither seems that implausible, given how inadequate the understanding of the inflation process has been, even without really big external shocks.

Which brings me to some more mundane observations and puzzles around the numbers they did produce in yesterday’s statement.

The big one relates to the fact that, on the Bank’s own telling, the OCR is above its best estimate of neutral now and never drops below neutral (the Bank’s current estimate is 2.9 per cent, while the OCR doesn’t drop below 3.1 per cent). And the current (negative) output gap is estimated (by the Bank) to be about 1.5 per cent of GDP (and the unemployment rate, picked to peak about now at 5.2 per cent, is also well above the Bank’s estimate of a NAIRU). And yet, as if by magic – because there is no visible explanation – quarterly GDP growth is expected to bounce back almost immediately to well above potential, and the unemployment and output gaps close over the next couple of years. But how (on the Bank’s numbers)? When one gets into an economic slump (material negative output gaps), it is normal for policy rates to undershoot neutral for a while to provide the impetus to get the economy back on course (and avoid inflation undershooting). The current slump (negative output gap) isn’t as deep as in, say, 2009, but it isn’t nothing either.

But then there is the other puzzle. Why isn’t inflation falling further (on the Bank’s numbers)? The Bank doesn’t help people trying to make sense of their inflation projections because (a) they don’t publish projections for core inflation (quite a major gap now), and b) they don’t publish their inflation projections in seasonally adjusted terms. But when the output gap is forecast to be negative for the next couple of years (and materially so this year), surely we should be expecting to see inflation fall further. But it doesn’t seem to.

Non-tradables is not core inflation, but it is the best they provide (bearing in mind that non-tradables historically averages well above headline, and so isn’t expected to settle anywhere near 2 per cent per annum). Their non-tradables forecasts for 2025 are already as low as they are ever thought likely to get.

I can do same sort of chart for their LCI wage inflation forecasts. The trough is already reached in the June quarter this year (just a few weeks away) with the unemployment rate still above 5 per cent.

It doesn’t seem to hang together very well as a story.

There aren’t many interesting charts in the MPS itself, but this one caught my eye.

It is based on a working paper that hasn’t yet been published (less than ideal) but seems to show that the bits of non-tradables inflation that are most responsive to monetary policy pressure have already fallen too or below the rates of inflation experience during the pre-Covid decade, where core inflation quite materially undershot the midpoint of the target range, that the MPC is required to focus on. It isn’t an ideal chart, including because it doesn’t show the earlier period when core inflation got beyond the top of the target range, but – given that the latest (Dec) outcomes will have been driven by the OCR at 5.5 per cent, and that (as above) the OCR never gets below neutral, you’d have to think it likely to more disinflation was already in the works, including with the OCR now at 3.75 per cent.

Perhaps there are good answers, but if so (a) they aren’t in the MPS, and b) the MPC members never give speeches or serious searching interviews.

I have noticed that the Bank has consistently been forecasting a large rise in the terms of trade – for reasons that elude me – and perhaps that is some part of a story, but surely any effects of even that puzzling projected rise are already included in those (disinflationary) output gap, unemployment gap, and OCR gap numbers?

Two final thoughts.

When the MPC was established six years ago, the hope – and perhaps promise – was that we would have better quality decision-making and more transparency and accountability. Sadly, any such suggestions have quickly turned to dust, whether under Grant Robertson as Minister of Finance or, more recently, Nicola Willis. The quality of the external members has improved a little over the last year, with two new appointments by this government, although one elderly retired academic who served on the committee from the start (through all the costly mistakes of 2020 to 2022) has recently been extended again by the Minister of Finance. But we hear nothing from any of these people, whether in speeches, interviews, testimony to Parliament’s FEC. Or the minutes of the MPC meetings (the Summary Record of Meeting, which takes up the first three pages of the MPS). These documents have become utterly pedestrian and largely repetitive of material elsewhere in the document. And perhaps more to the point, there is rarely if ever any sense of divergences of view or serious explorations of alternatives, this around subject matter where (see above) the consensus view has so often been so wrong in recent years. Here is the final page of yesterday’s Summary Record of Meeting, where there is just nothing suggested any sort of range of views.

One hears on the grapevine suggestions that the MPC does in fact sometimes have robust debates. Perhaps, but they give no hint of this – in a field that everyone knows is characterised by huge uncertainty, and where challenge and contest of ideas and evidence is vital – and there is no serious accountability. One can only hope that one day, perhaps looking to the end of the Governor’s final term (in March 2028) the Minister of Finance might seek some advice from The Treasury on how to finish the work that Grant Robertson began, but let run off the rails. Some of these people might be uncomfortable about having to front up with their views and analysis, or having to account for their judgements, but – academic or otherwise – if that is so they simply aren’t the right people for such powerful policymaking positions.

And finally, someone reminded me yesterday that the Reserve Bank is holding a closed-door conference in a couple of weeks to mark 35 years since the Reserve Bank Act of 1989 came into effect, and inflation targeting in New Zealand – pioneering as it was – took formal legal effect. They look to have a couple of good keynote speakers (Ben Bernanke, and Bank of England MPC member Catherine Mann – whose BOE speeches are always worth reading, even if her contribution (in a former role) to debate on New Zealand productivity and immigration a few years ago was spectacularly bad). I’m sure the select invitees will enjoy a good time and some expensive hospitality.

The Reserve Bank says that the aim is as follows

One hopes then this will include serious and self-critical reflections on how the last few years came to happen. The promise of inflation targeting was that serious outbreaks of core inflation – and aassociated real unexpected redistributions of wealth, and nasty adjustments to get things back under control – simply would not happen again. And yet they have. Much of the promise in the New Zealand context was that in exchange for delegating huge power to the Reserve Bank, we’d see serious accountability when mistakes were made – and yet, as far as I can see, no central banker anywhere has paid a price for the mistakes of recent years. Or perhaps they may reflect on the not-so-small matter of the massive financial losses central bankers here and abroad ran up on the taxpayers’ bill over the last few years. But – based on the approach of our own Governor, MPC and ministers in recent years – probably not. I’m certainly still in the camp that sees inflation targeting as better than the alternatives – at the 25th anniversary conference I offered some thoughts on why nominal GDP targeting didn’t seem a better choice for New Zealand, in 1989 or more recently – but I’m much less convinced than I was decades ago that delegating the power to central bank Governors or MPCs makes sense. We need expert advisers, but accountability for central bankers has proved so elusive we might be better off putting the decisionmaking back with the people we can toss out, the politicians.

PS: I also saw this comment, presumably from the Governor’s FEC appearance. If this means an end to the long summer holidays and a return to eight meetings a year then it would be most welcome.

Really?

Michael Reddell Fiscal policy, Treasury

A few weeks ago an invitation dropped into my email inbox to attend a joint Treasury/Motu seminar on recent, rather major, changes that had apparently been made to the discount rates used by The Treasury to evaluate proposals from government agencies.

It was all news to me, but when I went over to The Treasury’s website I found that the new policy had come into effect on 1 October last year (relevant Treasury circular here) and that the work on this major policy change had apparently going on for a long time, dating back to the days of the previous government (the two consultant reports are both dated June 2023). All the papers Treasury has released are here (I have also now lodged an OIA request for other relevant papers, including advice etc to current or former Ministers of Finance).

The new discount rates are shown here

This is a dramatically different model than what had been used until now, when all projects were required, as a starting point, to be evaluated using a 5 per cent real discount rate.

I have read all the papers The Treasury released and went along to the seminar on Monday, and came away even more troubled – about both the public policy and analytical dimensions – than I had been initially. Why, you might ask, should commercial projects be evaluated at dramatically different rates than non-commercial projects? Who is going to decide what counts as “commercial” and what as “non-commercial” (and should so much hang on what must, at the margin at least, be something of a line call)? And why would a change of this magnitude, which will materially affect advice going to ministers across the whole of government have been done with no public consultation whatever (and Treasury confirmed to me that this had indeed been the case, and that such consultation as there had been had only been with other government entities)?

But, first, those acronyms: SOC (social opportunity cost) and SRTP (social rate of time preference). Under certain restrictive conditions these two things should be the same, but estimates of them are rarely even close. There is a vast literature on this stuff, going back many decades.

Here is how The Treasury describes the two approaches

There is quite a bit of (questionable) editorial in these descriptions, but the gist is fine: SOC is designed to capture the cost to “society” of funding some public sector proposal (funds could be used for other purposes and projects by firms or individuals), while SRTP attempts to capture how much current consumption “society” (however represented) is willing to give up in exchange for more future consumption.

For decades, Treasury has used a SOC-based approach here, and in my view were right to do so. Of the other countries shown in the various reports, it seems that a majority also use the SOC approach while a small group of European countries used a SRTP approach.

Treasury and their consultants all seem to agree that on straightforward commercial projects, the SOC approach is the only sensible one to take. To do anything else – to use a materially lower discount rate – would be to skew the playing field in favour of the government investing in commercial projects that the private sector could do just as well. In that sense, moving to an 8 per cent real discount rate for unquestionably commercial projects is a step in the right direction (although I suspect that even at 8 per cent, the discount rate is likely to be lower than the hurdle rates of return required by many/most private sector companies in deciding on investment proposals).

A common argument that claims this is okay is based on the fact that government bond yields are typically lower than those for corporate bonds. I’ve long thought (and written about here) that that is a deeply flawed argument, because a key reason government bond yields are lower than those of private sector securities (no matter how large the corporate) is that government’s ability to pay is secured on the coercive power to tax, and that risk (to us, as taxpayers) needs to be priced in evaluating proposals to spend public money. All the more so when one realises that the likelihood of draconian tax increases to meet government obligations is probably pretty strongly correlated with adverse economic circumstances in the wider economy (and thus for the ability of taxpayers to comfortably pay). I’ve also long been uneasy about the idea that public sector proposals should be evaluated at rates that are probably below private sector hurdle rates because of the utter absence of market disciplines government agencies and politicians as decisionmakers face. When people who face no market disciplines want to take our money – tax now, or via debt – and use it on long-term projects, it seems not unreasonable that their schemes should be evaluated on at least as demanding a basis (but ideally more demanding) as private commercial entities do. After all, it is a pretty widely-accepted stylised fact that cost over-runs and execution failures are more the norm than the exception in major public projects in New Zealand (not only New Zealand of course). Remarkably, in none of the Treasury papers nor in the seminar on Monday was there any mention of incentives and disciplines: government failure was all but unknown in a land of benevolent and wise social planners.

But commercial projects (ones that are clearly so) are the easy bit of all this. The latest change was at least a step in the right direction. And the Treasury circular is clear that

The real problem arises in respect of the “non-commercial proposals”. You will look in vain in the Treasury Circular for any official justification for using such wildly different discount rates for the two types of proposals, with the far lower discount rates for those proposals that – almost by assumption – are subject to fewer market-type tests and greater uncertainty (including about specifying benefits and objectives). It will be interesting to see how The Treasury framed advice on this issue to the Minister of Finance. One hopes they mentioned that even so-called non-commercial projects have an opportunity cost – a real burden on taxpayers whose money could be used for other things.

Now, in fairness, the background papers briefly mentioned some arguments (including suggestions that future generations are not represented in today’s market prices, but may be represented by a benevolent government decisionmaker – although it is never clear why (eg) families are less likely to internalise interests of future generations than governments, the latter being individuals facing re-election every three years, and no effort is made to evaluate the actual demonstrated interest in or ability of past or present governments to effectively represent those interests). However, the main paper Treasury cites, that by academic economist Arthur Grimes, has just three recommendations at the end, and not one of them is for anything like this stark (although he notes that “long-term payoffs to projects for which the populace is likely to have a lower rate of pure time discount compared to that for generalised consumption could have a lower [social discount rate] than the default rate….This proposal…is one which warrants further investigation). Grimes was a little sharper in his slides on Monday, but even then his proposal was only for lower discount rates for “some non-market activities” (and quite whose preferences were to guide the choice of “some” wasn’t clear).

What that 2 per cent discount rate for non-commercial proposal does is to ignore the actual opportunity cost of funds (that 8 per cent, or more) and preference – in ranking possible proposals for using scarce societal resources – non-commercial proposals (that generally won’t cover the social cost of capital) over commercial ones. And that is quite regardless of the character of the individual non-commercial proposal, a category that even in concept covers a vast array of possibilities. It is really quite extraordinary, and perhaps all the more so to see it adopted by this government, which came into office focused (at least rhetorically) on low quality government spending, the rapid run-up in debt under the previous government. (I had been unsure until Monday whether these policies had simply been adopted by Treasury, but I was assured by Treasury officials that they had in fact been signed off by the current Minister of Finance).

Now, to be clear, there are some caveats. First, discount rates aren’t everything. All too often cost-benefit analyses have simply been ignored, even when done. And if one looked at the table of discount rates used in other countries that was presented on Monday, the only country using a lower discount rate than the New Zealand 2 per cent is Germany – a country that many of the great and good think does far too little government capital spending (their debt brake – a very sensible initiative in my view – acts as a constraint presumably). In a New Zealand context, simply changing discount rates won’t of itself get more projects off the ground.

But both operating and capital allowances are fluid over time – they are no sort of anchor – and there is no real debt constraint at all. What the change to discount rates will do is make many more non-commercial projects look to pass a cost-benefit assessment, creating pressure from interested parties on governments to raise taxes or take on more debt “because, you can see, so many good projects just aren’t being funded”. And going by the mood of the room on Monday – most attendees seemed to be public service affiliated – many officials will think that just a fine thing indeed (there were people getting up and thanking Treasury for making this change, which would make such a difference to their preferred types of schemes). What was the Minister of Finance thinking when she signed this off?

Especially as the entire thing seems like an indeterminate muddle.

First, there is this table from the Treasury circular, designed to assist agency CEs and CFOs in doing their cost-benefit analyses.

So things that politicians or officials happen to think are good for people (“merit goods”) – whether we value them or not – get evaluated at a much more favourable (lower) discount rate than other stuff. But even setting points like that aside, one is left with more questions than answers. Take schools for instance. Most are provided directly by the state with no charge at point of use, but not all are, and there is no technical reason why a quite different operating model couldn’t be chosen. Same goes for health and hospitals. Are they “commercial” or “non-commercial”? How will Dunedin hospital – a long-lived capital project – be evaluated (if at all)? Does a different discount rate get used if a PPP is involved (see final item in the “commercial” column), than if the government provides the finance directly? And if so, why? And “social housing” is in the right hand column, even though housebuilding and rental operations are directly amenable to commercial models (perhaps with income subsidies to poor users). One could go on.

I asked about some of these specifics at the seminar on Monday, and got no better than handwaving answers, along the lines of “well, we don’t really know, but time and experience will tell”. It was pretty breathtaking really, but then I came home and reread the official circular and that was more or less exactly what they’d told agencies too. It was there in the text above that table, and also in this “The Treasury may publish further guidance as we gain experience with the new PSDRs.”. May…..how helpful.

Now again, to be fair, the circular notes that agencies will be required to stress test proposals by presenting evaluations done at both high and low discount rates. And there will be plenty of public sector proposals where it may not make much difference (where the costs and benefits are both substantially spread through time), but for anything with a major long-lasting capital commitment (think infrastructure) the difference will be enormous. And there is just no guidance, either to agencies, or to enable the public to have a sense of how proposals are likely to be evaluated by officials.

But in case you were thinking that surely not too much would be done at 2 per cent, there was this final guidance to agencies

That is pretty much everything central government actually does.

The whole thing is rendered even more unsatisfactory by this note at the end of the Treasury Circular

If the social cost of capital estimate is 8 per cent real – per this new guidance – it is hard to see any decent basis for keeping the capital charge rate, which incentivises agencies to use scarce capital prudently, at 5 per cent. And whatever the capital charge rate is set at – 5 or 8 per cent, or something higher still – our Minister of Finance and Treasury are happy to evaluate almost all central government department proposals at a discount rate of 2 per cent, far below our cost of capital to enable and fund such activities. I’m happy to agree that there are probably a handful of things that might appropriately be evaluated at below the cost of capital, but….they are few indeed (and probably contentious across different groups in society). And the approach Treasury and the Minister have taken just increases the risk of more uneconomic proposals being adopted over time, with more of a bias towards proposals where there are fewer solid external benchmarks. That seems less than ideal, especially in a government that touts its commitment to “turbocharging” economic growth and productivity.

(I’m also not really persuaded by the case for generally declining discount rates on all non-commercial projects, especially beginning at such a short horizon (30 years, which seems to be shorter than those other countries that adopt this approach), but it would be largely irrelevant if these projects were being evaluated at discount rates nearer the cost of capital.)

Finally, in a country where so much is subject to public consultation, what possible grounds were there for moving ahead on a change of such (potential) magnitude with no wider consultation whatever?

Willis and Rennie speaking

Michael Reddell New Zealand economic performance, Treasury

Last week various of the great and good of New Zealand economics and public policy trooped off to Hamilton (of all places) for the annual Waikato Economics Forum, one of the successful marketing drives of university’s Vice-Chancellor.

My interest was in the speeches delivered by the Minister of Finance and by Iain Rennie, the newly appointed (by this government) Secretary to the Treasury. The Minister also used her speech to announce the launch of a Going for Growth website complete with a 44 page document (15 of which are photos and covers, and another 9 are lists of things (being) done) titled “Going for Growth: Unlocking New Zealand’s Potential” – in the Minister’s words, “Going For Growth outlines the approach the Government is taking to turbo-charge our economy”.

Yeah right.

Now, to be clear, there are some (mostly small) useful things the government has done in the area of economic policy. There are also some (fewer in number) overtly backward steps (eg increasing effective company tax rates by eliminating tax depreciation on buildings, free liquidity insurance for big end of town property developers, debt to income limits imposed by the Reserve Bank), and some important areas where the government has so far failed to act at all (eg last year’s Budget didn’t reduce, and actually marginally increased, the estimated structural fiscal deficit). There is just nothing in what the Minister said, or in what the government has done (or has concretely indicated it will shortly do), that comes even close to being likely to “turbo charge” the economy. It isn’t even clear that either the Minister or her Treasury advisers has anything close to a compelling model and narrative about how we got into the longer-term productivity mess, let alone how we might successfully get out of it (if any politicians really cared enough to want to do so).

Take the Minister’s speech first. I read it against her speech to the same forum last February, given just a couple of months after she had taken office. In that speech we got quite a lot of good stuff about things the incoming government had quickly undone. It made a reasonably impressive list for a first couple of months. By contrast, it is thin pickings in this year’s speech.

We are told, for example, that

Leaders around the world are being compelled to act more boldly than they have for several decades

But there isn’t much sign of it – with the growth focus she talked of – in either what the government is doing, or in what is discussed in the speech.

It isn’t a long speech (just under 8 pages of text) but two full pages are devoted to supermarkets. It is the centrepiece of the speech, to an economics forum just a couple of weeks after the Prime Minister’s big push on emphasising growth-focused policies. Now, I’m as much in favour as the next person of removing regulatory restrictions that might impede the entry of new supermarket competitors – and of cutting company tax rates when possible (which bear particularly heavily on overseas investors’ calculations) – but as the focus of the Minister’s speech it seems like not much more than populist rhetoric. One could eliminate every cent of supermarket profits in New Zealand – which presumably no one wants to do, because unprofitable businesses tend not to keep operating – and it might lower grocery prices by 5 per cent of so (half that for some more realistic scenario based on claims around “excess profits”). Nice to have of course, but not exactly transformative even for households, let alone for the productivity and performance of the economy as a whole. And yet the Minister touts there as being “massive gains for Kiwi shoppers”. And as for suggestions that the government might help hold the hands of potential entrants, how about just getting the regulatory roadblocks out of the way for everyone, rather than rewarding lobbying with special treatment for those who have a taste for and knack of bending the ear of governments for favourable treatment for their particular firms?

Following on from those two pages, the Minister lists four other areas of potential policy overhauls:

  • Government procurement rules. There is talk of a review underway.  It sounds sensible enough (but nothing specific), but it is a little hard to believe that what might eventually be delivered will be any sort of game-changer
  • Tax settings.  Here the Minister tells us that “I am considering a range of proposals to make out tax settings more competitive over time”.  Which is fine, but….there is barely any mention in the speech of the fiscal constraints (the structural deficit the government has so far done nothing about), or of course of the fact that the government increased taxes on business just last year.
  • Affordable energy sounds like a good thing of course.  But there is nothing specific in the speech, and in fact there is a potentially troubling reference to potential steps “the Government may need to take to incentivise new generation”.   Other than removing regulatory roadblocks and, perhaps one day, tax imposts?
  • Savings.  Here there is disconcerting talk of changes to KiwiSaver rules, although probably in the end with marginal effects at best (or worst).  There is talk of enabling more investment in private unlisted assets, even though KiwiSaver fund managers may have little expertise in those sectors, and liquidity and valuation challenges will be very real.  There is the suggestion that more KiwiSaver balances should be invested in New Zealand, which makes little sense for individual New Zealand savers’ whose assets these are and who diversification imperatives should be driving a heavy weighting on international assets.  The Minister tells us she is looking at taking options to Cabinet, but since there is little evidence that difficulty of raising wholesale funding has been a major obstacle to growth in New Zealand it is difficult to see that whatever she comes up with is likely to make much useful change.

And so, almost half way through the government’s term, supermarket reform seems to be what the Minister is holding out as the big prospect (and of course there is Kiwibank, another much-touted cause likely to deliver little useful). 

What of the Secretary to the Treasury’s speech?  You may recall last year that it was reported on several occasions that the Minister of Finance was wanting bold, fresh, innovative thinking from whoever got the job (and since she sets out the search requirements and Cabinet makes the appointment, it really is a government appointment, one in which PSC simply acts on their behalf).

I’m fairly ambivalent about heads of Treasury giving public speeches.  On the one hand, it should be an opportunity to advertise the analytical chops of the Secretary and his/her team, and thus to be welcomed.  On the other hand, the Secretary and the Treasury are the government’s principal economic advisers and those internal relationships are much more substantively important than Treasury public speeches.  There are distinct limits –  quite severe limits in practice –  on what the Secretary can really say, since he or she can’t really be out of step with the Minister in public.  Which means it is never quite clear whether what we are hearing is their best professional analysis, or just what they more or less have to say.

I was pretty underwhelmed by Rennie’s speech, and perhaps the more so as it was I think his first on-the-record speech, and was being delivered not to a provincial Rotary club but to a significant professional economics and policy forum.  No one forced him to accept the speaking invitation, and so we might reasonably have expected the best Treasury had to offer.

Instead, we got a fairly once-over-lightly treatment of both the productivity and fiscal challenges, and the highly dubious claim –  but perhaps it went over well in the Beehive –  that “the Government already has a significant economic reforms programme underway”.   Really?  Do tell.  Interestingly, on the productivity side of things Rennie stated (of Treasury) “we are confident that we understand the basic problems”.  But there was little in the speech to suggest that they really do.  Instead, we get the same rather mechanical growth-accounting stuff that The Treasury has been trotting out for 20 years, and that has found its way into speeches by ministers too.

Thus, we are told that “New Zealand’s low capital intensity is a key driver [note the choice of words] of our poor productivity performance”.   No one disputes that business investment as a share of GDP has been low in New Zealand for a long time, more particularly when considered in the light of rapid population growth.  So the capital stock per worker is, in some mechanical sense, quite low.  But what this approach invites –  and has for the 15-20 years Treasury has been running this line –  is some of “lump of capital” fallacy, that if only more capital was thrown at the economy things would be much better.  It is also captured in comments from both the Secretary and the Minister that are reasonably read as suggesting that somehow individual firms are making bad choices and not putting enough capital into their production processes.

The mentality is all wrong.   Low levels of capital intensity are at best seen as symptom not as any sort of cause or “driver” of productivity growth failures economywide.    New Zealand has never had a particularly problem attracting finance – for example, for decades we’ve financed largish current account deficits even as on average the real exchange rate has stayed high.  And we should assume that, on average, firms and potential investors are responding rationally, and even optimally on average, to the opportunities they face.     So the issue is not that firms are failing to use enough capital in their production processes –  they are most likely doing what is best for them – but that, having regard to all the other constraints (taxes, FDI rules, RMA regimes, other bits of regulation, real exchange rates) there just aren’t that many attractive projects here in New Zealand.  A highly successful New Zealand economy would be likely to be more capital intensive (and generate higher wages),but focusing on the capital intensity or otherwise is the wrong lens with which to look at the problem.    Firms and investors respond to opportunities, and sometimes (often) governments get in the road and make investment (particularly that in the tradables sector) unattractive.

The emphasis on “capital intensity” also drives a focus –  and it is there is the Secretary’s speech –  on something labelled “savings policy”.   I suspect there is a more sophisticated analysis behind some of this stuff, but again the way it comes across is to feed a mentality that if only more “savings” were available more productivity would flow.  As already noted, we’ve had no problem attracting generic foreign savings, but government policies do make business investment proposals often rather unattractive, whether the potential finance is from domestic or foreign sources.

Rennie also addressed (or largely avoided addressing) the fiscal challenges.   “Avoided addressing” because he was more or less stuck with his Minister’s choice to go very slowly and to keep postponing the date for a return to structural fiscal balance.   Instead we get lines like “the current Government has committed to concrete steps to address structural deficits” –  which is generous at best, since they have taken few actual concrete steps, and have only “committed” to the variable vapourware of future (changeable) operating allowances – and suggestions that somehow adjusting over a long period of time is just fine, when there was never a robust economic case for the current structural deficits at all.

And then of course there was the heartwarming, somewhat detached from reality, ending

Governments need to make progress in the here and now. Our job is to advise them on
which pathways are the best to start walking down. We do think hard about a coherent
programme, drawing on evidence and judgment but also remain mindful of the uncertain
connections between policy changes and policy outcomes when you look out over the
horizon. Over time governments will choose to stride faster or slower down those paths.
The important thing is to keep taking those steps and maintain momentum across a broad
front of economic and fiscal policy frameworks.

First, it has an implicit assumption that Treasury knows what is best to do, whether around fiscal or productivity issues.  This is the same Treasury that was advising Grant Robertson only a couple of years ago that higher spending was just fine, the Treasury that seems keen on more active use of fiscal policy (notwithstanding where that mentality got us in the last few years), and the same Treasury that does not have and has not had a compelling narrative around productivity failures or solutions.  And then there is the rather delusional suggestion that, Treasury having identified the right paths, different governments might just walk them at different paces.  The real world is one in which different governments will, at times, be walking in almost exactly the opposite direction to what either fiscal prudence or better productivity performance might call for.    One might think of raising corporate taxes last year, or film and gaming subsidies, or…..or……or……. (all parties, all governments).

Perhaps it really is the case that all the answers to New Zealand’s economic woes rest with failure to adopt the old-time religion.  I rather doubt it, but whatever the case the sad reality of the Secretary’s first public speech is that there was no sign even of fresh or interesting ways of articulating the old-time religion or any interesting or bold new angles.

But that probably suited his political masters.

Going for growth…..perhaps

Michael Reddell New Zealand economic performance, Productivity

The Prime Minister’s speech 10 days or so ago kicked off a flurry of commentary. No one much anywhere near the mainstream (ie excluding Greens supporters) questioned the rhetoric. New Zealand has done woefully poorly on productivity for a long time and we really need better outcomes, and the sorts of policy frameworks that would supports firms and markets delivering better material living standards for New Zealanders.

The Prime Minister asserted that “2025 will bring a relentless focus on unleashing the growth we need to lift incomes, strengthen local businesses and create opportunity”. Assuming that these are shorthands for measures intended to durably and substantially lift economywide productivity growth (I saw a nice quote the other day from the Canadian Leader of the Opposition to the effect that no one talks about productivity per se except economists and friends of economists), one could only respond “good if true”.

We have been promised a “rolling maul” of new policy measures as the year unfolds. And the Minister of Finance (now rejoicing in the rather absurdly named additional title of Minister for Economic Growth -albeit perhaps no more absurd that the Economic Development title it replaced) went further in her press release announcing the Budget date and promising

It is a distinctly different emphasis than in her Budget-date announcement press release last year.

Nothing like building up expectations….and one hopes journalists will keep an eye on this set of promises.

I’d give this government credit for a number of steps that, at the margin, may help boost growth, productivity, and efficiency of the New Zealand economy. But it is hardly a case of everything working in the same direction: last year, for example, we had increased business tax rates (re building depreciation), increased taxes on inbound tourists, more restrictions of bank mortgage lending, passing up chances to overhaul key personnel at the Reserve Bank, and of course a Budget that, taken together, slightly widened the structural fiscal deficit. And it wasn’t as if the growth rhetoric wasn’t around last year (eg this quite respectable, as far as these things go, speech from March 2024).

Perhaps this time they really will deliver “bold steps” in May. I’m open to being convinced – and in this case would love to be wrong- but count me sceptical.

For various reasons:

  • For all the rhetoric from the PM and Minister of Finance there is no specific goal which they are willing to use as a stake in the ground (even John Key for a short time would run the line that “our vision is to close the gap with Australian by 2025”),
  • There was nothing in the National Party’s campaign material in 2023 that suggested either a deep understanding of the issues or a policy agenda equal to the sort of challenge New Zealand faces (and that was so even when there were some specifics I thought made sense),
  • We are now 14-15 months into the government’s term –  the election is next year –  and not much has been done so far, no compelling narrative has been developed, no key government agencies have been overhauled and made fit for the challenge etc,
  • Where are the advisers? It isn’t obvious that there are first-rate productivity-focused political advisers in ministers’ (or the PM’s) offices, and what about MBIE and Treasury?  MBIE is a bureaucratic behemoth run by a former Air New Zealand HR senior manager (no, before Luxon’s time) and in appointing a new Secretary to the Treasury, and despite more fine words from Willis last year, the government ended settling for a recycled former Deputy Secretary, who is certainly skilled at managing upwards but would never have been mistaken for a bold and innovative policy reformer (or leader of such people/processes).  Oh, and the Ministry for Regulation is headed by a non-policy recycled public sector chief executive, who didn’t seem to be particularly well-regarded in her previous chief executive role.
  • The Budget is now a mere 3.5 months away.  Based on standard timings Treasury will be finishing their economic forecasts by the end of next month and the Budget is unlikely to incorporate anything not decided by the end of April.  Without excusing bureaucratic sludge, good policy processes take time, perhaps especially in a coalition government.
  • And, of course, none of the three measures announced in the last 10 days look to add up to very much (Invest NZ – one wonders why this spin-out from NZTE is needed at all, and what private sector advisers can’t provide –  the re-organisation of the CRIs, and the digital nomad visa)

There is, of course, some stuff in train that should in time prove helpful (for example, the RMA overhaul, although with the best of intentions it is likely to be years until we can be confident just how helpful – the original RMA having been understood at the time as a liberalising reform).

One can only assume that the word has gone out from the offices of Luxon and Willis to all ministers, and then all public service agencies, to pull together whatever they now can – and perhaps hold off on other announcements for a while – to enable a set of Budget announcements that can be dressed up as passably resembling “bold steps”. No doubt there is stuff in the works – there almost always is – so perhaps the net effect will even be positive (though with enough confidence to lift Treasury’s assumptions about real per capita potential GDP growth?) but I wouldn’t be holding my breath that it will be the real thing, or even begin to get to grips with the magnitude of the challenge. But – Trump ructions permitting – quite probably there will be some cyclical rebound in GDP growth in time for next October (for which the government will deserve no more credit than it deserves blame for the monetary policy induced recession last year),

On that note, the Sunday Star-Times yesterday ran an op-ed from Don Brash and me, prompted by some combination of memories of that goal of catching Australia by 2025 (Don chaired the taskforce and I provided analytical and drafting support) and the PM’s speech, trying not be to be particularly partisan (the failure – and the rhetoric, in varying volumes – has been common to all governments for decades). We ended the column this way.

For anyone interested, the full text follows:

When Don was young and Michael’s parents were young, New Zealand had among the very highest material standards of living in the world.  It really was, in the old line, one of the very best places to bring up children.  But no longer.

For 75 years now, with no more than brief interruptions, New Zealand has been losing ground relative to other countries.   Australia and the UK pulled ahead of us, previously poor places like Singapore and Taiwan caught up and overtook us, and increasingly now the former eastern bloc countries (Slovenia, Estonia, Poland, and so on) are catching and overtaking us. 

Don’t get us wrong: material living standards here are still well ahead of where they were in the 1950s, but if we were once a leader we are now a laggard.  All too many of our people have seen better opportunities across the Tasman for themselves and their kids and have made the move.  That’s good for them, of course, but a poor reflection on economic performance and policy back here.

For 40 years, successive governments have talked a good game about reversing that relative decline and closing the gaps that were opening up.    In the earlier part of the period there were far-reaching policy reforms, which probably helped slow the rate of relative decline.  In more recent decades, the ratio of talk to action has very much favoured talk.  And that is so whichever of our main political parties has led the government.

In late 2008, nearly 17 years ago now, as part of a post-election agreement with ACT, the then government led by John Key announced a goal of catching up with Australia by 2025.  A Taskforce was set up to advise the government on policy options that might enable aspiration to be turned into solid economic achievement.  Don chaired that 2025 Taskforce and Michael wrote much of the Taskforce’s first report.   

The report wasn’t well-received by the then government –  in fact, the then Prime Minister openly dismissed it even before it was released publicly – but that didn’t alter the facts:  New Zealand was lagging far behind Australia (and Australia itself wasn’t, and isn’t, a stellar economic performer).

It is now 2025 and over the intervening years –  under successive governments, led by both main parties – no progress at all has been made in closing the gaps to Australia.  If anything, and as measured by labour productivity (output per hour worked), the gaps have widened a bit further.  Recently the Australian government has made it easier, and more secure, for New Zealanders – any of us, skilled or unskilled, young or old –  to cross the Tasman.   It isn’t that Australia has done particularly well economically in recent years –  rather the contrary –  it is just that New Zealand hasn’t even managed to match their underperformance consistently.    Productivity growth – the only secure foundation for material prosperity – here dropped away further from about 2012.

This month we’ve heard a lot from the Prime Minister about the importance of economic growth.   It is fine rhetoric and we entirely endorse his argument.   Material prosperity – whether it is private consumption or better and more public services – rests on restarting sustained economic growth, which in turn rests on accelerated sustained growth in productivity. 

This isn’t just about the ups and downs of the business cycle. Economic activity has been particularly weak in the last 12-18 months as the Reserve Bank has been getting on top of the inflation it inadvertently generated with too easy monetary policy during the Covid period. Now that inflation is falling and interest rates are dropping, we should expect a cyclical recovery.    But a near-term bounce isn’t anything like enough; what we need is, say, 20 years of 2-3 per cent per annum productivity growth.  Over the last decade, actual productivity growth has averaged not much more than 0.5 per cent per annum.

The Prime Minister announced a couple of small reforms in his speech this week.  They may well be individually helpful, but small changes aren’t what will produce really big differences in outcomes. 

We’ll watch with interest the promised “rolling maul” of reforms but aren’t confident that this government, any more than its National and Labour predecessors this century, is likely to respond on the scale equal to the challenge.  

Sadly, it isn’t obvious either that the government has a public service with the energy, intellectual ferment, and concrete ideas that a willing government could pick up and run with.   But some of the options that should be considered are pretty obvious:  economics literature suggests that most of the burden of heavy taxes on business is actually borne by labour (in the form of lower wages than otherwise), and yet New Zealand –  plagued by decades of low levels of business investment – has one of the highest company tax rates in the OECD, and takes a higher percentage of GDP in corporate income tax than almost any OECD country.   Foreign investment in New Zealand remains harder than it should be, and is taxed more heavily than it should be.

We can choose to continue to drift, with just incremental reforms, as successive governments have done for 30 years even amid the fine talk.  But if we do, more and more New Zealanders are likely to conclude rationally that there are better opportunities abroad, and for those who stay aspirations to first world living standards and public services will increasingly become a pipe dream.  

It is a multi-decade challenge under successive future governments, but as the old line has it the longest journey start with the first step.  We hope the Prime Minister’s bold rhetoric signals the beginning of a willingness to lay things on the line, to lead the debate on serious options, to spend political capital, for the serious prospect of a much better tomorrow for our children and grandchildren.

ENDS

NB: Since I saw a BusinessDesk column this morning claiming that 1950-type cross-country comparisons are unfair (much of continental Europe was still recovering from the war), it is worth pointing out that exactly the same could have been said of 1939. New Zealand had among the very highest material living standards among advanced economies throughout the first half of the 20th century.

Reviewing Covid experiences and policies

Michael Reddell pandemic

I’ve spent the last week writing a fairly substantial review of a recent book (“Australia’s Pandemic Exceptionalism: How we crushed the curve but lost the race”) by a couple of Australian academic economists on Australia’s pandemic policies and experiences. For all its limitations, there isn’t anything similar in New Zealand.

What we do have is the Phase 1 report of the Covid Royal Commission which was released by the government at the end of November. You can find the full 700+ page report here. I haven’t read the full report but did read Chapter 6 on “Economic and social impacts and responses” (which starts on page 242 of the Report itself, or page 285 of the pdf). It was, frankly, a pretty disappointing read. If the overall Royal Commission report itself got surprisingly little coverage, I don’t think I’ve seen any mention at all (certainly no serious or sustained reporting or analysis) on the economic dimensions of that exceptional period.

It is disappointing on a number of counts. First, and perhaps least important to me at this point, we were told (and the terms of reference make clear) that the focus on the Royal Commission was supposed to be on lessons learned with a view to being better equipped/prepared to handle future pandemics. But in the economics section of chapter 6 there is almost none of that, and the focus seems to be almost entirely on describing and evaluating policy responses and the impact of them. Which would be fine, except that the chapter is very much an establishment perspective, with little or no sign of any critical scrutiny before reaching the generally rather complacent conclusions.

I went and had a look at the list of engagements and people the Royal Commission had met with had over the course of their inquiry. I was looking to see which economists, academic or otherwise, the Royal Commission might have met with. They had, of course, met with The Treasury and the Reserve Bank, they’d met with three [named] former Secretaries to the Treasury (another former Secretary to the Treasury was one of the commissioners), they note a meeting with one economist described as a “public policy expert” on aspects of the wage subsidy scheme. And other than that all we got was, in November 2023, a mention that they had met with “various [unnamed] independent economic commentators”. Which was more than a little surprising when, for example, leading New Zealand economist John Gibson had been producing work on related issues since early days of the pandemic (discussed first on this blog here), as had former academic Martin Lally. I worked my way through the 12 pages of end notes to Chapter 6, and not only was there no reference to anything by Gibson or Lally, but there was no reference to any commentary or critique etc by any outside economists, academic or otherwise (although there is a quote from a Bernard Hickey Substack). There is a one sentence reference to “considerable concern” they heard from “some expert stakeholders” about the LSAP, only to dismiss this on the grounds that “these policies are now well accepted by international organisations” and going on to channel the Reserve Bank’s own lines in its defence. Fiscal losses of “in the order of $11 billion” are noted. but there is no attempt to evaluate the strategy or to think about how support might better (and more cheaply) be provided in future. That isn’t scrutiny and evaluation; it is reporting.

The chapter is weak right from the start, when the Commissioners simply assert (there is no supporting analysis) that “the strict public health measures introduced in March 2020, especially the border closure and national lockdowns, were essential [emphasis added] to protect the economy and society from the immediate and devastating effects of the pandemic had the virus been allowed to spread unchecked”. There is no analysis as to what extent of restrictions was required (it is a very all or nothing assertion), there is no reference to the fact that significant reductions in movement were occurring prior to any legal restrictions (or, for example, to the work of Goolsbee and Syverson from the US, using mobile phone data, and suggesting that almost 90 per cent of reductions in movement pre-dated legal restrictions). There is no suggestion of any cost-benefit approach at the margins (as there was no sign of it in the official advice, and we recall the trouble the Productivity Commission got into when they did one brief illustrative exercise), and no comparison looking at how the economic costs and benefits of the New Zealand approach stacked up. Of course, no country let the virus “spread unchecked” but the US is often used as a foil and counterpoint to New Zealand and Australia, and for all the differences in approach it is striking how similar the respective paths of real GDP per capita proved to be (for quite different health outcomes of course).

I don’t have a strong view on what, if anything, in this area should have been done differently, but we should have expected more challenge and scrutiny from the Royal Commissioners.

There is no attempt anywhere in the chapter to consider whether the things fiscal policy was used for could have been done (materially) more cheaply – either in evaluating 2020 and 2021 or thinking about the future. The fiscal costs were staggeringly high. It also isn’t clear that the Royal Commission really understands the point of the initial fiscal approach. They talk about the aim being to support economic activity, when in fact it was quite the contrary: the point of the lockdowns (and private risk-averse behaviour) was to largely shut down the economy for a time. What the wage subsidy approach was designed to do was (a) tide individuals over (the government compelling many not to work, and b) facilitate a quicker rebound than otherwise by maintaining established firm-specific arrangements and human capital. It certainly did the former, but to what extent it really did the latter (see chart above) deserves more serious scrutiny. Headline unemployment rates in the US went far higher than in New Zealand (and Australia) reflecting different intervention approaches, but (see chart) it isn’t immediately obvious that overall US economic performance suffered.

The Royal Commission also runs a line one sees too often, taking the very gloomy economic forecasts that were around in the second quarter of 2020, contrasting them with actual outcomes, and concluding that credit belonged to the policymakers (the Royal Commission hedges a little but is in the same camp with its “No doubt, these better-than-scenario outcomes reflected, at least in part, the speed and generosity of the Government responses”. But that simply has to be wrong. Treasury and Reserve Bank forecasters in the second quarter of 2020 knew all about the scale and nature of all those responses (economic and public health): the effects they expected were already embedded in their forecasts/scenarios. What actually happened was a massive forecasting failure, misunderstanding the nature of the shock and the way the balance of supply and demand pressures was likely to play out. Of course, plenty of private sector commentators and forecasters made the same mistake, but official failures had rather more consequences.

The Royal Commission is keen on the Reserve Bank’s self-described “least regrets” strategy (which, incidentally, has just a single mention in the RB May 2020 MPS), by which they thought – sensibly enough – that faced with a big adverse shock you wanted to act early rather than late. The problem was never with that as applied to RB actions in March 2020, but that they failed to apply anything like the same logic when it started to be apparent that inflation was becoming a problem. They were slow to recognise the speed of the economic rebound or the emerging capacity and core inflation pressures, and were slow to act, and acting rather slowly (Orr to this day attempts distraction, around things like Ukraine that didn’t happen until after the economy was already well-overheated and core inflation had risen strongly). That series of mistakes – in common with many other central banks – added hugely to the overall cost to New Zealanders of the Covid experience, and we are still dealing with the aftermath now. The Royal Commission seemed much more inclined to channel Reserve Bank stories, down to and including repeating a cross-country chart from the Bank’s own self-defence publication designed to make New Zealand look good by using headline inflation in 2022 (much of Europe affected by a gas price shock) rather than core, and the level of unemployment (rather than either the change, the NAIRU gap or the output gap) when – quite unrelated to anything around Covid economic policy – New Zealand has one of the lower NAIRUs in the OECD. Most extraordinarily, and with no supporting analysis at all, the Royal Commissioners conclude that the severe inflation outbreak was an “unavoidable price” of good policies. If so, we’d really better change the Reserve Bank’s mandate, and perhaps whitewash from history their own very weak forecasts for inflation from late 2020 and early-mid 2021. They certainly didn’t think inflation was inevitable; they (paid to get these things roughly right) got their forecasts, and thus policy, badly wrong.

Now to be fair to the Commissioners they do note the obvious, that both fiscal and monetary policy were too loose for too long, but it is all very subdued, and with no insight on what went wrong and why, or what might be better in future. There are complacent comments that if there were some gaps in Reserve Bank/Treasury coordination “it was good by international standards”, even as though offer no evidence for such claims. They don’t even mention – a point the Reserve Bank acknowledged in early 2020 – that the Bank had failed to ensure that negative interest rates were a technical possibility: had it been otherwise they might never have gone so big and so long on the LSAP, at such vast risk and (as it turned out) fiscal costs (the Bank, to be fair to them, had not historically been keen on LSAP types of instruments).

I could go on with many smaller points, but that would mostly be to bore readers. I’ll end with just two: there is no attempt to evaluate whether the exporter freight subsidies really made sense, and for so long, nor is there any attempt to evaluate whether it made sense – as was done at the start of the pandemic response – to permanently increase welfare benefit levels going into a pandemic that was (a) likely to have large economic and fiscal costs, making us poorer on average, and b) wasn’t going to affect the real incomes of those on benefits.

Overall, I thought this bit of the report was a serious lost opportunity. Perhaps the economic establishment (RB, Treasury, Grant Robertson) like it because there is no serious challenge or scrutiny, but just the appearance of it (a 700 page report don’t you know) but what use is that to New Zealanders, either in holding powerful officeholders to account (and yes time were tough but you take these jobs for the tough times) or in being better prepared for the inevitable future adverse shocks.