Simply unfit

In yesterday’s Sunday Star-Times another article by their reporter Kate MacNamara shed further light on just how unsuited Adrian Orr is to be Governor of the Reserve Bank, exercising huge public policy and regulatory power still (in large chunks of the Bank’s responsibilities, often with crisis dimensions to them) as sole decisionmaker, with few/no effective checks and balances.  These disclosures should also raise serious questions about the judgement and diligence of the Board who were primarily responsible for Orr’s appointment and are primarily responsible for holding him to account, and of the Minister of Finance who formally appointed our, and is responsible now for both him and for the Board.

In this latest in her series of articles, MacNamara draws on the responses to one of several Official Information Act requests she had lodged late last year.  She had sought from the Bank copies of communications between the Governor and (a) the head of the financial sector body INFINZ and (b) Roger Beaumont the executive director of the Bankers’ Association (those responses are here), and copies of communications between Orr and the New Zealand Initiative think-tank, especially its chair Roger Partridge (responses here).    Her article draws mainly on the response re the New Zealand Initiative.

The context here is Orr’s (then) proposal to dramatically increase the volume of capital locally-incorporated banks would have to have to fund their existing loan books in New Zealand, disclosed in December 2018.    A wide range of commentators locally were critical of the Bank and many drew attention to the rather threadbare nature (at least initially) of the supporting material (it took three waves of releases over several months before we finally got the full extent of the Bank’s –  still-underwhelming –  case).   There had been no technical work preparing the ground, even though Orr was to be prosecutor and judge in his own case.  There was no serious cost-benefit analysis for what Orr was proposing, no serious benchmarking against capital requirements in other countries (notably Australia), no serious analysis of the nature of financial crises, and a strong sense that Orr wanted to compel us to pay for an insurance policy that simply wasn’t worth the price.    All this from an organisation where a recent careful stakeholder survey –  conducted by the New Zealand Initiative before Orr took office –  had highlighted very serious concerns about the Bank’s financial regulatory functions.    Meanwhile, Orr was already underway with his open attempts to cast anyone who disagreed with him as a “vested interest”, somehow “bought and paid for”.

Various people made public comments.  Among them was Roger Partridge, chair of the New Zealand Initiative, who had a column in NBR in early May critical of what was being proposed, and the processes used (at the time the Initiative was finalising its submission to the formal Bank consultation).    In my contact with Roger, he always seems much more interested in the substance and process of any issue.   But in a single decisionmaker model, it is a single person in focus

Anyway, the Governor did not like Roger’s column at all.  Normal people who disagree might either let things wash over them (being in public life, exercising great power, not only does but should, bring scrutiny, challenge, and criticism).  Or perhaps you might even ring the author and have an amiable chat.  But not Orr.

The OIA release begins with Partridge emailing Orr after learning that Orr had rung the Executive Director of the Initiative had been “upset” by Partridge’s column.  This is a bit of a problem for the Initiative, as Orr is scheduled to speak at a private lunch for their members the next day, so Partridge offers up one of those semi-apologies (“if I crossed the line I apologise, but don’t resile from the criticisms of the policy process”), and even goes so far as to send Orr a copy of the remarks he intends to use to introduce Orr the next day (typical gush).

But that is not nearly enough for our thin-skinned Governor who replies to Partridge with a page and a half email.  All this after Orr had already talked to Hartwich both before and after a flight to Auckland they had both been on.   Just a slight loss of perspective and focus you might wonder?

And so we read (of his conversation with Hartwich)

I talked of the personal abuse I receive in this role. I also talked of the vested-interest driven articles that are prevalent and portrayed as analysis.

and

I do not accept your apology as it provides no reflection on your:
1. Stating I have a gambling problem.
2. Mocking our use of a Maori mythology to connect with a wider NZ audience – something we have been tasked by the public and stakeholders to do (I noted to Oliver this is a common thread of online abuse I receive from other purported banking/economic experts that go even further in ethnic/religious/personal comment).
3. Claiming below that you aimed to provide a robust critique of the proposal. You do not. You quote selective work of purported experts. You also pull only selected components of our submission process (which has stretched nearly 2 years).

From context, I understand that Partridge had said something along the lines that Orr was doing little more than gambling with his ill-supported capital proposal.  If so that seemed (and seems) fair to me, and would not to any reasonable person, with any sense of perspective, suggest they thought the Governor had a gambling problem.

I guess we are expected to just believe the lines about “online abuse” (and, who knows, perhaps I’m one of the people he is alluding to).

It goes on, before ending this weird way

I do not see your article as a robust critique. What I do see is ongoing character assassination, an undertone of dislike of the RBNZ, and a clear bias in economic and ethnic preference.

At the Bank we are open minded and working on behalf of all New Zealand and do so in a transparent manner.

See you tomorrow. The introduction looks fine. I will be professional and courteous towards your members.

Adrian

The person

But, of course, he is calm, open-minded, and –  apparently unlike any of his critics – only focused on the national interest.  And what to make of that “The person”?     If any upset junior staffer sent such an email to his/her boss, you might seek to get them some support and counselling.  But this was the most powerful unelected person in New Zealand, responding to a private citizen who happened to disagree with him.

(Of course, I can well understand why they didn’t do so, but in some respects it is a shame the Initiative didn’t disclose this correspondence at the time, so poorly does it reflect on a leading public official, making major policy decisions while clearly not coping.  I hope at least they referred the matter to the Minister and the chair of the Bank’s Board.)

Partridge sent another placatory email to the Governor, only to get yet another page-long missive

The behaviours displayed by your institution make it appear that it is a low chance that a well informed discussion where all parties come out better off could be ever achieved. We Remain open minded.

ending

See you later today. I will be professional and respect your members. I do not gamble.

There had been no mention of the “gambling” thing in Partridge’s email Orr was here replying to.

The rest of that OIA release is fairly uncontroversial stuff from 2018 on the release of the Initiative’s report that dealt with the Bank’s financial regulatory functions (the one the Governor claimed at the time to take seriously and welcome, although also the one he was rubbishing by late last year.)

What about the other OIAs?  It is mostly less egregious stuff.  But with have this odd example from a letter to the Executive Direction of INFINZ on 24 May 2019

For closure sake as promised, I mentioned to you at the event that I was disappointed with the process that you adopted in the preparation of a submission to our bank capital proposals. I did so as I want to be open and frank consistent with the ‘relationship charter’ we recently established with our regulated banks I read about your views first in your published op-ed and then via a newsletter you sent to INFINZ members. It was some time after that you met with RBNZ staff. The process created a perception of a predetermined outcome for the submission.

How shocking.  A private sector industry group first published its views in an op-ed and a newsletter and didn’t first talk to RB staff.      Quite who does the Governor think he is in objecting to that?

Even odder was this

In the spirit of the ‘#me too’ commentary promoted at your awards evening, I have received personal written and verbal abuse from within the industry during this consultation process. For New Zealand’s capital markets to have the ‘social license’ to operate – another theme at your event – I believe the industry’s culture needs ongoing improvement.

As a reminder to the Governor, we don’t have lese-majeste laws in New Zealand, and certainly not for central bank Governors.   And as for this weird appropriation of the “#me too”  movement – mostly about the mistreatment of women by men in positions of power over them –  to apply to criticisms of a very powerful public figure…..well, weird is just the best term for it.

It wasn’t the only time he’d tried this line.  In a column late last year, Hamish Rutherford told us he’d even used it at a parliamentary committee

me too

Being in position of power, Orr’s complaints brought forward this response from the INFINZ Executive Director

We are concerned and disappointed that you have received verbal and written abuse from within the industry during the consultation process – bullying is not acceptable and we agree that all discussions should be both professional and respectful.

Quite how anyone in the industry –  or anywhere else for that matter –  could have “bullied” the Governor (who singlehandedly wields all the power that mattered on the bank capital issues) is beyond me, but I guess INFINZ didn’t want to jeopardise their ability to get the Governor as a speaker etc.

The final set of OIA responses cover the Executive Director of the Banker’s Association.

The first was a Saturday morning email to Beaumont and the chairs of the four main banks in April.     It isn’t offensive and thin-skinned as he later became, but while the submissions are still open, he is clearly trying to put pressure on them

FYI only as I am eager you understand the effort we are going to in order that the Bank is open and listening.
This was not the impression you all conveyed to me over the last couple of weeks in our individual one-to-one meetings.

Only there is nothing in the rest of the letter to give anyone any reassurance.

In late May there is a letter (presumably emailed) from Beaumont to the Governor, copied to the Minister of Finance, about the “independent experts” the Governor had selected to help make his case.    The letter isn’t aggressive in tone but noted that none of the independent experts had New Zealand specific knowledge and suggest a couple of locals they could work with.

But this sparks a petulant email back from Orr, also copied to Grant Robertson

Dear Roger,
Your letter is unsigned. Can you confirm it is legitimate please? Apologies, one must be careful.

and

I do not understand the reason you have copied the Minister of Finance in to this dialogue. Is there something specific you are looking for from the Minister’s office that I need to understand?

Minister of Finance? Well, you mean the elected person with overall responsibility for economic policy, the person who has formal responsibility for your performance etc etc?

Recall, that all the stuff covered in the material that came to light yesterday is really just another glimpse at what was apparently a pattern of quite inappropriate behaviour.    From one of Kate MacNamara’s earlier articles

But other observers were not surprised. Details of [Victoria banking academic Martien] Lubberink’s experience were already circulating in Wellington and industry sources say they match a pattern of hectoring by Orr of those who question the Reserve Bank’s plan.

“There is a pattern of [Orr] publicly belittling and berating people who disagree with him, at conferences, on the sidelines of financial industry events,” said one source who’s been involved in making submissions to the Reserve Bank on the capital proposal.

There have also been angry weekend phone calls made by Orr to submitters he doesn’t agree with.

“I’m worried about what he’s doing.”

The source said some companies have “withheld submissions,” for fear of being targeted by Orr.

“They’re absolutely scared of repercussions. It’s genuinely disturbing,” he said.

We can only wonder what he was like inside the Bank or around his own Board table.

Does any of it matter, or is this simply the degraded state of public life we now have to get used to?  Age of Trump, age of Orr etc.

It should be utterly unacceptable, in any public figure, but perhaps especially so when that one public figure is (a) unelected, and (b) wields such huge discretionary power on far-reaching policy matters, with few/no checks and balances.   I was tempted to suggest that the individuals in receipt of these particular Orr missives are big enough to stand up for themselves, except that evidently they aren’t really –  Partridge, Hartwich, and McElwain find themselves rushing around the placate Orr.  That’s costly and uncomfortable: much easier just to pull your punches and offer less challenge or scrutiny next time the bully (for on his revealed behaviour it is him not his critics who better fits that description) wants to push through some half-baked costly idea.

The banks themselves will long since have gotten the message –  it was Orr’s predecessor who heavied the BNZ to shutdown Stephen Toplis when he wrote a critical commentary on some aspect of Wheeler’s monetary policy –  but the experience last year will only have reinforced that extreme caution.  Recall that Orr wields direct power over them in all sorts of way, visible and less so, and clearly does not cope with being challenged or criticised (no matter how many times he claims to be “open-minded”.   It is great that Kate MacNamara has kept up the scrutiny, but that will presumably mean no access: much easier for her fellow journalists to keep their heads down and not ask hard questions of the Governor and Bank (who –  news though it may be –  are not infallible).

And what about people inside the organisation?  Recall that on regulatory matters the Governor is still the sole decisionmaker, and on monetary policy he has –  in effect –  most of the clout, all of voice, and no real transparency.  It is vital that the Governor’s priors, whims, and even well-considered ideas are seriously scrutinised –  and even that the Bank sticks to its statutory roles –  but seeing the Governor treats outsiders, how are people inside the Reserve Bank likely to respond.  All but the most brave or reckless will be strongly incentivised to keep quiet, go along, join the cheerleaders etc.  In any public agency that should be grossly unacceptable, but particularly so in one as powerful as the Bank.  Orr has grossly abused his office, and looks increasingly unfit to hold it.

And if Orr gets away with it what message does it send to other thin-skinned bullies elsewhere in the upper ranks for our public sector, let alone to those who work for them.

And yet it looks as lot like Orr will get away with it.  Perhaps there was some quiet word in the hallowed halls of the Bank’s Board room, but these are the same people who selected the Governor less than two years previously. They are invested in his success, and they and their predecessors have a long track record of providing cover and defence for the Governor, not serious scrutiny and accountability on behalf of the public. This behaviour occurred in 2018/19 and there is no hint of concern in the Board’s published Annual Report.

If any of this bothered Grant Robertson, it can’t have been much.  You’ll recall that response I had late last year from Robertson, when I wrote to highlight his formal responsibilities for the egregious conduct highlighted in earlier MacNamara articles.  He then expressed his full confidence in the Board and suggested he was satisfied with the Governor too.     In the great tradition of “lets look after each other” Robertson has just appointed the Board chairman to a further two year term, even as he walked by such appalling conduct by the person he is paid to oversee.

(It is sad to reflect that much of the material covered here relates to events in May 2019.  That was the same month the then Secretary to the Treasury was also going rogue, grossly mishandling –  and then refusing to apologise for –  his handling of the “Budget leak” episode.    Doesn’t exactly instill confidence in the top tier of our leading economic agencies –  or the Minister responsible for both –  does it?)

Perhaps it is all in the past now.  Perhaps having got through the year, made his final decisions etc, Orr has returned to some sort of stable equilibrium and is operating effectively, rigorously, and deeply to provide leadership in difficult times.  Perhaps.  But even if that were so –  and that sort of Orr was not on display last Wednesday –  no one who can lose all perspective as badly as Orr clearly did last year, who simply cannot cope with serious criticism and scrutiny, simply should not hold high office here or anywhere else.  It is risky for New Zealand, it is dreadful for the reputation of the Bank, bad for the reputation of the New Zealand public sector, and reflects pretty poorly on our political leaders –  in government and Opposition –  who simply walk by, at least in public, such egregiously unacceptable conduct from such a powerful public servant (one who doesn’t even have the redeeming quality of being consistently rigorous, excellent and right to perhaps compensate in some small measure for his grossly unacceptable).

 

The Productivity Commission

Writing, somewhat critically, the other day about the latest Productivity Commission paper got me thinking a little more about the Commission itself.

I welcomed the decision to set up the Commission, partly in the backwash to the then-government ignoring and thens disbanding the under-resourced one-off exercise in focusing on New Zealand’s productivity failures, the 2025 Taskforce. But I’ve long been fairly ambivalent about what it has become, and unsure what the future might hold.

It certainly isn’t anything personal.  The longserving chair of the Commission, Murray Sherwin, was an old boss of mine and until recently we shared the misfortune of being trustees of the Reserve Bank staff superannuation scheme (he got off, I still serve penance).  They’ve run numerous interesting seminars over the years.  The people I’ve known there are smart and happy to engage.  In fact, I was just on their website and clicked on a piece I thought sounded interesting only to find that it was a link to one of my posts.

The Minister of Finance must also have had some doubts.  Papers just (pro-actively, but very belatedly) released show that shortly after the Minister took office he asked Treasury to conduct a review of the Commission, and they in turn commissioned David Skilling (independent consultant, now based in Singapore, and former head of the centre-left New Zealand Institute think-tank) to write a report.   Remarkably, the Commission itself was not invited to provide input –  and perhaps was not even aware the review was going on, since were it aware it would surely have provided input pro-actively.    The Commission seems only to have been invited to comment on the final Skilling report, completed in June 2018.   That seems a strange way to treat an agency that wasn’t evidently dysfunctional, was headed by a respected former senior public service chief executive and which at the time had a respected former Secretary to the Treasury as another of its longserving commissioners.   Even if Graham Scott had once stood for Parliament on the ACT list, no one has seriously accused the Commission of being partisan (and if anything their inclinations often seem to lean in the direction of “smart active government”, of the sort centre-left parties have often favoured, with too little emphasis on “government failure”).

None of which is to criticise the Skilling report. I found it clarifying in a number of places and was pleasantly surprised to find myself agreeing with the bulk of his recommendations.  He draws extensively on some recent OECD work reviewing institutions in various countries trying to do things somewhat similar to the Productivity Commission, with a focus –  consistent with the emphasis of his consultancy firm – on small advanced economies.

As Skilling notes, the explicit model for our Productivity Commission was the Australian Productivity Commission, at the time a very highly-regarded body.  But Australia is a much bigger economy than New Zealand’s (big economies tend to have relatively smaller export sectors), and although still some considerable way from global productivity frontiers, has nothing like the economywide challenges facing New Zealand.  And there is the not-insignificant issue of resourcing: there aren’t that many economies of scale in policy analysis and associated research (policy issues are just as complex in fairly large as in fairly small countries) and yet our Productivity Commission has perhaps 20 staff, while the Australian Productivity Commission has about 170.   That allows for a much greater depth and specialisation than is possible at the NZPC, no matter how able the individuals here might be.

Skilling usefully highlights that the Productivity Commission is not really focused on economywide productivity at all (“bluntly, it is a misnomer”).  Rather, and rather like the Australian counterpart, it is really a detached (from day to day political pressures, or even just the immediacy of the urgent) policy advisory group on specific topics that take the fancy of ministers from time to time.  Sometimes those are really important issues, other times they have the feel of topics it is good to be seen having someone doing, or even (the current “future of work” inquiry, which there are signs the Commission has struggled with) just as –   in effect –  a research resource for a political party’s next election manifesto.  To be clear, topics are chosen by ministers, not by the Commission.

This “chip away at bite-sized topics” approach seems to have been deliberate.  After all, the previous government (which set up the Commission) had no interest in serious reform on the sort of scale that made have made a really significant difference.  2.5 years in, neither does the current government.

It is an approach that probably makes a lot of sense in a country that was already at or near the global productivity frontiers.   Whatever challenges you face in Belgium, Netherlands, Sweden, Denmark (let alone Norway) –  and there are always areas where specific policies could be improved –  you know that your overall economy (productivity) is already about as good as it gets anywhere.  That simply isn’t the New Zealand situation: you’ll recall I’ve highlighted previously that it would take a 60 per cent lift in average labour productivity in New Zealand to match that leading bunch of countries.

Here, the approach taken to the Productivity Commission ends up serving as a distraction.  There is a pretence of an institution devoted to the issue, to taking the whole thing seriously, but not the substance.  If the Commission is to be kept as it now operates it might better be renamed, more prosaically as something like the Medium-term Microeconomic Advisory Group.  But even then there is a real problem, in that because there is no sign that the Commission has a shared narrative, or model, of the bigger picture economic underperformance, causes and broad remedies, it is often hard to have much confidence in the specific recommendations they throw out, and whether they should be priority areas for a government interested in change.  It also means they have no consistent framework underpinning their public communications.  (There was a narrative document published a few years back –  which I wrote about here –  but it was still exploratory in nature, and although it was owned at the time by the Commission, it seems to have been more the thinking of the author, who has now left the Commission.)

This issue has become more stark over the years.  When the Commission was set up there were two separate allocations of funding by Parliament: 90 per cent of the total funding was for specific inquiries initiated by Ministers, and the remaining 10 per cent was for the Commission’s self-directed research programme and related activities.  That formal split, in parliamentary appropriations, has been discontinued, but in the context of a flat overall level of funding (the total level of funding is unchanged over 9 years –  a period in which there has been not-insignificant total inflation), it is likely to be the discretionary activities that get squeezed.

As the Commission’s last Annual Report noted

The 2018-19 year ended with an operating deficit of $98 000, our second successive year with a deficit. The Board has been acutely aware that with rising costs, especially from remuneration costs, and an appropriation unchanged since the Commission commenced operations in 2011, we would eventually reach a point where spending would run ahead of our appropriation. In early years, our budgets provided for surpluses in order to build a small buffer of reserves. But we clearly face a decision about reducing costs and outputs should our business case for additional funding be unsuccessful. Decisions on funding will take place within the context of the review of our operations.

and

Given resource constraints we were no longer in a position to facilitate the Productivity Hub nor provide support to the Government Economics Network.

and

It has also been suggested that the Commission should have greater capacity to undertake wider ranging productivity-relevant research, exploring the nature, sources and characteristics of New Zealand’s poor productivity performance.   Our capacity for such research remains limited. ….our capacity to pull resource away from our inquiry teams is quite limited. To provide more research output requires either an increase in funding or a reduction in inquiry outputs.

Of course, one challenge is that a generalist policy analysis function (essentially what the bulk of the Commission is doing) and something seriously focused on getting to the bottom of New Zealand’s longrunning economic underperformance might not sit that naturally together in the same small semi-detached organisation.

As all prudent government agencies must these days, if they want to impress ministers, they wave the flag for “wellbeing” (this from the front of the Annual Report)

NZPC wellbeing

Perhaps they will secure some more funding in this year’s Budget (though more policy advice might not be an election year priority).

Skilling’s report had four recommendations:

  •  a greater focus in inquiry topics on the external facing tradables sector of the economy (noting the centrality of outward-facing sectors to successful small economies)
  • a more structured inquiry selection process, with more emphasis on criteria relating to economywide productivity,
  • more flexibility in inquiry formats,
  • more public reporting and analysis on overall productivity performance issues, including international benchmarking.

I generally agree (and will take the opportunity to note one of his suggestions for a specific area that would repay further work from the Commission:  “important domestic issues, such as the impact of migration (and population) on New Zealand’s productivity performance”

But you can’t help thinking that there are severe limits on the value of any such agency (or any long-term thinking in major economic ministries such as The Treasury) unless and until some political leadership rises up that really wants to deliver something different for New Zealand, that takes seriously dealing with our economic failure.  Of course, in an ideal world if/when that time ever comes those political leaders would find a rich and deep literature –  from the Commission, from academics, from government agencies, from other researchers and commentators –  on the issues and options for change.  But why would politicians who are themselves indifferent want to spend much money on things they would do nothing with?

Part of my long-term pessimism about the Commission –  quite independent of any individuals involved –  involved reflecting on the fate of past New Zealand efforts and agencies.  There was the Monetary and Economic Council, and then there was not.  They produced some interesting reports in their time, but didn’t last much more than a decade.  Same goes for the Planning Council, some of whose papers are still worth reading.  What will make the Productivity Commission different?  One difference is that it has its own act of Parliament, but that just means that it could be left to wither on the vine, funding gradually squeezed, good people no longer wanting to work for it, before one day someone tidies thing up and abolishes it.   It does not have critical mass, it does not have specialist expertise (those generalist economic policy analysts instead)…..and there isn’t really much evident political appetite for excellent policy or the supporting analysis (even on the occasions –  not always –  when the Commission has delivered such).  And if there were such an appetite, a revitalised Treasury would have the institutional incentives to seek to become the key provider (and in a small public sector, their arguments wouldn’t all be wrong).

There will be an interesting test just a little way down the track.  Murray Sherwin’s second term as Commission chair ends next January and the government will need to find a replacement.  The sort of person the government chooses (whoever is in government by then) could be quite revealing about the sort of future and role they see for the Commission.  Sherwin is a very smooth and effective bureaucratic operator and effective manager –  well-equipped for the sort of role the Commission has largely come to occupy – but if any government were serious about a greater focus on whole economy underperformance they’d probably have to be looking to a different sort of person to either Sherwin or to the other existing commissioners (able as they each no doubt are).  I’m not holding my breath.

An unimpressive MPC

I didn’t expect to be particularly critical of the Reserve Bank after yesterday’s Monetary Policy Statement.  A journalist asked me yesterday morning what I’d say if they didn’t cut the OCR, and I noted to him that whether they cut or not, what I’d really be looking for was evidence of the Bank treating the issues in a serious way, alert to the magnitude of what was going on and the sheer uncertainty the world faces around the coronavirus.

They –  the almost a year old new Monetary Policy Committee –  did poorly on that score.  And in his press conference, I thought the Governor simply seemed out of his depth.  Much of what the Bank had to say might have seemed reasonable two weeks ago –  no doubt when the bulk of their forecasts were brought together – but the situation has been moving (deteriorating) quite rapidly since then.   They can’t update published forecasts by the day, but there was little sign in the record of yesterday’s meeting, or in the Governor’s remarks yesterday afternoon (or those of his senior staff), of anything more immediate or substantive.  The Governor seemed to attempt to cover himself by suggesting that the Bank”s line was consistent with some “whole of government” inter-agency perspective, but….that is (or should be) no cover at all, since Treasury and MBIE don’t face the same immediacy the Bank does (it had to make an OCR decision) and whatever the Ministry of Health might be able to pass along about the virus itself, it knows nothing about economic effects.  On those, the government should be able to look to the Bank for a lead.  Instead, we got something that seemed consistent with the lethargic, lagging, disengaged approach of our government (political and official) to the coronavirus situation.

Thus, remarkably, faced with one of the biggest out-of-the-blue economic disruptions we’ve seen for many years, arising directly and most immediately in one of the world’s two largest economies, we get three-quarters of the way through the press statement before there is any mention of the issue, ploughing our way through upbeat commentary including on the world economy.   Even when we do get there, the coronavirus effects are described only as an “emerging downside risk” –  for something which has already sharply reduced activity in parts of our economy.  It is the sort of language one might use for things where the effects are hard to see, not for something this visible, direct, and immediate.   And on the day when the head of the WHO –  who has often seemed to play defence for the PRC – was highlighting the scale of the global threat.  On a day when a CDC expert was on the wires noting that the only effective response is social distancing –  the more distant people stay the less economic activity there is.

The Bank loves to boast about how transparent it is. As I’ve noted, they are happy to tell us the (largely meaningless) forecasts for the OCR three years hence, but they are astonishingly secretive about their own analysis and deliberations.   Thus, we now get a “summary record” of the final MPC meeting.  Here is pretty much all we get to see about the coronavirus issue

The Committee discussed the initial assumption that the overall economic impact of the coronavirus outbreak in New Zealand will be of a short duration. The members acknowledged that some sectors were being significantly affected. They noted that their understanding of the duration and impact of the outbreak was changing quickly. The Committee discussed the monetary policy implications if the impacts of the outbreak were larger and more persistent than assumed and agreed that monetary policy had time to adjust if needed as more information became available.

….The Committee discussed alternative OCR settings and the various trade-offs involved.

There is no sense of the sort of models members were using to think about the issue and policy responses.  There is no sense of the key arguments for and against immediate action and how and why members agreed or disagreed with each of those points.  There is no sense of how the Bank balances risks, or of what they thought the downsides might have been to immediate action.  There is no effective accountability, and there is no guidance towards the next meeting.  Consistent with that, the document has one –  large meaningless (in the face of extreme uncertainty) – central view on the coronavirus effects, but no alternative scenarios, even though this is a situation best suited to scenario based analysis.   It is, frankly, a travesty of transparency, whether or not you or I happen to agree with the final OCR decision.

Consistent with that, there was no mention –  whether in the minutes or in the body of the document or in any remarks from the Governor –  of past OCR adjustments in the face of out-of-the-blue exogenous events.  Again, perhaps there are good reasons why the cuts in 2001 (after 9/11) or 2011 (after Christchurch) or –  less clearly –  around SARS in 2003 don’t offer good lessons for policy-setting now.  Presumably the MPC thought so, but they lay out no analysis or reasoning, and thus no way to check or contest (or even be convinced by) their thinking.  It really isn’t good enough.   Then again, in the press conference no journalist challenged the Governor on these omissions.

Similarly, there was no sign in any yesterday’s material or comments of having thought hard about the limitations on monetary policy (globally) as interest rates are near their effective lower bound.  All else equal, and with inflation well in check, that starting point should typically make central banks more ready to react early against clear negative demand shocks to do what can be done to minimise the risk of inflation expectations dropping away.  Perhaps again it still wouldn’t have been decisive this time –  and our Reserve Bank still has a little more leeway than many –  but to simply ignore the issue, and show no sign of having thought hard about the wider policy context, was pretty remiss.

From his tone in the press conference, it was as if the Governor really didn’t want monetary policy to have to play a part –  to do his job –  as if it was all just an unfortunate distraction from good news stories he’d been hoping to tell.   So he told one journalist that at best monetary policy would be a “bit player”: for individual sectors that is no doubt true (but then monetary policy is never about dealing with specific sectoral problems), but not really the point, since there has been a clear and significant, highly observable negative demand shocks, and a huge increase in uncertainty (often a theme of RB speeches etc over the last year).  In fact, in answer to another question the Governor was heard claiming that there was “no specific event” to consider reacting to (hundreds of millions of people locked down in China, second-largest economy in the world?) and –  worse –  then claimed that there was no need to act as we already have very low and stimulatory interest rates.  The problem with that argument is that they were just as low six weeks ago, and since then we’ve had a clear large negative demand shock.

Asked about the fact that implied long-term inflation expectations (from the government bond market) were barely above 1 per cent, the Governor took a lesson from politicians and simply refused to answer the direct question.  He then went to on to claim that the monetary policy foot was already on the accelerator, that we’ve had more positive global growth –  even as global projections are in the course of being revised down – and that if anything the question that should have been being asked was why we weren’t thinking about raising the OCR (“renormalising”).

One journalist thought to ask the Governor about the difference between the Bank’s GDP forecasts for the year ahead (2.8 per cent I think I heard) and those of various outside commentators (more like 2.0 per cent) and asked about the difference.  The Governor’s response was that of glib teenager: “0.8 per cent I think”.  Pushed a bit further, he indicated that he had no idea why the difference and (more importantly) no real interest. He claimed (fair enough) not to accountable for anyone else’s forecasts, but showed no interest in the cross-check (that used to be pretty standard around the MPC table) of understanding why the Bank is different from others, and why the Bank still thinks that is the best forecast.

There was also the line about market prices constantly adjusting and buffering……all this as the exchange rate rose the best part of 1 per cent on his announcement yesterday, rather undercutting any exchange rate buffering  of the economy that had been underway.

Oh, and then we had gung-ho political cheerleading for the government’s infrastructure spending plans.  He claimed to be “very excited” by it and rushing past any issues around “crowding out” was keen to talk up all the possibilities of “crowding in” accompanying new private sector investment etc.  No evidence, no analysis, but it probably went down well with the Labour Party.  Sadly, the Governor seems to do campaigning and cheerleading better than he does monetary policy, and there seems to be no serious and substantial figure on his team to compensate for those weaknesses (while, as far we can tell, the invisible unheard external MPC members just function as ciphers and political cover).

As an illustration of what the Bank simply seemed to be missing –  or choosing to ignore – a reader left this comment here last night

The shock from nCoV isn’t just confined to China. It’s spilling rapidly across the Asia-Pacific region…

I have just spent the past few days in Singapore and I write this on a flight to Hong Kong, which is maybe 15% occupied. Singapore is shutting down, which is worrying given its entrepôt status. Malls are emptying, as are hotels and restaurants. Traffic is thin. Companies are rolling out their business continuity plans which will further exacerbate the dislocation. This isn’t about just China, it’s region-wide.

The same reader sent me directly a photo of one of Changi airport’s main terminals at lunchtime yesterday, with this note “Changi T-3 unloading zone. Today, 12 noon. Not a soul in sight.. no cars no people..”

I noted yesterday that more or more people would be cancelling trips, business or leisure, in the face of some mix of risk aversion and sheer uncertainty.  That happened to me yesterday –  less about immediate threat than about the extreme uncertainty about the environment a few weeks hence.

And this morning we hear a local public health expert calling for our sluggish government to expand travel restrictions to people coming from various other countries (including Singapore and Hong Kong) where there is now established community outbreak. Or news of major international events in Hong Kong being cancelled. Or a major world telecoms convention in Barcelona being cancelled.

I’m not suggesting the Reserve Bank should have tried to turn itself into disease experts or even to pin their colours to a different central scenario.  But they simply don’t seem alert to the magnitude of what is already going on, including that huge rise in uncertainty, and they provided us with very little useful analysis about the way they think about monetary policy, demand shocks, risks, instrument stability etc –  nothing to give us any confidence in their stewardship.

Oh, and you’ll recall I mentioned yesterday their interesting –  and potentially positive – experiment in transparency, inviting real-time questions to the Governor during the press conference via Twitter.  As I’d noted in advance, one might well be sceptical about just which questions they would choose to answer.  Actuals were even worse than my expectations.  The Bank’s comms guy had clearly been primed not to expose the Governor to any searching questions, and only two were let through at all, essentially translated into patsy questions, allowing the Governor to wax eloquent on a couple of favoured themes.   No one forced them to adopt this particular approach to being more open.  But if they want kudos for it, they need to be seriously willing to allow real and searching questions to the Governor.

 

 

 

Coronavirus and the OCR

A month ago there were no commentators suggesting the OCR should be raised at the next review.   Since then we’ve watched day-by-day as the news about the coronavirus (now named “SARS-CoV-2” and the disease it causes “COVID-19.”) has got relentlessly worse.   Against that backdrop, the case for an OCR cut today looks pretty unanswerable. Not because an OCR cut will make any material difference to March quarter GDP – it won’t –  but because the job of discretionary monetary policy is to lean against demand shocks, positive or negative, so long as inflation is well in check.

As I noted the other day, core inflation hasn’t got as high as the target midpoint for the whole of the last decade.  In that context, when there is a clear-cut (if not readily calculable) adverse demand shock, the Monetary Policy Committee would be remiss if it simply sat on the sidelines today, suggesting that they would merely be “watching closely” and be ready to act down the track.  In the current macro climate –  quiescent inflation, flat or falling inflation expectations –  there is simply no downside to acting now.    There is no particular virtue in instrument stability: the instrument exists to lean against macroeconomic instability (doing what it can to maintain “maximum sustainable employment”, in the current jargon).

Even a couple of weeks ago one might perhaps reasonably have reached a different view.  But now we have Chinese inbound tourism cut to almost nothing overnight (first as a result of Chinese restrictions and then our own), and confirmation from the universities that perhaps 60 per cent of their PRC students are still out of the country and unable to travel here.    We have much the same situation in Australia, a key economy for us, and in China itself –  one of the world’s largest economies –  huge economic disruption, and a spreading range of restrictions on movement, social gathering etc etc.  We see photos of largely empty streets or public transports in big Chinese cities that aren’t locked down, quite limited returns to work after earlier shutdowns, and so on. From Hong Kong there are reports of more cases, but again the bigger impact is probably people staying home, avoiding social gatherings etc.  Investment banks doing business in China –  ie quite severely constrained in their freedom to run negative lines –  have been marking down their 2020 Chinese and global economic forecasts.  Even the WHO –  which previously presented as relatively complacent – is now talking of this as

WHO chief Tedros Adhanom Ghebreyesus told reporters in Geneva the vaccine lag meant “we have to do everything today using available weapons” and said the epidemic posed a “very grave threat”.

“To be honest, a virus is more powerful in creating political, economic and social upheaval than any terrorist attack,” Dr Ghebreyesus said.

“A virus can have more powerful consequences than any terrorist action.

I’ll leave the florid rhetoric to him, but if there was a good case for cutting the OCR after the 9/11 attacks and after the February 2011 earthquake (and I think there was) that case is at least as persuasive –  compelling in my view –  now.

It isn’t really clear to me why, faced with a decision to make today (not, say, a week ago as with the RBA), anyone would favour not cutting the OCR.   The OCR (monetary policy more generally) is designed to be flexible and responsive (easing and, if warranted later, reversing such easing).  The OCR isn’t about support for individual adversely affected sectors –  if that is really needed in some areas it is a fiscal policy/government matter –  but about stabilising the overall economy faced with (in this case) clear negative shocks.  The tool is fit for purpose.

One argument sometimes heard is that we shouldn’t do anything because things are so uncertain.  But that argument should run exactly the other way round. The high degree of uncertainty, which is probably now rising by the day, is exactly the conditions in which people put off spending, put off travel, are a bit warier about eating out, and so on. It represents a likely material adverse demand effect on top of the specific channels (tourists, students) we already knew about.  Think of travel.  You might have been planning a business trip into Asia.  You might be happy enough to go today, and yet you look ahead and wonder what things might be like when you want to get home again, let alone what conditions might be like if somehow you got sick.  I reckon we’ll see an increasingly number of non-essential trips postponed, whether business or leisure.  And that won’t be so just in New Zealand.   With each passing week, we’ll also see more spillover effects into spending elsewhere in the economy and the confidence surveys –  whatever we make of them –  are likely to take a hit.

There is also the argument that things will snap back once the virus is behind us.  No doubt that is the most sensible assumption, but an increasing number of commentaries are noting that a full snap back isn’t likely to be a matter of a few weeks: it seems increasingly likely that the level of economic activity over much of this year, in much of the world, will be weaker than otherwise –  perhaps not a lot by the end of the year, but that is still 10-11 months away.    And assuming things will simply snap back risks being a recipe for doing nothing with monetary policy when it was actually needed (there are plenty of things forecasters think will be shortlived, but turn out to drag on rather longer).

I’ve also heard a story that the Reserve Bank cutting the OCR by 50 basis points last August may have instilled in some a sense of unjustified worry, becoming a bit of an own goal. Is there a risk of something similar now?    First, the August cut wasn’t well-handled.  It may have been substantively justified, but was poorly communicated and was not clearly tied to specific and very visible adverse developments here and abroad.  As it happens, I don’t think the “own goal” effects, if they existed at all, lasted for long at all (little sustained evidence in eg confidence surveys).    What about a move now?  Sure it would be unexpected, in that surveys of economists were all picking no change.  But (a) those surveys were often done a week or more ago, (b) economists generally aren’t asked what they think the Bank should do, and (c) there is a very clearly identified adverse event, which every commentator will be focusing on.  It would be quite easy for the Bank to credibly justify a cut today, specifically tagged to the coronavirus (and referring to 9/11 and 2011).  And if in doing so the Bank raised a bit more public consciousness of the mounting economic issues, it would probably be no bad thing anyway.

Perhaps the final caveat I’ve seen is that global equity markets seem quite surprisingly sanguine.  If they aren’t pricing something quite bad –  or even high risk – why should central banks react?  It is a fair question.  One answer is a matter of different time-horizons.  Equity markets are pricing earnings prospects over the life of the firm, while central banks are (by design) supposed to be focused more on the short-term.  A few bad months might not rationally affect the value of most firms much, but might still warrant lower policy interest rates. It is just a different game.  But it is also worth noting that New Zealand markets are pricing an OCR cut by the end of this year.   If it is needed, and likely to be useful, in a coronavirus context, it is much more useful –  and more likely –  frontloaded.

Time (not long now) will tell what the Monetary Policy Committee decides to do.  I am encouraged by two things: first, was the MPC’s willingness to act decisively last August (even if the accompanying communications etc were hamfisted) on much less clear-cut evidence, and second by the fact that one of the external members of the MPC (retired economics professor, Bob Buckle) was heavily involved in The Treasury’s early work on pandemic economic effects last decade.

Whatever the MPC chooses to do, the Reserve Bank has introduced an interesting new exercise in transparency.  If you are on Twitter you can ask the Bank directly a question during the press conference this afternoon.

Product market regulation

Writing yesterday about the Productivity Commission’s draft report on why firms don’t invest more (in “technology”), prompted me to take a look at the OECD’s Product Market Regulation (PMR) indicators.    In the OECD’s own words

The economy-wide PMR indicators measure the regulatory barriers to firm entry and competition in a broad range of key policy areas, ranging from licensing and public procurement, to governance of SOEs, price controls, evaluation of new and existing regulations, and foreign trade.

There is both a summary economywide indicator (the focus here) and a range of detailed component indicators and sectoral indicators.   As always with cross-country attempts to assess policy, the indicator(s) won’t be perfect, but such indicators can still shed some light on differences across advanced economies and across time –  the OECD has published the data every five years starting in 1998.

Here are rankings for 1998.  (On this measure, the lower the score the less burdensome -or whatever your descriptor – the product market regulation is.)

PMR 1998

In the wake of those numbers, when people talked about the productivity performance in New Zealand you’d often here something like “well, our business regulation is less burdensome than almost anywhere in the OECD” so (among the optimists) gains will follow or (among those less sanguine) whatever the big issues are they seem unlikely to be those relating to product market regulation.   A few years on we were still 2nd (in 2003) or 3rd (in 2008).

But by 2013 we were only ranked fifth.  Perhaps not disastrous, but some slippage evident.  And here are the 2018 numbers, fairly newly released (data for two countries still not there) assessing things as they stood on 1 January 2018.

pmr 2018

That is now a pretty unambiguous drop back in the rankings.   And three former Communist countries now beat us, with another two just slightly behind.

And it isn’t as if New Zealand has just been improving a bit more slowly than the rest of the OECD.  Here is the absolute score for New Zealand and for the median OECD country (no material differences if I used just the subset of countries for which there is a score on all five dates).

PMR 3

We’ve gone backwards, in absolute terms, since 2008.

I get quite a few comments whenever I write about productivity, suggesting that the web of regulation has been more constraining and all-encompassing over the years.  I have a fair amount of sympathy with many of those comments, even while doubting that such regulations will explain much of our poor productivity performance.   But in the PMR indicator we score poorly in a quite different area of government involvement.

The OECD publishes the data broken out into two “high-level indicators”.  One is “Barriers to domestic and foreign entry” and the other is “Distortions induced by [direct] state involvement.   Here is how we did in 2018 on the first of those.

PMR 4

Not too bad I suppose –  5th equal, and very close to the couple of countries just above us.

But here is the other high-level indicator

PMR 5

In turn, there are four sub-components to public ownership bit of this high-level series, and on each of them we score less well than the median OECD country.

PMR 6

On the “involvement in business operations” sub-components of the “distortions induced by [direct] state involvement high-level indicator we are the OECD median on one, and do a little than the median on the other two.

Of the other sub-components in the overall indicator, there were six where New Zealand scored materially differently than the median OECD country: three better, three worse.  Of the “worse” ones, only six countries score worse than New Zealand, and on the FDI one (and I know the interpretation is contentious) we score worst of all: none look like the sorts of areas a small economy, with persistent current deficits, should aim to score poorly.

New Zealand Worse
Assessment of impact of regulations on competition
Complexity of regulatory procedures
Barriers to FDI
New Zealand Better
Admin requirements on new companies
Barriers in service sectors
Treatment of foreign suppliers

One could go playing around in the relevant spreadsheets (economywide, and the additional sectoral ones) at great length.  Perhaps I will come to them in another post next week.

One can also debate just how much regulatory and state intervention poor scores really matter in terms of overall economic performance.  It is no doubt easy to point to any of the sub-components and find some highly successful country scoring poorly.  But when you are starting as far behind the leaders as New Zealand now is, then even if regulation and state control issues –  of the sort captured here –  aren’t the key factors, if we are serious about improving productivity we should be doing whatever we can wherever we can to provide a more facilitative climate for firms to prosper on their merits.

UPDATE: An OECD economist, in comments below, has helpfully drawn my attention to some methodological changes in the 2018 PMR which mean that scores cannot be compared (reliably) across time (the 1998 to 2013 ones should work, but there is a discontinuity to 2018).   I think her comments leave most of this post looking okay (the relative rankings should still be meaningful, and the identification of where we now do poorly) but one should be a little cautious about the time series chart (noting, however, that the trends I was highlighting were already apparent by 2013).

The Productivity Commission again

The Productivity Commission looks into topics the government of the day asks them to.  The current government asked for a report on issues around the “future of work” (a favoured topic of the current Minister of Finance when he was in Opposition) and the final report is due out next month.

The Commission has released a series of five draft reports looking at various aspects of the issue.  Late last year I wrote quite critically about one of those reports in which the Commission championed the case for a larger and more active welfare state, claiming that by adopting such policies New Zealand’s productivity performance might be improved.  As I noted

What it boils down to, amid various reasonable insights, is a push for a much bigger welfare state, allegedly in the cause of lifting average New Zealand productivity (and sustainable wages), without a shred of evidence or careful considered analysis connecting one to the other.    It is the sort of thing you might expect a political party to come out with –  the Labour Party conference, for example, is meeting shortly –  but not so much independent bureaucrats supposedly focused on productivity.

It was one of the less impressive pieces I’ve seen from the Productivity Commission.

Just recently I noticed the Commission announcing the release of the last of its draft reports.  I was a little surprised that they were allowing only just over two weeks for submissions (they close next Monday if anyone is interested).  When I finally read the latest draft, “Technology adoption by firms”,  I was less surprised: there was very little of substance there (including only about 20 pages of core text).  There was, of course, a summary recapitulation of the argument that people who lose their jobs should get from the state.

Beyond that, and as often with the Commission, there were some interesting perspectives and charts.   They have apparently had some new research done (as yet unpublished) on the implications of land-use restrictions for worker mobility, and there are a couple of charts from that forthcoming paper but (a) it is hard to know what to make of them without seeing the underlying paper, and (b) there is no sign they done anything cross-country thinking on the issue (bad as land use restrictions often are, it seems unlikely that they explain much about New Zealand –  or Auckland –  economic performance relative to Sydney, London, San Francisco, Hong Kong or wherever.  It is a hobbyhorse cause of the Commission’s – and one I mostly agree with them on –  but the case for a strong connection to New Zealand aggregate productivity performance is poor (and our labour market functions pretty well as it is).

Of course, since the focus of the paper is on firms (mostly private entities) and the question seems to be why those firms operating in New Zealand don’t invest more heavily in technology (or, I suppose, why there aren’t more such firms), the answer surely has to be (when all boiled down) “because the risk-adjusted returns to doing so don’t seem sufficiently attractive”.    And yet I don’t think that line appeared at all.  Nor, therefore, is there any sense that we should assume firms, and their owners, are already doing what is in their own economic best interests.    If so, the focus should be less on individual firms – although perhaps case studies can sometimes enlighten –  and much more on the wider economic policy settings (and any exogenous constraints- remoteness possibly being one of them).

Some regard for history might be helpful too. The Commission suggests on a couple of occasions that policy stability can be important, which is no doubt true in the abstract, but might offer less than they suggest in a country where economic policy has been pretty stable for most of the last 25 years, but that particular stable policy regime has not been accompanied by good economic performance.  Materially different and better outcomes are likely to require some quite different policy approaches.

Instead, what they have to offer is really not much more than a grab-bag, not supported by much.  Perhaps it was telling that of the two case studies mentioned in boxes in the draft report, the one on Weta never mentioned the massive taxpayer subsidies to the industry/firm, and the other Zespri never seemed to mention that export monopoly Zespri has, even though the Commission has often pointed to the importance of competition and easy entry and exit.

At the policy level, it was notable that three whole-economy variables/tools did not get a mention at all.  There was no mention of the real exchange rate, even though ours have unfolded this century in ways quite out of step with productivity growth differentials.  There was, as far I could see, no mention of company tax rates, even though ours are now quite high by international standards, particularly as they affect overseas investors.  And despite the scale of New Zealand migration, there was no mention –  good or ill –  of how the system might be affecting firm incentives to invest.    Foreign investment doesn’t even get much of a mention, other than to note the way the recent foreign buyer restrictions might be limited new housebuilding.

And of what was there was fragmentary at best.   Thus, we are told that “increasing emissions prices” “would encourage technology adoption by firms”.   Quite possibly so, but with no way of knowing whether the resulting technology adoption would be good for the economy or otherwise (one of the Commission’s messages is that we should embrace technology to lift material living standards).  Higher minimum wages can also encourage “technology adoption”, as firms try to substitute away from the now artificially more expensive input.  All sort of regulations can require investment in new technology, but that isn’t –  simply by assumption –  a good thing from a living standards/productivity perspective.

We are also told that strengthening something called the “national innovation system” would help, but  –  as was the case when the government brought back R&D subsidies –  no serious attempt to analyse why the returns to private firms to invest more heavily seem to be not-overly-attractive (when there are other countries, without subsidies, that see high private R&D spending).

We are told that targeted government intervention can have a role.  At times you get a sense that here they are pandering to the government, citing the “industry transformation plans” that are currently in the works (actually, I hope they are pandering there). But they go on to attempt to spell out examples of “successful targeted interventions” in New Zealand’s history.  Their first item is “industry training” –  it is no more specific than that, so I can’t quite tell what they mean.  And the second is this

encouraging technology development, diffusion and adoption in New Zealand’s agricultural industries (eg, the establishment of experimental farms, a “farm extension service” to spread good practice, and research institutions such as Lincoln Agricultural College, Massey University and the Department of Scientific and Industrial Research)

Even if you thought these were all success stories –  I don’t claim the specific knowledge to know –  they date from 100 years ago (DSIR founded in 1926) or even 150 (Lincoln founded in 1878).   It isn’t exactly a compelling narrative of modern “targeted interventions”.

Much of the rest is similarly scattergun in nature.  I’d happily see some regulatory reform around genetic modification, perhaps there is a case for competition policy changes (but the Commission doesn’t really claim to know –  “competition laws have not been fundamentally reviewed to assess their suitability for the digital age”).  Perhaps legislation around “consumer data rights” has a place, but they don’t seriously attempt to link this to obstacles to business investment.  And so on.

It isn’t that I think most of the specific policy suggestions are wrong –  some may be, most probably aren’t, some I’d support quite strongly –  but that they are little more than grab-bag of favoured measures, not well-grounded in any compelling narrative about New Zealand’s economic underperformance, and the obstacles to matching our strong labour market performance with a highly productive overall economy.  The Productivity Commission has been around for almost 10 years now, and we really should have been able to hope for more.   But I guess some of the issues get awkward (for Commissioners and their masters) and politically uncomfortable, so it is easier to play at the margins.  Amid the championing of personal political/policy preferences, there will probably be the odd bit of interesting analysis, perhaps some useful peripheral reforms, but the core challenges will be no closer to being addressed.

But then it isn’t as if the Prime Minister and Minister of Finance want anything much different –  unless some magic fairy dust somehow conjured up better outcomes –  and there was that sadly telling quote the other day from the man who would be Minister of Finance.

How will doing more of what we’ve done for the past three decades finally make us wealthy? I asked. Goldsmith offered no explanation.

 

The OCR should be cut

The Reserve Bank Monetary Policy Committee releases its next Monetary Policy Statement and Official Cash Rate (OCR) decision next Wednesday –  the first we’ve heard from them since November.

Until a couple of weeks ago you could probably mount a pretty strong case for the status quo. If the MPC was right to have left the OCR unchanged at 1 per cent in November,  it probably looked as if that was still going to be the right decision in February.  I thought they should have cut in November, and so was still inclined to think they should cut now –  but it wasn’t a particularly strongly held view.  It is worth remembering that after all these years, the Bank’s favoured core inflation measure still isn’t back to 2 per cent (it was last there in 2009) and there wasn’t a lot in the wind suggesting it was likely to rise further.   But there hadn’t looked to be a lot in it.

The Reserve Bank’s Survey of Expectations, released at 3pm today, looks to be not-inconsistent with that sort of status quo story.  But the survey closed a week ago, and opened two weeks ago –  the Bank doesn’t tell us when responses came in, but I know I completed mine on 25 January.

Since then coronavirus has become a huge story.  From an economic perspective, the issue isn’t so much the number of deaths –  50 or so in total two weeks ago and 640 now, on official figures –  as the policy and personal responses, here (and in other similar countries) and in China.    Two weeks ago, perhaps optimists might have hoped a one week shutdown over Lunar New Year might break the back of the problem.  But then, of course, ever more cities in China were locked down, the PRC authorities banned most outbound tourism, countries starting putting restrictions on arrivals of non-citizens who’d been in the PRC, and finally New Zealand –  apparently dragged along by Australia –  banned the arrivals of anyone other than citizens (and their close family members) who’d been in China recently.  We’ve also seen dairy product prices falling, talking of serious disruption in the logging industry, and so on.   We’ve even seen some more-domestic effects, including the cancellation of the Lantern Festival in Auckland.  Oh, and there seems to be no sign in the PRC responses that suggests they think they’ve already got on top of the problem.

No one knows how long these effects will last, or whether things may yet get (perhaps materially) worse from here (I was talking to a journalist the other day about possible extreme scenarios, and it doesn’t really do to contemplate what would happen to world trade –  perhaps only for a short period – in such scenarios).

When I say ‘no one”, that of course includes the Monetary Policy Committee, who will have not a shred more information on the underlying situation –  and probably very little more on domestic economic effects – than you, I, or anyone else.   Any data available just yet –  perhaps daily air arrivals, or electronic transactions volumes in (say) Queenstown –  will be fragmentary at best, and there won’t even be new local business survey data for a few weeks.  So they have to work with what we know, perhaps how things would be likely to play out if the policy responses (here and abroad) remain much as they are for any length of time, and within a framework for thinking about risk and regret.

All of which looks a lot like the classic sort of shock monetary policy is designed to help manage (lean against).  Aggregate demand in New Zealand will take a not-insignificant hit: tourism and export education from the PRC is about 1 per cent of GDP, and tourist numbers will dry up almost completely for now, and (if our numbers are similar to those in Australia) the export education numbers are likely to more than halve.

These effects might not last long, but they are the situation we face now and no one has any idea how long the adverse effect will last.

But these aren’t the only demand effects.   Australia and the PRC are our two largest overall export markets: economic activity in China is likely to have taken a substantial hit this quarter, and Australian universities are (for example) even more dependent on the PRC student market than the New Zealand ones are.

And how would you respond to uncertainty if you were in business, or were (for example) a lending institution.  The rational response is to put projects on hold where possible.  That seems likely to happen –  perhaps on a very small scale initially (few new projects start each week, but mounting as the situation becomes more protracted (and perhaps doubts grow about just how quickly business might rebound).

Also, although the focus to date has been on services exports (tourism and export education), and a couple of goods export sectors, even if goods can be still shipped out to China, you have wonder how soon the flow of imports is going to be affected –  people who’ve been in China in the last 14 days can’t enter Singapore, Australia, PNG, Fiji, Taiwan or…..New Zealand (and, I understand it, much of New Zealand’s trade is trans-shipped through Australia or Singapore).  Ships need sailors.

I don’t know what the Reserve Bank will have chosen to do about their formal economic forecasts.  In their shoes, I’d probably publish ex-coronavirus forecasts, and then a series of scenarios around coronavirus effects (what else can they do: they usually treat other policies as a given, and in this case the ban of people who’ve visited the PRC is scheduled to lift next Sunday, but I doubt anyone much expects it will be, and more importantly neither they nor anyone else can credibly forecast the path of the virus, including how its is beginning to spread outside China).

But whatever they do in the body of the document is much less important than the policy call they make.     This is the time to cut the OCR. perhaps even by 50 basis points.  It would be a mix of risk-mitigation and responding to a real loss of demand (very rarely do we see such hard early evidence of a specific source of demand drying up so quickly).

The standard counter-argument is something along the lines of “early days”, “likely to rebound quite quickly –  eventually”, and so on.  But here is the thing about monetary policy: it can be adjusted quickly (to cut and to raise); it is the tool designed for short-term macro-stabilisation (unlike fiscal policy) and some of the channels –  notably those to the exchange rate –  work really quite quickly.  I’m not suggesting that cutting the OCR would make more than a trivial difference to GDP in the March quarter (the tourists and students still won’t have come), but if the effects are any longer-lasting we would start to see the benefits.

Twice before the Reserve Bank has cut the OCR is response to truly-exogenous external events.  The first was the unscheduled 50 basis point cut in September 2001 (a week or so after the terrorist attacks).  Here was the case we made then

“It seems more likely now that the current slowdown in the world economy will worsen. In these circumstances, New Zealand’s short-term economic outlook would be adversely affected, although any downturn might well be relatively short-lived.
“New Zealand business and consumer confidence will be hurt by recent international and domestic developments, and today’s move is a precaution in a period of heightened uncertainty.

I still reckon that was an appropriate response at the time, even though we had (a) no new survey or hard data, (b) there were no foreign or domestic government restrictions which would have the direct effect of biting into domestic demand in New Zealand and (c) the exchange rate –  already low –  was by this point almost 5 per cent lower than it had been on 11 September.  It was explicitly precautionary, but in a climate where our best judgement told us that if there was any effect it was going to be adverse (disinflationary).

The second such 50 point cut was in March 2011, after the severe February earthquake.    As the Governor put it at the time

“The earthquake has caused substantial damage to property and buildings, and immense disruption to business activity. While it is difficult to know exactly how large or long-lasting these effects will be, it is clear that economic activity, most certainly in Christchurch but also nationwide, will be negatively impacted. Business and consumer confidence has almost certainly deteriorated.

Going on to observe

We expect that the current monetary policy accommodation will need to be removed once the rebuilding phase materialises. This will take some time. For now we have acted pre-emptively in reducing the OCR to lessen the economic impact of the earthquake and guard against the risk of this impact becoming especially severe.”

We knew that the longer-term impact of the earthquake would be a big positive boost to demand (all that rebuilding activity, which would crowd out other activity in time) but still concluded that it was appropriate to cut early and quite hard to lean against adverse confidence effects etc (and some direct adverse demand effects –  eg to South Island tourism).    Perhaps we just got lucky, but it still looks like an appropriate response to me, even with years of hindsight.

In June 2003, SARS also played a role in the Bank’s decision to cut the OCR then.  I wasn’t involved in that decision –  I was working overseas –  so don’t have as strong a sense of the balance of factors.  One can mount an argument that it was unnecessary to have cut  –  the Governor eventually concluded as much –  but much of that argument was with the benefit of a hindsight that real-time decisionmakers could not have had (about how quickly the virus would be contained).

Set against the backdrop of those three cuts, I reckon the case for an OCR cut now –  even it had to be pullled back in six months’ time –  is stronger than in any of those other cases.  We have clear adverse domestic demand effects, that aren’t just about confidence but about policy choices in China and in New Zealand (and, more peripherally, in other countries), we don’t just have a one-day event which we live with the aftermath of (rather an ongoing situation, which is probably still worsening), the epicentre of the issue is in the world’s largest or second-largest economy which itself is taking a large negative economic hit for now, and Australia –   our other main trading partner, and major source of investment –  faces very similar issues to New Zealand.

Against that backdrop, it isn’t obvious what the downside would be to an OCR cut next week.  Core inflation is still below the target midpoint, and yet the demand shock is adverse.  Perhaps things resolve themselves very quickly in a couple of months and the Bank is slow to pull back the OCR cut.  The worst that could happen then might be core inflation going a bit above 2 per cent.  But since 2 per cent isn’t supposed to be a ceiling, and we’ve haven’t even been to 2 per cent in the last decade, that might count as a gain not a loss, in terms of supporting core medium-term inflation expectations.

Then, of course, think about really bad scenarios, and a world with very limited fiscal and monetary policy capacity to respond to a serious downturn. It really is important to keep those expectations up.  Recall that that was one of the stories the Reserve Bank told for a while after the unexpected 50 basis point cut last August.

But here is the implied inflation expectation measure from market prices, right up to today (the difference between yields on nominal and indexed 10 year government bonds)

IIB jan 2020

There was a bit of lift in this measure of implied expectations late last year (partly global, but a range of central banks were responding similarly).  But now we are pretty much back to where we were before the Bank cut the OCR unexpectedly sharply six months ago (and this even after bond yields have bounced off their lows earlier this week).   I guess we should take some comfort that implied expectations aren’t lower than those in August, but 0.98 per cent is a long way from 2.

And as one last straw in the wind, in 2017 the Bank (helpfully) added a couple of questions asking about respondents expectations for inflation five and ten years hence.  The answers have hewed pretty close to 2 per cent –  I usually put in 2 per cent for 10 years hence, noting that the current MPC/government won’t have any effect on those outcomes –  but when I opened the survey results today I noticed that even these expectations (which the Bank likes to boast of, as a sign of confidence) have been edging down.

long-term expecs

The differences are small, and in isolation I wouldn’t put much weight on them.  But not much is moving in the right direction, and these results were surveyed two weeks ago when most respondents thought the policy status quo was just fine for now.

It seems a pretty obvious call to me that they should cut on Wedneday –  absent some startling positive turn in the virus and related news between now and Wednesday morning –  rather than just idly handwringing about “watching and waiting”.  And the Governor/MPC was willing to make some big and unexpected calls (wisely or not) last year.    The Bank wouldn’t be the first central bank to move either.

Who knows whether or not the Bank will actually move on Wednesday – quite possibly not even them yet – but I’m sure the MPC will have been looking for some analysis of past responses to out-of-the-blue shocks and thinking about the similarities and differences here.    Whichever path they finally choose, that thinking should be laid out – not just noted – in the MPS and/or the minutes.