To what end?

It is two years today since my first post about pandemics (and the economy). Rereading it, and another the following week, over the weekend and it was interesting to reflect on what issues had (and hadn’t) sprung to mind. But back then, however fearful people might or might not have been initially, few would have supposed that two years on we’d be labouring under new, and even more onerous, restrictions, and that for the best part of two years few of us would have been able to travel.

I was quite supportive of the need for restrictions, especially at the border, for quite a long time. Even last year, when the government was so slow to roll out the vaccine, doing everything possible to keep the virus out would have seemed appropriate (ie more than the government actually did). As for domestic restrictions, in both 2020 and 2021 the government clearly overshot, imposing (and renewing) some restrictions that seemed more about asserting power and showing who was in control than about public health, and others that failed all tests of decent humanity. (None, of course, were ever justified by any sort of cost-benefit analysis – an abdication of any sort of decent policy analysis that I hope one day our politicians and senior officials look back on in shame.)

But that was then. Since late last year, the government’s approach has increasingly lost any coherence. Despite high vaccination rates, we’ve had extreme coercion used on those reluctant to get vaccinated, and we’ve lurched down a path of “papers please” where those who refuse to show their government papers are prohibited (either by law directly, or enabled by it) from undertaking many of the normal activities of life. All this as (a) it was clear that the biggest risk posed by the unvaccinated was to themselves, and (b) that lots of vaccinated people were getting Covid anyway, apparently often/mostly from other vaccinated people. Government guidelines as to when it would ease restrictions were repeatedly ignored by the government itself. The government meanwhile had confirmed that it had given up on elimination some time ago.

And then, of course, came Omicron – two months ago in other parts of the world. The experience of Omicron so far seems to be that it is highly highly infectious, partly as a result waves don’t last long, and among the vaccinated (even more so the boosted) the rates of serious illness and/or death seem remarkably low. In some places – the UK is the most obvious example – even with a lot of cases, numbers in hospital ICU care did not even increase during the Omicron wave (but there is a variety of experiences, depending in part on starting points). Nowhere, it seems, is there evidence of the spectre of “overwhelmed health system” having been realised (although you might expect, even hope, that systems would be put under some pressure).

As for our government, first it seemed that they shut down for the holidays. In normal times, no one would begrudge them that, but this was something more akin to “wartime” – a major threat unfolding, inter alia, just across the Tasman. You might have thought that all hands would have been on deck, led by the Prime Minister, with planning (and public consultation on those plans) advancing rapidly. And vaccination centres operating night and day to get vaccinated many more of those eligible for a third dose. Oh, and the child vaccination programme might have got going before Christmas too. But no, this was the government of complacency – we still don’t have their “plan” (apparently something is coming on Wednesday) – and now controls.

Even on what we have seen, policy is all over the place. Last week, they stopped allocating MIQ rooms for ordinary New Zealanders, but that was (a) done with no ministerial announcement, and (b) to affect arrivals a couple of months hence (when who knows what the environment will be). They keep telling us (sensibly, rightly) that Omicron will spread in the community, but then on Friday the government quietly put in place much-extended isolation requirements – of the sort that perhaps might make some sense (if complied with) in an elimination model, but which make no sense now – the more so as they will powerfully deter some from even getting tested.

And then yesterday we got the new general restrictions. From both the PM and the Director-General we were told they were still aiming to “stamp out” the outbreak, but even (especially?) they must know they are just making things up now – a Level 4 lockdown in August didn’t stamp out that outbreak (or wasn’t pursued long enough to), and this lot of restrictions is nothing like Level 4. The more realistic rhetoric/spin seems to be about “slowing the spread” – there are big adverts in the papers this morning enjoining us to get with the team, play our part.

But why do we want to “stop the spread”? I don’t. We are already two months behind much of the world – two months of repressive domestic restrictions and onerous border controls – and for what? Various other places are coming out the other side now, not having had particularly bad health experiences – England, Ireland, the eastern states of Australia, South Africa – while Ardern and her colleagues – apparently with little opposition from National – seem to be determined to try to slow the incoming tide. They’ve provided no supporting analysis, no cost-benefit analysis, there are no end-point dates for these controls (which may not do much “good” anyway, while disrupting lives), and no published criteria – not that on the past record they would ever stick to them – for getting controls off, getting our lives back to normal, binning the “papers please” regime, and opening the border (even just for New Zealanders).

Events are being cancelled all over the place, and whereas (say) we watched the Ashes test in Hobart a couple of weeks ago with large local crowds in attendance (in the middle of a not-small Omicron outbreak) the government is going to condemn us to the grim spectre of test matches with no crowds at all.

Of course, it could be worse. The government could – and may yet – resort to more onerous restrictions (have they done anything to prepare the public for several weeks of 30-40 deaths a day?) but it is unclear what they are trying to achieve, and how their cobbled-together policies fit a strategy. We hear talk about “flattening the curve” but that seems like a recipe for months and months of controls – the sort of restrictions that may appeal to public health professors and some left-wing politicians, but which should generally be anathema in a free and open society. There is talk, always talk, about getting our booster rate up – but (a) whose fault is it they weren’t offered earlier?, and b) even now, because of the delay, the percentage of our population with boosters is already higher than (say) the Australian share 6 weeks ago when their outbreak was getting underway.

People oriented to controls can always dream up reasons for delays – and I might have had a touch more sympathy if the government had shown itself ever willing to get rid of controls that were no longer self-evidently necessary – but they never attempt to show an overwhelming case. In an interesting Newsroom article over the weekend, on preparing for Omicron, Prof Michael Baker justified his case for more restrictions on the basis that “several hundred people” might die if we just let Omicron sweep through. Quite possibly – if one takes the Australian numbers as a guide – but 34000 people a year die in New Zealand, and that number fluctuates (easily plus or minus 1000) from year to year. It simply does not justify restrictions without limit, and lives lived – unable to sensibly plan – at the whim of politicians.

baker

And, of course, we are rightly reminded of the limitations of the public health system. It was a reasonable argument two years ago, but not now, when the government has done little or nothing to boost capacity over two years, and now wants to put us under their (somewhat half-hearted) controls anyway. Sure, there would be likely to be some weeks of extreme pressure on the system, but it is hard to conceive of any serious cost-benefit analysis – that value freedom at all – justifying society-wide restraints, indefinitely, to avoid a few weeks difficulty (and even some otherwise avoidable loss of life).

Now, of course, Omicron will be disruptive even if the government does nothing. Baker, in that same article, seemed to use that as justification for “oh well, we might as well just have lockdowns then”. But there is a big difference between government controls – backed by the coercive power of the state – and individuals and firms taking their own precautions, calibrated to their own individual risk and risk tolerance. I’m pretty sure no one would put off a quiet swim at a deserted beach, or a driving lesson for their child, except the state compelled them,

(And I say all this as someone who is almost 60, and hasn’t had the best of health in the last couple of years. There are risks to life, and – fully vaccinated and soon boosted – I’m quite happy to run those modest risks. I’m not happy seeing events cancelled willy-nilly at government fiat, or governments still stopping people travelling (indefinitely), and so on.)

There are lots of things the government could and should have done much better re Covid over the last 12-18 months. Had they been done we might be in a slightly better position now, but it is water under the bridge now, and nothing about the government or Ministry of Health gives any reason for confidence that we should put up with indefinite restrictions on their say so. They have the power of course, but they abuse and misuse it (down to and including the arrogant disdain evident in the way the government refuses to even put out case/hospitalisation data at a fixed time each day – a simple thing in some ways, but one that simply reveals their indifference and, quite possibly, incompetence).

Better to (a) scrap the vaccine pass system (which simply institutionalises repression, of the sort that should be alien to this country, for no significant public health benefit), (b) open the border to NZ citizens, and (c) cut the isolation requirements to something like those in the US and UK, with a view (d) to following the English lead and looking to remove all Covid restrictions by, say, 31 March (subject to renewal only by vote of Parliament, not arbitrary ministerial fiat with no consultation or transparency).

Oh, and release all the relevant Cabinet papers and ministerial briefings within two days of decisions having been made. These are our lives, our freedoms. We are not supposed to be just playthings of the government. The smallest regulatory changes in normal times have to go through proper (if often faux) consultative processes. Sometimes in emergencies needs must, but this was Omicron – they had the best part of two months to be prepared; do the analysis, test it in public, consult. Instead, perhaps we’ll see a “plan” on Wednesday, perhaps we’ll see the papers and analysis (if any exists) six months from now.

Central bank research

For some reason the other day I was prompted to have a look at how many research papers the Reserve Bank had published in recent years. This chart resulted.

RB DPs

Only one in the last two years, and that one paper – published last February – had five authors, four of whom worked for other institutions (overseas). It was really quite staggering. It wasn’t, after all, as if there had been no interesting issues, policy puzzles or the like over the last two years. It wasn’t as if universities had suddenly stepped up to the mark and were producing a superfluity of research on New Zealand macro and banking/financial regulation issues. It wasn’t even as if the Bank had suddenly been put on tight rations by a fiscally austere government – in fact, the latest Funding Agreement threw money and the Bank and staff numbers have blown out. Rather, or so it appears, management just stopped publishing research.

These research Discussion Papers are usually quite geeky pieces of work, formal research that is subjected to some external review before publication, and often written with the intention of being of a standard that might be submitted to an academic journal. The Reserve Bank had put quite an emphasis on this sort of research (mostly on macroeconomic matters) for probably 50 years, as one part of the sort of analytical work that underpins its policy, operations, and communications.

Of course, what ends up in published research papers like this isn’t all the thinking, analysis, or even research that the Bank has been doing – ever, not just now. Apart from anything else, they have a variety of other publications, including the Analytical Notes series that was started up a decade ago to fill a gap (for example, less-formal research, often with shorter turnaround times), and even the Reserve Bank Bulletin which had had a mix of types of articles, but itself appears to have been in steep decline. There are speeches from senior managers, but as I’ve pointed out previously these days these are few and rarely insightful (not much research, here or abroad, informs them). There will be other analysis and research that simply never sees the light of day – the Bank not being known for its transparency – but what appears in public is likely to be an indicator of what does (or doesn’t) lie beneath the surface. The Bank still has some staff who appear to have formal research skills – indeed a year ago they recruited one of New Zealand’s best economists apparently to work on preparations for the next review of the monetary policy Remit – but what we see is thin pickings indeed. Most of most able researchers of the last decade have left, and as far as I can see there is no one working in the research function with any long or deep experience of the New Zealand economy and financial system.

Recall that the previous Governor espoused a goal that the Bank should be not just adequate but the “best small central bank” in the world, while the current one often reminds people of his mantra “Great team, best central bank”, suggesting a vision not even constrained by the (small) size of New Zealand.

Does any of this matter? I could probably mount an argument that much of what the Bank is charged by Parliament with doing could, in principle, be done with little or no formal research (of the type that appears in Discussion Papers). In principle, a keen appetite for the products of overseas research, a climate that encouraged debate and diversity of ideas, active engagement with other central banks, and a steady flow of less-formal analysis wouldn’t necessarily lead to particularly bad outcomes. And having been around in the days when the Bank was doing some world-leading stuff (notably inflation targeting, but also some of the bank regulatory policies) it is fair to note that little or none of that drew on (or was reflected in) formal RBNZ Discussion Papers.

But it isn’t really the standard that we should expect these days, nor is there any sign that people in other countries do. It is not that a single research paper is likely to decisively change any particular policy setting (perhaps not even 5 or 10 would) and many of the papers might go nowhere much at all. But a flow of formal published research is one of the marks of an institution that thinks, that has an intellectually vibrant culture, that is open to new ideas etc etc. And on some policy calls, we really have a right to expect that the Bank – with huge amounts of policy discretion, and quite limited accountability – is doing world-standard research of its own, and/or commissioning it from others, and making that research available for challenge, scrutiny etc. One might think here of appproaches to bank capital policy, where the current Governor took a bold non-consensus decision, but where the institution has no published record of any substantive serious research. Sometimes these things might just be about trying to find frameworks that make some sense – never all of it – of what has been going on, or bringing formal evidence to bear on (for example) what the LSAP has accomplished.

But, these days, there is little sign of any of it from our central bank – and as a straw in the wind, it is at one with a record of few (and rarely good) speeches, inaccessible MPC members (themselves ruled out from doing research), and policy documents that rarely seem to reflect robust analysis.

Of course, one can expect formal research outputs to fluctuate a bit from year to year. Topics come and go, immediate management priorities come and go, particularly able and productive researchers come and go. But one paper (and that mostly co-authored) in two turbulent years isn’t a sign of an institution that any longer takes seriously generating research output, or the sort of climate that makes an institution attractive to really able people.

What about other countries? I went counting.

Much discussion in New Zealand compares us to other Anglo countries, and in central banking terms, Australia, Canada and the UK have had similar (inflation-targeting) macro policy frameworks.

anglo DPs

Of course, each of these are much bigger countries than New Zealand (and on that basis one might think the RBA rather light on its published research) but (a) there aren’t huge economies of scale in central banking (our economic puzzles can be just as intractable as those of much larger countries), and (b) both the RBA and the Bank of Canada have a narrower range of policy responsibilities than the Reserve Bank of New Zealand.

So how does the RBNZ compare with the central banks of other small advanced countries?

DPs adv countries

Central banks of very small countries (in this case, Iceland and Slovenia) have tended not to publish much formal research – although still more than the RBNZ in the last couple of years – and one might wonder at the budgetary priorities of the central bank of Lithuania (just under three million people and without a monetary policy of its own), but even before this decade the flow of formal research from our central bank looks to have been at low end of what one might expect given (a) our population, (b) the wider range of issues the RB is responsible for, and (c) the idiosyncratic nature of some aspects of our economy. There is no single right or wrong volume of formal research, but next-to-no published research simply looks like a dereliction of duty. (One might have hoped that a Board chaired by a university vice-chancellor – one with a reputation of getting research metrics looking good – might have raised questions, but…….this is the mostly-useless Reserve Bank Board.)

Again, does it matter? In my more cynical moments over the years I used to observe that perhaps the main difference inventing inflation targeting made was that we subsequently got invited to a better class of international conference. It might not sound much, but it is a straw in the wind for something that really does matter – the connectedness of the institution, the exposure to ideas, the ability to get leading people to take an interest and visit etc etc. We used to have that. Not all the conferences were useful, not all the visitors were useful, and so on, but becoming known as a central bank that (a) rules out from its MPC anyone with ongoing expertise in monetary policy, (b) publishes hardly any serious research, and (c) where senior management, if they speak at all (recall that the chief economist gave not a single published speech), make only the lightest-weight speeches isn’t a recipe for keeping engaged with the world, or the flow of ideas or research. When you are all already small, remote, idiosyncratic, and not as rich as Croesus (we can’t just throw money at potential visitors) it is a poor lookout.

These outcomes must have been the result of deliberate decisions. They need not be forever. Capability can be rebuilt, although doing so in an enduring way takes time and leadership. Who Orr appoints to the current key vacancies is likely to reveal quite a bit as to whether the Governor has any interest in creating a research-informed Reserve Bank, across the range of key policy areas he is responsible for. If not – and most likely not – it will be another sign of a deeply troubled institution, taking a similar path of decline to too many other New Zealand institutions in recent years. Responsibility for that rests not just with individual officials, but with a government (and Minister of Finance in particular) who seems not to care.

A sad ending

Yesterday morning’s news was an NBR headline – story accessible only to those with a subscription – in which the Reserve Bank appeared to have confirmed to this single media outlet that Deputy Governor, Geoff Bascand (a statutory appointee, and member of the Monetary Policy Committee) had left his job early, after speaking without authorisation to a third party about the Bank’s management restructuring. Later in the day, we got more accessible versions of this astonishing development (including this interest.co.nz account).

Bascand had been a public servant for a period spanning 40 years, starting in The Treasury in the 80s, and including stints as head of the Labour Market Policy Group (at the old Department of Labour), Government Statistician, and (since 2013) as Reserve Bank Deputy Governor. His public sector career had had its ups and downs, and he never quite reached the very top levels, but what a way to end it. In many ways, he was a classic public servant – most people seemed to like him, quite a few respected him, he wasn’t (it seemed) flamboyant or reckless. He went along. He wasn’t an intellectual leader, but he got things done. He didn’t seem to stand on titles etc – I was quite impressed that he was willing to take the step back from a CEO role at SNZ to (initially) the third-ranked position at the Reserve Bank (even as I assumed at the time that he saw it as a stepping stone back into the policy-institution mainstream, perhaps with aspirations to be Governor or Secretary to the Treasury). And in 2017 he was quite (unusually) open (to media) that he’d applied for the Governor’s role, knowing (presumably) that even as incumbent (but new) deputy chief executive he probably had no better than a 50/50 chance. In the first three years of the Monetary Policy Committee, he had been by far the least-unimpressive of the members, and gave speeches that were sometimes almost worthy of a member of a powerful independent policymaking committee in an advanced country.

I first met Geoff 35 years ago, but had only had off and on contact with him until he came to the Bank. We then sat on many of the same committees, but I left the Bank a couple of years later, and my main dealings with Geoff were actually over the last 8 years when we were both trustees of the troubled Reserve Bank staff pension scheme and spent too many hours locked in long meetings. We had our differences there – sometimes quite stark, sometimes on quite important issues – but in recent years in particular we seemed to have got on well, and even together crafted a resolution to one of the lesser issues the scheme was dealing with. I say this mostly as context. I don’t wish Geoff any ill at all.

When it was announced a few months ago that Bascand was leaving the Bank at the start of 2022, it wasn’t entirely clear what was going on. One plausible story was that at his age (60ish), unlikely now to ever become Governor, he’d simply opted for a slower pace of life – golf, grandkids, and some directorships/consultancies etc. Another was that he had become so frustrated with the Orr approach that he simply wanted out. The two weren’t incompatible necessarily, but if you are part of a project you are totally at one with, it isn’t usual to simply walk away – in good health, and not that old. But the new governance structure for the Bank was coming in mid-2022, and he might also have thought someone needed to be willing to commit several years to bedding in the new model. There was always the possibility Orr wanted him out, but as holder of a statutory office appointed by the Minister there was no direct way of effecting that, despite the reputation Orr had long had for churn among his senior staff. The speed with which Bascand’s replacement was announced – with no advertisement etc process – did tend to reinforce suspicions.

The concerns about top-level departures started to step up in November when it was announced that the Bank’s Chief Economist was leaving after less than three years in the job – having been appointed by Orr, it was quickly apparent he was being restructured out by Orr (Orr having restructured out the previous Chief Economist). Questions started to be raised, including at Parliament’s Finance and Expenditure Committee. With inflation rising sharply, and unease (justified and not) about the Bank’s handling of monetary policy through the Covid period, the Governor’s position was becoming somewhat exposed.

But there was more to come. The management restructuring was ongoing and now claimed the two senior managers responsible for banking regulation and supervision, who had been direct reports of Geoff Bascand’s (as deputy governor and head of financial stability). We still don’t know the details of the restructuring – the Bank is playing OIA obstruction – but both Andy Wood and Toby Fiennes decided to leave, their own previous jobs presumably having disappeared (Fiennes already having been effectively demoted in an earlier Orr restructuring). That might prove quite uncomfortable for the Governor, with annual select committee hearing coming up on 15 December (this time the annual Financial Review, focused on the year to 30 June, but allowing a very wide range of issues to be raised).

And so, it seems (Orr did not deny it when questioned on it at FEC), the Bank decided to keep this news secret (from staff and the public) until after the FEC hearing was over.

And yet the news got out, with a story from Business Desk’s Jenny Ruth late the previous afternoon (and a statement from the Bank confirming the departures). Orr faced repeated questions at FEC the following day (I wrote about it here), and some of the answers from him and his team proved to be quite misleading. There was a lot of bluster, and the Governor did not emerge well.

There were a couple of straws in the wind – no more – that week that suggested that the Bascand situation was less than happy. Watch the FEC hearing (accessible on the FEC Facebook page) and you will see that Bascand was there – Orr even mentions it at one point – but in the back seats with the large group the Bank brought along. That was odd. Bascand was at this point still the incumbent Deputy Governor, and the hearing was formally focused on the 2020/21 financial year. It wasn’t that there wasn’t room at the top table – Orr was joined there by the incoming Deputy Governor and one of the his many more-obscure Assistant Governors. Not having Bascand up front – and several MPs have made generous comments about Bascand – looked not quite right.

And then on the Friday of that week, Bascand simply did not turn up for a long and important meeting of the superannuation scheme trustees, a meeting that had been scheduled explicitly to draw on his expertise and experience before his scheduled departure in the first week of January. His replacement had already been appointed (from 5 Jan) and invited to attend the meeting as a silent observer. Initially not suspecting anything – other than idly wondering what financial stability drama there might be on 17 December – I asked the chair if Geoff had then nominated the replacement as his (legal) alternate, which would enable that person to participate fully. It would have been a natural thing to have done if something had come up and Geoff was simply too busy. But all we got was a rather flustered “no”.

But none of that took one anywhere, at least until yesterday’s story.

The story did not tell us what Bascand had told to whom, only that he had had unauthorised discussions with an outsider, had confessed and apologised, and had left the Bank on 17 December, several weeks before his scheduled (early Jan) departure date.

So it is hardly a stretch to suppose that he was the ultimate source of the 14 December story about the further senior management departures – since it (a) involved people who had directly worked for him for several years, and (b) came out late on 14 December, and while he was still there (FEC) on the early morning of the 15th he was gone by the 17th. Most probably Bascand didn’t directly communicate with the journalist who broke the story – although even had he done so, the journalist would have needed independent confirmation to help provide cover to her source – but may well have told someone with the explicit intention that the news get to a journalist with a reputation for taking RB issues seriously. (It is quite clear, on the other hand, that these unauthorised discussions weren’t, say, a passing mention to his wife – the consequences, confirmed by the Bank yesterday, tell us it was much more serious than that.)

There can’t have been many people at the Bank who knew (on say 13 Dec) that Wood and Fiennes were going. The Governor, the incoming deputy (who would soon be responsible for financial stability), perhaps the Assistant Governor responsible for HR, perhaps the respective PAs, Wood and Fiennes themselves, and Bascand. Bascand either because he was still incumbent Deputy Governor or because either or both of Wood and Fiennes would most likely have talked to Bascand – their boss for several years, but not now the person driving decisionmaking – before making their final decisions. Only disgruntled people had an incentive to leak, which would have quickly narrowed the field, and Bascand apparently confessed, apologised, and agreed to go early. It could reasonably have been seen as a sacking offence but (a) no doubt the Bank wanted to keep this quiet, and (b) getting rid of a statutory officeholder isn’t quite like dismissing an ordinary staff member.

Why would Bascand have done it? Presumably the motive was pure and simple to put Orr on the spot at FEC, perhaps driven by frustration at how his loyal and capable senior staff had been treated. But it was still a strange step for someone like Bascand – the mostly fairly buttoned-down bureaucrat – to have taken. After all, although the FEC hearing became more of a spectacle, and more uncomfortable for Orr, it wasn’t as if this was really whistleblowing – the FEC hearing itself was never going to be decisive (of anything), and the Bank would have announced the departures a day or two later anyway. If – as I think there are – there are serious questions to be asked about Orr’s stewardship, a couple of days wasn’t going to make much difference in the scheme of things. Perhaps Geoff was just at the end of his tether?

If this is the story – and while it seems likely we can’t be certain – did he suppose he’d not be found out? Perhaps, but why take the risk? Perhaps he thought there weren’t really any downsides for him? But if so, he was wrong. Leaving two weeks early a job you’d resigned from anyway isn’t the cost. But yesterday’s story is. I guess that story wasn’t guaranteed to leak out, but….Wellington is a small place, and who knows what story staff were told as to why Geoff wasn’t around for his scheduled last few days.

It is simply a really bad look. Even real whistleblowers – of information about (a) misbehaviour that (b) would never otherwise come out – rarely prosper (even though society needs such people). But this wasn’t whistleblowing – Orr was within his rights to restructure, and the news was going to come out anyway – and just looks rather petulant and undisciplined. And whatever you think of Orr’s stewardship of the Bank, a senior figure behaving this way – breaching his obligations (moral and otherwise) is unlikely to endear himself to people (government or private sector) considering Geoff for future directorships and consultancies. If he had real concerns about Orr’s stewardship – and he should have – a detailed letter to the Minister of Finance, after he had left the Bank, might have been in order. Perhaps even a serious interview with a major media outlet a few months down the track (Orr is up for reappointment early next year), although in cosy Wellington even that would have raised eyebrows. But not leaking to the media – with a high probability of being found out – simply for some short-term additional embarrassment for the boss. (And it is not as if Geoff in the past has not expressed firm views on anyone speaking out in a way that might embarrass him or those he supports.)

I was glad the news of those further senior management departures got out in time for FEC, was glad to see National and ACT MPs asking hard questions of Orr – and hope they now follow up further – but what Bascand (who had obligations to the Bank) appears to have done was quite inappropriate and unacceptable, and it is good that that news has belatedly come out. It is a sad way to end a long public service career.

But what a mess an important and powerful public agency is clearly in. So many key people going or gone, so little analytical, operational or policy excellence, so little banking or regulatory experience at the top of a major banking regulatory agency, and so on. Meanwhile, the Board chair who presided while all this went on has been given another term, and all indications are that none of this much bothers the person with the ultimate responsibility, the Minister of Finance. It should. We need to end, and reverse, the degradation of major New Zealand public institutions.

UPDATE: Continuing to mull over this business, I’m still a bit inclined to wonder if there is more to the story. Is there a possibility that Bascand took the fall, covering for someone else (for whom the consequences of discovery might have been greater)? I guess we’ll never know, and perhaps it is just that I don’t want to believe that someone like Geoff could have acted this way, even tired, even frustrated. There is something particularly treacherous about a deputy deliberately undercutting his boss in a way implied by the story told in this post. But probably only a couple of people know the truth of the matter, and they won’t be saying.

Something a bit odd in the data

I haven’t had time to look closely at last week’s GDP data, but as a last post for the year I thought I’d have a very quick look at the productivity (real GDP per hour worked) numbers that the various recent SNZ releases (national accounts and HLFS) suggest.

Over the years, I’ve often used as a proxy – SNZ not publishing an official series – a measure calculated by averaging the two quarterly GDP measures and dividing them by (an index from) an average of hours worked from the HLFS and hours paid from the QES. But in periods of lockdowns you really don’t want to be using hours paid, because things like the wage subsidy schemes were designed to get people paid even if they weren’t able to work, or their firm wasn’t able to generate much output. So in this chart I’ve simply used the average of the two GDP measures and the HLFS measure (self-reporting respondents) of hours worked.

This one starts from back just prior to the 2008/09 recession. As you see, the decade or so leading up to Covid wasn’t a good time for labour productivity growth in New Zealand (something not much more than 0.5 per cent per annum). And then came Covid and all the disruptions (and policy stimulus).

prod dec 21

Here is the same chart starting just prior to Covid (2019Q4).

prod dec 21 2

Perhaps unsurprisingly there has been quite a lot of variability in this measure of productivity, in ways that really don’t make a great of sense (to me).    There is always some variability –  one reason for using average measures –  but you can see from the first chart that the last couple of years look quite different, so far.  That “so far” is important, as there will be revisions to the GDP numbers for several years to come –  although none to the hours numbers (and who really knows how people were answering in lockdowns).

But if you believe these numbers –  and I recommend that you don’t –  we appear to have found the elixir of New Zealand productivity growth.  First take a global pandemic, then shut the borders, ease monetary policy, throw lots of government money at things, mess up the housing market further, compound it all with huge uncertainty from month to month (sometimes week to week).

Something just doesn’t ring true.  Sure, people find smart ways of doing things from home, but generally you’d have to assume that if the new ways were so great as to be better than what went before in 2019 they’d have been done then.  And no doubt macro policy has given a big boost to overall demand, activity, employment and hours….but this is a productivity measure, and whatever the boost was you’d normally think it would lift demand for people who on average were less productive than what went before.

There are always averaging effects –  in lockdowns perhaps some of the least productive people are disproportionately those who can’t work (waiters, motel cleaners etc) –  but….the picture was already looking surprisingly strong in Q2 this year, when there were hardly any domestic restrictions.

I just don’t believe that the picture represents reality, and that somehow productivity growth has –  after all these decades – started to accelerate.  There have been no micro policies working in that direction –  rather the opposite –  and no one really supposes that forcing businesses not to interact with overseas customers and suppliers etc face to face is good for medium-term productivity.  Add to that all the supply chain problems –  even the small weirdness that USPS no longer delivers to New Zealand –  and it suggests we should be pleasantly surprised if the level of labour productivity now is not lower than it was two years ago.  It just doesn’t make sense to think it is so much higher.  All else equal, the GDP estimates –  and that is all they are, in tough times for measurement and estimation –  look too high.

On which note, I will end the blogging year.

It has been a year of many fewer posts than in most since the blog began.  That was largely down to me getting a cold back in May 2020 from which I never fully recovered, graduating into what the doctor eventually diagnosed (labelled as) chronic fatigue syndrome.  By the standards of what one reads or hears of other people I had a mild version, but for long periods that meant I wasn’t good for much beyond the day to day basics, and sitting in front of a screen for even half an hour was at times astonishingly draining.  An attempt to walk much further than round the block could knock me back, sometimes for weeks.  I’m still not 100 per cent –  still need naps most afternoons – but seem to getting close; perhaps 90 per cent of normal, which is a considerable relief all round.

Having said that I don’t suppose I will drift back into a routine of a post each week day. Posts two or three times a week, supplemented with charts/links on Twitter, seems to be a useful and workable model for now.

Reviewing immigration policy

The Productivity Commission has been charged by the government with reviewing immigration policy with a view to identifying “what working-age immigration policy settings would best facilitate New Zealand’s long-term economic growth”, with a specific emphasis on productivity.

The draft report came out in early November, and I wrote a couple of sceptical/critical posts on it (here and here). The Commission invited submissions on the draft report (submissions close on Friday) and I’ve just lodged my submission. The full text is here:

Submission to the Productivity Commission inquiry on NZ immigration policy Dec 21

Most of the material in my submission will be familiar to regular readers, so I’m not going to quote extensively from it here. My overview was as follows:

There are plenty of individually interesting bits of material in the report (and supporting working papers) but overall, I’m left with the impression that the Commission has not yet done adequately what was asked of it. Specifically, in the Terms of Reference for the inquiry, you are invited to “explore what working-age immigration policy settings would best facilitate New Zealand’s long-term economic growth and promote the wellbeing of New Zealanders”, and in the next paragraph the connection to improving productivity is explicitly highlighted. Your draft report seems to touch on many of the more-detailed points listed in the Terms of Reference, but does not sufficiently stand back to evaluate the way in which immigration policy has (or has not) been contributing to productivity growth and material
living standards of New Zealanders.

Doing so well would require at least a pretty comprehensive review of New Zealand’s experience with large-scale non-citizen immigration over recent decades (arguably informed by the earlier post-war large scale immigration experiences that ended in the 1970s), including recognising that our approach to immigration policy has been something of an outlier among advanced countries, occurring against the (also unusual) backdrop of a very large net outflow of our own citizens. Without something of that sort, informed too by relevant overseas experiences and by a detailed engagement with the stylised facts of New Zealand’s dismal productivity record (recognising that the scale of New Zealand’s
immigration policy structural “intervention” has been huge), it is difficult to see how you can reach a view on what future immigration policy would be most suited to maximising, all else equal, New Zealand’s specific economywide productivity prospects. Moreover, nothing at all in the report seriously engages with the literature on economic geography, surely a startling omission when New Zealand immigration policy involves inviting large numbers of people to relocate to the most remote outpost in the advanced economy world, with the policymakers responsible claiming to have had explicit economic motivations for the policy.

Consistent with these omissions, two of the three highlighted Preliminary Recommendations are primarily process oriented, and the third is really a second-tier issue around absorption capacity. Other suggestions, some sensible, some questionable, play around the edges of the issue, perhaps focused simply on refining something like the last decade’s status quo. None gets to the heart of the issue: what sort of immigration policy should New Zealand run in future, if governments were interested in maximising the productivity and income prospects of New Zealanders?

The rest is there for anyone interested.

I had a quick look earlier in the week through the submissions the Commission had already received. The one that most caught my eye was a second submission by someone called Mike Lear (he’d already made a submission prior to the draft report). I don’t know who Lear is, although I deduce from his submission and this footnote that has had some past exposure to economic analysis and economic policy issues.

34 When I started work in the Department of Industries and Commerce in 1972 (in the newly formed
Productivity Centre!) I was told by the most senior person in the department responsible for overall industry policy that New Zealand should aim to be the Switzerland of the Pacific region for machine tools.

It is a very well-written submission, almost certainly easier to read than my own. Much of it represents a fairly trenchant championing of the “Reddell hypothesis” (the idea that our large-scale non-citizen immigration policy has detracted from New Zealand’s productivity performance) and point by point pushback on various points made (or ignored when they should have been made) by the Commission in the draft report. I don’t agree with every line of his submission, even where he is writing about my ideas, but it is a particularly clear and useful articulation of the arguments and identifies numerous issues that the Commission really needs to grapple with before publishing a final report next year.

Here is his Introduction

lear 1

lear 2

It will be interesting to see what the Commission comes up with in the final report. There is an opportunity to do a really valuable report standing back and asking how best this major structural policy intervention can contribute to improving our dismal economic fortunes. Or the Commission can keep to where the draft report got to, and focus mostly on process issues and tweaks (some sensible, some not) to the (pre-Covid) status quo. The former seemed to be what the government invited the Commission to do when it set out the Terms of Reference for the inquiry.

HYEFU bits and bobs

I don’t have too much to say about yesterday’s HYEFU, but two things caught my eye.

The first was a bit of attention on the $6 billion “operating allowance” the government has given itself to increase spending (or, I suppose, cut taxes) at next year’s Budget. It is a big number, but it doesn’t mean a great deal. In principle, the operating allowance covers things where the government has some discretion (whereas, by legislation, tax revenue tends to rise each year as nominal GDP does, and welfare benefits rise each year as inflation/wages do, and without new legislation the government of the day has no choice in the matter).

But governments tend to care about purchasing/delivering real goods and services, and they need actual people to work for them. And when there is inflation, the dollar cost of purchasing goods, services, and labour tends to rise. Governments don’t have to – and tend not to – compensate agencies/votes for inflation each and every year but when inflation is higher, over time more dollars need to be allocated for increased spending just to keep the real volume as the government intended. And since inflation – in principle – just blows up prices and incomes, making us as a whole neither richer nor poorer, they can do so with no particularly ill effects.

To illustrate, suppose the government spends $100 billion a year in an economy with nominal GDP of $330 billion (so roughly 30 per cent of GDP). Now assume that prices generally suddenly rise by 5 per cent, with nothing else changing. The things the government wants to purchase cost more, but its tax revenue also rises by more. In fact, it will now cost $5 billion more than otherwise to purchase the same volume of goods, services, labour (or real transfers). In practice, as noted above, quite a bit of government spending is indexed by legislation (roughly a third of core Crown spending is on welfare) and so not covered by the operating allowance. But in this scenario a 5 per cent lift in prices might require a $3.3 billion operating allowance, just to keep real government purchases unchanged.

I don’t have the time today or the patience to try to reconcile all the numbers, but to illustrate that inflation is a big part of the picture note that in this year’s Budget Treasury forecast that inflation for the year to June 2021 would be 2.4 per cent, for the year to June 2022 1.7 per cent, and for the year to June 2023 1.8 per cent. In the HYEFU, those numbers (2021 now known) are 3.3 per cent, 5.1 per cent, and 3.1 per cent. The total increase in the price level over those three years was expected to be 6.0 per cent, and is now expected to be 11.9 per cent. So of course the government needs to put more money (quite a lot more) in the operating allowance just to maintain real spending at the levels they intended only a few months ago. A lot of it is simply an inflation illusion. In the same way that a very small operating allowance would reveal nothing about the fiscal stance if inflation was to be unexpectedly low (as it was, say, a decade ago).

Don’t take it from me. Here are The Treasury’s forecasts of core Crown operating expenses as a per cent of GDP, including the government’s fiscal plans (those “big” operating allowances) as communicated to them and published yesterday.

core crown expenses hyefu 21

On these plans, core Crown spending as a share of GDP will be around the same share of the economy as it was going into John Key’s final term.

There is plenty to criticise about individual spending items under this government – take $51 million wasted on the aborted, always ludicrous, Auckland walking bridge, let alone $5 billion in Reserve Bank losses – but the bottom line at this stage is one in which total spending ends up much where it was as a share of GDP. One might, of course, worry more about timing. With an overheated economy (on Treasury and Reserve Bank numbers), with high and rising inflation, and with a high terms of trade, the government really should be running a surplus next year (headline surplus consistent with cyclically-adjusted balance. But, in fairness, the forecast deficit for 2022/23 is small.

As noted, there has been – and is expected to be – quite a bit more inflation. Like the Reserve Bank, Treasury now seems to think that even core inflation will move outside the top of the target band the government set for inflation. They expect 3.1 per cent inflation in the year to June 2023 – ages away, and fully within the control of monetary policy now – and won’t be forecasting the sorts of one-off price shocks that often distort near-term headline inflation forecasts.

But, on the Treasury’s numbers it doesn’t seem like anything to worry about because by the end of the forecast period (June 2025) inflation is back to 2.2 per cent, basically the midpoint of the target range.

But how is this being achieved? Sure, they expect the Reserve Bank to raise the OCR, to a peak of 3.2 per cent by June 2023. But raising the OCR above neutral – as the Governor told us they expect to – usually dampens (core) inflation mostly by generating some temporary excess capacity in the economy.

But here is The Treasury’s view on the output gap.

Tsy output gap

They reckon it was deeply negative a decade ago, when core inflation was low and falling (reaching a trough around the end of 2014), but now they reckon it will be positive – quite materially so for the next couple of years – throughout the forecast horizon. All else equal, that should normally be consistent with core inflation rising further.

What about the labour market? The Treasury doesn’t publish an “unemployment gap” number, but comparing their unemployment rate forecasts, and the medium-term trend assumptions they use in their Fiscal Strategy Model makes very clear that they expect the unemployment rate to be below sustainable levels over the next few years.

U gap Tsy

So how is it that they expect (core) inflation to come down?

I can think of two possibilities, neither very convincing. The first is that they are still treating all the current (and forecast over the next 18 months) surge in the inflation rate – including on the core measures – as really just transitory and having nothing to do with excess demand. If so, as (eg) supply chain disruptions dissipate, what now looks like core inflation vanishes like the morning mist. But that certainly doesn’t seem to be the Reserve Bank’s view, just doesn’t square with (eg) forecast positive output gaps, and isn’t really consistent with expecting fairly rapid increases in the OCR.

The second possible story might involve inflation expectations. Perhaps they too stay firmly rooted at 2 per cent and inflation just vanishes, despite the headline pressures, despite the (on Treasury’s own estimates) overheated economy. But it doesn’t make a lot of sense, and isn’t consistent with any of the other swings or slumps we’ve seen in core inflation over the decades.

I don’t know what Treasury thinks the story is. In the end, perhaps it doesn’t matter that much. The Reserve Bank will – we presume – eventually do what needs doing and adjust the OCR to get core inflation credibly heading for the midpoint. But if there is enough inflationary pressure built up that the OCR really needs to be raised more than 200 basis points more from here, it is a little hard to believe that would be consistent with an economy still generating a positive output gap and such low unemployment rates. Medium-term forecasting is a mug’s game – no one is any good at it – so my interest is more in the logic of their model than in what the economic outturns a couple of years hence might be. But if the OCR has to be raised a lot more over the next 18 months, you might normally expect the biggest adverse economic effects (normally needed to get core inflation back down) might well be showing themselves in the second half of 2023. Which might be awkward timing for the government.

But who knows how many shocks – positive, negative, Covid and other – will be along before then.

The Reserve Bank appears underwhelming

First thing this morning the Reserve Bank fronted up at Parliament’s Finance and Expenditure Committee for their Annual Review hearing.

The Governor kicked off with some introductory remarks that were celebratory (the focus of the hearing was notionally on the last financial year) but superficial. In some cases barely even honest. He was “very proud” of all the Bank had achieved, talked up monetary policy as having been “highly effective in preventing deflation”, claimed (wrongly) to have been one of the first central banks to have raised policy interest rates again, and ended with a paean to “diversity and inclusion” talking of having “many plans” and “much action” on that front. There was no mention, for example, of the $5 billion of taxpayers’ money they had lost, or of the continuing churn at the top of the organisation.

Last evening they had had to announce that two more senior managers were leaving, ousted in yet another of Orr’s restructurings. Orr didn’t deny the claim made by National’s Simon Bridges (and various journalists) that the Bank had hoped to keep these departures secret until after the hearing, and had only announced them late yesterday afternoon after the news had seeped out. It can be hard to keep track of all the departures – in several cases Orr can’t even blame his predecessors as at least two of the senior management departures have been of people who Orr had first promoted before changing tack and pushing them out. I’ll take the departure next year of the Bank’s long-serving CFO (who would be over 65) as a genuine retirement, but mostly the departures seem to have been Orr-initiated, such that of the large senior management group in place when he took office only 3.5 years ago, only two will soon be left.

And the departures aren’t simply in peripheral or support positions. Orr has now ousted two chief economists in succession, and we have no idea who will be filling that vacancy on the MPC, at a time when things are scarcely all quiet on the monetary policy front. On the financial stability side – largest part of the Bank and the growing bit – the gaps are even more obvious. The Deputy Governor (who ran that side of the Bank) is leaving, and now the two senior managers (heads of supervision and head of prudential policy/analysis) are leaving – the latter having already accepted a demotion a couple of years ago. Each of these guys has strengths and weaknesses (although I thought Andy Wood was good value), but all will be gone very shortly – and with them huge amounts of experience. In their place, we have a new Deputy Governor who has no background in banking, supervision or financial regulation, and two vacancies. So far at least, Orr has shown no ability to (or interest in doing so?) attract top-notch talent to the Bank at senior levels. And from 1 July next year, the Bank’s new Board is becoming the key decision-making body on prudential matters including policy. The Minister makes those appointments and so far no one whom one might think of as offering exceptional intellectual or practical leadership in these areas had been appointed. The Bank looks incredibly weak on that side of its business, and one wonders what their capable and experienced APRA counterparts make of it all.

But to return to this morning’s hearing, when Simon Bridges suggested that the volume of churn might almost be described as “reckless”, Orr’s only response was to suggest “or planned”. As Bridges noted the Bank was losing a lot of senior and experienced people, likely to be replaced with more junior less experienced people, perhaps “people who agree with you”. Bridges went on to comment on the number of people who had already got in touch with him to express concern at what was going on at the Bank. Orr offered no comment in response.

David Seymour also chipped in on this issue asking about turnover at senior levels. The Bank’s response seemed to be a mix of cute answers (people who had confirmed they were leaving shortly were nonetheless still there and so hadn’t left), obfuscation (emphasising how many more staff in total the Bank had – as if that too should not be a concern), and a bit of outright denial. Seymour asked Orr if he was “absolutely confident” that there was nothing about his (Orr’s) leadership that had led to conflicts resulting in departures”. Orr’s reply: “Absolutely”. I don’t suppose he was ever going to own up – the main who really hates being challenged or disagreed with – but it wasn’t a confidence-inspiring performance. And who is responsible for the Governor? Well, that would be the current ineffectual Board – whose chair has been carried over to the new and (legally) more powerful Board, and of course the Minister of Finance.

The Green Party’s Chloe Swarbrick also asked a couple of useful questions, and was simply fobbed off by Orr. Was there anything about the policy response over the last couple of years, she asked, that the Governor might have done differently with the benefit of hindsight? It was, she was told, a hypothetical that he wasn’t going to answer, but he then went on to say that he was “very confident” that “exactly the right decisions had been made”. With the benefit of hindsight, does any normal reflective human being make such bold claims? Well, Orr certainly does ($5bn of losses, as just one example, notwithstanding). Swarbrick went on to ask if there would be value in a review of Covid fiscal and monetary policy (a good idea, and a suggestion I’d also made to Treasury at a consultation session last week). Orr claimed that such reviews were ongoing and very transparent. If so, there is no evidence of it, and when someone reviews themself such reviews are often not received with total conviction.

David Seymour followed up, noting that the Governor had said earlier that house prices were above a “sustainable” level, employment was above the maximum sustainable level, and inflation was high and/or rising. Might it not be thought that the degree of monetary stimulus had been a bit overcooked?

Orr’s blustering response was that it was better than an alternative of extremely high unemployment and deflation, repeating his line that the Bank had been one of the first in the world to raise rates. Seymour pushed back and suggested some possibility of a middle ground – that, with hindsight, a bit less monetary stimulus might have been warranted, but Orr simply refused to engage.

There were no questions about the LSAP scheme ($5bn of losses notwithstanding) but National’s Andrew Bayly again asked about the Funding for Lending scheme. Crisis conditions have long passed, the OCR is working fine, and being raised, and yet the Bank keeps on for another year with the emergency facility that all else equal holds interest rates DOWN. The Assistant Governor burbled on about the need to provide certainty to banks – as if anything else about the economic (or virus) environment is certain. It is simply bizarre that emergency facilities are still providing stimulus, even as core inflation heads for top of the target range.

Not all the questions from non-Labour members was really to the point. As Orr noted, the MPC has to take the fiscal stance as given and adjust the OCR as required (having said that, National could point out that on occasion Orr has been an open cheerleader for bigger fiscal deficits), and National seems unable to decide whether it dislikes high inflation or a higher OCR more. Personally, I’m with the Governor on that one: high inflation needs to be brought back into check, and monetary policy is the most effective instrument. In fact, it was good to hear Assistant Governor Hawkesby explicitly note that inflation expectations had risen and that monetary policy was oriented towards getting inflation back to around the midpoint of the target range.

But two final questions are worth noting. A government member asked a patsy about the Bank’s climate change crusade, prompting National Andrew Bayly to note that the Federal Reserve of New York had recently published research suggested that climate change posed little threat to financial stability (he could have cited recent Bundesbank stress tests as well). Bayly asked if the Bank had done any modelling of its own. Orr’s response was an unequivocal “yes”. That was interesting because a quick check of the Bank’s climate change page showed that still the only “research” they listed was a single paper from 2018 which (“preliminary analysis”) also concluded that there wasn’t likely to be much to the climate change financial stability risk issue. You might have supposed that the Bank would be keen to get out in the public domain any research they’d done supporting the Governor’s ideological priors and political preferences. I have today lodged an OIA request for the modelling work the Governor was referring to this morning. On past form, we might see something six months from now.

And then Chloe Swarbrick got in one last question. You’ll recall that the Governor had told the Committee that in the Bank’s view house prices were currently higher than “sustainable”. All else equal, Swarbrick asked, how much would house prices need to drop to be considered “sustainable”. Orr’s response was “I don’t have that number” (he had what looked like a dozen staff present in support). It seemed an eminently reasonable question. The Bank has the biggest team of macroeconomists in the country, it has in-house research capability and has claimed – not once but many times – that prices are “unsustainable”. The way places like the Bank work is that there will be a range of model estimates informing the judgement that current prices are unsustainable. It wasn’t that Orr didn’t have a number (or, more likely, a range) it was that he simply refused to answer, and did not suggest he would follow up and get back to the member.

A year ago, one might have said (I would have) that it really wasn’t an issue for the Bank. But the Minister changed the Bank’s Remit, and Orr and the MPC have embraced the change. You may, like me, think that they way they approach “sustainable” is meaningless and often misleading (their concept has nothing at all to do with longer-term fundamental supply characteristics) but…….they are the ones openly opining that prices are “unsustainable”. How much then, even as a range? Orr’s refusal to reply really made a mockery of parliamentary scrutiny.

Overall, it was good to see the Bank and the Governor facing some serious questions. 55 minutes for the whole thing, including government patsys, really wasn’t enough in the circumstances, but what we saw was a weak and unpersuasive central bank. The Reserve Bank is a key economic agency in New Zealand, exercising a great deal of discretionary power, and we (and Parliament) should expect a solid team of really capable and experienced senior people, articulating credible and thoughtful nuanced responses to serious questions and challenges. It wasn’t at all what we saw today. But of course, there is little follow through, and no serious questioning on these issues of either the Bank’s Board or the Minister of Finance. Instead we just see the continued degradation of yet another of New Zealand key public sector institutions. I suppose unserious governments – there is little sign they care much about institutions or medium-term economic performance, let alone getting house prices down – invite increasingly unserious bureaucracies, of which today’s Reserve Bank is one. Perhaps Orr will surprise and he’ll soon announce the appointment of a phalanx really strong capable independent-minded senior managers, who last (perhaps outlast him) but nothing about his tenure to date (or the continued churn) should give us – or Parliament- much confidence.

Price/income ratios

Over the last couple of weeks we’ve had another round of politicians (so-called “leaders”) doing their utmost to deny any interest in seeing house prices much lower. At 60 per cent below current levels – which would be readily achievable with open and competitive land markets, and a genuinely open and competitive building products sector – we’d be looking at something a lot more reasonable. Real rents would probably then be lower than ever before. But our politicians are terrified of the very idea.

The new Leader of the Opposition made clear his opposition to any suggestion of a sustained fall in house prices (while noting that inevitably there would be some ups and downs). HIs new deputy – and National’s housing spokesperson – did suggest that much lower house price/income ratios might be desirable, with something like flat nominal house prices. And while the Prime Minister at the weekend was quoting as suggesting that she wanted lower house prices – quite a change of tone from her, perhaps just getting ahead of what may already be beginning to happen – she too was at pains to deny any interest in much lower house prices.

Of course, in principle, house price/income ratios could be steadily whittled away by some combination of flat nominal house prices and rising wage rate. But when one starts from such an unbalanced situation as New Zealand now does it would be the project of decades, even if anyone took it seriously. The great and good seem to rather like the idea of this “painless” whittling away, presumably as it enables them to sound serious, and not scary to the already-indebted.

Here is a chart of three scenarios, in each of which nominal house prices hold flat from here. In each scenario I’ve assumed 3 per cent annual growth in wage rates (basically inflation at target on average and something like 1 per cent per annum productivity growth). What differentiates the three scenarios is the starting point – a range from 8 times income to 10 times income.

price to income dec 21

At best, it takes 33 years for price/income ratios to get back to three – the sort of ratio seen in large chunks of the US, in cities large and small. At best, it would take almost a quarter of a century to get back to a price/income ratio of four.

In the next chart I’ve assumed a starting point of 10 times income and shown the implications for a range of wage growth assumptions. On these scenarios, my kids would my age before house price to income ratios were again what they were when I was their age.

price to income 2 dec 21

If your idea of political leadership is along the lines of “I must find where the people are going and get out in front of them”, I suppose I understand the apparent political terror at the prospect of much lower house prices, but what a pathetically weak approach, that abdicates any responsibility towards the next generation. These people – “leaders” of our political parties – appear content to get a whole other generation (or two) load up on debt based on house prices they know not to be based on any long-term fundamentals, rather than get to the heart of the issue now.

Of course, some in the media don’t help. I saw last night one journalist suggesting that even getting house prices 25 per cent lower would be reckless, irresponsible, and deeply economically damaging. But politicians put themselves forward, at least notionally, as leaders, people (allegedly) with the best interests of the country at heart. They are supposed to be the communicators, the coalition builders, the persuaders, the people who make things happen…..not those content to sit to the sidelines, idly hoping that well beyond their time in politics things might finally be sorted out.

Take the idea of a 25 per cent fall in house prices. That might take prices back to around where they were at the start of last year. No one who bought before then is put in any particular difficulty. And neither are most of those who bought more recently, as bank lending standards have not been loose, and LVR restrictions have become increasingly onerous. Some would be left temporarily with negative equity, but (a) typically not a large amount, and (b) in a fully-employed economy, modest negative equity isn’t typically a major problem (and to anyone going “easy for you to say”, it was exactly the situation I found myself in a couple of years after buying my first house). But our “leaders” can’t even enthusiastically embrace unwinding the last couple of years’ house price rises.

Of course, the major parties sometimes like to talk about the things they’ve done, up to and including the current amendment to the RMA being rushed through Parliament. But the proof of the pudding is in the prices, and expectations of future prices. Actually, in the political rhetoric as well. Not only have expectations of future house price inflation not gone negative – or even slowed noticeably after the latest “accord” – but the politicians’ own rhetoric reinforces the point: they themselves are scared of embracing lower prices.

Were they actually serious about fixing things, in their own terms of office, some creative thinking (and coalition building) might be required. Big changes in relative prices involve big shifts in wealth. Sharp rises in house prices have skewed the playing field away from the young and the poor. Sharp falls in house prices would skew things sharply away from the very highly-indebted. Of the latter, some don’t (and shouldn’t) command much sympathy at all. If you run a residential rentals business and took on huge amounts of debt to finance your business, well tough. It is a business, in this case built on systematically rigged markets (all that central and local government land-use regulation), and sometimes businesses fail. New entrants will emerge to replace you.

But first home buyers (in particular) command a lot more sympathy, and rightly so in my view. Young families didn’t ask the government to rig the market, or probably even support them doing so. They just want a secure home and backyard to raise their kids, and the only option governments left them for doing so was to pay these absurd price/income ratios, made barely feasible by the sustained decline in neutral interest rates (which in a functioning market should have made purchasing a home easier than ever). For them, some sort of partial compensation scheme might be a fair and necessary path to breaking through the political resistance to much-lower house and land prices. Not a first-best solution perhaps, but a great deal than putting another generation through this quite-unnecessary drama of rigged housing markets. When market prices are miles from the structural fundamentals, there is no merit in trying to foreshadow some very slow and allegedly “painless” adjustment. Better to get the prices (and market regulatory frameworks) sorted out now.

(Oh, and don’t be fooled if prices do fall back a bit over the next 12-18 months. Cyclical fluctuations happen. Falls happen (as over 2008/09). But without fixing the land-use restrictions – and the current RMA amendment does not even come close – the fundamental distortions remain. House prices did fall quite a bit in 2008/09 (even with much lower interest rates), until they rebounded to levels (and price/income ratios) higher than ever.

LSAP losses

The Minister of Finance and The Treasury appeared before Parliament’s Finance and Expenditure Committee yesterday. It was encouraging to see National MPs asking questions about the Reserve Bank’s Large Scale Asset Purchase programme, which was undertaken with the agreement of both the Minister and The Treasury and which has now run up staggering losses for the taxpayer.

A standard way of estimating those losses is the mark-to-market valuation of the Bank’s very large LSAP bond portfolio. As of the latest published Reserve Bank balance sheet, for 31 October, those losses were about $5.7 billion. When the 30 November balance sheet is out, probably next week, the total losses will be lower (bond rates fell over November), but with a very large open bond position still on the books taxpayers are exposed to large fluctuations in the value of the position (up or down), with no good basis for supposing that the expected returns are likely to compensate for the risk involved. If there was a case for putting on a large open bond position early last year – I doubt it, but take that as a given for now – there is no case for one now, in a fully-employed economy with rising inflation, and with the conventional instruments of monetary policy – which expose taxpayers to no financial risk – working normally and effectively.

A post from a few weeks ago set out the issues.

I didn’t watch the whole 2 hours (link to the video above) but from exchanges with various people I think I have seen all the questions and answers relevant to the LSAP issues.

First, at about 43 minutes in, National’s Andrew Bayly asked the Minister of Finance (a) why, when Crown indemnity was approved the Minister did not then require a plan for unwinding the position (the Bank is currently talking about having a plan early next year, almost two years on), and (b) why there was no limit to the indemnity.

I’m not sure either question was that well-targeted, and the Minister had no real trouble responding. As he noted, the LSAP programme had been initiated in the middle of a crisis, time was short etc. And although there isn’t a limit on the indemnity itself there is a limit of how many bonds can be bought, and the government determines which bonds are on issue which amounts to much the same thing. That said, both responses take as more or less given that the idea of an LSAP had never occurred to anyone on any corner of the Terrace/Bowen St triangle until late March 2020. We know the Bank had been (rather idly) talking about the option for several years, including saying they’d prefer not to use it, but it seems they had not done the hard ground work, and neither had The Treasury nor the Minister insisted on it, well in advance. There is no sign any cost-benefit analysis for something like the LSAP was ever done, no analysis of likely Sharpe ratios, no analysis of potential peak taxpayer losses and so on. The Bank should be held accountable for that, but…the Minister is primarily responsible for holding them to account, and The Treasury is the Minister’s principal adviser (and the Secretary is a non-voting member of the MPC).

After the Minister left, Bayly returned to the LSAP (at about 68 minutes), supported by National’s new finance spokesman Simon Bridges. Bayly asked the Secretary to the Treasury whether an increase in the OCR would increase the liability for the Crown for the indemnity. The Secretary responded that the indemnity was net neutral from a whole of Crown perspective. What followed was a slightly confused discussion with Bridges ending up suggesting that the Secretary was “plainly wrong”. I don’t think the Secretary answered well, and she certainly didn’t answer in a way designed to help clarify the issues around the LSAP, but she is correct that the indemnity itself does not affect the overall consolidated Crown financial position (the claim the Bank currently has on its balance sheet is fully offset by an obligation the (narrowly defined) central government has on its balance sheet. It is quite likely that without the indemnity the MPC would have been very reluctant to have run a large-scale LSAP programme (the Bank’s own capital would not support the risk), but once the programme was established what determines the financial gains or losses is, in short, just the movement in market interest rates. The indemnity just reallocates any losses within the wider Crown accounts. In that particular exchange, The Treasury made none of this clear, and Secretary herself seemed a bit confused when the discussion got onto the different ways the bond position might eventually be unwound (there is little or no indemnity if the bonds are held to maturity, but that doesn’t mean there are no costs to the taxpayer). And thus (reverting to Bayly’s initial question) an increase in the OCR – particularly one now expected – doesn’t itself change the Reserve Bank’s claim under the indemnity

About 25 minutes further on, Bridges returned to the fray and a rather more enlightening conversation followed. Bridges asked whether the LSAP did not represent a significant increase in Crown financial risk. The Secretary agreed and both she and one of her colleagues explained – as I have here repeatedly – that what had gone on was that the Bank had bought back long-term fixed rate bonds, effectively swapping them for the issuance of settlement cash, on which the interest rate is the (variable) OCR. Unfortunately some of the discussion still got bogged down in matters of Crown accounting (the difference between the purchase price of the bonds and the face value, which is of no economic significance), and the Secretary was very reluctant to allow herself to be pushed into acknowledging that the position of the LSAP portfolio – implemented with her support – is deeply underwater. As a simple matter of analysis, she was never willing to distinguish between the mark-to-market loss to now, and the potential gains, losses, and risks on continuing to hold a large open position from here on. One is a given – now a sunk cost – and conflating the two (in the hope “something will turn up”) obscures any sense of accountability, including for the choices to keep running the position. She and her staff wouldn’t accept that sort of explanation from any other government agency running large financial risks.

Were the position to be liquidated today – as, at least in principle (crisis having passed, economy full-employed) it should be – a large loss for the taxpayer would be realised. At a narrow financial level it is as simple as that. If the position continues to be run – in the limit through to maturity, finally in 2041 – what will matter is where the OCR averages relative to what is currently priced into bond yields, but it won’t change the fact that the portfolio is starting behind – the OCR is already much higher than was expected at the time most of the bonds were bought. And if the portfolio is let continue to run, taxpayers are exposed to ongoing large risk for no expected return (there is no reason to suppose the Bank is better than the market at guessing where the OCR will need to go over the next 10-20 years).

(The current agreement between the Minister and the Bank requires that if the Bank looks to sell the LSAP bonds it do so only to the Treasury itself. Such a sale, of course, changes nothing of economic substance (purely intra-Crown transactions don’t) – the high level of settlement cash balances would still be there, earning whatever OCR the macro situation requires – but from a political perspective it would be convenient, as there would no longer be monthly updates on the Bank’s website as to the extent of the losses caused by the MPC’s rash choices (backed by The Treasury).

Treasury officials did chip in a couple of caveats. First, the Secretary noted that in assessing the overall LSAP programme one had to look also at the (any) macroeconomic benefits. In principle, of course that is correct, but (as I’ve argued previously) any such gains are unlikely to have been large:

  • the LSAP was designed to lower long-term bond rates, but these are a very small element in the New Zealand transmission mechanism,
  • it is hard to see much evidence here or abroad of sustained effects of LSAP-like programmes on long bond rates (eg movements beyond what changing expectations of future OCR adjustments themselves would simply),
  • the Bank always had the option of cutting the OCR further (on their own telling, to zero last year, and lower still since the end of last year), at no financial risk to the taxpayer, and
  • if there is a macro effect, perhaps it was modestly beneficial last year, but must be unhelpful now (recall that the literature suggests it is the stock of bonds that matters, not the flow of purchases, and we now have an overheated economy with above-target inflation.

And one of her deputies chipped in noting that there might have been some savings to The Treasury from having been able to issue so heavily at such low rates last year, the suggestion being that without the LSAP the Crown might not have been able to get away so many bonds so cheaply. There is probably something to that point, in an overall accounting, but (a) the effect is unlikely to have been large relative to the scale of the subsequent rise in bond yields, and (b) especially with hindsight a better model would have been for the Bank not to have been purchasing bonds and the Crown to have been issuing fewer.

The Select Committee discussion ended with the offer that National MPs could lodge a follow-up question for written response by the The Treasury. I hope they avail themselves of that offer.

The Treasury could be, and should be, much clearer and more upfront about the analytics of the LSAP issues, but it isn’t clear – given their involvement all along – that their incentives are in this case that well-aligned with the interests of the public in scrutiny, transparency, and accountability.

Debt and deficits

The OECD’s latest Economic Outlook came out a few days ago. As always with the OECD, the value is rarely in the analysis or policy prescriptions, but mostly in the vast collection of more-or-less comparable tables, collating data for a wide range of advanced economies (and a few diversity hires).

Take public debt as an example. Next week our Treasury will be out with their HYEFU and more-detailed New Zealand numbers for central government. But there is no easy way of comparing Treasury’s New Zealand numbers with those for other countries. And so I tend to focus most often on the OECD series of “net general government financial liabilities”, which includes all layers of government, and doesn’t exclude things that particular national governments find it convenient to exclude (in New Zealand’s case, all the assets in the Crown’s hedge fund, the NZSF).

The OECD’s forecasts only a couple of years ahead, but that is probably about the most that is useful anyway, Here are their recent forecasts for net general government liabilities as a per cent of GDP (for the 30 countries they do these numbers for).

debt 2023

For New Zealand, the 2023 number is 14.82 per cent of GDP and on these forecasts we’d be 7th lowest of (these) OECD countries. There isn’t a forecast for Norway for 2023, but they have net financial assets of about 350 per cent of GDP, so call it 8th.

Going into the pandemic, our net general government liabilities as a per cent of GDP in 2019 was 0.8 per cent. (Including Norway) we were 8th lowest of these OECD countries.

That is a not-insignificant increase in net debt as a per cent of GDP. Between 2007 and 2012 – serious recession and the earthquakes – net general government financial liabilities were increased by about 12 percentage points of GDP. But, and on the other hand, in five good-times years (from 2002 to 2007) net general government liabilities as a share of GDP dropped by 23 percentage points of GDP.

Here is the cross-country comparison over time

gen govt liabs

I’m not suggesting we should be totally comfortable about that picture, but our net public debt is forecast to remain (a) low, and (b) much lower than the typical advanced country.

What if we break out the countries. Some argue (I’m not really convinced) that big countries, at least those with a history of reasonable government etc, can comfortably ran higher ratios of public debt than smaller countries. And, on the other hand, perhaps the countries most like New Zealand are the fairly-small places with their own central bank and floating exchange rate. Here are the relevant comparisions over time (medians in both cases).

gen govt small and big

The big countries – Germany excepted – really have been on a rising debt path. I’m not one who believes crisis and/or default is looming (generally – Italy remains a wild card) but were I a voter in one of those countries I’d be seriously uneasy. Were I involved in an opposition political party, I hope the high and rising debt would be made a salient political issue.

But – and generally – the small advanced countries have done pretty well (true on this sample of countries, or if one uses all the small countries – including those in the euro – in the database), and there has been (and is) nothing startling or particularly impressive about the New Zealand performance. If anything, one might note the widening gap at the end of the period.

Of course, none of this includes the fiscal challenges imposed by the rising NZS fiscal burden from maintaining the age of eligibility at 65 (although it is now a decade since baby boomers started turning 65) and the expected trend increase in public health expenditure….but I really can’t see public debt itself being a particularly salient issue in 2023.

But what about deficits? No one argues the government should have been running a balanced budget last year, and perhaps not even this year (given the renewed lockdowns and big output losses the government left itself open to), but why not 2023? These are the OECD’s projections – the primary balance excludes financing costs, and a common rule of thumb is that even a small primary surplus is consistent with keeping debt in check. “Underlying” captures cyclical-adjustment.

primary defs

In 2023, with the economy projected to be fully-employed (a reasonably significantly positive output gap), with a strong terms of trade, and (as ever) with some of the highest real interest rates anywhere in the advanced world, the OECD estimates that the government’s fiscal policy will see us in 2023 with a large primary deficit, a bit worse than the median OECD country. (Norway’s primary deficit is much larger, but remember that they have big net earnings (finance receipts) on the government’s huge net asset position.

Were one confident that spending initiatives were being ruthlessly scrutinised to keep waste to an absolute minimum, perhaps one might be a little less worried – although small structural surpluses, where spending is funded by taxes remains a good rule of thumb – but does anyone suppose that describes current New Zealand approaches to public spending.

I don’t suppose Ardern and Robertson are likely to let things get really out of hand. They seem oriented enough towards broad macro stability – in the traditions of all New Zealand governments of recent decades – even as they too watch our real economic performance decline, but at present the structural deficit picture (as the OECD interprets our data and policies) isn’t looking that good.

primary def nz

There should be considerable scrutiny on the government’s plans in the forthcoming Budget Policy Statement, and the Treasury’s HYEFU projections.