Author: Michael Reddell

Why not split up the Reserve Bank?

Michael Reddell Financial stability, Reserve Bank Act reforms

That is, deliberately, a slightly ambiguous title for the post.   I favour splitting the Reserve Bank in two, setting up a new New Zealand Prudential Regulatory Authority to pick up the regulatory and supervisory responsibilities the Bank currently has (subject to various refinement).   I’ve made the case here and here, and late last week highlighted my former colleague Geof Mortlock’s new article articulating the case for change.   We know that the Reserve Bank’s conduct of those functions isn’t highly regarded and the minutes (and OIA releases) suggest that the Reserve Bank’s Board –  paid to hold the Governor to account in the public interest –  were asleep at the wheel while this situation was developing.  All told, I reckon there is a pretty clear-cut case – in principle, and based on the actual track record – for structural reform.  Structural reform is never a panacea, but with the right will, and the political determination that things will be done better in future, it can play a part, making a demonstrable break with the past and establishing a new and better institutional culture.

But, of course, there are counter-arguments.  The Reserve Bank is likely to be making them forcefully at present.  I suspect the Governor’s populist participation in the current attack on the banks – not grounded in any of his own legislation, not related to any systemic soundness threats – may be a part of that effort, wanting to appear “useful” to the government and somehow “in touch” with some sort of “public mood”.  (If so, that in itself should be grounds enough for structural and personnel changes.)

If I were the Bank I would probably be trying to arrange a visit from (Sir) Paul Tucker, former Deputy Governor of the Bank of England, who has just published a new book Unelected Power, on the delegation of economic powers to independent agencies, with a particular focus on central banks.  Despite his background on the markets side of the Bank of England, Tucker didn’t leave officialdom to make money in the financial sector, but instead turned to academe and has produced an impressive book.  I’ve already referred to it in a couple of recent posts, and expect to do so in a few more relevant to the current efforts to overhaul the Reserve Bank Act.    As one UK commentator recently described it

….it is mainly about central banking, and on this is it authoritative. It will be an essential read for everybody involved in monetary policy, or researching it.

Not by any means will everything he writes be music to the ears of our central bankers, but Tucker’s views on the structural separation issue will be.  Perhaps that isn’t too surprising, since he was Deputy Governor at a time when the British government was bringing the financial sector supervisory and regulatory functions back inside the Bank of England (albeit with separate government-appointed decisionmaking structures for the various functions).  The Bank of England model informed Iain Rennie’s report last year, and if a decision is finally made to leave all the existing Reserve Bank functions together a structure like that of the Bank of England (but slimmed down for our circumstances) would probably be the way to go.

Tucker doesn’t argue that the regulatory and supervisory functions have to be in the same institution as monetary policy but that, subject to certain important conditions, it is better if they are.    To my mind, one of the weaknesses of his book is that it is very focused on the US and the UK (with some discussion of ECB/Europe but the issues are very different there given the idiosyncratic relationship between the ECB –  set up by international treaty and not really very accountable to anyone –  other EU institutiuons, and the national states of the EU/eurosystem).  Thus he simply doesn’t engage with the experience of the many other advanced countries – in fact, most of those outside the euro –  where the primary role in prudential regulation/supervision is undertaken by an entity other than the central bank.   This was the list of such countries I ran the other day

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

It is a mix of large and small, of countries with very big financial systems operating internationally and countries with mostly domestic banks, of countries where the split has been longstanding (eg Canada) and countries where it has been more recent (eg Australia), and countries that ran into financial crisis in 2008/09 and countries that did not.  I’d find Tucker’s claim for the superiority of his model (essentially the UK one) more compelling if he’d addressed the experience of some of these countries.

As I read his material on this issue, it seemed to me that Tucker had two main arguments for keeping prudential supervision/regulation and monetary policy together.

The first of these is about the central bank’s lender of last resort function (for which the relevant statutory provision in our legislation needs refinement).  A central bank is the only agency with the unquestioned ability to provide immediate liquidity to an individual bank, or to the system as a whole, when severe liquidity pressures arise –  whether it is a run to physical cash, or simply a freezing up of interbank markets leaving some players unable to operate with external injections of liquidity.     Failure to respond to systemwide increases in liquidity demand will, all else equal, be likely to result in the central bank falling short of its inflation target (through the resulting financial crisis and economic shakeout).  Provision of liquidity, and a responsiveness to changes in demand, is an integral part of modern central banking (even though the stress events may not occur even as frequently as once a decade –  in the New Zealand case, Y2K and the liquidity pressures around 2008/09).

Liquidity provision usually involves either buying assets outright from a bank, or lending on the security of those assets (mainly repo agreements).  That is easy when it involves the outright purchase of a well-known widely-traded asset like a government bond.  But it gets trickier when it is a loan (in economic substance, if not legal form) and when the assets involved are pretty opaque and not generally traded at all, and when the general injunction –  enshrined in legislation in some countries –  is that central banks should only lend to solvent institutions (solvency here being a positive net assets test, not an “ability to meet payments as they fall due” test).    To caricature just slightly, Tucker argues that a PhD in macroeconomics won’t be much use in enabling a central bank to decide whether or not to provide funds to a bank that comes knocking.  You need, instead (or as well), detailed banking and credit expertise.  Specifically he notes

Even opponents of “broad central banking” generally accept that, as the lender of last resort, the central bank cannot avoid inspecting banks that want to borrow.

Going on to argue that

A central bank must be in a position to track the health of individual banks during peacetime if it is to be equipped to act as the liquidity cavalry.

I’m not persuaded, for a number of reasons.  First, of course, we don’t “inspect” banks in New Zealand at all (but that is trivial point).   Second, clearly many countries operate with exactly the sort of model Tucker deems impossible or inadmissible (presumably by relying on some peacetime exchange of information, and wartime written recommendations or assurances from the prudential regulatory agency).   Third, the central bank making the decision to lend is not the only option: it would be possible to envisage a model in which the central bank was simply the operational agent, but the credit risk from any crisis support to an individual institution was taken directly by the government, on the advice (and analysis) of the prudential regulatory agency.   And, finally, LLR powers aren’t the only relevant ones.  In the 2008/09 crisis, perhaps the most important single regulatory response in New Zealand was the deployment of the Minister of Finances’s extensive guarantee powers (under the Public Finance Act).    The Minister of Finance doesn’t do prudential supervision, and to the extent he needed comfort that any institutions guaranteed were likely to be solvent, he had to rely on advice from officials.  In this case, it was primarily the Reserve Bank, but it could as easily have been advice from a Prudential Regulatory Authority.   The same goes for choices (regrettable as they may be) to bail out individual institutions.

My claim isn’t that there can never be any advantages in having prudential supervision and central bank liquidity operations in the same entity, just that the case for them to be so isn’t generally compelling once set against the other arguments for structural separation.  In a crisis, it is typically all hands to the deck (including, for example, the Treasury and the Reserve Bank working together, even though they are separate institutions) and. more generally, there are numerous examples of interagency arrangements for information sharing.   It is undoubtedly important for all relevant agencies to coordinate closely, and have in place appropriate protocols and be prepared to run exercises to war-game the handling of crises.  But the functions don’t all need to be in the same agency, and there are likely to be costs in normal times to having them all together.

One point Tucker touches on elsewhere, but not here, is the importance of having people running functions believing in them.  It is, for example, dangerous to have financial supervision (or AML) in an institution where the chief executive doesn’t really believe in the importance or value of the function.  Reasonable people could argue that that –  rather than separation –  was part of the UK’s problem in 2007: the then Governor, Mervyn King, seemed quite averse to lender of last resort responsibilities, even though they were still an intrinsic part of the powers assigned to the Bank of England.

Tucker’s other main argument for keeping prudential and monetary policy functions together is one he lists under a heading “Harnessing the authority of the central bank”. noting that

If an economy’s central bank is already endowed with both authority and legitimacy, giving it responsibility for stability might be preferable to the uncertainties of starting afresh. In particular, the risks of industry capture might be reduced, as monetary policy makers’ standing in the community does not depend on bankers.

I’m not even persuaded by that final sentence – too many central bank policymakers have seen their post-central bank opportunities being among the bankers (just among Governors, Glenn Stevens, Ian Macfarlane, Ben Bernanke).     Tucker’s argument appears to be made in the UK context, where the prudential functions were split out of the Bank of England after 1997, into a new standalone prudential agency.  Perhaps the FSA never had the prestige of the Bank of England but it isn’t obvious that the problems the UK ran into were a reflection of lack of prestige or legacy legitimacy.  Political emphasis on promoting the financial sector was a significant part of the story.  And the Bank of England’s own analysis of the emerging macro risks didn’t exactly cover the institution in glory.

But, perhaps more importantly, there are other case studies.  The Reserve Bank of Australia had been around for decades when APRA was split out of it. It looks to have been a pretty successful split, and it isn’t at all obvious now that the RBA enjoys any greater authority or respect in its areas of responsibility than APRA does in its.   And, given the feedback on the Reserve Bank of New Zealand’s regulatory stewardship, I don’t suppose anyone would want to mount a serious argument here to leave the functions together because the Reserve Bank’s reputation and authority stands so high.

As it happens, Tucker isn’t too keen on New Zealand’s contribution to public sector management, including the notion (from the New Public Management literature of the 1980s) that one function per agency helps to enhance accountability.

In the UK, I suspect that NPM was a subtle (and baleful) influence on the 1997 decision to transfer prudential supervision away from the Bank of England.  That mattered beyond Britain’s shores. Given London’s position as a global financial centre and given that various other countries, including China and Korea, followed the UK, at least in some cases probably encouraged by the IMF, the UK contrived to put the world onto a false, even delusional, path,  Administrative fashions come unstuck eventually, and this one did spectacularly.

Methinks he doth protest too much  (even as he goes on to note that there are hazards in having the functions together).

He highlights one issue which I hadn’t given much thought to, arguing that if the central bank is to be responsible for both monetary policy and prudential supervision it needs to have the same degree of autonomy in each function.  He argues that if the central bank has less authority in supervisory areas than in monetary policy, it could provide a wedge through which politicians could exert pressure on the Bank over monetary policy.  I’m not so sure that is right or that, realistically, it is that important an issue especially if (as he insists) each function has its own statutory committee, and its own direct accountability.

But if there is something in what Tucker says, it would reinforce my doubts about keeping the functions together.  At present, in the New Zealand system the PTA is set every five years (and central bank budgets too), and beyond that there is no routine ministerial involvement in monetary policy.  On the regulatory side, plenty of powers are reserved to ministers (eg around failure management, AML, the rules of non-bank deposit takers, disclosure rules for banks) and as I’ve argued here before the Reserve Bank still has too much discretionary policymaking power over banks (LVR limits, with significant distributional consequences are a good example –  and one Tucker seems to have quite a lot of reservations about).  As I read him, he would favour delegating more policy power to the central bank in the supervisory/regulatory area.  Personally, I think there is a good case for giving the regulator less power, and for a clearer delineation between setting the rules of the game (politicians) and implementing them (independent agency).  And keeping the functions in separate institutions will make for stronger effective accountability –  a key theme of Tucker’s –  than two or three committees with the Governor and his Deputy sitting on all of them.  You can only fire – or not reappoint –  a Governor once.

One of reasons Tucker worries about differing degrees of independence is that it would not ‘be conducive to successful institution-building’, citing the way in which the Greenspn Fed looked down on supervisors as a “lower form of life”.   Again, I’m not sure I fully buy the argument –  it is more about the priorities and beliefs of the people at the top than about formal statutory remits –  but as both Geof Mortlock and I have argued in the New Zealand context, standalone agencies helps enable the creation of cultures of excellence in both institutions.   And even Tucker recognises that culture is one of the challenges to a multi-function central bank, even if both functions have equal statutory importance.

In many cases, these aren’t open and shut issues.  There are different models around the world, although on my reading in most advanced countries –  and especially most small ones –  structural separation is the route chosen.  It is far from obvious that the new British model is better than the old (only the next crisis is likely to test that), even if appropriately some issues have been clarified and powers refined out of the 2008/09 experience.  But in the New Zealand context, most of the arguments now line up pretty clearly in favour of structural separation, and the creation of a new standalone prudential regulatory agency, with powers, personnel, and governance/accountability structures specifically fit for purposes, rather than shoehorned into an institution designed primarily for a monetary policy role.

 

Auckland labour market outcomes: do any political parties care?

Michael Reddell Auckland, Immigration, labour market

Among the various arguments advanced for why we should expect that large-scale government-led non-citizen immigration will prove economically beneficial to New Zealanders are claims about the labour market.

There are, for example, suggestions that the unemployment rate will tend to be (a bit) lower than otherwise, because ready access to offshore labour facilitates better skill-matching.  Larger labour markets  might work in the same direction –  easier for people displaced, or new entrants, to find jobs in a deeper more diverse market.

And there is the suggestion that average GDP per capita is likely to be raised just because the average immigrant is more likely to be of working age (few countries let in many 75 year olds). On this telling, even if there were no productivity gains (ie lifts in, say, GDP per hour worked) from large scale immigration, average incomes would be raised simply because of the implied higher rates of labour force participation.  In fact, this argument was run only a matter of weeks ago in an official Australian government document, a defence of Australia’s large-scale immigration programme published by the Federal Treasury and the Department of Home Affairs (the department directly responsible for immigration matters).  From page 27

After trending upward for almost three decades, Australia’s labour force participation rate declined from the early 2010s through to 2016 (Figure 22). This decline coincided with a large cohort of baby boomers reaching retirement, which weighed on Australia’s participation rate. Yet evidence shows that migrants, particularly skilled migrants, have helped curb the ageing of the population by boosting the labour force. Without the contribution from migrants, all else being equal, Australia’s participation rate would be lower than at present.

Many of these claims had initially seemed plausible enough to me.  In fact, in a major modelling exercise done for one of MBIE’s predecessor departments a decade ago –  and widely touted at the time –  the only overall economic gains from immigration resulted from this assumed higher participation rate.

But a while ago I noticed that the unemployment rate in Auckland hadn’t been any lower than that in the rest of New Zealand.  This chart uses annual data, up to and including the latest release last week.

U rate akld and RONZ

Auckland is a good place to focus on. Not only is it by far the biggest labour market in the country, but it also has by far the highest proportion of foreign-born residents, and receives a disproportionate –  but not surprising –  share of the new migrants, temporary and permanent.    Labour market laws apply nationwide, but you might think that some would be a little less binding in Auckland than elsewhere –  for example, there is a nationwide minimum wage, but average productivity is higher in Auckland than on average in the rest of the country.  All else equal, again one might expect Auckland’s unemployment rate to have been a little lower than that in the rest of the country.

And yet over the 32 years for which we have the data there is no sign that unemployment rates in Auckland have been lower than those elsewhere.  There might be a bit of a cyclical pattern –  Auckland does worse in downturns (see early 90s, and the period from 2008 until recently), and better in periods of strong economic growth (and that cyclicality may itself be exacerbated by the large New Zealand cycles in net migration) – but there is no sign of much beyond that.

What about employment rates (calculated as the share of those aged over 15 in paid employment)?

E rates akld and ronz

Interestingly, employment rates in Auckland used to be quite a bit higher than those in the rest of New Zealand, but they aren’t now.    Perhaps the difference in the earlier period reflects differences in how the economic restructuring and reduction in trade protection affected different regions –  it seems plausible (although I’m happy to see any confounding evidence) that the initial job losses might have been more heavily concentrated outside Auckland, with the gap closing again over time.  Whatever the explanation for the earlier period, average Auckland employment rates have struggled to match those in the rest of the country over the last 15 years or so (periods encompassing two big waves of non-citizen migration).

And as I thought about it, this chart started to puzzle me more.  After all, the denominator is the population of working age, which includes all the elderly, and yet as the recipient of the largest share of migrants wouldn’t one expect Auckland’s working age population to be concentrated in the age ranges with the highest rates of labour force participation?   And there are the persistent stories of old people moving out of Auckland –  the money tied up in the overpriced house goes further in the provinces.

And, sure enough, here are the official estimates of the share of the working age population aged over 65 in 2017 (the numbers aren’t materially different from the firmer numbers from the 2013 Census).

over 65s wap

Auckland has by far the lowest share of its working age population aged over 65.  Across the country, those aged over 65 have an average employment rate of about 24 per cent, while for the working age population as a whole the employment rate is more like 68 per cent.    And yet, despite having so many fewer old people the overall employment rate in Auckland is no higher than in the rest of New Zealand taken together.

There isn’t a great of information about labour force status disaggregated by both age and regional council, but I did find some data for the last few years comparing Auckland and the Wellington and Canterbury regional council areas.

e rates by age and regional council

Even among the older cohort, employment rates in Auckland have been a little below those in Wellington and Canterbury (in not a single year was the Auckland rate higher than in either Wellington or Canterbury –  despite the smaller number of over 65s).  But in the younger cohorts the differences are quite a bit larger.   Perhaps some of the difference among the 15-24 cohort reflects the presence of foreign students (although many of them are working), but in the prime age cohort (25 to 54) the average employment rate in Auckland over the last eight years has been, on average, a full four percentage points lower than that in Wellington and Canterbury.

To be clear, this is a not a comment on the employment rates of recent immigrants (which may well be quite – even very –  high).  The HLFS simply doesn’t have that sort of data.  It is an estimate based on the Auckland economy as a whole.   And quite what explains it, I’m not quite sure.   For anyone wondering if the ethnic composition of Auckland’s population is part (cause or consequence) of the story –  whatever factors result in lower Maori and Pacific participation rates – here are the average participation rates for the last decade by ethnicity for Auckland and the rest of the country.

partic rate by ethnicity

European participation rates have actually been higher in Auckland than in the rest of the country.   But Maori and –  especially –  Pacific participation rates average materially lower.

Whatever the explanation, it isn’t obviously a story in which one of the largest non-citizen immigration programmes anywhere in the world, over decades, has produced an Auckland labour market that seems to be functioning in a way that might suggest economic gains across the board.  Unemployment rates are no lower than in the country as a whole, employment rates are materially lower once one allows for the much smaller number of old people in Auckland, and there might be straws in the wind (that final chart) suggesting that the ethnic groups that typically do most poorly in New Zealand anyway are even less likely to be engaged in the labour market in Auckland than in the rest of the country.

Throw in the data I mentioned the other day –  average GDP per capita in Auckland lower relative to that in the rest of the country than it was at the turn of the century, and the internal migration data suggesting that (in modest numbers) New Zealanders (net) are leaving Auckland – and it should leave the champions of current immigration policy very much on the defensive.  Unwilling or unable to fix the housing/land market, and with no obvious productivity or labour market gains to show for their Auckland-focused strategy, it increasingly looks like a Think Big disaster of a severity and pervasive effect (including on many of our most disadvantaged) that makes the 1980s version (the shockingly uneconomic energy projects) look like a mere bagatelle.

But, remarkably, no political party –  major or minor –  seems bothered.

(And before anyone pops up to remind me that I often point out that employment is an input not an outcome –  not, in itself, a measure of economic success –  that is, of course, true.  Nonetheless, there aren’t particularly good reasons to suppose that working age Aucklanders have stronger leisure preferences than otherwise similar people in the rest of the country –  faced with, eg, the same tax rates –  and some reason to suppose it might be the other way round (eg the sheer cost of purchasing a house).)

Misconduct

Michael Reddell Reserve Bank, Superannuation

This week we’ve had the unseemly sight of leading public servants engaged in rank populism, publically demanding private companies prove their innocence of non-specific charges – and not in a court of law, but to the satisfaction of the “prosecutors” themselves, Adrian Orr and Rob Everett (with apparent encouragement from the Minister of Finance).  In the new Governor’s case, it wasn’t as if he’d even managed to keep to the same line from one week to the next: in interviews a couple of weeks ago he wanted us all to know that New Zealand was different and there wasn’t anything to worry about, but by this week he’d jumped on board –  perhaps not wanting to be left out –  with the chief executive of the Financial Markets Authority and was “demanding” answers from banks.

In the Governor’s case, the legislation he works under appears to give him no basis for such actions or demands –  his banking supervision powers are about the maintenance of a “sound and efficient” financial system, not about market conduct.   And independent central bankers –  overmighty citizens at present, with all that power in one man’s hand –  are well advised to stick to their knitting, the powers and responsibilities Parliament has specifically delegated to them.  Cheap populism is a dangerous path to take in pursuit of some faux legitimacy.    I’m much less familiar with the FMA’s statutory powers, but it is pretty unseemly to have public servants leaping into the public domain demanding that private companies justify themselves (with no specific charges or allegations) to them.   We are suppposed to be ruled by laws not by men, and just because Australian-owned banks aren’t overly popular in some quarters doesn’t exempt them from those precepts and protections.

Of course, the Governor and the FMA chief executive playing populism sets up its own equally unappealing set of responses.  The Bankers’ Association has published an open letter they sent back to Orr and Everett which is full of shameless pandering.  There was this

“Ultimately decisions about regulatory responses rightfully rest with you, and you have our commitment that we will support any response”

But

(a) none of this has anything to do with the Reserve Bank and the legislation it operates under,

(b) the FMA does not set its own regulations, but operates under legislation passed by Parliament and regulations promulgated by ministers,

(c) Royal Commissions, a la Australia, are entirely a matter for elected politicians, and

(c) no serious person is going to commit to support just any regulatory response, with no idea what form such responses might take.

There was also this

Proactive agenda of regulators: The New Zealand regulatory framework enables regulators to act dynamically and quickly before issues become significant, compared to the slower, less agile pace witnessed in Australia……We have also seen that foresign and adaptability in RBNZ’s use of loan-to-value lending restrictions, which proved effective in managing the escalating housing market and the associated economic risk.

Let me throw up now.

I’m still in the camp that thinks it inherently unlikely that matrix-managed subsidiaries of Australian parents are doing things that much differently here than in Australia (and, after all, the BNZ’s new chief executive has been part of the NAB Executive Leadership team for the last few years).  But evidence would be a good basis for regulators (those with suitable powers and responsibilities) to start inquiries, not highly-publicised populist fishing expeditions, and the associated slurs.  And evidence needs to go a bit beyond a suggestion that a bank might have suggested their Kiwisaver product to go along with your mortgage or cheque account –  akin to a burger chain encouraging you to consider fries with your burger.  If we must have populism, leave it to the politicians.  We can toss them out.

As I noted the other day, it isn’t as if the Reserve Bank and the FMA have been particularly good at dealing with specific conduct issues, on which they have detailed evidence.    The Reserve Bank’s misconduct –  and the passivity of the FMA –  doesn’t affect tens of thousands of people, but it doesn’t make it any more acceptable.  Perhaps it is a straw in the wind of the way many New Zealand institutions choose to operate?

After writing that post, into my email inbox popped the newsletter of that worthy NGO Transparency International.   Their website proclaims this mission

“A world with trusted integrity systems in which government, politics, business, civil society and the daily lives of people are free of corruption.”

The longserving chair of Transparency’s New Zealand arm is Suzanne Snively.  In this month’s newsletter she writes

The point of transparency and accountability is to strive to do the right thing in all activities.

New Zealand banks and insurance companies have been quick to distance themselves from the evidence found by the hearings before the Royal Commission.

The challenge is that New Zealand’s largest four registered banks – ANZ, ASB, BNZ and Westpac, are subsidiaries of Australia’s four largest banks. AMP is one of New Zealand’s largest insurance companies.

It is naive to believe that the New Zealand system is different without solid evidence. It is not enough to have the industry self-disclose. This after all, is what happened prior to the current Australian inquiry. Only through the process of independent scrutiny have we learnt what really is going on.

and

Based on evidence before the Commission that has to date been made public, much of the misconduct could be regarded as corruption. Corruption is the abuse of entrusted power for private gain.

The best antidote for corruption is the existence of strong integrity systems within organisations. An integrity system refers to the features of the entity’s structure that contribute to its transparency and accountability.

In high integrity organisations, transparency and accountability starts at the top, led by good governance supported by management policy and practice…….

New Zealand can own the leadership position and model good behaviour to the rest of the world.

Those are fine words.  So it is perhaps unfortunate that Ms Snively was closely involved in the abuse (misconduct at least) that I outlined the other day.

Back in the late 80s and early 90s, she was a Board member of the Reserve Bank.   Until the current Reserve Bank Act came into effect in early 1990, the Board was (in effect) the Reserve Bank –  all power and responsibility rested with them, and they delegated any powers they chose to the Governor.  After that, (in law) the Board assumed the current monitoring and accountability role.

The Bank’s Board had an active involvement in the reform of the Bank’s staff superannuation scheme (minutes from that era record substantive ongoing engagement).  Under the trust deed of the scheme, Board consent was required for any changes to the rules.   And a majority of the trustees of the superannuation scheme were either Board members themselves or appointed by the Board.  The then Governor was a trustee (ex officio), and so was Ms Snively.

And this  (extracted from the earlier post) was what happened in 1998, with Ms Snively serving as a Board member and trustee.

Suppose that the rules of a superannuation scheme explicitly required that any rules changes that could have an adverse effect on the interest of any member in that scheme could only be made with the unanimous consent of such members.

Suppose too that nonetheless the trustees of such a scheme went ahead and changed the rules of a defined benefit scheme in a way that allowed the employer to arbitrarily (ie no constraints at all) reduce the rate at which pension benefits were calculated (including in respect of periods of employment, and employee contributions, prior to the rule change).  No consent from potentially affected members was sought for this change.

Suppose that in making this change, they had the endorsement/consent of the board of directors of the employer, and of the chief executive of the organisation.

Suppose too that that new power was actually exercised by the employer, in a way which led to longstanding employees later retiring with pensions considerably lower than they would otherwise have been.  That represented a substantial wealth transfer (probably millions of dollars) to the employer.

It was an egregious abuse of power, and a betrayal of the trust responsibilities to members that all trustees had.

This wasn’t the only shady item during Ms Snively’s term as a government-appointed Board member, and as a trustee.   In 1991, a rule change was made to the scheme (not much more than a single line in a big package of changes).  It was done very late in the piece, with no consultation with members.   To this day, people argue whether it made anyone worse off, but under the law –  the Superannuation Schemes Act –  any rule changes were required to be advised in writing to members.  That simply wasn’t done.  It was an offence under the Act –  for which, fortunately for the trustees of the day, including Ms Snively, the statute of limitations has long since expired.  This point isn’t contentious: today’s trustees a few years ago issued a formal apology to members for that breach.

There is also reason to doubt that the rule change itself was ever properly made (consciously approved by the Board and trustees).  In fact, one trustee from that period has sworn an affadavit that he had no knowledge of the change (although he signed each page of the fairly-lengthy revised deed), suggesting questionable behaviour by Reserve Bank senior management.

Good governance when Ms Snively was on the Board and the trustees also appears to have involved the same law firm  (same lawyer) advising the trustees as was advising the Reserve Bank itself, despite the manifold potential for conflicts between the interests of members and those of the Bank.

These particular episodes occurred a long time ago (although, to the extent there was misconduct, the effects are still felt today –  that is nature of locked-in long-term retirement savings vehicles, one of the reasons there is a case for regulation).  And Ms Snively hasn’t been on the Board or a trustee for a long time.   But I understand that these issues were brought to her attention a few years ago, and she apparently displayed no interest in either getting to the bottom of them, or exerting the sort of moral suasion one might expect from someone who is head of Transparency International.

And it isn’t as if she is now completely detached from all things to do with the Reserve Bank.  A few months ago the new government appointed Ms Snively to head an Independent Expert Advisory Panel, listing as the first item that qualified her her former role as a director of the Reserve Bank.  She continues to play, apparently, a lead role in advising the government on the reform of the Reserve Bank Act, including the (rather large) chunks governing the Bank’s financial regulatory powers.

No doubt she has no legal powers or entitlements at this stage.  But part of leadership is a willingness to take a stand, to seek to exert some moral authority.  And particularly when you yourself are directly complicit in some institutional misconduct from years ago, all while now leading the cause of integrity in public life, one might have hoped –  perhaps might still hope? –  for more.  Integrity sometimes involves going the second mile; it isn’t just a matter of systems, processes, and bureaucratic procedures, or the attempted cover of “oh, I’ve moved on”.

Much the same might be said of today’s Reserve Bank Board.  They appoint a majority of the trustees, they appoint the chair of trustees, they have to give consent to any rule changes.  Until 2013 the then chair of the Board served as a trustee.  They are fully aware of all these issues, and until very recently the Governor himself served as a trustee.  But the Board seem to have seen their role as providing cover for the Governor, rather than ensuring that the right thing is done, and that past abuses are corrected, not kicked for touch, hoping the injured parties would just go away.   That sounds like the sort of misconduct –  not illegal, but not the sort of approach we should expect from ministerial-appointed people, explicitly there to hold management to account –  the authorities might make a start on.  There is, after all, something concrete to go on there, even if it doesn’t make such good headlines.

Debt: dodgy analysis from the IMF

Michael Reddell Fiscal policy, IMF

I should really be doing something else, but I just read Brian Fallow’s column in today’s Herald outlining his views on why the government shouldn’t relax its own fiscal rules.   Reasonable people can differ on that –  and as per my post yesterday I’m certainly not arguing for the government to raise debt levels (per cent of GDP) from here.  But what caught my eye was some IMF “analysis” Brian quoted.

He introduced his article noting that on IMF data (or any other measure you like) New Zealand’s net or gross government debt is quite low as a share of GDP.  On my preferred measure, net debt is about 8 per cent of GDP.    But he goes on

A third reason for being cautious about ramping up government debt is that not all of its obligations are on the balance sheet.

In particular, there is the future additional cost of superannuation and health spending as the population ages.

The IMF has had a stab at calculating the net present value (NPV) of those increased costs out to 2050. We can think of that as how big a pot of money we would need to have set aside, earning compound interest, if those liabilities were fully funded.

It reckons the NPV of the pension spending increase out to 2050 is 54 per cent of GDP. That is $150b in today’s dollars, only partially offset by $38b in the New Zealand Superannuation Fund. The NPV of the expectable health spending increase is even larger, at 66 per cent of GDP.

When those two factors are accounted for, New Zealand is no longer a fiscal outlier, but sits in the middle of the range for advanced economies, between Germany (with its challenging demographics) and Ireland (with its debt crisis legacy).

That sounded interesting, so I dug out the chart Brian appears to be referring to from the latest IMF Fiscal Monitor publication.

IMF fiscal monitor implied debt chart

I don’t know quite how the IMF did their health and public pension numbers, or how comparable their estimates are across countries.  But just take them as what they are (our pension numbers are high because, unlike many countries, we haven’t done anything to raise the NZS age).   Allegedly, New Zealand is now in the upper half of the indebted advanced countries.

But this is a nonsense chart, adding apples and oranges.    It might make some sense if every country had the same starting deficit/surplus, in which case future differences in discretionary spending associated with ageing might be the only difference in the projected future debt paths across countries.

In fact, some countries are in (cyclically-adjusted) surplus, and some are in (cyclically-adjusted) deficits.     Israel, for example, is estimated to have structural deficits of 3.5 per cent of GDP, and the US is now estimated to have structural estimates of about 6 per cent of GDP.   Israel is much further down that IMF chart than we are, but annual deficits of 3.5 per cent of GDP  (before the effects of additional ageing) soon compound into very large numbers.

And New Zealand?   Here are the IMF’s own estimates of the average cyclically-adjusted fiscal balance for 2018-2023 (their forecast period).

fisc balances IMF

On the IMF’s own numbers we have the largest (structural) surpluses projected over the next few years of any advanced economy.  Structural surpluses of 2 per cent per annum, in a country with high real interest rates, compounds to a very big (positive) NPV really quite quickly.

As it happens, Germany is also projected to be running quite large surpluses. No wonder markets aren’t remotely worried about fiscal/debt risks in either Germany or New Zealand.     You simply can’t sensibly start with today’s debt, add one bit of additional future spending, and not take account of the baseline fiscal parameters that, in countries like New Zealand, mean we already have material fiscal surpluses (on the books, and in prospect).   Fiscal people at the IMF sometimes liked to quip that IMF stood for “It’s mostly fiscal” (the problems, and macro solutions, that is).  But they really should be producing better fiscal analysis than this (even if, perhaps, their main interest is big countries with both high debt and ongoing deficits).

None of which means I think NZS shouldn’t be changed. To my mind –  as voter –  failure to do so is both a fiscal and moral failure.  But, despite those future pressures, by international standards our fiscal position remains very strong, and there is –  objectively –  plenty of time to adjust (even if I personally might prefer the adjustment had already begun years ago).

 

 

Split the Reserve Bank in two

Michael Reddell Reserve Bank Act reforms, Uncategorized

In the last few months, I’ve run a couple of posts making the case for splitting the prudential regulatory/supervisory functions of the Reserve Bank out into a standalone prudential regulatory agency.  The main post was here, with some follow-up comments here.  The case for structural reform has been further strengthened, in my view, by the results of the recent New Zealand Initiative survey on regulated entities, in which it is clear that most respondents have little or no respect or regard for the Reserve Bank in its supervisory roles (as distinct from the inevitable disagreements with a regulator that should be expected/encouraged).   There are good arguments in principle for structural separation, and there is no sign (say) that despite those in-principle arguments the Reserve Bank has been doing a superlative job anyway.

As I noted in the earlier post, in most OECD countries (outside the euro-area, where central banks no longer have a monetary policy job to do), banking regulation and supervision is done by a body other than the central bank.

But if we look at advanced countries that do have their own monetary policies, I could find only three others –  Czech Republic, Israel, and the United Kingdom –  in which the same agency is responsible for monetary policy as for prudential supervision.   The US is –  in this area as so many –  a curious hybrid system, in which the Federal Reserve has some –  but not remotely all – responsibility for prudential supervision.  But as far as I could tell, the following OECD countries have monetary policy and prudential supervision conducted by separate agencies:

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

I’m not sure that Turkey or Mexico offer models of governance for New Zealand, but the presence on that list of small well-governed countries like Norway, Sweden and Switzerland –  as well as tiny Iceland –   gave me pause for thought.

Perhaps of most direct relevance to us in Australia’s place in that list.

Some others have also made the case for structural separation, including my former colleague Geof Mortlock.  Geof has a new substantive column out today forcefully making the case for change.   Geof and I have been disagreeing about things for 35 years since we started at the Bank in adjoining offices a couple of weeks apart.  He spent most of his Reserve Bank career in the regulatory side of the Bank and for the last decade or so has been a consultant on banking risk/regulatory issues, including a stint at the Australian Prudential Regulatory Authority.      Judging by the occasional emails we exchange and occasional comments here, I suspect we still don’t agree about very much –  quite probably including the substance and extent of financial system regulation and supervision.

But I agree with almost everything in his column today. I encourage you to read it, and I hope that Treasury officials working on Reserve Bank reforms and the Minister of Finance (and his associates) not only read it, but heed it.  It is an overdue change, and if the chance for reform isn’t grasped now the issue is likely to drift for another decade or two, with weak governance, weak accountability, and a regulatory body that is unlikely to command the respect it should earn whether from regulated entities, overseas supervisors or (most importantly) the New Zealand public.

Here is Geof’s list of the main reasons for change

  • It would reduce the concentration of excessive power in one government agency. Currently, the Reserve Bank has a very wide range of powers compared to most central banks in the OECD. It has responsibility for monetary policy, foreign exchange reserves management, currency intervention, operating significant parts of the payment system and securities settlement system, prudential regulation of banks, insurers and NBDTs, regulation of money laundering, regulation of the payment system, financial stability oversight, macro-prudential regulation and currency management. I will stop there. The sentence is already too long!  So is the range of functions under one agency. This concentrates excessive power in the Reserve Bank. It also creates potential and actual conflicts of interest, as I argue later in this article. A narrower span of functions would reduce this concentration of power and avoid conflicts of interest.
  • Removing regulatory functions from the Reserve Bank would enable the supervisory agency to focus on the job at hand without being distracted by the other central bank tasks, particularly monetary policy. ………the Reserve Bank has tended over the years to accord much greater emphasis, attention, management oversight, resourcing and public reporting to the monetary policy function than to its regulatory responsibilities. The Reserve Bank Board, likewise, has generally paid much greater attention to the monetary policy function than to financial sector regulation. (That said, the Board has performed very poorly in all of its monitoring roles. Sadly, it has been little more than a compliant rubber stamp and cheer leader for senior management).
  • Separation of the regulatory functions would also enable the Reserve Bank to focus on its core role of monetary policy and related functions, undistracted by the many regulatory issues which it currently oversees. This would likely be conducive to a more focused and effective central bank. It would help the central bank to lift its game in monetary policy – i.e. to keep inflation broadly around the mid-point of the inflation target range; something that it has consistently failed to achieve in recent years.
  • Separation of the regulatory functions would enable a senior management team to be appointed with the skills, knowledge and experience to perform the role effectively – i.e. people with deep knowledge of, and practical experience in, banking, insurance and financial regulatory issues. The current senior management team – and its predecessors – generally lack the skills, knowledge and experience required for the role.  …..
  • It would enable the regulatory agency to build the depth of knowledge and skills in its staff to perform the functions required of them. Currently, although the Reserve Bank has able people in the supervisory area, it lacks the depth and breadth of knowledge and industry experience to do the job as effectively as it should. ……

He adds a couple of other considerations that resonated with me

  • Separation of the supervisory function from the Reserve Bank would also remove potential conflicts of interest between the Bank’s functions. For example, there is a conflict of interest between the Reserve Bank’s role as owner and operator of core parts of the payment and settlement systems [notably the NZClear securities settlement system], and its supervisory responsibilities in these areas. It is rather like the referee of a rugby game also being an active player on the field. Even worse, this referee gets to write the rules of the game!
  • It would ensure that macro-prudential supervision policy is directed at the promotion of financial system stability rather than being used as a de facto monetary policy instrument or for other nefarious purposes that do not necessarily anchor to financial stability. Reflecting this, I very much doubt that, had the responsibility for macro-prudential policy been allocated to a separate prudential regulator, and not the Reserve Bank, the macro-prudential policy tools would have been used as aggressively and relatively clumsily as has been the case under the Bank.

I’m hopeful more than convinced of the argument in that final sentence.

Of course, structural separation is no panacea.  A new agency would need to be built from scratch, even if it took over the existing Reserve Bank staff.  It isn’t as if the field of suitable candidates to lead such an agency is thick on the ground, and building the sort of expertise and culture that the job requires will be the work of several years.  But, on the one hand, we face that challenge anyway: the Governor can’t simply ignore, or pay only lip-service to, the shocking feedback in the NZ Initiative survey.  And, on the other hand, if we don’t make a start –  and put in place structural preconditions that increase the chances of better institutions in the longer-term – things are unlikely to ever reach the standard they should.

It remains disconcerting that the second stage of the Reserve Bank Act review is being led jointly by the Reserve Bank and the Treasury, in a climate in which the Minister of Finance has shown little interest in these sorts of issues.  The situation is crying out for leadership from the government, and not allowing the existing Reserve Bank management to persuade the Minister to settle for something as little different as possible from the inadequate status quo.

(Geof’s comment on the severe weaknesses of the Reserve Bank Board echo my own over the years.  Neither their Annual Reports nor the minutes of their meetings record any dissatisfaction with management ever – even though their primary role is holding the Bank to account, and the Bank is made up of fallible human beings.    I wrote a few weeks ago about the “Charter” (really a code of conduct) the Board has devised for itself.  The “charter” talks of the Board’s right to advise the Governor, and asserts a right to be heard

The Board may advise the Governor on any matter relating to the performance of the Bank’s functions and the exercise of its powers. The Governor is not required to act on the Board’s advice, but is required to have regard to it.

Where advice relates to matters of significance, the Board may give that advice to the Governor in writing, having first discussed the matter with the Governor in a Board meeting.

The Board will maintain a record of any formal Board advice given to the Governor.

There was no record in the minutes over the last couple of years of any material oral advice (despite (a) legal requirements to maintain records of public affairs, and (b) some difficult issues, including –  for example –  the Toplis affair).  So I lodged an OIA request seeking copies of any written advice.

There was none of course. In fact, the Board chair went so far as to claim that this was a mark of the effectiveness of the Board.   I think he must have left off an “in”.    Geof’s term –  and I think I’ve used it before too –  was cheerleaders.  But hopeless at almost anything else, and useless to the citizenry. )

Is vapid rhetoric all our leaders can offer?

Michael Reddell New Zealand economic performance, Productivity, Uncategorized

The Prime Minister gave what she billed as a “pre-Budget” speech yesterday to the leading business lobby group, Businss New Zealand.  It was, I’m pretty sure, her first prime ministerial speech mainly on economic matters.  In introducing her speech  she indicated that she would

outline our plans for the economy and how we want to partner with New Zealand businesses to bring about transformative change for the good of all New Zealanders.

and a few sentences later she added

We are committed to enabling a strong economy, to being fiscally responsible and to providing certainty. We have a clear focus on sustainable economic development, supporting regional economies, increasing exports, lifting wages and delivering greater fairness in our society.

But in the rest of the speech there was almost nothing there.   There were slogans, and feel-good phrases.  But there was no plans for the economy.  No plans to lift productivity –  a point she touched on not infrequently during the election campaign –  and barely even an acknowledgement of the problem, no plans to reverse the decline in the export/import shares of GDP in New Zealand, and no sign that she –  or her advisers or her Minister of Finance –  have a serious well thought-through story of how New Zealand ended up underperforming as badly as it has done, let alone how we might reverse the underperformance.

Governments of both political parties deserve credit for keeping the government’s finances more or less in order.  As I noted yesterday, that is more than most large OECD countries have managed in recent decades.  But it isn’t a substitute for policies that might finally offer a credible path out of the 70 years of relative economic decline –  drifting a bit further behind even as every country is richer than it was – that New Zealand has experienced.

Instead, we get attempts to shift the goalposts, aided and abetted by The Treasury.

On that score how we measure our success is important. In the past we have used economic growth as a sign of success. And yet a generation of New Zealanders can no longer afford a home. Some of our kids are growing up living in cars. Our levels of child poverty and homelessness in this country are much too high.

We all want a strong economy. But why do we want it? What is it for? It is vital that we remember the true purpose of having a strong economy is for us all to have better lives.

Well, sure.  GDP isn’t an end in itself, but it (and cognate measures) are a pretty important means to those ends, and a reflection of how well a society is providing for itself.    And how does the Prime Minister suppose that the crushing specifics of (New Zealand) poverty 100 years ago –  when New Zealand was the richest country on earth – became largely non-existent today?  By achieving sustained productivity growth.   And if we now score badly on some of the poverty indicator measures, it isn’t entirely surprising when productivity (real GDP per hour worked) isn’t even two-thirds of that in countries like France, Germany, the United States, and the Netherlands.  When it now also lags well behind Australia too.

In her speech, she claims that her plans are already clear

We have already spelled out our ambitious agenda to improve the wellbeing and living standards of New Zealanders through sustainable, productive and inclusive growth.  Now we want to work with business and investors to get on with it and to deliver shared prosperity for all.

and

We will encourage the economy to flourish, but not at the expense of damaging our sovereignty, our natural resources or people’s well-being. Our plans have been spelled out from the beginning, in the Speech from the Throne, in the first 100-days plan, and very soon you will see more detail in our first Budget.   ……

You will see a clear plan to build a robust, more resilient economy. You will see a strong focus on delivering economic growth, on running sustainable surpluses and reducing net debt as a proportion of GDP.

 

There was little of substance on this score in the Speech from the Throne.  And much as I wish it were otherwise, I won’t be holding my breath waiting for the “clear plan” for stronger sustained real economic (and productivity) growth in the Budget.  There is nothing in anything the government has said so far that suggests they or their advisers really grasp the issues.     Quite why simply wishing businesses would “get on with it” would now be expected to produce better outcomes than we’ve seen in recent decades is a bit beyond me.

Of course, there are nods in the direction of things Labour (or their partners believe in)

My Government is keen to future-proof our economy, to have both budget sustainability and environmental sustainability, to prepare people for climate change and the fact that 40 percent of today’s jobs will not exist in a few decades.

I’d love to see some data on what proportion of jobs that existed 40 years ago don’t exist today (the majority of the jobs that existed in the Reserve Bank I joined in 1983 don’t exist any more).  But while the government worries about work –  setting up a new tripartite forum involving the CTU and Business New Zealand – actual employment rates don’t seem to be the problem.

E rates by age

(Lack of) productivity is.   It is productivity growth that underpins any long-term growth in real incomes and living standards.

There is talk of skills, when OECD data have shown that New Zealander workers have some of the highest levels of skills anywhere in the OECD (indeed, the chair of the Productivity Commission was retweeting an OECD chart to that effect just a few days ago).

There is talk that “no-one has the same job for life any more”.  Perhaps, but there is data overseas suggesting that average length of time with a single employer is little different now than it was 30 years ago.

There is talk of “lifting R&D spending”, and the government has out for consultation at present its plan for new R&D subsidies, but no sense that the Prime Minister or her advisers have thought at all hard about why firms might not have found it worthwhile to do more R&D spending (or why, by contrast, firms in some rich countries with no R&D subsidies do a great deal).

There was lot of rhetoric

Business can be assured that this Government will support those who produce goods and services, export and provide decent jobs for New Zealanders.

But little substance, and nothing that shows signs of pulling it all together into a coherent narrative.

And, for all the mentions of climate change and related issues, nothing at all about how faster overall productivity growth –  and a stronger export/import orientation –  might be achieved in the face her government’s commitments to sharply reducing net emissions in a country with high marginal abatement costs.  “High marginal abatement costs” has meaning: it costs to do this stuff, and the cost is likely to be reflected in lower levels of economic activity (and productivity) than otherwise.  Perhaps the government disagrees –  and perhaps her audience were too polite to challenge her –  but there is nothing in the speech suggesting she has thought hard about squaring that circle.  There seems to be lots of wishful thinking, and not much substance.

And then there were “the regions”

And the regions need not fear they will be neglected. We have committed $1 billion per annum towards the new Provincial Growth Fund and over coming months there will be more detail about how this spending will be targeted. After all, nearly half of us live outside our main cities and our provinces also need to thrive if New Zealand is to do well.

The Provincial Growth Fund aims to enhance economic development opportunities, create sustainable jobs, contribute to community well-being, lift the productivity potential of regions, and help meet New Zealand’s climate change targets.

There might be a bit of a lolly scramble, redistributing the current cake.  But there is nothing from the government, or from the architects of the PGF –  and nothing in the announcements to data (eg here and here) suggesting that the government has any concept of how overall productivity growth rates, nationwide or in the regions, might be lifted.  (And not once was the real exchange rate mentioned.)

Perhaps defenders of the government would push back on one or another point.  But there is no sign of any sort of integrated narrative –  a rich understanding of how we got to our current sustained underperformance or, reflecting that, how might hope to reverse the decline.  No doubt in an attempt to woo her business audience, there weren’t even any references to tax system changes (CGT and all that) in this economic speech.

Perhaps that isn’t entirely the government’s fault.  The Treasury seems at sea as well.  But we don’t elect bureaucrats, and we do elect governments.

Of course, I wouldn’t want to be misinterpreted as suggesting that the Opposition was any less bad.  The new Leader of the Opposition also gave his first economic speech this week.   There were a few bits where I was nodding my head as I read

Labour and NZ First are more focused on government intervention. They believe they know how to run your businesses better than you do.

Shane Jones’ $1 billion Provincial Growth Fund is a good example. It’s terrible policy.

Now I’m sure there are some worthy projects that will get funded. But it will shift businesses from focusing on becoming more productive to chasing a subsidy from Matua Shane.

That’s not how to drive long-term productivity improvements.

Couldn’t disagree, but what did Bridges have to offer

When I was Economic Development Minister, our plan for the economy was set out in the Business Growth Agenda.

The BGA comprised over 500 different initiatives all designed to make it easier to do business by investing in infrastructure, removing red tape, and helping Kiwis develop the skills needed in a modern economy.

Some of those were big, some were small. I’ll admit some weren’t as exciting spending a billion dollars every year.

But together they were effective.

New Zealand has one of the best performing economies in the developed world.

500 initiatives and we still had barely any productivity growth in the last five years.  And, as I recall, one of the BGA goals was a big increase in the export (and, presumably, import) share of GDP: those shares have actually been shrinking.  Productivity levels languish miles behind the better advanced economis, and the gaps showed no sign of closing.

He ends

New Zealand is a great country. And if we maintain our direction and momentum of recent years we can make it even better for our kids.

Moving into opposition is a chance for National to look at our position on certain issues, and understand the things that New Zealanders want us to focus on.

Although the one thing I hope you’ll take from my speech is we won’t be changing our focus on the economy.

If we don’t start seeing a lot more hard-headed thinking –  and a quite material change of direction – from our political leaders and their advisers, a country that really was once the best place in the world to bring up kids, will increasingly be a country where wise parents can only counsel their kids that if they want first world living standards, the best option is to leave.     In my lifetime, 970000 (net) have already done so.  The Prime Minister and the Leader of the Opposition –  representing two sides of the same coin when it comes to our economic failure – are younger than me, but in just the 37 years the Prime Minister has lived, a net 780000 of our fellow New Zealanders have left.   Outflows of that scale – which, of course, ebb and flow with short-term developments in Australia and here –  just don’t happen in normal, successful, countries.

 

 

 

 

 

The government’s debt target

Michael Reddell Fiscal policy

I’d seen various news stories suggesting that in a speech on Tuesday the Minister of Finance had made the case for sticking with the Budget Responsibility Rules agreed with the Green Party this time last year.  So I thought I should read the speech.    There wasn’t much there.  The rules were restated, including the debt commitment, but there was no case made for following those particular rules, rather than some others.  The furthest the Minister got was the standard fallback line

We must be fiscally responsible. We must ensure that New Zealand is well-placed to handle any natural disasters or economic shocks.

Which doesn’t help, because it doesn’t differentiate the Minister’s rules from those of any other reasonably conceivable alternative.  Resilience to natural disasters or economic shocks is the fiscal equivalent of a motherhood and apple pie standard.

In terms of the government’s self-imposed fiscal rules, the only one that really troubles me is the debt one.    There are also these two

We will deliver a sustainable operating surplus across an economic cycle.

and

We will maintain Government expenditure within the recent historical range of spending to GDP, which has averaged around 30 percent over the last 20 years.

But what of debt

We will reduce the level of net core Crown debt to 20 percent of GDP within five years of taking office. 

In general, debt targets –  with relatively short time horizons to achieve them –  aren’t very sensible as operational rules.   Such a rule can mean that a few fairly small, essentially random, forecasting errors in the same direction can cumulate to produce a need for quite a bit of (perhaps unnecessary) adjustments to spending or revenue.  More seriously, recessions can throw things badly off course for a while, and risk pushing a government into a corner –  either abandon the target just as debt is rising, or fallback on pro-cyclical (recession exacerbating) fiscal adjustments –  even though, in across-the-cycle terms, the government’s finances might be just fine.  No one looks forward to a recession, but governments (and central banks) need to work on the likelihood that another will be along before too long.   Natural disasters –  the other shock the Minister mentioned –  can have the same effect.

Personally, I would be much more comfortable with only two key quantitative fiscal rules:

  • a commitment to maintaining the operating balance in modest surplus, once allowance is made for the state of the economic cycle (cyclical adjustment in other words) and for extraordinary one-off items (eg serious natural disasters), and
  • something about size of government.    Simply as an economist I don’t have a strong view on what the number should be, although as I’ve noted previously it is curious that the current left-wing government, arguing all sorts of past underspends, was elected on a fiscal plan that promised spending as a share of GDP that undershot their own medium-term benchmark (that around 30 per cent of GDP).

The suggested fiscal surplus rule isn’t an ironclad protection (any more than a real-world inflation target in a Policy Targets Agreement is).  There are uncertainties about the state of the cycle and how best to do the cyclical adjustment, and incentives to try to game what might be counted as an “extraordinary one-off”.   That is why the fiscal numbers and Budget plans will always need scrutinising and challenging.  But if followed, more or less, such a rule would be sufficient to see debt/GDP ratios typically falling in normal times, and to avoid things going badly wrong over a period of several decades.  That is probably about as much as one can realistically hope for.

There are those arguing for the government to increase its debt levels at present.    I’m a bit sceptical of that notion, for several reasons.  The quality of a lot of government capital spending –  whether it is cycleways, trains, or roads, just to take the transport area –  often leaves a great deal to be desired.  Advocates of more debt often talk up the relatively low interest rates at present, and suggest those low rates offer great opportunities.  Except that when interest rates have been low –  and if anything still falling –  for a decade, they probably need to be treated as semi-permanent, and thus as revealing something about the perceived economic opportunities advanced economies are offering.  And –  a point I’ve made often –  low as our interest rates are by historical standards, they are still high by the standards of most other advanced economies.

One consideration that might suggest it would be sensible for New Zealand to run higher debt than most other advanced countries is that our population (boosted by immigration policy) is growing much more rapidly than those of most other advanced countries.  All else equal, that should lead to faster growth in future GDP (not GDP per capita, just the total) and future tax revenue, suggesting more capacity to carry debt now.    There is certainly something to that argument at the local level, and hence I hope the government’s talk of facilitating local authority SPVs, which will enable debt to be taken on, serviced by specific property owners’ future rates commitments but outside existing core local authority debt limits, comes to something.     I’m much more sceptical of the story at the national level since on the one hand champions of immigration will stress the idea of immigration providing immediate fiscal gains (a claim there is probably something to, even if –  as Fry and Wilson suggest –  those effects die away over time).   If there is really an upfront windfall, there shouldn’t need to be more debt taken on.  And, on the other hand, for whatever reason, New Zealand’s trend productivity growth rate has been lousy for a long time, suggesting that even if our numbers (of people) are growing faster than in other countries, our (total) GDP won’t be that much faster.  It would be a different story if, say, more people was transforming (lifting sharply) our productivity performance, and future incomes, but there isn’t much sign of that.

What about some numbers/pictures.  Here is a chart (including Treasury forecasts) of core Crown net debt as a per cent of GDP.  This isn’t the variable the government (and its predecessor) choose to target, since it excludes assets held in the New Zealand Superannuation Fund.  But it is all just money, and NZSF assets could be liquidated in quite short order if necessary.  (Even this variables excludes some government on-lending (“advances” in Treasury parlance) which seem to be about 5 per cent of GDP).

net debt 2018

After a serious recession and a weak recovery, and a series of pretty costly natural disasters, this measure of net debt peaked at a level lower than we’d had a decade earlier.   The estimate for June 2018 (from HYEFU numbers) is debt of 8.5 per cent of GDP.  On current plans –  as communicated by the government to Treasury – debt would drop away to 3 per cent of GDP by 2022.  At that point, it wouldn’t be quite as low as the 2007 or 2008 levels –  reached after a sequence of huge, unexpectedly large, and economically unnecessary surpluses, and partly reflecting a prolonged expansion in which the economt ran ahead of medium-term capacity –  but it  would be pretty close.

There is no easy metric for what an appropriate level of government debt is.  And the agency issues around government debt are much more severe than those for private debt –  governments aren’t spending their own money.  The parallels here aren’t exact either, but a typical middle-aged household is likely to have debt materially higher than 3 per cent –  or even 8 per cent –  of their GDP.

What about some cross-country comparisons?  Here I turn to the OECD and, in particular, their series on general government (ie not just central) net financial liabilities.  I start from 1995, because that is when the OECD has data for almost all countries.

net debt OECD

I thought there were a couple of interesting points here:

  • for all the talk of governments piling on debt since the 2008/09 recession, net debt in the median OECD country (orange line) last year wasn’t materially higher than it had been 20 years previously,
  • but total net debt over all the OECD countries (the grey line) has increased very substantially.  Of the big OECD economies –  US, Japan, Germany, France, Italy, UK –  only Germany doesn’t have a much higher debt ratio now than in 1995.
  • small OECD countries seem to have been much more conservative in managing their public debt (yellow line).  That group includes – at one extreme –  Greece and –  at the other – Norway.  The median net debt of those countries is materially above where it was in 2007, but it isn’t much different than it was in, say, 2002 (15 years earlier).

New Zealand doesn’t have the lowest net debt by any means (Norway has net financial assets of 280 per cent of GDP). In fact, we mark out something around the lower quartile.  We’ve had some disadvantages the other small countries didn’t –  earthquakes –  but on the other hand we’ve had an unusually strong terms of trade and weren’t constrained (as many of them were) by being in the euro.  But it looks hard to make a strong case for actively pursuing lower net debt from here.  It isn’t as if, for example, there is any sign of the economy overheating.

(Things not shown are often as important as those shown.  Unlike many of the more indebted countries, we do not have a large unfunded pension liability for public servants in New Zealand.  Those liabilities are not included in these debt numbers.)

Feckless governments in other countries don’t necessarily make for much of a benchmark. And, as above, I’m not actively calling for New Zealand governments to take on more debt.   But simply producing a sequence of modest cyclically-adjusted operating surpluses  (NOT several per cent of GDP) over the next few budgets would seem to be about as much as it would be sensible –  from a macroeconomic perspective –  to ask from a government.

And, on a final note, I am increasingly uneasy about one aspect of the Labour-Greens budget responsibility pledges that seems to have disappeared almost totally.

This was the promise

  • The credibility of our Budget Responsibility Rules requires a mechanism that makes the government accountable. Independent oversight will provide the public with confidence that the government is sticking to the rules.

  • We will establish a body independent of Ministers of the Crown who will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public, and will cost policies of opposition parties.

But nothing more has been heard.   I wrote about it here, and suggested that the idea should be broadened to become a Macroeconomic Advisory Council.  That still seems sensible to me, especially as the Reserve Bank reforms the Minister has announced to date do nothing to strengthen effective scrutiny of the Reserve Bank. But for now, it would be good if the Minister could update us on what has happened to the Fiscal Council promise.

 

Perhaps the Reserve Bank (and the FMA) should heal themselves

Michael Reddell Adrian Orr, Reserve Bank, Superannuation

Suppose that the rules of a superannuation scheme explicitly required that any rules changes that could have an adverse effect on the interest of any member in that scheme could only be made with the unanimous consent of such members.

Suppose too that nonetheless the trustees of such a scheme went ahead and changed the rules of a defined benefit scheme in a way that allowed the employer to arbitrarily (ie no constraints at all) reduce the rate at which pension benefits were calculated (including in respect of periods of employment, and employee contributions, prior to the rule change).  No consent from potentially affected members was sought for this change.

Suppose that in making this change, they had the endorsement/consent of the board of directors of the employer, and of the chief executive of the organisation.

Suppose too that that new power was actually exercised by the employer, in a way which led to longstanding employees later retiring with pensions considerably lower than they would otherwise have been.  That represented a substantial wealth transfer (probably millions of dollars) to the employer.

And suppose that the Government Actuary had been required to give consent to such a rule change, and in fact did so.

That looks to me a lot like serious misconduct, quite possibly illegality.

And who are the players in this tawdry drama?

Well, there was the Government Actuary, a task now absorbed by the Financial Markets Authority.

And there was the Reserve Bank of New Zealand, its Governor (appointed by the then Minister of Finance), and its Board (all appointed by the then Minister of Finance).  Serving on both the board, and the trustees of this superannuation scheme, was the Governor, and someone who is now chair of the New Zealand arm of Transparency International, an NGO allegedly committed to good governance etc.

The initial misconduct happened quite long time ago.  In 1988 in fact.    But for years now some members have been trying to get redress, and even recognition of the problem.  It has been going for sufficiently long that when Adrian Orr was last at the Bank –  as Deputy Governor and Head of Financial Stability –  he was involved, fobbing off concerns raised by some of his own staff.

Four years ago, a particularly persistent member formally raised the issues (the one I’ve outlined here isn’t the only example, although is probably the most serious) with the trustees of the superannuation scheme.  The initial response of the Board-appointed chair (and current Deputy Governor and Head of Financial Stability) was to attempt to close the issues down immediately, without undertaking any investigation. I guess if you don’t turn over stones, there is no risk of finding awkward stuff under them.  Fortunately, other trustees stymied that bid.

After a couple of years’ delay, the trustees somewhat reluctantly came to the view that probably member consent should have sought, and that the decision not to have done so was not necessarily one they themselves would today have made.  But………they weren’t going to do anything at all about rectifying the situation, claiming (on grounds almost totally without foundation) that no one had actually been adversely affected.  These are trustees who, by common law and now by statute, are required to operate in the interests of the members of the scheme (beneficiaries of the trust).  But who could easily have been misinterpreted as operating in the interests of the Reserve Bank (a majority of trustees appointed by the Reserve Bank Board –  the entity that has spent the last few decades providing cover for Bank management).  Under the (relatively) new Financial Markets Conduct Act, superannuation schemes are now required to have an independent trustee –  the one on the Reserve Bank scheme (whatever his other useful contributions) declared early on that he had no desire to be caught in the middle trying to sort out such difficult issues, and (from my memory) has barely uttered a word in all the debates since about these issues.

And what of the FMA?  It is now must be almost a couple of years since the member elevated the issue to the FMA, lodging a formal complaint with them.    And since then the FMA appears to have done almost nothing (there was a meeting with the trustees well over a year ago, but it involved little more than description of the issue –  and at the time the FMA themselves didn’t even seem to have a good grasp on their own act).   Perhaps it is typical for the FMA?  I don’t have anything else to do with them, so have no basis for knowing.  Perhaps there are legal constraints (old legislation) on their ability to actually do anything formally.  But there has been no informal action, moral suasion, either.   Indeed, their inaction could be easily be misinterpreted as having something to do with the fact that the organisation itself (as the Government Actuary) had signed off on the, almost certainly unlawful, rule change.  And perhaps too from the sheer awkwardness of having to investigate serious concerns about an entity associated with their fellow regulator, the Reserve Bank, an entity then chaired by someone who is now Head of Financial Stability (Bascand is no longer the chair, but is still a trustee).  Or from signs that the independent trustee regime they administer seems to be adding only overhead.

I don’t want to bore readers with the details of this particular tawdry episode.

But when we have the new Governor  –  with legislative responsibility only for prudential issues –  lurching from two weeks ago suggesting there were no particular conduct issues in New Zealand, because we had a quite different culture, to last week suggesting that it really wasn’t his call (on an inquiry) but he was sure banks were examining themselves, to news this morning that he and the FMA head had summoned the heads of the big banks to a meeting, demanding they prove a negative (that there is no “misconduct” going on), and (in the FMA head’s case) apparently threatening legal action against those who don’t cooperate, I could only think

Physician heal thyself

or continuing the biblical theme

And why do you look at the speck in your brother’s eye, but do not consider the plank in your own eye? 4 Or how can you say to your brother, ‘Let me remove the speck from your eye’; and look, a plank is in your own eye? 5 Hypocrite! First remove the plank from your own eye, and then you will see clearly to remove the speck from your brother’s eye.

(As background, I am both a member and an elected trustee of this superannuation scheme. I have recorded in the minutes my dissent from the majority view of trustees, and have expressed my own concerns directly to the FMA.  As I joined the Bank, and the scheme, not long before this particular questionable rule change was made, it probably did not materially adversely affect me.)

New Zealanders leaving Auckland

Michael Reddell Auckland, Treasury

Last month The Treasury published some new research aimed at providing better information on the population changes in each territorial local authority (TLA) between censuses.   At present we only have a census every five years –  and in some quarters there seems to be a push to reduce that frequency – and subnational population estimates between censuses have often been pretty poor, only to be updated and revised when the next census results finally appear.  At present, the published subnational population numbers are anchored to the 2013 Census, adjusted for estimates of the overseas net migration flow and data on  births and deaths.  In New Zealand we don’t have to tell some specific government agency when we move house or city.

Except that, as The Treasury observes, in practice we often do end up telling some government agency (or government-funded agency) or other –  in fact, are coerced to do so –  and the government has collated all that data in a single (anonymised) database.   That opens up enormous possibilities to use that data to, for example, update subnational population estimates in a way likely to be more accurate (albeit not very timely).   You might worry, as I do, about governments getting their hands on all that data combined, by some mix of coercion and seduction (eg have the slightest accident and you get into the ACC system) and worry that it might be used for ill as much as for good.  But, like it or not, the data are there and The Treasury is using them.

This chart from their paper gives you the picture of the data they are using

tsy popn

But my interest is less in the details of how they calculate their estimates, as in some of the bottom line results, and particularly those around estimated internal migration.

There are some interesting snippets.  The results suggests that New Zealanders’ rates of internal migration (one TLA to another) have been pretty stable, but that of immigrants has increased quite a lot.  The author offers no ideas about why that might have been (and I don’t have any to suggest either).

tsy popn 2 There is a fascinating picture of Christchurch following the earthquakes, including the continuing losses in recent years to neighbouring Selwyn and Waimakariri.

tsy popn 3

And then there is Auckland

tsy popn 4

There was a slight move into Auckland from elsewhere in New Zealand (mostly from Christchurch, see previous chart) in 2011, but otherwise the net flow of New Zealanders has been away from Auckland.  In fact, in the final year of the chart, the net outflow of New Zealanders (this is a NZ-born measure) was larger than the natural increase, so that the entire increase in Auckland’s population is (estimated to have been) due to international migration.

Readers with long memories may recall that I touched on the outflow of New Zealanders (as captured in Census data) in an earlier post.

This was the picture from the five years from 2008 to the 2013 Census.
internal migration 08 to 13As I observed then, we didn’t know what had happened since 2013.   Perhaps things had turned around?    But the new Treasury estimates suggest that if anything the outflow – still modest each year – may have accelerated.

We have the data going further back. Here is the extract from the earlier post.

SNZ has compiled this data back as far as the 1986 to 1991 five-yearly period. The last five yearly period in which Auckland experienced a net inflow of people from elsewhere in the country was from 1991 to 1996.

Here is chart which covers the estimated net internal migration to each region for the period 1986 to 2013 (with the two years 2006 to 2008 missing, because they weren’t captured by any of the censuses).

internal migration 86 to 13.png

 

None of this should be very surprising.   After all:

  • Auckland house prices have become impossibly high,
  • Traffic congestion problems, if temporarily relieved now by Waterview, seem continually pressing, and
  • The gap between Auckland incomes and those in the rest of the country, never large, has been narrowing.

But it must be an inconvenient truth for boosters of the Auckland story, including bureaucrats in MBIE, the Secretary to the Treasury, assorted past and present ministers (recall John Key on “quality problems”).  The people who know Auckland best  –  the opportunities for themselves and their families –  are, at the margin, leaving the place.   People in the rest of New Zealand aren’t (net) flocking to the big city.   It simply doesn’t seem to offer them better opportunities than staying where they are (or going to Australia).

The latest issue of the London Review of Books turned up in the mail yesterday.   In one of the reviews –  of a new book by Richard Florida –  I found this

The new urban inequality has two distinct and related aspects. First, superstar cities have moved ahead of the nations they’re found in.  The trend is clear in the US, where cities like New York have become richer relative to the country as a whole. But it is most pronounced in the UK.  In the 1970s and 1980s, London’s GDP per head was around one and a quarter times that of the UK as a whole.  Today it’s one and three-quarters.

It isn’t just London or New York.   I’ve shown previously a chart looking at GDP per capita in EU countries, looking at the ratio over time of that in the biggest city relative to GDP per capita for the country as a whole.  Over this century there has been a clear upward trend.

As for Auckland, in 2000 GDP per head in Auckland was 15 per cent higher than for the country as a whole, but by last year it was only 9 per cent higher.   I’ve shown previously (a couple of years ago) this chart of how small the New Zealand gap is between GDP per capita in the biggest city and that for the country as a whole, by comparison with many other advanced countries.

gdp pc cross EU city margins

There are, perhaps, some good dimensions to the New Zealand story.   We don’t have whole swathes of the country being left behind as the metropolis powers ahead.  On the other hand, the metropolis isn’t powering ahead at all –  just getting more and more people, in a city which is underperforming a country with weak (almost non-existent in recent years) productivity growth.

It is well past time for a rethink, and for our politicians and officials to start focusing on the specifics of the New Zealand experience.   In terms of economic success, Auckland bears not the slightest resemblance to London or New York (or Paris, or perhaps even Bratislava).   And yet the growth strategy (perhaps flattering it to use the term “strategy”) has seemed to rest almost entirely on a wishful belief that if only we tried really hard, and poured more and more people into Auckland, it just might be.  But one of the lessons of economic geography is that location matters.  Ours –  Auckland’s –  is exceeedingly unpropitious.

That LRB review I mentioned earlier notes that trends in recent decades have turned out to be very good for “established global cities in particular”, in ways that few anticipated.  That particular discussion ends thus

The business districts of San Francisco, New York, and London are ludicrously prodigious. The Borough of Westminster produces as much wealth as all of Wales.

I can’t vouch for that final statistic, but it does leave one thinking that it is more likely that Auckland is a Cardiff or (moving north) Glasgow, than that it is a coming London or New York.

The Governor on banking and deposit insurance

Michael Reddell Adrian Orr, deposit insurance, Financial stability, Reserve Bank Act reforms, Uncategorized

There was another interview the other day with new Reserve Bank Governor Adrian Orr.  This one, on interest.co.nz, focused on issues somewhat connected to the Reserve Bank’s responsibility for financial sector prudential regulation/supervision, and associated failure management responsibilities.

In the interview Orr touched again on an idea he has already alluded to in one of his interviews: the idea of getting a clearer, more quantified, sense from Parliament as to what it is looking for from the Reserve Bank in its conduct of regulatory policy.

It is an appealing idea in principle.  For monetary policy, Parliament has specified a goal of price stability, and in the Policy Targets Agreement the (elected) Minister of Finance gives that operational form (a focus on 2 per cent annual inflation, within a range of 1 to 3 per cent).   There is nothing similar for the extensive regulatory powers the Bank has.

In respect of banks, section 68 of the Act sets out the goals

68 Exercise of powers under this Part

The powers conferred on the Governor-General, the Minister, and the Bank by this Part shall be exercised for the purposes of—

(a)  promoting the maintenance of a sound and efficient financial system; or

(b)  avoiding significant damage to the financial system that could result from the failure of a registered bank.

Which is fine as far as it goes –  and what isn’t there (eg a depositor protection mandate) is often as important as what is.   But it isn’t very specific, and provides no guidance as to how to interpret the idea of an “efficient” financial system (as a result, it has been debated internally for decades), no sense of how sound the system should be (or even what a “sound system”, as distinct from sound institutions, might be.   And the same overarching provision (sec 68) has seen the Reserve Bank’s approach to bank regulation and supervision change very substantially over the years, with little or no involvement from Parliament.

There is a reasonable argument –  made quite forcefully in former Bank of England Deputy Governor Paul Tucker’s new book on such matters – that if in a particular aspect society’s preferences aren’t reasonably stable, and able to be written down reasonably well, then policymaking powers in that area should not be delegated to an independent agency (let alone what is formally a one-man agency).  With the second stage of the review of the Reserve Bank Act underway, Orr can obviously see a threat to the Bank’s powers, and thus he suggests an attempt be made to have Parliament articulate its preferences, and views on possible trade-offs, more directly.  If they could do so, having unelected decisionmakers then working to deliver on that mandate might be less democratically objectionable, and the Reserve Bank might have a greater degree of legitimacy in these areas than it does now.

And so the Governor told his interviewer

“For inflation targeting we’ve got a clear target [being] 1% to 3% on average. For the prudential regulation, – how do we articulate that target? In other words what is the risk appetite of the people of New Zealand as represented by Members of Parliament for banking regulation? Do you screw it down to one corner where nothing can happen – it’s very sounds but totally inefficient, or do you have trade-offs allowing firms to come and go and consumers to be aware etc? So that is going to be a really good, useful articulation that will come out of that,” says Orr.

At first blush it sounds promising, and I’m certainly not going to discourage an effort to try to uncover such an articulation of preferences.  But I am a little sceptical that anything very stable or useful will emerge from the process.  I’d prefer that all rule-making powers were removed back to the Minister of Finance (or indeed Parliament), leaving the role of the Reserve Bank as (a) technical advisers, and (b) implementers.

It might be fine to express a view that banking system regulation should be designed on a view that there should be no major bank failure on average more than once in a hundred years   – actually about the rate in New Zealand history –  or, indeed, five hundred years.    That might (and has in the past internally) be some help in how one calibrates capital requirements for banks.  It will, however, be almost no help in deciding whether LVR restrictions are a legitimate use of coercive, redistributive, government powers.  Or whether we care much about small institutions.  Or, indeed, whether the Reserve Bank should have the power to approve (or not)  the appointment of senior staff in banks.   And even if society could express a stable preference for a regime designed to deliver no more than one failure per 100 years, it provides very little basis for that other vital strand of the governance of independent agencies –  serious accountability.    Good luck could readily deliver a 50 year run of no failures without reflecting any great actual credit on the central bankers in charge at the time (who might have been doing fine, or doing a lousy job).  And if the one in a hundred year shock happens next year, it will still be very difficult to say with any certainty that the central bankers were doing the job they were asked to do –  they may well have been, and just got unlucky, and the public is likely to want scapegoats.    Elected politicians serve that role better than unelected technocrats.

But if there is anything more to the idea the Governor is toying with, it would be good to get some material into the public domain in due course, and have it scrutinised or debated.

In his latest interview, the Governor also touched again on the calls for a royal commission into conduct in the financial sector, as underway at present in Australia.  This time he is a lot more moderate, explicitly recognising that it isn’t his call.

Against the backdrop of the unacceptable conduct coming to light in Australia’s Royal Commission on financial services, Orr doesn’t believe New Zealand needs its own Royal Commission. However, he says the impact of the Australian one is certainly being felt in NZ.

“There will be not a single bank in New Zealand that is not, at the moment, really checking every cupboard for skeletons here in New Zealand. That is without doubt. This has really put the wind up the banks to say ‘hey, what is the alternative to sound regulation, it’s a Royal Commission’. We’re meeting collectively with the CEOs, we’re meeting individually with the chairs, and we always do on a regular basis,” Orr says.

“Is a Royal Commission necessary? At the moment in my personal opinion no, but I’m not the one who would call one anyway.”

Orr says while the Australian Prudential Regulation Authority is “being held up as some [sort of] global best practice,” and works alongside the Australian Securities and Investments Commission and the Reserve Bank of Australia with all having “heavy boots on the ground,” they’re still having “this cultural challenge.” Thus more hands-on regulation than the Reserve Bank’s light touch regulatory oversight of banks isn’t necessarily the best way forward.

But it is an odd mix of responses.  On the one hand, Orr seems to come across as something of a champion or defender of the banks in New Zealand.  That is no part of his role.  He is the prudential (soundness) regulator, in the public interest –  recall section 68 of the Act, quoted earlier – and his role (the Reserve Bank’s role) has almost nothing to do with conduct standards.

And he seems to be attempting distraction on other issues by conflating prudential/systemic issues with conduct issues.  Thus, when various people (including the IMF) have argued that New Zealand should adopt a prudential regulatory regime more akin to APRA’s (which, in effect, operates here to a considerable extent anyway, because APRA is focused on the entire Australian banking groups), Orr doesn’t engage in the substance of that debate, but attempts to muddy the water by making the point that a more intensive prudential regime in Australia hasn’t prevented some of the conduct issues coming to light in the Royal Commission.  Indeed, but why would one imagine it should?   They are two quite different issues.  In the same way, an investigation into whether the local supermarket was meeting minimum wage or holiday pay provisions for its staff wouldn’t expect to shed any light on food-handling issues in the same supermarket.

Part of the legitimacy of independent central banks involves them being seen to speak in an authoritative and trustworthy way.

But the comment from the Governor that led me to read the account of the interview was on the vexed subject of deposit insurance.   The article had this as (part of) its headline

RBNZ Governor says differences between deposit insurance & minimum deposit not frozen in OBR scenario are ‘technicalities’

That sounded like an intriguing claim.  You’ll recall that the Reserve Bank has long staunchly opposed deposit insurance (eg articles/speeches referenced here), even though people like The Treasury, the IMF, and various other commentators (including me and my former RB colleague Geof Mortlock) favour it.  The new Governor doesn’t seem to share the Bank’s long-running opposition.

Asked whether the Reserve Bank should get an explicit statutory objective to protect bank depositors and/or insurance policyholders, Orr says deposit protection, or deposit insurance, is “something that’s going to be here in the future.” NZ’s currently an outlier among OCED countries in not having explicit deposit insurance.

“I think that’s something that’s going to be here in the future. We need to work our way through what it means

I’m surprised that change of stance didn’t get more coverage.  Of course, whether or not we have deposit insurance isn’t a decision for the Reserve Bank; it is a matter for the government and Parliament.  Nonetheless, if the Reserve Bank Governor is going to withdraw the bank’s opposition, that removes a significant bureaucratic roadblock.  Well done, Governor.    (To be clear, I favour deposit insurance not as a first-best outcome, but as a second-best that makes it more likely that future governments will allow troubled financial institutions to fail, rather than bail out all the creditors.)

But it was the Governor’s next comments on the issue that were more troubling, and which suggest he hasn’t yet got sufficiently to grips with the issue before opening his mouth.

I think people have been talking across each other a lot,” Orr says.

“The bank here has got a policy called Open Bank Resolution. And that is the idea that if a bank is too large to fail, we have to keep it open. But we have to recapitalise. So the current owners or investors who have largely done their dough, how do you recapitalise it and how do you have the door open the next day?”

“As part of that open bank resolution, we’ve already said there can be a de minimis around depositors money that they will have access to. We just need to speak in better English to say ‘you know you are going to have some cash there, you are going to be able to get your sandwiches, meet your bills, do all of that on the Monday. Because if it didn’t happen that way, then that one bank failure creates all banks to fail, there’s [bank] runs everywhere’,” adds Orr.

When it was put to him that depositors having access to a de minimis sum if open bank resolution was implemented on their bank isn’t the same as explicit deposit insurance, Orr suggested the difference is merely technical.

“We could have a discussion through that legislation to say ‘economically it’s the same, could we call it the same, or is it part of a failure management?’ I believe it’s the same end outcome, the technicalities behind it are just technicalities. We need to be able to say to the public ‘if we’re shutting the bank down, what do you have access to, what is the guaranteed de minimis or minimum, or protection,’ and then we need to work out how is that going to be funded.”

There is a lot of mixed-up stuff in there.

For a start, the question of how we manage the failure of a bank in New Zealand has nothing whatever to do with the idea of foreign taxpayers bailing out New Zealand depositors.  I’m not aware that anyone supposed that was very likely.  Indeed, all our planning –  including the requirement for most deposit-taking banks to incorporate locally –  has been based on the idea that New Zealand is on its own (although for the Australian banking groups, whatever happens in the event of failure is likely to be negotiated by politicians from the two countries).   Instead the general issue here is

  • should a large bank simply be allowed to close if it fails, and handled through normal liquidation procedures (few would say yes to that).
  • if not, how best can the bank be kept open,
  • it could be bailed out by the government (benefiting all creditors, including foreign wholesale ones),
  • or the OBR tool could be used, in which all creditors’ claims would be immediately “haircut”, so that the losses fall on shareholders and creditors not on taxpayers but  the bank’s doors remain open.

Within the OBR scheme there has always been the idea of a de minimis amount which might not be haircut at all.  It isn’t an issue about liquidity –  as the Governor suggests –  because in the reopened bank everyone has access to some of their money.  It is an explicitly distributional issue.   For example, a welfare beneficiary might have only $100 in their account (living almost from day to day),  such accounts in total won’t have much money in them, so it might be easier (involve many fewer creditors, and less immediate resort to eg foodbanks) and in some sense fairer just to give people with such small balances immediate access to all their money and not have them share in any losses (or have to bother about ongoing dealings with those handling the failure).  It has mostly been seen as a matter of administrative convenience, but also of realpolitik (reduce the number of voters affected by losses in a failure).   And if these very small creditors are fully paid out, it does involve a transfer of wealth from all other creditors, but the amounts involved, even cumulatively, are pretty small.

In recent years, there has been talk of this de minimis amount creeping up.    There have even been suggestions of something as large as $10000 –  in other words, if you have less than $10000 in your (failed) bank, you wouldn’t face any losses.    It must be this sort of thing the Governor has in mind when he talks of the difference between deposit insurance and the de minimis being little more than “technicalities”.

But he is still wrong:

  • first, the de minimis would only apply where OBR was used, and OBR is only one option.  Even if looks like an attractive option, in some circumstances, for a large bank, it might not be a necessary or appropriate response to the failure of a small bank.
  • second, the de minimis is being paid out of other creditors’ money (it is essentially a (small) depositor preference scheme).   That might be tolerable for very small balances –  other creditors have an interest in lowering administrative costs of managing the OBR –  but is most unlikely to be defensible, or acceptable, for larger de minimis amounts,   Perhaps the Governor has in mind, the government chipping in directly to cover the larger de minimis amounts, but relative to a proper priced deposit insurance regime that seems far inferior, and different by degree, not just by “technicalities”.
  • third, no de minimis amount I’ve ever heard mentioned comes close to the sorts of payout (coverage) limits in typical deposit insurance schemes abroad.  As the author of the interest.co.nz piece points out  “Under Australia’s deposit insurance scheme, deposits are protected up to a limit of A$250,000 for each account-holder at any bank, building society or credit union that’s authorised by the Australian Prudential Regulation Authority”.    Attempting to rely on the de minimis –  as people like the Governor sometimes do in advance of the failure –  is just a recipe for increasing the likelihood of a full bailout at point of failure, as the amount envisaged just won’t match public expectations/demands (as revealed in other countries).

To repeat, it is good that the new Governor appears to be shifting ground on deposit insurance.  But let’s not settle for half-baked responses, using a vehicle never designed to deal with the issue of deposit insurance.  Legislate and put in place a proper deposit insurance scheme, and levy depositors to pay for the insurance.

Do that and, as I’ve argued previously, the chances of being able to use OBR –  to impose losses on large and wholesale creditors, including foreign ones – will be materially increased.  Without sorting out deposit insurance properly, most likely any future government faced with a failure of a large bank will just fall back on the tried, true, and costly solution of a full state bailout.