Author: Michael Reddell

Reserve Bank BIM: resisting reform

Michael Reddell Reserve Bank Act reforms, Uncategorized

Once upon a time, post-election briefings to an incoming minister actually contained some free and frank official advice on major policy issues.  I have sitting on my desk the 1987 Treasury briefing  –  almost 800 pages of analysis and advice (good and bad).   But as the briefings started being  routinely published, it seemed to start an inexorable trend towards documents of astonishing banality, often containing little more than lists of the official ministerial responsibilities and/or the activities of agencies (I just flicked through the BIM of one major ministry, released yesterday, and it was a startlingly content-free zone).  If there still is free and frank advice offered by the public service, you won’t often find it in these documents.  It isn’t helped by the growing practice of writing (or finalising) the BIMs only after the composition of the new government is known, rather than in advance of the election.

Reserve Bank BIMs over the years have tended to go in the same banal descriptive direction.  So I didn’t expect to find anything interesting when I opened up the document released yesterday.  But I was wrong.    The (unlawfully appointed) “acting Governor” Grant Spencer had used the opportunity to make his case for minimal change to the governance and decisionmaking provisions of the Reserve Bank Act, including an eleven page appendix on that specific issue.

At the time of last month’s Monetary Policy Statement, Spencer –  and his deputy, Geoff Bascand –  went public on their opposition to any substantial change.  But they did that just in response to press conference questions.   I summed up their position –  “just cement in the status quo, and if we really have to have externals make sure they are silenced and that there is no greater transparency” –  this way

[their] approach is that of “the priesthood of the temple” –  we will tell you, the great unwashed, only what it suits us to tell you, in the form we want to present it.  It is simply out of step with notions of open government, or with a serious recognition that monetary policy is an area of great uncertainty and understanding is most likely to be advanced by the open challenge and contest of ideas.

In the BIM, they go further and stress how keen they are that any external appointments should be made by the Governor rather than –  as is the case in most other advanced democracies –  the Minister.   They were keen to keep any review of the Act very narrow, and to control the process themselves as far as possible

we would be happy to prepare a draft terms of reference, in consultation with the Treasury

Fortunately, they lost that one and the review is being led by The Treasury, supposedly supported by an (as yet unnamed – or unannounced – Independent Expert Advisory Panel).

But it was that eleven page appendix I really wanted to write about this morning.  They describe even it as a “brief summary” and refer to a more detailed version of the paper being available. I have lodged a request for it, without any great expectation of it ever seeing the light of day (it might, for example, have been logical to have released it when the Minister of Finance announced his review –  logical, that is, if the government or Bank were interested in open government).

The Bank’s first claim is that the current system –  a single unelected decisionmaker, appointed by other unelected people –  “works well” at least for monetary policy, and that the Reserve Bank’s monetary policy “is highly regarded internationally”.    In principle, those are two separate points.  It is hard to imagine the Reserve Bank being held in “high regard” internationally for its monetary policy over the last decade –  whatever sentimental respect there still is for the Bank as pioneer of inflation targeting almost 30 years ago.    Our central bank remains the only advanced country central bank to have launched into two tightening cycles since the 2008/09 recession, only to have to fully unwind both of them.   Perhaps it is the sort of mistake anyone might have made, but our Reserve Bank did.    And the Bank has no more successful than anyone else in keeping inflation close to target –  even though, with interest rates still well above zero, it faced fewer obstacles than most.

The one recent report the Bank attempts to use in its defence is a brief one written earlier this year by an old friend of the then Governor.  I wrote about it at the time.

When an old uncle or family friend is in town and comes for dinner, the visitor will usually compliment the cook, praise the kids’ efforts on the piano, the sportsfield, or in dinner table conversation, and pass over in silence any tensions or problems –  even burnt meals –  he or she happens to observe.    Mostly, it is the way society works.  No one takes the specific words too seriously –  they are social conventions as much as anything.  One certainly wouldn’t want to cite them as evidence of anything much else than an ongoing, mutually beneficial relationship.

It is a shame the Reserve Bank is reduced to publishing, and touting, a report like this in its own defence.  When good old Uncle Philip, a fan of yours for years, swings by, it must be mutally affirming to chat and exchange warm reassuring thoughts.  But as evidence for the defence his rather thin thoughts, reflecting the favourable prejudices of years gone by, and institutional biases against doing much about inflation deviating from target, isn’t exactly compelling evidence for the defence.    Sadly, getting too close to Graeme Wheeler as Governor seems to diminish anyone’s reputation.  It is a shame Turner has allowed himself to join that exclusive club.

In a way, what strikes me most about the Bank’s appendix is the near-complete absence of (a) any critical self-scrutiny, and (b) any sense of operating in a society that expects scrutiny and accountability of powerful public agencies, and not just on terms set by those agencies.

For example, they organise their thoughts around the notion that “the objective of decision-making design is to create a system that leads to rigorous decision making”.  I’m not sure which management textbook they got that from, but it doesn’t sound a lot like the way we should organise things  for making public decisions in a democratic society (internal management decisions in a private company might be another matter).  “Rigour” in decisionmaking is certainly important, but when those decision are outward-facing and have pervasive effects across a country, with no rights of review or appeal, it is far from being the only relevant criterion.   “Legitimacy” for example –  an ongoing sense of public confidence that the agency is being well run, in the interests of the public not just of officialdom – matters a lot.  So should openness.  For many year now our statute books have contained this provision (part of the purpose clause in the Official Information Act).

to increase progressively the availability of official information to the people of New Zealand in order—
(i) to enable their more effective participation in the making and administration of laws and policies; and
(ii) to promote the accountability of Ministers of the Crown and officials,—
and thereby to enhance respect for the law and to promote the good government of New Zealand:

Around their centrepiece –  the goal of “rigorous decisionmaking” –  they circle “four key components”

  • institutional design,
  • high quality inputs,
  • genuine deliberation, and
  • accountable for decisions

There is nothing of interest under their heading of “institutional design”.  As they note, the Governor is legally responsible for all Reserve Bank decisions, and although all Governors since 1989 have operated with advisory committees (the form and names have changed over time), in a single decisionmaker model there is only one Reserve Bank view.   However, it is worth noting that the Reserve Bank remains intensely secretive about the range of internal views or advice ever becoming known, in ways that do nothing to support good decisionmaking, let alone robust scrutiny, challenge, and accountability.

On ‘high quality inputs’, the Bank claims that its decisionmaking “is supported by a broad range of high quality inputs”.  Perhaps, but (a) despite the inputs they’ve still made some bad policy mistakes, which should at least raise questions about the inputs (recognising that in a field like monetary policy, riddled with uncertainty, some mistakes are inevitable), and (b) we don’t know, because they hold all the inputs very closely, and refuse to release any, even years later.   Just yesterday, we had the refusal to release their background analysis on the aspects of the new government’s policy they’ve incorporated in their latest projections.  I once wrote a paper with Grant Spencer to the then Minister of Finance in which we referred rather scathingly to one particular proposal as involving “trust us, we know what we are doing”.  These days, unfortunately, Grant seems to treat it as a practical guide to running a central bank (whether on most regulatory matters or monetary policy).

They claim, only briefly, that their current system produces “genuine deliberation”.  Again, how would we know?   They refuse to release the minutes of the Monetary Policy Committee, or of the Governing Committee, they refuse to release a summary of the individual recommendations on the OCR, and they refuse to release the background papers.  Not just in the weeks after a decision, but even years later. I know, I’ve asked.   How robust, for example, were the deliberations around the ill-judged tightening cycle than began in 2014?  In my observation –  I was still involved at the time –  not very.

Then there is “accountability”, which sounds good, but isn’t really.  Of course, they cite the role of the Reserve Bank Board, and its reports to the public and to the Minister. But this is the same Board that will have appointed the Governor and which, in history, has never openly said a remotely critical word about any Reserve Bank decision.   Perhaps in private they do a really good job  –  in my experience, at times some of them (usually the more awkward ones) asked some useful questions –  but that isn’t serious public accountability.  The Board seems to see their role primarily as having the back of the Governor –  how else, for example, did they stay silent in the face of Graeme Wheeler’s deployment of his entire senior management to try to silence Stephen Toplis?   The Bank goes on to claim (correctly) that the Board is given the materials used to lead up to OCR decisions, but then (outrageously) claims that “a subset of this information is made available to the general public”.  In fact, none is at all.    All we get is what the Governor chooses to allow us to see scrubbed up and sanitised in his Monetary Policy Statement, even though all the background material is public information, produced with public money.    They have a very strange definition of accountability at the Reserve Bank.

(As they do every few months, they roll out an academic paper from a few years ago suggesting that on that particular measure, the Reserve Bank is one of the most transparent central banks in the world.  As I’ve noted previously, there is a big difference between telling us a lot about what they know (almost) nothing about –  eg where the OCR might be in 2020 –  and telling us stuff they do know about (their own advice, analysis, range of views etc). They do the former well, and the latter is almost non-existent.)

The Bank then turns to potential modifications to the Act.   The (unlawfully appointed)
“acting Governor’s” preference is simply to codify the current committee (the Governing Committee, consisting at present of the “acting Governor”, the Deputy Governor and the chief economist).

In earlier incarnations of this idea, the proposal was that the members of such a statutory committee would all have formal voting rights.  But even that –  weak advance –  has now gone out the window and the Bank is now arguing to protect the single decisionmaker model, while putting into statute simply a requirement that the Governor have an advisory committee.  Under their proposal the Governor “would be responsible for the manner in which the Governing Committee conducts itself”.

Frankly, this is a worse than useless suggestion.  The Bank claims it would increase transparency around the decisionmaking process. In fact, the effect would be quite the reverse.  For a good Governor it might make no effective difference.  For a bad Governor, it would allow him or her the fig-leaf of being able to claim that decisions were made in (statutory) committee even though (a) the other members had no formal vote, and (b) all members would be appointed by, remunerated by, and accountable to, the Governor.  The Bank simply shows no sign of recognising the institutions need to built to be robust to bad appointees (because, in every human institution, they will happen from time to time).

Interestingly, they are open to the idea of separate committees for monetary and financial policy.  I’ve strongly favoured that, but recall that the sort of committees they propose are advisory only.  In fact, there is nothing to have stopped them putting such committees in place already.  Arguably, it was actually the way things worked before the Governing Committee was established: the Governor made OCR decisions in the OCR Advisory Group, and financial regulatory decisions in the Financial System Oversight Committee.  Those specialist committees still exist (OCRAG renamed as the – formal –  MPC).

We get to the real concerns –  they know they’ve lost the fight over keeping the single decisionmaker model –  when they come to the question of external members, the decisionmaking approach, and the communications.

On externals, they argue

The extent to which policy committees benefit from external members depends on the nature and objectives of the committee and the conditions associated with the external members’ appointment. Policy committees which have to interpret political objectives or indeed establish goals to be achieved should benefit from having external members. In New Zealand, the objectives of monetary policy are clear in the Act, and through the PTA. For prudential policy, the objectives of soundness and efficiency are clear, but their interpretation requires complex judgement.

To which my reaction is “yeah right”.  No one thinks the prudential policy objectives are clear –  in the sense of easily operationalisable.  There are big choices to be made about goals and instruments (eg around use of LVR restrictions). But actually it isn’t much different with monetary policy.  No one seriously regards the PTA as a document that avoids trade-offs, or involves no judgements –  indeed, wasn’t the “acting Governor” only the other day arguing for more flexibility in interpreting the goals?   More generally, they offer no support –  none –  for their claim that there is a special case for external members where goals are relatively more fuzzy.  External members can matter for a range of reasons, including minimising the risk of external groupthink, and helping ensure that a full range of models/perspectives are brought to the table.

They go on.

Policy making in monetary and financial policy often involves complex considerations based on multiple indicators, analytic models and competing economic theories. Full-time members with experience and expertise are likely to be better suited to this task than part-time external participants.

So you say.  But there are two separate issues here.  The first is about expertise (do we need subject experts only, or a range of perspectives) and the second is about whether the job is fulltime or part-time.   In Sweden, for example, most of the monetary policy committees members are outsiders (often academics or former market economists), but they are appointed to non-executive fulltime roles while they are on the committee (weirdly, this leads the Reserve Bank to claim they are insiders).  As for expertise, the Bank still seems to have made no effort to show that the issues it deals with an inherently more complex, or in more need of specialist expertise at the decisionmaking phase (as distinct from technical advice and supporting analysis) than many other agencies of the New Zealand government (which are typically run by part-time boards, appointed by ministers, with a range of backgrounds).  Even among executives, I don’t imagine the chief economist actually spends much time on financial regulatory matters on which he helps the Governor make decisions in the Governing Committee (at best, he is a part-timer non-expert in that area).

I’ve covered previously the Bank’s preference to avoid voting in committees, and (especially) to avoid any public revelation of differences of perspective.  They claim that

Research into decision-making practices finds that consensus is the preferred decision approach as it allows for more in-depth discussions, the frank exchange of views, more accurate judgement on average, and higher committee morale.

But they neither provide any references, nor engage with the practical experiences of various other advanced central banks that seem to have found a voting plus openness model works well –  I’ve noted previously the cases of the UK, the US, and Sweden.    And, as I’ve noted previously, you have to wonder how local councils, Parliaments, and higher courts manage?  The Supreme Court –  rather more important on the whole than the Reserve Bank –  seems to manage with both voting and disclosure of individual views.  The public –  a priority, if not for the Bank –  seems to be better for it.

Perhaps most extraordinary is the Reserve Bank’s assertion around the appointment process.

In New Zealand, the Governing Committee is a “technical” committee created to carry out the purpose and objectives set out in the Act, the PTA and the MoU. The Reserve Bank is the government’s agent in carrying out its monetary, prudential and macro-prudential policy objectives, and we consider it critical that policy committee appointments be made by the Reserve Bank for their policy competence and not through a political body.

I could understand if they thought that “on balance, we think it would be better” to have appointments made by the Bank itself.  But “critical”……….really?

You have to wonder what makes New Zealand so different from most other advanced countries.    In Australia, the Governor and the Deputy Governor are both appointed by the Treasurer.  In the UK, the Governor and the (various) Deputy Governors are appointed by the Chancellor.  In the UK, the members of Fed Board of Governors are all appointed by the President (confirmed by the Senate). In Sweden, the key appointments are made by the parliamentary committee that oversees the Riksbank.

It is a good practice that major policy decisions should be made only by elected people –  and the Reserve Bank can’t surely pretend their decisions aren’t “major”, including having significant redistributive consequences –  and that where any such powers are delegated they should be made by people appointed directly by elected officials.  Typically, such decisions –  like those of the Cabinet –  will actually be made (legally) collectively.  But for some reason –  that they refuse to state –  the Reserve Bank thinks it should be different.  It shouldn’t.   There are plenty of different models of how Reserve Bank goverance should be done, but a system that keeps single decisionmaking, or which has all decisionmakers appointed by the Reserve Bank itself, should simply be ruled out from the start.

As a final point, the Bank includes a table which they use to support a claim that “about two thirds of the monetary policy committees of inflation targeting central banks have external members”.  It is a pretty shonky table.  For example, they class Sweden as having no external members, when (as noted earlier) most members are non-executive (but fulltime) externals.  They seem to make the same mistake for the Czech Republic, which appears to have several fulltime non-executives.  Weirdly, they claim that the ECB has a majority of outsiders –  but they appear just to mean the Governors of the constituent central banks, who are insiders if ever there were.  But perhaps as importantly, I’m not sure that Armenia, Peru, Hungary, South Africa, Thailand, Guatemala –  none beacons of good governance –  are the sorts of places I’d be looking to for guidance in structuring a robust and accountable decisionmaking system for the central bank.    Not all of the more advanced countries do have externals on their monetary policy decisionmaking committees, but Australia, Norway, Sweden, the US, the UK, Israel, Iceland, Japan, and Korea do.  And of all those advanced countries, only New Zealand and Canada have the sort of single decisionmaker system that the Reserve Bank wants to maintain.

South Africa –  an embattled central bank, facing the increasing prospect of political interference –  doesn’t have externals, but I did find this nice quote on their website

In monetary policy decision-making processes, committees are preferred above individuals. Not one central bank has replaced a committee with a single decision-maker, a fact that has both theoretical and empirical support; the ability to draw diverse viewpoints from constituent members in committees ensures that there is likely to be some moderation of extreme positions and policies and more even policymaking.

Indeed.  We shouldn’t let the Reserve Bank keep such a flawed system, even gussied up with a statutory advisory committee appointed by the Governor himself.   Other countries don’t do it that way –  and our Reserve Bank has far more power than most central banks because of its regulatory functions –  and hardly any other government functions in New Zealand are run that way.

It was good that the Bank included this material in its BIM, rather than just quietly slipping it to the Minister of Finance in a document we didn’t know existed.  It would be better still if they now released the full version of the document making their case. At present, that case is looking pretty threadbare, not informed by either good comparisons or a strong recognition of what open government should look like, and –  if anything –  designed to serve the interests of career bureaucrats rather than of the public.  That’s not too surprising: bureaucrats typically do what they can to protect their bureau.  But it doesn’t make it a good basis for public policy.

As for the Minister of Finance, perhaps he could take a stronger lead by (a) encouraging the Bank to release the fuller paper, (b) ensuring that Treasury releases the Rennie report on similar issues (and associated supporting documents) and (c) actually named the Independent Expert Advisory Panel supposedly playing a key role in the current Treasury-led review of the relevant provisions of the Reserve Bank Act.

As non-transparent, and obstructive, as ever

Michael Reddell Monetary policy, OIA, Uncategorized

Just when you think there are the occasional promising signs that the Reserve Bank might, perhaps, be becoming a little more open…….they come along and confirm that they are just as secretive as ever.

At the last Monetary Policy Statement, the Reserve Bank indicated that it had made allowance for four (and only four) specific pieces of the new government’s policy programme.   They provided no details, beyond the barest descriptions, even though these assumptions fed directly into their projections and to the “acting Governor’s” OCR decision.  In one specific example, they indicated that they had assumed that half the planned Kiwibuild houses would displace private sector housebuilding activity that would otherwise have taken place.   That assumption directly feeds into their forecasts of resource pressures, but is also quite politically sensitive.  You might suppose that in an open democracy, a public agency that came up with such estimates would publish their workings, at least when a formal request was made.

You’d be quite wrong.  I lodged a request a few weeks ago, asking for “copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions”.  I wasn’t asking for emails back and forth between staff, and I wasn’t even asking for the minutes of meetings where these papers were discussed.  I certainly wasn’t asking for copies any other government department or minister might have supplied them.  Just the analysis and related background papers the Bank’s own staff had done.

In response –  having taken several weeks of delay –  they didn’t redact particularly sensitive items, they simply withheld everything (down to an including the names of the papers concerned).   This is, it is claimed, to “protect the substantial economic interests of New Zealand”, a claim which is simply laughable.  Protecting senior officials of the Reserve Bank from scrutiny is not, even approximately, the same thing as protecting the “substantial economic interests of New Zealand”.  It might even be less intolerable conduct if they had laid out the gist of their reasoning in the MPS itself.  But they didn’t.

Of course, it is par for the course from the Reserve Bank.  They consistently refuse to release any background papers related to the MPS, no matter how technical they might be, or how high the degree of legitimate public interest (I did once get them to release such papers from 10 years ago).  They simply have no conception of the sort of open government the Official Information Act envisages.

Reform –  including opening up the institution –  is long overdue.  I do hope that the Minister’s review of the Act is going to address these issues seriously.

And in the meantime you and I –  citizens, taxpayers, who paid for this analysis –  are left none the wiser as to why, say, the Bank thinks a 50 per cent offset is the right assumption for Kiwibuild.  Perhaps it is, perhaps it isn’t, but the debate –  including around monetary policy –  would be better for having the workings in the public domain.

I was tempted to reuse my “shameless and shameful” description from yesterday, but that might a) overstate slightly the true importance of this particular issue, and (b) is a description better kept today for the Prime Minister and her willed blindness to the issues around China’s interference in the domestic affairs of New Zealand.  Anything for an FTA extension, nothing for protecting the democratic institutions and values of New Zealanders.

Full letter from the Bank below.

Dear Mr Reddell

On 16 November you made an Official Information request seeking:

copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions about the impact of four specific policies of the new government (minimum wages, fiscal policy, immigration, and Kiwibuild), as published in last week’s Monetary Policy Statement.

The Reserve Bank is withholding the information for the following reasons, and under the following provisions, of the Official Information Act (the OIA):

  • section 9(2)(d) – to avoid prejudice to the substantial economic interests of New Zealand;
  • section 9(2)(g)(i) – to maintain the effective conduct of public affairs through the free and frank expression of opinions by or between officers and employees of the Reserve Bank in the course of their duty; and
  • section 9(2)(f)(iv) –  to maintain the constitutional convention for the time being which protects the confidentiality of advice provided by officials.

You have the right to seek a review of the Bank’s decision under section 28 of the OIA.

Yours sincerely

Roger Marwick

External Communications Adviser | Reserve Bank of New Zealand | Te Pūtea Matua

2 The Terrace, Wellington 6011 | P O Box 2498, Wellington 6140

  1. + 64 4 471 3694

Email: roger.marwick@rbnz.govt.nz  | www.rbnz.govt.nz

 

More excuses for a job not well done

Michael Reddell Monetary policy, Uncategorized

It is another glorious day in Wellington –  I always reckoned a 2 degrees warmer Wellington would be a good thing – and there is Christmas shopping to do, but I couldn’t let the latest speech from the Reserve Bank go by without comment.

It is presented as a speech by “Reserve Bank Governor Grant Spencer”.   Fortunately, most of the media haven’t fallen for that line –  which they’ve tried on in a number of recent documents.   If Spencer is anything, he is “acting Governor”, and no more.

How do I know?  Because Parliament was quite clear that

The Governor shall be appointed for a term of 5 years

And when he appointed Spencer, Steven Joyce was quite clear that the appointment was for six months only.   He only ever claimed to be appointing an “acting Governor”  –  who can, under certain conditions, be appointed for only up to six months.

As it happens, even that appointment is almost certainly unlawful.  The Act is also pretty clear that an acting Governor can only be appointed when a Governor leaves office before his or her term has expired.   That wasn’t the case here.  In other circumstances, the Minister and the Board are simply expected to get on and make a permanent appointment, so that a new permanent appointee can take office when the previous appointee’s term expires (a date known, in this case, for the previous five years).  It might not be ideal phrasing, but it is the law, and if there was a problem –  as there was in the case, around the election –  either the law needs to be worked within, or to be changed by Parliament.

But we now have the strange situation where the Minister who appointed him thought Spencer was acting Governor, while Spencer himself now seems to purport to be –  not just have the powers of  – Governor.  As I’ve been doing for the last couple of months, I will continue to describe him only as “acting Governor”, or “the economist purporting to be acting Governor”.

Whatever his label, there is a bit of sense of relief that Graeme Wheeler is gone and that Spencer –  someone well-liked and generally more open –  is minding the store.   But his speech earlier this week, on monetary policy and the challenges of low inflation, still left a great deal to be desired.  I suspect it wasn’t intended this way, but in practice it amounts to not much more than excuses for not keeping inflation near target for the last five years, partly by attempting to obscure a New Zealand debate with the (somewhat different) issues some other advanced countries face.  And, of course, whatever the merits of Spencer’s views, he’ll be gone in little over three months and as yet we have no idea who the new single decisionmaker will be (let alone who will eventually serve on the new statutory monetary policy committee to be put in place next year).

There is some interesting stuff in the speech though.  Most notable perhaps was the number of references to unemployment.  Often enough Reserve Bank monetary policy documents mention it barely at all –  the Bank even tried to displace it with a new (but sadly ill-fated) labour market capacity indicator of its own devising.  For decades, the capacity variable in the Bank’s inflation models was (its estimate of) the output gap, and there were typically lots of references to it in speeches or Monetary Policy Statements.  

But in Spencer’s speech –  his first as “acting Governor”, and the first under the new government – there is but one reference to the output gap (and then only in abstract terms) and 17 references to “unemployment”.    And to think that some people reckon it doesn’t make much difference who is appointed Governor.

But the odd thing is that much of the speech is devoted to making the case that the unemployment rate (itself) hasn’t been much help in explaining inflation in recent years.  Which might be true, to some extent, but so what (at least when considering events of the last decade)?  After all, for years the Bank told us they didn’t put much weight on the unemployment rate, didn’t think they could fix on a NAIRU etc etc, and that we really should be focusing –  as they did –  on the output gap and a broader suite of high-tech capacity indicators.    It might even –  if valid –  be an argument for not putting too much specific focus on a specific or precise unemployment rate in the new monetary policy regime the government envisages –  but that isn’t the case Spencer makes, and weirdly he suggests that the Bank is already (since when?) putting more weight than previously on employment indicators.  It isn’t very coherent, in a New Zealand context.

This chart ran in the recent Monetary Policy Statement (when I didn’t get round to commenting on it) and it appears again in Spencer’s speech.

GS speech 1

It is the sort of chart the word “chutzpah” might have been invented for.  They use it to try to suggest that much of the advanced world is “stuck” in a situation in which the unemployment rate is below the sustainable rate (a NAIRU) and yet inflation is also below target.

There are a number of odd things about the chart.  For example, they include three separate observations for Germany, the Netherlands, and France, even though all three are in a common currency (and thus common monetary policy) area.  And surely it would have been more enlightening to include the other advanced countries with independent monetary policies (eg Norway, South Korea, Israel, Iceland?  There is also no place at all for inflation expectations in the story the Bank is trying to tell in the chart.

But the biggest, most obvious, omission is New Zealand.  And where would New Zealand fit on the chart?  Well, core inflation is about half a per cent below target and on most estimates –  even on the most recently quarterly unemployment observation (4.6 per cent) –  the unemployment rate is still above an estimate of the NAIRU.    If these relationships hold at all, there are lags, and the average unemployment rate for the last four quarters was 4.9 per cent.  By contrast, before the major revision downwards to the HLFS unemployment rate last year, the Reserve Bank had a NAIRU estimate of 4.5 per cent in its models (a part of that model that had no implications for the inflation forecasts), and after those revisions, Treasury published estimates suggesting they thought the NAIRU was now nearer 4 per cent.   In other words, for now at least, New Zealand still belongs in the bottom right quadrant of the Reserve Bank chart, the one in which there isn’t much of a mystery or puzzle at all: with inflation below target and unemployment above a NAIRU, a typical response  –  in an inflation-targeting framework –  would be to cut the OCR.    Switzerland and France can’t do that –  Swiss interest rates are already negative, and France can’t control interest rates  –  but New Zealand could.  It is just that the Reserve Bank chose not to.

In the chart the Bank uses OECD estimates of the NAIRU.  That is understandable –  they are the only consistent cross-country estimates I’m aware of –  but not one without its problems.  For example, somewhat unusually, the OECD thinks the New Zealand NAIRU this year is still in excess of 5 per cent.   Then again, if you believe the OECD’s estimates, unemployment in New Zealand has been below the NAIRU for almost the entire 21st century so far (rising just very slightly above only in 2009, 2010, and 2012).  It simply doesn’t ring true.

nairu less U

The Reserve Bank’s next chart in this area is this one

GS speech 2

The suggestion is that there was a relationship between unemployment and inflation in the 2000s (when they also didn’t use the relationship), but that it has disappeared (for now at least) in the last few years.

Given that the relationship (even in the previous decade) wasn’t tight by any means, and many of the higher inflation numbers related to things –  eg oil shocks and short-term exchange rate movements –  that didn’t have much to do with New Zealand unemployment rates, I didn’t find the chart overly persuasive.   Moreover, since everyone recognises that the NAIRU changes over time –  with things like demographics, labour market regulation, some hysteresis etc –  even the theoretical relationship shouldn’t be with the unemployment rate itself, but with the gap between the NAIRU and unemployment rate.    I suspect the Bank is currently feverishly working on a suite of time-varying NAIRU estimates –  to reflect the new government’s interest –  but there is no hint of those in this speech.

Ideally, one might want to look at something more like an unemployment gap estimate against deviations of core inflation  from target (what the Bank was trying to do, in a snapshot) for other countries in the first chart).  As I’ve already said, I don’t have any confidence in the OECD’s levels estimates of the New Zealand NAIRU, although the changes in the associated gap from year to year might not be too bad.    For now, it is all I have.

So in this chart, using annual data (all we have for the unemployment gap) I’ve shown the deviations  of sectoral core factor model inflation from the midpoint of the inflation target and the OECD estimate of the unemployment gap from 1993 (when the core inflation data start) to 2016 (each dot is one year’s data).

GS speech 3

Even including the most recent years (the furthest left observations) there is still a relationship there, albeit not a very tight one.    Then again, it wasn’t very tight –  although a bit more upward sloping –  when I deleted those most recent years.  No doubt the Bank could –  and perhaps is doing so privately –  do this sort of analysis in a more sophisticated way.

I’m not suggesting there are no puzzles about New Zealand’s inflation performance in the last few years.    But simply plotting the raw unemployment rate (and not even looking at, say, the underutilisation rate or the gap) against headline inflation isn’t going to tell you much –  we aren’t in 1958 now (when Phillips wrote)  and, apart from anything else, inflation expectations matter.

For the last couple of years, the Bank has consistently tried to tell a story of how inflation expectations are firmly anchored at the 2 per cent midpoint of the inflation target.   That has always been a questionable proposition, especially as regards the sorts of expectations that might affect wage and price setting behaviour.     Their favoured two-year ahead measure of inflation expectations is now around 2 per cent, but a decade ago it was averaging almost 3 per cent.  Household inflation expectations are also lower than they were.  Again, that isn’t very surprising because a decade ago the Reserve Bank wasn’t seriously aiming to deliver inflation at 2 per cent (the target midpoint): we might have been happy enough to take it if inflation had got there of its own accord, but our projections (the Governor’s choice) rarely showed inflation dropping below 2.5 per cent any time soon.  Actual core inflation was up around 3 per cent.

And these days?  Well, core inflation hasn’t been anywhere near 2 per cent for years now –  persistently below.  And although the Bank consistently talks of getting inflation back to 2 per cent, it hasn’t done so, and for several years consistently erred on the hawkish side, with constant talk of wanting to “normalise” interest rates, and actually following through on an unnecessary and ill-judged tightening cycle.   Even now, “normalisation” got a lot of attention in last week’s FSR (although mercifully absent from the speech), and the Bank constantly talks about not wanting to act aggressively to get inflation back to target.  Any rational observer would not only assume inflation will be materially lower than it was, but that the Bank is quite relaxed about that (it more or less says so).  The practical target isn’t really 2 per cent –  any more than it was, on the other side, 10 years ago – but something a bit lower.

The Bank must hate data from the inflation-indexed bond market (because it never engages with it in any of its publications), but the gap between indexed and conventional bonds is not inconsistent with my story.     Interpreting that data in fine detail isn’t easy. For a long time, we had only a single indexed bond (matured in Feb 2016), and by late in its life headline inflation (eg the GST change in 2010) mattered much more than the medium to long-term outlook).  These days there are several indexed bonds, but they have fixed maturity dates while the Reserve Bank’s published “10 year bond rate” has, in effect, a maturity date that moves through time.

But consider this chart, showing the gap between yields on successive indexed bonds and the conventional 10 year bond rate.

IIB expecs to dec 17

In the years prior to 2008 (when the indexed bond still had 10 years to run), the implied inflation expectation was around 2.5 per cent.   As noted earlier, that wasn’t too far from how we were running things in practice.   What of now?  It is late 2017, so 10 years from now is roughly half way between 2025 and 2030, the two indexed bond maturity dates either side of 2027.   In November, the average gap between orange and grey lines was 1.3 per cent, and for the year to date the average gap has been 1.2 per cent.

No doubt, there are all sorts of idiosnycratic things going on, so these breakeven inflation rates may not be “true” inflation expectations (as, for example, they weren’t in the midst of the crisis in 2008).  There are, for example, a lot of inflation bonds on the market, and it is possible that Treasury has somewhat glutted the market.    My point simply is that if one wants to make sense of relationships between unemployment (or other capacity measures) and core inflation over the Wheeler years, it is wilfully blind to simply ignore a story about changing inflation norms.

The next chart is just a rough and ready thought experiment.  What if, when Graeme Wheeler took office in September 2012, inflation expectations were genuinely about 2 per cent, and people really thought that was what the Reserve Bank was serious about.  The indexed bond yields –  rough and ready as they are –  suggest that isn’t wildly implausible.  And, say, now people really think the target (for sectoral core inflation) is more like 1.3 per cent –  the most recent actuals are 1.4 per cent.  Then the chart just shows the relationship (using quarterly data) between the unemployment rate and the gap between actual core inflation and an implied target taken by interpolating from 2 per cent in 2012 to 1.3 per cent now.

GS speech 4

I”m not suggesting that is the “true” relationship, but it looks like an idea worth taking more seriously than the Bank has thus far been willing to do in public. After all, expectations adjust gradually in most circumstances.  It seems negligent, or deliberately obtuse, not even to engage with the possibility.

After all, the “acting Governor” –  I almost slipped there and initially typed it as Governor – ends his speech with the suggestion that

To the extent that the leverage of monetary policy over domestic inflation may have reduced, this suggests a cautious approach when responding to inflation deviations from target and careful attention to our assessment of economic slack. It may be appropriate for monetary policy to put relatively more weight on output, employment and financial stability relative to inflation.

Why wouldn’t a reasonable observer conclude that the Bank isn’t really targeting 2 per cent (although it might be happy enough to get there by accident) and continue to adjust their expectations and behaviour accordingly.

With a new government planning to revise the Bank’s mandate to increase the Bank’s focus on employment/unemployment, Spencer’s line would almost be some sort of sick joke if it weren’t so serious.    When the unemployment rate has been above New Zealand estimates of a NAIRU for nine years, and when the economic recovery (average growth in real per capita GDP) has been so muted, you might reasonably suppose that the government would have been expecting the Bank to do its job more energetically –  which would involve getting inflation back to target, and in the process finally delivering an unemployment rate around the (unobservable NAIRU) and even a bit faster real GDP growth.  But Spencer –  with no mandate whatever, but presumably with the support of his colleagues, Bascand and McDermott –  wants to tell us that their idea of putting more focus on “employment and output” than in the past has been to deliberately deliver such weak cyclical outcomes –  ie deliberately accept higher unemployment/lower employment than is strictly necessary.  And the implicit promise is more of the same to come, at least if people like them are left in charge.  I hope the Minister of Finance is paying attention, and that his recent talk of possibly removing the midpoint reference from the PTA wasn’t a sign that he has begun to buy into this Wheelerish mentality (even if given a glossed up public face by his colleagues now that they are minding the store).

 

 

 

Shameless and shameful

Michael Reddell China, NZ politics

On Monday, just across the road from Parliament, Victoria University’s Institute for Governance and Policy Studies hosted a lunchtime lecture from Professor Anne-Marie Brady.  The lecture was built around her Magic Weapons paper on the extent of Chinese government/Party influence activities in New Zealand (and elsewhere), and her shorter policy brief with some specific proposals for the new government on how to deal with the issue (I wrote about that latter piece recently here).     (Radio New Zealand also had a good interview with Brady this morning, prompted by the new legislation announced yesterday by the Australian government, as part of its efforts to deal with this official Chinese interference.)

New Zealanders owe Professor Brady a considerable debt of gratitude for, first, writing her detailed paper, and secondly for deciding to put it in the public domain (it was done as part of an international project on Chinese influence-seeking activities globally, and the papers by other scholars have not yet been made public).    Her paper has found a receptive audience internationally (and she mentioned that Francis Fukayama has underway work for a similar paper on Chinese influence-seeking in the US).

Listening to her, one gets the sense that she isn’t that comfortable in the public spotlight.  Many academics aren’t.   In her lecture the other day she felt the need to include a photo of her Chinese husband and her three half-Chinese children –  no doubt a push back against the sort of despicable pre-election attempt to discredit her and her research tried by the then Attorney-General.  It can be a lonely position for an academic when her expert and well-documented research runs head-on into a wall of political indifference (or worse), vested interests, and a media which seems not quite sure whether or not this is a “proper” issue even to be talking about.    It is not as if (I’m aware that ) anyone has seriously sought to question the factual basis of her paper, or has demonstrated major flaws in her analysis and reasoning.   It seems as if there is just a desperate desire that she, and the issue, would go away.    Absent that, the political and business elites simply want to pretend it doesn’t exist.   I hope she doesn’t just retreat to her study.

Her Victoria lecture the other day covered pretty familiar ground (although many of the attendees indicated that they hadn’t read either of her papers so much will have been new for them).     There was:

  • the active efforts (largely successful) of the Communist Party to get effective control of almost all Chinese language media in New Zealand (similar story in Australia) –  and thus the story of the issues she is raising goes unreported in that media,
  • the efforts of suborn former senior politicians, with roles that align their personal economic interests with those of the Chinese authorites,
  • concerns about political donations, especially from individuals/entities with close ties to the CCP, and the associated close ties between political party leaders and China,
  • Chinese government interests in influencing New Zealand, both to stay quiet on issues of concern to China, and to detach New Zealand from its historical defence and intelligence relationships,
  • China’s interests in Antartica,
  • Confucius Institutes, funded and controlled by China, as part of New Zealand universities, complete with restrictions on what can be talked about,
  • efforts to promote ethnic Chinese New Zealand citizens, with those ties to the Embassy/CCP, into electoral politics –  in New Zealand’s case, both Jian Yang and Raymond Huo.

Huo is now chair of Parliament’s Justice Committee – the same Huo who, as she pointed out, is responsible for Labour campaigning for the Chinese vote under a Xi Jinping slogan, and who – Professor Brady reports –  was present at a meeting in Auckland earlier this year in which Communist Party propaganda chiefs (“propaganda” is apparently a literal translation of the role/office) met with local Chinese language media to offer “guidance” on how issues of interest to China should be reported.   A serving member of New Zealand’s Parliament…….

Brady noted that the Communist Party’s United Front work has always been an integral element in how the Party works, but that the efforts are now being undertaken with an intensity and importance that is greater than at any time since 1949, when the CCP took power.  It is a China that has thrown off Deng Xiaoping’s injunction (post Tiananmen) that China should mask its growing power and bide its time.

When it came to the New Zealand government, in some respects I thought Professor Brady pulled her punches (although she was happy to note that she couldn’t understand how it was that National Party MP Jian Yang – self-confessed Communist Party member, former member of the Chinese intelligence services, and someone who has acknowledged misrepresenting his past on residency/citizenship application papers –  is still in Parliament).   I’m not sure how much of that is tactical –  giving the new government a chance, hoping to be heard by talking constructively.   I fear that any such hope is misplaced.

In just the last week we’ve had a couple of episodes that confirm that the new government is quite as craven –  indifferent, obsequious –  as its predecessor.

A month or two ago, at the time of the 19th Communist Party Congress, it came to light through the Chinese media that the presidents of both the National and Labour parties had been sending warm greetings and congratulations.   This last weekend, the Labour Party went one step worse.

The Chinese Communist Party held a congress in Beijing for representatives of such political parties from around the world (300 from 120 countries) as it could gather to its embrace.    Most of them were from developing countries.  Nigel Haworth, the President of the New Zealand Labour Party, attended.   Here is how one Chinese media outlet reported the event.

The CPC in Dialogue with World Political Parties High Level Meeting was the first major multilateral diplomacy event hosted by China after the recently concluded 19th CPC National Congress.

It was also the first time the CPC held a high-level meeting with such a wide range of political parties from around the world…..

During the closing ceremony, Chinese State Councilor Yang Jiechi stressed that the meeting was a complete success with a broad consensus reached. He also said CPC leaders elaborated on the new guiding theory introduced by the 19th CPC National Congress.

“The innovative theoretical and practical outcomes of the 19th CPC National Congress not only have milestone significance for the development of China, but also provide good examples for the development of other countries, especially developing countries,” Yang said.

The Beijing Initiative issued after the meeting states that over the past five years, China has achieved historic transformations and the country is making new and greater contributions to the world.

It also highlighted that lasting peace, universal security, and common prosperity have increasingly become the aspiration of people worldwide, and it’s the unshakable responsibility and mission of political parties to steer the world in this direction.

“The most important thing between the 18th and 19th CPC party congress was the belt and road initiative,” according to the Russian Communist Party’s Dmitry Novikov. “And the most important thing about the initiative is the economic cooperation among various countries. Such cooperation leads to the promotion of relations in culture and politics.”

And the President of the New Zealand Labour Party was party to all of this.    In fact, not just a party to it, but someone who was willing to come out openly in praise of Xi Jinping.

Here he is, talking of Xi Jinping’s opening speech  (here and here)

“I think it is a very good speech. I think it is a very challenging speech. I think he is taking a very brave step, trying to lead the world and to think about the global challenges in a cooperative manner.  Historically we have wars and we have crisis, but he is posing a possibility of a different way of moving forward, a way based on collaboration and cooperation.  Making cooperation work is difficult, but he think that’s a better way for mankind. I think we all share that view.”

It is shameful.     Probably not even Peter Goodfellow would have gone quite that far –  if only because there might have been some (understandable) rebellion in the ranks if he had gone that public.

This is the same Chinese Communist Party (and associated state) that

  • flouts international law, including with its aggressive expansionism in the South China Sea,
  • denies any political rights to its own people,
  • that is directly responsible for the deaths of tens of millions of people (and which only just pulled back from its forced abortions practices),
  • lets dissidents die in prison,
  • has no concept of the rule of law,
  • persecutes religious believers (Christian, Muslim, Falun Gong or whatever),
  • actively interferes in the domestic politics of other countries in all manner of different ways,
  • and so on.

In her lecture the other day, Professor Brady mentioned Haworth’s comments, but this was one of the places she pulled her punches.  She asked, rhetorically, if we could imagine a New Zealand political party president attending a Republican Party convention and making such public remarks.   Or even a Russian political event.    At one level it is a fair point –  Haworth’s participation in this CCP event, and his positive comments, have gone totally unremarked in the New Zealand media (or from Opposition parties), in a way that would be simply inconceivable in those other cases.    But at another, it falls into the trap beloved of China-sympathisers and people on the left (one such academic at her lecture attempted this), of drawing a moral equivalence between, say, the United States and the UK on the one hand, and Communist China on the other.    A much better comparison would be to ask if we could imagine a major New Zealand political party President attending Nazi Party congresses pre-war or Soviet Communist party congresses?  And whether, even if it had happened, we would look back now with equanimity at associating so strongly with such an evil.  Such is the CCP.   The fact that certain New Zealand firms make a lot of money trading with them –  or that our political parties appear to raise large donations –  doesn’t change that character.

Former National Party Prime Minister, Jenny Shipley, was apparently also at the meeting, speaking warmly of China’s One Belt One Road initiative (all about geopolitical influence).

Yesterday, we had yet more proof of how far gone the New Zealand authorities (and the new New Zealand government are).     As I’d noted a couple of weeks ago, Victoria University (specifically its China-funded and controlled Confucius Institute) and the New Zealand Institute for International Affairs put on a half day symposium (celebration?) of 45 years of diplomatic relations with the People’s Republic of China PRC).   Not a word of scepticism or criticism was to be expected from the programme –  there wasn’t for example an opportunity for Professor Brady to present her work, and alternative perspectives on it to be heard.

Quite late in the piece, reportedly, the new Minister of Foreign Affairs agreed to be a keynote speaker at this forum, his first major speech as Minister.  Winston Peters had, in Opposition, occasionally been heard to express some unease about the activities of the PRC in New Zealand, including the questions around National Party MP Jian Yang (recall that even Charles Finny, former senior diplomat, noted that he is always very careful about what he says in front on Yang and Raymond Huo, given their closeness to the PRC Embassy).   In office, the Rt Hon Winston Peters not just tows the MFAT line, repeating the same obsequious words as former National Party ministers, he takes it up another step.

There was the published text, which was bad enough.   In entire speech he could only manage this, that might be pointed to for a modicum of self-respect.

New Zealand supports a stable, rules-based order in the Asia-Pacific region in which free trade and connectivity can thrive.  We urge parties to resolve disputes in accordance with international law, on the basis of diplomacy and dialogue.

New Zealand and China do not always see eye to eye on every issue; we are different countries and New Zealanders are proudly independent.  However,  China and New Zealand have a close, constructive and increasingly mature relationship.  Where we do have different perspectives, we raise these with each other in ways that are cordial, constructive and clear.

“New Zealanders” might be proudly independent, but it isn’t clear that our governments are.  At a New Zealand event –  so it wasn’t even a matter of talking politely in China itself –  our Foreign Minister can’t bring himself to name any specific concerns or risks (despite rising international unease, and the material documented by Professor Brady).   And if he ever has concerns he’ll raise them in “cordial” way………”cordial” and direct interference by a foreign power in New Zealand, undermining the freedoms of hundreds of thousands of our own people (ethnic Chinese) doesn’t strike me as the sort of words that naturally belong together.  At least in a country whose government retains any self-respect.

But then it got worse, at least according to the Stuff report of how Peters departed from his written text.

“We should also remember this when we are making judgements about China – about freedom and their laws: that when you have hundreds of millions of people to be re-employed and relocated with the change of your economic structure, you have some massive, huge problems.

“Sometimes the West and commentators in the West should have a little more regard to that and the economic outcome for those people, rather than constantly harping on about the romance of ‘freedom’, or as famous singer Janis Joplin once sang in her song: ‘freedom is just another word for nothing else to lose’.

“In some ways the Chinese have a lot to teach us about uplifting everyone’s economic futures in their plans.”

It is so remarkably reminiscent of the Western fellow travellers of the Soviet Union in decades past –  tens of millions might die, but not to worry, a new Jerusalem is on the way to being built.   Basic rights and freedoms might be trampled on, or simply not exist at all, but not to worry….what is freedom after all?

Personally, I don’t think the biggest issue in the China/New Zealand official relationship should be how the Chinese party/state treats its own people –  abominable as that is.  The issues people like Professor Brady are raising are about the direct, systematic, in-depth, interference by another country  –  a hostile power, run by a regime with mostly alien values –  in the domestic affairs of other countries.  Our own most of all.  International expansionism and defiance of the rule of international law might matter too.  And none of that has any connection whatever to improvements in material living standards in China.

And what to make of the nonsense claim that “the Chinese have a lot to teach us about uplifting everyone’s economic future in their plans”.  That is about as ignorant as it is offensive.

I’ve shown this chart before

Here is a chart showing GDP per capita for China, and a range of now-advanced Asian countries/economies.  I’ve shown each country’s GDP per capita as a percentage of that for the United States for each of 1913, 1950, and 2014, using the Maddison database for the 1913 observation and the Conference Board (which built on Maddison’s work) for the more recent observations.  Data are a bit patchy in those earlier decades, but 1913 was before China descended into civil  and external wars (from the late 1920s), and 1950 was the year after the Communist Party took control of the mainland.

asia gdp pc cf US

What stands out is just how badly communist-ruled China has done economically, and especially relative to the three other ethnic-Chinese countries/territories.  Substantial re-convergence has happened in all the other countries on the chart, but that in China has been excruciatingly slow.  A few buoyant decades (the aftermath of which we have still to see) struggle to make up for the earlier decades of even worse Communist mis-rule.

Or how about this one, using Conference Board data for real GDP per person employed (they don’t have real GDP per hour worked for China, but estimates are very low)?

china GDP ppe

Even on official Chinese data, the record is pretty poor: China barely matches Sri Lanka which was torn apart by decades of civil war, and doesn’t even begin to match the performance of the better east Asian economies (none of which has anything like the waste, the massive distortions, of China).   Surely China is best seen as a (potential) wealth-destruction story?  Taiwan’s numbers might be a reasonable benchmark for what could have been.  Taiwan threatens no one.

Just to cap an egregious speech, the Opposition foreign affairs spokesman indicated that he didn’t disagree with what Winston Peters had had to say  (well, after his government’s track record of cravenness, he would, wouldn’t he).

I came home from Anne-Marie Brady’s lecture the other day and pulled off the bookshelf my copy of The Appeasers, written in the 1960s by Martin Gilbert and Richard Gott, a heavily-documented account of British appeasement of Germany from 1933 onwards.    As I started reading, lots seemed to ring true to today.

Two situations are never fully alike.  For a start, New Zealand isn’t a “great power” and China is (as Germany was becoming again).    And Germany had little real interest in interfering in domestic British politics –  and there was no large German diaspora in the UK to attempt to corral and control.    But there is a lot of the same willed blindness to the evil that the regime represented.    In the 1930s, it wasn’t the bureaucrats who were the problem –  from the very first, British Ambassadors in Berlin recognised and reported on the nature of the regime, its domestic abuses and its external threats.     There were various forces at work it seemed –  a fear of Communism (and thus Nazism as perhaps some sort of bulwark against something even worse), unease and even guilt over some of the Treaty of Versailles provisions, the fear of new conflict (only 15 years after the last war), and often some sort of admiration for the order the new German government was bringing to things (and some philo-Germanism among many of the British upper classes).  As Gilbert and Gott summarise it

“Like alcohol, pro-Germanism dulled the senses of those who over-indulged, and many English diplomats, politicians and men of influence insisted upon interpreting German developments in such a way as to suggest patterns of cooperation that did not exist.”

Britain and France could (and should) have stopped Germany earlier.  New Zealand can’t stop China, of course, but we can assert ourselves, and reassert some self-respect, for our system, our freedoms, and for the interests of like-minded countries.    We can call out, firmly (not cordially) Chinese influence-seeking etc where we see it –  as the Australian government has been much more willing to do.  We can cease to pander to such an obnoxious regime that not only abuses its own people (including failing to deliver economically) but represents a threat to its neighbours, and which persists in seeking to interfere directly in other countries, whether in its neighbourhood or not, whether with large ethnic Chinese minorities (as NZ, Australia, and Canada) or not.  Our politicians shame us by their deference to such an evil power –  and frankly, one that has little real ability to harm us (as distinct from harming a few vested interests).

In her lecture the other day, and in her policy brief, Anne-Marie Brady called for our political leaders to insist that none of their MPs will have anything further to do with entities involved in the PRC United Front efforts.   That would certainly be a start –  though the Jian Yang stain on our democracy really needs to be removed altogether –  but it is probably a rather small part of the issue: we need political leaders who will recognise  –  and openly acknowledge –  the nature of the regime, and stop fooling themselves (and attempting to fool us) about the nature of the regime they defend, and consort with.   Perhaps our leaders are no worse than, say, British Cabinet ministers in the 1930s who enjoyed hunting with Hermann Goering, but if that is the standard they are comfortable with, New Zealand is in an even worse place than I’d supposed.   In their book, Gilbert and Gott quote from the former head of the British foreign service:

“Looking back to the pre-1939 era Vansittart wrote: “I frequently said that those who ask to be deceived must not grumble if they are gratified”

Indeed.

I said that I thought Professor Brady was inclined to pull her punches a bit.  Asked what New Zealand can do,  she began her response claiming that “Australia can be more forceful”.   No doubt Australia is, and will remain, more forceful –  we’ve seen in the DFAT Secretary’s speech, in the ASIO report, in the foreign affairs White Paper, and in the new legislation details of which were announced yesterday.  But “can” isn’t the operative word.   If trade is your concern, Australia trades more heavily with China than New Zealand firms do.  If distance is your concern, Australia is physically closer to Asia –  and the waterways of the South China Sea.  Our political leaders – National, Labour, New Zealand First, Green –  could speak out, could act forcefully.  But they won’t.

Shameless and shameful.

 

UPDATE: As I pressed publish, I discovered that I’d been sent a link to some other reflections on Peters and Haworth by China expert Geremie Barme.

 

 

 

 

Whither cash?

Michael Reddell Currency, e-cash, zero lower bound

Last week the Reserve Bank released an interesting Analytical Note on “Crypto-currencies – An introduction to not-so-funny moneys” .    If, like me, you hadn’t paid a great deal of attention to Bitcoin and the like, it is a very useful introduction to the subject, from a monetary perspective (including some of the potential policy and regulatory issues).  At least for me, it struck just the right balance of detail and perspective.

Analytical Notes are published with the standard disclaimer that the material in them represents the views of the authors rather than, necessarily, of the Bank.  (That said, I’m pretty sure nothing has ever been published in one that the Bank was unhappy with.)  They are mostly written by researchers rather than policy people.  So it was interesting, and perhaps a little surprising, to get to the second to last page of this paper and find this

Work is currently under-way to assess the future demand for New Zealand fiat currency and to consider whether it would be feasible for the Reserve Bank to replace the physical currency that currently circulates with a digital alternative. Over time, analysis associated with this project will filter through into the public domain.

Interesting, because that is quite a radical and specific suggestion: to replace physical currency with a digital alternative.   And surprising because there was no hint of this work –  on a pretty major issue affecting all New Zealanders –  in the Reserve Bank’s Statement of Intent released only a few months ago.   Statements of Intent can seem like just another bureaucratic hoop to jump through, but the requirement to prepare and publish them was put in place for a reason: it is supposed to be the vehicle through which the Minister of Finance can inject his or her views on what the Bank’s work priorities should be, and is supposed to enable stakeholders and the public more generally to get a sense of what the Bank is up to.

I’m pleased the Reserve Bank is now doing this work on the future of currency.  Over the last couple of years I have been critical of the fact that, in published documents, there was no sign of any such preparatory work going on (including, more generally, around dealing with the problems of the near-zero lower bound, which will almost certainly become binding for New Zealand in our next recession).  In this year’s Statement of Intent, for example, published as recently as the end of June, there was 1.5 pages (pp 28-29) on the Bank’s currency functions, and not a hint of any work on the possibility of replacing physical currency with digital currency.   Perhaps doing the work is an initiative of temporary “acting Governor” –  but then he was required, by law, as Deputy Governor, to sign the Statement of Intent.  Or perhaps it was just the Bank deliberately keeping things secret?

As usual with the Bank, they talk loftily about how the analysis will eventually “filter through to the public domain”.  That isn’t good enough –  this is publicly funded work on a matter of considerable potential significance – , and I have lodged an Official Information Act request for the research and analysis they have already done.

I’ve come and gone for decades on what the best approach to physical currency is.  I’ve long been troubled by the monopoly Parliament gave to the Reserve Bank over the issuance of physical notes and coin.  There is no good economic reason for it (nothing about the efficacy of monetary policy for example) –  and for half of modern New Zealand history it wasn’t the situation in New Zealand.  For decades it may well have led to inefficiently low currency holdings: in a genuinely competitive market there is a reasonable chance that (eg) serial number lotteries would have provided a (expected) return to holders of bank notes.  In the high inflation years –  and especially as interest rates were deregulated –  holding as little currency as possible was the sensible thing to do.

notes and coin

As the chart shows, the ratio of notes and coins (in the hands of the public) to GDP troughed in the year to March 1988 –  when inflation and interest rates were both high (and, of course, returns to holding currency were zero).

At one level, the partial recovery in the amount of physical currency held isn’t too surprising.  Inflation has been low for decades, and interest rates are now very low too.  Holding physical currency isn’t very costly at all.

Then again, there have been huge advances in payments technologies.   Even when I started work, the Reserve Bank still offered to pay its staff (I think perhaps only the clerical and operational staff) in cash, and that wouldn’t have been too uncommon then.  ATMs didn’t exist then –  it was the queue at the local bank branch each Friday lunchtime –  let alone EFTPOS, internet banking and so on.   These days, by contrast, a huge proportion (by value) of transactions occur electronically.  Even school fairs –  often held out previously as the sort of place one really needed cash for –  have often gone electronic to some extent at least.

And although the ratio of cash to GDP is quite low in New Zealand (by international standards –  in many advanced economies something around 5 per cent isn’t uncommon –  there is still a lot of cash around.    The numbers in the chart are equivalent to a bit more than $1000 per man, woman, and child.    For a household like mine, more than $5000.    I’m a slow adapter, and almost always do have a reasonable amount of cash on me, but I’d be surprised if on an average day our household had more than $250 in cash in total (surveys from other countries suggest that isn’t unusual).   I’m not sure I’ve ever had a $100 bill, but Reserve Bank data suggest that on average each man, woman, and child has $400 in $100 bills.

As it happens, last week I was reading (Harvard economics professor) Ken Rogoff’s book The Curse of Cash.   As he notes, in the United States, there is around $3400 per man, woman, and child outstanding in US $100 bills –  while surveys of what ordinary consumers are actually carrying suggest that no more than 1 in 20 adults has a $100 bill on them at any one time.    Rogoff makes a pretty strong case that the bulk of physical currency holdings – even allowing, in say the US case, for the use of the USD in other countries – is held to facilitate illegality.   That could be outright illegal activities –  the drugs trade for example –  or tax evasion in respect of the proceeds of lawful activities.  The likely revenue losses, on his estimates, are very substantial.    The scale of the problem is probably smaller here, but there is no point pretending that the issue is specific to the United States (and, as Rogoff documents, a number of European countries have now put limits on the maximum size of cash payments –  although such rules seem more likely to catch those who comply with the law, rather than those who knowingly break it).

Somewhat reluctantly, Rogoff’s book has shifted my perspective on the physical cash issue.    As a macroeconomist, my main interest in this area in recent years has been to do something about the near-zero lower bound on nominal interest rates.  If the Reserve Bank cut interest rates to, say, -5 per cent, it would be attractive for people to pull money out of banks and hold it in physical currency in safe deposit boxes. If that happened to any large extent it would substantially undermine the effectiveness of monetary policy.  The fear that it might happen has already constrained central banks in various countries, and no one has been willing to cut official interest rates below 0.75 per cent (which was also about how far we thought the OCR could be cut when I led some work on the issue at the Reserve Bank some years ago).

Getting rid of physical currency altogether would solve the problem.  If there is no domestic cash, clearly you can’t hold any.  Of course, you could always seek out foreign cash, but the process of doing that would lower our exchange rate –  one of the ways monetary policy works, and thus not a problem.    But one doesn’t need to get rid of cash –  or even just large denomination notes –  to limit that risk.    There are various clever options that have been developed in the literature (effectively involving an exchange rate between physical and electronic cash), and as I’ve noted here previously, one could achieve the same result by simply putting a physical limit on the amount of currency the Reserve Bank issues, and then auctioning it to the banks (if demand surged this would, in effect, introduce an exchange rate or a fee).    It is disconcerting that, as far as we can tell, no country is properly prepared to use options like these in the next recession (which, in itself, risks exacerbating the recession because smart observers will recognise that governments have fewer options than usual) –  no one has (at least openly) done the preparatory legal work, or prepared the ground with the public.  Our Reserve Bank is, as as we can tell, no exception.

I’ve resisted the idea of getting rid of physical currency on both convenience and privacy grounds.  There is, as yet, no real substitute for cash if –  say –  one wants to send a child to the local dairy to buy the newspaper when one is on holiday.   And the ability to conduct entirely innocent transactions without the state being able to know what one is spending one’s money on (or one’s bank for that matter) remains a very attractive ideal.

And yet….and yet…..I wonder if it is a real freedom now to any great extent anyway.   We might not gone all the way –  yet –  to China’s “social credit” scoring system, but you have to be pretty determined to avoid the gaze of a government determined to find out what you’ve been up to.  Some of that is voluntary –  people choose to carry phones around, for example, which locate you –  and some of it isn’t (local councils put up CCTVs, and so do all too many retailers). AML provisions, and know-your-customer rules are ever more pervasive and intrusive.   Sure, using cash enables one to keep from a spouse what one spent on a birthday present, or where it was bought from, but it is a pretty small space left.

And so perhaps it is best for us to think now about serious steps towards phasing out physical currency.  Rogoff himself doesn’t recommend complete abolition at this stage, but rather ceasing to issue, and then over time withdrawing, high denomination notes.   Our largest note isn’t very large at all (NZD100 is only around USD70) but as I noted earlier a huge share of currency in circulation is in the form of $100 bills, even in New Zealand, which few people use for day-to-day transactions that are both lawful in themselves and where there is no intention to evade lawful tax obligations.   But if we were to amend the law to prohibit the Reserve Bank from issuing notes larger than (say) $20 –  and this is a decision that should be made by Parliament or at least an elected minister, not by a single bureaucrat –  we’d still make small cash transaction easy enough (school fair, or the kid sent to buy the newspaper, while greatly increasing the difficulty of a major flight to cash in the next serious recession, and increasing the difficulty of tax evasion and other criminal transactions.

If the government were to choose to go this way, it would still make sense for active precautions to be taken now to reduce the risk of the effectiveness of monetary policy being undermined even by a flight to $20 notes –   they take up roughly five times as much space as the equivalent amount in $100 notes, but you can still fit a lot of money in a secure vault.   Whatever the mix of measures, it is really important that the authorities –  Bank, Treasury, IRD, government, FMA –  adopt a greater degree of urgency.  No one knows when the next serious recession will be, but it isn’t prudent (ever) to assume it is far away.

And what of the Reserve Bank’s own scheme: the possibility of replacing physical currency with digital Reserve Bank currency?   We need to see more of what they have in mind.  My own long-held prediction is that they are two quite different products –  only the RB can issue physical notes, while anyone can issue electronic transactions media –  and that in normal times demand for a Reserve Bank retail-level digital currency would be almost non-existent.   That doesn’t mean they shouldn’t do it: there is something about the democratisation of finance, in enabling the public to hold the same sort of secure liability banks already can (in their case electronic settlement account balances), and  –  as we saw globally in 2008 –  banks runs can still happen.   Unless society decides to completely up-end the entire monetary system (and I have readers who favour that), we need an “outside money” that people can convert their bank liabilities into if/when they lose confidence in the issuing institution or system.    For most purposes, a digital Reserve Bank retail currency should be able to do that at least as well as physical banknotes.

Most….but not necessarily all (when serious people worry about EMP attacks on/by North Korea, there is no point pretending electronics is the answer to everything).   Those are the sorts of issues that need to be carefully examined, preferably in an open way, rather than with conclusions loftily filtered out to the public when it suits the officials.

Rogoff’s book is worth reading, especially (but not only) if you are new to the issue.  He covers a range of issues I didn’t have space for, including natural disasters (where cash might be more useful than cards, but most people don’t hold much cash anyway, so it actually isn’t that much of a help.)  Like the Reserve Bank paper, he also points out that things like Bitcoin offer a lot less effective anonymity than many people realise.

 

Exports in a cross-country perspective

Michael Reddell Exports, New Zealand economic performance

Across the advanced world, exports have been becoming a larger share of most countries’ GDP.  This chart shows the median export share for OECD countries going back to 1971.

export % of GDP OECD

The OECD only has complete data for all its member countries since 1995, but in that time total exports as a share of total OECD GDP have risen from 19.5 per cent to 28.3 per cent.

There is some short-term variability –  I’m not sure what explains the 2016 dip –  but the trend has been pretty strongly upwards.  That’s encouraging: trade (imports and exports, domestic and foreign) is a key element of prosperity.

For quite a while, New Zealand’s performance was very similar to that of the median OECD country

export %

and then it wasn’t.    The last time New Zealand’s export share matched that of the average OECD country was around 2000/01, when our exchange rate was temporarily very low (and commodity prices were quite high).   At very least, we’ve been diverging for 15 years now, although it looks to me that the divergence really dates back at least 20 years to the early-mid 1990s.

Once upon a time –  well before these charts –  New Zealand traded internationally much more than most other countries.   With a high share of exports in GDP, and a high GDP per capita, a common line you find in older books was that New Zealand had among the very highest per capita exports of any country.    These days, not only is GDP per capita below the OECD median, but so is our export share of GDP.

Small countries typically have a larger share of exports in their GDP than large countries.  That isn’t a mark of success for the small country, just a reflection of the fact that in a small country there are fewer trading partners.  If your firm has a great world-beating product and yet is based in the US quite a large proportion of your sales will naturally be at home.  If your firm is based in Iceland or Luxembourg, almost all your sales will be recorded as exports.  US exports as a share of GDP are about 12 per cent at present, but divide the country into two separate countries and even if nothing else changes the exports/GDP shares of both new countries will be higher than those of the United States.   The median small OECD country currently has gross exports of around 55 per cent of GDP  (New Zealand 26 per cent).

On the other hand, we also expect to see countries that are far away do less international trade than countries that are close to other countries (especially countries at similar stages of economic development).   That isn’t just a statistical issue, an artefact of where national boundaries are drawn.  Distance is costly –  there are fewer economic opportunities for trade.     That has become over more apparent in recent decades as cross-border production processes have become much more important: in the course of producing a complex product, component parts at different stages of assembly may cross international borders (and be recorded as exports) several times.   This has been a particular important possibility in Europe, and has been part of the success of formerly-Communist countries like Slovakia.    Distance is an enormous disadvantage –  enormous distance (such as New Zealand suffers) even more so.

The OECD is now producing data on the share of domestic value-added in a country’s exports.  The data only go back to 1995, and are only available with quite a lag (the latest are for 2014) but you can see the difference between New Zealand’s experience and that of the median OECD country.

value-added

These opportunities (gains from trade that weren’t economically posssible a few generations ago) generally aren’t available to New Zealand based firms.  Then again, a widening in this particular gap isn’t the explanation for the divergence between New Zealand’s export performance over the last decade and that of the median OECD country (since the gap hasn’t widened further).

New Zealand has just been doing poorly.

Here is one comparison I found interesting.

nz vs fr

France has more than ten times the population of New Zealand and yet its foreign trade share now exceeds that of New Zealand.    The United Kingdom –  similar population to France –  also now has a higher trade share than New Zealand.   And the difference isn’t just down to components shuffling back and forth across frontiers in the course of manufacturing (eg) Airbus planes.  New Zealand’s exports have a larger domestic value-added share than those of the UK or France, but adjust for that and all three countries now have export value-added shares of GDP of around 21 per cent.  In a successful small country you would expect –  and would typically find –  a much higher percentage.

Remoteness looks like an enormous disadvantage for New Zealand, at least for selling anything much other than natural resource based products  (even our tourism numbers aren’t that impressive by international standards).   Here is the comparison with another small remote country, Israel  (it is both some distance from other advanced country markets, and made more remote by the political barriers of its location/neighbours).

nz vs israel

The Israel series is more volatile than New Zealand’s –  probably partly reflecting the extreme macroeconomic instability in the Israel earlier in the period –  but the overall picture is depressingly similar (and that in a country where R&D spending is now around 4 per cent of GDP).    The other similarity with New Zealand: very rapid immigration-driven population growth, into an economically difficult location.  As I’ve illustrated in previous posts, Israel has struggled to achieve much productivity growth and has a similarly low level of real GDP per capita.

Looking back over the last few decades, it is sobering to note that natural-resource dependent advanced economies are foremost among those that have struggled to achieve higher international trade shares of GDP.    It isn’t some sort of fixed rule: if, like Australia, vast new deposits of minerals become economically exploitable, a remote natural resource dependent economy can see its export share of GDP rise.  And if you have enough natural resources and few enough people, you can be very well-off indeed, even if the export share of GDP isn’t rising (Norway is the only OECD country where exports have’t risen at all as a share of GDP since 1971).  But if you are very dependent on natural resource exports –  and that dependence doesn’t seem to be changing –  then you’d probably want to be very cautious about actively using policy to drive up the population unless –  as with Australia –  there are new waves of nature’s bounty to share around.

New Zealand –  apparently structurally unable to secure rapid growth in exports based on anything other than natural resource –  looks not only like the last place on earth, but the last place in the advanced world to which it would make sense to actively set out to locate ever more people.  And yet is exactly what one government after enough does, apparently blind to paucity of economic opportunities here.    They might wish it was different, and perhaps one day it even will be, but for now there is just no evidence to support their strategies.  Every year, in following that course, governments make it harder for New Zealanders as a whole to prosper.

Oh, and what changed in the last 20 years or so –  to go back to that second chart?  After 20 years of quite low levels of immigration, active pursuit of large non-citizen immigration targets became a centrepiece of policy again.   Without great economic opportunities here –  already or created by the migrants –  that renewed population pressures just made it even harder, despite all the good work on economic reform in the previous decade –  for outward-oriented firms to succeed, and made the prospects of ever closing the income and productivity gaps to the rest of the OECD more remote than ever.

No fix for the flawed fundamentals

Michael Reddell New Zealand economic performance

I’ve had fairly low expectations of what a change of government might mean for overall economic policy, but at present the new government seems to be charting a course to under-deliver even those low expectations.

The Minister of Finance yesterday gave his major public speech since taking office, explicitly selling it as an outline of the government’s economic strategy.     Sadly, there wasn’t very much there, and much of what was there focused –  as his speech title did –  on sharing and redistributing, with very little on reversing the decades of dismal economic underperformance.   Simply cutting the pie differently is no long-term solution to the sort of failure that has seen almost a million New Zealanders (net) leave New Zealand for a better life, for them and their families, abroad.

During the election campaign I was somewhat critical of Labour for simply accepting the National government’s narrative that the economy was basically doing fine.  But at least then I could sort of understand why they might do it –  something about not scaring the voters in the centre ground and not coming across as alarmist when they didn’t have much of a solution.    It is bit more surprising, and much more disappointing, to see that narrative carried over into office.

Here is what the Minister of Finance had to say this morning

While the fundamentals of our economy were, and are, strong, the purpose of it had become lost.

Again, perhaps after some bad business confidence numbers he doesn’t want to scare the horses.  But (a) you don’t produce better outcomes without actually facing what has gone wrong in the past, and (b) it is starting to seem as though the Minister of Finance actually believes the story on some level.

Grant Robertson was born in 1971.  Even by then, our economy had been in relative decline for a couple of decades –  and all the contemporary experts knew it.  But if we were no longer among the most productive and wealthiest of the then advanced economies, at least we were still in the middle of the pack.  Since then, we’ve just lost further ground –  the relative decline was particularly bad in the 1970s, but there has never been a sustained period since then when we’ve looked like reversing any of the relative decline.  Not under National governments, and not under Labour government’s either.    When Grant Robertson went off to university, eastern and central Europe was still Communist-run, with highly inefficient poorly-performing economies.    These days, the better performing of those countries –  Slovakia, Slovenia, the Czech Republic – are closing in on New Zealand levels of productivity/income, and places like Hungary and Poland aren’t that further behind.   Turkey is on the brink of going past us.   They’ve done quite well, but still have a long way to go to catch up with the West European leaders.  We’ve just done really rather badly; mediocre at a (generous) best.

Economies that are performing well  are typically ones in which the tradables sector of the economy is growing.   Local firms are finding more products and services which they can sell to, or compete with, the rest of world.   But we’ve had no growth in real per capita tradables sector GDP since around 2000.  Exports are a share of GDP are, as I illustrated the other day, now at the lowest level since 1976.

Over the last quarter century – even after the economic reforms –  our productivity growth has been among the lowest in the OECD (and we started from a bad position).  Most starkly –  and this a point that Robertson does mention –  we’ve had no productivity growth at all for the last five year.

And then, of course, there is the disastrously dysfunctional housing/land market: a country with so much land nonetheless has some of highest house price to income ratios anywhere in the advanced world.

Frankly, the “fundamentals of our economy” are pretty poor, especially if what we care about is the ability to support high incomes (fairly shared) for all of our people.  Yes, there are some things we can chalk up on the other side:  we’ve largely avoided a domestic financial crisis, our government accounts are sound, our people are pretty highly skilled (we’ll come back to that one), and our unemployment rate isn’t too bad (even if it is still above a NAIRU).   But mostly those are ‘inputs”: the “outputs” and “outcomes” don’t look very attractive at all.  And that makes it all the harder to deal effectively with some of the pressing social (and environmental) issues.

You might think an incoming government was well-positioned to point this stuff out.  But I guess there is no point in doing so if you haven’t got a strategy that is likely to be (a) materially different from what went before, and thus (b) likely to produce material different outcomes.

Instead, they seem to want to play down the dismal economic data and follow The Treasury down the not-particularly-well-grounded path of the Living Standards Framework (which I wrote about a couple of weeks ago)

I have asked the Treasury to further develop and accelerate the world-leading work they have been doing on the Living Standards Framework.  This focuses on measuring our success in developing four capitals – financial, physical, human and social. These give a rounded measure of success and of how government policy is improving our well-being.

This is a far better framework for judging our success.

As I’ve suggested previously, it looks more like a way of avoiding confronting our really bad long-term economic performance and the very large trend outflow of our own people.

The Minister of Finance claims they will keep a focus on productivity.

Low productivity has been a cloud over the New Zealand economy for decades and previous governments have failed to tackle this issue – this government will not.

Which sounds okay, perhaps even momentarily encouraging.  But how are they going to do this?  The Minister identifies only two areas.   The first is skills.

Lifting the skills of our people is critical to solving the productivity challenge.

In fact, there is not the slightest evidence for this proposition, which would lead the reader to suppose that skill levels in New Zealand lagged behind those in other, more economically successful, OECD countries.   No doubt we can do better (and there are specific pockets of underperformance), and there have been some disconcerting developments in the PISA results in recent years.  But the OECD produced data only last year suggesting that New Zealand workers were among the two or three most highly-skilled in the OECD.      They used three measures and this was one of them

oecd problem solving

As I summed it up at the time

Looking across the three measures, by my reckoning only Finland, Japan, and perhaps Sweden do better than New Zealand.

Increased subsidies for tertiary education (the policy Robertson then advances) will, no doubt, serve a redistributional function (even if one of questionable merit –  and I say that as a parent with three kids likely to go to university in the next eight years).  But there is little evidence they will do anything to close aggregate productivity gaps –  which, in New Zealand, aren’t about the skills or energies workers bring with them, or even about our legal institutions, but about the profitable business opportunities firms can find here.

And the second strand to Robertson’s response to our productivity failure is R&D.

Also critical for lifting productivity is increased investment in Research, Development and Innovation. The first step in this is the introduction of an R and D Tax Credit.  Beyond that we will move to work smarter, adding value to change the mix of our exports and using and creating new technologies.

I’m not aware of any serious observer, even among supporters of R&D tax credits, who believe that such credits are likely to make a transformative difference.

This is the data from the national accounts (March years) for research and development spending as a share of GDP.

R&D

It would be interesting to know quite what was going on in the 1970s, but really ever since then there hasn’t been much change in the share of GDP devoted to R&D (as captured by Statistics New Zealand).  Interestingly, the most recent year saw the highest R&D share in the 45 year history of the series.

Many observers point out that New Zealand is relatively unusual among advanced countries in not having an R&D tax credit.  There are various other countries, including Denmark and Switzerland, but on the extreme far end of the OECD’s chart of a summary indicator of such matters are New Zealand and Germany.

And yet here is the OECD’s data on R&D spending.  For this particular series they don’t have data for New Zealand for every year, but the picture is still clear enough.

R&D 2

The New Zealand R&D spend (as a share of GDP) is well below the OECD total, and Germany’s has been consistently above (as are those in Denmark and Switzerland).   And neither country has R&D tax credits.  In fact, when the OECD totted up all the different sorts of government support for business R&D, the New Zealand government was considerably more generous than Germany.

It suggests, as I’ve argued here for some time, a need to stand back and think about what it might be in the New Zealand economic environment that means so little R&D occurs here.  Firms typically take the risk of investing in R&D when they think the opportunities for profitable businesses are good.     That doesn’t appear to have been the case in New Zealand (in contrast, say, to Germany), and consistent with that overall business investment as a share of GDP in New Zealand has been low by advanced country standards, for decades, even though our population growth rate has been much faster than that in the typical OECD country (more people will typically require more business investment if living standards are to keep pace).   This is not the place for a lengthy discussion of factors that might discourage firms from investing here, but high interest rates (relative to those abroad), an out of line real exchange rate, and being the most remote advanced country on earth (at a time when personal connections, value-chains etc seem to have become more important) might be things to think about.  Not one of them appears in the Minister’s speech.

 

Perhaps the closest he comes is in a summary of the government’s approach

In other words, we’ll be swapping out population growth and the buying and selling houses to each other as our two main growth drivers for much more sustainable ones. That sounds like a good description of our plan.

But they aren’t changing the medium-term immigration targets at all (and various media report that the Prime Minister isn’t even keen on implementing Labour proposed changes re student and work visas),  and simply buying and selling houses has never, of itself, been a “growth driver”.

There is the beginning of an idea here, but sadly nothing in government policy –  as outlined so far – is likely to represent any sort of fix.  After all, a key thrust of government policy is to build lots more houses, and they plan to just keep on keeping on issuing 45000 residence approvals a year for people to settle in such a remote, unpropitious (from an economic perspective) location.  Perhaps worse still, they seem keen on continuing, and beefing-up, the previous government’s misguided approach of trying to steer migrants to places other than Auckland (which is, on my telling, to put the cart before the horse).

One gets to the end of the speech confident that the government knows how it wants to redistribute more/differently than what went before (much the same could be said of Phil Twyford’s housing speech yesterday), but without any sense of a compelling strategy that is likely to do anything to reverse New Zealand’s long-term economic underperformance, to fix those flawed fundamentals.  I hope they really care about fixing the fundamentals and are just keeping quiet because they don’t have any compelling ideas –  and aren’f finding them in The Treasury’s post-election advice.  I fear that, a bit like their predecessors, it is some mix of putting the problems in the too-hard basket, and of no longer really caring that much.

Transparency: Bank of England vs RBNZ

Michael Reddell Financial stabilty, Reserve Bank Act reforms

Open government –  or the lack of it –  has been getting a bit of attention in recent weeks.  The previous National-led government was pretty poor in that area, and if anything there now seems to be a risk that the current government could be worse.  But at least there is some debate around the issues.  Former Cabinet minister, and now Speaker, Trevor Mallard, had one promising suggestion in an article this morning

“Eventually getting some websites going which contain most of that material, for example, Cabinet papers two months after they’ve been to Cabinet automatically up unless there’s a good reason not to, just that sort of stuff would mean you’d have a lot of access to, actually quite boring information, but access to what’s going on.”

Easy to suggest, of course, when you are no longer a minister.  I hope the new Speaker will be as keen on extending the provisions of an (overhauled) Official Information Act to cover Parliament itself.

The Reserve Bank is one of the bodies that likes to claim that it is highly transparent.    There are plenty of counter-examples –  and occasional examples that might suggest that progress is actually being made –  but I stumbled across an interesting contrast this week between our central bank and the Bank of England, the central bank of the United Kingdom.  Recall that the British public sector was notoriously secretive for a very long time, and our Official Information Act was enacted many years before the UK’s comparable legislation.

In its Financial Stability Report this week, the Reserve Bank released a high-level summary of the results of its latest stress tests on the four major banks.  What they released was interesting enough but there wasn’t much of it; 850 words and a couple of charts.  There was, for example, no information on individual banks –  despite a disclosure-focused system –  and no detail on housing mortgage losses –  despite the active regulatory and rhetorical focus on those risks for the last five years.

Earlier in the week, the Bank of England released its Financial Stability Report, and as part of that they released their latest stress test results.  Their release –  on the stress tests alone –  was 64 pages, with a great deal of detail, on the test scenarios themselves, on the overall results, and on the results for individual banks.   It even has an interesting annex on how markets’ view of banks square with the stress test results.

To be sure, the UK banks are typically more complex than the New Zealand banks (some, such as HSBC, are primarily global banks with big international exposures), and there are more of them (seven in this test) so we might not expect 64 pages of results here.  But we really should be entitled to more than the Reserve Bank is giving us.  There is no obvious (good) reason for withholding the material –  including that at an individual bank level.  Disclosure statements are actually already supposed to disclose banks’ risks, and  stress tests are just shocks designed to test the circumstances under which those risks turn bad.  And, in the end, it is banks (individually) that fail, or not, not “banking systems”.

Sure, there is probably some cost to pulling all the material together and presenting it nicely, but those costs will be trivial compared to the costs the banks face in doing the stress tests, or even than the Reserve Bank faces in conducting them and writing them up for senior management and/or the Board.  Accountability provisions and openness do have direct costs –  and, for that reason among others, aren’t typically popular with bureaucrats – but we put them in place for good reason.  With such large and powerful governments we are long past the days when we could safely accept an approach of “trust us, we know what we are doing”, all the more so when it involves agencies – such as the Reserve Bank –  with huge power concentrated in one person’s hands and little direct effective accountability (we can’t vote him out).

I could, of course, lodge an Official Information Act request .  If I did they would probably release some more aggregated material.  But I wouldn’t get very far, as the Bank continues to shelter –  with the protection of the Ombudsman –  behind the egregious (or, more accurately, egregiously abused) section 105(1) of the Reserve Bank Act.  When the Reserve Bank Act is reviewed, doing something about that provision needs to be on the action list.

If the British can manage this high degree of openness around banking sector stress tests –  only a few years after they had to grapple with actual bank failures – surely so can we.

On the Reserve Bank FSR

Michael Reddell Financial stabilty, Reserve Bank Act reforms

There are some interesting things in the Reserve Bank’s Financial Stability Report, some questionable ones (including, at the mostly-trival end of the scale, Grant Spencer’s assertion that he is “Governor” when by law he is, at best, “acting Governor”) and some things that are missing altogether.

The Reserve Bank observes that banks have tightened their own (residential mortgage) lending standards

Banks have tightened lending standards, reducing the borrowing capacity of households. Typically, banks are using higher interest rates when assessing the ability of borrowers to service a new mortgage and their existing debt, restricting the use of foreign income in serviceability assessments, placing stricter requirements on interest-only lending, and ensuring that living expenses assumed in a loan assessment are reasonable given the borrower’s income.

If so, you have to wonder why the Reserve Bank is still intervening in such a heavy-handed way in the decisions banks would otherwise make about their mortgage lending.

But they go on to back their claim with an interesting, but on the face of it somewhat dubious, chart

The overall impact of the tightening in banks’ lending standards is illustrated by the Reserve Bank’s recent hypothetical borrower exercise,  which asked banks to calculate the maximum amount that they would lend to a range of hypothetical borrowers. This repeated an exercise that was conducted in 2014. The 2017 results suggest that maximum borrowing amounts have declined by around 5-10 percent since 2014 (figure 2.3).

max lending amounts

But it is hardly surprising that, with the same nominal income, banks would lend a little less now than they would have been willing to do so in 2014.  After all, there has been three years’ of inflation since then.   Even if the borrowers had declared the same monthly living expenses to their bank, banks use their own estimates/provisions for living expenses in deciding how much to lend.  Supervisors, indeed, encourage them to do so, and to be sure to leave adequate buffers.   An income of $120000 would comfortably support more debt in 2014 than the same income does in 2017  (the reduction in the maximum amount lent to owner-occupiers was 3.5 per cent in the chart).  It would probably be better to do all these comparisons using inflation-adjusted inputs.

In this FSR, the Reserve Bank reports the results of their latest set of bank stress tests.    This year’s macro stress test didn’t seem particularly demanding in some ways.

stress test.png

Previous scenarios have featured falls in house prices of more like 50 per cent (in Auckland) and 40 per cent nationwide, which seemed like suitably tough tests.  Previous test also featured an increase in the unemployment rate to 13 per cent (which was so implausible that I pointed out then that no floating exchange rate advanced country had ever experienced such a large sustained increase in its unemployment rate).

But there are several unrealistic things about this scenario

  • it is highly improbable that even a severe recession in another country would lower New Zealand house prices by 35 per cent.  A massive over-supply of houses here might do so, or even the end of a massive credit-driven speculative boom, but neither an Australian nor Chinese recession is going to have that sort of effect.  In the 2008/09 recession –  as severe a global event as we’d seen for many decades – we saw about a 10 per cent fall in nominal house prices in New Zealand.
  • it is also highly unlikely that house and farm prices would fall by much the same amount in this sort of scenario.  Why?  Because in this scenario it is all but certain that the exchange rate would fall a long way (helped by the fact that the Reserve Bank has more scope to cut interest rates than their peers in other countries), in which case the dairy payout (and any fall in farm prices) will also be buffered relative to the fall in prices of domestic-focused assets.
  • But perhaps most implausible of all was the requirement that “banks’ lending grows on average by 6 per cent over the course of the scenario”.   Governments of the day might, at the time, be keen for banks to keep taking on more credit exposures, but those private businesses –  amid a pretty severe shakeout –  are unlikely to be willing to do so.  And there wouldn’t be many potential borrowers. If the asset base was stable –  or even shrank a bit, as it would tend to do naturally with sharply lower asset prices –  a fixed stock of capital goes quite a bit further.

As it is, once again the stress tests suggests that on the lending practices banks have operated under over recent years –  and they can change –  our big banks are impressively resilient.   Here is the key chart.

buffer macro

The chart is presented to make the deterioration in banks’ capital positions look large (by being presented as a margin over the minimum regulatory capital, rather than an absolute capital ratio –  creditors lose money when banks run out of capital, not when they get to the regulatory minimum).   But even then, look at the results.   The blue line is the result if the banks do nothing in response.  Which bank would do that in the middle of a period of multi-year stress?  But even then, at worst, the banks in aggregate end up with a buffer of capital of 2 percentage points above their required minimum.  With mitigants –  the red line –  they never even dip into the capital conservation buffer (the margin over the minimum; if banks dip into that zone there are limits of their ability ot pay dividends).

It is good that the Reserve Bank does these stress tests.  It would be better if they provided more information on the results (eg in this scenario they tell us that half the credit losses come from farm lending and residential mortgage lending, but don’t provide the breakdown –  from previous tests’ results, I suspect the residential contribution is relatively small  –  and don’t give any hint where the other half of the losses is coming from (given that housing and farm lending get most of the coverage in FSRs).

It must surely be hard to justify onerous and distortionary controls on access to credit for one large sector of borrowers when year after year the results come back showing that the banks look pretty robust to pretty severe shocks.  And when the Bank also tells us that the prudential regime isn’t designed to avoid all failures.  In combination, could one mount an argument that banks aren’t being allowed to take enough risk?

Operating in a market economy, banks in New Zealand –  and those in Australia and Canada –  appear to have done a remarkably good job of managing their own risks and credit allocation choices.  It is, after all, more than a 100 years since a major privately-owned bank has failed in any of those three countries.  Things can go wrong –  and often have in heavily distorted financial systems (eg that of the United States) – and bank regulators are paid to be vigilant, but it might be nice –  just occasionally –  to hear senior Reserve Bankers pay credit to the competent (never perfect) management of the risks our banks take with their shareholders’ money.

I mentioned things that were missing entirely from the FSR.  

The Reserve Bank Act requires FSRs to be published

A financial stability report must—

(a) report on the soundness and efficiency of the financial system and other matters associated with the Bank’s statutory prudential purposes; and
(b) contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.

That second item is no less important than the first.  And when the Reserve Bank has, during the period under review, imposed significant regulatory sanctions on a major bank you might have supposed that in the next FSR there would be a substantial treatment of the issue (there is, after all, more space than in a press release).  It is, after all, an accountability document, designed to allow the public (and MPs) to evaluate the Reserve Bank’s handling of its responsibilities.

But in the case of the recent Westpac breach (operating unapproved capital models), which resulted in big temporary increases in Westpac’s minimum capital ratios and –  it appears –  a requirement that Westpac issue more capital over and above those minima you would be quite wrong.  I read the entire document yesterday and didn’t spot a single reference.  A proper search of the text revealed a single footnote, which simply noted that Westpac’s minimum capital ratios had been increased, with a link to last week’s Reserve Bank press release.

This really should be regarded –  by the Board, by MPs, by citizens and other stakeholders –  as unacceptable: an organisation, that despite its constant claims, seems to regard itself as above any sort of serious public accountability, despite the clear requirements imposed by Parliament.    You will recall that last week I noted that there was a range of unanswered questions about this whole episode (here and here).  The FSR answered none of them.  For example:

  • who discovered the error, and how?
  • how did it happen (both at the Westpac end, and at the Reserve Bank end)?,
  • what confidence can we have that there are not similar problems at other banks?,
  • what changes has the Reserve Bank made to its own procedures to reduce the risk of a repeat?
  • why was there no reference in the Reserve Bank statement to the failures of Westpac directors (even though director attestation is supposed to be central to the regulatory regime)?
  • did the Reserve Bank compel Westpac to raise new capital?
  • how much difference did the use of unauthorised models make to Westpac’s capital ratios?

Jenny Ruth of NBR (who covered the story in a column last week, noting that the Bank’s failure then to provide more information was “appalling”) asked some questions about the issue at press conference yesterday.     The answers weren’t particularly clear or helpful.

She asked why no directors were prosecuted (these were, after all, strict liability offences, and director attestations are a key part of the regime).  Grant Spencer basically refused to answer, just claiming that the steps they had taken were a “strong regulatory response”.

She asked about the other internal-ratings banks and whether there were such problems with them.  The first answer seemed to suggest that the Bank was confident, having checked, that there were not.  But as Spencer and Bascand went on, even that seemed to become less clear.  By the end it seemed to be a case of “we aren’t aware of any other problems and we are encouraged that some are having a look to check”.  It didn’t exactly seem like an aggressive pro-active response by the Reserve Bank, to a potential problem it has known about for more than a year (since the Westpac issues first came to light).  It turns out that ASB has had other problems around its capital calculations (apparently without penalty).

We learned one thing.  Asked who first uncovered the issue –  Ruth suggested she had heard that Westpac had uncovered the problem itself –  the Bank representatives responded that they had had their own suspicisions and had raised the matter with Westpac, who had then confirmed that there was a problem.   That was good to know, but it was only one small part of the questions that should be answered.

It is, perhaps, getting a bit repetitive to say so, but if the new government is at all serious about more open government –  and serious media outlets have raised questions about that in recent days –  then the Reserve Bank would be a good place to start.   The culture needs changing, and culture change is only likely to come from the (words and actions at the) top.    How the government can expect to find a Governor who would lead the Bank into a new era of openness and transparency when they are relying on the Board –  always emollient, always keen to have the Governor’s back, never revealing anything, never even documenting their meetings in accordance with the law,  – is a bit beyond me.  Sadly,a more probable conclusion is that the government doesn’t really care much, and that the repeated promises  by Labour, the Greens, and New Zealand First around the Reserve Bank were more about being seen to make legislative changes, rather than actually bringing about substantive change in the way this extraordinarily powerful, not very accountable, agency operates.  If so –  and I hope it isn’t –  that would be a shame.

 

Very slowly lifting LVR controls

Michael Reddell Financial stabilty

It is a strange form of democracy in which an unlawfully appointed (and certainly unelected) bureaucrat, who faces little or no effective accountability, can descend from the mountain-top and decree new limits for how much different types of (potential) house buyers can borrow from banks.  But that is what Grant Spencer of the Reserve Bank did this morning with the release of the latest –  his one and only –  Financial Stability Report.  Our politicians seem to see nothing strange about this –  rabbiting on about “respecting Reserve Bank independence” in an area where there is no obvious reason for Reserve Bank independence at all.  If we have to live under the burden of regulation –  especially of the sort that directly affects ordinary citizens –  those controls should be imposed, or lifted, by politicians.  We can toss them out.  In this particular case, it is not as if there is even a clear statutory framework: the Reserve Bank is required to exercise its powers to promote “the soundness and efficiency of the financial system”, but neither they –  nor anyone else –  can really tell us what that means, or hence what limits, if any, it places on a Governor’s (or “acting Governor’s”) freedom of action. Arbitrary whims aren’t a good basis for government.

Don’t get me wrong.  I’m pleased to see the Reserve Bank making another start on easing the LVR controls (there was a partial easing a couple of years ago, but that didn’t last long).     The controls should never have been put on in the first place.   They started as a knee-jerk reaction from the previous Governor, without any good supporting analysis, and –  as so often happens with controls –  one control, originally sold as temporary, soon led to others, ever more onerous, with ill-founded exceptions.   As I summed up LVR restrictions a few months ago

They are discrimatory –  across classes of borrowers, classes of borrowing, and classes of lending institutions –  they aren’t based on any robust analysis, as a tool to protect the financial system they are inferior to higher capital requirements, they penalise the marginal in favour of the established (or lucky), and generally undermine an efficient and well-functioning housing finance market, for little evident end.  Oh, and among types of housing lending, they deliberately carve-out an unrestricted space for the most risky class of housing lending –  that on new builds.

That discrimination?

We have direct controls on lending secured on housing, but none on lending secured on farms or property development –  even though the FSR notes that the dairy debt position still looks stretched, and recognises that internationally many of the losses in financial crises are on commercial property (especially development) loans.

We have much more onerous direct controls on potential owner-occupiers than on investors, even when the nature of the underlying collateral is identical.  Even if the investor borrower might, objectively, be a much better credit  (think of someone with a really secure job like a teacher or police officer buying a first investment property, and contrast then with a person (with the same income) with a job in a highly cyclical sector (thus at considerable risk of unemployment in the next recession) buying an owner-occupied dwelling).

And we have direct controls on housing lending by banks, but not by other lending institutions.

And, again as I noted earlier

You’d never know, from listening to the Governor or reading the Bank’s material, that New Zealand banks – like those in most other floating exchange rate countries –  appear to have done quite a good job over the decades in providing housing finance and managing the associated credit risks.   We had a huge credit boom last decade, followed by a nasty recession, and our banks’ housing loan books –  and those in other similar countries –  came through just fine.

The Reserve Bank has never seriously engaged with this sort of perspective, and never told us why we should be confident that they are better-placed to make credit allocation judgements than experienced bankers whose own shareholders’ money in on the line.

Some months ago the former Prime Minister called on the Bank to lay out clear and explicit markers that would see the LVR limits wound back and eventually removed.   Unfortunately we got nothing of the sort today (indeed, the idea that the restrictions will eventually go altogether –  and we can back to having banks making credit allocation decisions, at an individual and portfolio level –  got barely a mention in the FSR itself or in the subsequent press conference).    No doubt, the bureaucrats like having toys to play with.  They stress how hard it is  for them to lay down clear markers, but appear to put no weight at all on how hard it might be for citizens who have to make their own decisions against a backdrop of such regulatory uncertainty.  Sadly, there are few effective incentives to ensure that bureaucrats and politicians internalise those costs at all.   Politicians have to face re-election (and scrutiny in the House each day), but the Reserve Bank bosses face no such pressure.

Now, to be fair, this mess was primarily of Graeme Wheeler’s making, and Spencer and Bascand are left to tidy up the mess.  Since the LVRs were never grounded in good analysis in the first place, it is hard to set out analytically robust markers for lifting them.  But if analysis couldn’t offer much, perhaps there should have been a premium on predictability: the Bank could have laid out an expected numerical path under which over the next two years the LVR limits would be removed completely, with modest easing scheduled for each quarter.  Sure, they couldn’t have made binding commitments –  apart from anything else, some as-yet-unknown person will be calling the shots as Governor after March –  but indicative plans help provide certainty to banks, their competitors, to borrowers, and to other participants in the housing market.  And they create some hurdles that the Reserve Bank would need to get over before deviating from the announced path.    As it is, we have no idea –  no clues at all –  as to what pace the controls might be lifted at.

As a reminder, if the Reserve Bank is really concerned about the soundness of the financial system –  let alone the “efficiency” of the system, a key part of the mandate –  capital requirements (risk weights and required capital ratios) clearly dominate direct (and discriminatory) intervention in the credit allocation process.     That sort of insight was behind getting rid of direct controls back in the 1980s.

The Bank did attempt to lay out the criteria it would be using  in assessing whether and when to relax LVR limits further.  There were three.

  • Evidence that house price and credit growth have fallen to around the rate of household income growth.
  • A low risk of housing market resurgence once LVR restrictions are eased.
  • Confidence that an easing in policy will not undermine the resilience of the financial system.

The second and third aren’t specific at all, and provide little basis for citizens to hold the Bank to account.   But the second is also problematic, because the Bank has always claimed that its goal isn’t to eliminate, or even to materially dampen, house price cycles (the “acting Governor” this morning reiterated that there will always be housing cycles).  That second criterion only makes sense if there is evidence that house price cycles/increases are mostly caused by changes in bank lending standards, and the Bank has never produced any evidence for that in a New Zealand context.

The first criterion looks slightly more useful –  at least we can see the data for that.  But I’m not sure it is very robust.  First, why “household income”, when many of the houses are now bought by the small business sector –  nominal GDP growth might be as useful.  But, more importantly, the Bank’s criterion seems to cement in the current ratios of price and debt to income as some sort of equilibrium.   And they have absolutely no evidence at all for such a claim.  As they surely know, if land use is heavily-regulated then fresh shocks to demand –  from any source, including unexpected population growth –  will tend to raise debt and price to income ratios, with no particular reason to think that such movements raise financial stability concerns.  Lending standards are really what matter, not macroeconomic indicators.  And, of course, in floating exchange rate countries with a market-led allocation of housing credit, I’m not aware of a single case where housing loan losses have been central to systemic financial crises.

There was the customary self-congratulation this morning about the contribution the LVR controls have made.  The Bank keeps telling us LVR restrictions have “substantially improved” the resilience of the financial system.  It is another claim for which they advance no serious evidence.  They correctly note that the volume of high LVR loans is lower than otherwise (although a little footnote on page 6 suggests even that effect might have been quite modest), but they never ever explicitly recognise that if banks have fewer high-LVR loans they will be required to hold less capital than otherwise.  Or that since the incentive was now to lend lots of, say, 79.99 per cent LVRs –  not economically different from a loan of 80.01 per cent –  and yet capital requirements are typically materially lower on lower LVR loans, it is quite possible that the effective resilience of the banks has actually worsened a little.  As it is, their stress tests have told throughout that the banks are robust.

Two final points:

The first is that in some respects today’s moves further increase the regulatory wedge imposed between access to credit for investors, and that for owner-occupiers.  In essence, no one (or almost no one) can borrow from a bank to buy a residential rental property using a mortgage of more than 65 per cent of the value of the property.  (There is provision for up to 5 per cent of such loans to be above 65 per cent, but given the larger buffers banks operate to ensure that they don’t breach conditions of registration, it is effectively a near-zero limit).  That isn’t a decision of a professional credit-manager.  It is regulatory fiat, from people with little or no experience in credit allocation.  By contrast, 15 per cent of owner-occupied housing loans can now be to borrowers with LVRs in excess of 80 per cent.  If banks judge it prudent –  and it might well be, depending on the borrower and the overall portfolio –  some owner-occupiers will be able to borrow perhaps well above 90 per cent.    The Reserve Bank has not produced a shred of evidence –  in the past or today –  for such a huge gap, on identical collateral.   Recall my example earlier: lending an 82 per cent LVR loan to the police officer buying an investment property is likely to be materially safer than lending to, say, a person on the same salary buying a first home, but working in a highly-cyclical sector (eg construction or tourism).  Banks can make those sorts of distinctions – they get to know and evaluate their customers –  but the Reserve Bank can’t. Instead, we get crude controls slapped on and maintained for years.  It looks and feels a lot more like politicised credit preferences – owner-occupiers favoured over investors.  When politicians do it it might be odious and undesirable but….they are politicians, and they have to face the voters.  When bureaucrats do it, it is highly inappropriate.

As I noted in my housing post yesterday, in some ways it is a bit odd for the Reserve Bank to be starting to declare victory now.  For the last few years there has been little or no prospect of any material oversupply of physical dwellings (or urban land).  There was little effective liberalisation and huge population pressures, and much of the new building has been on a pretty small scale, done by the private sector.   But now net immigration looks as if it may have turned a corner, easing some of the demand pressures.  A series of tax and regulatory changes will also dampen demand, at least temporarily, a little.     And the government is talking up “build, build, build”, in a government-led process designed to generate a huge number of new houses in the next decade  You might be sceptical, as I am.  But it is explicit government policy.  And government-led investment projects face considerably weaker market disciplines –  and often operate on a considerably larger scale –  than private sector ones.    Government interventions in the housing finance market were a big part of what went wrong in the United States. Physical oversupply was a big issue in Spain, Ireland and (parts of) the United States.   How confident can the Reserve Bank be that if Kiwibuild really gets going at the scale envisaged that the risks can be effectively managed?   It is, after all, almost certain there will be at least one recession  –  wich won’t be foreseen – in the 10-year horizon of Kiwibuild.     I’m not using this as an argument for keeping LVR restrictions on –  they aren’t fit for purpose, and in any case the Bank bowed to political pressure to exclude loans for building new houses (the riskiest sort of housing loans) from the LVR controls altogether.  But I think they are wrong if they believe, as they stated this morning, that risks are now easing.  And capital standards are a better, less intrusive, way to manage any risks.

The sooner the LVR controls are behind us the better,  Sadly, unless the right Governor is chosen, that day doesn’t seem likely to be soon.

I’ll have some comments tomorrow on some other aspects of the FSR.