Author: Michael Reddell

Heading for 2.5% (or less) by this time next year?

Michael Reddell Adrian Orr, Monetary policy

There is a lot one could write about the Reserve Bank’s Monetary Policy Statement and the Governor’s (sadly all-too-typical) thin-skinned and defensive responses to questions since, whether from journalists or a lone MP at the Finance and Expenditure Committee this morning. He never ever acknowledges a mistake and seems utterly unable to cope with criticism or disagreement whether (as reports suggests) inside the Bank or (as we can all see) outside it. In a field where there is inevitably huge uncertainty, it renders him simply unfit for office. It remains appalling that Grant Robertson reappointed the Governor and that Nicola Willis just reappointed the chair of the board responsible for holding Orr to account and for having recommended – presumably captive to management – his reappointment. How much more honest – and frankly reassuring – had Orr simply stood up yesterday and noted ruefully that “perhaps our May MPS wasn’t one of our better efforts”. At least in my book, a bit of contrition and humility goes a long way.

While I want to focus on yesterday’s statement, the contrast with May, and the outlook from here, it is worth remembering that simply unacceptable as the huge flip-flop from May to July/August should be – the sort of episode that further undermines whatever respect the Reserve Bank, the MPC, and Orr himself, might command – in macroeconomic terms it matters much less than the really big mistakes from a few years back that still get far too little scrutiny, and for which there has been no accountability. Losing $11 billion of taxpayers’ money on an ill-considered huge punt in the bond market remains simply staggering. How much difference would $11bn make in, eg, our hard-pressed health sector? And then there was the small matter of the worst outbreak of core inflation in many decades, the most overheated economy in the advanced world, and the massive dislocations and redistributions that that glaring policy failure brought about. And if many other central banks made mistakes in similar directions (a) we can only hold our central bank to account (other central banks are the problem for their citizens/governments) and b) our central bank did a worse job than most (see “most overheated economy in the advanced world”). If you take the pay, prestige, and the power, there should be some serious accountability. There has been none. But to get back to the MPS.

Sometimes small things make you proud of your kids. My son is an honours student in economics, with a keen interest in monetary policy and macro. Within minutes of the release yesterday he’d spotted this and pointed it out to me

Does it matter? Not in substance of course (and if you check now, they have fixed it), but it seemed revealing of an institution that struggles to even get the basics consistently right. Excellent it is not.

That there was a huge shift from May to August isn’t really in doubt. Here are the two OCR tracks

There has been no nasty external shock in that time (global financial crisis, pandemic, collapse in commodity prices etc) but we’ve gone from a “hawkish hold” (best guess, no easing until this time next year, and possibly some tightening late this year) to not only an OCR cut now, but a really large (at peak 130 basis points) change in the projected forward track for the OCR. I can’t recall another change that large that quickly, in the absence of a major external shock, in the 27 years since the Bank started publishing these forward tracks. It was simply because Orr and the MPC badly misread how the economy was unfolding now (Orr himself made this point yesterday, when he noted that the change of stance wasn’t about the medium-term outlook, but about partial data etc about where the economy is right now.) Other commentators have used the label “U-turn”. I prefer flip-flop myself (and in reality that change wasn’t even from May to August, but was largely between May and the July OCR review just six weeks later). Getting the medium-term right is a challenge for everyone, but an MPC – delegated so much power, allegedly as technical experts – simply should not get the near-term so wrong. And its communications should be a lot of more assured and authoritative than they are (eg recall the chief economist in May attempting to blame his tools). Instead we have a central bank and MPC that no one has any confidence in or respect for – be it local observers or international markets. They wield the power of course (they still set the rates) but no one serious looks to them as an authoritative guide or interpreter, despite all the budget and analytical resource at their disposal.

What about some of the numbers? I’ve been banging on for a while about how IMF estimates suggested that New Zealand’s economy was the most overheated of any of the advanced economies in 2022. The Reserve Bank has largely avoided until now any such comparisons, so it was interesting to see this chart

accompanied by the explicit comment that “New Zealand’s output gap reached a higher level than other countries in our sample [wider than those shown in the chart] during the COIVD-19 pandemic, indicating higher capacity pressures relative to our sample countries.” As it happens, in this set of forecasts they revised further upwards the extent of that peak excess demand (“output gap”) – a really damning commentary on MPC’s stewardship a few years back.

Right now (September quarter) the Reserve Bank estimates that the output gap is about -1.8 per cent of GDP. That number will inevitably be revised, but it represents the MPC’s best guess of where we are now. There is a lot of slack in the economy (or so they think). And it is unusual for the easing phase to start when the MPC believe that so much excess capacity has already built up. The Bank hasn’t always published real-time quarterly output gap estimates, but I cannot think of a time when the first easing would have come so late (eg the first easing in 2008, in July, appears to have been when we thought the output gap was about zero, the easings in 2015 were against the backdrop of a zero output gap, and there was no negative output gap when the easing came in 2019).

The fact that the first easing is late, relative to real-time output gap estimates, is not itself a criticism. There had been a huge inflation shock, that wasn’t overly well understood, and anyone in the Reserve Bank’s shoes might understandably have been a little cautious. My concern is less on how we got here (there isn’t much point quibbling now as to whether – as I thought – the OCR should have been cut in July rather than August) but on where to from here.

In my commentary after the May MPS I included this chart and comment

Quite how was growth expected to rebound was a complete mystery then.

And although the Bank has pulled down its estimates of growth for the rest of this year, in their dramatic change in OCR track, the same puzzle remains.

Here is growth in real GDP per working age population from yesterday’s MPS (red, SNZ data, green remaining 2024 quarters, and blue beyond that)

After two years of really lousy GDP growth (sadly, needed to get inflation securely down), the Reserve Bank expects that everything on the growth front will be back to normal from the March quarter of next year. Those projected growth rates are above the Bank’s own estimates of potential GDP growth, and so the output gap is projected to close gradually.

But how? On their assumptions, the world economy remains pretty subdued, net immigration settles to a fairly low level not doing anything much to growth, reflecting the government’s numbers fiscal policy (after being slightly expansionary this year) is expected to be quite contractionary for the couple of years beyond that. Whatever useful micro reforms the government is doing don’t look large enough to make a material difference, and aren’t something cited by the Bank.

Ah, but perhaps you are thinking, monetary policy must be the answer. After all, the OCR has been cut and is projected to be cut quite a bit more over the next couple of years.

But that can’t be the answer either, because the Governor was quite explicit in his press conference yesterday that the OCR remains at or above their estimate of neutral throughout the entire forecast period (several years ahead). Easing the OCR might reduce the extent of downward pressure – and recall that the lags mean that economic activity well into next year will already be being dragged down by policy as it stood until yesterday – but it isn’t going to generate anything like above-potential growth rates. Absent other shocks (which the Bank doesn’t forecast) and by construction (the Bank’s own articulated model) you get that sort of stimulus only when the OCR is taken somewhat below neutral. (Note that as inflation expectations are likely to carry on falling as headline inflation gets back to near 2 per cent, real interest rates may still be flat or rising even when the nominal OCR is being cut).

Look back at the output gap estimates since 2000 (the period the Bank publishes for) – or even back to the 1990s – and you simply do not find a time when a negative output had emerged when it has been closed again without the OCR being taken below best estimates of neutral. It was so in the early 1990s, it was so around 2001, it was so (for far too long) after 2008, a period which encompassed the 2015/16 easings. There is simply no reason to think the economy is operating any differently now (and again the Bank has often recent years repeatedly reaffirmed that it thinks transmission mechanisms are operating normally). The economy has been taken into a hole – to get inflation down again – and to get out of the hole anything other than very very slowly needs some external intervention. That is what active discretionary monetary policy does.

And that is why, as I’ve said a few times over the last 24 hours, I wouldn’t be surprised if a year from now the OCR was 2.5 per cent, or perhaps even lower. In fact, I will be a bit bolder and say that I will surprised if it is not that low. People have looked/sounded puzzled when I’ve said it, but the logic – of the Bank’s own frameworks and projections – seems pretty clear. I don’t think it is a big call at all. On the Reserve Bank’s own numbers, the best guess of the longer-term term neutral OCR is 2.8 per cent. No one knows what the neutral OCR is with any precision whatever – it really only be revealed over time, after the event – but I don’t see any reason why, give or take say 0.5 percentage points, the Bank’s estimate should be so very wrong. My own guess is probably a bit lower, but stick with theirs for now: if neutral is 2.8 per cent then even an OCR of 2.5 per cent by this time next year is (a) barely stimulatory, and b) will have to be dealing with more disinflationary pressure that will have built up between now and then as in the meantime the OCR has been above neutral.

Frankly, it shouldn’t be a terribly controversial view (and market pricing is already well below the Bank’s projected path). Of course, there are risks to both sides, and almost inevitably some shocks (positive or negative) will change the outlook between now and then, but the simple point remains that if you run monetary policy in a highly contractionary way to get a nasty bout of inflation back down again, and in the process generate a big negative output gap, a period of stimulatory policy is likely to be required to settle back on a more normal path. On RB numbers that would mean 2.5 per cent or below, and before too long.

I’m not a big fan of central banks publishing medium-term macro forecasts – about the largely unknowable future – but when they choose to, they really should follow through on the logic of their own mental models. A significant rebound in economic growth from the start of next year simply doesn’t seem consistent – with all their other assumptions – with continued materially contractionary monetary policy settings. Stick with those settings and the recession is only even more likely to deepen.

(And finally, but fairly briefly as this post has gone long enough, could the Reserve Bank please stop playing games around fiscal policy. As I highlighted last year, they had then shifted to focusing on government consumption and investment spending, rather than deficit measures, seemingly to avoid putting any heat on the then government. They aren’t much better now. Most macroeconomic analysis around fiscal policy, here and abroad, uses measures like the cyclically-adjusted or structural balance estimates that The Treasury and the IMF/OECD produce. Those measures exist precisely to aid assessments of the impact of discretionary fiscal choices on demand, activity, and inflation pressures. On the Treasury Budget estimates, this year’s Budget means the cyclically-adjusted deficit in 24/25 is slightly larger than the estimated deficit for 23/24. It isn’t the Reserve Bank’s place normally to weigh in on what should or shouldn’t be done with fiscal policy, but they should be consistently straightforward and honest about the impact of the fiscal choices any government makes. That simply hasn’t been happening last year or this. It may be convenient for MPC members, but serving their convenience is not either our concern or their job.)

UPDATE: Finally, finally…..monetary policy (OCR) cycles, whether in New Zealand or the US, have tended to involve swings in policy rates of 500 basis points (on average, albeit with variance). We had a 525 basis point rise to deal with the inflation outbreak. We shouldn’t be at all surprised if most of that proves not something that needs to be sustained. Big lifts in policy rates are almost always followed by big cuts, and when those cuts come they usually come much more quickly than forecasters – public or private – had allowed for.

Still a bad idea

Michael Reddell Prudential regulation, Reserve Bank

The Minister of Finance has, over the last couple of weeks, been trailing various possible changes in the financial system. At the National Party conference there was the suggestion of trying to beef up Kiwibank, including by the injection of some additional capital from other than direct central government sources. And last Friday, there was an interview with the Herald’s Jenee Tibshraeny in which the Minister talked up the idea of overriding various bits of policy that are now squarely the legal responsibility of the Reserve Bank. Commentators suggest all this talk is to a considerable degree about preparing the ground for the release next week of the final report of the Commerce Commission’s report on elements of the banking sector, perhaps trying to ensure that there is little plausible ground for Labour or the Greens to attack the government on banking profits, access to services, or whatever.

I’m not going to respond in depth to all the Minister’s suggestions. On Kiwibank, I largely agree with VUW banking academic (and former regulator) Martien Lubberink’s column, and (rarely, and as it happens, even with John Key). If it were me, I would sell 100 per cent of Kiwibank tomorrow, simply because there is no good reason for a government to own a commercial bank, but I am even more wary of partial privatisation of a bank than of the status quo).

The Minister also suggested that she might change the law to force the Reserve Bank to (a) lower bank capital requirements, and b) provide carveouts for some or other favoured groups. Now, as it happens, I have long argued that prudential regulatory policy settings should be decided by the Minister of Finance, on the advice of the Reserve Bank and The Treasury. As Willis notes, she is accountable, and the Reserve Bank is not (although the Minister decided to reinforce that effective unaccountability recently by further extending the term of the chair of the Reserve Bank Board – and it is the board that now wields the prudential policysetting powers). But if you really want to make a change like that you do it after wide and serious consultation, or perhaps even as part of a well-trailed campaign promise, not simply (as it seems) to play distraction because another government agency might be about to release a briefly awkward report. I’m also inclined to think bank capital requirements are higher than is really warranted (that was my view when the policy was being set five years ago and remains so today) but if you want to be taken seriously as a Minister of Finance, you don’t just drop such a view into an interview – with, it appears, nothing in support – you outline carefully your case, or commission some reviewers to look into the matter carefully. Martien Lubberink also addressed this set of Willis comments, including this apt line.

But the item in the Minister’s grab-bag that I wanted to comment on was around the remuneration of settlement account balances held by banks at the Reserve Bank. On these balances – the aggregate level of which is determined wholly and solely by the Reserve Bank – banks are paid the OCR (currently 5.5%). The level of settlement cash balances is currently around $43 billion – off its highs, but still hugely higher than the $7bn or so that was more common pre-Covid. The reason for the difference? LSAP bond purchases by the Reserve Bank, and the subsidised direct lending (under the so-called “Funding for Lending” scheme) from the Reserve Bank to banks.

In the Herald interview the Minister is reported as saying that “she had asked officials for advice on the way the RBNZ manages banks’ settlement accounts”, and in further comments in the same interview making clear that she was referring to how interest was paid. She goes as far as to suggest that it might be appropriate to amend the Reserve Bank Act to compel any change in approach that she considered warranted.

The issue of remuneration of the high settlement cash balances has been around for a couple of years. I think I introduced it first to the New Zealand discussion with a post in late 2022 on a paper by a former Bank of England Deputy Governor in which, among other issues, he suggested a possible case for paying below market rates on some portion of the large (at present) settlement cash balances in the UK. My post was headed “A bad idea”, which remains my view. That October 2022 post prompted Tibshraeny to give the issue a bit of coverage, which in turned seemed to prompt the then Minister of Finance Grant Robertson to ask for some official advice on the matter. Tibshraeny OIAed that advice, and I wrote about it in another post in March 2023. Neither the Reserve Bank nor The Treasury were at all enthusiastic, and there even Grant Robertson – who, we later learned, had at the same time been toying with windfall profits taxes on banks – left it. It was, after all, on current legislation simply a matter for the Reserve Bank (the OCR, the rate paid on settlement cash balances, is the primary instrument of monetary policy, and the Reserve Bank has operational independence).

There is a bit of a view around in some quarters that changing remuneration practices could undermine the effectiveness of monetary policy (in fact, it was one of the lines the Reserve Bank used on Robertson). That isn’t necessarily so. Tiered approaches have been used elsewhere (including by the ECB when they had negative interest rates, as a subsidy to banks in that case), and so long as one clearly distinguishes between a first tranche that received a nil or below market rate from the marginal balances on which the full OCR would be paid, effective monetary control would not be impaired. But that doesn’t make the policy option the Minister was openly toying with a better idea. In fact, it is still a very bad idea. Bank settlement account balances don’t just arrive in a vacuum – rather they are a counterpart to a change in some or other items on bank balance sheets (eg a bank increases its settlement account balances when it wins deposits from another bank, or (in this case) when (say) a customer sells government bonds to the Reserve Bank and deposits the proceeds in a bank account, on which the customer will normally and reasonably expect a return). Running a tiered approach to remuneration of settlement cash balances, of the sort Paul Tucker first proposed a couple of years ago, is simply an arbitrary tax on banks, and financial intermediation more generally, without any analytical foundations or – if the RB simply did it – without any parliamentary scrutiny. Taxes should be imposed by those whom we elect, our MPs sitting in Parliament.

But changing the law to enable the Minister to direct the bank on policy on remuneration of settlement accounts, or simply to mandate a completely different model, would be hardly any better than the RB just arbitrarily making such a change. There would be some formal democratic legitimacy, but for a policy that has just no substantive merit. As there was no good case for a windfall profits tax for banks, so there is no decent case – not even a shred of one – for a targeted ongoing tax specifically on banks. It would be arbitrary, inefficient, largely borne by New Zealand depositors and borrowers, and would send a simply dreadful signal, at a time when international markets are already looking askance at the Reserve Bank and the conduct of policy – and the policy “debate” more generally.

I don’t suppose it is very likely that Willis and the government will end up doing any of the things she trailed in last week’ Herald interview. Doing them probably wasn’t the point – rather the pursuit of a good headline with a certain sector of the New Zealand audience, narrowing room for Labour and the Greens, seems to have been the point. Empty populist rhetoric seems a description closer to the mark than serious considered policy options and analysis (note that not a hint of any of this appeared in the election campaign, less than a year ago). Perhaps the rhetoric plays well with some focus groups, but it hardly enhances any reputation Willis aspires to to be (and be seen as) a more serious Minister of Finance (focused on things that might make a real difference) than her predecessor.

I’ve already noted that Willis could readily have changed the chair of the Reserve Bank board when his term expired (her government has been happy to replace various other chairs in agencies where dismissal at will as an option). She could have filled the vacancies on the board with people better qualified than those Robertson appointed but hasn’t done anything about that either. It remains almost beyond comprehension that she didn’t move on either front, and suggests she isn’t really serious about any of this. In the same vein, each year the Minister of Finance writes a Letter of Expectation to the Board, an opportunity to highlight her priorities or things she wants the board and Bank to have regard to etc. The 2024 letter is sitting on the Bank’s website, and has not a hint of any of the sorts of issues/concerns Willis was raising in the Herald interview. She also hasn’t revised the Financial Policy Remit (a new tool) issued by Robertson a couple of years ago. There are things around the Reserve Bank that the Minister can’t easily or quickly fix (eg she is stuck with the Governor, unless he chooses to go early, for another 3.5 years), but she has shown no sign of doing any of the things she could (eg Board chair and vacancies, unwinding new indemnities the Bank has been given) or of using any moral suasion (eg through the letter of expectation) around financial policy issues or the Bank’s budgetary excesses.

So it all just looks a lot like a search for a good headline, and political operatives managing tactical risks for a couple of weeks, rather than a Minister with any sort of serious interest in, or intent towards, a much better central bank, whether in its monetary policy or financial regulatory roles. Perhaps in that sense she and the Governor – who seemed to have such a testy relationship when National was in Opposition – deserve each other. It is just that New Zealanders deserve much better from both roles.

(I have submitted an OIA this morning for the advice etc around remuneration on settlement cash balances. It will be interesting to see if either Treasury or the Bank are giving Willis even slightly different advice now than they gave Grant Robertson last year (but it seems unlikely).

Treasury says one thing in a speech but quite another in the BEFU

Michael Reddell Treasury

I picked up The Post this morning to find the lead story headlined “Recession hits homes harder than businesses”, reporting a speech given earlier this week by Treasury’s deputy secretary and chief economic adviser Dominick Stephens. There was an account of the same speech, but with some different material, on BusinessDesk a couple of days ago. Astonishingly, despite being an on-the-record address, on what are clearly high profile macroeconomic issues, including touching on monetary policy, The Treasury has not issued the text of the address, so the rest of us – not the Auckland “business crowd” who heard it live – are entirely reliant on journalists’ reporting of what the chief economic adviser to the government’s principal economic adviser (which is how Treasury likes to style itself) actually said, let alone the context within which he said it. That seems less than ideal (to say the least).

The remarks, as reported, were no better, and seem remarkably loose from a very senior Treasury official. They also seemed at odds with – if probably somewhat more accurate than – the story Treasury was telling in Budget Economic and Fiscal Update (BEFU) only two months ago. I have long defended New Zealand’s system, in which the BEFU documents and forecasts are the best professional view of The Treasury, and are not the views of the Minister of Finance. The Secretary to the Treasury has to affirm this with each EFU

On the basis of the economic and fiscal information available to it, the Treasury has used
its best professional judgement in preparing, and supplying the Minister of Finance with,
this Economic and Fiscal Update.

Ministers spin, while public servants – a fearless Treasury – is supposed to be providing the Minister and the public with an unvarnished best professional view. That isn’t always easy for public servants – who have to deal with ministers and their offices every day on multiple matters – but if they aren’t up to that standard, they shouldn’t take the jobs.

Take this from the BusinessDesk report

It seems pretty clear that Stephens is claiming that they knew there was a quite serious recession underway running into the Budget, including as context for decisions ministers were making then, and that they knew things were getting quite a bit worse.

But….here are The Treasury’s quarterly GDP forecasts (quarterly per cent changes) from the BEFU

What they actually told the public (and ministers presumably) is that they thought that there had been positive GDP growth in the March quarter and that growth would be picking up – to at least semi-respectable levels – over the rest of the year. Now, in fairness, the economic forecasts are finalised quite early (in this case 5 April), but the text of the BEFU wasn’t finalised until 23 May (well after ministers had made their decisions and just a few days before delivery on 30 May). So there was plenty of opportunity to ensure that this view – a deepening recession – made it into the text, as an update to the older numbers.

So I went and checked the text. In dozens of pages of text, the word “recession” does not appear once – whether about the past year or the period ahead – and neither do “recessionary” or “downturn”, let alone perhaps more loaded words like “slump”.

So there seem to be three choices. Either The Treasury wasn’t providing us (or ministers) with their best professional forecasts and commentary, or Stephens is now rewriting history (consciously or not) to make Treasury look more prescient than it really seems to have been, or that Stephens – the chief economic adviser – had a quite different view from his boss, the Secretary, at the time the BEFU was done. My money is on the second of those explanations….which, frankly, if true is a pretty poor show from such a senior public servant. Perhaps there is something to the third story, but if there were such differences they shouldn’t be showing up like this.

There seems to have been another interesting contrast between BEFU and the Stephens speech. The Post’s report says “Stephens also confirmed the finance minister’s position that her Budget was disinflationary despite giving Kiwis more cash through tax cuts”. That description is reported, rather than a direct quotation, but if it is accurately reported it seems at odds both with The Treasury’s own published estimates in the BEFU, in which the structural deficit actually increases a little in 24/25 over the previous year, and also somewhat at odds with these words from the BEFU itself. This is from the very first page of the BEFU Executive Summary

Treasury expected that GDP would be picking up (see chart above) partly because of the boost to private sector incomes from the tax package. All else equal, that adds to inflationary pressures (and recall those structural balance estimates). (Note that the Minister of Finance is still stonewalling, deliberately delaying the release of actual Treasury advice in this area.)

Then there was this – the big text extract readers of The Post will have seen this morning –

Really? One of the biggest recessions we’ve had? This from the same agency – principal economic adviser to the government no less – that reckoned that GDP growth would be positive all this year. (Incidentally one wonders what the Minister of Finance, her office, or PMO thought when they read this story this morning.)

From later remarks in the article it would appear that Stephens is talking about per capita GDP – which has already fallen about 4 per cent from peak – but no one, no one, is going to compare the sort of economy we are now facing with the experience in, say, the 1991 recession. The big difference isn’t just that the economy had been subdued then for years before the specific 1991 downturn, but that the unemployment rate rose from just over 4 per cent to just over 11 per cent. Last we saw, Trreasury was picking the unemployment rate will peak next year at not much over 5 per cent. Perhaps there has been a radical change of view since BEFU, but if so perhaps Treasury could lay out some numbers, in a text or document we all have access to.

Stephens’ commentary on other matters also seems very very loose. Take those comments about the “fiscal response to Covid”. He seems not to give any weight to monetary policy, which in the way our system is set up is supposed to move last to keep overall economic activity close to potential and inflation close to target. Governments can spend freely or not, and it isn’t supposed to lead to a grossly overheated economy followed by a nasty recession. And while Stephens claims that we had a “really very big boom”, it really wasn’t that big – incomes just didn’t grow that much (real gross disposable income per capita at peak was just 3 per cent above the March quarter 2020 level), and while the economy became very stretched for a time (on RB estimates the biggest output gap in decades), the peak was really very shortlived. It was as nothing compared to past booms (whether the 2000s or the mid 1980s).

Somewhat surprisingly, Stephens was also apparently – description of his comments rather than a quote – offering a Treasury view on the OCR (“The Treasury is sticking to its guns and predicting interest rates will start to fall in September because there’s still work to do on bringing down non-tradeable inflation, said Stephens”). Which seems a bit odd given that the Secretary to the Treasury is herself a non-voting member of the Monetary Policy Committee. I’m all in favour of MPC members generally offering their views and analysis in public, but even in more transparent systems overseas it is rare for MPC members to be quite that blunt about specific forthcoming OCR decisions. And if Stephens wasn’t speaking conscious of Treasury’s MPC spot, he really shouldn’t be second-guessing, or perhaps implicitly pressuring, the independent central bank MPC in public. Frankly, it all seemed a bit half-baked.

Now, and to be fair, there was one bit of his reported remarks that I really liked (as which I have heard him articulate before at a Treasury seminar)

In principle that is exactly right (in practice, there is inevitable uncertainty about just how much, how deep, and how long will prove to have been required). (Incidentally “slowdown” does appear in the BEFU, but about productivity growth and about events abroad.) There is a price to be paid when our macroeconomic policymakers stuff things up, and unfortunately that price is paid by us and not by them.

But although that “this is the recession we had to have” type of sentiment is quite right, I’m then left wondering why Stephens was muddying the water by suggesting – reported in both articles – that events in China explain our recession (expected or otherwise). They simply don’t. The rest of the world – and China is a major source of demand globally, not just re New Zealand – is just one of the many factors the Reserve Bank has to take into account in setting monetary policy. So far they have judged that this downturn is what we had to have (rightly or wrongly, but if they thought otherwise they’d already have cut the OCR). Our policymakers did it to us – and given the stuff-up in 2020/21 it had to happen – not people or countries beyond our control.

There is a suggestion (this from Matthew Hooton’s column yesterday) that ministers have joined the club of those underwhelmed by The Treasury

but you’d like to think that a Kaikohe bookkeeper would keep matters rather tidier and more disciplined that what was on display this week from Treasury and its chief economic adviser.

Not a good case for a CBDC

Michael Reddell Cash, e-cash

The Reserve Bank’s latest round of consultation on a possible central bank digital currency (CBDC) closes today.

The thick and probably expensive (at least one of the documents was produced jointly with the consultancy firm Accenture) set of consultation documents came out a few months ago. I thought I had run out of time to read and submit on them because somehow I’d got it into my head that the deadline was last week. It was nice of the Reserve Bank to send out a reminder to interested parties that the deadline was in fact today.

Until I read the documents yesterday I still wasn’t sure I’d bother. But when I did read them I was astonished at how thin (in analytical etc substance) they were, and how weak the case seemed to be for the rather limited CBDC they were proposing (as well as how little thought seemed to have been given to how things might evolve, beyond the Reserve Bank’s control, once a CBDC was introduced (which, in fairness to the Bank, they envisage as still being some years away, beyond even the terms of Adrian Orr and Neil Quigley)).

I wrote a short submission on an earlier (2021) Reserve Bank consultation on these issues. The submission I lodged this afternoon was not much longer (5.5 pages). With more time I might have treated some of the issues in more depth, but really the onus is on the Bank to make their case, and to this point they have not done so.

My full submission is here.

The introduction and final paragraphs follow

It might make an interesting OIA for someone to ask the Reserve Bank how much money has been spent on CBDC analysis and proposals over the last five years. That sum seems unlikely to have been small.

Treasury wanting to use fiscal policy more

Michael Reddell Fiscal policy

Government departments are now all required by law to write and publish a Long-term Insights Briefing at least every three years.

and they have to consult the public on both choice of topic and the draft report

The Public Service Commission gives its take on these provisions here

Count me more than a little sceptical. Good agencies, addressing significant issues/challenges, would in days gone by been offering serious analysis and free and frank advice in Post-Election Briefings, which used to be written with a clear expectation that the same advice/analysis would be offered no matter which party won (I still remember finalising one such Reserve Bank briefing at about 6pm on election day, with a clear expectation that we had to be finished by the time the polls closed). Good agencies, dealing with complex analytical issues, will also often be publishing research from time to time. So I’m at a bit of a loss to understand what the Long-term Insights Briefing provisions are meant to add, other than more bureaucratic overlay. And if, perhaps, good agencies could readily find a first topic, churning out something different every three years feels like it will quickly become a compliance burden and little more.

But government department chief executives are stuck with the law as it is, including no less than the outgoing Secretary to the Treasury. Her staff are currently consulting on a proposed topic for their next Long-term Insights Briefing, complete with the somewhat pointed observation that resources available for “department stewardship work” are “finite” (presumably, “so don’t expect too much”). Submissions close on Friday, for anyone interested in sending them some comments (I sent in a few quick comments yesterday).

The proposed topic is focused on “sustainable and resilient fiscal policy over economic cycles”, and thus is quite (and probably appropriately distinct from the long-term fiscal pressures that Treasury addresses in its (also now somewhat repetitive) statutorily-required Long-term Fiscal Statement.

Ever since 2020, The Treasury has seemed to be hankering to use fiscal policy more actively for counter-cyclical stabilisation purposes. In a speech in 2021 (which I wrote about here), the Secretary (and those around her) were talking up what fiscal policy could do in this area. Those were the days before it was clear that both inflation and fiscal deficits had gone badly off the rails. But the enthusiasm still seems to be there. There was the work Claudia Sahm has been doing for them on so-called semi-automatic stabilisers, which I wrote about a few weeks ago. And now there is this consultation document, which has in it a very strong flavour of wanting to see fiscal policy used more actively for countercyclical purposes. If it was perhaps pardonable to think about that in the abstract five years ago, you’d have hoped that the actual experience of the last four years would have prompted a rethink, and some fresh humility. But there is no sign in Treasury’s consultation document that they plan any sort of hardheaded review of the experience of fiscal policy here since the start of 2020, or the use of active fiscal policy in other countries either in the 2008/09 recession or since 2020. You’d certainly get no hint that years after the shock – that did warrant deploying some government expenditure resources – we are now stuck with structural deficits, and successive governments repeatedly extending the horizon for a return to surplus.

Treasury repeatedly, and after all this time I can only conclude deliberately, choose to conflate counter-cyclical macroeconomic stabilisation (a role that has long been assigned primarily to monetary policy) and other natural or established functions of government (eg income support in crises, or tail risk insurance). Treasury officials like to talk up the wage subsidy scheme. And it isn’t unreasonable that they should do so, as income support (even if it was, arguably more generous than was really needed). When the government compels people to stay at home and directly or indirectly shutters their businesses, it isn’t an unreasonable quid pro quo (citizens might reasonably demand it) that governments ensure people can keep body and soul together (perhaps even keep together established employment relationships). Income support is something governments can do, and do quickly. Macroeconomic stabilisation policy isn’t primarily about income support, and typically doesn’t, and doesn’t need to, operate that fast. And income support might be needed even if the economy as whole was overheating (eg production was cut but expenditure demands stayed high). They are simply too different functions, and shouldn’t be conflated, either conceptually or in practical policymaking. One can think too – Treasury does – of things like the fiscal consequences of severe earthquakes. Such activity is likely to be net stimulatory for the economy as a whole (this was something the RB recognised way back in the first days after the 2011 quake). If the severe quake happens to come at a time when the economy has a lot of excess capacity – as was the case in 2010/11 – there is no tension between the two. But earthquakes don’t conveniently time themselves to fit the state of the economic cycle. The next severe one might hit when the economy happened to be already overheated for other reasons. In those circumstances, what it was right (or legally obligatory) for governments to do wouldn’t materially change. Managing the overall macroeconomic consequences – crowding out other spending to make way for this combination of government and private activity – would then just be the Reserve Bank doing its job. Two quite separate jobs, two quite separate set of tools. And yes, big government spending commitments have macro consequences, but the system is set up for the Reserve Bank to take those into account, to move last, and – as far as they are capable – maintain price stability.

One might think it was a bit of a fool’s errand to defend monetary policy after the experience of the last few years. But, if anything, I think it is to the contrary. What the last few years actually show – and I suspect the Governor would agree (he used to say it in 2020 and 2021) – is the potency of monetary policy. When mistakes are made it can do a great deal of damage (viz, the most severe outbreak of inflation in decades) but it can also be turned around very quickly (see the 525 basis point rise in the OCR in 19 months) and inflation is on course for being at target again before long. It would, clearly, have been better if they’d not made the mistake in the first place, but that is a forecasting and macroeconomic comprehensions issue not one about the tools – and an issue that faced The Treasury just as much as the Reserve Bank (noting that the Secretary to the Treasury now sits on the Monetary Policy Committee). Reversing fiscal policy is just evidently a great deal harder – not just here, but in most countries at most times. So-called “shovel-ready” projects, designed to provide short-term stimulus, were still going on years later, having exacerbated inflation pressures in the meantime.

Treasury has also appeared to be hankering for a greater role for itself using as justification the effective lower bound on nominal interest rates. This was an issue the Reserve Bank saw itself facing in 2020, belatedly realising it had done nothing for years to even alleviate the self-imposed problem. But it is also an issue that is quite easily fixed technically, and you might think that a Treasury – both sitting on the MPC, and concerned about unnecessary fiscal pressures, difficulty of reversing fiscal imbalances etc – would have been at the forefront of insisting that the Reserve Bank and the Minister of Finance get this technical issue fixed. It isn’t of course a problem today – with the OCR still at 5.5% – but no one has any great confidence where the neutral rate is, or how deeply below it the OCR might need to go in the next severe recession.

Treasury may think my comments are a little unfair. There is other stuff in their (short) consultation document, but nothing in what they have presented suggests anything like an appropriate degree of critical scrutiny of options for more active use of fiscal policy, or of their own fiscal policy advice in the last few years.

Perhaps it doesn’t matter that much. The new government seems unlikely to be interested in more-active fiscal policy (with asymmetric risks), and in some respects the Long-term Insights Briefing has the feel of a compliance burden they simply have to jump through. But if the work is going to be done it needs to be done in suitable critical and hard-headed way.

One of the questions Treasury poses is around “what rules and strategies can be used to support a credible commitment to rebuilding fiscal buffers after negative shocks”. Personally, I think there is a fairly simple response to that. Severe adverse shocks will come, and they will tend to be asymmetric, but fiscal policy is unlikely to knocked off the rails if there is a strong and shared commitment to a modest structural surplus. There will be one-offs that mean that in the year of a disaster (pandemic or earthquake) the cyclically-adjusted balances will be in deficit, but keeping the structural balance in modest surplus – and quickly restoring surpluses if there are unanticipated deviations – is the simplest and surest way to keep fiscal capacity able to do stuff only governments can do, while leaving countercyclical macro stabilisation to monetary policy, the tool best suited (and largely costless to the Crown) to doing that job. Unfortunately, the Treasury of the last decade – and more specifically the last four years – has tended to talk and write in ways that leave political parties more comfortable in deviating from that sort of standard.

Public sector bloat: Reserve Bank edition

Michael Reddell Reserve Bank

A week or so back I did a post, prompted by some tweets by @Charteddaily, about the Reserve Bank’s big-spending plans for the current (24/25) financial year – the financial year, that is, in which many Wellington bureaucracies are facing quite some considerable expenditure restraint/cuts, most particularly those that don’t really do stuff that directly faces members of the general public.

There was the 20 per cent planned increase in spending on staff salaries – with inflation coming down it must be a big increase planned in staff numbers, and the really extraordinary $35 million planned spending on “engagement with the public and other stakeholders” (this on top, apparently, of the item further down about communication of MPC decisions).

No one seems to have any clear idea what this $35 million is (nothing they’ve published gives any real sense) and although, as I noted to someone the other day who asked if I had any idea, it just can’t be quite as bad as it sounds, it sounds pretty bad indeed.

Today, @Charteddaily was at it again, having dug out from Parliament’s website the Reserve Bank’s responses to their 2022/23 financial year Annual Review undertaken by FEC. There are all sorts of gems apparently, from the $5500 spent at the Maranui cafe in Lyall Bay for offsite planning/team-building (lots more on other such events). Perhaps, and just possibly, some level of expense on those sorts of things is necessary and even warranted (it was, after all, 2022/23 a year of Labour fiscal excess), but when I scrolled through the documents what really caught my eye was the bloated spending on communications functions. Here are the permanent staff numbers

So that was eleven full-timers on “content and channels”, and six for internal communications alone (this is an organisation with only two offices and about 500 staff). @Chartedaily checked and found that The Treasury has only six communications staff in total……. Now, the Reserve Bank is a little more public facing than The Treasury, so you might expect a few more, but….more on internal comms than Treasury has in total? Really? Well, apparently so on the Orr/Quigley/Robertson watch (and Robertson gave them a second big boost to their funding agreement during this period).

Then there is some time series data

Note that on top of the 27 permanent staff there were 4 contractors (although a later table suggests they mostly work on other stuff). 27+ communications staff (and they still can’t even commuicate monetary policy competently – see last two OCR reviews). Oh, and the salary budget in 22/23 was five times what it had been in 2018/19, Orr’s first full year. (I recall doing an OIA several years ago when the comms staff were around 18, and that seemed flabbergasting enough……but 31 of them now).

What has the Board and Board chair been doing? Presumably just what Nicola Willis wanted given that (a) she just reappointed the Board chair, and (b) raised no issues around spending restraint in her letter of expectation to the Board.

One part of the communications empire is responsible for OIA requests, so you’d assume that with so many resources they’d be just superb in responding to those requests. But….whereas in 2019/20 78 per cent of their 100 OIA requests were responded to within the statutory 30 days, in 2022/23 only 54 per cent of their 94 requests were. That won’t greatly surprise anyone who has ever dealt with them, but is still striking to see it in print.

It is a great deal of money being spent by an organisation with very weak accountability, and without even the excuse/rationale that they do a lot of direct public-facing stuff. They don’t sell stuff to the general public, or grant things to the general public. They mostly deal with banks, financial institutions, other government agencies, and various vendors. Their policies affect many or most of us indirectly in various ways but – mercifully – we aren’t yet subject to massive billboards of Orr and the MPC, or full page newspaper adverts etc. Not even a mea culpa for losing taxpayers a mere…..$11 billion (which swamps even the comms budget).

And it isn’t even as if their communications is that good. It just isn’t obvious what they – and more importantly we – are getting for the money they are spending. Their main documents seem okayish, but nothing spectacular. They seem not (mercifully again) to be running a TikTok account, and although they do have an Instagram account it doesn’t seem to have very many followers (as you might expect: central banking done well is supposed to be pretty dry and boring; grey men and women operating technocratically and (supposedly) expertly). You are rather left wondering what these 27+ people actually do all day? But that is probably just a failure of imagination….always meetings to attend, coffee catch-ups to hold, and so on.

It really is quite extraordinary. Not so much that Orr and Quigley would do this if they could (bad bureaucrats will, and recall that in his day job at a university Quigley was spending $1m on a lobbyist), but that ministers enable it and now, apparently, endorse it. It was Robertson-era excess in 2022/23 – the stuff National rightly complained about – but…..the chair has just been reappointed, the budgets are expanding again.

And that is now on the new Minister of Finance who seems to have done nothing about it. (You rather hope The Treasury monitoring reports to the Minister are doing something about highlighting such excess.)

Flip flop flip flop

Michael Reddell Uncategorized

The Reserve Bank’s Monetary Policy Committee yesterday delivered their latest OCR review.

In my post on Tuesday, in which I suggested that an OCR cut was appropriate now, I’d noted

As it happens, yesterday was another reminder that it is unwise ever to bet against Reserve Bank induced volatility, sometimes intended, sometimes not.

You’ll recall that the May MPS (forecasts and words) was a lurch in the hawkish direction. This was their OCR track, revised out and up, showing an on-balance probability of OCR increases for the rest of this year, and nothing below the current rate until the August 2025 Monetary Policy Statement.

and this was a chart I’d constructed from the same projections:

Real interest rates kept on rising until the second half of next year, but somehow – as if by magic (given the absence of domestic or external macro stimulus) – the economy gradually recovered anyway.

The MPC then seemed to have barely understood what it was doing, and a couple of days later the chief economist was indulging in the old bad workman’s excuse (blaming his tools). We weren’t really meaning to suggest possible rate hikes, they claimed. but if so why publish the projections that showed exactly that, when any half-competent MPC member would have known precisely how they’d have been read? And in the end the markets seemed all rather underwhelmed and unconvinced and didn’t really move much at all.

But say what you like about the May MPS, at least it was done in the context of a full set of economic and inflation forecasts. And it was finalised with the full MPC present.

By contrast, what of yesterday’s statement? Not only wasn’t there a full set of forecasts (internally, let alone published), but the Bank’s chief economist – who is presumably primarily responsible for both sets of forecasts and economic analysis – had been allowed to go off on leave and wasn’t even at the meeting (they only happen seven times a year). And there really hasn’t been that much data since late May, and none of it that (to my eye anyway) seemed particularly surprising or game-changing. Most notably, especially in the context of all the explicit concerns in the May MPS, there hasn’t even been another CPI outcome (and the Bank rashly chooses to do these reviews a week before the CPI comes out).

Now, as it happens I think the view articulated in yesterday’s statement is much better and much more likely to accurately reflect what is going on, and is likely to go on, in the economy and inflation than the one delivered in May. And in that sense, and in isolation, I welcome it. Perhaps the two new MPC members have begun to make some useful difference (although in the culture, and under the obligations of silence they’ve assumed, we may never know – we get much more openness from our Supreme Court justices than we do from MPC members).

But we should be able to expect better than such policy lurches, that are neither signalled in advance (none of the frequent speeches we see in the better and more open central banks) nor evidently grounded in big shifts in hard data. Take as just one example: the May MPS was full of worries about and references to non-tradables inflation. The chief economist’s speech just a few weeks ago was in the same vein, and if anything more stark. By contrast, in yesterday’s two page statement there was not a mention, and barely even an allusion. And did I mention that in meantime we haven’t had a CPI outcome (in fact since April)?

It really isn’t good enough. In fact, it is amateur hour stuff from a statutory committee, allegedly with some expertise, which has been delegated by Parliament a huge amount of power and influence and yet seems to face almost no real accountability (apart perhaps from an ever-growing lack of respect, as if that seems to matter to Orr et al).

This time it seems that they did move the market (significant changes in both the exchange rate and short-term interest rates). And you can see why that might be the case. This was the concluding line in May

and this was yesterday’s

One is a great deal looser, leaning towards easing, than the other. That is especially so when they chose to frame yesterday’s statement in terms not of inflation itself, but of “inflation pressure” (usually a reference to the economic imbalances – output gaps, unemployment etc – that precede changes in inflation).

Combined with a unqualified statement that they are confident inflation will be under 3 per cent this year, and rather gloomy comments on the state of activity and demand, it would normally be a pretty strong signal of the likelihood of an OCR cut really rather soon (perhaps even in August).

But this is the MPC we are dealing with. Having lurched in one direction in May, in the other direction (without much data or a full set of forecasts) in early July, who knows where they will be by late August? No doubt next week’s CPI should be quite important, perhaps even decisive now in a normal MPC, but…..this is the Orr/Quigley MPC.

It really isn’t good enough. A couple of weeks ago the Associate Minister of Finance was defending the weird reappointment of Neil Quigley (as if everything had just been fine in the Bank), with a claim that too much “chopping and changing” wasn’t a good thing.

Quigley has been chair, through all the various mishaps, for eight years already. The MPC that he is responsible for – the Board determines who ministers can appoint or reappoint – can’t hold a stable view for even six weeks at a time.

But there is no sign any of it bothers the Minister of Finance, primarily responsible for the Bank and for Quigley/Orr, or presumably her boss or the rest of the Cabinet.

And perhaps again it is time to reflect on the monolithic approach to the MPC put in place by Orr/Quigley, with the imprimatur first of Grant Robertson and now apparently (since she has done nothing to change it) endorsed by Nicola Willis.

Monetary policy is an area of legitimate and real uncertainty. As I noted in the post earlier in the week, if ever a policymaker isn’t conscious of much uncertainty, either they aren’t thinking hard enough or they’ve left things far too late. But go back and read the May MPS, and you will search in vain for any sign of intelligent differences of opinion. There simply is none. In fact this is the only use of “some members” in the entire document

Nothing at all of different models of how things are playing out here, or how monetary policy might best respond. These are matters of real uncertainty (at least among sentient thinking people).

And as demonstrated by the fact that only six weeks later the Committee had lurched to a materially different position. And again unanimously. This time the only “some members” was this statement of the blindingly obvious.

This is a Committee that simply has not earned anything like deference. It, like any powerful goverment entity but perhaps especially after the record of recent years, deserves constant scrutiny and real accountability. Instead, we get lurches and bluster….and a government so unbothered they reappoint the man directly responsible for the MPC (appointments and performance) to yet another term.

On a slightly lighter note to end, the Committee yesterday expressed unconditional confidence that inflation will be under 3 per cent this year. You may recall this, little-reported, line from the Governor, captured by an ODT reporter just after the last MPS

From my comments at the time

We should be getting, and really need, something much better, much more commanding of respect and confidence, from our central bank. That is on the Minister of Finance. But she shows no sign of caring.

Still avoiding responsibility

Michael Reddell Uncategorized

I was away when Reserve Bank chief economist Paul Conway gave his recent speech, “The road back to 2% inflation”, and since I didn’t see any material commentary on it I didn’t bother going back to it when I got home. But my son – honours student researching monetary policy (anyone wanting a young economist at the end of year, get in touch…..) – prompted me to finally do so. And since I’ve been quite consistently critical of the lack of serious speeches from the MPC members, I shouldn’t overlook the handful (even if they are just selling a party line, rather than really opening up issues and alternative perspectives) that do emerge.

First, some kudos. With the speech on the Reserve Bank website there was a transcript of the following Q&A session (the speech was apparently delivered as a webinar). That should be standard practice, since the unscripted remarks of policymakers can be at least as informative as the scripted and carefully negotiated ones are, and we know central bankers can go off reservation. I’d link to the transcript but can’t now find it again (no doubt there somewhere, but not on their speeches page).

The speech seemed to mainly be an opportunity to report some recent research results from Reserve Bank staff (several Analytical Notes). It is good to see some of those coming out (in a telling comment on how bad things had been, in the Q&A session Conway himself highlights that it was good that they are now “really cranking out” research again).

Conway wasn’t at the Reserve Bank when the big and really costly mistakes were made by the Monetary Policy Committee, joining only in May 2022. One might therefore have hoped that he’d be able to take a more detached and objective view on what had gone before. After all, even though in his management role he works for the Governor (and his grossly underqualified direct boss, the DCE responsible for macroeconomics and monetary policy, with a marketing degree), he does actually hold a statutory position as a member of the Monetary Policy Committee, and isn’t supposed to simply defer to the boss (or institutional interests) in reaching his views and votes.

Conway’s speech is presented as forward-looking in nature (“the road back to 2%), but there is quite a lot of history in it too, and it is the historical dimensions that got my goat. In particular, there is a persistent and repeated refusal to accept (at least in public, which is where it counts in terms of accountability) that monetary policy mistakes and misjudgments are primarily responsible for the severe inflation outbreak, the aftermath of which we are still living with. All the arbitrary and never-to-be-reversed redistributions of wealth, all the dislocations of markets and businesses, and now the recession and significant rise in unemployment which the Bank, no doubt rightly, tells us is necessary to get inflation comfortably back down again.

To repeat one of my consistent lines, human beings are fallible, they make mistakes. Central banks – here and abroad – are made up of humans, so they make mistakes. Really serious ones, of the sort seen in the last few years, shouldn’t happen but they do. One might even offer perspectives in mitigation: the pandemic was something quite extraordinary, and many people (here and abroad) misread the macroeconomics of it for too long. But those responsible need to take responsibility for the mistakes that were made. Those who now hold office who weren’t even there at the time have even less justification for not detachedly owning that those who were there made (really serious and costly) mistakes. Plus, in most human affairs, contrition goes quite a long way…..including (but not limited to) as a sign that one is even interested in learning from the mistakes and doing less badly next time.

Instead, there is avoidance and minimisation right through the speech.

At one point we are told that during the Covid period interest rates were “relatively low”. Not the lowest they had ever been, just “relatively low”.

Then we get attempts to minimise Reserve Bank responsibility by highlighting (correctly) that fiscal policy was also expansionary (“at upper end across OECD economies”) and bemoaning that insufficient attention has been paid to the role of fiscal policy. But Conway knows very well that the system is set up in such a way that monetary policy is the last mover: fiscal authorities do what they will, do it transparently, and then the Reserve Bank does whatever is necessary to keep inflation in check. The responsibility for the high (core) inflation rests with the Reserve Bank, not with fiscal policy.

And so it goes on. Several times we find attempts to blame the labour market, or even border closures, as if the Reserve Bank MPC was not set up to be….the last mover, to respond to all other pressures and risks in a way that keeps core inflation in check. In the Conclusion, Conway articulates it this way

“Inflation spiked higher during the pandemic due to a range of factors, with a shortage of labour and materials in a period of strong demand being particularly important”.

But no mention of monetary policy, which is by design the main tool for influencing aggregate demand and capacity pressures to keep inflation at or near target. There are plenty of references to “demand” in the speech, but hardly any (backward looking) to the demand manager.

To read Conway in isolation, you would have absolutely no idea that the Reserve Bank itself now estimates that the economy got materially more badly overheated than at any time for decades. That is on them: minimising or avoiding such situations is an integral part of successful inflation targeting.

Or that on IMF estimates New Zealand in 2022 had the most overheated economy of any of the advanced countries/monetary areas. It was the result of what were, with hindsight, glaring monetary policy mistakes and misjudgments. But Conway – and no doubt his bosses – would simply prefer we looked the other way, and accepted that it was all somehow out of their control (except no doubt when they will take credit when inflation eventually comes down again).

What of the way ahead? There is an OCR review out tomorrow, continuing the weird RB choice to hold a review the week before the key (especially at present) quarterly CPI data are out. The Bank has signalled that Conway, their chief economist, is away and won’t be attending the meeting (which doesn’t seem like particularly good leave planning). Given that and the weirdly hawkish tone of the May MPS – the one picking an economic recovery even as the OCR is unchanged, or even rise, for the next year – one can’t expect much from the MPC tomorrow (although RB communications flip-flops haven’t been unknown).

I’m less interested in what they will do than in what they should do, and have come to believe that, on balance, an OCR cut would be appropriate. These are – or should be – almost always matters where risk and uncertainty are real considerations. If a monetary policymaker is 100% sure of their stance, they either aren’t thinking hard enough or have left things far too late, given the fairly long lags with which monetary policy works. I’m certainly not mounting an argument for a move to a neutral monetary policy stance – wherever the neutral nominal interest rate might currently be (itself highly uncertain) – but simply for taking the foot a little off the brake, and easing back a little on the extent of the disinflationary pressure. As I said, uncertainty is a pervasive factor in any forecast-based monetary policy regime. Quite possibly, time will show that by now the OCR should already be quite a bit lower, but I don’t think that is yet a view one could reach with great confidence, so mine is simply a call to begin edging in that direction (and to reverse May’s curious hawkish rhetoric and numbers).

Why? Annual inflation is still above the top of the target range after all. But it is clearly falling, and there are numerous indicators – hard data and surveys – pointing in the direction of a further material accumulation of excess capacity and disinflationary pressure, which will play out – even just on today’s policy – over the next 12-18 months. The worst of inflation is clearly past, and with it fears that some new and really bad rate of inflation was going to become embedded. And while the RB likes to talk up non-tradables inflation – which has no special role in the Remit – it is also true that a fair proportion of those pressures (insurance and rates) are resulting from non-monetary shocks (one clearly a supply shock, one about government charges), which really should be “looked through” by an inflation targeting central bank, unless (and to the extent that) they were spilling into public expectations of medium term inflation and wider price-setting and spending behaviour.

A move now to a 5.25 per cent OCR would not, of course, be game-changing in macroeconomic terms. It would, however, be a step in the right direction. One can understand the personal incentives on the Governor – who cares about the excess capacity so long as I finally am 100% sure inflation is back down again – but perhaps it would be easier for him and the MPC to take some of the risk, that is an integral part of the business they are in, if they hadn’t spent so much time and effort blustering and minimising the extent of their own mistakes from several years back.

Not on the “brink of bankruptcy”

Michael Reddell New Zealand economic history

This coming Sunday will be the 40th anniversary of the 1984 election, which ushered in a decade of radical economic reform in New Zealand. The Listener magazine has a cover story (or set of them) on “Rogernomics and how it continues to shape our lives”. The first article is by Danyl McLauchlan (and isn’t bad in itself, even if it could have done with some economic policy fact-checking in a few places), which the contents page introduced with the description that the accelerated reform programme was a “momentous shift in direction for a country on the brink of bankruptcy”. The only problem with that story is that it simply wasn’t so. For decades, people from left and right have run the line, seemingly in need of a foundation myth (on the left for why their beloved Labour did so much dreadful stuff, and on the right to accentuate the case for the far-reaching reform programme, often with a subtext of “see, there really was no alternative”), but the apparent felt need for such a myth doesn’t change the underlying facts. Neither the New Zealand government, nor wider New Zealand (whatever that might mean in this context) was anywhere near the “brink of bankruptcy” in July 1984.

There was, incidentally, a time when the New Zealand government could fairly be described as having been “on the brink of bankruptcy”. The New Zealand government went into the Great Depression with government debt of around 160 per cent of GDP, the subsequent sharp fall in real and nominal GDP drove that ratio well over 200 per cent at peak, and in 1933 there was a default (most countries defaulted in those years, simply never repaying some of their prior legal debt commitments). One could argue that, for different reasons, the New Zealand government was also in deep financial strife in 1939. But it wasn’t in mid 1984.

The long-term Treasury fiscal tables only go back as far as the year to March 1972. Even then, changes in accounting practices etc mean the data aren’t fully consistent over time. But this chart captures what there is, up to the current (24/25) financial year forecasts.

As at 31 March 1984 net debt was 29.6 per cent of GDP. On the current preferred measure (including NZSF assets), central government net debt is projected to be 23.1 per cent of GDP at the end of the 24/25 financial year (and lest there be any doubt the New Zealand government is also now not on the “brink of bankruptcy”). Had the debt been increasing quite a bit over the decade running up to 1984? Certainly it had, but nowhere near as fast as many vaguely familiar with the fiscal situation then might have supposed because of the combination of inflation and financial repression (holding interest rates artificially low). Things were a mess, but solvency simply wasn’t the issue.

Finding comparable data for other advanced countries back that far is a challenge, but looking at the OECD’s patchy tables three countries showed up with much higher net debt than New Zealand back then: Belgium, Italy, and Israel (which also happen to be the three I remember being commented on most often back in the 80s). Italy was the least bad of those three back then, but with net debt ratios twice those of New Zealand.

Now, it is fair to add that the official debt numbers back in the mid 1980s didn’t necessarily capture everything. The Think Big projects were being put in place, and if the government wasn’t always a direct financier, protective barriers accomplished similar effects. The reforming Labour government eventually took a lot of that project debt back onto the Crown balance sheet, but as you can see from the chart above even at peak several years later, after a post-liberalisation financial crisis and several years of difficult economic adjustment net debt still peaked at not much more than 50 per cent of GDP. Not good (at all) but simply not then “on the brink of bankruptcy” either (about half of the advanced countries today have net debt in excess of 50 per cent of GDP – IMF data).

Things were certainly in something of a mess in mid-1984. We were just emerging from the wage and price freeze (the price freeze had been lifted earlier that year) and the big uncertainty was how things were going to unfold: would inflation stay moderately low (even the IMF noted at the time that the freeze had gone better than expected) or race back up to 15 per cent? And both the headline fiscal and balance of payments current account deficits were large.

Then again, some context is in order. Inflation really messes up the interpretation of some of these flow balance measures (something the Reserve Bank was publishing a lot of work on at the time), because a big chunk of nominal interest payments are inflation compensation and really, in economic effect, principal repayments. And when international observers really worry about countries’ fiscal policies they often pay a lot of attention to the primary balance (ie excluding finance costs). If a country is running primary surpluses, no matter how small, the debt (and debt to GDP ratios) are most unlikely to explode (in ways that really would raise real solvency/”brink of bankruptcy” issues).

So what do those long-term Treasury tables show? Coming all the way up to the current (24/25) year, we have 54 years of data. In 14 of those years (including 24/25 and the five previous years) the government is/was running a primary deficit. Only three of those years were in the 20th century. One was the year to March 1984, when the primary deficit looks to have been about 0.6 per cent of GDP. Not good (at all), but then this year’s primary deficit is projected to be a touch under 1 per cent of GDP.

The New Zealand was not then (and is not now) on “the brink of bankruptcy”. Here it is perhaps worth noting the IMF’s 1984 Article IV review report on New Zealand, which was finalised in February 1984. In those days, IMF reports were not published and were much more free and frank (this one was leaked to the New Zealand media just prior to the 1984 election, presumably by someone in the RB or Treasury): remarkably, although there is a great of angst about flow fiscal deficits (although with no sense of “brink if bankruptcy” debt stock stuff), there was no discussion of primary deficits at all.

Was the New Zealand economy performing well in 1984? No, of course it wasn’t. It was a mess in many respects, with a great deal of uncertainty, significant imbalances, and lousy productivity growth. But it also wasn’t as if nothing had changed for decades. Liberalisation had been proceeding, at times fitfully and with reversals but the direction was still pretty clear (something recognised in both IMF and OECD reports at the time). The CER agreement with Australia had come into effect just the previous year, formal current account convertibility for foreign exchange transactions had been adopted in 1982, and just a few months earlier auctioning of government bonds (rather than administratively set rates) had commenced (even if it too proceeded in fits and starts). The exchange rate had been fixed since mid 1982, although adjusted once in 1983 when Australia devalued, and the 1984 IMF report notes that it was thought most likely that the crawling peg adjustment model would resume as New Zealand emerged from the freeze. There was a strong sense among advisers of a really overdue need for better macro-stabilisation policies and microeconomic liberalisation policies but no imminent sense of crisis.

There was strong sense (including explicitly by the IMF in that February 1984 report) that the real exchange rate was probably overvalued (not only were there large current account deficits and a really adverse terms of trade, but fixing the nominal exchange rate over the previous couple of years was tending to appreciate the real exchange rate. But it had been a case argued for years.

What changed was when Sir Robert Muldoon called the election and market participants were convinced that (a) there was a high probability of Labour winning, and (b) that if they did win, it was highly likely that Labour would devalue. Roger Douglas was understood to be in favour of a devaluation, and documents that found their way into the public domain only reinforced that sense (as did rumours that a senior Labour MP had told – or strongly implied to – one significant lobby group that Labour would devalue). It was, after all, conventional economic wisdom, not in itself particularly radical.

Intense pressure on New Zealand’s fairly modest liquid foreign exchange reserves began almost instantly (and here the word “liquid” has salience, as some of the funds notionally held as foreign exchange reserves were actually kept by The Treasury in rather illiquid form). These were the days before open and unrestricted short-term capital flows, but even without that possibility, any rational exporter would seek to hold proceeds offshore for as long as possible, while any rational importer would look to make payments as soon as possible. Even just those timing effects, and there were some capital flows too, were enough to create huge pressure. The immediate cash-flow pressure was eased by the Reserve Bank offering (relatively cheap) forward cover, but that didn’t change the basic pressure.

Runs on fixed exchange rates are very hard to stop. They usually don’t start out of the blue, as this one didn’t, and can usually only be stopped if there is a universal commitment – very strongly shared across elite and political circles – not to adjust the rate. Of course, limitless reserves help a lot – including in reducing the chances of runs starting – but in those decades few countries with fixed exchange rates held very high levels of foreign reserves. Interest rate adjustments can help, at least in principle. If liquidity conditions tighten sharply and interest rates rise a lot as a run gets underway it can prompt some people to rethink. In June/July 1984 the Reserve Bank and Treasury advised Muldoon to lift the wholesale interest rates controls and allow some of those effects to work. But even had he been so minded it probably wouldn’t have worked, simply reinforcing a mood that something had to give, and soon, and that that something would be the exchange rate. It wasn’t as if runs on advanced country fixed exchange rates were that uncommon: in 1992 for example, both the UK and Sweden tried to face down runs, allowing interest rates to adjust. In Sweden short-term interest rates got briefly to 500 per cent. But both countries devalued (if you are pretty sure a 20 per cent depreciation is coming within weeks even an interest rate of 10 per cent per month won’t stop you selling). And that was, more or less, the story. It would have been cheaper if Muldoon had accepted official advice and devalued in the middle of the election campaign but……you can understand why any politician would have resisted what would have looked like a mid-campaign concession of failure.

It was an expensive mess (the reserves were eventually – very quickly – bought back at a much higher price) but it was a liquidity issue, in the context of a strongly held official view that the rate needed to be lower, not a solvency one. The country was simply not on “the brink of bankruptcy”. The devaluation itself didn’t force any of the rest of what followed – as I noted, the reserves flowed back pretty quickly once the RB was no longer compelled to defend a rather arbitrary market price that people had lost confidence in. The IMF and external creditors forced nothing either. It was all just New Zealand policymakers’ own doing. And it wasn’t even all very consistent: in fact, the devaluation was followed – in a rather panicky move by Douglas – by the reimposition of a price freeze for several more months. But the atmosphere of crisis, exacerbated by the political shenanigans in the day or two after the election (NZ not having immediate transitions like the UK) made for a great foundation myth. (And curiously there was another run on the currency seven months later, in the days leading up to floating the exchange rate. The market consensus was that a floating exchange rate would fall, perhaps a lot. They were wrong. In fact, if one looks at a graph of the real exchange rate over decades, one could argue that the official view in mid 1984 (very strongly held, and repeated internally in the months following the devaluation) was also – with hindsight – wrong.)

I’ve marked the devaluation low. It was hardly ever revisited once the exchange rate was floated. But the beliefs in 1984 were widely held, in official and private circles here, as well as abroad (eg IMF). Devaluation itself was pretty inevitable against that backdrop.

Six months ago today I wrote a post looking back at the economic outcomes that followed the far-reaching reform programme put in place over the following years. Since some of my right wing friends looked askance at the post, suggesting I was offering aid and comfort to the left, I should add that (a) I don’t hunt in a pack, and b) at the time I supported most of what was done, and c) still think a lot of it was the right thing to have done (and that much would have happened anyway, if in a more gradual and less rigorous fashion – the counterfactual was never one of no change). But it is also impossible to just look past the failure of New Zealand to reconverge with the OECD productivity leaders over the subsequent decades (we’ve dropped further behind almost all of them), or to ignore the utter disaster that has been New Zealand house prices, land use law etc. Again, we cannot know the counterfactual with any certainty. And we also cannot overlook very real gains (eg substantial trade liberalisation and much lower cost of imports etc). But it simply hasn’t been an unalloyed success story. If it were otherwise, New Zealand today would be a quite different – and better – place.

And if perhaps there are some signs that the political system is finally taking seriously the house price disaster – I’m reluctant to go further than that just yet – there is no sign at all that either side of politics much cares about the productivity failure.

Reading Reserve Bank plans and budgets

Michael Reddell Adrian Orr, Reserve Bank, Reserve Bank Board

It isn’t something I’d usually recommend (or even do myself) but the useful new Twitter account @Charteddaily (basically one interesting New Zealand chart a day) posted a couple of charts drawn from the suite of Reserve Bank documents that were released last Thursday, and they piqued my interest (and, for reasons you will see below, concern).

But first, also on Thursday there was some attempt by the government to defend the extraordinary reappointment (yet again) of Neil Quigley as chair of the Reserve Bank’s board (which I’d written about, and lamented, here). The Herald’s Jenée Tibshraeny had got in touch with both the Minister of Finance and with David Seymour (both an Associate Minister of Finance, and leader of a party that had also firmly opposed Orr’s reappointment – something recommended by Quigley’s Board – and whose Finance spokesperson had only a few weeks earlier suggested that Orr (still supported by Quigley and his Board) was unfit for office). The article is headed “Nicola Willis and David Seymour confident in call to appoint…”. If you read the article carefully, Willis never actually explains why she did what she did. She says she stands by her previous criticisms of the Bank and of Orr’s reappointment – thus putting her clearly at odds with Quigley’s views – and the only new observation she makes (that Quigley played a “key role” in establishing the new RB Board) seems irrelevant (not only was that transition presumably why Grant Robertson gave him another two years in 2022, but the Reserve Bank itself shows no sign of any better performance now, whether Governor, MPC or more broadly).

I guess one should give credit to David Seymour for engaging more substantively (since he isn’t the responsible minister he could have just hidden behind Cabinet collective responsibility), but his more extended arguments simply don’t wash either. This was the bulk of his comments

None of this washes. I’m sure many people have heard the story of Orr once being pulled out of a Board meeting by Quigley to get him to calm down. That’s good, but what about the repeated active misrepresentations to FEC, or the dismissive approach Orr – Quigley’s man – routinely takes to any criticism or disagreement. And quite how losing 10 of your top 26 people in short order, several of whom had only recently been promoted by Orr, speaks to Quigley’s value I don’t know. And “chopping and changing”? Quigley has been on the Board since 2010, chair since 2016. Actually, turnover and fresh faces have value (as is widely recognised in other government appointments), especially when the institution has not itself done a good job (massive financial losses, serious inflation outbreak etc). When you can’t change the chief executive (and the government can’t until 2028) getting rid of the chair, at the end of his term, when the chair has backed the Governor all the way, was the way to signal a seriousness about wanting something different. On the evidence of the Willis/Seymour words and actions, this government – once in office – doesn’t.

And it isn’t as if the Bank – Orr or Quigley – is changing of its own accord. This was the first of the snippets that @Charteddaily had highlighted (drawn from RB Annual Reports and from the last two Statements of Performance Expectations).

That is a further 21 per cent planned increase in staff expenses in the year that began on Monday, on top of really large cumulative increases over the Orr era to date. It is just staggering, in a year when almost every other government agency is being expected to cut back, often quite materially. The Reserve Bank is funded through a five-yearly Funding Agreement, and the current one doesn’t expire until 30 June 2025, so the government couldn’t compel them to cut back immediately, but (a) there isn’t anything in the Minister’s letter of expectation (sent back in early April, only finally released last week) urging them to do so, and (b) it is in stark contrast to the voluntary savings in place by ACC, also not funded by direct parliamentary appropriations. The Orr/Quigley approach seems to be “hey, we are the Reserve Bank, we’ll just go our own way”. And there is not the slightest evidence that the Minister of Finance cares.

Then again, her government is throwing out new subsidies to fund Shortland Street.

And it is not as if they are throwing lots more money at improving their monetary policy and inflation research or analysis. Actually, comparing this year’s Statement of Performance Expectations to last year’s, in 2024/25 they plan to spend $46 million on monetary policy up just slightly from a planned $45 million in 2023/24.

So what are they spending their (well, our) money on. This was where I was really gobsmacked by a @Charteddaily tweet, trusting that the person behind that account read documents accurately but still not quite believing it.

Yes, you are reading that correctly: $35 million in 2024/25 on “engaging with the public and other stakeholders”. Since issuing physical cash (zero interest liabilities) is a highly profitable business (forecast net operating profit $483 million), this weird category of “engagement with the public and other stakeholders” is really their biggest item of spending.

I’ve been reading around their documents over the last day or so and I still find it incomprehensible, on numerous counts. First, one would normally have assumed that any costs – including communications costs – associated with the Bank’s various statutory functions (monetary policy, financial system regulation and oversight, foreign reserves etc) would have been allocated to those functions themselves. And you can see that when it comes to monetary policy there is a specific item for “Communication and implementation”. Promoting the institution itself, distinct from its specific statutory responsibilities and powers, is simply not a legitimate use of (very large amounts of) public money.

Here is a high level summary that I found on their website about this activity

But it doesn’t really help. The Reserve Bank, for example, doesn’t fund Parliament. Rather, like any public agency, it is required to front up when called, and the costs of providing information to FEC would, one would have thought, been (modest and) allocated to the respective functions (directly in the case of MPSs and FSRs, perhaps indirectly in respect of the overarching corporate documents).

Much the same goes for 6.1, with the added point that granting media interviews tends not to cost taxpayers anything. The Governor in particular seems to use his rare interviews to hand wave and distract rather than to engage with alternative perspectives or criticisms. As for speaking engagements, there is a bit of cost to them (getting out and around the country) but what has been noticeable for years is how few such engagements – at least on the record ones – they do; hardly any at all in the case of MPC members. And shouldn’t such costs be allocated to (in this case) the monetary policy function?

And so we are left with 6.2. What is proposed? Some massive advertising campaign, indirectly subsidising NZ media? Surely not, but then if not then what? A fair question for Treasury to be asking the Reserve Bank is something along the lines of what outcomes would be worse for New Zealanders if this line item was to be cut by 80 per cent?

The performance measures in the Statement of Performance Expectations are not really any more helpful

None of it tells us what they are actually spending so much money on (or why most of the costs are not allocated back to respective core functions).

There was some verbiage and effort at distraction in the Statement of Intent itself

Quite what any changes in the “media landscape” might have to do with the extent of trust people might repose in New Zealand’s central bank isn’t clear, but I guess playing distraction is better than identifying factors like:

  • presiding over the worst inflation outbreak in decades, and then trying to openly blame it on everyone than the central bank itself,
  • losing taxpayers $11.5 billion in a huge bond market punt, and then refusing to seriously engage on the extent of the loss and associated misjudgement,
  • everyone involved in these decisions (Governor, MPC members, Board chair) getting reappointed, only confirming that “accountability” has been emptied of all content,
  • the appointment of a DCE responsible for macro and monetary policy with not the slightest background in that area,
  • blackballing people with research expertise from the new Monetary Policy Committee, and then years later assserting openly that there never was such a ban,
  • a Governor who is universally known to be intolerant of debate or challenge/disagreement,
  • barely any (and then of no depth) serious speeches from key monetary policy figures through the worst inflation outbreak and period of greatest policy uncertainty in decades,
  • a central bank that shows little sign of being exclusively focused on the limited range of things Parliament instructs it to do, instead pursuing management/Board ideological causes.
  • and so on

But sure, try blaming the “media landscape”. Seems a bit more like an effort – at taxpayers’ expense, from public officials – at active disinformation.

And if you are inclined to doubt the point about loss of focus, I can only suggest reading the Statement of Intent itself. “Climate” gets more mentions than either “inflation” or “price stability”, and if that particular ratio is (much) less bad than it was in their previous Statement of Intent, what hasn’t changed is that while “inflation” gets five mentions, and “price stability” six, “Maori” features 52 times (pretty similar to the previous Statement of Intent). And, yes, I did check and it is not that they are publishing lists of all different ethnicities: neither Asian, Pacific, nor European get even a mention (and nor would you expect any of them to do so in a central bank actually focused on its mandate, which by its nature operates pretty pervasively across the entire economy, regardless of religion, ethnicity, sexuality or whatever).

But Orr and Quigley have a crusade.

I checked again the Reserve Bank Act. There is but one substantive reference to “Maori” in that legislation (in a “good employer” section) and none at all – again unsurprisingly – to the treaty of Waitangi.

But you wouldn’t guess it from reading the Statement of Intent. It starts – first substantive page – with the tree god nonsense Orr used to spout on about a few years ago (complete with dodgy economic history about the founding of the Reserve Bank). Their so-called Te Ao Maori strategy gets two whole pages, complete with links to their treaty of Waitangi statement, well before any serious discussion about monetary policy, the cash system, or the soundness of the financial system, none of it grounded in statute. It pervades the document.

Now, in fairness to Nicola Willis, her letter of expectations to the Bank’s Board is different than those from Robertson. There is nothing at all of the dubious ideological stuff that Robertson used to throw in. But what difference has it made? None, apparently, given that her letter is dated 3 April, all these corporate documents came out only last Thursday, and none will have been a surprise to the Minister, since she had to be consulted. And yet she and the Cabinet reappointed Quigley.

Just breathtaking.

I’m still at a loss to understand what they have included in that $35 million. Perhaps they will now stop stonewalling on OIAs, and stop trying to charge me for information they should have released 5 years ago (but then OIAs weren’t even mentioned in that “engagement” description). Pro-active openness also tends to be even cheaper than handling OIAs, but that is something the Bank seems totally averse to. Perhaps they could spend a bit on a better proofreader (the table that showed that $35m had a typo in its title).

But more seriously, we deserve to know what this total includes, and why they are spending so much of our money to try to make us like/respect them (when just doing their job well – and only their job – would do more of that, and have substantive benefits to us). I suspect – but can’t confirm – the $35 million includes a lot of spending on things that really can’t be tied at all to statutory functions: their climate advisers, their Maori advisers, their diversity and equity (so-called) people, their multi-national central bank indigenous network costs etc, although it is still really hard to see how it gets to $35m per annum (hard to tell how much of an increase it is for this year, as they have changed their presentation, athough a number from last year that looks to be similar is about $29m).

While pouring out lengthy bureaucratic documents they avoid real scrutiny, they don’t do their day jobs at all well (we are living with the aftermath of really bad misjudgements in 2020/21), never show the slightest contrition, and feel free to use large amounts of public money to pursue personal ideological agendas not even slightly grounded in their statutory responsibilities, they rarely engage substantively, publish next to no research, and so on.

And yet Nicola Willis (and her leader and Cabinet) seem quite unbothered and just went ahead and reappointed the chair yet again.

Then again, this is the government – that campaigned up hill and down dale on fiscal excess and waste – which yesterday announced big new subsidies for……keeping an old local soap opera going.