Author: Michael Reddell

A wrong decision, but perhaps not too surprising

Michael Reddell Monetary policy, OCR

Graeme Wheeler’s OCR decision this morning –  perhaps he will tell us how many of his advisers backed this one? – was the wrong decision.  Core inflation measures remain well below the midpoint of the inflation target, and there are few or no pressures taking inflation sustainably back to the midpoint, even though it is now almost 11 months since the Reserve Bank began unwinding the ill-fated 2014 tightening cycle.

Keeping medium-term inflation near 2 per cent is the monetary policy job that has been given to the Governor.    Nothing else matters very much in the Policy Targets Agreement.  There has been talk in some quarters that the inflation target should be lowered.  The Minister of Finance says he hasn’t found that case persuasive, and he sets the target.

But if it was the wrong decision, it perhaps wasn’t too surprising a decision.  Graeme Wheeler has been reluctant to cut the OCR all along.  He continues to talk of how “accommodative” monetary policy is, but that appears to be referenced against a view that the “neutral” interest rate is 4.5 per cent (their last published estimates, although one hears that they tell investors in private meetings that that estimate is now around 4 per cent –  perhaps reflecting the fall in inflation expectations?).  He thought he was getting things “finally” back to normal when he launched the 2014 tightening cycle, talking confidently then of the prospects of 200 basis points of tightening.   It would be better, frankly, if the concept of a neutral interest rate was largely excised from central bankers’ vocabulary for the time being, because neither they nor we have any good sense of what “neutral” actually is.  Any such estimates have too often been a dragging anchor, helping hold back central bankers from the sorts of policy adjustments that meeting their respective inflation targets would have warranted.

So the Governor has been consistently reluctant to cut the OCR –  and even more reluctant to admit his past mistakes – and has only done so when the weight of evidence has overwhelmed his preferences.  Last year it seemed to be some mix of further falls in dairy prices, the failure of inflation to recover,  and/or high unemployment.  As recently as the start of February, in his forthright speech, the Governor was again holding out against the prospect of further cuts –  never ruling them out, but making pretty clear where his inclinations lay.  But then the data overwhelmed him again.   The new inflation expectations data shook the Bank, and the deteriorating global economic outlook and rising financial market unease (including widening credit spreads) prompted a move in March, with the prospect (projection) of one more cut to come before too long.

But in the past six weeks, there hasn’t been that much news, and little to change anyone’s baseline story.  There hasn’t been any new labour market data, the CPI had something for everyone, there was no material new inflation expectations data, and if the global economic outlook still looks unpromising, financial markets have recovered somewhat (including credit spreads banks face) and oil and various hard commodity prices have been rising.  If your reference point is that the OCR “really should” be something more like 4 per cent, why would you take the “risk” of cutting the OCR now?  It might be different if your reference point was that core inflation measures have been persistently below target for years, and that that gap shows little or no signs of closing.

What of the housing market?  I explicitly commended the Governor’s approach to house prices at the time of the March MPS:  asked about the risks that a lower OCR could provide a big further impetus to house prices, he  had simply observed “well, that’s just something we’ll have to keep an eye on”.   It helped that, at the time, the Bank  noted that house price pressures in Auckland had been “moderating”.  Recall that house prices are explicitly not something the Reserve Bank has a mandate to use monetary policy to target.

Six weeks on and house price issues are all over the headlines again, given added impetus by the Prime Minister’s talk of land taxes for non-residents etc.   The Bank’s tone has changed, although it is still somewhat cautious: “there are some indicators that house price inflation in Auckland may be picking up”.  Frankly, it would be surprising if it were not –  new distortionary policies introduced by the Bank and the government late last year should only ever have been expected to have had short-term effects.  Nothing fundamental about the market has changed.  It still isn’t the Bank’s responsibility at all, and certainly not something that should be driving monetary policy.  But when all his inclinations seem to be against cutting, unless “forced” to by new data, and with a potentially awkward Financial Stability Report only a couple of weeks off, it would have been another reason to hold back.

Are house prices really taking off?  The Dominion-Post would have one think so, highlighting this morning a sharp rise in the price of a house in the sunny but unprepossessing suburb of Berhampore, perhaps a kilometre from where I sit.  In terms of activity levels, I run this chart of the number of (per capita) mortgage approvals from time to time.  There doesn’t seem anything extraordinary about current volumes of mortgage approvals (again, the x axis is weeks of the year, numbering 1 to 52/53).

weekly mortgage approvals

Various people who talk to the Reserve Bank have been telling me since March that the Bank has finally “got it” and recognized that the overall domestic and economic climate is such that materially lower interest rates were needed.  I wish it were so, but I think today’s statement confirms my “model”, in which the Bank will cut only reluctantly, and only if  –  in effect – “forced” to.  The Governor just doesn’t seem worried about having the economy is a position where  the best guess of next year’s inflation rate would in fact be 2 per cent.  He seems content so long as (a) he can mount a semi-credible story that headline inflation gets back above 1 per cent before too long, and (b) so long as the measures of core inflation don’t consistently drop below 1 per cent.  Otherwise, house prices seem to play too large a role in his “reaction function” –  he can play them down and suggest they aren’t a consideration when they look a bit quiescent, but they act as quite a drag on good monetary policy at any other time.

I’m not overly keen on central banks reacting much to exchange rate movements in most circumstances.  Often enough, the exchange rate changes reflect something “real” or fundamental going on.   The Bank’s own research has suggested that falls in the exchange rate haven’t materially boosted overall inflation –  probably for exactly that reason.  But it is the Governor who keeps going on about the exchange rate and how uncomfortable or inappropriate or undesirable it is.  And yet the one thing he can do that make a difference to the exchange rate is the stance of monetary policy.  A lower OCR, all else equal, will tend to lower the exchange rate.  As it, the Governor must have gone into this morning’s announcement knowing that it was almost certain that there would be quite a bounce in the exchange rate.   Despite the absence of media lock-ups, there didn’t seem to be much uncertainty about the market reaction this morning.

Trade-weighted index measure of the exchange rate:

twi

And so we are delivered an exchange rate a full per cent higher than the level the Governor considered inappropriately high at 8:59am. That seems unnecessary and unfortunate.

The disastrous New Zealand (especially Auckland) housing market is primarily the responsibility of elected central and local government politicians.  It is not something to be controlled or moderated, except incidentally, by good monetary policy (to be aimed at stability in the general level of prices) or regulatory imposts on banks (supposed to be used only to promote the soundness and efficiency of the financial system.    If the Reserve Bank thinks banks need more capital, let it make such a proposal, advance the evidence, and consult on it.   If it thinks  banks are making reckless lending choices, again let them lay out the evidence in the forthcoming FSR, and tell us about the conversations it is having with bankers, and any regulatory measures it is thinking about.  But it simply is not a matter for monetary policy.

Looking ahead, there is not much key New Zealand macro data due before decisions are made on the June MPS.  The quarterly labour market data are out shortly, but after the noise in  the unemployment rate recently, it may be difficult to get much very new from that data yet.  Perhaps as important might be the next Survey of Expectations, and particularly the inflation expectations results in it.  Today’s statement is quite relaxed about inflation, and adamant that “long-term inflation expectations are well-anchored at 2 per cent” (not “seem to be”, not “close to”, but “are”  and “at”).

That certainly isn’t the message from financial markets.  Yes, I know that the implied inflation expectations from indexed bonds aren’t a perfect indicator –  then again, neither are the other measures of expectations or core inflation –  but the current level, just above 1 per cent, seems pretty close to the average of the various core inflation measures the Reserve Bank highlighted in the last MPS.  The central view just doesn’t seem to be that we can count on 2 per cent average inflation any time soon.  That should be a mark against the Reserve Bank.

iib breakevens

In closing, I should note a couple of small aspects of the Bank’s press release that I welcome.  I (and no doubt others) had lamented the Governor’s recent high profile focus on a single, complex, prone to end-point issues, measure of core inflation.  In this statement, that is replaced with a  simple “core inflation remains within the target range”.  Only just within, I would argue, but it is better than putting so much official weight on a single measure.

And in the final paragraph, I have noted for some time an unease at how much weight the Bank has been putting on recent and near-term headline inflation in these statements  –   in the near-term, headline inflation is thrown around by all sorts of things.  This time, they have gravitated towards something more (PTA consistent) medium-term in focus: “we expect inflation to strengthen as the effects of low oil prices drop out and as capacity pressures gradually build”.  One could reasonably question whether there is any sign that capacity pressures really are building, or are likely to over the next year or two –  after all, they have been relying on this “gradual build” for some years now – but at least it puts the emphasis in the right place: the factors that shape the medium-term outlook for inflation.

 

Lessons from the losers: Reflections on (Struan) Little

Michael Reddell New Zealand economic performance, Treasury, Uncategorized

As I noted a few weeks ago, about fifteen years ago Struan Little, then at The Treasury, sparked my interest in Uruguay, and comparisons between its long-run economic performance and that of New Zealand.  When I wrote that earlier post, I searched around to see if anything Struan had written on New Zealand’s economic performance was on the web.    Nothing was now, but it became clear that something had been.  Various old articles (eg here) referred to a paper released at the end of 2001 by Treasury, drawing “lessons from the losers” –  other reasonably advanced. reasonably democratic, countries, or regions, with some similarities to New Zealand, which had also done poorly.   The paper had even been cited by the IMF in one of their Article IV reviews of New Zealand.

The author no longer had a copy of the paper, but fortunately Treasury was able to track it down for me.  The OIA response should be on their website before too long, but in the meantime here is the document itself, “Growth and Policy in other countries: lessons from the losers”, dated 31 October 2001.

Lessons from the Losers by Struan Little

As Treasury is at pains to note, this was a personal thinkpiece, and although it was publicly released back in 2001 to influence debate and discussion, it was never finalized.  It isn’t a long paper (12 pages of text), so couldn’t cover everything, or document every caveat or qualification, but papers like this help us see the issues in slightly different ways.  It is to Treasury’s credit that they made space for the work to be done, and then put it out proactively for discussion.

In his stimulating paper, Little thinks about New Zealand’s experience in light of  eight comparators, four of which he saw as having had a “disappointing economic performance over a long period of time”

  • Uruguay
  • Switzerland
  • Tasmania
  • Atlantic provinces of Canada

And four of which “have gone through very difficult periods but moved on to become some of the richest economies in the OECD”

  • Denmark
  • Finland
  • Iceland
  • Ireland

The inclusion of Switzerland might surprise some, since it is –  and consistently has been –  one of richest countries in the world.  But its productivity growth had been strikingly weak over several decades.  Overall, it is a fascinating alternative lens to look at New Zealand’s experience through  – a contrast to, say, simply looking at the US or the UK, or even the OECD as a whole.

To structure his discussion, Little drew seven “broad lessons”

  1. Losers can’t be saved.    He isn’t quite as pessimistic as this sounds but observes “once you are gifted with the “loser economy” tag, there is no single policy (or even groups of policies) that can easily reverse this decline”.
  2. Don’t just blame size and distance.
  3. We spend a lot on education and training but do we get results?
  4. Technology-Driven Productivity Growth Went Out with the Tech Bubble. NZ firms don’t do much (that is classified as) R&D spending, but “the links between R&D and economic success are not clear”.
  5. You are either on the internationalization bus or plugging through the mud. NZers attitudes to internationalization weren’t very positive, and the volatility of the real exchange rate had been a problem, holding back our tradables sector/
  6. Social consensus matters
  7. Are individual interventions effective?
    • Size of government doesn’t matter
    • Centralisation isn’t all bad
    • FDI can help
    • Public infrastructure investment can be a waste of money

His own view, in conclusion, was that three policy areas were paramount for New Zealand, if it was to sustain a higher growth rate in future

  • Sound and stable macro policies, with a particular emphasis on a less volatile real exchange rate.
  • A shared social vision as to New Zealand’s future
  • Greater internationalization (changing attitudes, more emphasis on trade agreements, and “perhaps greater assistance to exporters”.

Any 15 year old paper on a topic of this sort is going to read a bit oddly in places –  at the time, for example, Italy was cited as an example of a notably successful economy (unfortunately it has had no per capita growth at all since then).  And although all of his four success stories remain much richer than New Zealand, each has had a new very rocky time in the last decade or so.

And whatever any author writes on a topic like this is going to be partly a product of his/her experiences and context.  2001 was two years into the first term of the Labour government, and I suspect Michael Cullen would not have been unreceptive to many of the sorts of messages in this note (which is perhaps why Treasury was able to publish it).

But I wanted to comment on one of the strands of policy Struan emphasizes, and then highlight a few that I was interested to find no mention of (perhaps partly reflecting the fact that today’s context is different to his).  And then offer a few thoughts on whether “losers’ can be saved.

The first is the volatility of the real exchange rate.  Little notes the materially greater volatility of New Zealand’s real exchange rate than those of Denmark, Iceland, Finland, and Ireland and observes:

“I see this as one of the key reasons why our export performance has been relatively weak compared to more successful economies.  While more extreme than New Zealand, the experience of Uruguay and the Southern Cone countries shows than an upward appreciation of the real exchange rate can undermine a reform programme and prevent a country from getting out of a low growth trap……..I would hope that improvements in our monetary framework may resolve the real exchange rate issue.”

What was the context?  We had had a relatively volatile real exchange rate in fifteen years since the exchange rate had been floated.  In 2001 the real exchange rate was actually very low –  only just off its all-time lows –  but there had been a lot of recent focus on the conduct of monetary policy.  In fact, Struan and I had been the bulk of the secretariat to Lars Svensson’s review of New Zealand’s monetary policy arrangements, which had been commissioned by the incoming Labour government –  concerned about the exchange rate, and disconcerted by things like the Bank’s unfortunate Monetary Conditions Index experiment.  That inquiry had reported earlier in 2001.

The Reserve Bank has always cautioned against emphasizing the volatility of the real exchange rate as a factor in New Zealand’s economic underperformance. As various people have noted, our real exchange rate is not extraordinarily volatile by advanced country standards –  which sample you compare it with matters a lot –  and much of the volatility reflects the real and financial external shocks the country faces. I largely agree with the Bank’s perspective on this issue –  and it isn’t obvious that much could be done to attenuate the big cycles in the real exchange rate anyway –  but we need to be open to the possibility that the impact is greater than we realise (if, eg, fluctuations in commodity prices contribute directly to exchange rate fluctuations, making it very difficult for other industries to successfully emerge and compete internationally).  But changing the details of the monetary policy framework isn’t likely to make much difference –  we’ve been through a wide variety of regimes over the decades, and had quite big real exchange rate fluctuations in each of them.

I’ve been more concerned about the average level of the real exchange rate.  Right from the early days of the reforms, experts (themselves supportive of the reform programme) have emphasized the importance of a lower real exchange rate as part of a path towards rebalancing the economy and establishing a stronger growth trajectory.  It was the Reserve Bank and Treasury view as far back as 1985.  Leading international scholars like Anne Krueger and Sebastian Edwards re-emphasized it –  partly in reference to the Latin American experience Little alludes to in the quote above.   It isn’t a line that is so widely heard in the mainstream these days, but the failure to achieve any per capita growth in New Zealand’s tradables sector in the 15 years since Little was writing suggests that the issue has not gone away.  Our persistently high (relative to other advanced countries) real interest rates look to be related to the failure of the exchange rate to adjust –  but that gap wouldn’t have been so evident in 2001.

T and NT components of real GDP

Reading through Little’s paper yesterday, three omissions struck me:

  • first, there was no specific mention of Auckland whatever.  I’m not critical of that  –  as I’ve made clear, I think the policy focus on growing Auckland is seriously misguided –  but one could not imagine a similar paper today not touching on the Auckland (and agglomeration) issues.
  • second, there was no mention of taxation and particular not the taxation of capital.  Perhaps it isn’t a material explanatory factor, or a tool that might make much difference, but the Irish experience with a very low company tax rate, and the Nordic experience with setting tax rates on capital income much lower than those of labour income look as though they should be candidates for inclusion in a list of explanatory factors.
  • third, there was no mention of immigration (policy) at all.  Emigration –  from all the “losers”  – got a mention, but not the role of policy-facilitated immigration of non-citizens.  Perhaps it just reflected the times – overall net immigration was quite modest around the turn of the century –  but the scale of our non-citizen immigration programme, unparalleled in the other countries and explicitly seen as an economic growth lever, looks as though it probably should have rated a mention of some sort.  (Of course, the paper was written just before the New Zealand house price boom started, so not even immediate house price effects of immigration were salient then).

Perhaps relatedly, in his final section Little talks of the contrast between fixed and mobile factors of production, emphasizing labour (“at least to an extent”) and social institutions as fixed factors.  It was a surprise that, in an economy whose exports are overwhelmingly natural resource based, our land wasn’t considered as an important fixed factor –  an opportunity and, perhaps, a constraint.

I’m explicitly not writing to criticize Little’s paper.  There is so little good material on these issues, and his note offers a lens that helps stimulate one’s thoughst even when not fully agreeing with it.  But there is perhaps one area where experience might suggest he was a little too pessimistic.  Even his “losers” can, it seems, turn themselves around, at least to some extent.

Of course, even in 2000 we knew that in some cases –  the better countries of Eastern Europe were already rebounding from the dark decades of Communist rule.  But it seems to have been true of some of Little’s losers too.

Switzerland’s productivity growth still isn’t stellar, but the Swiss have very large net foreign assets. I checked the net national income per capita data from the OECD this morning, and over the last 15 years, Switzerland –  already richer than most –  has outstripped growth in the OECD as a whole, and in the United States in particular.

For Uruguay, I showed this chart a few weeks ago, of TFP growth over the last couple of decades.

uruguay nz 4

Uruguay has a long way to go, but they’ve made an impressive start.

And what about Tasmania?  The Australian state GDP data start from 1990, and Little writing in late 2001 discusses the record in the 1990s.  Here is how NSW and Victoria, on the one hand, and Tasmania on the other have done over the subperiods 1990 to 2001 and 2001 to 2015.

real gspQuite a rebound in relative performance.

New Zealand, meanwhile, has shown no signs of even beginning to close any of the big gaps in productivity  –  if anything, on many measures they are still widening.

In terms of my narrative of New Zealand’s policy problems, one thing that marks out territories, states or regions from countries is that the former do not have an immigration policy.  Population growth in Tasmania may be very slightly influenced by Australia’s overall immigration programme, but largely people move to Tasmania only if the relative opportunities within Australia are better in Tasmania than they are elsewhere in Australia.    Tasmania looks like the sort of place –  like my story of New Zealand –  that can generate good incomes for a small number of people.  And in the last 25 years, Tasmania’s population has increased by around 12 per cent, while the populations of New South Wales and Victoria have increased by more than 30 per cent.   By contrast, in New Zealand’s case, the central government’s immigration policy directly boosts the population of the entire country.  Unlike Tasmania, we’ve had more than 35 per cent population growth since 1990, mostly concentrated in Auckland.  In such an unpropitious location for economic activity, it has just made it that much harder to even begin to close the income gaps.

Old papers aren’t to everyone’s taste, but the issues Little’s paper treats (or those treated in my own speculative entry to the field from a few years ago) haven’t gone away.  Unfortunately there is little sign of our political leaders –  government or opposition –  really doing much to reverse the decline of this “loser”.

 

 

Financial capability: what New Zealanders could do with from their governments

Michael Reddell Financial literacy/capability

I’ve written previously, and skeptically, about the financial capability strategy the government released last year. It is something of a wonder that civilisations have reached their current prosperity and sophistication without the aid of governments and their officials strategizing and pontificating about what we, citizens, “need” to know about money.  “Building the financial capability of New Zealanders is”, we are told, “a priority for the government”.  But what business is it of theirs?   And each time I read that line, I can’t help thinking that it would be better, and much more legitimate, if it were reversed: building financial capability of governments (and its agencies and officials) should be a priority for New Zealanders.

Last week, the bureaucrats were at it again.  The Financial Markets Authority published a so-called White Paper, with a Foreword written by the Chief Executive (so this is no mere background research paper, simply reporting the views of the authors), headed Using behavioural insights to improve financial capability.   The paper seems to be laying down markers for future regulatory initiatives.  It is probably better that the paper is out for scrutiny, rather than being held closely among the various government agencies.  But as I read it, the words of Jesus kept coming to mind

You hypocrite, first take the plank out of your own eye, and then you will see clearly to remove the speck from your brother’s eye.

The report is full of enthusiasm for understanding better the way in which consumers make decisions –  as if marketers and advertising agencies have not been doing that for decades.   It does so by drawing on a variety of insights from the behavioural financial literature, but in a fairly highly simplified (and one-sided) manner –  the entire report has 12 pages of text, with plenty of white space.   The behavioural financial literature does offer some fascinating perspectives on how people make decisions, but not often on why they have evolved to make those decisions that way.   And it does offer useful insights for marketers, and even for government officials trying to improve compliance rates (getting taxes, fines or fees paid on time).  Framing clearly matters.

But the leap from better understanding how consumers and citizens makes decisions to recommendations for policy interventions is not typically based on very much at all.  Assertions such as the claim by FMA CEO Rob Everett that “it is no one’s interest….for any investment decision to be made on the basis of bias or behavioural idiosyncrasy” seems to be based on nothing at all.  Or to be charitable, perhaps it is based on some benchmark of conforming human behaviour to some simple, particularly sterile but tractable, economic model, rather than recognizing that our biases and idiosyncracies (as he calls them) are often intrinsic to our humanity.  The authors seem to have a particular distaste for any involvement of emotion in decision-making.

It is a short paper, and so in a sense it is all too easy to pick holes.  But these bureaucrats appear to want to shape policy thinking, and they made the choice about what to put out for discussion.  So when they say “we overspend on credit cards and pay down debt less than we should”, we might reasonably ask not whether they can cite a single paper that shows that under certain experimental conditions this result might be able to be produced, but rather “where is the systematic evidence of a problem?”    Advances outstanding on credit cards at present are less than 3 per cent of GDP –  any credit card debt ever is too much for me personally, but across the economy  it is hard to find evidence of a problem spiraling out of control.

And, of course, much of the discussion of these issues has a subtext of unease about the choices people make for retirement provision. But again, where is the evidence of a problem justifying policy intervention?  The FMA paper asserts that “most people struggle to plan for future needs”,  But, as is widely recognized, New Zealand has one of the very lowest rates of poverty among elderly people of any advanced country, and older people seem to score their own life-satisfaction quite highly.  Is there any public policy interest at all in particular consumption outcomes for middle and upper income people in their later years?  Subject to the basics being met –  which they clearly have been in New Zealand –  I can’t see one.

Thus, when the paper cites interesting experiments which can lead to people saving more, it never stops to ask “by what measure, against what benchmark, is higher savings a desirable outcome for these population groups as a whole”.  There is simply no evidence of a “savings problem” in New Zealand, either at a micro level or a macro one.  Kiwisaver’s auto-enrolment (with opt-out) feature is described as “demonstrating the success of this approach”, but against what benchmark? To what end?

And when they report that research “shows people who have a plan are more likely to feel prepared for their retirement. The effect was consistent across all income levels”, are they telling us anything more than that some people like to have all the i’s dotted and t’s crossed, and they feel better if they have a “plan”.  It tells us nothing whatever about the ability of people to get through life.

In devising regulatory interventions, when they are well-warranted, it is important for regulators to understand how humans are likely to behave and respond.  And if those insights help get fines or taxes paid more promptly, then I’m right behind the use of them.  But when governments and their officials think they can do better than people, and market institutions, somehow correcting for the “flaw” in human nature, which have evolved over tens of thousands of years, we should be much much more skeptical.

Among the many reasons for such skepticism is the unspoken point that government officials and ministers, even those in the FMA, are human beings too, subject to all the same characteristics of human nature.  There is no class of detached super beings able to wisely choreograph the rest of us (directly or indirectly). And frankly it would be frightening, not reassuring, if there were,

But none of the weaknesses of regulators or governments appear in this White Paper at all.  There is a passing acknowledgement on the final page that “not every intervention is good” (really????) but no sense at all of the weaknesess, or biases to which regulators and officials and politicians are prone.    A good first question for every official or politician proposing new controls is something along the lines of “and what biases etc are you subject to, and how do the institutions protect citizens from (unwitting) bad outcomes from that actions of people like you –  including if the regime was run by your politicial opponents or the officials from the agency you have least time (and respect) for.”

As I noted earlier, a much stronger case could be made that citizens need a stronger financial capability among our governments and government agencies, and protections from all the “biases” or behavioural inclinations to which governments are prone.  Governments get countries into expensive wars.  Government choices are most often at the root of financial crises.  Governments mess up countries’ growth (and future consumption) prospects.  Governments badly distort housing markets.  Governments build expensive white elephants (whether sports stadiums, Think Big projects, or airport runway extensions).  Governments regulate on the whims of key individuals, with little or no regard for the consequences.  Governments put in place new programmes with little ability to assess longer-term consequences for individuals or society (eg welfare systems). Governments repeatedly eschew rigorous cost-benefit analysis.  And so on.   Not all governments, not everywhere –  and almost always with good intentions – but all too often.

This isn’t an anti-government tirade.  Societies need governments.  And they need governments to do well what only governments can effectively do (police, defence, administration of justice and so on). But the fact that we need governments does not mean that we safely can, or should, trust governments and their agents and agencies. Before they try to sort out human nature, we might more aptly aim to put in place much stronger checks and balances to restrain the flaws and biases to which governments seem intrinsically prone.

Last week, US economist Bryan Caplan on Econlog drew attention to a fascinating looking (quite long) new paper from Texas A&M University School of Law, “Behavioral Public Choice and the Law”.  I haven’t read it all yet, but I intend to.  The table of contents alone looks promising.

public choice

When we’ve seen the FMA –  and perhaps more importantly policy agencies like Treasury and MBIE –  seriously grapple with this sort of literature, I might be more interested in listening to their proposals for how they think government interventions might help improve citizens’ own decision-making.

This looked as though it should be a good topic for the New Zealand Initiative to pick up, following on from their new report on other paternalistic interventions (sugar taxes and the like). But then I noticed that the chairman of the FMA is also on the Board of the New Zealand Initiative.

 

Some perspectives on reform and the RB in the 1980s

Michael Reddell New Zealand economic history

A new book came in the post the other day.  It is a scholarly look at the long-term relative economic performance of New Zealand and Uruguay, something I wrote about quite recently and a subject I may come back to when I’ve read the book.

But there is an old line, especially applied to newspaper and magazine articles, that when the coverage of something you know about doesn’t ring true, be wary of the rest of the article.  And flicking through this new book my eye lit on a strange reference to the Reserve Bank.

In a paragraph on the reform period from the mid-1980s to the early 1990s (“which showed characteristics of a coup”), the author writes

Douglas as well as further members of the Cabinet, the Business Roundtable, and other strategically located institutions represented the exclusive inner circle of the new right. Until at least 1988, they used their large human capacities at the Treasury and the Reserve Bank to suppress alternative views and to limit the choices for MPs to a laissez-faire policy agenda.  Just as under Muldoon before, opponents were driven out to other departments and the private sector through informal pressure or became subject to petty harassment [ a footnote at this point adds “even university staff were affected, as controversial articles were less likely to be published in 1990 than in 1930”].

Very little of this rings true to me.

I’m not going to speak much of the Treasury, except to note that (a) Roger Kerr always spoke of how Muldoon respected the traditional boundaries of the public service, allowing Treasury (and people like Kerr) to develop their more market-oriented approach to analysis and advice (even if the Minister himself was not receptive to much of that advice), and (b) that I do know a few very able (and later successful) people who were either turned down from jobs with Treasury in the late 80s, or chose not to apply, because they were not-entirely-sympathetic to the reform process.  Plenty of people from the “right” in Treasury left for the private sector during those post-liberalization years –  opportunities abounded.

What of the Reserve Bank?  I was a manager in the Bank’s Economics Department (then, its main economics and policy wing) from 1987 to 1993.  At any one time, there were around six of us in the management group (led by Grant Spencer, and then Arthur Grimes), and above the department were the Governor and two or three Deputy/Assistant Governors.  There were a handful of other key people leading other departments (Financial Markets, International, Financial Institutions).  I suppose we should be flattered to be described as “large human capacities”, but to read the extract above one might suppose this was some phalanx of right-wing zealotry, demolishing all in our path.

There was a fair amount of turnover at the Bank during these years.  It wasn’t mostly people fleeing to the rich rewards of the financial markets –  mostly that was the next tier down –  but people coming and going from positions with international agencies such as the IMF and World Bank and advisory positions in developing country central banks.  I jotted down a list of 24 people who held the various key economic roles in the Reserve Bank over those years, and went looking for the right wing zealots.  No doubt some would class Roderick Deane in that category, but he had left the Reserve Bank in 1986.  What was left was a very short list.  I recall one very able colleague who wrote a nice think piece on free banking, and another who (in the abstract) was keen on open borders.  We liked to believe we were keen on rigorous economic analysis –  others can judge how well we did.  Most probably believed in fewer controls rather than more, and lower inflation rather than the New Zealand track record of the 70s and 80s.  Probably all wanted to be part of turning around New Zealand’s disappointing economic performance.  But a haven of ideological zealots it was not –  and what research we were publishing was mostly quite technocratic (at the time, most of the Bank’s research resource was devoted to building a new macro model, which proved largely useless amid the transitions and data discontinuities) and not much oriented to the overall policy framework at all.   Assistant Governor, Peter Nicholl, was said –  I never knew if it was true –  to have been involved in the Labour Party in his younger days before Labour became market-oriented, and at least two of us canvassed for National in the 1984 election (I blame my colleague..).  Largely, we were not-very-ideological technocrats.  I wasn’t much involved with recruitment at that time, but I don’t recall any suggestion of ideological tests

Even when it came to the new goal of price stability, launched on  the public somewhat surprisingly one April Fool’s Day, and us a day earlier, by Roger Douglas, the Bank was hardly champing at the bit to get going and eliminate inflation.   Grant Spencer – then chief economist –  and Peter Nicholl, his boss –  were both pretty wary, very uneasy about the (unemployment) costs of getting there.  For some, enthusiasm waxed and waned as economic fortunes changed.

In fact, that was somewhat so for the institution as a whole.  Don Brash is other name associated with an ideological perspective.  Don only joined the Bank in late 1988, but was hardly pursuing very low inflation aggressively –  at least from the perspective of the in-house hawks (it did, after all, take more than seven years to get inflation down). Don was also the one who signed up to Mike Moore’s Growth Agreement with the trade union movement during the 1990 election campaign.  Don recommended extending the target date from 1992 to 1993, explicitly to help allow room for a fall in the real exchange rate, to assist with rebalancing the economy.  And during 1991 Don and his, by then deputy, Peter Nicholl shocked some of younger enthusiasts by easing policy on the argument that “preserving the framework [RB Act] was more important [in the near term] than price stability”.  (Some of this material I dealt with here.)

I’m not suggesting that we were without fault, but equally –  and contrary to the impression given in the quote above –  we were operating in a climate in which everything was contested, and no one was confident that the reforms would endure.  It is fine to say that both main parties supported the reforms, but the big divisions were within the two parties not  between the leadership of the two (Labour had large left-wing factions which had Jim Anderton as their most prominent figure, and National had Sir Robert Muldoon, Winston Peters –  and Bill Birch, then still mostly thought of as the former minister of Think Big).  It is no secret, for example, that National’s support for the Reserve Bank Act was the result of an extremely close caucus vote, which Muldoon missed on account of illness.  Even when National won the 1990 election, we in the Reserve Bank were not remotely confident that the Richardson wing would be in the ascendant (or for long).  For the first year of that government, we (and Treasury) were constantly uneasy that political fortunes would change quickly, and many of the reforms could go as quickly.

I was also a bit surprised by the comment about the universities. I know various academics felt quite embattled, and ignored (and there was some grievance about cuts of government funding for the NZIER eg), but from our perspective in the Reserve Bank we also felt embattled, and were the subject of frequent academic attacks  (those were the days, unlike now, when university economics academics were very engaged with policy issues).  There had been the several rounds of exchanges between Victoria academics and the Bank and Treasury in 1985, on the analysis in the respective post-election briefings.  And when the Reserve Bank legislation was going through Parliament in 1989, the New Zealand academic economics community was pretty united in opposition (there may have been the odd supporter, but they kept very quiet).  This was the occasion of one of the more embarrassing lines I wrote in my decades in the public sector: we published an official response I had written to one prominent submission that had noted the absence of local academic support for the legislation: that said, we asserted, more about the quality of New Zealand academic economics than about the merits of the proposal.  We felt pretty embattled –  even if it didn’t always look that way to outsiders.

There was a lot about the reform period that isn’t particularly attractive, and of course –  although I continue to think that most of what was substantively done was in the right direction –  it doesn’t help that our relative economic decline continues, albeit at a slower pace.  New Zealand political institutions in those days  (single chamber, FPP) allowed small groups of politicians to do a lot quickly with few formal checks and balances. Publishing manifestos the week after an election, or simply abandoning high profile campaign promises really shouldn’t be the done thing.

But this simply wasn’t a period of a monolithic reforming class dominating everything.  Battles within parties were often vociferous, and opponents often had to be bought off with one concession or other.   And Roger Douglas was ousted after only four years, and Ruth Richardson was to last only three years as Minister of Finance.  As it happens, most things that were done haven’t been reversed, but that was never inevitable.  Things were contested and challenged –  perhaps not as well as they could have been (the quality of public debate has long seemed to lack something, on all sides) –  and probably nobody emerged unscathed, or totally satisfied.

Perhaps one small marker of the times was a snippet I stumbled on in a scholarly biography of Ken Douglas, picked up at a charity sale over the weekend.   Douglas was then the head of the trade union movement, and was not exactly from modernizing centre-left: he was prominent in the Moscow-aligned Socialist Unity Party (openly defending, only a few years previously, the Soviet invasion of Afghanistan and the suppression of the Polish Solidarity movement). The book records that in 1988/89 there was a political furore over the possibility of Douglas being appointed to the Board of the Reserve Bank.  It didn’t proceed – the government at the time would not confirm or deny the possible appointment, suggesting there was something to it (and Douglas has subsequently confirmed that he was approached.)  Would it have been an inappropriate appointment? Not necessarily, but that the idea was even raised goes against any sense of Roger Douglas, and his Treasury and Reserve Bank “large human capacities” simply ramming through anything they liked.

I really hope the rest of the Uruguay/New Zealand book is better. If so, I’ll let you know.

 

Should household debt be a worry?

Michael Reddell Financial stabilty, Housing, Uncategorized

Westpac had a note out the other day under the heading “Household debt levels now higher than before the financial crisis”.  Using December data for household and consumer debt (including debt used to finance residential rental businesses) and comparing it with household disposable income, they calculated that household debt was 162 per cent of income, compared to 159 per cent at the previous peak in September 2009.

Using slightly different numerators or denominators alters the picture only a little. Debt to income ratios fell back during and after the 08/09 recession, and have been increasing quite a bit in the last couple of years.  Credit growth has picked up and income growth has slowed.  I prefer to focus on debt to GDP measures, and here is my version of the chart.

household debt to gdp

The ratios haven’t yet reached the previous peaks, but aren’t that far away, and may well go past the previous peak this year.  One gets much the same picture looking at broader credit aggregates relative to GDP.

One could look at these trends in a variety of ways. I’d tend to emphasise the fact that over the last 7.5 years there has been no growth at all in the ratio of household debt to GDP, whereas over the previous 15 years that ratio had increased by around 60 percentage points.   Westpac seems much more worried than that.

But there are a couple of important things we know (or know we don’t know):

  • that we have no idea what any sort of “equilibrium” ratio of household debt to income is.
  • that when household debt levels were first at these sorts of levels, around the time of the 08/09 recession, it didn’t lead to any serious stresses on the financial system –  we had a pretty serious recession, mostly reflecting global developments, and yet there was never any question about the soundness of the New Zealand financial system.
  • that vanilla household debt has very rarely been at the heart of serious financial system problems in this or other countries  –  the Reserve Bank drew our attention to that in an article only a couple of years ago. Lending on speculative commercial (and residential) developments, and other (typically unsecured) business lending, has usually been the presenting source of financial system problems.

But I’m also puzzled by two points about the Westpac piece –  one presence, and one absence.

Westpac talks of high house prices boosting consumption.

household C to GDP

But household consumption as a share of GDP is currently just slightly below the average ratio for the last 30 years or so.  This shouldn’t be very surprising –  higher house prices don’t make New Zealanders as a whole any better off.  A longer discussion of this issue is contained in this Reserve Bank Bulletin article from a few years ago.

The “absence” is any sense that changes in household debt to GDP (or income) ratios are not mostly some exogenous phenomenon of reckless banks and households taking on new debt with gay abandon.  I discussed this issue a couple of weeks ago.  If there are shocks to the population, and land supply restrictions exist, then house prices will rise.  New purchasers will typically (and probably rather reluctantly) need to take on more debt than their predecessors did.  As a result, debt to income ratios will rise. Since the housing stock turns over only quite slowly, an initial shock boosting house prices will go on boosting debt to income ratios for many years.

In the chart below I’ve done a very simple exercise.  I’ve assumed that at the start of the exercise, housing debt is 50 per cent of income, house prices and incomes are flat, and people repay mortgages evenly over 25 years.  Only a minority of houses is traded each year, but each year the new purchasers take on new debt just enough to balance the repayments across the entire mortgage book.

And then a shock happens –  call it tighter land use regulation –  the impact of which is instantly recognized, and house prices double as a result.  Following that shock, house purchasers also double the amount of debt they take on with each purchase, while the (now rising) stock of debt continues to be repaid in equal installments over 25 years.

In this scenario remember, house prices rose only in year 1.  There is no subsequent increase in house prices or incomes.  But this is what happens to the debt to income ratio:

debt to income scenario

In this particular scenario, 100 years after the initial doubling in house prices, the debt to income ratio is still rising, solely as a result of the initial shock, converging (ever so slowly by then) to the new steady-state level of 1.  One could play around with the parameters, but a permanently higher level of real house prices will, in almost any of them, produce a permanently higher level of gross housing debt, and it will take many years to get to that new level.  The flipside, which I could also show, is the deposit balances of the other parts of the household sectors – the young who have to save for a higher deposit (even for a constant LVR) and the older cohorts who extract more money from the housing market when they downsize or exit the market.  Higher house prices do not, of themselves, require banks to raise more funding offshore.

This is deliberately highly-stylized, but it is designed to illustrate just two main points: higher debt ratios can be primarily a symptom of higher house prices (rather than any sort of cause) and the adjustment upwards in debt levels following an upward house price movement can take many years to work through.

Given the huge population pressures, especially in Auckland, and the lack of much material progress in easing land use constraints, it is hardly surprising that real house prices have increased quite a lot further in some places. If anything, it might be a little surprising that debt to income ratios have not increased more. But these things take time – the point of the chart above.

Westpac has long been of the view that low interest rates have been a major factor explaining rising house prices.  I’ve never found that story particularly persuasive.  We’ve had a 600 point cut in the nominal OCR since 2008 (and a bit more in real terms).  If all else was equal and the Reserve Bank had not cut the OCR as much no doubt house prices would be lower (and quite a lot of other aspects of the economy would be doing even less well).  But the OCR cuts have been done for a reason: the economy hasn’t been performing that well, and inflation has persistently surprised on the downside. In Wicksellian terms, it looks a lot as though the natural interest rate has fallen quite a bit.  Westpac worries about what happens when (if) interest rates rise, but they are only likely to rise much if the economy is performing much better, and is generating much stronger income growth (which would support the existing debt).

There is a still a strong sense around that, when it comes to housing, what goes up must come down.  But when a market is so heavily influenced by regulatory factors, there is no such natural adjustment.  As a loose parallel, we have plenty of people who find it hard to get a job, but the minimum wage keeps on being increased.  Urban residential property prices, especially in Auckland, are a disgrace –  the responsibility of the choices (active and passive) of a succession of central (and local) government politicians. They are hard to defend under any conception of justice or fairness. But there is little sign that they are any sort of macroeconomic risk.  Debt to income is little higher than it was a decade ago, consumption to GDP has not gone crazy, there is nothing of the sort of debt fuelled speculative construction boom seen in, say, Ireland, and there is no sign of reckless behaviour by lenders.  And the banks are very well-capitalized.  It is awful for the many adversely affected, but there is no reason why things should necessarily change much for the better any time soon,

Finally, one of the points of the Westpac note seemed to be to foreshadow the risk of new layers of regulatory controls (so-called “macro-prudential” measures) being imposed on the banking system by the Reserve Bank.  Perhaps they are right about what might be coming. But there would be no good (financial system soundness) basis for further intrusions on the ability of borrowers and lenders to freely arrange finance.    There is simply no evidence that the soundness of the financial system is at risk –  or would be even if, say, the population pressures reversed and land use restrictions were freed up.  Then again, the last two sets of LVR restrictions, undermining the efficiency of the financial system and the wider economy in the process were unwarranted, but that didn’t stop the Reserve Bank charging ahead then.

 

Questions about the OCR leak, the inquiry etc

Michael Reddell OCR leak, Reserve Bank

Questions about the handling of the OCR leak issue aren’t going away.  Last Saturday, I posted some thoughts on some issues that the Reserve Bank and MediaWorks should be asked about, flowing from a careful rereading of the relevant documents.

Since then there has been a variety of articles –  especially focused on MediaWorks – in the mainstream media.   Jenny Ruth had a piece on the NBR website “Were there other MediaWorks leaks from Reserve Bank lockups”.  Hamish Rutherford has a substantial and useful piece in the Dominion-Post this morning “MediaWorks Owes an Explanation” (although I have considerably more readers than he reports) and John Drinnan’s media column in the Herald today is largely devoted to media aspects of the leak and its aftermath.

It is perhaps understandable that the mainstream media has focused mainly on the media dimensions –  many of them are grumpy at losing the opportunities previously afforded by the lockups (although others quietly acknowledge that the lockups were really products of a different technological age and probably had to go).  I don’t have much sympathy on that count, having called a month ago for the lockups to be scrapped.  But I do share the surprise that there has been no evident specific  sanctions meted out to MediaWorks, the chief culprits in the whole affair.  Various people have suggested that MediaWorks should have been banned from lock-ups, rather than ending the practice altogether.  Ending lock-ups was the right thing to do, but it is still surprising that there appear to be no other concrete consequences for MediaWorks’ flagrant breach of the rules (not reported to the Bank for weeks).   Then again, what other sanctions were available?  One might have been to deprive MediaWorks of, say, opportunities for any interviews with the Governor. But since he doesn’t give interviews, I guess that option wasn’t available.

There are questions for MediaWorks, but in the end they are a private company and have to make their own judgements about what to tell us.  It is disappointing that they have not been more open.  I’m not so much bothered about them not naming the person who sent the email from the lock-up, but about things like:

  • had these sorts of leaks happened before by MediaWorks staff?
  • why did it take more than three weeks for MediaWorks to acknowledge that its employees were responsible (including more than two weeks after the issue had extensive media coverage).

But, as I say, MediaWorks is a private organization.  The Reserve Bank, by contrast, is a powerful public body.  We should expect an open and transparent approach by public institutions when bad stuff happens, and the Bank is subject not just to the Official Information Act, but also to parliamentary scrutiny.  I think there is a range of questions to which the public deserves answers from the Bank:

  • Did the Bank, or Deloitte, ask MediaWorks whether these sorts of breaches had occurred before.  If not, why not.  If so, what was the response?
  • Why does the inquiry report not address issues around “the process for transmitting the Governor’s OCR decision to see if any improvements are needed”, even though the Bank had told me the Deloitte inquiry would cover such matters?
  • Was MediaWorks given a chance to comment on the draft inquiry report, or the draft of the Reserve Bank news release of 14 April?
  • Why does the Reserve Bank press release go out of its way to stress the cooperation of MediaWorks, when MediaWorks did not report the breach until more than three weeks after it occurred?
  • Why does the news release not accept any responsibility for the Bank having run lock-ups with such lax security procedures that a breach of this sort could happen so easily?
  • Have any Reserve Bank officials been disciplined or reprimanded for failing to update security procedures to reflect the advances of technology?

In support of seeking answers to these, and other, questions, I have lodged an Official Information Act request with the Reserve Bank.  It requests the following information:

Terms of reference

  • Copies of the terms of reference for the Deloitte inquiry, including the TOR as at 15 March 2015 (the date of Nick McBride’s approach to me), and any subsequent variants, (formal or informal).
  • Copies of any advice to or from the Board regarding the terms of reference

MediaWorks’ 5 April advice

  • Copies of the initial MediaWorks advice to the Reserve Bank and Deloitte on 5 April (date as per the inquiry report).  In the event that the advice was oral, please provide copies of any filenotes or other records of conversations with MediaWorks.
  • Copies of any follow-up requests for further information made to MediaWorks or its representatives by the Reserve Bank or the Deloitte inquiry team.

The Deloitte inquiry report

  • Names of any person or organisation, beyond the Reserve Bank’s staff or Deloitte, invited to comment on the draft report.
  • Copies of any advice provided to the Reserve Bank by non-executive members of the Reserve Bank Board on the draft report.

The Reserve Bank’s 14 April news release

  • Copies of all drafts of the 14 April news release
  • Names of any persons or organisation beyond the Reserve Bank’s staff or Deloitte, invited to comment on the draft news release.
  • The time at which MediaWorks was given a copy of (a) the draft, and (b) the final news release.
  • Copies of any comments made to the Bank by (a) MediaWorks and/or (b) non-executive Board members on the draft news release.

Internal Reserve Bank committees

  • Copies of the relevant sections of the minutes of any meetings of (a) the Governing Committee, and (b) the Senior Management Group at which the (possible/actual) OCR leak, and/or the Reserve Bank’s response to it, were discussed.

I remain more than a little aggrieved, having brought the issue to light in the first place, at having my conduct described by the Governor as “irresponsible”, but I have addressed those issues in a separate letter to Governor.
 

 

 

 

Ambivalence about expectations of the Board

Michael Reddell Governance, Reserve Bank

(For those interested in the ongoing lock-up issues, my thanks to an offshore reader for drawing my attention to newly-released Audit Report by the Federal Reserve’s Office of Inspector General on the Fed’s lock-up procedures and processes.  The Fed procedures appear to have left open significant risks of leaks and breaches of embargoes –  and there was one actual breach last year.  In effect, again the system relied largely on trust.  The report contains a variety of recommendations to tighten security. A Reuters article on the OIG is here.)

Since reading yesterday morning (eg here ) about the OIA release by the Minister of Finance of a near-final draft of a new (November 2015) “letter of expectation” to Rod Carr, chair of the Reserve Bank’s Board, I’ve been trying to work out what to make of it. (The letter itself is near the back of the document released here.)   On the whole, I think it is probably a step forward, at least in the specific current circumstances.  But it has some dangers too, and risks undermining some of the good features of the statutory governance model for the Reserve Bank.

I’ve written previously about the Minister of Finance’s letter of expectation to the Governor , and in due course will be interested in this year’s letter.  Last year’s was surprisingly light on (ie there was no reference at all to) any concerns about the persistent deviation of inflation from the target.  The Minister and the Governor have a clear and direct legal relationship across a variety of strands: the Minister appoints (and can dismiss) the Governor, the Minister and the Governor sign a PTA that governs  the Bank’s conduct of monetary policy, and the Minister has a wide range of powers in a variety of matters (mostly regulatory, but including also fx intervention) dealt with in the various pieces of legislation the Reserve Bank is responsible for.

The relationship between the Minister and Board members is designed to be much weaker than that.   Board members are appointed by the Minister, and can be dismissed by the Minister (for cause),  but (unusually) the Minister does not even get to decide which of the Board members will be the Chair.  That is decided by Board members themselves.    The Board has quite a limited ongoing legal relationship with the Minister of Finance.  They are responsible for making a recommendation to the Minister as to who to appoint as Governor, and they are required to provide advice to the Minister on the Bank’s annual dividend.   But that is about it.  The Board must prepare a (published) Annual Report, which must be physically delivered to the Minister, but is not specifically described in the Act as a report to the Minister.

It is when things go seriously wrong that the Board is supposed to start talking to the Minister.   Section 53(3) of the Act provides that

If the Board is satisfied—

(a) that the Bank is not adequately carrying out its functions; or
(b) that the Governor has not adequately discharged the responsibilities of that office; or
(c) that the performance of the Governor in ensuring that the Bank achieves the policy targets fixed under section 9 or section 12(7)(b) has been inadequate; or
(d) that a policy statement made pursuant to section 15 is inconsistent in a material respect with the Bank’s primary function or any policy target fixed under section 9 or section 12(7)(b); or
(e) that the resources of the Bank have not been properly or effectively managed; or
(f) that the Governor, except as provided in his or her conditions of employment has, while holding office as Governor,—
  • (i) held any other office of profit; or
  • (ii) engaged in any other occupation for reward; or
  • (iv) had an interest in a bank carrying on business outside New Zealand; or
(g) that the Governor is unable to carry out the responsibilities of office, or has been guilty of serious neglect of duty, or has been guilty of misconduct,—

the Board shall advise the Minister in writing and may recommend to the Minister that the Governor be removed from office.

That is (rightly) quite a high threshold to cross before the Board must make such reports to the Minister.  The Act never envisaged a close or regular reporting relationship between the Board and the Minister.

I have sometimes written of the Board as being essentially the Minister’s monitoring agent (and I see the new letter uses the same language).  But if it was a pardonable shorthand, on further reflection I don’t think it is a fully accurate description either.  What the Act seems to envisage is a model in which the Board is charged with reporting publicly on how well, or otherwise, the Governor has been doing his job, but is supposed to stay at quite an arms-length from the Minister: paid to keep an eye on the Governor certainly, but expected to stay quite clear of the Minister unless things are so bad that the possibility of dismissal is coming into focus.

And I think that is the way it should be, at least if we want to maintain an operationally autonomous central bank.   Why?  Because the whole logic of making the central bank operationally independent, especially on monetary policy, is based on the (not totally uncontentious) view that we will typically get worse outcomes if elected politicians are too close to the decision-making process.  Instead, we set up an open and transparent medium-term PTA, in which the Minister takes the lead in setting the target, and the Governor is responsible for implementing policy consistent with that agreement .  PTAs are deliberately written for terms of five years, and the Governor is left to get on with the job (with all the reporting requirements, public and market scrutiny etc).

And so I am a little uneasy about this new letter of expectation, even if it supposedly flowed from a conversation initiated by the Board (I take that with a pinch of salt, as the Board may well have been responding to the Minister’s public expression of unease with the Bank last year).

The letter seems to have three broad areas of substance.  The first is a list of Minister’s specific interests for the Board in its monitoring role.

  • Monitoring the performance of monetary policy with respect to the Policy Targets Agreement (PTA).  I expect the Board to provide me with a clear sense of its judgements and the basis for them in assessing performance in meeting the PTA, recognising that the policy targets have evolved to be flexible and forward looking.

  • Assessing the performance of the Bank in promoting the maintenance of a sound and efficient financial system.  I expect the Board to articulate how it judges performance with respect to this statutory objective. I am particularly interested in how the objectives of soundness and efficiency are promoted and balanced.

  • Monitoring the Bank’s regulatory policy processes. The Bank has important regulatory responsibilities.  I expect the Board to take a close interest in the robustness of regulatory policy development and to articulate how it judges performance with respect to this function.   In particular, the Board should:

    • – Keep under review how the Bank’s regulatory policy is developed in light of the Government’s response to the Productivity Commission’s report on regulatory institutions and practices, and how these changes improve regulatory practice.
    • – Test the Bank’s thinking on regulatory policy developments and be satisfied that the Bank has reasonably addressed any alternative perspectives from other relevant parties (eg, the Government, the Treasury, the Council of Financial Regulators, Australian stakeholders, the financial sector and the wider public through consultation).

  • Monitoring the Bank’s relationships.  The Bank has a number of important stakeholder relationships – with me, with the Treasury, with regulated entities and with other agencies.  I would expect the Board to keep under review how these relationships are operating in practice.

  • • Monitoring of operational functions.  The Bank has a range of operational functions, including those related to payment systems and currency.  I expect the Board to monitor the Bank’s operational performance and risk, particularly with regard to the use of the Crown’s resources and wider economic efficiency.  •

  • Organisational strategy and financial management.  The Bank is a complex organisation with a large balance sheet. I expect the Board to take a strong interest in the Bank’s strategy and financial management.  The Board should closely monitor the Bank’s performance against the Statement of Intent (SOI)

It is an interesting list, and in some cases quite pointed.  For example, the explicit recognition of the possible tensions between regulatory measures to promote system soundness, and the statutory provisions around the efficiency of the financial system.  Or “the Board should test the Bank’s thinking on regulatory policy developments and be satisfied that the Bank has reasonably addressed any alternative perspectives…. [including from] the wider public through consultation”.  That would certainly be welcome.

The letter of expectation also deals with the Annual Report

The annual Board report, as required under the Act, is the formal document that sets out the Board’s assessment of performance.  I expect this to provide enough detail to enable me and the wider public to understand how the Board has undertaken its review role.

I have written previously about the severe shortcomings in past Board annual reports.  Last year’s said almost nothing of any substance, and tended to reflect the prevailing practice in which the Board has seen itself as “having the Governor’s back”, and being part of the Bank’s efforts to spread its messages.

If this provision in the letter of expectation is a shot across the bows, suggesting that better and fuller Annual Reports should be produced, it is most welcome.  The Minister outlined a variety of specific areas he is interested in (above), and we should hope that there would be substantive material on each in the next Annual Report –  not just about the processes the Board used, but about its substantive assessments and residual uncertainties. I remain somewhat skeptical, but time will tell.

Towards the end of the letter, the Minister includes these paragraphs

The duties of the Board include keeping under review the performance of the Governor.  I would expect to discuss your assessment of the Governor’s performance from time to time.  I would not expect you to limit your communications on the performance of the Governor or the Bank to the narrow criteria set out in section 53(3), as I hope those circumstances would apply rarely if ever.

Greater visibility of the Board’s activities throughout the year would also be welcome and I would be interested in any suggestions you have to facilitate that.  In addition, I will ask my office to establish six-monthly meetings with me.  In advance of those meetings, I invite you to share any other documents regarding the Bank’s performance which would support the discussion.

Here I am just not sure.  It is no secret that I don’t think the current Governor has done a particularly good job, so in one sense the more questions asked about his performance the better.  But the institutions are not designed around any particular individual, and probably nor should the practical implementation arrangements be.  Non-transparent regular discussions between the Board and the Minister about the Governor’s performance create risks of inappropriate pressures being placed on the Governor (not just on monetary policy, perhaps more especially in regulatory matters).  Since the Minister has deliberately been given the power to dismiss the Governor only in fairly extreme circumstances, it isn’t clear what is gained by the Minister and the Board holding such conversations, unless those potential-dismissal thresholds are coming into view (and, as the Minister notes, he hopes that is “rarely if ever”).  Indeed, is there even a legitimate ministerial interest, given the choices Parliament has made about the structure of the Bank and the role of the Governor?  I think there are material flaws in the allocation of responsibilities under the Reserve Bank Act.  One of those is that the Governor has too much control of financial regulatory policy (as distinct from the application of that policy).  The Minister might share some of those concerns, but the right way to deal with the issue is to amend the Act, not use the Board as back-channel leverage.

When I first read that final paragraph in the letter, I wondered if “greater visibility” meant public visibility.  If it did, that would be quite inappropriate –  a good published Annual Report is the appropriate model and at other times the Board should have a low profile, not detracting from that of the Governor.  In fact, I think the Minister is only talking about the Board being ‘visible’ to him.  But, as discussed above, I remain uneasy about the idea of regular formal meetings with the Minister –  as distinct perhaps from the odd informal discussion over lunch –  especially if it involves additional “documents” being provided to the Minister.  It runs the risk of the Minister and Board second-guessing individual decisions by the Governor, and that simply isn’t the statutory model.

But there is another risk.  I’ve noted previously that the Reserve Bank Board has tended to act as if its role is to provide cover for the Governor.  In principle, they should be able to have free and frank exchanges with the Governor in private –  including on the issues the Minister touched on in his letter.  But if the Board is getting into a regular/routine reporting relationship with the Minister, I fear that the “have the Governor’s back” tendency will just be reinforced.  The Minister might appoint Board members, but they meet at the Bank, the Governor is a Board member, the Board has no resources of its own (only what the Bank provides), and a senior Bank manager is Secretary of the Board.  So far, they have only chosen former staff (Arthur Grimes and now Rod Carr) as chair.  They have become quasi-insiders.   None of this is intended as criticism of any of the individuals concerned; the incentives simply work together to make it a model that is never likely to generate regular hard-nosed rigorous scrutiny of the Governor’s performance.  It is a model that few, if any, other countries have adopted.

And so I’m left ambivalent about the letter of expectation to the Board.  On the one hand, it seems likely that this initiative has flowed, at least in part, from the tensions around the current Governor’s performance –  and so in that short-term sense, I’m pleased to see more questions being asked, and challenges posed.  And anything that produces better quality Board Annual Reports would be welcome.

But the model of governance Parliament established for the Reserve Bank 27 years ago does not envisage routine close ties between the Board and the Minister.   Indeed, I’m aware of no advanced country with an operationally independent central bank where there are such close ties.  If we want a central bank with operational independence, the Minister of Finance should be at a considerable arms-length.  In one sense, the Board is the Minister’s monitoring agent, but only with qualifications –  the role the Act envisages for the Board, as it related to the Minister, is for quite extreme circumstances.  The Board are not, say, the Minister’s employees who just happen to be representing him on some committee or other.

Of course, my overarching view is that the Bank’s governance model is flawed, and if there as ever a sound argument for it, it is no longer well-suited to range of functions the Bank undertakes, and is out of step both with international practice and with how New Zealand governs other public sector agencies. The model should be changed, and it remains something of a mystery why the Minister is so resistant to change.  My alternative, which uses the able people on the Board more actively in a decisionmaking role, was outlined here.

 

 

A bouquet for Statistics New Zealand

Michael Reddell Statistics

(and some questions as well).

I got home at lunchtime after a couple of hours out with the kids to find a very pleasant surprise.

Following the kerfuffle last week about the Reserve Bank’s leak inquiry, and the discontinuation of the Bank’s lock-ups for media and analysts, someone reminded me that not just Treasury but also Statistics New Zealand holds regular lock-ups involving market-sensitive macroeconomic information.   Statistics New Zealand runs lock-ups

for media and market commentators for Gross Domestic Product, Balance of Payments and International Investment Position, Consumers Price Index, and Labour Market Statistics releases.

I wondered (a) what procedures Treasury and Statistics New Zealand used,  and (b) whether either organisation had changed their procedures in light of the Reserve Bank’s leak inquiry and subsequent decision to discontinue lock-ups.

So last weekend I logged OIA requests with each organization, and assumed I’d hear something in a few weeks time.

But Statistics New Zealand responded this morning (in due course, their full response will be here).  Often enough, blanket refusals take 20 working days or more, but here was a department offering a prompt, clear and helpful reply, and offering to answer any follow-up questions.

Here are the SNZ procedures

Prior to the commencement of a media conference, Statistics NZ requires attendees to sign in and surrender their cell phones. In addition, Statistics NZ displays the following media conference rules for attendees to abide by:

  • the media conference is held as a ‘lock-up’
  • once you have entered the room, you must not leave until 10:45am when the embargo is lifted
  • please sign in, turn off your mobile phones, including smartphones, and put them in the compartment at the conference room entrance
  • laptop external wireless communication devices must be placed beside the laptop on the media room table for the duration of the media conference, and cannot be connected to the computer until the embargo is lifted
  • laptops or other devices that have internal wireless network capability must not connect or transmit until the embargo has been lifted
  • we reserve the right to inspect devices to ensure that internal wireless capability is turned off.

Statistics NZ staff are happy to assist you with any questions about these guidelines.

 Note: Before the media conference starts, attendees are permitted to call their office, from Statistics NZ provided phones, to set up redial capability for use at 10:45am.

And here is the response as to whether they have made any changes or reviewed their procedures

Statistics NZ has not undertaken any reviews or made any changes to the department’s policy for media conferences following the Official Cash Rate leak at the Reserve Bank of New Zealand and the subsequent Deloitte report into that leak released last week.

Unfortunately, Statistics New Zealand seems still to be relying, in effect, on trust  (in much the same way the Reserve Bank was doing).   But the headline statistics that they hold lock-ups for are highly market-sensitive, and will not infrequently move markets more than an OCR announcement will (as one would expect; it is the same data the Reserve Bank uses).  There is no sign of, say, any jamming technology (or other technical means) being used, to buttress the role of trust.

Statistics New Zealand notes that

While Statistics NZ has never had a breach, if that trust is abused and an embargo is broken, offenders and their organisation would be barred from attending future media conferences.

Unfortunately, that was probably the sort of discipline/incentive the Reserve Bank was implicitly relying on as well.

As I’ve argued previously, the case for pre-release lock-ups for monetary policy announcements is weak (with the possible exception of a highly secure 10 minute lock-up for core financial journalists, with no additional briefings –  something like the model the US Federal Reserve apparently uses).  Is Statistics New Zealand that different?  There is, obviously, no policy message SNZ is trying to put across with its releases, and so no risks of different messages getting to different people.  But the security risks are the same.  Perhaps it is simply more efficient to have everyone in the same room, to clarify key technical points, but couldn’t the same end be achieved –  on a more competitively neutral basis (to analysts based abroad, say) –  by a dial-in (even webcast) conference call held a bit later on the day of the release?

Anyway, the point of this post was to praise Statistics New Zealand for its timely (“as soon as reasonably practicable”) response to an OIA request.    Quite what approach Statistics New Zealand should take in future is a matter for them, but I would encourage them to think again about the risks, and about alternative –  perhaps preferable –  models for helping to ensure that users can get whatever technical insight SNZ can offer into the numbers it releases.    Breaches may never have happened, but when one does happen –  and (by accident or intent) with current systems  it must be a matter of time – it can suddenly get extremely uncomfortable.

UPDATE: For those with a taste for obscure historical episodes, chapter 1 of this document –  linked to by a commenter – is well worth a read on the great data leak of 1905.

 

 

Regional GDP revisited: has Auckland really been that weak?

Michael Reddell Auckland, Housing, New Zealand economic performance

In a couple of posts earlier last week, I used the regional (nominal) GDP data, showing how weak Auckland’s per capita GDP growth appears to have been over the last 15 years (the period for which the data exist).   And it didn’t appear that terms of trade changes could explain the regional patterns, since most of the gains in New Zealand’s terms of trade has reached our shores in the form of lower import prices, the effects of which should have been quite pervasive across the economy.

But as I got to the end of the second of those posts, I started to get a bit uneasy about the data.  I had noted that over the 15 years, Auckland’s population had increased by 30 per cent, and that of the rest of the country by only 13 per cent.  And yet, over the years (to 2013, for which we have detailed industry breakdowns), construction had been a smaller segment of Auckland’s GDP than in most other regions in the country. This was the chart:

construction share of gdp

I started digging into the data a bit further, and also got in touch with Statistics New Zealand (who provided me with some prompt, very helpful, assistance, including suggesting that some readers might be interested in how they put the numbers together).  My digging didn’t resolve any puzzles, but it didn’t highlight any very obvious errors either.

In a city with a rapidly growing population one would normally see a larger share of GDP devoted to construction (than at other times, or other places).  Construction isn’t just about houses, but the whole panoply of structures that a growing population needs over time.

Over the 15 years to 2015, Auckland accounted for 50 per cent of all the population growth in New Zealand.  And yet here is the Auckland share of the value of all building consents, and the Auckland share of the construction component of GDP (for which we only have regional data to 2013).

akld consents

One wouldn’t expect an exact mapping, since the two series are measuring quite different things (quite a bit of construction won’t need a building consent), but both are a long way below Auckland’s share of population growth  (and Auckland’s share of population growth was highest in 2001 and 2002).

The regional GDP data also have two components that should normally have a strong relationship with housing, and also with population growth.  These are:

Rental, hiring, and real estate services
Owner-occupied property operation

The latter series is straightforward –  in effect, the rental value of living in an owner-occupied house, which is proxied using market rental data.

The “rental, hiring, and real estate services” is more complex.  It includes various sub-categories, for which the data are not provided separately.  Here is what is included, from a table SNZ sent me:

reg gdp categories

Ideally, I would like to look at only the LL12 and LL2 components, and thus exclude the non real estate leasing services (eg cars, machinery etc), but the data aren’t publicly available.

Surely, I thought, if Auckland’s population has been growing so much faster than the population in the rest of the country, this should be reflected in faster growth in these components of GDP.  I didn’t really expect it in respect of owner-occupied dwellings, because although Auckland rents have risen a bit faster than those in the rest of the country, rates of owner-occupation have been falling faster.  But everyone needs to live somewhere, renting if not owning, so I thought the effect should still show up if I combined the two components.  After all, the rental component also includes non-residential property, and more people generally implies more offices and shops too.

But this scatter plot is what I came up with (population growth on the x axis and growth in the sum of the two GDP components on the y axis):

housing scatter plot

I’d expected to see an upward-sloping relationship (recall, these aren’t GDP per capita components, but total GDP).  As I put it to SNZ, isn’t it a bit puzzling that growth in these two nominal GDP components over 13 years was greater in Southland than in Auckland?  Given where all the other regions sit, in a well-functioning housing market surely one might have expected the growth in these GDP components for Auckland to be up in the 140 to 160 range?

SNZ were able to tell me that there was a large growth, from a low base, in non-financial non real estate asset leasing in Southland.  That might help explain why these GDP components together grew surprisingly fast in Southland.  But it doesn’t explain why Auckland has been so weak relative to almost all the other regions (given the extent of its population growth).

Here is a chart showing Auckland’s share of total nominal GDP for each of these two components.

akld shares

And yet over this period Auckland’s share of the total population increased from 31 per cent to 33.5 per cent.

I guess that, overall, this is not wholly inconsistent with the divergence that has opened up in the population per dwelling numbers: trending down in the rest of the country but not in Auckland as house prices become increasingly unaffordable.

Out of curiosity, I redid the per capita regional GDP numbers excluding these two real estate related components.  In my original chart, Auckland had the third slowest growth in nominal per capita GDP from 200 to 2015.   In this alternative chart, we have the data only to 2013.    Over that period, Auckland had the slowest per capita total nominal GDP growth of any region.

What about on this adjusted, non-real estate, measure?

adjusted regional GDP growth

It doesn’t improve the picture.

I’m still not quite sure what to make of all this.  Ideally, we would have regional real GDP  data, but unfortunately that does not appear likely any time soon.  But on the basis of what we have, Auckland seems to have done particularly poorly over the last 15 years, despite (or partly because?) all the policy-induced population growth.  Some of that seems to relate to the poorly functioning housing supply market.  But even abstracting from the direct effects of that, it has to be seen as a pretty disappointing outcome, leaving many questions on the table.

(It also leaves me with some new questions, which I have not yet attempted to work through in my own mind, about my explanation for New Zealand’s persistently high (relative to other countries) real interest rates.  A topic for another day.)

 

China and New Zealand

Michael Reddell China, Exports, FTAs

The Prime Minister, a large flock of New Zealand business people, and various media representatives are in China.  It is not a particularly attractive sight, perhaps one of many reminders of why bilateral or regional preferential trade agreements are such an unfortunate policy option (as leading trade experts, and entities like the Australia Productivity Commission often remind us).  Allow for some trade diversion risks, and the ever-more-entangled rules of origin, and such deals are often bad enough.  And then there is the matter of making repeated obeisance before the leaders of a tyrannical regime, begging for their favour; the crumbs off their table.   Perhaps worst of all, our elected leaders don’t even seem to find it distasteful.

New Zealand firms do a fair amount of trade with Chinese firms, and that trade has increased considerably in the last decade. Despite some breathless commentary, China was never our largest “trading partner”,  but New Zealand firms do more trade with the Chinese than with firms and individuals in any other country than Australia.  But then our trade is quite widely spread across many countries, and much of it is in products which are pretty homogeneous (it isn’t clear that it much matters whether New Zealand firms export dairy products to Venezuela, Saudi Arabia, or China: New Zealand producers sell somewhere whatever is produced, and what matters most is the global prices for dairy products).  There is a great deal of talk about the benefits (or risks) of being concentrated on whole milk powder (WMP), but the prices of the various different dairy products all seem to cycle together, and idiosyncratic patterns for individual products don’t seem to last for long.   (GDT only has a long run of data for these three, but over the last five years one can also see it in a chart from a wider range of dairy products).

dairy prices components

Here are our merchandise (goods) exports to China as a share of GDP.

exports to china % of GDP

Services exports data by country is only available annually.  Here are total New Zealand exports to China for the last four (June) years.

total exports to china

But how much difference has it all made?  The government has made much of trying to lift the export share of GDP, but here is a chart of that series.

total exports as % of GDP

Which has, as I’ve noted previously, been going nowhere for 25 years now.

Of course, New Zealand firms import a lot from China as well.  Here is the merchandise trade balance between New Zealand and China since 1981.

merch trade balance with china

But once services trade is included, for the last three years New Zealand has run a goods and services surplus with China.

It was a little surprising to hear the Prime Minister in pursuit of investment from China

“But we in New Zealand will take that view from a Government perspective, that we’re a fast-growing economy, we want to to develop great international relationship and we also want to have a higher standard of living. We fundamentally don’t have enough private-sector capital of our own to fund that growth.”

Set aside the “fast-growing” economy claim for now – I guess the total economy has been growing quite a bit by OECD standards, even as per capita growth has been pretty dismal –  but what really struck me was the observation that “we fundamentally don’t have enough private-sector capital of our own to fund that growth”.  If the Prime Minister simply means that we run current account deficits (in which total domestic investment exceeds total national savings) that is, of course, true.    But it is not as if we have any trouble financing that current account deficit on world markets –  apart from any other indicators, that is evident in the persistently high level of the exchange rate.  Countries that have trouble financing themselves tend to have persistently weak real exchange rates.  We don’t.

To be clear, I have no particular problem with foreign direct investment, and in general I think we should have fewer restrictions on it.   China is a slightly different issue, but mostly because all major businesses are ultimately state-controlled. I’m not suggesting any specific restrictions on Chinese FDI (except perhaps where national security considerations warrant it) but we need to remember just how badly distorted and underperforming China’s economy is.  It isn’t exactly one of the success stories of market capitalism, unlike say Taiwan.  New Zealand hasn’t done well in recent decades, but for all its fast growth (much real, some probably illusory), China’s overall levels of productivity are still astonishingly poor.

gdp phw nz china taiwan

The better of China’s firms may be very good at managing the twisted eddys of Chinese politics.  That is very different from thriving in a proper market economy, where the rule of law prevails, and connections to the powerful don’t (or are not meant to) matter much.  If FDI from China happens, so be it and some it may add wider value, but it isn’t the most obvious place to be pursuing FDI from (if politicians should be doing such marketing at all).  The real gains from FDI aren’t dollars of foreign capital but rather the ideas, technologies etc that really successful global firms can bring with them, with spillovers into the New Zealand business sector and the wider New Zealand economy.

And all this is without devoting space to our apparent studied indifference on the South China Sea issue (“we aren’t taking sides, we just want a resolution”, as if there is no difference between tyrannies and democracies –  Philippines and Japan for example), or talk of extradition treaties with China.  If people can be shown to have lied on their immigration applications, no doubt we should revoke their approval to be here, but are we seriously comparing the so-called “justice” system of China to that of countries like our own?   For all the talk of “fugitives” in New Zealand, we need to remember that much of the so-called anti-corruption programme of the last few years has been about purging those who got offside with the winners in the latest Party realignments.  Some of those now abroad might well be “bad guys”, but it isn’t clear that any people who matter in China’s government are, in any sense, “good guys”.

Finally, in all our enthusiasm for trade with emerging China, I amused myself yesterday by downloading the 1939 New Zealand Official Yearbook to see what trade we were doing with Germany and Japan in the 1930s.  Not much with Germany, but I’m imagining there must have been some breathless enthusiasm, at least in some circles, about our rising trade with large and emerging Japan, by then our third largest export market.

japan exports

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