I watched the Q&A interview yesterday with the Leader of the Opposition Chris Luxon. Monetary policy and the position of the Reserve Bank Governor came up.
It is really quite disappointing that the Minister of Finance, presumably with the acquiescence of the Prime Minister, has so politicised the situation that a Leader of the Opposition can reasonably be asked what he would expect (eg possible resignation) of the Reserve Bank Governor after the election if National wins. If he is at all serious about his answer – appoint an independent reviewer as soon as they take office and only decide after that – it is a recipe for considerable, unwelcome, market uncertainty, and further reputational risk for New Zealand and its system of economic governance.
We really should have appointees to such positions that both sides of politics can respect and trust. That has always been implicit in the model under which the central bank is given operational autonomy over monetary policy (and the massive cyclical influence that involves), the Governor (and MPC members) are appointed for terms not coinciding with, and longer than, parliamentary terms, and (in NZ since 1990) where the Minister of Finance cannot simply appoint his or her own person as Governor. That expectation was further reinforced when the current Prime Minister and Minister of Finance in 2018 amended the Reserve Bank Act to explicitly require consultation with other parties in Parliament before a person is (re)appointed as Governor.
When Adrian Orr was first appointed at the end of 2017 that “general acceptance” threshold was probably met. There was plenty of Orr sceptics about. although often rather quietly (since they or their employers had to deal with either NZSF or the Reserve Bank, and Orr was never known for embracing criticism), but there was no great controversy about the appointment (as it happened the search and selection process had been well underway before the election and change of government, and the Bank’s Board – which put forward Orr’s nomination – had been entirely appointed by the previous National government).
It isn’t the case now. The two main Opposition parties had both made clear to the government, when the legally-required consultation occurred, that they had concerns about the proposed reappointment. But there has been no hint or sign that the Minister of Finance made any effort to engage to allay those concerns, instead – his own legislation notwithstanding – he simply pushed ahead and reappointed Orr, having had the nomination made by the new Reserve Bank Board, possessed of almost no subject expertise, he himself had appointed just a couple of months earlier. Perhaps a bit like the entrenchment outrage in the headlines today, it was lawful (much is in New Zealand) but it was far from proper.
(As I’ve pointed out before the actual argument National made in their letter re Orr was weak and their historical parallel was flawed, but then they were caught in a difficult position – unless Robertson heeded their concerns and looked elsewhere for a new Governor, they could be stuck with Orr as Governor, almost certainly unable to dismiss him (unless he did something particularly new and egregious in his new term) – and may have felt reluctant to outline a range of specific concerns about Orr and his stewardship in writing.)
TVNZ’s interviewer, who usually does a fairly good job, seemed to come to yesterday’s interview holding a brief for Orr. Among the lines he put to Luxon was the suggestion that he shouldn’t be too critical or Orr and the Bank because they had been the first developed country to raise their policy interest rate. This is the sort of spin the Bank itself likes to hear, and it uses a more-muted version of it at times. I don’t know how many times it has to be said but it is simply a false claim. It isn’t a matter of interpretation or nuance, it is simply false.
There are probably two main sets of groupings that are used to capture a list of developed countries or advanced economies. The first is membership of the OECD, and the second is the IMF’s “advanced economies” groupings. Neither is ideal. The OECD includes several Latin American countries (Costa Rica, Colombia, Chile, and Mexico) that are mostly much poorer and less productive than other members (I’ve often suggested they are “diversity hires”),and excludes Singapore and Taiwan. The IMF list on the other hand does not include any of the Latin American countries, but in central and eastern Europe seems to include countries if they are in the euro but not if not, even if the latter are equally productive. Since so many advanced countries are in the euro, there are really only 20 or so countries with monetary autonomy, setting their own interest rate.
On several occasions in the past on Twitter I’ve used the BIS’s monthly data on policy interest rates. Of the countries there that are on either the OECD or IMF lists, these were the first countries to raise policy interest rates in 2021.
Discount Mexico and Chile if you like and you are still left with five advanced country central banks having moved before our Reserve Bank did, all of them for countries that are either materially richer/more productive than New Zealand or (Korea, Hungary, Czech Republic) about the same. You could make further allowance for the Reserve Bank and accept that if their MPC meeting in August 2021 had been a day earlier, the OCR would first have been raised then, but they still wouldn’t have been the first to move.
There is no question but that our Reserve Bank moved earlier than the other Anglo central banks (or even the ECB) but what of it?
More generally, when individual central banks moved (early or late in calendar time) is really neither here nor there anyway. Each central bank faced different domestic situations in terms of capacity pressures, emergent inflation, and the core inflation outlook.
I’m not going to attempt to analyse the story each central bank faced last year, but I’ve shown this chart in a previous post.
On the most recent data, for the only internationally comparable measure of core inflation we readily have, New Zealand’s core inflation rate now – a year on from the first OCR increase – is nothing special, being just above that of the median OECD country. If we focus only on OECD countries with their own monetary policies (and the euro area as a single observation) we get this chart showing the increase in the core inflation rate since just prior to Covid (actual Turkey increase is far larger than the scale allows).
It isn’t one of the worst, but again it is slightly worse than the median country (and, as it happens, worse than in three of the four Anglo countries, and worse than the euro area).
This isn’t another post trying to evaluate in any detail the Bank’s absolute or relative performance, but as a general observation almost all central banks have done poorly in the last couple of years, and little about the Reserve Bank’s policies or policy outcomes stands out from the pack. Media defenders of the Governor should take note, and/or get better basic researchers.
What the post is mainly about is central bank appointments. We’ve had some dreadful ones this year – the deputy chief executive responsible for matters macroeconomic who has no background or evident expertise in the subject, and who yet is a full voting MPC member, and (see above) the reappointment of the Governor. Then there was the decision (apparently joint between the Governor, Minister and (old) Board) to keep in place the blackball prohibiting anyone with current in-depth expertise in matters macroeconomic or monetary from serving on the MPC, all as prelude to the reappointment without much scrutiny of two external MPC members whose terms were expiring.
On which note, I had another OIA request back the other day, which included the letter from the Reserve Bank Board chair to the Minister of Finance recommending those reappointments. It was perhaps even more lame than I had expected. There was no attempt to evaluate or describe the contributions Buckle and Harris had made, nothing at all about the rapidly rising (core) inflation backdrop for which they shared responsibility, no suggestion of having considered any alternative candidates (neither Buckle nor Harris are young). In fact, the strongest (only) argument for reappointment seems to have been that “the Bank is implementing a number of significant changes in governance in accordance with its new legislation”, even though almost none of the 2021 Act had anything to do with monetary policy or the MPC
That letter did, however, partly answer one question I’d had. Peter Harris – former politically-appointed adviser in Michael Cullen’s office – was reappointed for a term of only 18 months to expire on 1 October 2023, right in the middle of the likely election campaign. Why, I wondered, would Robertson have done that – ministers after all being well aware of the convention that new appointments should not be made to positions starting close to likely election dates? But it turns out it was the Board’s doing, and there is no sign they gave any thought to the fact that the end of Harris’s term was going to land in the midst of the election period. Which seems quite unnecessarily careless of them. One hopes there is no question of any new appointment being made until after the election. If National were to win, the vacancy would give them an opportunity to begin to exert some influence; one would hope they would remove the bar on expertise, and at the same time amend the MPC’s charter to make it clearer that individual members were expected to bring expertise to bear and to be individually accountable.
But the current government is quite free to make the next MPC appointment. The worst of the first batch of external MPC members was Caroline Saunders. Her term expires on 31 March 2023. The papers released at the time of those 2019 appointments make it pretty clear that she was a diversity hire. Professor Saunders may be very capable in her own field but she has no background at all in macroeconomics or monetary policy. Consistent with that, we have heard not a word from here in her (almost) four years on the MPC. She has taken the taxpayers’ dime and there is no evidence she has made any contribution at all, and has done or said nothing – no speech, no interview, no parliamentary committee appearance – to provide any basis for holding her to account, even as she shares formal responsibility for the biggest monetary policy stuff-up in decades
It would be quite unfortunate if Saunders is reappointed (but most probably it is already a fait accompli, given that no vacancies have been advertised). If there was ever a case for a token female appointment (which there wasn’t; token appointees are never desirable), the ultimate in token appointees now holds a senior executive role on the committee. More generally, in any body – public or private – fresh blood should be introduced from time to time, and yet none of the externals has been changed, and (by the rules they themselves signed up to) those members are not allowed to foster any independent subject expertise themselves in their time on the MPC (and the Bank has been doing very little serious research, so there won’t be much expertise being fostered/extended inside). From a narrowly political perspective, one might have thought it might have been in the government’s interest to have found a strong new appointee who might have a good chance of doing two future terms.
Which bring us back to Luxon. It isn’t clear that National cares very much about any of this,or will fllow through if and when it takes office (why rock the boat when you now have an office to hold and savour?). I’m not at all optimistic, but if they are more serious than they seem, here was a post outlining some of things they could look at.
If you’d been given a great deal of delegated power and had messed up badly – not through any particular ill-intent, but perhaps you’d misjudged some important things or belatedly realised you didn’t have the knowledge to cope with an unexpected circumstance that you thought you had – and if you are anything like a normal decent person you would be extremely apologetic and quite contrite. Heck, borrow a friend’s car for the afternoon and come back with a dent in it – not even necessarily your fault – and most of us would be incredibly embarrassed and very apologetic. Bump into someone (literally) in the supermarket aisle and most of us will be quite apologetic – often enough proferring a “sorry” just in case, even if it is pretty clear it is the other person who knocked into us.
But the apparently sociopathic world of central banking seems to be different. The Reserve Bank (Governor and MPC) are delegated a great deal of power and influence. Back before the days of the MPC I used to describe the Governor as by far the most powerful unelected person in New Zealand (and more powerful individually than almost all elected people too). The powers – exercised for good or for ill – haven’t changed, they’ve just been (at least on paper) slightly diffused among a group of (mostly silent) people whose views we never quite know, and whose appointment is largely (effectively) controlled by the Govenor. (There was a nice piece in Stuff yesterday on the problems of the MPC, echoing many points made here over the years.)
It is not as if the Bank took on these powers reluctantly, or that the Governor had to have his arm twisted to do the job. The Bank championed the delegation (and reasonably enough) and every single member of the MPC took on the role – amply remunerated – entirely voluntarily. But they seem to have long since forgotten that counterpart to autonomy and operational independence that used to feature so prominently in all their literature, that great delegated power needs to be accompanied by serious accountability. Among decent people that would include evident contrition when things go wrong, no matter how good your intentions might have been, even if you thought you’d done just the best you personally could have.
The Auditor-General was reported yesterday raising concerns about the serious decline in standards of accountability in New Zealand public life. Whatever the situation elsewhere – and I have no reason to question the Auditor-General’s view – nowhere is it more evident than around the Reserve Bank, which exercises so much power with so few formal constraints. Much too little attention has been given to the fact that, having delegated them huge amounts of discretionary power to keep (core) inflation near 2 per cent, the Reserve Bank has messed up very badly over the last couple of years.
The issue here is not about intent or lack of goodwill, but about outcomes. When central banks were given operational autonomy it was on the implied promise that they’d deliver those sort of inflation outcomes, pretty much year in year out. The public wouldn’t need to worry about inflation because control of it – under a target set by elected politicians who would hold them to account – had been delegated to a specialist, notionally expert, agency, which would know what it was doing. 20 years ago the expectation on the Bank was fleshed out a little more: that they should do their job while avoiding unnecessary variability in interest rates, exchange rates, and output.
And what do we now have? Roughly 6 per cent core inflation, three years of annual headline inflation above the top of the target range, public doubts about just whether the Bank will deliver 2 per cent in future. Oh, and now the necessity (very belatedly acknowledged by the Bank yesterday) of a recession and a significant rise in unemployment to levels well beyond any sort of NAIRU to get inflation back in check. Add in the arbitrary wealth distributions – that no Parliament voted on – with the heavily indebted (including the government) benefiting from the unexpected surge of inflation the Reserve Bank has overseen, at the expense of those with financial savings. And the huge disruptions to lives and businesses from both the extremely overheated economy we’ve had for the last 12-18 months and the coming nasty shakeout. Oh, and that is not to mention more than in passing the $9.2 billion of LSAP losses the Reserve Bank up entirely unnecessarily (foreseeably).
It has not, to put it mildly, been the finest hour of the Reserve Bank. But there has been no a word of contrition – from the Governor or any of the rest of the Committee – and no real accountability at all (among other things, Orr and two of the MPC have been reappointed this year, with no sign of any searching scrutiny of their records or contributions).
Instead we just get lots of spin, and lightweight analysis. One of Orr’s favourite lines (repeated as I type at FEC this morning) is that the Reserve Bank was one of the very first central banks to tighten “by some considerable margin”, when in fact there were half a dozen OECD central banks that moved before our central bank did. We had claims from Orr a while ago that the macro benefits of the LSAP programme were “multiples” of those mark to market losses to taxpayers – a claim that quietly disappeared when they actually published their review of monetary policy. A few weeks ago Orr was telling Parliament that if it weren’t for the Ukraine war inflation would have been in the target range – notwithstanding the hard data showing core inflation was already very high well before the war – and then nothing more is heard of that claim when the MPS itself was published.
Yesterday we heard lots of bluster about workers, firms and households being enjoined to change their behaviour – even trying to damp down Christmas – as if inflation was the responsibility of the private sector, not the outcome of a succession of Bank choices and mistakes. But not a word from the Bank or Governor accepting any responsibility themselves.
To repeat, I don’t doubt that the Bank was well-intentioned throughout the last few years. Plenty of other people made similar mistakes in interpreting events. But it is the Reserve Bank and its MPC who are charged with – and paid for – the job of keeping the inflation rate and check. They’ve failed. Given that stuff-up they may now fix things up, but it is no consolation or offset to the initial huge series of mistakes. And not a word of contrition, barely even much acceptance of responsibility.
Which is a bit of a rant, but about a serious issue: with great power must go great responsibility, accountability….and a considerably degree of humility. Little or none has been evident here.
But what of the substance of the Monetary Policy Statement? Here I really had only three points.
The first is the glaring absence of any serious in-depth analysis of what has actually been going on with inflation, at a time of some of the biggest forecast errors – and revisions in the OCR outlook – we’ve seen for many years. For example, every chart seems to feature annual inflation, which is fine for headlines but tells you nothing about what has been happening within that one year period. What signs are there, for example, that quarterly core inflation might have peaked (or not) – eg some of the charts I included here? There seemed to be no disaggregated analysis at all, for example of the sort one economic analyst pointed to in comments here the other day. This from the organisation that is responsible for inflation, and which has by far the biggest team of macroeconomists in the country. We – and those paid to hold the Bank to account – really should expect better.
And almost equally absent was any persuasive supporting analysis for the really big lift in the forecast path of the OCR, now projected to peak at 5.5 per cent. My main point is not that I think they are wrong but that there is little or no recognition that having misread badly the last 2-3 years (in good company to be sure), there is little reason for them or us to have any particular confidence in their forecast view now. Models and sets of understandings that didn’t do well in preventing us getting into this mess probably haven’t suddenly become reliable for the getting out phase. But even granting that, the scale of the revision up seems disproportionate to the surprises in the new data of the last few months. It has the distinct feel of just another stab in the dark (but then I’ve been a long-term sceptic of the value of central bank OCR forecasts), with little engagement with either weakening forward indicators or the lags in the system (in the last 6 weeks the Bank has now increased the OCR by as much as it did in the first six months of the tightening cycle. With a recession already now finally in the forecasts based on what the MPC has already done (they don’t meet again until late February and the deepest forecast fall in GDP is in the quarter starting just 5 weeks later – the lags aren’t that short) they can’t really be very confident of how much more (if any) OCR action might be needed.
Finally, it is constantly worth bearing in mind the scale of the task. Core inflation has been running around 6 per cent and should be close to 2 per cent. That scale of reduction in core inflation hasn’t been needed/sought since around 1990. In 2007/08 inflation had got away on us to some extent, but a 1.5 percentage point reduction would have done the job of getting back to around 2 per cent. As Westpac pointed out in their commentary, the scale of the economic adjustment envisaged in these forecasts (change in estimated output gap) is very similar to what (the Bank now estimates) we experienced over 2008 to 2010.
The open question then is perhaps whether this sort of change in the output gap is likely to be sufficient: 13 years ago it delivered a 2 percentage point reduction in core inflation, but at present it looks as though we need a 4 percentage point reduction now. It isn’t obvious that other surrounding circumstances now will prove more propitious than then (eg for supply chains normalising now read the deep fall in world oil prices then).
Perhaps it will, perhaps it won’t, but you might have expected a rigorously analytical central bank and MPC to have attempted to shed some light on the issue. But once again they didn’t.
(My own money is probably on a deeper recession next year, here and abroad but……and it applies to me as much as to anyone else … if you got the last 2-3 years so wrong you have to be very modest in your claims to have the current and year-ahead story right.)
The Reserve Bank’sMonetary Policy Committee has its final meeting for the year on Wednesday, and then they shut up shop. For a long time. The next scheduled announcement is not until 22 February, a full 13 weeks (3 months) away. Nice job if you can get it, and although I’m sure management and staff will still be working for much of the intervening period, the same is unlikely to be said for the three non-executive members, who are generously remunerated by the taxpayer, utterly invisible, and only need to show up when meetings are scheduled.
This strange schedule has been in place for quite a few years now, having been adopted at a time when the OCR wasn’t being moved much at all (and when the Bank was raising the OCR, it often proved to have been a mistake). But having been in place for a while does not make it any more defensible or sensible. In fact, last year’s three month summer break almost certainly was one factor in how slow the MPC was to get on with raising the OCR once they’d finally made a start. On no reading of the data (contemporary data that is) did it make sense for us to have ended 2021 with the OCR still lower, in nominal terms, than it had been just prior to Covid. And having experienced the issue last summer (when perhaps it caught them by surprise) there was no excuse for not resetting the schedule for this summer.
One can always mount defences (for almost anything I suppose). Monetary policy works with a lag, the OCR adjustments can be just as large as they have to be, perhaps there is a bit of a tradeoff between time doing analysis and time spent preparing for meetings. But none of it is very convincing in this context. And it is out of step with their peers.
Here is a table of the monetary policy announcements dates over November to February for a fairly wide range of OECD country central banks. None, not even Sweden and tiny Iceland, are taking as long a break as our MPC (and although I didn’t tot up all the northern hemisphere summer meeting dates, it didn’t look as though any took as long a break then as our MPC takes now). The median country has a longest gap of seven weeks between meetings over this period.
[UPDATE: In addition, the South Korean central bank meets on 24 Nov, 13 Jan, and 23 Feb]
There are substantive macroeconomic arguments for (and against) a 75 basis point OCR adjustment this week, but one of arguments some have advanced is that they really need to go 75 basis points this week because they don’t have another opportunity until late February. But whose fault is that? It is entirely an MPC choice. They have a very flexible instrument and just choose to tie their hands behind their backs to give themselves a very long summer break.
The whole situation is compounded by the inadequacies of New Zealand’s key bits of macroeconomic data. We now have the CPI and the unemployment rate for mid-August (the midpoint of the September quarter). Most OECD central banks already have October CPI data, almost all have September unemployment rate data (and several have October unemployment rate data), and three-quarters of OECD countries already have September quarter GDP data (a few even have monthly GDP estimates).
The combination of slow and inadequate data and widely-spaced summer meetings really isn’t good enough, especially at a time when there is so much (perhaps inevitable) uncertainty about the inflation situation and outlook. The inadequacies of our national macroeconomic statistics cannot be fixed in short order (not that the government shows any interest in doing so anyway). But how often, and when, the MPC meets is entirely at the Committee’s discretion, and easily altered with little or no disruption other than to the holiday plans of some appointed and (supposedly) accountable policymakers (people who not incidentially – and pardonably or otherwise – have done such a demonstrably poor job of their main responsibility, keeping core inflation in the target range, in recent times.
The MPC should be announcing on Wednesday (a) an extra OCR review for a few days after the CPI release in January, and (b) a commitment to revisit the meeting schedule for future years to bring the length of the long summer break back to (say) no longer than the one the RBA takes. If they don’t journalists at the press conference and MPs at FEC should be asking why not.
(Writing this post brought to mind memories of Orr 20+ years ago when the OCR was first introduced championing having only four reviews a year. The OCR then was new, inflation was low and stable. One hopes that sort of thinking no longer lurks in the back of the Governor’s mind.)
Way back in 1990 Parliament formally handed over the general responsibility for implementing monetary policy to the Reserve Bank. The government has always had the lead in setting the objectives the Bank is required to work to, and has the power to hire and fire if the Bank doesn’t do its job adequately, but a great deal of discretion has rested with the Bank. With power is supposed to come responsibility, transparency, and accountability.
And every so often in the intervening period there have been reviews. The Bank has itself done several over the years, looking (roughly speaking) at each past business cycle and, distinctly, what role monetary policy has played. These have generally been published as articles in the Bank’s Bulletin. When I looked back, I even found Adrian Orr’s name on one of the policy review articles and mine on another. It was a good initiative by the Bank, intended as some mix of contribution to debate, offering insights that were useful to the Bank itself, and defensive cover (there has rarely been a time over those decades when some controversy or other has not swirled around the Bank and monetary policy).
There have also been a couple of (broader-ranging) independent reviews. Both had some partisan intent, but one was a more serious effort than the other. When the Labour-led government took office in 1999 they had promised an independent review, partly in reaction to their sense that we had messed up over the previous few years. A leading Swedish academic economist Lars Svensson, who had written quite a bit about inflation targeting, was commissioned to do the review (you can read the report here). And towards the end of that government’s term – monetary policy (and the exchange rate) again being in the spotlight – Parliament’s Finance and Expenditure Committee did a review.
When the monetary policy provisions of the Reserve Bank Act were overhauled a few years ago this requirement was added
It made sense to separate out this provision explicitly from that for Monetary Policy Statements (in fact, I recall arguing for such an amendment years ago) but the clause has an odd feature: MPSs (and the conduct of monetary policy itself) are the responsibility of the MPC, but these five-yearly longer-term reviews are the responsibility of “the Bank”. In the Act, the Bank’s Board is responsible for evaluating the performance of both management and the MPC, but the emphasis here does not seem to be on the Board. It seems pretty clear that this is management’s document, and of course management (mainly the Governor) dominates the MPC. Since the Board has no expertise whatever in monetary policy, it is pretty clear that the first of these reports, released last week, really was, in effect, the Governor reporting on himself.
And although plenty of people have made scathing comments about that, there isn’t anything necessarily wrong about a report of that sort. After all, it isn’t uncommon (although I always thought it odious and unfair given the evident power imbalance) for managers to ask staff to write about notes on their own performance, as part of an annual performance appraisal, before the manager adds his/her perspective. The insights an employee can offer about his or her own performance can often be quite revealing. And it isn’t as if the Bank’s own take on its performance is ever going to be the only relevant perspective (although, of course, the Governor has far more resources and information at his disposal than anyone else is going to have). The only real question is how good a job the Bank has done of its self-review and what we learn from the documents.
On which note, I remain rather sceptical about the case (National in particular is making) for an independent review specifically on the recent conduct of monetary policy. Some of those advocating such an inquiry come across as if what they have in mind is something more akin to a final court verdict on the Bank’s handling of affairs – one decisive report that resolve all the points of contention. That sort of finality is hardly ever on offer – scholars are still debating aspects of the handling of the Great Depression – and if there was ever a time when choice of reviewer would largely determine the broad thrust of the review’s conclusions this would be among them. Anyone (or group) with the expertise to do a serious review will already have put their views on record – not necessarily about the RBNZ specifically (if they were an overseas hire) but about the handling of the last few years by central banks generally. There is precedent: the Svensson review (mentioned above) was a serious effort, but the key decision was made right at the start when Michael Cullen agreed to appoint someone who was generally sympathetic to the RB rather than some other people, some of equal eminence if different backgrounds, who were less so. It would be no different this time around (with the best will in the world all round). A review might throw up a few useful points and suggestions, and would probably do no harm, but at this point the idea is mostly a substantive distraction. Conclusions about the Reserve Bank and about its stewardship are now more a matter for New Zealand expert observers and the New Zealand political process (ideally the two might engage). Ideally, we might see some New Zealand economics academics weighing in, although in matters macroeconomics most are notable mainly by their absence from the public square.
That is a somewhat longwinded introduction to some thoughts about the report the Bank came out with last week (120 pages of it, plus some comments from their overseas reviewers, and a couple of other background staff papers).
I didn’t think the report presented the Bank in a very good light at all. And that isn’t because they concluded that monetary policy could/should (they alternate between the two) have been tightened earlier. That took no insight whatever, when your primary target is keeping inflation near the middle of the target range and actual core inflation ends up miles outside the range. Blind Freddy could recognise that monetary policy should have been tightened earlier. When humans make decisions, mistakes will happen.
The rest of the conclusions of the report were mostly almost equally obvious and/or banal (eg several along the lines of “we should understand the economy better” Really?). And, of course, we had the Minister of Finance – not exactly a disinterested party – spinning the report as follows: “It is really important to note that the report does indicate that they got the big decisions right”. It should take no more than two seconds thought to realise that that is simply not true: were it so we would not now have core inflation so far outside the target range and (as the report itself does note) pretty widespread public doubts about how quickly inflation will be got down again. It would be much closer to the truth to say that the Reserve Bank – and, no doubt, many of their peers abroad – got most of the big decisions wrong. It has, after all, been the worst miss in the 32 years our Reserve Bank has been independent, and across many countries probably the worst miss in the modern era of operationally independent central banks (in most countries, after all, monetary policy in the great inflation of the 1970s was presided over by Ministers of Finance not central banks).
But there is no sense in the report at all of the scale of the mistake, no sense of contrition, and – perhaps most importantly in my view – no insight as to why those mistakes were made, and not even any sign of any curiosity about the issue. The focus is almost entirely defensive, and shows no sense of any self-critical reflection. There are no fresh analytical insights and (again) not even any effort to frame the questions that might in time lead to those insights. And no doubt that is just the way the Governor (who has repeatedly told us he had ‘no regrets’) would have liked it. And here we are reminded that this is very much the Orr Reserve Bank: the two senior managers most responsible for the review (the chief economist and his boss, the deputy chief executive responsible for monetary policy and macroeconomics) only joined the Bank this year, and so had no personal responsibility for the analysis, preparation and policy of 2020 and 2021 but still produced a report offering so little insight and so much spin. Silk, in particular, probably had no capacity to do more, but the occasional hope still lingered that perhaps Paul Conway, the new chief economist, might do better. But these were Orr’s hires, and it is widely recognised that Orr brooks no dissent, no challenge, and in his almost five years as Governor has never offered any material insight himself on monetary policy or cyclical economic developments. Even if they had no better analysis to offer – and perhaps they didn’t, so degraded does the Bank’s capabilities now seem – contrition could have taken them some way. But nothing in the report suggests they feel in their bones the shame of having delivered New Zealanders 6 per cent core inflation, with all the arbitrary unexpected wealth redistributions that go with that, let alone the inevitable economic disruption now involved in bringing inflation a long way back down again. It comes across as more like a game to them: how can we put ourselves in the least bad light possible with a mid-market not-very-demanding audience (all made more unserious as we realised that the Minister of Finance had made the decision a couple of months ago to reappoint Orr, not even waiting for the 120 pages of spin).
At this juncture, a good report would be most unlikely to have had all the answers. After all, similar questions exist in a whole bunch of other countries/central banks, and if the Reserve Bank has the biggest team of macroeconomists in New Zealand, there are many more globally (in central banks, academe, and beyond) but it doesn’t take having all the answers to recognise the questions, or the scale of the mistakes. In fact, answers usually require an openness to questions, even about your own performance, first. And there is none of that in the Bank’s report.
Thus, we get lame lines – of the sort Conway ran several times at Thursday’s press conference – that if the Bank had tightened a bit more a bit earlier it would have made only a marginal difference to annual inflation by now. And quite possibly that is so, but where is the questioning about what it would have taken – in terms of understanding the economy and the inflation process – to have kept core inflation inside the target range? What is it that they missed? (And when I say “they” of course I recognise that most everyone else, me included, also missed it and misunderstood it, but……central banks are charged by Parliaments with the job of keeping inflation at/near target, exercise huge discretion, carry all the prestige, and have big budgets for analytical purposes, so when central banks report on their performance, we should expect something much better than “well, we acted on the forecasts we had at the time and, with hindsight, those forecasts were (wildly) wrong”.) The question is why, what did they miss, and what have they learned that reduces the chances of future mistakes (including over the next year or two – if your model for how we got into this mess was so astray, why should the public have any confidence that you have the right model – understanding of the economy and inflation – for getting out of the mess? At the press conference the other day the Governor and the Board chair prattled on about being a “learning organisation” but you aren’t likely to have learned much if you never recognised the scale of the failure or shown any sign of digging deep in your thought, analysis, and willingness to engage in self-criticism. We – citizens – should have much more confidence in an organisation and chief executive will to do that sort of hard, uncomfortable, work than in one of the sort evident in last week’s report.
With hindsight one can make a pretty good case that no material monetary policy action was required at all in 2020. One might be more generous and say that by September/October 2020 with hindsight it was clear that what had been done was no longer needed. But that wasn’t the judgement the Reserve Bank came to at the time – and it is the Bank that has been tasked with getting these things right. Why? (And, of course, the same questions can be asked of other central banks and private forecasters, but the Reserve Bank is responsible for monetary policy and for inflation outcomes in this country.)
I may come back in subsequent posts to look at more detail at a number of specific aspects of the report (including a couple of genuinely interesting revelations) but at the big picture level the report does not even approach providing the sort of analysis and reflection the times and circumstances called for (in some easier times a report of this sort might have not been too bad, although you would always look for some serious research backing even then).
And if you think that I’m the only sceptic, I’d commend to you the comments from the former Deputy Governor of the Bank of Canada. On page after page – amid the politeness (and going along with distractions like the alleged role of the Russian invasion) – he highlights just how relatively weak the analysis in the report is, how many questions there still are, and a number of areas in which he thinks the Bank’s defensive spin is less than entirely convincing.
New Zealanders deserved better. That we did not get it in this report just highlights again that Orr is not really fit for the office he holds. In times like those of the last few years – with all the uncertainties – an openness to alternative perspectives, willingness to engage, willingness to self-critically reflect, and modelling a demand for analytical excellence are more important than ever.
Last week I reread Victoria University historian Jim McAloon’s history of New Zealand economic policymaking from 1945 to 1984, Judgements of all Kinds, first published a decade or so ago. Good works of economic history, let alone of the history of economic policymaking, aren’t thick on the ground in New Zealand, and as McAloon himself notes in a journal article published a year or two later:
“Economic history has a relatively low profile in New Zealand. Few economics programmes offer much in the way of economic history, and none of them offer courses in New Zealand economic history. Very few academics in New Zealand economics programmes publish in economic history. Victoria University, once boasting the only New Zealand chair in economic history, has largely abandoned the field.”
(Actually, when I was at Victoria in the early 80s – and not wise enough myself to have done much economic history – there were two professors of economic history)
Against this background of rather slim pickings, McAloon’s work is a useful contribution, including because he has gone back to at least some of the relevant archives. If you are at all interested in this period of New Zealand history – the backdrop in time to the post-1984 reforms and upheaval – I’d recommend the book, not because it is great or comprehensive but because it is (ie exists). In truth, although the title advertises coverage starting from 1945, there is quite a bit of material on economic policymaking in the 1930s and during the war too.
There is lots of interesting material, including about episodes few people now are particularly aware of (notably around the sterling area after the war). McAloon has his bugbears – not having much time for the British generally, or New Zealand farmers more specifically. And the phrase “the settler economy” keeps popping up, even when referring to events and developments decades after such a label had any more than rhetorical weight. I think he envisages the book as serving a somewhat revisionist purpose, in redeeming the tarnished reputation of the policymakers and advisers of the pre-1984 decades. I’m partial to a little of that sort of thing myself – for all his faults, for example, Muldoon clearly faced some of the most very adverse times to be a Minister of Finance almost throughout the 17 years that his terms spanned – but my sense is that McAloon sets himself rather too easy a target, in pushing back against some of the more florid rhetoric one still sometimes hears (from older politicians, economists, and business people) about the post-war New Zealand economy, and in the process acquits the policymakers, and most of their advisers, rather too readily. There is no doubt that the New Zealand economy in 1984 was a very different thing than it had been in 1945, and there had been plenty of sensible changes of policy made over the intervening decades. But the overall story remains one of deep relative decline, with no evident prospect of reversing that deterioration. And it wasn’t as if policymakers and advisers were innocents, unaware of the decline: by the very early 1960s serious independent reports from respected New Zealand economists were explicitly highlighting the extent of the relative productivity decline.
I’ve show numerous graphs here over the years highlighting New Zealand’s relative decline. But perhaps this simple one captures a significant aspect of what was going wrong. Read any book writing about inter-war New Zealand economic developments and it will make the point that per capita exports from New Zealand then were thought to be the highest of any country. That reflected a high level of GDP per capita and a high export share of GDP.
Consistent data over many decades is a challenge, but here are exports as a share of GDP as they were on the brink of the Great Depression (using as the GDP denominator the average of the three historical estimates on Infoshare) and by the early 1970s (using data from the OECD database).
By the early 1970s, not only had exports shrunk markedly as a share of New Zealand’s GDP, but that share was only around the median of the OECD countries (for which the OECD has data back that far), and that despite small countries typically trading more than large ones and New Zealand being in the smaller population grouping of OECD countries. One can debate the various possible causes of this steep relative decline, but New Zealand government policies did not, to say the least, help.
Anyway, the prompt to reading McAloon’s book again was that my son had been enrolled in McAloon’s second year New Zealand history course. If there are no specialist economic history courses at Victoria – which almost beggars belief given the way the university (and especially its commerce etc faculty) used to try to tout itself as preparing young people for careers in the public sector – at least there is some exposure to economic history topics in some of the history courses. Among the many essay topics students could choose from was one about New Zealand economic management from 1929 to 1975, and when my son chose to do that topic I suggested that reading the lecturer’s book might be worthwhile.
And here I divert into proud parent mode. I’ve included below the essay that Jonathan wrote on economic management over that period. I don’t agree with all of it (and had not read it until after the lecturer’s (high) marks came back) but – like the lecturer – I thought it was a pretty strong effort for a second-year student, and some of my readers may find the subject matter of interest. (And if anyone wants to hire a budding macroeconomist, he’ll probably be on the market in a couple of years.)
Controlling into Decline: Assessing government management of the New Zealand economy, 1929-1975.
by Jonathan Reddell
The period from 1929 to 1975 was an age of evolution in the New Zealand (NZ) economy. The upheavals of the Great Depression created a new consensus, while the economy continued to undergo the transition from a colonial to an independent economy. It cannot be said, however, that the period was an age of success. New Zealand’s relative decline during the period should not be understated. In 1939, New Zealand’s GDP per capita was $10,297, ahead of the Netherlands’ $7,079 and Canada’s $7,600. By 1975, both had surged ahead of New Zealand, as had others including Sweden.[1] New Zealand’s per capita growth rate lagged about 1% behind that of other developed market economies throughout the post-war period.[2] From 1929-1975, the performance of governments has been mixed, but that the economy was more often ill-managed than not. There are success stories, such as the diversification from Britain, and New Zealand remained one of the most prosperous countries on the planet, but on balance it was a drift into (relative) decline.
The role of the Great Depression in reshaping consensus economic thought in advanced capitalist economies is well known. The dislocations caused by the worst recession in modern history created the post-war consensus on full employment and the role of the state. This consensus would endure until the 1970s, when it was overturned by another crisis. New Zealand was no exception to this.[3] The following paragraphs will discuss government management of the Depression, and the new economic thought that was put into practice by the First Labour Government. The essay will then discuss the post-war consensus policies and assess how well governments managed the economy to achieve them.
The Depression’s impact on New Zealand was severe. A primary exporter, New Zealand was hard-hit by a shock whose hardest blow fell on commodities. Exports fell between 55-60% between 1928-29 and 32-33.[4] Rankin has estimated that joblessness peaked at over 35% of the workforce in 1932.[5] To compound matters, the New Zealand economy had been weakened by Britain’s anaemic economic performance in the 1920s due to the overvaluation of sterling from 1925.[6] Meanwhile the government’s ability to respond was constrained by the immense burden of public debt. In the 1931 Budget, public debt charges were by far the largest component of state expenditure, amounting to £10.9 million out of £24.7 million.[7] The debt burden and global loss of confidence severely constrained the government’s ability to borrow in London, while the inelastic debt payments meant that other sources of expenditure had to be cut, as a balanced budget was considered key to stability.[8]
While New Zealand did devalue against other currencies when Britain went off gold in September 1931, it did not devalue against sterling until 1933, prolonging the pain for exporters. From 1933, recovery was relatively rapid, as reforms including devaluation and the creation of a new monetary system under the Reserve Bank which allowed the Indemnity Act to lapse and monetary expansion while agricultural exports improved; by 1935 GDP per capita had recovered to the 1929 level.[9] Overall, the Coalition government’s management of the Depression was mixed. Belief in the desirability of a balanced budget constrained policy, as did the debt burden. On the other hand, the recovery was eventually strong, and as Hawke notes, actions were generally “sensible and sometimes imaginative.”[10] While it can be argued that the government could have taken more steps after Britain went off gold, overall, it is hard to argue with his judgement that, given the circumstances, the government did about as well as anyone else would have.[11]
By the time Labour came to power in 1935, the economy had generally recovered. Members of the new government had been greatly affected by the Depression and came to believe in the importance of boosting demand and that unemployment should never be allowed to reach such levels again.[12] Policy would be aimed at stabilisation, at security, at protecting the populace from the swings of the global economy. This would be achieved through polices such as expanded welfare and guaranteed prices for exporters. Nash wrote that the government, “intended to protect the producer…from the uncertainties of price.”[13] For dairy, this was done through the 1936 Primary Products Marketing Act. Labour perceived that the Depression illustrated New Zealand’s excessive vulnerability to the world economy, and aimed to counteract it, to ensure long term full employment. The state would lead industrial development to achieve both full employment and a less dependent economy. Labour’s policies marked a profound departure from the pre-Depression economy and created the basis of the post-war consensus which would last until 1975.[14] Stabilisation policy was locked in through the experiences of World War II (WW2), when the state took strong direct action and was generally successful.[15]
The post-war economic consensus consisted of several elements. National accepted the focus on full employment, and the welfare state, with Holland professing a belief that everyone had the right to employment and necessities.[16] A 1956 Royal Commission laid out the objectives of economic policy as: full employment, price stability, development, and promoting economic, social, and financial welfare of New Zealanders.[17] Governments from 1935 looked to manage the economy in pursuit of these goals, particularly full employment. The following paragraphs will assess their success regarding the economy.
The 1938-39 crisis was important in setting in the controls that would characterise the economy to 1984. From 1935 recovery continued apace, with GDP per capita one of the highest in the world in 1939. This would lead to crisis. The 1938-39 balance of payments crisis was a problem of the government’s own making, and a sign of things to come. Labour’s demand policies had resulted in a red-hot domestic economy, while a slowdown in the world economy resulted in a significant fall in export receipts. The trade balance fell from £10.5 million in 1937 to £2.9 million a year later.[18] Labour, unwilling to take actions that might harm workers like devaluation or fiscal retrenchment, opted for capital and import controls, which in some form would last until 1984. According to Hawke, the controls symbolised Labour’s move to an ‘insulationist’ economy.[19] The story of an overheated, full employment economy leading to a balance of payments crisis would be repeated periodically throughout the consensus period, including the crises of 1957-58 and 1966-67. The controls gave rise to a distorted economy and would have significant future negative impacts. Labour’s stabilisation policies undoubtedly had some value, but the obsession with full employment resulted in mismanagement in the 1930s, as it would again.
Post-depression governments would manage the economy with full employment front of mind. For Labour, it was, according to McAloon, “not negotiable.”[20] Speaking on the Employment Bill in 1945, Fraser said that “there is no greater tragedy than…being denied the opportunity,” to work, and being prevented from “contributing…to the production of goods and services.”[21] This undoubtedly succeeded, at least until the 1970s. From the late 1930s, the number of registered unemployed was incredibly low, bottoming out at 38 in 1950 and 1951.[22] While this number understates the true unemployment rate, estimates of that are as low as 1%.[23] This was a very low number by international standards.
While other countries also looked to achieve full employment, New Zealand’s unemployment was extremely low. For example, the United States, through the 1946 Employment Act declared a goal of “maximum employment.” However, even when the 1960s governments sought to make it a reality, unemployment never fell below 2.5%.[24] Therefore successive governments succeeded at managing the economy to achieve a level of full employment that was very low compared to other countries. A low unemployment rate has obvious benefits, but it also has costs. As was discussed, running a full employment economy with unemployment below the natural rate required import controls, to prevent domestic demand resulting in balance of payments crises. If unemployment had been allowed to rise to its natural level, which, as Gould notes, was likely quite low[25], the economy would have been less prone to fluctuations, whether in fiscal policy or the terms of trade, as demand for imports would have been generally weaker and there would have been less need for controls. Another negative of New Zealand’s extremely low unemployment rate was that fears of unemployment levels like other countries, particularly on the left, delayed NZ’s entry into the International Monetary Fund (IMF). Kirk exemplified those sentiments when he declared during the debate that NZ had “built up a social order that is unique,”[26] which IMF membership would imperil. In fact, non-membership of the IMF raised the cost of dealing with crises, while it did not prevent or cause higher unemployment.
Related to the full employment goal were import controls. As has been noted, successive governments looked to defend full employment while staving off balance of payments crises with import and capital controls, which would minimise the ability for New Zealand’s foreign reserves to drain. While National attempted to liberalise after 1949, controls were reimposed in 1951-52. These stop-go policies would repeat themselves, as the perceived foreign exchange constraint remained strong.[27] Import controls had major negative impacts. One was that import controls gave rise to import-substituting industries like textiles. These were often inefficient and misallocated resources away from potential export sectors. The high capital-output ratio of the economy through the 1950s and 1960s suggests inefficient usage, as it indicates a high level of capital was being used for low levels of output.[28] A 1968 World Bank report argued that “import restrictions are a hidden form of protectionism, which tend to result in a misallocation of resources,” and that they have failed to result in net exchange savings.[29] This seems believable as other sources have identified the high level of effective protection on NZ manufacturing, perhaps as high as 70% by the mid-1960s, and as a result, a functional tax on productive farmers, which weakened the NZ economy.[30]
While some level of control was understandable, particularly after WW2 given dollar shortages, New Zealand’s controls outlasted those of other OECD countries. Australia abolished import licencing in 1961.[31] A significant issue with New Zealand’s approach was the unwillingness to regard interest rates as a meaningful stabilisation tool. While many central banks abandoned interest rate control after WW2, New Zealand did not use interest rates even into the 1970s, while Australia had done so since the 1950s, due to factors including social credit influences and the sensitivity of farmers.[32] This had significant drawbacks because it meant more heavy-handed, distortionary controls were necessary to manage the economy. If interest rates, rather than direct controls, had been utilised as a policy tool, it seems likely that New Zealand’s relative decline would have been less marked. Easton argues that other OECD economies suffered from high protection of their agriculture sectors.[33] However, this mainly held up a dying industry and didn’t constrain the growth of industries like technology, while in New Zealand, controls raised the cost of inputs, effectively taxed agriculture, a growth sector, and allocated industrial capacity away from exports to import substitution.
The management of price stability is a mixed picture. An overheated economy continuously exerted inflation pressure. However, these pressures were mostly well constrained from the late 1940s. Condliffe observed that the New Zealand economy came out of WW2 “taut with supressed inflation.”[34] As wartime controls eased, inflation picked up to about 10% in 1947-48.[35] The government enacted several sensible measures to ease demand pressures and bring inflation down. These included a continued emphasis on national saving rather than overseas borrowing, which took money out of circulation, and the revaluation of 1948, which lowered the prices of exports and imports.[36] The New Zealand experience continued to be shaped by global conditions, as the Korean boom drove inflation to new heights in the early 1950s. While inflation fell and was generally relatively low between 1955 and 1970 it continued to be perceived as a threat. Hawke has observed that “prices rose by 2-3% in most years…worrying to many contemporaries.”[37] This perception is illustrated by a farmer, writing to the Press in 1961 that, “for the genuine farmer inflation is the worst thing that can happen.”[38] Thus, to the extent that governments are responsible for assuaging the fears of their citizens, NZ governments failed in that regard.
However, from a macroeconomic perspective, inflation was well managed until the late 1960s. The breakdown of the consensus between government, employers, and unions, particularly with the Nil Wage Order of 1968 was significant.[39] It combined with the overheated economy to produce significant levels of inflation that was managed inadequately through blunt instruments like freezes, due to ongoing full employment commitments. On balance, controlled inflation with overfull employment endured for a surprisingly long time. It is not clear, however, how much credit can be given to governments. New Zealand’s experience continued to be shaped by the global environment, and the inflation experience was similar to other countries, albeit at a lower level of unemployment.[40] A stronger factor seems to be the enduring legacy of Depression leading to a moderation of union militancy, which constrained wage, and thus price, inflation. However, governments do deserve at least some credit for keeping inflation as low as it was.
The third objective of economic policy was industrial development, which, from the mid-1950s linked with the need to diversify export markets as bulk purchase agreements ended in 1954 and Britain desired to join the European Economic Community. McAloon notes that “industrial development, trade development…were closely related over the decade after 1957.”[41] Industrial development was viewed as desirable from the late 1930s, as part of the quest to make New Zealand more insulated from price swings. This received greater focus under the Second Labour Government from 1957, particularly under the influence of Bill Sutch. Sutch wrote that “rapid and radical action is needed to readjust our economic structure,” towards manufacturing.[42] Sutch’s ideas reflected the flawed but orthodox view that there was a long-term decline in the terms of trade of commodity producers relative to industrial producers, known as the Prebisch-Singer thesis.[43] Its orthodoxy is illustrated by the World Bank’s report which argued that New Zealand’s fundamental problem was being “still too narrowly dependent on a few export commodities.”[44] Successive governments believed that industrial development was a priority, both for reducing balance of payments difficulties and maintaining prosperity.
The success of industrial development is a mixed picture. There were successful developments, such as the Kawerau pulp and paper mill and the wider forestry industry, and the domestic economy diversified throughout the 1960s. However, as was already noted, import controls resulted in misallocation towards import substitution, and experiments such as a cotton mill in Nelson were highly problematic.[45] The belief that too much agriculture was making New Zealand poorer seems particularly strange given that it remained the most productive industry.[46] The dominance of sheep and cow products did decline, from 90% of receipts in the 1930s to 53% in 1977/78, as new industries picked up: manufactured and forest products made up 23.4% of exports.[47] However, these exporters were often heavily subsidised, illustrated by the large incentives put on machinery in 1972.[48] These subsidies created their own inefficiencies. Again, governments were deploying distortionary solutions to questionably real problems. On the other hand, management of the diversification from Britain was successful. Trade agreements were signed with Japan in 1958, and significantly, with Australia in 1965.[49] Britain’s share of New Zealand exports fell from 51% in 1965 to 34% in 1971.[50] While there is much to criticise governments for how they handled the economy, they managed this landmark transition well, even if Britain’s relative economic marginalisation made trade readjustment inevitable.
In conclusion, the Depression shook the New Zealand economy, establishing a new order which sought full employment, price stability, and industrial development. While these were, for a time, achieved, it came at the cost of extensive controls which were a leading contributor to New Zealand’s relative decline. While successes like trade diversification cannot be overlooked, overall government management of the economy cannot be said to have been successful. The fundamental duty of government is to deliver prosperity and while New Zealand remained prosperous, it could have been much more so.
World Bank. The World Bank Report on the New Zealand Economy 1968. (1968).
Secondary Sources
Bernanke, Ben S. 21st Century Monetary Policy. New York: W.W. Norton & Company, 2022.
Bertram, Geoff. “The New Zealand Economy 1900-2000.” In The New Oxford History of New Zealand, edited by Giselle Byrnes, pp. 537-572. Melbourne: Oxford University Press, 2009.
Bloomfield, G.T. New Zealand: A Handbook of Historical Statistics. Boston: G.K Hall & Co., 1984.
Condliffe, J.B. The Welfare State in New Zealand. London: Allen and Unwin, 1959.
Easton, Brian. In Stormy Seas: The Post-War New Zealand Economy. Dunedin: University of Otago Press, 1997.
Gould, John. The Rake’s Progress? The New Zealand Economy Since 1945. Auckland: Hodder and Stoughton, 1982.
Greasley, David, and Les Oxley. “Regime Shift and Fast Recovery on the Periphery: New Zealand in the 1930s.” The Economic History Review 55, no. 4 (2002): pp. 697-720. https://doi.org/10.1111/1468-0289.00237
Gustafson, Barry. From the Cradle to the Grave. Auckland: Reed Methuen, 1986.
Hawke, G.R. The Making of New Zealand: An Economic History. Cambridge: Cambridge University Press, 1985.
Holland, Sidney. Passwords to Progress. Christchurch: Whitcombe and Tombs, 1943.
Kindleberger, Charles P. The World in Depression, 1929-1939. Revised Edition. Berkeley: University of California Press, 1986.
McAloon, Jim. Judgements of all Kinds: Economic Policy-Making in New Zealand 1945-1984. Wellington: Victoria University Press, 2013.
Nash, Walter. New Zealand: A Working Democracy. London: J.M Dent & Sons., 1944.
Rankin, Keith. “Workforce and Employment Estimates: New Zealand 1921-1939.” In Labour, Employment and Work in New Zealand, pp. 332-343, 1994.
Reddell, Michael, and Cath Sleeman. “Some perspectives on past recessions.” Reserve Bank of New Zealand, Bulletin, 71, no. 2 (2008): pp. 5-21.
Singleton, John, Arthur Grimes, Gary Hawke, and Frank Holmes. Innovation + Independence: The Reserve Bank of New Zealand 1973-2002. Auckland: Auckland University Press, 2006.
Sutch, W.B. “Colony or Nation? The Crisis of the Mid-1960s.” In Colony or Nation? edited by Michael Turnbull, pp. 163-183. Sydney: Sydney University Press, 1966.
Toye, John, and Richard Toye. “Origins and Interpretations of the Prebisch-Singer Thesis.” History of Political Economy 35, no. 3 (2003): pp. 437-467. muse.jhu.edu/article/46958.
[8] Michael Reddell and Cath Sleeman, “Some perspectives on past recessions,” Reserve Bank of New Zealand: Bulletin 71, no.2 (2008), p. 7.
[9] David Greasley and Les Oxley, “Regime shift and fast recovery on the periphery: New Zealand in the 1930s,” The Economic History Review 55, no.4 (2002), pp. 709-710.
[10] G.R. Hawke, The Making of New Zealand: An Economic History (Cambridge: Cambridge University Press, 1985), p .158.
[29] World Bank, The World Bank Report on the New Zealand Economy 1968 (1968), pp. 44-45.
[30] Geoff Bertram, “The New Zealand Economy: 1900-2000,” in The New Oxford History of New Zealand, ed. Giselle Byrnes (Melbourne: Oxford University Press, 2009), p. 557.
[31] John Singleton et al., Innovation + Independence: The Reserve Bank of New Zealand 1973-2002 (Auckland: Auckland University Press, 2006), pp. 17-21.
[42] W.B. Sutch, “Colony or Nation? The Crisis of the Mid-1960s,” in Colony or Nation?, ed. Michael Turnbull (Sydney: Sydney University Press, 1966), p. 183.
[43] John Toye and Richard Toye, “The Origins and Interpretation of the Prebisch-Singer Thesis,” History of Political Economy 35, no. 3 (2003), p. 437.
[44] World Bank, Report on the New Zealand Economy, p. 20.
[45] McAloon, Judgements of all Kinds, pp.112-115.
Over the last couple of months, the National Party has been running the line that a Reserve Bank Governor should not be appointed to the normal full five-year term when Orr’s existing term expires in late March, but that rather an appointment should be made for just a year so that whichever party takes office after next year’s election can appoint a Governor of their preference. We are told (although we have not yet seen the letter) that they made this case to the Minister of Finance when, as he was required to, he came consulting on his plan to reappoint Orr.
It is a terrible idea, on multiple counts.
But what is also irksome is the idea that in making a five year appointment, for a term beginning probably at least six months prior to the election, the Minister is breaching some established convention. That is simply a nonsense claim. This clip (from Bernard Hickey’s newsletter, this one opened to everyone) has some relevant quotes
There is simply no foundation to what Luxon is saying about what happened in the past. Since the Reserve Bank was made operationally independent in 1990, there have been two cases in which a Governor’s term has expired in election year but before the scheduled election. The first was in 1993, when Don Brash’s term expired on 31 August. The 1990 election had been held on 6 November 1990, so presumptively any new term was going to start within three months of the 1993 election. As it is, and partly to allay any possible market concerns (these were still fairly early days), Don’s reappointment was made and announced very early (if memory serves correctly in late 1992). I don’t recall any particular controversy about that reappointment (although the then Prime Minister had not been a huge Brash fan), but then Brash had initially been appointed by a Labour government (and the then Labour leader and finance spokesman had both sat in the Cabinet that had appointed him).
Of the next few (re)appointments:
Don Brash was appointed to a third term commencing in September 1998, not an election year
Don Brash resigned suddenly in April 2002, about three months before the general election. The then Deputy Governor was immediately appointed (lawfully) as acting Governor, both to run the Bank in the interim and to enable a proper search process to take place. Recall that under New Zealand law, the Minister of Finance cannot simply appoint his or her own person as Governor, and in those days the Bank’s Board used to guard its prerogatives (right and responsibility to nominate). The eventual appointment of Alan Bollard was not made until after the election.
Bollard was reappointed in 2007 (not an election year) and Wheeler was appointed in 2012 (also not an election year)
Which brings us to 2017. In 2016 Graeme Wheeler had advised that he would not be seeking a second term (probably to the general relief of both government and opposition parties at the time). Documents later released show that The Treasury (and the Board and minister) envisaged making a permanent new appointment some time early in 2017, well clear of the likely election date. However, those same papers also show that when the relevant authorities (in this case, Cabinet Office) were consulted it was established that the convention now (though perhaps not in 1992/93) was that permanent appointments should not be made when the new appointment would commence very close to (within three months of) an election date. In other words, the government could not get round the fact that Wheeler’s term expired close to the expected election date simply by making an early announcement of a permanent replacement. And thus they more or less had to settle on the idea of an acting Governor (Grant Spencer). Unfortunately, the then law was badly written (did not envisage the circumstances), and Graeme Wheeler (who could lawfully have been extended for six months) seemed keen to get back to commercial life ASAP, and the actual solution they landed on was almost certainly unlawful (I wrote a lot about it at the time, but here is a post that comments on the best arguments the Crown’s lawyers could make in defence).
So there is a precedent for an acting appointment (which, since the law was amended, could now be done lawfully) when the Governor’s term expired within three months of the election. That same convention, about not making permanent appointments, isn’t just about the central bank. But Orr’s term expires on 27 March, and the election seems likely to be at least six months after that, in a system with a three-year parliamentary term. It simply isn’t very serious or credible to argue that the government – otherwise still governing fully – should be unable (or even unwilling) to appoint a permanent Governor six or more months out from an election. You might argue, and I might have a bit of sympathy for such a view, that perhaps it would be better to give a Governor a six year term (the RBA Governor has a seven year term), so that overlaps with election years happened much less often, but the law is as it is, and I don’t recall the Opposition opposing five year terms when the reform bills were before the House. But there is no established precedent or convention about not making permanent appointments that start that far out from a likely election.
In passing, one might note that whereas with past appointments all powers of the Reserve Bank rested with the Governor, the various reforms put in place by this government have (at least on paper) considerably diminished the extent of the Governor’s powers, and created other appointments (notably external MPC members) which (at least on paper) provide avenues to shape and influence the Bank. I don’t want to put too much weight on this argument – I’ve spent years arguing that many of these changes in practice have been largely cosmetic – but not only could those provisions be used more aggressively by an incoming government that cared, but it would be quite legitimate for an incoming government to amend the legislation further (at the margin) to reduce the relative dominance of any particular individual serving as Governor. Our system would be better for such changes. (To be clear, like various other commenters, I would not support law changes designed directly to remove Orr: that way lies Erdogan type central banking.)
Whatever the law and precedent, it would also be a bad idea to be making acting appointments in circumstances like the present one. Our whole system around the Reserve Bank – and central banks in other advanced economies of our type – is set up around the idea that incoming governments don’t just get to pick their central bankers as soon as it suits. Instead, the system of operationally independent central banks has been built on (among others) the notion of technically capable, respected, non-partisan figures serving (whether as Governor or MPC members) for terms that do not align with the parliamentary term. Consistent with that vision, New Zealand’s legislation went further than most (too far in my view) in not even allowing the Minister of Finance to choose a Governor (or MPC members), but rather requiring that the Minister only appoint people who had first been nominated by the Board of the central bank, itself appointed for staggered terms by the Minister of Finance. Legislation was recently amended to even further reinforce this vision – of technically competent, respected, non-partisan appointees – when Labour explicitly added provisions requiring that other parties in Parliament be consulted before appointments are made (whether as Governor or Board members).
You could mount a counter-argument that this approach is a bit wrongheaded. After all, the legislation has also been amended recently to make it clear, that in monetary policy at least, the target the Bank works to is directly set by the government of the day. But notwithstanding that, the central bank still has a lot of practical policy discretion, and not just around monetary policy. Most advanced countries have made the choice that we do not want key central bank decisionmakers changing routinely when the government changes. That still seems, on balance, prudent to me, and in their calmer moments I’d be surprised if National really disagreed.
So the big problem in the current situation is NOT that an appointment has been made for five years. That should be the norm, whether or not it is six months from an election. The problem is specifically with the appointment (at all) of Adrian Orr. National seems reluctant to say that (perhaps because they may well be stuck working with him) but it is the main issue. There would be no such concern had a (hypothetical) generally highly-regarded (professionally, and among politicians), technically excellent, respected, non-partisan figure been appointed to the role. Specifically, National (and ACT) would not be raising concerns about the term of the appointment if they had any confidence in Orr. They do not. One can perhaps debate whether or not they should have such confidence, but in our system respect and confidence are earned, they are not something anyone can simply be forced to adopt. As I noted in yesterday’s post, the rank politicisation that has happened this week is not of National’s or ACT’s making, but of Robertson, in pushing ahead with an appointment – to a long-term position, where cross-party respect etc is important for the institution and its functioning – that the main Opposition parties seem to have been quite clear in opposing. It is not the job of Opposition parties to simply go along with whoever Robertson (and his, technically ill-equipped, board (itself, in some cases appointed over Opposition objections) determine). All the more so when Robertson himself was the one who introduced the formal consultation requirements, seeming to establish an expectation that strong (and reasoned) objections would be taken seriously. The responsibility was on Robertson – who holds the power to appoint or not – to respect the notion of only appointing someone who commands (even grudging) professional and personal respect. Orr no longer qualifies on that count. It is hard to think of any advanced country central bank Governor who will start a new term commanding so little respect, support, and confidence. That is really bad for the institution, and the institutional arrangements.
(Having said all this it would be good if National and ACT would pro-actively release their responses to Robertson’s consultation, rather than making us wait for OIA releases. It would be helpful to see what grounds the parties objected on, and whether they actually raised substantive concerns, or just relied on ill-founded process arguments.)
UPDATE: Having been sent a copy of the National letter of 30 September, it is now clear that National did not raise any substantive concerns about Orr, and focused wholly on the non-existent “convention” about not appointing a substantive Governor even 6-7 months out from an election.
Yesterday’s announcement from the Minister of Finance that he was reappointing Adrian Orr as Governor of the Reserve Bank was not unexpected but was most unfortunate. I was inclined to think another commentator (can’t remember who, so as to link to) who reckoned that it may have been Robertson’s worst decision in his five years in office was pretty much on the mark.
When Orr was first appointed, emerging out of a selection process kicked off by the Reserve Bank’s Board while National had still been in office, it seemed to me it was the sort of appointment that could have gone either way. I captured some of that in the post I wrote the day after that first appointment was announced, and rereading that post last night it seemed to at least hint at many of the issues that might arise and come to render the appointment problematic at best. Some things – a good example is $9.5 billion of losses to the taxpayer – weren’t so easy to foresee.
The timing of the reappointment announcement itself was something of a kick in the face for (a) critics, and (b) any sense that the better features of the new Reserve Bank legislation were ever intended as anything more than cosmetic. The Reserve Bank is tomorrow publishing its own review (with comments from a couple of carefully selected overseas people) of monetary policy over the past five years. Adding the statutory requirement for such a review made a certain amount of sense, but if there is value in a review conducted by the agency itself of its own performance, it was only going to be in the subsequent scrutiny and dialogue, as outsiders tested the analysis and conclusions the Bank itself has reached. But never mind that says Robertson, I’ll just reappoint Adrian anyway. Perhaps the Bank has a really compelling case around its stewardship of monetary policy – and just the right mix of contrition and context etc – but we don’t know (and frankly neither does Robertson – who has no expertise in these matters, and who appointed a Reserve Bank Board -the people who formally recommend the reappointment – full of people with almost no subject expertise).
But, as I say, the reappointment was hardly a surprise.
It could have been different. I’ve seen a few people say it would have been hard to sack Orr, but I don’t think that is so at all. No one has a right to reappointment (not even a presumptive right) and Robertson could quite easily have taken Orr aside a few months ago and told him that he (Orr) would not be reappointed, allowing Orr in turn the dignity of announcing that he wouldn’t be seeking a second term and would be pursuing fresh opportunities (perhaps Mark Carney would like an offsider for his climate change crusades?) Often enough – last week’s FEC appearance was just the latest example – Orr’s heart doesn’t really seem to be in the core bits of the job.
There are many reasons why Orr should not have been reappointed. The recent inflation record is not foremost among them, although it certainly doesn’t act as any sort of mitigant (in a way that an unexpectedly superlative inflation record in a troubled and uncertain world might – hypothetically – have).
There is nothing good, admirable, or even “less bad than most” about the inflation record. This chart is from my post last week
A whole bunch of central banks made pretty similar mistakes (and the nature of floating exchange rates is that each central bank is responsible for its country’s own inflation rate). Among the Anglo countries, we are a bit worse than the UK and Canada and slightly less bad than the US and Australia. Among the small advanced inflation targeters – a group the RB sometimes identified with – we have done worse than Switzerland, Norway, and Israel, and better than Sweden and Iceland. In a couple of years (2021 and 2022) in which the world’s central bankers have – in the jargon – stuffed up badly, Orr and his MPC have been about as bad on inflation as their typical peers.
You could mount an argument – akin to Voltaire on the execution of Admiral Byng – that all the world’s monetary policymakers (at least those without a clear record of dissent – for the right reasons – on key policy calls) should be dismissed, or not reappointed when their terms end, to establish that accountability is something serious and to encourage future policymakers to do better. You take (voluntarily) responsibility for inflation outcomes, and when you fail you pay the price, or something of the sort. Inflation failures – including the massive unexpected wealth redistributions – matter.
Maybe, but it was never likely to happen, and it isn’t really clear it should. As I’ve noted here in earlier posts until well into 2021 the Reserve Bank’s forecasts weren’t very different from those of other forecasters, and I’m pretty sure that was also the case in other countries. Inflation outcomes now (year to September 2022) are the result of policy choices 12-18 months earlier. With hindsight it is clear that monetary policy should have been tightened a lot earlier and more aggressively last year, but last February or even May there was hardly anyone calling for that. Absent big policy tightenings then, it is now clear it was inevitable that core inflation would move well outside the target range. There are plenty of things to criticise the Bank for – including Orr’s repeated “I have no regrets” line – but if one wants to make a serious case for dismissing Orr for his conduct of monetary policy it is probably going to have to centre on (in)actions from say August 2021 to February 2022 (whereafter they finally stepped up the pace) but on its own – it was only six months – it would just not be enough to have got rid of the Governor (even just by non-reappointment). The limitations of knowledge and understanding are very real (and perhaps undersold by central bankers in the past), and even if Orr and the MPC chose entirely voluntarily to take the job (and all its perks and pay) those limitations simply have to be grappled with. Were New Zealand an outlier it might be different. Had the Bank run views very much at odds with private forecasters etc it might be different. But it wasn’t.
I am, however, 100 per cent convinced that Orr should not have been reappointed. I jotted down a list of 20 reasons last night, and at that I’m sure I’ve forgotten some things.
I’m not going to bore you with a comprehensive elaboration of each of them, most of which have been discussed in other posts. but here is a summary list in no particular order:
the extremely rapid of turnover of senior managers (in several case, first promoted by Orr and then ousted) and associated loss of experience and institutional knowledge
the block placed – almost certainly at Orr’s behest – on anyone with current and ongoing expertise in monetary policy nad macroeconomic analysis from serving as an external member of the MPC
the appointment as deputy chief executive responsible for macroeconomics and monetary policy (with a place on the MPC) of someone with no subject expertise or relevant background
$9.5 billion of losses on the LSAP – warranting a lifetime achievement award for reckless use of public resources – with almost nothing positive to show for the risk/loss
the failure to ensure that the Bank was positioned for possible negative OCRs (having had a decade’s advance warning of the issue), in turn prompting the ill-considered rush to the LSAP
the failure to do any serious advance risk analysis on the LSAP instrument, as being applied to NZ in 2020
the sharp decline in the volume of research being published by the Reserve Bank, and the associated decline in research capabilities
the way the Funding for Lending programme, a crisis measure, has been kept functioning, pumping attractively-priced loans out to banks two years after the crisis itself had passed (and negative OCR capability had been established)
lack of any serious and robust cost-benefit analysis for the new capital requirements Orr imposed on banks (even as he repeatedly tells us how robust the system is at current capital levels)
repeatedly misleading Parliament’s Finance and Expenditure Committee (most recently, his claim last week that the war was to blame for inflation being outside the target range), in ways that cast severe doubts on his commitment to integrity and transparency
his refusal to ever admit a mistake about anything (notwithstanding eg the biggest inflation failure in decades)
the fact that four and a half years in there has never been a serious and thoughtful speech on monetary policy and economic developments from the Governor (through one of the most turbulent times in many decades)
Orr’s active involvement in supporting and facilitating the appointment of Board members with clear conflicts of interest (Rodger Finlay especially, but also Byron Pepper)
his testiness and intolerance of disagreement/dissent/alternative views
his often disdainful approach to MPs
his polarising style, internally and externally
all indications are that he is much more interested in, and intellectually engaged by, things he isn’t responsible for than for the things Parliament has charged him with
organisational bloat (think of the 17-20 people in the Communications team or the large number of senior managers now earning more than $400000 pa)
the distraction of his focus on climate change, but much more so the rank dishonesty of so much of it – claims to have done modelling that doesn’t exist, attempts to suppress release of information on what little had been done, and sheer spin like last week’s flood stress test. It might be one thing for a bloated overfunded bureaucracy to do work on things it isn’t really responsible for if it were first-rate in-depth work. It hasn’t been under Orr.
much the same could be said of Orr’s evident passion for all things Maori – in an organisation with a wholesale macroeconomic focus, where the same instruments apply to people of all ethnicities, religions, handedness, political affiliation or whatever. What “analysis” they have attempted or offered has been threadbare, at times verging on the dishonest.
the failure to use the opportunity of an overhaul of the RB Act to establish a highly credible open and transparent MPC (instead we have a committee where Orr dominates selection, expertise is barred, and nothing at all is heard from most members)
And, no doubt, so on. He is simply unfit to hold the office, and all indications are that he would have been so (if less visibly in some ways) had Covid, and all that followed (including inflation), never happened.
But the crowning reason why Orr should not have been reappointed is that doing so has further politicised the position, in a most unfortunate way.
In the course of the overhaul of the Reserve Bank Act, Grant Robertson introduced a legislative requirement that before appointing someone as Governor the Minister of Finance needed to consult with other parties in Parliament (parallel provision for RB Board members). It was a curious provision, that no one was particularly pushing for (in most countries the Minister of Finance or President can simply appoint the Governor, without even the formal interposition of something like the RB Board), but Robertson himself chose to put it in. The clear message it looked to be sending was that these were not only very important positions but ones where there should be a certain measure of cross-party acceptance of whoever was appointed, recogising (especially in the Governor’s case) just how much power the appointee would wield. That provision never meant that governments could not appoint someone who happened to share their general view of the world and economy, but there was a clear expectation that whoever was appointed would be sufficient to command cross-party respect for the person’s technical expertise, non-partisan nature, dispassionate judgement and so on. Robertson simply ignored Opposition dissents on a couple of the Board appointees. That was of second order significance, but it is really significant in the case of the Governor. It isn’t easy to dismiss a Governor (and rightly so) so for a Minister of Finance to simply ignore the explicit unease and opposition of the two main Opposition parties in Parliament is to make a mockery of the legislation Robertson himself had put in place so recently. The Opposition parties are being criticised in some places (eg RNZ this morning) for “politicising the position/appointment” but they seem to have been simply doing their job – it was Parliament/Robertson who established the consultation provision – and the consultation provisions, if they meant anything, never meant giving a blank slate for whomever the Minister wanted to offer up, no matter the widely-recognised concerns about such a nominee. No one has a right to reappointment and when it was clear that the main Opposition parties would not support reappointment, Robertson should have taken a step back, called Adrian in and told him the reappointment could not go ahead, in the longer-term interests of the institution and the system. If you were an Orr sympathiser, you might think that was tough, but….no one has right to reappointment, and the institution matters.
And, of course, now the position of the Governor has inevitably been put into play, with huge uncertainty as to what might happen if/when National/ACT form a government after the election next year. (And here is where I depart from National’s stance – I never liked the idea of a one year appointment, made well before the traditional pre-election bar on new permanent appointments. We want able non-partisan respected figures appointed for long terms (it is the way these things work in most places), not for each incoming PM to be able to appoint his or her own Governor.)
A few months ago, anticipating that Orr would probably be reappointed, I wrote a post on what an incoming government next year could do about the Bank. The key point to emphasise is that a new government cannot simply dismiss a Governor they don’t like (or nor should they be able to). I saw a comment on a key political commentary site this morning noting that the process for dismissal isn’t technically challenging, which is true, but the substantive standards are quite demanding (the Governor can be dismissed only for specific statutory causes, and for (in)actions that occurred in his new term (which doesn’t start until March)). Generally, we do not want Governors to be able to be easily dismissed (in most countries it is even harder than in New Zealand). More to the realpolitik point, any dismissal could be challenged in the courts, and no one would (or should) want the prolonged uncertainty (political and market) such actions might entail. Moreover, senior public figures cannot just be bought out of contracts.
We still don’t know – and perhaps they don’t either – how exercised National and ACT would be about any of this were they to form a government next year, but unless Orr was himself minded to resign (as the Herald’s columnist suggests might happen) things would have to be handled carefully and indirectly (perhaps along lines in that earlier post of mine) to change the environment and the incentives around the institution. Most of those changes should be pursued anyway, to begin to fix what has been done over the last few years And if Orr were to be inclined not to stick around for long, perhaps an offer of appointment as High Commissioner to the Cooks Islands might smooth his way?
In my post last Friday I highlighted how the Governor of the Reserve Bank had just been making up stuff, and apparently knowingly misleading Parliament, to distract from the Bank’s own responsibility for New Zealand’s current very high core inflation. There may well be a case to be made that central banks did about as well as could reasonably be expected over the last couple of years – “reasonably be expected” here set by reference to the general views at the time of other expert observers (none of whom, admittedly, had chosen to take on statutory responsibility for inflation) but simply making stuff up blaming the Moscow bogeyman helps no one, and detracts from any serious conversation about what went on with inflation – core and headline – and why. To put my own cards on the table, there are many reasons why Adrian Orr should not be reappointed, but the poor inflation outcomes are not the most important of those reasons (of course, a superlative performance on inflation might have covered over a multitude of other sins and shortcomings).
After Friday’s post, someone got in touch to point out that I had not mentioned one other episode in that FEC appearance which could also reasonably be described as “making stuff up” and misleading Parliament. Opposition members were asking questions that included that rather loaded phrase “printing money”, to which Orr responded – apparently in reference to the LSAP – that the Reserve Bank did not create money, that all they did was to lower bond yields, and that banks etc were the people who increased the money supply.
In normal circumstances, the Governor’s comment would not be far wrong. The “money supply” – deposits with financial intermediaries (those included in the Bank’s survey) held by “the public” (ie people and firms not themselves included in the survey) – mostly increases in the process of private sector credit creation. For example, each new mortgage to purchase a house results simultaneously in the creation of either a deposit or a reduction in another mortgage as the house seller deals with the proceeds of the sale. Monetary policy operates typically by adjusting interest rates to influence, among other things, the demand for credit.
Some of the Reserve Bank’s emergency crisis tools don’t have any direct effect on the money supply measures the Reserve Bank compiles and reports. The Funding for Lending programme – a crisis programme that bizarrely is still injecting cheap liquidity now – simply lends money to banks (against collateral). That transaction boosts settlement cash balances held by banks at the Reserve Bank, but those balances aren’t part of “money supply” measures (they are deposits held by one lot of surveyed institutions – banks – at another surveyed institution – the Reserve Bank).
The LSAP is different. If, for example, a pension fund had been holding government bonds and had then sold those bonds to the Reserve Bank. the pension fund would receive payment from the Reserve Bank in a form that adds to that pension fund’s deposits at a bank. Settlement cash balances increase in the process, but so does the money supply (the pension fund’s deposits count in the money supply just the same way that your deposits do). Had the Reserve Bank bought all those tens of billions of dollars of bonds from local banks, the transaction would have boosted only settlement cash and not the money supply measures. But it didn’t. There were plenty of sellers – the Reserve Bank was eagerly buying at the top of the market – and some were local banks, and others were not. And so when the Governor suggested to Parliament that the Bank’s bond-buying did not increase the money supply, he wasn’t really being strictly accurate.
If you are now drumming your fingers are thinking this is all very technical and not really to the point, then in some respects you are correct. We’ve heard a lot about “the money supply” in the last couple of years. Most of it isn’t very accurate, but in many respects the difference doesn’t matter very much. “Money supply” measures (the formal ones referred to above) have not mattered very much to central bankers for decades, and that has been so whether inflation was falling sharply and undershooting inflation targets, or (as at present) proving very troublesome on the high side. The general view has been that money supply measures have not contained consistently useful information about the outlook for inflation, over and above what is in other indicators.
That does not mean – to be clear – that inflation is anything other than a monetary phenomenon for which central banks (and their masters) are responsible. It also does not mean that in extreme circumstances, in which say the government/central bank is flinging huge amounts of money at households without any intention of paying for those handouts now or later through higher taxes, that straight-out government money creation will not be a problem, paving the way for something that could end in hyperinflation. It is simply that specific official measures of the money supply have not proved very useful as inflation forecasters. Decades ago we hoped they did – and money supply growth targets were the rage for a decade or more in some central banks – but they didn’t.
And perhaps you can begin to see why if we go back a couple of paragraphs to the LSAP purchases. If the Reserve Bank purchases bonds from you and me (or our Kiwisaver fund) that will add to the money suply measures the Reserve Bank compiles and reports. If the Reserve Bank instead buy bonds from banks who bank with the Reserve Bank, it won’t add to the money supply measures. Does anyone really suppose there are materially different macroeconomic implications from those two different scenarios? The Reserve Bank doesn’t (from all they have said and written about how they think the LSAP works) and – for what it may be worth – I agree with them. You could add a third scenario, in which the Bank buys a bond from a non-bank entity that itself had bought the bond on credit. In that case, even RB purchasing from a non-bank won’t add to the money supply measures, but will (presumably) reduce any credit aggregates that captured the initial loan.
It might all have been different decades ago when, for example, central banks paid no interest on settlement cash balances, sometimes (as in New Zealand) banks were forbidden from paying interest on short-term or transactions deposits, and where banks were subject to variable reserve asset ratios. That was the world I started work in, but none of that is true today. Money supply measures usually aren’t very enlightening about inflation prospects, and these days neither even is the level of settlement cash balances (since the Reserve Bank pays the full OCR on whatever balances have accumulated). Thus, the LSAP may have been a dumb idea (and a very expensive one so it proved), but not because it may or may not have boosted official measures of the money supply to some extent. The pension fund that sold a government bond and now has bank CD in its books instead is no better or worse off because one asset wasn’t in the money supply official measures and the other one is. Neither are its members.
What matters is (mostly) two things: first, level and structure of interest rates, and second whether or not more purchasing power is put in the hands of public. The LSAP purports to change the former – which it seems was probably what the Governor was trying to claim at FEC the other day – but does not, and does not purport to, change the latter directly.
(By contrast, when for example the government sharply ran down its cash balances at the Reserve Bank and paid out at short notice a huge level of wage subsidy payments, not only did those payments boost the money supply measures (in most cases) but they put more purchasing power in the hands of the private sector (households supported by those payments). That isn’t a comment about the merits or otherwise of the wage subsidy scheme – I thought it was mostly great, directly counteracting what would otherwise have been a huge loss of purchasing power – just a description of how things work technically).
What about some numbers and charts?
This is a chart of annual growth in the Reserve Bank broad money measure
Annual growth rates have fluctuated a lot. There was a surge in the annual growth rate in 2020 (and a 3.5 per cent lift in the month of March 2020 alone, presumably largely reflecting the wage subsidy payments) but (a) it proved shortlived, (b) the peak was still materially below peaks in the 90s and 00s, and c) core inflation in the mid 90s and mid-late 00s did not get near the current core inflation rates (depending on your measure somewhere between 5 and 7 per cent).
For those of you who remember studying money in your economics courses, here is a measure of the velocity of money (in this case, quarterly nominal GDP divided by the broad money stock at the end of each quarter.
This measure of the money supply has been been growing faster than nominal GDP pretty much every year since 1988 (mostly just reflecting the fact that regulatory restrictions on land use have inflated house prices to absurd levels, driving up both money and credit as shares of GDP). You can see a bit of noise in 2020 – the big initial increase in the money supply I mentioned earlier and the temporary sharp reduction in GDP – but two years on there is nothing now that looks unusual.
Here is a chart of the level of broad money, expressed in logs (which means that if the slope of the line is unchanged so is the percentage rate of growth in the underlying series).
Nothing particularly out of the ordinary in money supply developments (on this formal measure) over the last few years.
But for anyone out there who still wants to put some weight on this official measure of the broad money supply, here is the chart of quarterly percentage changes.
Eyeballing it, the most recent three quarters (to September this year) appear to have had the weakest growth since 2009. a period when nominal GDP growth and core inflation falling away sharply. Since I don’t put much weight on money supply measures, as offering anything much about the inflation outlook, I wouldn’t emphasise the comparison myself.
Inflation is primarily a monetary phenomenon, and a national phenomenon (that was why the exchange rate was floated, to make it so), and something for which central banks are responsible and should be accountable. Core inflation has been – and still is – at unacceptably high rates, as a result of choices and misunderstandings by our central bank (their misunderstandings were widely shared, among private sector economists and in other countries, but that does not change the responsibility even if it might mitigate the appropriate consequences for those central bank decision makers). Monetary policy choices matter, a lot. But official measures of the money supply don’t usually shed much additional light, and have not done so over the last couple of years.
Legislatures typically take a dim view of efforts to mislead them or their committees. This is from our own Parliament’s online “How Parliament works”
The Governor of the Reserve Bank seems just not to care, treating Parliament’s Finance and Expenditure Committee with as much contempt, and disregard for basic standards of honesty and care as some juvenile delinquent.
Yesterday the Governor and a couple of offsiders fronted up to the FEC, as they always do, following the release of the six-monthly Financial Stability Report. Were one of a particularly generous cast of mind one might almost have felt a little sorry for the Governor at times: the report was about financial stability not monetary policy, and yet most of the serious questioning was more about monetary policy, and then there was the old game of MPs attempting to get officials to say something (whether on tax, spending, immigration policy or whatever) that helps their party in its partisan jostling, even if such matters were nothing to do with the Bank’s own responsibilities. But Orr is paid a lot of money and given a lot of power, and doesn’t even make an attempt to treat elected MPs – from whose legislation flows his power and his office – with even a modicum of respect. As it was, no one forced him to answer monetary policy questions – he responded to most of them by referring MPs to their internal review of the last five years of monetary policy, to be released next week. But when he chose to answer, he had some fundamental obligation to give straight answers, not trail red herrings and other outright spin (or worse) across the path.
Orr has form. Last December, he fronted up for the Bank’s Annual Review and he and a senior offsider actively misled the committee about senior staff turnover (something that became very clear very quickly). It took a little longer, and an OIA request, to show that he had also actively misled the committee with claims that the Bank had done modelling of its own about the (supposed) climate change threat to financial stability, when in fact they’d done none.
You can watch the full hearing here, or you read an account of the relevant bits here. Orr was on the backfoot over the stewardship of monetary policy – and there is at least an arguable connection to financial stability (more so to individual financial stress) given the cycle in both interest rates and house prices, and the likely cycle in unemployment). There are some things Orr (and the MPC) can and should be held accountable for – floating exchange rates mean that what happens with inflation in New Zealand is largely a New Zealand monetary policy (passive or active) choice – and others that the central bank has never been expected to counter (the most obvious example is the price effect of GST increases, but you could think too of exogenous shocks like sudden oil price changes).
Orr’s first claim in his defence was that New Zealand has one of the “lower inflation rates in the OECD”. That is probably defensible. The ways CPIs are calculated differs across countries but on the headline numbers reported by the OECD for the year to September 2022 there were eight OECD countries with lower inflation rates than New Zealand’s 7.2 per cent (and Australia’s was almost the same at 7.3 per cent). Even if one were to treat the euro-area countries as a single unit (they all have the same monetary policy), the picture doesn’t change much. Not, of course, that we should care too much what inflation rates other countries have when we are so far from target – the exchange rate was floated 37 years ago to give us effective monetary policy independence – but when a bunch of countries have made similar mistakes (not that Orr yet concedes to regretting anything), it is better to be on the less-bad side of the pack.
But not all countries experience the same shocks the same way. Wars, rumours of war, and associated sanctions/boycotts etc have affected energy prices in particular this year. No one has ever expected inflation targeting central banks to prevent the direct price effects of immediate energy price shocks – indeed, mandates (including in NZ) have often explicitly urged central banks to “look through” such effects and focus or core measures and/or any spillover into generalised future inflation).
The CPI ex food and energy is the most commonly used measure for international comparisons of core inflation (not because it is ideal, but because it exists), and is well-suited this year when fuel and (to a lesser extent) food have been in the spotlight in the context of the Russian invasion etc. Some countries are very very heavily exposed to changes in gas prices in particular, and others (notably including New Zealand which for better or worse is not linked into a global LNG supply chain) are not. But here is how CPI ex food and energy inflation for the year to September looked (chart scale truncated – Turkey is worse than that).
New Zealand? Middle of the pack, and almost identical to the numbers for Australia and the United States (a bit higher than the UK, and a lot higher than the euro-area). This is closer to the stuff central banks individually are responsible for.
But this is really just scene-setting. Orr’s most egregious claim – and it was particularly egregious for being repeated twice perhaps 40 minutes apart – was that for New Zealand’s inflation to have been inside the target range now, the Bank would have had to have forecast the Russian invasion back in 2020.
It was just a mind-boggling claim – not that any MP on the FEC seemed to be alert enough to notice. It seemed to be implying that if we abstracted from the direct price effects of the war, inflation would otherwise be in the 1 to 3 per cent per annum target range. But here is what those data show, using the SNZ exclusions covering both fuel individually and fuel and food.
For the year to September [2021], all those exclusion measure of inflation were still in excess of 6 per cent, more than double the rate of inflation envisaged by the very top of the target range.
Oh, and when did the war start? The invasion began on 24 February. The March quarter CPI is centred on mid-February, and all those exclusion measures were already between 5.7 and 6 per cent by then. Before the war began. Now, it is certainly true that oil prices had risen in the preceding months as rumours of war mounted but (a) that wasn’t until late last year, and b) these are exclusion measures (ie excluding the direct effects of higher fuel prices). And the best indicator of domestic cyclical stress – the unemployment rate was already at 3.2 per cent in the December quarter last year (and again in March), also before the war began.
And what about more analytical measures of core inflation here in New Zealand?
For what it is worth, the highest rate of quarterly inflation on these core measures had already been recorded in the March quarter CPI, which (need I remind you) is centred on 15 February (most prices are surveyed mid-quarter), before the war began. Perhaps unsurprisingly, the worst of the (core) inflation was around the time the unemployment rate was falling to its lowest level (at a time when monetary policy was being particularly slow to act – recall that it was not until February that the OCR got back to pre-Covid levels). High core inflation – in annual terms on these measures now between 5 and 7 per cent – is a domestic phenomenon, for which monetary policy is (by default, being the last mover) responsible.
Of course, Orr knows all this (and, linking back to that parliamentary document, ought reasonably to have known it – having chosen to take the job, and accepted the $830000 salary for it). And his staff knew all this. The Governor was appearing at FEC remotely from his office, and it would have been easy for his economics staff to have slipped him a note saying “Governor, you really can’t make those claims about inflation and the war”, but (a) Orr is known to be intolerant of dissent and correction, and (b) if perhaps some brave staffer did slip him such a note, he went ahead and repeated the big and preposterous claim again later in the same appearance.
There are many many reasons why Orr should not be reappointed but simply making out stuff, that he knows – and certainly should know if he holds that job – to be simply false is not one of the least of his offences. Misleading Parliament really should matter, if we care at all about good governance any longer. On the further evidence of yesterday’s performance Orr seems not to. Just imagine if one of the institutions he regulated tried that sort of performance on him.
A couple of weeks ago I wrote a post here, prompted by a paper by the former Bank of England Deputy Governor Sir Paul Tucker. Tucker’s paper was written in the context of the huge losses central banks in many countries, including his own UK, have run up through their large scale asset purchase programmes, especially those undertaken in 2020 and 2021 when bond yields (actual and implied forwards) were already incredibly low. While central banks continue to hold the bonds, the losses are seen every year now as the funding costs on those bond positions (the interest paid on the resulting settlement cash balances) swamp the low earnings yields on the bonds themselves. Bond positions purchased at yields perhaps around 1 per cent are financed with floating rate debt now paying (in New Zealand) 3.5 per cent (a rate generally expected to rise quite a bit further).
Tucker explored the idea that central banks might in future choose not to fully remunerate all settlement cash balances (while still applying the policy rate at the margin), and that if they did not then politicians might in future be reluctant to authorise future LSAPs and associated taxpayer indemnities (this seemed like a bonus to me, but Tucker is a bit more open to the potential of QE generally than I am (for New Zealand). With $60 billion or so of settlement cash injections still in the system (although with other offsets, total settlement cash balances are less than that), there is a lot of money potentially at stake.
My post was pretty sceptical of the idea – it seemed like arbitrary “taxation” by an entity with no mandate and little accountability – and in a Herald article at about the same time I was pleased to see several former colleagues also expressing considerable scepticism. In the wake of my post I had a bit of an email exchange with Tucker and while that didn’t change my mind it did help clarify the importance of reaching a view on whether the LSAP additions to settlement cash balances had resulted in something akin to a windfall boost to bank profits or not. Here is Tucker
Now, reaching a definitive view on a matter like this isn’t easy. Formalised models might even help, although I’m a bit sceptical even they could ever offer anything very definitive, and – in arbitrary taxation at least as much as criminal justice – we might reasonably expect something close to a “beyond reasonable doubt” test to be applied (especially when no one compelled the state to ever do LSAPs at all). You could think of a hypothetical world in which such a windfall might appear to rise – central banks buy the bonds from pension or hedge funds who simply deposit the proceeds with banks and happily (or resignedly) just accept zero interest on the resulting deposits – but it doesn’t seem very plausible. Perhaps there are other hypotheticals, but it still seems a stretch (and we aren’t in the world decades ago where, for example, banks were forbidden from paying interest on transactions balances).
I don’t have the resources or data for the sort of in-depth analysis that might be required if governments and central banks were to be seriously considering the Tucker option. But what do the high-level indicators we do have show? This, inevitably, bleeds into the recent (and annual or semi-annual) ritual in which the political left and the popular media bemoan the profitability of the banking system more generally.
The first increase in the OCR was in October 2021. Until then, settlement balances had been earning 0.25 per cent per annum, so that even if banks had somehow been paying nothing on the counterpart deposits, the amounts involved would have been too small to have shown up in the aggregate data (0.25 per cent per annum on $60 billion is about $150m per annum). But we have aggregate data now up to and including this year’s June quarter.
I’m including some long-term charts here (from the Reserve Bank website data, going as far back as their data go), as background to some comments on bank profitability too.
There is return on assets
return on equity
and the net interest margin (shown on the same chart as the average interest rate earned on interest-earning assets)
It is early days – the much higher OCRs for the September and December quarters may shed more light in some months’ time – but at present there isn’t anything much pointing to windfall earnings, whether directly from the Tucker effect or from the LSAP or other Covid interventions. Returns dipped during the 2020 deep (if brief) downturn, and then seem to have returned to about pre-Covid average levels. If the net interest margin has risen a bit, in the June quarter it was at about the average level for the previous 15 years.
On the other hand, supporters of the Tucker story could point to this chart. It is interesting that interest-bearing liabilities have dropped to a record (over this 30 year period anyway) low but (a) perhaps it is less surprising given that, at least to June, the absolute level of interest rates remained very low (and well below the prolonged period 20 years earlier when the interest-bearing share of total liabilities was also unusually low) and (b) as yet, there is no sign of this reflected in unusually high bank returns (see earlier charts).
Time will tell, but to this point there is no smoking gun, in New Zealand anyway. Tucker does note that (at least in the UK context) windfall returns could be paid away in management bonuses, so that they wouldn’t show up in after-tax profit figures, but (a) that seems more like a UK issues (big bonuses in the City etc) and (b) you would expect to see it showing up in bank disclosures (eg CEO salaries etc) and I’m not aware of any sign it (yet) has.
More generally, what to make of the bank profits story? On a cyclical basis there were reasons one might have expected the last year to have been the best for some time: the economy was extremely overheated, unemployment was extremely low, and although house prices have been falling more recently they only peaked in November last year, having risen to an extraordinary extent over the previous 15 months or so. Banks tend to make lots of money in circumstances like that (and, on the other hand, to do poorly in deep recessions). Perhaps reflecting the abnormal and uncertain state of the Covid world over 2021/22, in fact none of those charts above suggest anything exceptional about bank profitability (at times, really high reported bank profits can themselves be a worrying financial stability indicator – lots of poor quality loans with high upfront fees and/or dodgy accounting can produce very flattering short-term numbers, all while storing up big future losses. Cyclically, the year ahead looks a lot less favourable for banks (as the ANZ CEO noted they are now writing a tiny fraction of the number of new mortgages they were doing at peak) and a recession (with all the attendant reduction in demand for products, reduction in servicing capacity, and outright losses) is generally agreed to be looming.
What about overall average rates of return? When they left aren’t making cyclical complaints, this tends to be where they focus. And of course the return on equity is better than you are going to get on a bank deposit, but it is also a great deal riskier.
One obstacle to analysing the issue in a specifically New Zealand context is that hardly any New Zealand banks are listed on the stock exchange as such, so we don’t have a good read on the value the market puts on them. But the big-4 banks are the dominant players in Australia too, housing lending makes up almost two-thirds of credit in Australia, and Australia has similarly absurd house price to income ratios in its largest cities. Historically, rates of return have also looked quite high
(One might also add that in recent decades the New Zealand and Australian banking systems have been amongst the most stable anywhere).
Then again, the market seems less impressed with the Australian banks than the New Zealand political left are. Price to book value ratios don’t look particularly impressive – for long-established “licence to print money” entities – and of the four big Australian banking groups, in three cases the first time the current share price was reached was well over a decade ago.
We (and Australia) have big banks. When regulation renders house prices absurdly expensive, you need entities that will facilitate very large amounts of debt. Big banks require lots of capital, and on lots of capital lots of money can and should be made. But if the left is so convinced there is money for jam on offer there is a readily accessible market response: buy more shares with their own savings.
Instead, from the party that wants to make us all poorer, force people to live in expensive townhouses, and do all they can to discourage cars and planes (oh, and free speech too), yesterday we got a proposal that there should be an “excess profits tax”. The Green Party’s discussion document is here. I guess it is mostly just political spin to try to keep up the radical left vote, but it really was an astonishingly threadbare document.
For precedent, we are reminded on a couple of occasions that there were excess profits taxes in World Wars One and Two. And since we actually conscripting people – and ordering them into the military or directed service – and restricting all manner of other economic activity probably few people had much problem with that (the idea of “conscripting capital” was (understandably) big on the left in New Zealand. But while the left may like to claim we are now in some “moral equivalent of war”, in fact we are running a market economy in which firms and individuals are free to come and go, invest or not, as they choose. We are also told about windfall taxes on energy companies in Europe at present, but again these are rather more equivalent to an actual wartime situation (very high returns to lower cost renewables producers for example are arising out of the foreign policy choices of governments around the Russian/Ukraine situation).
But nothing in the Greens’ document establishes a serious case for New Zealand now (eg for better or worse we aren’t tied into the global LNG supply chain)
And then there are the basics. This appears early on.
I followed the footnote to be sure I was using the same sources. From the Annual Enterprise Survey
So you can see the $103.3 billion. But you might also note the sharp fall in this measure of profits the previous year (Covid disruption and all that), and the smaller fall the year prior to that. Actual profits before tax on this measure were about 5 per cent high in the 2021 years than in the 2018 years.
And nominal GDP? Well, it was up 17 per cent over roughly the same period (calendar 2021 over calendar 2018).
Then we get charts like this.
I have no idea where any of the lines comes from but note (a) the orange line, which claims to be taken from the AES, has a latest observation LOWER than the one a couple of years earlier, and (b) while the Greens claim that “the graph below demonstrates that profits are already exceeding prepandemic levels; and are several times higher in real terms than in the 1990s” they fail to point out that real GDP is a lot higher than it was in the 1990s too.
How do those ratios look? From the national accounts we have a breakdown between compensation of employees on the one hand and returns to business (including labour income for self-employed operations). Wage and profit shares have ebbed and flowed but nothing about the last few years looks very unusual.
The same data are now available on a quarterly basis, but only since 2016 (and inevitably the more recent observations are subject ot revisions). This time I’ve just shown the two series as cumulative growth rates since 2016
Labour costs and non-labour components of the income measure of GDP have risen over the full period by almost exactly the same percentage (seasonally adjusting through the Covid lockdowns is a real challenge so I wouldn’t pay much attention to those particular quarters).
We are left wondering where all these excess returns the Greens are on about really are. If they mean house prices rising in 2020 and 2021, well of course I can quite understand (and we know they like the idea of a capital gains tax) but……house prices are now falling quite a lot, and excess profits taxes aren’t usually aimed at Mum and Dad (indeed the rest of the document is all about th rapacious capitalists).
One could go on, but I won’t. The Greens seem keener on planning to spend the proceeds of their tax than provide firm analytical underpinnings to it, and of course while feeding the narrative that somehow there is money for jam being left on the table, there seemed to be no mention of countervailing reductions in business taxation if/when there is a deep recession or windfall losses (and in the nature of windfalls, losses are as likely as gains). But why would anyone really be surprised?
The document has this line: “The Green Party considers that record profits during a time of economic hardship for many New Zealanders are immoral and unsustainable”. Except that whether one uses their AES measure, or national accounts measures there isn’t anything very remarkable about profits in recent years – except of course that there is lots of inflation, but even then as that final chart shows returns to labour in total have been growing at about the same rate of returns to providers of other resources.
croaking cassandra 