Australia

Reviewing and reforming the RBA

Michael Reddell Australia, Monetary policy, MPC

The incoming Australian Labor government last year established an independent review of the Reserve Bank of Australia’s monetary policy functions, structures and performance. The review panel (chaired by a former Bank of Canada Deputy Governor) reported a few weeks ago and their full report is here. Periodic reviews of this sort aren’t uncommon, and are often triggered by episodes of discontent around the performance of the respective central bank (in New Zealand, the 2001 review conducted by Lars Svensson was an example).

There is no clear-cut single preferred way to organise policy functions that society (as represented by government and parliament) wishes to delegate decision-making responsibility to. That is true whether one thinks globally, or just of the subset of advanced economies that countries like New Zealand and Australia usually use as benchmarks or experiences/structures that might offer insight.

If this proposition is true generally, it is no less true of monetary policy specifically. And that shouldn’t really be surprising, including because monetary policy is really quite a recent thing. In New Zealand and Australia the transition to a market-based financial system and a floating exchange rate is not quite yet 40 years old, and even among larger economies floating exchange rates more generally date back only 50 years or so. Modern monetary policy is a cyclical management function (leaning against cyclical macroeconomic fluctuations subject to a constraint of keeping the inflation rate in check), and yet our data sets are really quite limited (since 1984/85 New Zealand has had 4 or 5 business cycles, and the creation of the euro means there are really only perhaps 15 or so advanced-country monetary policy agencies). We simply do not know with any degree of confidence that one form of monetary policy governance etc structure will produce better results over time than another. Instead we (all, including the RBA review panel) argue from small select samples, from specific historical incidents (where multiple influences are always likely to have been at work), and from the mental models we carry round (some likely to have achieved a professional consensus, others not).

None of which is to suggest that such reviews should not take place. Of course they should, and with good people and a government that is interested in good future structures (as distinct, say, from just being seen to having had the review – there were dimensions of the latter around the review then then New Zealand government commissioned from Lars Svensson) useful insights, outcomes, and reforms can often emerge. There will always be aspects of current practice or legislation than benefit from someone standing back and concluding that it is really time for an update, even if in practice the old arrangements were working tolerably adequately.

But one should also be cautious about expecting too much from any particular review or any particular set of reforms.

The current RBA model is not one anyone would prescribe today if they were setting up a central bank from scratch. A fair bit of the legislation dates back to the founding in 1959, including this

It has been interpreted, stretching language and concepts to a considerable extent, as encompassing the way monetary policy has been run for the last few decades, but really it was written for an age of (among other things) fixed exchange rates. No one would write it that way now.

And the governance? The Reserve Bank of Australia Board makes the monetary policy decisions (back in the day in practice the Treasurer did) and is much as constituted decades ago. The Governor, Deputy Governor, and the Secretary to the Treasury are ex officio members and there are six non-executive directors appointed by the Treasurer. The non-executive members have typically been (often quite prominent) business figures, but over recent decades it has been normal for one of the six to be a professional economist. It is a very unusual model these days for the conduct of monetary policy, although note that the sort of people appointed as non-executive directors is a matter of political choice (successive Treasurers) and I can’t see anything in the legislation that would have prevented six technical experts being appointed.

If the relevant bits of the legislation haven’t changed a lot over the decades, practice has. Monetary policy decisions are clearly made independently by the RBA, in pursuit of a target that is in practice agreed in advance with the Treasurer, they are announced transparently, there are minutes of a sort published, as well as the quarterly Statements on Monetary Policy. Senior managers appears before parliamentary committees and have fairly extensive and serious speech programmes. The RBA is a modern inflation targeting advanced country central bank, but operating on quite old legislative foundations. As an organisation, over the decades it has had considerable strengths, including typically a strong bench of very capable senior managers, and people coming up behind them. Successful organisations in many fields tend to promote mainly from within: that has been the RBA approach (and is very much in contrast, say, to the RBNZ). Note here that promoting from within is not itself a basis for a successful organisation, simply one feature that already successful organisations, continually refreshing themselves, often display.

I was an admirer of the RBA for a long time, and 20+ years ago when the Svensson review was underway (when I was both part of the small secretariat and a senior manager at the RB) thought that New Zealand should look to adopt elements of the structure and culture of the Reserve Bank of Australia. They tended to produce more stable outcomes, produce better research, communicate more effectively, and have a stronger sense of legitimacy than our “Governor as sole decisionmaker” system had achieved (or than Svensson’s preference, of a small internal decision-making committee (of which the position I then held would have been a member) was likely to be able to achieve. The RBA on the other hand saw us as somewhat strange, not always entirely fairly. I recall a time when Glenn Stevens as Assistant Governor and he came over to observe our monetary policy and forecasting week leading up to an MPS (shortly after we had started publishing forward interest rate projections), and he emerged from the week genuinely surprised that our approach was far less mechanical, nay mechanistic, than he had been led to expect. Or a visit from David Gruen, then head of research at the RBA, suggesting that the fact that our interest rates averaged higher than those in Australia suggested we had monetary policy consistently too tight (in fact prior to 2009 New Zealand inflation typically averaged in the top part of the target range).

Over recent decades, Australia has enjoyed a reasonable degree of macroeconomic stability (the review report includes a table showing the standard deviation of real GDP growth less than for any other country shown), this in any economy exposed to very big swings in the terms of trade. As noted above, the samples are small but there is nothing obvious to suggest that overall the Australian approach to monetary policy has delivered worse than other advanced country central banks. But there have been troubling episodes, notably including the one in the years running to Covid when Australian core inflation ran consistently well below target (much more so than anything seen at the time in other countries, including New Zealand where core inflation by then was getting close to the target midpoint). There are also more recent episodes of concern – about specifics of the RBA Covid response and latterly about the sharp rise in core inflation – but through that period it is perhaps hard to differentiate the RBA’s failure (underperformance) from that of a wide range of other advanced country central banks (themselves with a wide range of governance models).

This was one of the things that troubled me about the review report. The first substantive chapter is focused specifically on these recent episodes. It is easy to highlight areas where things could have been done better in (almost any) specific episode – and some of the material cited is pretty disconcerting – but that is almost certainly true of every central bank, and there is no attempt I saw in the report to illustrate that anything would have been very much different with a different governance/committee structure. We might hope it would have been, but the panel offers little reason (and realistically they couldn’t offer more) that it would have been. New Zealand, after all, has introduced a committee, and the panel notes favourably (too favourably) the expertise of its members relative to RBA external board members, but many or most of the same mistakes or weaknesses the panel highlight in Australia over the last three years were also evident in New Zealand – as far as we can tell, as less material has been released here than there, us not having had a recent external review and the Reserve Bank’s own review was largely defensive and unenlightening in nature). Should there have been a proper cost-benefit analysis, and serious questioning from the Board, before the RBA bond-buying programme was launched? No doubt (and the review report is properly critical about the absence, and the likely weak case) but there is no evidence of anything even slightly better in New Zealand. Or, as far as I’m aware, in any or many other advanced countries. Perhaps the RBA case was less excusable, since they started bond buying a lot later, rather than in the heat of the crisis, but the practical difference ends up being slight.

The review panel proposes a new model with these important features

  • monetary policy decisions would in future be made by a Monetary Policy Board (with a separate RBA governance board, and the existing Payment Systems Board),
  • the MPB would have nine members, the Governor, the Deputy Governor, the Secretary to the Treasury, and six expert non-executives appointed for non-renewable terms of five years, extendable for up to one year)
  • non-executive members would be expected to devote about one day a week to the role (around eight monetary policy decisions a year)
  • there would be a press conference for each decision,
  • votes would be disclosed but not attributable (ie a decision might be made 7:2, but the two would not be identified by name)
  • non-executive members would be expected to do at least one public engagement or speech a year,
  • non-executive vacancies would be advertised, but recommendations to the Treasurer (who would make the final appointments) would be by the Governor, the Deputy Governor and a third person (presumably to be chosen –  altho by whom, Treasurer or the officials? –  from time to time).

If you were starting from scratch, one could think of worse systems. But this proposal seems to have a number of weaknesses and reason to suspect that unless a strong political consensus developed early around making things work really differently (rather than differently in appearance) it is far less good a system than could have been devised. Even then, I would not be overly optimistic. More generally, my impression is that the report tends to underweight the relative importance of the Governor and very senior management to how central banks operate.

Starting with the small stuff, as the report notes it is highly unusual for the Secretary to the Treasury to be a full voting member of a central bank monetary policy decision-making body. It was one thing in 1959 – at that time New Zealand also had the Secretary to the Treasury as a full member of the (largely toothless) central bank board – but it is 2023. Other countries – including the UK and New Zealand – have preferred the model of a non-voting Treasury observer, which seems bit suited to (a) the desire to ensure at the highest levels that information flows freely between monetary and fiscal agencies) and (b) the Secretary’s own primary responsibilities and loyalties. The report proposes amending the legislation to make clear that the Secretary is voting his/her own judgement, but if so that tends to defeat the purpose of their place on the Board (being there solely ex officio), and in times of tension – and one should build system for resilience in tough times, not for when everyone is getting on fine and everything is going swimmingly – will likely complicate the Secretary’s own position (including as adviser to the Treasurer in holding MPB members to account for performance).

In general I am in favour of a model in which external members outnumber executives, but 6:3 in a nine person board doesn’t feel right (even if it parallels current numbers). 4:3, with the third executive being the Assistant Governor responsible for economic policy, seems a better size overall, and also more realistic about the ability of the system to continue to generate a steady stream of able people to fill (only) five year non-executive terms. And a 7 person committee is more likely to limit the risk of free-riding by individual non-executives.

It is difficult to see how a “day a week” model is likely to work IF the goal really were one having a powerful role, including as expert counterweight to staff, if non-executives were devoting only one day a week to the role. I am not aware of any precedents for such a small contribution, which seems to sit closer to the current RBA Board model (might such board members devote 2 days a month to the role, one to the meeting, one to the papers?) than to other advanced country MPCs. At the Bank of England MPC, probably still the best model, non-executives are paid for 3 days a week work, and at a rate that (least by academic standards would be a reasonable fulltime income). On a day a week model, not only is the actual amount of time any member can devote to RBA matters limited, but the remuneration would that for any non-retired person it would have to be just one part of the member’s employment/income. Most plausibly, they would be current academics, who might otherwise not spend a vast amount of time keeping track of data or of the literature in the specific fields relevant to central banking. We might assume that people will not be disbarred (as is NZ) for doing ongoing research in relevant fields, but even in Australia the numbers of such people are not limitless. One day a week looks like a recipe for an ongoing dominance of management and staff. Consistent with this, while the report suggests that externals should have direct access to staff, if they do not have dedicated analytical support staff of their own their ability to make a difference and shape what is in front of the MPB is likely to be limited. This is, incidentally, one argument for a quite different system – as in Sweden or the US – in which outsiders become full insiders while they are MPC members.

The appointment process is also a concern. One of the weaknesses of the New Zealand MPC system is that the Governor exercises considerable effective control on who serves on the MPC. A really good Governor would have a strong interest in promoting genuine diversity of view and real ongoing intellectual and policy challenge. Real world bureaucrats, running their own bureau, perhaps less so. No doubt there will be arguments about “fit” etc, but the value of outsiders is often in the extent to which they are willing to bring fresh thinking and not be easily deterred by management flannel and weight of paper. With a strong “third person”, perhaps it would work out okay, especially if a Treasurer was clearly committed to viewpoint diversity, challenge etc, but many potential “third persons” might be inclined just to defer to the perceived expertise of the Governor and Secretary.

Accountability does not appear to be a key element in the RBA reform proposal. That seems unfortunate – perhaps especially coming hard on the heels of the massive financial losses central bankers have run up and the scale of their inflation forecasting and policy mistake. If as a society we delegate great discretionary power to unelected officials – and that is what we do in MPCs – accountability is a key counterbalance, including in maintaining the long-term legitimacy of the model. At very least, MPB members should be required to have their named votes recorded and disclosed. Ideally – but it is probably only an ideal – people should be able to be removed from office for non-performance. In fact, one of the other weaknesses of the proposed single term model for externals is the complete absence of accountability. Their views don’t have to be disclosed, their votes don’t have to be disclosed, and since they can’t be reappointed, there is really no accountability at all. Lack of accountability doesn’t exactly encourage members to devote intense energies to getting things right. Some no doubt will, but it will be all too easy to defer to management and treat membership of the MPB as a prestige appointment (like being on the RBA Board now), this time narrowed down to being for economists, rather than a role in which one will make a difference and expect to be held to account.

As I said earlier, there is no one ideal structure. In the end, one is trying to combine technical expertise, experience, judgement, ability to communicate, and something around accountability to produce good policy outcomes taken in ways consistent with our open and democratic societies and under structures that are resilient to bad times and to bad people All in a field where uncertainty is pervasive.

Many of these requirements might well be met with no outsiders at all. You won’t see it highlighted in the review report but the Bank of Canada is one in which, formally and legally, the Governor himself wields the monetary policy powers (akin in that feature to the RBNZ system pre-2019). But in practice the BoC has built a strong internal culture and an effective system where a Governing Council of senior internal managers makes monetary policy decisions by consensus. I don’t think it is ideal – there is no individual accountability except (presumably) to the Governor – but the BoC has built partially compensating mechanisms with extensive research programmes, self-review programmes, and extensive engagement with academic and other wider communities. Indeed, the Bank of Canada model – which I do not champion – highlights just how important the quality of staff and internal processes are. It isn’t necessarily a problem if decisionmakers typically defer to staff and management expertise – in fact it is what you would expect in a normal corporate board – so long as those decisionmakers can continually assure themselves that staff and management have robust and resilient processes in place, including those that encourage, generate and accommodate, genuine diversity of view and openness to alternative perspectives. In that sort of context, some expert external MPC members can be very helpful (especially if they are familiar with, engaging with, perhaps contributing to) emerging literature, but they aren’t the only type of member who could add value. The willingness to actually ask the idiot question, and never to be content with management bluster, is valuable in any governance context. Thus, in an RBA context, one might wonder whether it is really worth having a whole new Board (especially when the RBA is not a “full service central bank” (doing prudential supervision)), when one could have left the RBA Board responsible for monetary policy but with a requirement say that several members should have directly relevant professional expertise. One could argue that being a board member, responsible for all the RBA functions and governance, might make for a person better able to contribute effectively as a monetary policy decisionmaker (and note that there is plenty of role for outside expert advisers anyway, and the report does suggest a more active macro research programme for Australia generally). And of course, in all our systems Ministers of Finance – rarely very expert at all – make major contentious economic policy decisions in climates of extreme uncertainty, drawing on expert advisers but rarely handing decision-making power to such experts.

Overall, I can’t help feeling that if the Australian government goes ahead and legislates all these changes, none of them (not all taken together) will matter quite as much as who gets appointed as Governor, and the sort of internal culture and people, the Governor (and his/her successors) build. That is a critical choice – in Australia, in New Zealand, probably anywhere – and is likely to far outweigh any potential difference that a few day-a-week academics, cycled through the decisionmaking system on five year terms, might make. A great Governor (and we can’t build systems that assume one) will build and maintain a culture that delivers most of what the review panel (often rightly) seems to be looking for.

This post has gone on long enough. It is about someone else’s country so why my interest? Two reasons I think. First, it is a significant report on a central bank in the midst of troubled times, and there are few of those yet. And second because the choices Australia makes are always likely to be an important backdrop to any future reforms in New Zealand. We have had extensive reforms, clearly designed to look different rather than be different, and any new government needs to look to do over quite a few of the aspects of the New Zealand model.

I was going to engage specifically with the AFR article last Friday by Ian Macfarlane, former RBA Governor, criticising the review (and I thank the two readers who sent me copies). Time and space is limited, so I won’t. It is worth reading, and he makes some fair points (some less so), but it is perhaps worth remembering that Macfarlane was Governor at the peak of the RBA’s past standing. The starting point now is less favourable.

Finally, one of the background papers for the review was commissioned from Professor Prasanna Gai at Auckland University (and ex BOE). Gai currently serves on the FMA board, but probably should be one of those considered for our MPC, but……he would be disqualified by our Governor and Board on the grounds of an ongoing active interest in areas the MPC would actually be responsible for. Anyway, his paper is quite a good read on international models around the governance of monetary policy, and he pulls few punches about the weaknesses of the New Zealand model.

Two countries

Michael Reddell Australia, Monetary policy

The Reserve Bank of Australia yesterday left its policy rate unchanged at 3.6 per cent. The Reserve Bank of New Zealand’s MPC is generally expected to today raise its OCR by another 25 basis points to 5 per cent.

In the broad sweep of decades it isn’t an unusually large gap. Most of the time, New Zealand short-term nominal interest rates are at least a bit higher than those in Australia (Australia’s inflation target is a little lower than New Zealand so the real interest differential tends to be a bit larger).

Sometimes economic circumstances in the two countries are very different. Thus, that period a decade or so ago when the RBA cash rate was higher than the RBNZ OCR coincided with the later stages of the Australian mining investment boom, for which there was nothing comparable in New Zealand.

But over the last two or three years, the similarities have seemed more evident. Both countries of course went through Covid, with overall quite similar virus/restrictions experiences. Prolonged closed borders affected both countries, notably the important tourism and export education sectors. Both had very expansionary macro policies. In the scheme of thing, both opened up at about the same time. Both have been characterised by labour shortages and very low rates of unemployment. And both have seen inflation sky-rocket, whether on headline or core measures.

There are differences of course. Take commodity prices as an example. If world prices have recently been falling for both countries, relative to levels just a couple of years back Australian incomes are still being supported much more by the high level of commodity prices.

What of the respective unemployment rates? Both are very low, but if anything Australia’s seems lower relative to (a) history and (b) likely NAIRU. Australia’s current unemployment rate is a half percentage point lower than the previous cyclical low, and has not yet shown any sign of lifting.

New Zealand’s unemployment rate (quarterly only) seems already to be off its trough and is now about the same as the unsustainably low level reached late in the 00s boom.

One can’t make much of that difference – and the unemployment rate isn’t the only relevant labour market indicator – but the comparison doesn’t obviously point to the RBA needing to do less than the RBNZ. As far as I can see, business survey measures suggest that difficulty of finding labour may have been easing a bit more in New Zealand than is yet apparent in Australia.

What about (core) inflation measures themselves? Bear in mind that the Australian inflation target is centred on 2.5 per cent and the New Zealand one is centred on 2 per cent.

Here is the annual trimmed mean measure of core CPI inflation for the two countries

And here are the annual weighted median measures

Core inflation started higher in New Zealand than in Australia (the RBA had been badly undershooting the target in the late 10s) but on both annual measures (a) New Zealand annual core inflation appears to have levelled out and (b) Australian core CPI annual inflation now appears to be higher than that in New Zealand. The differences between the two countries core inflation rates in the most recent quarter are more or less in line with the differences in the respective inflation target.

What about the quarterly measures? Here there is some difficulty because the ABS produces seasonally adjusted measures and SNZ does not. Eyeballing the New Zealand series there appears to be some seasonality, although not terribly strong.

Here are the quarterly trimmed mean inflation rates

and here are the weighted medians

The latest observations for the two series for Australia are quite similar (1.6 and 1.7) but there is quite a divergence in the two NZ series (0.9 and 1.3). But in both series there are signs the NZ peak has passed (if you worry about seasonality, even the latest quarterly observations are lower than those a year earlier), while there is no such sign in the Australian quarterly data. And while one can’t meaningfully annualise these data, the differences in the quarterly inflation rates look like more than is really consistent with the differences in the respective inflation data.

I’m not here running a strong view on whether one of these two central banks is right and the other wrong. But it remains a challenge to see how both can be right at present. The two central banks tend to articulate somewhat different models (I’m always surprised at the weight the RBA appears to continue to place on wage inflation, in rhetoric that sometimes seems misplaced from the 1980s), central banks are shaped by their past (the RBA was badly undershooting the inflation target pre-Covid), the political climates are now different (the RBA Governor’s term expires shortly, and governance reforms are in the wind) and there are other material differences in the demand pressures in the two economies that I’ve not touched on here (eg New Zealand has had a bigger housebuilding boom and may be exposed to a deeper bust).

Neither central bank has handled the last three years particularly well – or we wouldn’t have that unacceptably high core inflation – and I am far from being the RBNZ’s biggest fan, but for now my sense is that they are probably closer to right than the RBA is. That may, of course, mean that the near-inevitable recession is nearer at hand here than in Australia.

NZ and Australia

Michael Reddell Australia, New Zealand economic performance, Productivity

In a couple of weeks it will be 2023. And then in a couple of years it will be 2025.

Those with longish geeky memories may recall that there was once talk of closing the gap between New Zealand and Australian incomes/productivity by 2025. Without any great enthusiasm no doubt, the incoming National government led by John Key agreed to ACT’s request for a (time and resource-limited) official 2025 Taskforce that would offer some analysis and advice on what it would take to achieve such a goal. The Taskforce’s first report had been dismissed by the Prime Minister before it was even released and after the second report the Taskforce was quietly disbanded. I held the pen on the first report and had some input on the second one (itself written by the current chair of the Reserve Bank Board), and since the reports were written when my kids were very young and I still held some vague hope that they might grow up into a first world country that goal of catching Australia has stayed with me, as has the disillusionment with our political and bureaucratic classes who, no doubt comfortable themselves, seem to have lost all interest. It need hardly be repeated – I’ve made the point often enough – that, despite all its mineral riches, Australia is not a stellar productivity performer, so aiming to catch them was hardly reaching for the stars.

My preferred summary metric for such comparisons is real GDP per hour worked. It isn’t the only meaningful national accounts measure but (for example) it isn’t thrown around by the vagaries of commodity price (terms of trade) fluctuations which, especially in economies like ours, are exogenous variables our governments can’t do a lot about. In 2007, just prior to the last recession, OECD estimates have Australian real GDP per hour worked about 23 per cent higher than that in New Zealand.

What has happened since? On that same (annual) OECD metric the gap last year was about 31 per cent.

The ABS produces an official quarterly series of real GDP per hour worked. SNZ does not, but it does publish two measures of real GDP (production and expenditure) and both the HLFS hours worked series and the QES hours paid series. Over time the various possible New Zealand productivity growth measures tend to converge (as they should), but at any point in time the estimates for the most recent few years can and often do diverge quite substantially. Here is a chart with the most recent data.

Covid has probably only compounded the situation, both because measuring what actually happened to GDP over the disrupted last three years is more than usually challenging and because hours worked and hours paid series will have diverged in ways that make sense but hadn’t really been anticipated. In doing charts like this I used to simply work on the basis that the two were just roughly the same thing, each measured noisily and so averages would usually be the least bad way to go. But then governments compelled people to stay at home (often not able to work) and yet funded employers to enable them to be paid. Hours paid held up in lockdowns even as hours worked fell away. More recently of course there is a lot more sickness than usual – for much of which people will have been paid, but may not have worked.

I still don’t have any particular reason to favour one GDP measure over the other, but the HLFS hours actually worked (self-reported) seems a better denominator for labour productivity estimates at present. Here is that line, together with the official Australian series.

And here is the same chart just for the Covid period

The New Zealand series is much more volatile, but count me a bit sceptical for both countries. Go back one chart and it looks as if productivity growth in both countries has been faster during the Covid period than in the previous half-dozen years, and that doesn’t make a lot of sense. There are plenty of puzzles about how the economy has performed over the last three years – starting with what everyone missed and got wrong on inflation – but if “true” labour productivity growth really accelerated over the Covid period that should spark a lot of future research papers.

I remember back in 2020 people suggesting that (eg) that lift in reported productivity in Australia in June 2020 might have been because (eg) the shock to tourism saw a lot of very low wage workers not working, so simply averaging up productivity for the rest. But a couple of years on both countries have very high labour force participation rates and very low unemployment rates (relative to history Australia even more so than New Zealand). And we’ve had huge (probably largely inevitable) policy and virus uncertainty, and it isn’t many years since economics commentary used to full of talk of the damage that increased (policy) uncertainty would cause. And when supply chains have been disrupted, and people haven’t been able to foster face-to-face connections globally, it isn’t usually a climate considered most conducive to productivity growth. It isn’t as if productivity growth in these estimates has been stellar, but it is a bit puzzling. Perhaps where we are now the numbers are just flattered by overheated economies. Perhaps it will all end revised a way anyway, but for now at least (a) both countries have had a bit more productivity growth in the data that might have been expected, and (b) over the Covid period, the gap between New Zealand and Australia does not appear to have gotten any wider.

As I noted earlier, for commodity exporting countries, fluctuations in the terms of trade are largely exogenous. But, unfortunately for New Zealanders, whether one starts one’s comparison 15 years ago just before the last big recession or focuses just on the last couple of years, Australia’s terms of trade has performed better than New Zealand’s.

Indications from the Australian government that it is going to make it easier for New Zealanders to move to Australia is great for young New Zealanders, opening up higher income opportunities that have been harder to access in recent years. It isn’t so good for a community of people who choose to dwell in these islands. But there is no sign either main political party actually cares enough to think hard about overhauling policy here in a way that might one day mean New Zealand might offer the world-matching living standards it did not that many decades ago.

Decomposing the NZ economy…and Australia’s

Michael Reddell Australia, Exchange rate, New Zealand economic performance, Uncategorized

Continuing on with updating my regular charts in light of the national accounts revisions released last month, I got to the one distinguishing (indicatively) between real growth in the tradables and non-tradables sectors of the economy.    Recall that for these purposes the primary sector (agriculture, forestry, fishing, and mining) and the manufacturing sector count as tradable, together with exports of services.  The rest of GDP is classed, loosely, as non-tradables.   As I’ve noted in an earlier post

The idea is to split out those sectors which face international competition from those that don’t.     It is no more than an indicator, and people often like to point out the components of “non-tradables” where, at least in principle, there is international competition.   But as a rough and ready indicator, it serves its purpose.   It was first developed by a visiting IMF mission about 15 years ago to help illustrate how one might think about the impact of a lift in the real exchange rate.

Here is the latest version of the chart, with both series expressed in per capita terms.

T and NT to sept 19

In per capita terms, there has been no growth at all in (this indicator of) the tradables sector since about 2002.   That is 17 years now.  The economy is increasingly concentrated in the non-tradables sector, the bits (generally) not very exposed to international competition.

One can –  people do –  quibble about adding up these components, so here is a chart of the individual components of the tradables sector measure.    It starts from mid-2002, when the tradables aggregate first got to around the current level.

T and NT components NZ to sept 19

None of these sectors has done particularly well,  The best performer –  oft-cited hope of the future –  services has averaged per capita growth of 0.6 per cent annum.  The mining sector is smaller than it was, and agriculture, forestry and fishing (taken together) has managed no per capita growth since 2012.

Perhaps there is no connection at all between this performance and developments in the real exchange rate

OECD ULC RER 2020

but I doubt many detached observers would think so.

It can get a little repetitive making the point, so this time I decided to put together –  for the first time in some years – the comparable charts for Australia.

Here is the aggregate chart for Australia

Aus T and NT to sept 19

Australia’s tradables sector had also gone more or less sideways for a while, but no longer.     Here is how the two countries’ tradables sectors look like on the same chart.

T and NT tradables

The 1990s were pretty good for the tradables sectors of both countries.  And although Australia has again been performing better in the last few years, even that growth is slower than Australia experienced in the 1990s.  As for New Zealand….well, no growth at all.

Here, for completeness, are the non-tradables sectors of the two countries.

NT components

Our non-tradables sector has been growing a bit faster than Australia’s in recent years.  That looks to be mostly because we’ve had a period of faster population growth –  rapid population growth tends to require more resources devoted to non-tradables sectors (notably construction).

nz and aus popn growth

And what about the breakdown of Australia’s tradables sector?

Aus T components

It is very different from the New Zealand picture in almost every respect.    The mining line didn’t surprise me –  it was the story I expected to be telling –  but the others did, including the continued strong growth of services exports.  Back in 2014 and 2015 it looked as though something similar was happening on both sides of the Tasman, but no longer: services exports here (per capita) have simply stagnated again.

New Zealand and Australia have both enjoyed pretty strong terms of trade in the last couple of decades (Australia’s more volatile than ours).  But over the decades, New Zealand average productivity (real GDP per hour worked) has kept dropping further behind Australia’s –  roughly 42 per cent ahead of us now, compared to about 25 per cent in 1970.   And yet OECD data suggest our real exchange rate has risen relative to Australia’s over that half-century.

aus nz RER

It isn’t that much of a rise –  around 15 per cent –  but the longer-term economic fundamentals pointed in the direction of a fall at least that large.      Policymakers here have, unwittingly (although that isn’t much of an excuse after all this time) delivered a climate –  a combination of factors –  that mean it is very difficult for the tradables sector to grow much in New Zealand.     Unless that changes it is difficult to envisage New Zealand not continuing to slip further behind, not just Australia but other advanced countries as well.

If the government were at all serious about responding to the productivity failings, these are sorts of imbalances they’d be instructing the Productivity Commission to investigate and make sense of.

The mediocre performer across the Tasman

Michael Reddell Australia

The other day, courtesy of the Twitter feed of the chair of our own Productivity Commission, I noticed a link to a speech by the chair of the Australian Productivity Commission, Michael Brennan, under the title “Economic Knowledge and the State” given to an ANU symposium last week with the same title.   That sounded intriguing.

In truth there was less there than I hoped there might be.   It was mostly an attempt to argue that economics has been a generally positive influence on policy in Australia in recent decades and can be expected to continue to be so.  But he was a bit modest about that, partly because it can be very hard to unpick quite how much difference economic analysis and the advice of economists made, and what the counterfactual might have been.

Brennan starts with a nice illustration of the power of productivity to make a difference in material living standards.

Average incomes in Australia today are 7 times higher than they were in 1900. To give you a tangible illustration of what this means, in 1900 we estimate that it would take an average worker over 500 working hours (a couple of months) to earn enough to buy a bicycle, which was then a staple form of transport.

For an average worker in the 21st century, it would take about a day. And of course, in 1900 you couldn’t buy anti-biotics, air-conditioning or a refrigerator.

But the focus of this post was Brennan’s short discussion of Australia’s overall economic performance.

In the post war period, Australia’s per capita GDP went from being nearly $6,000 above the OECD average in 1950, to below the average in 1990.

That is partly due to the comparator — several OECD nations converged rapidly towards US living standards in the post war era.

But there is no denying that Australia’s relative fortunes have improved since 1990.

Over that 30 year period, our real per capita GDP (that is, excluding population growth and terms of trade effects) has out-performed all of the G7 economies, and our incomes have risen back to being well above the OECD average.

It was the first part of that final sentence that caught my eye.  It is true –  using the OECD’s real per capita GDP numbers, Australia’s growth since 1990 has exceeded that of all the G7 countries.  I was a little surprised to learn that the UK had been (narrowly) the best of the G7 grouping over that period.

But lets unpick that a little.

First, the OECD data themselves only go back to 1970.  At that stage there were only (from memory) 22 member countries (not including Australia or New Zealand) but the OECD has data for 1970 for 27 of the countries that are now members (most of the others were then in the communist bloc, or weren’t yet separate countries at all).

Going back further, if we use the Conference Board Total Economy database for those 27 countries we get something like the margin Mr Brennan quotes (he may have used a slightly different comparator).  In 1950, Australia’s real GDP per capita was not only higher than the OECD average, but massively so: real GDP per capita in Australia was around 50 per cent higher than that for the average OECD country.

But how about the more recent decades.   As Mr Brennan implies, there were various countries still ravaged by war in 1950 that did quite a lot of catching up subsequently.  The OECD data start from 1970, which largely deals with that particular issue.

Here are two comparisons since 1970: first, Australian real GDP per capita relative to the G7 average, and second Australia relative to the average for the 27 (now) OECD countries for which there is complete data.

aus 19 1.png

As recently as 1970, Australia had real GDP per capita almost 20 per cent above the average in this core older group of OECD countries.   Now, it is almost bang on the average.   Relative to the G7 countries there has certainly been some recovery since 1990 –  Australia really has grown faster than each of those countries –  but (a) relative to the wider OECD grouping Australia now sits about where it did at the end of the 1980s, and (b) both lines have been falling fall, at least a bit, in the last half dozen years.

(Relative to the whole OECD –  the metric Brennan quotes –  Australia’s real GDP per capita is certainly above that of the average OECD country, but given the pace of convergence of many of the former eastern bloc OECD members that margin is narrower than it was in 1995 (when the complete data for all countries is available).

All those comparisons were about real GDP per capita.  But, as I noted, Brennan’s case had been about the power of productivity growth.  And yet there were no data in the speech about Australia’s productivity performance.

Those data are even less favourable.

aus 19 2.png

Whether the comparison is to the G7 countries or to the wider group of 27 OECD countries, average labour productivity in Australia is below the median of the other advanced countries.   There has certainly been some improvement relative to the G7 countries, but even then Australia does less well than it was doing in the early 1970s.

(Relative to the full OECD, for which there is data only from 2000 onwards, Australia is a little above the median, but has managed no improvement this century to date.)

A little further on in his discussion, Brennan notes that Australia does not face the “stagnation of Japan”.   Well, maybe.  Here is a chart showing Australia’s real GDP per capita relative to that of Japan (and also relative to the US, a common comparator in Australian debate).

aus 19 3.png

1989 was the peak of the Japanese share market boom/bubble.    Australia’s productivity is no higher now, relative to that in Japan, than it was in 1989  (no higher relative to the US either).

In various posts this year I’ve used as a comparator on productivity a grouping of leading OECD countries.  Here is how Australia compares.

Aus 19 4

It would take a 25 per cent lift for Australia to match the median of that leading bunch.

And all this against the backdrop of the abundant natural resources, new waves of which Australia has been able to begin to bring to market in the last decade or so.    I don’t show Norway in these “leading group” charts but it is the other advanced OECD country really blessed by nature with natural resources, and its real GDP per hour worked is almost another 15 per cent higher than that in Belgium.  In many respects, given what it had going for it, Australia’s productivity performance has been woeful.

I reckon there is a pretty straightforward explanation –  over and above all the normal areas any country could improve policy on –  around the interaction between distance (in an era when personal connections, integrated value chains etc have often become more important not less) and the renewed determination of Australian policymakers to drive up the population more rapidly than almost anywhere in the OECD.  But when he mentions geography is his speech, Mr Brennan refers only to the

mysterious but very real spill-over effects of agglomeration, particularly in large, dense cities.

perhaps not aware that, unlike the situation in typical (non natural resource dependent) OECD countries, in Australia real GDP per capita in the big cities –  Sydney and Melbourne –  barely matches that for the country as a whole.

Of course, writing from this side of the Tasman it behooves me to point out that New Zealand’s economic performance has been consistently materially poorer even than that of Australia, that the ability of hundreds of thousands of New Zealanders to move to Australia has helped many New Zealanders……and that Australia continues to have a consistently better cricket team.

But were I Australian I’d be a little uneasy at just how relatively poorly my economy had done, and is still doing, on the counts that matter –  productivity –  especially when the economy had been able to ride a mineral investment/export wave in a way open to few other OECD countries.  And I might be asking questions about the quality of the economic analysis and advice from leading official institutions.

 

Saving: New Zealand and Australia compared

Michael Reddell Australia, Savings

In a post earlier this week looking at national saving rates across the OECD, I included this chart

net savings aus nz

For the last few years, national saving rates in New Zealand have been higher than those in Australia.  That isn’t the popular perception, and it hasn’t been common in the past –  although for now, the gaps are no larger or more persistent than those recorded for a few years in the 00s.

Before digging behind the numbers, at least a bit, a reminder:

  • these are flow saving rates we are looking at here (the share of the year’s net income accruing to residents of the country in question that is not consumed).   In the case of business savings, the concept is akin to retained earnings from the profits for the year in question
  • I am not looking at stock measures of accumulated wealth, financial assets or anything of the sort.

We can break down these saving rates for each country and see what has been happening in each of the broad sectors: households, governments, and business.   All the charts below are expressed as a share of NNI (rather than of the income of that particular sector).  In each of the charts below, New Zealand data are for March years and Australian data for June years.

First, lets have a look at general government savings

govt s

Every year but one the government savings rate (share of NNI) in New Zealand has been higher than that in Australia.

And that is so even though, diverting briefly to stock numbers, in every single year for which we have data, general government net financial liabilites (loosely, net debt) is larger, as a share of GDP/NNI, in New Zealand than in Australia.  There are probably two main factors at work: first, the size of government here is larger, as a share of the total economy, than in Australia, and second, New Zealand tends to have a relatively large amount of government investment (GFCF) as a share of GDP.

What about households?

Probably to no one’s surprise

household s 2.png

In all but one year, household (net) saving in Australia has been higher, as a per cent of NNI, than that in New Zealand.  The size of the gap between the two series hasn’t changed much over time, and there is little sign that the gap now is consistently larger than it was 30 years ago before the compulsory private savings scheme was introduced in Australia.  Both countries have had fairly rapid rates of population growth over these decades –  although the growth has been concentrated in different periods.  Over long periods of time, you’d expect a country with rapid population growth to have a higher household savings rate than one that doesn’t.   What is, perhaps, interesting about the Australian series is how far the household savings rate has dropped back again in the last few years.

And what about the business saving rate?  In aggregate the picture looks like this

business s.png

For the first decade or so of the data things are much as you’d expect.  Business saving in Australia averaged a bit higher than that in New Zealand, consistent with the fact that business investment rates tend to be higher (partly reflecting the Australian economy concentrating in quite capital intensive sector).  You can, loosely, see some cyclical effects: profits tend to fall away quite sharply in recessions and so, typically, will business savings rates.

But once one gets to this century things become harder to make sense of.  And the Australia numbers seem easier to make sense of than the New Zealand ones: in Australia as the terms of trade surged and huge new mining sector investment opportunities opened up you’d expect firms to be using higher profits and higher retained earnings to finance part of the huge surge in mining investment.  The Australian terms of trade peaked in 2011 and is much lower now.  Mining sector investment is also well past its peak.  Still, I was a bit surprised to see that overall business saving rates are now lower than they were, on average, in the 15 or so years before the terms of trade boom.

But what of New Zealand?  Why did business saving rates surge at the very start of the 00s, and then fall away so sharply –  the amplitude of that fluctuation is larger than for Australia more recently.  Some of it probably had to do with the exchange rate –  which reached a deep trough in 2000 at a time when commodity prices were high.  But it doesn’t really seem like a sufficient explanation.  And that trough was in the year to March 2007, more than a year before the recession really hit.

Despite my inclinations to look on the gloomy side, I’d almost be inclined to think positively about the recent rise in business savings rates –  higher now than they were at any other time in the 1990s –  except that there is little or no sign that these higher saving rates reflect any sense of an abundance of investment opportunities.  Business saving rates in New Zealand may well now be being boosted by the pressure on dairy farmers to use whatever earnings they can generate to pay down debt.

We can use official data to look a little further behind the business saving story, splitting the business saving rate into financial businesses and other businesses. I’m not sure why one would want to –  they are all businesses after all – but as it happened there are some interesting, but puzzling, differences uncovered by doing so.  Note that for New Zealand the data are not yet available for the March 2019 year.  And the New Zealand data are available only for the last 20 years.

Here is financial sector (net) saving

fin.png

and here is the non-financial business sector

non-fin.png

I just don’t know what to make of the earlier years: why would NZ financial sector saving (retained earnings) be so much lower than that in Australia, at precisely the same time non-financial sector business saving was materially higher.  Something doesn’t look quite right (but perhaps it is, and I’d be happy to have any authoritative explanations).

More recently, this decade, the financial sector savings rates have been very similar on both sides of the Tasman: rather what one might expect given that the biggest players here (banks) are also big Australian banks.  But if that is plausible and roughly right, it leaves the business saving rate in the rest of the business sector quite a bit higher here than in Australia.   Which is interesting, and not necessarily what I would have guessed without checking.

I don’t purport to have any particular insights to offer on quite what has been going on.   Digging any deeper would probably require more resources and data that I don’t have.  But it is interesting that the relationship between New Zealand government savings and Australian government saving, and New Zealand and Australian household saving, have been pretty stable for a long time.  The puzzles seem to rest in the business sector data, and unfortunately business saving is quite routinely overlooked when people talk,or think, about saving behaviour in New Zealand.   A Treasury, Reserve Bank or Productivity Commission note might be able to shed more light on developments that we probably should understand better than (at very least) I do.

 

Rygbi

Michael Reddell Australia, Immigration, New Zealand economic performance, UK

My 12 year old daughter has been teaching herself Welsh –  a recent birthday present was a good Welsh-English dictionary – we’ve recently been watching a rather bleak Welsh detective series together, and this year she has also become (unlike her father) a bit of a rugby (“rygbi” in Welsh apparently) fanatic so I promised her that if Wales made the World Cup semi-finals I’d do a Welsh-themed post.  That’s economics rather than rugby though.

One of the themes of much modern economics literature is things about cities, location, agglomeration, distance and so on.  According to Eurostat data, London has the one of the very highest GDPs per capita of any region in the EU¹.  The two largest cities in Wales –  Cardiff and Swansea –  are each less than 200 miles from London.  And yet estimated GDP per capita in Wales is only about 40 per cent of that in London and 75 per cent of that in the EU as a whole (71 per cent of the UK as a whole).  Productivity in Wales (GDP per hour worked) might be about that of New Zealand.

And yet Wales has much the same policy regime as London.  Much the same regulatory environment, same income, consumption, and company tax rates, same currency (and interest rates and banks), same external trade regime, same national government (and as I understand it the Welsh regional administration doesn’t have control of very much), and the same immigration regime.  Most of the people are native English speakers (even many of those who also speak Welsh).

Huge populations are free to move to Wales.  There are 66 million people in the UK who face no regulatory obstacles to doing so.  They could set up firms in Wales.  So –  for the moment –  could people in most of the EU, and all legal migrants to the United Kingdom (with no particular ties to any other UK region) could move to Wales.  It isn’t open borders but in practical terms it is much closer to it than almost any sovereign state.

And yet……by and large they don’t.  The population of Wales today is only 50 per cent larger than it was in 1900 and only about 5 per cent of the population is born outside the British Isles.  Here is the share of Wales in the total population of the Great Britain.

wales 1

Wales used to have things going for it: plenty of room for sheep (wool and meat were two of our big exports to the urban population of the UK), the world’s largest slate industry,  and coal (lots of it) and the associated iron and steel (the latter booming from the start of the 20th century) industries.

But not, it appears, very much at all these days.   There is some tourism, some electricity exports (to the rest of Britain) and, of course, a variety of other industries.  It all generates tolerable living standards. albeit supported by significant inward fiscal transfers.  Unemployment is low, and (by New Zealand or London standards) house prices are fairly low –  Swansea (second biggest city) has median house prices around $350000.  But people in the rest of the UK, migrants to the UK, and –  importantly – actual/potential entrepreneurs don’t seem to find it terribly attractive.  Perhaps it would be different if it were an independent country –  the Irish company tax regime is apparently eyed up by some. But as it isn’t, one gets a cleaner read on the pure economic geography effects.

It is interesting to wonder what might have happened to Wales if it were an independent country and, all else equal, had had control of its own immigration policy.  What if they’d adopted a Canadian or New Zealand immigration policy –  or something even more liberal –  20 years ago?   Since there are plenty of places in the world much poorer than Wales (or New Zealand), and Wales itself is a small place, presumably they’d have had no trouble attracting people –  at least modestly qualified people from places poorer, or less safe, again: China, India, South Africa, the Philippines (to name just four significant source countries for New Zealand).   Even if many of the migrants initially saw Wales as backdoor entry to England, if New Zealand’s experience is anything to go by (become a citizen here and you can immediately move to much wealthier Australia) most wouldn’t.  Presumably the Welsh building sector would have been a lot bigger, but it isn’t obvious that many more outward-oriented businesses would have chosen Cardiff or Swansea over London or Paris or Amsterdam, even with the rest of Europe more or less on the doorstep.

Tasmania is another interesting example.  Like Wales, it shares essentially the same  policy regime (taxes, currency, external trade, most regulation) with the sovereign country it is a part of, in this case Australia.  There is unrestricted mobility for people within Australia, and external migrants –  including those from New Zealand –  can as readily settle in Tasmania as anywhere else in Australia. Hobart always looks like a really nice place.

Oh, and the population share of the total country is also small.  But the fall in the population share has been much sharper than for Wales.

wales 2

People –  and firms –  could choose to go to Tasmania but, by and large, they choose not to.  It is, after all, quite a way from Melbourne, and you can neither drive nor take a fairly-speedy train.   And unlike Wales, Tasmania is close to nothing else: Cardiff is much to closer to Dublin, Paris, Brussels, Amsterdam or even Frankfurt than Hobart is to Adelaide or Sydney.  Perhaps even more than Wales, the economic opportunities seem to be mostly in the natural resources (and no big new developments there in recent decades) and a few niche industries that might be there because the founder happens to like living there.   GDP per capita in Tasmania is just under 80 per cent of the whole of Australia average.

One could also do an interesting thought experiment as to what might have happened if Tasmania had been an independent country and had its own immigration policy.  Even had they just adopted the same policy as Australia did, almost certainly their population today would be materially larger than it now is (Tasmania now has three times the population it had in 1900, while Australia as a whole has more like seven times the 1900 population).  Being even smaller than Wales they’d have had no trouble attracting people.   But –  even more so than for Wales –  you are left wondering how many more outward-oriented businesses would have chosen to stay based in little Tasmania (few enough outward-oriented businesses are based in even the big Australian cities).

Are there lessons for New Zealand.  Our population has increased almost sixfold since 1900. In that time, we’ve fallen from (roughly) the highest GDP per capita anywhere to somewhere badly trailing the OECD field –  and maintaining even that standing only by work long hours per capita.

wales 3

It looks great to the strain of “big New Zealand” thought that has been around since Vogel at least.  But to what end, for New Zealanders?

Think of one last thought experiment.  What say we’d agreed a completely common immigration policy with Australia and held that in place for the last few decades?  More or less exactly the same number of people would probably have come to Australasia in total, but what do we supposed would have been the split between Australia and New Zealand.   It seems only reasonable to assume that a much larger proportion would have gone to Australia (than did).  After all, even those who went to Australia had a choice of Tasmania if they wanted cooler climes and a slightly slower pace –  but, to a very large extent they didn’t.  And we know what New Zealanders themselves –  who had ties to this physical places –  were choosing over the last 50 years, as hundreds of thousands left for the other side of Tasman.

And had that happened –  and perhaps New Zealand’s population was 3 million not almost 5 million –  is it likely that any fewer market-driven outward-oriented businesses would be based here than are today.   The land, the water, the minerals and the scenery would all still be there.  And how much else is there?

As a best guess, if by some exogenous policy intervention there had been another two million people –  of moderate skills etc – put in Wales, or another half million in Tasmania, it is difficult to have any confidence that average real incomes in either place would be any larger than they are now.  Most probably, they’d be worse off –  as say, the residents of Taihape probably would be if some exogenous intervention put another 5000 people there.  Having put an extra couple of million people in New Zealand – more remote than Tasmania, much more remote than Wales –  and not seen the outward-oriented industries, based on anything other than natural resources growing – we might reasonably assume we (New Zealanders) are poorer as a result.

Smart people are almost always a prerequisite to high incomes, but globally the top tier of incomes seems to focused on industries located in or near big cities, near big population concentrations, or on (finite) natural resources.   You can earn a very standard of living from finite natural resources –  it is the edge Norway has over the rest of Europe – but it looks pretty insane to confuse the two types of economies (when you have no realistic hope of transitioning from one to the other) and spread natural resource based wealth much more thinly by using policy to actively encourage rapid population growth.

From a narrow economic perspective –  and it isn’t of course, the only one the matters – the best thing for people from a lagging economic performance area is to leave.  It is what people did from Taihape or Invercargill, from Ireland for many decades, and (more recently and on a really large scale) what people did from New Zealand as a whole.   Governments can mess up that picture. In a way the Welsh are fortunate to have a rugby team but not an immigration policy, at least had they had the misfortune to have had policymakers like New Zealand’s.

 

  1.  Technically Luxembourg tops the table, but since a very large chunk of Luxembourg’s workforce doesn’t live there the numbers aren’t particularly meaningful (sensible comparisons need to take account of all the  – typical modest-earning –  support services populations need/use where they live).

Productivity (lack of it) and other things

Michael Reddell Australia, bank capital requirements, New Zealand economic performance, Productivity

When I was writing some comments last week on Reserve Bank Deputy Governor Geoff Bascand’s speech in Australia I was playing round with some comparative data and stumbled on this chart.

nzau 1

Over the entire period (since 1991) real GDP per capita has grown at exactly the same rate in Australia and New Zealand.   And I haven’t even cherrypicked the starting point: my chart starts when the SNZ quarterly GDP per capita series starts.

Of course, even in 1991 we were materially less well off than Australians, but should we take some comfort from having kept pace over now almost 30 years?  I’d say not.

Here’s why.   Look at the employment rates in the two countries

nzau2

You might be among those who think the more employment the better but (a) working is a cost (an input) to the employee and (b) wouldn’t it have been much preferable, even if you think higher employment rates are some great thing, for it to have resulted in more growth in average per capita income than in the country where employment rates didn’t increase as much?   Australia’s unemployment rate is a bit higher than ours, and that is a mark against them, but it is only a small part of the difference in the employment rates.

And here is a chart that is perhaps even more stark.

NZau3

Across the whole population, the average Australian is now working 5 per cent more hours than in 1991, while the average New Zealander is working 22 per cent more hours.

And yet the bottom line, growth in average real output per capita, is the same.

The difference is productivity – or, more specifically, in our case the lack of anywhere near enough productivity growth.

I’ve got other things on today, so that is it for original content.  But earlier this morning I was rereading my submission to the Reserve Bank consultation on the Governor’s plans to require large increases in bank capital.   There wasn’t anything in it I would now resile from.  I also skimmed through former colleague, and expert in bank capital modelling, Ian Harrison’s papers (here and here) and I doubt he would resile from anything in there.

But what remains striking is how little engagement there has been from the Governor on his proposals.    He has only given four on-the-record speeches this year, not one of which has involved a serious sustained attempt to make his case, let alone engage with alternative perspectives.  The only attempts I’ve seen to respond to alternative perspectives seem to simply involve suggesting that anyone who disagrees with him is somehow bought and paid for, and therefore their views aren’t worthy of serious notice or scrutiny.

At one level, it shouldn’t be surprising, given Orr’s personality and intolerance of challenge or disagreement –  and the fact that, formally at least, he doesn’t have to convince anyone but himself (since he is prosecutor, judge, and jury in his own case, and there are no rights of appeal). But as matter of good governance, in a democratic society, it reflects very poorly on him, on his handpicked senior managers, and on the Bank’s Board and Minister of Finance who are paid to hold the Governor to account but in fact act as if there role is to simply get out of the way and let the Governor get on with it, poor as the process and substance have been, poor as Governor’s conduct increasingly seems to have been.

And so I’ll leave you with some of the unanswered points from my submission

An unbiased observer, looking at the New Zealand economy and financial system, would struggle to find a case for higher minimum capital ratios.   Among the factors such an observer might consider would be:

• The fact that the New Zealand financial system has not experienced a systemic financial crisis for more than hundred years (and to the extent it approximated one in the late 1980s, that was in the idiosyncratic circumstances of an extensive and fast financial liberalisation which left neither market participants nor regulators particularly well-equipped),

• Our major banks – the only ones that might pose any serious economywide risks – come from a country with very much the same historical record as New Zealand,

• Despite very rapid credit growth in the years prior to 2008 (increases in the credit to GDP ratios among the larger in the advanced world, spread across housing, farm, and other business/property lending), and a severe recession in 2008/09 and afterwards, the banking system emerged with low loan losses,

• Since then, banks have not only increased their actual capital ratios (and been required to calculate farm risk-weighted assets more stringently) but have also substantially improved their funding and liquidity positions (under some mix of regulatory and market pressure).

• Over the decade, bank credit growth (relative to GDP) has been pretty subdued and there has been little or no evidence (in, for example, Reserve Bank FSRs) of any serious degradation of lending standards.

• The balance sheets of the large banks remain relatively simple, and there has been no sign (per FSRs) of the sort of financial innovation that might raise significant doubts about the adequacy of existing models.

• In terms of the wider policy environment, government fiscal policy remains very strong, we continue to have a freely-floating exchange rate, and there has been neither legislation nor judicial rulings that will have materially impaired the ability of banks to realise collateral.

• And the Open Bank Resolution option for bank resolution has been more firmly established in the official toolkit (note that if OBR were fully credible then, in the absence of deposit insurance, there would be little case for regulatory minimum capital requirements at all).

• And repeated stress tests –  over a period when the regulator had no incentive to skew the tests to show favourable results –  suggested that even if exposed to extremely severe adverse macro shocks, and associated large price adjustments for houses, farms, and commercial property, not only would no bank fail, but no bank would even drop below current minimum capital requirements.

• Consistent with this experience – also observed in Australia, the home jurisdiction of the parents of our major banks – the major banks operating here continue to have strong credit ratings (consistent with a very low probability of default), and the ratings of the parent banks are even higher.

• There has been no change in the ownership structure of our major banks, or in the implied willingness of the Australian authorities to support the (systemically significant) parents of the New Zealand banks were they ever to get into difficulty.

Add into the mix indications that New Zealand banks CET1 ratios, if calculated on a properly comparable basis, would already be among the highest in the advanced world –  in a macro environment with more scope for stabilisation (floating exchange rate, strong fiscal position, little unhedged foreign currency lending) than in many advanced countries –  and there would be a fairly strong prima facie case for leaving things much as they are.

But the Reserve Bank’s consultative document – and associated material, including speeches and interviews – engages substantively with almost none of this context.

And

It is grossly unsatisfactory that throughout months of consultation the Bank has made no effort to illustrate how its proposals for minimum CET1 ratios and the associated floors around the calculation of risk-weighted assets, compare with those planned by APRA for the Australian banks.

Such an exercise should have been relatively straightforward, especially if the Reserve Bank had done what most New Zealanders might reasonably have expected, and worked closely together with APRA in formulating its proposals.  Of course, New Zealand is a sovereign nation and the Reserve Bank (regrettably) has final decision-making powers in New Zealand but:

• APRA has a considerably deeper pool of expertise, including at the top of the organisation, than the Reserve Bank of New Zealand,

• The nature of the risks in the two economies and markets is quite similar (including similar legal institutions, and similar housing markets),

• If anything there is a case for thinking that APRA minima would be ceilings below which New Zealand requirements for our large banks should be set (since we have the benefit of strong parent banks, and well-regarded supervisor of those banks, whereas the parents  – and parents’ supervisors – themselves are on their own, and we have also chosen to have the OBR as a frontline resolution option),

• For the institutions that might pose potential systemic issues in New Zealand, any substantial increase in capital requirements can reasonably be seen as an attempt to grab group capital for New Zealand.  Why not work these things out together?

The onus should, surely, be on the Reserve Bank of New Zealand to demonstrate – make the case in detail – why the New Zealand subsidiaries of Australian banks should be subject to more onerous capital requirements than the parents, and banking groups as a whole, are subject to.  But not once has the Reserve Bank attempted to make that case.

I ended

New Zealanders deserve better than they have had in the poor process and weak substance that together made up this consultation.

To which one can only add that the repeated reports  –  some of things in public, others less so –  of the way the Governor has handled himself, his own conduct, through this episode are deeply disquieting.  There is little sign of the sort of character and temperament we should expect from a senior public servant exercise so much barely-trammelled power.  The Minister of Finance may declare that he has full confidence in the Governor.  The public should not, and if the Minister continues to sit on the sidelines doing nothing but expressing full confidence that should probably raise more questions about the Minister himself.

Meanwhile, one wonders what our new Australian Secretary to the Treasury makes of her first encounters with national policymaking and advice.

New Zealand and Australia

Michael Reddell Australia, bank capital requirements

Yesterday’s post unpicked some of Reserve Bank Deputy Governor Geoff Bascand’s speech in Sydney earlier this week.  As I noted, the goal of the speech seemed to be to leave readers with a sense that there really were good grounds for New Zealand to impose materially more onerous core capital ratios on locally-incorporated banks (recall that none of these requirements apply to any other lenders, banks or otherwise) than those imposed in Australia.   The gist of the case was, we were told

Our conservatism, relative to Australia, in our bank capital proposals reflects the higher macroeconomic volatility that we have endured, as I pointed out earlier.

Even over the nearly 30 years Bascand asked us to focus on, this wasn’t a very convincing argument.

As I pondered further the claim that New Zealand was exposed to materially more macroeconomic volality than Australia –  and the differences have to be “material” to support the material differences in proposed core capital requirements –  and conscious of the huge and wrenching Australian crisis of the 1890s, I’d just decided to look at a rather longer run of data when a reader, an academic economist, sent me an email making exactly the same point, and conveniently drawing my attention to this chart (from the Phil Briggs NZIER compilation of charts and text in New Zealand economic history).

briggs.png

It uses smoothed data because the estimates for the earlier decades, for both countries, are incredibly noisy.

But, if anything, over that 150 years, the Australian experience was more volatile than that of New Zealand.    Their financial crisis was much more severe than ours in the 1890s, and their experience of the Great Depression (including in the financial sector) is generally regarded as having been worse than ours, as examples.

You’ll recall that the Governor has chosen to attempt to calibrate his capital requirements so that, in principle, New Zealand experiences a financial (banking) crisis no more than once in 200 years.  We don’t have 200 years (of data, or experience) for New Zealand –  although the Australian data start from 1820 –  but if you want to mount arguments that we are (and will be) exposed to materially higher macro volatility than another country, it surely is only reasonable to look at as long a history of those two countries as one can reasonably get.  Unless, that is, one is using statistics/history for support –  for the boss’s whims –  rather than for illumination.

One can always discount history –  this, that or the other thing will always have been different, even if human nature isn’t –  but to mount a major policy case on a carefully chosen subset of history seems more akin to propaganda than to good policy process.

Or here is another chart.  Bascand included in his speech a chart on New Zealand GDP since 1965.   Here are the unemployment rates for the two countries since 1966 –  the official Australia data starts then and our series was backdated (from when the HLFS started in 1986) by Simon Chapple.  Not 200 years of data, but more than 50.

U rates long-term

Do those look like two economies prone to materially differing degrees of macroeconomic volaility?  If anything, Australia might have been a bit more volatile (over this particular period).  Peak unemployment rates in Australia in the Great Depression also appear to have been higher than those in New Zealand.

But I don’t want to mount an argument that Australia is more exposed to macroeconomic volatility than New Zealand is.   If anything, rather the contrary.  Over long periods, New Zealand and Australia have been two of the more similar countries on earth.  The modern countries emerged at much the same time, for almost all their histories they’ve had much the same exchange rate regimes, they’ve had strongly overlapping banking systems, they’ve been heavily dependent on foreign capital (especially in the development phase), they liberalised again at much the same time, they both run public debt sky high at much the same times, they both turned fairly inwards for a time, they’ve had pretty similar migration policies, they’ve mostly had very similar terms of trade cycles, and they’ve both had the rule of law (and similar legal systems) and democratic government throughout their modern histories.  They’ve been tolerably well-governed, tolerably successful in economic terms (Australia more than us in recent decades), with a high degree of financial stability in both countries for now well over 100 years –  with the sole exception of the brief period of shared craziness immediately after the 1980s liberalisation when no one (regulators, lenders or borrowers) really knew quite what they were doing.

2025 TOT

So if Adrian Orr and Geoff Bascand really want to mount a case for putting much more onerous capital requirements on in New Zealand than in Australia, it is simply absurd and untenable to  mount it on the basis of some intrinsic greater level of economic risk in New Zealand than in Australia.  It hasn’t been so in history, and they’ve not even sought to advance an argument for why it might be so in future.

Perhaps the Australians really have it wrong and superior wisdom rests with Messrs Orr and Bascand.  But, frankly, it seems unlikely.  Not only are the key Australian officials much more experienced in these matters than ours, and they have the additional worry that there is no prospect of parental support for their banks, but it is the New Zealand proposals which appear to put us out of line with (above) international benchmarks, despite the impressive long-term track record of financial stability here, the floating exchange rate regime, and a now well-established history of keeping governments out of credit allocation.

More generally, in banking systems that have so much in common, in economies with so much in common, surely we should have looked to our authorities to have worked closely with the Australians to have developed as common a regime as possible, recognising (inter alia) that if and when anything really goes wrong with any of the big 4 the problems will be trans-Tasman in nature and are likely to be resolved –  and be best resolved –  at a trans-Tasman political level.    I’m not suggesting Australian officials and politicians have our best interests at heart.  Both sides need to look after their own national interests, but those interests can be protected –  probably better protected –  by working closely together, on as common a framework as possibly, consistent with maintaining/pursuing an unquestionably strong banking and financial system.

As for New Zealand citizens and voters, we really should be demanding much higher standards from our top central bankers, who seem unable or unwilling to answer simple questions and challenges about what the Governor is proposing, or to do so in ways that are straightforward and reasonably defensible  That really should worry Grant Robertson, who is responsible for these men and for the institution.

How unusual is Australia’s record without “recessions”?

Michael Reddell Australia

Over the weekend a reader posted a link to a blog post by a couple of researchers at the St Louis Fed.  People often point out –  sometimes to boast (if you are an Australian politician), sometimes just out of curiosity –  that Australia has gone 28 years with “a recession”, where “recession” here is defined by that convenient (not overly helpful) benchmark of two successive quarterly falls in the level of real GDP,

As a definition of recession it seems to serve mostly because there is no better definition in general use. In the US, there is the NBER business cycle dating committee, which draws on a range of different indicators to reach a judgemental determination of the dates of recession, but those dates are typically only available with a lag, and there isn’t anything similar in most other countries (including New Zealand).

The rather obvious, but all too frequently forgotten, point that the St Louis Fed observers are making is that any sensible interpretation of GDP growth has to take account of the rate of population growth.  There are countries in eastern Europe where the fall in population has been large enough that one could see GDP falling every quarter and yet the average citizen would still their per capita GDP rising.  Even setting aside that extreme, there is a big difference between, say, Germany (with almost no population growth this century, Japan which has had a slight fall in its population in the last five years, and New Zealand with population growth in excess of 10 per cent over the same period.     Australia is another advanced country with rapid average population growth.

As the St Louis Fed researchers point out, once you focus on per capita real GDP the chart for Australia looks a bit different

st louis fed 1

On the “two consecutive negative quarter” rule, Australia would have had three (fairly mild) ‘recessions’ in the period since the end of the early 1990s recession.

In case you are wondering, New Zealand (using the average of our two GDP measures) would also have had three “recessions” (rather more severe) on this per capita metric: 1997/98, 2008/09, and 2010.

It is still fair to note that even on a per capita basis, Australia did not have a recession in real GDP in 2008/09.  As far as I can see that makes it the only OECD country to have avoided two consecutive quarterly falls in real per capita GDP over that period.

But (as the NBER business cycle dating methodology recognises) simply looking at GDP isn’t a particular sensible basis for assessing whether (more broadly) things are going backwards.  Personally, I find looking at the unemployment rate quite useful.   All else equal, if the unemployment rate rises the economy is generating fewer new jobs than the increase in the number of people ready and willing to work.  As with any measure there is some month to month and quarter to quarter “noise” (often just measurement challenges), but if the unemployment has been rising for a couple of quarters (especially in a climate where the long-term trend is downwards) that too is probably a suggestion of an economy going backwards where it counts.

Here is the quarterly series for Australia’s unemployment rate back to the early 1990s.

Aus U to sept 19

Over that period there were seven episodes where the unemployment rate rose for two or more consecutive quarters.  Most of the increases were small, but there were three episodes where the increase was 1 percentage point or more.

Over the same period, New Zealand had four episodes where the unemployment rate rose for two or more consecutive quarters, two of them by a percentage point or more.  The UK and the USA had three and two episodes respectively –  including the very sharp increase in the US unemployment rate at the time of the 2008/09 recession.

It isn’t even as if the extent of the rise in the unemployment rate in Australia over 2008/09/10 was unusually small.  Australia’s unemployment rose less than in the other Anglo countries, but on OECD numbers there were about 10 European countries where the unemployment rate rose by a similar amount (mostly) or even less than in Australia.

Another variable I find worth looking at for Australia is a measure of real income that takes account of terms of trade fluctuations (for commodity exporters much of any adverse shocks show up in price rather than volume, whereas for manufactures and services exporters the balance is the other way round).

This is a chart of real net national disposable income per capita series, produced by the ABS.

RNNDI to 19

It really quite a startling record of steady growth in this series from about 1993 to about 2008.  But the period since then has been quite different (a point that various of the more downbeat domestic Australian commentators often point out – real Australian incomes have not been doing well).  There have been seven periods since 2008 when RNNDI per capita has fallen for two or more consecutive quarters.    Somewhat to my surprise, when I looked at the closest New Zealand series there had only been two such falls since the early 1990s.   The fall in Australia’s per capita RNNDI over 2008/09 was a actually larger than the fall in New Zealand’s per capita real GDI measure.

The St Louis Fed researchers ended their post this way

So should we use Australia as a benchmark when thinking about possible duration of expansions? If so, we have to take it with a grain of salt because looking at just GDP growth doesn’t paint the whole picture. It is important to look at per capita GDP growth to have a broader view.

Their goal wasn’t to bag Australia but to put its experience in some perspective, specifically the importance of taking account of population growth trends when looking at GDP numbers and headline about presence or absence of GDP “recessions”.

This post is in much the same spirit.   I really like Australia and can’t stand the “chip on our shoulder” too many New Zealanders seem to have about the place.  It is different from most other OECD countries –  heavy resource dependence does that, as does rapid population growth – and that needs to be taken into account in comparing cyclical economic performance.      Through some mix of good luck and good management –  mostly the latter in my view (including choices around a floating exchange rate, low and stable public debt, and keeping the state out of the housing finance market) Australia has avoided anything like the worst downturns (whether per capita GDP or unemployment) seen in some other OECD countries (eg the US and –  even more savagely – a number of euro-area economies).  But it is a normal economy, it has upswings and downswings: if no one else the unemployed (and the underemployed) know it (relative to, say, the end of 2007, the median OECD economy now has an unemployment little changed from then, while Australia’s unemployment rate is almost 1 percentage point higher than it was then).

Incidentally, and while on the topic of per capita GDP growth, I had a look at the latest annual growth rates for New Zealand and the 30+ countries for which the OECD has data.  Despite all the talk  –  including from the PM –  about New Zealand doing better than its peers, our real per capita GDP growth in the year to the June quarter (or four quarters on four quarters) was just lower than the median country in the sample (and quite a bit below the unweighted averages of those countries).  Better than Australia over that year (see the first chart) but then –  as this post and the St Louis Fed one help illustrate –  Australia is no stellar performer.