A policy costing unit

The Government’s plans for an independent policy costings unit were back in the news this week, with the announcement that Cabinet had agreed that the proposed new body should enjoy the exalted status of an Officer of Parliament  (a status it would share with the Auditor-General and the Ombudsman –  where the case is clear-cut –  and the Parliamentary Commissioner for the Environment –  where any case seems more grounded in feel-goodism).

Back when I was still a bureaucrat, I favoured the establishment of a small Fiscal Council (along Irish or Swedish lines) and thought (and think) that the mandate of such a body could usefully be widened to monitoring and reviewing macro policy more generally.   But what the government appears now to have in mind is primarily a policy costings unit, as championed for several years by the Green Party.   I’ve written about the idea on several occasions and have become increasingly sceptical.

This post in early 2016 dates from when the Greens first openly called for such a body.  And there have been various others since, including here, here, and here.    There was a Treasury-led consultation process last year (the document is here) which I made a short submission to (submissions are here).

Rereading my submission now, I find my views largely unchanged, with the exception that I am now much more sceptical than I was then of the case for making any new entity an Officer of Parliament –  the more so if, as now seems envisaged, the entity serves primarily as a costings unit for political parties (thus, essentially playing the sort of role economic consulting firms do).  If such a body is to be established, an independent Crown entity model might have been more appropriate, better protecting the relative status of the two absolutely vital Officers of Parliament (Auditor-General and Ombudsman), which act as crucial checks on the Executive.     It would be odd to have a policy costings unit as an Officer of Parliament while the –  much more vital –  Electoral Commission is only an independent Crown entity.

My summary observation was as follows:

I am much more sceptical (opposed) to the case for an institution to cost political party proposals (and in this respect associate myself with many of the comments in the New Zealand Initiative submission).  Parties have adequate incentives already to make the case for their policies, in whatever level of detail the political (voter) market demands, and (as the NZI note) already have access to the Parliamentary Library resources, parliamentary questions, and Official Information Act requests.  A policy costing office –  not found in any small OECD country –  would be, in effect, just a backdoor route to more state funding of parties (and not necessarily an efficient route – bulk funding would be preferable if state funded was to be more extensively adopted).  It also reflects a “inside the Beltway” conceit that specific costings are highly important, and that use of a single “model” or set of analysts somehow puts everyone on equal footing  (it doesn’t –  public service analysts having their own embedded assumptions about what is important, what behaviours are sensitive to what levers etc.)   With the possible exception of the Netherlands, I’m not aware of any country where a political costings office products plays any material or sustained role in election campaigns and outcomes.

There is an important distinction here.  Private entities (parties and their supporters) have every incentive to invest in convincing voters of their case/ideology/competence/costings. By contrast, no one has a strong private incentive to do the sort of analysis and commentary –  often longer-term in nature –  that a traditional (narrow) Fiscal Council does.  That is why a reasonable case can be made for a public institution of this sort (preferably macro policy focused –  since the same absence of incentives applies to monetary and financial regulatory policy).

There has been plenty of talk this week of how 29 of 36 OECD countries have some sort of independent fiscal institution.  This was the chart from the consultation document.

fisc council chart

But only a small number of those do policy costings, and none of the countries where the independent fiscal body does policy costings are themselves small.   I’ve not seen Treasury or the government engage with that point –  resources are more scarce in small countries, especially perhaps in relative poorer ones.   And although the US Congressional Budget Office is widely cited in such debates (and is pretty well-regarded) it doesn’t do policy costings for political parties or candidates as part of the election process, but rather produces independent expert analysis on proposals actually before Congress (the sort of role our less-politicised public service is supposed to play).   A policy costings unit for political parties, for use heading into an election, and paid for by taxpayers, remains quite unusual in OECD countries.

I’ve listed most of my objections previously, but just quickly:

  • there isn’t an obvious gap in the market.   At present, political parties produce costings (sometimes reviewed by independent experts) to the extent they judge it to be in their own interests to do so.  Voters, in turn, can judge whether the presence or absence of any costings, or any debate around them, matters much.  Existing parliamentary parties have access to considerable taxpayer resources which they can draw on to develop and test policy proposals,
  • it isn’t obvious when, if ever, a New Zealand election in at least the last fifty years has turned on the presence, absence, quality (or otherwise) of election costings.  It is a technocratic conceit to suppose otherwise: people vote for parties for all sorts of reasons (values, mood affiliation, fear/hope, being sick of the incumbent, trust (or otherwise)) which have little or nothing to do with specific policy costings,
  • the relevance of specific policy costings (and indeed overall fiscal plans) is even less under MMP than it was in years gone by.  Party promises are now little more than opening bids, as coalitions of support are put together after the election to govern (and on almost every specific piece of legislation).  We simply aren’t in a world where a few dominant ministers dominate a Cabinet which in turn has a majority (or near so) in the government caucus, which in turn has an unchallenged majority in Parliament,
  • the “fiscal hole” argument (from the 2017 campaign) remains an utter straw man in this context.   First, when Steven Joyce made his claims in 2017 lots of people, including experienced ex-Treasury officials, weighed in voluntarily, and debate ensued about whether, and in what sense, Joyce was saying something important.  The system –  open scrutiny and debate –  worked.  And, secondly, a policy costings unit –  of the sort the government apparently envisages – would not have made any useful contribution to such a debate, which was about the overall implications of Labour’s fiscal plans, not about the costs of specific proposals Labour was putting forward.     Elections are messy things –  always were and probably always will be, and that isn’t even necessarily a bad thing.
  • some of the arguments made for a policy costings unit might have more traction if, somehow, every political party and candidate could be forced to use it (say, submit all campaign promises to the costings unit at least three months prior to an election, with the costings unit issuing a report on all of them say at least one month prior to an election).  But even if you thought that might be a good model, it isn’t going to happen (and there is no credible way that such a model could be enforced).  Instead, the proposed costings unit will be used when it suits parties, and not when it doesn’t, and will probably be most heavily used by parties that are (a) small, (b) cash-strapped, and (c) like to present themselves as policy-geeky.  The Greens, for example.  One might add that the unit would most likely be used by parties that believe their own mindset is most akin to that of those staffing the unit –  likely to be a bunch of active-government instinctively centre-left public servants.  Embedded assumptions can matter a lot –  The Treasury used to generate wildly over-optimistic revenue estimates for a capital gains tax, and it was probably no coincidence that as an agency they supported such a tax. 
  • the policy costings unit seems, in effect, to largely represent more state-funding for (established) political parties.  That might appeal to some, but even if you thought more state funding was a good idea (and I don’t) it isn’t obvious why this particular form of delivery is likely to be the best or the most efficient.  Money might be better spent on research and policy development (say) rather than “scoring” at the end of the process, for detailed plans that will almost inevitable change before they are ever legislated.  And if we want to spend more on policy scrutiny, I reckon a (much) stronger case could be made for better-resourcing parliamentary select committees.
  • the interim proposal for next year’s election would enable only parties already in Parliament to utilise the facility.  Again, this has the effect of further entrenching the advantage established parties have in our system (I hope it will be re-thought when the legislation itself is considered).
  • practicalities matter: there probably won’t be much demand on a policy costings unit in the year after an election, and could be quite a bit in the year prior to one.  How then will be unit be staffed and a critical mass of expertise maintained?  If people are seconded in from government agencies, would we really have an independence (including of mindset and model) at all?  And costings skills aren’t readily substitutable with bigger-picture fiscal policy (or macro policy) analysis skills.
  • the lack of transparency around the proposed institution should be deeply concerning.  As far as I’m aware there has not yet been any indication as to whether the policy costings unit would be subject to the OIA (as the Auditor-General and Ombudsman are not, and nor is Parliament more generally).   The Minister of Finance has indicated that any costings the unit did would only be released with the consent of the political party seeking the costings.  That should be a major red flag.  In my view, any new unit should be (a) explicitly under the OIA, and (b) the enabling legislation should require that any costings done for political parties should automatically be released 20 working days after being delivered to the relevant political party (or more quickly if the costing is delivered within 20 days of an election).  A policy costings unit should not be a research resource for political parties – the only possible basis for confidentiality – but a body that at the end of the process provides estimates based on the details the relevant party has submitted. (As I understand the system in Australia, costings provided during the immediate pre-election period are automatically released, but others are not.)

In sum, I’ve become quite strongly opposed to the notion of a costings unit.  Mostly it probably won’t do much harm – I thought some of the comments from Simon Bridges were a bit overblown –  and relative to other stuff governments waste money on to buy off their bases or to win over small support parties (Super Gold Card anyone) it is probably small in the scheme of things.  It won’t improve policymaking, it won’t change the character of elections, but it might –  at the margin –  create a few more jobs for economists.

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Fiscal policy

Bernard Hickey, of Newsroom, had a passionate piece out the other day lamenting the fiscal conservatism of the Prime Minister and the Minister of Finance, and calling for a  large increase in New Zealand government net indebtedness (albeit over “the next decade or two”) under the ambit of something he calls the “Re-Engineering New Zealand” project.

It was a curious article because it seemed to throw together a variety of different things that don’t necessarily belong together: the cyclical on the one hand (potential limits of monetary policy in the next recession, at least on current technologies) and long-term structural issues (climate change, skills, productivity, infrastructure, housing etc) on the other.

On the cyclical side, Hickey’s case isn’t helped by the claim that monetary policy “did little to solve…the short term…problems facing the economy”, which simply has to be not true.    Unemployment rates, which shot up sharply during the last recession are as low as, or lower than, they were just prior to that recession in most advanced countries (not too far away even in New Zealand).  I wouldn’t recommend the alternative –  places like Spain, Greece, and Italy that had no nation-specific monetary policy open to them.    Central banks were often too slow to ease, and too often looking towards the next tightening (see NZ with two lots of pre-emptive, soon-reversed, tightenings) but monetary policy worked when it was embraced and given a chance.

But, of course, in many of those countries the limits of conventional monetary policy were reached, which slowed the recovery in some countries.  In New Zealand and Australia the limits weren’t reached, but as we head towards the next severe downturn –  whenever it is –  almost every advanced country now needs to be planning on the likelihood of monetary policy reaching its limits (on current laws and technologies).    There are monetary ways through that obstacle –  which I’ve been drawing attention to here for years – although for reasons not entirely clear central banks globally have been reluctant to embrace those sorts of options.   If central banks won’t do anything to free-up monetary policy leeway, then it seems quite likely to me that in the next recession there will be significant discretionary fiscal stimulus –  if politicians are not totally indifferent to the plight of the unemployed.

Since we are not now in a recession in New Zealand (well, we may be, but not a single forecaster is suggesting we yet are), and since conventional monetary policy has probably 175 basis points of leeway to go –  and the real exchange rate is still so high – now isn’t the time for rushing to temporary counter-cyclical fiscal stimulus.  Do it now – on the promise of being temporary –  and you might well find that when it was actually needed the political pressure was already mounting to tighten up again, to unwind the stimulus, just when it might do some good.   It was, after all, the Governor the other day who was openly worrying about additional government spending now either crowding out private sector activity, or being unable to be implemented because private sector activity crowded it out.

I’m sure Hickey is quite sincere about his cyclical point –  and the next serious downturn globally is going to be very tough to get through for many countries – but his real argument seems to be a structural one.  He is a bigger-government man, and one who favours much larger government debt (the two are, of course, separate issues).  He wants governments that do more, and seems pretty confident that he knows what they should spend our money on (and is quite dismissive of anyone complaining about potentially injudicious use of public money).  Interest rates are low on his telling primarily because of quantitative easing –  a strange story to tell in a country where there has been no quantitative easing and yet where five year real government bond rates are now zero or slightly negative –  and thus represent a windfall opportunity for borrowers.

Here is his list of what needs doing

Productivity, which is the only thing that matters in the long run, is slowing globally and has been stagnant here for more than five years. Housing affordability is collapsing in most developed countries because of rising house prices, restrictions on new developments and, tragically, falling interest rates.

Real climate change action is scarce because it requires massive public investment in public transport and new medium density housing close to city centres. Our skills, economies and cities need re-engineering massively if we’re going to restart productivity, make housing affordable for the young and poor and achieve net zero emissions by 2050.

It is a global problem, but even more acute here because we have among the worst housing affordability, productivity and climate change emissions figures in the world.

Massive investment in transport, health and housing infrastructure, education, workplace skills, business technology and research and development is required everywhere, but the central and local governments who are the only ones with the authority and balance sheets to do it are frozen in the headlights of politics and 30 years of austerity and smaller Government dogma.

And yet one was left wondering whether there might not be at least some connection between weak productivity growth and low interest rates –  firms just don’t see the profitable opportunities and so aren’t looking to invest heavily.   And if –  as is so –  regulatory restrictions limit land use and housebuilding why not get on and get government out of the way: remove or greatly ease up those restrictions (as some in the Labour Party suggested they might) and let the private sector get on with building the sorts of houses people would prefer when they are free to choose (rather than the sort some experts might prefer them to adopt).

Quite how this proposed large scale government investment was going to solve the productivity problems wasn’t clear –  when private firms aren’t investing it has the feel of the old line about “fools rush in where angels fear to tread”.  We’ve been that before in New Zealand –  not that long ago with the Think Big programme.  And –  all else equal-  big government investment programmes will push real interest rates and the real exchange rate further against the prospects of large outward-oriented private sector investment.  Perhaps it might be helpful to see some robust empirical evidence or argumentation about the past ability to New Zealand governments to do these sorts of projects wisely and well, in ways that make us consistently better off.

And I’m always uneasy when people suggest that the relevant cost of capital is the borrowing rate on (even the longest-term) government debt.  It isn’t.    The cost of equity has to be factored in, and just because the government doesn’t have a share price doesn’t the issue less relevant.  When the government undertakes projects it is using your money and mine to do so –  either actual (already taken) or potential (the power to increase taxes whenever it likes).  No commercial operation is going to be undertaking projects that seek a zero or one per cent real rate of return –  even if they can raise at that price –  and the standard Treasury advice, which I endorse, is that governments should not do so either.  Given that the incentives on the governments to get things right are relatively weak, and the disciplines when they fail are weaker still, I’d argue that the required rate of return on government projects should be higher than those on a comparable private project.  The relevant hurdle rates are lower than they were, but the cost of capital is still by no means trivial.

Hickey makes quite a play of a claim that the entire New Zealand political and official class is still living under the shadow of the potential double credit-rating downgrade in 1991.  I don’t fully buy that story.  It isn’t that long –  how soon we forget –  since people used to talk a lot about the desirability of the government running a low level of debt as some of counter-balance to the large negative net international investment position (ours still among the more negative in the advanced world), in a country with a fairly modest rate of national savings.  Sure, there was a credit-rating dimension to that story, but it wasn’t the whole story by any means.  Perhaps one can run some sort of over-savings story in places like the Netherlands or Germany (or Singapore) –  and some might even find the argument for more government debt in those places persuasive –  but this is New Zealand we are talking about.   Savings rate haven’t suddenly gone stratospheric, and –  low as our interest rates are now in absolute terms –  the implied long-term forward rates are still higher than those anywhere else in the advanced world (while, as Hickey notes, our productivity growth record is terrible).  And don’t forget the argument that if you run as pay-as-you-go age pension system –  something most New Zealanders support –  there is a good argument for also aiming to keep net government debt lower than one might find in other countries with different state-sponsored retirement income systems.

None of this is to suggest that the world would come to end if, instead of the current level of net general government financial liabilities (about zero on the OECD measure, and a little above the median advanced country rated AAA by Moody’s) we had net public 20 percentage points of GDP higher. It wouldn’t.  All else equal, interest rates would be a little higher.  But, equally, we can only say that we would be better off by doing so with some really hard-headed realistic analysis of the sorts of specific projects people would propose to use the debt for.  I’m sure there would be beneficial projects –  as there are daft and costly ones that happen now –  but across the gamut it is as well to be very cautious.  We’ve been this way before.

(As an alternative we could look at getting out of the way of private investment: freeing-up urban land use, foreign investment law, resource management act constraints, prohibitions on GE, prohibitions on offshore oil and gas drilling, and lowering our company tax rate which –  from a foreign investor perspective – is among the highest in the advanced world.   And here I’m not even going to my story on immigration: since short-term demand effects of immigration outweigh the short-term supply effects even I would be wary of large cuts to immigration right now –  helpful as they would be in the longer–term.)

Having said all that, I come back to what has puzzled me for at least the last couple of years, and where perhaps my story overlaps to a much greater extent with Hickey’s. It is about how small a share of GDP the current government is spending, and is planning to spend.  Here is core Crown operating expenses as a share of GDP, using Budget numbers out to 2023.

CC 1

Spending in every year under this government (or on its fiscal plans) would be smaller as a share of GDP than the average under the previous government –  mostly smaller than the average under the previous Labour government.  By the year to June 2023, spending as a share of GDP would be lower than all but the last two years of the previous government.  And yet in the run-up to the last election we kept hearing talk of critical underfunding in all sorts of areas of government.   I guess the swing voters who just thought it was time for change weren’t looking for lots more government spending, but it is hard to believe the base in Labour and the Greens (and true believers among the journalists) weren’t looking for material increases.

In a way, what staggers me more is this chart.   All that talk about underspending was focused on health and education.  But here is core Crown health and education spending, only to 2019/20, because budget operating allowances haven’t yet been allocated for later years.   The first version goes all the way back to when Treasury’s data start (1972)

cc2.png

and this version just for this century

cc3.png

Education spending this year was last this low in 1988.  Health spending has increased a little, but the share of GDP spent this year is lower than in all but the last two years of the previous National government.  And this in a sector where the ageing population –  and, arguably, advances in technology – could probably make a case for a rising share of goverment spending in GDP.  At least if you were a party making the sorts of arguments Labour was making at the last election.

There is something about their fiscal choices that –  based on their professed values and rhetoric –  doesn’t make a lot of sense to me, a mere centre-right economist.

Of course, one reason why government spending no longer needs to be quite as high is that interest rates have come down.    Finance costs (mostly interest) were almost 2 per cent of GDP in 2000 and were still about 1.5 per cent in the middle of this decade, but are projected to fall to only 0.9 per cent of GDP by 2023.

On the other hand, there is the fiscal burden of New Zealand Superannuation, the age of eligibility not now having been changed for many years, even as more of the baby boomers got to 65 and the life expectancies more generally increased.   In 2008 –  just as the last recession began NZS cost 3.9 per cent of GDP, in 2015 4.75 per cent, and in 2023 the cost is projected to be 5.04 per cent.

Strip out both finance costs and NZS costs and all the rest of the stuff governments do, operating spending as a share of GDP in 2023 is projected to be 2 whole percentage points of GDP less than it was when Labour ended its previous term in government (year to June 2008), and about the same as in 2015 and 2016.  It is a curious achievement for a party that talked so much about underfunding, generational change etc etc.   Perhaps it would be one thing if it were genuinely the result of winnowing out wasteful programmes etc, but there has been little real sign of that.   Perhaps –  whatever your view on the extent to which health should be funded by the state –  it is one reason why our national statistics agency, something close to a public good, appears so badly underfunded.

So sceptical as I am of the Crown taking on another $150 billion of debt –  as Hickey calls for – with net general government liabilities at zero, real interest rates basically zero, and the budget in surplus throughout the forecast period, one could make a reasonable case for a slightly higher level of government spending (or lower taxes).  A small deficit –  consistent with a small primary surplus –  is consistent with keeping net debt at around its current level (share of GDP) in normal times, while providing plenty of leeway to handle the next serious recession (some mix, probably, of automatic stabilisers and discretionary stimulus).

 

Keep the focus on monetary policy

As we approach the OCR decision this afternoon and as some market economists are now talking about the possibility that the OCR could be below 1 per cent before too long, there has been more and more talk about whether fiscal policy should be brought to bear, to stimulate demand and (in some sense) assist monetary policy in its macroeconomic stabilisation role.  Just this morning there was an editorial in the Herald, a column on Stuff, and a comment from Bernard Hickey at Newsroom.   Some of the discussion is about what should be done now, and the rest is about contingency planning –  what happens when the next serious recession happens if the OCR is still constrained.

Much of the discussion seems to stem from people on the left who aren’t that happy with the government’s fiscal policy.  As someone not on the left, it has always seemed strange to me that Labour and the Greens pledged themselves to keep much the same size of government (and much the same debt) as National –  especially when, at the same time, you were running round the country talking about severe underspending on this, that, and the other thing.   I’m also of the view that structural budget surpluses are a bad thing, in principle, when net government debt is already acceptably low (on the OECD measure of net general government financial liabilities, New Zealand is now about 0 per cent of GDP, which seems like a nice round number – an anchor – to target).  There is an argument there –  whether from left or right – for some fiscal adjustment (taxes or spending), which might have the effect of a bit more of a boost to demand.

But those arguments really have almost nothing to do with the situation facing monetary policy.    They are fiscal and political arguments that should be made, and scrutinised, on their own merits: the arguments would be as good (or not) if the OCR was still 2.5 per cent as they are now, and you can be pretty sure that people on the left would have been making them then anyway?   The Governor of the Reserve Bank, for example, (a pretty staunch representative of the centre left) seemed keen on more infrastructure spending a year ago.  I guess he is a voter to so is entitled to his opinion, but it really doesn’t have much to do with monetary policy.

The general arguments that led countries around the world to adopt monetary policy more exclusively as the primary stabilisation policy tool have not changed.  Monetary policy can be adjusted quickly (to ease or tighten), operates pervasively (gets in all the cracks, without making specific distributional calls), is transparent, and so on.  If we had a fixed exchange rate –  as individual euro area countries largely do –  it would be a bit different (individual countries don’t have the monetary policy option any longer) but we have a floating exchange rate system which, mostly, works well for New Zealand.

To the extent that there is a monetary policy connection to the current calls for fiscal policy to be used (or the ground prepared to use it), it has to do with the looming floor on nominal interest rates.  International experience suggests that, on current laws and technologies, short-term nominal interest rates can’t be reduced below about -0.75 per cent without becoming ineffective (as more and more people shifted from other financial instruments into physical cash).  We don’t know quite where that floor is, as no central banks has been willing to take the risk of going further, but there is a fair degree of consensus (and it has long been my view too).

But that still means that in a New Zealand context there is 200 basis points of OCR cuts that could be used if required.    That isn’t enough for a typical New Zealand recession (rates have often been cut by 500bps), but is still quite a degree of leeway if what we are entering were to turn out to be a fairly mild slowdown in New Zealand.  It could (I’m not hedging here).   That capacity should be used energetically, not timorously.   So the issue –  monetary policy needing “mates” deployed now –  is not immediate.  It is about preparing the ground.

And there, the best macro stabilisation option remains the one the Reserve Bank –  and other central banks –  have done nothing active about, but really should.  Authorities (and it probably needs political support to do so) should be moving to make the effective floor on short-term nominal interest rates much less binding than it is.   It binds because the practice of central banks –  perhaps backed by law – has been to sell banknotes, in unlimited quantities, at par.   That practice can be changed.  It could be as simple as putting an (adjustable) cap on the volume of notes in circulation (quite a bit above the current level, but not at a level that would be transformative) and then, say, auctioning the right to buy additional tranches of bank notes from the Reserve Bank.  In normal times –  with the OCR at, say, current levels – the auction price would be at par.  If the OCR were cut to, say, -3 per cent (and be expected to stay there for some time) the auction price would move well above par, acting as a disincentive on people to attempt to make the switch from deposits to cash.  There is a variety of other ideas in the literature, as well (no doubt) as much less efficient regulatory interventions that could prevent really large-scale conversions happening.

Unusual as such options may sound, this is where the authorities –  here and abroad –  should really be concentrating their energies: giving monetary policy more leeway, in ways that will buttress market confidence that monetary policy will do the job when it is required.  At present, by contrast, when market participants contemplate a severe downturn they look into an abyss wondering what, if anything, will eventually be done, by whom, and for how long.  In a serious downturn that will just worsen the problem, driving down inflation expectations as economies slow (note that in the RB survey out yesterday, medium-term inflation expectations fell away quite noticeably –  and this while we still have conventional monetary policy to use).   And if there are objections that all this is somehow “unnatural”, bear in mind that had the inflation target been set at zero (rather than 2 per cent), as was the normal average inflation rate for centuries, we’d already have run into these practical limits, and been unable to get real interest rates even as low as they are now.

So there is plenty to be done with monetary policy, and the work programme to do it should be something open and active, drawing in the Bank, the Treasury, the Minister, and other interested parties.  The time to do preparation is now, not in the middle of a surprisingly severe downturn.

I have a few other reasons –  than “it shouldn’t be necessary” –  to be wary of calls for large scale fiscal stimulus now.  Just briefly:

  • there would be little agreement on what should be done –  these are inherently intensely political issues.  There is lots of talk of infrastructure gaps etc, but no agreement on what those are, let alone recognition of the twin facts that (a) the best projects, with the highest economic returns, have probably already been done, and (b) New Zealand government project evaluation is not such as to inspire confidence that new projects would add economic value.    And suppose there were attractive roading projects –  perhaps central Wellington and the second Mt Vic tunnel? – we know the attitude of the government’s support partner to new major roads.  Not a thing.  So what should we then spend on?  Uneconomic new railway lines?  Or what?  Perhaps some just favour more consumption or transfers spending – which might be fine if you are a lefty who believes in permanently bigger government, but if you aren’t the issue has to be addressed of how programmes once put in place are unwound later.
  • I don’t rule out the possible case for discretionary fiscal stimulus in the event of a new severe recession (especially if the authorities refuse to address the monetary policy issues above) but my prediction is that (in many ways fortunately) the political appetite for large deficits would not last very long, and that therefore we should preserve the option for when it might really be needed.  It isn’t now.   I take much of the rest of the world after 2008 as illustrations of my point: in late 2008 all the talk was of fiscal stimulus, but within two or three years all the political pressure was to pull deficits back again.  I don’t see why New Zealand would be any different (and that is to our credit, since low and stable debt has become established as a desirable baseline).
  • And thirdly, a point we don’t often hear from champions of more fiscal stimulus, relying more on fiscal policy and less on monetary policy to support economic activity and demand will, all else equal, put more upward pressure on the real exchange rate, further unbalancing an already severely-unbalanced economy (see yesterday’s long-term chart of the real exchange rate).  In a severe recession –  when the NZD tends to plummet –  that isn’t a particular problem, but it should be a worry now (when the TWI is still a bit higher than it was a year ago, let alone thinking about the longer-term imbalances.

Perhaps the Governor and the (experts-excluded) Monetary Policy Committee will proactively address some of these issues this afternoon. I do hope so. If not, I hope some journalists take the opportunity to push the Governor on why he (and the Minister and Treasury) aren’t actively pursuing work to make the lower bound on nominal interest rates much less binding, in turn instilling confidence in the capacity of New Zealand policy to cope conventionally with a severe downturn if/when it happens.

Oh, and I do hope some journalists might also ask the Governor this afternoon about the justification for ruling out from consideration for appointment to the Monetary Policy Committee

“any individuals who are engaged, or who are likely to engage in future, in active research on monetary policy or macroeconomics”

The Governor is, after all, a Board member and was one of the three person interview panel.    What was it that he –  or the Board generally –  were afraid of?    Expertise?  An independent cast of mind?  Of course, it isn’t only active researchers who have such qualities –  indeed, not all of them do either –  but it simply seems weird, and without precedent in serious central banks elsewhere in the advanced world, to simply disqualify from consideration for the (part-time) MPC anyone with the sort of background that many other central banks (Australia, the UK, the euro area, Sweden, the United States, and so on) have found useful, as one part of a diverse committee.

Overselling past reforms

Today is, apparently, the 30th anniversary of the Public Finance Act.    There is a conference being held this weekend at Victoria University to mark the occasion, with all manner of speakers over three days, including various famous figures from the reform era including Roger Douglas, Ruth Richardson, Graham Scott, and David Caygill.

There is nothing particularly wrong with conferences of this sort –  although the ever-present question is how much taxpayers’ money gets spent, one way or another –  but much depends on the extent to which such conferences lean towards on the one hand the self-congratulatory and, on the other, the self-scrutinising and challenging.    There was a conference in Wellington a few years ago to mark the 25th anniversary of inflation targeting and the Reserve Bank Act, and although it leaned to the mutually self-congratulatory, a) it had speakers who seemed to offer greater rigour than this weekend’s conference programme suggests is likely, and (b) even partial sceptics occasionally got a word in.   Time will tell about this weekend’s conference, and I hope that at least the New Zealand academic and public sector speakers make their addresses available more widely.

I have no particular problem with the Public Finance Act, which now incorporates the provisions of the later Fiscal Responsibility Act.  But what consistently irks me is the way a handful of champions of the Act oversell it.   Most prominent among the oversellers in Professor Ian Ball of Victoria, who had a fairly senior role in financial management at The Treasury at the time the Public Finance Act and the Fiscal Responsibility Act were being passed.   And the real prompt for this post was an article he had in yesterday’s Dominion-Post.   Whatever else Professor Ball picked up, or contributed, in his time at The Treasury, he seems to have missed the pretty elementary line, drummed into students from an early age, that correlation is not the same as causation.   And that isn’t the worst of what was on display in the article.

He begins

When New Zealand’s Public Finance Act was passed in 1989, it represented a set of changes that was both radical and untested. Partway through its implementation, in 1992, the Economist published an article describing the changes in a generally positive way, but withholding judgment and concluding: “Time will tell.”

With the act’s 30th anniversary on July 26,  it seems the right moment to consider what time has to say, and whether New Zealanders should, at last, break open the bubbly.

To jump to the end, he thinks we should be breaking out the bubbly.  But why?

Much of his case seems to rest on this

[Government] Net worth now stands at over $134b, equivalent to about 45 per cent of gross domestic product (GDP).

But he makes no effort at all –  not even hinting at more-developed arguments in fuller papers –  to demonstrate why we should conclude that the improvement in New Zealand’s fiscal position stems in whole, or even in large part, from these process-focused pieces of legislation (Public Finance Act and Fiscal Responsibility Act).  He also offers no particular reason to suppose the government net worth of 45 per cent of GDP is somehow optimal, or better than (for example) a number near zero, or even negative  (given that by far the Crown’s largest asset, its sovereign power to increase taxes is not included in these balance sheet calculations, and that the actual taxes supporting the net worth Professor Ball celebrates have material –  large in some cases –  deadweight costs, in an economy that has continued to badly underperform).

And while no one is going to disagree that a decent fiscal position (whatever that means) can be a “source of security” (Ball’s words), the evidence he adduces in support of his claim is less than convincing.

The comparison with other countries is striking – the governments of Australia, Canada, the United States and the United Kingdom all have significantly negative net worth, and in the case of the UK and US the negative net worth is roughly the size of their respective GDPs.

The principles of fiscal responsibility imported into the Public Finance Act from the Fiscal Responsibility Act see positive net worth as a “buffer” to economic and other shocks. So it has turned out.

While net worth declined for only four years after the financial crisis, in the four countries cited above government net worth remains, a decade later, on a downward track. A strong balance sheet apparently allows a much quicker recovery.

But, but, but…..Our recovery wasn’t “much quicker”, let along stronger, than those in Australia (which on some measures didn’t have a recession in the first place), Canada, or the US.  And whether one approves of those choices or not, the fact remains that unlike those countries we didn’t use discretionary stimulatory fiscal policy to respond to the last recession (I argue we didn’t need to because we could still cut interest rates).

Ball continues with his straw men

But has the history of running surpluses resulted in slower economic growth than in the comparable countries that have been incurring consistent deficits?

I’m not sure anyone would think there was such a relationship, but set that to one side.  What does Ball have to say?

Apparently not. The latest World Bank numbers (for 2017) show that the five countries have growth rates between 1.8 and 3.0 per cent, with New Zealand second at 2.8 per cent.

Can he be serious?  A senior professor, former senior official, really thinks one year’s GDP growth data, not even correcting for differences in population growth (hint: New Zealand’s has recently been extremely rapid) is some sort of support for his case about legislation focused on the medium to long term?

Perhaps instead he might consider the productivity record over 30 years?  Of his group of countries, ours has been the worst (to be clear, I’m not suggesting that has anything to do with the PFA, simply that one can’t seriously advance New Zealand “economic success” as support for the PFA).

He moves on to matters social.

Perhaps, then, the impressive fiscal and economic results have been at the expense of the social fabric? By no means are things perfect in New Zealand.

To which he responds

The Wellbeing Budget in May focuses on problems of child poverty and mental health, among many other issues that require government attention and resources. Yet these issues are still able to be addressed while budgeting to maintain a surplus.

Few of the (few) cheerleaders for this year’s Budget would claim it was any more than a start, but since the PFA was never supposed to constrain the size of government (it is mostly about process and transparency), of course it doesn’t stop governments spending more –  wisely and otherwise –  if they choose.

Ah, but we are “happy”

New Zealand stacks up very well, scoring near the top in a number of international rankings of social progress, living standards and even happiness (where we are eighth, ahead of the other four countries).

And yet –  and not because of the PFA –  the net flow of New Zealanders is still from here to other countries.

We then get into the folksy analogies

But do New Zealanders benefit from their government having a strong balance sheet?

It is very like having a strong personal balance sheet. There is a greater ability to absorb shocks or surprises without being forced into taking drastic remedial steps – you can fix the car without having to cut the food budget. This was demonstrated in the way the government bounced back, financially, from the financial crisis and the earthquakes.

As part of managing a shock, a strong balance sheet also enables easier access to emergency debt financing. Coupled with this is the benefit of being able to borrow more easily and more cheaply in normal times, if it is necessary or desirable to do so. This might be useful, for example, if there is a need to invest in infrastructure.

I like a folksy analogy as much as the next person, but you always need to be careful using them to ensure that the key elements of comparison are valid.   Here they mostly aren’t.  Positive accounting net worth means nothing about a sovereign’s access to credit, none of the comparator countries whose fiscal performance he laments have had any problem raising debt, New Zealand bond yields (for other reasons) have been consistently among the highest in the advanced world……and, unlike someone whose car breaks down, governments have the power to tax.  And did I note that there was nothing impressive about New Zealand’s recovery from the 2008/09 recession, and New Zealand’s productivity record this decade is even more dire than usual.

And then, without even really noticing, he rather undercuts his own case.

At the time the Public Finance Bill was going through Parliament, the auditor-general said the reforms “will give effect to the most fundamental changes to financial management practices seen in New Zealand’s history. These reforms are enormous, ambitious, and, in large part, unprecedented anywhere in the world”.

Thirty years on, the act has been amended  several times, but the most ambitious elements remain firmly in place. Notwithstanding the apparent success of these reforms, a number of key elements have been attempted by few, if any, other countries.

Reforms that, 30 years on, have not been followed by many, if any, other countries surely should be deemed to have failed an important test.  Other smart people have looked at those “key elements” and concluded that actually they weren’t so valuable or generally appropriate after all.  It was a bit like that with the Reserve Bank Act and inflation targeting: various countries did take some practices and inspiration from our model, but not a single one followed for long our model of putting all the power in the hands of a single Governor and building an accountability framework primarily around the ability to sack the Governor.  Eventually, even New Zealand changed those bits of law, and moved back towards the international mainstream.

Professor Ball ends this way

In October 2018, the Economist weighed in again, saying: “Only in one country, New Zealand, is public-sector accounting up to scratch. It updates its public-sector balance-sheet every month, allowing for a timely assessment of public-sector net worth.”

Perhaps, ahead of any further changes, this might be an opportunity to raise a glass to celebrate an ambitious and successful act.

I don’t update my personal balance sheet every month.   Superannuation funds I’m a trustee of don’t look at their balance sheets every month.   For what conceivable practical purpose do we have monthly estimates of the government’s financial net worth?  At best, financial net worth is some sort of constraint on governments, not the reason for being –  as in, say, corporate accounts.  I’m not necessarily opposed to having the data, but it looks a lot like an example of giving prominent place to what is measurable (on all sorts of assumptions) and not necessarily to what actually matters.   We don’t even need monthly house price data (although we have it) or monthly productivity data (we don’t, and probably shouldn’t) to highlight these egregious failures of New Zealand governments.  And monthly government net worth data –  or the rest of the panoply of features of the PFA –  has done nothing discernible to improve the actual quality of New Zealand government spending (or taxation).

As I’ve argued repeatedly here over the years, I think fiscal policy outcomes are something that successive waves of New Zealand politicians can take considerable credit for.   We had a bad scare in the mid 80s and early 90s and that clearly played a pretty formative part, both in choices political parties made in successive elections/budgets, and in the legislation (eg PFA/FRA) they’ve been willing to pass –  but my hypothesis is that there is a common explanation for both, rather than causation running from the (facilitative, transparent) legislation to the fiscal outcomes.

I tend to be relatively sceptical of net worth numbers (for governments) and the data often aren’t available for lots of countries for long runs of time.  But I’ve run this chart in an earlier post, looking at net general government (ie all layers of government) financial liabilities.

net debt OECD

Here I’d concentrate on the comparison between the blue line (New Zealand) and the yellow line (the median of small OECD countries). New Zealand’s performance doesn’t particularly stand out relative to those other small countries (or to Australia, which has lower net general government financial liabilities than New Zealand), even though we – like them – even though there is a stark contrast to several of the largest OECD countries (notably US and Japan).

Any story about the successes of New Zealand fiscal policy that tries to put much weight on New Zealand specific legislative reforms needs to grapple more seriously with the experience of other well-governed small advanced countries, and make more effort to demonstrate how our legislation accounts for any (rather more marginal) differences.    It also has to ask how credible is a story that suggests that, say, US fiscal problems result largely from, say, insufficient transparency (and other bureaucratic type solutions).  In that respect, it is a bit like the Reserve Bank Act: it wasn’t responsible for the much lower inflation of the 1990s and 2000s (there were global phenomena at work, including widespread political choices to lower inflation), but was a broadly useful framework for managing a commitment to lower inflation and (at least in principle) being open and transparent about how policy would be conducted.

I guess it is good to be able to be proud of things one was involved in over the course of one’s working life.  But I hope this weekend’s conference is a bit more rigorous, and self-scrutinising, than what was on display to Dominion-Post readers yesterday.   Careful evaluation, careful analysis, should be key inputs to the design and updating of good policy.

 

 

 

 

A useful but modest step forward on fiscal management

A year ago the Minister of Finance gave a pre-Budget speech in which he restated the fiscal rules Labour and the Greens had campaigned on.  Among them

We will reduce the level of net core Crown debt to 20 percent of GDP within five years of taking office.

Here was what I said at the time

In general, debt targets –  with relatively short time horizons to achieve them –  aren’t very sensible as operational rules.   Such a rule can mean that a few fairly small, essentially random, forecasting errors in the same direction can cumulate to produce a need for quite a bit of (perhaps unnecessary) adjustments to spending or revenue.  More seriously, recessions can throw things badly off course for a while, and risk pushing a government into a corner –  either abandon the target just as debt is rising, or fallback on pro-cyclical (recession exacerbating) fiscal adjustments –  even though, in across-the-cycle terms, the government’s finances might be just fine.  No one looks forward to a recession, but governments (and central banks) need to work on the likelihood that another will be along before too long.   Natural disasters –  the other shock the Minister mentioned –  can have the same effect.

I see I omitted to mention that other pro-cyclical fiscal risk that a (point) debt target exacerbates: the temptation to spend up further in good times to keep debt from undershooting the target.

And so I am pleased see reports today of another pre-Budget speech from the (same) Minister of Finance, in which he said

The Government will scrap specific debt targets in favour of moving towards a target range, Finance Minister Grant Robertson has announced.

The current target, part of Labour’s Budget Responsibility Rules, is to reduce net debt to 20 percent of GDP by 2021/22. When that target is achieved, it will be replaced with a debt range.

Robertson did not specify what this was, but said Treasury had provided him with advice.

“At this point we are looking at a range of 15-25 percent of GDP, based on advice from the Treasury,” Robertson said.

Does it create risks?  Yes, it does, and that is why I would still favour dropping debt targets altogether.  There will be increased pressure for more spending up front.  But, operated responsibly, the proposed new debt-range provides only trivially greater amounts of flexibility.    Why?  Because no one ever expects the government will keep debt/GDP at a constant point every single year, but if they take the new range seriously people will expect them to keep within the sort of range all the time.  It is wide enough, it should be able to encompass the effects of most booms and busts, but only if in normal times debt/GDP is kept close to the midpoint of the range.  You probably give yourself a degree of freedom to have debt fluctuate between 19 and 21 per cent in normal times, but you always have to remember that a recession could be along any time.  A couple of years in which revenue is 2 percentage points of GDP below average and you will be on course for the top of the debt target range pretty quickly if your starting point is anything much higher than 21 per cent.  Tax revenue as a share of GDP fell from 31 per cent in the year to March 2006 to 25 per cent in the year to March 2011, and (a) while the economy started from a materially positive output gap, and (b) there were some tax cuts, a fall of a couple of percentage points of GDP is easy to envisage, and necessary to plan around.

My own preferred approach, without a debt target, is as I outlined it last year.

Personally, I would be much more comfortable with only two key quantitative fiscal rules:

  • a commitment to maintaining the operating balance in modest surplus, once allowance is made for the state of the economic cycle (cyclical adjustment in other words) and for extraordinary one-off items (eg serious natural disasters), and
  • something about size of government.    Simply as an economist I don’t have a strong view on what the number should be, although as I’ve noted previously it is curious that the current left-wing government, arguing all sorts of past underspends, was elected on a fiscal plan that promised spending as a share of GDP that undershot their own medium-term benchmark (that around 30 per cent of GDP).

The suggested fiscal surplus rule isn’t an ironclad protection (any more than a real-world inflation target in a Policy Targets Agreement is).  There are uncertainties about the state of the cycle and how best to do the cyclical adjustment, and incentives to try to game what might be counted as an “extraordinary one-off”.   That is why the fiscal numbers and Budget plans will always need scrutinising and challenging.  But if followed, more or less, such a rule would be sufficient to see debt/GDP ratios typically falling in normal times, and to avoid things going badly wrong over a period of several decades.  That is probably about as much as one can realistically hope for.

The focus would be on the first of those, the structural balance rule.

Part of the necessary scrutiny and challenge would be provided by that fiscal council the government consulted on last year, but about which nothing has been heard for months.

Thoughts prompted by a government debt chart

I’ve just started reading an interesting new book on sovereign debt defaults (including the question of why there aren’t more of them).    When I’ve finished the book and done the review I’m supposed to be writing, I might even do a post on that intriguing issue.  But on page 3 of the book, this scene-setting chart appeared.

world public debt

It is a pretty strong upward trend, and the trend isn’t obviously different after 2008.

It is important to remember how dramatically the composition of world GDP has changed since 1980 (think of China in particular, where public debt is much higher than it was).

It is quite a remarkable contrast to New Zealand’s record.  This chart uses data from The Treasury’s website, for the longest gross-debt time series they show.

GSID

Gross (central) government debt, as a share of GDP, is lower than it was at any time in the 1970s and 1980s.

New Zealand readers are probably mostly aware that our choices have been different from those of many other countries.  But I was a bit surprised by quite how unusual.

Consistent historical data are not easy to come by.  The OECD has gross government debt data back to 1980 for only 13 of the 35 member countries (not including New Zealand).   All thirteen recorded increases in the ratio of general government gross debt to GDP over the period 1980 to 2018.    The OECD has data for even fewer countries back to 1972 (when my New Zealand chart starts), and none of those countries have  seen a fall in the ratio of government debt to GDP over that full period.

For many, but not all, purposes net government debt is a more useful measure.   Long-term historical data are even more patchy for net debt than gross debt, but what there is of it suggests New Zealand’s public debt record doesn’t stand out quite as much: Denmark, Finland, Norway (in particular), and Sweden all recorded falls over 1980 to 2018, as would New Zealand properly measured (the series Treasury reports excludes the assets of the New Zealand Superannuation Fund).

What of the more recent period?  The OECD has reasonably complete data for the net liabilities of the general government since around 1995.   Here is how New Zealand compares to the OECD total.

net debt nz and OECD.png

Unlike the world series I started this post with, in this chart the OECD total line really does look different after the 2008/09 recession than before it.

But this picture tends to flatter New Zealand.  Here is another chart, this time showing the line for the median OECD country, and for the two largest OECD economies (US and Japan).

net debt median

Net debt in New Zealand has fallen while that for the median OECD country is little changed (if anything, there are some reasons why you might think “optimal” public debt would be higher than in the median OECD country) but what really stands out is the deterioration in the net debt ratios of both the US and Japan.

China isn’t a member of the OECD and the IMF doesn’t have net debt data for China, but Chinese gross government debt (share of GDP) has increased substantially –  more than for the US –  over this period.

And here is one more chart

net debt 3

Here the orange line is the median for the small (population 10m or less) OECD countries, including everyone from Norway to Greece).  Our net debt as a share of GDP has fallen a bit more than that small country median,  but a median of under 20 per cent of GDP scarcely seems troubling or inappropriate.  I’ve also shown Canada and Australia –  not small but two other Anglo countries.  Australia has had consistently lower net debt than New Zealand –  despite all the political huffing and puffing there over the last decade –  and while Canada is more indebted the fall since 1995 has been larger.

Overall, our ratio of net government debt to GDP is just inside the lower quartile among OECD countries (seven countries have lower numbers).   Rising public debt may be a real issue for some countries –  and perhaps even for the world, given the possibilities of spillovers if/when things go wrong – but it is hardly a ubiquitous experience.

I don’t have any strong policy point to make with this post.  Personally I think fiscal policy in New Zealand has been managed fairly well by successive governments over most of the last 30+ years.  On the OECD net debt metric, we show as having an estimated 0.00 per cent net general government debt in 2018.

I’m not a strong supporter of the current government’s budget responsibility rules –  although I’m more puzzled at their commitments around spending (very similar to the previous government’s plans) than around debt.   But while there are plenty of people out there championing the idea that the government should take on a higher level of debt (especially given that interest rates are low),  I remain sceptical of those claims.  That is partly because I see little sign that governments spend wisely within current limits (and possible new projects must, almost by definition be less-valuable, lower ranked, proposals), partly because interest rates are low for a reason (not necessarily a fully-understood reason) about expected demand for, or expected returns on, investment, and partly because much about what government do tends to reduce the need for private individuals to save, and in that context a benchmark of something like net zero public debt (which we might fluctuate below in good times, and above in bad times) seems a not-inappropriate counterbalance.

 

Modern monetary theory, old-school fiscal practice

On various occasions previously, I’ve used here survey results from the IGM Economic Experts panel, run out of the University of Chicago Booth School.   They survey academic economists in the US and Europe and the results often shed some interesting light on consensus, and difference, within the academic economics discipline.  As ever of course, much depends on how the questions are framed.

Their latest effort was not one of their best.  There were two questions.

MMT1

MMT2

Glancing through the individual responses, if there are differences among these academic economists they seem to be mainly ones of temperament (some people are just very relucant to ever use either 1 or 5 on a five point scale).

But so what?  No serious observer has ever really argued otherwise.

So-called Modern Monetary Theory has been around for some time, but has had a fresh wave of attention in recent weeks in the context of the so-called “Green New Deal” that is being propounded by various more or less radical figures of the left of American politics.  Primary season is coming.  The brightest new star on that firmament, Alexandria Ocasio-Cortez, has associated herself with the MMT label.

One of the more substantial proponents of MMT thinking, Professor Bill Mitchell of the University of Newcastle, visited New Zealand a couple of years ago.  I wrote about his presentation and a subsequent roundtable discussion in a post here.    We had a bit of an email exchange after he stumbled on my post, and although we disagree on policy, I was encouraged that he thought my treatment had been “very fair and reasonable”.  I mention that only so that in the extracts that follow people realise that I’m not describing a straw man.   I don’t know how Professor Mitchell would have answered the IGM survey questions above, but what I heard that day in 2017 should logically have led him to join the consensus.  That’s a mark of how useless the survey questions were.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were remarkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit.    It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.

I don’t think advocates of MMT really help their cause by using the label Modern Monetary Theory.   I understand the desire to make the point –  pushing back against those too ready to invoke “but the market will never buy it” argument –  that countries issuing their own currency never need to default.  As a technical matter they don’t.  Politically, some still choose to do so, and even if they never do there are very real (if not readily observable) limits well short of default, where the costs and risks no longer make any benefits worthwhile.  Only failed states actually lapse into hyperinflation.

But in substance, MMT isn’t primarily about monetary policy at all, and as I noted at the start of the earlier post.

He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

One can mount a case for a more active use of macro policy to counter unemployment running above inevitable frictional/structural minima (I’ve made itself for several years), one can also mount a case for a more joined-up approach to fiscal and monetary policy (I’m not persuaded by the case, but it was standard practice in much of the OECD for several decades), and any politicians who doesn’t have a burning passion about minimising involuntary unemployment isn’t really worthy of the office.  At present, in much of the world, that should be driving officials and politicians to (at very least) be better preparing to handle the next serious recession, in particular by doing something (there are various options) about the binding nature of the effective lower bound on nominal interest rates.  It might not be a cause that resonates in Democratic primary debates, but it could make a real difference to the prospects of many ordinary people caught up through no fault of their own when the next serious downturn happens.   Whatever one believes about the possibilities of fiscal policy –  and I tend towards the sceptical end in most circumstances –  you’d want to have as much help from monetary policy as one could get.

Perhaps next time, those who write the IGM questions could consider something a bit more nuanced, that might shed some light on the areas where there are real divergences of view around the light that economic theory and analysis can shed on such issues.

UPDATE: A post here, by a senior researcher at one of the regional Federal Reserve banks, also responds to this particular IGM survey.