There was a quite odd paper released yesterday by the New Zealand Initiative – the business-funded think tank, that has done quite a range of work on coronavirus-related policy issues – on monetary policy, fiscal policy, interest rates, and asset prices. I know some of my readers will agree with at least some of Bryce Wilkinson’s paper. I disagree with it almost entirely, unlike the previous paper on some related macro issues the Initiative released under Bryce’s name (where my reaction was my along the lines of “yes, but…” or “perhaps, but that isn’t the whole story”. On Bryce’s telling in this latest paper, central banks appear to be little more than wreckers and debauchers, driving the world inexorably towards its next (real) economic and financial crisis.
If I were fully well, I would devote a lengthy post (or two) to the paper. Bryce is a smart guy and there is a range of material there that really should be carefully unpicked and scrutinised. As it is, for today there will be just something brief.
Bryce seems to hold it against our Reserve Bank that it has cut the OCR to 0.25 per cent. This is from pages 7 and 8
First, the sharp reductions in policy discount rates are an active response to hurtful economic shocks rather than a passive response to secular trends. Think of it as a response to signs of financial market stress – falling share prices, rising bond yields, a ‘dash for cash’ and market turnover drying up – causing step reductions in policy discount rates, with limited reversals for fear of triggering renewed signs of stress.
Second, policy discount rates still differ considerably around the world. They are the lowest by far amongst European and Scandinavian countries, Japan, the UK and the US. Outside that group, the Bank of International Settlements shows only Israel has a policy interest rate lower than New Zealand and Australia’s 0.25%. Of the 38 central banks in its dataset, half had policy discount rates in April of 1% or more.
and this footnote appears a page or so earlier
The Bank of International Settlements database shows that in April 2020 the policy rates of 29 of 38 central banks around the world were higher than for these four central banks. Israel, with a policy rate of 0.1%, was the only non-European central bank to be below New Zealand and Australia’s 0.25%. Almost one third of the central banks had policy rates of 2.5% or higher in April.
The first paragraph is mostly just out of step with the actual historical record. Policy rates around the world have not been cut this year mostly because of financial market stresses – which didn’t even really appear until mid-March – but in response to rapidly deteriorating economic situations and emerging downside risks to inflation.
But what of those policy rates? Here is the chart of nominal policy interest rates from the BIS.
(I capped the scale at 10 per cent – Argentina actually has a policy rate of 38 per cent, but I guess Bryce won’t be commending their example to us.)
One can quibble about precisely which policy rate to use – most reckonings for the ECB would probably use the deposit rate of -0.5 per cent, and although New Zealand and Australia are shown here as having the same rate in fact the effective rate in Australia is 15 basis points lower than it is here. One could reasonably delete a couple of entries from the chart altogether – Hong Kong and Denmark have long-term fixed exchange rates, and Croatia describes its monetary policy as keeping the exchange rate to the euro stable. Korea cut by another 25 basis points last month. But these are small institutional details: the main point is that pretty much the entire group of advanced economies have nominal interest rates of less than 1 per cent. In almost all those cases, real interest rates – which central banks do not control – are negative.
On the other hand, Bryce is right to note that there are still countries with higher rates. In fact, I could link to a longer list with many more countries with higher interest rates (Pakistan 8 per cent, Uzbekistan 15 per cent, Ukraine 6 per cent, Zambia 9.25 per cent).
But it is hard to see what is appealing about almost any of those countries’ macro management. Quite a few have higher inflation targets (Turkey, for example, has a notional target of 5 per cent, and actual outcomes last year of almost 12 per cent). Of all those higher interest rate countries, only Iceland really counts as an advanced economy and it is the country in the chart with (by far) the largest cumulative fall in its policy interest rate since just prior to the 2008/09 recession (where, on the Wilkinson telling, the rot really began to set in). There’s China of course, but (a) interest rates aren’t a key part of the transmission mechanism in the PRC, and (b) whether it is public or private credit one worried about, China took the great-debauch path more than most.
I don’t know all those countries to the right of the chart at all well, but I can’t think of a single one that I’d exchange for most of the countries on the left of the chart, New Zealand included, whether it was macro management or political stability (often somewhat connected) that I had in view. In fact, even Japan and the US – for all their faults and all their debt – easily look a better (nominal) bet than any of those on the right of the chart.
And although one wouldn’t really know it from the New Zealand Initiative piece all the OECD countries with the lowest net government debt are also bunched towards the left hand end of the chart.
|2019 govt net debt (% of GDP) (OECD)|
Plus Norway of course, with huge net financial assets. Any of them could readily borrow more – much more – with no central bank hand on the scale, but they (probably responsibly) chose not to.
Two final brief thoughts.
First, what I always find striking among the critics of central banks from the side Bryce comes from is how powerful they seem to think central banks are over very long-term real interest rates. I think central banks have quite a degree of influence over economic activity over perhaps a 1-3 year horizon, but beyond that their only real influence is on inflation. I’m pretty sure that would probably have been the view of a younger Wilkinson – Muldoon might, as the story went, juice the economy in the short-run for electoral purposes, but before long all we’d be left with was higher inflation. Thus, Bryce declares himself scandalised that in its LSAP programme the Reserve Bank bought long-term inflation-indexed bonds at negative real interest rates but (a) long-term real interest rates have been falling for decades (I always recall the funds manager who for years afterwards proudly boasted of having bought New Zealand inflation indexed bonds at a real yield of 6 per cent) and (b) market real yields for New Zealand indexed linked bonds first went negative in August last year, way before there was any talk of RB asset purchases. There are deeper forces at work – real savings and investment preferences – which Wilkinson’s paper seems not to address at all.
Second, related to this Wilkinson appears to have a hankering for deflation. I’m not unsympathetic – although not wholly persuaded – by the case that if there was rapid trend productivity growth it could be attractive to take the gains in a lower general price level rather than higher nominal wages. But that bears no resemblance to the world in which we actually live today. Productivity growth in the frontier economies has slowed materially – and on many reckonings was slowing even before 2008/09 – and, of course, the New Zealand productivity record has been particularly dire. And there tends not to be a huge demand for investment when firms don’t perceive substantial profitable – often productivity-enhancing – investment opportunities. When investment demand is weak and savings preferences are relatively strong, real interest rates will be very low, perhaps even negative. There is no iron-law of nature that says that the market-clearing price for using savings need be positive (in nominal or real terms). That doesn’t saving unwise or imprudent at an individual level – one of Wilkinson’s concerns – but does suggest you can’t expect much, if any, of a low-risk return to such savings. That is, of course, true of many prudent things we do in life (insurance most notably).