Disagreeing with Don Brash on monetary policy

The Labour Party is campaigning on a couple of changes to the Reserve Bank Act.  One would make a statutory committee, rather than the Governor alone, legally responsble for monetary policy decisions, and would require the minutes of that committee to be published fairly shortly after the relevant meeting.   I don’t think that change goes far enough – and it doesn’t deal at all with the extensive (and much less constrained) decisionmaking powers the Bank has around financial institution regulation –  but if not everyone actively favours change, there aren’t now that many defenders of the (single decisionmaker, secretive) status quo.  Even Steven Joyce got The Treasury to commission some advice on possible changes, although his officials now refuse to release that report.

There is more dispute around the other limb of Labour’s proposed changes, in which they proposed to amend the statutory goal of monetary policy from “stability in the general level of prices” only “to also include a commitment to full employment”.

Earlier this week, so NBR reports, Grant Robertson and former longserving Governor Don Brash came head to head at BusinessNZ election conference.   Don thinks the proposed change is wrong and was reported as pointing to two reviews undertaken during the term of the previous Labour government, both of which saw no reason to change the statutory objective for monetary policy.

My initial reaction to the proposed Labour change was also sceptical, and I initially went as far as to describe it as “virtue signalling”.  I was discussant at an Victoria University event a few months ago where Robertson launched his policy, and this is how I summarised my view in a post written the following day.

I was (and am) much more sceptical, and nothing that was said in response to questions really clarified things much.    I get that full employment is an historical aspiration of the labour movement, and one that the Labour Party wants to make quite a lot of this year.  In many respects I applaud that.  I’m often surprised by how little outrage there is that one in 20 of our labour force, ready to start work straight away, is unemployed.  That is about two years per person over a 45 year working life.  Two years……     How many readers of this blog envisage anything like that for themselves or their kids?

But still the question is one of what the role of monetary policy is in all this, over and above what is already implied by inflation targeting (ie when core inflation is persistently  below target then even on its own current terms monetary policy hasn’t been well run, and a looser monetary policy would have brought the unemployment rate closer to the NAIRU (probably now not much above 4 per cent)).

I noted that I’m sceptical that the wording of section 8 of the RB Act is much to blame.  After all, for several years prior to the recession, our unemployment rate was not just one of the lowest in the OECD, it was also below any NAIRU estimates.  And when I checked this morning, I found that our unemployment rate this century has averaged lower than those of Australia, Canada, the US and the UK, and our legislation hasn’t changed in that times.  Robertson often cites Australia and the US.

The last few years haven’t been so good relatively speaking.  But if the legislation hasn’t changed and the (relative) outcomes have, that suggests it is the people in the institution who made a mistake –  they used the wrong mental model and were slow to recognise their error and respond to it.  Getting the right people, and a well-functioning organisation, is probably more important than tweaking section 8.

I stand by most of those individual comments.  But as I thought about things further, I’ve come to conclude that the direction Labour is wanting to go is the right one (although details matter, and there are few/no details).   If anything, one could mount an argument that defence of the current statutory formulation risks being “virtue signalling”.

Don Brash relies in part on the two enquiries undertaken in the term of the previous Labour government.  The second, conducted by Parliament’s Finance and Expenditure Committee, can largely be discounted.  It was set up in 2007 at time when there was quite a bit of caucus (and ministerial) discontent with the Reserve Bank –  the OCR had been raised again, and the exchange rate was again strong.   A lot of work went into the inquiry, and it reported in 2008, just weeks before the 2008 election.  But however much grumpiness there had been, a government-dominated committee was never going to come out a few weeks before an election their party looked like losing arguing that a key aspect of macroeconomic policy had been done badly throughout their term in office.

The earlier inquiry, conducted by Swedish economist, Lars Svensson at the request of the incoming Minister of Finance in 2000/01 would normally be a more potent argument.    Svensson was an academic expert in matters around inflation targeting and he was content to recommend retaining the statutory goal for monetary policy as it was.

So what has changed?   Robertson is quoted in the NBR article as saying that monetary policy has “enormously changed” since the international crises of 2008/09.  Here I simply disagree with him, and find myself (I think) strongly agreeing with the outgoing Governor of the Reserve Bank, who  notes that for all the talk it is remarkable how little change there has been in monetary policy anywhere.  Sure, interest rates are a lot lower, and various major central banks resorted to unconventional quantity-based measures to supplement their toolkit.  But there is no sign of any material change in any of those countries in how the goals of monetary policy have been specified (whether in statute or in more-operational documents).  As the Governor often notes, no one has abandoned inflation targeting, and no one has lowered (or raised) their inflation target.

Of course, if there was once in some circles a degree of hubris around quite how much good stuff central banks can deliver, much of that has now dissipated.  And the use of unconventional tools has raised questions about accountability, given that some of those tools can verge quite close to fiscal policy, for which legislatures are typically responsible.

But perhaps two relevant things have changed.  The first is Lars Svensson, who –  having had several years experience as a senior policymaker – now quite openly argues that flexible inflation targeting should involve a clear and explicit specification of an inflation target and  the identification of a sustainable long-run unemployment rate, with explicit weights assigned to deviations from these two variables.      I wrote at some length about Svensson’s view of these things in a post in April.   As I noted then

I don’t know specifically what Svensson would make of the current debate in New Zealand, or of what the Labour Party (at quite a high level of generality) is proposing.    What we do know is that Labour is proposing nothing nearly as specific or formal as Svensson argues for: there would be no numerical unemployment target or an official external assessment of the NAIRU (or LSRU).  My impression would be that his reaction would be along the lines of “well, of course the unemployment rate –  and short to medium term deviations from the long-run level, determined by non-monetary factors – should be a key consideration for monetary policymakers; in fact it is more or less intrinsic to what flexible inflation targeting is”.   He might suggest there are already elements of that in the PTA, but that making it a little more high profile, with an explicit reference to unemployment, might be helpful.

At the time, I suggested they might find it useful to get in touch with Svensson, who retains an interest in New Zealand.    Should they form the government after the election next month, he would be someone that they would be wise to consult, both in making their proposed legislative change, and in articulating a social-democratic vision of what should be looked for from a central bank.

The other thing that has changed over the last 15 years or so is our own central bank.   It is striking how little public attention they ever pay to unemployment, even though it is the most tangible measure of excess capacity – and one directly involving people’s lives and livelihoods.  But perhaps more striking still is the way in which they have conducted monetary policy in a way that has left the unemployment rate above any reasonable estimates of the NAIRU for eight years.    That would have seemed staggering to us when we were looking at getting inflation under control in the late 1980s –  when we knew that temporarily higher unemployment was a price of getting inflation down.  It is pretty inexcusable in today’s climate –  which doesn’t stop people making excuses.

And so I come back to the point I made in the remarks quoted above.   Getting the right person –  and people –  into the senior positions responsible for the conduct of monetary policy probably matters more than changing the statutory objective.  At the moment, an incoming Minister of Finance has no way of putting his or her preferred types of people in those roles –  all that power rests with the Board (the company directors and the like appointed by the outgoing government, with almost no accountability).  That needs to be tackled directly, and quickly.

But the way the statutory goal is expressed should affect expectations on the new Governor (and any committee that is established as part of governance reforms).    Over recent years, fear of booms seems to have driven the Governor (and his staff)  – with no statutory mandate at all –  and there has been no pressure on them to focus on delivering low and sustainable rates of unemployment.    Changing the Act  –  in the generalised way Labour seems to be talking of  – and not changing the sort of people making the decisions won’t have much impact at all.  But changing the Act in this area, can be one part of an array of changes that lead the Reserve Bank in future to put much more emphasis on unemployment, in public and in private, in the way that many other advanced country central banks do.  Policy is, after all, supposed to be about people.

What array of changes should any new government make?

  • a move to a decisionmaking committee, appointed by the Minister, and subject to parliamentary hearings before taking up the appointment,
  • making a low sustainable rate of unemployment (“full employment” if you must) a part of the statutory goal of monetary policy,
  • require the Reserve Bank to publish estimates of the NAIRU and, in the Monetary Policy Statement,  require them to explain reasons for any material deviations from those NAIRU estimates,
  • require the timely publication of minutes of the decisionmaking committee and (with a longer lag) of the background analysis papers provided to the committee, and
  • in the immediate future, change the Act to allow the Minister and Cabinet to appoint the new Governor directly (this is the normal way such appointments are made in other countries).  Getting the right person to lead these reforms is vital and there is no reason to think people like the current Board would deliver that person.

And just briefly on the substantive issue: the reason we have active discretionary monetary policy is because people have judged, over decades, that, were we not to do so, output and employment would be much more variable, and in particular recessions –  and periods of high unemployment –  would be more more savage and sustained than they need to be.   That is not a novel proposition now, and it isn’t even a particular controversial one (although some free bankers will point out that, say, the worst US recessions have been since the central bank was set up) –  it is a standard insight of modern macroeconomics.  Greeece is a particularly nasty example of the alternative approach.   That’s why I’m uneasy about those defending a single price stability goal for monetary policy: it may well be the medium-term constraint on what else monetary policy can do, it is one of desired outcomes we want to preserve (I say preserve because sustained inflation is a phenomenon of the central banking era, whereas longer-term price stability was a feature of earlier centuries), but it isn’t the main reason why we have active discretionary central banks.  We have such institutions primarily because we care about minimising the bad times –  sustained periods of excess capacity and high unemployment.  We aren’t –  or shouldn’t be – averse to booms (except to the extent they portend busts) but we should be, and mostly are, very averse to significant deviations from “full employment”.  Keeping unemployment as low as the other labour market institutions (welfare systems, minimum wages etc) allow could reasonably be seen as the primary goal of monetary policy.     Rising inflation would then be an indicator that the central bank had overdone things, and thus price stability represents a useful constraint or check on over-optimism about how low the unemployment rate can be got at any particular point in time.   At present however, defenders of the current specification of the goal can almost come across as if it is a point of virtue not to care, let alone to mention, about those who are unemployed.

Things were a little different in 1989 when Parliament was first debating the Reserve Bank legislation. Arguably it made a lot of sense then to put in a single goal of price stability –  because having lost sight of the constraint (price stability) in earlier decades, it was important to establish confidence that inflation would in future be taken very seriously.    That isn’t the main message we, the markets, or the Reserve Bank need to hear after years of below-target inflation, and even more years of above-NAIRU unemployment rates.

So although I have a great deal of respect for Don Brash, and these days count him as a friend, on this occasion I think he’s wrong and Grant Robertson is much closer to right.

Debating housing

The centrepieces of the two weekend TV current affairs shows were political debates: The Nation had Phil Twyford and Amy Adams on housing, and Q&A had Grant Robertson and Steven Joyce on the economy more generally (but with a large chunk on housing).   I only saw the Q&A debate, but I have glanced through the transcript of Twyford/Adams.

In the course of his debate, Phil Twyford was asked how much house prices should be relative to income.    His response was excellent

Twyford: Ideally, they should be three times. If we had a housing market that was working properly, your housing would be— the median price would be about three to four times the median household income.

Grant Robertson repeated those sorts of numbers in his exchange with Steven Joyce.  It was good, clear, encouraging stuff.    A reminder of just how totally out of whack things are in the New Zealand house and urban land market.   And a suggestion that the main opposition party wants things to be materially different and better.

But I can’t help wondering in which decade they expect things to be more or less okay again.   In time for, say, my children –  perhaps 10 to 15 years from now –  or will it only be the grandchildren?

Don’t get me wrong.   Watching the Robertson/Joyce debate, as someone who has no idea who he will vote for, I thought Robertson had much the better of the housing side of the debate.   The current government seems reduced to some mix of lamenting that it is “a global problem”, reluctantly conceding that Auckland prices are a bit too high, and claiming that just over the horizon there is a wave of supply that will substantially address the problems.   So if I’m critical of Labour here, take for granted that almost all the criticisms apply with more force to National.

Here is Phil Twyford avoiding suggesting that Labour wants house prices to come down

So is it Labour’s goal to get it down to that – about four times?
Twyford: We want to stabilise the housing market and stop these ridiculous, year on year, capital gains that have made housing unaffordable for a whole generation of young Kiwis.
But in essence, you’re going to drop the value of houses, if you want them to be four times the price of the average income.
Twyford: Well, we’re going to build through KiwiBuild. We’re going to 100,000 affordable homes.
I want to come to KiwiBuild in a moment. I just want to talk to you about the price.
Twyford: That will make housing affordable for young Kiwi families. That’s our policy.

Stabilising the housing market, and ending rapid house price appreciation, isn’t a recipe for fixing up the housing market for the current generation of young people.

Grant Robertson was much the same –  reiterating the goal of house prices of 3 to 4 times income, but he couldn’t or wouldn’t say how long it would take.  There was plenty of talk about building “affordable houses” (around $600000?) and “cracking down on speculators” and beyond that it all seemed to be down to growing incomes.   But there wasn’t even a mention of freeing up land supply –  a topic where formal Labour policy looks better than anything else on offer from major parties.  Even though, the largest single component in the increase in New Zealand (especially Auckland) house prices has been the land component.

On the other side of the exchange Steven Joyce was taunting Robertson with the suggestion that “Labour wants to crash house prices with a punitive capital gains tax” –  as if, whatever the (de)merits of a CGT, much lower house prices would be the worst thing in the world.

Lifting growth in productivity and real incomes is highly desirable.   All else equal, flat nominal house prices and faster income growth is a recipe for improved housing affordability.  But how long might it take on reasonable assumptions?

I’ve shown similar charts on this point previously.  Here I assume a starting point of a price to income ratio of 10 (around current Auckland levels) and that (a) nominal house prices hold at current levels for the indefinite future, and (b) incomes grow at a rate equal to 2 per cent (midpoint inflation target) plus the rate of economywide productivity growth.  I’m just going to assume that the 2 per cent average inflation could be achieved quite easily if the government wanted to. Productivity is the harder issue.  Here I’m showing four lines using:

  • actual productivity growth (GDP per hour worked) over the last decade (just under 0.6 per cent per annum),
  • actual productivity growth over the last thirty years (for which we have quarterly real GDP and hours data), of just under 1.2 per cent per annum,
  • productivity growth of 1.5 per cent per annum, and
  • productivity growth of 2 per cent per annum.

The straight line on the chart is at a price to income ratio of 3.5 (ie the midpoint of the 3 to 4 times income Labour is talking of).

house price to income ratio with flat nominal house prices

On the best of these scenarios, price to income ratios get to 3.5 in about 27 years time.   If we manage productivity growth equal to that for the last 30 years –  which itself would be quite an achievement at present – we’d be waiting almost 35 years.

Affordable housing, and a functional housing market, for the current generation simply requires a fall in nominal house prices.   And yet no major party politicians seems to have the courage, or the self-belief (in their ability to communicate and take people with them), to make that simple point.

For most existing home-owners, the market value of their house does not matter a great deal.  A large proportion of home-owners have a modest mortgage or none at all, so negative equity isn’t a risk.  And since most people retire in the same city they’ve spent their working lives in, their house price doesn’t even affect very materially their own expected future purchasing power.

Fear of falling house prices seems to reduce to two particular dimensions:

  • people who, having bought in perhaps the last five years, would find themselves with negative equity if house prices fell markedly (in turn divisible between new owner-occupiers and purchasers of additional rental properties), and
  • some generalised fear that a fall in house prices goes hand in hand with economic disaster, serious recessions and the sort of experience the US or Ireland had.

The latter is mostly a category error.  In both the US and Ireland, there was material overbuilding (excess stocks of actual houses).  There is no prospect of that situation in New Zealand on any of the policies of the major parties.  In Ireland, the situation had been compounded by joining the euro, which gave Ireland interest rates set in Frankfurt that bore no relationship to the needs of the Irish economy.  In the US, there had been persistent official efforts –  from Congress, the Fed, and successive Administrations –  to encourage, or compel, the financial system to take on housing lending risk that the private sector would be unlikely to have assumed willingly.   None of that resembles New Zealand.  Not only do we set our own interest rates, but to the extent there is state involvement in the housing finance market it is reducing the supply of credit.

A severe recession could, at least for a time, lower New Zealand house prices.  Recessions –  severe or otherwise –  aren’t things to welcome.  But the sort of land market liberalisation (with associated infrastructure rules) that might, as a matter of policy, set out to materially lower New Zealand house and land prices would be most unlikely to materially dampen demand or economic activity.  If anything, it could represent a material boost to demand, as building became more affordable.   (And if some people would find themselves with negative equity, whole swathes of younger generations would suddenly face new opportunities and less of a desperate need to save.)

What about the people facing negative equity?  I don’t have any particular sympathy with those who’ve purchased investment properties in recent years and might face being wiped out.   They’d have taken a business and investment risk –  in this case on the regulatory distortions never being fixed –  and lost.  That happens in all sorts of market –  think of the people with exposures to shares after 1987, or in finance companies 10 years ago.  Or those with businesses based in import licenses in earlier decades.  It is tough for them individually, and almost all of them have votes.  But it was a business risk, and a conscious voluntary choice.

I’m much more sympathetic to those who bought a first house and could face a large chunk of negative equity.    I touched on this in a post a few weeks ago

No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.

Those numbers were made up on the the fly, but even on later reflection they look like a reasonable basis for something that might not be unreasonable, and also might not be unbearably expensive.  It would recognise that people need to bear some material risk themselves (a 25 per cent fall in nominal house prices is not small).  But it is also designed in recognition of the fact that since 2013, it has been hard for first home buyers to get a mortgage above an initial LVR of 80 per cent, so that not many would be in negative equity now even if house prices fell by 25 per cent from here.

Since many people will stay in their existing house for a long time if they have to, and the scheme only compensates if the house is sold, that also limits the potential fiscal cost.  In fact, the biggest pool of owner-occupiers who would sell at a material loss would be those forced in the event of new severe recession (unemployment is typically the biggest threat to the ability to service mortgage debt) and (a) those people would naturally command a degree of public sympathy and (b) land liberalisation would be a stimulatory policy, reducing the chances of a near-term future recession.  There would be some voluntary sellers, to capture the compensation, but the cost of selling and buying a house, and of moving house, is not trivial.   If 100000 households were to claim the maximum compensation of $100000 that would be total additional government expenditure of around $1 billion, spread over a considerable period of time.   And to claim $100000, you’d have to have bought say a $1 million first house and seen house prices fall 45 per cent from your entry price.

It isn’t a perfect scheme by any means, and lots of details would need to be fleshed out.   One could relatively easily restrict it to apply only to those in a first owner-occupied house, again the people who will naturally command the most sympathy anyway.    But if something of this sort could be done for, say $1 billion, and it helped the pave the way for a genuine structural fix in the housing market –  a willingness to actively embrace lower house prices –  it would seem likely to offer more value than, say, the least valuable of the proposed 10 new “roads of national significance”, which are estimated to cost on  average just over $1 billion each.  How much congestion is there on the existing road from Levin to Sanson?

And three final points on housing:

  • it was depressing to read the housing section of Jacinda Ardern’s campaign opening speech.  It wasn’t the focus of her speech, but –  just like Andrew Little at his conference speech earlier in the year –  there was reference to dealing to “speculators”, barring foreign purchasers, and to the state building more houses, but not a word –  not even hint –  about freeing up the land market in a way that might make those price to income aspirations achievable,
  • it was slightly strange listening to Robertson and Joyce debating the possibilities of a capital gains tax, focused on housing.  Weirdly Robertson didn’t take the opportunity to rule out applying a CGT to unrealised gains –  even though he surely really realises that, whatever the theoretical appeal, there is no way anyone is going apply a CGT to anything other than realisations.  But it was even more strange to hear this debate going on after both sides were insisting they “had a plan” to fix housing.  If they really did then surely there would be few/no systematic capital gains in the housing market for decades to come?
  • and finally, Steven Joyce ran his line that house prices are a global problem.  This seemed to be a variant of the sort of “problems of success” line John Key often ran.  Out of curiosity, I dug out the OECD’s real house prices series this morning.   They don’t have data for quite every country, but here is the change in real house prices from 2007 to 2016 (annual data) for the countries they have the data for.    There are a few countries that have done worse, but not many.  In the median OECD country, real house prices have fallen over the last decade.

house prices last decade

Mostly, the countries that have been about as bad as us have also had quite rapid population growth (Israel, Australia and Luxembourg in the lead on that count) –  not, of course, that either Finance spokesperson suggested doing anything about that.

What about a longer-term comparison.  There are lots of gaps in the OECD data for earlier decades, but here are real house prices increases for the countries they have data for over the three decades to 2016.

house prices since 86

Worst of them all, without even the income growth to match.

We need to face up to the importance of lowering house prices, of adopting policies likely to sustainably make that happen, and – if necessary –  consider compensation packages for some to help make that transition possible.

A fresher approach for ordinary New Zealanders

I’m as fascinated by the rise of Jacinda Ardern as any other political junkie.  I’ve always been a bit puzzled, struggling to see what issue she has led or what blows she had managed to land on the government.    Then again, she seems to have something different –  perhaps even more electorally important.   I’ve been dipping into accounts of Bob Hawke’s rise –  the last case I’m aware of that where major opposition party changed leaders close to an election (in that case only four weeks out) and won.     It isn’t clear that Bob Hawke was a better Prime Minister than Bill Hayden might have been, or that David Lange was a better Prime Minister than Bill Rowling would have been, but in both cases the new leaders had something –  a degree of connection, engagement etc –  that the deposed leaders didn’t.     Reading the accounts of the last weeks of Bill Hayden’s leadership of the ALP, the party had become as disheartened and lacking belief in its own ability to win (despite still leading in the polls), as some suggest the New Zealand Labour Party had become.    Quite what the Ardern phenomenon amounts to I guess we’ll see over the next few weeks.  From her comments so far, I could imagine her campaigning as Hawke did –  both the upbeat theme of “reconciliation”, and the more cynical description in (sympathetic) leading Australian journalist Paul Kelly’s book “no avenue of vote-buying or economic expansion was left untouched”.

For now, we are told that the “Fresh Approach” slogan is apparently out, and a new slogan and some new policies are soon to be launched.  Since no party really seemed to be campaigning on policies that might make a real and decisive for ordinary New Zealanders’ prospects, in many respect a fresher approach should be welcome.  Of course, it rather depends what is in that policy mix.

My interests here are primarily economic.  In an interview with the Dominion-Post this morning, the journalist put it to Ardern that “National will campaign on its economic record. Is that where Labour is weak?”.     Perhaps it is Labour’s weak point.  But what sort of “record” is the government to campaign on?  An unemployment rate that, while inching down, has been above the level it was when they took office –  already almost a year into a recession –  every single quarter of their entire term?  An economy that has had no productivity growth for almost five years?     House prices that, in our largest city, have gone through the roof?  Exports that are shrinking as a share of GDP?    And, at best, anaemic per capita real GDP growth?   If it is a weakness for Labour, it must be in large part because (a) their messaging has been terrible, and (b) nothing they offer seems likely to make any very decisive difference to the mass of ordinary New Zealanders.

What might?   Here’s my list of three main sets of proposals.    An effective confident radical Labour Party could offer the public these sorts of measures –  in fact, on some points arguably only a left-wing party could effectively do so (Nixon to China, and all that).

  1. A serious commitment to cheap urban land and much lower construction costs.
    • In a country with abundant land, urban land prices are simply scandalous.   The system is rigged, intentionally or not, against the young and the poor, those just starting out.  Too many of Jacinda Ardern’s own generation simply cannot afford to buy a house.
    • To the extent that there are poverty and inequality issues in New Zealand, many of them increasingly trace back to the shocking unaffordability of decent housing.   With interest rates at record lows, housing should never have been cheaper or easier to put in place.
    • And yet instead of committing to get land and house prices down again, the Labour Party has been reluctant to go beyond talk of stabilising at current levels.  Talk about entrenching disadvantage……(and advantage).
    • It is fine to talk about the government building lots of houses, but the bigger –  and more fundamental –  issue is land prices.  It is outrageous, and should be shameful, for people to be talking of “affordable” houses of $500000, $600000 or even more, in a country of such modest incomes.  International experience shows one can have, sustainably, quite different –  much better –  outcomes, but only if the land market is substantially deregulated.
    • I don’t have any problem if people want to live in denser cities –  I suspect mostly they don’t –  but it is much easier and quicker to remove the boundaries on physical expansion of cities (while putting in place measure for the associated infrastructure).   Labour’s policy documents have talked of moves in this direction –  as National’s used to do –  but it is never a line that has been heard from the party leader.     If –  as I propose –  population growth is cut right back, there won’t be much more rapid expansion of cities, but make the legislative and regulatory changes, and choice and competition will quickly collapse the price of much urban, and potentially developable, land.
    • It is clear that there is also something deeply amiss with our construction products market –  no one seriously disputes that basic building products are much more expensive here than in Australia or the US.  Make a firm commitment to fix this.  Perhaps it involves Commerce Commission interventions (supported by new legislation?)?  Perhaps it might even involve –  somewhat heretically –  a government entity entering the market directly.     But commit to change, to producing something far better for New Zealanders.
    • The vision should be one in which house+land prices are quickly –  not over 20 years –  headed back to something around three times income.  A much better prospect for the next generation.
    • No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.
  2. Deep cuts in taxes on business and capital income
    • the political tide is running the other way on this one –  calls for increased taxes on foreign multi-nationals and so on –   but it remains straightforwardly true that taxes on business activity are borne primarily not by “the rich”, but by workers, in the form of lower incomes than otherwise.  So if you really care about New Zealand workers’ prospects, cut those taxes, deeply.
    • and one of the bigger presenting symptoms of New Zealand’s economic problems is relatively low levels of business investment.   Taxes aren’t the only thing businesses  –  and owners of capital  –  think about, but they are almost pure cost.   Tax a discretionary activity and you’ll get a lot less of it.   That is especially true as regard foreign investment –  those owners of foreign capital have no need to be here if the after-tax returns aren’t great.  For all the (mostly misplaced) concerns about sovereignty, foreign investment benefits New Zealanders –  ordinary working New Zealanders.     Cut the tax rates on such activity  –  they are already higher than in most advanced countries –  and you’ll see more of it taking place.    More investment, and higher labour productivity, translates into meaningful prospects of much higher on-market wages –  the sorts of wages they have in the advanced countries we were once richer than.
    • simply cutting the company tax rate will make a material difference to potential foreign investors.   It won’t make much difference for New Zealanders’ looking to build or expand businesses here, because of our imputation system    That’s why I’ve argued previously for adopting a Nordic system of income taxation  –  in which capital income is taxed at a lower rate than labour income.  Note the description –  it is a system not run in some non-existent libertarian “paradise” but in those bastions of social democracy, the Nordic countries.  Not because they want to advantage owners of capital over providers of labour, but because the recognise the well-established economic proposition that taxes on capital are mostly borne in the former of lower returns to labour.
    • some argue against cuts to business taxes on the grounds that it will provide a windfall to firms (especially foreign firms) already operating here.  Mostly, that is false.  It might be true if foreign firms dominated our tradables sector –  where product selling prices are set internationally.  But in New Zealand, foreign investment is much more important in the non-tradables sectors.  Cut taxes on, say, the banks, and you’ll find the gains being competed away, flowing back to New Zealand firms and households in lower fees and interest margins.  If for some reason it doesn’t happen, feel free to invoke the Commerce Commission (and/or expand its powers).
    • much lower business taxes should be a no-brainer for an intellectually self-confident centre-left party serious about doing something about long-term economic underperformance and lifting medium-term returns to labour.     I’m not really a fan of capital gains taxes, but if you need political cover promise a well-designed CGT –  it probably won’t do much harm, especially if you take seriously the goal of delivering much cheaper houses and urban land (see above –  there won’t be many housing capital gains for a long time).
  3. Deep cuts to target levels of non-citizen immigration
    • This item might be entirely predictable from me, but it is no less important for that.    Labour started out with some rhetoric along these lines, but as I’ve noted previously what they actually came out with was a damp squib, that would change very little beyond a year or so.   So
      • Cut the number of annual residence approvals to 10000 to 15000 per annum –  the same rate, per capita, as in Barack Obama’s (or George Bush’s) United States,
      • Remove the existing rights of foreign students to work in New Zealand while studying here.
      • Institute work visa provisions that are  (a) capped in length of time (a single maximum term of three years, with at least a year overseas before any return on a subsequent work visa) and (b) subject to a fee, of perhaps $20000 per annum or 20 per cent of the employee’s annual income (whichever is greater).
    • In substance, you will be putting the interests of New Zealanders first, but you will also strongly give that impression –  a good feature if you are serious about lifting sustained economic performance, while being relentlessly positive about it, and about your aspirations for New Zealanders.
    • Change in this area would immediately take a fair degree of pressure off house prices, working together with the structural housing/land market reforms (see above) to quickly produce much much more affordable houses and land.  Markets trade on expectations –  land markets too.
    • You’ll also very quickly alter the trajectory of urban congestion –  those big numbers NZIER produced in a report earlier this week.
    • But much more importantly in the longer-term, you’ll be markedly reducing the pressures that give us persistently the highest real interest rates in the advanced world, and
    • In doing so you’ll remove a lot of pressure from the exchange rate.  Lets say the OCR was able to be reduced to around typical advanced country levels (say 0.25 per cent at present).  In that world, the NZD offers no great attraction to foreign (or NZ institutional) holders – it is just one of many reasonably well-governed countries, offering rather low interest rates.  In that world, why won’t the exchange rate be averaging 20 per cent (or more) lower than it is now?
    • And that should be an adjustment to be embraced.  Sure, it will make overseas holidays and Amazon books etc more expensive, but in sense that is part of the point.  We need a rebalanced economy, better-positioned for firms to take on the world from here.  Combine a lower exchange rate, lower interest rates, and lower business tax rates, and you’ll see a lot more investment occurring –  and firms successfully selling more stuff internationally.  And with more investment will come the opportunities for sustainably higher wages –  and all the good stuff the centre-left parties like to do with the fiscal fruits of growth.

I don’t suppose anything like this will actually be part of the fresher approach.  But if it were……we could really look forward to a better, more prosperous, and a fairer New Zealand.

Two sides of the same coin

When, a couple of months ago, the current National-led government announced plans to tighten immigration policy in several areas, I summed up the changes as “a modest step that ignores the big picture“.

Yesterday, the Labour Party announced the immigration policy it will campaign on.  I’d use exactly the same words to describe their proposals.  Some of the changes –  the largest ones –  seem broadly sensible, but they won’t come close to tackling the real problems with New Zealand’s immigration policy.

In some ways the biggest difference between the two parties’ approaches is that National provided us with no estimates about what impact their changes would have on numbers (and the Prime Minister apparently claimed yesterday they would,  in fact, have no impact on numbers), while Labour is touting large numerical impacts but not acknowledging that they will actually have little or no medium to long-term effect on the net inflows of non-New Zealand citizens.

In many ways, none of this should be a surprise.  The “big New Zealand” strategy, revitalised over the last 25 years, has been a bipartisan project.   On either party’s policy, it remains one.   There is really no material difference between them –  just details which, while not unimportant, don’t affect the underlying strategy.  A strategy which, to the extent it had an economic performance objective behind it (recall how MBIE used to call our immigration policy, “a critical economic enabler”), has simply failed.  There is no reason to expect anything much better if future if we keep on with the same policies.

What determines the medium-term contribution of immigration policy to population growth is the residence programme, which aims to give out around 45000 residence approvals each year.  The government cut that target a little last year.  Labour’s policy doesn’t even mention it.   At 45000 approvals, the programme is roughly three times the size, in per capita terms, of the equivalent programme is the United States (where about one million green cards are issued each year).

But what of the proposals Labour did put forward.  Their policy document is here.   It is misconceived from the first sentences where they state

Migrants bring to New Zealand the skills we need to grow our economy

Have they not seen the OECD data showing that New Zealanders are among the most highly-skilled people in the advanced world, and that –  on average –  immigrants are a bit less skilled than natives?    On the scale the New Zealand immigration programme attempts to operate at, the typical new additions to the labour force from non-citizen migration are not as highly skilled as the people who are already here, and our own young people who enter, and move up in, the workforce each year.   There are, of course, no doubt some exceptionally talented people.   But most are people from poorer countries looking for better opportunities here for themselves and their families –  typically, too, people who couldn’t get into the richer and more successful Anglo countries.  (None of this is a criticism of the migrants –  pursing the best for themselves and their families is probably what all of us seek to do too – but it is a criticism of the policy framework that enables such large inflows of not overly-skilled people.)

Mostly Labour’s policy seems to be about fixing some pretty dubious changes made to the student visa system over recent years.   In fact, three-quarters of the total numerical impact of their policy comes (on their own numbers) from student visa changes.

Labour will stop issuing student visas for courses below a bachelor’s degree which are not independently assessed by the TEC and NZQA to be of high quality.

Labour will also limit the ability to work while studying to international students studying at Bachelor-level or higher. For those below that level, their course will have to have the ability to work approved as part of the course.

Labour will limit the “Post Study Work Visa – Open” after graduating from a course of study in New Zealand to those who have studied at Bachelor-level or higher.

Mostly, those seem like a broadly sensible direction of change.   That said, I’m slightly uneasy about relying on bureaucratic agencies to decide whether courses are “high quality” –  in principle, surely the market can take care of reputational and branding issues?

And while it might look good on paper, I’m a little uneasy about the line drawn between bachelor’s degree and other lines of study.  It seems to prioritise more academic courses of study over more vocational ones, and while the former will often require a higher level of skill, the potential for the system to be gamed, and for smart tertiary operators to further degrade some of the quality of their (very numerous) bachelor’s degree offerings can’t be ignored.  In the student visa data we already see some slightly suspicious signs (bottom right chart) of switching from PTEs to universities  I’d probably have been happier if the right to work while studying had been withdrawn, or more tightly limited, for all courses.   And if open post-study work visas had been restricted to those completing post-graduate qualifications.

Selling education to foreign students is an export industry, and tighter rules will (on Labour’s own numbers) mean a reduction in the total sales of that industry.   Does that bother me?  No, not really.  When you subsidise an activity you tend to get more of it.  We saw that with subsidies to manufacturing exporters in the 1970s and 80s, and with subsidies to farmers at around the same time.  We see it with film subsidies today.  Export incentives simply distort the economy, and leave us with lower levels of productivity, and wealth/income, than we would otherwise have.   In export education, we haven’t been giving out government cash with the export sales, but the work rights (during study and post-study) and the preferential access to points in applying for residence are subsidies nonetheless.  If the industry can stand on its own feet, with good quality educational offerings pitched at a price the market can stand, then good luck to it.  If not, we shouldn’t be wanting it here any more than we want car assembly plants or TV manufacturing operations here.

Labour estimates that their changes to student visas and post-work study visas will reduce numbers by around 17000, roughly evenly split between the two classes of changes.  But what they don’t tell you is that these will be one-off reductions in the total number of people here on those visas.    Since the number of people who settle here permanently is determined by the residence approvals programme, and that hasn’t changed, the changes Labour is promising around student visas –  while broadly sensible –  while make a difference to the net migration flow in the first year they are implemented (the transition to the lower stock level) and none at all thereafter.   They might change, a little, who ends up with a residence visa, but not how many are issued.  If you favour high levels of non-citizen immigration but just want the “rorts” tidied up, it makes quite a lot of sense.

The changes Labour proposes to work visas are also something of a mixed bag.  They are promising (but with few/no specifics) to make it harder for people to get work visas

Since 2011/12, the number of low-skill (ANZSCO 4 and 5) work visas issued has surged from 14,000 to 22,000. For example, the number of “retail supervisor” work visas has increased from 700 to 1,700. Labour will work with firms to train New Zealanders to fill skills gaps so we don’t have to permanently rely on immigration. A developed nation should be able to train enough retail staff to meet its own needs. Immigration should be a stop-gap to meet skills shortages, not a permanent crutch.

Labour will make changes that preserve and enhance the ability of businesses to get skilled workers to fill real skills gaps but which prevent the abuses of the system that currently happen.

The broad direction seems sensible enough –  after all, the official rhetoric about the gains from immigration relate to really highly-skilled people, but what does it mean specifically?

And I get much more wary about proposals to move to a more regional approach (on top of the additional points for regional jobs the government introduced last year, thus further reducing the skill level of the average migrant).  This is what they say:

Currently, few skill shortages are regionalised. This makes it hard for a region with a skills shortage in a specific occupation to get on the list if the shortage is not nationwide. Importantly it means that work visas are issued for jobs in regions where there is not actually a shortage which puts unnecessary pressures on housing and transport infrastructure there.

Labour’s regionalised system will work with local councils, unions and business to determine where shortages exist and will require that skilled immigrants work in the region that their visa is issued for. This will prevent skills shortages in one region being used to justify work visas in another, while also making it easier for regions with specific needs to have those skills shortages met.

Where skills shortages are identified, Labour will develop training plans with Industry Training Organisations so that the need for skilled workers is met domestically in the long-term. We will invest in training through Dole for Apprenticeships and Three Years Fees Free policies.

Frankly, it seems like a bureaucrat’s paradise, and just the thing for influential business groups that get the ear of some local council or other.  It is hard enough to ensure that local authorities operate in the interests of their people, without setting up more incentives that will allow local authorities to be used to pursue the interests of one particular class of voters.

More generally, it is an approach that suggests no confidence at all in market mechanisms to deal with incipient labour market pressures.  There is no suggestion in the document, at all, that higher wages might be a natural adjustment mechanism, whether to deal with increased demand in a particular region or for a particular set of skills.  Even the Prime Minister was running that line recently  –  and he isn’t from the party supported by the union movement.

Again, changes to reduce the number of work visas granted to people for fairly low-skilled occupations aren’t a bad thing, but they won’t make any difference to the average net inflow of non New Zealanders beyond the initial (quite small) one-off level adjustment.     And there is no willingness to rely on market mechanisms –  eg set a (say) $15000 per annum fee, and allow limited work visas for jobs where the employer is willing to pay the taxpayer that additional price.

There were two other initiatives in the package.  The first was the proposed new Exceptional Skills visa.

Labour will introduce an Exceptional Skills Visa. This visa will enable people with exceptional skills and talents that will enrich New Zealand society — not just its economy — to gain residency here. 

It will be available to people who can show they are in an occupation on the long-terms skills list and have significant experience or qualifications beyond that required (for example, experienced paediatric oncologist) or are internationally renowned for their skills or talents. Successful applicants will avoid the usual points system requirements for a Skilled Migrant Category visa and would be able to bring their partner and children within the visa. This visa will help grow high-tech new industries, meet the increasingly complex needs of the 21st Century and enrich our society. Exceptional Skills Visas for up to 1,000 people, including partners and children, will be offered every year

When I first saw reference to this I was quite encouraged.  And if it makes a little easier for people who are genuinely highly-skilled to get first claim on those 45000 residence approvals each year, then I don’t have any problem with it.   But it isn’t exactly the American exceptional ability visa, and we need to be realistic about New Zealand’s relative attractiveness (or lack of it) to people with really exceptional talents.   The suggestion that the programme will “help growth high-tech new industries, meet the increasingly complex needs of the 21st century” is probably little more than late 20th century vapourware.

As for the proposed KiwiBuild visas, I suppose they were politically necessary. You leave yourself open if you campaign on both big reductions in migrant numbers, and massive increases in house-building, if you don’t prioritise construction workers.  In fact, of course, this programme makes a one-off reduction in the number of people here –  reductions concentrated in the population group that probably has the least housing needs..  None of the medium-term pressures will have been eased at all, even if some dodgy rules around students do end tightened.

In passing, I was also interested in this comment

We will investigate ways to ensure that the Pacific Access Quota and Samoan Quota which are currently underutilised are fully met.

I guess there are really large numbers of Pacific voters in Labour’s South Auckland heartland.    These Pacific quotas, again, lower the average skill level of those we given residence approval too (since people only come in on those quotas if they can’t qualify otherwise, all within the 45000 approvals per annum total).  I imagine, too, that the Australian High Commission will have taken note of that line.

Overall, some interesting steps, some of which are genuinely in the right direction.  But, like the government, Labour is still in the thrall of the “big New Zealand” mentality, and its immigration policy –  like the government’s – remain this generation’s version of Think Big.  And it is just as damaging.    The policy doesn’t face up to the symptoms of our longer-term economic underperformance –  the feeble productivity growth, the persistently high real interest and exchange rates, the failure to see market-led exports growing as a share of GDP, and the constraints of extreme distance.  None of those suggest it makes any sense to keep running one here of the large non-citizen immigration programmes anywhere in the world, pulling in lots of new people year after year, even as decade after decade we drift slowly further behind other advanced countries, and se the opportunities for our own very able people deteriorate.

But that is Labour’s policy.  And that is National’s policy.

For anyone interested, the Law and Economics Association is hosting a seminar on immigration policy and economic performance on Monday evening 26 June.   Eric Crampton of the New Zealand Initiative and I will be speaking.  Details are here.

UPDATE: Here is what I said to Radio New Zealand yesterday afternoon on immigration, in a reasonably extended interview, partly on Labour’s announcement, but mostly on the more general issues.

Labour on housing

There was nothing positive to be said about the previous Labour-led government’s approach to housing and house prices.  There is nothing positive to be said about the current National-led government’s approach.  The rhetoric while they were in Opposition had been encouraging.  The substance of reform has been almost non-existent, all the while cloaked in fairly brazen, even offensive, rhetoric from both Prime Ministers (Key and English) suggesting that it was all a mark of success, a quality problem, and so on, along with suggestions that the government’s approach was working.    By that standard, I hope I don’t live to see a failed housing policy.

There have been some hopes, in some circles, that the Labour Party, if they were to lead a new government after this year’s election, might be different.  Their housing spokesman seems pretty impressive, and seems to understand the issues.  In a no doubt mutually beneficial move, he and Oliver Hartwich, head of the business-funded New Zealand Initiative, even did a joint op-ed on freeing-up the market in urban land.   Places where landowners can use their land pretty freely tend not to have the sorts of grossly dysfunctional housing markets New Zealand (and Australia, and the UK, and much of the US east and west coasts) have, even if those places are big and fast-growing.

I’ve liked the talk, but have been a bit sceptical that it will come to much.  In part, I’m sceptical because no other country (or even large area) I’m aware of that once got into the morass of planning and land use laws has successfully cut through the mess and re-established a well-functioning housing and urban land market.  In such a hypothetical country, we wouldn’t need multiple ministers for different dimensions of housing policy.  I’m also sceptical because there is a great deal local government could do to free up urban land markets, but even though our big cities all have Labour-affiliated mayors, there has been no sign of such liberalisation.    The Deputy Mayor of Wellington for example leads the Wellington City Council ‘housing taskforce”.  Paul Eagle is about to step into a safe Labour seat.   His taskforce seems keen on the council building more houses, and tossing more out subsidies, but nothing is heard of simply freeing up the market in land.  Or even of looking for innovative ways to allow local communities to both protect existing interests and respond, over time, to changing opportunities.

I first wrote about this last October, when Phil Twyford had put out a substantial piece on Labour’s housing programme.   There was a five point plan.  Reform of the planning system appeared on the list, but briefly and well down the list.    As I noted then

It has the feel of a ritual incantation –  feeling the need to acknowledge the point –  rather than being any sort of centrepiece of a housing reform programme.

Yesterday, my doubts only intensified.  Labour’s leader, Andrew Little, devoted the bulk of his election year conference speech to housing, complete with the sorts of personal touches audiences like (although he didn’t mention the tasteful lavender out the front of his current house, which I walk past each day).  Media reports say the speech went down well with the faithful.

This time there was a four point plan.  It was a lot like Twyford’s plan from late last year, with one omission.   The continuing features were:

  • the state building more “affordable” houses,
  • restrictions on “overseas speculators” buying existing houses,
  • making “speculators who flip houses with five years pay tax on their profits,
  • “ring-fencing” losses on investment properties.

But in the entire speech –  and recall that most of it was devoted to housing –  there was not a single mention of freeing up the market in urban land, reforming the planning system etc.  Not even a hint.    I understand that giving landowners choice etc probably isn’t the sort of stuff that gets the Labour faithful to their feet with applause.   But to include not a single mention of the key distortion that has given us some of the most expensive (relative to income) house prices in the advanced world, doesn’t inspire much confidence.     Planning reform isn’t going to be easy.  Few big reforms are under MMP.  It probably isn’t something the Greens are keen on.  And if the putative Prime Minister isn’t on-board, hasn’t yet internalised (or even been willing to simply state it openly) that this is where the biggest problems lie, it is hard to believe that a new government would really be willing to spend much political capital in reforming and freeing up the system, no matter how capable, hardworking and insightful a portfolio minister might be.

Probably reforms of this sort don’t play well in focus groups (although surely there is some responsibility on political leaders to help shape the debate, and change what people respond positively to?)   On the other hand, presumably the data suggest that people react well to attacks on “speculators”, “loopholes”, “subsidies”, which appeared numerous time in Little’s speech.

The headlines around the speech were around the leader’s official confirmation that Labour will prohibit people from offsetting tax losses from investment properties against other non-property income.   This is, apparently, to “close a loophole” to stop “speculators” receiving “subsidies”.     In fact, it is nothing of the sort.

For better or worse, New Zealand has a comprehensive income tax system in which different types of factor income are treated much the same, and taxed at much the same rate.  There are various exceptions, and lots of devil in the detail (thus, for example, the establishment of the PIE regime a decade or so gave an advantage to funds in widely-held entities over individually-held assets).  It has long been pretty fundamental to that system that one tots up all the gains and losses over the course of the year, and then pays tax only on the overall net income.  It would be absurd, for example, to take a business with five operating divisions and tax them on the basis only of the lines of business that made profits, even though several of the other divisions may have made large losses.    Since time is money, it wouldn’t be much consolation to say “oh, don’t worry, you can offset those losses against future profits in those particular operating divisions”.

But that is just what Labour proposes to do.    There is no “subsidy”, there is no “loophole”.   There is simply a conventional comprehensive income tax system at work.  If you lose money on one activity, you can offset it against gains on other activities.

And, if you are concerned about favourable tax treatments then, within the comprehensive income tax model, the clear and unambiguous feature of the tax system that favours one group of potential house purchasers over another is the non-taxation of imputed rents on owner-occupied houses.    Relative to other potential purchasers, this feature provides a big advantage to unleveraged owner-occupiers (ie mostly those in late middle age and the elderly).   This isn’t some idle Reddellian claim.  You can see the calculations worked out carefully in a Reserve Bank discussion paper, The tax system and housing demand in New Zealand, from a few years ago, showing how the features of the New Zealand tax system affect what different types of potential purchasers will be willing to pay.

Within a comprehensive income tax system, I’m at a loss to understand the economic logic behind Labour’s proposed policy.  Presumably it will be fine to buy a farm (or shares in a farm) and offset losses on that investment against labour income?  Presumably it will still be okay to set up a small sideline business which makes losses for several years in the establishment phase, and to offset those losses against labour income?   But not for residential investment properties (or, one assumes, for shares in companies mainly devoted to holding such properties?)   Even though setting oneself up as the owner of an investment property, renting a house to tenants, is a small business.  In fact, it is a way that many people get into business, taking risks to get ahead.

Much of the discussion in the time since Little gave his speech has been on what sort of people will be affected –  whether it is the evil “speculators”, as opposed to “Mum and Dad”.  I’m not sure if there is much data available on that in New Zealand, but they are having a very similar debate in Australia, and I was interested to see a list from Australian Tax Office data published on the ABC website as to who had claimed rental losses in Australia, by occupational group.  People can make of it what they will.  The occupational groups most likely to claim rental losses in 2013/14 were anaesthetists (28.7 per cent of them).  But 22 per cent of Police did as well.

I’m opposed to ring-fencing, if we are going to have a comprehensive income tax system.  And, I’m doubly opposed to singling out housing for ring-fencing.   If there is an economic logic to ring-fencing, apply it more generally or leave it alone.  As it happens, we tried something similar before.  From 1982 to 1991, there were restrictions put on loss-offsetting against labour income for “specified activities” (at the time, the bugbear was people investing in things like kiwifruit orchards).  Even then, loss-offsetting was limited to $10000 per annum (rather than zero).

Are there problems with the current tax treatment?  Arguably so.  Some would claim that the absence of a full capital gains tax is such a distortion, allowing people to run operating losses in the expectation of future capital gains.     As it happens, Labour proposes to address that by, in effect, imposing a capital gains tax on any sales of investment properties within five years (presumably these are typically the “speculators”).  But even if they weren’t, the argument still fails.  In even a moderately efficient market, there are no rationally-expected real future capital gains on offer across the market as a whole.  If there were, people would bid up the prices further now to take advantage of (and thus eliminate) those gains.     There are windfalls –  gains and losses –  from large actual changes in capital values of assets, but it isn’t a systematic distortion in the system.     (In principle, I don’t have too much problem with a capital gains tax that (a) applies only to real (inflation-adjusted) gains, (b) applies on a valuation basis rather than a realisations basis, and (c) treats gains and losses symmetrically.  In practice, no such systems exist).

Where there is a systematic distortion in the system is around the treatment of inflation.  In an ideal system, there would be no systematically expected inflation.  In practice, we have an inflation target centred on 2 per cent annual inflation.  As a result, roughly speaking, nominal interest rates are around 2 percentage points higher than real interest rates, and real assets should be expected to increase in value by around 2 per cent per annum, even if there is no change in their real value.      The two percentage point component of interest rates that is just inflation compensation isn’t real income (no one is better off as a result of receiving it; no one’s purchasing power is improved).  And yet it is taxed as real income.  And for those borrowers who can deduct expenses, interest is fully deductible, even though the inflation compensation component doesn’t reduce the borrower’s real income.   That is a systematic advantage to such borrowers, and one for which there is not a shred of economic logic.

In my preferred approach, the inflation compensation component of interest income would not be taxed.  And the inflation compensation component of interest expenses would not be tax deductible for anyone.    As the Reserve Bank discussion paper I linked to earlier showed, this change alone would make quite a substantial difference to how much highly-geared investment borrowers would be willing to pay.  And it would be a genuine improvement in the comprehensive income tax system as well, without singling out on class of purchasers of one class of asset.

But it is worth bearing in mind, that none of these issues can explain anything about house price inflation behaviour in the last 10 or 15 years.  Over that period:

  • the loss-offsetting rules have been much the same,
  • the introduction of the PIE system disadvantaged individual holders of investment properties relative to, say, holders of financial assets in PIE vehicles,
  • in 2005, the tax depreciation rules were tightened,
  • from 2010, depreciation on properties was no longer tax deductible,
  • the inflation target was raised in 2002, but for the last eight or nine years, inflation expectations have been trending down again,
  • maximum personal income tax rates were also cut in 2010 (reducing the value of deductibility and loss-offsetting).

Any of these “distortions” should be capitalised into the price pretty quickly once they are announced and understood,  The only new measures in the last decade or so have reduced the relative attractiveness of property investment  (and that is before even mentioning LVR controls).  It typically takes shocks to displace markets.  In principle, the advent of non-resident foreign purchasers could have been an example (in the presence of supply constraints), but we don’t have good data.  So could unexpected population growth.

We should probably also be sceptical as to how much difference ring-fencing, as Labour propose, might make.  When I was at the Reserve Bank we came and went in our views on tax issues around housing.  But the one consistent observation over the years was to point out that many different countries had quite different regimes for the tax treatment of housing.  Some allowed loss-offsetting, some didn’t.  Some had capital gains taxes, some didn’t (and all those who did had various different rules).  Some had differential income tax rates for capital and labour income. Some even made a stab at taxing imputed rentals.  But it wasn’t obvious that the differences in tax treatments explained much about the levels of house prices, or about cycles in them.    And in a well-functioning land market, land –  the asset value that is, in principle, affected by tax system changes –  is only a fairly small component of a typical house+land price.

What tax rules do is affect who owns which assets.  Thus, for decades our tax system has tended to treat all owners of investment properties pretty equally.   Loss-offsetting was part of that.   But so was the fact that we didn’t give favourable tax treatment (generally) to insurance companies and superannuation funds.  In many countries, assets held in those sorts of vehicles are more lightly taxed.  Not surprisingly, managers of those vehicles can afford to pay more for the assets, and a larger share of the assets end up in such vehicles.

Ring-fencing rules can be expected to have similar effects.     If “Mum and Dad” with one investment property can’t offset a bad year’s losses against other income, but have to carry it forward and wait for a good income year from property, while a superannuation fund with lots of investment properties can (either because it is less leveraged or because losses on some properties can be offset against profits on others) more properties will be held in such vehicles.  It isn’t clear what the public policy interest is in such an outcome?  More generally, the change will disadvantage people starting out in the rental services businesses relative to those who are better-established and have larger equity.

In the end, so-called “speculative” opportunities, on any sort of widespread scale, arise mostly because governments got themselves into the land market, and by regulatory interventions, disabled the market from working smoothly to increase supply in response to increases in demand, or changes in tastes.   Wouldn’t it be better, more in the interests of middle New Zealand (and economic efficiency) to address the problem at source –  fix the regulatory failures –  rather than falling back on rhetoric about speculators and subsidies, which at best in tackling symptoms, not grappling with causes?

Fix up the planning system and all this will be yesterday’s issue.  Fix up the inflation distortion and you’ll also have a better tax system.  But if the planning system isn’t fixed then, whatever other short-term stuff Labour does (including immigration changes) will only provide temporary relief, and in a few years time we’ll be back with the same old housing affordability problems.  What a lost opportunity that would have been.

PS.  I see that Labour is invoking the Reserve Bank in support of ring-fencing.  Perhaps the current Governor does favour such a change –  although we’ve not seen any economic analysis in support of it from them –  but if so, it is an example of a proposal which the Bank was against before it was for.    In 2005, at the request of the then Minister of Finance, a group of senior Reserve Bank and Treasury staff was asked to review policy options for dealing with house prices.  I was part of that group (as was Adrian Orr, and incoming acting Governor Grant Spencer, and the current Chief Economist at The Treasury).  There is a nice treatment of the ring-fencing issues on pages 19 to 22 of our report.

 

 

Reducing non-citizen immigration by “tens of thousands”

Debate around New Zealand immigration policy continues to heat up.  That is what one should not only expect, but hope for, in an election year, especially in a country where non-citizen immigration is such a significant economic instrument, contributor to population growth etc, and even more so where –  despite all the talk of a skills-led immigration programme to lift overall New Zealand productivity – our productivity performance remains woeful.   And it isn’t as if the Think Big immigration experiment is a new thing, so that the gains might be just over the horizon (“the cheque is in the mail”).  Rather, the last few years have just been a somewhat intensified version of a strategy adopted for almost 30 years now.   Serious debate is long overdue.

Of course, some want to pretend that to pose any questions, raise any doubts, propose any cutbacks, about one of the most aggressive immigration programmes anywhere in the world is somehow “xenophobic”.  That’s just nonsense.  No doubt there are all sorts of reasons why some are in favour of large scale migration –  I’ve read New Zealand perspectives along those lines from libertarians and  from Marxists –  and all sorts of reasons why different people might now have some significant doubts.    Lack of any good robust evidence that New Zealanders have benefited economically from the large scale non-citizen immigration is only one of those reasons.     But when an experiment hasn’t shown clear signs of working after almost 30 years, it is almost a definition of insanity to expect different outcomes in future from keeping on doing the same thing.  And, while house prices shouldn’t be the main issue, for all the talk from the pro-immigration people that we should just “build more houses” (or free up the land) –  which I happen to agree with –  there is no sign at all of it happening to any great extent.  And it hasn’t in other places that got themselves into the mire of “town planning” and land use restrictions.

The government is keen to suggest that much of the high net migration numbers is about a return of New Zealanders from abroad.  In fact, of course, all that has happened is that the net flow of New Zealanders has slowed down (to near zero) at present.    Basically, all the 71000 or so net arrivals over the last year have been non-New Zealand citizens.   Here is the chart I’ve run many times before.

plt by citizenship apr 17

Over the last three months there has been an annualised net inflow (seasonally adjusted) of 75280 non-citizens, on a PLT basis.    (Relative to history it isn’t quite as high as it looks –  later SNZ research showed that in the 2002/03 boom there were more net permanent and long-term arrivals than the self-reported arrival/departure card estimates suggested –  but it is a large number, and large as a share of the population). That is around 35000 per annum more than were coming in, on average, in the decade prior to around 2012/13.       Almost all those non-citizens who come here require a discretionary decision by the New Zealand government (the exception being Australian citizens, for whom there is a long-term New Zealand government decision to allow free access).

Too few commentators focus on these non-citizen numbers.     Each of the main opposition parties seem to talk in terms of targeting the overall net PLT inflow.  NZ First talk in terms of, I think, 10000 to 15000, the Greens talk of 1 per cent of population, and now it appears that Andrew Little is talking of a target net inflow of around 20000 to 25000.      As I’ve noted before, and as many others have also argued, it is all but impossible, and not very sensible, to try to target the net PLT flow, and certainly not on a year to year basis.  The decisions of New Zealanders –  in turn heavily influenced by the state of the Australian labour market –  often play the largest role in fluctuations in the PLT numbers, and we don’t, can’t and shouldn’t try to control what New Zealanders do.

It is relatively straightforward, as a technical matter, to materially reduce (even by “tens of thousands”  –  Little’s language)  the net and gross inflow of non-citizens.  I outlined my own preferred approach in a post a week or two back.    Frankly, I’m a little sceptical that you could make quite that much difference if one focused narrowly on work visas, but even they offer a lot of potential.

The centrepiece of our medium-term immigration policy is the residence approvals programme.    Current policy is to offer around 45000 residence approvals each year.   Most of those approvals are offered to people who are already in New Zealand –  either on work or student visas  –  but over time it is the number of residence approvals on offer that largely determines the contribution of immigration policy to population growth (and, in the absence of good supply side policies) and to the pressure on roading infrastructure, house prices etc.    Many people only seek work or student visas to help them get points for residency.  If fewer residency places were on offer, there would be many fewer applicants for short-term positions.

The residence approvals target was reduced a little (from a range centred on 47500) last year.  But if I’ve done my calculations correctly on MBIE’s very unwieldy spreadsheet, 57623 people were approved for residence in the year to end of March 2017.     (UPDATE: I hadn’t done the calculations correctly, and the actual number seems to be 49991.  Readily accessible summary statistics – as we have in the rest of the economy –  would avoid such slips.)

Sometimes MBIE officials like to tell stories about being overwhelmed with good applicants in good times, whom it might be a shame to turn away.  But we now know, from MBIE’s own data, that that simply isn’t the situation.    Of the people applying for the most skilled stream in the residence approvals programme, more than half weren’t able to command an income as high as $49000 –  roughly what a starting primary school teacher earns – in the New Zealand labour market.    Our migrants might be more skilled than those in many other countries, but they aren’t very skilled at all, and most of them simply aren’t likely to be making a positive difference to the economic fortunes of New Zealanders (as a whole).

So let’s cut the target.  And in my view this is the nettle that the Labour Party really should grasp –  the key on which the whole programme turns.  If they want to look to their own past and their own traditions, it was one of the icons of the Labour movement, Norman Kirk who led the government that sharply cut back on non-citizen immigration, easing pressure on house prices and wider economic performance, in the mid 1970s.  Kirk did it by limiting open access for Britons.  In today’s term, the relevant metric is the residence approvals target (or “planning range”).

I’ve proposed pulling that target down to a range of 10000 to 15000 per annum.   But one doesn’t need to go that far to make a big difference.    For example, an incoming government could direct MBIE to ensure first that residence approvals for a year are capped at the upper end of the range (that would now be 47500 per annum).  Then they could, to provide a degree of certainty all round, announce that the target range would be reduced by another 20000, phased in evenly over a first electoral term, so that by the end of that term, the residence approvals target would be centred on 25000 people per annum.    That would still be getting on for twice as many approvals, per capita, as the number of green cards issued for US permanent residence.   It would be a thoroughly mainstream thing for a responsible centre-left party to do.    (As part of trying to refocus the programme on genuinely highly-skilled people I’d review and probably terminate the Pacific Access categories –  if we are serious about a skills-led economic programme we need to be hard-headed, but I don’t suppose a Labour Party with a big Pacific base could really do that.)

Of course, changing the residence approvals numbers doesn’t affect actual arrivals on day 1.  Even people approved overseas take some time to arrive, and I’m not suggesting cancelling approvals already granted.   But over time the reduced number of approvals will make a lot of difference (“tens of thousands” in fact) to the expected net inflows, even if all other visa programmes were unchanged.

But there are plenty of other changes that should be made.  We put far too much emphasis, in offering residence points, on people already having a job, or a firm job offer, in New Zealand.   Being at the ends of the earth, that isn’t always easy if you haven’t been willing to take the big risk and first relocate yourself and family to New Zealand (it isn’t exactly like moving from Brussels to Paris, or Dublin to London).  We probably do miss out on really skilled and innovative people who might otherwise come.  If we are going to give residence points for people already having a NZ job, or job offer, do it only for pretty highly paid roles –  perhaps those paying $100000 or more (you could age adjust it a bit too –  older people who are likely to be of real value as permanent residents should probably be earning rather more than that; younger people perhaps a bit less).    Again, changes like this will reduce the appeal of New Zealand work visas –  to what they should be (something where there is a specific short-term labour market need –  eg a temporary surge in demand like earthquake repairs).

What of short-term visas themselves?   A lot of government rhetoric has claimed that a huge upsurge in student numbers is a big part of the surge in net PLT immigration.    First, what we’ve seen in the last few years around students is as nothing compared to what saw 15 years ago.   Between 1997/98 and 2002/03 the number of people granted student visas increased by 70000.  Between 2012/23 and 2015/16 the increase was only 27000 (and MBIE data show that the number of valid student visas outstanding didn’t increase over the 12 months to February 2017).    As importantly, no one seriously questions that much of the increase in student visas –  mostly via lower-level PTE courses –  isn’t about the quality (or even cost) of our export education offerings, as about the residence points that such courses offer, both directly, and by providing access to a post-study “study to work” visa, which allows those completing these lower-level courses to work in any job they can find, no matter how relatively unskilled.      Severely cut back the ability of foreign students to work while doing lower-level courses, remove any residence points offered for such courses, and cut back on the “study to work” options and (the export incentives would drop away and) foreign student numbers would quite quickly fall back a long way.   One doesn’t even need to cut for every programme –  one can treat lower-level PTE courses differently to university degree courses, and even within university programmes treat post-graduate courses rather more generously.  We are happy to take –  even want –  really able people.  We shouldn’t be taking people who can’t even command $49000 per annum in the domestic labour market.

There were 25000 valid student visas outstanding earlier this year for PTE courses (and another 13000 or so for polytechs).  Halve those numbers and you make a material contribution to reducing the inflows of people (many of them working in quite lowly-skilled roles) by ”tens of thousands”.   It will be tough for those running the providers (the PTEs etc).  It was tough for many firms in the 1980s when export incentives and import protection were stripped away.  But they are changes that really need to be made.  Give some notice, sure, but many of the rule changes that facilitated the big inflows are themselves quite recent, so there shouldn’t be any sense of obligation to phase these concessions out very slowly.

I could go on, but won’t.   But as one last immigration thought for the day, I was rather puzzled by Fran O’Sullivan’s column in the Herald this morning.  Headed Forget immigration –  let’s talk wages, it was something of a mixed bag.    She seemed to recognise that immigration historically mostly raised total GDP and total population, and hadn’t been any sort of answer to New Zealand’s long-term productivity underperformance.    But her alternative was one that I suspect both pro-immigration economists like Eric Crampton, and sceptical ones like me, would both look at rather askance (to put in politely)

But if New Zealand is to evolve as a highly skilled economy it needs to set the bar higher, and pay decent wages which will also spur employers to take initiatives to drive greater movement on the productivity front.

This requires a major reset of the NZ economy – not simply using immigration to spur economic growth, then screwing the taps down when the cost of running things too hot becomes a political negative.

Where Labour is on point is with addressing the “Future of Work”.

Raising wages –  whether by government fiat (as in “pay equity” deals, or simply from employers swayed by the rhetoric) without the pre-conditions for growth in productivity is just a recipe for more unemployment (for New Zealanders), and the sort of insider/outsider bifurcated labour market that has given Spain what has long been one of the worst unemployment records anywhere.     We all want a high-wage high-productivity economy, but for everyone not just those who keep their jobs, and there is little evidence that putting the cart before the horse in the way O’Sullivan appears to suggest has ever worked on any sort of widespread basis.   The structural problems New Zealand faces aren’t mostly about bad choices by New Zealand firms (or indeed, foreign firms investing here) –  mostly they do their very best in the environment governments deliver to them –  but about that wider macro environment.

Higher real wages is a highly desirable outcome –  and on offer from policies that lead to closing the gap between New Zealand and world real interest rates (which, to be clear, has nothing to do with monetary policy) and allowing the real exchange rate to finally fall back to the sorts of levels that our dismal productivity performance suggests should have been warranted.  I hope that whatever Labour has in mind on the “future of work” it doesn’t involve leading with higher wage increases.  Rather, when they happen, consistent with low sustainable unemployment rates, it will be sign that we’ve got right much more of the rest of the policy mix.

 

Svensson and Labour’s monetary policy

In 1999, having been out of office for nine years, the Labour Party campaign platform included promises about monetary policy.  They undertook to change the Policy Targets Agreement –  and they did, adding the words (still) requiring the Bank to “seek to avoid unnecessary instability in output, interest rates and the exchange rate”.

But they also promised an independent inquiry into the operation of monetary policy.    It was then 10 years since the Reserve Bank Act had been passed, and we’d gone through both a wrenching but successful disinflation, and through one full business cycle since something like price stability had been established.    Some of elements of the management of that cycle hadn’t been the Reserve Bank at its finest:  use of the Monetary Conditions Index to guide short-term policy management had given us a (relatively short) period of quite astonishing interest rate volatility, not helped by being slow to appreciate the significance of the Asian financial crisis.

I don’t suppose Michael Cullen was ever a great fan of Don Brash’s.  But Brash had already been reappointed for a third term in 1998 (arguably fortunate that the reappointment was done before the nature of the MCI debacle was fully appreciated).   And Cullen was clearly uneasy about the volatility in New Zealand interest rates, and about the big cycles in the exchange rate.   There were also suggestions that he was a bit uneasy about the rule of a single unelected technocrat at the Reserve Bank of New Zealand, and Labour at times seemed to look longingly across the water at the Reserve Bank of Australia (with a higher target, more flexible rhetoric, and a reputation for being a steady hand).    And, of course, Labour was coming into government with Jim Anderton as Deputy Prime Minister.  Anderton had still not been reconciled to the Reserve Bank Act framework at all.   So it was, all round, opportune to have an inquiry.

But of course whenever one sets up an independent inquiry, the name of the person appointed to conduct the inquiry tells one a lot about what the appointer is looking for.    There were all sorts of names bandied about at the time, including (for example) Bernie Fraser who had until recently been Governor of the Reserve Bank of Australia, and whose centre-left sympathies were not exactly unknown.  But the government settled on Swedish academic Lars Svensson.  Perhaps being Swedish  –  home of centre-left big government – lulled some on the left of New Zealand politics.  But, more importantly, Svensson was also a leading academic author on aspects of the (then still relatively new) theory and practice of inflation targeting.  He’d also spent some time in New Zealand a couple of years earlier, as the Reserve Bank professorial fellow.    In other words, it was never likely to be a terribly radical report.

And it wasn’t.    Which is not to say that it wasn’t a useful exercise, or that Svensson did not make some useful recommendations.  He did.  Some of the less important recommendations –  eg around the make-up of the Bank’s Board, and the publication of a Board Annual Report –  were even adopted.    Some others that should have been adopted –  for example, the introduction of a monthly CPI –  still, unfortunately, haven’t been.  Svensson also proposed legislating for committee decision-making for monetary policy, but his proposal of a committee of insiders (including the role I then held) went nowhere: among other reasons no doubt, Michael Cullen hadn’t come into politics to give statutory power to more Reserve Bank pointy-heads.

I was quite heavily involved in the review, both in contributing to the Reserve Bank’s own substantial submission to the inquiry and –  along with a couple of Treasury economists –  as part of the secretariat to the inquiry itself.  For an inquiry into the Bank, it was a bit of an odd arrangement  –  shortly after the inquiry began I was promoted into one of the half dozen top policy/management roles in the Bank and did the two roles in tandem –  but I guess it is a small country, and there was never much doubt about the overall favourable stance Svensson was likely to take.  He was a big fan of Don Brash, and the conclusions were his not those of the secretariat (in fact, flicking through notes stapled in my copy of the report yesterday I noticed that in some places we –  and the Bank –  urged Svensson to toughen up his comments, lest the report look in places a bit like a whitewash.)

But the main point of this post isn’t about history.  It was initially prompted by an observation in a column in the Sunday Star-Times the other day, in which their resident right-wing columnist was quoting Svensson from 2001.  Damien Grant, in commenting sceptically on Grant Robertson’s proposals,

Robertson might find it useful to know that when Cullen became finance minister he commissioned a review of the Reserve Act by Swedish economist Lars Svensson who concluded:

“It is beyond the capacity of any central bank to increase the average level or the growth rate of real variables such as GDP and employment.”

The understanding that monetary policy can only influence the value of money and nothing else is one of the few untarnished successes of modern economic thought. It is deeply disturbing that Grant Robertson does not seem to appreciate this.

As a commenter observed yesterday, no mainstream economist believes that monetary policy can change the long-term level of employment/unemployment/real GDP or whatever.  In the long-term monetary policy can only affect nominal variables.   Svensson certainly believed that then and believes it now.   I don’t know whether Grant Robertson does, but I expect so.

But equally, not many mainstream economists believe that active monetary policy typically has no effect (short to medium term) on real variables.   There is pretty general acceptance, I think, that the depth and severity of the Great Depression was in substantial part a matter of monetary mismanagement.  That’s a deliberately extreme example, but it both illustrates the point and (historically) provides some of the backdrop to modern more active discretionary monetary policy.  In earlier decades, adjustments in central bank interest rates (where central banks existed at all) were mostly about maintaining the gold (or silver) convertibility of the currency.  Domestic economic conditions didn’t play much of a role.    Really bad experiences like the Depression, along perhaps with the rise of universal suffrage (the more marginal got a say in politics), helped change that focus.

Writing in 2001, reviewing New Zealand policy, Lars Svensson had no doubt about the importance of real variables in the management of monetary policy.   He didn’t question section 8 of the Reserve Bank Act –  the focus on price stability.  But his articulation of flexible inflation targeting –  what the Reserve Bank saw itself practising – involved short-term trade-offs between pursuit of the inflation target, and the variability of the real economy.  At the time, as an academic, he focused explicitly on the trade-off with variability in the output gap (the gap between actual and potential output), and devoted several pages of the report to a discussion of the issue, describing it not just as a very short-term matter, but as a “short and medium term” issue.    (For anyone interested, the full report and associated documents are here.)     What he was talking about wasn’t at all inconsistent with the 1999 addition to the PTA, quoted above, about seeking to “avoid unnecessary instability in output”).    And there was only one tool –  the OCR.

Standing back from his more theoretical perspective, there was good reason why one might want explicit consideration of real variables in the official articulation of what an independent central bank was asked to do.   One doesn’t need active monetary policy if all one is concerned about is long-term stability in the general level of prices –  something passive like the Gold Standard would do it.    But the Reserve Bank Act –  and other comparable legislation abroad –  was about a regime for governing the discretionary active use of monetary policy.   We had –  and have –  such a policy because it was believed that discretionary monetary policy could make a difference, over meaningful horizons, to real economic outcomes (GDP, unemployment or the like) even if not to the trend or potential levels of those variables.

Some years later Lars Svensson himself became a policymaker, as a fulltime member of the executive board of Sweden’s Riksbank.  The Executive Board makes the monetary policy decisions in Sweden.    Many of my old Reserve Bank colleagues don’t agree, but I think Svensson proved to be an ideal person to have on a monetary policy decisionmaking committee.   He had strong expertise in the subject – albeit initially at a rather abstract level –  and a cast of mind which meant that he wasn’t just going to fall into line with the preferences of the Governor and the long-term staff advisers.  He strongly and opened argued against the Riksbank’s strategy, adopted several years back in the wake of the global recession of 2008/09, of trying to use monetary policy to lean against the accumulation of household debt, even at the expense of inflation undershooting the target (and unemployment remaining very high).   It was a costly failed experiment, which the Riksbank eventually abandoned.

His experience as a policymaker led Svensson to recraft how he thinks about the objective of the central bank and explicit role that unemployment should have in that thinking.   He hasn’t, of course, changed by one iota his belief that in the long-term the level of real variables is determined by a whole bunch of regulatory, demographic etc factors, but not by monetary policy.    He reflected on these issues a couple of years ago in a lengthy lecture, Some Lessons from Six Years of Practical Inflation Targeting (of which only the first 10 pages are directly relevant to this post), and in another article How to weigh unemployment relative to inflation in monetary policy?

He notes

Flexible inflation targeting involves both stabilizing inflation around an inflation target and stabilizing the real economy.  A clear objective for monetary policy contributes to monetary policy being systematic and not arbitrary. Furthermore, for central-bank independence to be consistent with a democratic society, it must be possible to evaluate monetary policy and hold the central bank accountable for achieving its objective. This requires that the degree of achieving the objective can be measured. A numerical inflation target allows target achievement with regard to inflation to be measured and the central bank to be held accountable for its performance regarding inflation stabilization. But if monetary policy also has the objective of stabilizing the real economy, that part of the objective must also be measurable, in order for monetary policy to be evaluated and the central bank be held accountable. Given this, how should stabilization of the real economy be measured?

and

Stabilization of the real economy can be specified as the stabilization of resource utilization around an estimated sustainable rate of resource utilization, accepting the conventional wisdom that the sustainable rate of resource utilization is determined by nonmonetary factors and not monetary policy and therefore has to be estimated. But how should resource utilization be measured? More precisely, besides inflation, what target variable (or variables) should enter the monetary-policy loss function? One can answer this question by interpreting the legislated mandate for monetary policy and by examining what economic analysis suggests about a suitable measure of resource utilization.

In Sweden, the Riksbank’s own act mentions only price stability.  But

 The Riksbank’s mandate for monetary policy follows from the Sveriges Riksbank Act 1988:1385 and the preparatory works of the Act, the Government Bill 1997/98:4 to the Riksdag (Swedish Government 1997) that contained the proposal for this legislation. In Sweden, the preparatory works of laws carry legal weight, since they contain guidance on how the laws should be interpreted. According to the Riksbank Act, the objective of monetary policy is “to maintain price stability.” The Bill further states (p. 1): “As an authority under the Riksdag, the Riksbank should, without prejudice to the objective of price stability, support the objectives of the general economic policy with the aim to achieve sustainable growth and high employment.”

(I didn’t know this when in 2014 we wrote a Reserve Bank Bulletin article on the statutory goals for monetary policy in a range of countries, the Swedish entry in which thus should thus be discounted, or read in the light of these Svensson comments.)

Svensson continues

The idea in the Bill is hardly that there is any conflict or tradeoff between sustainable growth and high employment. Furthermore, for many years Swedish governments have emphasized full employment as the main objective for general economic policy.  Also, in this context, high employment should be interpreted as the highest sustainable rate of employment, if we accept that monetary policy cannot achieve any level of unemployment and that the sustainable rate of employment is determined by nonmonetary factors. According to this line of reasoning, the Riksbank’s mandate for monetary policy is price stability and the highest sustainable rate of employment.

In practice, he argues that the unemployment rate –  and in particular the gap between the actual unemployment rate and the long run sustainable rate of unemployment (LSRU, determined by those non-monetary factors) should be the focus.   15 years ago his focus was on the output gap but

What does economic analysis say about the output gap as a measure of resource utilization? Estimates of potential output actually have severe problems. Estimates of potential output requires estimates or assumptions not only of the potential labor force but also of potential worked hours, potential total factor productivity, and the potential capital stock. Furthermore, potential output is not stationary but grows over time, whereas the LSRU is stationary and changes slowly. Output data is measured less frequently, is subject to substantial revisions, and has larger measurement errors compared to employment and unemployment data. This makes estimates of potential output not only very uncertain and unreliable but more or less impossible to verify and also possible to manipulate for various purposes, for instance, to give better target achievement and rationalizing a particular policy choice. This problem is clearly larger for potential output than for the LSRU.

and

Compared to potential-output estimates, estimates of the LSRU are much easier to verify, more difficult to manipulate and can be publicly debated. Independent academic labor economists can and do provide estimates of the LSRU and can verify or dispute central-bank estimates. Several government agencies have labor-market expertise and provide verifiable estimates of the LSRU. One could even think of an arrangement where an independent committee rather than the central bank provides an estimate of the LSRU that the central bank should use as its estimate, to minimize the risk of manipulation by the central bank. Furthermore, unemployment is better known and understood by the general public than output and GDP.

He concludes

Most importantly, it has much more drastic effects on welfare. As expressed by [academic labour economist, and former Bank of England Monetary Policy Committee member]   Blanchflower (2009):

Unemployment hurts. Unemployment has undeniably adverse effects on those unfortunate enough to experience it. A range of evidence indicates that unemployment tends to be associated with malnutrition, illness, mental stress, depression, increases in the suicide rate, poor physical health in later life and reductions in life expectancy. However, there is also a wider social aspect. Many studies find a strong relationship between crime rates and unemployment, particularly for property crime. Sustained unemployment while young is especially damaging. By preventing labour market entrants from gaining a foothold in employment, sustained youth unemployment may reduce their productivity. Those that suffer youth unemployment tend to have lower incomes and poorer labour market experiences in later life. Unemployment while young creates permanent scars rather than temporary blemishes. 

When unemployment rises, the happiness of both workers and non-workers falls. Unemployment affects not only the mental wellbeing of those concerned but also that of their families, colleagues, neighbours and others who are in direct or indirect contact with them.

Thus, I think there are strong reasons to use the gap between unemployment and an estimated LSRU as the measure of resource utilization that the central bank should stabilize in addition to stabilizing inflation around the inflation target.

Svensson proposes reduces all this to a “loss function”, to which, in principle at least, central bank monetary policy decisionmakers can be held to account, with formal weights attached to each of the inflation gap (from target) and the unemployment gap (from the LSRU).

Personally, I think he is rather unrealistic in supposing such a formulation is possible, at least as the basis for formalised accountability.    But if it is practically challenging (or even impossible), the sort of analysis he advances here isn’t unorthodox or out of the mainstream.  It is simply one plausible extension of the conventional economics of modern monetary policy, from one of the leading contributors to the academic literature (and someone who has himself been exposed to the real world challenges of policymaking).

I don’t know specifically what Svensson would make of the current debate in New Zealand, or of what the Labour Party (at quite a high level of generality) is proposing.    What we do know is that Labour is proposing nothing nearly as specific or formal as Svensson argues for: there would be no numerical unemployment target or an official external assessment of the NAIRU (or LSRU).  My impression would be that his reaction would be along the lines of “well, of course the unemployment rate –  and short to medium term deviations from the long-run level, determined by non-monetary factors – should be a key consideration for monetary policymakers; in fact it is more or less intrinsic to what flexible inflation targeting is”.   He might suggest there are already elements of that in the PTA, but that making it a little more high profile, with an explicit reference to unemployment, might be helpful.     I might be wrong about, but it could be worth Robertson or his advisers getting in touch with Svensson –  who retains an interest in New Zealand, and gave a paper here only a couple of years ago –  and asking.