Setting interest rates: no need to change the system

Andrew Little has moved on from wanting to “stiff-arm” banks over dairy foreclosures, to talking of the possibility of legislating to force banks (and other lenders?) to pass on in full any OCR changes.

It isn’t the oddest idea in the world – and personally I find the new talk of a Universal Basic Income, much as it has also been propounded by some  on the right, including Milton Friedman, rather more consequential, and worrying.  Many quite sensible countries set fixed exchange rates.

For 15 years in New Zealand –  1984 to 1999 –  we didn’t have a government agency setting interest rates at all.  For much of that time, many of us at the Reserve Bank thought that was only right and proper.  And when we first proposed an OCR-like system, many of the leading economics commentators and bank economists were pretty dismissive.  But in 1999 we simply concluded that –  like most of the rest of the advanced world –  it made more sense to set, or manage directly, an official interest rate.  And now that model is just taken for granted.

Of course, setting the OCR isn’t the same as setting the individual interest rates for each borrower, but I’m sure that if he gave it any thought that isn’t what Little means either.  Perhaps he just means that the Reserve Bank should be able to direct set some commercial bank base lending rate against which all other lending rates have to be calculated? It seems administratively cumbersome, and perhaps prone to being circumvented –  not unlike much other government regulation, including (for example) direct restrictions on mortgage lending of the sort once unknown in New Zealand but now imposed by the Reserve Bank and accommodated by the current government.  And it is not as if governments universally eschew price-setting in other markets either –  the government recently proudly announced an increase in the regulated minimum price for labour, talking of wanting to push that price (once just a market price) up as fast as possible.

One of the attractions of an OCR-type arrangement is that it is a fairly indirect instrument.  The Reserve Bank can put the OCR pretty much wherever it needs to to deliver on an inflation target.  That is an imprecise linkage, but it works pretty well (at least if the Reserve Bank is reading underlying inflation pressures correctly) and it does so without needing lots of direct controls or impinging very directly on anyone’s business or financial affairs.  The OCR is simply the rate the Reserve Bank pays on deposits banks (and any other settlement account holders) have at the Reserve Bank, and the rate at which the Reserve Bank will lend to banks on demand (against good quality collateral) is pegged to the OCR.   The amounts banks borrow from and deposit with the Reserve Bank aren’t that large : bank balance sheets total almost $500 billion, and bank deposits with the Reserve Bank are fairly stable, currently around $9 billion.  And yet changes in the rate paid on these balances, which don’t move around much, provide substantial and sufficient leverage (partly signaling, partly a change in pricing on one component of the balance sheet) for macroeconomic stabilization purposes.    It isn’t a mechanical connection, but it works.

A variety of other models might too, but the judgement has been –  not just here, but in other similar countries – that an indirect approach like the OCR is less intrusive and has fewer efficiency costs than the alternatives.

And it is not as if there is some obvious problem.  Here is a chart, drawn from data on the Reserve Bank website, showing floating residential mortgage interest rates and six month term deposit rates since 1965.  (It is an ugly chart because the mortgage rate data are monthly throughout, but the term deposit rates are quarterly until 1987).

retail interest rates

Largely, lending rates reflect deposit rates (and to some extent vice versa).   These aren’t perfectly representative indicators, just what we have.  But for the almost 30 years for which we have the full monthly data are available, the average spread between these two series was 2.45 percentage points, with a standard deviation of 0.6 percentage points.  The latest data are for February, and the spread was 2.49 percentage points.  One would expect spreads to move around a bit –  demand for individual products ebbs and flows, and the links between foreign funding markets and domestic term deposit markets aren’t instant or mechanical –  and they do, but there is no obvious or disconcerting trend.

Through the period since 1965 we have had all manner of regimes.  Direct controls on lending rates, direct controls on deposit rates, indirect controls on one, other or both, no controls at all, and then for the last 17 years direct control of the interest rates on one small component of bank balance sheets.  Go back far enough, and during the 1930s a conservative government legislated to lower all lending rates.  But it just isn’t obvious that there is any need to change the operating system now.

To a mere economist, it is a bit of a puzzle what Little is up to.  No doubt the Opposition needs to be seen to be offering alternative policies, but these issues (bank lending rates and dairy foreclosures) don’t seem like an area where there is a substantive policy issue (while there are many other areas of policy where the same could not be said, such as New Zealand’s continuing slow relative decline).  But there does seem to be quite a strain of anti-bank sentiment in New Zealand –  perhaps especially anti foreign banks, the same sentiment that gave us state-owned Kiwibank under the previous Labour-Alliance government.  Perhaps people on the left here are looking to the US and the striking degree of response Bernie Sanders is achieving for his populist message, much of which is centred on an anti Wall St message?


Labour and the dairy debt

It often isn’t clear quite what the Labour Party means.  Andrew Little is reported as follows:

Little said the banks needed to be “stiff-armed and told we’re not going to see, wholesale, farmers pushed off the land”.

His only argument for this sort of intervention –  whatever it means in practice –  appeared to be that

“We expose more New Zealand farm land to the risk of overseas ownership and I think that is a matter in which there is a national interest the Government should be alert to, and take action on.”

Which all sounds quite dramatic, and yet what follows seems like a rather damp squib.

A summit should be called and dairy cooperative Fonterra should be at the table. Farmers needed to agree on a long term plan for the cooperative to move its products up the value chain, even if that meant taking less cash out once the immediate crisis was over, to allow Fonterra to invest to generate better long term returns.

Government assistance should be provided to get farmers over the crisis, in a similar way to the help offered during drought, but it did not need to be any more than that.

So, apart from more talk, what is Labour actually proposing?

Keen as any individual bank might be to be rid of some of the more questionable exposures in its dairy book, it seems unlikely that banks, as a group, will be that keen on precipitating large scale exits from the dairy industry.  Force one farmer to sell and there won’t be any material impact on the value of dairy farms more generally.  Try to force several thousand to do so, and (a) it will be next to impossible to find buyers in the short-term, and (b) the value of the collateral banks hold could collapse.  The Reserve Bank talked last week of an extreme scenario in which dairy farm prices fell by 40 per cent, but in an illiquid market like that for dairy farms there is no reason why land values should not fall by much more than 40 per cent if serious stresses were to develop.   No one really knows what dairy land is worth in the longer-term (where will oil prices settle, where will the New Zealand real exchange rate settle are just two of the many relevant questions) but it is the sort of market where it is quite easy to envisage a severe overshoot.  I’ve been tantalized for several years by parallels to some of the very illiquid mortgage-backed products in the US –  not the ones that eventually saw huge defaults, but the ones where prices massively overshot in a climate of fear and illiquidity.

If each bank would prefer to be rid of some of its dairy exposures, each of them also knows that farm lending is going to be a major area of credit exposure in New Zealand for decades to come.  It isn’t like lending to, say, a new industry which comes to nothing and goes away.  If some individual farmers will leave the industry, the rural sector will still be around and collective memories can be powerful forces for good or ill.  Banks were scarred by their experiences in the last major rural debt shake-out  in the 1980s, and I doubt they will be eager to burn off goodwill among future potential clients.  That doesn’t mean there won’t be forced sales, but it is hard to envisage the major rural lending banks rushing for the door  (no matter how much unease the risk departments of bank HQs in Sydney or Melbourne or Utrecht might be feeling).

In some ways, a more concerning scenario for banks might be borrower panic.  If enough farmers concluded that they were working for nothing and that there was no prospect of serious relief in the next few years they could, one by one, just choose to (try to) exit the industry.  Of course, they’d still have to find buyers, but in a climate like that collateral values could collapse anyway.  From the perspective of banks, it may be preferable if most farmers doggedly fight to stay on the land, allowing banks to make the calls on who to sell up and when, having regard to the potential impact on the rest of their national dairy portfolios.  No individual farmers cares much about that.

But I still have no idea what, if anything, Labour is proposing the government or the Reserve Bank should do to “stiff arm” the banks, to prevent widespread sales.  I’m pretty sure there are no existing legal powers that could appropriately be used for that purpose.  Of course, behind the scenes all sorts of threats and pressures could be brought to bear, but surely that isn’t how we want to country to be run?    So if Labour’s call means anything much they must be talking of new special legislative provisions.    There was a great deal of resort to such measures in New Zealand during the Great Depression of the 1930s –  allowing writedowns of loans, and of interest rates. Perhaps one could mount an argument for those interventions –  on a basis of a totally unexpected collapse in the entire price level, an issue in macroeconomic mismanagement  –  but what would the case for intervention now be?

It seems pretty clear that any dairy debt losses are not likely to be large enough to threaten the health of the financial system –  especially, as this is a slowly developing situation in which banks have plenty of time to bolster their capital buffers if that is required.   And to bailout individual farmers, or the sector as a whole, would represent a material new source of moral hazard –  a message to borrowers that they need not bear the consequences of their bad choices.  That would only increase future demand for debt –  in an industry that seems likely to continue to face considerable output price fluctuations

Of course, it may be that there is nothing much to Labour’s call at all –  other perhaps than a desire to be heard.  I’m not a fan of government assistance to farmers experiencing drought conditions –  if managing weather risk is not one of the things farmers have to do, I’m not sure what is –  but if Labour is talking of things only on that scale then I probably couldn’t get too excited.  Then again, action on that scale doesn’t seem likely to make the sort of difference that would prevent “wholesale” exits and large scale increases in foreign land ownership.

Perhaps that “foreign land ownership” issue is really at the heart of Labour’s call.   I’m not an absolutist on foreign ownership of land.  After all, to be blunt, large scale English purchases of New Zealand land in the 19th century –  even if mostly, individually, on a willing-buyer/willing-seller basis, did rather dramatically and permanently change the character of the country.    But in the current situation we seem very far from that sort of risk.  And in the shorter-term, the best hope for embattled farmers, and lenders, is the presence of a contested market of keen potential buyers.

And what of the call for a summit?  It seemed like a pretty tired old suggestion, and it isn’t obvious what the role of the government is in such industry issues.  We’ve heard endless talk over the years of “moving up the value chain” and farmers (the Fonterra owners) might reasonably be sceptical of the results to date.   But summits about long-term industry strategy don’t seem that relevant to the issues of the current overhang of farmer debt.

Do I have any sympathy for indebted dairy farmers?  Yes, to some extent.  There are individuals and families involved, and the stresses –  as in any struggling small to medium business –  must be pretty intense and hard to cope with.  It isn’t something those of us who spent our working lives as government officials never face.  Then again, the upsides in the good years are also pretty extreme.  Running a leveraged business is a high-variance operation.

Cyclically, of course, farmers would be somewhat better off if we had a Reserve Bank that was doing its job better.  With core inflation probably around 1 per cent, and real interest rates higher than they were a couple of years ago (and real retail rates probably higher than they were at the start of the year), there is simply no need for the OCR to be anything like as high as it is now.  The OCR isn’t, and shouldn’t be, set with a view to supporting dairy farmers (or people in any other specific sector) but an OCR more consistent with the Bank’s own Policy Targets Agreement would (to a small extent) ease farmers’ financing costs and be likely to result in an exchange rate rather lower than it is now.  We saw the impact of last Thursday’s surprise (itself mostly a timing surprise).  It isn’t obvious that the OCR at present needs to be any higher than 1.5 per cent.  At that level, we’d be likely to see the exchange rate quite a bit lower again, and every cent off the exchange rate raises the prospective payout to diary farmers, materially affecting prospective profitability of people in the industry.  Not many farmers probably did contingency plans in which the TWI would still be above 71 even with WMP prices at current levels.

For the longer-term, if governments want to focus on more structural issues, there is a whole range of policy measures which help and hinder the dairy sector.

The ability to import large numbers of foreign dairy workers acts as a direct subsidy to the industry –  holding down industry-specific wages rates – and has probably largely been capitalized into rural land prices.   Water quality rules have been being tightened, but the ability to pollute, and pollute without paying, is another subsidy to the dairy industry.  Subsidised irrigation schemes go in the same direction.  None seems well-warranted.

And on the other hand, all tradables industries in New Zealand suffer from our very large scale immigration programme.  Whatever monetary policy is doing, the resulting quite rapid growth in the population keeps upward pressure on the real exchange rate, driving up the price of non-tradables relative to the (largely fixed) global price of tradables.  That makes it harder for firms operating here to compete in international markets, and helps explain why the per capita output of the tradables sector as a whole is no higher now than it was 10-15 years ago.    We shouldn’t be reorienting our immigration programme around the short-term needs of particular industries, but the biggest single factor New Zealand has some control over that would help the dairy industry at present would be a lower exchange rate.  A much lower immigration programme would, among other things, achieve that.  It might also allow a more hard-headed longer-term conversation about some of those industry subsidies.

Grant Robertson, the Reserve Bank, and the end of the Governor’s term

Further to my post the other day on Grant Robertson’s latest statement on monetary policy, Bernard Hickey has posted a substantial article about his interview with Robertson on these matters.  It is a useful piece to have –  certainly the most sustained discussion of monetary policy and Reserve Bank issues from Robertson since he became Labour’s finance spokesperson.

And yet it still poses more questions than answers, and still leaves Labour looking as though it has not really thought hard about either monetary policy or the reasons for New Zealand’s continuing economic underperformance (including the continuing large gap between New Zealand and “world” real interest rates).  As a voter and an interested observer/commentator, I found that pretty disappointing.   There is certainly space for a different approach to economic policy in New Zealand –  it is not as if either recent Labour or National led governments have managed to do anything that begins to reverse New Zealand’s relative economic decline.

But it is still looks as though they are more interested –  at least at this stage of the electoral cycle – in positioning (with their party base, and with the business community), and being seen to be different, than in the harder aspects of substantive economic analysis and concrete alternative policies (and the connection between the two of them).

Thus he says “the lowest inflation since last century combined with rising unemployment…is making a farce of monetary policy”, and “when you reach 15 quarters outside of the mid-point we do have to ask ourselves what we’re doing with monetary policy”.  And yet Robertson is very reluctant to criticize the Reserve Bank, and the Governor (formally the single decision-maker) in particular.  Indeed, he goes out of his way to praise the Governor and –  despite the single decision-maker model  – says “the targets agreement has not been met, but I wouldn’t want to bring that down to him personally at this time”.  Certainly, the Governor has advisers, but they are all employed by, and accountable to, him.

Instead, Robertson repeatedly argues for changing the framework.  He isn’t very specific about what he wants –  and it is still 20 months from the election – but the only point that keeps recurring in all his statements is a desire to have the Reserve Bank actively promote higher employment.  But he adduces no evidence whatever to suggest the reframing the wording of the Bank’s goal, along the lines of the Fed or RBA objectives, would make the slightest bit of difference to how the Reserve Bank actually runs monetary policy.  Past Reserve Bank research suggests that, on average over time, the Reserve Bank of New Zealand has reacted to incoming data in much the same way as the RBA or Fed have done.  Robertson either knows that, or should do, so the onus is on him to explain how his approach would make a difference, in substance rather than rhetoric.

And there is still nothing on the “new tools” Robertson has talked of needing.  When Hickey asked him about the variable Kiwisaver rate proposal Labour took into the last election, all he would say was that it was under review, and “that wasn’t mentioned today and won’t be in the foreseeable future”, adding (Hickey’s words) that “Labour preferred to have a simple policy that gave voters certainty”.  Which is all fine no doubt, but doesn’t give hardheaded observers reason to think Labour actually has serious alternative tools in mind.  That shouldn’t be surprising, as the tool the Reserve Bank does use is the tool other central banks use –  at least until they exhaust its potential when policy rates get to or just below zero.

It seems to me that there are two quite important separable issues:

  • the Reserve Bank has not done a particularly good job in the last few years of carrying out the Policy Targets Agreement.  That failure has been particularly stark since the 2 per cent midpoint reference was added in 2012.  With (as Robertson notes) inflation very low and unemployment high and rising, it is a pretty clear-cut case of a shortfall of demand, and a lower OCR is the best tool for stimulating additional demand.    The Reserve Bank can do something about that, but has failed to do so –  as Robertson notes, he was among those uneasy about the OCR increases in 2014, which were unnecessary, and the Bank (the Governor) has been slow to lower rates since.  Real interest rates now remain higher than were two years ago, when dairy prices were at their peak.
  • the disappointingly poor economic performance of New Zealand over recent decades, including such symptoms as the large gap between New Zealand real interest rates and those abroad, and the persistently high average real exchange rate.    As it has abandoned support for the existing monetary policy framework over the last few years, Labour has tried to imply (perhaps especially to its base) that there is something about the monetary policy framework that Labour could fix, offering some material improvement in our economic performance.  Neither Phil Goff, David Cunliffe nor David Parker ever quite managed to explain the connection.  Robertson has done no better.  That isn’t surprising, because it really isn’t there.  There might be better ways of articulating the objective, and there are better ways of running/governing the Reserve Bank etc, but none of them offer anything much in addressing the structural underperformance of the New Zealand economy.

Veteran commentator and analyst of left-wing politics, Chris Trotter wrote a piece the other day suggesting that Labour and the Greens were adopting an approach, akin to that in the early 1980s, of getting alongside the business community  –  getting them to the point where business was comfortable that an alternative government would not “scare the horses”.  I’ve no idea if that is an accurate description, but Robertson’s comments don’t look inconsistent with Trotter’s story.  I was interested, for example, in Robertson’s reaction to the question of whether Graeme Wheeler should be reappointed next year: Wheeler’s term expires almost three years to day from the date of the last election. Robertson doesn’t refuse to comment, but goes on to express his regard for Wheeler (twice), only then concluding that “ultimately it won’t be a decision I’ll be involved in”.

I have no idea, of course, whether Graeme Wheeler will even seek a second term, but whether he does or not, I think there should be some disquiet about the fact that his term expires in late September next year.  Monetary policy is now hardly something that the main political parties are united on (unlike the situation from 1990 until 2008, when any differences were about details, and the statutory goal united National and Labour), and it doesn’t seem very satisfactory that, for example, the current government could appoint someone to the office of Governor (single decisionmaker across a range of policy areas), taking office perhaps in the middle of an election campaign, or indeed just as a new government was taking office.  It isn’t a problem if the current government is re-elected, but (say) a Labour-led government supported by the Greens and/or New Zealand First might have a rather different view about priorities and emphases for the Bank.  The Governor has a degree of personal policy autonomy not shared, for example, by heads of core government departments (eg the Secretary to the Treasury).

The last time a Governor’s term expired in an election year was in 1993 (2002 was different –  Don Brash resigned just before the election campaign, and a new permanent appointment was not made until after the election result was determined).  But, as I noted, on that occasion National and Labour went into the election with no real difference on the Reserve Bank Act.  On that occasion, the Reserve Bank’s Board and the then Minister agreed to reappoint Don Brash in December 1992, well before any election year market uncertainty  (or campaigning) took hold.  And the first Brash term was due to expire a couple of months before the election would normally be due.

The situation next year seems much less tractable.    Wheeler’s term expires more than three years after the date of the last election.  And Labour seems sure to campaign for material changes to the Act (as would its potential future support parties).   And if Graeme Wheeler does not seek another term, any capable person pondering applying for the job in early to mid 2017 might be more than slightly uneasy –  it not being clear what the substance of the role might actually be.    I hope the Board –  and perhaps the Minister  – have already begun to think about the issue.  I’m not sure what the best way ahead is.  These clashes don’t happen often, but perhaps one option for the longer-term might be six year terms for the Governor, rather than five –  so that a new gubernatorial appointment was always in the middle of an electoral cycle.  For now, I wonder if it might be wise to consider extending the Governor’s term for another year. to allow longer-term decisions to be made with greater clarity about the longer-term direction of the Reserve Bank and New Zealand’s monetary policy regime.  As longerstanding readers might imagine, I’m hesitant about that option for a number of reasons, but none of the alternatives look ideal either.

In this post I haven’t touched at all on Robertson’s comments on immigration –  with which I am generally sympathetic, although sceptical about the extent to which immigration policy can be managed in a countercyclical way.  And countercyclical issues are not where the real debates about the economics of New Zealand’s large scale inward migration programme should be centred.


Grant Robertson and a 21st century monetary policy

Grant Robertson  has a statement out today asserting that “Monetary Policy Must Get into 21st Century”.  Setting aside the fact that his party was in office for half the 21st century so far, had two reviews undertaken of the framework (one by Lars Svensson, an internationally-regarded expert, and one by the Finance and Expenditure Committee), and made no changes to the thrust of the framework (goals, powers, responsibilities etc), it really isn’t clear what Robertson wants.   He talks of wanting “modern tools”, but the tools our Reserve Bank uses are entirely normal.  Indeed, since the OCR was introduced to New Zealand only in March 1999, it must almost count as a 21st century tool.  Going into the last election, Labour did propose a (fairly weak) new tool, the variable Kiwisaver rate, but indications since have been that they were backing away from that.  So what alternative tools does Robertson now have in mind?

Robertson rightly points out that inflation has not been at 2 per cent –  the Bank’s target –  since the current Policy Targets Agreement was signed.  We didn’t have that problem previously –  inflation was, if anything, typically a bit above the mid-point of the target range.  That suggests the problem is not with the goal –  a medium-term focus on price stability  – but with the way the Reserve Bank has been handling incoming information.  Quite possibly the challenges they face have intensified in recent years, but despite having full policy flexibility –  never close to zero interest rates –  they haven’t handled them very well.  One might reasonably raise questions about that failure, and the failure of those charged with holding the Bank (and the Governor personally) to account (the Board and the Minister), but there is just no evidence that the target or the tools are the problem.

As I’ve said before, I’m not suggesting the way the Act is written is ideal, and if we started from scratch I would probably suggesting writing the goal a bit differently.  But doing so would be to help articulate why we aim for something like price stability over the medium-term.  It would be unlikely to make much difference at all to how policy was actually conducted.  That depends primarily on the Governor and the senior advisers he gathers around him.

Better monetary policy –  delivering better outcomes around 2 per cent inflation –  over the last few years would have narrowed the gap between New Zealand and world interest rates, which was (temporarily) unnecessarily widened by the Governor, but it wouldn’t have closed it.  That gap has been there for decades, and isn’t a reflection of how the Reserve Bank runs monetary policy.  There are things that governments can – and should – do that would sustainably close the gap, but (rightly) they aren’t things the Governor or the Reserve Bank has any power over.

A previous rant on much the same subject from a few months ago is here.


Flexicurity: the way ahead for New Zealand?

I finally caught up yesterday with Grant Robertson’s interview on The Nation.

There was the odd good aspect.  It sounds as though the variable Kiwisaver policy, as a tweaky tool to supplement to monetary policy, is heading for the dustbin, joining the capital gains tax proposal.  Other bits bothered me –  in particular, the lack of any sense in Robertson’s comments of the importance of markets, competition, relative prices etc.  He is clearly a believer in the power and beneficence of “smart active government”.

And I’m still a bit uneasy when I hear Robertson talk about changing the Reserve Bank Act to place a specific onus on the Reserve Bank to promote employment (or reduce unemployment).  It will be important to see details.  In principle, an amendment to section 8 of the Reserve Bank Act to say something along the lines of “achieve and maintain a stable level of prices, so that monetary policy can makes it maximum contribution to sustainable full employment and the economic and social welfare of the people of New Zealand” might do no harm.  It would, in fact, be not dissimilar to words that have been in the Policy Targets Agreement in the past.  On other hand, requiring the Bank to, say, actively target the lowest rate of unemployment consistent with maintaining price stability would be another matter.  Right at the moment it might be quite good advice to this Governor, who seems particularly uninterested in the plight of the (cyclically) unemployed.  But over time it would risk imparting a bias to the Reserve Bank’s choices that might well lead to persistently higher inflation outcomes over time.  That wouldn’t help anyone.

But the bit of the interview I was most interested in was the discussion around a possible different approach to help facilitate people moving from one job to another, as technology and opportunities evolve and change.  Robertson seems taken with the Danish “flexicurity” approach.  I didn’t know much about it, but in my younger days the idea of active labour market policies had had some appeal, so I thought I would take a quick look.  In some respects, Denmark’s experience is one to try to emulate:  prior to World War Two it was largely an agricultural economy, heavily reliant on agricultural exports to the United Kingdom, but poorer than us.  Now, while agriculture still plays an important part in the Danish economy ,other sectors have become much more important in the external trade and Denmark’s per capita income is far higher than New Zealand’s.

Here is how the Danish government describes “flexicurity”

A Golden Triangle Flexicurity is a compound of flexibility and security. The Danish model has a third element – active labour market policy – and together these elements comprise the golden triangle of flexicurity.

One side of the triangle is flexible rules for hiring and firing, which make it easy for the employers to dismiss employees during downturns and hire new staff when things improve. About 25% of Danish private sector workers change jobs each year.

The second side of the triangle is unemployment security in the form of a guarantee for a legally specified unemployment benefit at a relatively high level – up to 90% for the lowest paid workers.

The third side of the triangle is the active labour market policy. An effective system is in place to offer guidance, a job or education to all unemployed. Denmark spends approx. 1.5% of its GDP on active labour market policy.

Dual advantages The aim of flexicurity is to promote employment security over job security. The model has the dual advantages of ensuring employers a flexible labour force while employees enjoy the safety net of an unemployment benefit system and an active employment policy.

The Danish flexicurity model rests on a century-long tradition of social dialogue and negotiation among the social partners. The development of the labour market owes much to the Danish collective bargaining model, which has ensured extensive worker protection while taking changing production and market conditions into account. The organisation rate for workers in Denmark is approx. 75%.

The Danish model is supported by the social partners headed by the two main organisations – The Danish Confederation of Trade Unions (LO) and The Confederation of Danish Employers (DA). The organisations – in cooperation with the Ministry of Employment have also jointly contributed to the development of common principles of flexicurity in the EU, resulting in the presentation of the communication “Towards common principles of flexicurity” by the European Commission in mid-2007.

And here is a link to an accessible VoxEu piece from a few years ago on the flexicurity approach and Denmark’s experience after 2007.

The Danish “flexicurity” model has achieved outstanding labour-market performance. The model is best characterised by a triangle. It combines flexible hiring and firing with a generous social safety net and an extensive system of activation policies. The Danish model has resulted in low (long-term) unemployment rates and the high job flows have led to high perceived job security (Eurobarometer 2010).


The employment protection constitutes the first corner of the triangle. For firms in Denmark, it is relatively easy to shed employees. Not only notice periods and severance payments are limited, also procedural inconveniences are limited. The employment protection legislation index of the OECD for regular contracts is only 1.5. The Netherlands and Germany, countries with employment protection legislation, have an index of 2.7 and 2.9 respectively.

And here I started getting a bit puzzled.  Denmark certainly makes it a lot easier than many European countries to shed employees.  But it is even easier in New Zealand.  On all 4 components of the OECD’s indicators of employment protection legislation, New Zealand ranks as less restrictive than Denmark –  quite materially so by the look of it.

The OECD indicators on Employment Protection Legislation
Scale from 0 (least restrictions) to 6 (most restrictions), last year available
  Protection of permanent workers against individual and collective dismissals Protection of permanent workers against (individual) dismissal Specific requirements for collective dismissal Regulation on temporary forms of employment
OECD countries
Australia 1.94 1.57 2.88 1.04
Austria 2.44 2.12 3.25 2.17
Belgium 2.99 2.14 5.13 2.42
Canada 1.51 0.92 2.97 0.21
Chile 1.80 2.53 0.00 2.42
Czech Republic 2.66 2.87 2.13 2.13
Denmark 2.32 2.10 2.88 1.79
Estonia 2.07 1.74 2.88 3.04
Finland 2.17 2.38 1.63 1.88
France 2.82 2.60 3.38 3.75
Germany 2.84 2.53 3.63 1.75
Greece 2.41 2.07 3.25 2.92
Hungary 2.07 1.45 3.63 2.00
Iceland 2.46 2.04 3.50 1.29
Ireland 2.07 1.50 3.50 1.21
Israel 2.22 2.35 1.88 1.58
Italy 2.89 2.55 3.75 2.71
Japan 2.09 1.62 3.25 1.25
Korea 2.17 2.29 1.88 2.54
Luxembourg 2.74 2.28 3.88 3.83
Mexico 2.62 1.91 4.38 2.29
Netherlands 2.94 2.84 3.19 1.17
New Zealand 1.01 1.41 0.00 0.92

And then I wondered about just how the unemployment rates of the two countries had compared.

denmark U

At least for the last 15 years, our unemployment rate has hardly ever been higher than Denmark’s.

And what of the share of the population in employment.  There the difference in recent years is quite startling, and all in favour of New Zealand.  The sustained fall since 2007 in the Danish share of the population that is employed is among the largest in the OECD, matched only by Greece, Ireland and Spain.

denmark E

Of course, the recent employment (and unemployment outcomes) aren’t just the result of employment protection legislation and active labour market policies.  Demand is an issue too, and by pegging to the euro Denmark gave up the ability to use monetary policy to support demand (and the euro area authorities have largely exhausted their capacity).  I guess the Danish unemployment rate isn’t too bad, but I wasn’t quite sure what the Danish labour market experience had to offer that should attract New Zealand.

I imagine that life on the unemployment benefit is a bit more pleasant in Denmark than in New Zealand, but it isn’t obvious that the Danish structure, as a package, is producing, over time, better outcomes than what we have here.  And their model is vastly more expensive, and more heavily regulated, consistent (of course) with Denmark’s position as the OECD country with the third largest share of government spending as a per cent of GDP (57 per cent).  New Zealand, by contrast, has total government spending of around 41 per cent of GDP

Perhaps more regulation and more spending was Robertson’s point.  I guess we have elections to debate such preferences, but it seems a stretch to believe it would be an approach that would make our labour market function better.  It isn’t obvious Denmark’s does.

Who speaks for the 35000 unnecessarily out of work?

The Labour Party’s finance spokesperson, Grant Robertson, yesterday took the opportunity of today’s OCR review to make another statement on monetary policy.  I was pretty critical of his previous effort, which seemed to involve trying to blame Bill English for Graeme Wheeler’s errors and misjudgements.

The latest statement is little more inspiring.  It was good to see him focus on the high and rising rate of unemployment, and to point out that inflation hasn’t been at the 2 per cent midpoint since that target was set three years ago.

But he wants to use this record as a basis for amending the Reserve Bank Act to “put employment up as a core objective“.  I presume he would really mean low unemployment, since the Reserve Bank would (reasonably) point out that employment growth and participation rates have done quite well over the last few years.  And unemployment is the measure of excess capacity in the labour market.

Robertson talks about a dilemma that the Governor apparently faces.  But there simply isn’t one.  Inflation (and more particularly core inflation measures) is well below where it should be, and unemployment is (rising and is) much higher than it needs to be (than any plausible NAIRU).  That is a classic case of a demand shortfall, and the standard prescription is looser monetary policy.  Lower interest rates and a lower exchange rate will tend to raise both activity and inflation, and lower unemployment.

There are times when monetary policy faces hard choices –  when keeping inflation near the target might involve measures that will temporarily raise unemployment.    Some of them are explicitly addressed in the Policy Targets Agreement (and have been ever since 1990), and others are captured in a more general way –  the PTA is quite clear, for example, that the focus of monetary policy is supposed to be on the medium-term trend in inflation, not the near-term wobbles.  And, for better or worse, for 15 years the PTA has explicitly enjoined the Bank to avoid unnecessary variability in output.

I’m not a diehard defender of the way the monetary policy bits of the Reserve Bank Act are worded, or even of inflation targeting itself.  There might even be some sensible ways of formulating section 8 of the Act to include references to unemployment.  But section 8 of the Reserve Bank Act has almost nothing to do with the combination (persistent low inflation and persistent high unemployment) that Robertson rightly worries about.   Rather those outcomes are about a persistent series of misjudgements by the Governor (and, apparently, most of his advisers).

I’ve pointed out previously that central banks in other countries have also been taken by surprise by the events of the last few years.   But most of them have reached the limits of conventional monetary policy.  Several – including the ECB and the Swedish Riksbank –  even started to tighten, only to have to fully reverse those tightenings.   But the Reserve Bank of New Zealand is the only advanced country central bank that has (a) never been constrained by the near-zero bound on nominal interest rates, and (b) has twice (repeat twice) started tightening only to have to reverse itself again.    Taken together with the outcomes (too-low inflation, and too-high unemployment) it is a pretty poor track record.  And the Bank –  the Governor, recalling that the system is one of personalised accountability – has not been seriously called to account for that failure.

Legal responsibility for calling the Governor to account rests with the Minister of Finance and the Reserve Bank’s Board.  As I’ve noted, the Board seems to see itself as champions and defenders of the Bank, rather than being there to provide serious scrutiny and challenge.  And it isn’t clear that the Minister does more than grumble privately, and occasionally make slightly cryptic public asides.

But where has the political Opposition been?  In both his last two statements, Robertson absolves the Governor of any responsibility –  in his view the problem is the mandate, or even the Minister, not the month to month choices the Governor has actually been making.

Perhaps it is easy to call for changes in the mandate. It isn’t going to happen any time soon..  It might be harder to actually have a go at the Governor.  And one shouldn’t do so lightly, but this is an episode of repeated failure, and a stubborn reluctance to acknowledge, or learn the lessons from, those failures.  Of course, lots of the great and good have agreed with the Governor’s stance –  as I’ve pointed out before the NZIER Shadow Board’s recommendation have tended to mirror what the Governor actually does.  But they have been wrong, not just once, but again and again.  And the Governor is the person who is paid to get it right more often than not.   Why isn’t Robertson taking more of a stand and saying so.

And what about the governance arrangements?  Robertson notes that the Act was passed in the 1980s and is ‘out of date and out of touch with changes in the global economy’.  But if he looks at central banking legislation around the world what he will really find is that it is the governance aspects of the Bank –  the single decision-maker –  that look odd.  As the Reserve Bank’s survey showed, there is a wide variety of ways of expressing the statutory objectives for monetary policy, but there has been no trend away from something like a medium-term focus on price stability.  Our Governor simply has too much power.  Treasury reports that the Minister likes the current model because it provides better accountability, but where is the evidence of the accountability in the failures of the last few years?  The Minister can’t be blamed for who was appointed as Governor –  he had to appoint someone the Board nominated –  but he and the Board can, and should, be blamed for how little effective accountability there has been.

The unemployment rate is currently 5.9 per cent (and expected to rise further).  A reasonable estimate of the NAIRU might be 4.5 per cent.  If so, that is about 35000 people who are unemployed now who might not be unemployed if the Governor had run monetary policy, within his current mandate, rather better.  Even if the NAIRU, is nearer 5 per cent, it is still more than 20000 people unnecessarily out of work.   Does he get out and meet any of these people?  If so, I wonder how he explains his failure, and excuses the way his choices have blighted the lives of these people?

I suspect the answer to my question is “no”.  In fact, I just had a quick look through the list of audiences the Governor has given on-the-record speeches to since he took office.   There are various official forums and conferences, but not one of the remaining nine speeches was to groups representing workers, beneficiaries, or the wider community.  Most are to top-end business audiences (the “Admiral’s Breakfast Club” in Auckland, the Institute of Directors, INFINZ, Chambers of Commerce etc), and speeches given by the Deputy Governors seem to be to equally select audiences.  Perhaps the Governor gets no invitations from other sorts of groups, although in my experience that is unlikely.  Perhaps he gives lots of off-the-record speeches to such groups, and just by coincidence it is only the on-the-record speeches that were to upper-end business groups?

I’m not suggesting that the Governor is exercising anything other than his best judgement in making OCR decisions.   And his business audiences would also typically have been better off if the Bank had not been persistently and unnecessarily holding back the recovery, but his choices typically hit hardest on those at the bottom.  And it isn’t apparent that he is even listening to their plight, simply taking comfort from the echo chamber of the elite.

Traditionally, one might have expected an Opposition Labour Party to be their loud and clear voice.  Robertson’s is currently anything but that.