We were away for a month and it has taken time to work through the backlog that inevitably builds up over such a mid-year absence. In the meantime, a fair bit more detail has emerged about the Orr/Quigley/Willis saga, between various OIA responses to me, one I’ve seen to another person, a bit more on the Bank’s extravagant new Auckland premises, the Bank’s Annual Report, and the pro-active (but very belated) detailed disclosures about the Orr golden payoff (other OIA responses are still being slow-walked by the Bank). And, of course, we’ve had the announcement of the new Governor and the, perhaps predictable and certainly appropriate, notice of resignation by the temporary Governor (and substantive Deputy Governor). I may eventually get to writing about some of that material, but I have updated my timeline of the Orr/Quigley/Willis saga where relevant.

The Reserve Bank isn’t exactly, in the jargon, a “learning organisation”, but more akin to one determined never to acknowledge a mistake (in a field in which, with the best will in the world, uncertainty means mistakes are pretty much inevitable). The last of the old guard – the Orr team – was at it again last week. Orr may have gone months ago, but Christian Hawkesby (who was the DCE responsible for monetary policy throughout the Covid period itself) is serving out his last few weeks, the other foundation MPC member (Bob Buckle) left just a few weeks ago, and no one expects the manifestly unqualified Karen Silk, the Orr DCE responsible for monetary policy for the last few years, to survive much longer. (There is the old and problematic board too, but monetary policy isn’t their field.) But the face of the latest effort in defence was the chief economist, another Orr groupie, Paul Conway (among many, the line that sticks with me was his closing remarks at the Bank’s early March conference, about having “lost a much-loved Governor”). Time is moving on but they seem determined to defend the Orr legacy, in which they’d all played greater or lesser parts. Specifically, the hugely expensive and risky LSAP.

There were a number of pieces released last Wednesday (links to them all here), headlined by a speech in Australia by Conway, supplemented by some comments from Conway in a Herald article on the Bank’s case (that really the LSAP paid for itself and, what’s more, it is really hard to assign any blame). Of the Bulletin article, “Pandemic lessons on the monetary and fiscal policy mix” by a couple of staff economists I haven’t got much to say: it is wordy and despite 10 pages of references offers little or no insight on the issues or the institution. Perhaps the only line in it that really caught my eye was a heading that claimed that fiscal and monetary policy “Coordination is an intricate and dynamic challenge”, a claim which not only seemed quite wrong, but also at odds with the thrust of Conway’s comments on that issue in his speech (where he seemed, rightly in my view, to be suggesting that what was needed was independence in operations, but keeping each other informed, and exchanging views on what works, what limitations there might be etc). As it ever was, but perhaps now institutionalised in that the Secretary to the Treasury is a non-voting member of the MPC. (Of course, the Treasury is also charged formally with monitoring the performance of the Bank, but the last 18 months suggests how hopeless they’ve been in that role.)

The centrepiece of what the Bank released last week is an Analytical Note by some of their researchers and some IMF staff which uses a model developed at the IMF to attempt to show that really the LSAP was a great success – macroeconomically and that it paid for itself (notwithstanding the $11 billion or so of direct losses incurred). It is a more elaborate version of the framework used by the IMF in a brief early note attached to their 2023 Article IV report (and talked up at the time by the former Governor as offering the “proper story” not some “piecemeal accounting story”), a piece whose claims I unpicked in a post at the time (link a couple of lines up).

So much money has been lost by central banks in the Covid QE interventions – in countries across the advanced world – that too many of those institutions, and their institutional allies (places like the IMF), now seem determined to try to prove a very weak case, that it was really all worthwhile (a case only made harder given the inflation mess that many advanced countries then went through, and which we are still living with the aftermath of). The effectiveness of generalised QE in government bonds – as distinct from specific interventions in dysfunctional markets – has been debated for 10-15 years now but my prior going into Covid was pretty much that of the eminent UK economist Charles Goodhart who in a Foreword to a book I reviewed some years ago (book completed just prior to Covid) opined that in his judgement:

“the direct effect on the real economy via interest rates, with actual or expected, and on portfolio balance, was of second-order importance, QE2, QE3 and QE Infinity are relatively toothless”.

It seemed to be pretty much the Reserve Bank’s approach then too (see this substantive interview with Orr in August 2019, and even just prior to the launch of the LSAP the then chief economist was quoted as playing down the likely impact of such policies), with an explicit preference from the Governor to use negative interest rates (as in Europe and Japan) instead.

I don’t want to bore readers with an interminable critique of all the papers (having already run various posts – eg here in response to some of their earlier claims – over the years of my scepticism that this big asset swap – all it was – made much useful difference to anything, to justify the risk and losses the Bank incurred for the Crown).

So I’m going to work backwards, responding to some of the easier-to-rebut assertions, and only at the end coming back to specific concerns about the particular model they are using in support (recall the distinction between support and illumination).

First, some Conway claims reported in the Herald article

“Conway said it was difficult to isolate the impact of a single tool the Monetary Policy Committee used at a time the Reserve Bank and Government were throwing a lot at the economy to keep it buoyed. He also recognised the collective response caused prices to soar. However, he cautioned against people assuming money printing was largely to blame for the economy overheating.”

You might easily forget reading that that the way our system is set up the Reserve Bank moves last. If the economy overheated – and on everyone’s reckoning it did (both IMF and Reserve Bank positive output gap estimates were very large) – it is the MPC’s fault. It is their job to, as far as possible, lean against the economy overheating (or the opposite) and keep core inflation near the target midpoint. They failed, and that is on them not on the government of the day (which might have run bigger deficits than many were comfortable with, but those deficits weren’t kept secret – most especially from the MPC). Whether or not the LSAP made much difference to demand (Conway believes it did), the responsibility clearly rests with the overall package of monetary policy measures – OCR setting, LSAP, and the Funding for Lending programme (that went on offering cheap loans to banks until the end of 2022). There is no sign in his speech, press release, or interview that Conway – and presumably his bosses – ever really accept that responsibility/blame. Nor is there any real mention of what was actually at the root of the problem: an egregious forecasting failure. Like many/most other forecasters – but unlike them actually wielding power and responsible for outcomes – the MPC badly badly misread the state of demand and resource pressures through Covid, and the result was the inflationary mess that followed. It was hard to get right – few did – but when you take the role you need to take the responsibility. All too few central bankers have. Conway wasn’t there when the worst mistakes were being made, but he now speaks for the institution (and, currently, specifically for Hawkesby, who held the critical role of DCE responsible for monetary policy when it mattered).

But if the forecasting mistakes were pretty common and widespread (inside and outside central banks, here and abroad), the most evident costly failure is purely on the Reserve Bank itself. This is from Conway’s speech

In other words, even granting for the moment the Bank’s view that the LSAP did a lot of good to justify the large losses, really they would prefer not to have used it at all, because a modestly negative OCR would have achieved the same (claimed) benefits without the massive financial risk and actual $11 billion in losses to the taxpayer. Last week’s papers use quite a bit of the passive voice, suggesting that the inability to use negative rates had been something quite out of their control, perhaps something banks were to blame for. Someone, anyone, no one…but certainly not the Bank.

Actually, it was all on the Reserve Bank. An internal working party in 2012 had recommended (I chaired it) that the Bank ensure our own systems and those of banks were able to cope with negative rates should they ever be needed. The then Governor accepted those recommendations, but it seems that nothing happened until it was far too late (it wasn’t until Covid was almost upon them that the Bank realised nothing had been done and some banks – apparently it wasn’t even all – weren’t operationally capable). It is all the more extraordinary because in the second half of the decade the Bank had clearly been doing preparatory thinking for coping with the next severe downturn – there was a thoughtful Bullletin article on options in 2018, and of course that serious interview of Orr’s I’d linked to earlier. But no one seems to have done the basic engine-room sort of work, reviewing with banks their ability to cope with an instrument used in other countries for many years by then. There was turnover at the top – Orr came on board in March 2018, Hawkesby in March 2019 – but it isn’t as if in mid 2019 these should have been remote issues (the OCR had been cut to its then lowest ever level of 1 per cent, and it wasn’t going to take a particuarly savage shock to put zero in view). And yet nothing was done and – on the Bank’s own telling – the cost to the taxpayer was the full $11 billion or so (since they themselves now say they could have had the macro benefits they claim without the risks/losses if only they – Orr, Hawkesby, the 2019 MPC – had ensured basic operational readiness). That was on them, and only them. (Incidentally, the Bank reckone that by Q42020 those issues were sorted out, and yet they went on taking additional LSAP risk – and then incurring further losses – well into mid 2021.)

A learning organisation, the sort that acknowledges mistakes and learns from them, would be quite open about the cost of their own failure. The Hawkesby/Conway Bank, not so much.

All that was on the assumption the Bank was right and there were huge gains achieved through their monetary policy efforts, notably including the LSAP purchases/punt.

And that rests on two propositions. The first is that there were substantial boosts to GDP, and second that government tax revenue was permanently higher as a result.

Conway used this chart (from the Analytical Note modelling effort)

(No, they aren’t saying tax revenue got to 42 per cent of GDP; it is just an illustrative device).

In principle, if there had been a very deep hole in economic activity which monetary policy choices had closed much quickly than otherwise, there’d also be a windfall gain in tax revenue. (That was the scenario for the highly questionable little IMF exercise in 2023 linked to earlier.)

Unfortunately, while in 2020 the Bank thought there was such a hole (eg as late as the November 2020 MPS the Bank thought there was a negative output gap of about 2.5 per cent, which would persist around those levels for the whole of 2021), they are now quite clear in there view that there was no such hole. In their most recent projections, they estimate that even in the September quarter of 2020 (ie straight after the first and longest severe lockdown) the output gap was (barely) positive. And in the real world monetary policy actions (starting from late March) just don’t have such large and immediate real effects as to have made a big difference to activity as soon as mid-August (ie halfway through the September quarter). With hindsight – albeit only with hindsight – monetary policy choices, including the LSAP if it had real effects, were driving the economy further away from a balanced position (ie into a substantially positive output gap, now estimated to have peaked at almost 4 per cent of GDP, and the associated surge in core inflation).

And this is where the Bank’s package last week gets borderline dishonest. Conway uses this chart

which a casual reader might think was all gain. But the chart ends just around the point where the output gap crosses into negative territory, and thus completely – and deliberately (we must assert for a senior policymaker) – ignores the more recent period, in which the Bank estimates that we are now in a materially negative output gap, and will in time have had three years of a negative output gap (ie GDP tracking below potential, with government tax revenue consequences). Pretty much all observers ascribe that negative output gap to the necessary working off of the earlier, marked, RB-allowed/enabled overheating (ie dealing with the inflation). Any honest reckoning of the fiscal consequences needs to take into account the entire period. There probably were some fiscal gains from the Bank’s monetary policy choices – surprise inflation reduced the real debt burden, and resulting fiscal drag picked up some extra revenue – but I doubt the Bank really wants to claim credit for that inflation they weren’t supposed to be aiming for and did not forecast.

Most likely, over the full period, there were modest – but largely unsought and undesired – revenue gains (achievable, see above, with conventional instruments if only the Bank had done its preparatory job – and for central banks, like airport fire brigades, preparation for crises is a core part of the job), but large and easily identifiable losses from the risky punt made on the LSAP.

But all that assumes that the LSAPs made a material difference at all. That has long seemed quite unlikely to me. You can – as the Bank and IMF staff have done – construct a stylised model in which the LSAP makes a material difference, but that model doesn’t really seem to fit very well what was going on, here and abroad, and the LSAP simply isn’t necessary to explain almost everything that did go on.

To be clear, I think most economists will agree that if the LSAP worked it wasn’t as (in the Herald’s unfortunate term) “money-printing”. The volume of settlement cash created – all reimbursed at the OCR – was simply not a material channel. If the LSAP made a difference it did so by one of two (perhaps mutually reinforcing) mechanisms: altering market interest rates in ways that had macro consequences (this is the Reserve Bank’s own story going back to 2020), and/or reinforcing market convictions/views that the OCR will be kept extraordinarily low for a protracted period.

This is from the model Conway hung his hat on, in which he

cites the modelling exercise – not an empirical estimation but a stylised representation – in which the choice not to use the LSAP (in New Zealand) makes at peak about 150 basis points of difference to long-term government bond rates (relative to the counterfactual in which only the actual OCR cut was done) and a 20 per cent difference to the exchange rate. In this modelling exercise we are told that most of the work is being done by the exchange rate adjustment (itself responding to changing interest rate differentials), noting that long-term interest rates themselves aren’t a material part of the New Zealand domestic transmission mechanism.

But we are also told that the LSAP was roughly equivalent in its economic impacts to a 100 basis points cut in the OCR. And we’ve had plenty of swings in the relative policy rate spreads of 100 basis points or more (including since 2021) and none of them has resulted in a 20 per cent change in our exchange rate (which has been astonishingly stable over the last 15 years or so).

Another chart from Conway’s speech is this

where you’ll see (red bars) that New Zealand’s use of government bond purchases was one of the largest among advanced countries (similar to the UK and Canada). But you will also see quite a group of countries to the left of the chart that seem to have done little or no QE over this period. Korea, for example, also cuts its policy rate by 75 basis points, but is there any sign of its real exchange rate rocketing upwards because they did no QE? Well, no. And one can run through the other countries and you will search in vain for such large effects (and yes each country has its own idiosyncrasies). Australia did no material QE until the end of 2020 (for much of the year they relied on policy rate cuts and an announced target for a three year rate) and there isn’t any sign of the AUD appreciating sharply against the NZD (where our central bank was actively pursuing QE).

And there are similar problems with the long-term bond yield story. Eyeballing that chart Conway cited, you’d have to think that advanced countries that did no little or QE in government bonds would have seen their long-term government bond yields rise sharply (and, to be clear, the New Zealand OCR was about middle of the pack for how much advanced country central banks cut in 2020). But again, evidence of such effects is sparse indeed. Take Korea again, their long-term bond yields didn’t fall as much as New Zealand’s did, but they certainly didn’t rise in 2020. Nor did Norway’s or Iceland’s – or, indeed, any advanced country. I don’t find it implausible that the scale of New Zealand’s LSAP might have made a bit of difference to longer-term bond rates, but eyeballing the cross-country experiences something like 20-40 basis points looks more plausible – eg our long-term bond rate did fall more than Australia’s in mid 2020.

And that is for a 10 year bond. What matters in the domestic economy is mostly 1 and 2 year rates (including through the mortgage lending and refinancing channel). And so the important question is likely to be whether the LSAP did anything much – directly or by signalling reinforcement effects – to affect those short-term rates. And there I think champions of the effect of the policy will find themselves on the backfoot. Those shorter-term bond and swap rates certainly fell very low (some were briefly slightly negative for a few weeks around September 2020, although by the end of 2020 all the short-term bond yields were at or above the 25 basis points that was then the OCR), but is there good reason to suppose those rates would have been much different absent the LSAP (or with an LSAP brought to an end in say December 2020)?

What else was going on? By late 2020 the Reserve Bank told us the operational issues around negative rates had been sorted out. In the Survey of Expectations (semi-expert respondents), the December quarter survey remarkably – looking back now – had the mean expectation for the OCR a year ahead at -0.16 per cent (with inflation two years out nonetheless still expected to well undershoot the midpoint). The MPC itself had pledged back in March 2020 (rashly) not to change the OCR for a year. And what of the Bank’s own forecasts? With all the stimulus already built in the Bank in the November 2020 MPS was projecting that inflation would stay at or marginally below the bottom of the target range through 2021 and 2022, and that the output gap would remain deeply negative at least through all of 2021. The Bank published “unconstrained OCR” numbers – where the OCR would go if deeply negative OCRs were possible, to get inflation back towards target – getting down to -1.5 per cent by the end of 2021. The fact that those forecasts and expectations were deeply wrong – as we know now – is irrelevant to the fact that that was the air people were breathing (and markets were trading) in late 2020. The prospect of any rise in the OCR any time soon seemed remote, and cuts couldn’t be ruled out (remember that only the MPC pledge to March 2021 had ever prevented the OCR being cut to at least zero).

Is it plausible that the LSAP had some effect on these rates? Well, perhaps. I wouldn’t quibble if someone was suggesting 20 or 30 basis points but…..short-term rates were always going to be much more heavily influenced by expectations of future OCR moves, and – independent of any LSAP announcements – the macro forecasts at the time were very very weak (as actually they were in Australia – check the RBA November 2020 inflation projections).

What of the stylised modelling results themselves? Well, I’d take them with a considerable pinch of salt. You might have hoped that someone in the Reserve Bank with an instinctive feel for NZ business cycles etc (surely there are still one or two of them) might have interjected and asked at some point how it was that this model posited near-instantaneous real economic effects from a change in the real exchange rate (the usual stylised view has been that those lags are particularly long, longer than those for interest rate effecs)

Or someone might have asked how it was – so very convenient – that the model produces only helpful effects on inflation from the LSAP (with no LSAP and a higher exchange rate perhaps direct price effects hold up inflation in 2020), and no unhelpful ones, despite the large positive impact on the output gap. And, as a reminder, it is the standard view that the real economic effects of monetary policy take more like 6-8 quarters to be substantially seen in inflation. If the LSAP made a real and material difference, it should have made one also to inflation – exacerbating the problems – in mid-late 2021, but this exercise somehow manages to tidy away any such effect.

Who can know quite what is driving the people at the top of the Reserve Bank. Perhaps they genuinely believe all this stuff, but I guess if you’d been a prominent part in the loss to taxpayers of getting on for $11 billion you’d have a fairly strong incentive to convince yourself it had all really been worthwhile. And I guess with the current more-moderate personalities at least we’ve moved on from those claims Orr used to make that the benefits had actually been multiples of the cost.

But whatever now drives them, these are lessons I think you should take away:

• had the Bank done its basic crisis preparedness job in the years leading up to Covid, LSAP would probably never have been deployed at all (or used only on a much smaller and briefer scale – the Bank also likes to claim they helped settle markets in late March 2020 although the evidence suggests any effect was small and entirely incidental to the Fed addressing problems at source).   Orr’s instincts on preferred policy instruments (effective and with much lower financial risk) were correct,
• ultimately the major failure was a forecasting one.    On the path of forecasts as they were in 2020, 2021 and early 2022, the Bank would still have wanted to be providing lots of monetary policy stimulus for a long time (that is what forecasts of very low inflation and large negative output gaps tell central banks to do –  and contrary to Conway’s claim, this had nothing to do with the 2019-2023 specification of the Bank’s target; it would be the same today).  Thus, the path of inflation would have been very much as we actually experienced it.
• but at least if we were going to experience the consequences of a major macro forecasting failure, the taxpayer wouldn’t have been facing almost $11 billion of losses in addition (to the inflation and the dislocation, still being experienced, in getting rid of it).
• responsibility for the substance rests with those in office over 2019-2021 (Orr, Hawkesby, Bascand primarily –  and the rest of the then MPC)
• responsibility for the spin now rests with Hawkesby, Conway, and (presumably) Silk.    Who knows if the rest of the MPC even saw this stuff before it went out.  It would be interesting to hear perspectives from some of them –  not involved over 2019 to 2021. 

Finally, in fairness one might note that central banks generally have not been great at acknowledging failure and mis-steps. But being in bad company really is no defence. Recall that the quid pro quo for central bank operating autonomy was supposed to be serious transparency and accountability, built on demonstrable expertise. All appear to have been lacking at 2 The Terrace.

It was in mid-August that this particular bit of shameless Reserve Bank spin got going. From a post in late August

It proved to be nonsense of course. Once we had access to the short little IMF piece, published at the back of the Fund’s Article IV review, it was clear that it all amounted to a case of “if you assume big beneficial economic effects from the LSAP, then you get material tax revenue gains”, which might be set against the actual losses on the trade.

But the IMF’s picture bore not the slightest relationship to New Zealand reality through the LSAP period.

But none of that stops the Bank.

Here was their Annual Report, which will have been signed off by the Bank’s Board – the ones with little or no subject expertise.

And then this week their deputy chief executive responsible for monetary policy and markets – the one with no subject expertise at all – was at it in a speech given to investors etc in Sydney.

Now I have not seen any analyst endorse that little IMF exercise. And you can sort of tell that even the Bank knows it is shonky (but convenient). Note that both in the Annual Report and Silk’s speech they are careful not themselves to claim that the LSAP was profitable for the taxpayer, just to report (what is factually accurate) that the IMF – or at least a couple of back office researchers, given a couple of hours to play with a toy model – said it was. Silk herself only claims that the losses (they aren’t just “accounting losses” but real ones for taxpayers) are offset “to some extent” by other fiscal benefits to the Crown (and there might be even some very slight extent to which that is so, but it is by no means guaranteed). And the Annual Report text takes a similar approach – citing the IMF, without actually endorsing its work, but leading the casual reader to assume they did. The Bank knows better and simply choose egregious spin – the sort of dishonesty we might have got used to from politicians, but shouldn’t have to put up with from independent technocrats.

But here we are dealing with Quigley and Orr, who know better but seem to have a tenuous relationship with truth and serious analysis whenever something otherwise suits. And Silk, who may know no better – but can surely read, if she were at all curious – who is the senior manager with overall responsibility for the Bank’s macro and monetary policy analysis.

None of them should be in their roles (Silk should simply never have been appointed to hers). But will the new government care enough to do anything about this situation, or will spin and dishonesty continue to characterise our central bank, while those with the power to do anything about the situation get on with simply holding office?

One of the great things about being a prominent organisation that releases complex material to select media under embargo is that you can get uncontested coverage in the first (and probably only) news cycle. Adrian Orr will have been glad of that when it came to the embargoed release yesterday (the public only got to see it at 5:43 this morning) of the IMF’s Article IV report, and in particular the short (600 words) annex on the fiscal implications of the Reserve Bank’s LSAP programme – the one on which the Reserve Bank has so far lost $11bn.

It was 10 days or so ago that we first heard that some such paper was coming. The Governor was being interviewed by the Herald‘s Madison Reidy after the Monetary Policy Statement. She asked Orr about the LSAP losses and noted in contrast the fiscal costs of the storms/cyclone this year. In his usual effusive style he responded that the LSAP itself had already more than paid for the cyclone recovery costs, moving on to suggest that only accountants could think otherwise “who know the cost of everything and the value of nothing”. He then went to say that the IMF had a paper, which he hoped would be published, showing that the LSAP had actually improved the government’s finances, and that it would offer the “proper story” not some “piecemeal accounting story”.

That caught my eye. Knowing that the IMF Article IV report was due before long, I wondered if they’d have a Selected Issues paper on the topic. These are supplementary research pieces, usually 15-20 pages or so, undertaken by Fund staff (often on topics requested by the authorities) as part of the Article IV review process. The latest two such papers are here.

But it proved not. Instead, we got only a little annex on the topic (600 words and two pictures) on pages 64-66 of the main report. The “proper story” it certainly isn’t – and in fairness to the Fund, as distinct from the Governor, it doesn’t really purport to be. What it is is a little exercise by a few researchers (not working specifically on New Zealand) using a model, as yet unpublished, that they have developed for work on central bank exit strategies, showing that on certain assumptions something like the LSAP could end up producing net fiscal benefits. Surprise, surprise. Of course. It could. The question really is about the realism of the assumptions etc.

Orr, and probably the Fund, will have been pretty happy with the Herald‘s coverage this morning, under the headline “Reserve Bank’s money-printing buoyed Govt books, says IMF” (well except that – rightly – the Governor and IMF would disavow the suggestion that the LSAP was “money-printing”: it was just an enormous asset swap). The results could be read as backing the Governor’s claim – a year ago in an interview with the same journalist – that the benefits to the economy had been “multiples” of the direct cost (although she seems not to have realised that because she contrasts these results with Orr’s 2022 claim).

The first of the two charts really captures the gist of why the little model analysis sheds no useful light at all (SS here simply means steady state).

I showed the top left chart to a 3rd year economics undergraduate, who immediately spotted the problem. It isn’t very hard.

You’ll note that in this example real GDP falls materially below the steady state, or potential, and stays there – converging ever so slowly – for years. By construction of the model, the LSAP intervention – about the scale of the actual LSAP programme – lifts real GDP, but again throughout the entire forecast period real output is at or below potential. There is, in other words, a negative output gap right through the period in the scenario. As the model is constructed, the LSAP intervention boosts real GDP, so that there is a smaller negative output gap. But it is always either negative or zero. Thus, the LSAP has unambiguously boosted real GDP, and thus tax revenues. Working back from the (few) numbers in the little note, and knowing the tax/GDP ratio in New Zealand is about 30 per cent, the total GDP difference must be of the order of 7-8 per cent of GDP. The current LSAP losses to the Reserve Bank are just over 2.5 per cent of GDP, so on those numbers the gains from the LSAP would be “multiples” of the Reserve Bank losses.

But have we had a negative output gap throughout the last 3+ years since the LSAP got underway at the end of March 2020?

Not according to the Reserve Bank, or to any other serious macroeconomic analyst. But since it is the Reserve Bank making the bold claims, and because their numbers are easy to find, here is the Reserve Bank’s current view of the output gap over the period since the start of 2019. I’ve also shown their projections from the last (pre Covid, pre LSAP) MPS.

The output gap is now estimated – several years on – to have been negative for only two quarters, March and June 2020. Every quarter from September 2020 onwards has been positive.

Doesn’t that just mean even more tax revenue and more net benefit?

No, it doesn’t. What went with the persistently positive and large output gap? Why, that was the sharp and now sustained rise in inflation. And how do the Reserve Bank’s modelling and forecast efforts envisage that core inflation comes back to target again? Why, via (raising the OCR and engendering) a fairly protracted negative output gap

and when output is running below potential for several years (and on these projections it isn’t even back to potential by 2026), tax revenue will, all else equal, be running lower than it would otherwise have been. In fact, the way the forecasting models are set up, things are pretty much symmetrical – it will be take roughly as much excess capacity as there was excess demand. We simply haven’t been in the world the IMF’s little desk exercise assumed/portrayed. And thus the numbers are just pretty meaningless when it comes to making claims about the fiscal or other net costs/ benefits of the LSAP. In his day, the Governor would have recognised that once he read the short note and thought for a minute or two.

There are many other limitations to the analysis, even on its own terms. First, the subsequent inflation seems to be treated as quite unrelated to the (with hindsight excessive) stimulus that had gone before. Second, while they assert that the LSAP was a better (net cheaper) intervention than anything else they make no attempt to show this. Thus, had we wanted to throw another $11bn at the economy we could instead have simply given the money to households ($2000 or so per capita). That almost certainly would have engendered a significant demand response (and more than what most New Zealand economists outside Bank believe the LSAP actually did). And we know that actually the OCR hadn’t been lowered to any sort of effective floor, just to the 0.25 per cent the MPC had chosen to set it at. So at least some of any stimulus the LSAP provided could have been done simply by setting the OCR lower – at no risk to the Crown at all. The Funding for Lending programme, used long and late by the Bank, seemed to be an effective tool for stimulus…..and involved no financial risk to taxpayers at all. Had the Bank been doing its job in the run-up to Covid, the negative OCR tool would have been available from the start. You might not like that tool, but the Governor had told us before Covid that he did, and it could have been used at no financial risk to the Crown.

And all this simply assumes – no serious attempt has ever been made to show – that in the specific circumstances of New Zealand (where shorter-term rates are overwhelmingly what matter, and they were anchored by OCR expectations), the LSAP had any material (even inflationary) stimulus at all, to justify the huge financial risks that were taken with no serious advance scrutiny, and which ended up going very bad.

I could take the opportunity to run through all the arguments around LSAP effectiveness again, but I won’t. About a year ago Orr made a strong play to defend it, and the alleged benefits, and I spent a long post then unpicking his arguments. Sometimes – there are so many – one just forgets occasions when Orr has just made stuff up. He was at it again this week.

As for the IMF piece, it is what it is. If you ever find yourself in a deep economic hole, seemingly intractable, you want all the monetary policy stimulus you can get. Best of all, use the OCR and use it aggressively. Perhaps QE can add some value on occasion (probably not much in New Zealand, but perhaps anything might help then in such a scenario). But that – we now realise – just isn’t where the New Zealand economy – or most other economies – found themselves after March 2020. In fact, it is the Reserve Bank itself that now reckons the economy was already overheating – GDP above potential – by the second half of 2020.

Three months ago I wrote a short post here using some new data the Reserve Bank had started to publish on the monthly payments Treasury was making to the Reserve Bank as the losses were gradually realised on the huge portfolio of bonds the Bank and MPC had run up in 2020 and 2021 (the LSAP). It was to the Bank’s credit that they have started making the data available, and although there have been a few glitches since then, when I have got in touch they have been very helpful.

I can remember the days when I and a few others used to jeer at them for having lost $7 billion (and these numbers are a proxy – albeit an imperfect one – for big and very real losses for the taxpayer from the asset swap programme, executed at probably the single most inopportune time since interest rates were liberalised 40 years ago). Last year, the Taxpayers’ Union gave the Governor a lifetime achievement award for waste, citing then estimates of $8.5 billion of losses.

That was then. When I ran the first post in May total RB losses (now properly measured, with the indemnity payment data) had been bobbling just either side of $10 billion. With today’s update by the Bank of the relevant spreadsheet, here is the position to the end of July.

Yes, total RB losses from this grossly overblown under-analysed programme have now reached $11 billion (which was also the last total estimate from The Treasury I’d seen).

But, again, that was then, and in August to date bond yields appear to have risen another 20 basis points or so. As the portfolio slowly shrinks and the longest bonds are sold off first, the extent of further losses should diminish, but there is no sign we’ve yet reached the limit.

I’ve tended to focus in on the Governor as responsible, and there is little doubt that he is the dominant figure on the MPC.

But we shouldn’t forget the other internal MPC members who shared in the decisions to accumulate the risk:

Then Deputy Governor, Geoff Bascand

Then Assistant (now Deputy) Governor, Christian Hawkesby

Then Chief Economist, Yuong Ha

One has since been promoted and two have moved on, although with no hint that sharing responsibility for absolutely huge taxpayer losses was a part of either move.

More recently, Karen Silk and Paul Conway have joined the MPC. They weren’t there when the risk was taken on, but they have been part of the decision not to close it out quickly, and thus to continue to expose taxpayers to further losses.

And then of course, there are the three externals, all reappointed since the LSAP folly: Bob Buckle, Peter Harris, and Caroline Saunders.

And who reappointed them and Orr? Well, that would be the Minister of Finance and the Bank’s Board, the latter chaired by Neil Quigley, who has just proved you can apparently just make up stuff to Treasury, lead Treasury to lie to the press, and still carry right on as chair of a government board. In this country new depths of poor governance seem to be plumbed almost every week.

Finally, we shouldn’t completely exclude the Secretary to the Treasury from responsibility. She sits as a non-voting member of the MPC and she advises the Minister on things like indemnities and Bank performance. There is not even a hint (eg in the MPC minutes or OIAed papers) that she has ever dissented from the highly risky and costly LSAP intervention.

That is quite a list of people who share responsibility for losses that have now reached $2000 per man, woman and child in this country. Readers will reflect on just what nice-to-haves that politicians are now competing to bribe us with (with borrowed money) might have been considerably more affordable had the Bank stuck to the OCR which, boring as it may be, tends not to make or lose taxpayers much money at all.

I suppose one way of looking at that list of the responsible men and women is that if we averaged it out, the loss was a bit under $1 billion per responsible public figure. There wasn’t even a good party (as Mr Leauanae enjoyed on leaving MPP) just reckless waste and losses on a scale not seen in New Zealand public finances for a very long time.

And no one paid any personal price. There was no personal accountability at all. Most of these people still hold their high, and highly paid, offices. While you and I are covering the losses they so carelessly racked up. It is some slim consolation that one of them is up for election in a few weeks.

There have been various posts here over the last couple of years about the losses to the taxpayer resulting from the Reserve Bank’s Large Scale Asset Purchase (LSAP) programme. Some of these have been more about explaining than excoriating (the latest such explanatory post is here).

As I noted in that most recent post, in the early days of the LSAP the line item on the Reserve Bank balance sheet for the claim on the Crown indemnity was a rough but reasonable estimate of the total losses, based on market prices as at the successive balance dates. It became an increasingly inadequate indicator as the LSAP programme started to be unwound, with the longest-dated bonds being sold back to Treasury, losses being realised, and payments being made from the Treasury to the Reserve Bank under the indemnity.

But the amounts of those indemnity payments were not being routinely disclosed (eg the RB does not publish a monthly income statement) and analysts were reduced to picking up snippets of information from OIAed documents. It wasn’t exactly transparent.

Anyway, in an OIA request to the Treasury and in a conversation with someone from the Bank I suggested it would be helpful if the monthly indemnity payment amounts by Treasury were to be routinely disclosed. That way, whatever debates we might want to have about the merits or otherwise of the LSAP programme, at least we would all be working with the same numbers.

And thus it has come to be, and this morning a new spreadsheet on the Bank’s website went live with monthly updates on payments and receipts under the LSAP indemnity. The link to it is about half-way down this page.

Here are the two components

Here is the Bank’s own description of the numbers in the blue line

There were net transfers to Treasury for a while because the coupon rates the Reserve Bank was receiving were higher than the (OCR) funding cost.

And here is the chart showing total losses, realised and unrealised.

The total will keep fluctuating a bit from month to month as market rates change, but the variability will gradually diminish as (a) the size of the remaining LSAP portfolio continues to steadily shrink, and (b) the longest-dated bonds have been sold back first. But for at least the last eight months, something around $10bn in total losses has been the best (market price) guess.

There were two points to this post. The first was to use the new data to illustrate better than has been possible until now with hard numbers just what has happened with the LSAP gains and losses over time. And the second was to acknowledge the Bank and thank them for making the data available. The losses probably aren’t something the Bank is really comfortable with, but one shouldn’t be hiding from the hard numbers, and in publishing them regularly now the Bank apparently is not. And that is welcome.

$10 billion is, however, a lot of taxpayers’ money to have lost.

This is mostly a follow-up to my post last Saturday on the LSAP losses.

In that post I noted that while the LSAP was still running, the monthly line item on the Reserve Bank balance sheet recording the Bank’s mark-to-market claim on The Treasury under the indemnity was a reasonable proxy, on prevailing market prices, of the direct fiscal losses the LSAP programme would result in. And it was an official number.

The Reserve Bank published its monthly balance sheet for the end of March. The Bank’s claim under the indemnity as at 31 March stood at $7821 million.

However, as I also noted in Saturday’s post, this number is no longer even an approximate estimate of the direct fiscal losses from the LSAP programme. It is still a best guess, on market prices, of the unrealised losses on the bonds the Bank is still holding.

But the Bank’s holding of bonds are now much lower than they were at peak. In the programme as a whole, the Bank purchased government bonds with a face value of $53480 million and LGFA bonds with a face value of $1735 million. All of those purchases were covered by the indemnity.

However, since July last year the Bank has been selling back to The Treasury each month government bonds with a face value of $415 million. Total sales to date – most recently a parcel on Monday – total $4150 million. The resales programme is starting with the longest-dated (most risky) bonds, on which the largest percentage losses will typically have been made. As those bonds are sold back to The Treasury the Reserve Bank’s losses are realised, and their claim on the indemnity is met each month by The Treasury. (In addition, as the table below records, there were some payments from the RB to Treasury in the period before resales began, which may represent higher coupon payments to the Reserve Bank exceeding the Reserve Bank’s (OCR) funding costs during the very low OCR period.)

There appears to be no easy place to find the monthly indemnity payments (I have suggested to Treasury that in the interests of transparency it would be good if they or the Bank provided such a table), but there were some hard numbers, and some indications, in a November 2022 Treasury paper that I drew from in Saturday’s post

Actual market rates have changed since then, but the total payouts to date could be almost $2 billion.

In addition to the sales back to The Treasury, some of the bonds the Reserve Bank purchased have matured in their hands.

On the LGFA side, $216m (face value) matured in May 2021, $250m in April 2022, and another $250m this month.

In respect of government bonds, $1300m matured in May 2021 (and on those bonds the Crown appears to have roughly broken even from having done the LSAP purchases – the OCR, the Bank’s funding cost, having been 0.25 per cent throughout the period the May 2021 bonds were held), and another $7471 million (face value) matured a few days ago, 15 April 2023.

As a reminder, here is what the Reserve Bank is indemnified for

Whatever claim the Reserve Bank had in respect of the April 2023 bonds will presumably drop out of the reported indemnity claim balance sheet item in the next balance sheet and will have been met by Treasury in their monthly payment.

Total LSAP bond purchases were $55215 million (face value). Maturities and resales mean that the face value has been reduced by (face value) $9487 million [correction $13637m – the original number was just maturities]. The monthly reported indemnity claim item on the Reserve Bank’s balance sheet captures only the market-implied loss on the bonds still held. But the total direct fiscal losses on the programme – not reported very transparently – include the substantial realised losses already settled by The Treasury. Each month – while market bond rates remain high – the realised losses will mount and the indemnity claim item (while fluctuating from month to month) will be trending down. When the last bonds mature or are sold (several years away yet on current plans), the Reserve Bank balance sheet indemnity item will drop away to zero. But large losses will have been met by the taxpayer – on what we know at present, probably something like $10bn of them.

There was an article on Business Desk yesterday that led with the suggestion that the LSAP losses now totalled almost $20 billion.

As soon as the article appeared I emailed the author and pointed out that the two numbers she was using could not be added together and that the best estimate of the direct fiscal losses were still around $10 billion. We had a few email exchanges and a telephone conversation, by which point she accepted that her number was wrong, but didn’t fully understand why she was wrong (apparently several other journalists were also confused), and indicated that there would be a further article forthcoming, using quotes I (and others?) had provided. I didn’t have the time for anything in depth yesterday but suggested I might write a post today that attempted a fuller and more intuitive explanation.

Unfortunately I didn’t print off the original piece and the article online has now been changed. The original opening has been modified to remove the explicit $20 billion assertion (it is still in the heading but with a question mark) and this note has been added at the start.

As it stands, the article now begins

But it isn’t “before” it at all. Instead, the number labelled as the mark-to-market losses on the LSAP portfolio is just, in effect, a subset of the Treasury estimate referred to in the first paragraph.

Note that everything in this post, in Jenny Ruth’s article, and in the Treasury papers referred to, deals only with the direct fiscal losses to the taxpayer from the LSAP programme. It does not deal with any possible offsetting savings by lowering general Treasury issuance costs or with possible macroeconomic benefits (or costs), not because either of these might not be important, but simply because the issue at hand is about the direct fiscal costs only.

Jenny Ruth’s article drew on the Treasury paper to the Minister of Finance, dated 6 December 2022, which I discussed (together with a follow up note from the Reserve Bank) in this recent post on the idea of tiering returns on the current very large level of settlement cash balances. The paper itself is included in the huge recent OIA release from the Minister of Finance, hosted on Treasury’s website. So too is one other Treasury paper I will draw from.

Here is the $10.5 billion number from the Treasury paper Ruth draws on

Note that there is a footnote at the end of that sentence. Here is the footnote, some of which was withheld

This, on its own, really should have been enough to suggest to any reader that the two numbers were approximating to the same thing, and thus could not be added together. (All that said, this paper was about tiering and so did not go into any great depth on how the various LSAP loss numbers were derived.)

But here it is worth taking a step back.

For the last 18 months or more I have been banging on about the rising scale of the direct fiscal losses associated with the LSAP. To illustrate that point I regularly used, both here and on Twitter, a chart of the line item on the Reserve Bank’s monthly published balance sheet of the Bank’s claim under the Crown indemnity the Minister of Finance has given them for any LSAP losses. I used that because (a) it was available monthly, and it was an official number and (b) because, while there were no realisations (bonds sold off again) it was a reasonable best estimate (the market price) at the time of what the actual direct fiscal losses were.

But, as I have pointed out, and as The Treasury itself has frequently pointed out, the indemnity claim itself does not represent the cost to the wider Crown finances. The indemnity claim is just a transfer from the Treasury to the Reserve Bank. Had the indemnity not been given, the Reserve Bank could still have done the LSAP. Instead of a large claim on The Treasury for the indemnity it would instead be showing large losses itself and deeply negative equity (as is the situation with the RBA, which did large scale bond buying, without an indemnity). Either way, taxpayers are worse off but they are worse off because of the LSAP (and subsequent movement in market prices for bonds) not because of the indemnity. The Reserve Bank balance sheet is consolidated into the Crown accounts, and transfers among entities included in that consolidation don’t make us taxpayers any worse (or better) off. They are really just intra-group transfers.

It is also worth noting – as many early sceptics did in their responses – that if the LSAP bonds were to be held to maturity by the Reserve Bank no indemnity claim would have been payable at all. The market price of the bonds approaching matiruty would have tended towards the face value of the bonds.

But that is not the same as saying there would have been no direct fiscal losses from the decision to do the LSAP.

What matters in assessing the direct fiscal costs is not the flows between the Reserve Bank and the Treasury (intra-group transfers) but the flows between the government as a whole (here, Treasury and Reserve Bank combined) and the private sector. The LSAP changed the private sector’s lending to the government from bond holdings to settlement cash balances at the Reserve Bank. This is the story I’ve been telling for ages that the LSAP is just a big asset swap. Treasury says the same thing (from that same 6 December paper)

In what follows, I’m treating the Reseve Bank and Treasury as one consolidated entity (whole-of-Crown). In decision making terms it doesn’t work that way (the RB MPC made independent decisions to do the LSAP), but I think the substance may be clearer if I do.

Take a very simplified example in which these are the only transactions whole-of-Crown does:

Step 1

• the government issues $50 billion of long-term bonds to the private sector to finance $50 billion of spending,
• the net effect of those two transactions is no change to the level of settlement cash balances (spending boosts settlement cash, but issuing bonds drains those balances)
• in this scenario, the government now has $50 billion of long-term debt outstanding and no extra (RB) settlement cash balances outstanding

Step 2 (the LSAP)

• the Reserve Bank (branch of government) buys back the $50 billions of bonds on the open market,
• paying for its purchases boosts the total level of settlement cash by the full purchase price (for simplicity, assume also $50 billion)
• having done this, the government (whole of Crown) now has a) no long-term debt outstanding (one division might have issued the debt while another has repurchased it, but they net to zero) and (b) $50 billion of extra settlement cash liabilities outstanding.

The government could have financed that $50 billion at the market interest rate on the long-term bonds.  Instead, it is now financing itself with settlement cash balances (in economic substance, borrowing from banks) on which its Reserve Bank arm pays the full OCR interest rate, reviewed every six weeks or so.

The direct fiscal cost of the decision to do the LSAP is the difference in the debt servicing costs in these two scenarios (how much whole-of-Crown pays the private sector).   Transfers between the government and the Reserve Bank themselves don’t add to or subtract from those numbers at all.

When the LSAP was underway, the Reserve Bank was probably buying back the bonds at yields to maturity of around 1 per cent.   In other words, the Crown was giving up, say, 1 per cent fixed rate financing and replacing it with variable rate financing.  Had the OCR averaged below that (approximate) 1 per cent over the remaining life of the bonds, there would have been a net direct fiscal saving.   If that seemed unlikely even in 2020, it wasn’t impossible (for the first year or more the OCR was 0.25 per cent).

But it hasn’t happened (or, to be strictly accurate, since we do not know what disasters might lie just around the corner, it now seems most unlikely to happen).  The OCR is now 5.25 per cent.  From here, in its latest OCR review the Reserve Bank indicated it isn’t sure where the OCR will go next.   The market is looking towards rate cuts at some point, but the market does not expect anything like an average of 1 per cent or less.  There will, almost certainly, be substantial net direct fiscal costs from the LSAP programme.   

That number was what The Treasury was estimating (reporting in early December) at about $10.5 billion.  Bond yields, changing from day to day, encapsulate implicit market expectations of future short-term rates, including the future path of the OCR over the remaining life of the relevant bond.  Thus, the mark-to-market value of a bond position is going to approximate to the estimated net direct fiscal losses from a decision to purchase those bonds (as Treasury notes in the first quote above).  They are two ways of looking at the same thing, not different losses that can be added together.

Current market bond yields are a little below those at the end of October, so Treasury’s best estimate now of the net direct fiscal losses would probably be a little lower.   Since we don’t know exactly the date as at which they came up with the $10.5 billion or the precise details of their methodology we can’t be quite sure how much lower, but $10 billion or perhaps a touch below look to be about right.  Those estimates too will, in principle, change every day.

As Jenny Ruth’s article notes, the Reserve Bank balance sheet for 31 March will be published on Tuesday, and we will get an update on the Bank’s claim on the Treasury under the indemnity.   However, the claim under the indemnity no longer approximates the total expected net fiscal direct losses (or the Reserve Bank’s own losses).  That is (mostly) because some of the LSAP bonds have been sold (back to Treasury), under a steady announced monthly programme, crystallising some of the Reserve Bank’s losses, and triggering payments from the government to the Reserve Bank under the indemnity (some of the shorter-term bonds have also been held to maturity).   I am not aware of where we might find an up-to-date time series of these payments, but in that big Treasury OIA release there is a 24 November 2022 paper to the Minister of Finance on monthly indemnity payments.  It includes a table of actual indemnity payments to date

 

and one of expected payments over the followng year (on market rates prevailing when the estimates were done)

Jenny Ruth reported (correctly) the Bank’s outstanding indemnity claim as at the end of February of around $8.75bn. But to get the total Reserve Bank losses under the indemnity one would have to add to that (a) the $438 million of known indemnity payments already made, and (b) any other indemnity payments between November and February, estimated in the Treasury papers then at another $1.1bn or so. In other words, a total a bit over $10 billion. Note that the entire interest rate yield curve for medium to long term bonds is lower now than it was in Oct/Nov (or in February) so accurate estimates now would be a bit lower – probably a touch below $10 billion.

If I think back to yesterday’s conversation I think one issue that may be playing on people’s mind is “yes, we know about the settlement cash payments you describe, but…..surely there are still those mark to market losses showing on the RB balance sheet”.

And that is true, but if the Treasury were to engage in full mark to market accounting of the value of its debts (which few entities do, or are required to be accounting standards, but which is nonetheless the economic substance), what would have happened to the market value of the debt Treasury had issued? It would have increased massively – low interest outstandings are very valuable when the market rate is so much higher. In fact, the market value of the increased value of the Treasury’s liability in respect of the LSAP bonds would be equal to the reduced market value of the Reserve Bank’s holdings of those LSAP bonds. The two net out – reverting to my oversimplified scenario it is as if the whole-of-Crown no longer has that debt outstanding at all.

The indemnity (claim and payments) matters a lot to the Reserve Bank. It doesn’t much matter to us, or to the Treasury. We face whatever gains (or losses) the LSAP gives rise to whether or not there was an indemnity. The remaining claim – latest estimate out on Tuesday – is (from our perspective) little more than an intra-group memo item. But as taxpayers we don’t care much about either the RB or the Treasury finances individually, but about the consolidated financial position, which is what determines the losses we ultimately have to bear.

Finally, because some LSAP bonds are being held to maturity (and there are losses arising from them, albeit often smaller) there will never be a single government accounts line item capturing the full net direct fiscal costs of the LSAP programme.

I hope this post has made things a bit clearer. I’m happy to engage with anyone on the points in it, or any that are relevant that I may have missed.

UPDATE (17/4): Jenny Ruth’s follow-up story written on Friday is here. Note that this line she was given by Treasury is wrong or at best misleading.

If the Reserve Bank sold the LSAP bonds on-market that would certainly and automatically drain settlement cash levels. If the Reserve Bank sold the bonds back to the Treasury that transaction alone would not affect banks’ settlement account balances at all (it would just deplete the government’s account at the RB). The effect on settlement cash would arise only as and when the Treasury issued new bonds on-market to replenish the government’s account and (in effect) replace the bonds the RB had sold back to them.

It is a small point, but since the Treasury line is now on the public record and there is evident lack of clarity in some quarters about the LSAP issues it is worth being as clear as possible. As per the post above, transfers/flows between the RB and Treasurydo not directly affect banks or the wider public. For many purposes (but not all) there are just intra-group transfers among branches of whole-of-government.