Credit conditions

The Reserve Bank conducts a six-monthly survey of banks on aspects of credit conditions, trying to get at things not just captured in headline base bank lending rates.  The last regular survey was conducted in March but, of course, quite a lot has happened since then.  So, to their credit, the Bank has conducted a one-off additional survey in June to try to get a sense of how Covid and the associated economic disruption has changed things.    The numbers and the Bank’s write-up are here.  There is a good series of summary charts at the back of the write-up, some of which I will be using in what follows.

The survey has both current/backward looking questions and questions about the outlook, differentiated by type of borrower (SME (turnover less than $50m per annum), household, corporate, agriculture, and commercial property).   Here is the Bank’s note

The June Survey was completed in the last two weeks of June 2020 by 12 New Zealand registered banks, including all of the five largest banks. The period covers credit conditions observed over the first six months of 2020 and asks how banks expect them to evolve over the second half of the year.

In the face of a severe, unexpected, economic downturn, and a substantial lift in uncertainty about the outlook, you’d probably have expected credit conditions to have tightened.  For any given level of interest rates, banks would be less willing to lend.   That would be an entirely rational response, even if banks were quite confident about their overall financial health based on the existing loan book.  Credit demand –  which respondents are also asked about –  is a bit more ambiguous: credit demand for new activities might reasonably be expected to take a hit, but some borrowers will have a heightened demand for credit to tide them over a sudden unexpected loss of income.

What we see in the survey is, more or less, what one might have expected.  Sadly, the survey hasn’t been running long enough to benchmark the data against developments in previous recessions.

On the demand side, the two competing effects are most visible in the responses for SMEs.

cconditions 1

Working capital demand has increased a lot, and is expected to increase a lot more in the second half of the year, while demand to finance capital expenditure has fallen quite a bit and is expected to fall a lot further.     The picture for bigger corporates is similar, if perhaps not as stark.   Overall demand for credit increased for these two business categories, but fell for all the others.  “Credit availability” fell, as one would expect, across all these subsectors, and is expected to tighten further in the second half of the year.

One of the good things about this release write-up is that the Reserve Bank has released detailed disaggregated data from the survey that they do not usually publish.  Quite why they don’t publish it routinely is an interesting question, but then this is an organisation not exactly known for its routine transparency –  although you’d think that data collected under a statutory mandate, collated at tsaxpayers’ expense, should be routinely published.

Anyway, the data are there this time.    First, there is a distinction between the price and non-price aspects of credit availability, actual and expected.  Higher credit spreads will be the key aspect of price.

For households (mortgage and personal lending) all the actual and expected tightening in credit availability took the form of non-price measures, but for all four business categories the price effect (higher credit margins over base lending rates) dominated.  Here again, as illustration, is the chart for SMEs.

c conditions 2

There is a further degree of disaggregation on the aspects of the credit availability responses, but only for the period already been.  For each subsector respondents are asked about:

  • collateral requirements,
  • serviceability requirements,
  • maturity and repayment terms,
  • covenants,
  • interest markups
  • other price factors.

For households, the only material changes were (tighter) serviceability requirements.  That is interesting –  if not too surprising –  given (a) slightly lower interest rates, and (b) some temporary easing in the Bank’s LVR restrictions.

Here is the chart for SMEs

CC SME

and for larger corporates

CC corporate

There are some interesting differences, but the stark similarity is in the higher interest rate mark-ups.  For both subgroups, covenant requirements appear to have eased – one guesses semi-involuntarily as many borrowers will probably have blown through previous loan covenants.  I don’t know quite what to make of the differences in the green bars –  “other price factors” – but would welcome any comments/suggestions.

What of commercial property loans?

cc comm property

That’s pretty stark.  For every component, policies and conditions have tightened, apparently quite materially.  Perhaps not too surprising –  and in many past downturns –  commercial property loans, especially those on new developments, have been a key source of bank losses-  but interesting nonetheless.

And, finally, agricultural loans.  Farmers keep farming, and –  for the moment anyway –  commodity prices have held up. But in any global economic downturn, commodity prices often bear the brunt. In this case, the adjustment by lenders appears to have been mostly in the interest mark-up agricultural borrowers face.  As the graph shows, credit spreads have been widening for some time, in the face of some mix of factors including the Bank’s markedly increased capital requirements (farm borrowers tend to have alternative sources of finance).

cc agric

The final component of the survey asks about factors influencing the availability of credit.  There isn’t a line for “severe unexpected recession etc”, but here were the interesting aggregate responses to the standard list of items.

cc factors

Cost of funds is almost invisible as an issue –  whether wider credit spreads in funding markets or lower base (OCR etc) rates –  and so is any change in competitive pressures.

Respondents suggested that regulatory changes had been helpful –  presumably this will refer to the temporary suspension of the OCR restrictions, the temporary delay in the increase in minimum capital ratios, and perhaps the temporary reduction in the minimum core funding ratios.  Together these changes have, as one might expect, worked to mitigate a tightening in credit availability, but note the aggregate effect is not that large.   On the other side of course, the two material effects are an adverse change in the banks’ assessment of risk, and in the willingness of banks to take any given level of risk.  Both seem highly rational and sensible responses in a climate like that of recent months.

What to make of it all?   Probably none of the results is terribly surprising, and it will be interesting to see how these results compare with those of the next regular survey in September (when we must hope the Bank will again release more-disaggregated data).

I guess what struck me was the widening in the credit spreads business borrowers have been facing.  The published time series data from the Reserve Bank on business lending rate is pretty lousy –  a single series for “SME new overdraft rate”.   That headline rate has fallen only about 70 basis points this year.   That isn’t too surprising –  since the OCR has fallen 75 basis points, and floating mortgage and bank bill rates not much more.  The credit conditions survey tells us that typical business credit spreads over base rates have risen (probably quite rationally so in the changed economic climate).  But we also know that inflation expectations have fallen quite a lot –  data from the indexed bond market suggests about 70 basis points this year.  In other words, the combination of increased risk perceptions and a passive central bank doing little or nothing, in the face of one of the most severe economic downturns, here and abroad, for many decades, real business lending rates are rising.     That is quite insane outcome, but a choice made by Orr and the MPC, and apparently condoned by the government (and the Opposition for that matter).  It is quite extraordinary, almost certainly without precedent in a country with (a) a floating exchange rate, and (b) a sound financial system, and (c) sound government finances.

One half of the government’s brain seems to recognise the issue.  They just extended the scheme whereby small businesses can get interest-free loans from the government.   Quite why they think those favoured few –  in many cases, probably some of the worst credits –  should be able to borrow at zero while the rest of the economy  (but especially the business sector) borrows at materially positive real interest rates, often complemented by tightening non-price conditions is a bit beyond me.

Oh, and remember that this surveys suggest banks expect credit conditions to tighten further from here.

Economic policy malaise

Reflecting on the economic outlook, it hasn’t been the best of weeks.

Across the Tasman, a large chunk of Australia –  key market/source of exports, imports, investment etc – is locked down again for six weeks.   It is a reminder, including to anyone contemplating investment decisions, how easily things can be blown off track again.  And that is in a country with a death rate still (slightly) lower than New Zealand’s.  The coronavirus situation in much of the rest of the world doesn’t look that great either, and with it the outlook for the world economy.  Perhaps, at the margin, that troubled world economy contributed to the decision announced this morning to close Comalco.

Closer to home, the NZIER QSBO results were out.   ANZ’s commentary summed it up succinctly but bleakly under the heading “Worrying”.  Of course the June quarter outcomes will have been dreadful, but the forward-looking indicators weren’t really much better.   These sorts of surveys don’t always have much predictive power –  more unexpected stuff happens –  but they paint a pretty bleak picture of how businesses were seeing things just a couple of weeks ago.  Again from the ANZ

Today’s data will be worrying for the RBNZ and Government; firms are reportedly hunkering down, shedding workers, and cutting prices. But more monetary stimulus is needed, and an aggressive, front-loaded approach is warranted.

And all that is despite the massive fiscal spend over the last four months, which has for now replaced a fair chunk of the lost private sector income during that period, even as it saddles us –  and future governments –  with much more severe constraints on fiscal freedom of action in the years to come.    All that income support (in one form or another) will have helped keep private spending quite a bit higher than otherwise.  All the talk was about “tiding over”, but to what, to when?  It has always had the feel of a policy approach dreamed up back in late February/early March when the government (and Reserve Bank) were still refusing to take very seriously that economic shock that was already engulfing the world.

In that context, it was interesting to have confirmation from the Prime Minister that the wage subsidy scheme will not be extended further –  and given that firms get it as a lump sum, presumably the bulk of what will ever be paid out even under the extended scheme will already have been paid out.     Ending the scheme seems appropriate –  extending it the first time was probably more about politics than economics.    Anything else would have looked like a bizarre attempt to freeze chunks of the economy as they were six months ago, refusing to face the reality of a changed world.    But the scheme was putting large amounts of cash in the pockets of people in the private sector, supporting spending and holding GDP higher than otherwise.  And what comes after it?

Part of the answer, of course, is the higher-than-otherwise benefit paid to those who’ve lost their jobs as a result of Covid.   But it is only for 12 weeks, is still mostly about income replacement (buying time) rather than supporting a self-sustaining recovery in underlying economic activity, and of course many people just won’t be eligible for it.  Perhaps the government will decide to extend this scheme, but even if that were to happen it has its own problems (deterring the search for a new job).

One might, perhaps, have hoped for signs of a serious, rigorous, well-thought-out strategy from the Prime Minister.  As it happens, she gave a pre-election speech to her party’s Congress on Sunday.   As her party is odds-on favourite to dominate the next government I read it, twice actually.  In the speech the Prime Minister purported to offer a plan – a five-point plan even.

Today I am announcing our 5 point plan for our economic recovery.

It’s about investing in our people, it’s about jobs, preparing for our future, supporting our small businesses, entrepreneurs and job creators and positioning ourselves globally.

Sadly, she showed no sign of actually understanding how economies work or prosperity arises.    Anyone, what of the five points?

Which brings me to point one of our plan – investing in our people.

Whence follows a list of handouts, which might (or might not) individually make sense, but by no stretch of the imagination or language can be called investments.  Income support is fine, but it is no basis for recovery.

Perhaps this was a little closer to “investment”

That’s why we made a $1.6 billion investment in trades and apprenticeships training, which includes making all apprenticeships free.

We’ve also made those areas of vocational training where we need people the most like building and construction and mental health support workers – all free. The potential impact of these policies is huge.

Except that this is the government that had already introduced the fees-free policy, only for it be revealed that it was mostly income support too (transfers to people who would already have been undertaking tertiary education anyway).    And the new measures could have a feel of measures designed more to keep headline unemployment down than to actually revive the economy.

Even the Prime Minister recognises that training isn’t much use if there are no jobs.

But retraining isn’t enough if there aren’t jobs to go into at the end of it.

And this is where the second part of our plan kicks in, what I like to simply call, jobs, jobs, jobs.

She proceeds to run through some government initiatives.

First is the Big New Zealand Upgrade Programme designed to tackle our core infrastructure deficit. We announced it at the beginning of the year, and it amounts to $12 billion of road, rail, public transport, school and health capital funding. It could not have come at a better time.

That programme may or may not have merit, but as she says it was announced in January,  judged appropriate/necessary then –  pre-Covid.  It was factored into economic forecasts, including those of the Reserve Bank, then.  On to some other spending.

As part of our COVID response we have committed funding to providing an additional 8000 public houses, bring the total number of state and transitional houses to be built by this Government to over 18,000 by 2024 – thank you Megan Woods and Kainga Ora.

It is the largest house building programme of any Government in decades, and I’m proud of it.

But when we’re talking about infrastructure, it’s not just about the projects we in the government are responsible for, we also have the opportunity to partner with communities, with iwi and local government.

That’s what the $2.6 billion worth of shovel ready projects we announced earlier this week were all about.

Things like Home Ground, a project by the Auckland City Mission that will provide 80 apartments with wrap-around support and care, or the Poverty Bay Rugby Park Grandstand, least Kiri Allen stage a sit-in, right through to the Invercargill inner-city development.

It would take someone closer to the detailed data than I am to unpick quite how much of this is really new spending, and how much is just putting details to spending programmes (like the PGF) already allowed for.  Nor is there any sense of (a) displacement (lots more state houses will, almost certainly, mean fewer private houses being built) or (b) value-for-money (what is the taxpayer doing funding the Invercargill city redevelopment, throwing more money at KiwiRail or –  wonder of wonders –  tens of millions at the Wanganui port.

And then at the end of the “jobs, jobs, jobs” section we get this

Collectively these projects are estimated to create over 20,000 jobs in the next five years.

No analysis to support that number (and we’ve seen before how PGF job estimates are concocted) but even if it is correct, total employment in New Zealand is about 2.8 million people.   “Jobs, jobs, jobs”, even on the PM’s numbers, looks tiny.

She goes on to list a few environmental jobs projects.  Perhaps they are worthwhile, but they certainly aren’t a private sector led recovery.

But moving along

That brings me to the third plank of our plan – preparing for the future.

The whole of that plank is here

Restoring our environment is one thing, decarbonising it is another.

Investments in waste management and improving energy generation will be key- and this is where I am signalling there is more to come.

Preparing for the future also means supporting our businesses to innovate, especially as we go through a period of digital transformation.

There will be few among us who haven’t changed our routines and habits as a result of COVID-19. By the end of lockdown I can confirm that Damien O’Connor did indeed discover the unmute button on zoom.

We want to support our small businesses through this digital transition, which is why we established a $10 million fund to incentivise e-commerce and train more digital advisors.

It’s also why we will keep encouraging innovation in all forms. So we’ve created a $150 million fund to provide loans to R&D-intensive businesses.

Well, okay.  If you are of the left, you might find that appealing, but even then you’d have to concede there wasn’t much to it, not much that will help generate a rapid and strong economic recovery.

But there is, it appears, a role for the private sector.

All of this builds to the fourth part of our plan, supporting our small businesses, our entrepreneurs and our job creators

Which sounds good, until you read the text and realise that all she has to offer is the wage subsidy scheme, and the small business interest-free loan scheme, which was extended for a few months.    Income support etc has its place, but it isn’t the foundation for a strong robust economy or a rapid return to full employment.

And what of the final plank?

And the final plank of our five-point plan is to continue to position New Zealand globally as a place to trade with, to invest in, and eventually to visit again.

This has been an export-led lockdown, and so too will it be an export-led recovery.

Sounds good as an aspiration, but frankly seems unlikely.   What does Labour have to offer specifically?

That’s why a few months ago we provided $200m to help exporters re-engage with international markets, and support firms looking to export for the first time.

It’s also why we continue to expand our trade relationships. The limitations of the last few months didn’t stop us launching our free trade agreement talks with the UK …

We are investing $400 million in tourism because we know it is part of our future, and because open borders will be again too. It is not a matter of if, but when it is safe.

And on that, we already have work underway.

We are progressing with all the checks and balances needed for a trans-Tasman bubble, and also on reconnecting with our Pacific neighbours. We have a framework in place that will help Cabinet make a decision on when quarantine free travel with these parts of the world should resume.

All pretty small beer really.  No one supposes that a UK preferential trade agreement is going to matter very much, and in recent weeks we’ve heard David Parker fulminating about the frustrations of the EU’s position on trade negotiations with them.   And, of course, this is the economy that –  for all the talk of trade agreements –  has had foreign trade shares (exports and imports) falling as a share of GDP this century, the high point of this wave of globalisation.   There is also no sense of recognising that the real exchange rate remains very high –  not down at all, despite the big hit to one of our main tradables sectors.   And all this was nicely complemented by the government’s primary industries strategy announced early in the week and now championed as Labour Party policy, which (as the economist Cameron Bagrie pointed out) involved primary exports falling as a share of GDP over the next decade, even as that sector was supposedly going to help lead the recovery.

And that was it.  That, apparently, was the government’s economic recovery plan.

Typically we look to monetary policy at the main counter-cyclical stabilisation tool.  Ideally, it might be complemented by good pro-productivity structural reforms – of that sort successive New Zealand governments have lost interest in –  but they take time to design well and implement –  whereas monetary policy can be deployed very quickly.

Of course, in the context of the Covid shock it would have made sense to have deployed fiscal policy and monetary policy together.  Even if monetary policy can be deployed very quickly, it does not put money in the pockets of households instantly (and in the context of a “lockdown” and the immediate (quite rational) fear-induced drop in economic activity, there was a place for immediate income support.  But if monetary policy does not work instantly that is why it should be being deployed aggressively and early.  Had monetary policy been used aggressively and early –  starting back in February when the first OCR cut should have been done – by now we would be seeing quite a lot of the fruits (the full effects of monetary policy adjustments typically take 12-18 months), providing a stimulus to demand and activity as the fiscal support is wound back (as it is being, on announced government policy).

As it is, we have had almost nothing from monetary policy.  The OCR was cut belatedly, then an irrational floor was put on the OCR by a Monetary Policy Committee that was still struggling to comprehend the severity of what they were facing.  And because the Reserve Bank reacted only slowly and to a very limited extent, we’ve ended up with hardly any fall in real interest rates at all (inflation expectations have fallen almost as much as the OCR).   The exchange rate hasn’t fallen at all.  The Reserve Bank likes to make great play of their LSAP programme, but it mostly works –  if at all –  by lowering interest rates and underpinning inflation expectations.  And since we know expectations have fallen, and real interest rates have barely fallen, at the very best the LSAP programme can only have stopped things tightening.  In the Prime Minister’s words, this is a really severe global economic downturn……and yet monetary policy has done almost nothing; none of that necessary support is now in place even as the fiscal income support winds back and the domestic and world economies remain deeply troubled.

Of course, the failure of the Reserve Bank to do anything much useful rests initially with the Governor and his committee (the one he so dominates that we’ve never heard a word from any of the three external members, the one he ensured had no one with serious ongoing expertise in monetary policy appointed to it).  But they are officials, ultimately accountable to the elected government.  In fact, ever since the Parliament made the Bank operationally autonomous in 1989, the Act has always recognised that officials could get things wrong, and allowed for the Minister of Finance to directly override (transparently) the Bank.  The current government carried those provisions into its reform of the Reserve Bank, but now –  in a really severe economic downturn, in which the Reserve Bank is simply not doing its job –  they seem too conservative, too scared, to use well-established statutory powers.  They are happy to put in place limited zero-interest loan schemes for small businesses, but unwilling to ensure that –  amid the bleak economic outlook –  market prices for business and household credit are anywhere near that low.   In effect, that means they prefer to let more businesses fail, more people end up languishing on the dole, more “scarring” (a point the PM made in her speech) as if wishful thinking and idle hope was a substitute for serious policy.

Right from the start of the coronavirus, this government’s approach has been –  in essence –  to provide lots of income support and hope that the world gets back to normal pretty quickly.   It was a dangerous and deluded approach from the start, something that becomes more evident with each passing month.  All the more so as other countries’ governments are similarly failing to do much that might support a robust recovery elsewhere.  The current New Zealand government seems to have no ideas, no plan, to be unwilling to use the (low cost) powers they do have to help get relative prices better attuned to supporting recovery.  There is a growing risk that we are drifting into another of those periods –  perhaps worse this time –  as we saw after 2008, when it took 10 years to get the unemployment rate back to something like normal (with little or no productivity growth), and no one much among the political elites (either side) seemed to really care.

Of course, if Labour’s approach is bad, at least (being the government) it is on the table.  It is now less than two months until voting starts and we have no idea what National’s approach might be, but no reason to suppose it would be materially different or better.

 

On the trail of negative interest rates

I’m still less than entirely well, so posts here will stay less frequent and less regular than usual for a while yet.   That means things like last week’s OCR decision pass by with little comment (my only one will be, in what conceivable world five years ago would a severe global recession, the drying up of a major local export industry, falling inflation and inflation expectations here and abroad, and recognised downside risks be met with precisely no monetary policy action?).

But I see that the Governor has been out giving interviews –  the ones I noticed were with Stuff and the Herald – and some of his comments conveniently tie in with what I was wanting to write about the results of an OIA request to the Bank that belatedly turned up in my inbox on Monday, on the elusive question of what the Bank is (and isn’t) doing about negative interest rates.

You’ll recall that in the second half of last year the Governor was dead-keen on the option of negative interest rates.  It wasn’t just a passing comment, but a very substantial interview.   Who knows, perhaps the rest of the MPC didn’t agree with him, but he was supposed to be the spokesman for the Committee as a whole.  We don’t know what the other MPC members –  the ones who don’t, at least on paper, work for Orr –  think, and they seem to exist in a state of purdah, refusing ever to make speeches or give interviews.

As recently as the Governor’s speech on 10 March this year –  when he and his colleagues were still attempting to play down the economic challenges of Covid – the Governor outlined his preferred tools.  He promised then that

We will provide our full analysis of each of these tools against the principles we hold in coming weeks – so that people can fully understand our thinking and, of course, provide input.

None of that analysis has ever been published.  The list of tools was clearly organised in order of the Governor’s then preference: forward guidance (just a variant on what they always do) was first, and then

Negative OCR

Reduction of the OCR to the effective lower bound (the point at which further OCR cuts become ineffective), which may be below zero. The Reserve Bank could consider changes to the cash system to mitigate cash hoarding if lower deposit rates led to significant hoarding.

Not only did a negative OCR appear to be in play, but that really encouraging second sentence suggested they might actually have considered doing something –  they are technically easy things to do – to allow the OCR to have been cut even further below the negative levels which at present could lead to large-scale shifts into physical cash.

That was then.  A few days later the MPC decreed that in fact that OCR would not be changed, up or down, from 0.25 per cent for a year, claiming the matter was really ou of their hands as “banks weren’t ready”.

It was, and remains, a very strange argument given that:

  • several other advanced countries had had negative official rates for some years,
  • a large share of global government bonds had been trading with negative yields for some years,
  • in New Zealand the first negative yields (on indexed government bonds) were recorded last year, at about the time of that interview the Governor gave,
  • the Reserve Bank had shown revived interest in these issues for a couple of years, and
  • that eight years previously an internal working group (set up by the then Governor, chaired by me) recommended that relevant departments should ensure that (a) the Bank’s own operating systems, and (b) commercial banks’ systems could cope with negative interest rates.  Those recommendations were accepted at the time.

In other words, if the Bank’s claims now are really true, commercial banks seem to have been astonishingly (or conveniently, since banks hate negative interest rates) remiss and (more importantly, since it is a powerful public agency) the Reserve Bank ((Governor, Deputy Governor, MPC –  and the Board paid to hold them to account) had to have been asleep at the wheel.  Given a decade’s advance notice of the risk that market-clearing interest rates would go negative here too, they would appear to have done nothing.  That would be egregious neglect –  for which people at the bottom, the involuntarily unemployed, would pay the price.

The Bank, of course, likes to claim that it is highly transparent –  they have been at it again this week – even as they remain as obstructive as possible on anything they don’t want to be transparent about.    The negative interest rates situation has been one of those topics.  For example, they’ve staunchly refused to release any of the background or advisory papers the MPC received running up to 16 March, on this or any aspect of monetary policy (as a reminder, the government itself has been pro-actively open, even with papers that may embarrass some or other bits of government).

I had one go with an Official Information Act request that got nowhere.  But it is a bit harder to stonewall Parliament, and thanks to the efforts of the National Party members of the Epidemic Response Committee we got some useful material out of the Bank.    The Bank didn’t want to draw any attention to this material, but it was there on Parliament’s website, and I wrote about it here.

The Bank told MPs that they’d started to take things seriously at the end of last year

More broadly, bank supervisors raised the issue of preparedness for negative interest rates at banking sector workshops in December 2019.

In late January 2020, the Reserve Bank’s Head of Supervision sent a letter to banks’ chief executives formally requesting they report on the status of their systems and capability.

By late January, of course, Wuhan was already locked-down.

The Bank told the MPs that there had been a range of issues identified, and while they hoped banks were doing something about them, it didn’t want to put any pressure on banks because they were busy people, and had other priorities (which, even if so, would not have been the case had the Bank done its job several years earlier).

None of this was very satisfactory.  They never explained –  or were pressured to –  their own past failures, nor why these alleged readiness issues had not been obstacles in other advanced countries (the euro-area, Sweden, Switzerland, Denmark, Japan), the prevalence of negative wholesale rates abroad.

A few weeks later again, the Governor told the Finance and Expenditure Committee (hearing on the May MPS) that a letter had gone out to banks just the previous week apparently urging or requiring them to have systems ready by the end of the year.   I then lodged a further OIA request

OIA 16 may

Section 105 is the dreadful provision in the Reserve Bank Act which allows the Bank to avoid any scrutiny of its bank regulatory activities under the OIA.  When the response to this OIA arrived this week, they had invoked it to allow themselves (so they claimed) to refuse to release anything in response to item (a) in my request.    This is a provision that, to the extent it had any merit, is designed to protect highly sensitive individual institution material in the middle of a banking crisis (in fact, of course, anything commercially confidential is already protected, and reasonably so, under the OIA).  The readiness of banks’ systems and document for negative interest rates is clearly not primarily –  barely at all – a prudential issue, but primarily a monetary policy one.  But that doesn’t stop the Bank –  the ones that always claim to be so transparent.

However, the Bank did belatedly release what I was after under the second and third strands of my request.  The full response is here.

The 29 January letter is on page 4 of the response.  It is a catch-all letter from the head of bank supervision drawing attention to various issues large and small that the Bank wanted to deal with this year (among the latter, the Bank’s Maori strategy).  Here is the relevant text on negative interest rates

wood negative

Okay I guess, but with little or no sense of urgency.

There is a three page table summarising the responses from each individual bank (although remarkably one banks appears to have never even responded), complete with this interesting  somewhat defensive observation from the Reserve Bank which I had not initially noticed.

“We acknowledge the banks’ responses to our letter of 29 January were a preliminary assessment of their readiness to implement negative interest rates.”

The table is interesting.  Of the 19 banks, a fair number are described as ready, but it is fair to note that a number of issues are also highlighted, in some cases in enough detail to be genuinely somewhat enlightening.    This is all, however, material that could have been pro-actively published in March, and which the Governor –  and those commenting on his draft speech –  must have been aware of on 10 March.

Perhaps it is also worth noting that these are individual bank responses, without the benefit of any RB pushing and prodding to better understand how binding perceived constraints might be, what workarounds might be possible, let alone with any sign of the Bank itself having learned from the experience of their counterparts in countries that had operated with negative interest rates for years.

Anyway, all this was then somewhat overtaken by the new letter, dated 7 May.  It is from the Deputy Governor, Geoff Bascand to the chief executives of banks.    This must have represented the Bank’s (or MPC’s) thinking at the time of the May MPS, although there is no hint –  of course –  of it in the minutes of the MPC meeting.   The letter set out a deadline of 1 December 2020 for banks to ensure that they were capable (with status reports due yesterday).  That wasn’t news, but what was was how limited the Bank’s requirement’s (and ambitions) now are, in the middle of the deepest economic slump in a long time.

Bascand letter

In other words, they’ve just given up on negative retail interest rates.    It isn’t true that in other countries there have been no negative retail interest rates, even with policy rates slightly negative (here is story from just last year of negative retail mortgage rates in Denmark, and recall that lending rates are usually higher than funding rates).  And, of course, look back up to the quote from the Governor’s March speech –  as recently as then they were open to the possibility of taking the steps that might allow the OCR usefully to be cut more deeply than other countries have done.

Coming back to today, what also interested me was that the Governor continues to muddy the waters on this.  In his interview with Stuff there are quite a few comments about negative interest rates.

The Reserve Bank is still warning retail banks to get ready for a negative official cash rate. Rolling this out has been said to be difficult because banks systems weren’t ready and some contracts with depositors didn’t envisage a negative interest rate – effectively a charge on depositors.

Orr said most banks were in a good position to deal with negative rates.

“Some large multinational banks have been dealing with negative interest rates for a long time and some of the smaller banks, which have much simpler systems, are good to go,” Orr said.

“Only a handful of banks” were having difficulty with negative rates.

Orr appeared to downplay the extent to which a negative rate would impact all areas of a bank.

“What we’re doing at the moment is double checking with all of the banks, so they’re not trying to get absolutely everything capable of a negative [rate] because we don’t need absolutely everything.

“We’re saying it’s a small proportion; it’s the wholesale side of the business,” Orr said.

Ordinary depositors likely wouldn’t notice a difference because rates would still be positive for depositors.

“Internationally the experience has been that banks have been highly reluctant to go below zero for a deposit.

“In fact, retail banks’ reluctance to pass on negative rates to consumers are likely to act as a brake on the Reserve Bank’s appetite to push rates lower.

“There is a limit to how far negative wholesale rates can go in large part because the retail rates end up holding up,” he said.

Read that and you wouldn’t know that the Reserve Bank had told banks they didn’t need to bother about negative retail rates –  in fact, you’d get the impression it was banks that could never envisage offering such products, even though they are on offer in other countries.

But you’d also get the impression that the Governor was more concerned for banks than for the New Zealand economy and the people who become unemployed because monetary policy isn’t doing its job.  If his Committee had aggressively cut the OCR another 100 basis points, to (say) the -0.75 per cent often envisaged as an effective floor until steps are taken to disincentivise cash hoarding, not only would the banks that had prepared themselves got on with things, and presumably been advantaged, but the others would have snapped to pretty quickly and got workarounds in place.  (That, after all, must have been what happened in other countries, and is more like the way the rest of government operated –  when a wage subsidy was decided on, MSD wasn’t given nine months to do systems testing etc; when a small business loan scheme was decided on IRD didn’t months to prepare).

And there is no sign at all of the Reserve Bank taking seriously steps to remove the obstacles to a more deeply negative OCR, even though those obstacles are all of the public sector’s making.

Perhaps none of this would matter very much if you believed the spin about what good monetary policy was doing overall, including through the LSAP programme.    But it is just spin.   Benchmark term deposit rates have been falling a bit more recently, but that means they are now 85-90 basis points lower than they were at the start of the year.  But, of course, expectations of future inflation have also fallen quite a lot.  There is a range of possible measures, but a reasonable pick might be a fall of about 60 basis points.  In other words, real retail deposit rates are down perhaps 30 basis points in the midst of a savage slump for which there is no obvious end.   The exchange rate is usually a key buffer for New Zealand, a significant part of how the monetary transmission mechanism works.  It bounces around a bit, but at present the TWI is sitting almost bang-on the average level for the second half of last year.  For all the handwaving and big numbers (around the LSAP) monetary policy just isn’t doing its job, and the Bank seems to have little interest in it doing so.

On Monday I went to hear a speech the Governor gave.  In the course of that address he seemed to defend monetary policy doing not much on the grounds that “the expenditure had to be immediate”.  And at one level, for the March/June quarters no one is really going to dispute that –  monetary policy doesn’t work that fast, and there was a need (or a good case) for lots of immediate income support, especially for people rendered unable to work by government fiat.  But that was then.    Wage subsidies have replaced lost income (a large chunk of it) for a few months –  at the expense of an increased involuntary burden on taxpayers to come – but meanwhile we are still in a deep recession, still have our borders largely closed, and the state of the world economy appears to be worsening.  Monetary policy should have been positioned –  and should now be positioned, it isn’t too late –  to support domestic demand and activity through the (probably protracted) recovery phase –  much lower interest rates, and a much lower exchange rate.  As it is, monetary policy –  designed as the primary countercylical tool – has done almost nothing and the Bank seems quite unbothered about that.

It isn’t good enough.  We need better from the Governor and his Committee (including, for example, to actually hear the excuses of the rest of the Committee members), and we need the Bank’s Board –  hopeless cause I guess –  to be doing its job holding the Committee to account.  But, of course, the person who could make this all happen is the Minister of Finance, who has long-established directive powers, but seems to prefer to do nothing, content to spend taxpayers’ money while doing nothing to remove the roadblock to getting market price signals better aligned with responding aggressively to our economic plight.  Don’t rock the boat, don’t be bold, don’t worry too much about the actual unemployed seems to be the government’s approach.  Robertson and his boss like to invoke memories of the first Labour government, but it is hard to imagine those big figures in Labour’s history being happy to sit by and see a central bank wave its arms and do nothing to get us quickly back to full employment.

 

 

 

 

 

Recovering

It is very difficult to get a good sense right now of how much excess capacity there is, here or other countries  In New Zealand’s case, part of that is about the gross inadequacies of our official statistics.  We are one of only two OECD countries without official monthly employment/unemployment data (the other is Switzerland) –  and if this has been a long-running deficiency, it seems more striking than ever from a government that amended the central bank act to highlight the focus it wanted on avoiding as much as possible excess labour market capacity.

Of course, there is a variety of less formal, or less fit-for-purpose, partial indicators.  We know how many people get the unemployment benefit but many people looking for work are not (rightly in my view) eligible for the unemployment benefit.  There is a new SNZ indicator using IRD data and providing a monthly employment indicator which should be quite useful in normal times, but isn’t when the government is paying firms to keep people notionally on the payroll, even if doing little or no work.   And although SNZ collects HLFS survey data steadily through the quarter, they seem uninterested in making even that partial monthly data available (larger margins of error as it would inevitably have).    We’ll only finally get the June quarter HLFS data in August.

There are other hints of excess capacity.  The wage subsidy scheme paid out in respect of some staggering share (around half) of New Zealand workers and the self-employed, but that is now very backward-looking since the bulk of the eligibility related to the severe regulatory restrictions on many/most business during the government’s so-called “Level 4” period, from late March to late April.     Most of the employees covered would not have been made unemployed even if no wage subsidy had then been on offer.

The new wage subsidy scheme comes into effect this week.  The rules were tweaked again last week, and although this scheme only covers eight weeks (rather than twelve in the original scheme), the expected cost (close to $3.5 billion) suggests a lot of excess capacity still exists, or is expected to exist.  Not, of course, that we have any official data on that.

Of course, other countries have also had the mix of regulatory restrictions (“lockdowns”), self-chosen reductions in social and commercial activity, and the impact of the sharp disruption to world economic activity.   Labour is generally not being particularly fully-employed at present.  But in most advanced countries, even those with monthly labour force survey data, this excess capacity does not really show up in the official unemployment rate at present –  after all, most other countries have deployed some form or other of fiscal support designed to keep workers attached to firms, even if for now they are doing little or nothing.   In most countries, the monthly official unemployment rate has risen this year, but mostly not by much (and there are vagaries in the statistics such that in Italy the official unemployment rate has fallen).

Only three OECD countries are reporting really large increases in their official unemployment rates.  These are percentage points changes this year to date.

Canada                                                  +8.1

Colombia (new to the OECD)           +9.5

United States                                       +9.8

The US numbers came out on Friday night.  There is some controversy about the monthly change, but all the caveats (including those from the BLS themselves) suggest that the “true” or “underlying” number is even higher than the reported number.

I’m not putting much weight on Colombia (knowing almost nothing about it), but we have every reason to suppose that the dislocation of the economy in New Zealand over recent months in New Zealand was at least as large as those in the US and Canada (whether one looks at a regulatory restrictions index, mobility data, or stylised indicators like the degree of dependence on the labour-intensive foreign tourism sector).  Forecasts of the drop in June quarter GDP are higher for New Zealand than for most other advanced countries.

The “true” increase in excess capacity to last month (the US and Canadian data are for May) in New Zealand is almost certain to have been at least as large as those in the US and Canada.    One might think in terms of an unemployment rate equivalent of at least 13 per cent, which would be (by some margin) the worst New Zealand had experienced since the 1930s.

One can debate the merits of the wage subsidy scheme –  and even more so the extended version, which seems focused on tying workers to firms that are least likely to recover any time soon, if ever – but without it we would have a much clearer sense of just how severe the labout market excess capacity actually is.  (Even if, as I have favoured, one took a more generous approach to individuals facing serious income loss this year.)    Perhaps even when all the wage subsidy schemes have passed the official unemployment rate will be “only” in the high single figure range –  although if the schemes expire in September I’m still sceptical of that –  but for now it is all but certain that the excess capacity in the labour market, that needs reabsorbing one way or the other, is well into double-digit percentages.  And political debate about what needs to be done should operate with those sorts of numbers in mind.

On which note, I’ve been reflecting over the last few days on what it takes to see full employment restored.   It isn’t like, for example, everyone simply coming back to work after the summer holidays.   Everyone –  individuals and firms –  planned on summer holidays and planned on returning.  By contrast, even in New Zealand with (for now) almost no Covid, that isn’t the parallel at all.  The income lost over the last couple of months – probably well in excess of $20 billion, relative to normal expectations – isn’t coming back.  The border is still largely closed. The virus still stalks the earth, with associated heightened uncertainty.  The world economy is in a severe recession and (rightly or wrongly) almost all forecasters think it will take several years for activity levels to get back to normal.  So if wealth has taken a hit already, and some significant sources of external demand are either restricted (by regulation) or impaired, where is the demand going to come from to quickly reabsorb workers who are either already displaced, or who are hanging in some temporary wage-subsidy limbo.

You see occasional talk of people “doing their bit” for New Zealand businesses by going out and spending more than usual, but it is a bit hard to envisage it happening on any significant or sustained scale.  I tried some introspection.  My household hasn’t been materially adversely economically affected by Covid shocks, and there doesn’t seem to be any material employment risk.  And yet we aren’t spending any more than usual, possibly a bit less.  Why would it be otherwise?   We’ll have a break in the school holidays, but then we always do (and when we booked the other day it was a bit shorter than it might have been, Auckland Museum having had to cancel/postpone the exhibition we hoped to see). Many shops are still a pain to go in to.   And I find myself still slightly shell-shocked after the last few months and a bit more cautious and abstemious than otherwise.  And if I thought about “doing my bit” on any serious scale – there are always jobs around the house than could be done –  then I’d contemplate the dramatic change in the fiscal position.  I’m not suggesting some full-blown Ricardian effect here, but (whether I approved of the scheme or not) it seems rather less likely than it was a few months ago that my kids will get fees-free tertiary education, and even if a centre-right government were to be elected  tax cuts seem less likely than they did.  And even prospects for the kids to get part-time jobs don’t seem what they were (and there are probably people needing the jobs more anyway).  Oh, and I’m conscious that another round of Covid restrictions, and economic dislocation, isn’t impossible or even unlikely.

Perhaps you are different.  Perhaps you are energetically contemplating spending more aggressively.  But I suspect most people won’t be, even those (notably in the public sector) fairly confident of keeping their jobs).

In a typical serious recession, changes in incentives (relative prices) do quite a lot of the work.   Lower real interest rates ease pressure on the most-indebted but (more importantly) they draw spending forward.  Often those changes in real interest rates have been rather large.  Sometimes, tax rates (income or consumption) are cut.  And, particularly in countries with a fair bit of foreign debt and not typically treated as international safe-havens (or home bases for pools of savings), the exchange rate falls a lot, drawing demand (from locals and foreigners) towards New Zealand.  Oh, and of course sometimes the government itself does a lot more direct spending on goods and services.

(Oh, and of course there is always pro-productivity and pro-investment micro reforms but…….this is modern New Zealand.)

The key point is that if, at some like current real wages, we are to get back fairly quickly to full employment (which, in my view, should be a high policy priority, given the dreadful scarring effects sustained periods of unemployment can have on some individuals) it needs quite a lot of people to spend quite a bit more than they otherwise would, to replace the demand that has (for now at least) disappeared or been somewhat impaired).

Of those mechanisms:

  • real interest rates have barely changed.    The Reserve Bank can huff and puff all it likes about possible portfolio balance effects etc from its LSAP programme, but if they don’t change prices in ways that encourage more spending than was happening at the start of the year (and they haven’t) it is really little more than sound and fury (and, just possibly, having stopped things getting worse),
  • the exchange rate is now about the same level it averaged last year,
  • consumption tax rates haven’t changed, and although there have been some business tax changes (a) most of the effects will be intra-marginal (flowing to people who woin’t change their behaviour, and (b) uncertainty is very bad for business investment (ie even if the effects are in the right direction, they are likely to be very weak for now)

The government is, of course, spending a lot.  Most of that isn’t direct spending on goods and services  (consumption and investment) but income transfers in one guise or another.  Even there however, the largest and most concentrated spend has already happened over the last three months (with some more in the next couple of months).

From the “fiscal hawk” side of the debate, one hears quite a bit of worry about fiscal excess and heavy future burdens.  I come and go on how sympathetic I am to those complaints and warning, but mostly I end up not being that sympathetic (and I noticed over the weekend a centre-right UK think-tank, Policy Exchange, taking what appeared to be a similar stance, of for different reasons).  And why?  Because if we are concerned at all about getting people back into work faster than simply allowing nature to take its course –  recessions will heal themselves eventually, but it could take quite a few years (perhaps tourism will be back to normal levels in 2025?) –  someone (many actually) have to be willing to spend more now than they were otherwise planning to.  I’d much prefer that monetary policy were doing its job –  not just here, but in Australia and most other developed countries –  because I think much lower interest rates and a much lower exchange rate would do a lot (as they did after 1933, 1967, 1991, 1998, and 2008/09), by changing relative prices/incentives, but it isn’t.   And with a hole this deep –  and borrowing costs this low (which don’t make fiscal policy a “free lunch”) and on-market borrowing this easy – it would imprudent for fiscal policy to be doing no more than just letting the automatic stabilisers work.  And, in truth, at least on the domestic interest rate leg, letting monetary policy do its job also involves people taking on more debt now than they’d otherwise planned to (voluntarily chosen and all that, but debt nonetheless).

If we are starting from (effectively) perhaps double-digits effective rates of unemployment, it is far from clear that anything like enough macro policy stimulus is being done.  If fiscal policy hasn’t reached its political limits –  it is nowhere near the market limits, but neither should we test those –  it must be much closer than it was and, on the other hand, monetary policy is doing almost nothing.  That is really inexcusable, If Orr and the rest of the MPC want to take on themselves some sort of mantle of Hayek or Mellon (as caricatured) as do-nothing liquidationists, Robertson, Ardern Peters, Shaw (and, it seems, Muller and Goldsmith) shouldn’t be standing idly by, by default offering their imprimatur.

(The post was headed “Recovering”: unfortunately, I am doing so only slowly from some bug I’ve picked up, so posts this week may continue to be patchier than I’d like.)

Just how little interest rates have fallen

There was a little flurry of media coverage over the weekend about the latest set of cuts in retail mortgage interest rates.  But it is worth keeping these changes in some perspective.

The Reserve Bank publishes monthly data for the “special” rates advertised for new borrowers (or those moving to another bank) and we can get a read of current rates from bank websites, as summarised in the tables on interest.co.nz.

So how much have residential mortgage rates fallen since the coronavirus slump began?  As it happens, rates had been pretty stable for several months up to February, so this chart compares the latest rates on offer with the average for the period November to February.

special mortgages

For most maturities, that’s not nothing.

On the hand, these are nominal interest rates.  And we know that the expected future inflation rate has fallen.   There is a variety of measures, survey-based and market.  The one the Reserve Bank has typically paid most attention to is the two-year ahead measure in its quarterly Survey of Expectations.  On that measure, inflation expectations have fallen by 0.62 percentage points since the pre-crisis period (the one year ahead measure shows a larger fall, the ANZ one year ahead measure a smaller fall).

Apply that fall in inflation expectations to those “specials” and the real –  inflation-adjusted – version of the chart now looks like this.

specials 2

I guess there is still a slight reduction in longer-term real rates, but…..not many people in New Zealand fix for four or five years.  The market is concentrated on the shorter-term fixed rates (at present, it appears, the 18 month term) and there has been no reduction in real interest rates there at all.

Term deposit rates have come down a bit more too.  But here is how the chart of those rates looks if we compare current rates with those around the turn of the year.  I’ve shown the nominal rates and real rates (using the same drop in inflationn expectations as above) on the same chart.

TD may 20

Pretty much across the board, real term deposit rates have risen slightly since the crisis began (including at what appears to be the most competitive part of the market, for terms of 6-12 months).  It is an odd response to a really serious economic slump.

Don’t blame the banks, or depositors for that matter; this is about choices made by the Reserve Bank Monetary Policy Committee – the prominent ones (Orr especially) and those faceless unaccountable external ones (Buckle, Harris, Saunders), all appointed by the current Minister of Finance.

The Governor keeps talking about getting interest rates as low as possible.  But they clearly aren’t – term deposits are mostly still a bit above 2 per cent (and far higher than in Australia) –  and yet the MPC has pledged, and repeatedly reiterated its dogmatic commitment based on no published analysis, to not cut rates any further until at least next March, still 10 months away.

And yet this is a really serious downturn.   Everyone seems to agree on that.  All the unemployment predictions –  even with the temporary cover (keeping people out of the official statistics) of the wage subsidy scheme –  involve higher peaks than we saw in the 2008/09 recession.  Even with big fiscal commitments, nominal GDP is expected to be way lower than previously expected, and the Bank expects to undershoot the bottom of its inflation target for a couple of years (for which there was nothing comparable in 2008/09).

How, then, did retail rates (real and nominal) behave over 2008/09?  Recall that that was an event that had its foundation in financial system problems, and even if the credit concerns weren’t specific to New Zealand the problems affected our banks’ access to funds, pricing etc.

The data are bit thinner for that period.   The Reserve Bank was only publishing “standard” mortgage rates, and single (six month) term deposit rate.  Oh, and it is a bit less clear when to date comparisons from.  Retail rates had gone on rising into 2008 (with the Bank’s acquiescence) as offshore funding costs were rising, and at the other end, shorter-term rates kept dropping further into 2009 than longer-term fixed rates did.    Inflation expectations also fell during that recession, on the Bank’s two-year ahead measure perhaps by about half a per cent.

But this is what happened from the end of 2007 to April 2009. (Changing start or end dates changes some of the numbers –  either way – by up to perhaps 50 basis points, mostly small on the scale of this chart.)

0809 retail

In other words, falls in retail rates (at the horizons where most of the business was written) of hundreds of basis points.   And that, in the Bank’s view (correctly as it turned out) was consistent with keeping inflation in the target range, even if not quite as high as they would have liked).

The Governor keeps claiming that his Large Scale Asset Purchase programme –  buying huge amounts of government bonds now yielding less than 1 per cent, in exchange for issuing huge amount of Reserve Bank deposits currently yielding 0.25 per cent –  is hugely effective and a fully adequate substitute for choosing not to do more with the OCR.    One can get down in the weeds of detailed arguments about what the LSAP may or may not be doing at the margin to bond rates or swaps rates, but whatever those effects may be –  and I reckon we are pretty safe in concluding that they are mostly small –  the rates that firms and households are actually receiving/paying is the bottom line.

In real terms, the household rates shown above have hardly moved at all, and there is little or nothing to suggest that picture facing businesses will be materially better (eg headline SME rates have fallen no further, and many larger businesses have facilities on which they pay a fixed margin over bank bill rates.  Bank bill rates have fallen by about 1 per cent since the start of the year, so in real terms a fall of perhaps 0.4 percentage points.  The contrast to 08/09 remains striking.

Of course, there is also the exchange rate.  The Governor claims to be successfully influencing it as well.   It is always difficult to know where to date comparisons for exchange rates, but here I’ve shown the fall in the exchange rate in the last two recessions:

  • for 08/09 the average in April 2009 relative to the average for the second half of 2007, and
  • for the current event, yesterday’s TWI relative to the average for the second half of 2019

TWi recessions

Monetary policy just is not doing its bit, even once all the fiscal support is factored into the projections.  That is a pure choice by the MPC.

We don’t know why they’ve just chosen not to do their job –  aiming for 2 per cent inflation and, as much as they can consistent with that, supporting a speedy return to full employment.  Last year, MPC seemed to embrace their mandate with some gusto. Now they appear like stunned animals caught in the headlights, uninterested in doing what they are paid for –  all while their spokesman keeps claiming to be doing a lot.

It is pretty reprehensible, and I find it quite remarkable that the MPC –  all of them, not just the Governor –  have not been asked harder questions about their failures.  Instead, much of the media seem to treat their acknowledged failure to ensure that banks’ operational systems etc were ready for negative rates as just “one of those things”, as if it could happen to anyone –  never for example drawing the contrast with Y2K, when the Bank proactively ensured it and the banks were ready, with contingency plans as well.   And notwithstanding that all of the data in this post are readily available, none has been yet heard to ask the Governor –  and his MPC –  why they are content with such trivial changes in real interest rates even when, with all their avowed enthusiasm for it, in combination fiscal policy and monetary policy in combination still have the Bank quite openly acknowledging that inflation will undershoot, and apparently not very bothered about the unemployed either.

Of course, the Minister of Finance bears responsibility for all this, and for all the individuals involved. Perhaps an Opposition that wanted to ask hard questions about the government’s stewardship at present –  even perhaps flag a different more pro-active approach –  might ask him just why he thinks it is appropriate for real interest rates to have hardly changed at all (and the real exchange rate not much more), even as he is willing to lend to the weakest business credits are far lower rates than his central bank’s monetary policy would support more generally.

Financing the government

In normal circumstances governments finance themselves primarily with visible legislated taxes, with a bit of additional debt on the side.

In New Zealand, over the last complete 10 years, core Crown revenue was $715 billion (mostly taxes) and debt contributed between $10 and $40 billion –  depending which gross or net measure you prefer.    That borrowing was almost all from the private sector, again as one would expect.  The Reserve Bank’s holdings of government bonds. for example, hardly changed at all (nor did bank settlement cash balances at the Reserve Bank).   And the government mostly had credit balances in its account at the Reserve Bank.

In the last couple of months, everything has been thrown up in the air.   On the Budget numbers I mentioned in Friday’s post, almost a quarter of government spending over the five years (including 2019/20) is expected to be financed by increased debt.   And on the Reserve Bank’s own numbers we could easily see at least half of that increase in debt take the form of Reserve Bank lending to the Crown (the forecast rise in net debt is $134 billion, and the Governor has talked of the possibility of raising further the current $60 billion limit on the LSAP programme).

That the Bank is buying those bonds on the secondary market, rather than getting some or all direct from the government (as some advanced country secondary banks are now doing to an extent), is a second or third order issue, making little or no macroeconomic difference.   The important point at present is that (a) the Bank is buying the bonds, and (b) the Bank is sterilising the liquidity effect on those purchases by paying an at-or-above market rate on the resulting settlement cash balances.

Oh, and the most important points of all were that the decision to buy bonds at all is (a) wholly a decision for the Monetary Policy Committee, and (b) working with an unchanged (from pre-crisis) mandate: delivering inflation near 2 per cent and, as much as it can consistent with that, supporting employment.  The government has given the Bank an indemnity, which makes the Bank feel more comfortable taking the associated interest rate risk, but if the government had not done so, it need not have stopped the Bank making the purchases if the MPC felt that was what the monetary policy mandate required.

I wrote about all this a month ago when there was first a flurry of concern about reported comments suggesting that at some point the Bank might buy bonds direct from the Crown, in a post intended to be basically supportive of the Bank.

Now, as you know, I don’t think the LSAP is making much difference at all now to anything that matters much to macroecononomic outcomes.  It is slightly perverse in that it involves shifting the duration of the Crown’s effective debt portfolio much shorter –  swapping long-dated government bonds for on-demand instantly repriceable settlement cash liabilities –  but if you believe interest rates are going to be low for quite some time, you might even downplay that.  Other than that, it probably does little harm –  and adds to our database of monetary experiments for future analysis – if little good.

But in the last couple of weeks there have been a number of comments from the Governor that suggest that something much more troubling is afoot.

The first hint I heard of it was when the Bank turned up to Parliament’s Finance and Expenditure Committee on the day after the Monetary Policy Statement.  This is an extract from the post I wrote then.

Goldsmith asked the Governor about those comments a few weeks ago that the Bank could consider buying government bonds directly from the Crown, rather than (as at present) in the secondary market.  He seemed to just be wanting to close off the issue, but the Governor opened it up all over again, in a way that seems to have attracted no attention.

The expected answer would probably have been along the lines that there were no plans at present, the secondary market was working well, but if there ever were dysfunction there was really no macro difference in the Bank buying direct, so long as the decision rested with the Bank, consistent with the inflation target.   In backing the Governor on this point previously, that is what I have said.

Instead, the Governor launched into a discussion noting that while the Bank did not rule out lending direct to the Crown, that was really fiscal policy not monetary policy, that the central bank can always lend as much as fiscal policy requires, but that that would be a matter for the government to decide, not the Bank.

Goldsmith then challenged him on that, asking whether he was really saying that the Minister could decide whether the Bank would lend direct.  Orr reiterated the possibility of market dysfunction, while noting that at present markets were functioning well, but then repeated that what he called “pure monetary financing” would be a matter for the Minister of Finance to decide.

At this point, the Governor invited the Deputy Governor Geoff Bascand –  usually the safe pair of hands in that senior management cohort –  to comment.  He indicated that it would be a matter of ministerial direction, but which would involve a substantial process including looking at whether what the minister might be directing would still be consistent with the existing price stability etc target.  And then he tried to close things down by suggesting that this was all just an “esoteric discussion”.

Reasonably enough ACT’s David Seymour reacted to that, suggesting that if the Bank was seriously saying the Minister of Finance could direct them to lend to the government, in any amount he chose, it was “anything but esoteric”.

I went on to articulate the (possibly) relevant provisions of the Act as I saw them, concluding

But……there is no hint in this provision [section 12 override powers], or anywhere else in the Act, suggesting that the Minister of Finance can direct the Bank to lend to the government.  Perhaps the Bank and its lawyers think/worry that “lend to the government at zero interest up to $…billion” is an alternative “economic objective” within the meaning of section 12 of the Act.   But, at very least, it would be a stretch –  it isn’t an “economic objective”, but an instrument,  and favouring one specific party in the economy.    And note that if a government did attempt to impose such an “economic objective” there would still be nothing to stop the Bank setting interest rates for the rest of the economy at a sufficiently high level to counter the inflationary effects of this coerced lending.

I’m at a loss to know what the Governor and Deputy Governor mean.   I’m tempted to lodge an OIA request, but am not sure I’ll bother, as they would find myriad ways to refuse to release anything.  But journalists could directly ask the Bank what the Governor/Deputy Governor were on about?   MPs could use parliamentary questions to ask the Minister of Finance whether (a) he has received any advice as regard his direction powers over the Reserve Bank, and (b) whether he or Treasury believe he has the statutory power to compel the Bank to lend to the Crown.  Most everyone I’m aware of has always assumed they can’t –  and took great reassurance in that –  so if the powers that be now believe differently we deserve to know?    (Of course, if the government just wants more inflation, it can always raise the inflation target, but that is a rather different issue).

And there I left it, a bit puzzled, none the wiser, and even wondering whether Orr had perhaps confused some details and there really wasn’t anything to worry about.

At least until over this last weekend.  Then I happened to listen to a post-MPS presentation Orr had given to clients of Jardens (on 15 May), in which he touched on the issue and noted that (paraphrasing from my notes) “if we were to take a direction from the government to finance it directly – as distinct from what monetary policy needs might imply – we would have to have different legislation”

I then read an interesting interest.co.nz article reporting comments the Governor had given to their journalist Jenee Tibshraeny late last week in which this topic was addressed at some length.

Orr said it was up to government to decide if it wanted to go further and give the RBNZ the mandate to buy bonds for fiscal policy purposes, rather than monetary policy purposes – IE buy bonds to help pay for government spending initiatives rather than to keep inflation and employment in check.

“There’s no right or wrong,” Orr said.

“It’s just that it is different and you would need legislative and/or institutional instructions, because when I last looked at my job description, I’m not allowed to go off and buy whatever I feel like because I’ve got the ATM…

“That would take some significant transparency as well as operational structures to ensure everyone knew who was doing what, why, how, where, when.”

Asked whether he would be hesitant to go down this path if Robertson asked him to, Orr responded: “Yes, I mean, it really depends to what purpose… and under what conditions is this managed.

“Because you could take it to the extreme immediately and you’ve gone back in time 30, 40 years and the central bank is being used as the ATM for a government and it’s unclear whether we can control inflation anymore, and it’s back in the hands of the elected officials…

“It’s not for me to choose the policy. I would implement the policy, but I would be extremely cautious about making sure the risks are understood, managed and mitigated wherever they could be.

“And I imagine I would be surrounded by many many people with free and often unsolicited advice around whether it did or didn’t work… which is good…

“People are very passionate about the structures that have been built and you don’t muck around with them lightly.

“These things are achievable; they’re just different.”

On the one hand, it is good to know that the Governor seems to think that under current law he can’t just go and buy anything he likes (he probably can, but it has to be consistent with the Bank’s statutory functions, including the monetary policy Remit the Minister has given him, which in turn is subordinate to the Act).   But then note those Bascand comments earlier suggesting the Bank thinks it could be directed under existing legislation, even if that might involve overriding or changing the Remit.

The Bank has clearly been giving such radical options quite a bit of thought, not just as extreme contingency plans (Parliament, being sovereign, can empower almost anything) but as something they are quite openly talking about.    That suggests something that they are either keen on themselves, or which the Minister and/or Treasury has raised fairly seriously as a possibility.

Given the Governor’s longstanding belief in a bigger government and a more aggresssive use of fiscal policy, it wouldn’t be entirely surprising if this were something he was championing (indeed, it would be the best explanation for why (a) he is the only one talking about it, and (b) doing so in a non-negative sort of way).

Going down such a path would, however, be a seriously retrograde step. Perhaps it might lift inflation expectations a bit –  governments acting to direct the central bank to lend to them will create some concern – but in a quite undesirable sort of way (even if Social Credit and the more rabid MMT enthusiasts might be salivating at the prospect).

For a start, there is no obvious need for such a mandate.  The New Zealand government is a highly creditworthy borrower which, on current government plans, will remain one of the least-indebted of all the advanced countries.   One can never rule out a new extreme global crisis that might seize up markets for a few days, but the prospects of the New Zealand government not being able to issue on market the quantity of debt believes it requires is slim indeed.   And the Crown already has an overdraft facility at the Reserve Bank that it can draw on to smooths ups and downs.

More disconcertingly, although technically the Reserve Bank could be required to lend to the government –  beyond anything consistent with the Remit –  and that wouldn’t immediately tip us into serious inflationary problems, it would be a highly distortionary policy.  In principle, the Bank could lend lots of money to the Crown at zero interest, and the government then further increases its spending beyond what would normally be consistent with the inflation target. If that happened, you would expect the MPC to start raising the OCR, to keep overall demand in check.  And then we’d be in the bizarre throwback world in which the government was borrowing for zero and the rest of the economy faced really quite high interest rates, squeezing out private sector activity to favour the government.

I’m not going to allow myself to be drawn into an inconsistency here.  At present, if anything, the presenting issue is that the Reserve Bank is not doing its core monetary policy job sufficiently well that either the market, survey respondents, or the Bank itself believe that inflation will be consistent with the target set for them.  If they persist in that stance, amid a really savage recession, I believe the Minister of Finance should act, using existing powers either to replace the key individuals (to ensure the current Remit is being followed) or to explicitly direct the Bank to adopt an easier monetary policy (consistent with the current Remit over the medium term).  Those powers are in the Act for a reason, to protect citizens.   There is no such power to direct the Bank to lend to the government and there has long been an international consensus that it would be quite unwise to provide for such a power.  It would be to step away from any sense that monetary policy operates in a neutral way, not setting out to favour or disadvantage any particular party or sector (private or public), and into a world where governments could regard control of the “printing press” as an acceptable way for them to finance their spending (or reluctance to tax) preferences.  With reasonable people, it isn’t some immediate path to hyperinflation, but it would be undesirable on numerous counts and further increase the politicisation of the Reserve Bank.

One can make an argument against central bank operational autonomy –  I sometimes come and go and whether there are real advantages that justify the costs and lack of accountability (part of the reason why I keep on about enhancing real central bank transparency) – but giving the government reason to think control of the printing press is a legitimate tool has nothing going for it at all.

We need some answers as to just what is going on.   When I tweeted about this on Saturday, Tibshraeny responded

That is encouraging, and I will look forward to her story.  But if Robertson –  who always seem conservative and risk averse (sometimes beyond what is warranted) – is not interested, then what cause is Orr championing, to what end, and why?

If he thinks more macroeconomic stimulus is required, try conventional monetary policy (would have helped, of course, if he’d sorted out those alleged “operational issues” some banks are claimed to have, but even those obstacles exist they can be overcome).  If the governments thinks it needs to spend more, the conventional options are still open to them –  higher taxes (probably not a great idea at present) or tapping the global market for public debt.  Maintaining that borrowing capability was, as you’ll recall, one of the main reasons why successive governments kept net debt low and stable.  (Of course. it also has a $40 billion fund –  which it insists on putting more money into, even as its new borrowings are large, to speculate on world markets –  much of which could be quite readily liquidated.)

 

 

Losing $128 billion

I don’t usually pay much attention to forecasts of nominal GDP.  Not many people in New Zealand really seem to.  But The Treasury takes nominal GDP forecasts more seriously than most, since nominal GDP (in aggregate) is, more or less, the tax base.

Out of little more than idle curiosity I dug out the numbers from last December’s HYEFU forecasts –  the last before the coronavirus –  and compared them to the numbers published in last week’s BEFU, accompanying the Budget.  And this was what I found.

Nominal GDP ($bn)
HYEFU BEFU Difference
2019/20 319.8 294.2 -25.6
2020/21 336.4 294.2 -42.2
2021/22 354.1 328.3 -25.8
2022/23 371.5 352.3 -19.2
2023/24 389.2 374.3 -14.9
Total 1771 1643.3 -127.7

Over the full five years, New Zealand’s nominal GDP is projected to be $128 billion less than The Treasury thought only a few months ago.

Recall that changes in nominal GDP can be broken down into three broad components:

  • the change in real GDP  (the volume of stuff produced here),
  • the change in the general price level (inflation), and
  • the terms of trade

On this occasion, changes in the terms of trade make only a tiny difference over the five years taken together.

General (CPI) inflation is expected to be lower than previously thought.    On average over the five years, the price level in the BEFU forecasts is about 1.8 per cent lower than in the HYEFU forecasts.  That accounts for about $33 billion in lost nominal GDP.

The balance –  the overwhelming bulk of the loss –  is real GDP.

I haven’t written anything much about The Treasury’s forecasts, which were done quite a while ago, and could not fully incorporate the final fiscal decisions the government made.  But for what it is worth, I reckon Treasury’s numbers were on the optimistic side –  quite possibly on all three components of nominal GDP.  On inflation, for example, they are more optimistic than the Reserve Bank (which finished its forecasts later), even as they assume tighter monetary conditions than the Bank does.

But the point I really wanted to make was that these forecast GDP losses will never be made back (in the sense that some future year will be higher to compensate –  resources not used this year mostly represents a permanent loss of wealth).  And that these losses occur despite all the fiscal support (and rather limited monetary support).   And fiscal here includes both the effects of the automatic stabilisers (mainly lower tax revenue as the economy shrinks) and the discretionary policy initiatives (temporary and permanent).

How large are those fiscal numbers?  Well, here is core Crown revenue (more than 90 per cent of which is tax)

Core Crown revenue ($bn)
HYEFU BEFU Difference
2019/20 95.8 89.5 -6.3
2020/21 101.6 87 -14.6
2021/22 106.5 94.6 -11.9
2022/23 112.7 104 -8.7
2023/24 117.7 109.9 -7.8
534.3 485 -49.3

Almost $50 billion the Crown was expecting but which it won’t now receive.  Some of that will be the result of discretionary initiatives –  the corporate tax clawback scheme, much of which will result in permanent losses, and the business tax changes announced in the 17 March package –  but the bulk of the loss will be the automatic stabilisers at work.

And on the expenditure side?

Core Crown expenses ($bn)
HYEFU BEFU Difference
2019/20 93.8 114 20.2
2020/21 98.8 113.5 14.7
2021/22 102 119.8 17.8
2022/23 106.3 118.6 12.3
2023/24 109.2 113 3.8
Total 510.1 578.9 68.8

Almost $70 billion of current spending the Crown didn’t expect to make only a few months ago.  A small amount of this will be the automatic stabilisers at work (the unemployment benefit), but The Treasury is pretty optimistic about unemployment.  Most of the change is discretionary policy initiatives (announced or provided for).

And here is the change in net debt

Net core Crown debt (incl NZSF) as at year end  ($bn)
HYEFU BEFU
2018/19 14.1 14.1
2019/20 14.6 47.6
2020/21 17.6 82.8
2021/22 17.1 111.7
2022/23 12.3 131.7
2023/24 3.9 138.2 134.3

That will be almost $135 billion higher than expected.

As I’ve noted in earlier posts, I don’t have too much problem with the extent of overall fiscal support (although I would have structured it differently and made it more frontloaded –  consistent with the “pandemic insurance” model).

But even on this scale, fiscal policy is nowhere near enough to stop the losses.  Some of those losses are now unavoidable.  It is only five weeks until the end of 2019/2020, so we can treat $26 billion of nominal GDP losses (see first table) as water under the bridge now.   As it happens, fiscal policy looks to have more than fully “replaced” the income loss in aggregate (whether $27 billion from operating revenue and expenses in combination, or the $33 billion increase in net debt) –  not as windfall, but as borrowing (narrowing future choices).   (UPDATE: Even in quote marks “replaced” isn’t really quite right there, as without the fiscal initiatives it is near-certain that actual nominal GDP would have been at least a bit lower than The Treasury now forecasts, even for 19/20.)

But there is a great deal of lost income/output ahead of us, even on these (relatively optimistic) Treasury numbers.

Which is really where monetary policy should be coming in.   The Treasury assumes that monetary policy does almost nothing: there is no further fall in the 90 day rate (the variable they forecast), and as they will recognise as well as anyone inflation expectations have fallen, so real rates are little changed from where they were at the start of the year.  And although the exchange rate is lower throughout than they assumed in the HYEFU, the difference is less than 5 per cent –  better than nothing of course, but tiny by comparison with exchange rate adjustments that have been part of previous recoveries.  It isn’t entirely clear how The Treasury has allowed for the LSAP bond purchase programme, but whatever effect they are assuming…….there is still a great deal of lost output.

The Governor has often been heard calling for banks –  private businesses – to be “courageous”.  It is never quite clear what he means, but he apparently wants to risk other peoples’ money.  But the central bank is ours –  a public institution.   A courageous central bank, that had really grasped the likely severity of this slump, could have begun to make a real difference.  If they’d cut the OCR back in February, and taken steps to ensure that large amounts of deposits couldn’t be converted to physical cash, and then cut the OCR to deeply negative levels (perhaps – 5 per cent) as the full horror dawned, we’d be in a much better position now looking ahead.     Wholesale lending and deposit rates would be substantially negative at the short end, and even real rates on longer-term assets might be as low as they now, without much need for bond purchases.   Retail rates might also in many case be modestly negative –  perhaps for small depositors achieved through fees.   And, almost certainly, the exchange rate would have fallen a long way, assisting in the stabilisation and recovery goal.  There are winners and losers from such steps –  as there are from any interventions, or from choices just to sit to the sidelines –  but it is really just conventional macroeconomics: in a time of serious excess capacity and falling inflation expectations, act to seek to bring domestic demand forward, and net demand towards New Zealand producers.    Working hand in hand with the substantial fiscal support (see above), we’d be hugely better positioned to minimise those large future nominal GDP losses –  losses that at present, we risk never making back.

But neither the Governor nor, apparently, the Minister of Finance seem bothered.

Finally, if nominal GDP appears to be a slightly abstract thing, it is worth recalling that almost all debt is nominal and it is nominal incomes that support outstanding debt.  There is about $500 billion of (intermediated) Private Sector Credit at present (and some other private credit on top of that).  Most likely that stock won’t grow much over the next few years. But government debt will –  on Treasury’s numbers net debt rises by $134 billion.   Against those stocks, a cumulative loss of nominal GDP of $128 billion over five years is no small loss.  As noted earlier, amid all the uncertainties, the precise numbers are only illustrative, but the broad magnitude of the likely losses (on current policies) are what –  and that magnitude is large, if anything perhaps understated on The Treasury’s numbers.

 

A practical suggestion for the Governor

A commenter on a recent post left the reasonable question

if the RBNZ is flooding banks with deposits/reserves to pay for its QE, why are the banks still paying 2.5% to raise term deposits from the public ? Surely the banks have more cash than they know what to do with ?

Well might she ask.  And her question prompted me to think a bit harder about useful steps that could be taken in response to what looks like quite a glaring anomaly.    At present, the Reserve Bank pays 0.25 per cent on settlement balances banks hold at the Reserve Bank, banks are paying much the same rate on (wholesale) 90 day bank bills, but when I checked this morning the average retail rate on offer for a six month term from our five largest banks was about 2.15 per cent.

It wasn’t always so.  Here is a chart showing the 90 day bank bill rate and the 6 month term deposit rate (the one the Reserve Bank provides a long time series for) back almost 30 years.

retail and wholesale

Short-term wholesale rates used to be a bit higher than comparable maturity retail rates.  That made sense.   The marketing and admin costs associated with one $20 million bank bill are going to be a lot lower than those associated with 400 retail deposits of $50000 each.  The margin ebbed and flowed a bit, but it was rare for retail rates to be below wholesale.  All that changed at the time of the 2008/09 recession and financial crisis, and the old relationships have never resumed.

In this chart I’ve taken a shorter period –  since the start of 2007 –  and have also shown the rate on a 1 year interest rate swap (for which the Bank has only published data since mid 2010).

retail and wholesale 2

The maturities differ a bit, but despite that you can see how similar the two wholesale rates have mostly been and how different they’ve been to retail rates.    And here, for the same period, are the margins between the 6 month retail rate and the 1 year swap rate respectively and the 90 day bank bill rate (itself usually moving very similarly to the OCR).

retail and wholesale margins

The gaps that sometimes open up for a while between the swap and bill rate just reflect the maturity differences – eg in 2013 and 2014 the Bank was strongly expected to raise the OCR so swaps yields rose in anticipation.  Over time, the differences have been small and non-persistent.    By contrast, the margin between retail and wholesale rates has typically been large and somewhat variable.

What accounts for this weird situation in which Michael Reddell private saver can get, pretty consistently, 150 basis points more for my smaller deposit than Michael Reddell trustee of the Reserve Bank staff pension scheme can get for the much larger amounts of money he (and other trustees) formally own (on behalf of the members)?

(Totally parenthetically, hasn’t policy been pushing people into collective savings vehicles –  where they can only get the lower rates – ever since Kiwisaver was set up?)

It has a great deal to do with the 2008/09 crisis conditions, and perceptions and regulatory responses thereto.    In New Zealand in the run-up to 2008/09 banks had had a very large share of their funding in the form of very short-term foreign wholesale instruments.  That funding was cheap and easy to raise –  times were good, money was easy, the mood was exuberant – and banks simply did not believe those markets could ever seize up  (I’ve told the story previously of one very senior risk manager of one of the big banks who when we were doing pandemic planning in about 2006 asserted that very strongly).  They did.  More generally, wholesale runs were the catalyst for the failure of various major institutions abroad.

And so, perhaps understandably, there was a quite a reaction, by banks themselves (scares change behaviour, for a time at least), rating agencies, investors in bank debt, and regulators.  In this post I will be focusing on the New Zealand regulatory intervention, but I don’t want to be read as suggesting it was the whole story (in fact, some readers may have memories long enough to recall my arguing 10 years ago that the regulatory effect then was probably small, relative to the private market response in those early post-crisis days).

Prior to 2008/09, the Reserve Bank had never had minimum liquidity requirements for banks.  It was talked about from time to time –  we used to worry, some more than others, about the macro risks associated with very high levels of short-term foreign debt –  but in a small organisation it had never been a top priority, and there was Basle II to implement.

The Reserve Bank, The Treasury, and the banks got a fright in late 2008.  It generally wasn’t totally impossible for our banks to borrow abroad but for a time it was very difficult to borrow (including on terms that didn’t send an atrocious signal) for much longer than overnight.  Even with their prior fondness for fairly short-term debt, that was troubling for banks.  (None of this, of course, was about the health of our banks or their parents; it was all about global markets seizing up.)

There were immediate policy responses to get through that episode –  Reserve Bank liquidity provision, Crown guarantees for new wholesale borrowing – but also a fairly quick Reserve Bank policy response to try to reduce or substantiallly eliminate the risk of finding ourselves in that situation again.   For a bank with a sound asset base, it is almost a given that a central bank will eventually lend if necessary, but the idea was to put buffers in place that meant we weren’t the port of first resort if things got tough, and (since banks’ board never like relying on central bank funding) to reduce the extent of pro-cyclical shocks to credit availability.

There are a number of strands to Reserve Bank liquidity policy but the bit I want to focus on is the one-year Core Funding Ratio (CFR) requirement: now that “core funding” must equal at least 75 per cent of each bank’s total loans and advances.  In practice, as banks do with capital buffers, they typically hold a considerable margin above the regulatory minimum.     Here are systemwide numbers since 2013, when the minimum ratio was raised to 75 per cent.

CFR data

And what counts as “core funding”?

Well, here is the summary from the policy document

CFR defn

Simplifying a bit, core (Tier 1) capital counts, as does all funding with a residual maturity in excess of one year, half of any long-term securities in the period between six months and one year to maturity, and (per the table) “short-term non-market funding”.

There is quite a lot of other detail defining “market funding”, but suffice to say that long-term wholesale (market) funding is attractive for these purposes (sell a 7 year bond, and the bank can count it as core funding fully for six year, and half for six months), but so is money from the little person –  you and me.  Anything we hold, so long as it less in total than $5 million per bank, counts at 90 per cent as term funding, even if the relevant account is fully liquid and the deposit are withdrawable on demand without question.  It isn’t just individuals; corporate cash holdings are treated the same (not on an instrument by instrument basis but based on the total holdings of that firms and all its related parties).  And other financial institutions – even small and passive ones (like the Reserve Bank superannuation one) – are explicitly excluded.

It is just great if you are an individual depositor.  But it is really rather anomalous, and not based on any terribly-robust analysis.

Now the missing bit in all this is the cost of that long-term wholesale funding, which is more or less as valuable as a retail term deposit for CFR purposes.  It is hard for outsiders to get a reliable fix over time on those costs, but from time to time the Reserve Bank includes a chart like this in the MPS, as it did last week.

fundingcosts

Quite how they put it together isn’t that clear (and the underlying data aren’t disclosed), but the line to focus on is really the grey one –  the estimated all-in cost of long-term foreign funding (issuing the debt in foreign currency and hedging it back into NZD for the term of the loan).  The margin between the grey line and the OCR is both large and variable.  Much of that typically has to do with the hedging costs –  again not something easy for outsiders to track routinely, but which have typically been more adverse, and more variable, over the last decade or so than was typically the case in the years prior to 2007.     If the hedging costs were consistently low, the grey line would be a lot closer to the OCR and the cost of domestic wholesale short-term funding, which in turn would mean banks would price term deposits much closer to the OCR/bank bill or to those domestic interest rate swaps.

Perhaps the other relevant consideration here is that the New Zealand economy as a whole is still quite heavily dependent on foreign capital, and in particular on foreign debt intermediated through the banking system.    If our net international investment position was different, there would be a larger stock of domestic retail/corporate deposits, and the relevance of the offshore funding costs (including hedging) might be a lot less.

But as it is, the banks are compelled to have –  in total – a lot of funding from retail and long-term wholesale sources.  A rational bank will price term deposits so that the cost of that form of core funding is typically and roughly equivalent to the cost of equivalently-useful long-term wholesale funding (the latter mostly from abroad).

When the CFR was put in place there was a recognition that core funding would be a bit more expensive that other funding, and that was a price judged worth paying. By the time of the increase in the minimum ratio to 75 per cent, this huge margin between the cost of “core funding” and the cost of other liabilities seems –  from the relevant RIS –  to have come to be accepted as some sort of new-normal, perhaps even desirable.  At the time, the Bank even toyed with the idea of the CFR as a so-called macroprudential tool (it appears in the MOU on such things agreed in 2013), and there was a view afoot that a higher CFR might enable us to tighten overall conditions without pushing up the exchange rate.

But, frankly, it all looks a bit daft at present.    The policy is premised on the notion not only that Michael Reddell as personal depositor is less likely to run on his bank than Michael Reddell the super fund trustee and that – even if granted that that was true –  that stickiness (possibly not even rational, since I might just be slacker about my finances than about my fiduciary responsibilities) was so valuable from a financial stability perspective to be worth driving such a massive wedge between the rates available on two products with absolutely the same credit risk.    More generally, if you were around in 2007/08 you may recall (a) the retail runs on domestic finance companies,  and (b) Northern Rock and the queues down the streets in the UK.     There probably is some value in encouraging banks to have a reasonable volume of longer-term funding, that can’t be encashed on demand by the holder, but there is little obvious basis for distinguishing deposits of the same maturity held by individuals, by companies, by other small financial institutions and so on.    A cost-benefit analysis simply could not support the sorts of –  inefficient –  wedges we have come to see.   I emphasis the “inefficient” because (a) the Governor likes now to refer to efficiency, and (b) more importantly, because the provisions of the Reserve Bank Act governing the exercise of prudential powers still do, as an important constraint on what the Bank does.

From a macroeconomic perspective, none of this much mattered when the Bank was freely able and willing to adjust the OCR as required, to more or less keep inflation towards target.  If term deposit rates were going to be a little high, the OCR would be lowered, and although there would still be much the same wedge between retail and wholesale rates, the level of retail lending and borrowing rates could be more or less managed to what the Bank regarded as consistent with the inflation target.

These days, however, the Bank seems to regard itself as bound to an exceptionally rash commitment it made in a hurry on 16 March, not to reduce the OCR further.  And the Governor and Deputy Governor are reduced to asking really really nicely (or not so) for the banks to lower lending rates, even as they say they can ‘rationalise’ –  in terms of those funding costs –  why they don’t.  To me the answer is straightforward: if as a central bank you think retail rates need to be lower, consistent with your inflation target, then cut the OCR until retail rates get there.  Simple as that.

But if the Governor really does regard himself as honour-bound –  like some teenager’s promise to a dying parent that he’d never ever partake of the demon drink – there are still options, and ones that might make a real difference where it matters to depositors/borrowers.   Specifically, the CFR.

For example, the Governor –  and this is his decision, not the MPC’s –  could lower the minimum CFR to, say, 65 per cent (and commit to keep it no higher than that for, say, the next five years).  Do that and the pressure would come off term deposit rates very quickly and the relevance of those marginal foreign term funding costs would abate.  He could do more complicated things as well – options we looked at a decade ago –  of imposing a minimum requirement only on the share of foreign funding that is long-term (recognising that we don’t have largely repo-funded investment banks as they had in the US). I wouldn’t recommend the more complex changes in the short-term –  action is what is called for, and not things that take lots of careful drafting and consultation.

You might  –  perhaps especially if you were a bank supervisor –  think it strange to propose such a relaxation in the middle of a very troubled period.     But bear in mind several points:

  • we aren’t in the exuberant phase of the cycle (unlike, say, 2005 to 2007), where banks are just pursuing whatever is cheapest regardless of rollover risk,
  • we’ve already got to the point where the Bank is happy to provide almost limitless funding to the banks.  They are running term loan liquidity auctions, and for now getting no takers.  And although the wholesale deposits that arise through the bond purchase are technically pretty short-term, I heard the Governor on the radio yesterday stating that he thought the Bank would be holding the bonds to maturity (in which case the funding will also be there for years).  None of this funding counts as ‘core funding” for CFR purposes,
  • there was no robust cost-benefit analysis of just what was being gained from the CFR, let alone the specific parameter settings (nothing even to match what was done for capital last year). In other words, the current 75 per cent is no less or more ad hoc than a 65 per cent ratio for a few years would be.
  • the Bank has already wound back its capital requirements (delayed the start of the increase in required capital), so there would be no particular inconsistency in doing the same for liquidity, given the anomalous pricing the Bank’s rules are producing.

The Reserve Bank was a fairly early adopter of a core funding requirement after the last recession.  Many other countries now have something called a net stable funding requirement as part of their bank supervision arrangements.   The rules are a bit different, and no doubt each country has its own specific calibrations (and I’m not that familiar with the details of any of them).  This post is not an argument for getting rid of a funding requirement rule –  although in the end it is the quality of bank assets that matters mostly –  but for recognising how large a wedge our specific rules have driven, and the way that now (with the self-imposed OCR floor) contributes to holding our retail lending rates up.

I’ve noted in a couple of posts, including yesterday’s, that even though the New Zealand and Australian policy rates are essentially the same, retail term deposit rates in Australia are much lower than those –  offered by the same banking groups –  in New Zealand (and by much more than any slight differences in credit quality might explain).  As I noted earlier, it isn’t just regulatory provisions that explain the wedge between core and non-core funding of the same term and credit, but it seems likely that the specification of the NZ rules explains the bulk of the difference between New Zealand and Australian term deposit rates.

If the Governor is determined to stick to his crazy OCR promise for now, action on the CFR offers the fastest surest mechanism to materially lower domestic retail interest rates.  The Governor says that is a priority for him.  This decision is entirely his.

It is fair here to point out that the Governor’s prudential regulatory powers have to be used for prudential regulatory purposes –  soundness and efficiency of the financial system –  and can’t just be used as a monetary policy tool (any more than LVRs could).    But on this occasion that should not act as a constraint: after all, that large wedge between returns on instruments of the same maturity and credit, dependent solely on who holds the instrument, doesn’t look good on any sort of efficiency test, and I’m sure I’ve heard in recent weeks the Governor suggest –  quite credibly –  that lower retail lending rates were likely to be, at the margin, a positive contribution to financial stability.   When efficiency and soundness ends are both served it really should be an easy call.  There is a Bank Financial Stability Report due next week, which would be a good opportunity to announce such a change –  or for MPs and journalists to grill the Governor on why he would continue to oversee a policy that drives such a wedge into the interest rate structure.

UPDATE:   Shows how many initiatives there have been that one can lose track of.  A reader draws my attention to the fact that the Reserve Bank had already cut the CFR in late March.   I must have read that at the time and then forgotten it.  Will have to reflect further then on why term deposit rates are still so high relative to wholesale rates.  One possibility might be uncertainty about how long the relief will last.

 

Monetary policy again

One way of looking at developments in New Zealand’s monetary policy is to compare what has been done, and how that has affected market prices, in the country that is in many respects most similar to New Zealand, Australia.

There are no perfect comparators –  and in many ways everyone is flying a bit blind at present – but the two economies do have many of the same banks, similar institutions (variable or short-term fixed mortgages) and a fairly similar experience of the virus.   Sceptic that I am of the Reserve Bank of New Zealand, I am not starting from a view that the Reserve Bank of Australia’s monetary management is some sort of standard to which we should aspire.  Coming into this crisis, for example, both central banks have presided over core inflation undershooting the midpoint of their respective inflation targets, the RBA by more than the RBNZ.      And for reasons that are not very clear (at least to me), the Reserve Bank of Australia is more resolved not to adopt a negative policy rate than our own central bank.

What was the starting point at the end of last year (a time when no one in either country had the coronavirus in focus)?  Recall that Australia’s inflation target (centred on 2.5 per cent) is a bit higher than ours (centred on 2 per cent).  Here are the interest rates I could find, all from the respective central bank websites, except the Australian interest rate swaps yields.

31 dec 2019 int rates

Every single one of the New Zealand rates was higher than the comparable Australian rates –  the smallest gap of all being in the two policy rates, and by far the largest being in term deposit rates.   Note that at the end of last year, markets were looking to the prospect of a cut in the RBA cash rate later this year, while in New Zealand attention was beginning to turn to the possibility of an OCR increase at some point.

So what has happened since then?

  • the RBA cuts its cash rate by 50 basis points to 0.25 per cent, while the RBA cuts its OCR by 75 basis points to 0.25 per cent,
  • both central banks have massively increased the volume of settlement cash in the respective systems.  At the RBNZ, all those balances (currently around $28bn) are remunerated at 0.25 per cent, while at the RBA balances are remunerated at 0.10 per cent (both central banks changed their rules for remunerating large balances),
  • the RBNZ announced its large-scale asset purchase programme, concentrated on government bonds, currently with a limit of $60 billion,
  • the RBA announced a target rate of 0.25 per cent for the yield on three year government bonds, indicating that they would operate in the market (primarily that for government securities) to maintain market rates at or near that target.

And here is how much those rates have changed to now (latest available data)

int rate changes

Tracking down old mortgage rates for Australia is beyond me, but note that both variable and fixed mortgage rates in New Zealand are well above those in Australia.    But so are term deposit rates: averaging across the big four banks, in Australia for AUD six month term deposits the banks are paying about 0.8 per cent, and in New Zealand for NZD six month term deposits the banks are paying about 2.2 per cent.

As you can see from the table, wholesale rates (bills, bonds, swaps) have fallen by more in New Zealand than in Australia.  That is not inconsistent with the fact that the Reserve Bank of New Zealand cut its effective policy rate by more than the RBA cut its effective rate.  Here are the current wholesale rates (Australia in the second column)

wholesale 3

It is notable that longer-term rates are now lower in New Zealand than in Australia –  quite a contrast to the situation at the end of last year.

Consistent with all that, incidentially, the NZD/AUD exchange rate fell by about 4 per cent over this period.

What might explain these developments?

On the one hand, quite possibly people trading the markets in the two countries may reckon the New Zealand recession will be more severe and/or longer-lasting than Australia’s.    It is certainly true that forecasts of the decline in June quarter GDP are much steeper for New Zealand than for Australia, although beyond that –  looking ahead a year or two –  it isn’t obvious at this stage why things might be so very different at the sort of horizon more relevant to longer-term rates.  So for now I’ll just note that possibility and pass on.

What about central bank words and choices?

The Reserve Bank of Australia has apparently been pretty clear that it will not lower than cash rate from here.   The market seems to more or less believe them (the OIS rates on the RBA website are consistent with the current effective cash rate).  By contrast, the Reserve Bank of New Zealand has opened the door to the possibility of a negative OCR next year. I don’t have access to New Zealand OIS data, but I did notice this chart in a Westpac market report, dated yesterday, that someone sent me.

NZ OIS

Markets here are pricing a negative OCR throughout next year.  In other words, our longer-term interest rates price in even more conventional monetary policy easing.  Consistent with that, a reasonable chunk of the fall in the exchange rate has occurred since the Reserve Bank’s MPS last week.

All of which then leaves the question of quite what difference the Reserve Bank’s vaunted long-term asset purchase (LSAP) programme is making.  The Reserve Bank repeatedly tries to suggest the answer is “a lot”.  But there is reason to be more than a little sceptical that it is making much difference where it matters.

As I noted above, both central banks launched novel asset purchase programmes.  The RBA’s approach involved purchasing whatever it took to keep the three year government bond rate around 0.25 per cent.   In the early days –  amid the global bond market liquidation –  achieving that goal took a lot of purchases.  But here are the RBA’s total bond purchases

A$mn
Total 51348
March 27000
1st half Apr 17500
2nd half Apr 5748
May 1100

You’ll recall that the Australian economy is quite a lot bigger than New Zealand’s.  A$51 billion in bond purchases there might be akin to perhaps NZ$7-8 billion purchases here.

But note what has happened: after heavy purchases in late March and early April, the RBA’s bond purchases have almost completely dried up.  Despite the heavy expected federal government bond issuance, expectations about short-term rates are now sufficiently subdued that the three year government bond rate is holding at the target rate with no material bond purchases at all.  And the purchases the RBA has been doing have been heavily concentrated in relatively short-dated government bonds, consistent with reinforcing monetary policy signalling and with the fact that, as in New Zealand, most private sector borrowing tends to be on variable or short-term fixed terms.

What about the Reserve Bank of New Zealand?    Here is the same table for them (government bonds only –  there is a small amount of LGFA purchases also).

NZ$m
Total 11,228
March (from 26th) 950
1st half April 3,833
2nd half April 2,845
May 3,600

Relative to the size of the economy, total purchases here have been somewhat larger, but the real difference is that the Bank is buying just as heavily as ever.  And as I noted in my post on Monday more than two-thirds of all their purchases have been for maturity dates from 2027 and beyond –  and virtually no one I’m aware of, other than the government itself, takes funding exposed to rates that long.

In other words, it seems plausible that the LSAP programme might be knocking 20-30 basis points off long-term government bond yields and swaps rates, while making almost no difference at the short-end (where the RBA would seem now to provide a reasonable benchmark).  And yet it is the short-end that influences borrowing costs for most households and corporates.  At the long end……well, there is the government.    It all looks quite a lot like a programme designed to do two things:

  • by waving around very big numbers to suggest that monetary policy is doing a lot when it actually isn’t really doing that much at all, and
  • to lower the marginal borrowing costs of the Crown, at a time when the Crown has a very big borrowing programme.  At very least, that is a questionable use of monetary policy – not at all consistent with the MPC’s Remit (since fiscal policy will be what it will be whether or not bond yields are 20 points higher or lower) –  and all while exposing the Crown to a really high degree of unnecessary degree of interest rate risk (if the authorities really believe interest rates are extraordinarily low they should be markedly lengthening the duration of the Crown’s debt to the private sector, not skewing it dramatically shorter by buying in government bonds and issuing variable rate settlement cash in exchange).

And, on the other hand, if the Bank were really serious about getting retail interest rates down –  rather than anguishing in public and suggesting that commercial banks aren’t doing their job –  it would just get on and cut the OCR quite a lot further.  As it is, go back briefly to the changes table (the second one from top): nominal rates have fallen to a moderate extent this year, but survey and market measures of inflation expectations suggest that expectations of future inflation have fallen by probably 0.7 percentage points.  Real rates generally haven’t fallen much at all, while retail deposit rates –  held up by the combination of the Bank’s core funding requirement regulation (their choice) and the continuing relatively high cost of offshore terms finance (illustrated in the MPS last week) –  have actually risen in real terms.

Quite a claim to fame that: to be the central bank, in a country with a highly safe banking system (as the Governor now repeatedly avers), that presided over a rise in real deposit rates in the face of the biggest economic slump in decades.  Extraordinary.

Meanwhile, in the last 24 hours we’ve had the Deputy Governor offering interviews to both Stuff and the Herald reaffirming the MPC’s commitment to stick to its bizarre promise on 16 March not to cut the OCR further before next March, come what may.   Apart from anything else, it has the objective effect of tightening monetary conditions relative to where they were –  in effect, urging markets to price out those early negative OIS prices and, all else equal, push up the exchange rate.

There is, of course, something to be said for sticking to one’s word.  But rash promises generally should not be followed through on.  I suppose we should be thankful that the MPC in February –  recall, they were upbeat about the rest of the year then –  had not offered “forward guidance” committing not to cut the OCR this year, come what may.  Perhaps they’d have felt obliged to stick to that rash pledge as well?  As it is, this was a pledge made on 16 March, at a time when the Governor was reluctant to even concede that a recession was happening, at a time when the Secretary to the Treasury (observer on the MPC) was telling the PM that things might be not much worse than the 2008/09 recession.   Perhaps (or not) those were pardonable calls at the time, but they were clearly mistakes, and not small ones.   Sticking to a rash pledge made in some highly uncertain and fast-moving circumstances is almost akin to the suicidal person talked down from the edge, but still averring that “I promised I’d jump, I even left a note, I need to stick to my word”.  Among the sick, such misperceptions might be pardonable.  From highly-paid public figures charged with conducting a nation’s monetary policy, it is simply stubborn, verging on the crazy –  the more so if the MPC thinks that sticking to that pledge in any way enhances the sort of credility that matters.  After all, it was the MPC last week that published projections showing inflation below the bottom of the target range for two years, and unemployment unacceptably high.  Those were supposed to be the considerations people judged the Bank on.

Finally, I see that Stuff’s Thomas Coughlan in his column this morning has picked up my call that if the MPC won’t move –  won’t do the job that is really needed, to provide a lot more stimulus, to get us on the path back to full employment and price stability –  that the Minister of Finance should use the override powers Parliament has long provided him with.  They aren’t powers that should be exercised lightly, but these are exceptional times, and the Bank seems to be content to do little of substance, while pretending otherwise.  Of course, the Act was initially written primarily to protect us from inflation-happy politicians, but also has to protect us from central bankers just not doing their job –  in this case, on either the employment or inflation dimensions.  If he fails to act –  as surely, risk averse as he is, the Minister of Finance will fully share responsibility for the unncessarily slow recovery that he and his MPC seem set to risk.   To what end?

LSAP scepticism

The Governor of the Reserve Bank is always keen to tell us what an important contribution the Reserve Bank is making through its large-scale asset purchase programme (LSAP).  Recall that the Bank cut the OCR by 75 basis points and then gave up on using conventional monetary policy –  promising (in one of the weirdest pledges in the history of modern monetary policy) to do no more for 12 months, come what may – in favour of buying lots of (mostly) government bonds.  At present, the MPC has authorised the Bank to buy up to $60 billion of bonds, and there is speculation from some banks that that total may even be raised further at the next  Monetary Policy Statement in August.   The Bank claims –  as it did in the MPS last week and at its appearance at FEC the next day –  to be making a big difference, but it is mostly a smoke and mirrors show.  There are big numbers involved, but the differences being made to things that might matter economically are really rather small.

Sadly, it seems to suit our very conservative and risk-averse Minister of Finance to believe –  or acts as if he believes –  the Bank’s story, even if by doing so he aids and abets an insuffficient macro policy response to the savage recession that is upon us.  The macro consequences of his indifference probably won’t show up before the election, but even beyond that horizon in his entire term in office he has been remarkably deferential towards the Bank. It is if he is scared of doing what the economy needs.

It is fair to say that there has been an active debate over quite what these asset purchase programmes have achieved ever since they were launched.   While I was still at the Reserve Bank I recall a couple of visits from Dan Thornton, then a senior researcher from the St Louis Fed, who presented versions of papers arguing that the Fed’s various asset purchase programmes really hadn’t made much sustained difference to anything.    I was never fully convinced but if you’d asked me a year ago I’d have said that my summary impression was that earliest Fed programme –  in the midst of the financial crisis –  probably added some value, but that the later ones didn’t achieve much at all, perhaps beyond some announcement signalling.  (The issues in Europe were a bit different, since breakup risk was in play).  Long-term interest rates in the US, for example, hadn’t seemed to have fallen more, relative to the change in the policy rate, than we’d seen in New Zealand or Australia (which, to then, had not resorted to asset purchase programmes).

In truth that didn’t seem very different to the approach being taken by the Reserve Bank’s chief economist only two months ago.  This was reported in the Herald on 13 March

yuong ha

That sounded –  sounds in fact –  about right to me.   It isn’t, of course, the line that either Ha or his boss are running now.  Instead, we get repeated suggestions – never quite pinned down with hard estimates or illustrations –  that what the Bank is doing with the LSAP is some sort of fully adequate substitute for the sort of scale of OCR adjustment we’ve had in past serious recession (recessions which, it might be added, it has often taken years for the unenemployment rate to drop back acceptably).

Strangely, the Governor has found some supporters among the local bank economists.  I presume they really believe what they are saying, but I still don’t find it very persuasive at all.

Much has been made of the claimed impact of the bond purchase programme on wholesale interest rates.  But even there, the story isn’t particularly persuasive.

Typically, the biggest influence on longer-term interest rates is the expected future path of short-term interest rates.  Why?   Because, in principle at least, someone holding a 10 year bond has as an alternative investing in a series of 40 day 90 day bills.  If the market thinks the short-term rates wil rise or fall materially over the life of the bond, that will influence bond yields themselves.

Sometimes, there is a serious recession, involving significant cuts in the OCR, but where the effect is expected to be quite shortlived; before long it is expected that the Reserve Bank will be raising the OCR again.   If so, bond yields might not fall much, and in particular the implied forward interest rates (eg the second five years of a 10 year bond, backed out using yields for five and ten year maturities).   That was more or less exactly how markets reacted in 2008/09.

5 yr forward rate

It took a couple of years for markets to really begin to appreciate that future policy rates were likely to be low for some considerable time.  This New Zealand experience wasn’t that unusual.  In fact, it took a while for the Reserve Bank to learn –  they’d actually started tightening in mid 2010.

But what about this recession?  I’ve not seen a single serious commentator here or abroad –  I’ll set aside the columnists who reckon we are now on an inexorable path towards Venezuela –  who think there is any material chance of policy rates being raised any time in the foreseeable future (several years at least).  By contrast, just a few months ago people were beginning about the possibility of OCR increases perhaps later this year or next year.

And yet even with all that Reserve Bank bond buying –  actual and promised –  the implied five year forward government bond rate hasn’t really fallen that much at all.  It is down 80-90 since the middle of last year and 60 points since January.  It just isn’t very much –  look at the size of some of the past movements even just in the period of this chart –  and all this against a backdrop of a 70-80 basis point fall in medium-term inflation expectations (whether one uses survey measures or market prices).  Unfortunately, long-term historical swaps data isn’t readily available, but for the more recent period the picture is much the same: implied forward rates haven’t fallen very much relative to history, relative to the scale of the economic shock, or relative to the fall in inflation expectations.  And yet it was this fall in swaps rates on which the Bank seems to pin its claims.

Ah, but what about the counterfactual?  What would have happened if the Reserve Bank had not launched and then expanded the Large Scale Asset Purchase programme?    The only fully honest answer of course is that we do not know.

The Bank likes to run the charts showing how bond yields surged upwards in late March, and then fell after it intervened with the LSAP.

10 yr yield may 2020

The global rush to cash and liquidation panic was well-recognised.  Quite probably, central bank interventions helped to stabilise things.  But that is a different proposition from a claim –  which is the one the Bank and its supporters are making –  that the current level of yields, six weeks on, is being very materially influenced by central bank purchases.  One could mount a counterargument that where yields are now isn’t much different than where they might have been anyway given (a) the OCR being stuck at 0.25 per cent for now, and (b) the economic situation having got a whole lot worse than it was, say, on 16 March, and (c) medium-term inflation expectations having fallen quite a bit further.

One might say the same looking at this chart of the swaps yield curve on various dates.

swaps curves

The grey line was the peak in rates amid that flight to cash that most severely affected te bond market.  But again, compare the 16 March line (the day the Bank cut the OCR) with the latest observation last Thursday.  It has the feel of the sort of fall –  concentrated over the front five years –  you might have expected if you’d been told that in the interim the economic situation had got so much worse and inflation expectations had fallen materially.

But, again, the counter-argument will come: what about all those fiscal deficit and the big volume of debt issuance coming down the track?  To a first approximation, my response is “what of it?”.

First, recall what else is going on.  Investment demand has slumped and is likely to remain lower than it was for several years.  And private savings preferences also appear to have risen. So if we are thinking about what might be expected to happen to interest rates  – even if the Reserve Bank were buying nothing –  we have to think not just about what the government is doing but about the private sector.  Money is, after all, fungible.  Absorption, frankly, seems unlikely to have been an issue, in a very lightly-indebted sovereign –  even if the Reserve Bank had not done any LSAP.

Gross public debt as a share of GDP is now projected to rise by 30 percentage points between last year and 2023/24.  But it isn’t as if big increases in public debt have never been seen before.  In fact, the last time was only a decade or so ago, when gross public debt as a share of GDP rose by 20 percentage points between 2008 and 2012.   There was no asset purchase programme then and –  as illustrated above –  once markets became convinced that the OCR would have to stay down for a while, it wasn’t enough to stop implied forward rates falling a long way.

And how much would we expect changes in government debt to affect interest rates, absent central bank intervention?   Views will differ on that, but the Governor did write about exactly that issue in his relative youth, publishing empirical estimates drawing on work he’d previously been part of at the OECD.  Perhaps the Governor has changed his view since 2002, but then he estimated that 30 percentage points on net debt might have been worth perhaps 15 basis points on bond yields, all else equal (which it decidedly isn’t right now, with very high levels of excess capacity).

Another point worth bearing in mind is that even the Reserve Bank will, I think, concede, that very long-term interest rates just don’t make that much difference to many people in New Zealand, other than just lowering the government’s own financing costs.  The marginal activity in the residential mortgage market, for example, is typically around one and two year fixed rates.  And yet the data on the Bank’s LSAP shows that more than two-thirds of all the Bank’s government bond purchases have been for maturities of 2027 and later.   So even if those purchases are having a material impact on those very long-term rates, so what?  To what end?  As it is, we know that shorter-term fixed rates have hardly fallen at all in real terms –  what one might have expected with a small, badly lagging, OCR response, not with all the power the Bank asserts its balance sheet purchases can have.

Perhaps also the Bank is right that there has been some helpful exchange rate effect, and we do not know the counterfactual. But we do know how much the TWI has often fallen in past serious recessions, and it is much more than anything we’ve seen to date this time.  The LSAP might be a little better than nothing, but it is no substitute for the OCR the Bank is now so reluctant to use.

Are there other possible channels where there might have been an impact?    A commenter last week noted that perhaps equity markets were higher as a result?  Perhaps, although the effect must surely be small, but equity markets have always been seen as much less important a part of the transmission process here than in, notably, the US.  The Bank and its supporters have also been talking up portfolio balance effects –  in other words, the people selling bonds to the Bank have to do something with the money that is freed up.  Again, perhaps there is some small effect, but it is difficult to see where such material tangible effects might be.    For example, I’ve seen this chart a couple of times in ANZ publications

corp bonds

It is a useful chart (altho perhaps with a line missing?), with data on corporate bond yields that those of without a Bloomberg terminal can’t otherwise easily track.  The Reserve Bank doesn’t buy the corporate bonds, but purchasing government bonds may displace some holders into corporate debt.  But, again, count me fairly sceptical that the ongoing LSAP programme is explaining much about the current level of these yields, given (a) weakening OCR expectations, and (b) the weakening economic environment.  It is hard to be sure, but it is hard to believe that any effect is very large.

We don’t have real-time inflation data, but we do have near real-time proxies for inflation expectations –  and especially changes in them –  from the inflation-indexed government debt market.   When implied inflation expectations for the next five years on average have fallen by about 80 basis points (measured imprecisely, so call it anything from 70 to 90 points) in just a couple of months

IIBs mAY 20

it is not a sign of a central bank that is doing its job well, of a central bank whose instrument is doing what needs to be done, even allowing for all the fiscal support as well.   If we had a Minister of Finance who really cared about macroeconomic stabilisation he’d insist on change.

A deeply negative OCR, generating retail rates near-zero (consistent with what the governments is lending to SMEs at) is more like the sort of monetary policy stance we need, one that might make a real and sustantive difference to inflation, inflation expectations, output and (un)employment.    What we have at present is theatre –  arguably doing little harm and perhaps a modicum of good, but successfully (it appears) from the Bank’s perspective distracting from where the real gains might be had.