Active monetary policy exists because unemployment matters

Monetary policy as we know it today –  discretionary choices made by central banks (or Ministers) –  is a relatively new thing.    Of course, money has been around for a very long time, and the state has often had a role in specifying the metal content of various units of money, and (not unrelatedly) what money was acceptable in settlement of tax obligations.  But there was no such thing as “monetary policy” in, say, the 16th century –  when prices rose across Europe, it was because the additional gold and silver being mined in South America, adding to purchasing power of (first) Spaniards and then more generally.     The gold rushes of the mid 19th century –  in which New Zealand had a small part –  had qualitatively similar effects.

Even in the heyday of the classical Gold Standard –  the few decades prior to World War One –  when central banks did exist in a growing number of countries (although not, for example, the US, Australia, Canada or New Zealand, there wasn’t much to monetary policy.  Convertibility into gold, at a fixed (government-set) parity, was at the heart of the regime, and variations in official interest rates –  eg by the Bank of England or the Banque de France – were largely about managing pressures on gold reserves.   If there was a net loss of reserves from the UK, the Bank of England would typically raise its interest rates.  It wasn’t a mechanical process, and central banks would at times borrow from each other to tide themselves over what were thought to be purely temporary pressures.   In places without central banks –  New Zealand was an example –  banks were obliged by law to convert their notes into gold on demand.  Banks themselves had to manage pressures on their own reserves –  whether gold, or balances held with banks in London –  by altering the interest rates they offered, and varying their credit standards (tightening credit would reduce demand for imports).

Across much of the world, World War One disrupted these arrangements.  New Zealand suspended gold convertibility on the outbreak of the war, and never restored it.  Much of the world attempted to go back onto gold in the 1920s – the UK famously restoring convertibility in 1925 –  as part of trying to restore normalcy and monetary stability.  But the restoration didn’t last.  Many authors see the attempt to return to gold, in a somewhat hybridized manner, as a key cause of the Great Depression, and by the mid 1930s the Gold Standard had been largely abandoned.  The imperatives of short to medium-term macroeconomic stabilisation displaced the belief in fixed parities.  Voters –  this was the new age of universal suffrage –  demanded that governments “do something”.  And the evidence is pretty clear that countries that went off gold earliest –  or devalued earliest –  recovered soonest from the Depression.  The imperative of doing something about really severe cyclical unemployment drove monetary actions and monetary regime choices, including the establishment in 1934 of the Reserve Bank of New Zealand.

There was an attempt after World War Two to re-establish something that looked like a system based on gold (the US offered governments –  only –  convertibility into gold, while other countries had fixed exchange rates to the US dollar), but it was a much different beast.  Most countries had quite tight controls on cross-border capital flows –  of the sort that had not previously existed in peacetime in democratic societies –  which allowed countries to use counter-cyclical domestic fiscal and monetary policy to do more to promote something akin to full employment, without too readily putting the exchange rate pegs in jeopardy.   It didn’t end the business cycle (of course), and didn’t avoid periodic exchange rate crises but for a time –  a couple of decades –  it more or less worked.  But pushed too far, under pressure of various political and demographic shocks, it broke down into the era of the Great Inflation –  loosely, from around the mid 1960s to the mid 1980s.

And thus monetary policy as we recognise it today really only dates back a few decades.  The major Western economies floated their exchange rates in the early 1970s, New Zealand and Australia did in the mid 1980s, and some advanced OECD countries (eg Sweden and Norway) only did so in the 1990s.  Tiny Iceland only floated in 2001.  Inflation targeting –  whether formally (as pioneered by New Zealand) or less formally –  makes sense only in the context of a pretty flexible (probably floating) exchange rate.  It is a regime that exist with twin goals in mind, whether or not they are written down in statute book somewhere or not.

Floating your currency allows a country to choose its own inflation rate.   That was a big consideration in the 70s and 80s: if, like Switzerland, you wanted to maintain low inflation, you couldn’t do so with a fixed exchange rate to the rest of the world that was running an inflation rate of 10 per cent.  But it also allows your country to cope better with severe adverse real economic shocks; in particular shocks specific (or more intense than typical) to your particular country.    I wrote last week about the Finnish situation in the late 80s and early 90s.    We had it pretty tough here during that period, but it was nothing like as bad as the Finnish experience – despite big structural reforms going on at the same time –  because we had our own monetary policy and could allow interest rates to fall, and the exchange rate, when times turned tough.   We didn’t give up on inflation – in fact this was the period we were getting inflation to target for the first time –  but we had an institutional arrangement that provided a better mix of low inflation and somewhat-mitigated real economic downturns.    (In fact, it wasn’t so different back in the 1960s when, faced with a big fall in the terms of trade, New Zealand chose to devalue its nominal exchange rate –  an active monetary choice –  rather than attempt to force the adjustment through lower domestic prices and wages.  Most observers –  then and now –  would have thought that alternative would have been much more costly, in unemployment and lost output.)

All of this so far is really a rather long prelude to articulating a disagreement with an eminent former colleague.

Last week, Reuters ran an article under the heading “New government in New Zealand could spell changes for pioneering central bank”, with a particular focus on what a Labour-led government might mean.   The article quoted various people (including me –  my own thoughts were elaborated here) but the comments that caught my eye were those by Arthur Grimes.  These days Arthur is a researcher at Motu –  mostly focused on issues other than macroeconomics –  a professor (of wellbeing and public policy), and generally one of the “great and the good” of New Zealand economics (president of the Association of Economists etc).  But in his younger days he spent 15 years or so at the Reserve Bank, rising to Head of Economics and then Head of Financial Markets before leaving for the private sector and academe.  In that time, he was one of those closely involved from the Bank’s side in the design of the Reserve Bank Act, and was also involved in the practical development of inflation targeting (the two developed in parallel).    Later, he ended up on the Reserve Bank’s Board, serving as chair of the Board until about four years ago.   As chair of the Board, he probably should be seen as having had prime responsibility for the appointment of Graeme Wheeler as Governor.    In many respects, were he to be interested, Grimes could have been the best of the status quo candidates to replace Wheeler permanently.

Grimes is pretty deeply committed to the status quo on monetary policy (I’m not sure what his views now would be on single decisionmaker vs a committee, although interestingly he has been a longserving Board member of the Financial Markets Authority,  where decisionmaking responsibility rests with the Board not the chief executive).

And that commitment to the status quo was on display in the Reuters article.

“It’s a huge change. We’ve had over 25 years of an extraordinarily successful monetary policy that has been copied around the world,” said Arthur Grimes, RBNZ’s chief economist in the early 1990s and Board Chair between 2003 and 2013. Any change without careful consideration and analysis would be “extraordinary”, he added.

For 28 years, New Zealand’s central bank has had the single aim of keeping inflation between a set range. But Labour wants to add employment to the bank‘s mandate, a goal shared by NZ First which also wants to broaden the Reserve Bank of New Zealand’s (RBNZ) focus to include greater management of the local dollar’s value against other currencies.

Grimes, however, argues that history proves monetary policy cannot have a sustained impact on employment.

“It would be like having someone who is running for health minister argue for a cancer drug to be used for heart issues,” said Grimes

I’m not sure what benchmarks Grimes is using to describe New Zealand’s monetary policy as “extraordinarily successful”.  There is no doubt that inflation has been much lower and more stable than it was in the 1970s and 1980s –  although not much different than it was in the 15 years prior to 1967 –  but that is true almost everywhere.  So if one is going to argue that the specifics of the way the New Zealand target/Act are specified have been “extraordinarily successful”, and need protecting, one would need to show that that particular specification has led us to have better outcomes than, say, other advanced countries that did inflation targeting differently, that specified things (formally) less tightly, than put less emphasis on formalised accountability mechanisms, or which even kept “dual mandate” types of language in their statutes and official communications/rhetoric.    The United States and Australia might be obvious cases to look at.  But it would be impossible, as far as I can see, to demonstrate such superior New Zealand performance.

Now it is no doubt true that the New Zealand (and near-parallel Canadian) early experiences with inflation targeting did influence other countries’ choices to some extent.  But it would be flattering (and fooling) ourselves to suppose that the specifics of the New Zealand model have been widely copied at all.    Indeed, in several important areas –  including governance/accountability –  what is striking is how few countries have gone the same way we did.   We remain, I think, the only inflation targeting country to have (a) twice changed its target, and (b) where monetary policy has been an election issue for some parliamentary parties or other every single election since the 1989 Act was passed.  Even on the specification of the mandate, a Reserve Bank Bulletin article a few years ago highlighted just how a wide a range of ways mandates and overarching goal for monetary policy are specified even among advanced country inflation targeters.    It is not, after all, as if what the Labour Party has proposed involves tossing out inflation targeting.  That would indeed be extraordinarily bold – not necessarily wrong, as there are plausible alternatives bruited about internationally – without a lot more work.  But simply adding a formal statutory recognition that we have active discretionary monetary policy because of concerns about shocks that can take unemployment well away from its full employment (non-inflationary) level isn’t radical or extraordinary at all.

Analogies can be powerful rhetorical devices, so it is always worth testing analogies that people propose to see if they capture a useful and valid point or not.  And it was Grimes’s analogy that really prompted this post.  He suggests that adding something –  and recall that all of us are reacting to a general point not specific proposed wording –  about unemployment to the Reserve Bank’s statutory monetary policy mandate

“It would be like having someone who is running for health minister argue for a cancer drug to be used for heart issues,” said Grimes

And that is simply an invalid analogy (assuming, as I imagine both Grimes and I do as non-medical laymen, that there is no connection between cancer drugs and heart issues).  It is generally recognised that monetary choices can have output and employment consequences and that, at times, those effects can be large, and persistent enough to be troubling for individuals and (voting) populations.     Of course, no one argues (I think) that monetary policy choices today will affect the unemployment rate 15 years hence.  If there are problems there, you need a different set of tools (labour market reforms, welfare reforms etc).  But a succession of monetary policy choices today can, if mistaken, leave the unemployment rate away from a long-term sustainable rate for some considerable time.   One could mount a plausible argument –  for example –  that the fact that the New Zealand unemployment rate has been above all official estimates of the NAIRU for some years now, while at the same time core inflation has been below target, might be one of those examples.  Choices –  risks taken, or not, under uncertainty –  have consequences.

And that sort of example (demand shocks, or surprises) is the easy case –  after all, getting inflation back to target and getting unemployment down work in the same direction.  For plenty of shocks it works the other way.  A big boost to oil prices tends to raise CPI inflation.  Attempting to prevent, or reverse, those inflation effects can only be done by monetary policy actions that would raise unemployment.   The Reserve Bank –  and those setting its specific goals –  have always considered that would (normally) be an inappropriate response.  In those circumstances, we allow a bit more inflation temporarily –  and a permanently higher price level –  to avoid unnecessary departures of the unemployment rate from its sustainable level.   We articulated that logic in public right from the very first days of inflation targeting (it is explicit in the first Monetary Policy Statements –  which I wrote and Grimes commented on).

Don’t get me wrong. There are some arguments for not including the unemployment references in the Reserve Bank Act. I was persuaded by them for a long time, even if I no longer am.    But they are fine judgements at the margin, nothing remotely like the suggestion of snake-oil peddling implicit in Arthur Grimes’ medical analogy.    Price and wage rigidities –  that exist for rational and efficient reasons –  mean that in the short to medium term, targeting inflation and targeting unemployment are inextricably linked (not mechancially, but inextricably).

Other people recognise this.   I’ve linked previously to the writings of leading academic in the field, Lars Svensson (also former monetary policy board member in Sweden, and former independent reviewer of New Zealand monetary policy), who favours explicit statutory recognition of the role that deviations of unemployment from a long-run sustainable rate play in monetary policy.    The Reuters article quotes Phil Lowe, current RBA Governor, in defence of such language in the RBA Act (although I’d argue that the RBA experience illustrates that words make less difference than people).  Janet Yellen and Ben Bernanke have similarly been comfortable in the United States, and although Alan Greenspan was a well-known hard money man (favouring, at least in principle, a “true zero” inflation average), (a) he was never that keen on inflation targeting itself, preferring to keep a considerable measure of discretion to himself, and (b) he was not averse to talking about unemployment (“we are keenly interested in what we can do to maximise sustainable employment growth and to reduce unemployment” as his biographer records him noting at a Jackson Hole conference at which Don Brash was one of the speakers).

So, of course, the specific wording a Labour-led government might seek to introduce  –  should things go their way –  should be carefully scrutinised.  But it wouldn’t be extraordinary at all to make such a change, rather it would be a pretty straightforward translation into statute of the reasons why we have a discretionary and active monetary policy in the first place.   If we didn’t care about the output and employment consequences of adjusting to shocks, we might as well just go back to the Gold Standard, or a fixed exchange rate.

Not a word of this would be particularly surprising to Arthur Grimes.  A few years ago, on leaving the Reserve Bank Board, he gave a series of lectures in the UK on central banking.   They were a pretty robust defence of the status quo, broadly defined.  In some places, I thought he claimed too much, but the underlying economics wasn’t much different than anything I’ve articulated here.   There was, for example, a nice piece on the exchange rate system headed “A floating exchange rate is the worst exchange rate regime (except for all the others that have been tried)”.  I’d agree with him entirely.  And what reasons does he give?  This is from his conclusion

Third, dynamics do matter. The evidence shows that countries that adopt a hard peg may experience greater persistence in economic cycles than those with a floating currency. If domestic prices and costs can adjust easily, a hard peg may not be problematic. But in a country with sluggish domestic price adjustment, the hard peg can result in persistent real sector imbalances as we have seen both in the upward and downward direction for several Euro-zone countries.

If we rule out a soft peg as being the worst of all worlds, how should a country decide whether to adopt a hard peg or a floating rate? The trade-offs are complex: How flexible is domestic price adjustment? How diverse are the country’s trading partners, and hence what are the effective currency impacts of pegging to a specific country or bloc? How likely is it that a government will adopt sensible economic reforms under one or other regime?

In the end, a floating rate appears to have advantages, especially in relation to persistence of real sector variables, over a hard peg. However, if the political economy is such that a country with weak policies is more likely to adopt reforms under a hard peg than under a float, then it may be better for it to retain a hard peg and be forced to reform its other policy settings.

Ultimately, in terms of long run economic performance, the choice of regime does not matter much, so we cannot expect substantive changes in long term outcomes through a change in the exchange rate regime. But while the long term destination may not change, the quality of the ride does differ depending on the chosen vehicle.

Ignoring unemployment in choosing monetary policy regimes, and conducting monetary policy, might be more like caring only about the speed at which one drove from Auckland to Wellington, not the comfort or the safety of the journey.    No one does.  In practice, no one ignores unemployment in monetary policy design either.  The question is whether explicit recognition of that fact, in statute or even in the Policy Targets Agreement, in conjuction with the appointment of a good Governor, might (a) assist communications, around what the Reserve Bank really exists for, and (b) at times, produce better outcomes, and better accountability for performance against the unemployment dimension of what we care about in monetary policy management.   Reasonable people can reach different conclusions on that point, but whichever side one lands it simply isn’t a terribly radical choice.  And, on the other hand, the status quo –  whether around the Bank itself, or short to medium term, economic outcomes, or the ongoing political debate around these issues-  isn’t so obviously superior that we should not explore alternatives.

Implications of a new government for monetary policy

Whichever way New Zealand First decides to go, we’ll have a different government than we’ve had for the last few years.   Whatever form that government takes –  coalition, confidence and supply agreements, or just sitting on the cross-benches – New Zealand First’s votes will typically be vital for passing any legislation, and whichever party leads the government will constantly be needing to consult with New Zealand First to avoid inadvertently getting offside with them.

As issues around the Reserve Bank and the exchange rate have been a significant part of Winston Peters’ stated concerns over the years (including attempts to amend the Act through a private members’ bill, and repeated references to a Singaporean style of monetary policy), it is interesting to speculate on what difference his bloc of votes in Parliament might make to these issues over the next few years.  A journalist asked for my thoughts the other day, and this post fleshes out what I said in response to those questions.

There are probably at least three –  separable – areas worth touching on (simply as regards the Bank’s monetary policy roles):

  • the specification of the target for monetary policy, whether in the Act or the Policy Targets Agreement,
  • any changes to the legislated decisionmaking and accountability provisions for monetary policy, and
  • the type of person appointed as Governor.

I find it worthwhile to recall that Winston Peters has history in this area.  In 1996, New Zealand First was campaigning vigorously on bringing about change at the Reserve Bank.  At the time, the particular concern was that in focusing on price stability (0 to 2 per cent inflation at the time) we were encouraging/causing an overvalued exchange rate.  The proposed remedy was that we should instead target inflation around the average of our main trading partners (then a bit higher than New Zealand).    What actually happened was that as part of the horse-trading for the coalition agreement with National, Don Brash agreed to an amended Policy Targets Agreement, in which the target was raised from 0 to 2 per cent annual inflation, to 0 to 3 per cent annual inflation.  Actual inflation had been averaging about 1.5 per  cent anyway, so although the change made a small difference to policy for a short period, the difference was pretty minimal.  After that, Winston Peters –  as Treasurer – displayed little real interest in monetary policy and never bothered the Bank again.

So my starting point, in thinking about New Zealand First influence on Reserve Bank matters now, is that although I’m quite sure that the concerns Peters expresses –  including around overvalued real exchange rates –  are quite real (and in many respects valid –  shared as they’ve been by people spanning the range from Graeme Wheeler to me), in the end not much about the conduct of monetary policy is likely to change at his insistence.  And that is probably as it should be –  our real exchange rate problems are not primarily grounded in monetary policy problems.

We also know that although Peters has repeatedly talked of preferring a Singaporean model of monetary policy (a guided exchange rate, without an officially-set OCR), both Steven Joyce and Grant Robertson during the campaign flatly ruled out such a change.  They were right to do so.  I’ve explained why in a post earlier this year.    Even if such a system was desirable, it isn’t workable (at all) for New Zealand unless and until the structural demand factors behind our interest rates being persistently higher than those abroad are tackled –  and that isn’t a matter for monetary policy.

And the Singaporean model is not one of an absolutely fixed exchange rate.  It is a managed regime (historically, “managed” in all sorts of ways, including direct controls and strong moral suasion).  It produces a fairly high degree of short-term stability in the basket measure of the Singapore dollar.      But it works, to the extent it does, mostly because the SGD interest rates consistent with domestic medium-term price stability in Singapore are typically a bit lower than those in other advanced countries (in turn a reflection of the large current account surpluses Singapore now runs –  national savings rates far outstripping desired domestic investment).  As the Reserve Bank paper I linked to earlier noted

“From 1990 to 2011, the average short term Singapore government borrowing rate was 1.8 percent p.a. below returns on the US Treasury bill.”

Those are big differences (materially larger than the difference between the two countries’ average inflation rates).  And they mean that Singapore dollar fixed income assets are not particularly attractive to foreign investment funds.  By contrast, New Zealand’s short-term real and nominal interest rates are almost always materially higher than those in other advanced countries.   Partly as a result, even though Singapore’s economy is now materially larger than New Zealand’s, there is less international trade in the Singapore dollar than in the New Zealand dollar.

So a Singaporean model just is not going to be launched in New Zealand any time soon.

If Peters sides with National, what then might he secure in this area?

An obvious possibility would be a change to the Policy Targets Agreement.  There has to be a new one when a Governor is appointed, and (if they think the current interim one is lawful and binding –  which I don’t) they could also seek an immediate change.  Such changes immediately upon a change of government have been the norm rather than the exception (having happened, to a greater ot lesser extent, in 1990, 1996, 1999, and 2008).

At the start of each Policy Targets Agreement it has become customary (Peters began the pattern in 1996) to have a preamble about what the government is hoping to achieve.  The current government’s preamble reads this way:

The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.

It would be easy enough to craft a form of words that talked about avoiding an overvalued and excessively volatile exchange rate and promoting the tradables sector of the New Zealand economy.

But it won’t make any difference –  one iota of difference –  to the way monetary policy is conducted.  It is a statement of political aspiration –  and can perhaps be sold to the base as such –  not a mandate for the Governor.

Recall too that the Policy Targets Agreements since 1999 have required the Bank, while pursuing price stability to” seek to avoid unnecessary instability in output, interest rates and the exchange rate”.  On occasion, that provision has (modestly) influenced monetary policy choices at the margin (one reason I’ve favoured removing it), at least with a Governor who was that way inclined anyway.  In principle, the exchange rate element could be singled out and given more prominence further up the document.

Winston Peters’ private members bill sought to amend the statutory goal of monetary policy (section 8 of the Act) this way (adding the bolded words)

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of maintaining stability in the general level of prices while maintaining an exchange rate that is conducive to real export growth and job creation.

I simply cannot see the National Party agreeing to that specific formulation. I hope they wouldn’t.  It goes too far and asks the Reserve Bank to do something that is impossible (real exchange rates are real phenomena, not monetary ones).   But could they consider a formulation like this one?

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of maintaining stability in the general level of prices while promoting the highest levels of production, trade and employment that can be achieved by monetary policy.

It is very similar to the legislative provisions introduced by the National government in 1950, in providing a greater degree of (formal) independence for the Reserve Bank and a new focus on price stability.  But in that framing the caveat “the highest levels…that can be achieved by monetary policy” is vital.   Beyond the short to medium term, monetary policy can’t do much other than maintain stable prices.

Perhaps they could find, and agree on, some clever wording.   It would be a rhetorical victory for Peters, and since rhetoric and symbolism do matter not necessarily an insignificant one.

But, so I would argue, not one that would, on its own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

What about possible governance changes –  to the formal statutory provisions around monetary policy decisionmaking?  At present, all power is vested in the Governor personally, the Governor’s appointment is largely controlled by the Bank’s Board (unlike most countries where the Minister of Finance has the main power).

I can’t imagine that the National Party would be averse to some changes in this area.  After all, Steven Joyce commissioned the Rennie review and in doing so was presumably open to at least some modest changes (perhaps legislating something like the current internal advisory committee).   But equally, it is difficult to see why New Zealand First would regard it as any sort of win to hand power to more internal technocrats.  To the extent New Zealand First favours governance changes they probably prefer a decisionmaking Board dominated by outsiders, with a strong export sector orientation.  Perhaps it isn’t a die in the ditch issue for National, but it is harder to see the two parties reaching agreement on that sort of change, even if it did produce something that looked rather like the (generally highly-regarded) Reserve Bank of Australia.

But if Peters and New Zealand First care about making a difference to the actual conduct of monetary policy over the next few years, or even to how the Bank talks about monetary policy, the key consideration is who becomes Governor.   Whatever the formal specification of the target, whatever flowery words exist around goals, the personality, instincts, “models”, and preferences of whoever is appointed Governor matters a great deal.  Partly because it is a single decisionmaker system, and partly because as chief executive the Governor (inevitably and appropriately) has a big influence on how the institution evolves, where it focuses its analytical energies and advice etc.

But the Governor selection process has been underway for months, and the Bank’s Board – all appointed by the National government –  must be getting close to delivering an initial recommendation to whoever is appointed as Minister of Finance.   No doubt the Minister of Finance would consult New Zealand First –  whether through the Cabinet appointments process, or outside it –  and the Minister can reject a Board nomination.  But the Minister can’t impose his or her own candidate, they just have to consider the next person the Board puts forward.  Since the Board were (a) appointed under the current system, and (b) have had no concerns at all about the conduct of monetary policy or the leadership of the Bank in recent years, it seems reasonable to assume they’ll be putting forward a status quo candidate (there are no known exceptional candidates).  If so, my money is on Deputy Governor Geoff Bascand who –  as I’ve written about recently –  might be a safe pair of hands, but is unlikely to be more than that, and about whom there are some concerns (especially if, as Peters appears to, one cares about the interests of bank depositors.)

In short, if National leads the next government I wouldn’t expect any material differences on the monetary policy front, even if there are some symbolic wins for New Zealand First.  Even governance reform –  which most people think desirable –  might be hard to actually deliver (the status quo will avoid any conflicts).

And what if Labour leads the next government, requiring support of the Greens and New Zealand First for legislation?

In that case, legislative reforms are more certain, but somewhat similar questions remain about what difference they might make.

Thus, the Labour Party campaigned on amending section 8 of the Act to include some sort of full employment objective.   They haven’t provided specific suggested wording, and would no doubt want official advice on that.  The Greens have endorsed that proposal and there is no obvious reason why New Zealand First would oppose it. But they might want to try to get some reference to the exchange rate or the tradables sector included, whether in the Act itself or in the Policy Targets Agreement.  The sort of wording I floated earlier in this post might provide a basis for something workable.

I’ve also previously suggested that if Labour is serious about the full employment concern, it might make sense to amend section 15 of the Act (governing monetary policy statements) to require the Bank to periodically publish its estimates of a non-inflationary unemployment rate (a NAIRU), and explain deviations of the actual unemployment rate from that (moving) estimate.  In principle, something similar could be done for the real exchange rate, but the (theoretical) grounds for doing so are rather weaker.  Perhaps the political grounds are stronger, and such a change might encourage the Bank to devote more of its research efforts to real exchange rate and economic performance issues.

But –  and I deliberately use the same words I used above –  such legislative changes are not ones that would, on their own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

The Labour Party and the Greens also campaigned on legislative reforms to the monetary policy governance model (including a decisionmaking committee with a mix of insiders and relatively expert outsiders, and the timely publication of the minutes of such a committee.)   Although those proposals would represent a step in the right direction, they are rather weak. In particular, since Labour proposed that all the committee members would be appointed by the Governor, the change would largely just cement-in the undue dominance of the Governor.    But I’d be surprised if they were wedded to those details, and it shouldn’t be too hard to reach a tri-party agreement on a decisionmaking structure for monetary policy –  probably one that put more of the appointment powers in the hands of the Minister of Finance (as elsewhere) and allowed for non-expert members (as is quite common on Crown boards –  or, indeed, in Cabinet).

So legislative change in that area –  probably quite significant change –  seems like something we could count on under a Labour-led government.

But whether it would make much difference to the actual conduct of policy over the next few years still depends considerably on who is appointed as Governor.   Not only will whoever is appointed as Governor going to be the sole decisionmaker until new legislation is passed and implemented –  which could easily be 12 to 18 months away –  but that individual will be an important part of the design of the new legislation and the sort of culture that is built (or rebuilt) at the Reserve Bank.

As I noted earlier, the appointment process for the Governor has been underway for months.  Applications closed at a time –  early July –  when few people would have given the left much chance of forming a government.  And the Board, all appointed by the current government and strong public backers of the conduct of policy in recent years, have the lead role in the appointment.   Perhaps a new Labour-led government would reject a Bascand nomination.  But even if they did so, they have no idea which name would be wheeled up next.

There are alternatives, if the parties to a left-led government actually wanted things done differently at the Bank.   First, they could insist that the Bank’s Board reopen the selection process, working within the sorts of priorities such a new government would be legislating for.  Or they could simply pass a very simple and short amending Act to give the appointment power to the Minister of Finance (which is how things work almost everywhere else).  Of course, there is still the question of who would be the right candidate, but at least they would establish alignment of vision from the start –  a reasonable aspiration, given that the Reserve Bank Governor has more influence on short-term macro outcomes than the Minister of Finance, and yet the Minister of Finance has to live with the electoral consequences.

Over time, governance changes are important as part of putting things at the Reserve Bank on a more conventional footing (relative to other central banks, and to the rest of the New Zealand public sector).   I think some legislative respecification of the statutory goal for monetary policy  –  along the lines Labour has suggested –  is probably appropriate: if nothing else, it reminds people why we do active monetary policy at all.   But on their own, those changes won’t make any material difference to the conduct of monetary policy  –  or even to the way the Bank communicates –  in the shorter-term (next couple of years) unless the right person is chosen as Governor.  Perhaps so much shouldn’t hang on one unelected individual, but in our system at present it does.

Symbols matter, but so does substance.  It will be interesting to see which turns out to matter more to a new government with New Zealand First support.

In closing, there is a long and interesting article in today’s Financial Times on some of the challenges – technical and political –  facing central bankers.  As the author notes, in many countries authorities are grappling with a mix that includes very low unemployment and little wage inflation.  In appointing a Governor for the Reserve Bank of New Zealand, it would be highly desirable to find someone who recognises, and internalises, that the challenges here are rather different.  Unlike the US, UK, or Japan (for example) New Zealand’s unemployment rate is still well above pre-recessionary levels –  when demographic factors are probably lowering the NAIRU –  and real wage inflation, while quite low in absolute terms, is running well ahead of (non-existent) productivity growth.    There are some other countries – the UK and Finland notably –  that also have non-existent productivity growth, but it is far from a universal story.  Productivity growth carries on in the US and Australia and (according to a commentary I read last night) in Japan real output per hour worked is up 8.5 per cent in the last five years (comparable number for New Zealand, zero).

Some of these issues are relevant to monetary policy (eg unemployment gaps) and some are relevant to medium-term competitiveness (wages rising ahead of productivity growth).  We should expect a Governor who can recognise the similarities between New Zealand’s experiences and those abroad, but also the significant differences, and who can talk authoritatively about what monetary policy can, and cannot, do to help.  Perhaps even, as a bonus, one who might even be able to provide some research and advice to governments on the nature of the economic issues that only governments can act to fix.





Various views on Reserve Bank reform

Undecided to the end, earlier this afternoon I went out for a walk resolved that I wouldn’t come home until I’d voted.  With guests to cook dinner for, it was an effective constraint.

The other day, the Herald ran a Bloomberg column by journalist Tracy Withers headed “RBNZ could be in for a shake-up”.  Much of the column is familiar ground, and complements my own post the other day on the coming reform of the Reserve Bank –  whichever party forms the next government.    But there were a couple of interesting snippets, one of which wasn’t in the version the Herald used but is now in the updated column the link will take you to.

The first is an explicit comment from the Secretary to the Treasury, Gabs Makhlouf.  It seems quite unusual for a neutral public servant to be commenting in public –  in another country as it happens – on any matter of possible new policy just a few days out from an election.   Save it for the post-election briefing to the incoming Minister of Finance, would surely have been the stance of most senior public servants (all the more so when it is an issue on which at several parties have explicit public policies).

Anyway, what does Makhlouf think about Reserve Bank reform?

Gabriel Makhlouf, head of New Zealand’s Treasury Department, said he favors formalizing committee-based decision making at the central bank but doesn’t have a view on whether the committee should include external members.
“I can see why people may be concerned about that, and I can also see the value of having externals, and the different perspective they bring,” he said in an interview in Singapore Friday. “It’s something we are definitely going to study quite carefully before we decide what to recommend to the government.”

Treasury has long-favoured a move to formalise a committee-based decisionmaking structure.  They unsuccessfully attempted to interest the then Minister of Finance, Bill English, back in 2012 before Graeme Wheeler was appointed.  But it is surely a little surprising that, after all these years, and five months after Iain Rennie’s report on such issues was finalised, that Treasury still doesn’t have a view on a key aspect of possible reform.  Or are they simply waiting for the election results to come in, and will then tailor their advice to the proferences of their new masters?  I’d like to think not, but is there good reason to do so?

The other interesting snippet –  and maybe it wasn’t new but I hadn’t seen the specific quote previously –  was about the views of the current Minister of Finance.

If a National-led government is returned to power, Finance Minister Steven Joyce has said he’s open to formalizing the existing committee structure but doesn’t favor outside members.
“We should have a look at it,” Joyce said in a July interview. “I wouldn’t see radical change. I think the Reserve Bank model serves us very well.”

I’d certainly disagree with his final sentence, but of course he is welcome to his view. But it does tend to confirm the suggestion I made in the post earlier in the week that the Rennie report must have proposed quite far-reaching reforms.  After all, if Rennie had concluded that the current governance model “serves us very well” and that no change was required, or only some minor changes such as formalising the current Governing Committee, surely the Minister of Finance would have released the report by now.  Rennie may not command enormous respect beyond, say, the current occupants of the Beehive, but had a former State Services Commissioner and former Treasury deputy secretary for macroeconomics concluded that no material change was appropriate –  and certainly nothing like the changes (still modest themselves) that Labour and the Greens have campaigned on – it would have been modestly useful to the National Party, who have attempted to argue that Labour and the Greens simply don’t have what it takes to be economic managers.

Given that the Rennie report to Treasury was paid for with public money, was finished five months ago, and is official information, it is pretty inexcusable that it has not yet seen the light of day.

(I should note that neither the Joyce comments nor those of Makhlouf comments seem to address the Reserve Bank functions other than monetary policy.   In those regulatory areas, reform is even more vital, given the relative lack of constraints on the Governor’s personal freedom of action –  nothing like the Policy Targets Agreement exists.)

The other thing that prompted this post was the Herald’s editorial on Thursday, prompted by the Bloomberg column, and headed “Meddling with OCR carries risks”.  The text doesn’t appear to be online.

Over recent years, the Herald has been a useful mouthpiece for the Reserve Bank, and for outgoing Governor Graeme Wheeler in particular.  By not asking any awkward questions, they’ve been given preferential access to soft interviews and profiles, and have reliably backed up the Governor’s choices –  even when hindsight proves those choices weren’t always the best.

The editorial is somewhat overblown, and lacking in any serious supporting analysis. It asserts

This country has no need to copy any country’s conduct of monetary policy.  New Zealand pioneered inflation targeting by an independent central bank and it served this country will through the global financial crisis whatever mistakes were others may have made.   The divergent targets of the US Federal Reserve possibly contributed to the crisis.

We certainly pioneered formal inflation targeting, although independent central banks had been around in several other countries for decades –  on that count we followed an international lead.  Actually, I’d agree that inflation targeting served us reasonable well through the crisis, as it served well a bunch of other countries.  The US only formally adopted inflation targeting after the crisis was over.  Some would argue that different rules (nominal GDP, price level targeting, wage targeting) might have led to even better responses, although I’m a bit sceptical of that claim.  And any suggestion that the “divergent targets” of the Federal Reserve may have contributed to the crisis probably rests on claims by US economist John Taylor that interest rates were held too low –  below the Taylor rule prescription –  in the early 2000s.  There may be something to that specific point, but…..the Reserve Bank’s own published analysis shows that we did much the same thing during that period.  It is one thing to argue that New Zealand’s monetary policy isn’t much different than that in countries with differently expressed statutory goals (including the US and Australia), but another to argue that our monetary policy is somehow superior to that of those countries.   There is just no evidence for that latter proposition.

Then there is a weird paragraph about the Labour Party’s proposal to add an employment/unemployment dimension to the monetary policy goal.  There are certainly some questions Labour needs to answer if they do happen to form the next government, but to conclude (rhetorically), “could a Labour Party bear a target of 0-4 per cent unemployment”?  one can only suppose the answer must be “yes, but they probably wouldn’t suggest being that prescriptive”.   Only a few people –  some able ones among them –  think full employment in New Zealand at present is lower than 4 per cent.

In the end, the editorial writers seem to conclude that adding an unemployment dimension might not do much harm after all (although they can’t conceive of it doing any good), and what really worries them is the governance proposals.

Labour’s proposed changes to the way the Bank operates may be more damaging.  The Governor would no longer be solely answerable for the key interest rate, the official cash rate (OCR) set eight times a year [isn’t it seven now?].  Labour would give the decision to a committee with some appointees from outside the bank.  Already the Governor consults widely. But sole accountability can produce better decisions. A committee allows blame to be dispersed.

I was pretty gobsmacked. As I noted in my post the other day, I criticize Labour`s proposals as excessively timid, and leaving too much effective power in the Governor.  But quite what is the Herald concerned about?  That we might have a decision-making structure for monetary policy a little more like those in

  • Australia,
  • the United States,
  • the United Kingdom,
  • Norway,
  • Sweden,
  • the euro-area
  • Israel (which had a single decisionmaker until a few years ago, but changed)

They are correct that we don’t need to follow what other countries do.  But there is often wisdom in the choices those other countries make, and when the current Reserve Bank Act was written few countries had reformed their practices in recent decades.  We were (so we thought) pathbreakers, but no country has followed us along this particular path.

Or perhaps the Herald is concerned that monetary policy might be governed the way the rest of the country is?  For example,

  • the Cabinet (actually a committee of people who aren`t technical experts),
  • most companies, while final decision-making power typically rests with a Board,
  • the governance of most or all other Crown entities, from the Board of Trustees of the local primary school, to that of powerful regulatory agencies like the Financial Markets Authority, or
  • our higher courts –  both the Court of Appeal and the Supreme Court decide each case with a panel of judges.

But perhaps New Zealand monetary policy is uniquely suited to single (formal) decision-making? It is possible I suppose, but frankly it seems unlikely.

And do notice the careful wording “sole accountability can produce better decisions”.  In theory perhaps it can, if we have as Governor someone uniquely talented and gifted with insight and judgements far beyond those of mere mortals.  But this is a real world.  If such people existed, it would be very hard to identify them in advance –  or perhaps even persuade them to serve.   And if those responsible for appointing a Governor thought they`d found such a superstar, only for reality to turn out a bit differently, that would be a recipe for worse outcomes than under a (much more robust) formal committee-based decision-making model. It is why in most areas of life we choose governance models of that sort, rather than beating on supermen (or women).

And today, I`m not even getting into questions of the actual judgements or track record of accountability of Graeme Wheeler.     That can wait for next week.

The editorial concludes that

our system of monetary management is working well. Labour should hesitate to meddle with it.

Actually, not many people would really agree.  Even Steven Joyce says he is open to some change. It is a risky system, out of step with international practice and New Zealand practice in other areas of public life.  It has gone hand in hand with a progressive weakening in the quality of the institution, and if one does wants to talk about relatively uncontroversial specific failures, bear in mind that the Reserve Bank of New Zealand is the only central bank in the world to have launched two tightening cycles since the 2008/09 recession, only to have to quickly reverse both of them.  Those were choices made by individuals given too much power by Parliament. Whoever forms the next government, it is time for a change at the Reserve Bank.

Disagreeing with Don Brash on monetary policy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What array of changes should any new government make?

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

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

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

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

Doomed to repeat history…..or not

Last week marked 10 years since the pressures that were to culminate in the so-called “global financial crisis” burst into the headlines .

Local economist Shamubeel Eaqub marked the anniversary in his Sunday Star-Times column yesterday.  It grabbed my attention with the headlines Ten years on from the GFC” and “We appear dooomed to repeat history” .  

Frankly, it all seemed a bit overwrought.

It seems inevitable that there will be yet another crisis in the global financial system in the coming decade.

There have been few lessons from the GFC. There is more debt now than ever before and asset prices are super expensive. The next crisis will hopefully lead to much tighter regulation of the financial sector, that will force it to change from its current cancerous form, to one that does what it’s meant to.

The first half of the column is about the rest of the world.  But what really caught my attention was the second half, where he excoriates both the Reserve Bank and the government for their handling of the last decade or so.    This time, I’m defending both institutions.

There are some weird claims.

We were well into a recession when the GFC hit. So, when global money supplies dried up, it didn’t matter too much, because there was so little demand to borrow money in New Zealand anyway.

Here he can’t make his mind as to whether he wants to date the crisis to, say, August 2007 (10 years ago, when liquidity pressures started to flare up) or to the really intense phase from, say, September 2008 to early 2009.

Our recession dates from the March quarter of 2008 (while the US recession is dated from December 2007), but quite where he gets the idea that when funding markets froze it didn’t matter here, I do not know.  Banks had big balance sheets that needed to be continuously funded, whether or not they were still expecting any growth in those balance sheets. And they had a great deal of short-term foreign funding.  Frozen foreign funding markets, which made it difficult for banks to rollover any such funding for more than extremely short terms, made a huge impression on local banks.  For months I was in the thick of our (Treasury and Reserve Bank) efforts to use Crown guarantees to enable banks to re-enter term wholesale funding markets.  Banks were telling us that their boards wouldn’t allow them to maintain outstanding credit if they were simply reliant on temporary Reserve Bank liquidity as a form of life support.

Despite what he says I doubt Eaqub really believes the global liquidity crunch was irrelevant to New Zealand, because his next argument is that the Reserve Bank mishandled the crisis.

The GFC highlighted that our central bank is slow to recognise big international challenges. They were too slow to cut rates aggressively. They were not part of the large economies that clubbed together to co-ordinate rate cuts and share understanding of the crisis.

I have a little bit of sympathy here –  but only a little.  I well remember through late 2007 and the first half of 2008 our international economics people patting me on the head and telling me to go away whenever I suggested that perhaps events in the US might lead to something very bad (and I’m not claiming any great foresight into just how bad things would actually get).  And I still have a copy of an email from (incoming acting Governor) Grant Spencer in August 2007 suggesting that it was very unlikely the international events would come to much and that contingency planning wasn’t worth investing in.

And, with hindsight, of course every central bank should have cut harder and earlier.  I recall going to an international central banking meeting in June 2007 when a very senior Fed official commented along the lines of “some in the market are talking about the prospect of rate cuts, but if anything we are thinking we might have to tighten again”.

As for international coordination, well the Reserve Bank was part of the BIS –  something initiated in Alan Bollard’s term.  Then again, we were tiny.   So it was hardly likely than when various central banks did coordinate a cut in October 2008 they would invite New Zealand to join in.  Of its own accord, the Reserve Bank of New Zealand cut by 100 basis points only two weeks later (having already cut a few weeks earlier).

But what did the Reserve Bank of New Zealand actually do, and how did it compare with other advanced country central banks?

The OECD has data on (a proxy for) policy rates for 19 OECD countries/regions with their own currencies, and a few other major emerging markets.   Here is the change in the policy rates between August 2007 (when the liquidity pressures first became very evident) and August 2008, just before the Lehmans/AIG/ agencies dramatic intensification of the crisis.

policy rate to aug 08

The Reserve Bank had cut only once by this time.  But most of these countries had done nothing to ease monetary policy.  It wasn’t enough, but it wasn’t exactly at the back of the field, especially when one recalls that at the time core inflation was outside the top of the target range, and oil prices had recently been hitting new record highs.

That was the record to the brink of the intense phase of the crisis.  Here is the same chart showing the total interest rate adjustment between August 2007 and August 2009 –  a few months after the crisis phase had ended.

policy rate to aug 09

Only Iceland (having had its own crisis, and increased interest rates, in the midst of this all) and Turkey cut policy rates more than our Reserve Bank did.   In many cases, the other central banks might like to have cut by more but they got to around the zero bound.  Nonetheless, the Reserve Bank cut very aggressively, to the credit of the then Governor.  It was hardly as if by then the Reserve Bank was sitting to one side oblivious.

Obviously I’m not going to defend the Reserve Bank when, as Eaqub does, he criticises them for the mistaken 2010 and 2014 tightening cycles.  And the overall Reserve Bank record over several decades isn’t that good (as I touched on in a post on Friday), but their monetary policy performance during the crisis itself doesn’t look out of the international mainstream.   Neither, for that matter, did their handling of domestic liquidity issues during that period.

Eaqub also takes the government to task

The government bizarrely embarked on two terms of fiscal contraction. This contraction was at a time of historically low cost of money, and a long list of worthy infrastructure projects in housing and transport.

Projects that would have created long term economic growth and made our future economy much more productive, tax revenue higher, and debt position better.

Our fiscal policy is economically illiterate: choosing fiscal tightening at a time when the economy needed spending and that spending made financially made sense.

To which I’d make several points in response:

  • our interest rates, while historically low, remain very high relative to those in other countries,
  • in fact, our real interest rates remain materially higher than our rate of productivity growth (ie no productivity growth in the last four or five years),
  • we had a very large fiscal stimulus in place at the time the 2008/09 recession hit, and
  • we had another material fiscal stimulus resulting from the Canterbury earthquakes.

Actually, I’d agree with Eaqub that the economy needed more spending (per capita) over most of the last decade –  the best indicator of that is the lingering high unemployment rate – but monetary policy is the natural, and typical, tool for cyclical management.

And, in any case, here is what has happened to gross government debt as a share of GDP over the last 20 years.

gross govt debt

Not a trivial increase in the government’s debt.   Not necessarily an inappropriate response either, given the combination of shocks, but it is a bit hard to see why it counts as “economically illiterate”.  Much appears to rest on Eaqub’s confidence that there are lots of thing governments could have spent money on that would have returned more than the cost of government capital.  In some respects I’d like to share his confidence.  But I don’t.   Not far from here, for example, one of the bigger infrastructure projects is being built –  Transmission Gully –  for which the expected returns are very poor.

Eaqub isn’t just concerned about how the Reserve Bank handled the crisis period.

Our central bank needs to own up to regulate our banks much better: they have allowed mortgage borrowing to reach new and more dangerous highs.

I’d certainly agree they could do better –  taking off LVR controls for a start.  But bank capital requirements, and liquidity requirements, are materially more onerous than they were a decade ago.  And our banking system came through the last global crisis largely unscathed –  a serious liquidity scare, but no material or system-threatening credit losses.  Their own stress tests suggest the system is resilient today.  If Eaqub disagrees, that is fine but surely there is some onus on him to advance some arguments or evidence as to why our system is now in such a perilous position.

Macro-based crisis prediction models seem to have gone rather out of fashion since the last crisis.  In a way, that isn’t so surprising as those models didn’t do very well.     Countries with big increases in credit (as a share of GDP), big increases in asset prices, and big increases in the real exchange rate were supposed to be particularly vulnerable.  Countries like New Zealand.   The intuitive logic behind those models remained sound, but many countries had those sorts of experiences and had banks that proved able to make decent credit decisions.  And we know that historically loan losses on housing mortgage books have rarely been a key part in any subsequent crisis.     Thus, the domestic loan books of countries like New Zealand, Australia, Canada, the UK, Norway and Sweden all came through the last boom, and subsequent recession, pretty much unscathed.

One of the key indicators that used to worry people (it was the centrepiece of BIS concerns) was the ratio of credit to GDP.  Here is private sector credit as a per cent of GDP, annually, back to when the Reserve Bank data start in 1988.

psc to gdp

Private sector credit to GDP was trending up over the two decades leading up to the 2008/09 recession.   There was a particularly sharp increase from around 2002 to 2008 –  I recall once getting someone to dig out the numbers suggesting that over this period credit to GDP had increased more in New Zealand than it had increased in the late 1980s in Japan.  It wasn’t just housing credit.  Dairy debt was increasing even more rapidly, and business credit was also growing strongly.   There was good reason for analysts and central bankers to be a bit concerned during that period.  But what actually happened?  Loan losses picked up, especially in dairy, but despite this huge increase in credit –  to levels not seen as a share of GDP since the 1920s and 30s – there was nothing that represented a systemic threat.

And what has happened since?  Private sector credit to GDP has barely changed from the 2008 peak.  In other words, overall credit to the private sector has increased at around the same rate as nominal GDP itself.  It doesn’t look very concerning on the face of it.  Of course, total credit in the economy has increased as a share of GDP, but that reflects the growth in government debt (see earlier chart), and Eaqub apparently thinks that debt stock should have been increased even more rapidly.

It is certainly true that household debt, taken in isolation, has increased a little relative to household income.  But even there (a) the increase has been mild compared to the run-up in the years prior to 2008, and (b) higher house prices –  driven by the interaction of population pressure and regulatory land scarcity – typically require more gross credit (if “young” people are to purchase houses from “old” people).

If anything, what is striking is how little new net indebtedness there has been in the New Zealand economy in recent years.  Despite unexpectedly rapid population growth and despite big earthquake shocks, our net indebtedness to the rest of the world has been shrinking (as a share of GDP) not increasing.  Again, big increases in the adverse NIIP position has often been associated with the build up of risks that culminated in a crisis –  see Spain, Ireland, Greece, and to some extent even the US.   I can’t readily think of cases where crisis risk has been associated with flat or falling net indebtedness to the rest of the world.

There is plenty wrong with the performance of the New Zealand economy, issues that warrant debate and intense scrutiny leading up to next month’s election.  In his previous week’s column, Eaqub foreshadowed the possibility of a domestic recession here in the next year or two: that seems a real possibility and our policymakers don’t seem remotely well-positioned to cope with such a downturn.     But there seems little basis for “GFC redux” concerns, especially here:

  • for a start, we didn’t have a domestic financial crisis last time round, even at the culmination of two decades of rapid credit expansion,
  • private sector credit as a share of GDP has been roughly flat for a decade,
  • our net indebtedness to the rest of the world has been flat or falling for a decade,
  • there is little sign of much domestic financial innovation such that risks are ending up in strange and unrecognised places, and
  • whereas misplaced and over-optimistic investment plans are often at the heart of brutal economic and financial adjustments, investment here has been pretty subdued (especially once one looks at capital stock growth per capita).

In other words, we have almost none of the makings of any sort of financial crisis, “GFC” like, or otherwise.

House prices are a disgrace. We seem to have no politicians willing to call for, or commit to, seeking lower house prices.  But markets distorted by flawed regulation can stay out of line with more structural fundamentals for decades.  If house prices are distorted that way, it means a need for lots of gross credit.  But it tells you nothing about the risks of financial crisis, or the ability of banks to manage and price the associated risks.

LVRs, interest rates and so on

I was recording an interview earlier this afternoon, in which the focus of the questioning was the Real Estate Institute’s call for some easing in the Reserve Bank’s LVR restrictions.

Of course, I never favoured putting the successive waves of LVR restrictions on in the first place.  They are discrimatory –  across classes of borrowers, classes of borrowing, and classes of lending institutions –  they aren’t based on any robust analysis, as a tool to protect the financial system they are inferior to higher capital requirements, they penalise the marginal in favour of the established (or lucky), and generally undermine an efficient and well-functioning housing finance market, for little evident end.  Oh, and among types of housing lending, they deliberately carve-out an unrestricted space for the most risky class of housing lending –  that on new builds.

That doesn’t mean I think it is remotely likely that the Reserve Bank will be easing the restrictions any time soon –  apart from anything else, it would leave their consultation paper on debt to income ratio restrictions looking a little silly.   Of course, it would be good if the Reserve Bank did lay out some specific criteria for lifting these ostensibly temporary restrictions, but with the toxic brew of rapid population growth and continuing land use restrictions in place, if I saw the world as they seem to, I wouldn’t be in a hurry to lift the restrictions either.

In any case, it isn’t that clear quite how large a role the LVR restrictions are playing in the reduction in sales volumes.   They must be playing a part, but so too will higher interest rates, and the apparent increase in banks’ own lending standards, and pressure through the parents from APRA (on the lending standards across the whole of Australian banking groups).  Which, of course, is also why it isn’t clear quite how much difference any easing back in the New Zealand LVR controls might make.  Some presumably, but even the Reserve Bank has never claimed that LVR controls would have a very large impact on house prices, or housing market activity, for very long.   And while I noticed an article this morning about negative equity, it is worth bearing in mind that, on the REINZ index (not using median prices), house prices have risen 65 per cent in the last five years, and are currently 0.6 per cent off their peak.

But what of interest rates?  A year ago, the OCR was 2.25 per cent, and today it is 1.75 per cent.  Thus, the Reserve Bank talks of having eased monetary policy.   Here are mortgage rates though.

mortgage ratesI don’t suppose anyone is taking out four or five year fixed rate mortgages, but across the entire curve, interest rates are higher not lower.   Or we could go back another year or so, to just prior to when the Reserve Bank began cutting the OCR.   The OCR has been cut by 175 basis points since then.   Even at the shortish end of the mortgage curve, rates are down only 50-70 basis points.

Having been reflecting this morning on Graeme Wheeler’s performance over his term, I had a look back at where interest rates were when Wheeler took office in September 2012.

mortgage rates sept 12Barely lower, even though core inflation –  on their own favoured measure – is as low today as it was then (and has been consistently low throughout his term).

I wondered if there were offsetting factors but:

  • Two year ahead inflation expectations are about 25 basis points lower than they were then (largely offsetting any reductions in nominal mortgage rates, to leave real rates little changed)
  • the TWI measure of the exchange rate is a bit higher than it was then,
  • the ANZ commodity price index, in inflation-adjusted world price terms, is hardly changed from what it was then.

Of course, the unemployment rate has fallen since September 2012, but there hasn’t been any sign of a pick-up in the best indicator of labour scarcity –  real wage inflation.

So, overall, it is a bit of a puzzle how the Governor expected to get core inflation back to fluctuating around the target midpoint without actually easing monetary conditions.  I don’t happen to agree with him on this one, but he keeps talking about how the huge migration inflows have reduced net inflation pressures (supply effects outweighing the demand effects).  If he really believes that it is even more puzzling that monetary conditions haven’t been eased.

I’m not sure how he’d respond.  But perhaps he could explain that too in the forthcoming speech.


Three Governors and monetary policy

Graeme Wheeler indicated yesterday that he will shortly be giving a speech offering some reflections on his time as Governor.    It is a good idea, at least in principle.  Wrapping up his 10 years as RBA Governor last year, Glenn Stevens gave a thoughtful speech along those lines (which I had intended to write about, but never got round to).   Wrapping up his 10 years as Governor of the Reserve Bank, Alan Bollard did an interesting interview with one of the editors of the Bulletin – he even acknowledged having made a mistake early in his term.

It is hard to be very optimistic about the forthcoming Wheeler speech, but ….. perhaps……this time.  Someone emailed me last night, after my comments on yesterday’s news conference, suggesting that

surely at heart you would have been more disappointed if Wheeler had finally answered questions in a meaningful way.  Would have made the past 5 years of communication even more painful.

I’d have been astonished certainly, but I have a naively optimistic streak and I’d like to  be pleasantly surprised, even this late in the game.  When he was appointed, I had had high hopes for the Governor.

But the promise of a forthcoming review speech, and an exchange with someone yesterday about the relative performance of the three Governors who have operated in the inflation-targeting era (in which I found myself defending Graeme), got me reflecting on how one might do those comparisons, at least in respect of monetary policy.

One could simply look at deviations of inflation from target.   Using headline CPI inflation wouldn’t help much there –  the CPI in the 1990s was constructed materially differently than it is now.  And when Don Brash took office there wasn’t an inflation target at all.  But the Bank is fond of its sectoral factor model measure of core inflation.  That measure has only been around for the last five years or so, but the Bank has calculated the series back to September 1993.   And as it happens, the first inflation target that last long enough for performance to be measured against it was the one adopted by the incoming National government in December 1990 –  inflation was to be 0 to 2 per cent by December 1993.

So here is the sectoral factor model measure graphed against the midpoint of the successive target ranges.

targets and outcomes

There are several things to notice:

  • this measure of core inflation has been much more stable in the Wheeler years than in any previous five year period,
  • none of the three Governors kept sectoral core inflation (or any other measure) close to the midpoint of the target range, and
  • the biggest deviations were in the last years of the previous boom, when this measure of core inflation was actually outside the target range.

In terms of average deviations

Brash 0.5
Bollard 0.5
Wheeler 0.6

But the Bollard decade was a tale of two halves: far above the target midpoint for his first six years or so, and then increasingly below the midpoint by the end of the period.

All this said, I wouldn’t want to put too much weight on those numbers, for various reasons including:

  • monetary policy works with a lag.  One can’t blame Graeme Wheeler for the first 12-18 months’ outcomes during his term.  Then again, the last three or four years’ numbers aren’t much different from those early in his term,
  • this measure didn’t exist, and certainly wasn’t being used, in the Brash or Bollard years (that said, no one disputes that inflation ran above the target midpoint during their terms, for various –  different –  reasons),
  • only since Wheeler took office has the target midpoint had any formal status.  In practice, Don Brash did aim for the midpoint, and often referred to it in public communications.  Alan Bollard didn’t regard the midpoint as being particularly important, and thought (and talked) in terms only of being comfortably inside the target range (thus at times we published projections with inflation settling back to around 2.5 per cent).

The fact that inflation averaged well above the target midpoints during the Brash years often surprises people.  Don had a reputation as an inflation-hating hardliner (an “inflation nutter”), which was –  at least in some respects –  well-warranted (he could also, at times, be a political pragmatist, to the dismay of the real hardliners).   He took the targets, and the midpoints, seriously.  So why was inflation averaging persistently above target?  My story is that he – we –  never quite realised how much higher than international interest rates New Zealand interest rates needed to be to keep inflation here in check.  In today’s terms, we underestimated the neutral interest rate.  In a way that wasn’t surprising.  After the great disinflation, we expected our interest rates to converge to those of the rest of the world –  and international visitors encouraged us in that view (I well recall the day a visiting senior Australian sat in my office trying to argue that we must have policy wrong because interest rates were still so much higher than those in Australia).    That convergence has simply never proved possible –  I argue because of the interaction of high immigration and low savings, but the “why” is a topic for another day.  Everyone realises that now, but we didn’t in the 1990s.   It led us to forecast lower inflation rates than we ended up achieving, and because – in effect – we believed our model we kept making what amounted to the same mistake.

Alan Bollard’s “mistake” was different.  He came into office with a sense that Don –  and those around him –  had been too hardline, and that if only we “gave growth a chance” we could get better outcomes all round.  I suspect he really did care about unemployment. He certainly cared a lot about the tradables sector, and the rising and high exchange rate quickly became quite a constraint on what he was willing to do with the OCR  (it was something of a political constraint too).  He was probably less willing to tighten than the median of the staff advice would have been, but actually staff advice also had something of the wrong model.  People just didn’t realise how much momentum there was behind the boom, or how structural (to the interaction of population and land use regulation) the lift in house prices was.   Because of the exchange rate, Alan was unwilling for too long to contemplate taking the OCR anywhere near the (real) peaks of the 1990s, even though by most measures –  whether unemployment or capacity utilisation –  the pressure on resources was much greater.

All three Governors made what would now be generally recognised as mistakes.  Some lasted shorter than others.  We held off adopting an OCR for years too long.  In 1991 we made the now-incomprehensible mistake (I strongly supported it at the time) of trying to hold up interest rates even as the economy was falling away rapidly into a recession, on some misguided view around the interpretation of the yield curve slope.  That lasted only a matter of months.  Then there was the MCI debacle in 1997 and 1998.  And scarred by that experience, we were too quick to cut the OCR in 2001 –  responding to a US recession that never much affected us.

Alan Bollard later openly acknowledged that his interest rates cuts in 2003 had been a mistake (at the time I’d thought at least the first one was appropriate).  And in 2010 the Bank was too quick to start raising interest rates, and had to reverse itself quite quickly.

As for the (single) Wheeler term, it was dominated by the mistake of promising to raise the OCR a lot, actually raising it by 100 basis points, and then the Bank only slowly and reluctantly having to more than fully reverse itself.     Perhaps more seriously still, there has been no apparent effort to position New Zealand for the next recession, when the OCR won’t be starting at 8.25 per cent.

Some of the mistakes the Reserve Bank has made have been in company (other central banks doing similar things).  Most haven’t.  In some cases, it has been a clear example of the Governor imposing his will on the organisation –  those 2003 OCR cuts were over the advice of a majority of OCRAG –  but most haven’t.  Then again, chief executives shape organisations, recruit people they are comfortable with, and sometimes don’t really welcome the airing of alternative views.  I don’t think, with hindsight, the institution’s record has been particularly good –  and I say that as someone who was heavily involved, at times at very senior levels, for a long time.  Sadly, it doesn’t seem to be improving.

I’m reluctant to try to reach a view on whether, overall, Wheeler has been worse than his two predecessors.     After all, the circumstances the three men faced were very different:

  • Don Brash was in charge during what we liked to think of as the “heroic” phase, slaying the inflation beast that ravaged New Zealand for the previous 25 years.  But, beyond that, he –  and we –  were learning what it meant to run monetary policy in a low inflation environment.  We had few effective yardsticks –  although we were probably more reluctant than we should have been to have consulted other countries’ practices and experiences.
  • On the other hand, Don presided over monetary policy through probably the most stable period ever in New Zealand’s terms of trade.
  • Alan Bollard presided during the most dramatic financial crisis the world had seen for decades –  perhaps since 1914.  I didn’t agree with all his stances in that time –  some he himself changed quite quickly –  but in many ways that 18 months or so was his finest hour: the willingness to improvise liquidity policies and to cut the OCR again and again, in large dollops.
  • Recessions: Bollard and Brash had to cope with them (ie externally sourced ones –  1991, the Asian crisis, the dot-com bust, and 2008/09). and Wheeler simply hasn’t.
  • Different shocks: Brash presided over the period of wrenching fiscal and structural adjustment, which made much of the data harder to read.  Bollard presided during a whole new period of persistent and unexpected strength in the terms of trade (we hadn’t paid them much attention until to then) and the Canterbury earthquakes.  All three Governors have had to grapple with the toxic mix of population growth and land use regulation spilling into rising trend house prices –  but it was the Bollard years that saw the largest, and most widespread, increase in debt/GDP ratios and private sector lending more generally.
  • In his early years, Brash had to deal with a severe domestic financial crisis and the aftermath of a very damaging credit, equity and commercial property boom.  Neither Bollard (despite the finance companies) nor Wheeler had to face something similar.

But, in many ways, I’d argue that Graeme Wheeler, and the Bank he presides over, have had it relatively easy.    Over his period there has been:

  • no international recession,
  • no major overseas financial crisis (the euro crisis transitioned into chronic state around the time Wheeler took office),
  • no deeply dislocative domestic shocks,
  • a stable backdrop of global inflation,

And unlike many of his international peers, he has always had total flexibility to adjust the OCR as required (the near-zero bound simply wasn’t an issue) and there were no looming fiscal crises in the background either.

You might be surprised by the comment about stable global inflation. But here is the OECD’s measure of G7 core inflation (ie CPI ex food and energy).

CPI ex G7

Pretty stable for almost 20 years now.  Of course, within that some countries have done better than others.  And the interest rates that have been consistent with keeping inflation around these levels have fallen a long way.  But there aren’t huge inflationary or deflationary shocks from other advanced economies.  Contrast this chart with the New Zealand core inflation chart above.    And recall that, unlike New Zealand, most of the G7 countries were pushed to the absolute limits of conventional monetary policy.

It is fair to acknowledge that the recent swings in the terms of trade have been quite large –  so I’m not trying to suggest that getting monetary policy just right was easy (if it were that easy, we wouldn’t be paying a lot of people a lot of money to get it right).    But broadly speaking, a lot of things have been working in the Reserve Bank’s favour in recent years, that their peers in other countries haven’t had:

  • as already mentioned, the Reserve Bank had full OCR flexibility, and
  • an unemployment rate persistently above their own estimates of the NAIRU (a basic pointer to a demand shortfall, something conventional monetary policy can remedy),
  • high terms of trade (on average), supporting demand overall,
  • the effects of Canterbury earthquakes were quite disruptive late in Bollard’s term, but ever since Wheeler took office, they’ve been a consistent source of demand growth [NB I’m not suggesting earthquakes make us richer, but the reconstruction is a significant source of demand –  helpful if demand is otherwise scarce.] and
  • really rapid population growth (hard to forecast, but persistently surprising on the upside throughout Wheeler’s term –  the last quarter of net outflows, seasonally adjusted, ended a few days after he took office), and
  • although fiscal policy was net contractionary at the start of his term, even that has swung round to neutral or mildly expansionary more recently.

There is no reason to think it has been any harder to get things right –  forecasts and reality – than in the earlier years, and some reasons why it should have been easier to keep inflation up near target.

Non-tradables inflation, the bit the Reserve Bank has most medium-term influence over, should have been relatively easy to get up to levels more consistent with meeting the overall inflation target.  And yet, the Bank’s sectoral factor model measure of non-tradables inflation is no higher now than it was when the Governor took office.

Arguments about technological change, structural changes in labour demand, or whatever simply aren’t relevant to this conclusion.  They provide opportunities for faster growth without unduly fast inflation –  surely, broadly speaking, the goal of economic policy?  They provide the oppportunity to run the labour market a bit harder and get more people –  often people who find life a bit difficult – into employment.   In such a world, one does well –  getting inflation back to target –  by doing good.    Instead, all too often it has come to seem as though the Wheeler Reserve Bank is more concerned about house prices –  especially in Auckland – than it is about inflation or unemployment, even though –  when pushed –  they will acknowledge that monetary policy can’t do much about house prices.  And all this with no good model of house prices, and the failures of land use regulation.

So, yes, we’ve had stable (core) inflation in the Wheeler years, but stable at too low a level –  in his own words, an “unnecessarily” low levels.  He agreed to deliver it higher, and had a lot of things working in his favour to get it higher.  He wasn’t faced with rapid productivity growth –  driving prices down  –  rather the contrary.  And he was never faced with a fully employed labour market.    He simply didn’t do his job, when he easily could have.  He seemed to allow himself too readily to believe that somehow he faced the same challenges some of his peers bemoaned at BIS meetings –  when the preconditions for rapid (per capita) demand growth, a strong labour market, and inflation around target were much different here.

Would another Governor faced with the same circumstances have done differently in recent years?  We can’t really know.  There have always been some economists and commentators running a different tack but (a) as far as we can tell, most of the rest of the Reserve Bank senior officials have supported the Governor’s approach, and (b) most domestic market economists have done so most of the time as well.     It was the sort of defence we used in the Bollard and Brash years –  few ever consistently argued for tougher policy.  But it isn’t that persuasive an argument –  we charge the Reserve Bank Governor, resource him, and pay him well, to do better.

Where I suspect we can conclude that a different Governor would have done better is in perhaps the more peripheral aspects of monetary policy:

  • it is hard to believe that any other Governor would have been so reluctant to acknowledge a mistake.  Even if reluctant to accept the fact, most would have found more effective, appealing, lines to use,
  • Most possible Governors would have been much more willing to open themselves up to serious scrutiny, especially when questions around performance started arising.  Good ones would prove their competence and capability in part by their ability to engage with and deal with alternative perspectives.
  • Surely no other possible Governor would have taken the pursuit of Stephen Toplis to quite such lengths.  We know other Governors have at times expressed irritation with particular views, but that is very different from deploying your entire senior management team to attempt to close a critic down, and then when that failed  writing to Toplis’s employer – an institution the Bank actively regulates – to attempt to have him censored,
  • (oh, and other possible Governors probably wouldn’t have attempted to tar publically, in the cool light of day, someone who highlighted a serious weakness in the Bank’s systems).

It is hard not to think that a different Governor wouldn’t have produced stronger speeches – more akin to the quality one finds from Governors in other advanced countries –  or demanded, and received, more consistent depth and excellence in the quality of the analytical work underpinning the advice on monetary policy.

I’m not going to conclude that Wheeler did monetary policy worse than his predecessors –  and I will be interested to see his own arguments in his forthcoming speech –  but even considered in isolation it doesn’t look to have been a creditable record, whether on substance or on style.   That is something the Bank’s Board –  and whoever might shortly be Minister of Finance –  need to reflect on seriously, not just in identifying a specific successor, but in strengthening the institution as a whole.