Monetary policy in 2020

On Saturday I did a guest lecture to the Master of Applied Finance course at Victoria University. Martien Lubberink, who runs the course, invited me along to talk to the students about the Reserve Bank’s monetary policy this year (as it happens, most years for the best part of two decades I used to do a lecture to this same course articulating and championing the monetary policy framework and the Bank’s conduct of policy).

There wasn’t a great deal in the lecture that hasn’t already been covered in one or (many) more posts over the course of the year, but if anyone is interested here are the slides I used

Activity over substance VUW presentation 12 Dec 2020

and this is the story I was trying to tell

Notes for VUW MAF lecture on 2020 mon pol 12 Dec 2020

For the most part, I tried to look at what the Bank has, and hasn’t, done on their own terms. I didn’t, for example, spend lots of time on whether negative OCRs would “work”, but rather took as given the Bank’s repeatedly stated view that they would. I didn’t challenge the “least regrets” approach they have claimed, since the second half of last year, to be guiding them, but looked at how they had done relative to that worthy aspiration. I took for granted their embrace of the notion that in downturns when both inflation forecasts undershoot and unemployment forecasts overshoot aggressive monetary action is warranted. And against the backdrop of all that sort of thing I suggested that the year was best characterised as one of lots of activity, and rhetoric, and not a great deal of monetary policy substance.

For example, I included these two indicative charts comparing (real) interest rate and (nominal) exchange rates this year and in each of the three previous recessions since inflation targeting was adopted.

activity over substance

Whatever the impact of the LSAP and the funding for lending programme etc, the bottom line remains that key financial market prices just haven’t moved very much (and that is another area where I take as given – but also agree with the Bank – that to the extent those programmes work they do so largely by altering interest and exchange rates).

I ended the lecture with some thoughts on how we should evaluate the Bank’s monetary policy performance this year. From my notes

How should we evaluate the Bank’s performance?

We always have to be careful, when evaluating government agencies, not to hold them to unreasonable standards.  In this talk I’ve tried to ensure that I use either information that was available to them when they made decisions, their own rhetoric and arguments, or common international central banking practices and standards.   We can’t blame the RB, for example, for not pre-emptively easing a year ago in anticipation of a pandemic no one –  no central banker anyway –  could reasonably know about.

But we, and should, criticise them for:

  • The failure to recognise and respond to the emerging risks early (monetary policy works with a lag, risks around being near the lower bound were well known),
  • The failure, having decided that the negative OCR was a preferred option, to have ensured the bulk of the system was operationally ready (almost inexcusable, and has meant we have had monetary conditions tighter than otherwise for most of the year,
  • The failure to operate as if “least regrets” was actually guiding policy – the evidence for this not being my independent analysis, but their own numbers,
  • Falling back on exuberant spin regarding the impact of the LSAP, when realistically the effective impact is likely to have been small,
  • Opening the way to the “$100bn money printing” rhetoric by adopting LSAP rather than a mod-point on the yield curve target (as the RBA initially did, and even the LSAP the RBA is now doing is much smaller relative to the size of the economy),
  • Allowing the (second-best) sensible FFL instrument to also be framed as some dangerous money printing exercise,
  • Lack of serious transparency – whether the utter refusal to publish background analysis/research behind the mon policy choices/instruments, even in extremely unsettled times and when the rest of govt was being proactively transparent, or the continued invisibility and silence of the non-executive members of the MPC, and
  • The lack of effective communications and framing. There have been few speeches all year, hardly any published research, nothing from the non-exec MPC members.  Instead, they’ve largely left the framing of issues to critics –  notably the ones who think the Bank has done too much and is to blame either for house price inflation and some looming general inflation.  There has been nothing authoritative from the Bank, and they seem constantly to have been running to catch up.

    It has been a poor performance, that reflects poorly on all those involved: the Governor, his senior staff, the invisible non-exec MPC members, the Board (paid to hold management to account) and the Minister with responsibility for management and the Board.

    Of course, it is fair to ask how much difference a better monetary policy –  substance and presentation –  might have made.  By now, perhaps not a lot substantively – the mon pol lags are longer –  but into next year it would have helped lay the foundations for a strong recovery, a lift in inflation, and a rapid return to full employment (we can’t afford the 10 years it took after 2007).  And, agree with them or not, the RB would stand higher in informed opinion, and if we value the idea of an operationally independent central bank, that would have to have been a good thing.  It would truly have been a least regrets strategy.

At the end of the lecture, we had some time for questions. Perhaps the best question was the one I could not give a compelling answer to: why – given their projections, given their avowed “least regrets” approach – has the Bank and MPC not been willing to do more?

I had noted that there were similar issues with central banks in a number of other countries, and indeed that it was striking how relatively little monetary policy had done in this downturn and period of greatly-heightened uncertainty. You can see it in, for example, the published projections of the Reserve Bank of Australia, the ECB, and probably others too – where for several years to come not only is inflation expected to be below target, but unemployment is above general estimates of the respective NAIRUs. As our Governor notes, that is a combination that points in the direction of a lot of monetary policy support.

(As just one example of what is going on elsewhere, the ECB released its latest projections late last week.

ECB inflation

Three years out inflation is still barely back to 1.5 per cent, compared with a target of just under 2 per cent. In these same projections, the unemployment rate rises further from here.)

Central banks could do more to boost the recovery in activity and employment. The quiescent inflation numbers – their own projections – tell us that. In fact, those projections (and market and survey expectations) are best seen as a constraint limiting how much central banks can do; a constraint that when inflation projections are below target should be thought of as a non-binding constraint (especially when central banks around the world have had an upward bias to their inflation forecasts for the last decade).

So why don’t they do more? I don’t know. They don’t say – especially not our Reserve Bank which talks one set of rhetoric (often quite good rhetoric) and acts inconsistently with that rhetoric. Perhaps there is something in the story that active-government left-liberal Governor doesn’t want to use monetary policy because he wants to put pressure on the government to run bigger deficits and further increase public spending. I hope that isn’t a part of the story – it would be profoundly inconsistent with our democratic institutions of government for a non-elected official (and his lackeys on the MPC) to refuse to do their job simply to try to advance their personal political preferences in other areas. Perhaps they don’t believe the rhetoric (they themselves use) and doubt that monetary policy can do much more good in stabilising the economy. Perhaps there is some secure-public-employee indifference to the scandal of prolonged and unnecessarily high unemployment (which never affects senior central bankers, and probably rarely their children): it did, after all, take 10 long years after 2007 to get unemployment in New Zealand back down again. Perhaps there is some embarrassment that with all those years of advance notice they didn’t get their act together and ensure that banks were operationally ready for negative OCRs? Perhaps, globally, there is some discomfort that with all those years advance notice – most having got to the lower bound in the last recession – nothing (repeat nothing) has been done anywhere to make the lower bound less binding, and enable the sorts of deeply negative interest rates that (for example) former IMF chief economist Ken Rogoff has called for.

Sure, it is easy for people to talk about all the fiscal stimulus that has been provided instead of monetary policy. But those published central bank forecasts – here or in other countries – capture all those effects. It is the job of monetary policy to estimate all the other effects and then, if the inflation outlook is below target and the unemployment outlook is above NAIRU-type estimates, to do more, to do what it takes. with monetary policy. That is what we have discretionary monetary policy for. (There are, of course, hard cases where the inflation and unemployment strands aren’t aligned, but as our own Governor has repeatedly pointed out this year, this isn’t one of those times.)

So, I really don’t know the answer to the student’s question. But I should (as should anyone who follows central banks closely), because they should be telling us. Instead, we’ve had a year of few speeches, no visibility (still) for the non-executive MPC members, little or no published research, a refusal to release background documents and analysis, and little or no attempt to articulate and defend a robust framework. 10 days or so ago, for example, the Governor gave a speech to an Australian audience on New Zealand monetary policy this year. As far it went, and by Orr’s standards, it wasn’t a bad speech but it addressed none of these questions. That isn’t good enough, and reflects poorly on everyone involved – the Governor, the MPC, the Board supposed to hold them to account, and the Minister of Finance with overall responsibility for the Bank, for monetary policy, and for economic performance more broadly.

There has been a lot of rhetoric, a lot of busy-work, but not a lot of monetary policy doing what it is there for, and not much transparency and accountability either.

Robertson playing distraction

On Tuesday afternoon we learned that the Minister of Finance had written to the Governor of the Reserve Bank about housing and monetary policy. At his press conference yesterday, the Governor told us that the first thing he knew about it was on Monday, suggesting that the government had become worried over the weekend that it was on the political backfoot on housing and felt a need to be seen to be doing something/anything, to change the headlines for a day or two at least.

There wasn’t much to the Minister’s press statement. Perhaps it might even have seemed not-unreasonable if he’d come into office for the first time just a few days ago, but he’s been Minister of Finance for three years, and the housing disaster has just got steadily worse over that time. Little or nothing useful has happened in that time to do anything other than paper over a few symptoms of the problem. And no one believes any agenda the government has is likely to markedly change things for the better: if they did, expectations would already be shaping behaviour and land/house prices would already be falling. Why would one believe it when the Prime Minister refuses to talk in terms of materially lower house prices, and even the Minister of Finance yesterday could only talk about wanting “a sustained period of moderation in house prices” – ie enough to get the story of the front pages, not to actually fix the problem? That makes them no better than their National predecessors.

And so he made a bid to play distraction, writing to the Governor and suggesting that he (the Minister) might change the Remit the Monetary Policy Committee operates under. The Minister can make such changes himself (he does not need the Bank’s consent), but must seek comment from the Bank first.

It was a limp suggestion, as the Minister must have known when he wrote the letter (and as The Treasury would almost certainly advised him, if he asked for advice from them). In the Remit, consistent with the Act, the MPC is required to use monetary policy to keep inflation near 2 per cent, and consistent with that to do what it can to support “maximum sustainable employment” (in practical terms, low unemployment). And then there is this

4b

The Minister suggested in his letter that he might like to add “and house prices” to the end of the worthy grab-bag phrase in b(ii).

b(ii) has been in the Bank’s monetary policy mandate (the old Policy Targets Agreements –  which I’d link to, but the Bank seems to have removed them from their website) since the end of 1999.    It was inserted when Labour became government that year and the new Minister of Finance, Michael Cullen, wanted some product differentiation.  The Bank had had a bad run over the previous parliamentary term, including the period when it ran things using a Monetary Conditions Index operating guideline, which led to us actively inducing a wildly unnecessary degree of variability in short-term interest rates.  Cullen had also, for some years, been somewhat exercised about the cyclical variability of the exchange rate.

It was cleverly-crafted wording.  Don Brash agreed to some new words that sounded worthy –  who, after all, wants “unnecessary” variability in anything – but which really changed nothing at all.  Better (or worse) still, no one has ever known quite what it meant, or if it meant anything at all beyond what was already implicit in a medium-term approach to inflation targeting (looking through short-term price fluctuations –  per b(iii) now –  had always been integral to the way we’d run thing).  A lot of time and energy was spent trying to articulate what it might mean –  the Bank’s Board were particularly exercised, since they were supposed to hold the Governor to account, and it wasn’t clear how, if it all, b(ii) changed anything.  For practical purposes, in all the years I sat on the OCR Advisory Committee, with b(ii) as part of the mandate we were advising against, I’m not convinced it ever made any material difference to any specific OCR decision.   If the Governor didn’t want to tighten much anyway, it was sometimes a convenient reference point –  wanting to avoid “unnecessary instability” in the exchange rate –  but a more hawkish Governor, or a more accurate set of forecasts, might just as easily have determined that any resulting pressure on the exchange rate, while perhaps a little regrettable, was nonetheless, “necessary”.    And then there were the tensions –  avoiding a bit more upward pressure on the exchange rate might actually contribute to increasing the variability in output, and so on.  

The clause was, and is, largely meaningless in any substantive sense.  From a purely substantive perspective I’ve argued for some years that it should simply have been dropped, but the fact that it lives on is a reminder that documents grow not necessarily because the substance requires it, but because there is a political itch to scratch. 

So Grant Robertson’s suggestion that he might change the Remit to add “and house prices”  to b(ii) should be seen in exactly that light. It is about scratching political itches – and distracting from the government’s own failures on housing –  not about substance.     We know this also because the Minister was at pains to reassure people that he wasn’t proposing to change the operational objectives the MPC is required to pursue.   If not, then adding “and house prices” is really no more than getting the MPC to add another few lines to the occasional MPS, to imply that they had paid ritual obeisance.  It might do no harm, but it will do no substantive good either.

But it won Robertson quite a few headlines, and even got the markets excited for a while, temporarily prompting the sort of lift in the exchange rate that might otherwise appear appear out of step with the government’s alleged desire to promote investment in more “productive assets”. 

But if there was anything real to it –  if the aim was actually to make the MPC set monetary policy differently (tighter at present) –  it would, of course, have to have come at the cost of a more sluggish recovery, lower than target inflation, and cyclical unemployment higher than necessary.  Which would have seemed very odd coming from a Minister of Finance who had explicitly introduced to the Act –  what was always implicit –  the cyclical unemployment dimension just a couple of years ago, complete with reminders of the importance his Labour forebears –  notably Peter Fraser –  had placed on full employment.    (I suppose, charitably, it could have involved some more fiscal stimulus to offset less monetary stimulus, but if the Minister had been serious about that he could do it anyway – the RB sets monetary policy in the light of government fiscal choices whatever they are.)

But of course it wasn’t serious. It was political theatre, and distraction, including an attempt to distance himself from monetary policy policy that he had explicitly authorised.  Thus he claims 

mof letter

But as the Minister knows very well, not only was the Bank well advanced in thinking about unconventional monetary policy options by then – they’d published a whole Bulletin article about it in May 2018 – and much of the rest of the world had been using them for some years, but that the LSAP programme (the one actually in effect this year) has been inauguarated with the explicit and repeated consent of the Minister of Finance himself (through the guarantees he has provided to the Bank). Unconventional monetary policy is, in any case, yet another ministerial distraction, since no supposes that whatever contribution monetary policy might have made to this year’s house price developments, it would have materially different if the Minister had ensured that the Bank had its act together in ways that meant that they used a negative OCR this year.

Anyway, the Minister’s letter prompted a quick response from the Bank. Perhaps some wonder if that was necessary – these things could be dealt with to a greater extent in private – but I’m with the Governor on this one. It was the Minister who chose to issue his letter the afternoon before the Bank’s long-scheduled FSR press conference. The Bank had no effective choice but to respond, and better to put things in writing than just rely on throwaway comments at a press conference.

I thought the Governor’s letter was mostly a fairly sensible and moderate holding response. He promised to come back to the Minister with more considered thoughts on the suggested addition to b(ii). There were a couple of bits that could be read more pointedly. For example, the Governor noted that

We welcome the opportunity to contribute to your work programme aimed at improving housing affordability. As I’ve said publicly on many occasions, monetary and financial regulatory policy alone cannot address this challenge. There are many long-term, structural issues at play.

The Bank had, in fact, had some nice lines to that effect in its Monetary Policy Statement just a couple of weeks ago

RB on housing

This is a government failure, not a central bank one. But I guess I wouldn’t expect any central bank Governor to be quite that pointed in public.

Several have also noted that the Governor pointed out that the Bank already considers house prices in setting monetary policy.

I can assure you that the MPC, in making its decisions, gives consideration to the potential impact of monetary policy on asset prices, including house prices. These are important transmission channels that affect employment and inflation. Housing market related prices are
also included in the Consumer Price Index, for example rents, rates, construction costs, and housing transaction costs.

But actually that was a bit cheeky. On those terms, at times like these the Bank positively welcomes higher house price inflation because of the beneficial spillovers they think that leads to in raising CPI inflation. Recall just a few weeks ago their chief economist was actively welcoming higher house prices, distinctly averse to falling prices.

Out of that first round, I’d suggest that the Governor came out ahead on points. The Minister got his headlines – lots of them in some media – but the Governor gave no hint of believing that there was likely to be anything of real substance there.

But the Governor must have over-reached yesterday. At the FSR press conference he expansively declared his pleasure that the Bank has been invited to share its expertise in advising on the wider issues of supply and affordability. In an interview with Stuff – now the frontpage story in the Dom-Post – Orr went further, talking about the tax advice they might also offer. It wasn’t clear what expertise the Governor thought the Bank had in these areas – there is nothing in their research publications or speeches in recent years that suggests any – but I guess that doesn’t often deter the Governor.

But all that talk can’t have gone down well with the Minister, as the newsroompro newsletter this morning includes this

milnes rb

Ouch.

All seems not to be sweetness and light between the Governor and the Minister. But then they deserve each other really. Robertson was engaged in a transparent attempt to distract briefly from the three years of failure of his own government, writing to the Reserve Bank – sure to get headlines – rather than putting the hard word on his own boss and his ministerial colleagues. And Orr, who surely knows there is nothing there and how empty b(ii) really is – and who genuinely seems to think monetary policy should be focused on boosting aggregate demand in ways that lift inflation and employment, can’t help himself in openly trying to embrace a much wider role as adviser on all manner of things that really have nothing much to do with the Bank. Meanwhile, through this period we have had precisely no serious speeches or research papers on monetary policy, we have a central bank that fell back on LSAP partly because it didn’t think to do the basics and check that banks could operate with a negative OCR, and (of course, still) the invisible external members of the Monetary Policy Committee. A high-performing central bank and Monetary Policy Committee would have done a much better job over months of articulating a story, and explaining the place of monetary policy in the mix.

Then, of course, there was the question as to whether had the proposed amendment to b(ii) been in place back in March anything about monetary policy this year would have been different. Orr – probably diplomatically – avoided answering that, but of course the straightforward answer is no. That is so for two reasons. First – and this is a point Orr made in his MPS press conference – the threat to output, employment, and inflation in March was so large that the operational objectives the Minister has given the MPC would simply have impelled a significant easing in monetary policy. But the other reason – actually more an explanation for monetary policy choices than is often realised – is the forecasts. Back in March, hardly anyone (no one I’m aware) would have forecast the rise in house prices we’ve actually seen. Most probably expected – I did – something more like 2008/09, with a dip in prices for a time. So sitting in an MPC meeting in March with an amended b(ii) the house price issues would have appeared moot. Monetary policy would have been conducted just as it was. Oh, and not to forget my point earlier: no one knows what b(ii) means in practice anyway.

But of course if the Minister took any economic advice at all before sending his political theatre letter, he’d have known that too.

So change the Remit, or don’t, in this way and (a) it won’t make any difference to the conduct of monetary policy, and (b) it won’t change the fact that the reforms that might make a real difference now to land/house prices are all matters under the control of ministers already, backed by their majority in Parliament. If my kids can’t buy houses 10 years hence, it is going to be the fault of Ardern and Robertson, and not at all that of the Reserve Bank.

LSAP, deposits, bonds, house prices etc

There has been a flurry of commentary in the last couple of weeks about the (alleged) impact of the Reserve Bank’s Large Scale Asset Purchase programme. Much of it has seemed to me really quite confused. I don’t really want to pick on individual people – none of whom, as far as I’m aware, is a macro or monetary economist – although, for recency if nothing else, Bernard Hickey’s column yesterday is as good an example as any. But the Reserve Bank itself has not helped, tending to materially oversell what the LSAP programme has actually done.

There is, for example, a complaint (there in the headline of Hickey’s article) that “printed money being parked, not invested or spent”. But this seems to completely ignore the fact – it isn’t contested – that really only Reserve Bank actions affect the stock of settlement cash. All else equal, when the Bank buys an assets from someone in the private sector, that purchase will boost aggregate settlement cash, and only some other action by the Reserve Bank will subsequently alter the level of settlement cash. When private banks lend (borrow) more (less) aggressively, that may change an individual bank’s holding of settlement cash, but it won’t change the system total. Some of my views and interpretations may be idiosyncratic or controversial, but this one isn’t. It is totally straightforward and really beyond serious question. For anyone who wants to check out the influences on the aggregate level of settlement cash balances, the Reserve Bank produces a table – only monthly and too-long delayed in publication – detailing them (table D10 on their website). I’ll come back to those numbers.

Now, of course, the transactions that give rise to changes in settlement account balances aren’t always – or even normally – primarily with banks themselves. If the Reserve Bank bought a government bond I was holding, that would increase – more or less simultaneously – (a) my balance in my account at my bank, and (b) my bank’s balance in its account at the Reserve Bank. And because the government banks with the Reserve Bank, the same goes for (say) government pension payments: all else equal, they add to the recipient’s own deposits at his/her bank, and also to that recipient’s own bank’s deposits at the Reserve Bank (in normal times, the Reserve Bank does open market operations that roughly neutralise these fiscal flows – revenue or spending).

Much of the coverage of the LSAP purchases suggests that there has been a big net transfer of cash (deposits, settlement cash) from the Reserve Bank to private sector bondholders in recent months. Thus, we get stories and narratives about what “rich people” and other bond holders are (and aren’t – often the point) doing with all the cash they are now holding. But it simply isn’t a narrative relevant to New Zealand over recent months. The Reserve Bank publishes a table showing holdings of government securities (Table D30). Again, it is only monthly and we only have data to the end of July. But over the five months from the end of February to the end of July, secondary market holdings of New Zealand government securities (ie excluding those held by the Reserve Bank and EQC) increased by around $10 billion. It simply is not the case that funds managers, pension funds and the like (private bondholders generally) are suddenly awash with extra cash. In fact, collectively they have more tied up in loans to the Crown than they had back in February.

None of which should be really very surprising. After all, the government has run a massive (cash) fiscal deficit over the last six months – a reduced tax take and programmes that put lots of extra money into the accounts of businesses and households.

We can get a sense of just how large from that Influences on Settlement Cash table (D10) I referred to earlier. In the five months March to July the government paid out $23.8 billion more than it received. There is some seasonality in government flows, but for the same period last year the equivalent net payout (“government cash influence”) was $4.5 billion (and $4.9 billion in the same period in 2018). That is a lot of money put into the accounts of firms and households – the largest chunk will have been the wage subsidy payments, but there was also the corporate tax clawback, and various other one-offs, as well as the effect of the weaker economy in reducing the regular tax-take.

Over those five months the government has also issued, on-market as primary issuance, a great deal of debt (bonds and Treasury bills) offset by maturities (and early repurchases of maturing bonds by the Reserve Bank). Over the five months, the net of all these on-market transactions was $34.4 billion – as it happens, a whole lot more than the cash deficit for that period.

Now, of course, we know that the Reserve Bank – another arm of government – has been entering the secondary market to buy lots of government bonds. For the five months, the cash value of those purchases was $27.2 billion.

Take those two debt limbs together and issuance has exceeded RB LSAP purchases by about $7.2 billion.

And those are almost all the main influences on aggregate settlement cash balances. Other Reserve Bank liquidity management transactions can at times have a significant influence, but over these five months the net effect was tiny, at around $300m.

So broadly speaking, over the five months from the end of February to the end of July, the total level of settlement cash balances increased by about $16.4 billion (to $23.8 billion at the end of July). Roughly speaking, a cash deficit (also, coincidentally) of $23.8 billion, and net debt sales by the NZDMO/RB combined of $7.2 billion. And a few rates and mice.

Another way of looking at it is that the $23.8 billion “fiscal deficit” has been financed by $7.2 billion of net debt sales to the private sector, and by the issuance of $16.4 billion in Reserve Bank demand deposits (another name for settlement cash balances).

(And thus the biggest effect of the LSAP programme itself has really just been to change the balance between those last two numbers – consistent with the line that I keep running that to a first approximation the LSAP is just a large-scale asset swap, exchanging one set of low-yielding government liabilities (that anyone can hold) for another set of low-yielding government liabilities (that only banks can hold, while banks themselves assume new liabilities to their own depositors).

But taking the private sector as a whole what has happened over the last few months is that the fiscal policy choices (spending and revenue) have put lots more money in the pockets (and bank accounts) of firms and households. And the government as a whole (NZDMO/RB) has offset the settlement cash effects of that in part by (net) selling really rather a lot (by any normal standards) of net new bonds to private sector investors/funds managers etc. They, in turn, have less cash. Firms and ordinary households have more (at least than they otherwise would).

There have been strange arguments – and the Reserve Bank Governor sometimes feeds this silly line – that banks are not “doing their bit” by lending more to businesses, even though – we are told – they have so much more settlement cash. But this is a wrongheaded argument, because systemwide availability of settlement cash has rarely, if ever, in recent times (last couple of decades) been a significant constraints on bank lending. Aggregate settlement cash balances barely changed over the previous decade and plenty of lending occurred. In a severe and quite unexpected recession, it would generally be more reasonable to suppose that lack of demand from creditworthy borrowers, some caution among banks as to quite what really is creditworthy, and sheer uncertainty about the economic environment would explain why there wasn’t much new business lending occurring. In fact, sensible bank supervisors would typically welcome that outcome. And remember my point right at the start, even if banks were doing lots of new business lending, it would not change the level of settlement cash balances in the system as a whole by one jot.

So then we get to the question of house prices. Many people – me included – expected that we would have seen house prices beginning to fall already. Severe recessions and considerable uncertainty tends to have that affect. Often, tighter bank lending standards reinforce that. So what did we miss? I can’t speak for anyone else, but for me:

  • I have not been surprised by the extent of the fall in retail interest rates.  That fall has been small in total, and modest by the standards of significant past recessions.  When people idly talk about lower lending rates driving up house prices, they seem completely oblivious to the way –  whether over 1990/91, after 1997/98, or in 2008/09 –  falling interest rates initially went hand in hand with flat or falling house prices.  Interest rates were, after all, falling for a reason in the middle of a recession.  One can argue that trend lower interest rates are raising trend house prices (I don’t think so, but that is for another day) but there isn’t really a credible story that this modest fall in interest rates –  amid a big and uncertain recession –  is raising house prices now, in and of itself,
  • we also know that people who usually hold bonds are not suddenly finding themselves at a loose end, unable to invest their cash in government bonds and having to fall back on buying a house instead.  The aggregate figures tell us instead they are holding a lot more bonds than they were (and as a trustee of super funds that do have substantial bond exposures, I know our advisers have not come and urged us to sell out and buy houses).
  • but we’ve also had a highly unusual combination of events that together probably do explain why, to now anyway, house prices are holding up in most places, perhaps even rising.  
  • we’d never previously gone into a recession with binding LVR limits in place.  The Bank removed those limits when the recession began –  sensibly enough –  for a flawed policy –  and consistent with the way they’d always talked of operating, enabling some people who regulation had forced out of the market to get back in.  Regulatory credit constraints were eased.
  • We also had the mortgage holiday scheme, which had two legs to it.  The first was that banks generally agreed to show forbearance to people who would have otherwise had trouble servicing their mortgage over this period, allowing them to defer to later payments due now.  Mostly that was probably pretty sensible, and banks might done something along those lines for most customers even with no heavy-handed government involvement.  But then the Reserve Bank engaged in questionable regulatory forbearance, telling banks that even though the credit quality of their residential loan books had deteriorated –  people unable to pay, even if perhaps just for a time, but with threats of rising unemployment –  they could pretend otherwise, at least for the purposes of the capital requirements the Reserve Bank imposes on locally-incorporated banks.
  • And, third, we’ve had an unprecedented series of fiscal support measures, putting lots (and lots) of taxpayer money into the accounts of businesses (mostly, directly) and households, to offset to a considerable extent the immediate substantial loss of market incomes and GDP.

My approach then is to reason from the counterfactual.   Suppose these actions had not been taken, what then would we have expected to have seen in house prices?

I reckon it would be a safe bet that house prices would have fallen.  Sure, retail interest rates would still have come down, but as I noted earlier that happens in almost every recession, and the falls are typically larger than those we’ve seen this year.   But even just suppose the virus had done as it did, here and abroad, and that the anti-virus choices (policy and private) were as they were.  There would have been a huge increase, almost immediately, in unemployment, and a large number of households would have been thrown onto no more than the unemployment benefit, and many of those that weren’t would have running very scared.  The cashed-up might still have been interested in buying, at low interest rates, but there would have lots of sellers –  whether forced by the bank, or people just needing to cut their debt urgently –  and that wave of desired selling would have fed doubts that would have left buyers more wary than otherwise.    But it was the fiscal policy choices that put additional money in the pockets of those who might otherwise have been rushing to sell.

The thing is, that for all the moans and laments about house prices rising a little, no one seems to have been arguing that we should not have taken a generous approach to supporting households through recent months.  Given the logic of the LVRs, probably most people think it reasonable that those restrictions were suspended.   Few people think banks should have been more hard-hearted (even if a few geeks like me might be uneasy about the capital relief the RB provided). 

And it is those that are the choices that really mattered.  (They are also why I remain sceptical that any strength in the housing market will last much longer, given that the fiscal support is rapidly coming to an end, unemployment is rising (and is expected to continue to do so), the world economy looks sick, we’ve been reminded afresh of virus uncertainty, and deferred debt has not gone away.  Time will tell.)

Now none of this is to suggest we should be at all comfortable with the level of house prices in New Zealand.  They are a disgrace, and the direct responsibility of successive governments of all stripes, and of their local authority counterparts.    But given that all of them refuse to address the real issues –  opening up land use on the fringes of our towns and cities in ways that would bring land prices dramatically down – they can’t really be surprised by where we are now.

And it is has nothing whatever to do with the LSAP programme:

  •  which has not put more money in the hands of people who buy houses,
  • has not made any material difference to wholesale or retail interest rates over the relatively short-term maturities most New Zealand borrowers borrow at (even if there is a case that the might have a material difference to long-term rates, benefiting really only the government as borrower),
  • may have actually held short-term interest rates up a little, if the Reserve Bank is being honest in its claim that it preferred using the LSAP to cutting the OCR further this year,and
  • which has not enabled, empowered, or encouraged the government to run any larger deficits than it would otherwise have chosen to run (which could readily have been financed on-market, except perhaps in the torrid week or two in late March when global bond markets were dysfunctional.   Government deficits put money in the pockets of people.  Most people –  me included –  think they were right to do so (even if we might quibble about details).

Observant readers may have noticed that the government issued much more debt over those five months than the deficits it ran.  Without the LSAP, these transactions in isolation would have tended to drain the level of settlement cash.  But that would not have happened in practice.   Either the NZDMO would have spread out its issuance a bit more, or the Reserve Bank would have done (routine for it) open market operations to stabilise the aggregate level of settlement cash balances at levels consistent with their target level of short-term interest rates.

Other observant readers might wonder how the LSAP can be so relatively unimportant (in many ways almost as unimportant as the MMT authors might suggest).  A key issue here is that the yields the (whole of) government is paying on bonds is very similar now to the yield (the OCR) it is paying on unlimited settlement cash balances.   One could imagine a different world in which things would work out differently.  It used to be common for settlement cash balances to earn either zero interest, or a materially below market rate.  So if, say, the Reserve Bank was buying bonds at yields of 10  per cent –  where they were in the early 1990s –  and paying zero interest (or even a significant margin below market) on settlement cash balances, each individual bank would be very keen to get rid of any settlement cash building up in its account.  They still couldn’t change the total level of settlement cash balances but they could, for example, bid deposit rates down aggressively, which would (among other things) be expected to materially weaken the exchange rate.  But on current policy –  only adopted in March –  the Bank pays the full OCR on all and any settlement cash balances.  25 basis points isn’t a great return, but it is probably high enough –  relative say to bank bill yields – that banks aren’t desperate to offload settlement cash.  The transmission mechanism is then muted, as a matter of policy choice.

Finally, note that –  because of the inadequacies of the Bank’s data publication (influences on settlement cash really should be daily, published daily, in times like this) – all my numbers refer only to the period to the end of July.  But note that since the end of July the level of settlement cash balances has fallen further ($19 billion as of last Friday).  I haven’t tried to unpick what specifically has gone on in any detail, but my guess is that the cash fiscal deficit has diminished, while heavy bond and bill issuance by DMO has continued.  The Reserve Bank has stepped-up its own purchases but the bottom line remains one in which (a) if anything the Bank is draining funds from banks, although in doing so not really constraining any one or any thing, while (b) it is fiscal choices –  pretty widely supported ones –  that have still been putting money in the pockets of people who might, for example, be holding houses (and owing the attendant debt).  Unsurprisingly, bank deposits have risen in recent months, exactly as one should have expected.

And there endeth the lecture,  My son (doing Scholarship economics) asked about this stuff the other day and I ran him through most of this material.  My wife suggested I’d had my best schoolmaster’s voice on at the time.  I suspect the tone of this post is somewhat similar.  I hope the substance is some help in clarifying some of the issues. 

Macro policy pitfalls and options

The sad sight of someone who has seemed to be a normally honourable man –  Greens co-leader James Shaw – heading off down the path of Shane Jones-ism, is perhaps a general reminder of the temptations of politics and power, but also of much that is wrong about how the government is tackling the severe economic downturn we are now in.   Fiscal discipline around scarce real resources, always pretty weak at the best of times. is flung out the window and there is a mad scamper for ministerial announceables, and thus rewards to those who successfully bend the ear of ministers in a hurry.  Connections, lobbying, and the ability to spin a good yarn seem to become foremost, with a good dose of partisanship thrown in too.   The extraordinary large grant to a private business  planning to operate a school is just the example that happens to have grabbed the headlines, but there will be more no doubt through the list (apparently not all yet announced) of “shovel-ready projects”, and we’ve seen many through the Provincial Growth Fund almost from day one of its existence.

Don’t get me wrong.  I’m not opposed to the government running deficits –  even really rather large deficits – for a year or two.   Some mix of external events and government actions have tipped the economy into a severe recession and –  against a dismal global backdrop – the outlook is not at all promising.  Tax revenue would be down anyway, and that automatic stabiliser is a desirable feature of the fiscal system.   And one can make –  I have made –  a case for a pretty generous approach across the board to those, through no direct fault of their own, are caught in the backwash of the pandemic.  I’ve argued for thinking of such assistance as if we some ACC-like pandemic insurance, for which we paid the premiums in decades past through higher tax rates/lower government spending rates –  and thus lower debt – than would otherwise have been likely.

And some aspects of the government’s economic policy response have –  whatever their other faults –  had elements of that broadbased no-fault/no-favours approach.   I guess ministers couldn’t put a press statement for each individual who benefited from the wage subsidy, or the weird business tax clawback scheme.  But beyond that, and increasingly, what is supposed to be countercyclical stabilisation policy has become a stage for ministers to choose favourites, to support one and not another, to announce particular bailouts as acts of political favour.  It is a dreadful way to run things, rewarding not just ministerial favourites but the chancers and opportunists who are particularly aggressive in pursuing handouts.  So some tourist operators get handouts and other don’t.  Some sports got handouts and others don’t.     Favoured festivals –  I see the nearby festival on the list this morning –  get handouts.  And, in general, unless you are among the favoured, businesses (the myriad of small and low profile ones) get little or nothing at all.  James Shaw’s green school gets a huge capital grant and while no one –  of any ideological stripe –  should be getting such handouts, we can be quite sure no-one of a different ideological stripe than those associated with the governing parties would be getting one.    Perhaps many people involved really have the best of intentions, but frankly it is corrupt, and predictably so.

I was reading last night an open letter on economic policy that Keynes had addressed to Franklin Roosevelt in late 1933.  It was a bit of mixed bag as a letter, and had really a rather condescending tone, but the couple of sentences that caught my eye were these

“our own experience has shown how difficult it is to improvise useful Loan-expenditures at short notice. There are many obstacles to be patiently overcome, if waste, inefficiency and corruption are to be avoided”

Quite.

Now, of course, elections have consequences, and one would expect a government of the left to be deploying public resources in directions consistent with (a) manifesto commitments, and (b) their own general sympathies.    But in this case (a) the government was elected on a promise (wise or not) of considerable fiscal restraint, and (b) whatever the broad tenor of their policy approach, we should not expect public resources to be handed to individuals or favoured groups and companies, solely on the basis of the ability of those entities to get access to, and bend the ear of, ministers.  And it is not necessary to do so to deploy very substantial fiscal resources –  whether with a focus on consumption, investment, or business etc support more generally.  Broadbased tools, that do not rely on rewarding favourites, aren’t hard to devise or deploy.

More generally, of course, monetary policy is an option that has barely been used at all.   We have a severe recession, with little or no relief in sight (including globally) and yet whereas, faced with a serious downturn, we usually see perhaps a 500 basis point fall in interest rates and a sharp fall in the exchange rate, we’ve had no more than a 100 basis point fall in interest rates and no fall at all in the exchange rate.  And not because of some alarming inflationary threat that means further monetary support can’t prudently be risked…..but because the appointed Monetary Policy Committee, faced with very weak inflation forecasts and lingering higher unemployment, choose to do nothing.  And those with responsibility for the Bank –  the Minister of Finance, and the PM and Cabinet –  seem to be quite content with this abdication.

The beauty of monetary policy, and one of the reasons it has been a preferred stabilisation tool for most of the time since countercyclical macro policy became a thing, is that even if ministers are the ones making the day to day decisions –  and they usually aren’t because we mostly have central banks with day-to-day operational autonomy –  they don’t get to pick which firm, which party favourite, gets the benefit of lower borrowing costs, who suffers from reduced interest income, or what is affected by the lower exchange rate.    It is broad-based instrument, operating without fear or favour, and doing so pervasively –  it takes one decision by the relevant decisionmaking body and relative prices across the whole economy are altered virtually immediately, not some crude process of ministers and officials poring over thousands of applications for grants and loans and deciding –  on who knows what criteria –  whether or not to grant them.  And it has the subsidiary merit, when used wisely, of working with market forces –  in times like these investment demand is weak and precautionary savings demand is high, so one would normally expect –  if no government agency were in the way – the market-clearing interest rate would fall a long way.

On the left there still seems to be a view that monetary has done a great deal, and perhaps all it could.  I saw the other day a commentary from retired academic Keith Rankin on fiscal and monetary policy.  He claims not to be a “left-wing economist” –  although I suspect most would see him as generally being on the left –  but has no hesitation in pegging me as “right-wing economist”.  Apparently “right-wing economists tend to have a philosophical preference for monetary policy over fiscal policy”.   Anyway….he was picking up on some comments I made in a recent interview on Radio New Zealand.

To a non-right-wing economist, Reddell’s position in the interview seems strange; Reddell argues that New Zealand has – so far during the Covid19 pandemic – experienced a large fiscal stimulus and an inadequate monetary stimulus. In fact, while the fiscal outlay is large compared to any previous fiscal stimulus, much of the money available may remain unspent, and the government is showing reluctance to augment that outlay despite this month’s Covid19 outbreak. And, as a particular example, the government keeps pouring salt into the running sore that is the Canterbury District Health Board’s historic deficit (see here and here and here and here); the Minister of Health showed little sign of compassion towards the people of Canterbury when questioned about this on yesterday’s Covid19 press conference.

Further, monetary policy has been very expansionary. In its recent Monetary Policy Statement (and see here), the Reserve bank has committed to ongoing expansions of the money supply through quantitative easing. Because the Reserve Bank must act as a silo, however, it has to participate in the casino (the secondary bond market) to do this; perhaps a less than ideal way to run monetary policy. Reddell has too much faith in the ability of the Reserve Bank to expand business investment spending.

Reddell is a committed supporter of negative interest rates – indeed he cites the same American economist, Kenneth Rogoff, who I cited in Keith Rankin on Deeply Negative Interest Rates (28 May 2020). This call for deeply negative rates is tantamount to a call for negative interest on bank term deposits and savings accounts; that is, negative ‘retail interest rates’. While Reddell does not address the issue in the short interview cited, Rogoff notes that an interest rate setting this low would require something close to a fully electronic monetary system to prevent people withdrawing wads of cash to stuff under the bed or bury under the house.

I struggle to see how anyone can doubt that we have had a very large fiscal stimulus this year to date.  One can debate the merits of extending (or not) the wage subsidy –  personally (despite being a “right-wing economist”) I’d have favoured the certainty my pandemic insurance scheme would have provided –  but it doesn’t change the fact a great deal has been spent.  Similarly, one can have important debates about the base level of health funding –  and I’ve run several posts here in recent years expressing surprise at how low health spending as a share of GDP has been under this government, given their expressed priorities and views –  but it isn’t really relevant to the question of the make-up of the countercyclical policies deployed this year.  With big government or small government in normal times, cyclical challenges (including serious ones like this year’s) will still arise.

And so the important difference seems to turn on how we see the contribution of monetary policy.  Here Rankin seems to run the Reserve Bank line –  perhaps even more strongly than they would –  about policy being “highly expansionary”, without pointing to any evidence, arguments, or market prices to support that.  It is as if an announced intent to swap one lot of general government low-interest liabilities (bonds) for another lot (settlement cash deposits at the Reserve Bank) was hugely macroeconomically significant.  Perhaps it is, but the evidence is lacking…whether from the Reserve Bank or from those on the left (Rankin and others, see below) or those on the right (some who fear it is terribly effective and worrying about resurgent inflation.

While on Rankin, I just wanted to make two more brief points:

    • first, Rankin suggests I “have too much faith in the ability  of the Reserve Bank to expand  business investment spending”.  That took me by surprise, as I have no confidence in the Bank’s ability to expand investment spending directly at all, and nor is it a key channel by which I would be expecting monetary policy to work in the near-term.  It really is a straw man, whether recognised as such, often cited by those opposed to more use of monetary policy.  Early in a recession –  any recession –  interest rates are never what is holding back investment spending –  that would be things like a surprise drop in demand, heightened uncertainty, and perhaps some unease among providers of either debt or equity finance.  Only rarely do people invest into downturns,  When they can, they will postpone planned investment, and wait to see what happens.  There is a whole variety of channels by which monetary policy works –  and I expect I’m largely at one with the Reserve Bank on this –  including confidence effects, wealth effects, expectations effects and (importantly in New Zealand) exchange rate effects.  Be the first country to take its policy rate deeply negative and one would expect a significant new support for our tradables sector through a much lower exchange rate.  In turn, over time, as domestic and external demand improved investment could be expected to rise, in turn supported by temporarily lower interest rates, but that is some way down the track.
    • second, as Rankin notes I have continued to champion the use of deeply negative OCR (and right now any negative OCR at all, rather than the current RB passivity).  As he notes, in the interview he cites I did not mention the need to deal with the ability to convert deposits into physical cash at par, but that has been a longstanding theme of mine.  I don’t favour abolishing physical currency, but I do favour a potentially-variable premium price on large-scale conversions to cash (as do other advocates of deeply negative policy rates).  Those mechanisms would be quite easy to put in place, if there was the will to use monetary policy.

From people on the left-  at least in the New Zealand media –  there also seems to be some angst that (a) monetary policy has done a great deal, and that (b) in doing so it has exacerbated “inequality” in a way that we should, apparently, regret.   I’ve seen this line in particular from interest.co.nz’s Jenee Tibshraeny and (including again this morning) from Stuff’s Thomas Coughlan.  On occasion, Adrian Orr seems to give some encouragement to this line of thinking, but I think he is mostly wrong to do so

Perhaps the most important point here is the otherwise obvious one.  The worst sort of economic outcome, including from an inequality perspective (short or long term) is likely to be one in which unemployment goes up a long way and stays high, and where labour market participation rates fall away.  Sustained time out of employment, involuntarily, is one of the worst things for anyone’s lifetime economic prospects, and if some of the people who end up unemployed have plenty of resources to fall back on, the burden of unemployment tends to fall hardest on the people at the bottom, people are just starting out, and in many cases people from ethnic minorities (these are often overlapping groups).  From a macroeconomic policy perspective, the overriding priority should be getting people who want to work back into work just as quickly as possible.   That doesn’t mean we do just anything –  grants to favoured private companies to build new buildings are still a bad idea  – but it should mean we don’t hold back on tools with a long track record of contributing effectively to macroeconomic stabilisation because of ill-defined concerns about other aspects of “inequality”.

Asset prices appear to worry people in this context.    I’m probably as puzzled as the next person about the strength of global equity prices –  and I don’t think low interest rates (low for a reason) are a compelling story –  but it is unlikely that anything our Reserve Bank is doing is a big contributor to the current level of the NZX indices.  Even if it were, that would not necessarily be a bad thing, since one way to encourage new real investment is as the price of existing investment assets rises relative to the cost of building new.

And if house prices have risen a little (a) it is small compared to the 25 year rise governments have imposed on us, and (b) not that surprising once the Reserve Bank eased the LVR restrictions for which there was never a compelling financial stability rationale in the first place.

More generally, I think this commentators are still overestimating (quite dramatically) what monetary policy has done.   I read commentaries talking about “money flowing into the hands of asset holders” (Coughlan today) from the LSAP programme, but that really isn’t the story at all.  Across this year to date there has been little change in private sector holdings of government bonds, and certainly no large scale liquidation by existing holders (of the sort that sometimes happened in QE-type programmes in other countries).  Most investors are holding just as many New Zealand government bonds as they were.  All that has really happened is that (a) the government has spent a great deal more money than it has received in taxes, (b) that has been initially to them by the Reserve Bank, and (c) that net fiscal spending is mirrored in a rise in banks’ settlement account deposit balances at the Reserve Bank.  It would not have made any difference to anything that matters much if the Reserve Bank had just given the government a huge overdraft facility at, say, 25 basis points interest, rather than going through the bond issuance/LSAP rigmarole.  The public sector could have sold more bonds into the market instead, in which case the private sector would be holding more bonds and less settlement cash.  But the transactions that put more money in people’s pockets –  people with mortgages, people with businesses –  are the fiscal policy programmes.   Without them we might, reasonably, have anticipated a considerably weaker housing market.  Since few on the left would have favoured less fiscal outlays this year –  and neither would I for that matter –  they can’t easily have it both ways (Well, of course, they could, but the current government of the left has been almost as bad as previous governments of the left and right in dealing with the land use restrictions that create the housing-related dimensions of inequality.

Coughlan also seems to still belief that what happens to the debt the government owes the (government-owned and controlled) Reserve Bank matters macroeconomically.  See, on this, his column in last weekend’s Sunday Star-Times.   As I outlined last week, this is simply wrong: what matter isn’t the transactions between the government and the RB, but those between the whole-of-government and the private sector.  Those arise mostly from the fiscal policy choices.  The whole-of-government now owes the non-government a great deal more than it did in February –  reflecting the fiscal deficit.  That happens to take the form primarily of much higher settlement cash balances, but it could have been much higher private bond holdings.   Either way, the asset the Reserve Bank holds is largely irrelevant: the liabilities of the Crown are what matter.  And as the economy re recovers one would expect that the government will have to pay a higher price on those liabilities.   It could avoid doing so –  simply refusing to, engaged in “financial repression” –  but doing so would not avoid the associated real resource pressures. The same real resources can’t be used for two things at once.  Finally on Coughlan’s article, it seems weird to headline a column “It’s not a question of how, but if we’ll pay back the debt” when, on the government’s own numbers and depending on your preferred measure, debt to GDP will peak at around 50 per cent.  Default is usually more of a political choice than an economic one, but I’d be surprised if any stable democracy, issuing its own currency, has ever chosen to default with such a low level of debt –  low relative to other advanced countries, and (for that matter) low relative to our own history.

Monetary policy really should have been –  and should now, belatedly –  used much more aggressively.  It gets in all the cracks, it avoids the temptations of ministerial corruption, it works (even the RB thinks so), and it has the great merit that in committing claims over real resources the people best-placed to make decisions –  individual firms and households, accountable for their choices –  are making them, not politicians on a whim.

For anyone interested, the Reserve Bank Governor Adrian Orr is talking about the Bank’s use of monetary policy this year at Victoria University at 12:30pm today.  The event is now entirely by Zoom, and the organisers invited us to share the link with anyone interested.

Reviewing monetary policy (US) and spin (NZ)

There was an interesting development in US monetary policy last week with the announcement by the Fed that it would in future be thinking of  –  and operating – its inflation targeting regime a bit differently than in the past.  Note that for the last decade or more inflation has typically been below the 2 per cent annual rate (PCE deflator measure) the Fed described itself as targeting.

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

Note that the US system itself is very different from our own.   Congress gave the Fed a single goal a long time ago, expressed in a way no one would today,

Section 2A. Monetary policy objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

And then left everything to the Fed.  The President (or the The Treasury) has no further power over how goals are conceptualised and operationalised, other than through powers of appointment (and potentially dismissal).

And last week, after a review that has gone on for some years, the Fed announced a new articulation of its target (emphasis added)

The Committee reaffirms its judgment that inflation at the rate of 2 percent, as
measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee’s ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.

Reasonable people can probably differ on the merits of this change which, at least on paper, represents quite a material shift from the way inflation targets have been articulated pretty much everywhere since the regime was developed in the 1990s.

Previously, bygones were treated as bygones: if inflation was above (below) target for a period of time, the goal was to get it back down (up) to target over some reasonable period, and thus to support the goal –  repeated in that Fed statement –  of keeping longer-term inflation expectations at close to the target level.    Mistakes would happen, shocks would happen, but there was no reason to think they would be consistently on one side of the target rather than the other.

There was always the alternative of price level targeting.  People had discussed the option for years, researchers had analysed it, but no one (no country, no central bank) had ever found it sufficiently attractive to adopt as the basis for running policy.  There are good reasons for that.  Under price-level targeting, bygones are not bygones.  Run a few years with inflation higher (lower) than consistent with the price level target, and the central bank then has to deliberately and consciously set out to offset that deviation with a few years of inflation lower (higher) than the rate consistent with the longer-term price level target.  And since there are very few long-term nominal contracts, it was never really clear what was to be gained by a price level target.  And there were real doubts as to whether such targets would prove to be credible and time-consistent.   Would central banks really drive inflation a long way below target –  with likely unemployment consequences –  just to offset a period of above-target inflation?  At the Reserve Bank we never thought that likely or credible.

But the Fed has decided to give it a try, at least after a fashion.  As expressed, their new self-chosen goal is asymmetric –  there is no reference to how they would treat periods in which inflation had run persistently above 2 per cent  –  and it has the feel of something a bit jerry-built and opportunistic.

Like a number of other central banks, the Fed has undershot its inflation target for some years now. In part, as they themselves identify, that reflected mistakes in assessing how low the unemployment rate could go without resulting in higher trend inflation.   Arguably there is enough uncertainty about that –  and other indicators of excess capacity – that it no longer really made much sense to try to set and adjust the Fed funds rate on the basis of macroeconomic forecasts (a common description of inflation targeting was that it was really “inflation forecast targeting”).    If so, one might have to wait until one actually saw inflation itself moving clearly upwards. to or beyond target, before it would be safe or prudent to tighten monetary policy.  But since monetary policy adjustments only work with a lag –  a standard line is that the full effects take perhaps 18-24 months to be reflected in the inflation rate – if such an approach was taken seriously it would almost guarantee that if inflation had been persistently below target, there would be at least some offsetting errors later.  In a New Zealand context –  on which more later –  I’ve argued that against a backdrop of 10 years of having undershot the target, and inflation expectations quite subdued, if we ended with a few years with inflation a bit above 2 per cent it shouldn’t be viewed as particularly problematic.  As an outcome, it might not be a first-best desired thing, but –  given the uncertainties –  it wasn’t worth paying a significant price (eg in lost employment) to avoid.

But that has a different feel to what the Fed is now articulating.  They are now saying that they expect to consciously and deliberately set out to offset years of undershoots with years of overshoots.  And you can be sure it won’t be a case of careless drafting but of conscious choice.

There is perhaps one good argument for this approach.   Since the Fed refuses to use monetary policy instruments themselves aggressively to counter directly the persistent inflation undershoot, and more latterly the recession –  notably refusing to take their policy rate even modestly negative, let alone the “deeply negative” that people like former IMF chief economist Ken Rogoff have called for – they want to try to hold up inflation expectations by persuading some people that they won’t be aggressive on the other side either –  jumping to tighten monetary policy at the first glimmer of sustained recovery, the first hint of higher inflation.

There are some hints in market prices – breakeven inflation rates, between indexed and conventional government bond yields –  that the announcement generated a small move of this sort. But…..breakeven inflation rates in the US had been rising fairly steadily for the last few months, and even now are only back to where they were at the end of last year.      That isn’t nothing – especially against the economic backdrop – but at the end of last year five and ten year breakevens were not high enough to be consistent with the Fed meeting its own target in future.  And now they certainly aren’t consistent with inflation outcomes being expected to overshoot the 2 per cent inflation target for several years, to consciously offset the past undershoots.

And then there is the problem of time-consistency.  It is one thing to suggest now that you –  or, typically, your successors –  will be quite content to deliberately target inflation persistently above target for several years several years in the future.  It is quite another to actually deliver on that.    Like many other central banks, the Fed has consistently undershot its target for a long time, preferencing one sort of error over another.  Why will people believe things will be different this time?  The Fed isn’t operating monetary policy more aggressively right now.  And if the core inflation rate does look like getting sustainably back to 2 per cent in a few years, won’t there be plenty of people running arguments like “well, that was then, that statement about overshooting served a purpose in the crisis, but this is now, the economy is recovering, and anyway who really wants core inflation above 2 per cent.  Remember, inflation itself is costly.”    And any rational observer will have to recognise that risk.

In the absence of a symmetrical approach to errors, one has to wonder why not just raise the inflation target itself –  something various prominent economists have called for over the years since 2008/09.  But perhaps to have done that would have stretched credulity just too far: it is one thing to set an inflation target at, say, 3 or even 4 per cent, but another to do effective things to actually deliver such an outcome.  The monetary policy the Fed has actually chosen to run –  and they are all choices –  over the last decade hasn’t successfully delivered 2 per cent inflation, let alone anything higher.

Interesting as the US change of stance is, my main focus is still New Zealand, and so I was interested to spot a short article on Bloomberg yesterday. in which the journalist reported on our Reserve Bank’s response to questions about the new Fed monetary policy strategy.    Somewhat surprisingly, Orr’s chief deputy on monetary policy Christian Hawkesby was willing to go on record.

“Our observation is that the U.S. Federal Reserve implementing its approach through ‘flexible average inflation targeting’ has a number of parallels with the Monetary Policy Committee’s stated preference to take a ‘least regrets’ approach to achieving its inflation and employment objectives,” Hawkesby said in response to written questions from Bloomberg News. “That is, if inflation has been below the mid-point of the target range for a time, the Committee’s least regret is to set policy where inflation might spend some time above the mid-point of the target range in the future.”

That final sentence might initially look the same as what the Fed is now saying, but it isn’t really the same thing.   From memory, we have seen lines of this sort once or twice before from individuals at the Reserve Bank,  and they seemed then to be saying something like what I was suggesting earlier: since it is hard to forecast with confidence, it probably doesn’t make much sense to be tightening until you are confident core inflation is actually back to target, and if so the lags mean there has to be some chance there will be a bit of an overshoot.    That is different in character from actually setting out to deliver above-target outcomes.

As it is, the policy documents the Reserve Bank works to still explicitly require them to focus on the target midpoint, and explicitly treat bygones as bygones in most circumstances –  so long as inflation expectations remain in check.

Here is the inflation bit of the Remit –  the document in which, by law, the Minister of Finance sets out the job of the MPC.

remit bit

The operative word there is “future”  – which has been in target documents (previously Policy Targets Agreements) – for many years.  Bygones are supposed to be treated as bygones, with a focus always on inflation in the period ahead.

I checked out the latest Letter of Expectation from the Minister to the Governor, dated early April this year (so well into the current crisis).   These documents have no legal force, but the Minister of Finance is the ultimate authority, including in deciding whether the Governor and MPC members keep their jobs.    There is no mention of the inflation target, and no suggestion that the Minister thinks the MPC should be reinterpreting their legal mandate to target inflation outcomes above the “2 percent midpoint” (only the strange suggestion that the Bank should be “ensuring a Māori world view is incorporated into core functions” –  whatever that might (or might not) mean for monetary policy.

Just in case, I read through the minutes of each of the Monetary Policy Committee meetings this year.  Unsurprisingly there was no hint of any idea of actively targeting inflation above the target midpoint –  despite 10 years of outcomes below target.    Consistent with that, in February the MPC has adopted a very slight tightening bias consistent with forecasts that delivered medium-term inflation outcomes right on 2 per  cent.

But, of course, none of this should be surprising given how little the Reserve Bank has actually done this year.    We can debate what contribution the LSAP programme may or may not have made, but the bottom line –  as even the RB says –  is how much interest rates have fallen,  Term deposits rates have fallen by perhaps 100-120 basis points.  Mortgage interest rates seem to have fallen by similar amounts (and as the Bank acknowledges their business lending rate data are inadequate for purpose).   Inflation expectations have fallen quite a lot –  affirmed again in yesterday’s ANZ survey – which is both a problem directly (people no longer expect 2 per cent to be achieved) and because it diminishes the impact of those (quite limited by historical standards) falls in nominal retail rates.  And, of course, the exchange rate is only slightly lower than it was before the Covid economic slump.

And what of the inflation outlook?  With all the Reserve Bank thinks it has thrown at the situation –  all the beneficial impact it thinks it is getting from the LSAP – even the Bank’s August inflation projections had inflation below the bottom of the target range for two years from now, only getting back to 2 per cent –  on their numbers, on which they have a long-term record of being over-optimistic –  three years from now.   By then it would have been almost 14 years with core inflation continuously less than 2 per cent.

Despite those years of actual undershoots –  the sorts of ones Hawkesby alluded to in his response to Bloomberg –  there is no hint at all in the actual conduct of policy of the Reserve Bank consciously and deliberately acting as if it is willing to see inflation come out a bit above 2 per cent (of course, it could still turn out that way, events can change and all forecasts have considerably margins of uncertainty).

After all, having failed in one of their prime duties –  to ensure banks could easily adjust to the negative interest rates they recognised that the next recession might require – they now suggest that they are bound by a rash pledge they made in March, not to change the OCR at all for a year.  No one except them regards such a pledge –  and certainly not one made when the Bank itself was still underestimating coronavirus –  as binding.  But they choose to do so, choose to run the consequent risks.  Thus, the OCR is still set at 0.25 per cent, only 75 basis points lower than it was at the start of the year.  90 day bank bill rates, as a result, sit at about 30 basis points.  By contrast in Australia –   where the Governor is also pretty hesitant about using monetary policy aggressively – the comparable rates are about 10 basis points.  Even if one accepted as valid the Governor’s claim that banks can’t cope with negative rates –  and I don’t; people adjust quickly when they have to, and those who are best-prepared get a jump on the rest, as it should be –  there is no reason at all not to have the OCR at zero now (and don’t tell me systems can’t cope with zero either, since there are numerous non-interest bearing products).   The MPC chooses not to change, and as a result monetary conditions are tighter than they need to be.   Of course, 25 basis points in isolation isn’t huge –  in typical recession we have 500+ points of easing –  but when so little has been done, when inflation forecasts and expectations are so low, and against the backdrop of a consistent undershoot, it is inexcusable not to use the capacity that unquestionably exists now, not idly talking of possible cuts sometime next year.

The MPC is running risks, but they are the opposite of those the Assistant Governor alluded to.  His attempt to suggest some sort of parallel with the new Fed approach –  which, in fairness, we have yet to see making real differences to policy –  has the feel of opportunistic spin.

(For those recalling my past emphasis on New Zealand inflation breakevens, yes I am conscious that they have risen a long way in the last few weeks.    I’m not sure quite what to make of that –  especially as it has been reflected in a sharp fall in real yields (20 year indexed bond (real) yields are down 40+ basis points over August) –  and it is certainly better than the alternative. But we still left with inflation breakeven numbersthat, even on the surface, are no higher than they were at the end of last year, when they were not consistent with the Bank consistently delivering on the inflation target,)

MMT

So-called Modern Monetary Theory (MMT) has been attracting a great deal more attention than usual this year.  I guess that isn’t overly surprising, in view of (a) the severe recession the world is now in, and (b) the passivity and inaction (and the ineffectiveness of what actions they do take) of central banks, those with day-to-day responsibility for the conduct of monetary policy.

Until about three years ago I had had only the haziest conception of what the MMTers were on about.  But then Professor Bill Mitchell, one of the leading academic (UNSW) champions of MMT ideas, visited New Zealand, and as part of that visit there was a roundtable discussion with a relatively small group in which I was able to participate.  I wrote about his presentation and the subsequent discussion in a post in July 2017.   I’d still stand by that.  (As it happens, someone sent Mitchell a link to my post and he got in touch suggesting that even though we disagreed on conclusions he thought my representation of the issues and his ideas was “very fair and reasonable”.)  But not many people click through to old posts and, of course, the actual presenting circumstances are quite a bit different now than they were in the New Zealand of 2017.  Back then, most notably, there was no dispute that the Reserve Bank had a lot more OCR leeway should events have required them to use it.

Among the various people championing MMT ideas this year, one of the most prominent is the US academic Stephanie Kelton in her new book The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (very widely available – I got my copy at Whitcoulls, a chain not known for the breadth of its economics section).   Since it is widely available –  and is very clearly written in most places – it will be my main point of reference in this post, but where appropriate I may touch on the earlier Mitchell discussion and this recent interview on interest.co.nz with another Australian academic champion of MMT ideas.

As a starting point, I reckon MMT isn’t particularly modern, is mostly about fiscal policy, and is more about political preferences than any sort of theoretical framework (certainly not really an economics-based theoretical framework).     But I guess the name is good marketing, and good marketing matters, especially in politics.

The starting proposition is a pretty elementary one that, I’d have thought, had been pretty uncontroversial for decades among central bankers and people thinking hard about monetary/fiscal interactions: a government with its own central bank cannot be forced –  by unavailability of local currency –  to default on its local currency debt.  They can always “print some more” (legislating to take direct control of the central bank if necessary).  So far so good.  But it doesn’t really take one very far, since actual defaults are typically more about politics than narrow liquidity considerations and governments may still choose to default, and the actual level of public debt (share of GDP) maintained by advanced countries with their own currencies varies enormously.

A second, and related, point is that governments in such countries don’t need to issue bonds –  or raise taxes – to spend just as much as they want, or run deficits as large as they want.  They can simply have the central bank pay for those expenses.  And again, at least if the appropriate legislation was worded in ways that allowed this (which is a domestic political choice) then, of course, that is largely true.  That means governments of such countries are in a different position than you and I –  we either need to have earned claims on real resources, or have found an arms-length lender to provide them, before we spend.    Again, it might be a fresh insight to a few politicians –  Kelton spent a couple of years, recruited by Bernie Sanders, as an adviser to (Democrat members of) the Senate Budget Committee, and has a few good stories to tell.  But to anyone who has thought much about money, it has always been one of the features –  weaknesses, and perhaps a strength on occasion – of fiat money systems.

Kelton also devotes a full chapter to the identity that any public sector surplus (deficit) must, necessarily, mean a private sector deficit (surplus).  Identities can usefully focus the mind sometimes in thinking about the economy, but I didn’t find the discussion of this one particularly enlightening.

It all sounds terribly radical, at least in potential.  One might reinforce that interpretation with Kelton’s line that “in almost all instances, fiscal deficits are good for the economy. They are necessary.”

But in some respects –  at least as a technical matter –  it is all much less radical than it is sometimes made to sound.   As a matter of technique and institutional arrangements, it is mostly akin to “use fiscal policy rather than monetary policy to keep excess capacity to a minimum consistent with maintaining low and stable inflation”.    Supplemented by the proposition that advance availability of cash –  taxes, on-market borrowing –  shouldn’t be the constraint on government spending, but rather that the inflation outlook should be.

Quoting Kelton again “it is possible for governments to spend too much. Deficits can be too big”.

What isn’t entirely clear is why, as a technical matter, the MMTers prefer fiscal policy to monetary policy as a stabilisation policy.    In the earlier discussion with Bill Mitchell, it seemed that his view was the monetary policy just wasn’t as (reliably) effective as fiscal policy.  In Kelton’s book, it seems to reflect a view that using monetary policy alone there is inescapable sustained trade-off between low inflation and full employment (a view that most conventional macroeconomists would reject), and that only fiscal policy can fill the gap, to deliver full employment.    Kelton explicitly says “evidence of a deficit that is too small is unemployment” –  it seems, any unemployment, no matter how frictional, no matter how much caused by other labour market restrictions.

I can think of two other reasons.  The first is quite specific to the current context.  Some might prefer fiscal policy because they believe monetary policy has reached its limits (some effective lower bound on the nominal policy rate).   Kelton’s book was largely finished before Covid hit –  and US rates at the start of this year weren’t super-low –  but it seems to be a factor in the current interest in MMT.     The other reason –  not really stated, but sometimes implied by Kelton – is that central bankers might have been consistently running monetary policy too tight – running with too-optimistic forecasts and in the process falling down on achieving what they can around economic stabilisation.  Since 2007 I’d have quite a bit of sympathy with that view –  although note that in New Zealand prior to 2007 inflation was consistently too high relative to the midpoint of the target ranges governments had set.  But it is, at least initially, more of an argument for getting some better central bankers, or perhaps even for governments to take back day-to-day control of monetary policy, than an argument for preferring fiscal policy over monetary policy as the prime macro-stabilisation tool.

But in general there is little reason to suppose that fiscal policy is any more reliably effective than monetary policy.  Sure, if the government goes out and buys all the (say) cabbages in stock that is likely to directly boost cabbage production.  If –  in a deep recession – it hires workers to dig ditches and fill them in again that too will directly boost activity.  But most government activity –  taxes and spending (and MMTers aren’t opposed to taxes, in fact would almost certainly have higher average tax rates than we have now) –  aren’t like that.  If it is uncertain what macro effect a cut in the OCR will have, it is also uncertain how  –  and how quickly – a change in tax rates will affect the economy, and even if governments directly put money in the pockets of households we don’t know what proportion will be saved, and how the rest of the population might react to this fiscal largesse.  In principle, there is no particular reason why fiscal policy should be better, as a technical matter, than monetary policy in stabilising economic activity and inflation.  But Kelton just seems to take for granted the superiority of fiscal policy, and never really seems to engage with the sorts of considerations that led most advanced countries –  with their own central banks, borrowing in local currencies –  to assign stabilisation functions to monetary policy, at arms-length from politicians, while leaving longer-term structural choices around spending and tax to the politicians.

These probably shouldn’t be hard and fast assignments. In particular, there are some things only  governments (fiscal policy) can do.  Thus, if an economy largely shuts down –  whether from private initiative or government fiat –  in response to a pandemic, monetary policy can’t do much to feed the hungry.  Charity and fiscal initiatives are what make a difference in this very immediate circumstances –  just as after floods or other severe natural disasters.    And we consciously build in some automatic stabilisers to our tax and spending systems.  But none of that is an argument for junking monetary policy completely, whether that monetary policy is conducted by an independent agency, or whether such agencies (central banks) just serve as technical advisers to a decisionmaking minister (as, for example, tended to be the norm in post-war decades in most advanced countries, including New Zealand).

The MMTers claim to take seriously inflation risk.  This is from the Australian academic interest.co.nz interviewed (Kelton has very similar lines, but I can cut and paste the other)

“They should always be looking at inflation risk. Because when we say that our governments can never become insolvent, what we are saying is that there is no purely financial constraint that they work under. But there is still a real constraint. So New Zealand has a limited productive capacity. Limited by the labour and skills of the people and capital equipment, technology, infrastructure and the institutional capacity of business organisations and government in New Zealand. That limits the quantities of goods and services that can be produced there is a limitation there. Also it depends on the natural resources of a country,” says Hail.

“If you spend beyond that productive capacity it can be inflationary and that can frustrate your objectives, frustrate what you’re trying to do. So it’s always inflation risks that’s important. Within that productive capacity, however, what it is technically possible to do the Government can always fund. So yes, you can fund any of those things but there’s always an inflation risk and that inflation risk is not specific to government spending. It’s specific to all spending.”

There is a tendency to be a bit slippery about this stuff.  Thus Kelton devotes quite some space to a claim that government spending/deficits can’t crowd out private sector activity.  And she is quite right that the government can just “print the money” –  so in a narrow financing sense there need not be crowing out –  but quite wrong when it comes to the real capacity of the economy.  Real resources can’t be used twice for the same thing.  When the attempt is made to do so, that is when inflation becomes a problem –  and the MMTers aver their seriousness about controlling inflation (and I take them at their word re intentions).

Partly I take them at their word because Kelton says “the economic framework I’m advocating for is asking for more fiscal responsibility from the federal government not less”.     And it certainly does, because instead of using monetary policy, the primary stabilisation role would rest with fiscal policy.  That might involve easy choices for politicians flinging more money around to favoured causes/people in bad times, but it involves exactly the opposite when times are good, resources are coming under pressure, and inflation risks are mounting.  Under this model, a government could be running a fiscal surplus and still have to take action to markedly tighten fiscal policy because –  in their own terms –  it isn’t deficits or surpluses that matter but overall pressure on real resources.  And they want fiscal policy to do all the discretionary adjustment.

Maybe, just maybe, that is a model that could be made to work in (say) a single chamber Parliament, elected under something like FPP, so that there is almost always a majority government.  Perhaps even in New Zealand’s current system, at a pinch, since to form a government the Governor-General has to be assured of supply.

But in the US, where party disciplines are weak, different parties can control the two Houses, and where the President is another force completely.     What about US governance in the last 30 years would give you any confidence in the ability to use fiscal policy to successfully fine-tune economic activity and inflation, while respecting the fundamental powers of the legislature (no taxation without representation, no expenditure without legislative appropriation)?   In a US context, I’m genuinely puzzled about that. [UPDATE:  A US commentator on Twitter objected to the use of ‘fine-tune” here, suggesting it wasn’t what the MMTers are about.  Perhaps different people read “fine-tune” differently, but as I read MMTers they are committed to maintaining near-continuous full employment, and keeping inflation in check, and even if some like rules –  rather than discretion –  it seems to me frankly no more likely that preset rules for fiscal policy would successfully accomplish that macrostabilisation than preset rules for monetary policy did.  “Successfully managed discretion” is what I have in mind when talking about “fine-tuning” in this context.]

But even in a relatively easy country/case like New Zealand using fiscal policy that way doesn’t seem at all attractive.    It takes time to legislate (at least when did properly).  It takes time to put most programmes in place, at least if done well –  and don’t come back with the wage subsidy scheme, since few events will ever be as broad-brush and liberal as that, especially if fine-tuning is what macro-management is mostly about.   And every single tax or spending programme has a particular constituency –  people who will bend the ear of ministers to advance their cause/programme and resist vociferously attempts to wind such programmes back.  And there are real economic costs to unpredictable variable tax rates.

By contrast –  and these are old arguments, but no less true for that  – monetary policy adjustments can be made and implemented instantly.  They don’t have their full effect instantly, but neither do those for most fiscal outlays –  think, at the extreme, of any serious infrastructure project.   And monetary policy works pretty pervasively –  interest rate effects, exchange rate effects, expectations effects (“getting in all the cracks”) –  which is both good in itself (if we are trying to stabilise the entire economy) and good for citizens since it doesn’t rely on connections, lobbying, election campaign considerations, and the whim of particular political parties or ministers.  And what would get cut if/when serious fiscal consolidation was required?  Causes with the weakest constituencies, the least investment in lobbying, or just causes favoured by the (at the time) political Opposition.     Perhaps I can see some attraction for some types of politicians –  one can see at the moment how the government has managed to turn fiscal stabilisation policy into a long series of announceables for campaigning ministers, rewarding connections etc rather than producing neutral stabilisation instruments –  but the better among them will recognise that it is no way to run things.  It is the sort of reason why shorter-term stabilisation was assigned to monetary policy in the first place.

Reverting to Kelton, her book is quite a mix.  Much of the first half is a clear and accessible description of how various technical aspects of the system work, and what does and doesn’t matter in extremis.   But do note the second half of the book’s title (“How to Build a Better Economy”): the second half of the book is really an agenda for a fairly far-reaching bigger government – (much) more spending, and probably more taxes.    There is material promoting lots more (government) spending on health, welfare, infrastructure, and so on –  all the sort of stuff the left of the Democratic Party in the USA is keen on.

That is the stuff of politics, but it really has nothing at all to do with the question of whether fiscal or monetary policy is better for macro-stabilisation.   I guess it may be effective political rhetoric –  at least among the already converted –  to say –  as Kelton does –  “cash needn’t be a constraint on us doing any of this stuff”.  But –  and this is where I think the book verges on the dishonest (or perhaps just a tension not fully resolved in her own mind) – the constraint, or issue, is always about real resources, which  – per the quote above –  can’t be conjured out of thin air.    Resources used for one purpose can’t be used for others, and even if some forms of government spending (or lower taxes?) might themselves be growth-enhancing in the long run, that can’t just be assumed, and almost certainly won’t be the case for many of the causes Kelton champions (or that local advocates of MMT would champion).

I can go along quite easily with much of Kelton’s description of how the technical aspects of economies and financial systems work, but the really hard issues are the political ones.   So, of course, we needn’t stop government spending for fear that a deficit will quickly lead to default and financial crisis, or because in some narrow sense we don’t have the cash available in advance.   But we still have to make choices, as a society, about where government programmes and preferences will be prioritised over private ones –  the contest for those scarce real resources, consistent with keeping inflation in check.    And we know that rigorous and honest evaluation of individual government tax, spending and regulatory programmes is difficult to achieve and maintain.  And we know that programmes committed to are hard to end,  And that government failure is at least as real a phenomenon as market failure –  and quite pervasive when it comes to many spending programmes.    And so while Kelton might argue that, for example, balanced budget rules (in normal circumstances, on average over the cycle) are some sort of legacy of different world, something appropriate and necessary for households but not a necessary constraint for governments, I’d run the alternative argument that they act as check and balance, forcing governments to think harder –  and openly account for –  choices they are making about whose real resources will be paying for the latest preferrred programme.

Kelton tries to avoid these issues in part by claiming that “outside World War Two, the US never sustained anything approximating full employment”,  and yet she knows very well that real resource constraints still bind –  inflation does pick up, and was a big problem for a time.  Hard choices need to be made –  not by the hour (government cheques can always be honoured) but over any longer horizon.

There are perfectly reasonable debates to be had about the appropriate size of government. but they really have nothing to do with the more-technical aspects of the MMT argument.  Even if, for example, one accepted the MMT claim that there was something generally beneficial about fiscal deficits, we could run deficits –  presumably still varying with the cycle –  with a government spending 25 per cent of GDP (less than New Zealand at present) or 45 per cent of GDP (I suspect nearer the Kelton preference).

This post has probably run on too long already.  Perhaps I will come back in another post to elaborate a few points.  But before finishing this post I wanted to mention one of the signature proposals of the MMTers – the job guarantee.  There is apparently some debate as to just how central such a scheme is –  that is really one for the MMTers to debate among themselves, although it seems to me logically separable from issues around the relative weight given to fiscal and monetary policy.   I covered some of the potential pitfalls in the earlier post and I’m still left unpersuaded that the scheme has anything like the economic or social benefits the MMTers claim for it, even as I abhor the too-common indifference of authorities (fiscal and monetary to entrenched unemployment.  In the current context, one could think of the wage subsidy scheme as having had some functional similarities, but it is a tool that kept people connected to (what had been) real jobs, and which works well for identifiable shocks of known short duration.  That seems very different from the sort of well-intentioned job creation schemes the MMTers talk about. From the earlier post

It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the private market?

And much of Kelton’s idealistic discussion of the job guarantee rather overlooked the potential corruption of the process –  favoured causes, favoured individuals, favoured local authorities getting funding.  It is a risk in New Zealand, but it seems a near-certainty in the United States.

Abdication of responsibility

There was stuff to like in yesterday’s Monetary Policy Statement and the associated press conference.

There was the remarkable statement from the Governor that “we don’t comment on government policy”, which we can only hope –  unrealistically –  heralds a new policy for the Governor (as it was it simply got him off the hook of answering an inappropriate question about lockdown policy etc).

More seriously, there was some sense that the MPC and the Bank were beginning to appreciate just how poor the world economic outlook is. I wouldn’t go quite as far as ANZ”s chief economist whom I saw reported in the paper this morning saying “it was hard to imagine a more dovish sets of policies and commentary today”, but my own initial comment to a journalist re the commentary etc was

The overall tone –  downside risks, worrying world economy situation –  is encouraging

It is a step in the right direction, even if there is little depth to the analysis (and, for example, no links to more-rigorous supporting analysis).   And of course even the Bank was caught out between the projections being finalised (on the 5th) and released: they’d idly assumed a “level 1” regime from June on.  Perhaps they had little choice in the central track, but there was far too little about the risks of new “lockdowns” and (a) the associated real income/output losses, and (b) associated addition to the already high level of uncertainty facing firms and households –  whether about the virus, the wider economy, or the government’s chosen response.

There was even some recognition that inflation expectations had been falling, usually a sign –  at least if starting at or below the inflation target midpoint –  that people don’t think the Reserve Bank is doing its job. It was all rather played down –  with more emphasis on risks of further falls than the large falls we’ve already seen –  and, as almost always, they chose to totally ignore whatever information is in the inflation breakevens derived from the government bond market.

And yet what did the Bank actually do, that might affect real interest and exchange rates, credit conditions or whatever –  in ways that might make a real difference to the inflation and employment/output outlook?  Nothing.  And that is the problem.

There was plenty of renewed talk of the possibility of negative interest rates. (This was  in conjunction with some possible new instrument – Funding for Lending –  which is unlikely to have very much effect at all: the Governor nicely articulated in the press conference why buying foreign assets wasn’t a good  –  likely to be effective – option at present, and a very similar analysis could be presented for his scheme of lending to banks –  banks (a) not notably being short of funds, and (b) not being known for being keen on dependence on central bank funding, at least outside the immediate white-heat of a crisis. )

But there was no action (not even on the new idea tool).  In fact, the Governor reiterated the commitment that the MPC had made back in mid March not to change the OCR for a year.   And that is even though, as the Governor himself noted, “March feels like a long time ago”.  It isn’t of course, but a great deal has changed since the MPC made that rash commitment –  notably, the MPC itself has belatedly come to appreciate the severity and duration of the economic downturn.    No one expected them to walk away from the commitment yesterday, but it would have been good –  good policy –  if they had. Central bankers should no more be encouraged to keep rash promises than moody teenagers who in a moment of upset threaten to run away from home, or perhaps kill themselves, should be encouraged to keep those rash promises.  From the evidence we have –  what the Bank choses to make available –  little more thought seem to go into the former pledge than into pledges of the latter sort.

Of course, the MPC did pledge to buy a whole lot more government bonds, over the next couple of years.    They still to seem to believe that such actions make a real-world difference to things that affect the inflation/output outlook. But they are wrong to do so. As it happens, I’ve this week been reading Stephanie Kelton’s  MMT tract. The Deficit Myth.  Much of it is a socialist tract, beloved no doubt by Bernie Sanders (her former boss) and Alexandria Ocasio-Cortez, but a fair bit of the first half is a (really clearly written, if somewhat loaded in interpretation) articulation of how fiat money systems work.  It is all stuff most serious central bankers know, even if they don’t use her language.  One of her arguments that it really doesn’t make much difference whether the government pays for its activities by creating settlement account balances at the central bank or by selling bonds (she calls one “yellow Treasurys” and one “green Treasurys”).  And in the current context that is much the same as my argument: the Reserve Bank buying tens of billions of government bonds (generally yielding less than 1 per cent) and issuing tens of billions of dollars of settlement account balances earning, currently, 0.25 per cent just doesn’t –  and wouldn’t reasonably be expected to –  make much useful difference to anything.  It is just an asset swap, doing little more than shifting around interest rate risk (the Crown is now quite highly exposed if something dramatic happens and interest rates need to rise a lot in the next few years).

The Bank continues to claim otherwise. But it is just a claim.  They have a substantial research and analysis operation but have published nothing that would support their claim, nothing that could be externally scrutinised. I guess they believe it, but they’ve gone out on quite a limb with the LSAP so of course they would.

The Bank claims that “the LSAP has [note the certainty] helped keep the New Zealand dollar exchange rate lower than it would have been otherwise”.  They do acknowledge that it is hard to tell but then tell us –  with no supporting analysis – that they think “the exchange rate is 4-10 per cent lower than it would have been without the LSAP programme”.    To which my response would be:

  • well perhaps, but the real exchange rate is still –  as you yourselves acknowledge –  where it was at the start of the year, so that even if the LSAP has kept the exchange rate down a bit, there is no absolute easing in this component of monetary conditions (despite a really big slump, and a shutting down of two major export industries),
  • much depends on the counterfactual.  I reckon there is a reasonable argument that the LSAP has left the exchange rate higher than otherwise, since the prime alternative policy – a zero or negative OCR – would have taken the TWI lower, and
  • yesterday’s announcement wasn’t great for the Bank’s story: the exchange rate barely moving.

They also claim that the LSAP has made a big difference to bond yields: “we estimate that NZGB yields are at least 50 bps lower, and potentially more than 100bps lower, than they would have been without the LSAP programm”.   They present no analysis – at all – in support of this claim, not even telling us which point on the yield curve they are referring to (the shorter-end will be strongly anchored by the expectation that the OCR won’t be raised for several years).   And perhaps more importantly:

  • if it is the long end they are referring to (where the LSAP has been concentrated) they’ve never articulated a convincing story for how, in New Zealand, long-term bond rates affect the transmission mechanism (long rates may be lower –  probably are to some extent –  but so what, and are we sure this isn’t an unwise distortion, at least if the Bank believes monetary policy is going to work and in a few years we will be back to a neutral OCR, according to them in excess of 2 per cent?), and
  • even if the LSAP has somehow imparted a great deal of stimulus –  and yesterday’s announcement didn’t move market prices much further, the Governor acknowledging diminishing returns to LSAP –  there is the small point of a pretty worrying outlook for the economy and inflation.  With all that estimated stimulus included, inflation is still at or below the bottom of the target range until the end of 2022, and the unemployment rate was still forecast to be 6 per cent by then.  And the Bank was emphasising downside risks, even before the new lockdowns.

I’m pretty sure I heard the Governor say that there was quite a bit more to do.  And yet, they did nothing.

At the last MPS the MPC chose not to publish projections for the OCR itself, but instead to publish a chart showing an “Unconstrained OCR”, apparently estimated by letting the forecasting model run and give us an estimate of “the broad level of stimulus needed to achieve the Reserve Bank’s employment and inflation objectives”.  This was yesterday’s chart.

unconstrained OCR 2

Throw in a whole lot more fiscal deficits and a whole lot more announced bond buying since May and the model still reckons the OCR should be at some below -2 per cent.   Instead, it sits and sits and sits at 0.25 per cent.  On their own numbers, they aren’t doing their job.  In the presence of self-acknowledging downside risks to activity, inflation, and inflation expectations.

So I discovered this morning, it was a year yesterday since the Governor’s extensive interview with Newsroom was published, in which he championed negative interest rates as the preferred policy tool in the next serious downturn.  It was a good –  informative, thoughtful – interview and we’ve never had an explanation for why he changed his mind (or, less probably, was overruled).  We do know, of course, that he and his staff did nothing to ensure that banks’ systems were ready and able, despite years of advanced notice, and now we are left with any serious monetary policy apparently dependent on how accommodating the Governor is of bank preferences –  and we know banks aren’t keen.   There is evidence that the Reserve Bank now has a serious work programme –  see this response to an OIA request someone else lodged (which the Bank said it was going to post on its website but did not do so)

OIA negative interest rates

but they fiddle –  move banks slowly ahead –  while the economy –  real people, real firms –  suffer unnecessarily.

It is simply inconceivable that at any other time, presented with projections this weak, downside risks, and serious new adverse news on the eve of the announcement, that the Bank would not have cut the OCR, perhaps by quite a lot –  not just fooling around with handwaving instruments that they can’t even demonstrate are making a material difference especially at the margin.

Jim Bolger has been in the news briefly this week –  for his irrelevant suggestion that the government bonds held by the Bank be “written off”, which would change precisely nothing of macroeconomic significance –  but he was Prime Minister in early 1991 when the Bank was very reluctant to ease monetary conditions.   There was significant political pressure – with hindsight quite warranted really – brought to bear on the Bank –  and Don Brash had been advised to watch his back when he went overseas.   But this time?  We have a Prime Minister and Minister of Finance who simply seen indifferent, whose innate conservatism seems to extend to not rocking the boat even when officials aren’t doing their job (and when the Minister of Finance has formal delegated intervention powers).

Once again yesterday, the MPC seemed keen to fob off responsibility to fiscal policy. But whatever the MMTers may wish, under New Zealand law fiscal policy does its own thing and then monetary policy –  the MPC – is charged with the residual stabilisation (full employment and all that).   The Bank has the effects of huge fiscal deficits included in its projections –  including that unconstrained OCR chart –  and it presents a nice chart showing that the estimated fiscal stimulus peaks this quarter and tails off from there (with neither main political party appearing keen on further increases in deficits from here).  Fiscal policy has played the ball –  wisely, responsibly, appropriately or not – and responsibility now rests with the Bank and the MPC.  Who are doing nothing, and seem more interested in giving little lectures to banks are to how they should run themselves than in using the tools Parliament has put at their disposal.   Perhaps they’ll do so next year –  still seven months away at least –  but they should have been acting much more decisively not just now but months ago.

Two final notes:

  • it was interesting to see the updated Bank forecast for the GDP contraction in the June quarter.  They expect a fall of 14.3 per cent following the March quarter fall of 1.6 per cent.  No one really knows and there are likely to be big revisions through time, but it was sobering to contrast these estimates with the falls in hours worked recorded in the HLFS, up 1.0 per cent in March and down 10.3 per cent in June.  That is a cumulative estimated fall in GDP of 16.1 per cent and a cumulative fall in hours worked of 9.4 per cent.  In other words, on the face of it, a huge fall in productivity.  Since both sets of numbers are probably not that much more than educated guesses, perhaps the truth was less bad, but –  properly measured – it seems almost certain that productivity in the June quarter would have been far lower than usual.  And yet, optimistic as ever, if anything the Bank is forecasting trend productivity growth in the next couple of years a bit higher than it has been in recent years,
  • I mentioned Stephanie Kelton’s book, MMT and all that.  This morning I recorded an interview with Radio New Zealand’s Jim Mora on monetary policy, fiscal policy, MMT, the Bank and so on, in the current New Zealand context.  It is scheduled to be broadcast on Sunday morning, although at present I’m not sure when specifically.   My previous post on MMT still seems about right to me, although Kelton’s approach is more radical than the presentation from,  and discussion with, Bill Mitchell that the previous post was built on.  There is a macro policy dimension to Kelton, but her real agenda is big government across the board –  an explicitly political agenda that doesn’t have much to do with the best design for macro policy.

Expectations

The Reserve Bank’s Monetary Policy Statement is due out on Wednesday.  It will be interesting to see what tone the MPC comes out with.   Quite a bit of the recent media commentary in New Zealand has been rather upbeat, for reasons that aren’t fully clear.  No one seems to expect the MPC to do much that might make a difference, although there will be interest in what the Committee has to say on its handwaving supplementary tools (that do little useful), the Large Scale Asset Purchase programme and, for example, the idea of buying foreign assets.  The latter, if launched at some stage, might get them some headline effects for a day or two – as happened when we tried fx intervention back in 2007 – but beyond that is likely to be even less effective than the LSAP.

Where the MPC could still be of us,  even if they aren’t going to change the OCR, is to apply to refreshing dose of bleak reality to the discussion of New Zealand’s economic situation.  I don’t suppose they will go very far in that direction –  after all, doing so wouldn’t help their ideological allies in the current election campaign –  but they might still help that they shift the ground somewhat.  Even the Minister of Finance has been heard recently reporting that The Treasury –  whose own PREFU numbers are due out next week –  are now really quite pessimistic on the world economy.    And a small, moderately open, economy isn’t that well-positioned if (a) the rest of the world is doing poorly, and (b) domestic macro policy is doing less than usual in a downturn.

The latest expectations data was a reminder as to just how little monetary policy has done this year.  Take inflation expectations as just an example.

The ANZ’s survey of the year-ahead inflation expectations of a reasonably large sample of their business customers hasn’t produced a result as high as 2 per cent since May last year.   As recently as their February survey –  mostly taken before the February MPS when the Reserve Bank was sufficiently upbeat they adopted a slight tightening bias – year ahead expectations were as high as 1.89 per cent.  Now those expectations are about 1.4 per cent, a long way below the target midpoint the MPC is supposed to focus on.

What about the Reserve Bank’s own survey of a smaller sample of supposedly relatively expert observers?  We got the latest read on that last week.

RB infl expecs

As expected, there is a slight recovery in the latest survey, but both lots of expectations are a long way below the target midpoint.  If you were charitable you might argue that the year ahead outlook was at least in part still beyond the Bank’s control, but there is ample opportunity for the Bank to have inflation back to 2 per cent by the year to June 2022.  But respondents don’t believe they will.

And what about market-based measures?   These are the five year breakevens (from the indexed and conventional government bond yields) for the United States and New Zealand.

five year breakevens

The breakevens fell sharply in March, especially in the US –  the focal point for the stresses in government bond markets.  But since then US breakevens have retraced most of this year’s falls.  The New Zealand picture is very different: not only did the implied breakevens start the year miles below the inflation target, but that gap has widened substantially further this year, with little sign now of any convergence/correction.    These implied expectations are 55 basis points lower than they were at the end of last year, or than they were when the MPC was setting policy in February.

Perhaps the best thing about the Reserve Bank’s Survey of Expectations is that it asks the same respondents about a bunch of macro variables, not just about inflation.   If we assume those people are each answering somewhat consistently, we can look at one set of answers in light of others.    For example, we know that the OCR has been cut by only 75 basis point this year, but there is also a question about where respondents think the OCR will a year ahead.  Since the survey done in early February, those expectations have fallen by 78 basis points.  That is actually a bit less than the fall in those same respondents’ year-ahead inflation expectations.  Even if you think (as the Bank typically did) that the two year-ahead measure is more important, you are left with results in which these respondents think real interest rates have fallen only perhaps 25-30 basis points.  It is a derisory change in the face of a shock of this magnitude.

What about government bond rates?  Well, we hear a great deal from the Bank –  and some of their market acolytes – about the difference the LSAP is making.    But how much have year-ahead expectations of the long-term bond rate fallen since February, even taking account of the LSAP (actual and expected)?   A mere 54 basis points.    To be sure, we do not know the counterfactual –  without the bond-buying actual and expectation bond yields might be higher, but the bottom line remains that yields have not fallen much, especially in real terms.

Respondents are also asked about GDP growth and although these responses seem to have got no media coverage in some respects they are the most disconcerting of them all.  Respondents expect real GDP growth of 4.24 per cent in the four quarters to June 2021 (the median response is actually much lower at only 3 per cent) and 2.77 per cent over the following four quarters.   Those numbers might not seem so bad until you realise that the (generally expected) trough in GDP will have been in the June quarter 2020.  It is quite likely that GDP in the four quarters to June 2020 will have fallen by perhaps 15 per cent.    A rebound of only 7 per cent over the following eight quarters would be alarmingly bad.   The question is quite clearly posed: it is not an annual average growth rate that was asked for, although I suppose some may have misinterpreted it that way.    However respondents answered the GDP question-  and there is a huge range of estimates for the year ahead (from -18  per cent to 24 per cent) – respondents expect the unemployment rate to remain high.

The Bank introduced a couple of interesting new questions to the latest survey (I hope they become standard features, and that the results are reported on the main tables on the website).  First, they asked respondents what they expect the OCR to be in June 2030 –  ten years’ hence.  The point here is not that there is anything very special about the specific June 2030 date, but that it is far enough ahead that one could expect respondents to look beyond the current crisis or evident cyclical pressures and think mostly about the long-term structural features of the economy.    The range of estimates was wide –  from 1 per cent to 4.5 per cent –  with a median of 2.5 per cent.    My own response to that question was 2.25 per cent, but since my 10 year ahead inflation expectations (1.5 per cent) were  lower than those of the median respondent (2 per cent) I was a bit surprised to find that I had an above-median estimate of the neutral OCR.

(It would be interesting to invite the MPC members to follow the lead of the FOMC and publish their individual –  unnamed –  estimates of the neutral OCR.)

The other new question asked respondents to estimate the average OCR for the next 10 year.  Again, the median response (1.5 per cent) was higher than my response (1 per cent), a difference likely to be mirrored in a difference in inflation expectations).

If these responses to the Reserve Bank survey capture anything useful at all, they should really be quite concerning to the Governor, to the Monetary Policy Committee, and to those with the legal responsibility for holding the Bank to account (that’s you Reserve Bank  Board and Grant Robertson).  Inflation is expected to be well below target, unemployment is expected to remain worryingly high, the recovery in GDP is expected to be pretty feeble at best, and hardly anyone expects that the Bank will manage to establish any material policy leeway in the period before the next economic downturn hits.    It is a pretty clear case where the informed respondents do not act (write down expectations) as if they believe the Bank is adequately doing its job.

Now perhaps on Wednesday the MPC will come out with some much more upbeat story, and tell us reasons why the views of survey respondents should be discounted.  But if anything at the time of their last MPS, the Bank was more pessimistic than survey respondents, even though their official line has been the monetary policy is providing large amount of stimulus.

Now, of course, the Committee likes to abdicate its responsibilities and put everything on fiscal policy.  But that isn’t the way the regime is supposed to work.  Rather, governments set fiscal policy and then the MPC is supposed to do whatever it takes (loosening or tightening) to deliver the inflation target the government has set out for them.  Respondents to the Bank’s survey know all about fiscal policy, and yet they conclude that the Bank is not acting to do its job, isn’t acting consistent with getting inflation promptly back to 2 per cent or –  for that matter –  with quickly re-establishing full employment.   The peak contribution to fiscal policy is already passing, monetary policy could have been aggressively deployed months ago to be in a position to take up the slack.  Instead, we sit here now with real interest rates barely down much at all, a real exchange rate that hasn’t budged, and yet with really worrying  –  and remediable –  economic and inflation outcomes in prospect.

I’m sure many readers are inclined to discount the significance of inflation expectations.  I’m not one of those who runs a model in which inflation expectations directly set inflation outcomes, but when both expectations (all measures) of inflation are below target and unemployment is well away from full employment, what it tells us is that monetary policy simply isn’t being used to the full.  There is a reasonable debate to be had about whether some countries, or the world,  might emerge from this crisis with much higher –  troublingly high, or (to some) usefully high – but when there is no indication at all, from surveys or market prices, that inflation is even likely to be at target, let alone far overshooting it, we should be able to expect more from the Reserve Bank, not just some handwringing exercise –  from the macro-stabilisation agency –  suggesting that the unemployment is someone else’s problem.

In this case, notably, we need deeply negative interest rates. I’ve seen some banks suggesting that interest rates will eventually go a bit negative because more stimulus is needed.  But it is clear –  including from those banks’ own commentaries –  that that stimulus/support from monetary policy is needed now, not –  even then in half-measures –  sometime next year.

 

 

Credit conditions

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

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

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

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

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

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

cconditions 1

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

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

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

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

c conditions 2

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

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

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

Here is the chart for SMEs

CC SME

and for larger corporates

CC corporate

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

What of commercial property loans?

cc comm property

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

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

cc agric

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

cc factors

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

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

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

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

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

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

Economic policy malaise

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

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

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

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

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

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

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

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

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

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

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

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

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

Perhaps this was a little closer to “investment”

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

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

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

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

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

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

She proceeds to run through some government initiatives.

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

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

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

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

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

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

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

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

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

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

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

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

But moving along

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

The whole of that plank is here

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

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

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

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

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

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

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

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

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

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

And what of the final plank?

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

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

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

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

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

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

And on that, we already have work underway.

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

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

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

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

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

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

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

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

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