As non-transparent, and obstructive, as ever

Just when you think there are the occasional promising signs that the Reserve Bank might, perhaps, be becoming a little more open…….they come along and confirm that they are just as secretive as ever.

At the last Monetary Policy Statement, the Reserve Bank indicated that it had made allowance for four (and only four) specific pieces of the new government’s policy programme.   They provided no details, beyond the barest descriptions, even though these assumptions fed directly into their projections and to the “acting Governor’s” OCR decision.  In one specific example, they indicated that they had assumed that half the planned Kiwibuild houses would displace private sector housebuilding activity that would otherwise have taken place.   That assumption directly feeds into their forecasts of resource pressures, but is also quite politically sensitive.  You might suppose that in an open democracy, a public agency that came up with such estimates would publish their workings, at least when a formal request was made.

You’d be quite wrong.  I lodged a request a few weeks ago, asking for “copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions”.  I wasn’t asking for emails back and forth between staff, and I wasn’t even asking for the minutes of meetings where these papers were discussed.  I certainly wasn’t asking for copies any other government department or minister might have supplied them.  Just the analysis and related background papers the Bank’s own staff had done.

In response –  having taken several weeks of delay –  they didn’t redact particularly sensitive items, they simply withheld everything (down to an including the names of the papers concerned).   This is, it is claimed, to “protect the substantial economic interests of New Zealand”, a claim which is simply laughable.  Protecting senior officials of the Reserve Bank from scrutiny is not, even approximately, the same thing as protecting the “substantial economic interests of New Zealand”.  It might even be less intolerable conduct if they had laid out the gist of their reasoning in the MPS itself.  But they didn’t.

Of course, it is par for the course from the Reserve Bank.  They consistently refuse to release any background papers related to the MPS, no matter how technical they might be, or how high the degree of legitimate public interest (I did once get them to release such papers from 10 years ago).  They simply have no conception of the sort of open government the Official Information Act envisages.

Reform –  including opening up the institution –  is long overdue.  I do hope that the Minister’s review of the Act is going to address these issues seriously.

And in the meantime you and I –  citizens, taxpayers, who paid for this analysis –  are left none the wiser as to why, say, the Bank thinks a 50 per cent offset is the right assumption for Kiwibuild.  Perhaps it is, perhaps it isn’t, but the debate –  including around monetary policy –  would be better for having the workings in the public domain.

I was tempted to reuse my “shameless and shameful” description from yesterday, but that might a) overstate slightly the true importance of this particular issue, and (b) is a description better kept today for the Prime Minister and her willed blindness to the issues around China’s interference in the domestic affairs of New Zealand.  Anything for an FTA extension, nothing for protecting the democratic institutions and values of New Zealanders.

Full letter from the Bank below.

Dear Mr Reddell

On 16 November you made an Official Information request seeking:

copies of any analysis or other background papers prepared by Bank staff that were used in the formulation of the assumptions about the impact of four specific policies of the new government (minimum wages, fiscal policy, immigration, and Kiwibuild), as published in last week’s Monetary Policy Statement.

The Reserve Bank is withholding the information for the following reasons, and under the following provisions, of the Official Information Act (the OIA):

  • section 9(2)(d) – to avoid prejudice to the substantial economic interests of New Zealand;
  • section 9(2)(g)(i) – to maintain the effective conduct of public affairs through the free and frank expression of opinions by or between officers and employees of the Reserve Bank in the course of their duty; and
  • section 9(2)(f)(iv) –  to maintain the constitutional convention for the time being which protects the confidentiality of advice provided by officials.

You have the right to seek a review of the Bank’s decision under section 28 of the OIA.

Yours sincerely

Roger Marwick

External Communications Adviser | Reserve Bank of New Zealand | Te Pūtea Matua

2 The Terrace, Wellington 6011 | P O Box 2498, Wellington 6140

  1. + 64 4 471 3694

Email: roger.marwick@rbnz.govt.nz  | www.rbnz.govt.nz

 

More excuses for a job not well done

It is another glorious day in Wellington –  I always reckoned a 2 degrees warmer Wellington would be a good thing – and there is Christmas shopping to do, but I couldn’t let the latest speech from the Reserve Bank go by without comment.

It is presented as a speech by “Reserve Bank Governor Grant Spencer”.   Fortunately, most of the media haven’t fallen for that line –  which they’ve tried on in a number of recent documents.   If Spencer is anything, he is “acting Governor”, and no more.

How do I know?  Because Parliament was quite clear that

The Governor shall be appointed for a term of 5 years

And when he appointed Spencer, Steven Joyce was quite clear that the appointment was for six months only.   He only ever claimed to be appointing an “acting Governor”  –  who can, under certain conditions, be appointed for only up to six months.

As it happens, even that appointment is almost certainly unlawful.  The Act is also pretty clear that an acting Governor can only be appointed when a Governor leaves office before his or her term has expired.   That wasn’t the case here.  In other circumstances, the Minister and the Board are simply expected to get on and make a permanent appointment, so that a new permanent appointee can take office when the previous appointee’s term expires (a date known, in this case, for the previous five years).  It might not be ideal phrasing, but it is the law, and if there was a problem –  as there was in the case, around the election –  either the law needs to be worked within, or to be changed by Parliament.

But we now have the strange situation where the Minister who appointed him thought Spencer was acting Governor, while Spencer himself now seems to purport to be –  not just have the powers of  – Governor.  As I’ve been doing for the last couple of months, I will continue to describe him only as “acting Governor”, or “the economist purporting to be acting Governor”.

Whatever his label, there is a bit of sense of relief that Graeme Wheeler is gone and that Spencer –  someone well-liked and generally more open –  is minding the store.   But his speech earlier this week, on monetary policy and the challenges of low inflation, still left a great deal to be desired.  I suspect it wasn’t intended this way, but in practice it amounts to not much more than excuses for not keeping inflation near target for the last five years, partly by attempting to obscure a New Zealand debate with the (somewhat different) issues some other advanced countries face.  And, of course, whatever the merits of Spencer’s views, he’ll be gone in little over three months and as yet we have no idea who the new single decisionmaker will be (let alone who will eventually serve on the new statutory monetary policy committee to be put in place next year).

There is some interesting stuff in the speech though.  Most notable perhaps was the number of references to unemployment.  Often enough Reserve Bank monetary policy documents mention it barely at all –  the Bank even tried to displace it with a new (but sadly ill-fated) labour market capacity indicator of its own devising.  For decades, the capacity variable in the Bank’s inflation models was (its estimate of) the output gap, and there were typically lots of references to it in speeches or Monetary Policy Statements.  

But in Spencer’s speech –  his first as “acting Governor”, and the first under the new government – there is but one reference to the output gap (and then only in abstract terms) and 17 references to “unemployment”.    And to think that some people reckon it doesn’t make much difference who is appointed Governor.

But the odd thing is that much of the speech is devoted to making the case that the unemployment rate (itself) hasn’t been much help in explaining inflation in recent years.  Which might be true, to some extent, but so what (at least when considering events of the last decade)?  After all, for years the Bank told us they didn’t put much weight on the unemployment rate, didn’t think they could fix on a NAIRU etc etc, and that we really should be focusing –  as they did –  on the output gap and a broader suite of high-tech capacity indicators.    It might even –  if valid –  be an argument for not putting too much specific focus on a specific or precise unemployment rate in the new monetary policy regime the government envisages –  but that isn’t the case Spencer makes, and weirdly he suggests that the Bank is already (since when?) putting more weight than previously on employment indicators.  It isn’t very coherent, in a New Zealand context.

This chart ran in the recent Monetary Policy Statement (when I didn’t get round to commenting on it) and it appears again in Spencer’s speech.

GS speech 1

It is the sort of chart the word “chutzpah” might have been invented for.  They use it to try to suggest that much of the advanced world is “stuck” in a situation in which the unemployment rate is below the sustainable rate (a NAIRU) and yet inflation is also below target.

There are a number of odd things about the chart.  For example, they include three separate observations for Germany, the Netherlands, and France, even though all three are in a common currency (and thus common monetary policy) area.  And surely it would have been more enlightening to include the other advanced countries with independent monetary policies (eg Norway, South Korea, Israel, Iceland?  There is also no place at all for inflation expectations in the story the Bank is trying to tell in the chart.

But the biggest, most obvious, omission is New Zealand.  And where would New Zealand fit on the chart?  Well, core inflation is about half a per cent below target and on most estimates –  even on the most recently quarterly unemployment observation (4.6 per cent) –  the unemployment rate is still above an estimate of the NAIRU.    If these relationships hold at all, there are lags, and the average unemployment rate for the last four quarters was 4.9 per cent.  By contrast, before the major revision downwards to the HLFS unemployment rate last year, the Reserve Bank had a NAIRU estimate of 4.5 per cent in its models (a part of that model that had no implications for the inflation forecasts), and after those revisions, Treasury published estimates suggesting they thought the NAIRU was now nearer 4 per cent.   In other words, for now at least, New Zealand still belongs in the bottom right quadrant of the Reserve Bank chart, the one in which there isn’t much of a mystery or puzzle at all: with inflation below target and unemployment above a NAIRU, a typical response  –  in an inflation-targeting framework –  would be to cut the OCR.    Switzerland and France can’t do that –  Swiss interest rates are already negative, and France can’t control interest rates  –  but New Zealand could.  It is just that the Reserve Bank chose not to.

In the chart the Bank uses OECD estimates of the NAIRU.  That is understandable –  they are the only consistent cross-country estimates I’m aware of –  but not one without its problems.  For example, somewhat unusually, the OECD thinks the New Zealand NAIRU this year is still in excess of 5 per cent.   Then again, if you believe the OECD’s estimates, unemployment in New Zealand has been below the NAIRU for almost the entire 21st century so far (rising just very slightly above only in 2009, 2010, and 2012).  It simply doesn’t ring true.

nairu less U

The Reserve Bank’s next chart in this area is this one

GS speech 2

The suggestion is that there was a relationship between unemployment and inflation in the 2000s (when they also didn’t use the relationship), but that it has disappeared (for now at least) in the last few years.

Given that the relationship (even in the previous decade) wasn’t tight by any means, and many of the higher inflation numbers related to things –  eg oil shocks and short-term exchange rate movements –  that didn’t have much to do with New Zealand unemployment rates, I didn’t find the chart overly persuasive.   Moreover, since everyone recognises that the NAIRU changes over time –  with things like demographics, labour market regulation, some hysteresis etc –  even the theoretical relationship shouldn’t be with the unemployment rate itself, but with the gap between the NAIRU and unemployment rate.    I suspect the Bank is currently feverishly working on a suite of time-varying NAIRU estimates –  to reflect the new government’s interest –  but there is no hint of those in this speech.

Ideally, one might want to look at something more like an unemployment gap estimate against deviations of core inflation  from target (what the Bank was trying to do, in a snapshot) for other countries in the first chart).  As I’ve already said, I don’t have any confidence in the OECD’s levels estimates of the New Zealand NAIRU, although the changes in the associated gap from year to year might not be too bad.    For now, it is all I have.

So in this chart, using annual data (all we have for the unemployment gap) I’ve shown the deviations  of sectoral core factor model inflation from the midpoint of the inflation target and the OECD estimate of the unemployment gap from 1993 (when the core inflation data start) to 2016 (each dot is one year’s data).

GS speech 3

Even including the most recent years (the furthest left observations) there is still a relationship there, albeit not a very tight one.    Then again, it wasn’t very tight –  although a bit more upward sloping –  when I deleted those most recent years.  No doubt the Bank could –  and perhaps is doing so privately –  do this sort of analysis in a more sophisticated way.

I’m not suggesting there are no puzzles about New Zealand’s inflation performance in the last few years.    But simply plotting the raw unemployment rate (and not even looking at, say, the underutilisation rate or the gap) against headline inflation isn’t going to tell you much –  we aren’t in 1958 now (when Phillips wrote)  and, apart from anything else, inflation expectations matter.

For the last couple of years, the Bank has consistently tried to tell a story of how inflation expectations are firmly anchored at the 2 per cent midpoint of the inflation target.   That has always been a questionable proposition, especially as regards the sorts of expectations that might affect wage and price setting behaviour.     Their favoured two-year ahead measure of inflation expectations is now around 2 per cent, but a decade ago it was averaging almost 3 per cent.  Household inflation expectations are also lower than they were.  Again, that isn’t very surprising because a decade ago the Reserve Bank wasn’t seriously aiming to deliver inflation at 2 per cent (the target midpoint): we might have been happy enough to take it if inflation had got there of its own accord, but our projections (the Governor’s choice) rarely showed inflation dropping below 2.5 per cent any time soon.  Actual core inflation was up around 3 per cent.

And these days?  Well, core inflation hasn’t been anywhere near 2 per cent for years now –  persistently below.  And although the Bank consistently talks of getting inflation back to 2 per cent, it hasn’t done so, and for several years consistently erred on the hawkish side, with constant talk of wanting to “normalise” interest rates, and actually following through on an unnecessary and ill-judged tightening cycle.   Even now, “normalisation” got a lot of attention in last week’s FSR (although mercifully absent from the speech), and the Bank constantly talks about not wanting to act aggressively to get inflation back to target.  Any rational observer would not only assume inflation will be materially lower than it was, but that the Bank is quite relaxed about that (it more or less says so).  The practical target isn’t really 2 per cent –  any more than it was, on the other side, 10 years ago – but something a bit lower.

The Bank must hate data from the inflation-indexed bond market (because it never engages with it in any of its publications), but the gap between indexed and conventional bonds is not inconsistent with my story.     Interpreting that data in fine detail isn’t easy. For a long time, we had only a single indexed bond (matured in Feb 2016), and by late in its life headline inflation (eg the GST change in 2010) mattered much more than the medium to long-term outlook).  These days there are several indexed bonds, but they have fixed maturity dates while the Reserve Bank’s published “10 year bond rate” has, in effect, a maturity date that moves through time.

But consider this chart, showing the gap between yields on successive indexed bonds and the conventional 10 year bond rate.

IIB expecs to dec 17

In the years prior to 2008 (when the indexed bond still had 10 years to run), the implied inflation expectation was around 2.5 per cent.   As noted earlier, that wasn’t too far from how we were running things in practice.   What of now?  It is late 2017, so 10 years from now is roughly half way between 2025 and 2030, the two indexed bond maturity dates either side of 2027.   In November, the average gap between orange and grey lines was 1.3 per cent, and for the year to date the average gap has been 1.2 per cent.

No doubt, there are all sorts of idiosnycratic things going on, so these breakeven inflation rates may not be “true” inflation expectations (as, for example, they weren’t in the midst of the crisis in 2008).  There are, for example, a lot of inflation bonds on the market, and it is possible that Treasury has somewhat glutted the market.    My point simply is that if one wants to make sense of relationships between unemployment (or other capacity measures) and core inflation over the Wheeler years, it is wilfully blind to simply ignore a story about changing inflation norms.

The next chart is just a rough and ready thought experiment.  What if, when Graeme Wheeler took office in September 2012, inflation expectations were genuinely about 2 per cent, and people really thought that was what the Reserve Bank was serious about.  The indexed bond yields –  rough and ready as they are –  suggest that isn’t wildly implausible.  And, say, now people really think the target (for sectoral core inflation) is more like 1.3 per cent –  the most recent actuals are 1.4 per cent.  Then the chart just shows the relationship (using quarterly data) between the unemployment rate and the gap between actual core inflation and an implied target taken by interpolating from 2 per cent in 2012 to 1.3 per cent now.

GS speech 4

I”m not suggesting that is the “true” relationship, but it looks like an idea worth taking more seriously than the Bank has thus far been willing to do in public. After all, expectations adjust gradually in most circumstances.  It seems negligent, or deliberately obtuse, not even to engage with the possibility.

After all, the “acting Governor” –  I almost slipped there and initially typed it as Governor – ends his speech with the suggestion that

To the extent that the leverage of monetary policy over domestic inflation may have reduced, this suggests a cautious approach when responding to inflation deviations from target and careful attention to our assessment of economic slack. It may be appropriate for monetary policy to put relatively more weight on output, employment and financial stability relative to inflation.

Why wouldn’t a reasonable observer conclude that the Bank isn’t really targeting 2 per cent (although it might be happy enough to get there by accident) and continue to adjust their expectations and behaviour accordingly.

With a new government planning to revise the Bank’s mandate to increase the Bank’s focus on employment/unemployment, Spencer’s line would almost be some sort of sick joke if it weren’t so serious.    When the unemployment rate has been above New Zealand estimates of a NAIRU for nine years, and when the economic recovery (average growth in real per capita GDP) has been so muted, you might reasonably suppose that the government would have been expecting the Bank to do its job more energetically –  which would involve getting inflation back to target, and in the process finally delivering an unemployment rate around the (unobservable NAIRU) and even a bit faster real GDP growth.  But Spencer –  with no mandate whatever, but presumably with the support of his colleagues, Bascand and McDermott –  wants to tell us that their idea of putting more focus on “employment and output” than in the past has been to deliberately deliver such weak cyclical outcomes –  ie deliberately accept higher unemployment/lower employment than is strictly necessary.  And the implicit promise is more of the same to come, at least if people like them are left in charge.  I hope the Minister of Finance is paying attention, and that his recent talk of possibly removing the midpoint reference from the PTA wasn’t a sign that he has begun to buy into this Wheelerish mentality (even if given a glossed up public face by his colleagues now that they are minding the store).

 

 

 

The Reserve Bank second XI takes the field

The second XI at the Reserve Bank fronted up to present today’s Monetary Policy Statement.    There was the unlawfully appointed “acting Governor” Grant Spencer –  who is now signing himself as “Governor”, not even as acting Governor –  the chief economist, John McDermott, and the new head of financial stability (and openly acknowledged applicant for Governor) Geoff Bascand.    At best, they are holding the fort until the new Governor is appointed, and a new Policy Targets Agreement put in place, but despite that Spencer still felt confident enough to assert that “monetary policy will remain accommodative for a considerable period”.     How would he know?  He won’t be there.

One could feel a little sorry for the Bank.  After all, not only is the second XI holding the fort, but a new government took office only a week or so ago.    Between Labour’s manifesto commitments and the agreements with New Zealand First and the Greens, there are a lot of new policy measures coming.  But there is not a lot of detail on most of them.    The Bank’s typical approach in the past has been not to incorporate things into the economic projections until they become law (at, in the case of fiscal policy, in a Budget).   They’ve departed from that approach on this occasion, and have incorporated estimates of the macro effects of four new policies:

  • fiscal policy,
  • minimum wage policy,
  • Kiwibuild, and
  • changes to visa requirements affecting students and work visas.

I suspect they’d have been better to have waited.  On fiscal policy, for example, there are no publically available numbers yet –  just last week the Prime Minister told us to wait for the HYEFU.    On immigration, there has been nothing from the new government on the timing of any changes.  And on Kiwibuild, there is no sign of any analysis behind the assumption the Bank has made that around half of Kiwibuild activity will displace private sector building that would otherwise have taken place.  And so on.

And then there are the numerous other policy promises the Bank hasn’t accounted for.  In the Speech from the Throne yesterday there was a clear commitment to “remove the Auckland urban growth boundary and free up density controls” in this term of government.  If so, surely that would be expected to affect house prices and perhaps building activity?   Binding carbon budgets are also likely to have macro effects.

I’m not suggesting the Bank can produce good estimates for any of these effects.  Rather, they’d have been better to have stayed on the sidelines for a bit longer, since they were under no pressure at all to change the OCR today, rather than incorporate rough and ready estimates of a handful of forthcoming changes, with little sign that they have really stood back and thought about how the economy is unfolding.

And the conclusions they’ve come to do seem rather questionable.  The “acting Governor” kicked off his press conference talking of the “very positive” economic outlook.  I’m not sure how many other people will agree with him. As the Bank themselves note, they’ve been surprised on the downside by recent GDP outcomes, and housing market activity has been fading.  Even dairy prices have been edging back down, and oil prices have been rising.  (And, of course, there has been no productivity growth for years.)

The Bank forecasts an acceleration of economic growth –  even as population growth slows –  on the back of additional fiscal stimulus and additional building activity under the Kiwibuild programme.    Like other commentators, I’m rather sceptical that we will see anything quite that strong.  But even on their own numbers, productivity growth over the next few years is now projected to be weaker than the Bank was projecting in August.       And if Kiwibuild really is going to add so much to housing supply, in conjunction with slower population growth than the Bank was expecting, how plausible is it real house prices will simply be flat as far the eye can see (or the forecasts go)?  Not very, I’d have thought.

In the end, the numbers don’t matter very much.  Spencer will be gone at the end of March, and we’ll have a new Governor and a new PTA.  A new Governor will make his or her own assessment, and own OCR decisions.  But part of what that person will need to do is take a look at lifting the quality of the Bank’s economic analysis.

For all the talk of initiatives promised by the new government, the Monetary Policy Statement itself was striking for containing not a word –  not one –  mentioning that the monetary policy regime itself is under review.  Of course the “acting Governor” can’t pre-empt changes the detail of which aren’t known, but the Act does require the Bank to discuss in MPSs how monetary policy might be conducted over the following five years: a horizon over which we’ll have a different PTA, a different Governor, an amended statutory mandate, and a statutory committee to make decisions.

My main interest was in the contents of the press conference, where journalists raised both the issue of the proposed new mandate and the proposed changes to the statutory decisionmaking model.    In both cases, I suspect the second XI said too much.

Asked about the proposed mandate changes, Spencer began noting that he couldn’t say too much as the review was just getting started.  He then went on to assert that “moving to a dual mandate was unlikely to have a major impact on how policy is run”, explaining that in many ways flexible inflation targeting is akin to a “dual mandate” (something that, in principle, I agree with).     But then, somewhat surprisingly, he claimed that the proposed change could lead the Bank to become more flexible, potentially allowing greater volatility in inflation to promote greater stability in employment.  I guess it depends on the details of the changes, which none of us yet knows, but it was the first I’d heard of anyone calling for more volatility in inflation.  Over the last decade, those who think the Bank hasn’t put sufficient weight on the labour market indicators (like me) would have been quite happy to have seen core inflation at the target midpoint on average.  The previous Governor committed to that, but didn’t deliver.

On which note, it was a little surprising to hear the Chief Economist talk about how the Bank had improved its forecasts, and got its inflation forecasts right over the last couple of years.  That would then explain why core inflation has remained persistently below the target midpoint???  And has not got even a jot closer in the last couple of years?

Spencer noted that at present the Bank regarded the labour market as ‘pretty balanced’, such that a dual mandate wouldn’t make much difference right now.   But it turns out that they really don’t know.

They were asked a question about the government’s goal of getting the unemployment rate below 4 per cent, and –  fairly enough –  drew a distinction between structural policies that might lower the NAIRU and anything monetary policy could do.  When pushed, they argued that on current structural policies, an unemployment rate lower than 4 per cent would be inflationary, and suggested that estimates of the NAIRU range from 4 to 5 per cent at present.

But then all three of the second XI went on.  Spencer noted that the estimates are ‘very uncertain” and that in anticipation of a “dual mandate” the Bank was now doing some work to come up with some estimates of the NAIRU, suggesting that they haven’t had a precise estimate until now [although there were always assumptions embedded in the model].    Then the chief economist –  who at almost every press conference tries to discourage the use  of a NAIRU concept –  chipped in claiming that any NAIRU was “very very variable” and “changes all the time”, without offering a shred of evidence for that proposition.

And then the head of financial stability chipped in, opining that estimates of NAIRUs around the world have been declining (not apparently seeing any connection between this thought and (a) the NZ experience, and (b) his colleague’s observation a few moments earlier that the numbers were pretty meaningless anyway.

Out of curiousity I had a look at the OECD’s published NAIRU estimates.  This is the NAIRU for the median OECD monetary areas (ie countries with their own monetary policy plus the euro-area as a whole).

nairu oecd

The estimate for 2017 is 5.3 per cent.  That for 2007 was 5.5 per cent.     There just isn’t much short-run variability in the structural estimates of the long-run sustainable unemployment rate. That is true for other advanced countries.  It is almost certainly true for New Zealand.    It reflects poorly on the Reserve Bank how little they’ve done in this area, and it one reason why a change in the wording of the statutory mandate is appropriate.  The unemployment rate is a major measure of excess capacity, pretty closely studied by most central banks but not, until now it appears, by our own.

(Of course, had they wanted to be a little controversial, they could have noted that proposed structural policy changes –  notably the increased minimum wages they explicitly allowed for –  will tend to raise (not lower) the NAIRU to some extent.)

If they were at sea on the unemployment rate issue, what really staggered me was the way Spencer (and Bascand) used the press conference to campaign for minimal changes to the statutory governance and decisionmaking model for monetary policy.      They didn’t need to say more than “decisionmaking structures are ultimately a matter for Parliament, and we will be providing some technical input and advice to the Treasury-led process the Minister of FInance announced earlier in the week”.

But instead, they took the opportunity to campaign for as little change as possible.  Spencer noted that they agreed the Act should be changed to provide for a committee, but noted that they already had a committee, they thought it worked well, and they would like to reflect that in the Act.   Others might challenge whether the advisory committee, or the Governor, has done such a good job in the last five years (or today) but set that to one side for the moment.

They loftily conceded that there were possible advantages to having externals on a committee –  the potential for greater diversity of view. But they were concerned that in a small country it could be very difficult to find outsiders with unconflicted expertise to make the system work.  There was nothing to back this –  no explanation, for example, as to how places like Norway and Sweden manage, or how we manage to fill the numerous other government boards in New Zealand.

But what they really hate –  and I knew this, but was still surprised to hear them proclaim it so openly, just as a proper review is getting underway –  is the idea that any differences of view might be known to the public.   They could, we were told, tolerate a system of ‘collective responsibility’ –  in which all debates are in-house and then everyone presents a monolithic front externally –  but were strongly opposed to any sort “individualistic committee” in which individual views might become known.    These systems –  of the sort prevailing in the UK, the United States, Sweden, and the euro-area –  have, they claimed, the potential to become a “circus” with too much media focus on monetary policy, and a concern about “heightened volaility” in financial markets.   Spencer went so far as to suggest that an individualistic approach could undermine the reputation and credibility of the institution.

A slightly flippant observer might suggest that the second XI and their former boss have done that all by themselves –  between the actual conduct of policy, and attempts (in which they all participated) to silence one of their chief critics.  A more serious observer might ask for some evidence from the international experience, to suggest that the more individualistic approach has damaged the standing of the Fed, the BOE, or the Riksbank.  Are these less well-regarded organisations than the Reserve Bank of New Zealand?    I’d have thought it would be hard to find such evidence.

Bascand –  one of the declared candidates for Governor –  then chipped in to note that what management was concerned about was to ensure that the focus of discussion was on the issues “the Bank” had identified, not on individuals or their particular views. Loftily –  earnestly no doubt – he declared that they wanted the focus to be on substance.  No doubt, as defined by management.   It reinforces the point I’ve made often that Bascand is the candidate for the status quo.  Bureaucrats setting out to protect their bureau.  Predictable behaviour – even if usually more subtle than this –  and what the public need protecting from.

There are successful central banks that adopt the collegial approach –  the RBA is one, albeit one with a rather old-fashioned committee decisionmaking model –  but there is nothing to suggest, in the international experience, that that model produces better outcomes, or a more credible central bank, than the individualistic approach.  Indeed, many observers would regard Lars Svensson’s open disagreement with his colleagues on the Riksbank decisionmaking committee as a useful part of the process that finally led the rest of the committee, including the Governor, to abandon their previous excessively hawkish approach a few years ago.

The second XI’s approach is that of “the priesthood of the temple” –  we will tell you, the great unwashed, only what it suits us to tell you, in the form we want to present it.  It is simply out of step with notions of open government, or with a serious recognition that monetary policy is an area of great uncertainty and understanding is most likely to be advanced by the open challenge and contest of ideas.

Fortunately, the new government shows signs of seeing things differently.   There is a minister for open government (admittedly, lowly ranked), a commitment to improving transparency under the Official Information Act.  And in the Speech from the Throne yesterday there was an explicit commitment –  not referenced by the Second XI, still trying to relitigate – that

“The Bank’s decision-making processes will be changed so that a committee, including external appointees, will be responsible for setting the Official Cash Rate, improving transparency.”

Note the use of “will”.   The Bank management’s preference for a “collective model” would do nothing at all to improve transparency.

It is all a reminder of how uncertain things still are, and how important the membership of the Independent Expert Advisory Panel the Minister of Finance has pledged to appoint as part of review of the Act might be (including whether the panel is really “expert” or –  as rumour suggests – a politician might chair it).   And also how important it is that Bank management do not have a leading say in the advice that goes to the Minister.  Management is paid to implement Parliament’s choices, not to devise models that cement in the dominance (and secrecy) of management.

It is also a reminder of just how important the appointment of the new Governor is, and why it remains hard to be confident about just how committed the government is to serious change when they’ve left that appointment in the hands of the Reserve Bank Board –  all appointed by the previous government, all on record endorsing the way things have gone for the last five years, and with a strong track record of serving the interests of management rather than those of (a) the public and (b) good public policy.

Towards a definition of the (un)employment objective

In my post the other day, I outlined one way in which the unemployment concerns that appear to be behind the Labour Party’s desire to amend the statutory objective for monetary policy could be implemented in a new Policy Targets Agreement, even before the Reserve Bank Act itself is amended.

We still have no specifics as to how the Labour Party (and now the Labour-led government) envisages changing the Act.  But in an interview on Radio New Zealand this morning I heard the Minister of Finance talking about looking to the specifics of the Australian and US legislation.   I didn’t find that very enlightening or reassuring.

The Reserve Bank of Australia was set up in 1959, and the section of its legislation relating to monetary policy goals and objectives was in the original.

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

a.  the stability of the currency of Australia;

b.  the maintenance of full employment in Australia; and

c.  the economic prosperity and welfare of the people of Australia.

In 1959, Australia –  like most countries –  had a fixed exchange rate, so that “the stability of the currency of Australia” meant the external value of the currency.  The provision has since been re-interpreted, and as is now taken as meaning the domestic value of the currency (ie domestic price stability), but no one would write the provision that way today.

This wording is also legitimately subject to the criticism made by those who disagree with what Labour is proposing.  It makes no attempt to distinguish between the short and long run, and thus does not recognise that monetary policy cannot affect the longer-term rate of unemployment at all.    The Australian legislation also has nothing like a Policy Targets Agreement (the document that resembles a PTA is informal and non-binding) and provides far too much discretion to the Reserve Bank.  That discretion has not been blatantly misused in recent decades –  a period when the actual conduct of monetary policy in New Zealand and Australia have mostly been quite similar –  but the legislation should not provide any sort of model for New Zealand as to how best to specify the goals of monetary policy.

What of the United States?   Much is made of the “dual mandate” that has guided the Federal Reserve over the decades.   But even that, mostly quite sensible, conduct of policy rests on a rather slender and unreliable legislative footing.    The statutory objectives in the Federal Reserve Act were set out in 1977, around the high tide of monetarism, and read as follows:

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.

In other words, the Fed is actually mandated to pursue long-term money and credit growth targets, in the belief that doing so will promote (a) maximum employment, (b) stable prices, and (c) moderate long-term interest rates.  Again, no one would write the statutory objectives that way today, and the formulation should offer little or no guide to anyone looking to overhaul the objectives of our own central bank.  In practice, of course, the Federal Reserve works around the statutory formulation, rarely citing it directly.  I think they way they run monetary policy in practice is quite sensible –  and typically not that different to the way the Reserve Bank here has often run policy –  but I bet they wish Congress had written the goal a bit differently in 1977.

In an ideal world, both the Australian and US statutory provisions would be updated and amended.  It isn’t desirable to have powerful autonomous agencies working under the mandates that don’t reflect today’s understandings of policy, leading those agencies to creatively reinvent their own mandates.  Those reinventions probably lead to better policy in the short-run, but the process of doing so undermines confidence in the role of legislatures in mandating, and holding to account, such agencies.

If one looks around the advanced world, there are lots of different ways of specifying central bank objectives. In most cases, the wording is considerably more recent than either the US and Australian examples.  A few years ago a colleague and I did a Reserve Bank Bulletin article reviewing those formulations –  the work initially prompted by the approach of the 2014 election, when Labour was also proposing changes.   As we noted,

Despite the similarities in how monetary policy is operated, there is a wide range of ways in which legislation and supplementary documents specify the medium- and longer-run aims societies have for monetary policy. In some countries the focus is more on the economic outcomes that a successful monetary policy could contribute to over the longer-term.  In others it is more on what monetary policy can more directly achieve. These differences do not seem to primarily reflect very different views of what monetary policy could reasonably accomplish. Specific national circumstances influence how formal documents are written. And older legislation often looks different than legislation adopted in the past 10-20 years, with the latter typically having a more explicit focus on domestic price stability. In some countries, formal documents say relatively little about what monetary policy is expected to achieve, while in other countries the formal documentation is more extensive.

As I’ve noted here previously, I think the sort of statutory change Labour seems to be talking about makes some sense.  In part, that is because monetary policy has –  ever since the late 80s –  been a divisive political issue here in a way that it hasn’t been in other countries.  In part, it is because of the failings of the Reserve Bank –  with many fewer constraints than their peers in many other advanced countries –  over the Wheeler years in particular.    But I’m not sure that the way other countries have worded their legislation is going to be of very much assistance to Treasury and the Minister of Finance as they attempt to come up with some specific proposals.     If I was to offer them specific suggestions, they would involve changes to the purpose clauses , to the clause governing the primary function of monetary policy, to clause 10, and to the clause governing Monetary Policy Statements.

It is perhaps worth remembering that over the life of the Reserve Bank –  now 83 years –  there have been various different formulations of the statutory goals of monetary policy.  Those changing goals were also discussed in a Bulletin article a few years ago.  When the first legislation was enacted in 1933, the statutory goal was simple, if not specific

It shall be the primary duty of the Reserve Bank to exercise control […] over monetary circulation and credit in New Zealand, to the end that the economic welfare of the Dominion may be promoted and maintained (1933, s12).

It is worth remembering that it simply isn’t possible to write down, whether in statute or in a PTA, all that one wants a good central bank to do in conducting monetary policy.  Or, at least, it hasn’t been since we went off the Gold Standard in 1914.     There is no perfect formulation, and good people –  sound judgement and a good understanding of the issues and constraints –  matter as much as precise wording.  Each generation faces differing shocks, differing sets of circumstances, and different things that aren’t well understood.  It is easy, and tempting, simply to set out simple wording like what is in the Reserve Bank Act now.  So long as it is understood not to capture everything –  and successive Governors and Ministers have recognised that –  it may not do much harm, and it keeps a focus on the long-term limitations of monetary policy.  But, equally, we have active discretionary monetary policy because we believe that monetary policy can do other useful stuff in the short to medium term.  Finding ways that reflect that understanding and translating them into legislative wording has its risks –  as not doing so does –  and can’t be done perfectly, but that isn’t a reason for not doing it at all.

And finally, it is worth remembering that, whatever the precise statutory wording, past research has found that, on average, the Federal Reserve, the Reserve Bank of Australia, and the Reserve Bank of New Zealand have tended to conduct monetary policy in much the same way, faced with similar shocks.

 

 

 

A possible new Policy Targets Agreement

“we have unemployment stuck stubbornly at 5% when it should be below 4%”

Those were the words of the Prime Minister in her speech to the CTU on Wednesday.  The latest published unemployment rate was a bit below 5 per cent.   But the average for the last four quarters is 4.95 per cent, and that for the last seven quarters is 5.0 per cent.

And “it should be below 4%”?   That’s a great aspiration –  ideally the unemployment rate should be much lower than 4 per cent, because even 2.5 per cent means that over a 40 year working life the average person spends a whole year unemployed – ie without any work, but ready to start work, and actively looking for work.     But I presume the reference to “below 4%” is more than that, and is something about what is attainable (sustainably) on, broadly speaking, the current labour market regulations, demographics, and welfare provisions.   Most observers think that the rate of unemployment consistent with stable inflation near the target is around 4 per cent.    Some, plausibly –  but we won’t know unless/until we get there – think it is lower than that.   Certainly there has been no sign of any acceleration in wage inflation with the unemployment rate near 5 per cent.

Most material deviations of the unemployment rate from the true (but not directly observable) long-run sustainable rate are, to a first approximation, due to monetary policy choices.    That was true in years leading up to 2008, when the unemployment rate was lower than the long-run sustainable rate –  monetary policy was too loose, and inflation was rising to outside the target band.  It has been true for the last eight or nine years when, at least with hindsight, monetary policy has mostly been a bit too tight. People who are unemployed, unnecessarily, have paid the price.    It isn’t the done thing to mention this in polite society –  few of whose members are affected directly by unemployment –  but it is true nonetheless.

And so I welcome the fact that we have a government that says it is serious about expecting the Reserve Bank to run monetary policy in a way that promotes full employment –  keeping unemployment as low as is consistent with a sustainable low and stable inflation rate.     I like the fact that the Prime Minister talks about lowering unemployment in her first speech.  (Whether she will do so as readily later in her term is another question).    And I’ve come to agree that adding some reference to unemployment to the mandate given to the Reserve Bank is desirable.     It has always been implicit.  We have active discretionary monetary policy to minimise the output and employment losses when severe adverse shocks hit.  Otherwise, we’d have stuck with the Gold Standard, which was really good for delivering long-run average price stability but –  by design –  less good at short-term stabilisation.

The New Zealand Initiative –  from the right –  disagrees.   In their newsletter this week Oliver Hartwich writes

Yet the real problem is that dual mandates do not work, not even in theory. They are the result of a misunderstanding as anyone who studied economics over the past half a century would know.

The best way for a central bank to achieve both low inflation and low unemployment is to make it pursue price stability alone.

The next RBNZ governor will no doubt be aware of that. In which case, she could safely ignore any dual mandate passed down from the new Government. And keep focussing on targeting inflation.

But that is simply not so.    It is certainly true that over the medium to longer-term monetary policy can only affect nominal variables (inflation, nominal GDP or whatever) and has no impact on real ones such as unemployment.  Most everyone agrees on that.  But it is equally true that monetary policy actions have a short to medium term impact on real variables, not just on prices.  Indeed, in the short-term the real effects are often larger than the price ones.   It isn’t something one can exploit to get unemployment permanently lower –  the long-run Phillips curve is more or less vertical – but it does mean that all discretionary choices about monetary policy are simultaneously choices about both inflation and output/unemployment.  The Reserve Bank knows that.  In fact, every advanced country central bank –  in countries with fairly stable inflation expectations –  knows that.

There is also some disagreement from the left.  In his column in yesterday’s Herald, Brian Fallow was sceptical about Labour’s proposed changes (the details of which we have not yet seen)

…in a later speech outlining his approach, Robertson said: “Had a mandate to maintain full employment been in operation in New Zealand it is likely that it would have constrained the bank’s [subsequently] aborted tightening of the official cash rate in 2010 and 2014. This would in turn likely have seen a faster return to target inflation and faster economic growth.”

Well, maybe. But counterfactual assertions about what would have happened if what did happen had not happened stand on epistemologically boggy ground.

Back here in the actual world, data from the OECD last week shows that New Zealand’s employment rate – the proportion of people aged between 15 and 64 who are employed – is at 76.2 per cent, the fourth highest level among the OECD’s 35 members.

Fallow goes on at some length about employment rates.   But employment rates simply aren’t the relevant variable for monetary policy (although they might tell us about all sorts of other areas of labour market, tax, retirement income etc policies): unemployment rates (and other measures of excess capacity) are.   People who want a job, are available now to start work, who are actively searching for a job, but just can’t find one.

(Having said that, as I’ve written previously I’m not sure that simply a different mandate would have changed the policy mistake of 2014.    With most reasonable possible formulations of an unemployment objective, a hawkish Governor misreading the data (as Wheeler was) would have been likely to have made the same mistake: the right person (“people” when they move to a committee model) matter at least as much as any tweaks to the formal mandate.)

I noticed in the Dominion-Post this morning what appeared to be a suggestion that amendments to the statutory goal for monetary policy might find their way onto the government’s 100 day plan, perhaps in part to ensure that the new mandate was in place before the new Governor is due to take office in March.

No doubt such a limited statutory change could be done quite quickly.  To simply make that narrow change would involve quite a short piece of legislation.  But getting the words right matters – and it isn’t something Parliament should be changing frequently.

Then again, all parties to the new government have also favoured changes to the governance model of the Reserve Bank, and that isn’t something that should be rushed.  The focus to date has been on monetary policy decisionmaking, but the case for reform is probably stronger for the Bank’s financial regulatory functions (where there is nothing akin to the PTA, and too much depends on what is little more than personal gubernatorial whim).   Getting the right governance model for these two quite different functions, and for all the remaining functions of the Bank, and all the consequential changes, takes time to do properly, and would benefit from a full Select Committee process.

As it happens, much of what the government appears to want to achieve can be done through the Policy Targets Agreement anyway.   There is no (lawful) Policy Targets Agreement at present, but a new one needs to be agreed with the incoming Governor before he or she is appointed.   Since the proposed emphasis on unemployment is implicit in the existing framework anyway – it is what a Governor doing his or her job should be keeping a keen eye on in determining the appropriate stance of policy –  simply writing it down more explicitly in the PTA does not raise any particular issues of inconsistency with the existing legislation.

Some might question that, but I’ve had a go at producing a concrete draft of a PTA that captures what seems likely to be the sorts of issues that motivated the Labour Party to promote legislative change.     The resulting text (below) isn’t my ideal framing of the PTA.  Instead, I worked with the text of the most recent document and made as few changes as possible while (a) capturing the spirit of the proposed changes, and (b) avoiding any inconsistency with the existing legislation.  I’ve highlighted the three paragraphs where I’ve proposed changes:

  • 1(b), a now-customary part of the document, where the government of the day lays out briefly its economic objectives, and how it sees monetary policy fitting in,
  • 3(b) where I’ve added words to make clear what has been well-understood since day 1 of inflation targeting, that in managing deviations of inflation from target a key consideration is to minimise short-term output and employment costs, and
  • a new 4(c) which would require the Bank to publish NAIRU estimates, explain why any (actual or forecast) deviations of the actual rate from those estimates was occurring, and to explain what steps it was taking (with monetary policy) to minimise the extent (magnitude and time) of those deviations.

There might well be improvements to this suggested wording.  But these, relatively simple, changes could quickly give effect to what seems to be the thrust of Labour’s proposals.   I’d welcome any comments or alternative suggestions.

Of course, if the government is serious about making a difference –  rather than just signalling one – words alone won’t suffice, whether in the PTA or the Act.  They need to take steps also to find, and put in office, the right people.  The combination –  people and mandate –  gives us a more serious chance of getting unemployment down to around the long-run sustainable rate, and keeping it near there as much as possible, than continuation of the status quo.

These are changes of the sort that the leading academic who reviewed the Reserve Bank’s handling of monetary policy for the previous Labour goverment  (Lars Svensson) would seem likely to endorse.  Svensson served subsequently for several years on the Monetary Policy Board of the central bank of Sweden, where his firm advocacy of an unemployment focus helped get Swedish monetary policy back on track, delivering lower unemployment and inflation nearer the target.  He might be worth consulting again.

Policy Targets Agreement

This agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand (the Bank) is made under section 9 of the Reserve Bank of New Zealand Act 1989 (the Act). The Minister and the Governor agree as follows:

1. Price stability

a) Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices.

b) The Government’s economic objective is to promote a growing economy in which full employment is achieved and maintained.   The management of monetary policy, subject to the medium-term constraint of a low and stable inflation rate, plays an important part in supporting this objective.

2. Policy target

a) In pursuing the objective of a stable general level of prices, the Bank shall monitor prices, including asset prices, as measured by a range of price indices. The price stability target will be defined in terms of the All Groups Consumers Price Index (CPI), as published by Statistics New Zealand.

b) For the purpose of this agreement, the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint.

3. Inflation variations around target

a) For a variety of reasons, the actual annual rate of CPI inflation will vary around the medium-term trend of inflation, which is the focus of the policy target. Amongst these reasons, there is a range of events whose impact would normally be temporary. Such events include, for example, shifts in the aggregate price level as a result of exceptional movements in the prices of commodities traded in world markets, changes in indirect taxes, significant government policy changes that directly affect prices, or a natural disaster affecting a major part of the economy.

b) When disturbances of the kind described in clause 3(a) arise, and consistent with a goal of minimising the short-term output and employment costs, the Bank will respond consistent with meeting its medium-term target.

4. Communication, implementation and accountability

a) On occasions when the annual rate of inflation is outside the medium-term target range, or when such occasions are projected, the Bank shall explain in Policy Statements made under section 15 of the Act why such outcomes have occurred, or are projected to occur, and what measures it has taken, or proposes to take, to ensure that inflation outcomes remain consistent with the medium-term target.

b) In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate.

c) The Bank shall publish its estimates of the sustainable long-run rate of unemployment in each Policy Statement made under section 15 of the Act.   When the unemployment rate (as measured in the HLFS) deviates, or is forecast to deviate, from this estimate the Bank shall explain why these outcomes are occurring, or are expected to occur, and what steps it is taking to minimise the extent to which the unemployment rate deviates from its estimate of the long-run sustainable rate.

c) The Bank shall be fully accountable for its judgements and actions in implementing monetary policy.

Grant Robertson
Minister of FInance

 

…….
Governor Designate
Reserve Bank of New Zealand

Dated at Wellington this ..th day of …. 201….

 

 

 

 

Active monetary policy exists because unemployment matters

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Implications of a new government for monetary policy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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