Easy to underestimate how far things may go

I was at a meeting earlier this week at which a funds manager from one of the leading firms in the New Zealand market was giving us a presentation on our money, their performance etc etc.  We had a light agenda and the presentation was basically over and I like to probe funds managers to see how they think about things.  So I asked him about the possibility of New Zealand getting to negative interest rates, deliberately phrased in  a fairly vague way (rather than, say, “what is the probability in the next 12 months?”).  You’ll recall that the OCR at present is 1 per cent.

Anyway, the funds manager’s response was that it was “highly unlikely”, going on to note that although a “couple of people” had been talking up the possibility that had been a while ago.  The implication was that those people had been, most likely, proved wrong.

I found it a really surprising answer.  Maybe many clients (at least on our fairly modest scale) don’t like talk about uncertainty, contingency etc and want to hear more definitive views from their funds manager.  If so, they are ill-advised.  The world isn’t like that.     And it isn’t 1990 when negative interest rates anywhere in the world might have seemed all-but inconceivable.

Closer to now and to home, even the Governor of the Reserve Bank has been quite open about the possibility of negative rates.

If someone asks me my question –  and they do from time to time –  my answer is along these lines: in many respects it would be surprising if we didn’t get to a negative OCR at some point in the next few years, just because the starting point is one per cent and we know so little about the future.  I often go on to add that after nine years since the last recession the chances of some fairly significant downturn at some point in the next few years must be quite high (statistically, the probability of a significant downturn in any particular year is never that low).

Fan charts are one of the techniques people use to illustrate the plausible ranges of uncertainty around macroeconomic (and similar) forecasts.  Here is an example, applied to the US, from an RBA Discussion Paper published a couple of years ago.

fan charts 1.png

Focus on the bottom-right chart.  Over a three-year ahead horizon, only 70 per cent of historical forecasting errors for the Fed funds target rate would be captured in a range five percentage points wide.

Our OCR system has only been running for 20 years, but I had a look at the historical record to see how much the OCR moved over a three year horizon. (One could do the exercise looking at outcomes vs RB forecasts, but that would be more time-consuming.)  The (absolute value) median change in the OCR over a three year horizon was 1.25 per cent.  Take a longer run of data and look at changes over three years in the 90 day bill rate since financial markets were liberalised here and the median change was 1.8 per cent.

Those are medians, so encompassing only 50 per cent of the changes.  From a starting OCR of 1 per cent, a reasonable description of the range of possibilities –  knowing precisely nothing about the macro outlook –  simply based on historical variability would be along the lines of a 50 per cent chance that the OCR three years hence would be in a range of -0.25 to 2.25 per cent, with a 25 per cent chance each that the OCR would be lower or higher than that the options encompassed by that range.     Simply based on historical variability, there might be something like a 30 per cent chance that the OCR would go negative, from this starting point, in the next few years.

Another way of looking at the issue is to look at how large the falls in short-term interest rates have been when the economy turned down.

For the pre-OCR period we had these examples:

1987 to 1989:   about 600 basis points

1991-1992:   about 700 basis points

1997-1998:   about 450 basis points

And since the OCR was adopted

2001:    175 basis points (not measured as a New Zealand recession)

2008-09:    575 basis points

Recessions in New Zealand look to have been associated with 500 (or more) basis points of cuts in short-term interest rates.

That isn’t particularly unusual: I was reading last night a recent speech by one of Fed Board of Governors who noted, in a quite matter-of-fact way, that the Fed has typically needed about 4.5-5 percentage points of policy leeway in recessionary periods in the last 50 years.

(Under current laws and technologies) the OCR can’t be cut by 500 basis points, but cut by 125 basis points from here and we would already be negative.

Of course, it might be reasonable to ask what is the appropriate starting point. The last time the OCR was raised was back in late 2014, and the OCR is already 250 points lower than it was then.   Since those OCR increases were never really warranted by the data (with hindsight –  and some with foresight – never really needed to meet the inflation target), perhaps 3.5 per cent isn’t really a sensible starting point.

But this year’s 75 basis points of OCR cuts have been in response to actual/forecast data on weakening economies and inflation pressures. If so, perhaps 1.75 per cent might be a reasonable starting point for comparison.  And if a recession hits in the next few years, historical experience suggests that (the equivalent) of 500 basis points of easing will be required.  Again, we can’t cut 500 basis points from 1.75 per cent, but we don’t need anything like that –  less than half in fact –  to get negative.

What are the chances of a recession in the next three years?   Well, no one can tell you with any great confidence.  But if we look at (a) the array of risks, locally but especially internationally, (b) the passage of time since the last recessions, and (c) the very limited conventional macro firepower authorities have at their disposal (and are known by markets to have at their disposal) it would be a brave forecaster –  or funds manager – who didn’t have such a possibility in their reasonable range of outcomes over the next few years.   One could add into that mix the fact that in most advanced economies inflation starts below target (quite different from, say, the New Zealand starting point in 2008).   With the best will (wishfulness?) in the world, I’d have thought a significant downturn, requiring a lot more macro policy support, had to be more than “highly unlikely”.

The Reserve Bank surveys professional expectations/forecasts of the OCR, but only a year ahead, and it only asks for point estimates, not (say) a band within which the forecaster would be fairly confident.  The latest survey has a range – for September next year –  of point estimates of 0.0 per cent to 1.25 per cent.  Even if the more pessimistic of the respondents might have pulled back their point estimates a bit, they aren’t responses suggesting negative rates in the next few years are “highly unlikely”.

I’m not sure whether anyone sells options on, say, bank bill futures in New Zealand.  If so, it would be interesting to know what the prices of those instruments are saying about the range of plausible outcomes for the next few years.

I suspect our fund manager was really just giving (a) his point estimate, and (b) implicitly at least, something about the next 12 months or so.  But the general point is independent of his specific comment: when the OCR is already 1 per cent and the economy is still relatively near a NAIRU (not deep in a downturn already), little or nothing from historical experience should give anyone grounds for confidently predicting that New Zealand will avoid a negative OCR at some point in the next few years.   Constantly thinking the OCR is as low as it will go has been a pretty consistent mistake of observers of New Zealand for 10 years now.

Deputy Governor talking up the economy

On Friday afternoon a reader sent through a copy of a Bloomberg story quoting Geoff Bascand, Deputy Governor, on the health of the New Zealand economy.    As reported, it was pretty upbeat to say the least.   But the foundations for such an upbeat tone seemed more akin to sand than to solid rock.  Storms expose houses built on sand.

This was the opening section of the article

New Zealand’s central bank doesn’t expect its new bank capital rules to present a headwind for the economy, which looks to be near the point of entering a recovery, Deputy Governor Geoff Bascand said.

“We don’t expect major economic impacts” from banks raising their capital buffers, Bascand said in an interview Friday in Wellington. Furthermore, latest developments are “supportive of the story that we’re near or around that turning point” in the economic cycle, he said.

Bascand had been interviewed by Bloomberg’s local reporter, Matthew Brockett, following the announcement on Thursday of the final bank capital decisions: very big increases in required bank capital ratios, even if some portion of that can be met a bit more cheaply than the Governor’s initial proposal had envisaged.  So I guess we should expect spin.  Bascand’s day job is as the senior manager responsible for financial stability, banking regulation etc.  All the advice and the documents published on Thursday emerged from his wing of the Bank.  But he is also a statutory member of the Monetary Policy Committee, with personal responsibility –  with his colleagues –  for actual delivering inflation rates near target, something the Bank hasn’t managed for years now.  For most of that time, the Bank has been consistently too optimistic about the economy, and about the prospects for getting inflation back to target (fluctuating around the target midpoint, perhaps especially in core inflation terms).

I guess the characterisation “doesn’t expect its new bank capital rules to present a headwind for the economy” is the journalist’s, and there is quite a lot of leeway in Bascand’s own words: “we don’t expect major economic impacts”.  If “major” here means “singlehandedly tip the economy into recession” then I suspect everyone would agree, but that shouldn’t be the standard.   The Bank’s own numbers tell us that they think the base level of GDP –  absent crises –  will be lower as a result of the change in the capital rules.  And their modelling effort focuses on the long-term, not the transition.  The headline out of last week’s announcement was that the transition period had been stretched out, from five years in the consultative document to seven years.  But (a) in making decisions now, and in the next couple of years, people will sensibly factor in changes in the regulatory environment that have already been announced (and are final, in the Governor’s words) –  expectations matter, as the Bank often (and rightly) tells us, with its monetary policy hat on and (b) for the big banks a significant chunk of the policy change is frontloaded, because the change in rules to increase risk-weighted assets calculated using internal models to 90 per cent of what would be calculated using the standardised rules happens right at the start.  That change alone is equivalent to a 20 per cent increase in minimum capital.

And it isn’t as if there are no hints of effects already, even before the final decisions were made.  The Governor and Deputy Governor clearly prefer to avoid addressing these data, but the Bank’s own credit conditions survey showed not only that credit conditions (a) have already been tightening, (b) are expected to continue tightening, and (c) respondents ascribe much of that effect to the impact of regulatory changes.

credit 4

Perhaps the banks were just making it up when they responded to this survey?  Perhaps, but the Bank was happy to cite either components of the survey in its recent FSR, just not these awkward ones.

And why wouldn’t much higher capital requirements, in a world where there is no full MM offset (as the Bank itself recognises), no full or immediate scope for disintermediation to entities/channels not subject to the Bank’s rules, constrain credit availability to some extent, especially in the early stages of a multi-year transition period?   And, as the Bank also keeps telling us, the availability of credit is one of lubricants to economic activity.  If credit isn’t as readily available, all else equal economic growth is likely to be dented.

And what about Bascand’s other big claim that indicators are

“supportive of the story that we’re near or around that turning point” in the economic cycle,

Count me sceptical.     At best, what we’ve seen so far might support the possibility of an inflection point.  If you want a nice summary, with charts, I thought last week’s ANZ economics weekly was about right.

It is worth remembering just how subdued economic growth rates have been this decade –  headline, not even per capita –  and that the slowing has been underway for several years.

GDP growth

On the home front, business confidence and related measure seem to have bounced a bit, but aren’t outside the range we’ve seen over the last couple of years  (when actual growth has been falling and low).   Some agricultural products prices are doing very well, but (a) surely the best estimate is that many of these lifts will be shortlived, and (b) debt overhangs and tightening credit constraints locally will limit the extent to which near-term income gains materially increase activity.  Bascand makes quite a bit of the promise of fiscal stimulus, but recall that on the Treasury fiscal impulse indicator there was a fairly substantial fiscal stimulus in the year to June 2019, and growth was low and slowing.

And that is before we start on the rest of the world.  Here is an ANZ chart of growth in world trade and industrial production

ANZ trade

Data out of Europe, Australia, and the PRC (the latter two being the largest New Zealand export markets) have remained pretty downbeat, even as sentiment ebbs and flows at the margin.  The latest Chinese export data offered little encouragement,  And there isn’t much optimism about the US either, with a considerable chunk of US forecasters expecting a recession in the next two years.   And all this against a backdrop in which people (markets in particular) know that there are quite severe limits on how much macro policy can do if a new serious downturn happens.  That alone is likely to engender caution.

The TWI doesn’t move independently of all these domestic and foreign influences, but it is worth noting that it is now a bit higher than it was when the Bank surprised everyone with their 50 basis point OCR cut in August.

TWI dec 19

Perhaps time will prove the Deputy Governor right, but at present I’d suggest his claims should be taken with a considerable pinch of salt.  Things probably aren’t getting worse right now, but it seems heroic –  against the backdrop of both domestic and foreign constraints and headwinds (including those capital changes) to be talking up the idea of a turning point in the economy.    And rather concerning if this is the sort of sentiment shaping the Bank’s monetary policy thinking right now, after a decade in which things have kept disappointing on the downside.   It doesn’t have that “whatever it takes” sound about it, of which we heard quite a bit in the wake of the August OCR cut.  It sounds more like the sort of spin we hear repeatedly from the Minister of Finance and Prime Minister, who go on endlessly about headline GDP growth rates here and abroad, and never once mention how much faster population growth is here than in most advanced countries.

A few weeks ago I wrote a post about the sudden mysterious, but very welcome, appearance of inflation expectations as a factor in the Bank’s storytelling about policy.    For a few weeks the Governor was outspoken in his desire to act boldly to boost inflation expectations, and do what he could to minimise the risk of hitting lower bound constraints in the next downturn.

And then, like the morning mist, all that concern was gone again –  totally absent in the presentation of the latest MPS.   If anything, inflation expectations measures had fallen a bit further from August to November.

I don’t typically pay much attention to the Reserve Bank’s survey measure of household inflation expectations.  Neither, I expect, do they.  But it has been running for a long time now, and the latest numbers –  finally released late last month – look as though they should be a bit troubling for the Bank.

household expecs 19

This series is nowhere near as volatile as the ANZ’s household expectations survey (although, for what it is worth, recent observations in that series have also been pretty low).   It began in the far-flung days when the inflation target was 0 to 2 per cent (centred on 1 per cent) and yet this is the first time ever that household year ahead inflation expectations (median measure) have dropped below 2 per cent.  At one level, that might be welcome –  the series has historically had quite an upward bias –  but when household expectations are converging towards professional and market expectations, and all those are below the 2 per cent target midpoint it shouldn’t be a matter of comfort at all.    This is the sort of drop the Governor claimed (at least in August and September) he was trying to prevent.   In the same survey, respondents are also asked whether they expect inflation to rise, fall, or stay the same over the next year (probably easier to answer than a point estimate).  There too respondents have become less confident that inflation is going to pick up.

For a brief period a few months ago it looked as though the Bank, and the Governor, were really taking seriously the challenges we face, in a context where conventional monetary policy just does not have much more leeway.  More recently, they seem more interested in talking things up again –  keeping pace with the political rhetoric, and perhaps playing defence re the bank capital changes.  A more realistic tone would offer a better chance of getting through tough times with as little damage as possible, including by better preparing firms and households for the risks that arise if the global downturn intensifies, with little monetary policy leeway, the risk of significant policy-induced tightening in credit conditions, and inflation (and particularly at present inflation expectations) falling away.

We are getting very late in the business cycle and we’d be better served by a strongly counter-cyclical central bank, rather than one playing defence for its own (deeply flawed) other policies, and whistling to keep spirits up (and political masters, making decisions about the future of the Bank, happy).  With the sort of mindset on display at present they risk being blindsided by events, in a context where –  as the Governor himself put it only a few months ago –  the costs and consequences of being wrong the other way (inflation gets to say 2.3 per cent) are pretty slight and inconsequential after a decade of such low inflation.

Compass gone wonky

Having delivered his Monetary Policy Statement, done his press conference, fronted up to the Finance and Expenditure Committee –  oh, and roiled the markets –  Reserve Bank Governor appears to have jumped on a plane for a quieter couple of days at conference in San Francisco.  I don’t begrudge him that –  the conference in question is usually pretty good (I got to go once) and this year’s programme looked as interesting as ever.  The topic was “Monetary Policy Under Global Uncertainty”.

The Governor was on a “Policymaker’s Panel” –  along with a Deputy Governor from Korea and a former Deputy Governor from Brazil.    It can’t have been a very in-depth panel (the programme allowed only 50 minutes in total), but we don’t hear much systematic from the Governor on monetary policy and so it was welcome that he chose to release his short (four pages or so of text) remarks.  I don’t think I’ve seen them covered in the local media at all.    That is perhaps a little surprising as, having greatly surprised commentators and markets in two MPSs in succession, his remarks to this FRBSF panel were under the heading Monetary Policy: A Compass Point in Uncertain Times.   Sounds like a worthy aspiration.  Shame about the execution.

But what did Orr have to say in his brief remarks?

First, he attempts to suggest that policy (etc) uncertainty isn’t really much of an issue in New Zealand.  Yes, he really does claim that, drawing on a measure – of the dispersion of GDP forecasts –  which isn’t an indicator of policy uncertainty at all.    Now, no one is going to claim that we have anything like the degree of policy uncertainty they face in the UK (or, thus, its major trading partners including Ireland). We don’t even have a “trade war”.   Then again, we had months of uncertainty around capital gains taxes, ongoing uncertainty about the future labour market regulatory regime, and now about the future water pollution regime. Oh, and bank capital requirements…..to name just a few.

Then we come to paragraph that I agree with, quite strongly, and yet it seems he no longer does.   In the light of the uncertainty (globally) he tells us

it is vital that monetary policy acts as a compass point for decision making

going on to note

For New Zealand, this means setting policy to achieve our price stability target and support maximum sustainable employment. It means acting decisively to prevent an unnecessary worsening in economic conditions and the un-anchoring of long-term inflation expectations. And it means recognising the limits of monetary policy.

I’m not going to disagree, but quite how he justifies his MPC’s decisions, and communications, in and around both the August and November MPSs is less clear.  As I noted the other day, in August –  when they did act “decisively” there was little attempt to invoke arguments about inflation expectations in support, then we had a couple of months of wheeling out such arguments, only for them largely to be abandoned last week when he chose to err on the side of caution, “unnecessarily” so, at least in my view, against a backdrop of inflation and inflation expectations below targets with (in their own words) downside risks.   Not much of guiding light there.

Then we get the sort of paragraph beloved of self-important central bankers

In discussing these topics, I will touch on how, since the Great Financial Crisis, central banks have been tasked with a widened set of objectives. On one hand, we appreciate the constraints faced by other institutes, and the peril that may have resulted from the crisis had central banks not stepped up to the task. On the other hand, central banks are sometimes expected to solve phenomena that are structural in nature, and that do not sit easily within the conventional realm of monetary policy. At the Reserve Bank, we are always exploring new policy options to meet our broadened mandate.

Except that, typically, central banks don’t have a wider mandate how than they did before.  That is certainly true of New Zealand –  where nothing at all (in legislation) has changed around regulation/supervision, and where the change to the formal goal of monetary policy was, in the Bank’s own telling, more cosmetic than substantive, designed to capture something about the way the Bank had long sought to operate, while altering some rhetoric.  The big change in New Zealand has been central bankers looking to extend their own reach, both within and beyond the mandate Parliament has given them –  whether LVR limits (arguably within the letter of the law), focus on “culture and conduct” (clearly not),  the Maori strategy (not), the green agenda (largely not) and so on.    Perhaps in a few corners of the world there has been a belief, by a few people, that central banks can markedly change structural growth outcomes.   If so, such a mantra has rarely, if ever, been heard here in the last decade. But it makes central bankers feel important and valued to pretend otherwise.

Keeping on through the speech, we do actually get some recognition that “policy uncertainty” –  and “regulatory requirements” –  were acting as a barrier to business investment in New Zealand.  As he notes, most of this doesn’t have much to do with monetary policy, except that monetary policy needs to take account of whatever is influncing overall demand and supply pressures/balances.

From a central bank perspective, uncertainty has one clear impact: it makes our job harder. Good monetary policy depends on reasonable forecasts. High uncertainty makes forecasting harder. There is more noise in the data and forecasts are more subject to revision. A consequence of this is that the Official Cash Rate (OCR) may be less predictable simply because the world in which we are making our decisions is less predictable.

Except that earlier he showed that chart (mentioned above) in which the dispersion of GDP forecasts has been quite a bit lower than usual in the last couple of years.  So it might be a fair point in principle, but in practice –  in recent months –  the real source of short-term uncertainty about the OCR has been……the Reserve Bank itself.    Not a point that Governor chose to address.

He then moves on to a section headed “Monetary policy response to uncertainty”.

First up is a straw man

Firstly, maintaining low and stable inflation enables organisations and individuals to carry out meaningful financial planning, by reducing overall uncertainty. This is something that is nearly impossible when prices are high and volatile or falling uncontrollably.

Neither is a world any advanced country has been dealing with in recent decades (I’m assuming he meant “inflation” was high and volatile), and in the case of “falling uncontrollably” never.

Then we do get to recent New Zealand policy

In particular, it is now more suitable for us to take a risk-management approach. In short, this means we look to minimise our regrets. We would rather act quickly and decisively, with a risk that we are too effective, than do too little, too late, and see conditions worsen. This approach was visible in our August OCR decision when we cut the rate by 50 basis points. It was clear that providing more stimulus sooner held little risk of overshooting our objectives—whereas holding the OCR flat ran the risk of needing to provide significantly more stimulus later.

And yet, wasn’t that title something about a reliable “compasss point”.   None of his August approach was flagged in advance, arguments for it unfolded only slowly even after the event, and then –  when there was still (on his own numbers) “little risk of overshooting our objectives” they abandoned that particular “least regrets” line, without explanation in advance, in the release, or subsequently.  He goes on

We can also address uncertainty through our communication and forward guidance, which are broad-ranging. We reveal our assessment of the economy—good or bad—to the public, so they can make decisions based on the best possible information amid the prevailing uncertainty. We voice the types of policies we believe may be needed to sustain long and prosperous growth—be they monetary, fiscal, or financial policies.

But that is almost exactly the opposite of what the Governor and MPC are doing.  We have still not had a single substantive speech from the Governor on monetary policy and the economy.  We haven’t at all from three of the statutory members of the MPC.  It is harder to make good decisions when central banks spring –  quite unnessary – surprises.  Oh, and actually it is no part of the Bank’s mandate to be opining on what policies are best for “long and prosperous growth” (although it is remarkable that structural policies appear not to be relevant to the Governor’s view of growth, productivity etc).

There is a final page on “Beyond conventional monetary policy” which I don’t have particular problem with.  It is good that the Governor again repeats his intention to publish their analysis. It is only a shame that (a) this process has been so long delayed, including under his predecessor, and (b) that the work done so far has not proceeded in a more open and consultative way, rather than being something akin to the “wisdom” delivered to the masses from the wise experts on the mountain top.

Orr ends in a typically upbeat tone.   I just want to highlight the last few sentences in which (as so often) he overreaches, partly in the process of distracting attentions from the failings in areas he is directly responsible for.

Yes, there is uncertainty. Yes, it is affecting us. No, monetary policy cannot directly resolve this issue. But we can offset its effects and empower others to fuel economic activity that will benefit us in both the short and long-term. There has never been a greater time to make use of accommodative monetary policy for investing in productive assets.

Yes, monetary policy has a (vitally) important stabilisation role.  It was why countries set up discretionary monetary policy many decades ago.   But it can do nothing to offset the blow to potential output created by policy uncertainty and other regulatory burdens.  It does nothing to boost our longer-term prosperity.  And as for the final sentence…….he falls into the trap again of trying to convince us that low interest rates are some exogenous gift, empowering whole new opportunities, when in fact interest rates –  long-term market-set ones and official OCRs –  are low for reasons that seem to have to do with diminished opportunities, diminished prospects for profitable investments.  Don’t get me wrong – given all that, the OCR should be lower (mimicking what real market forces would be doing if short-term interest rates were a market phenomenon), but when interest rates are falling in response to deteriorating fundamentals it is a stretch –  at very least –  to expect the sort of pick-up in business investment the Bank often forecasts but rarely gets to see.

It wasn’t a persuasive or particularly insightful set of comments.  Perhaps his San Francisco audience –  knowing little of New Zealand –  weren’t bothered, but we should be.  We should expect a lot more from such a powerful, not very accountable, public figure.

(And if you want a speech from a much more serious figure, try this one –  given at the same conference –  by Stephen Poloz, Governor of the Bank of Canada.  There is a depth and seriousness to it that is simply now not seen from senior figures in our own economic policy agencies.)

Effective communications and consistent messaging (not)

One can debate whether or not the Reserve Bank should have cut or not.  Reasonable people can differ on that.  But their communications quite clearly needs (a lot of) work.   This post is just one illustrative example of the sort of problem there is: the role of inflation expectations in their thinking and public commentary.

Back in the August Monetary Policy Statement – the one where they announced the rather panicked 50 basis point cut, not really consistent with either the rest of the document or their own numbers – there wasn’t much mention of inflation expectations.  To be specific:

  • they are not mentioned at all in chapter 1, the main policy assessment/OCR announcement,
  • they are mentioned more or less in passing in the minutes, viz

Some members noted that survey measures of short-term inflation expectations in New Zealand had declined recently. Others were encouraged that longer-term expectations remained anchored at close to 2 percent.

with no suggestion that it was a significant part of the story

  • of the seven other references in the document, five are simply labels of charts, and one was in the standard descriptive framework section (“how we do monetary policy”).  The only other substantive reference was pretty unbothered.

Although survey measures suggest inflation expectations remain anchored at around 2 percent, firms and households continue to reflect past low inflation in
their pricing decisions.

If that had been all, a reasonable reader might have assumed expectations measures were something they were keeping an eye on, but weren’t much of a concern, or playing much of a role in the OCR decision.

But in his press conference, we got the first hint of a quite different line.  Perhaps the Governor genuinely felt differently than the majority of the MPC –  which frankly seems unlikely, given that he chairs the committee and he and has staff have a majority on it –  or perhaps he was simply casting around, more or less on the spur of the moment, for reasons to justify cutting by 50 basis points rather than the 25 points everyone had expected (50 point moves not having been used since the height of the 08/09 recession).

But whatever the reason, in answer to a question (just after the 10 minute mark here) he made the following points:

  • they’d tossed and turned between going 50 points then, or 25 points then and 25 later and,
  • over recent days they had become increasingly convinced that doing more sooner was a safer strategy to achieve their targets than a strategy of going more slowly over a longer period. He went on to note that
  • it was all about the least regrets analysis and stated that in a year’s time he would much prefer to have the quality problem of inflation expectations getting away on us, and possibly having to think about “other activity” [ tightening?]
  • that was preferable (better/nicer) than finding a year hence that they had done too little too late.

I was quite taken with those comments at the time, and commented positively on them in my own review of that MPS.  It seemed exactly the right way to think about things, especially as in the same press conference he was highlighting the risks of the OCR having to go negative (the more that could be done now to boost expectations, the less likely the exhaustion of conventional monetary policy capacity).

But do note that none of that “least regrets” perspective was reflected in the MPC minutes.

The Governor obviously took something of a fancy to this line.  In a interview with Bernard Hickey a few days later, of which we have the full transcript, he is quoted thus

“Doing the 50 points cut was interesting: whilst you get closer to zero, you also shift the probability of going below zero further away,” Orr said.

and

We’ve spent a lot of time around, I suppose, regret analysis, and I spoke about – you know, in a year’s time looking back, thinking ‘well, I wish I had done what?’ And I thought it’s – I would far prefer – and the committee agreed – far prefer to have the quality problem of inflation expectations starting to rise and us having to start thinking about re-normalizing interest rates back to, you know, something far more positive than where they are now. And that would be, you know, it would be a wonderful place to have regret relative to the alternative: which would be where inflation expectations keep grinding down.

and a few days later, in a speech given in Japan, the Assistant Governor was also now running this message (emphasis added)

A key part of the final consensus decision to cut the OCR by 50 basis points to 1.0 percent was that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives. In particular, it would demonstrate our ongoing commitment to ensure inflation increases to the mid-point of the target. This commitment would support a lift in inflation expectations and thus an eventual impact on actual inflation.

On balance, we judged that it would be better to do too much too early, than do too little too late. The alternative approach risked inflation remaining stubbornly below target, with little room to lift inflation expectations later with conventional tools in the face of a downside shock. By contrast, a more decisive action now gave inflation the best chance to lift earlier, reducing the probability that unconventional tools would be needed in the response to any future adverse shock.

I commented positively on that too.  It was good orthodox stuff.

And it kept coming.  In an interview with the Australian Financial Review, at Jackson Hole, a few days later, here was Orr

Q Was this [falling world rates][ front of mind when you did your recent interest rate cut?

A. It was front of mind. Without doubt the single biggest….one [factor] was domestic.  We saw our inflation expectations starting to decline and we didn’t want to be behind the curve.  We want to keep inflation expectations positive-  near the centre of the band.

And it was also referred to in passing in the folksy piece the Governor put out back here that week, noting “lower inflation expectations” as second in the list of influences on the OCR decision.

And here it was again in the Governor’s 26 September speech

We also judged that it would be better to move early and large, rather than risk doing too little too late. A more tentative easing of monetary policy risked inflation expectations remaining stubbornly below our inflation target, making our work that much more difficult in the future.

By this point – less than two months ago – any reasonable observer would have been taking note.

So what had actually happened to inflation expectations by this point?  At the time of the August MPS the Bank already knew that the 2 year ahead expectations had fallen quite a bit  –  from 2.01 per cent to 1.86 per cent in a single quarter.  That’s not huge, but it is not nothing either, and with core inflation still below 2 per cent it wasn’t something the Bank should have been that comfortable with.  The year ahead measure (noisier) had dropped by more.

As it happens, the other main inflation expectations survey –  the ANZ’s year ahead measure –  hadn’t dropped at all by the time the Bank acted in August: from May to July year ahead expectations were in a 1.8 to 1.9 per cent range.   In August – but not published until 29 August –  they fell to 1.7 per cent, and over the last couple of months they’ve fallen a bit further, the latest observation being 1.62 per cent.

As for the RB survey, there was also a slight further drop in mean expectations in the latest survey that was released on Tuesday (but which the Bank had in hand throughout its November MPS deliberations).

Both the latest ANZ and latest RB surveys were completed exclusively in the period well after the Bank’s surprise 50 point cut in August.  If the Governor (and Hawkesby) were serious about that rhetoric they’d surely have hoped to have seen at least some bounce in the latest survey –  after all, that was the logic of preferring a big cut early.   Instead, those survey measures fell a bit further (not to perilous levels of course –  in fact, current levels are just consistent with where core inflation has been for some time, a bit below the target midpoint).

During the Wheeler/McDermott years the Reserve Bank rarely if ever mentioned the market implied inflation expectations, calculated as the breakeven rate between indexed and nominal government bond yields. I used to bore readers pointing out this curious omission –  they never even explained why they felt safe totally discarding this indicator.

Inflation breakevens have been below 1.5 per cent now consistently for four years now and fell further this year.  In recent months, those implied expectations –  average inflation expectations for the coming 10 years –  were just on 1 per cent.  In monthly average terms, the low point wasn’t even July/August (ie just prior to the MPC’s bold action) but October.

Here is the chart, monthly averages but with the last observation being today’s.

breakevens nov 19

As the Governor was very keen to point out yesterday, there has been a small lift in this measure……but he was less keen to mention the level; the small lift only takes the breakeven rate back to aroud 1.13 per cent.  This time last year it was 1.41 per cent, still miles below the target midpoint.  Perhaps the recent lift will be sustained –  we should hope so –  but on any reasonable balancing of survey and market measures you could really only say things hadn’t got worse over the period since August.  On the clear words of the Governor and Assistant Governor, it was quite reasonable for analysts/markets to look at the inflation expectations data and expect it to feature prominently in this week’s MPS – after all the merits of the Governor’s August/September arguments (agree with them or not) hadn’t changed, expectations hadn’t lifted, and the Bank had given no hint they’d changed their way of thinking, yet again.

But what did the MPC have to say about inflation expectations on Wednesday?  Again there was nothing at all in the chapter 1 policy assessment/announcement, and there was just this in the minutes

The Committee also noted the slight decline in one- and two-year ahead survey measures of inflation expectations. Nevertheless, long-term inflation expectations remain anchored at close to the 2 percent target mid-point and market measures of inflation expectations have increased from their recent lows.

They were pretty half-hearted, even about those market breakevens.  No mention at all of the arguments the Governor and Assistant Governor were running only a couple of months ago, and although the minutes do now mention the idea of least regrets this was all they said

In terms of least regrets, the Committee discussed the relative benefits of inflation ending up in the upper half of the target range relative to being persistently below 2 percent.

The Governor’s comments in August certainly suggested he’d have thought it better then to run the risk of being a bit above 2 per cent (after a decade below).  But this time, the Bank as a whole has reverted back to the cautious approach the Governor was looking unfavourably on, in public, only three months ago.   We are back to “oh well, never mind”, or so it seems, and all that pre-emptive talk,  doing what they can to minimise the risk of needing to go below zero, is supposed to disappear down the memory hole?

It seems all too symptomatic of what is wrong with the way the Bank is conducting monetary policy at present.    There are few/no substantive speeches, the minutes capture little of the flavour of thinking, half the MPC members are simply never heard from (and no one knows if they have any clout or not), there is no personalised accountability (as a market commenter here noted, it is incredible that no one on the Committee was willing to record a dissent yesterday, all hiding behind the Governor)….and then we get the Governor just making up policy rationales (quite sensible ones in this case) on the fly, only to then jettison them, without explanation or a chain of articulated thought, when for some reason (still unknown) they no longer support his instincts.

Was it ever an approved MPC line?  If not, why was the Governor just making up stuff  –  and then repeating it several times in open fora?  Under the rules he is supposed to be the spokesman for the whole committee.   And if it was an approved line why (a) did it never make it into the MPS, and (b) why has the MPC now changed its thinking when there is no sign of significant rebound in expectations, the effective lower bound is still in view, and the domestic measures have actually been drifting lower?

There is little basis for observers and markets to make any reliable sense of the MPC.  We know little, that is in any way consistent, about their reaction functions, their loss functions, their models, or even their stories about what is going on locally and internationally.  Big surprises, of the sort we’ve had in New Zealand at the last two MPSs, have become quite uncommon internationally, and that is generally a good thing.  Where are we now –  18 months into the Orr governorship, 7 months into the new MPC –  simply isn’t good enough  The reforms the government initiated last year could have been the opportunity for something genuinely much better.  Instead all we seem to get is a bit more expense –  all those high fees for the silent, invisible, and unaccountable externals.

Monetary policy isn’t being handled well, and neither is bank supervision (bank capital and all that).   Together, these twin failings in the Bank’s two main functions paint the Bank and the Governor –  and those responsibe for holding them to account in a pretty poor light.    There are hints that, under pressure, the Governor may have recently toned down his act and started to operate a bit more professionally.  If so, it would not be before time, but if this week was anything to go by the tone may be a bit better but the substance of the messaging and communications still leaves a lot to be desired.  At present, the best guess (sadly) would be on another lurch, in an unpredictable direction, relying on new arguments plucked fresh from the air, with no one certain quite who they represent or how long they will last.

Good in a few parts….pretty poor otherwise

There were some good aspects to yesterday’s Reserve Bank Monetary Policy Statement:

  • the Bank has abandoned its long-running over-optimism about future productivity growth and has thus revised down its estimates of potential (GDP) growth to more reasonable rates.  Nothing in the economic strategy –  this government or its predecessor –  seemed set to deliver better, and it is good that the central bank has stopped spinning candy floss numbers (at least on that count),
  • the Governor also seemed less effervescent, and perhaps consistent with the previous point there was little or no spin about just how well the economy was doing,
  • in the document there weren’t even further direct calls for more government spending/borrowing.  This change was defended on the grounds that the message had already been given, but I doubt that was all there is to explain the change (having said something once, even loudly, rarely discourages central banks from saying them again),
  • oh, and the folksy Maori salutations at the start of the main statement –  beloved by the tree-god Governor when it was his statement alone –  seem to have quietly disappeared.  Perhaps we might hope for the eventual quiet discontinuance of the cartoon version of the statement too?

But that was about all that could be said for it.

The document itself was weak on substance, building on consistently poor (largely non-existent) communications from the Bank.

You can tell that there are problems with communications when the Governor is reduced to repeating (numerous time in the parts of the press conference I saw) “we are trying to be as transparent as possible”.  He isn’t seriously trying, and certainly isn’t succeeding.  We’ve not yet had a serious speech on the economy and monetary policy from the Governor, after seven months we’ve heard not a word from four of the MPC members (including all the externals), background papers aren’t released even with a long lag, the MPS documents themselves offer ever-less insight or sense of how (or even whether) the MPC thinks in depth about the economy, and the Bank holds data close to its chest when it could release it more promptly (asked about this latter point yesterday the Governor did undertake to review their practice).

When two successive MPS OCR wrongfoot those paying closest attention to the data and to the Bank, it suggests the problem is with the Bank, not the observers.      It would be interesting to know what advice the Bank’s financial markets staff gave the MPC about the market movements that were likely to occur as a result of yesterday’s decision.

It was only a few weeks ago that the Assistant Governor, Christian Hawkesby, gave a speech on central bank communications, probably mostly trying to fend off criticism of how they’d done in August.    In that speech he highlighted –  and overstated, at least in practical terms –  the risks if central banks do what markets expect them to do

In this scenario there is a danger that markets end up paying too much attention to our communications for what we have said ‘we will do’, leaving no one left to analyse the incoming economic data for what ‘we should do’. As a central banker, I am far more interested in listening to what ‘we should do’.

And yet, yesterday’s MPS suggested that Hawkesby and his colleagues actually had no interest in that perspective either.   As I noted in yesterday’s post, the MPC has had available to it throughout its deliberations the results of the Bank’s survey of expectations, the macro views of several dozen informed observers of the New Zealand economy. I wrote about the results yesterday.  Those respondents expected the Bank to cut yesterday (and again next year) and even so they didn’t expect two-year ahead inflation to get above 1.8 per cent and expected no rebound in GDP growth either.    Implicit in those numbers (and consistent with the mandate given to the MPC by the government) is a pretty clear view that the Bank should have cut the OCR, and should probably do so again next year.  The Bank, apparently uninterested, chooses to ignore this weight of opinion and runs with its own idiosyncratic view that even with higher interest rates they were still get the growth rebound the outside observers couldn’t see (either three weeks ago when they completed the survey or –  judging by comments from market economists in the last day –  now).  In the end, the MPC is charged with making decisions, but having got things wrong –  below target inflation –  for the last decade, the onus is surely on them to explain why they (mostly non-experts themselves) are so willing to back an away-from-consensus call.   But they made no effort to.

In fact, if you started into the document without knowing the bottom line you’d think the case for easing yesterday was pretty unambiguous.  They told us that the economy had slowed and risk were to the downside, the world economy was slowing, inflation expectations were very low and/or falling and, of course, core inflation was below target.  And all that without even so much as a single mention –  in the entire document, includung the minutes –  of the apparently significant tightening in credit conditions respondents to their own credit conditions survey were foreshadowing, those same respondents having highlighted regulatory changes (ie most likely the coming big increases in minimum capital requirements) as a big issue.

credit 4 Or perhaps the MPC is back to thinking that credit conditions really don’t matter at all?  Surely, either way it would be reasonable to explain their perspective.  Instead they seem to have simply ignored the issue (or tried to pretend the Governor’s whim wasn’t an issue –  I heard Hawkesby on the radio this morning saying they had in fact taken account of credit conditions issues, in which case the OCR decision is still more mystifying, and the absence of any reference in the official documents looks even worse).

One of the disappointing features of yesterday was that there were signs of the Wheeler Reserve Bank returning.   Under the former, not widely lamented, Governor we heard endlessly from the Bank about how stimulatory monetary conditions really were –  even as inflation just kept on falling below their forecasts.  There was a lot of that line yesterday.    As then, so now, the Bank does not have a good read on where the neutral interest rates are, and the best guide is really something like the rear-view mirror: all else equal, look at what is happening to demand (and early indicators like business activity measures) and inflation.   In the Wheeler years, there was also a strong tendency to constantly be focusing on the merest hint that something might be picking up, because of the strong belief (see above) that conditions were “highly stimulatory”.  It was all rather circular –  we think we are right because we think we are right.     There was quite a bit of that sort of flavour in yesterday’s statement too: both the forecast pick-up in growth (that few other observers appear to believe) and the repeated mysterious suggestions that inflation itself was picking up now.

In the MPS the Bank shows five core inflation measures, and also highlights as a preferred measure the (highly persistent and stable) sectoral core factor model measure

core infl nov 19

Across the wider suite of measures, there has been no lift since 2016.   And the sectoral core factor measure has been flat at 1.7 per cent for more than a year.  And core inflation is a lagging indicator in a climate where (to quote the Bank) the New Zealand economy has been slowing and the world economy has been slowing).

What about core non-tradables inflation?  The headline non-tradables inflation rate did rise recently.

core infl NT.png

The blue line is an official SNZ series, while the orange line in an RB series.  Again, no sense of any pick-up in core domestic inflation pressures –  and nor, really, would one expect there to be in an economy where activity growth has slowed, unemployment has levelled out, confidence is low, policy uncertainty is quite high, and inflation expectations (remember them) are low.

In short, there was a (welcome and overdue) pick-up in inflation a couple of years ago, but there is no sign it is continuing.  And –  since the OCR cuts this year were against the backdrop of materially deteriorating fundamentals –  there isn’t much reason to expect further increases in inflation from here on current policy (perhaps especially not when credit conditions are tightening, and RB announcements are pushing up interest and exchange rates).

Incidentally, one line –  used several times yesterday – that you shouldn’t be fooled by was the one that “the projections were consistent with either choice –  a cut or leaving the OCR unchanged”.  Well, of course…….    Unless practice has changed very very markedly from the way things were when I was closely involved in these processes, the final projections track –  especially the interest rate track –  is tailored to be consistent with the policy options and messages the decisionmakers (in my day the Governor, these days –  at least on paper –  the MPC) want to send. If the MPC wasn’t clear in its own mind last week what it was finally going to do, they’d prudently have ensured that the final track was consistent with either option.  If they’d been clear but wanted to send a message that they’d been open to a possible cut, they have done the same thing.  There is no independent evidence or perspective in (the first few quarters) of that track.

I want to circle back to the claims around the (asserted) high degree of transparency.  One of the innovations in the new monetary policy governance model is the publication of the summary record of the meeting (aka “minutes).    These are typically a bit longer than the initial policy announcement statement itself, and do provide the opportunity to note a few issues there wouldn’t otherwise be room for.  But they are proving even less enlightening than one might have feared (given the way the Governor and the Minister got together to oppose a more genuinely open model, of the sort seen in central banks in places like the US, the UK, Japan, or Sweden).

Here are four examples from yesterday’s minutes.  First, fiscal policy

The Committee discussed the impact of fiscal stimulus on the economy. The members noted that fiscal stimulus could be greater than assumed. The members also discussed the potential delays in implementing approved spending and investment programmes.

So far, so banal.  As I noted earlier, in the official documents the Bank was back to staying in its line re fiscal policy (as the Governor said, “we take fiscal policy as announced and run on that basis” –  which is how things are supposed to work).   And yet this morning on Radio New Zealand Christian Hawkesby was heard stating that “we think more fiscal spending would be helpful in stimulating the economy”.     If that is the Committee view, why isn’t it in the MPS or the minutes, if it was substantively discussed why isn’t it in the minutes, and if it is true then – given that the, as the Governor said, the Bank takes fiscal policy as given – isn’t Hawkesby’s statement further evidence that they should in fact have cut the OCR yesterday (if they think the economy needs more stimlus, and they are responsible for deploying the primary counter-cyclical tool)?

Then, the work programme on how the Bank might handle reaching the limits of conventional monetary policy

The Committee noted the Bank’s work programme assessing alternative monetary policy tools in the New Zealand environment, as part of contingency planning for an unlikely scenario where additional monetary instruments are required.

A statement which tells readers precisely nothing (especially as it is now three months since the Governor told a press conference that the work then was “well-advanced”).  As it happens, reality seems a bit better than the minutes imply because when he was asked about this work programme yesterday and bringing it to light, the Governor revealed  that they will release a document on frameworks and principles in the new year, and will (he says) be keen on feedback and discussion.  That sounds more promising, but then where does the MPC fit into all this given the unrevealing comment from the minutes (and there are longstanding doubts about just who has power over any unconventional instruments –  whether the MPC will get much say at all)?

Then we are told they had a discussion on an important immediate policy issue

In terms of least regrets, the Committee discussed the relative benefits of inflation ending up in the upper half of the target range relative to being persistently below 2 percent.

But that’s it.  We are given no insight into the arguments deployed, the competing cases made, or the conclusion.  Given their OCR decision we are left to deduce that the Committee would be quite worried indeed about (core) inflation getting above 2 per cent.  But we are given no hint of why –  despite 10 years now below that midpoint.   And this is what the Governor calls being as transparent as possible?

And finally, the OCR decision itself

The Committee debated the costs and benefits of keeping the OCR at 1.0 percent versus reducing it to 0.75 percent. The Committee agreed that both actions were broadly consistent with the current OCR projection. The Committee agreed that the reduction in the OCR over the past year was transmitting through the economy and that it would take time to have its full effect.

And, again, that is it.  No hint of the competing arguments –  which could readily be done without identifying individuals –  and no hint of why they chose to come down where they did?  What were the key costs the Committee saw to cutting the OCR (especially when both market expectations and observer implict recommendations were to cut).  There is no insight into the current decision or, importantly given the absence of speeches etc, no insight into the reaction functions/loss functions members (individually or collectively are using).  It simply isn’t very transparent at all.    The mantra overnight “just watch the data, just watch the data” isn’t really much use at all –  especially when the MPC is going to run with such a non-consensus view of the data (and/or the risks around policy reactions).

It is all pretty underwhelming and confidence-draining.   The point isn’t that a huge amount macroeconomically hung on any specific OCR decision. Nor for now is the economy in cyclical crisis –  we aren’t in recession, inflation isn’t falling away sharply.   The concern is that we have a central bank led by pygmies (no offence to the central Africans).  Not one of the MPC members –  all of whom are probably pleasant people (even the Governor if people aren’t challenging him) –  command any great respect for their insight into the economy, their judgement or intellectual leadership, or for their willingness/ability to communicate a persuasive story or a sense that they themselves have a good and robust framework for thinking about the economy.   In the case of the Treasury observer – who gets to participate not vote – it might have been her first ever significant meeting on advanced economy macro issues, but in the end responsibility rests with the voting members.  They are failing us, corralled by the unconvincing Governor.    Having substantially surprised the market (deliberately and consciously so) two MPSin a row, and chosen to ignore consensus opinion on likely economic developments, you’d have thought we’d be hearing a lot from the MPC members –  minutes that clearly outlined the issues and judgements, speeches articulating mental models and perspectives on the New Zealand economy, wide-ranging interviews (of the sort senior Fed officials give).  Instead, we have weak official stories (the MPS), unrevealing minutes and –  seven months into the new model –  not a word in public from any of the external members nor from the Bank’s chief economist.

It isn’t good enough.  The Bank’s Board should be demanding better, as should the Minister of Finance (including when he comes to appoint new Board members and the Board chair in the next couple of months).   Transparency and communications aren’t about publishing forward tracks –  one of the Bank’s own recently-departed researchers published research last year suggesting they make little difference – but about open and honest engagement, laying out the uncertainties and (inevitable) differences of possible perspective in a business characterised by so much uncertainty.  How decisionmakers demonstrate that they handle uncertainty, competing narratives and even disagreement, is the sort of thing that helps build confidence, not rote publications (let alone poor, surprising, decisions) or Soviet-style phalanxes of grey bureaucrats all lined up with the Governor.

UPDATE:

You might think I sometimes put things fairly strongly (if often at considerable length).  I wouldn’t have wanted people to miss this comment on my post left by a banker. It was both strident and succinct.

conal

 

 

No big improvements expected

This afternoon brings the release of the Monetary Policy Committee’s latest Monetary Policy Statement and OCR decision.  Most commentators expect the Bank to cut the OCR by another 25 points.  I’m more focused on what they should do than on what they will do – the two can diverge for quite a while at times –  and I’ve been consistently clear that the OCR should be cut further.  If the MPC was wavering though, you’d have to suppose that they would want to avoid a second successive big surprise for markets which would –  rightly –  renew the focus on how poor their communications have been this year.

The last piece of data relevant to the decision was finally released by the Bank yesterday afternoon: their survey of the macroeconomic expectations of a few dozen supposedly somewhat-expert observers (of whom I’m one).   As I’ve noted already, this release once again gives the lie to the repeated Bank claims of how open and transparent they are: survey responses were due on 22 October, the Bank could easily have had them a couple of days later at most, and yet they held the information to themselves –  to no public benefit at all – until 12 November.  As for private benefits/costs, having the information in public on a timely basis might have spared poor Westpac from going out on a limb calling no change in the OCR, only to reverse themselves yesterday.   Market whipsawing, in the absence of data the Bank already had, serves no public benefit.

The expectations survey has been running, in one form or another (changing questions, big reductions in numbers surveyed) for more than 30 years now and provides a fairly rich array of data (although there are some important gaps –  eg immigration, the terms of trade – the Bank refuses to remedy).    We know that the surveyed expectations (mostly a quarter ahead, a year ahead, or two years ahead) aren’t in any sense accurate predictions about what actually happens in future.  But neither are the Reserve Bank’s forecasts (and that isn’t a criticism of anyone: forecasting is hard, shocks happen).   What they do provide is a useful read on how the somewhat-expert observer community sees things, in a reasonably internally consistent manner –  eg answers about GDP or unemployment are presumably done simultaneously with (recognising two-way influences) views on the future OCR or the future exchange rate.

The headline news –  well, only media coverage –  in yesterday’s release was the further fall in (mean) inflation expectations.  Two-year ahead expectations had fallen quite a lot in the previous survey, and there was no bounceback, just a further fall from 1.86 per cent to 1.81 per cent.   You wouldn’t want to make much of it –  dig just a little deeper and the median expectation didn’t change at all – but the absence of any bounce, especially coming on the back of the 50 point cut, explicitly linked to inflation expectations and a desire to keep them close to 2 per cent –  should still have disconcerted MPC members.

And these weren’t inflation expectations conditional on the OCR remaining at the current 1 per cent.  Instead respondents expect a 25 basis point cut today (median OCR expectation for the end of the year is 0.75 per cent) and a further cut next year.    And they still expect no recovery in medium-term inflation (and in financial markets themselves, the implied 10 year average inflation expectations –  the breakeven rate between indexed and nominal bonds – are still pretty close to 1 per cent, when the Bank’s target is 2 per cent).

Consistent with this, there is no rebound expected in economic growth either, whether as a result of things already in train or of those further expected OCR cuts.

expecs 19.png

No respondents expected a recession, although the lowest individual expected 2 year ahead growth rate was as low as 0.6 per cent.

There wasn’t much sign of an expected strengthening in the labour market either (although those series have been volatile and the survey was taken before last week’s labour market data were published).

What about overall monetary conditions?  The survey asks about assessments –  on a seven step scale – as of now, and expectations for (on this occasion) the end of March and the end of September 2020 (the latter roughly a year ahead),   “Monetary conditions” isn’t defined –  it is up to each respondent to factor in things considered relevant.   What was striking this time was the sharp increase in the proportion of respondents expecting monetary conditions to become “very relaxed”

mon con nov 19.png

I was left wondering what weight respondents were giving to tightening credit conditions (this chart from the Bank’s credit conditions survey, also released after the expectations survey was done)

credit 2.png

But whatever went into those “monetary conditions” answers, they weren’t producing an expected rebound in either growth or inflation.

In a speech a couple of weeks ago the Bank’s Assistant Governor ran one of his boss’s frequent lines bemoaning the risks central banks face if they simply follow short-term market prices (since those prices themselves include market implicit expectations of what central banks will do).  It was  –  and is – a real but overstated point.   But it is also where surveys of macroeconomic expectations are relevant and useful, not subject to the same critique.   This pool of respondents –  with no better or worse information on average than the MPC – expressed not just expectations for the OCR but for overall monetary conditions, and for economic activity and inflation.  So they factored in what they expect the Reserve Bank to do, and are (in effect) feeding back a collective assessment that it really looks, at best, like barely enough.  Who knows why: perhaps expected adverse world developments, perhaps more initial weakness here, perhaps a weaker transmission mechanism, but the data (expectations) are there for all to see.

Against that backdrop the MPC would really have to produce a quite compelling alternative narrative to justify not cutting the OCR further now, perhaps especially when there isn’t another review until February.

(As I’ve noted before, there is a rich amount of data in this survey not open to the public.  For example, on the OCR expectations question at least one respondent expected the OCR to be zero by September and another for it to be 1.25 per cent. It would be fascinating to see the –  one hopes consistent –  forecasts of each of those respondents and the stories that underpin them.  Reminding ourselves of the sheer uncertainty of the future, and the possible stories that might underpin such alternative outcomes, can be a useful discipline.)

Credit conditions

Back in mid-2009, just as the first glimmers of recovery  from the severe recession were emerging, the Reserve Bank launched a credit conditions survey (of lending institutions).  It was a sensible enough initiative but, to be honest, I never paid much attention to it.  We knew conditions had got very tight during the recession and (at least in my remaining time at the Bank) the data weren’t that interesting –  of course credit conditions were easier than they’d been in the midst of that financial scare, and when there were changes shown they were for pretty obvious reasons (eg access to housing credit was reported as tightening when the Governor imposed LVR restrictions).   Also, the number of institutions covered was quite small, and one had to worry that results could be affected by who happened to fill out the form in a particular institution on a particular occasion (plus, when reporting to your prudential regulator incentives aren’t entirely straightforward).

There is a series of questions about:

  • observed loan demand (by class of loan),
  • expected loan demand,
  • observed credit availability,
  • expected credit availability, and (since early last year)
  • a series of factors potentially affecting the availability of credit.

That makes for lots of series.  I’m less interested in the demand side, which is largely going to reflect stuff we see captured in other data (eg housing turnover, business surveys etc).  But demand for new business loans does seem to have fallen away somewhat in recent years.

But what about the supply side?

Here is observed credit availability over the last six months (the survey is six monthly) for the four business sectors (there was no particular change in availability to households).

credit 1

And here is what respondents expect (presumably from a position of knowledge, responsible for something around overall credit within their own institution).

credit 2.png

Yes, there is some idiosyncratic variability in the response at times, but in the ten year history of the series we’ve seen nothing like the tightening in expected conditions observed in the last few quarters, now across all the business classes (there is little movement on the mortgage and personal household lending categories).

It isn’t easy to know quite how much weight to put on these responses –  for a start, with only one incomplete cycle of observations, we have little idea of “normal” variability as economic conditions turn down.  But as the recent downturn is larger than the post-2009 upturn (coming off a pretty savage tightening in conditions) it doesn’t have the look of something that should be quickly glossed over.   It looks to represent a potentially quite material tightening in monetary and financial conditions.

The other question they have about actual credit availability might also tend to confirm that unease.  Respondents are asked about how credit availability is now compared to the past three years (I guess to smooth through idiosyncratic influences on the past six months).  Here are the responses for the business sector loans (household was directly and materially affected by the waxing and waning of LVR restrictions, a policy intervention).

credit 3.png

Again interesting that there had been little movement re SMEs, but for the other three business categories the scores are getting back towards levels we saw just after the last recession.

Early last year the Reserve Bank did a welcome extension to the survey and started asking respondents about the influence of various specific factors that could reasonably influence credit availability.  Here are answers.

credit 4

Cost of funds hasn’t been an issue in changing credit availability (nor would you really expect it to be –  should affect price rather than availability), and neither has competitive pressure, but look at those four striking negative yellow bars.    Risk appetite among the lenders, risk capacity, and (distinctively) regulatory changes have all worked to (apparently materially) tightened credit conditions.

Sadly, here we reach the limits of the survey. It would be fascinating to be able to disentangle quite what is going on.  There is a quite plausible story that all three of the other negative yellow bars are primarily a reflection of the fourth, regulatory change (presumably the Governor’s capital whims).  Perhaps it isn’t so, and there are independent reassessments of risk and willingness to bear risk going on in head offices, whether here or in Australia, but whatever the precise combination of factors it is pretty likely that regulation is already weighing fairly heavily on credit availability in New Zealand. (I only qualify that claim a little because banks perhaps have an incentive to play up the issue, knowing that the Governor is about to make his final capital decisions, but I doubt that is more than a marginal factor here, given the small number of respondents and the ability of the Bank to query each).

You may recall the consultation document the Bank published almost a year ago on the Governor’s proposals to greatly increase capital requirements for locally-incorporated lenders.  You may not recall the discusssion of these sorts of effects, let alone the apparent differential sectoral effects.  That isn’t the fault of your memory.  There just was no discussion of those issues in the document.  Which seemed odd at the time, and even more extraordinary now.  It will be interesting to see how the Governor responds to these data in his two scheduled press conferences in the next few weeks (MPS and FSR).

While these data are clearly of some relevance to the bank capital debate, my main interest in them was in the more immediate issues around the appropriate stance of monetary policy and the setting of the OCR.   There appears to have been quite a sharp change in market sentiment/pricing and the views of some market economists this week on the chances of the Bank cutting the OCR on 13 November (the reasons for that change still aren’t fully clear, and one is left wondering if the Bank has been signalling –  by accident or design –  some change in its own view).

My interest is much less in what the Bank will do in the short-term, but in what they should do (which should, of course, make my commentary of interest to the Bank, given the Assistant Governor’s speech the other day, but…..).  “Will” and “should” eventually tend to converge, but it can take some considerable time for them to do so.

But if we grant that this credit conditions data is material the MPC did not have when they did their August forecasts, or made their slightly panicked last minute decision on a 50 basis point cut, and did not even have at the last OCR review, it really should be  colouring the projections they finalise next week (even if the variable might not feature in their formal models).  Add in own-activity business survey data that has shown no signs of rebounding since August, inflation expectations that have either fallen further (surveys) or remained very low (inflation bond breakevens), and a core inflation rate that remains consistently materially below the (focal) midpoint of the inflation target, the case for not cutting the OCR in November seems weak at best.  There isn’t another review opportunity until February, the world situation (if not one of sentiment spiralling downwards) seems no stronger substantively, and for a committee that was sufficiently rattled to do a 50 point cut only three months ago –  and not to have seen anything much improve since then –  to do nothing now would only further muddy the communications waters, leaving people even less clear about how the MPC thinks, or that there is a consistent and disciplined process at work, secreted away from the public/market spotlight.

(Bearing in mind that there is still some material local data to be released before 13 November) the risks around a further OCR cut in November at present look quite asymmetric.  As we drift closer to the next recession, and to the limits of conventional monetary policy, the very best thing that could possibly happen would be positive surprises on core inflation, spilling over into somewhat higher inflation expectations.  People are no longer convinced inflation will settle at 2 per cent or above. It would be better, for almost everyone (certainly for the management of the next downturn) if they were.   When credit conditions appear to be tightening quite materially –  and that even before the final decisions are announced –  getting that sort of outcome will be made harder than necessary if the Bank ends up setting on its hands, confusing messaging, all for what?  So that the Governor can get some perverse psychic satisfaction from surprising people again?   Unpredictability is not a desirable feature of public policy.